Edgar Filing: TRICO BANCSHARES /

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Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

for the quarterly period ended: March 31, 2013

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

for the transition period from to .

Commission File Number: 000-10661

TriCo Bancshares

(Exact Name of Registrant as Specified in Its Charter)

CALIFORNIA

94-2792841

(State or Other Jurisdiction

of Incorporation or Organization)

(I.R.S. Employer

Identification Number)

63 Constitution Drive

Chico, California 95973

(Address of Principal Executive Offices)(Zip Code)

(530) 898-0300

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ 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). x Yes ¨ No

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

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

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

Common stock, no par value: 16,017,127 shares outstanding as of May 3, 2013

TriCo Bancshares

FORM 10-Q

TABLE OF CONTENTS


	Page
Forward-Looking Statements		1

PART I – FINANCIAL INFORMATION		2

Item 1 – Financial Statements		2

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations		41

Item 3 – Quantitative and Qualitative Disclosures about Market Risk		60

Item 4 – Controls and Procedures		60

PART II – OTHER INFORMATION		60

Item 1 – Legal Proceedings		60

Item 1A – Risk Factors		60

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds		60

Item 6 – Exhibits		60

Signatures		62

Exhibits

FORWARD-LOOKING STATEMENTS

This report on Form 10-Q contains forward-looking statements about TriCo Bancshares (the “Company”) that are subject to the protection of the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on the current knowledge and belief of the Company’s management (“Management”) and include information concerning the Company’s possible or assumed future financial condition and results of operations. When you see any of the words “believes”, “expects”, “anticipates”, “estimates”, or similar expressions, it may mean the Company is making forward-looking statements. A number of factors, some of which are beyond the Company’s ability to predict or control, could cause future results to differ materially from those contemplated. The reader is directed to the Company’s annual report on Form 10-K for the year ended December 31, 2012, and Part II, Item 1A of this report for further discussion of factors which could affect the Company’s business and cause actual results to differ materially from those suggested by any forward-looking statement made in this report. Such Form 10-K and this report should be read to put any forward-looking statements in context and to gain a more complete understanding of the risks and uncertainties involved in the Company’s business. Any forward-looking statement may turn out to be wrong and cannot be guaranteed. The Company does not intend to update any forward-looking statement after the date of this report.

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

TRICO BANCSHARES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data; unaudited)


	At March 31, 2013			At December 31, 2012
Assets:
Cash and due from banks	$	70,023		$	81,086
Cash at Federal Reserve and other banks		732,248			667,813

Cash and cash equivalents		802,271			748,899
Securities available-for-sale		144,454			163,027
Restricted equity securities		9,647			9,647
Loans held for sale		7,931			12,053
Loans		1,532,362			1,564,823
Allowance for loan losses		(39,867	)		(42,648	)

Total loans, net		1,492,495			1,522,175
Foreclosed assets, net		6,124			7,498
Premises and equipment, net		29,468			26,985
Cash value of life insurance		51,008			50,582
Accrued interest receivable		7,201			6,636
Goodwill		15,519			15,519
Other intangible assets, net		1,040			1,092
Mortgage servicing rights		4,984			4,552
Indemnification asset		1,807			1,997
Other assets		38,484			38,607

Total assets	$	2,612,433		$	2,609,269

Liabilities and Shareholders’ Equity:
Liabilities:
Deposits:
Noninterest-bearing demand	$	639,420		$	684,833
Interest-bearing		1,646,130			1,604,869

Total deposits		2,285,550			2,289,702
Accrued interest payable		975			1,036
Reserve for unfunded commitments		3,175			3,615
Other liabilities		37,340			35,122
Other borrowings		8,125			9,197
Junior subordinated debt		41,238			41,238

Total liabilities		2,376,403			2,379,910

Commitments and contingencies (Note 18)
Shareholders’ equity:
Common stock, no par value: 50,000,000 shares authorized; issued and outstanding:
16,005,191 at March 31, 2013		85,995
16,000,838 at December 31, 2012					85,561
Retained earnings		148,497			141,639
Accumulated other comprehensive income, net of tax		1,538			2,159

Total shareholders’ equity		236,030			229,359

Total liabilities and shareholders’ equity	$	2,612,433		$	2,609,269

See accompanying notes to unaudited condensed consolidated financial statements.

TRICO BANCSHARES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data; unaudited)


	Three months ended March 31,
	2013			2012
Interest and dividend income:
Loans, including fees	$	24,072		$	24,929
Debt securities:
Taxable		1,131			1,746
Tax exempt		101			108
Dividends		56			13
Interest bearing cash at Federal Reserve and other banks		446			368

Total interest and dividend income		25,806			27,164

Interest expense:
Deposits		925			1,184
Other borrowings		1			606
Junior subordinated debt		311			338

Total interest expense		1,237			2,128

Net interest income		24,569			25,036
(Benefit from) provision for loan losses		(1,108	)		3,996

Net interest income after provision for loan losses		25,677			21,040

Noninterest income:
Service charges and fees		5,929			5,952
Gain on sale of loans		2,294			1,650
Commissions on sale of non-deposit investment products		761			819
Increase in cash value of life insurance		426			450
Change in indemnification asset		(101	)		(353	)
Gain (loss) on sale of foreclosed assets		551			(358	)
Other		358			105

Total noninterest income		10,218			8,265

Noninterest expense:
Salaries and related benefits		12,961			12,762
Other		8,640			10,153

Total noninterest expense		21,601			22,915

Income before income taxes		14,294			6,390

Provision for income taxes		5,817			2,459

Net income	$	8,477		$	3,931

Earnings per share:
Basic	$	0.53		$	0.25
Diluted	$	0.53		$	0.25

See accompanying notes to unaudited condensed consolidated financial statements.

TRICO BANCSHARES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands; unaudited)


	Three months ended March 31,
	2013			2012
Net income	$	8,477		$	3,931
Other comprehensive loss, net of tax:
Decrease in unrealized gains on available-for-sale securities arising during the period		(621	)		(153	)

Other comprehensive loss		(621	)		(153	)

Comprehensive income	$	7,856		$	3,778

See accompanying notes to unaudited condensed consolidated financial statements.

TRICO BANCSHARES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(In thousands, except share and per share data; unaudited)


	Shares of Common Stock			Common Stock			Retained Earnings			Accumulated Other Comprehensive Income			Total
Balance at December 31, 2011		15,978,958		$	84,079		$	128,551		$	3,811		$	216,441
Net income								3,931						3,931
Other comprehensive loss											(153	)		(153	)
Stock option vesting					257									257
Dividends paid ($ 0.09 per share)								(1,438	)					(1,438	)

Balance at March 31, 2012		15,978,958		$	84,336		$	131,044		$	3,658		$	219,038

Balance at December 31, 2012		16,000,838		$	85,561		$	141,639		$	2,159		$	229,359
Net income								8,477						8,477
Other comprehensive loss											(621	)		(621	)
Stock option vesting					236									236
Stock options exercised		20,000			262									262
Tax benefit of stock options exercised					20									20
Repurchase of common stock		(15,647	)		(84	)		(178	)					(262	)
Dividends paid ($ 0.09 per share)								(1,441	)					(1,441	)

Balance at March 31, 2013		16,005,191		$	85,995		$	148,497		$	1,538		$	236,030

See accompanying notes to unaudited condensed consolidated financial statements.

TRICO BANCSHARES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands; unaudited)


	For the three months ended March 31,
	2013			2012
Operating activities:
Net income	$	8,477		$	3,931
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation of premises and equipment, and amortization		982			1,018
Amortization of intangible assets		52			53
(Benefit from) provision for loan losses		(1,108	)		3,996
Amortization of investment securities premium, net		214			329
Originations of loans for resale		(53,415	)		(58,041	)
Proceeds from sale of loans originated for resale		59,338			63,491
Gain on sale of loans		(2,294	)		(1,650	)
Change in market value of mortgage servicing rights		61			369
Provision for losses on foreclosed assets		27			83
(Gain) loss on sale of foreclosed assets		(551	)		358
Loss on disposal of fixed assets		16			235
Increase in cash value of life insurance		(426	)		(450	)
Life insurance proceeds		706			2,811
Stock option vesting expense		236			257
Stock option tax benefits		(20	)		—
Change in:
Reserve for unfunded commitments		(440	)		(190	)
Interest receivable		(565	)		217
Interest payable		(61	)		(87	)
Other assets and liabilities, net		2,056			1,223

Net cash from operating activities		13,285			17,953

Investing activities:
Proceeds from maturities of securities available-for-sale		17,286			20,060
Purchases of securities available-for-sale		—			(3,588	)
Net redemption of restricted equity securities		—			102
Loan principal decrease, net		25,051			33,795
Proceeds from sale of foreclosed assets		7,635			3,021
Improvements of foreclosed assets		—			(225	)
Proceeds from sale of premises and equipment		1			—
Purchases of premises and equipment		(3,241	)		(938	)

Net cash from investing activities		46,732			52,227

Financing activities:
Net decrease in deposits		(4,152	)		(20,790	)
Net change in short-term other borrowings		(1,072	)		(3,467	)
Stock option excess tax benefits		20			—
Dividends paid		(1,441	)		(1,438	)

Net cash used for financing activities		(6,645	)		(25,695	)

Net change in cash and cash equivalents		53,372			44,485

Cash and cash equivalents at beginning of period		748,899			637,275

Cash and cash equivalents at end of period	$	802,271		$	681,760

Supplemental disclosure of noncash activities:
Loans transferred to other real estate owned	$	5,737		$	1,694
Unrealized net loss on securities available for sale	$	(1,073	)	$	(265	)
Supplemental disclosure of cash flow activity:
Cash paid for interest expense	$	1,298		$	2,215
Cash paid for income taxes	$	2,600			—

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

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Summary of Significant Accounting Policies

Description of Business

TriCo Bancshares is a California corporation organized to act as a bank holding company for Tri Counties Bank (the “Bank”). The Bank is a state-chartered financial institution that is engaged in the general commercial banking business in the California counties of Butte, Contra Costa, Del Norte, Fresno, Glenn, Kern, Lake, Lassen, Madera, Mendocino, Merced, Napa, Nevada, Placer, Sacramento, Shasta, Siskiyou, Stanislaus, Sutter, Tehama, Tulare, Yolo and Yuba. Tri Counties Bank currently operates from 41 traditional branches and 25 in-store branches. The Company also formed two subsidiary business trusts, TriCo Capital Trust I and TriCo Capital Trust II (collectively, the Trusts), to issue trust preferred securities.

Basis of Presentation

The following unaudited condensed financial statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made 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 results for the interim periods presented have been included. These interim condensed consolidated financial statements should be read in conjunction with the financial statements and related notes contained in the Company’s 2012 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 18, 2013.

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned financial subsidiary, Tri Counties Bank. All significant intercompany balances and transactions have been eliminated. TriCo Capital Trust I and TriCo Capital Trust II, which were formed solely for the purpose of issuing trust preferred securities, are unconsolidated subsidiaries as the Company is not the primary beneficiary of the trusts and they are not considered variable interest entities. Operating results for the three months ended March 31, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. Certain amounts in the consolidated financial statements for the year ended December 31, 2012 and for the three months ended March 31, 2012 may have been reclassified to conform to the presentation of the condensed consolidated financial statements in 2013.

Use of Estimates in the Preparation of Financial Statements

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

As described in Note 2, the Bank assumed the banking operations of two failed financial institutions from the FDIC under whole bank purchase agreements. The acquired assets and assumed liabilities were measured at estimated fair value values under the acquisition method of accounting. The Company made significant estimates and exercised significant judgment in accounting for the acquisitions. The Company determined loan fair values based on loan file reviews, loan risk ratings, appraised collateral values, expected cash flows and historical loss factors. Foreclosed assets were primarily valued based on appraised values of the repossessed loan collateral. An identifiable intangible was also recorded representing the fair value of the core deposit customer base based on an evaluation of the cost of such deposits relative to alternative funding sources. The fair value of time deposits and borrowings were determined based on the present value of estimated future cash flows using current rates as of the acquisition date.

Significant Group Concentration of Credit Risk

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

Cash and Cash Equivalents

For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Net cash flows are reported for loan and deposit transactions and other borrowings.

Investment Securities

The Company classifies its debt and marketable equity securities into one of three categories: trading, available-for-sale or held-to-maturity. Trading securities are bought and held principally for the purpose of selling in the near term. Held-to-maturity securities are those securities which the Company has the ability and intent to hold until maturity. All other securities not included in trading or held-to-maturity are classified as available-for-sale. During the three months ended March 31, 2013, and the year ended December 31, 2012, the Company did not have any securities classified as either held-to-maturity or trading. Available-for-sale securities are recorded at fair value. Unrealized gains and losses, net of the related tax effect, on available-for-sale securities are reported as a separate component of other accumulated comprehensive income in shareholders’ equity until realized. Premiums and discounts are amortized or accreted over the life of the related investment security as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned. Realized gains and losses are derived from the amortized cost of the security sold.

The Company assesses other-than-temporary impairment (“OTTI”) based on whether it intends to sell a security or if it is likely that the Company would be required to sell the security before recovery of the amortized cost basis of the investment, which may be maturity. For debt securities, if we intend to sell the security or it is likely that we will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If we do not intend to sell the security and it is not likely that we will be required to sell the security but we do not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income (“OCI”). Impairment losses related to all other factors are presented as separate categories within OCI. The accretion of the amount recorded in OCI increases the carrying value of the investment and does not affect earnings. If there is an indication of additional credit losses the security is re-evaluated according to the procedures described above. No OTTI losses were recognized during the three months ended March 31, 2013, and the year ended December 31, 2012.

Restricted Equity Securities

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

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

Loans Held for Sale

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

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

Loans and Allowance for Loan Losses

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

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

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

In situations related to originated loans where, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession for other than an insignificant period of time to the borrower that the Company would not otherwise consider, the related loan is classified as a troubled debt restructuring (TDR). The Company strives to identify borrowers in financial difficulty early and work with them to modify to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where the Company grants the borrower new terms that result in the loan being classified as a TDR, the Company measures any impairment on the restructuring as noted above for impaired loans. TDR loans are classified as impaired until they are fully paid off or charged off. Loans that are in nonaccrual status at the time they become TDR loans, remain in nonaccrual status until the borrower demonstrates a sustained period of performance which the Company generally believes to be six consecutive months of payments, or equivalent. Otherwise, TDR loans are subject to the same nonaccrual and charge-off policies as noted above with respect to their restructured principal balance.

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

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

The Company’s method for assessing the appropriateness of the allowance for originated loan losses includes specific allowances for impaired originated loans and leases, formula allowance factors for pools of credits, and allowances for changing environmental factors (e.g., interest rates, growth, economic conditions, etc.). Allowance factors for loan pools were based on historical loss experience by product type and prior risk rating.

During the three months ended March 31, 2013, the Company changed the method it uses to estimate net sale proceeds from real estate collateral sales when calculating the allowance for loan losses associated with impaired real estate collateral dependent loans. Previously, the Company used the greater of fifteen percent or actual estimated selling costs. Currently, the Company uses the actual estimated selling costs, and an adjustment to appraised value based on the age of the appraisal. These changes are intended to more accurately reflect the estimated net sale proceeds from the sale of impaired collateral dependent real estate loans. This change in methodology resulted in the allowance for loan losses as of March 31, 2013 being $494,000 more than it would have been without this change in methodology.

Loans purchased or acquired in a business combination are referred to as acquired loans. Acquired loans are valued as of the acquisition date in accordance with Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) Topic 805, Business Combinations. Loans acquired with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are referred to as purchased credit impaired (PCI) loans. PCI loans are accounted for under FASB ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. Under FASB ASC Topic 805 and FASB ASC Topic 310-30, PCI loans are recorded at fair value at acquisition date, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded as of the acquisition date. Fair value is defined as the present value of the future estimated principal and interest payments of the loan, with the discount rate used in the present value calculation representing the estimated effective yield of the loan. Default rates, loss severity, and prepayment speed assumptions are periodically

reassessed and our estimate of future payments is adjusted accordingly. The difference between contractual future payments and estimated future payments is referred to as the nonaccretable difference. The difference between estimated future payments and the present value of the estimated future payments is referred to as the accretable yield. The accretable yield represents the amount that is expected to be recorded as interest income over the remaining life of the loan. If after acquisition, the Company determines that the estimated future cash flows of a PCI loan are expected to be more than originally estimated, an increase in the discount rate (effective yield) would be made such that the newly increased accretable yield would be recognized, on a level yield basis, over the remaining estimated life of the loan. If, after acquisition, the Company determines that the estimated future cash flows of a PCI loan are expected to be less than previously estimated, the discount rate would first be reduced until the present value of the reduced cash flow estimate equals the previous present value however, the discount rate may not be lowered below its original level at acquisition. If the discount rate has been lowered to its original level and the present value has not been sufficiently lowered, an allowance for loan loss would be established through a provision for loan losses charged to expense to decrease the present value to the required level. If the estimated cash flows improve after an allowance has been established for a loan, the allowance may be partially or fully reversed depending on the improvement in the estimated cash flows. Only after the allowance has been fully reversed may the discount rate be increased. PCI loans are put on nonaccrual status when cash flows cannot be reasonably estimated. PCI loans on nonaccrual status are accounted for using the cost recovery method or cash basis method of income recognition. PCI loans are charged off when evidence suggests cash flows are not recoverable. Foreclosed assets from PCI loans are recorded in foreclosed assets at fair value with the fair value at time of foreclosure representing cash flow from the loan. ASC 310-30 allows PCI loans with similar risk characteristics and acquisition time frame to be “pooled” and have their cash flows aggregated as if they were one loan. The Company elected to use the “pooled” method of ASC 310-30 for PCI – other loans in the acquisition of certain assets and liabilities of Granite Community Bank (“Granite”) and Citizens Bank of Northern California (“Citizens”).

Acquired loans that are not PCI loans are referred to as purchased not credit impaired (PNCI) loans. PNCI loans are accounted for under FASB ASC Topic 310-20, Receivables – Nonrefundable Fees and Other Costs, in which interest income is accrued on a level-yield basis for performing loans. For income recognition purposes, this method assumes that all contractual cash flows will be collected, and no allowance for loan losses is established at the time of acquistion. Post-acquisition date, an allowance for loan losses may need to be established for acquired loans through a provision charged to earnings for credit losses incurred subsequent to acquisition. Under ASC 310-20, the loss would be measured based on the probable shortfall in relation to the contractual note requirements, consistent with our allowance for loan loss policy for similar loans.

When referring to PNCI and PCI loans we will use the terms “nonaccretable difference”, “accretable yield”, or “purchase discount”. Nonaccretable difference is the difference between undiscounted contractual cash flows due and undiscounted cash flows we expect to collect, or put another way, it is the undiscounted contractual cash flows we do not expect to collect. Accretable yield is the difference between undiscounted cash flows we expect to collect and the value at which we have recorded the loan on our financial statements. On the date of acquisition, all purchased loans are recorded on our consolidated financial statements at estimated fair value. Purchase discount is the difference between the estimated fair value of loans on the date of acquisition and the principal amount owed by the borrower, net of charge offs, on the date of acquisition. We may also refer to “discounts to principal balance of loans owed, net of charge-offs”. Discounts to principal balance of loans owed, net of charge-offs is the difference between principal balance of loans owed, net of charge-offs, and loans as recorded on our financial statements. Discounts to principal balance of loans owed, net of charge-offs arise from purchase discounts, and equal the purchase discount on the acquisition date.

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

Foreclosed Assets

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

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

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

Premises and Equipment

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

Goodwill and Other Intangible Assets

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

The Company has an identifiable intangible asset consisting of core deposit intangibles (CDI). CDI are amortized over their respective estimated useful lives, and reviewed for impairment.

Impairment of Long-Lived Assets and Goodwill

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

As of December 31 of each year, goodwill is tested for impairment, and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. This determination is made at the reporting unit level. The Company may choose to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, the Company determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then goodwill is deemed not to be impaired. However, if the Company concludes otherwise, or if the Company elected not to first assess qualitative factors, then the Company performs the first step of a two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. Second, if the carrying amount of the reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. Currently, and historically, the Company is comprised of only one reporting unit that operates within the business segment it has identified as “community banking”. Goodwill was not impaired as of December 31, 2012 or 2011 because the fair value of the reporting unit exceeded its carrying value.

Mortgage Servicing Rights

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

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

Indemnification Asset

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

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

Reserve for Unfunded Commitments

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

Income Taxes

The Company’s accounting for income taxes is based on an asset and liability approach. The Company recognizes the amount of taxes payable or refundable for the current year, and deferred tax assets and liabilities for the future tax consequences that have been recognized in its financial statements or tax returns. The measurement of tax assets and liabilities is based on the provisions of enacted tax laws. A valuation allowance, if needed, reduces deferred tax assets to the expected amount most likely to be realized. Realization of deferred tax assets is dependent upon the generation of a sufficient level of future taxable income and recoverable taxes paid in prior years. Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized. Interest and/or penalties related to income taxes are reported as a component of noninterest income.

Off-Balance Sheet Credit Related Financial Instruments

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

Geographical Descriptions

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

Reclassifications

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

Recent Accounting Pronouncements

FASB issued ASU No. 2012-06, Business Combinations (Topic 805): Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution. ASU 2012-06 requires that when a reporting entity recognizes an indemnification asset (in accordance with Subtopic 805-20) as a result of a government-assisted acquisition of a financial institution and subsequently a change in the cash flows expected to be collected on the indemnification asset occurs (as a result of a change in cash flows expected to be collected on the assets subject to indemnification), the reporting entity should subsequently account for the change in the measurement of the indemnification asset on the same basis as the change in the assets subject to indemnification. Any amortization of changes in value should be limited to the contractual term of the indemnification agreement (that is, the lesser of the term of the indemnification agreement and the remaining life of the indemnified assets). The Company adopted this Standard on January 1, 2013, and the adoption did not have a significant impact on the Company’s consolidated financial statements.

FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. ASU 2013-02 amends recent guidance related to the reporting of comprehensive income to enhance the reporting of reclassifications out of accumulated other comprehensive income. The Company adopted this Standard on January 1, 2013, and the adoption did not have a significant impact on the Company’s consolidated financial statements.

Note 2—Business Combinations

On September 23, 2011, the California Department of Financial Institutions closed Citizens Bank of Northern California (“Citizens”), Nevada City, California and appointed the FDIC as receiver. That same date, the Bank assumed the banking operations of Citizens from the FDIC under a whole bank purchase and assumption agreement without loss sharing.

On May 28, 2010, the Office of the Comptroller of the Currency closed Granite Community Bank (“Granite”), Granite Bay, California and appointed the FDIC as receiver. That same date, the Bank assumed the banking operations of Granite from the FDIC under a whole bank purchase and assumption agreement with loss sharing. Under the terms of the loss sharing agreement, the FDIC will cover a substantial portion of any future losses on loans, related unfunded loan commitments, other real estate owned (OREO)/foreclosed assets and accrued interest on loans for up to 90 days. The FDIC will absorb 80% of losses and share in 80% of loss recoveries on the covered assets acquired from Granite. The loss sharing arrangements for non-single family residential and single family residential loans are in effect for 5 years and 10 years, respectively, and the loss recovery provisions are in effect for 8 years and 10 years, respectively, from the acquisition date.

Note 3—Investment Securities

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


	March 31, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Securities Available-for-Sale	(in thousands)
Obligations of U.S. government corporations and agencies	$	126,912	$	7,052		—	$	133,964
Obligations of states and political subdivisions		8,315		263		—		8,578
Corporate debt securities		1,866		46		—		1,912

Total securities available-for-sale	$	137,093	$	7,361		—	$	144,454


	December 31, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Securities Available-for-Sale	(in thousands)
Obligations of U.S. government corporations and agencies	$	143,633	$	8,068		—	$	151,701
Obligations of states and political subdivisions		9,098		323		—		9,421
Corporate debt securities		1,862		43		—		1,905

Total securities available-for-sale	$	154,593	$	8,434		—	$	163,027

No investment securities were sold during the three months ended March 31, 2013 or the year ended December 31, 2012. Investment securities with an aggregate carrying value of $67,078,000 and $66,911,000 at March 31, 2013 and December 31, 2012, respectively, were pledged as collateral for specific borrowings, lines of credit and local agency deposits.

The amortized cost and estimated fair value of debt securities at March 31, 2013 by contractual maturity are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. At March 31, 2013, obligations of U.S. government corporations and agencies with a cost basis totaling $126,912,000 consist almost entirely of mortgage-backed securities whose contractual maturity, or principal repayment, will follow the repayment of the underlying mortgages. For purposes of the following table, the entire outstanding balance of these mortgage-backed securities issued by U.S. government corporations and agencies is categorized based on final maturity date. At March 31, 2013, the Company estimates the average remaining life of these mortgage-backed securities issued by U.S. government corporations and agencies to be approximately 3.5 years. Average remaining life is defined as the time span after which the principal balance has been reduced by half.


	Amortized Cost		Estimated Fair Value
Investment Securities	(in thousands)
Due in one year	$	2,692	$	2,766
Due after one year through five years		4,637		4,872
Due after five years through ten years		43,900		45,569
Due after ten years		85,864		91,247

Totals	$	137,093	$	144,454

At March 31, 2013 and December 31, 2012, the Company had no investment securities with gross unrealized losses.

Note 4—Loans

A summary of loan balances follows (in thousands):


	March 31, 2013
	Originated			PNCI			PCI - Cash basis			PCI - Other			Total
Mortgage loans on real estate:
Residential 1-4 family	$	125,875		$	5,075			—		$	5,010		$	135,960
Commercial		772,296			69,982			—			32,011			874,289

Total mortgage loan on real estate		898,171			75,057			—			37,021			1,010,249
Consumer:
Home equity lines of credit		303,638			16,341			7,413			5,652			333,044
Home equity loans		12,533			347			48			155			13,083
Auto Indirect		2,821			—			—			—			2,821
Other		24,826			2,264			—			25			27,115

Total consumer loans		343,818			18,952			7,461			5,832			376,063
Commercial		106,275			779			36			8,393			115,483
Construction:
Residential		14,498			—			—			5,023			19,521
Commercial		9,909			—			—			1,137			11,046

Total construction		24,407			—			—			6,160			30,567

Total loans, net of deferred loan fees	$	1,372,671		$	94,788		$	7,497		$	57,406		$	1,532,362

Total principal balance of loans owed, net of charge-offs	$	1,375,615		$	107,268		$	18,783		$	71,426		$	1,573,092
Unamortized net deferred loan fees		(2,944	)		—			—			—			(2,944	)
Discounts to principal balance of loans owed, net of charge-offs		—			(12,480	)		(11,286	)		(14,020	)		(37,786	)

Total loans, net of unamortized deferred loan fees	$	1,372,671		$	94,788		$	7,497		$	57,406		$	1,532,362

Noncovered loans	$	1,372,671		$	94,788		$	7,497		$	17,614		$	1,492,570
Covered loans		—			—			—			39,792			39,792

Total loans, net of unamortized deferred loan fees	$	1,372,671		$	94,788		$	7,497		$	57,406		$	1,532,362

Allowance for loan losses	$	32,698		$	2,867		$	1,039		$	3,263		$	39,867

Note 4—Loans (continued)

A summary of loan balances follows (in thousands):


	December 31, 2012
	Originated			PNCI			PCI - Cash basis			PCI - Other			Total
Mortgage loans on real estate:
Residential 1-4 family	$	121,255		$	5,413			—		$	5,016		$	131,684
Commercial		775,124			72,090		$	1,289			29,943			878,446

Total mortgage loan on real estate		896,379			77,503			1,289			34,959			1,010,130
Consumer:
Home equity lines of credit		311,671			16,788			7,612			5,954			342,025
Home equity loans		13,011			342			49			155			13,557
Auto Indirect		3,816			—			—			—			3,816
Other		24,263			2,418			—			32			26,713

Total consumer loans		352,761			19,548			7,661			6,141			386,111
Commercial		125,122			869			22			9,515			135,528
Construction:
Residential		11,877			—			—			6,582			18,459
Commercial		11,196			—			—			3,399			14,595

Total construction		23,073			—			—			9,981			33,054

Total loans, net of deferred loan fees	$	1,397,335		$	97,920		$	8,972		$	60,596		$	1,564,823

Total principal balance of loans owed, net of charge-offs	$	1,400,147		$	111,286		$	20,621		$	75,277		$	1,607,331
Unamortized net deferred loan fees		(2,812	)		—			—			—			(2,812	)
Discounts to principal balance of loans owed, net of charge-offs		—			(13,366	)		(11,649	)		(14,681	)		(39,696	)

Total loans, net of unamortized deferred loan fees	$	1,397,335		$	97,920		$	8,972		$	60,596		$	1,564,823

Noncovered loans	$	1,397,335		$	97,920		$	8,972		$	18,708		$	1,522,935
Covered loans		—			—			—			41,888			41,888

Total loans, net of unamortized deferred loan fees	$	1,397,335		$	97,920		$	8,972		$	60,596		$	1,564,823

Allowance for loan losses	$	(35,769	)	$	(1,969	)	$	(1,054	)	$	(3,856	)	$	(42,648	)

The following is a summary of the change in accretable yield for PCI – other loans during the periods indicated (in thousands):


	Three months ended March 31,
	2013			2012
Change in accretable yield:
Balance at beginning of period	$	22,337		$	25,145
Accretion to interest income		(1,623	)		(1,959	)
Reclassification (to) from nonaccretable difference		(23	)		1,429

Balance at end of period	$	20,691		$	24,615

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

Note 5—Allowance for Loan Losses

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


	Allowance for Loan Losses – As of and three months ended March 31, 2013
	RE Mortgage						Home Equity						Auto			Other						Construction
(In thousands)	Resid.			Comm.			Lines			Loans			Indirect			Consum.			C&I			Resid.			Comm.			Total
Beginning balance	$	3,523		$	8,782		$	21,367		$	1,155		$	243		$	696		$	4,703		$	1,400		$	779		$	42,648
Charge-offs		(7	)		(803	)		(766	)		(26	)		(25	)		(273	)		(790	)		(20	)		(61	)		(2,771	)
Recoveries		—			353			290			9			85			224			70			61			6			1,098
(Benefit) provision		(173	)		1,078			(1,568	)		(1	)		(155	)		(84	)		252			(105	)		(352	)		(1,108	)

Ending balance	$	3,343		$	9,410		$	19,323		$	1,137		$	148		$	563		$	4,235		$	1,336		$	372		$	39,867

Ending balance:
Individ. evaluated for impairment	$	479		$	1,804		$	1,613		$	50		$	7		$	8		$	823		$	219		$	42		$	5,045

Loans pooled for evaluation	$	2,498		$	7,326		$	16,496		$	1,006		$	141		$	555		$	1,935		$	438		$	125		$	30,520

Loans acquired with deteriorated credit quality	$	366		$	280		$	1,214		$	81			—			—		$	1,477		$	679		$	205		$	4,302


	Loans, net of unearned fees – As of March 31, 2013
	RE Mortgage						Home Equity						Auto			Other						Construction
(In thousands)	Resid.			Comm.			Lines			Loans			Indirect			Consum.			C&I			Resid.			Comm.			Total
Ending balance:
Total loans	$	135,960		$	874,289		$	333,044		$	13,083		$	2,821		$	27,115		$	115,483		$	19,521		$	11,046		$	1,532,362

Individ. evaluated for impairment	$	6,238		$	64,812		$	8,721		$	576		$	176		$	97		$	5,867		$	3,410		$	343		$	90,240

Loans pooled for evaluation	$	124,712		$	777,466		$	311,258		$	12,304		$	2,645		$	26,993		$	101,187		$	11,088		$	9,566		$	1,377,219

Loans acquired with deteriorated credit quality	$	5,010		$	32,011		$	13,065		$	203			—		$	25		$	8,429		$	5,023		$	1,137		$	64,903


	Allowance for Loan Losses – As of and year ended December 31, 2012
	RE Mortgage						Home Equity						Auto			Other						Construction
(In thousands)	Resid.			Comm.			Lines			Loans			Indirect			Consum.			C&I			Resid.			Comm.			Total
Beginning balance	$	2,404		$	13,217		$	18,258		$	1,101		$	215		$	932		$	6,545		$	1,817		$	1,425		$	45,914
Charge-offs		(1,558	)		(3,457	)		(8,042	)		(385	)		(83	)		(1,202	)		(1,251	)		(406	)		(100	)		(16,484	)
Recoveries		147			1,020			398			100			215			860			643			412			—			3,795
(Benefit) provision		2,530			(1,998	)		10,753			339			(104	)		106			(1,234	)		(423	)		(546	)		9,423

Ending balance	$	3,523		$	8,782		$	21,367		$	1,155		$	243		$	696		$	4,703		$	1,400		$	779		$	42,648

Ending balance:
Individ. evaluated for impairment	$	631		$	515		$	2,264		$	81		$	5		$	47		$	840		$	11		$	111		$	4,505

Loans pooled for evaluation	$	2,526		$	8,026		$	17,862		$	995		$	238		$	649		$	2,342		$	430		$	165		$	33,233

Loans acquired with deteriorated credit quality	$	366		$	241		$	1,241		$	79			—			—		$	1,521		$	959		$	503		$	4,910


	Loans, net of unearned fees – As of December 31, 2012
	RE Mortgage						Home Equity						Auto			Other						Construction
(In thousands)	Resid.			Comm.			Lines			Loans			Indirect			Consum.			C&I			Resid.			Comm.			Total
Ending balance:
Total loans	$	131,684		$	878,446		$	342,025		$	13,557		$	3,816		$	26,713		$	135,528		$	18,459		$	14,595		$	1,564,823

Individ. evaluated for impairment	$	6,586		$	71,077		$	10,056		$	528		$	197		$	121		$	8,562		$	3,596		$	607		$	101,330

Loans pooled for evaluation	$	120,082		$	776,137		$	318,403		$	12,825		$	3,619		$	26,560		$	117,429		$	8,281		$	10,589		$	1,393,925

Loans acquired with deteriorated credit quality	$	5,016		$	31,232		$	13,566		$	204			—		$	32		$	9,537		$	6,582		$	3,399		$	69,568

Note 5 – Allowance for Loan Losses (Continued)


	Allowance for Loan Losses – As of and three months ended March 31, 2012
	RE Mortgage						Home Equity						Auto			Other						Construction
(In thousands)	Resid.			Comm.			Lines			Loans			Indirect			Consum.			C&I			Resid.			Comm.		Total
Beginning balance	$	2,404		$	13,217		$	18,258		$	1,101		$	215		$	932		$	6,545		$	1,817		$	1,425	$	45,914
Charge-offs		(223	)		(1,305	)		(2,625	)		(41	)		(40	)		(339	)		(281	)		(68	)		—		(4,922	)
Recoveries		-			36			63			3			57			255			50			—			—		464
Provision (benefit)		976			(1,967	)		6,336			204			343			(248	)		(1,764	)		(77	)		193		3,996

Ending balance	$	3,157		$	9,981		$	22,032		$	1,267		$	575		$	600		$	4,550		$	1,672		$	1,618	$	45,452

Ending balance:
Individ. evaluated for impairment	$	582		$	1,041		$	1,578		$	59		$	14		$	17		$	357		$	80		$	1,048	$	4,776

Loans pooled for evaluation	$	2,463		$	8,939		$	18,949		$	1,096		$	560		$	584		$	2,563		$	625		$	110	$	35,889

Loans acquired with deteriorated credit quality	$	113			—		$	1,505		$	111			—			—		$	1,630		$	967		$	461	$	4,787


	Loans, net of unearned fees – As of March 31, 2012
	RE Mortgage						Home Equity						Auto			Other						Construction
(In thousands)	Resid.			Comm.			Lines			Loans			Indirect			Consum.			C&I			Resid.			Comm.		Total
Ending balance:
Total loans	$	130,500		$	816,859		$	350,062		$	14,559		$	8,397		$	23,671		$	128,343		$	22,364		$	16,330	$	1,511,085

Individ. evaluated for impairment	$	10,490		$	69,817		$	8,777		$	549		$	404		$	177		$	9,286		$	5,606		$	7,114	$	112,220

Loans pooled for evaluation	$	113,808		$	714,579		$	327,018		$	13,805		$	7,993		$	23,446		$	106,689		$	7,569		$	5,552	$	1,320,459

Loans acquired with deteriorated credit quality	$	6,202		$	32,463		$	14,267		$	205			—		$	48		$	12,368		$	9,189		$	3,664	$	78,406

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

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

•

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

•

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

•

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

•

Doubtful – This grade represents “Doubtful” loans in accordance with regulatory guidelines. An asset classified as Doubtful has all the weaknesses inherent in a loan classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral, and financing plans.

•

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

Note 5 – Allowance for Loan Losses (Continued)

The following tables present ending loan balances by loan category and risk grade as of the dates indicated:


	Credit Quality Indicators – As of March 31, 2013
	RE Mortgage				Home Equity				Auto Indirect		Other Consumer		C&I		Construction
(In thousands)	Resid.		Comm.		Lines		Loans		Auto Indirect		Other Consumer		C&I		Resid.		Comm.		Total
Originated loans:
Pass	$	116,293		686,714	$	288,765	$	11,508	$	2,185	$	24,007	$	96,302	$	10,487	$	9,200	$	1,245,461
Special mention		1,920		21,690		4,450		295		367		693		4,461		385		401		34,662
Substandard		7,662		63,892		10,423		730		269		126		5,512		3,626		308		92,548

Total Originated loans	$	125,875	$	772,296	$	303,638	$	12,533	$	2,821	$	24,826	$	106,275	$	14,498	$	9,909	$	1,372,671

PNCI loans:
Pass	$	4,532	$	62,804	$	15,292	$	347		—	$	2,162	$	760		—		—	$	85,897
Special mention		—		3,711		282		—		—		61		19		—		—		4,073
Substandard		543		3,467		767		—		—		41		—		—		—		4,818

Total PNCI loans	$	5,075	$	69,982	$	16,341	$	347		—	$	2,264	$	779		—		—	$	94,788

PCI loans	$	5,010	$	32,011	$	13,065	$	203		—	$	25	$	8,429	$	5,023	$	1,137	$	64,903

Total loans	$	135,960	$	874,289	$	333,044	$	13,083	$	2,821	$	27,115	$	115,483	$	19,521	$	11,046	$	1,532,362


	Credit Quality Indicators – As of December 31, 2012
	RE Mortgage				Home Equity				Auto Indirect		Other Consumer		C&I		Construction
(In thousands)	Resid.		Comm.		Lines		Loans		Auto Indirect		Other Consumer		C&I		Resid.		Comm.		Total
Originated loans:
Pass	$	108,946	$	686,593	$	291,701	$	11,892	$	2,949	$	23,154	$	113,595	$	7,744	$	10,221	$	1,256,795
Special mention		3,122		21,184		6,955		555		531		958		3,224		285		356		37,170
Substandard		9,187		67,347		13,015		564		336		151		8,303		3,848		619		103,370

Total Originated loans	$	121,255	$	775,124	$	311,671	$	13,011	$	3,816	$	24,263	$	125,122	$	11,877	$	11,196	$	1,397,335

PNCI loans:
Pass	$	4,968	$	64,917	$	15,915	$	342		—	$	2,240	$	848		—		—	$	89,230
Special mention		—		5,249		193		—		—		104		21		—		—		5,567
Substandard		436		1,924		680		—		—		74		—		—		—		3,114
Loss		9		—		—		—		—		—		—		—		—		9

Total PNCI loans	$	5,413	$	72,090	$	16,788	$	342		—	$	2,418	$	869		—		—	$	97,920

PCI loans	$	5,016	$	31,232	$	13,566	$	204		—	$	32	$	9,537	$	6,582	$	3,399	$	69,568

Total loans	$	131,684	$	878,446	$	342,025	$	13,557	$	3,816	$	26,713	$	135,528	$	18,459	$	14,595	$	1,564,823

Consumer loans, whether unsecured or secured by real estate, automobiles, or other personal property, are primarily susceptible to three primary risks; non-payment due to income loss, over-extension of credit and, when the borrower is unable to pay, shortfall in collateral value. Typically non-payment is due to loss of job and will follow general economic trends in the marketplace driven primarily by rises in the unemployment rate. Loss of collateral value can be due to market demand shifts, damage to collateral itself or a combination of the two.

Problem consumer loans are generally identified by payment history of the borrower (delinquency) or significant changes in the borrower’s credit rating. Current credit scores are obtained for all consumer loans on a quarterly basis, and risk ratings are adjusted appropriately. The Bank manages its consumer loan portfolios by monitoring delinquency and contacting borrowers to encourage repayment, suggest modifications if appropriate, and, when continued scheduled payments become unrealistic, initiate repossession or foreclosure through appropriate channels. Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, public value information (blue book values for autos), sales invoices, or other appropriate means. Appropriate valuations are obtained at initiation of the credit and periodically (every 3-12 months depending on collateral type) once repayment is questionable and the loan has been classified.

Commercial real estate loans generally fall into two categories, owner-occupied and non-owner occupied. Loans secured by owner occupied real estate are primarily susceptible to changes in the business conditions of the related business. This may be driven by, among other things, industry changes, geographic business changes, changes in the individual fortunes of the business owner, and general economic conditions and changes in business cycles. These same risks apply to commercial loans whether secured by equipment or other personal property or unsecured. Losses on loans secured by owner occupied real estate, equipment, or other personal property generally are dictated by the value of underlying collateral at the time of default and liquidation of the collateral. When default is driven by issues related specifically to the business owner, collateral values tend to provide better repayment support and may result in little or no loss. Alternatively, when default is driven by more general economic conditions, underlying collateral generally has devalued more and results in larger losses due to default. Loans secured by non-owner occupied real estate are primarily susceptible to risks associated with swings in occupancy or vacancy and related shifts in lease rates, rental rates or room rates. Most often these shifts are a result of changes in general

economic or market conditions or overbuilding and resultant over-supply. Losses are dependent on value of underlying collateral at the time of default. Values are generally driven by these same factors and influenced by interest rates and required rates of return as well as changes in occupancy costs.

Construction loans, whether owner occupied or non-owner occupied commercial real estate loans or residential development loans, are not only susceptible to the related risks described above but the added risks of construction itself including cost over-runs, mismanagement of the project, or lack of demand or market changes experienced at time of completion. Again, losses are primarily related to underlying collateral value and changes therein as described above.

Problem commercial loans are generally identified by periodic review of financial information which may include financial statements, tax returns, rent rolls and payment history of the borrower (delinquency). Based on this information the Bank may decide to take any of several courses of action including demand for repayment, additional collateral or guarantors, and, when repayment becomes unlikely through borrower’s income and cash flow, repossession or foreclosure of the underlying collateral.

Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, public value information (blue book values for autos), sales invoices, or other appropriate means. Appropriate valuations are obtained at initiation of the credit and periodically (every 3-12 months depending on collateral type) once repayment is questionable and the loan has been classified.

Once a loan becomes delinquent and repayment becomes questionable, a Bank collection officer will address collateral shortfalls with the borrower and attempt to obtain additional collateral. If this is not forthcoming and payment in full is unlikely, the Bank will estimate its probable loss, using a recent valuation as appropriate to the underlying collateral less estimated costs of sale, and charge the loan down to the estimated net realizable amount. Depending on the length of time until ultimate collection, the Bank may revalue the underlying collateral and take additional charge-offs as warranted. Revaluations may occur as often as every 3-12 months depending on the underlying collateral and volatility of values. Final charge-offs or recoveries are taken when collateral is liquidated and actual loss is known. Unpaid balances on loans after or during collection and liquidation may also be pursued through lawsuit and attachment of wages or judgment liens on borrower’s other assets.

The following table shows the ending balance of current, past due, and nonaccrual originated loans by loan category as of the date indicated:


	Analysis of Past Due and Nonaccrual Originated Loans – As of March 31, 2013
(In thousands)	RE Mortgage				Home Equity				Auto Indirect		Other Consumer		C&I		Construction
Originated loan balance:	Resid.		Comm.		Lines		Loans		Auto Indirect		Other Consumer		C&I		Resid.		Comm.		Total
Past due:
30-59 Days	$	1,305	$	2,326	$	2,635	$	109	$	28	$	50	$	333		—		—	$	6,786
60-89 Days		650		265		1,226		—		36		9		35		—		—		2,221
> 90 Days		732		7,852		2,072		217		94		2		2,616		31		75		13,691

Total past due		2,687		10,443		5,933		326		158		61		2,984		31		75		22,698
Current		123,188		761,853		297,705		12,207		2,663		24,765		103,291		14,467		9,834		1,349,973

Total Originated loans	$	125,875	$	772,296	$	303,638	$	12,533	$	2,821	$	24,826	$	106,275	$	14,498	$	9,909	$	1,372,671

> 90 Days and still accruing	$	190		—		—		—		—		—		—		—		—	$	190

Nonaccrual loans	$	4,459	$	34,853	$	7,027	$	515	$	166	$	27	$	4,131	$	3,125	$	270	$	54,573

The following table shows the ending balance of current, past due, and nonaccrual PNCI loans by loan category as of the date indicated:


	Analysis of Past Due and Nonaccrual PNCI Loans – As of March 31, 2013
(In thousands)	RE Mortgage				Home Equity				Auto Indirect		Other Consumer		C&I		Construction
PNCI loan balance:	Resid.		Comm.		Lines		Loans		Auto Indirect		Other Consumer		C&I		Resid.		Comm.		Total
Past due:
30-59 Days	$	1,709	$	526	$	857		—		—	$	1		—		—		—	$	3,093
60-89 Days		204		569		—		—		—		—		—		—		—		773
> 90 Days		43		—		—		—		—		—		—		—		—		43

Total past due		1,956		1,095		857		—		—		1		—		—		—		3,909
Current		3,119		68,887		15,484		347		—		2,263		779		—		—		90,879

Total PNCI loans	$	5,075	$	69,982	$	16,341	$	347		—	$	2,264	$	779		—		—	$	94,788

> 90 Days and still accruing		—		—		—		—		—		—		—		—		—		—
Nonaccrual loans	$	111	$	1,212	$	339		—		—	$	41		—		—		—	$	1,703

Note 5 – Allowance for Loan Losses (Continued)

The following table shows the ending balance of current, past due, and nonaccrual originated loans by loan category as of the date indicated:


	Analysis of Past Due and Nonaccrual Originated Loans – As of December 31, 2012
(In thousands)	RE Mortgage				Home Equity				Auto Indirect		Other Consumer				Construction
Originated loan balance:	Resid.		Comm.		Lines		Loans		Auto Indirect		Other Consumer		C&I		Resid.		Comm.		Total
Past due:
30-59 Days	$	1,702	$	2,695	$	3,371	$	67	$	77	$	67	$	1,848	$	309		—	$	10,136
60-89 Days		278		1,578		819		33		40		40		138		—		—		2,926
> 90 Days		674		13,829		3,395		217		79		14		4,782		42	$	94		23,126

Total past due		2,654		18,102		7,585		317		196		121		6,768		351		94		36,188
Current		118,601		757,022		304,086		12,694		3,620		24,142		118,354		11,526		11,102		1,361,147

Total Originated loans	$	121,255	$	775,124	$	311,671	$	13,011	$	3,816	$	24,263	$	125,122	$	11,877	$	11,196	$	1,397,335

> 90 Days and still accruing		—		—		—		—		—		—		—		—		—		—

Nonaccrual loans	$	4,781	$	37,220	$	8,486	$	465	$	174	$	49	$	6,750	$	3,312	$	532	$	61,769

The following table shows the ending balance of current, past due, and nonaccrual PNCI loans by loan category as of the date indicated:


	Analysis of Past Due and Nonaccrual PNCI Loans – As of December 31, 2012
(In thousands)	RE Mortgage				Home Equity				Auto Indirect		Other Consumer		C&I		Construction
PNCI loan balance:	Resid.		Comm.		Lines		Loans		Auto Indirect		Other Consumer		C&I		Resid.		Comm.		Total
Past due:
30-59 Days	$	1,024	$	500	$	124		—		—	$	31		—		—		—	$	1,679
60-89 Days		—		—		63		—		—		—		—		—		—		63
> 90 Days		43		148		157		—		—		—		—		—		—		348

Total past due		1,067		648		344		—		—		31		—		—		—		2,090
Current		4,346		71,442		16,444	$	342		—		2,387	$	869		—		—		95,830

Total PNCI loans	$	5,413	$	72,090	$	16,788	$	342		—	$	2,418	$	869		—		—	$	97,920

> 90 Days and still accruing		—		—		—		—		—		—		—		—		—		—

Nonaccrual loans	$	113	$	1,218	$	403		—		—	$	42		—		—		—	$	1,776

Impaired Originated and PNCI loans are those where management has concluded that it is probable that the borrower will be unable to pay all amounts due under the contractual terms.

The following tables show the recorded investment (financial statement balance), unpaid principal balance, average recorded investment, and interest income recognized for impaired Originated and PNCI loans, segregated by those with no related allowance recorded and those with an allowance recorded for the periods indicated.


	Impaired Originated Loans – As of March 31, 2013
	RE Mortgage				Home Equity				Auto Indirect		Other Consumer		C&I		Construction
(In thousands)	Resid.		Comm.		Lines		Loans		Auto Indirect		Other Consumer		C&I		Resid.		Comm.		Total
With no related allowance recorded:
Recorded investment	$	4,017	$	57,206	$	5,138	$	460	$	151	$	23	$	4,240	$	696	$	195	$	72,126

Unpaid principal	$	6,192	$	62,263	$	8,437	$	1,110	$	292	$	40	$	5,392	$	1,442	$	426	$	85,594

Average recorded Investment	$	3,769	$	61,619	$	4,690	$	411	$	157	$	21	$	4,239	$	2,125	$	240	$	77,271

Interest income Recognized	$	7	$	362	$	5		—	$	1		—	$	11		—		—	$	386

With an allowance recorded:
Recorded investment	$	2,025	$	5,816	$	3,244	$	116	$	25	$	4	$	1,626	$	2,713	$	149	$	15,718

Unpaid principal	$	2,252	$	6,095	$	4,086	$	166	$	32	$	4	$	1,680	$	6,680	$	181	$	21,176

Related allowance	$	447	$	1,296	$	1,576	$	50	$	7	$	4	$	823	$	219	$	42	$	4,464

Average recorded Investment	$	2,446	$	4,537	$	4,328	$	142	$	30	$	17	$	2,975	$	1,378	$	236	$	16,089

Interest income Recognized	$	15	$	47	$	16	$	1		—		—	$	19	$	5	$	1	$	104

Note 5 – Allowance for Loan Losses (Continued)


	Impaired PNCI Loans – As of March 31, 2013
	RE Mortgage				Home Equity				Auto Indirect		Other Consumer		C&I		Construction
(In thousands)	Resid.		Comm.		Lines		Loans		Auto Indirect		Other Consumer		C&I		Resid.		Comm.		Total
With no relatedallowance recorded:
Recorded investment		—	$	1,271	$	302		—		—	$	41		—		—		—	$	1,614

Unpaid principal		—	$	3,300	$	343		—		—	$	46		—		—		—	$	3,689

Average recorded Investment		—	$	1,370	$	334		—		—	$	21		—		—		—	$	1,725

Interest income Recognized		—	$	4		—		—		—		—		—		—		—	$	4

With anallowance recorded:
Recorded investment	$	197	$	519	$	37		—		—	$	29		—		—		—	$	782

Unpaid principal	$	224	$	519	$	41		—		—	$	29		—		—		—	$	813

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company