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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

S Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
  For the period ended March 31, 2012.

 

£ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the
Quarterly Transition Period From ___________ to ___________
   

 

Commission file number 0-10652

 

NORTH VALLEY BANCORP
(Exact name of registrant as specified in its charter)

 

California   94-2751350
(State or other jurisdiction of incorporation or organization)   (IRS Employer ID Number)

 

300 Park Marina Circle, Redding, CA   96001
(Address of principal executive offices)   (Zip code)

 

Registrant’s telephone number, including area code (530) 226-2900

 

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

Yes S No £

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes S No £

 

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

 

  Large accelerated filer £ Accelerated filer £
     
  Non-accelerated filer S Smaller reporting company £

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes £ No S

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common Stock – 6,833,752 shares as of May 10, 2012.

 

1
 

 

INDEX

 

NORTH VALLEY BANCORP AND SUBSIDIARIES

 

PART I. FINANCIAL INFORMATION  
     
Item 1. Financial Statements (Unaudited)
  Condensed Consolidated Balance Sheets—March 31, 2012 and December 31, 2011 3
  Condensed Consolidated Statement of Income and Comprehensive Income—For the three months ended March 31, 2012 and 2011 4
  Condensed Consolidated Statements of Cash Flows—For the three months ended March 31, 2012 and 2011 5
  Notes to Condensed Consolidated Financial Statements 6
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 22
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 37
     
Item 4. Controls and Procedures 37
     
PART II. OTHER INFORMATION  
     
Item 1. Legal Proceedings 38
     
Item 1A. Risk Factors 38
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 38
     
Item 3. Defaults Upon Senior Securities 38
     
Item 4. Mine Safety Disclosures 38
     
Item 5. Other Information  38
     
Item 6. Exhibits 38
     
SIGNATURES 39

 

2
 

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

NORTH VALLEY BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands except share data) (Unaudited)  

   March 31,  December 31,
   2012  2011
ASSETS          
Cash and cash equivalents:          
Cash and due from banks  $19,314   $18,758 
Federal funds sold   16,400    40,210 
Total cash and cash equivalents   35,714    58,968 
           
Time deposits at other financial institutions   1,960    1,959 
Investment securities available-for-sale, at fair value   354,154    312,205 
Investment securities held-to-maturity, at amortized cost   6    6 
           
Loans   448,649    456,215 
Less: Allowance for loan losses   (12,274)   (12,656)
Net loans   436,375    443,559 
           
Premises and equipment, net   8,738    8,661 
Accrued interest receivable   2,599    2,557 
Other real estate owned   16,906    20,106 
FHLB and FRB stock and other nonmarketable securities   8,044    8,044 
Bank-owned life insurance policies   35,225    34,972 
Core deposit intangibles, net   364    401 
Other assets   13,644    13,528 
           
TOTAL ASSETS  $913,729   $904,966 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
           
LIABILITIES:          
Deposits:          
Noninterest-bearing  $156,030   $167,506 
Interest-bearing   616,534    598,733 
Total deposits   772,564    766,239 
           
Accrued interest payable and other liabilities   18,215    17,301 
Subordinated debentures   31,961    31,961 
Total liabilities   822,740    815,501 
           
STOCKHOLDERS’ EQUITY:          
Preferred stock, no par value: authorized 5,000,000 shares; no shares outstanding at March 31, 2012 and December 31, 2011        
Common stock, no par value: authorized 60,000,000 shares; outstanding 6,833,752 at March 31, 2012 and December 31, 2011, respectively   98,325    98,285 
Accumulated deficit   (9,810)   (10,290)
Accumulated other comprehensive income, net of tax   2,474    1,470 
Total stockholders’ equity   90,989    89,465 
           
 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY  $913,729   $904,966 

 

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

 

3
 

 

NORTH VALLEY BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF INCOME

(In thousands except per share data) (Unaudited)

   For the three months ended March 31, 
   2012  2011
Interest income          
Loans, including fees  $6,470   $7,450 
Taxable securities   1,967    1,795 
Tax exempt securities   144    165 
Federal funds sold and repurchase agreements   28    8 
Total interest income   8,609    9,418 
           
Interest expense          
Deposits   734    1,082 
Subordinated debentures   483    530 
Total interest expense   1,217    1,612 
           
Net interest income   7,392    7,806 
           
Provision for loan losses   400    1,000 
           
Net interest income after provision for loan losses   6,992    6,806 
           
Noninterest income          
Service charges on deposit accounts   1,052    1,166 
Other fees and charges   1,197    1,121 
Earnings on cash surrender value of life insurance policies   324    330 
Gain on sale of loans, net   405    256 
Loss on sales or calls of securities, net   (9)   (10)
Other   290    290 
Total noninterest income   3,259    3,153 
           
Noninterest expense          
Salaries and employee benefits   5,057    4,717 
Occupancy expense   640    692 
Furniture and equipment expense   245    296 
FDIC and state assessments   313    443 
Other real estate owned expense   634    452 
Other   2,767    2,871 
Total noninterest expenses   9,656    9,471 
           
Income before provision for income taxes   595    488 
           
Provision for income taxes   115    89 
           
Net income   480    399 
           
Total other comprehensive income, net of tax   1,004    351 
           
Comprehensive income  $1,484   $750 
           
Per share amounts          
Basic and diluted income per share  $0.07   $0.06 

 

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

 

4
 

 

NORTH VALLEY BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands except per share data) (Unaudited)

   For the three months ended March 31, 
    2012    2011 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income  $480   $399 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization   272    319 
Amortization of premium on securities, net   448    459 
Amortization of core deposit intangible   37    36 
Provision for loan losses   400    1,000 
Net losses on sale and write-down of other real estate owned   478    366 
Gain on sale of loans   (405)   (256)
Loss on sales or calls of securities   9    10 
Loss on sale of premises and equipment   8    1 
Stock-based compensation expense   40    31 
Effect of changes in:          
Accrued interest receivable   (42)   65 
Other assets   (1,067)   (1,055)
Accrued interest payable and other liabilities   914    3,248 
Net cash provided by operating activities   1,572    4,623 
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Purchases of available-for-sale securities   (53,437)   (40,077)
Proceeds from maturities/calls of available-for-sale securities   12,733    15,932 
Net decrease in loans   6,854    16,875 
Proceeds from sales of other real estate owned   3,056    2,915 
Purchases of premises and equipment   (357)   (73)
Net cash used in investing activities   (31,151)   (4,428)
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
Net increase in deposits   6,325    4,845 
Net cash provided by financing activities   6,325    4,845 
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS   (23,254)   5,040 
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD   58,968    23,634 
CASH AND CASH EQUIVALENTS, END OF PERIOD  $35,714   $28,674 
           
Supplemental Disclosures of Cash Flow Information          
Cash paid during the year for:          
Interest  $743   $1,069 
Income taxes paid  $80   $ 
           
Noncash investing and financing activities:          
Transfer from loans to other real estate owned  $335   $816 

 

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

 

5
 

 

NORTH VALLEY BANCORP AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

NOTE 1 - BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements of North Valley Bancorp and subsidiaries (the “Company”) have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, certain information and notes required by accounting principles generally accepted in the United States for annual financial statements are not included herein. Management believes that the disclosures are adequate to make the information not misleading. In the opinion of management, all adjustments (consisting solely of normal recurring adjustments) considered necessary for a fair presentation of the results for the interim periods presented have been included. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Operating results for the three months ended March 31, 2012 are not necessarily indicative of the results that may be expected for any subsequent period or for the year ended December 31, 2012.

 

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries North Valley Bank, a California banking corporation (“NVB”) and North Valley Trading Company, a California corporation, which is inactive. Significant intercompany items and transactions have been eliminated in consolidation. The Company owns the common stock of four business trusts that have issued trust preferred securities fully and unconditionally guaranteed by the Company. North Valley Capital Trust I, North Valley Capital Trust II, North Valley Capital Trust III and North Valley Capital Statutory Trust IV are unconsolidated subsidiaries and have issued an aggregate of $31,961,000 in trust preferred securities, which are reflected as debt on the Company’s condensed consolidated balance sheets.

 

The preparation of 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

 

Management has determined that since all of the banking products and services offered by the Company are available in each branch of NVB, 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 NVB branches and report them as a single operating segment. No single customer accounts for more than ten percent of revenues for the Company or NVB.

 

6
 

 

NOTE 2 – INVESTMENT SECURITIES

 

The amortized cost of securities and their approximate fair value were as follows (in thousands):

 

      Gross  Gross  Estimated
   Amortized  Unrealized  Unrealized  Fair
   Cost  Gains  Losses  Value
March 31, 2012                    
Available-for-Sale:                    
Obligations of U.S. government sponsored agencies  $15,031   $157   $   $15,188 
Obligations of state and political subdivisions   12,395    698    (20)   13,073 
Government sponsored agency mortgage-backed securities   312,010    6,482    (86)   318,406 
Corporate debt securities   6,000        (1,596)   4,404 
Equity securities   3,000    83        3,083 
   $348,436   $7,420   $(1,702)  $354,154 
Held-to-Maturity:                    
Government sponsored agency mortgage-backed securities  $6   $   $   $6 
                     
December 31, 2011                    
Available-for-Sale:                    
Obligations of U.S. government sponsored agencies  $15,042   $192   $   $15,234 
Obligations of state and political subdivisions   13,811    696    (52)   14,455 
Government sponsored agency mortgage-backed securities   270,337    5,212    (345)   275,204 
Corporate debt securities   6,000        (1,768)   4,232 
Equity securities   3,000    80        3,080 
   $308,190   $6,180   $(2,165)  $312,205 
Held-to-Maturity:                    
Government sponsored agency mortgage-backed securities  $6   $   $   $6 

 

 

For the three months ended March 31, 2012 and 2011 there were no gross realized gains on sales or calls of available for sale securities. For the three months ended March 31, 2012 and 2011 there were $9,000 and $10,000, respectively, in gross realized losses on sales or calls of securities categorized as available for sale securities. For the three months ended March 31, 2012 and 2011 there were $1,450,000 and $6,000,000, respectively, in gross proceeds from sales or calls of available for sale securities. There were no sales or transfers of held to maturity securities for the three months ended March 31, 2012 and 2011. For the three months ended March 31, 2012 and 2011 there were no gross proceeds from maturities or calls of held to maturity securities. Maturities of all investment securities are consistent with those reported in the December 31, 2011 Form 10-K.

 

At March 31, 2012 and December 31, 2011, securities having fair value amounts of approximately $344,871,000 and $302,852,000, respectively, were pledged to secure public deposits, short-term borrowings, treasury, tax and loan balances and for other purposes required by law or contract. Although the Company had no short-term borrowings at March 31, 2012 and December 31, 2011, the Company pledges most of its securities at the Federal Home Loan Bank (“FHLB”) to provide borrowing capacity. See “Liquidity” on page 36.

 

Investment securities are evaluated for other-than-temporary impairment on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in their value below amortized cost is other-than-temporary. Management utilizes criteria such as the magnitude and duration of the decline and the intent and ability of the Company to retain its investment in the issues for a period of time sufficient to allow for an anticipated recovery in fair value, in addition to the reasons underlying the decline, to determine whether the loss in value is other-than-temporary. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, and management does not intend to sell the security or it is more likely than not that the Company will not be required to sell the security before recovery, only the portion of the impairment loss representing credit exposure is recognized as a charge to earnings, with the balance recognized as a charge to other comprehensive income. If management intends to sell the security or it is more likely than not that the Company will be required to sell the security before recovering its forecasted cost, the entire impairment loss is recognized as a charge to earnings. For debt securities, the credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.

 

7
 

 

A summary of investments securities in an unrealized loss for less than twelve months and twelve months or longer is as follows (in thousands).

 

   As of March 31, 2012 
   Less than 12 Months   12 Months or Longer   Total 
   Estimated   Unrealized   Estimated   Unrealized   Estimated   Unrealized 
   Fair Value   Losses   Fair Value   Losses   Fair Value   Losses 
Description of Securities                              
Obligations of states and political subdivisions  $607   $(20)  $   $   $607   $(20)
Government sponsored agency mortgage-backed securities   54,982    (85)   30    (1)   55,012    (86)
Corporate debt securities           4,403    (1,596)   4,403    (1,596)
Total impaired securities  $55,589   $(105)  $4,433   $(1,597)  $60,022   $(1,702)

 

   As of December 31, 2011 
   Less than 12 Months   12 Months or Longer   Total 
   Estimated   Unrealized   Estimated   Unrealized   Estimated   Unrealized 
   Fair Value   Losses   Fair Value   Losses   Fair Value   Losses 
Description of Securities                              
Obligations of states and political subdivisions  $714   $(4)  $572   $(48)  $1,286   $(52)
Government sponsored agency mortgage-backed securities   96,629    (336)   16,858    (9)   113,487    (345)
Corporate debt securities           4,232    (1,768)   4,232    (1,768)
Total impaired securities  $97,343   $(340)  $21,662   $(1,825)  $119,005   $(2,165)

 

As of March 31, 2012 and December 31, 2011, there were two corporate debt securities in a loss position for twelve months or more. There is a current active market for these securities and management believes that the unrealized losses on the Company’s investment in these corporate debt securities is due to the yield of the securities and is not attributable to changes in credit quality. The two corporate debt securities are each a $3,000,000 single-issuer trust preferred security issued by two separate large publicly-traded financial institutions. The securities are tied to the front-end of the yield curve, three-month LIBOR (a short-term interest rate) and have a spread over that. The Company does not intend to sell and does not believe it will be required to sell these securities and expects a full recovery of value. The Company does not consider these investments to be other-than-temporarily impaired at March 31, 2012 or December 31, 2011.

 

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 has the ability and intent to hold securities with established maturity dates until recovery of fair value, which may be at maturity, and believes it will be able to collect all amounts due according to the contractual terms for all of the underlying investment securities; therefore, management does not consider these investments to be other-than-temporarily impaired.

 

NOTE 3 – LOANS

 

The Company originates loans for business, consumer and real estate activities and for equipment purchases. Such loans are concentrated in the Company’s market areas which consist of Yolo, Placer, Sonoma, Shasta, Humboldt, Mendocino, Trinity and Del Norte Counties and neighboring communities. Loans decreased $7,641,000 for the first three months ending March 31, 2012 to $448,878,000 from $456,519,000 at December 31, 2011. At March 31, 2012 compared to December 31, 2011, real estate construction loans increased by $908,000 while commercial loans decreased by $5,237,000 and real estate commercial loans decreased by $903,000 due to loan pay-offs and charge-offs. Loan demand for these products continues to remain soft in 2012. Major classifications of loans were as follows (in thousands):

 

   March 31,  December 31,
   2012  2011
Commercial  $40,923   $46,160 
Real estate - commercial   275,741    276,644 
Real estate - construction   28,371    27,463 
Real estate - mortgage   47,530    47,362 
Installment   8,705    10,925 
Other   47,608    47,965 
Gross loans   448,878    456,519 
Deferred loan fees, net   (229)   (304)
Allowance for loan losses   (12,274)   (12,656)
Total loans, net  $436,375   $443,559 

 

Certain real estate loans receivable are pledged as collateral for available borrowings with the FHLB, FRB, and certain correspondent banks. Pledged loans totaled $130,905,000 and $137,528,000 at March 31, 2012 and December 31, 2011, respectively.

 

8
 

 

The Company did not recognize any interest income on impaired loans for the periods ending March 31, 2012 and December 31, 2011. The following table presents impaired loans and the related allowance for loan losses as of the dates indicated (in thousands):

 

   As of March 31, 2012   As of December 31, 2011 
      Unpaid        Unpaid   
   Recorded  Principal  Related  Recorded  Principal  Related
   Investment  Balance  Allowance  Investment  Balance  Allowance
With no allocated allowance                              
Commercial  $   $   $   $   $   $ 
Real estate - commercial   954    1,079        1,502    1,556     
Real estate - construction   3,557    3,589        4,128    4,153     
Real estate - mortgage   610    692        643    751     
Installment   159    170        70    75     
Other   86    89        88    91     
Subtotal   5,366    5,619        6,431    6,626     
                               
With allocated allowance                              
Commercial   1,174    1,177    371    1,788    1,849    450 
Real estate - commercial   3,436    3,500    2    4,496    5,302    606 
Real estate - construction   5,312    5,312    520    5,312    5,312    504 
Real estate - mortgage   295    324    47    295    314    37 
Installment               37    39    13 
Other   51    51    34             
Subtotal   10,268    10,364    974    11,928    12,816    1,610 
Total Impaired Loans  $15,634   $15,983   $974   $18,359   $19,442   $1,610 

 

The following table presents the average balance related to impaired loans for the period indicated (in thousands):

 

   Average Recorded Investment  
   for the three months ended  
   March 31,  
    2012     2011 
           
Commercial  $1,202   $526 
Real estate - commercial   4,564    9,438 
Real estate - construction   8,867    3,207 
Real estate - mortgage   921    1,729 
Installment   166    53 
Other   138     
Total  $15,858   $14,953 

 

Nonperforming loans include all such loans that are either on nonaccrual status or are 90 days past due as to principal or interest but still accrue interest because such loans are well-secured and in the process of collection. Nonperforming loans are summarized as follows (in thousands):

 

   March 31,  December 31,
   2012  2011
Nonaccrual loans  $15,634   $18,359 
Loans 90 days past due or more but still accruing interest       52 
Total nonperforming loans  $15,634   $18,411 

 

If interest on nonaccrual loans had been accrued, such income would have approximated $155,000 and $259,000 for the three months ended March 31, 2012 and 2011, respectively.

 

9
 

 

The following table shows an aging analysis of the loan portfolio by the amount of time past due (in thousands):

 

   As of March 31, 2012
   Accruing Interest      
         30-89    Greater than      
          Days    90 Days           
    Current    Past Due    Past Due    Nonaccrual    Total 
                          
Commercial  $39,612   $137   $   $1,174   $40,923 
Real estate - commercial   269,263    2,088        4,390    275,741 
Real estate - construction   19,026    476        8,869    28,371 
Real estate - mortgage   46,024    601        905    47,530 
Installment   8,505    41        159    8,705 
Other   47,363    108        137    47,608 
Total  $429,793   $3,451   $   $15,634   $448,878 

 

   As of December 31, 2011
   Accruing Interest      
         30-89    Greater than      
          Days    90 Days           
    Current    Past Due    Past Due    Nonaccrual    Total 
                          
Commercial  $44,325   $47   $   $1,788   $46,160 
Real estate - commercial   264,143    6,503        5,998    276,644 
Real estate - construction   18,023            9,440    27,463 
Real estate - mortgage   45,170    1,254        938    47,362 
Installment   10,614    152    52    107    10,925 
Other   47,877            88    47,965 
Total  $430,152   $7,956   $52   $18,359   $456,519 

 

During the period ending March 31, 2012, there were no loans modified as troubled debt restructurings. There were no loans modified as troubled debt restructurings in the past twelve months that had a payment default during the period ended March 31, 2012. There are no commitments to lend additional amounts at March 31, 2012 to customers with outstanding loans that are classified as troubled debt restructurings.

 

NOTE 4 – ALLOWANCE FOR LOAN LOSSES

 

The following table shows the changes in the allowance for loan losses were as follows (in thousands):

 

   For the three months ended March 31, 2012
         Real Estate    Real Estate    Real Estate                     
    Commercial    Commercial    Construction    Mortgage    Installment    Other    Unallocated    Total 
                                         
Allowance for Loan Losses                                        
Balance December 31, 2011  $1,333   $7,528   $1,039   $935   $185   $736   $900   $12,656 
Charge-offs   (120)   (439)   (204)       (97)   (25)       (885)
Recoveries   12    61            24    6        103 
Provisions for loan losses   151    (303)   515    110    42    94    (209)   400 
Balance March 31, 2012  $1,376   $6,847   $1,350   $1,045   $154   $811   $691   $12,274 
                                         
   As of March 31, 2012  
Reserve to impaired loans  $371   $2   $520   $47   $   $34   $   $974 
Reserve to non-impaired loans  $1,005   $6,845   $830   $998   $154   $777   $691   $11,300 

 

 

   For the three months ended March 31, 2011
      Real Estate  Real Estate  Real Estate            
   Commercial  Commercial  Construction  Mortgage  Installment  Other  Unallocated  Total
                         
Allowance for Loan Losses                        
Balance December 31, 2010  $1,517   $8,439   $1,936   $956   $339   $666   $1,140   $14,993 
Charge-offs   (874)   (62)       (200)   (168)   (301)       (1,605)
Recoveries   10                73            83 
Provisions for loan losses   615    610    (370)   163    60    390    (468)   1,000 
Balance March 31, 2011  $1,268   $8,987   $1,566   $919   $304   $755   $672   $14,471 
                                         
    As of December 31, 2011  
Reserve to impaired loans  $87   $784   $   $54   $   $   $   $925 
Reserve to non-impaired loans  $1,181   $8,203   $1,566   $865   $304   $755   $672   $13,546 

 

 

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The following table shows the loan portfolio by segment as follows (in thousands):

 

Loans  As of March 31, 2012
         Real Estate     Real Estate    Real Estate           
    Commercial    Commercial     Construction    Mortgage    Installment    Other   Total
                                
Total Loans  $40,923   $275,741    $28,371   $47,530   $8,705   $47,608   $ 448,878
Impaired Loans  $1,174   $4,390    $8,869   $905   $159   $137   $ 15,634
Non-impaired loans  $39,749   $271,351    $19,502   $46,625   $8,546   $47,471   $ 433,244

 

   As of December 31, 2011
         Real Estate    Real Estate    Real Estate                
    Commercial    Commercial    Construction    Mortgage    Installment    Other    Total 
                                    
Total Loans  $46,160   $276,644   $27,463   $47,362   $10,925   $47,965   $456,519 
Impaired Loans  $1,788   $5,998   $9,440   $938   $107   $88   $18,359 
Non-impaired loans  $44,372   $270,646   $18,023   $46,424   $10,818   $47,877   $438,160 

 

The following table shows the loan portfolio allocated by management’s internal risk ratings as defined in Footnote 1 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 (in thousands):

 

   As of March 31, 2012
    Pass    Special Mention    Substandard    Doubtful    Total 
Commercial  $38,280   $10   $2,633   $   $40,923 
Real estate - commercial   246,644    9,466    19,631        275,741 
Real estate - construction   19,247        9,124        28,371 
Real estate - mortgage   45,158        2,372        47,530 
Installment   8,506        199        8,705 
Other   47,340        268        47,608 
Total  $405,175   $9,476   $34,227   $   $448,878 

 

   As of December 31, 2011
    Pass    Special Mention    Substandard    Doubtful    Total 
Commercial  $39,319   $3,067   $3,774   $   $46,160 
Real estate - commercial   248,696    5,055    22,893        276,644 
Real estate - construction   17,624    167    9,672        27,463 
Real estate - mortgage   43,760    886    2,716        47,362 
Installment   10,702        223        10,925 
Other   47,638        327        47,965 
Total  $407,739   $9,175   $39,605   $   $456,519 

 

The allowance for loan losses is established through a provision for loan losses based on management’s evaluation of the risks inherent in the loan portfolio. In determining levels of risk, management considers a variety of factors, including, but not limited to, asset classifications, economic trends, industry experience and trends, geographic concentrations, estimated collateral values, historical loan loss experience, and the Company’s underwriting policies. During the quarter ended March 31, 2012, the Company extended the loss look back period from two years to three years to expand the data range for historical loss factors. The allowance for loan losses is maintained at an amount management considers adequate to cover the probable losses in loans receivable. While management uses the best information available to make these estimates, future adjustments to allowances may be necessary due to economic, operating, regulatory, and other conditions that may be beyond the Company’s control. The Company also engages a third party credit review consultant to analyze the Company’s loan loss adequacy each calendar quarter. In addition, the regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on judgments different from those of management.

 

The allowance for loan losses is comprised of several components including the specific, formula and unallocated allowance relating to loans in the loan portfolio. Our methodology for determining the allowance for loan losses consists of several key elements, which include:

 

  Specific Allowances. A specific allowance is established when management has identified unique or particular risks that were related to a specific loan that demonstrated risk characteristics consistent with impairment. Specific allowances are established when management can estimate the amount of an impairment of a loan.

 

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  Formula Allowance. The formula allowance is calculated by applying loss factors through the assignment of loss factors to homogenous pools of loans. Changes in risk grades of both performing and nonperforming loans affect the amount of the formula allowance. Loss factors are based on our historical loss experience and such other data as management believes to be pertinent. Management, also, considers a variety of subjective factors, including regional economic and business conditions that impact important segments of our portfolio, loan growth rates, the depth and skill of lending staff, the interest rate environment, and the results of bank regulatory examinations and findings of our internal credit examiners to establish the formula allowance.
   
  Unallocated Allowance. The unallocated loan loss allowance represents an amount for imprecision or uncertainty that is inherent in estimates used to determine the allowance.

 

The Company also maintains a separate allowance for off-balance-sheet commitments. A reserve for unfunded commitments is maintained at a level that, in the opinion of management, is adequate to absorb probable losses associated with commitments to lend funds under existing agreements, for example, NVB’s commitment to fund advances under lines of credit. The reserve amount for unfunded commitments is determined based on our methodologies described above with respect to the formula allowance. The allowance for off-balance-sheet commitments is included in accrued interest payable and other liabilities on the consolidated balance sheet and was $173,000 and $161,000, as of March 31, 2012 and December 31, 2011, respectively.

 

Management anticipates modest growth in commercial lending and commercial real estate and to a lesser extent consumer and real estate mortgage lending, while it anticipates a further decline in construction lending. As a result, future provisions may be required and the ratio of the allowance for loan losses to loans outstanding may increase to reflect portfolio risk, increasing concentrations, loan type and changes in economic conditions. In addition, the regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses, and may require the Company to make additions to the allowance based on their judgment about information available to them at the time of their examinations.

 

NOTE 5 – OTHER REAL ESTATE OWNED

 

The Company had $16,906,000 and $20,106,000 in other real estate owned (“OREO”) at March 31, 2012 and December 31, 2011, respectively. Below is a table with details of the changes in OREO (in thousands):

 

   March 31,
   2012  2011
Balance, December 31, 2011  $20,106   $25,784 
Properties transferred in   335    816 
Sales of property   (3,056)   (2,915)
Loss on sale or writedown of property   (479)   (366)
Balance at March 31, 2012  $16,906   $23,319 

 

The following table presents the components of other real estate owned expense (in thousands):

 

   March 31,
   2012  2011
Operating expenses  $155   $86 
Provision for losses   396    511 
Net, loss(gain) on disposal   83    (145)
Total other real estate owned expense  $634   $452 

 

NOTE 6 – SUBORDINATED DEBENTURES

 

On November 9, 2009, the Company elected to defer the payment of interest on the Company’s Junior Subordinated Deferrable Interest Debentures Due 2031 (the “2031 Debentures”) issued to North Valley Capital Trust I in 2001; the Company’s Floating Rate Junior Subordinated Debt Securities Due 2033 (the “2033 Debentures”) issued to North Valley Capital Trust II in 2003; the Company’s Floating Rate Junior Subordinated Debt Securities Due 2034 (the “2034 Debentures”) issued to North Valley Capital Trust III in 2004; and the Company’s Junior Subordinated Debt Securities Due 2036 (the “2036 Debentures”) issued to North Valley Capital Statutory Trust IV in 2005. The 2031, 2033, 2034 and 2036 Debentures are administered under the terms and conditions of four separate Indentures and the Company gave notice of deferral to each Indenture Trustee on November 12, 2009.

 

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The Indentures provide generally that the payment of interest is deferrable, at the option of the Company, for up to 20 consecutive quarters (or 10 consecutive semi-annual periods). Nonpayment of interest for more than 20 consecutive quarters (or 10 semi-annual periods) is an event of default pursuant to which the payment of principal and interest may be accelerated by the Indenture Trustee. As of March 31, 2012, the Company had deferred the payment of interest for a total of ten consecutive quarters.

 

This series of deferrals of interest represent the first time that the Company has deferred payment of interest on the Debentures. The obligation to pay interest on the Debentures is cumulative and will continue to accrue, currently at a fixed rate of 10.25% on the 2031 Debentures, variable rate of 3.80% on the 2033 Debentures, variable rate of 3.36% on the 2034 Debentures and a variable rate of 1.80%, on the 2036 Debentures. Interest is generally set at variable rates based on the three-month LIBOR, reset and payable quarterly, plus 3.25% for the 2033 Debentures, plus 2.80% for the 2034 Debentures and plus 1.33% for the 2036 Debentures. As of March 31, 2012 and December 31, 2011, the amount of accrued interest payable on the Debentures was $5,352,000 and $4,854,000, respectively. Subject to regulatory approval, the Company may redeem some or all of the debentures earlier than their maturity dates.

 

NOTE 7 – INCOME TAXES

 

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

 

The Company applies the asset and liability method to account for income taxes. Deferred tax assets and liabilities are calculated by applying applicable tax laws to the differences between the financial statement basis and the tax basis of assets and liabilities. The effect on deferred taxes of changes in tax laws and rates is recognized in income in the period that includes the enactment date. On the consolidated balance sheet, net deferred tax assets are included in other assets.

 

The Company accounts for uncertainty in income taxes by recording only tax positions that met the more likely than not recognition threshold, that the tax position would be sustained in a tax examination.

 

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

 

Net deferred tax assets totaled $10,023,000 and $10,721,000 at March 31, 2012 and December 31, 2011, respectively. The Company evaluates deferred income tax assets for recoverability based on all available evidence. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws, our ability to successfully implement tax planning strategies, or variances between our future projected operating performance and our actual results. For purposes of establishing a deferred tax valuation allowance, the Company considers its inability to meet its financial goals in years 2011 and 2010, and its pre-tax loss in the prior year as significant, objective evidence that the Company may not be able to realize some portion of its deferred tax assets in the future. Higher than expected OREO expenses in 2011 and 2010 provided further evidence that some of the tax benefits had not met the “more likely than not” standard and may not be realized. Management also considered available tax planning strategies, the scheduled reversal of deferred tax assets and liabilities, and the nature and amount of historical and projected future taxable income that provide positive evidence that some of the tax benefits will be realizable. Accordingly, the Company established a partial valuation allowance in 2010 of $4,500,000 to reflect the portion of the deferred tax assets that the Company determined to be more likely than not that it will not be realized. During the quarter ended December 31, 2011, the Company reversed the Federal portion of its valuation allowance in the amount of $223,000, and at March 31, 2012 had a remaining valuation allowance of $4,277,000.

 

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NOTE 8 - PENSION PLAN BENEFITS

 

The Company has a supplemental retirement plan for key executives and a supplemental retirement plan for certain retired key executives and directors. These plans are nonqualified defined benefit plans and are unsecured. Total contributions paid were $63,000 for the three months ended March 31, 2012 and 2011. Effective October 1, 2009, the Company entered into an agreement to “freeze” the vested benefits under the North Valley Bancorp Salary Continuation Plan (amended and restated effective January 1, 2007) with each active officer currently participating in the Plan. Each agreement provided that vested accrued benefits under the Plan would remain fixed at the amount determined as of September 30, 2009 until such time as the Board of Directors might elect to recommence accruals. On July 28, 2011, the Board of Directors determined that Plan accruals should recommence, with retroactive effect to September 30, 2009. Components of net periodic benefit cost for the Company’s supplemental nonqualified defined benefit plans for the three months ended March 31, 2012 and 2011 are presented in the following table (in thousands):

 

   Three months ended March 31,
Components of net periodic benefits cost:  2012  2011
Service cost  $150   $ 
Interest cost   84    76 
Prior service amortization   25    8 
Recognized net actuarial loss   10    4 
Total components of net periodic cost  $269   $88 

 

      March 31,
2012
    December 31,
2011
             
Total Liability of Pension Plan Benefits   $ 7,603   $ 7,397

 

NOTE 9 – STOCK-BASED COMPENSATION

 

Stock Option Plans

 

At March 31, 2012, the Company had two shareholder approved stock-based compensation plans: the 1998 Employee Stock Incentive Plan and the 2008 Stock Incentive Plan. A total of 480,050 shares were authorized under all plans at March 31, 2012. The plans do not provide for the settlement of awards in cash and new shares are issued upon exercise of the options. The North Valley Bancorp 1998 Employee Stock Incentive Plan provides for awards in the form of options (which may constitute incentive stock options (“ISOs”) or non-statutory stock options (“NSOs”) to key employees) and also provides for the award of shares of Common Stock to outside directors. As provided in the 1998 Employee Stock Incentive Plan, the authorization to award incentive stock options terminated on February 19, 2008. Pursuant to the 1998 Employee Stock Incentive Plan there were outstanding options to purchase 66,759 shares of Common Stock at March 31, 2012. The North Valley Bancorp 2008 Stock Incentive Plan was adopted by the Company’s Board of Directors on February 27, 2008, effective that date, and was approved by the Company’s shareholders at the annual meeting, May 22, 2008. The terms of the 2008 Stock Incentive Plan are substantially the same as the North Valley Bancorp 1998 Employee Stock Incentive Plan. The 2008 Stock Incentive Plan provides for the grant to key employees of stock options, which may consist of NSOs and ISOs. Under the 2008 Stock Incentive Plan, options may not be granted at a price less than the fair market value at the date of the grant. Under all plans, options may be exercised over a ten year term. The vesting period is generally four years; however the vesting period can be modified at the discretion of the Company’s Board of Directors, and for all options granted after the fourth quarter in 2008 the vesting period is five years. The 2008 Stock Incentive Plan also provides for the grant to outside directors, and to consultants and advisers to the Company, of stock options, all of which must be NSOs. The shares of Common Stock authorized to be granted as options under the 2008 Stock Incentive Plan consist 413,291 shares of Common Stock reserved for issuance under the terms of the 2008 Stock Incentive Plan, consisting of 188,026 shares to be issued upon the exercise of options granted and still outstanding as of that date, 2,700 shares issued as stock awards and 222,565 shares reserved for future stock option grants and director stock awards at March 31, 2012. Effective January 1, 2009, and on each January 1 thereafter for the remaining term of the 2008 Stock Incentive Plan, the aggregate number of shares of Common Stock which are reserved for issuance pursuant to options granted under the terms of the 2008 Stock Incentive Plan shall be increased by a number of shares of Common Stock equal to 2% of the total number of the shares of Common Stock of the Company outstanding at the end of the most recently concluded calendar year. Any shares of Common Stock that have been reserved but not issued as options during any calendar year shall remain available for grant during any subsequent calendar year. Each outside director of the Company shall also be eligible to receive a stock award of 180 shares of Common Stock as part of his or her annual retainer paid by the Company for his or her services as a director. Each stock award shall be fully vested when granted to the outside director. The number of shares of Common Stock available as stock awards to outside directors shall equal the number of shares of Common Stock to be awarded to such outside directors. Outstanding options under the plans are exercisable until their expiration.

 

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Stock-based Compensation

 

There were 75,408 and 1,000 options granted in the three month period ended March 31, 2012 and 2011, respectively. For the three month periods ended March 31, 2012 and 2011, the compensation cost recognized for share based compensation was $40,000 and $31,000, respectively. At March 31, 2012, the total unrecognized compensation cost related to stock-based awards granted to employees under the Company’s stock option plans was $858,000. This cost is expected to be amortized on a straight-line basis over a weighted average period of approximately 4.5 years and will be adjusted for subsequent changes in estimated forfeitures. The weighted average grant date fair value of options granted for the three month period ended March 31, 2012 and 2011 was $6.25 and $5.29, respectively, based on the following assumptions used in a Black-Scholes Merton model. Options issued for the period ended March 31, 2011 were not material.

 

   2012 
Weighted average grant date fair value per share of options granted  $6.25 
Significant weighted average assumptions used in calculating fair value:     
Expected term   6.49 years 
Expected annual volatility   58%
Expected annual dividend yield   N/A 
Risk-free interest rate   1.40%

 

A summary of outstanding stock options follows: 

 

   Shares   Weighted Average Exercise Price   Weighted Average Remaining Contractual Term   Exercise Price Range  Aggregate Intrinsic Value ($000)
                     
Outstanding at January 1, 2012   184,070   $38.55    7 years    $8.99-$103.10  $ 127
                     
Granted   75,408   $11.08         $9.97-$11.25   
Exercised                 
Expired or Forfeited   (4,693)  $51.82         $23.95-$103.10   
                     
Outstanding at March 31, 2012   254,785   $30.17    8 years    $8.99-$103.10  $ 219
Fully vested and exercisable at March 31, 2012   94,924   $60.35    5 years    $8.99-$103.10  $ 1
Options expected to vest   159,861   $12.25    9 years    $8.99-$23.95  $ 218

 

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 as of March 31, 2012. There were no options exercised during the three months ended March 31, 2012 and 2011.

 

NOTE 10 – EARNINGS PER SHARE

 

Basic earnings per share (“EPS”), which excludes dilution, is computed by dividing income or loss available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as stock options, result in the issuance of common stock which shares in the earnings of the Company. The treasury stock method has been applied to determine the dilutive effect of stock options in computing diluted EPS. Diluted EPS are not presented when a net loss occurs because the conversion of potential common stock is antidilutive. Earnings per share are retroactively adjusted for stock dividends and stock splits for all periods presented. Stock options for 254,785 and 133,497 shares of common stock were not considered in computing diluted earnings per common share for the three months ended March 31, 2012 and 2011, respectively, because they were anti-dilutive. The weighted average common shares outstanding used in the calculation of earnings per share totaled 6,833,752 and 6,832,492 for the period ending March 31, 2012 and 2011, respectively. There was no difference in the denominator used in the calculation of basic earnings per share and diluted earnings per share in 2012 and 2011.

15
 

 

NOTE 11 – OTHER COMPREHENSIVE INCOME

 

At March 31, 2012 and 2011, the Company’s other comprehensive income components were as follows (in thousands):

 

March 31, 2012  Before Tax   Tax Effect   After Tax 
Other comprehensive income:               
Unrealized holding gains  $1,694   $(695)  $999 
Less: reclassification adjustment for realized losses included in net income   (9)   4    (5)
Other comprehensive income on investment securities   1,703    (699)   1,004 
                
Prior service costs arising during the period   (125)   74    (51)
Less: amortization of prior service costs included in net periodic pension costs   (125)   74    (51)
Other comprehensive income on pension plan            
                
Total other comprehensive income  $1,703   $(699)  $1,004 

                
March 31, 2011   Before Tax    Tax Effect    After Tax 
Other comprehensive income:               
Unrealized holding gains  $584   $(239)  $345 
Less: reclassification adjustment for realized losses included in net income   (10)   4    (6)
Other comprehensive income on investment securities   594    (243)   351 
                
Prior service costs arising during the period   8    (5)   3 
Less: amortization of prior service costs included in net periodic pension costs   8    (5)   3 
Other comprehensive income on pension plan            
                
Total other comprehensive income  $594   $(243)  $351 

 

NOTE 12 – COMMITMENTS AND CONTINGENCIES

 

The Company is involved in legal actions arising from normal business activities. Management, based upon the advice of legal counsel, believes that the ultimate resolution of all pending legal actions will not have a material effect on the Company’s financial position, results of its operations or its cash flows.

 

The Company was contingently liable under letters of credit issued on behalf of its customers in the amount of $4,524,000 and $4,946,000 at March 31, 2012 and December 31, 2011, respectively. At March 31, 2012, commercial and consumer lines of credit and real estate loans of approximately $46,083,000 and $38,954,000, respectively, were undisbursed. At December 31, 2011, commercial and consumer lines of credit and real estate loans of approximately $45,033,000 and $41,077,000, respectively, were undisbursed.

 

Loan commitments are typically contingent upon the borrower meeting certain financial and other covenants and such commitments typically have fixed expiration dates and require payment of a fee. As many of these commitments are expected to expire without being drawn upon, the total commitments do not necessarily represent future cash requirements. The Company evaluates each potential borrower and the necessary collateral on an individual basis. Collateral varies, but may include real property, bank deposits, debt securities, equity securities or business or personal assets.

16
 

 

Standby letters of credit are conditional commitments written by the Company to guarantee the performance of a customer to a third party. These guarantees are issued primarily relating to real estate projects and inventory purchases by the Company’s commercial customers and such guarantees are typically short term. Credit risk is similar to that involved in extending loan commitments to customers and the Company, accordingly, uses evaluation and collateral requirements similar to those for loan commitments. Most of such commitments are collateralized. The fair value of the liability related to these standby letters of credit, which represents the fees received for issuing the guarantees, was not significant at March 31, 2012 and December 31, 2011. The Company recognizes these fees as revenues over the term of the commitment or when the commitment is used.

 

Loan commitments and standby letters of credit involve, to varying degrees, elements of credit and market risk in excess of the amounts recognized in the balance sheet and do not necessarily represent the actual amount subject to credit loss. At March 31, 2012, the Company had a reserve for unfunded commitments of $173,000.

 

A large portion of the loan portfolio of the Company is collateralized by real estate. At March 31, 2012 and December 31, 2011, real estate served as the principal source of collateral with respect to approximately 78% of the Company’s loan portfolio. At March 31, 2012, real estate construction loans totaled $28,371,000, or 6% of the total loan portfolio, commercial loans secured by real estate totaled $275,741,000, or 61% of the total loan portfolio, and real estate mortgage loans totaled $47,530,000, or 11% of the total loan portfolio. See the discussion under “Loan Portfolio” starting on page 29. A further decline in the state and national economy, in general, combined with further deterioration in real estate values in the Company’s primary operating market areas, would have an adverse effect on the value of real estate as well as other collateral securing loans, plus the ability of certain borrowers to repay their outstanding loans and the overall demand for new loans, and this could have a material impact on the Company’s financial position, results of operations or its cash flows.

 

NOTE 13 – FAIR VALUE MEASUREMENTS

 

The Company groups its assets and liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

  Quoted prices in active markets for identical assets (Level 1): Inputs that are quoted unadjusted prices in active markets for identical assets that the Company has the ability to access at the measurement date. An active market for the asset is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
     
  Significant other observable inputs (Level 2): Inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity including quoted prices for similar assets or liabilities, quoted prices for securities in inactive markets and inputs derived principally from, or corroborated by, observable market data by correlation or other means.
     
  Significant unobservable inputs (Level 3): Inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

17
 

 

Assets Recorded at Fair Value on a Recurring Basis:

 

The table below presents assets measured at fair value on a recurring basis (in thousands).

 

   As of March 31, 2012 
   Fair Value   Level 1   Level 2   Level 3 
Available-for-sale securities:                    
Obligations of U.S. government sponsored agencies  $15,188   $   $15,188   $ 
Obligations of state and political subdivisions   13,073        13,073     
Government sponsored agency mortgage-backed securities   318,406        318,406     
Corporate debt securities   4,404        4,404     
Equity securities   3,083        3,083     
   $354,154   $   $354,154   $ 

 

   At December 31, 2011 
   Fair Value   Level 1   Level 2   Level 3 
Available-for-sale securities:                    
Obligations of U.S. government sponsored agencies  $15,234   $   $15,234   $ 
Obligations of state and political subdivisions   14,455        14,455     
Government sponsored agency mortgage-backed securities   275,204        275,204     
Corporate debt securities   4,232        4,232     
Equity securities   3,080        3,080     
   $312,205   $   $312,205   $ 

 

Fair values for available-for-sale investment securities are based on quoted market prices for similar securities at March 31, 2012 and December 31, 2011. During the quarter ended March 31, 2012, there were no transfers between Levels 1 and 2.

 

Assets Recorded at Fair Value on a Nonrecurring Basis:

 

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. GAAP. These adjustments to fair value usually result from application of lower-of-cost-or-fair value accounting or write-downs of individual assets. For assets measured at fair value on a nonrecurring basis that were still held in the balance sheet at quarter end, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related assets at quarter end (in thousands).

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   As of March 31, 2012 
   Fair Value   Level 1   Level 2   Level 3 
Impaired loans:                    
Commercial  $803   $   $   $803 
Real estate - commercial   382            382 
Real estate - construction   957            957 
Real estate - mortgage   248            248 
Other   17            17 
Other real estate owned:                    
Real estate - commercial   782            782 
Real estate - construction   966            966 
Real estate - mortgage   248            248 
Total assets measured at fair value on a nonrecurring basis  $4,403   $   $   $4,403 

 

   At December 31, 2011 
   Fair Value   Level 1   Level 2   Level 3 
                 
Impaired loans:                    
Commercial  $1,338   $   $   $1,338 
Real estate - commercial   4,811            4,811 
Real estate - construction   5,223            5,223 
Real estate - mortgage   268            268 
Installment   37            37 
Other real estate owned:                    
Real estate - commercial   1,270            1,270 
Real estate - construction   14,575            14,575 
Real estate - mortgage   1,276            1,276 
Total assets measured at fair value on a nonrecurring basis  $28,798   $   $   $28,798 

 

 

Impaired loans - The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available, and additional discounts by management for known market factors and time since the last appraisal. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

 

Impaired loans that are measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal balance of $2,923,000, with a valuation allowance of $516,000 at March 31, 2012, resulting in an additional provision for loan losses of $633,000 for the quarter ended March 31, 2012. At March 31, 2011, impaired loans had a principal balance of $5,105,000, with a valuation allowance of $735,000, resulting in an additional provision for loan losses of $740,000 for the quarter ended March 31, 2011.

 

Other Real Estate Owned – Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at fair value, less costs to sell. Fair values are based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

 

Other real estate owned measured at fair value less costs to sell, had a net carrying amount of $1,996,000, resulting in write-downs of $396,000 for the quarter ended March 31, 2012. Other real estate owned had a net carrying amount of $4,997,000, resulting in write-downs of $511,000 for the quarter ended March 31, 2011.

 

All impaired loans and OREO are measured using the sales comparison approach performed by certified appraisers. On a quarterly basis, the Company compares the actual selling price of collateral that has been liquidated to the most recent appraised value to evaluate if any additional adjustment should be made to arrive at fair value. The most common adjustment to report appraised values are discounts linked to the estimated decline in value over the passage of time since the last appraisal. These adjustments are based on current comparable sales or market data. This discount factor ranges between 8% and 15%. The weighted average adjustment for the unobservable inputs is 10%.

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Disclosures about Fair Value of Financial Instruments

 

The fair values presented represent the Company’s best estimate of fair value using the methodologies discussed below. The fair values of financial instruments which have a relatively short period of time between their origination and their expected realization were valued using historical cost. The values assigned do not necessarily represent amounts which ultimately may be realized. In addition, these values do not give effect to discounts to fair value which may occur when financial instruments are sold in larger quantities.

 

The following assumptions were used as of March 31, 2012 and December 31, 2011 to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value.

 

  a) Cash and Due From Banks - The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.
     
  b) Federal Funds Sold - The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.
     
  c) Time Deposits at Other Financial Institutions - The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.
     
  d) FHLB, FRB Stock and Other Securities - It was not practicable to determine the fair value of FHLB or FRB stock due to the restrictions placed on its transferability
     
  e) Investment Securities – The fair value of investment securities are based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Available-for-sale securities are carried at fair value.
     
  f) Loans - Commercial loans, residential mortgages, construction loans and direct financing leases are segmented by fixed and adjustable rate interest terms, by maturity, and by performing and nonperforming categories.
     
    The fair value of performing loans are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.
     
    The fair value of nonperforming loans is estimated by discounting estimated future cash flows using current interest rates with an additional risk adjustment reflecting the individual characteristics of the loans, or using the fair value of underlying collateral for collateral dependent loans as a practical expedient.
     
  g) Deposits – The fair values disclosed for noninterest-bearing and interest-bearing demand deposits and savings and money market accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. Fair values for certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.
     
  h) Subordinated Debentures - The fair values of the Company’s Subordinated Debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.
     
  i) Commitments to Fund Loans/Standby Letters of Credit - The fair values of commitments are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. The differences between the carrying value of commitments to fund loans or standby letters of credit and their fair value are not significant and therefore not included in the following table.
     
  j) Accrued Interest Receivable/Payable – The carrying amounts of accrued interest approximate fair value and therefore follow the same classification as the related asset or liability.

20
 

 

The carrying amounts and estimated fair values of the Company’s financial instruments are as follows (in thousands):

 

       Fair Value Measurements at     
       March 31, 2012 Using     
   Carrying                 
   Amount   Level 1   Level 2   Level 3   Total 
FINANCIAL ASSETS                         
Cash and due from banks  $19,314   $19,314   $   $   $19,314 
Federal funds sold   16,400    16,400            16,400 
Time deposits at other financial institutions   1,960    1,960            1,960 
FHLB, FRB and other securities   8,044                    N/A 
Securities:                         
Available-for-sale   354,154        354,154        354,154 
Held-to-maturity   6        6        6 
Loans   436,375            452,691    452,691 
Accrued interest receivable   2,599        1,162    1,437    2,599 
                          
FINANCIAL LIABILITIES                         
Deposits:                         
Nonmaturity deposits  $563,913   $563,913   $   $   $563,913 
Time deposits   208,651        209,682        209,682 
Subordinated debentures   31,961            20,544    20,544 
Accrued interest payable   5,472    7    113    5,352    5,472 

 

   December 31, 2011 
   Carrying   Fair 
   Amount   Value 
FINANCIAL ASSETS        
Cash and due from banks  $18,758   $18,758 
Federal funds sold   40,210    40,210 
Time deposits at other financial institutions   1,959    1,959 
FHLB, FRB and other securities   8,044     N/A 
Securities:          
Available-for-sale   312,205    312,205 
Held-to-maturity   6    6 
Loans   443,559    461,205 
Accrued interest receivable   2,557    2,557 
           
FINANCIAL LIABILITIES          
Deposits  $766,239   $767,487 
Subordinated debentures   31,961    21,420 
Accrued interest payable   4,998    4,998 

 

NOTE 14 - NEW ACCOUNTING PRONOUNCEMENTS

 

Fair value measurement. In May, 2011, the FASB issued an amendment to achieve common fair value measurement and disclosure requirements between U.S. and International accounting principles. Overall, the guidance is consistent with existing U.S. accounting principles; however, there are some amendments that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The amendments in this guidance are effective for interim and annual reporting periods beginning after December 15, 2011. The effect of adopting this standard did not have a material effect on the Company’s operating results or financial condition, but the additional disclosures are included in Note 13.

 

Comprehensive income. In June 2011, the FASB amended existing guidance and eliminated the option to present the components of other comprehensive income as part of the statement of changes in shareholder’s equity. The amendment requires that comprehensive income be presented in either a single continuous statement or in two separate consecutive statements. The amendments in this guidance are effective as of the beginning of a fiscal reporting year, and interim periods within that year, that begins after December 15, 2011. The adoption of this amendment changed the presentation of the components of comprehensive income for the Company as part of the consolidated statement of shareholder’s equity.

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

 

Certain statements in this Form 10-Q (excluding statements of fact or historical financial information) involve forward-looking information within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the “safe harbor” created by those sections. These forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Such risks and uncertainties include, but are not limited to, the following factors: competitive pressure in banking industry increases significantly; changes in the interest rate environment reduce margins; general economic conditions, either nationally or regionally, are less favorable than expected, resulting in, among other things, a deterioration in credit quality and an increase in the provision for possible loan losses; changes in the regulatory environment; changes in business conditions, particularly in the Northern California region; volatility of rate sensitive deposits; operational risks including data processing system failures or fraud; asset/liability matching risks and liquidity risks; California state budget problems; the U.S. “war on terrorism” and military action by the U.S. in the Middle East; and changes in the securities markets.

 

Critical Accounting Policies

 

General

 

North Valley Bancorp’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our financial statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. Another estimate that we use is related to the expected useful lives of our depreciable assets. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

 

Allowance for Loan Losses. The allowance for loan losses is an estimate of loan losses inherent in the Company’s loan portfolio as of the balance-sheet date. The allowance is established through a provision for loan losses which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after loan losses and loan growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The overall allowance consists of two primary components, specific reserves related to impaired loans and general reserves for inherent losses related to non-impaired loans. Non-impaired loans are evaluated collectively for impairment as a group by loan type and common risk characteristics.

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement. Loans determined to be impaired are individually evaluated for impairment. When a loan is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, it may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. For further information on the allowance for loan losses, see Note 4 to the Notes to Condensed Consolidated Financial Statements in Item I above.

 

Allowance for Loan Losses on Off-Balance-Sheet Credit Exposures. The Company also maintains a separate allowance for off-balance-sheet commitments. Management estimates anticipated losses using historical data and utilization assumptions. The allowance for off-balance-sheet commitments is included in accrued interest payable and other liabilities on the consolidated balance sheet.

 

Other Real Estate Owned (“OREO”). OREO represents properties acquired through foreclosure or physical possession. Write-downs to fair value at the time of transfer to OREO are charged to allowance for loan losses. Subsequent to foreclosure, management periodically evaluate the value of OREO held for sale and record a valuation allowance for any subsequent declines in fair value less selling costs. Subsequent declines in value are charged to operations. Fair value is based on our assessment of information available to us at the end of a reporting period and depends upon a number of factors, including our historical experience, economic conditions, and issues specific to individual properties. Management’s evaluation of these factors involves subjective estimates and judgments that may change.

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Share Based Compensation. At March 31, 2012, the Company had two stock-based compensation plans: the 1998 Employee Stock Incentive Plan and the 2008 Stock Incentive Plan, which are described more fully in Note 9 to the Notes to Condensed Consolidated Financial Statements. Compensation cost is recognized on all share-based payments over the requisite service periods of the awards based on the grant-date fair value of the options determined using the Black-Scholes-Merton based option valuation model. Critical assumptions that are assessed in computing the fair value of share-based payments include stock price volatility, expected dividend rates, the risk free interest rate and the expected lives of such options. Compensation cost recorded is net of estimated forfeitures expected to occur prior to vesting. For further information on the computation of the fair value of share-based payments, see Note 9 to the Notes to Condensed Consolidated Financial Statements in Item I above.

 

Impairment of Investment Securities. An investment security is impaired when its carrying value is greater than its fair value. Investment securities that are impaired are evaluated on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether such a decline in their fair value is other than temporary. Management utilizes criteria such as the magnitude and duration of the decline and the intent and ability of the Company to retain its investment in the securities for a period of time sufficient to allow for an anticipated recovery in fair value, in addition to the reasons underlying the decline, to determine whether the loss in value is other than temporary. The term “other than temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other than temporary, and management does not intend to sell the security or it is more likely than not that the Company will not be required to sell the security before recovery, only the portion of the impairment loss representing credit exposure is recognized as a charge to earnings, with the balance recognized as a charge to other comprehensive income. If management intends to sell the security or it is more likely than not that the Company will be required to sell the security before recovering its forecasted cost, the entire impairment loss is recognized as a charge to earnings.

 

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

 

The Company applies the asset and liability method to account for income taxes. Deferred tax assets and liabilities are calculated by applying applicable tax laws to the differences between the financial statement basis and the tax basis of assets and liabilities. The effect on deferred taxes of changes in tax laws and rates is recognized in income in the period that includes the enactment date. On the consolidated balance sheet, net deferred tax assets are included in other assets.

 

The Company accounts for uncertainty in income taxes by recording only tax positions that met the more likely than not recognition threshold, that the tax position would be sustained in a tax examination.

 

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

 

The Company evaluates deferred income tax assets for recoverability based on all available evidence. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws, our ability to successfully implement tax planning strategies, or variances between our future projected operating performance and our actual results. The Company is required to establish a valuation allowance for deferred tax assets if we determine, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In determining the more-likely-than-not criterion, we evaluate all positive and negative available evidence as of the end of each reporting period. Future adjustments to the deferred tax asset valuation allowance, if any, will be determined based upon changes in the expected realization of net deferred tax assets. The realization of deferred tax assets ultimately depends on the existence of sufficient taxable income in the carry back and carries forward periods under the tax law. Due to the Company’s cumulative tax losses in 2009 and 2010, it was determined to establish a partial valuation allowance in 2010 of $4,500,000 to reflect the portion of the deferred tax assets that the Company determined to be more likely than not that it will not be realized. During the quarter ended December 31, 2011, the Company reversed the Federal portion of its valuation allowance in the amount of $223,000, and at March 31, 2012 had a remaining valuation allowance of $4,277,000.

23
 

 

Business Organization

 

North Valley Bancorp (the “Company”) is a California corporation and a bank holding company for North Valley Bank, a California state-chartered, Federal Reserve member bank (“NVB”). NVB operates out of its main office located at 300 Park Marina Circle, Redding, California 96001, with twenty-four branches, including two supermarket branches in eight counties in Northern California. The Company views its service area as having four distinct markets: the Redding market, the Coastal market, the I-80 Corridor market and the Santa Rosa market.

 

The Company’s principal business consists of attracting deposits from the general public and using the funds to originate commercial, real estate and installment loans to customers, who are predominately small and middle market businesses and middle income individuals. The Company’s primary source of revenues is interest income from its loan and investment securities portfolios. The Company is not dependent on any single customer for more than ten percent of its revenues.

 

Overview

 

Financial Results

 

(in thousands except per share amounts)  Three months ended March 31, 
   2012   2011 
Net interest income  $7,392   $7,806 
Provision for loan losses   400    1,000 
Noninterest income   3,259    3,153 
Noninterest expense   9,656    9,471 
Provision for income taxes   115    89 
Net income  $480   $399 
           
Per Share Amounts          
Basic and Diluted Income Per Share  $0.07   $0.06 
           
Annualized Return on Average Assets   0.21%   0.18%
Annualized Return on Average Equity   2.12%   1.92%

 

The Company had net income of $480,000 for the three months ended March 31, 2012, compared to $399,000 for the three months ended March 31, 2011. The increase in net income for three months ended March 31, 2012 compared to the three months ended March 31, 2011 was primarily attributed to a decrease in the provision for loan losses, and partially offset by changes in net interest income. The Company’s provision for loan losses were $400,000 for the three months ended March 31, 2012, compared to a provision for loan losses of $1,000,000 for the three months ended March 31, 2011. Net interest income decreased $414,000 for the three months ended March 31, 2012, compared to the same period in 2011. Noninterest income increased $106,000 for the three months ended March 31, 2012 compared to the same period in 2011 primarily due to the recording of gains on sale of real estate loans. Noninterest expense increased $185,000 for the three months ended March 31, 2012 compared to the three months ended March 31, 2011 due to higher salaries and benefit costs and other real estate owned expense offset by FDIC assessment decreases.

 

The supervisory agreement signed on January 6, 2010 by and among North Valley Bancorp, North Valley Bank and the Federal Reserve Bank of San Francisco was terminated, effective as of April 16, 2012, and resolutions adopted by the Board of Directors of NVB at the request of the California Department of Financial Institutions were previously terminated, effective March 1, 2012.

 

Results of Operation

 

Net Interest Income and Net Interest Margin (fully taxable equivalent basis)

 

Net interest income is the difference between interest earned on loans and investments and interest paid on deposits and borrowings, and is the primary revenue source for the Company. Net interest margin is net interest income expressed as a percentage of average earning assets. These items have been adjusted to give effect to $74,000 and $84,000 in taxable-equivalent interest income on tax-free investments for the three month periods ended March 31, 2012 and 2011, respectively.

24
 

 

Net interest income for the three months ended March 31, 2012 was $7,466,000, a $424,000, or 5.4%, decrease from net interest income of $7,890,000 for the same period in 2011. Interest income decreased $819,000, or 8.6%, to $8,683,000 for the three month period ended March 31, 2012 due primarily to a decrease in average loans. The Company had foregone interest income for the loans placed on nonaccrual status of $155,000 during the three months ended March 31, 2012 compared to $259,000 for the same period in 2011. The average loans outstanding during the three months ended March 31, 2012 decreased $50,952,000, or 10.1%, to $451,479,000. This lower loan volume decreased interest income by $766,000. The average yield earned on the loan portfolio decreased 26 basis points to 5.75% for the three months ended March 31, 2012. This decrease in yield decreased interest income by $214,000. The total decrease to interest income from the loan portfolio was $980,000. The average balance of the investment portfolio increased $44,180,000, or 15.5%, which accounted for a $281,000 increase in interest income and a decrease in average yield of the investment portfolio of 24 basis points reduced interest income by $140,000.

 

Interest expense for the three months ended March 31, 2012 decreased $395,000, or 24.5%, to $1,217,000 compared to the same period in 2011. The largest decrease to interest expense was in time deposit accounts which decreased $11,319,000 as the average rates paid on these accounts decreased 33 basis points to 1.02% and reduced interest expense by $165,000 while a decrease in the average balances of these accounts decreased interest expense by $38,000. The average rate paid on savings and money market accounts decreased 22 basis points to 0.26% for the three month period ended March 31, 2012 compared to 0.48% for the same period in 2011, resulting in a decrease to interest expense of $117,000. This decrease was offset partially by higher average balances in savings and money market accounts of $2,194,000, resulting in a $3,000 increase in interest expense.

 

The net interest margin for the three months ended March 31, 2012 decreased 38 basis points to 3.61% from 3.99% for the same period in 2011 and a 7 basis point increase from the 3.68% net interest margin for the linked quarter ended December 31, 2011.

25
 

 

The following table sets forth the Company’s consolidated condensed average daily balances and the corresponding average yields received and average rates paid of each major category of assets, liabilities, and stockholders’ equity for the periods indicated:

 

Schedule of Average Daily Balance and Average Yields and Rates

(Dollars in thousands)

 

   Three months ended
March 31, 2012
   Three months ended
March 31, 2011
 
   Average   Yield/   Interest   Average   Yield/   Interest 
   Balance   Rate   Amount   Balance   Rate   Amount 
                         
Assets                              
Earning assets:                              
Federal funds sold  $48,950    0.23%  $28   $14,210    0.23%  $8 
Investment securities:                              
Taxable   316,776    2.49%   1,967    271,224    2.68%   1,795 
Tax exempt (1)   12,985    6.73%   218    14,357    7.03%   249 
Total investments   329,761    2.66%   2,185    285,581    2.90%   2,044 
Loans (2)(3)   451,479    5.75%   6,470    502,431    6.01%   7,450 
Total earning assets   830,190    4.20%   8,683    802,222    4.80%   9,502 
                               
Nonearning assets   98,614              106,715           
Allowance for loan losses   (12,628)             (14,635)          
Total nonearning assets   85,986              92,080           
                               
Total assets  $916,176             $894,302           
                               
Liabilities and Stockholders’ Equity                              
Interest bearing liabilities:                              
Transaction accounts  $175,999    0.11%  $47   $161,324    0.20%  $78 
Savings and money market   219,729    0.26%   145    217,535    0.48%   259 
Time certificates   212,900    1.02%   542    224,219    1.35%   745 
Other borrowed funds   31,961    6.06%   483    31,961    6.73%   530 
Total interest bearing liabilities   640,589    0.76%   1,217    635,039    1.03%   1,612 
Demand deposits   158,384              155,494           
Other liabilities   26,478              19,605           
Total liabilities   825,451              810,138           
Stockholders’ equity   90,725              84,164           
Total liabilities and stockholders’ equity  $916,176             $894,302           
Net interest income            $7,466             $7,890 
Net interest spread        3.44%             3.77%     
Net interest margin        3.61%             3.99%     

 


(1) Tax-equivalent basis; non-taxable securities are exempt from federal taxation.

(2) Loans on nonaccrual status have been included in the computations of averages balances.

(3) Includes loan fees of $38 and $60 for the three months ended March 31, 2012 and 2011, respectively.

 

The following table sets forth a summary of the changes in interest income and interest expense due to changes in average asset and liability balances (volume) and changes in average interest rates for the periods indicated. The change in interest due to both rate and volume has been allocated to the change in rate.

26
 

 

Changes in Volume/Rate            
(Dollars in thousands)  Three months ended March 31, 2012 
   compared with 
   Three months ended March 31, 2011 
           Total 
   Average   Average   Increase 
   Volume   Yield/Rate   (Decrease) 
Interest Income               
Interest on Federal funds sold  $20   $   $20 
Interest on investments:               
Taxable securities   305    (133)   172 
Tax exempt securities (1)   (24)   (7)   (31)
Total investments   281    (140)   141 
Interest on loans   (766)   (214)   (980)
Total interest income   (465)   (354)   (819)
                
Interest Expense               
Transaction accounts  $7   $(38)  $(31)
Savings and money market   3    (117)   (114)
Time deposits   (38)   (165)   (203)
Other borrowed funds       (47)   (47)
Total interest expense   (28)   (367)   (395)
                
Total change in net interest income  $(437)  $13   $(424)

 

(1) Taxable equivalent

 

Provision for Loan Losses

 

The provision for loan losses reflects changes in the credit quality of the entire loan portfolio. The provision for loan losses is recorded to bring the allowance for loan losses and the reserve for unfunded commitments to amounts considered appropriate by management based on factors which are discussed under “Allowance for Loan Losses” starting on page 33.

 

The Company recorded a provision for loan loss of $400,000 for the three months ended March 31, 2012, compared to a provision for loan losses of $1,000,000 for the three months ended March 31, 2011. The process for determining allowance adequacy and the resultant provision for loan losses includes a comprehensive analysis of the loan portfolio. Factors in the analysis include size and mix of the loan portfolio, nonperforming loan levels, charge-off/recovery activity and other qualitative factors including economic environment and activity. The decision to record the $400,000 provision for the three months ended March 31, 2012 reflects management’s assessment of the overall adequacy of the allowance for loan losses including the consideration of the level of nonperforming loans and the overall effect of the slowing economy, particularly in real estate. Management believes that the current level of allowance for loan losses as of March 31, 2012 of $12,274,000, or 2.7% of total loans, is adequate at this time. The allowance for loan losses was $12,656,000, or 2.8% of total loans, at December 31, 2011. For further information regarding our allowance for loan losses, see “Allowance for Loan Losses” starting on page 33.

27
 

 

Noninterest Income

 

The following table is a summary of the Company’s noninterest income for the periods indicated (in thousands):

 

   Three months ended March 31, 
   2012   2011 
Service charges on deposit accounts  $1,052   $1,166 
Other fees and charges   1,197    1,121 
Increase in cash value of life insurance   324    330 
Gain on sale of loans   405    256 
Loss on sales or calls of securities, net   (9)   (10)
Other   290    290 
Total  $3,259   $3,153 

 

Noninterest income for the quarter ended March 31, 2012 increased $106,000, or 3.4%, to $3,259,000 compared to $3,153,000 for the same period in 2011. Service charges on deposits decreased by $114,000 to $1,052,000 for the first quarter of 2012 compared to $1,166,000 for the same period in 2011. All other sources of fees and charges increased by $76,000 to $1,197,000 for the first quarter of 2012 compared to $1,121,000 for the first quarter of 2011. The Company had a $405,000 gain on sale of loans for the quarter ended March 31, 2012, an increase of $149,000 compared to $256,000 for the same period in 2011 due primarily to a gain on sale of mortgage loans. Of the $405,000 gain on sale of loans for the first quarter of 2012, the sale of mortgage loans was $361,000 and the sale of SBA loans was $44,000 compared to the sale of mortgage loans of $43,000 and the sale of SBA loans of $213,000 for the first quarter of 2011.

 

Noninterest Expense

 

The following table is a summary of the Company’s noninterest expense for the periods indicated (in thousands):

 

   Three months ended March 31, 
   2012   2011 
Salaries and employee benefits  $5,057   $4,717 
Occupancy expense   640    692 
Other real estate owned expense   634    452 
Data processing   617    675 
FDIC and state assessments   313    443 
Professional services   287    325 
ATM and on-line banking   250    288 
Furniture and equipment expense   245    296 
Marketing expense   195    119 
Director expense   138    102 
Loan expense   128    125 
Printing and supplies   124    123 
Postage   121    158 
Operations expense   117    142 
Messenger   113    145 
Amortization of intangibles   36    36 
Other   641    633 
Total  $9,656   $9,471 

 

Noninterest expense increased $185,000, or 2.0%, to $9,656,000 for the first quarter of 2012 from $9,471,000 for the first quarter in 2011. Salaries and employee benefits increased $340,000, for the first quarter of 2012 compared to the first quarter of 2011 due primarily to salary continuation plan expense of $269,000 for the first quarter of 2012 compared to $88,000 for the first quarter of 2011, and secondarily due to the hiring of production personnel and the development of production incentive plans. Occupancy and furniture and equipment expense decreased $103,000 for the first quarter of 2012 compared to the first quarter of 2011 due to a decrease in depreciation and rent expense as a result of facilities consolidation initiatives completed in 2011. OREO expense increased $182,000 to $634,000, for the first quarter of 2012 compared to $452,000 for the same period in 2011, and FDIC and state assessments decreased $130,000 to $313,000 for the first quarter of 2012, compared to $443,000 for the same period in 2011, as a result of a change in FDIC insurance assessment methodology, which changed the assessment base from total deposits to average total assets less tangible capital. All other expenses decreased $104,000 to $2,767,000 for the first quarter 2012 compared to $2,871,000 for the same period in 2011.

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Income Taxes

 

The Company recorded a provision for income taxes for the quarter ended March 31, 2012 of $115,000, resulting in an effective tax rate of 19.3%, compared to a provision for income taxes of $89,000, or an effective tax rate of 18.2%, for the quarter ended March 31, 2011. 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”.

 

Management evaluates the Company’s deferred tax assets quarterly for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including the Company’s historical profitability and projections of future taxable income. Management also considered available tax planning strategies, the scheduled reversal of deferred tax assets and liabilities, and the nature and amount of historical and projected future taxable income that provide positive evidence that some of the tax benefits will be realizable. Accordingly, the Company established a partial valuation allowance in 2010 of $4,500,000 to reflect the portion of the deferred tax assets that the Company determined to be more likely than not that it will not be realized. During the quarter ended December 31, 2011, the Company reversed the Federal portion of its valuation allowance in the amount of $223,000, and at March 31, 2012 had a remaining valuation allowance of $4,277,000.

 

The deferred tax assets will continue to be analyzed quarterly for changes affecting realizability and the valuation allowance may be adjusted in future periods accordingly.

 

Financial Condition as of March 31, 2012 As Compared to December 31, 2011

 

Overview

 

Total assets at March 31, 2012 increased $8,763,000, or 1.0%, to $913,729,000, compared to $904,966,000 at December 31, 2011. Loans, net of deferred loan fees, decreased $7,566,000, or 1.7%, to $448,649,000 at March 31, 2012 from $456,215,000 at December 31, 2011. Investment securities increased $41,949,000, or 13.4%, to $354,154,000 at March 31, 2012 from $312,205,000 at December 31, 2011, and Federal funds sold decreased to $16,400,000 at March 31, 2012 from $40,210,000 at December 31, 2011. The increase in investment securities was due primarily to a decrease in loans for the first three months of 2012. Deposits increased $6,325,000, or 0.8%, from December 31, 2011 to $772,564,000 at March 31, 2012.

 

Loan Portfolio

 

The Company originates loans for business, consumer and real estate activities for equipment purchases. Such loans are concentrated in the primary markets in which the Company operates. Substantially all loans are collateralized. Generally, real estate loans are secured by real property. Commercial and other loans are secured by bank deposits or business or personal assets and leases are generally secured by equipment. The Company’s policy for requiring collateral is through analysis of the borrower, the borrower’s industry and the economic environment in which the loan would be granted. The loans are expected to be repaid from cash flows or proceeds from the sale of selected assets of the borrower.

 

Loans, the Company’s major component of earning assets, decreased $7,641,000 during the first three months of 2011 to $448,878,000 at March 31, 2012 from $456,519,000 at December 31, 2011. Real estate construction loans increased by $908,000 while commercial loans decreased by $5,237,000 and real estate commercial loans decreased by $903,000. The remaining loan categories remained relatively unchanged from their December 31, 2011 balances.

 

The Company’s average loan to deposit ratio was 58.9% for the quarter ended March 31, 2012 compared to 66.2% for the quarter ended March 31, 2011. The decrease in the Company’s average loan to deposit ratio is driven by the decrease in total average loans of $50,952,000.

29
 

 

Major classifications of loans are summarized as follows (in thousands):

 

   March 31,   December 31, 
   2012   2011 
Commercial  $40,923   $46,160 
Real estate - commercial   275,741    276,644 
Real estate - construction   28,371    27,463 
Real estate - mortgage   47,530    47,362 
Installment   8,705    10,925 
Other   47,608    47,965 
Gross loans   448,878    456,519 
Deferred loan fees, net   (229)   (304)
Allowance for loan losses   (12,274)   (12,656)
Total loans, net  $436,375   $443,559 

 

Impaired, Nonaccrual, Past Due and Restructured Loans and Other Nonperforming Assets

 

The Company considers a loan impaired if, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral.

 

During the portion of the year that the loans were impaired, the Company did not recognize any interest income in 2012 and 2011. The following table presents impaired loans and the related allowance for loan losses as of the dates indicated (in thousands):

 

   As of March 31, 2012   As of December 31, 2011 
       Unpaid           Unpaid     
   Recorded   Principal   Related   Recorded   Principal   Related 
   Investment   Balance   Allowance   Investment   Balance   Allowance 
With no allocated allowance                              
Commercial  $   $   $   $   $   $ 
Real estate - commercial   954    1,079        1,502    1,556     
Real estate - construction   3,557    3,589        4,128    4,153     
Real estate - mortgage   610    692        643    751     
Installment   159    170        70    75     
Other   86    89        88    91     
Subtotal   5,366    5,619        6,431    6,626     
                               
With allocated allowance                              
Commercial   1,174    1,177    371    1,788    1,849    450 
Real estate - commercial   3,436    3,500    2    4,496    5,302    606 
Real estate - construction   5,312    5,312    520    5,312    5,312    504 
Real estate - mortgage   295    324    47    295    314    37 
Installment               37    39    13 
Other   51    51    34             
Subtotal   10,268    10,364    974    11,928    12,816    1,610 
Total Impaired Loans  $15,634   $15,983   $974   $18,359   $19,442   $1,610 

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The following table presents the average balance related to impaired loans for the period indicated (in thousands):

 

   Average Recorded Investment 
   for the three months ended 
   March 31, 
   2012   2011 
         
Commercial  $1,202   $526 
Real estate - commercial   4,564    9,438 
Real estate - construction   8,867    3,207 
Real estate - mortgage   921    1,729 
Installment   166    53 
Other   138     
Total  $15,858   $14,953 

 

Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Accrual of interest on loans is discontinued either when reasonable doubt exists as to the full and timely collection of interest or principal, or when a loan becomes contractually past due by 90 days or more with respect to interest or principal (except that when management believes a loan is well secured and in the process of collection, interest accruals are continued on loans deemed by management to be fully collectible). When a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Interest accruals are resumed on such loans when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.

 

Nonperforming assets are summarized as follows (in thousands):

 

   March 31,   December 31, 
   2012   2011 
Nonaccrual loans  $15,634   $18,359 
Loans past due 90 days or more and still accruing interest       52 
Total nonperforming loans   15,634    18,411 
Other real estate owned   16,906    20,106 
Total nonperforming assets  $32,540   $38,517 
           
Nonaccrual loans to total gross loans   3.48%   4.02%
Nonperforming loans to total gross loans   3.48%   4.04%
Total nonperforming assets to total assets   3.56%   4.26%

 

At March 31, 2012 and December 31, 2011, the recorded investment in nonperforming loans (defined as nonaccrual loans and loans 90 days or more past due and still accruing interest) was approximately $15,634,000 and $18,411,000, respectively. The Company had $974,000 of specific allowance for loan losses on impaired loans of $10,268,000 at March 31, 2012 as compared to $1,610,000 of specific allowance for loan losses on impaired loans of $11,929,000 at December 31, 2011. Nonperforming assets (nonperforming loans and OREO) totaled $32,540,000 at March 31, 2012, a decrease of $5,977,000 from the total at December 31, 2011.

 

If interest on nonaccrual loans had been accrued, such income would have approximated $155,000 and $259,000, respectively for the three month periods ended March 31, 2012 and 2011.

 

At March 31, 2012 there were no commitments to lend additional funds to borrowers whose loans were classified as nonaccrual.

31
 

 

The composition of nonaccrual loans as of March 31, 2012, December 31, 2011, September 30, 2011 and June 30, 2011 was as follows (in thousands):

 

   March   December   September   June 
   2012   2011   2011   2011 
       % of       % of       % of       % of 
   Amount    total   Amount    total   Amount    total   Amount    total 
Commercial  $1,174    7.5%  $1,788    9.7%  $1,993    16.7%  $2,273    12.9%
Real estate - commercial   4,390    28.1%   5,998    32.7%   5,068    42.4%   9,846    56.0%
Real estate - construction   8,869    56.7%   9,440    51.4%   3,387    28.3%   4,247    24.2%
Real estate - mortgage   905    5.8%   938    5.1%   1,281    10.7%   1,146    6.5%
Installment   159    1.0%   107    0.6%   111    0.9%   23    0.1%
Other   137    0.9%   88    0.5%   113    0.9%   50    0.3%
Total nonaccrual loans  $15,634    100.0%  $18,359    100.0%  $11,953    100.0%  $17,585    100.0%

 

At March 31, 2012, nonaccrual real-estate-construction loans totaled $8,869,000, or 56.7%, of the nonaccrual loans. There are ten loans that make up the balance. Charge-offs of $197,000 has been taken on these loans and $520,000 in specific reserves has been established for these loans as of March 31, 2012. Three of these loans are residential land loans totaling $2,742,000. Charge-offs of $195,000 has been taken on these loans and $3,000 in specific reserves has been established. There are five loans for nonaccrual residential construction development projects totaling $5,762,000. Charge-offs of $2,000 has been taken on these loans and $517,000 in specific reserves has been established for these loans at March 31, 2012. The remaining two loans were residential construction loans totaling $365,000. No charge-offs have been taken on these loans and no specific reserves have been established.

 

At March 31, 2012, there were four real-estate-commercial loans totaling $4,390,000, or 28.1%, of the nonperforming loans. The largest real estate-commercial loan is for a commercial real estate building located in Sacramento County for $3,436,000. Charge-offs of $693,000 has been taken on this loan and a $2,000 specific reserve has been established for this loan. The remaining three real estate-commercial loans total $954,000 (approximate average loan balance of $318,000). Charge-offs of $327,000 has been taken on these loans and no specific reserves have been established for these loans.

 

At March 31, 2012, net carrying value of other real estate owned decreased $3,200,000 to $16,906,000 from $20,106,000 at December 31, 2011. During the three month period ending March 31, 2012, the Company transferred one property into OREO totaling $335,000, sold six properties totaling $3,056,000, had write-downs of OREO of $396,000, and recorded loss on sale of OREO of $83,000. As part of the financial close process, valuations of OREO are performed by management and write-downs are recorded as warranted. At March 31, 2012, OREO was comprised of twenty-two properties which consisted of the following: four residential construction properties totaling $4,338,000, eleven residential land parcels totaling $9,582,000, one commercial land parcel for $382,000, two non-farm non-residential properties totaling $1,145,000 and four residential properties totaling $1,459,000.

 

The following table shows an aging analysis of the loan portfolio by the amount of time past due (in thousands):

 

   As of March 31, 2012 
   Accruing Interest         
       Greater than         
       30-89 Days   90 Days         
   Current   Past Due   Past Due   Nonaccrual   Total 
                     
Commercial  $39,612   $137   $   $1,174   $40,923 
Real estate - commercial   269,263    2,088        4,390    275,741 
Real estate - construction   19,026    476        8,869    28,371 
Real estate - mortgage   46,024    601        905    47,530 
Installment   8,505    41        159    8,705 
Other   47,363    108        137    47,608 
Total  $429,793   $3,451   $   $15,634   $448,878 

32
 

 

   As of December 31, 2011 
   Accruing Interest         
       Greater than         
       30-89 Days   90 Days         
   Current   Past Due   Past Due   Nonaccrual   Total 
                     
Commercial  $44,325   $47   $   $1,788   $46,160 
Real estate - commercial   264,143    6,503        5,998    276,644 
Real estate - construction   18,023            9,440    27,463 
Real estate - mortgage   45,170    1,254        938    47,362 
Installment   10,614    152    52    107    10,925 
Other   47,877            88    47,965 
Total  $430,152   $7,956   $52   $18,359   $456,519 

 

During the period ending March 31, 2012, there were no loans modified as troubled debt restructurings. There were no loans modified as troubled debt restructurings in the past twelve months that had a payment default. There are no commitments to lend additional amounts at March 31, 2012 to customers with outstanding loans that are classified as troubled debt restructurings.

 

Allowance for Loan Losses

 

The following table shows the changes in the allowance for loan losses were as follows (in thousands):

 

   For the three months ended March 31, 2012 
       Real Estate   Real Estate   Real Estate                 
   Commercial   Commercial   Construction   Mortgage   Installment   Other   Unallocated   Total 
                                 
Allowance for Loan Losses                                        
Balance December 31, 2011  $1,333   $7,528   $1,039   $935   $185   $736   $900   $12,656 
Charge-offs   (120)   (439)   (204)       (97)   (25)       (885)
Recoveries   12    61            24    6        103 
Provisions for loan losses   151    (303)   515    110    42    94    (209)   400 
Balance March 31, 2012  $1,376   $6,847   $1,350   $1,045   $154   $811   $691   $12,274 
Reserve to impaired loans  $371   $2   $520   $47   $   $34   $   $974 
Reserve to non-impaired loans  $1,005   $6,845   $830   $998   $154   $777   $691   $11,300 

 

   For the three months ended March 31, 2011 
       Real Estate   Real Estate   Real Estate                 
   Commercial   Commercial   Construction   Mortgage   Installment   Other   Unallocated   Total 
                                 
Allowance for Loan Losses                                        
Balance December 31, 2010  $1,517   $8,439   $1,936   $956   $339   $666   $1,140   $14,993 
Charge-offs   (874)   (62)       (200)   (168)   (301)       (1,605)
Recoveries   10                73            83 
Provisions for loan losses   615    610    (370)   163    60    390    (468)   1,000 
Balance March 31, 2011  $1,268   $8,987   $1,566   $919   $304   $755   $672   $14,471 
Reserve to impaired loans  $87   $784   $   $54   $   $   $   $925 
Reserve to non-impaired loans  $1,181   $8,203   $1,566   $865   $304   $755   $672   $13,546 

 

The following table shows the loan portfolio by segment as follows (in thousands):

 

   As of March 31, 2012 
       Real Estate   Real Estate   Real Estate             
   Commercial   Commercial   Construction   Mortgage   Installment   Other   Total 
                             
Loans                            
Balance March 31, 2012  $40,923   $275,741   $28,371   $47,530   $8,705   $47,608   $448,878 
Impaired Loans  $1,174   $4,390   $8,869   $905   $159   $137   $15,634 
Non-impaired loans  $39,749   $271,351   $19,502   $46,625   $8,546   $47,471   $433,244 

 

Loans  As of December 31, 2011 
       Real Estate   Real Estate   Real Estate             
   Commercial   Commercial   Construction   Mortgage   Installment   Other   Total 
                             
Balance December 31, 2011  $46,160   $276,644   $27,463   $47,362   $10,925   $47,965   $456,519 
Impaired Loans  $1,788   $5,998   $9,440   $938   $107   $88   $18,359 
Non-impaired loans  $44,372   $270,646   $18,023   $46,424   $10,818   $47,877   $438,160 

33
 

 

The following table shows the loan portfolio allocated by management’s internal risk ratings (in thousands):

 

   As of March 31, 2012 
   Pass   Special Mention   Substandard   Doubtful   Total 
Commercial  $38,280   $10   $2,633   $   $40,923 
Real estate - commercial   246,644    9,466    19,631        275,741 
Real estate - construction   19,247        9,124        28,371 
Real estate - mortgage   45,158        2,372        47,530 
Installment   8,506        199        8,705 
Other   47,340        268        47,608 
Total  $405,175   $9,476   $34,227   $   $448,878 

 

   As of December 31, 2011 
   Pass   Special Mention   Substandard   Doubtful   Total 
Commercial  $39,319   $3,067   $3,774   $   $46,160 
Real estate - commercial   248,696    5,055    22,893        276,644 
Real estate - construction   17,624    167    9,672        27,463 
Real estate - mortgage   43,760    886    2,716        47,362 
Installment   10,702        223        10,925 
Other   47,638        327        47,965 
Total  $407,739   $9,175   $39,605   $   $456,519 

 

The allowance for loan losses is established through a provision for loan losses based on management’s evaluation of the risks inherent in the loan portfolio. In determining levels of risk, management considers a variety of factors, including, but not limited to, asset classifications, economic trends, industry experience and trends, geographic concentrations, estimated collateral values, historical loan loss experience, and the Company’s underwriting policies. The allowance for loan losses is maintained at an amount management considers adequate to cover the probable losses in loans receivable. While management uses the best information available to make these estimates, future adjustments to allowances may be necessary due to economic, operating, regulatory, and other conditions that may be beyond the Company’s control. The Company also engages a third party credit review consultant to analyze the Company’s loan loss adequacy each calendar quarter. In addition, the regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on judgments different from those of management.

 

The allowance for loan losses is comprised of several components including the specific, formula and unallocated allowance relating to loans in the loan portfolio. Our methodology for determining the allowance for loan losses consists of several key elements, which include:

 

  Specific Allowances. A specific allowance is established when management has identified unique or particular risks that were related to a specific loan that demonstrated risk characteristics consistent with impairment. Specific allowances are established when management can estimate the amount of an impairment of a loan.
     
  Formula Allowance. The formula allowance is calculated by applying loss factors through the assignment of loss factors to homogenous pools of loans. Changes in risk grades of both performing and nonperforming loans affect the amount of the formula allowance. Loss factors are based on our historical loss experience and such other data as management believes to be pertinent. Management, also, considers a variety of subjective factors, including regional economic and business conditions that impact important segments of our portfolio, loan growth rates, the depth and skill of lending staff, the interest rate environment, and the results of bank regulatory examinations and findings of our internal credit examiners to establish the formula allowance.
     
  Unallocated Allowance. The unallocated loan loss allowance represents an amount for imprecision or uncertainty that is inherent in estimates used to determine the allowance.

 

The Company also maintains a separate allowance for off-balance-sheet commitments. A reserve for unfunded commitments is maintained at a level that, in the opinion of management, is adequate to absorb probable losses associated with commitments to lend funds under existing agreements, for example, the Bank’s commitment to fund advances under lines of credit. The reserve amount for unfunded commitments is determined based on our methodologies described above with respect to the formula allowance. The allowance for off-balance-sheet commitments is included in accrued interest payable and other liabilities on the consolidated balance sheet and was $173,000 and $161,000, as of March 31, 2012 and December 31, 2011, respectively.

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Management anticipates modest growth in commercial lending and commercial real estate and to a lesser extent consumer and real estate mortgage lending, while it anticipates a further decline in construction lending. As a result, future provisions may be required and the ratio of the allowance for loan losses to loans outstanding may increase to reflect portfolio risk, increasing concentrations, loan type and changes in economic conditions. In addition, the regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses, and may require the Company to make additions to the allowance based on their judgment about information available to them at the time of their examinations.

 

Deposits

 

Total deposits increased $6,325,000, or 0.8%, to $772,564,000 at March 31, 2012 compared to $766,239,000 at December 31, 2011. During the three months ended March 31, 2012, savings and money market deposits increased $7,176,000 or 3.2%, and interest-bearing demand deposits increased $14,284,000, or 7.8%, while noninterest-bearing demand deposits decreased $11,476,000, or 7.4% and certificates of deposit decreased $3,659,000, or 1.8%.

 

   March 31,   December 31, 
   2012   2011 
Noninterest-bearing demand  $156,030   $167,506 
Interest-bearing demand   184,408    170,124 
Savings and money market   223,475    216,299 
Time certificates   208,651    212,310 
Total deposits  $772,564   $766,239 

 

Capital Resources

 

The Company maintains capital to support future growth and maintain financial strength while trying to effectively manage the capital on hand. From the depositor standpoint, a greater amount of capital on hand relative to total assets is generally viewed as positive. At the same time, from the standpoint of the shareholder, a greater amount of capital on hand may not be viewed as positive because it limits the Company’s ability to earn a high rate of return on stockholders’ equity (ROE). Stockholders’ equity increased $1,524,000 to $90,989,000 as of March 31, 2012, as compared to $89,465,000 at December 31, 2011. The increase was the result of net income of $480,000, a change in accumulated other comprehensive income of $1,004,000 and stock based compensation expense of $40,000, all during the first three months of 2012. Under current regulations, management believes that the Company meets all capital adequacy requirements. The Company suspended indefinitely the payment of quarterly cash dividends on its common stock beginning in 2009. This Board decision was made to strengthen and preserve the Company’s capital base in these challenging economic times. Future dividends will be determined by the Board of Directors after consideration of the Company’s earnings, financial condition, future capital funds, regulatory requirements and other factors as the Board of Directors may deem relevant.

 

The Company’s and North Valley Bank’s capital amounts and risk-based capital ratios are presented below (in thousands).

 

                   To be Well Capitalized 
           For Capital   Under Prompt Corrective 
           Adequacy Purposes   Action Provisions 
   Actual   Minimum   Minimum   Minimum   Minimum 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
Company                              
As of March 31, 2012:                              
Total capital (to risk weighted assets)  $117,932    20.00%  $47,173    8.00%   N/A    N/A 
Tier 1 capital (to risk weighted assets)  $108,964    18.47%  $23,598    4.00%   N/A    N/A 
Tier 1 capital (to average assets)  $108,964    12.01%  $36,291    4.00%   N/A    N/A 
                               
As of December 31, 2011:                              
Total capital (to risk weighted assets)  $116,464    19.53%  $47,707    8.00%   N/A    N/A 
Tier 1 capital (to risk weighted assets)  $107,240    17.99%  $23,844    4.00%   N/A    N/A 
Tier 1 capital (to average assets)  $107,240    11.82%  $36,291    4.00%   N/A    N/A 
                               
North Valley Bank                              
As of March 31, 2012:                              
Total capital (to risk weighted assets)  $123,303    20.92%  $47,152    8.00%  $58,940    10.00%
Tier 1 capital (to risk weighted assets)  $115,836    19.65%  $23,580    4.00%  $35,370    6.00%
Tier 1 capital (to average assets)  $115,836    12.77%  $36,284    4.00%  $45,355    5.00%
                               
As of December 31, 2011:                              
Total capital (to risk weighted assets)  $121,221    20.33%  $47,701    8.00%  $59,627    10.00%
Tier 1 capital (to risk weighted assets)  $113,666    19.06%  $23,854    4.00%  $35,782    6.00%
Tier 1 capital (to average assets)  $113,666    12.54%  $36,257    4.00%  $45,321    5.00%

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Liquidity

 

The objective of liquidity management is to ensure the continuous availability of funds to meet the demands of depositors and borrowers. Collection of principal and interest on loans, the liquidations and maturities of investment securities, deposits with other banks, customer deposits and short term borrowings, when needed, are primary sources of funds that contribute to liquidity. As of March 31, 2012, $31,961,000 was outstanding in the form of subordinated debt issued by the Company. Unused lines of credit with correspondent banks to provide federal funds of $10,000,000 as of March 31, 2012 were also available to provide liquidity. In addition, NVB is a member of the Federal Home Loan Bank providing additional unused borrowing capacity of $322,758,000 secured by certain loans and investment securities as of March 31, 2012. The Company also has an unused line of credit with the Federal Reserve Bank of San Francisco of $6,486,000 secured by investment securities.

 

The Company manages both assets and liabilities by monitoring asset and liability mixes, volumes, maturities, yields and rates in order to preserve liquidity and earnings stability. Total liquid assets (cash and due from banks, Federal funds sold and available for sale investment securities) totaled $389,868,000 and $371,173,000 (or 42.67% and 41.02% of total assets) at March 31, 2012 and December 31, 2011, respectively.

 

Core deposits, defined as demand deposits, interest bearing demand deposits, regular savings, money market deposit accounts and time deposits of less than $100,000, continue to provide a relatively stable and low cost source of funds. Core deposits totaled $674,418,000 and $669,342,000 at March 31, 2012 and December 31, 2011, respectively.

 

In assessing liquidity, historical information such as seasonal loan demand, local economic cycles and the economy in general are considered along with current ratios, management goals and unique characteristics of the Company. Management believes the Company is in compliance with its policies relating to liquidity.

 

Interest Rate Sensitivity

 

Overview. The Company constantly monitors earning asset and deposit levels, developments and trends in interest rates, liquidity, capital adequacy and marketplace opportunities with the view towards maximizing shareholder value and earnings while maintaining a high quality balance sheet without exposing the Company to undue market risk. Management responds to all of these to protect and possibly enhance net interest income while managing risks within acceptable levels as set forth in the Company’s policies. In addition, alternative business plans and contemplated transactions are also analyzed for their impact. This process, known as asset/liability management is carried out by changing the maturities and relative proportions of the various types of loans, investments, deposits and other borrowings.

 

Market Risk. Market risk results from the fact that the market values of assets or liabilities on which the interest rate is fixed will increase or decrease with changes in market interest rates. If the Company invests in a fixed-rate, long term security and then interest rates rise, the security is worth less than a comparable security just issued because the older security pays less interest than the newly issued security. If the security had to be sold before maturity, then the Company would incur a loss on the sale. Conversely, if interest rates fall after a fixed-rate security is purchased, its value increases, because it is paying at a higher rate than newly issued securities. The fixed rate liabilities of the Company, like certificates of deposit and fixed-rate borrowings, also change in value with changes in interest rates. As rates drop, they become more valuable to the depositor and hence more costly to the Company. As rates rise, they become more valuable to the Company. Therefore, while the value changes when rates move in either direction, the adverse impacts of market risk to the Company’s fixed-rate assets are due to rising rates and for the Company’s fixed-rate liabilities, they are due to falling rates. In general, the change in market value due to changes in interest rates is greater in financial instruments that have longer remaining maturities. Therefore, the exposure to market risk of assets is lessened by managing the amount of fixed-rate assets and by keeping maturities relatively short. These steps, however, must be balanced against the need for adequate interest income because variable-rate and shorter-term assets generally yield less interest than longer-term or fixed-rate assets.

 

Mismatch Risk. The second interest-related risk, mismatched risk, arises from the fact that when interest rates change, the changes do not occur equally in the rates of interest earned and paid because of differences in the contractual terms of the assets and liabilities held. A difference in the contractual terms, a mismatch, can cause adverse impacts on net interest income.

36
 

 

The Company has a certain portion of its loan portfolio tied to the national prime rate. If these rates are lowered because of general market conditions, e.g., the prime rate decreases in response to a rate decrease by the Federal Reserve Open Market Committee (“FOMC”), these loans will be repriced. If the Company were at the same time to have a large proportion of its deposits in long-term fixed-rate certificates, interest earned on loans would decline while interest paid on the certificates would remain at higher levels for a period of time until they mature. Therefore, net interest income would decrease immediately. A decrease in net interest income could also occur with rising interest rates if the Company had a large portfolio of fixed-rate loans and securities that was funded by deposit accounts on which the rate is steadily rising.

 

This exposure to mismatch risk is managed by attempting to match the maturities and repricing opportunities of assets and liabilities. This may be done by varying the terms and conditions of the products that are offered to depositors and borrowers. For example, if many depositors want shorter-term certificates while most borrowers are requesting longer-term fixed rate loans, the Company will adjust the interest rates on the certificates and loans to try to match up demand for similar maturities. The Company can then partially fill in mismatches by purchasing securities or borrowing funds from the Federal Home Loan Bank with the appropriate maturity or repricing characteristics.

 

Basis Risk. The third interest-related risk, basis risk, arises from the fact that interest rates rarely change in a parallel or equal manner. The interest rates associated with the various assets and liabilities differ in how often they change, the extent to which they change, and whether they change sooner or later than other interest rates. For example, while the repricing of a specific asset and a specific liability may occur at roughly the same time, the interest rate on the liability may rise one percent in response to rising market rates while the asset increases only one-half percent. While the Company would appear to be evenly matched with respect to mismatch risk, it would suffer a decrease in net interest income. This exposure to basis risk is the type of interest risk least able to be managed, but is also the least dramatic. Avoiding concentrations in only a few types of assets or liabilities is the best means of increasing the chance that the average interest received and paid will move in tandem. The wider diversification means that many different rates, each with their own volatility characteristics, will come into play.

 

Net Interest Income and Net Economic Value Simulations. The tool used to manage and analyze the interest rate sensitivity of a financial institution is known as a simulation model and is performed with specialized software built for this specific purpose for financial institutions. This model allows management to analyze the three specific types of risks; market risk, mismatch risk, and basis risk.

 

To quantify the extent of all of these risks both in its current position and in transactions it might make in the future, the Company uses computer modeling to simulate the impact of different interest rate scenarios on net interest income and on net economic value. Net economic value or the market value of portfolio equity is defined as the difference between the market value of financial assets and liabilities. These hypothetical scenarios include both sudden and gradual interest rate changes, and interest rate changes in both directions. This modeling is the primary means the Company uses for interest rate risk management decisions.

 

The hypothetical impact of sudden interest rate shocks applied to the Company’s asset and liability balances are modeled quarterly. The results of this modeling indicate how much of the Company’s net interest income and net economic value are “at risk” (deviation from the base level) from various sudden rate changes. This exercise is valuable in identifying risk exposures. The results for the Company’s most recent simulation analysis indicate that the Company’s net interest income at risk over a one-year period and net economic value at risk from 2% shocks are within normal expectations for sudden changes and do not materially differ from those of March 31, 2012.

 

For this simulation analysis, the Company has made certain assumptions about the duration of its non-maturity deposits that are important to determining net economic value at risk.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

In management’s opinion, there has not been a material change in the Company’s market risk profile for the three months ended March 31, 2012 compared to December 31, 2011. Please see discussion under the caption “Interest Rate Sensitivity” on page 36.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

Disclosure controls and procedures are designed with the objective of ensuring that information required to be disclosed in reports filed by the Company under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Disclosure controls and procedures are also designed with the objective of ensuring that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

37
 

 

Evaluation of Disclosure Controls and Procedures

 

The Company’s management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of March 31, 2012. Based on this evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective.

 

Internal Control over Financial Reporting

 

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. There was no change in the Company’s internal control over financial reporting that occurred during the quarter ended March 31, 2012 that has materially affected or is reasonable likely to materially affect, the Company’s internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

There are no material legal proceedings pending against the Company or against any of its property. The Company, because of the nature of its business, is generally subject to various legal actions, threatened or filed, which involve ordinary, routine litigation incidental to its business. Although the amount of the ultimate exposure, if any, cannot be determined at this time, the Company does not expect that the final outcome of threatened or filed suits will have a materially adverse effect on its consolidated financial position.

 

ITEM 1A. RISK FACTORS

 

There have been no material changes from risk factors as previously disclosed by the Company in its response to Item 1A of Part 1 of Form 10-K for the fiscal year ended December 31, 2011.

 

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

 

Not applicable

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

Not applicable

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable

 

ITEM 5. OTHER INFORMATION

 

None

 

ITEM 6. EXHIBITS

 

31 Rule 13a-14(a) / 15d-14(a) Certifications
32 Section 1350 Certifications
101.INS XBRL Instance Document (furnished herewith)*
101.SCH XBRL Taxonomy Extension Schema Document (furnished herewith)*
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document (furnished herewith)*
101.DEF XBRL Taxonomy Extension Definition Linkbase Document (furnished herewith)*
101.LAB XBRL Taxonomy Extension Label Linkbase Document (furnished herewith)*
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document (furnished herewith)*
   

*The interactive data files listed above shall not be deemed filed for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, or Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability under those sections.

38
 

 

SIGNATURES

 

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

 

NORTH VALLEY BANCORP

(Registrant)

 

Date     May 11, 2012

 

By:  
   
/s/ Michael J. Cushman  
Michael J. Cushman  
President & Chief Executive Officer  
(Principal Executive Officer)  
   
/s/ Kevin R. Watson  
Kevin R. Watson  
Executive Vice President & Chief Financial Officer  
(Principal Financial Officer & Principal Accounting Officer)  

 

39