XNAS:CVBF CVB Financial Corp Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012

or

 

¨ 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: 0-10140

CVB FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

 

California   95-3629339

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

701 North Haven Ave, Suite 350, Ontario, California   91764
(Address of Principal Executive Offices)   (Zip Code)
(Registrant’s telephone number, including area code)   (909) 980-4030

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.    Yes  x    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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨      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  x

Number of shares of common stock of the registrant: 104,725,224 outstanding as of April 30, 2012.


Table of Contents

CVB FINANCIAL CORP.

2012 QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION (UNAUDITED)

     4   

ITEM 1.

  

FINANCIAL STATEMENTS

     4   
  

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

     9   

ITEM 2.

  

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     38   
  

OVERVIEW

     38   
  

CRITICAL ACCOUNTING ESTIMATES

     39   
  

ANALYSIS OF THE RESULTS OF OPERATIONS

     42   
  

RESULTS BY BUSINESS SEGMENTS

     48   
  

ANALYSIS OF FINANCIAL CONDITION

     49   
  

RISK MANAGEMENT

     62   

ITEM 3.

  

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     66   

ITEM 4.

  

CONTROLS AND PROCEDURES

     70   

PART II – OTHER INFORMATION

     71   

ITEM 1.

  

LEGAL PROCEEDINGS

     71   

ITEM 1A.

  

RISK FACTORS

     72   

ITEM 2.

  

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

     72   

ITEM 3.

  

DEFAULTS UPON SENIOR SECURITIES

     72   

ITEM 4.

  

MINE SAFETY DISCLOSURES

     73   

ITEM 5.

  

OTHER INFORMATION

     73   

ITEM 6.

  

EXHIBITS

     74   

SIGNATURE

        75   

 

2


Table of Contents

GENERAL

Forward Looking Statements

Certain statements in this Report on Form 10-Q, including, but not limited to, statements under the heading “Management Discussion and Analysis of Financial Condition and Results of Operations” constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995, including but not limited to, statements about anticipated future operating and financial performance, financial position and liquidity, business prospects, strategic alternatives, business strategies, regulatory and competitive outlook, capital and financing needs and availability, acquisition and divestiture opportunities, investment and expenditure plans, plans and objectives of management for future operations and other similar forecasts and statements of expectations of assumptions underlying any of the foregoing. Words such as “will likely result, “aims”, “anticipates”, “believes”, “could”, “estimates”, “expects”, “hopes”, “intends”, “may”, “plans”, “projects”, “seeks”, “should”, “will” and variations of these words and similar expressions are intended to identify these forward looking statements, which involve risks and uncertainties. Our actual results may differ significantly from the results discussed in such forward-looking statements. Factors that might cause such a difference include, but are not limited to, local, regional, national and international economic conditions and events and the impact they may have on us and our customers; ability to attract deposits and other sources of liquidity; oversupply of property inventory and continued deterioration in values of California real estate, both residential and commercial; a prolonged slowdown or decline in construction activity; changes in the financial performance and/or condition of our borrowers; changes in the level of non-performing assets and charge-offs; the cost or effect of acquisitions we may make; the effect of changes in laws and regulations (including laws, regulations and judicial decisions concerning financial reform, taxes, banking, securities, employment, executive compensation, insurance, and information security) with which we and our subsidiaries must comply; changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements; inflation, interest rate, securities market and monetary fluctuations; cyber-security threats including loss of system functionality or theft or loss of data; political instability; acts of war or terrorism, or natural disasters, such as earthquakes, or the effects of pandemic flu; the timely development and acceptance of new banking products and services and perceived overall value of these products and services by users; changes in consumer spending, borrowing and savings habits; technological changes; the ability to increase market share, retain customers and control expenses; changes in the competitive environment among financial and bank holding companies and other financial service providers; continued volatility in the credit and equity markets and its effect on the general economy; the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters; changes in our organization, management, compensation and benefit plans, and our ability to retain or expand our management team; the costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquiries, including, but not limited to, the current investigation by the Securities and Exchange Commission and the related class-action lawsuits filed against us, and the results of regulatory examinations or reviews. The Company cautions that the foregoing factors are not exclusive. For additional information concerning these factors and other factors which may cause actual results to differ from the results discussed in our forward-looking statements, see the periodic filings the Company makes with the Securities and Exchange Commission, and, in particular, the information set forth in Item 1A herein and in “Item 1A. Risk Factors” contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. The Company does not undertake, and specifically disclaims, any obligation to update any forward-looking statements to reflect the occurrence of events or circumstances after the date of such statements except as required by law.

 

3


Table of Contents

PART I – FINANCIAL INFORMATION (UNAUDITED)

ITEM 1. FINANCIAL STATEMENTS

CVB FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

(Unaudited)

 

     March 31,
2012
    December 31,
2011
 
ASSETS     

Cash and due from banks

   $ 94,523      $ 35,407   

Interest-earning balances due from Federal Reserve

     181,795        309,936   
  

 

 

   

 

 

 

Total cash and cash equivalents

     276,318        345,343   

Interest-earning balances due from depository institutions

     60,000        60,000   

Investment securities available-for-sale, at fair value (with amortized cost of $2,301,303 at March 31, 2012 and $2,130,029 at December 31, 2011)

     2,372,729        2,201,526   

Investment securities held-to-maturity

     2,280        2,383   

Investment in stock of Federal Home Loan Bank (FHLB)

     69,222        72,689   

Non-covered loans held-for-sale

     630        348   

Covered loans held-for-sale

     3,771        5,664   

Loans and lease finance receivables, excluding covered loans

     3,186,013        3,219,727   

Allowance for credit losses

     (91,922     (93,964
  

 

 

   

 

 

 

Net non-covered loans and lease finance receivables

     3,094,091        3,125,763   
  

 

 

   

 

 

 

Covered loans and lease finance receivables, net

     241,943        256,869   

Premises and equipment, net

     35,624        36,280   

Bank owned life insurance

     116,878        116,132   

Accrued interest receivable

     23,375        23,512   

Intangibles

     4,731        5,548   

Goodwill

     55,097        55,097   

FDIC loss sharing asset

     55,193        59,453   

Non-covered other real estate owned

     11,427        13,820   

Covered other real estate owned

     6,401        9,782   

Income taxes

     36,794        48,033   

Other assets

     39,579        44,673   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 6,506,083      $ 6,482,915   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Liabilities:

    

Deposits:

    

Noninterest-bearing

   $ 2,120,382      $ 2,027,876   

Interest-bearing

     2,559,725        2,576,672   
  

 

 

   

 

 

 

Total deposits

     4,680,107        4,604,548   

Customer repurchase agreements

     477,568        509,370   

Borrowings

     448,730        448,662   

Accrued interest payable

     3,417        3,526   

Deferred compensation

     9,092        8,735   

Junior subordinated debentures

     108,250        115,055   

Other liabilities

     48,912        78,205   
  

 

 

   

 

 

 

TOTAL LIABILITIES

     5,776,076        5,768,101   
  

 

 

   

 

 

 

COMMITMENTS AND CONTINGENCIES

    

Stockholders’ Equity:

    

Preferred stock, authorized, 20,000,000 shares
without par; none issued or outstanding

     —          —     

Common stock, authorized, 225,000,000 shares
without par; issued and outstanding
104,707,012 at March 31, 2012 and 104,482,271 at December 31, 2011

     481,843        479,973   

Retained earnings

     206,737        193,372   

Accumulated other comprehensive income, net of tax

     41,427        41,469   
  

 

 

   

 

 

 

Total stockholders’ equity

     730,007        714,814   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 6,506,083      $ 6,482,915   
  

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

4


Table of Contents

CVB FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS AND COMPREHENSIVE INCOME

(Dollars in thousands, except per share amounts)

(Unaudited)

 

     For the Three Months
Ended March 31,
 
     2012     2011  

Interest income:

    

Loans held-for-sale

   $ 4      $ 20   

Loans and leases, including fees

     46,028        49,344   

Accelerated accretion on acquired loans

     4,692        1,951   
  

 

 

   

 

 

 

Loans, including fees

     50,724        51,315   
  

 

 

   

 

 

 

Investment securities:

    

Taxable

     9,170        8,839   

Tax-advantaged

     5,796        5,919   
  

 

 

   

 

 

 

Total investment income

     14,966        14,758   
  

 

 

   

 

 

 

Dividends from FHLB

     90        65   

Federal funds sold and interest-bearing deposits with other institutions

     285        374   
  

 

 

   

 

 

 

Total interest income

     66,065        66,512   
  

 

 

   

 

 

 

Interest expense:

    

Deposits

     1,653        2,788   

Borrowings

     4,971        5,796   

Junior subordinated debentures

     839        819   
  

 

 

   

 

 

 

Total interest expense

     7,463        9,403   
  

 

 

   

 

 

 

Net interest income before provision for credit losses

     58,602        57,109   

Provision for credit losses

     —          7,068   
  

 

 

   

 

 

 

Net interest income after provision for credit losses

     58,602        50,041   
  

 

 

   

 

 

 

Noninterest income:

    

Service charges on deposit accounts

     4,124        3,723   

Trust and investment services

     2,185        2,152   

Bankcard services

     919        708   

BOLI Income

     750        707   

Increase (decrease) in FDIC loss sharing asset, net

     (2,944     1,415   

Other

     222        1,273   
  

 

 

   

 

 

 

Total noninterest income

     5,256        9,978   
  

 

 

   

 

 

 

Noninterest expense:

    

Salaries and employee benefits

     16,721        17,660   

Occupancy and equipment

     3,948        4,321   

Professional services

     1,991        3,610   

Software licenses and maintenance

     909        960   

Promotion

     1,251        1,326   

Amortization of Intangibles

     816        901   

Provision for unfunded commitments

     —          732   

OREO expense

     730        1,105   

Other

     3,846        5,690   
  

 

 

   

 

 

 

Total noninterest expense

     30,212        36,305   
  

 

 

   

 

 

 

Earnings before income taxes

     33,646        23,714   

Income taxes

     11,378        7,114   
  

 

 

   

 

 

 

Net earnings

   $ 22,268      $ 16,600   
  

 

 

   

 

 

 

Other comprehensive income:

    

Unrealized (loss) gain on securities arising during the period

   $ (73   $ 4,291   

Less: Reclassification adjustment for net gain on securities included in net income

     —          —     
  

 

 

   

 

 

 

Other comprehensive income, before tax

     (73     4,291   

Income tax related to items of other comprehensive income

     31        (1,736
  

 

 

   

 

 

 

Other comprehensive income, net of tax

   $ (42   $ 2,555   
  

 

 

   

 

 

 

Comprehensive income

   $ 22,226      $ 19,155   
  

 

 

   

 

 

 

Basic earnings per common share

   $ 0.21      $ 0.16   
  

 

 

   

 

 

 

Diluted earnings per common share

   $ 0.21      $ 0.16   
  

 

 

   

 

 

 

Cash dividends per common share

   $ 0.085      $ 0.085   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

5


Table of Contents

CVB FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

Three Months Ended March 31, 2012 and 2011

(unaudited)

 

     Common
Shares
Outstanding
     Common
Stock
     Retained
Earnings
    Accumulated
Other
Comprehensive
Income/(Loss)
    Total  
     (Dollars and shares in thousands)  

Balance January 1, 2011

     106,076       $ 490,226       $ 147,444      $ 6,185      $ 643,855   

Exercise of stock options

     2         19             19   

Tax benefit from exercise of stock options

        2             2   

Stock-based compensation expense

        590             590   

Cash dividends declared

            

Common ($0.085 per share)

           (9,017       (9,017

Net earnings

           16,600          16,600   

Other comprehensive income

             2,555        2,555   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance March 31, 2011

     106,078       $ 490,837       $ 155,027      $ 8,740      $ 654,604   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance January 1, 2012

     104,482       $ 479,973       $ 193,372      $ 41,469      $ 714,814   

Exercise of stock options

     225         1,355             1,355   

Tax benefit from exercise of stock options

        110             110   

Stock-based compensation expense

        405             405   

Cash dividends declared

            

Common ($0.085 per share)

           (8,903       (8,903

Net earnings

           22,268          22,268   

Other comprehensive income

             (42     (42
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance March 31, 2012

     104,707       $ 481,843       $ 206,737      $ 41,427      $ 730,007   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

6


Table of Contents

CVB FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(unaudited)

 

     For the Three Months
Ended March 31,
 
     2012     2011  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Interest and dividends received

   $ 66,789      $ 67,948   

Service charges and other fees received

     8,030        8,446   

Interest paid

     (7,504     (9,695

Cash paid to vendors and employees

     (34,081     (33,942

Income taxes paid

     —          (27,000

Proceeds from FDIC shared-loss agreements

     1,316        21,734   
  

 

 

   

 

 

 

Net cash provided by operating activities

     34,550        27,491   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

    

Proceeds from redemption of FHLB Stock

     3,467        3,434   

Proceeds from repayment of investment securities

     129,203        86,684   

Proceeds from maturity of investment securities

     36,397        25,055   

Purchases of investment securities

     (360,846     (280,623

Net decrease in loans and lease finance receivables

     52,869        136,380   

Proceeds from sales of premises and equipment

     25        147   

Proceeds from sales of other real estate owned

     6,507        1,789   

Purchase of premises and equipment

     (711     (309

Other, net

     —          (1
  

 

 

   

 

 

 

Net cash used in investing activities

     (133,089     (27,444
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Net increase in transaction deposits

     115,807        95,328   

Net decrease in time deposits

     (40,248     (128,464

Net decrease in other borrowings

     —          1,049   

Net (decrease)/ increase in customer repurchase agreements

     (31,802     35,821   

Repayment of FCB Statutory Trust II

     (6,805     —     

Cash dividends on common stock

     (8,903     (9,017

Proceeds from exercise of stock options

     1,355        19   

Tax benefit related to exercise of stock options

     110        2   
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     29,514        (5,262
  

 

 

   

 

 

 

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

     (69,025     (5,215

CASH AND CASH EQUIVALENTS, beginning of period

     345,343        404,275   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, end of period

   $ 276,318      $ 399,060   
  

 

 

   

 

 

 

 

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Table of Contents

CVB FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Dollars in thousands)

(unaudited)

 

CONSOLIDATED STATEMENTS OF CASH FLOWS
     For the Three Months
Ended March 31,
 
     2012     2011  

RECONCILIATION OF NET EARNINGS TO NET CASH PROVIDED BY OPERATING ACTIVITIES

    

Net earnings

   $ 22,268      $ 16,600   

Adjustments to reconcile net earnings to net cash provided by operating activities:

    

Amortization of capitalized prepayment penalty on borrowings

     68        —     

(Gain)/loss on sale of premises and equipment

     —          (7

(Gain)/loss on sale of other real estate owned

     (151     (74

Increase from bank owned life insurance

     (750     (707

Net amortization of premiums on investment securities

     5,448        3,212   

Accretion of SJB Discount

     (4,692     (1,951

Provisions for credit losses

     —          7,068   

Provisions for losses on other real estate owned

     226        820   

Change in FDIC Loss Sharing Asset

     2,944        (1,415

Stock-based compensation

     405        590   

Depreciation and amortization

     2,158        2,560   

Proceeds from FDIC shared-loss agreements

     1,316        21,734   

Change in accrued interest receivable

     137        384   

Change in accrued interest payable

     (109     (359

Change in other assets and liabilities

     5,282        (20,964
  

 

 

   

 

 

 

Total adjustments

     12,282        10,891   
  

 

 

   

 

 

 

NET CASH PROVIDED BY OPERATING ACTIVITIES

   $ 34,550      $ 27,491   
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES

    

Securities purchased and not settled

   $ 2,014      $ 55,791   

Transfer from loans to Other Real Estate Owned

   $ 808      $ 3,669   

See accompanying notes to the consolidated financial statements.

 

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Table of Contents

CVB FINANCIAL CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the three months ended March 31, 2012, and 2011

(unaudited)

 

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying condensed consolidated unaudited financial statements and notes thereto have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) for Form 10-Q and conform to practices within the banking industry and include all of the information and disclosures required by accounting principles generally accepted in the United States of America (“GAAP”) for interim financial reporting. The results of operations for the three months ended March 31, 2012 are not necessarily indicative of the results for the full year. These unaudited financial statements should be read in conjunction with the financial statements, accounting policies and financial notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011 filed with the Securities and Exchange Commission. In the opinion of management, the accompanying condensed consolidated unaudited financial statements reflect all adjustments (consisting only of normal recurring adjustments), which are necessary for a fair presentation of financial results for the interim periods presented. A summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows.

Principles of Consolidation – The consolidated financial statements include the accounts of CVB Financial Corp. and its wholly owned subsidiaries (the “Company”): Citizens Business Bank (the “Bank”) after elimination of all intercompany transactions and balances. The Company also has three inactive subsidiaries; CVB Ventures, Inc.; Chino Valley Bancorp; and ONB Bancorp. The Company is also the common stockholder of CVB Statutory Trust I, CVB Statutory Trust II, and CVB Statutory Trust III. CVB Statutory Trusts I and II were created in December 2003 and CVB Statutory Trust III was created in January 2006 to issue trust preferred securities in order to raise capital for the Company. The Company acquired FCB Trust II through the acquisition of First Coastal Bancshares (“FCB”). The FCB Trust II was redeemed on January 7, 2012. In accordance with ASC 810 Consolidation (previously Financial Accounting Standards Board (“FASB”) Interpretation No. 46R “Consolidation of Variable Interest Entities”), these trusts do not meet the criteria for consolidation.

Nature of Operations – The Company’s primary operations are related to traditional banking activities, including the acceptance of deposits and the lending and investing of money through the operations of the Bank. The Bank also provides automobile and equipment leasing to customers through its Citizens Financial Services Group and trust and investment-related services to customers through its CitizensTrust Division. The Bank’s customers consist primarily of small to mid-sized businesses and individuals located in San Bernardino County, Riverside County, Orange County, Los Angeles County, Madera County, Fresno County, Tulare County, Kern County and San Joaquin County. The Bank operates 42 Business Financial Centers, five Commercial Banking Centers, and two trust office locations with its headquarters located in the city of Ontario.

The Company’s operating business units have been divided into two main segments: (i) Business Financial and Commercial Banking Centers (“Centers”) and (ii) Treasury. The Business Financial and Commercial Banking Centers lines of business generally consist of loans, deposits, and fee generating products and services that the Bank offers to its clients and prospects. The other segment is Treasury, which manages the investment portfolio of the Company. The Company’s remaining centralized functions and eliminations of inter-segment amounts have been aggregated and included in “Other.”

The internal reporting of the Company considers all business units. Funds are allocated to each business unit based on its need to fund assets (use of funds) or its need to invest funds (source of funds). Net income is determined based on the actual net income of the business unit plus the allocated income or expense based on the sources and uses of funds for each business unit. Non-interest income and non-interest expense are those items directly attributable to a business unit.

Cash and cash equivalents Cash on hand, cash items in the process of collection, and amounts due from correspondent banks, the Federal Reserve Bank and interest-bearing balances due from depository institutions, with initial terms of ninety days or less, are included in Cash and cash equivalents.

 

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Investment Securities – The Company classifies as held-to-maturity those debt securities that the Company has the positive intent and ability to hold to maturity. Securities classified as trading are those securities that are bought and held principally for the purpose of selling them in the near term. All other debt and equity securities are classified as available-for-sale. Securities held-to-maturity are accounted for at cost and adjusted for amortization of premiums and accretion of discounts. Trading securities are accounted for at fair value with the unrealized gains and losses being included in current earnings. Available-for-sale securities are accounted for at fair value, with the net unrealized gains and losses, net of income tax effects, presented as a separate component of stockholders’ equity. Realized gains and losses on sales of securities are recognized in earnings at the time of sale and are determined on a specific-identification basis. Purchase premiums and discounts are recognized in interest income using the effective-yield method over the terms of the securities. For mortgage-backed securities (“MBS”), the amortization or accretion is based on estimated average lives of the securities. The lives of these securities can fluctuate based on the amount of prepayments received on the underlying collateral of the securities. The Company’s investment in Federal Home Loan Bank of San Francisco (“FHLB”) stock is carried at cost.

At each reporting date, securities are assessed to determine whether there is an other-than-temporary impairment (“OTTI”). Other-than-temporary impairment on investment securities is recognized in earnings when there are credit losses on a debt security for which management does not intend to sell and for which it is more-likely-than-not that the Company will not have to sell prior to recovery of the noncredit impairment. In those situations, the portion of the total impairment that is attributable to the credit loss would be recognized in earnings, and the remaining difference between the debt security’s amortized cost and its fair value would be included in other comprehensive income.

Loans Held-for-Sale – Loans held-for-sale include mortgage loans originated for resale and other non-covered or covered loans transferred from our held-for-investment portfolio when a decision is made to sell a loan(s) and are reported at the lower of cost or fair value. Occasionally, we may transfer other loans from our held-for-investment loan portfolio to loans held-for-sale when a decision is made to sell a loan(s). Normally a formal marketing strategy or plan for sale is developed at the time the decision to sell the loan(s) is made. Cost generally approximates fair value at any reporting date, as the mortgage loans were recently originated. The transfer of the loan to held-for-sale is done at the lower of cost or fair value and if a reduction in value is required at time of the transfer, a charge-off is recorded against the allowance for credit losses (“ALLL”). Any subsequent decline in value or any subsequent gain on sale of the loan is recorded to current earnings and reported as part of other non-interest income. Gains or losses on the sale of loans that are held for sale are recognized at the time of sale and determined by the difference between net sale proceeds and the net book value of the loans. We do not currently retain servicing on any mortgage loans sold.

Loans and Lease Finance Receivables – Non-covered loans and lease finance receivables that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, less deferred net loan origination fees. In the ordinary course of business, the Company enters into commitments to extend credit to its customers. To the extent that such commitments are funded, the unfunded amounts are not reflected in the accompanying consolidated financial statements.

Interest on non-covered loans and lease finance receivables is credited to income based on the principal amount outstanding. Non-covered loans are considered delinquent when principal or interest payments are past due 30 days or more and generally remain on accrual status between 30 and 89 days past due. Interest income is not recognized on non-covered loans and lease finance receivables when collection of interest is deemed by management to be doubtful. Non-covered loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. In general, the accrual of interest on non-covered loans is discontinued when the loan becomes 90 days past due, or when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors considered in determining that the full collection of principal and interest is no longer probable include cash flow and liquidity of the borrower or property, the financial position of the guarantors and their willingness to support the loan as well as other factors and involve significant judgment. When an asset is placed on nonaccrual status, previously accrued but unpaid interest is reversed against income. Subsequent collections of cash are applied as reductions to the principal balance unless the loan is returned to accrual status. Interest is not recognized using a cash-basis method. Nonaccrual loans may be restored to accrual status when principal and interest become current and when the borrower is able to demonstrate payment performance for a sustained period, typically for six months. A nonaccrual loan may return to accrual status sooner based on other significant events or mitigating circumstances. This policy is consistently applied to all classes of non-covered financing receivables.

 

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The Company receives collateral to support loans, lease finance receivables, and commitments to extend credit for which collateral is deemed necessary. The most significant categories of collateral are real estate, principally commercial and industrial income-producing properties, real estate mortgages, and assets utilized in dairy, livestock and agribusiness, and various personal property assets utilized in commercial and industrial business governed under the Uniform Commercial Code.

Nonrefundable fees and direct costs associated with the origination or purchase of non-covered loans are deferred and netted against outstanding loan balances. The deferred net loan fees and costs are recognized in interest income over the loan term using the effective-yield method.

Loans are reported as a Troubled Debt Restructuring (“TDR”) if the Company for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor that it would not otherwise consider. Examples of such concessions may include deferral of principal or accrued interest, extending the payment due dates or loan maturity date(s), or providing a lower interest rate than would be normally available for new debt with similar risk. Where collateral is offered by a borrower and it is significant in proportion to the nature of the concession requested, to the extent that it substantially reduces the Company’s risk of loss we may provide a concession. In such cases, these modifications are not considered a TDR as, in substance, no concession was made as a result of the significant additional collateral obtained.

When determining whether or not a loan modification is a TDR under ASC 310-40, the Company evaluates loan modification requests from borrowers experiencing financial difficulties on a case-by-case basis. Any such modifications granted are unique to the borrower’s circumstances, and are not easily categorized by type, key features, or other terms, but are evaluated individually based on all relevant facts and circumstances pertaining to the modification request and the borrower’s/guarantor’s financial condition at the time of the request. The evaluation of whether or not the borrower is experiencing financial difficulties will include, among other relevant factors considered by the Company, a review of significant factors such as (i) whether the borrower is in default on any of its debt, (ii) whether the borrower is experiencing payment delinquency, (iii) whether the borrower’s current cash flows have diminished below what is necessary to service existing debt obligations, (iv) whether the borrower forecasts its cash flows will be insufficient to service the debt in future periods or in accordance with the contractual terms of the existing agreement through maturity, (v) whether the borrower is unable to refinance the subject debt from other financing sources with similar terms, and (vi) whether the borrower is in jeopardy as a going-concern and/or is the borrower considering bankruptcy. In any case, the debtor is presumed to be experiencing financial difficulties if the Company determines it is probable the debtor will default on the original loan if the modification is not granted.

The types of loans subject to modification vary greatly, but during the subject period are concentrated in commercial and industrial loans, dairy and agricultural loans, and term loans to commercial real estate investors. Some examples of key features include payment deferrals and delays, interest rate reductions, and extensions or renewals where the contract rate may or may not be below the market rate of interest for debt with similar characteristics as those of the modified debt. The typical length of the modified terms often ranges from three (3) to twelve (12) months; however, all actual modified terms will depend on the facts, circumstances and attributes of the specific borrower requesting a modification. In general, after a careful evaluation of all relevant facts and circumstances taken together, including the nature of any concession, certain modification requests will result in troubled debt restructurings while certain other modifications will not, pursuant to the criteria and judgments as discussed throughout this report. In many cases, modification requests for delays or deferrals of principal were evaluated and determined to be exempt from TDR reporting because they constituted insignificant delays under ASC 310-40-15.

In situations where the Company has determined that the borrower is experiencing financial difficulties and is evaluating whether a concession is insignificant, and therefore does not result in a troubled debt restructuring, is based on an evaluation of both the amount and the timing of the restructured payments, including the following factors:

 

  1. Whether the amount of the restructured payments subject to delay is insignificant relative to the unpaid principal balance or collateral value of the debt and will result in an insignificant shortfall in the contractual amount due; and

 

  2. The delay is insignificant relative to any of the following:

 

   

The frequency of payments due;

 

   

The debt’s original contractual maturity; or

 

   

The debt’s original expected duration.

 

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Most modified loans not classified and accounted for as troubled debt restructurings were performing and paying as agreed under their original terms in the six-month period immediately preceding a request for modification. Subsequently, these modified loans continue to perform under the modified terms and deferrals that amounted to insignificant delays which is supported by the fact and circumstances of each individual loan as described above. Payment performance continues to be monitored once modifications are made. The Company’s favorable experience regarding “re-defaults” under modified terms, or upon return of the loan to its original terms, indicates that such relief often improves ultimate collection and reduces the Company’s risk of loss.

A loan is generally considered impaired when based on current events and information it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. A loan including a restructured loan, for which there is an insignificant delay relative to the frequency of payments due, and/or original contractual maturity is not considered an impaired loan. Generally, impaired loans include loans on nonaccrual status and TDRs.

The Company’s policy is to record a specific valuation allowance, which is included in the allowance for credit losses, or charge-off that portion of an impaired loan that represents the impairment or shortfall amount as determined utilizing one of the three methods described in ASC 310-10-35-22. Impairment on non-collateral dependent restructured loans are measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s carrying value. The impairment amount, if any, is generally charged-off and recorded against the allowance for credit losses at the time impairment is measurable and a probable loss is determined. As a result, most of the TDRs have no specific allowance allocated because, consistent with the Company’s stated practice, any impairment is typically charged-off in the period in which it is identified. Impairment on collateral dependent restructured loans are measured by determining the amount the impaired loan exceeds the fair value of the collateral less estimated selling costs. The fair value is generally determined by an appraisal of the collateral performed by a Company-approved third-party independent appraiser. The majority of impaired loans that are collateral dependent are charged-off down to their estimated fair value of the collateral (less selling costs) at each reporting date based on current appraised value.

Appraisals of the collateral for impaired collateral-dependent loans are typically ordered at the earlier of the time the loan is identified as showing signs of inherent weakness, which may jeopardize repayment of when the loan is identified as impaired. These appraisals are normally updated at least annually, or more frequently, if there are concerns or indications that the value of the collateral may have changed significantly since the previous appraisal. On exception, a specific valuation allowance is only recorded on collateral dependent impaired loans when a current appraisal is not yet available, a recent appraisal is still under review or on single-family mortgage loans if the loans are currently under review for a loan modification. Such valuation allowances are generally based on previous appraisals adjusted for current market conditions, based on preliminary appraisal values that are still being reviewed or for single-family loans under review for modification on an appraisal or indications of comparable home sales from external sources.

Charge-offs of unsecured consumer loans are recorded when the loan reaches 120 days past due or sooner as circumstances dictate. Except for the charge-offs of unsecured consumer loans, the charge-off policy is applied consistently across all portfolio segments.

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, the Company may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is a collateral-dependent loan. Impaired single-family mortgage loans that have been modified in accordance with the various government modification programs are also measured based on the present value of the expected cash flows discounted at the loan’s pre-modification interest rate. The Company recognizes the change in present value attributable to the passage of time as interest income on such performing single-family mortgage loans and the amount of interest income recognized has been insignificant. During 2011, eleven such single-family mortgage loans have been returned to accrual status after demonstrating sustained repayment performance.

Covered Loans – We refer to “covered loans” as those loans that we acquired in the San Joaquin Bank (“SJB”) acquisition for which we will be reimbursed for a substantial portion of any future losses under the terms of the Federal Deposit Insurance Corporation (“FDIC”) loss sharing agreement. We account for loans under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“acquired impaired loan accounting”) when (i) we acquire loans deemed to be impaired when there is evidence of credit deterioration since their origination and

 

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it is probable at the date of acquisition that we would be unable to collect all contractually required payments and (ii) as a general policy election for non-impaired loans that we acquire in a distressed bank acquisition. Acquired impaired loans are accounted for individually or in pools of loans based on common risk characteristics. The excess of the loan’s or pool’s scheduled contractual principal and interest payments over all cash flows expected at acquisition is the nonaccretable difference. The remaining amount, representing the excess of the loan’s cash flows expected to be collected over the fair value is the accretable yield (accreted into interest income over the remaining life of the loan or pool).

Provision and Allowance for Credit Losses – The allowance for credit losses is established as management’s estimate of probable losses inherent in the loan and lease receivables portfolio. The allowance is increased by the provision for losses and decreased by charge-offs when management believes the uncollectability of a loan is confirmed. Subsequent recoveries, if any, are credited to the allowance. The determination of the balance in the allowance for credit losses is based on an analysis of the loan and lease finance receivables portfolio using a systematic methodology and reflects an amount that, in management’s judgment, is appropriate to provide for probable credit losses inherent in the portfolio, after giving consideration to the character of the loan portfolio, current economic conditions, past credit loss experience, and such other factors that would deserve current recognition in estimating inherent credit losses.

There are different qualitative risks for the loans in each portfolio segment. The construction and real estate segments’ predominant risk characteristic is the collateral and the geographic location of the property collateralizing the loan as well as the operating cash flow for commercial real estate properties. The commercial and industrial segment’s predominant risk characteristics are the cash flow of the businesses we lend to, the global cash flows and liquidity of the guarantors as well as economic and market conditions. The dairy and livestock segment’s predominant risk characteristics are milk and beef prices in the market as well as the cost of feed and cattle. The municipal lease segment’s predominant risk characteristics are the municipality’s general financial condition and tax revenues or if applicable the specific project related financial condition. The consumer, auto and other segment’s predominant risk characteristics are employment and income levels as it relates to consumers and cash flows of the businesses as it relates to equipment and vehicle leases to businesses.

The Company’s methodology is consistently applied across all the portfolio segments taken into account the applicable historical loss rates and the qualitative factors applicable to each pool of loans. A key factor in the Company’s methodology is the loan risk rating (Pass, Special Mention, Substandard, Doubtful and Loss). Loan risk ratings are updated as facts related to the loan or borrower become available. In addition, all term loans in excess of $1.0 million are subject to an annual internal credit review process where all factors underlying the loan, borrower and guarantors are reviewed and may result in changes to the loan’s risk rating. Periodically, we assess various attributes utilized in adjusting our historical loss factors to reflect current economic conditions. The estimate is reviewed quarterly by the Board of Directors and management and periodically by various regulatory entities and, as adjustments become necessary, they are reported in earnings in the periods in which they become known.

A provision for credit losses on the covered portfolio will be recorded if there is deterioration in the expected cash flows on covered loans compared to those previously estimated without regard to the reimbursement from the FDIC under the FDIC loss sharing agreement. The portion of the loss on covered loans reimbursable from the FDIC is recorded in noninterest income as an increase in FDIC loss sharing asset. Decreases in expected cash flows on the acquired impaired loans as of the measurement date compared to previously estimated are recognized by recording a provision for credit losses on acquired impaired loans. Loans accounted for as part of a pool are measured based on the expected cash flows of the entire pool.

FDIC Loss Sharing AssetThe FDIC loss sharing asset is initially recorded at fair value which represents the present value of the estimated cash payments from the FDIC for future losses on covered loans. The estimated gross cash flows associated with this asset were $144.9 million as of October 16, 2009. The ultimate collectability of this asset is dependent upon the performance of the underlying covered loans, the passage of time and claims paid by the FDIC. The loss estimates used in calculating the FDIC loss sharing asset are determined on the same basis as the loss estimates on the related covered loans and is the present value of the cash flows the Company expects to collect from the FDIC under the shared-loss agreement. The difference between the present value and the undiscounted cash flow the Company expects to collect from the FDIC is accreted into noninterest income over the life of the FDIC indemnification asset. The FDIC indemnification asset is adjusted for any changes in expected cash flows based on

 

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the loan performance. Any increases in cash flow of the loans over those expected will reduce the FDIC indemnification asset and any decreases in cash flow of the loans over those expected will increase the FDIC indemnification asset. Increases and decreases to the FDIC indemnification asset are recorded as adjustments to noninterest income.

Non-covered Other Real Estate Owned – Non-covered other real estate owned (“OREO”) represents real estate acquired through foreclosure in lieu of repayment of commercial and real estate loans and is stated at fair value, minus estimated costs to sell (fair value at time of foreclosure). Non-covered loan balances in excess of fair value of the real estate acquired at the date of acquisition are charged against the allowance for credit losses. Any subsequent operating expenses or income, reduction in estimated values, and gains or losses on disposition of such properties are charged to current operations. Gain recognition upon disposition of a property is dependent on the sale having met certain criteria relating to the buyer’s initial investment in the property sold.

Covered Other Real Estate Owned – All other real estate owned acquired in the FDIC-assisted acquisition of SJB are included in a FDIC shared-loss agreement and are referred to as covered other real estate owned. Covered other real estate owned is reported exclusive of expected reimbursement cash flows from the FDIC. Fair value adjustments on covered other real estate owned result in a reduction of the covered other real estate carrying amount and a corresponding increase in the estimated FDIC reimbursement, with the estimated net loss to the Company charged against earnings.

Premises and Equipment – Premises and equipment are stated at cost, less accumulated depreciation, which is provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives using the straight-line method. Properties under capital lease and leasehold improvements are amortized over the shorter of estimated economic lives of 15 years or the initial terms of the leases. Estimated lives are 3 to 5 years for computer equipment, 5 to 7 years for furniture, fixtures and equipment, and 15 to 40 years for buildings and improvements. Long-lived assets are reviewed periodically for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. The existence of impairment is based on undiscounted cash flows. To the extent impairment exists, the impairment is calculated as the difference in fair value of assets and their carrying value. The impairment loss, if any, would be recorded in noninterest expense.

Goodwill and Intangible Assets – Goodwill resulting from business combinations prior to January 1, 2009, represents the excess of the purchase price over the fair value of the net assets of the businesses acquired. Goodwill resulting from business combinations after January 1, 2009, is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interest in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually, or more frequently if events and circumstances exists that indicate that a goodwill impairment test should be performed. The Company selected July 1 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on our balance sheet. There was zero recorded impairment as of March 31, 2012.

Other intangible assets consist of core deposit intangible assets arising from business combinations and are amortized over an accelerated method over their estimated useful lives.

At March 31, 2012, goodwill was $55.1 million. As of March 31, 2012, intangible assets that continue to be subject to amortization include core deposit premiums of $4.7 million (net of $27.3 million of accumulated amortization). Amortization expense for such intangible assets was $816,000 for the three months ended March 31, 2012. Estimated amortization expense for the remainder of 2012 is expected to be $1.3 million. Estimated amortization expense for the succeeding years is $1.1 million for 2013, $475,000 for 2014, $437,000 for 2015, $395,000 for 2016 and $955,000 for the period from 2017 to 2019. The weighted average remaining life of intangible assets is approximately 1.4 years.

Fair Value of Financial Instruments – We use fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. Investment securities available-for-sale and interest-rate swaps are financial instruments recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other financial assets on a non-recurring basis, such as impaired loans and OREO. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or writedowns of individual assets. Further, we include in Note 5 to the Consolidated Financial Statements information about the extent to which fair value is used to measure assets and liabilities, the valuation methodologies used and its impact to earnings. Additionally, for financial instruments not recorded at fair value we disclose the estimate of their fair value.

 

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Bank Owned Life Insurance – The Company invests in Bank-Owned Life Insurance (“BOLI”). BOLI involves the purchasing of life insurance by the Company on a select group of employees. The Company is the owner and primary beneficiary of these policies. BOLI is recorded as an asset at cash surrender value. Increases in the cash value of these policies, as well as insurance proceeds received, are recorded in other non-interest income and are not subject to income tax.

Income Taxes – Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Future realization of deferred tax assets ultimately depends on the existence of sufficient taxable income of the appropriate character (for example, ordinary income or capital gain) within the carryback or carryforward periods available under the tax law. Based on historical and future expected taxable earnings and available strategies, the Company considers the future realization of these deferred tax assets more likely than not.

The tax effects from an uncertain tax position are recognized in the financial statements only if, based on its merits, the position is more likely than not to be sustained on audit by the taxing authorities. Interest and penalties related to uncertain tax positions are recorded as part of noninterest expense .

Earnings per Common Share – The Company calculates earnings per common share (“EPS”) using the two-class method. The two-class method requires the Company to present EPS as if all of the earnings for the period are distributed to common shareholders and any participating securities, regardless of whether any actual dividends or distributions are made. All outstanding unvested share-based payment awards that contain rights to non-forfeitable dividends are considered participating securities. The Company grants restricted shares under the 2008 Equity Incentive Plan that qualify as participating securities. Restricted shares issued under this plan are entitled to dividends at the same rate as common stock.

Basic earnings per common share are computed by dividing income allocated to common stockholders by the weighted-average number of common shares outstanding during each period. The computation of diluted earnings per common share considers the number of tax-effected shares issuable upon the assumed exercise of outstanding common stock options. Share and per share amounts have been retroactively restated to give effect to all stock dividends and splits. The number of shares outstanding at March 31, 2012 was 104,707,012. The tables below presents the reconciliation of earnings per share for the periods indicated.

Earnings Per Share Reconciliation

 

     For the Three Months
Ended March 31,
 
     2012      2011  
     (In thousands, except per share amount)  

Earnings per common share

     

Net earnings available to common shareholders

   $ 22,268       $ 16,600   

Less: Net earnings allocated to restricted stock

     72         66   
  

 

 

    

 

 

 

Net earnings allocated to common shareholders (numerator)

   $ 22,196         16,534   
  

 

 

    

 

 

 

Weighted Average Shares Outstanding (denominator)

     104,303         105,651   

Earnings per common share

   $ 0.21         0.16   
  

 

 

    

 

 

 

Diluted earnings per common share

     

Net income allocated to common shareholders (numerator)

   $ 22,196       $ 16,534   
  

 

 

    

 

 

 

Weighted Average Shares Outstanding

     104,303         105,651   

Incremental shares from assumed exercise of outstanding options

     197         53   
  

 

 

    

 

 

 

Diluted Weighted Average Shares Outstanding (denominator)

     104,500         105,704   

Diluted earnings per common share

   $ 0.21         0.16   
  

 

 

    

 

 

 

 

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Stock-Based Compensation – At March 31, 2012, the Company has three stock-based employee compensation plans, which are described more fully in Note 18 in the Company’s Annual Report on Form 10-K. The Company accounts for stock compensation using the “modified prospective” method. Under this method, awards that are granted, modified, or settled after December 31, 2005, are fair valued as of grant date and compensation costs recognized over the vesting period on a straight-lined basis. Also under this method, unvested stock awards as of January 1, 2006 are recognized over the remaining service period with no change in historical reported earnings.

Derivative Financial Instruments – All derivative instruments, including certain derivative instruments embedded in other contracts, are recognized on the consolidated balance sheet at fair value. For derivatives designated as fair value hedges, changes in the fair value of the derivative and the hedged item related to the hedged risk are recognized in earnings. Changes in fair value of derivatives designated and accounted for as cash flow hedges, to the extent they are effective as hedges, are recorded in “Other Comprehensive Income,” net of deferred taxes, and are subsequently reclassified to earnings when the hedged transaction affects earnings. Any hedge ineffectiveness would be recognized in the income statement line item pertaining to the hedged item.

Statement of Cash Flows – Cash and cash equivalents as reported in the statements of cash flows include cash and due from banks, interest-bearing balances due from depository institutions and federal funds sold with original maturities of three months or less. Cash flows from loans and deposits are reported net.

CitizensTrust – This division provides trust, investment and brokerage related services, as well as financial, estate and business succession planning services. CitizensTrust services its clients through two offices in Southern California: Pasadena and Ontario. CitizensTrust has approximately $2.11 billion in assets under administration, including $1.65 billion in assets under management. The amount of these funds and the related liabilities have not been recorded in the accompanying consolidated balance sheets because they are not assets or liabilities of the Bank or Company, with the exception of any funds held on deposit with the Bank.

Use of Estimates in the Preparation of Financial Statements – The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for credit losses. Other significant estimates which may be subject to change include fair value determinations and disclosures, impairment of investments, goodwill, loans, determining the amount and realization of the FDIC loss sharing asset, and valuation of deferred tax assets, other intangibles and OREO.

Other Contingencies – In the ordinary course of business, the Company becomes involved in litigation. Based upon the Company’s internal records and discussions with legal counsel, the Company records reserves as appropriate, for estimates of the probable outcome of all cases brought against the Company. Except as discussed in Part II – Other Information Item 1. “Legal Proceedings,” at March 31, 2012 the Company does not have any litigation reserves and is not aware of any material pending legal action or complaints asserted against the Company.

Recent Accounting Pronouncements – In September 2011, the FASB issued Accounting Standards Update (“ASU”) 2011-08, “Testing Goodwill for Impairment.” The provisions of ASU 2011-08 permits an entity an option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity believes, as a result of its qualitative assessment, that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. Otherwise, no further impairment testing is required. ASU 2011-08 includes examples of events and circumstances that may indicate that a reporting unit’s fair value is less than its carrying amount. The provisions of ASU No. 2011-08 are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted provided that the entity has not yet performed its annual impairment test for goodwill. The Company performs its annual impairment test for goodwill on July 1 of each year. The Company does not expect adoption of this amendment to have a material effect on its consolidated financial statements.

In December 2011, the FASB issued ASU 2011-12, “Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” ASU No. 2011-12 defers the effective date of the requirement to present separate line items on the income statement for reclassification adjustments of items out of accumulated other comprehensive income into net income for all periods presented. The ASU does not change the other requirements of FASB ASU No. 2011-05, Presentation of Comprehensive Income. Entities are still required to

 

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present reclassification adjustments within other comprehensive income either on the face of the statement that reports other comprehensive income or in the notes to the financial statements. The requirement to present comprehensive income in either a single continuous statement or two consecutive condensed statements remains for both annual and interim reporting. The deferral of the requirement for the presentation of reclassification adjustments is intended to be temporary until the Board reconsiders the operational concerns and needs of financial statement users. The amendments in this Update are effective at the same time as ASU 2011-05, which is effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this amendment did not have a material effect on the Company’s consolidated financial statements.

In April 2011, the FASB issued ASU No. 2011-03, “Reconsideration of Effective Control for Repurchase Agreements.” The provisions of ASU No. 2011-03 modify the criteria for determining when repurchase agreements would be accounted for as a secured borrowing rather than as a sale. Currently, an entity that maintains effective control over transferred financial assets must account for the transfer as a secured borrowing rather than as a sale. ASU No. 2011-03 removes from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee. The FASB believes that contractual rights and obligations determine effective control and that there does not need to be a requirement to assess the ability to exercise those rights. ASU No. 2011-03 does not change the other existing criteria used in the assessment of effective control. The Company adopted the provisions of ASU No. 2011-03 prospectively for transactions or modifications of existing transactions that occurred on or after January 1, 2012. As the Company accounted for all of its repurchase agreements as collateralized financing arrangements prior to the adoption of ASU No. 2011-03, the adoption had no impact on the Company’s Consolidated Financial Statements.

In May 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” The provisions of ASU No. 2011-04 result in a consistent definition of fair value and common requirements for the measurement of and disclosure about fair value between U.S. GAAP and International Financial Reporting Standards (“IFRS”). The changes to U.S. GAAP as a result of ASU No. 2011-04 are as follows: (1) The concepts of highest and best use and valuation premise are only relevant when measuring the fair value of nonfinancial assets (that is, it does not apply to financial assets or any liabilities); (2) U.S. GAAP currently prohibits application of a blockage factor in valuing financial instruments with quoted prices in active markets. ASU No. 2011-04 extends that prohibition to all fair value measurements; (3) An exception is provided to the basic fair value measurement principles for an entity that holds a group of financial assets and financial liabilities with offsetting positions in market risks or counterparty credit risk that are managed on the basis of the entity’s net exposure to either of those risks. This exception allows the entity, if certain criteria are met, to measure the fair value of the net asset or liability position in a manner consistent with how market participants would price the net risk position; (4) Aligns the fair value measurement of instruments classified within an entity’s shareholders’ equity with the guidance for liabilities; and (5) Disclosure requirements have been enhanced for Level 3 fair value measurements to disclose quantitative information about unobservable inputs and assumptions used, to describe the valuation processes used by the entity, and to qualitatively describe the sensitivity of fair value measurements to changes in unobservable inputs and the interrelationships between those inputs. In addition, entities must report the level in the fair value hierarchy of items that are not measured at fair value in the statement of condition but whose fair value must be disclosed. The Company adopted the provisions of ASU No. 2011-04 effective January 1, 2012. The fair value measurement provisions of ASU No. 2011-04 had no impact on the Company’s Consolidated Financial Statements. See Note 5 to the Consolidated Financial Statements for the enhanced disclosures required by ASU No. 2011-04.

Reclassification – Certain amounts in the prior periods’ financial statements and related footnote disclosures have been reclassified to conform to the current presentation with no impact on previously reported net income or stockholders’ equity.

 

2. FEDERALLY ASSISTED ACQUISITION OF SAN JOAQUIN BANK

On October 16, 2009, Citizens Business Bank acquired substantially all of the assets and assumed substantially all of the liabilities of San Joaquin Bank (“SJB”) from the FDIC in an FDIC-assisted transaction. The Bank entered into a loss sharing agreement with the FDIC, whereby the FDIC will cover a substantial portion of any future losses on certain acquired assets. The acquired assets subject to the loss sharing agreement are referred to collectively as “covered assets.” Under the terms of such loss sharing agreement, the FDIC will absorb 80% of losses and share in 80% of loss recoveries up to $144.0 million with respect to covered assets, after a first loss amount of $26.7 million. The FDIC will reimburse the Bank for 95% of losses and share in 95% of loss recoveries in excess of $144.0 million with respect to covered assets. The loss sharing agreement is in effect for 5 years for commercial loans and 10 years for single-family residential loans from the October 16, 2009 acquisition date and the loss recovery provisions are in effect for 8 and 10 years, respectively for commercial and single-family residential loans from the acquisition date. The purpose of this acquisition was to expand our presence in the Central Valley region of California.

The acquisition has been accounted for under the purchase method of accounting. The assets and liabilities were recorded at their estimated fair values as of the October 16, 2009 acquisition date. The application of the purchase method of accounting resulted in an after-tax gain of $12.3 million which is included in 2009 earnings. The gain is the negative goodwill resulting from the acquired assets and liabilities recognized at fair value.

 

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3. INVESTMENT SECURITIES

The amortized cost and estimated fair value of investment securities are summarized below. The majority of securities held are publicly traded, and the estimated fair values were obtained from an independent pricing service based upon market quotes.

 

     March 31, 2012  
     Amortized
Cost
     Gross
Unrealized
Holding

Gain
     Gross
Unrealized
Holding

Loss
    Fair Value      Total
Percent
 
     (Dollars in thousands)  

Investment Securities Available-for-Sale:

             

Government agency & government-sponsored enterprises

   $ 37,191       $ 175       $ (4   $ 37,362         1.57

Residential mortgage-backed securities

     918,726         20,300         (135     938,891         39.58

CMO’s / REMIC’s – Residential

     729,815         10,437         (1,050     739,202         31.15

Municipal bonds

     605,114         42,251         (623     646,742         27.26

Other securities

     10,457         75         —          10,532         0.44
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total Investment Securities

   $ 2,301,303       $ 73,238       $ (1,812   $ 2,372,729         100.00
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

     December 31, 2011  
     Amortized
Cost
     Gross
Unrealized
Holding
Gain
     Gross
Unrealized
Holding
Loss
    Fair Value      Total
Percent
 
     (Dollars in thousands)  

Investment Securities Available-for-Sale:

             

Government agency & government-sponsored enterprises

   $ 46,273       $ 234       $ —        $ 46,507         2.11

Residential mortgage-backed securities

     869,847         18,487         (334     888,000         40.33

CMO’s / REMIC’s – Residential

     594,866         10,307         (665     604,508         27.46

Municipal bonds

     608,575         43,665         (203     652,037         29.62

Other securities

     10,468         10         (4     10,474         0.48
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total Investment Securities

   $ 2,130,029       $ 72,703       $ (1,206   $ 2,201,526         100.00
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Approximately 72% of the available-for-sale portfolio at March 31, 2012 represents securities issued by the U.S government or U.S. government-sponsored enterprises, with the implied guarantee of payment of principal and interest. The remaining CMO/REMICs are backed by agency-pooled collateral or whole loan collateral. All non-agency available-for-sale CMO/REMIC issues held are rated investment grade or better by either Standard & Poor’s or Moody’s, as of March 31, 2012 and December 31, 2011. We have $4.0 million in CMO/REMIC’s backed by whole loans issued by private-label companies (non-government sponsored).

There were zero realized gains or losses for the three months ended March 31, 2012 and 2011.

 

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Composition of the Fair Value and Gross Unrealized Losses of Securities:

 

     March 31, 2012  
     Less than 12 months      12 months or longer      Total  
Description of Securities    Fair Value      Gross
Unrealized
Holding
Losses
     Fair Value      Gross
Unrealized
Holding
Losses
     Fair Value      Gross
Unrealized
Holding
Losses
 
     (Dollars in thousands)  

Held-To-Maturity

                 

CMO

   $ 2,280       $ —         $ —         $ —         $ 2,280       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-Sale

                 

Government agency

   $ 10,977       $ 4       $ —         $ —         $ 10,977       $ 4   

Residential mortgage-backed securities

     55,729         135         —           —           55,729         135   

CMO/REMICs – Residential

     196,395         1,050         —           —           196,395         1,050   

Municipal bonds

     31,823         623         —           —           31,823         623   

Other Securities

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 294,924       $ 1,812       $ —         $ —         $ 294,924       $ 1,812   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2011  
     Less than 12 months      12 months or longer      Total  
Description of Securities    Fair Value      Gross
Unrealized
Holding
Losses
     Fair Value      Gross
Unrealized
Holding
Losses
     Fair Value      Gross
Unrealized
Holding
Losses
 
     (Dollars in thousands)  

Held-To-Maturity

                 

CMO

   $ 2,383       $ —         $ —         $ —         $ 2,383       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-Sale

                 

Government agency

   $ —         $ —         $ —         $ —         $ —         $ —     

Residential mortgage-backed securities

     75,754         334         —           —           75,754         334   

CMO/REMICs – Residential

     133,471         665         —           —           133,471         665   

Municipal bonds

     22,184         203         —           —           22,184         203   

Other Securities

     2,500         4         —           —           2,500         4   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 233,909       $ 1,206       $ —         $ —         $ 233,909       $ 1,206   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The tables above show the Company’s investment securities’ gross unrealized losses and fair value by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2012 and December 31, 2011. The Company has reviewed individual securities to determine whether a decline in fair value below the amortized cost basis is other-than-temporary.

The following summarizes our analysis of these securities and the unrealized losses. This assessment was based on the following factors: i) the length of the time and the extent to which the fair value has been less than amortized cost; ii) adverse condition specifically related to the security, an industry, or a geographic area and whether or not the Company expects to recover the entire amortized cost, iii) historical and implied volatility of the fair value of the security; iv) the payment structure of the security and the likelihood of the issuer being able to make payments in the future; v) failure of the issuer of the security to make scheduled interest or principal payments, vi) any changes to the rating of the security by a rating agency, and vii) recoveries or additional declines in fair value subsequent to the balance sheet date.

CMO Held-to-Maturity – We have one investment security classified as held-to-maturity. This security was issued by Countrywide Financial and is collateralized by Alt-A mortgages. The mortgages are primarily fixed-rate, 30-year loans, originated in early 2006 with average FICO scores of 715 and an average LTV of 71% at origination. The security was a senior security in the securitization, was rated triple AAA at origination and was supported by subordinate securities. This security is classified as held-to-maturity as we have both the intent and ability to hold this debt security to maturity as the amount of the security, $2.3 million, is not significant to our liquidity needs. We acquired this security in February 2008 at a price of 98.25%. The significant decline in the fair value of the security first appeared in August 2008 as the current financial crisis in the markets occurred and the market for securities collateralized by Alt-A mortgages diminished.

 

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As of March 31, 2012, the unrealized loss on this security was zero and the fair value on the security was 57% of the current par value. The security is rated non-investment grade. We evaluated the security for an other-than-temporary decline in fair value as of March 31, 2012. The key assumptions include default rates, severities and prepayment rates. This security was determined to be credit impaired during 2009 due to continued degradation in expected cash flows primarily due to higher loss forecasts. We determined the amount of the credit impairment by discounting the expected future cash flows of the underlying collateral. In 2009, we recognized an other-than-temporary impairment of $2.0 million reduced by $1.7 million for the non-credit portion which was reflected in other comprehensive income. The remaining loss of $323,000 was recognized in earnings for the year ended December 31, 2009. This Alt-A bond, with a book value of $2.3 million as of March 31, 2012, has had $1.9 million in net impairment losses to date. These losses have been recorded as a reduction to noninterest income.

There were no changes in credit-related other-than temporary impairment recognized in earnings for the three months ended March 31, 2012 and 2011.

Government Agency & Government-Sponsored Enterprise – The government agency bonds are backed by the full faith and credit of Agencies of the U.S. Government. These securities are bullet securities, that is, they have a defined maturity date on which the principal is paid. The contractual term of these investments provides that the Company will receive the face value of the bond at maturity which will equal the amortized cost of the bond. Interest is received throughout the life of the security. There was no loss greater than 12 months on these securities at March 31, 2012.

Mortgage-Backed Securities and CMO/REMICs – Almost all of the mortgage-backed and CMO/REMICs securities are issued by the government-sponsored enterprises such as Ginnie Mae, Fannie Mae and Freddie Mac. These securities are collateralized or backed by the underlying residential mortgages. All mortgage-backed securities are considered to be rated investment grade with an average life of approximately 3.0 years. The contractual cash flows of 99.76% of these investments have the implied guarantee of U.S. government-sponsored agencies. The remaining 0.24% are issued by banks. Accordingly, it is expected the securities would not be settled at a price less than the amortized cost of the bonds. At March 31, 2012, there was no unrealized loss greater than 12 months.

Municipal Bonds – The majority of our municipal bonds are insured by the largest bond insurance companies with maturities of approximately 9.8 years. There were zero securities with an unrealized loss greater than 12 months and all municipal securities were performing at March 31, 2012. The Company diversifies its holdings by owning selections of securities from different issuers and by holding securities from geographically diversified municipal issuers, thus reducing the Company’s exposure to any single adverse event. Because we believe the decline in fair value is attributable to the changes in interest rates and not credit quality and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized costs, which may be at maturity, management does not consider these investments to be other than temporarily impaired at Mach 31, 2012.

We are continually monitoring the quality of our municipal bond portfolio in light of the current financial problems exhibited by certain monoline insurance companies. Many of the securities that would not be rated without insurance are pre-refunded and/or are general obligation bonds. We continue to monitor municipalities to determine any audit or performance issues. We use outside brokers to assist us in these analyses. Based on our monitoring of the municipal marketplace, to our knowledge, none of the municipalities are exhibiting financial problems that would lead us to believe that there is an OTTI for any given security.

At March 31, 2012 and December 31, 2011, investment securities having an amortized cost of approximately $2.30 billion and $1.85 billion, respectively, were pledged to secure public deposits, short and long-term borrowings, and for other purposes as required or permitted by law.

The amortized cost and fair value of debt securities at March 31, 2012, by contractual maturity, are shown below. Although mortgage-backed securities and CMO/REMICs have contractual maturities through 2041, expected maturities will differ from contractual maturities because borrowers may have the right to prepay such obligations without penalty. Mortgage-backed securities and CMO/REMICs are included in maturity categories based upon estimated prepayment speeds.

 

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     Available-for-sale  
     Amortized
Cost
     Fair
Value
     Weighted-
Average
Yield
 
     (Dollars in thousands)  

Due in one year or less

   $ 108,908       $ 110,725         3.60

Due after one year through five years

     1,921,408         1,970,933         2.62

Due after five years through ten years

     235,086         251,431         3.79

Due after ten years

     35,901         39,640         3.64
  

 

 

    

 

 

    
   $ 2,301,303       $ 2,372,729         2.80
  

 

 

    

 

 

    

The investment in FHLB stock is periodically evaluated for impairment based on, among other things, the capital adequacy of the FHLB and its overall financial condition. No impairment losses have been recorded through March 31, 2012.

 

4. LOAN AND LEASE FINANCE RECEIVABLES AND ALLOWANCE FOR CREDIT LOSSES

The following is a summary of the components of loan and lease finance receivables:

 

     As of March 31, 2012  
     Non-Covered
Loans
    Covered
Loans
    Total  
     (Dollars in thousands)  

Commercial and Industrial

   $ 497,625      $ 24,154      $ 521,779   

Real Estate:

      

Construction

     67,382        10,003        77,385   

Commercial Real Estate

     1,987,798        235,735        2,223,533   

SFR Mortgage

     165,547        1,918        167,465   

Consumer

     50,757        7,856        58,613   

Municipal lease finance receivables

     114,724        68        114,792   

Auto and equipment leases, net of unearned discount

     17,105        —          17,105   

Dairy and Livestock

     285,653        374        286,027   

Agribusiness

     4,925        7,291        12,216   
  

 

 

   

 

 

   

 

 

 

Gross loans

   $ 3,191,516      $ 287,399      $ 3,478,915   

Less:

      

Purchase accounting discount

     —          (45,456     (45,456

Deferred loan fees, net

     (5,503     —          (5,503
  

 

 

   

 

 

   

 

 

 

Gross loans, net of deferred loan fees

   $ 3,186,013      $ 241,943      $ 3,427,956   

Less: Allowance for credit losses

     (91,922     —          (91,922
  

 

 

   

 

 

   

 

 

 

Net loans and lease finance receivables

   $ 3,094,091      $ 241,943      $ 3,336,034   
  

 

 

   

 

 

   

 

 

 

 

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     As of December 31, 2011  
     Non-Covered
Loans
    Covered Loans     Total  
     (Dollars in thousands)  

Commercial and Industrial

   $ 494,299      $ 29,651      $ 523,950   

Real Estate:

      

Construction

     76,146        18,685        94,831   

Commercial Real Estate

     1,948,292        223,107        2,171,399   

SFR Mortgage

     176,442        3,289        179,731   

Consumer

     51,436        8,353        59,789   

Municipal lease finance receivables

     113,460        169        113,629   

Auto and equipment leases, net of unearned discount

     17,370        —          17,370   

Dairy and Livestock

     343,350        199        343,549   

Agribusiness

     4,327        24,196        28,523   
  

 

 

   

 

 

   

 

 

 

Gross loans

   $ 3,225,122      $ 307,649      $ 3,532,771   

Less:

      

Purchase accounting discount

     —          (50,780     (50,780

Deferred loan fees, net

     (5,395     —          (5,395
  

 

 

   

 

 

   

 

 

 

Gross loans, net of deferred loan fees

   $ 3,219,727      $ 256,869      $ 3,476,596   

Less: Allowance for credit losses

     (93,964     —          (93,964
  

 

 

   

 

 

   

 

 

 

Net loans and lease finance receivables

   $ 3,125,763      $ 256,869      $ 3,382,632   
  

 

 

   

 

 

   

 

 

 

At March 31, 2012, the Company held approximately $1.54 billion of fixed rate loans. As of March 31, 2012, 63.91% of the loan portfolio consisted of commercial real estate loans and 2.22% of the loan portfolio consisted of construction loans. Substantially all of the Company’s real estate loans and construction loans are secured by real properties located in California.

At March 31, 2012 and December 31, 2011, loans totaling $2.30 billion and $2.31 billion, respectively, were pledged to secure borrowings from the FHLB and the Federal Reserve Bank.

The following is the activity of loans held for sale for the three months ended March 31, 2012 and 2011:

Non-Covered Loans Held for Sale Activity

 

     For the Three Months
Ended March 31,
 
     2012     2011  
     (Dollars in thousands)  

Balance, beginning of period

   $ 348      $ 2,954   

Originations of mortage loans

     5,739        11,508   

Sales of mortgage loans

     (5,457     (10,957

Transfer of mortgage loans to held for investment

     —          —     

Sales of other loans

     —          —     

Transfers of other loans to held for sale

     —          —     

Write-down of loans held for sale

     —          —     
  

 

 

   

 

 

 

Balance, end of period

   $    630      $ 3,505   
  

 

 

   

 

 

 

Covered Loans Held for Sale Activity

 

     For the Three Months
Ended March 31,
 
     2012     2011  
     (Dollars in thousands)  

Balance, beginning of period

   $ 5,664      $      —     

Originations of mortage loans

     —          —     

Sales of mortgage loans

     —          —     

Transfer of other loans to held for investment

     —          —     

Sales of other loans

     —          —     

Transfers of other loans to held for sale

       —     

Write-down of loans held for sale

     (1,219     —     

Payment on other loans

     (674  
  

 

 

   

 

 

 

Balance, end of period

   $ 3,771      $ —     
  

 

 

   

 

 

 

 

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Occasionally, the Company may decide to retain and not sell certain mortgage loans originated and will transfer them to its held for investment loan portfolio. This is generally done for customer service purposes.

Credit Quality Indicators

Central to our credit risk management is our loan risk rating system. The originating credit officer assigns borrowers an initial risk rating, which is reviewed and possibly changed by Credit Management, which is based primarily on a thorough analysis of each borrower’s financial capacity in conjunction with industry and economic trends. Approvals are made based upon the amount of inherent credit risk specific to the transaction and are reviewed for appropriateness by senior line and credit management personnel. Credits are monitored by line and credit management personnel for deterioration in a borrower’s financial condition, which would impact the ability of the borrower to perform under the contract. Risk ratings are adjusted as necessary.

Loans are risk rated into the following categories (Credit Quality Indicators): Pass, Pass Watch List, Special Mention, Substandard, Doubtful and Loss. Each of these groups is assessed for the proper amount to be used in determining the adequacy of our allowance for losses. These categories can be described as follows:

Pass – These loans range from minimal credit risk to lower than average, but still acceptable, credit risk.

Pass Watch List – Pass Watch list loans usually require more than normal management attention. Loans which qualify for the Pass Watch List may involve borrowers with adverse financial trends, higher debt/equity ratios, or weaker liquidity positions, but not to the degree of being considered a defined weakness or problem loan where risk of loss may be apparent.

Special Mention – Loans assigned to this category are currently protected but are weak. Although concerns exist, the Company is currently protected and loss is unlikely. Such loans have potential weaknesses that may, if not checked or corrected, weaken the asset or inadequately protect the Company’s credit position at some future date.

Substandard – Loans classified as substandard include poor liquidity, high leverage, and erratic earnings or losses. The primary source of repayment is no longer realistic, and asset or collateral liquidation may be the only source of repayment. Loans are marginal and require continuing and close supervision by credit management. Substandard loans have the distinct possibility that the Company will sustain some loss if deficiencies are not corrected.

Doubtful – Loans classified doubtful have all the weaknesses inherent in those classified substandard with the added provision that the weaknesses make collection or the liquidation, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonable specific pending factors which may work to the advantage and strengthening of the assets, their classifications as losses are deferred until their more exact status may be determined.

Loss – Loans classified as loss are considered uncollectible and of such little value that their continuance as active assets of the Company is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.

 

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The following table summarizes our internal risk grouping by loan class as of March 31, 2012 and December 31, 2011:

Credit Quality Indicators

As of March 31, 2012 and December 31, 2011

(Dollars in thousands)

Credit Risk Profile by Internally Assigned Grade

 

     March 31, 2012  
     Pass      Watch List      Special
Mention
     Substandard      Doubtful &
Loss
     Total  

Commercial & Industrial

   $ 317,336       $ 101,482       $ 53,088       $ 24,637       $ 1,082       $ 497,625   

Construction - Speculative

     3,902         —           20,363         31,117         —           55,382   

Construction - Non-Speculative

     2,490         291         —           9,219         —           12,000   

Commercial Real Estate - Owner-Occupied

     406,068         155,026         76,577         74,699         —           712,370   

Commercial Real Estate - Non-Owner-Occupied

     848,015         202,159         109,440         114,989         825         1,275,428   

Residential Real Estate (SFR 1-4)

     137,110         10,862         2,780         14,795         —           165,547   

Dairy & Livestock

     49,378         113,995         70,972         51,117         191         285,653   

Agribusiness

     2,450         1,683         792         —           —           4,925   

Municipal Lease Finance Receivables

     73,255         29,651         3,226         8,592         —           114,724   

Consumer

     43,142         3,671         2,414         1,482         48         50,757   

Auto & Equipment Leases

     11,459         3,870         452         1,324         —           17,105   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Non-covered Loans

     1,894,605         622,690         340,104         331,971         2,146         3,191,516   

Covered Loans

     47,894         68,478         30,081         140,661         285         287,399   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Loans excluding held-for-sale

     1,942,499         691,168         370,185         472,632         2,431         3,478,915   

Non-covered loans held-for-sale

     630         —           —           —           —           630   

Covered loans held-for-sale

     —           —           —           3,771         —           3,771   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Gross Loans

   $ 1,943,129       $ 691,168       $ 370,185       $ 476,403       $ 2,431       $ 3,483,316   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2011  
     Pass      Watch List      Special
Mention
     Substandard      Doubtful &
Loss
     Total  

Commercial & Industrial

   $ 323,653       $ 94,059       $ 55,140       $ 21,447       $ —         $ 494,299   

Construction - Speculative

     2,654         —           25,610         35,191         —           63,455   

Construction - Non-Speculative

     1,314         137         687         10,553         —           12,691   

Commercial Real Estate - Owner-Occupied

     370,801         176,958         74,315         77,884         —           699,958   

Commercial Real Estate - Non-Owner-Occupied

     836,465         193,751         108,798         108,482         838         1,248,334   

Residential Real Estate (SFR 1-4)

     143,841         8,336         6,807         17,458         —           176,442   

Dairy & Livestock

     73,074         106,024         91,416         72,619         217         343,350   

Agribusiness

     2,800         860         667         —           —           4,327   

Municipal Lease Finance Receivables

     70,781         23,106         8,927         10,646         —           113,460   

Consumer

     42,295         3,474         3,906         1,740         21         51,436   

Auto & Equipment Leases

     11,742         39         3,506         522         1,561         17,370   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Non-covered Loans

     1,879,420         606,744         379,779         356,542         2,637         3,225,122   

Covered Loans

     48,440         73,718         20,728         164,198         565         307,649   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Loans excluding held-for-sale

     1,927,860         680,462         400,507         520,740         3,202         3,532,771   

Non-covered loans held-for-sale

     348         —           —           —           —           348   

Covered loans held-for-sale

     —           —           —           5,664         —           5,664   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Gross Loans

   $ 1,928,208       $ 680,462       $ 400,507       $ 526,404       $ 3,202       $ 3,538,783   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

24


Table of Contents

Allowance for Credit Losses

The Credit Management Division is responsible for regularly reviewing the allowance for credit losses (“ALLL”) methodology, including loss factors and economic risk factors. The Bank’s Director Loan Committee provides Board oversight of the ALLL process and approves the ALLL methodology on a quarterly basis.

Our methodology for assessing the appropriateness of the allowance is conducted on a regular basis and considers all loans. The systematic methodology consists of two major phases.

In the first phase, individual loans are reviewed to identify loans for impairment. A loan is generally considered impaired when principal and interest are deemed uncollectible in accordance with the contractual terms of the loan. A loan for which there is an insignificant delay in the amount of payments is not considered an impaired loan. Impairment is measured as either the expected future cash flows discounted at each loan’s effective interest rate, the fair value of the loan’s collateral if the loan is collateral dependent, or an observable market price of the loan (if one exists). If we determine that the value of the impaired loan is less than the recorded investment of the loan, we either recognize an impairment reserve as a Specific Allowance to be provided for in the allowance for credit losses or charge-off the impaired balance if it is determined that such amount represents a confirmed loss. Loans determined to be impaired are excluded from the formula allowance so as not to double-count the loss exposure.

The second phase is conducted by evaluating or segmenting the remainder of the loan portfolio into groups or pools of loans with similar characteristics. In this second phase, groups or pools of homogeneous loans are reviewed to determine a portfolio formula allowance. In the case of the portfolio formula allowance, homogeneous portfolios, such as small business loans, consumer loans, agricultural loans, and real estate loans, are aggregated or pooled in determining the appropriate allowance. The risk assessment process in this case emphasizes trends in the different portfolios for delinquency, loss, and other behavioral characteristics of the subject portfolios.

Included in this second phase is our considerations of qualitative factors, including, all known relevant internal and external factors that may affect the collectability of a loan. This includes our estimates of the amounts necessary for concentrations, economic uncertainties, the volatility of the market value of collateral, and other relevant factors. These qualitative factors are used to adjust the historical loan loss rates for each pool of loans to determine the probable credit losses inherent in the portfolio.

The methodology is consistently applied across all the portfolio segments taking into account the applicable historical loss rates and the qualitative factors applicable to each pool of loans. Periodically, we assess various attributes utilized in adjusting our historical loss factors to reflect current economic conditions. During the first quarter of 2012, our dairy and livestock borrowers experienced an increase in feed costs, a decrease in milk prices, and tightened profit margins. As part of our qualitative analysis during the first quarter of 2012, we adjusted the attributes used in the allowance for credit losses to contemplate the current economic environment of the dairy and livestock industry.

Management believes that the ALLL was appropriate at March 31, 2012. No assurance can be given that economic conditions which adversely affect our service areas or other circumstances will not be reflected in increased provisions for credit losses in the future.

 

25


Table of Contents

The following table presents the balance and activity in the allowance for credit losses; and the recorded investment in held-for-investment loans by portfolio segment and based upon our impairment method as of March 31, 2012 and 2011:

Allowance for Credit Losses and Recorded Investment in Financing Receivables

(Dollars in thousands)

 

0000000000 0000000000 0000000000 0000000000 0000000000 0000000000 0000000000 0000000000 0000000000
    Commercial
and
Industrial
    Construction     Real Estate     Municipal
Lease

Finance
Receivables
    Dairy and
Livestock
    Consumer,
Auto & Other
    Covered
Loans (1)
    Unallocated     Total  

Three Months Ended March 31, 2012

                 

Allowance for Credit Losses:

                 

Beginning balance, January 1, 2012

  $ 10,654      $ 4,947      $ 51,873      $ 2,403      $ 17,230      $ 1,638      $ —        $ 5,219      $ 93,964   

Charge-offs

    (560     —          (530     —          (1,150     (85     (31     —          (2,356

Recoveries

    62        27        221        —          —          4        —          —          314   

Provision/Reallocation of ALLL

    1,751        (651     371        (383     (54     (14     31        (1,051     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance, March 31, 2012

  $ 11,907      $ 4,323      $ 51,935      $ 2,020      $ 16,026      $ 1,543      $ —        $ 4,168      $ 91,922   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: Individually evaluated for impairment

  $ 421      $ —        $ 787      $ —        $ 221      $ 81      $ —        $ —        $ 1,510   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: Collectively evaluated for impairment

  $ 11,486      $ 4,323      $ 51,148      $ 2,020      $ 15,805      $ 1,462      $ —        $ 4,168      $ 90,412   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans and financing receivables: (1)

                 

Ending balance, March 31, 2012

  $ 497,625      $ 67,382      $ 2,153,345      $ 114,724      $ 285,653      $ 72,787      $ 241,943      $ —        $ 3,433,459   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: Individually evaluated for impairment

  $ 7,820      $ 29,354      $ 51,153      $ —        $ 8,470      $ 389      $ 2,506      $ —        $ 99,692   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: Collectively evaluated for impairment

  $ 489,805      $   38,028      $ 2,102,192      $ 114,724      $ 277,183      $ 72,398      $ 239,437      $ —        $ 3,333,767   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

0000000000 0000000000 0000000000 0000000000 0000000000 0000000000 0000000000 0000000000 0000000000
    Commercial
and
Industrial
    Construction     Real Estate     Municipal
Lease
Finance
Receivables
    Dairy and
Livestock
    Consumer,
Auto & Other
    Covered
Loans (1)
    Unallocated     Total  

Three Months Ended March 31, 2011

                 

Allowance for Credit Losses:

                 

Beginning balance, January 1, 2011

  $ 11,472      $ 10,188      $ 43,529      $ 2,172      $ 36,061      $ 1,034      $ —        $ 803      $ 105,259   

Charge-offs

    (689     (6,160     (2,471     —          (2,204     (120     (394     —          (12,038

Recoveries

    142        —          581        —          —          52        3        —          778   

Provision/Reallocation of ALLL

    (482     2,350        1,151        639        (430     707        391        2,742        7,068   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance, March 31, 2011

  $ 10,443      $ 6,378      $ 42,790      $ 2,811      $ 33,427      $ 1,673      $ —        $ 3,545      $ 101,067   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: Individually evaluated for impairment

  $ 364      $ —        $ 885      $ —        $ —        $ 37      $ —        $ —        $ 1,286   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: Collectively evaluated for impairment

  $ 10,079      $ 6,378      $ 41,905      $ 2,811      $ 33,427      $ 1,636      $ —        $ 3,545      $ 99,781   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans and financing receivables: (1)

                 

Ending balance, March 31, 2011

  $ 456,925      $ 109,540      $ 2,172,172      $ 122,422      $ 325,052      $ 69,217      $ 348,759      $ —        $ 3,604,087   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: Individually evaluated for impairment

  $ 10,136      $ 42,320      $ 62,707      $ —        $ 2,996      $ 260      $ 14,965      $ —        $ 133,384   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: Collectively evaluated for impairment

  $ 446,789      $ 67,220      $ 2,109,465      $ 122,422      $ 322,056      $ 68,957      $ 333,794      $ —        $ 3,470,703   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Net of purchase accounting discount and deferred loan fees.

 

26


Table of Contents

Past Due and Non-Performing Loans

We manage asset quality and control credit risk through diversification of the non-covered loan portfolio and the application of policies designed to promote sound underwriting and loan monitoring practices. The Bank’s Credit Management Division is in charge of monitoring asset quality, establishing credit policies and procedures and enforcing the consistent application of these policies and procedures across the Bank. Reviews of non-performing, past due non-covered loans and larger credits, designed to identify potential charges to the allowance for credit losses, and to determine the adequacy of the allowance, are conducted on an ongoing basis. These reviews consider such factors as the financial strength of borrowers and any guarantors, the value of the applicable collateral, loan loss experience, estimated loan losses, growth in the loan portfolio, prevailing economic conditions and other factors.

Loans are reported as a troubled debt restructuring when the Bank grants a concession(s) to a borrower experiencing financial difficulties that it would not otherwise consider. Examples of such concessions include a reduction in the loan rate, deferral of principal or accrued interest, extending the payment due dates or loan maturity date(s), or providing a lower interest rate than would be normally available for new debt of similar risk. As a result of these concessions, restructured loans are classified as impaired. Impairment reserves on non-collateral dependent restructured loans are measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s carrying value. These impairment reserves are recognized as a specific component to be provided for in the allowance for loan and credit losses.

Generally, when loans are identified as impaired they are moved to our Special Assets Division. When we identify a loan as impaired, we measure the loan for potential impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of collateral, less selling costs. The starting point for determining the fair value of collateral is through obtaining external appraisals.

The accrual of interest on loans is discontinued when the loan becomes 90 days past due based on the contractual term of the loan, or when the full collection of principal and interest is in doubt. When an asset is placed on nonaccrual status, previously accrued but unpaid interest is reversed against income. Subsequent collections of cash are applied as reductions to the principal balance unless the loan is returned to accrual status. Nonaccrual loans may be restored to accrual status when principal and interest become current and full payment of principal and interest is expected. Had nonaccrual loans for which interest was no longer accruing complied with the original terms and conditions of their notes, interest income would have been $594,000 and $831,000 greater for the three months ended March 31, 2012 and 2011, respectively.

Speculative construction loans are generally for properties where there is no identified buyer or renter.

 

27


Table of Contents

The following table presents the recorded investment in non-covered past due and nonaccrual loans and loans past due by class of loans as of March 31, 2012 and December 31, 2011:

Non-Covered Past Due and Nonaccrual Loans

As of March 31, 2012 and December 31, 2011

(Dollars in Thousands)

 

March 31, 2012

  30-59 Days
Past Due
    60-89 Days
Past Due
    Greater
Than 90
Days Past
Due and
Accruing
    Total Past
Due and
Accruing
    Nonaccrual     Current     Total Loans
and Financing
Receivables
 

Commercial & Industrial

  $ 1,317      $ —        $ —        $ 1,317      $ 4,082      $ 492,226      $ 497,625   

Construction - Speculative

    —          —          —          —          9,269        46,113        55,382   

Construction - Non-Speculative

    —          —          —          —          —          12,000        12,000   

Commercial Real Estate - Owner-Occupied

    902        —          —          902        9,383        702,085        712,370   

Commercial Real Estate - Non-Owner-Occupied

    4,834        62        —          4,896        17,855        1,252,677        1,275,428   

Residential Real Estate (SFR 1-4)

    4,109        —          —          4,109        13,129        148,309        165,547   

Dairy & Livestock

    —          —          —          —          1,200        284,453        285,653   

Agribusiness

    —          —          —          —          —          4,925        4,925   

Municipal Lease Finance Receivables

    —          —          —          —          —          114,724        114,724   

Consumer

    1        12        —          13        308        50,436        50,757   

Auto & Equipment Leases

    —          —          —          —          86        17,019        17,105   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Non-covered Loans excluding held-for-sale

    11,163        74        —          11,237        55,312        3,124,967        3,191,516   

Loans Held-for-Sale Residential Real Estate (SFR 1-4)

    —          —          —          —          —          630        630   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 11,163      $ 74      $ —        $ 11,237      $ 55,312      $ 3,125,597      $ 3,192,146   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

December 31, 2011

  30-59 Days
Past Due
    60-89 Days
Past Due
    Greater
Than 90
Days Past
Due and
Accruing
    Total Past
Due and
Accruing
    Nonaccrual     Current     Total Loans
and Financing
Receivables
 

Commercial & Industrial

  $ 2,872      $ 150      $ —          3,022      $ 3,432      $ 487,845      $ 494,299   

Construction - Speculative

    —          —          —          —          13,317        42,203        55,520   

Construction - Non-Speculative

    —          —          —          —          —          20,626        20,626   

Commercial Real Estate - Owner-Occupied

    133        280        —          413        9,474        690,071        699,958   

Commercial Real Estate - Non-Owner-Occupied

    374        —          —          374        16,518        1,231,442        1,248,334   

Residential Real Estate (SFR 1-4)

    1,568        —          —          1,568        16,970        157,904        176,442   

Dairy & Livestock

    —          —          —          —          2,475        340,875        343,350   

Agribusiness

    —          —          —          —          —          4,327        4,327   

Municipal Lease Finance Receivables

    —          —          —          —          —          113,460        113,460   

Consumer

    59        —          —          59        382        50,995        51,436   

Auto & Equipment Leases

    14        6        —          20        104        17,246        17,370   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Non-covered Loans excluding held-for-sale

    5,020        436        —          5,456        62,672        3,156,994        3,225,122   

Loans Held-for-Sale Residential Real Estate (SFR 1-4)

    —          —          —          —          —          348        348   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 5,020      $ 436      $ —        $ 5,456      $ 62,672      $ 3,157,342      $ 3,225,470   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-covered Impaired Loans

At March 31, 2012, the Company had non-covered impaired loans of $97.2 million. Of this amount, $920,000 consisted of nonaccrual residential construction and land loans, $8.4 million in nonaccrual commercial construction loans, $13.1 million of nonaccrual single family mortgage loans, $27.2 million of nonaccrual commercial real estate loans, $4.1 million of nonaccrual commercial and industrial loans, $1.2 million of nonaccrual dairy and livestock loans and $394,000 of other loans. These non-covered impaired loans included $60.5 million of loans whose terms were modified in a troubled debt restructure, of which $18.6 million are classified as nonaccrual. The remaining balance of $41.9 million consists of 21 loans performing according to the restructured terms. These impaired loans had specific allowance of $1.5 million at March 31, 2012. At December 31, 2011, the Company had classified as impaired, non-covered loans with a balance of $101.2 million with a related allowance of $3.0 million.

 

28


Table of Contents

The following table presents held-for-investment and held-for-sale loans, individually evaluated for impairment by class of loans, as of March 31, 2012 and December 31, 2011:

Non-Covered Impaired Loans

As of March 31 ,2012 and December 31, 2011

(Dollars in Thousands)

 

     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

March 31, 2012

                                  

With no related allowance recorded:

              

Commercial & Industrial

   $ 5,684       $ 6,834       $ —         $ 4,517       $ 27   

Held for Sale Construction - Speculative

     —           —           —           —           —     

Construction - Speculative

     9,269         11,860         —           11,293         —     

Construction - Non-Speculative

     20,085         20,085         —           20,085         283   

Commercial Real Estate - Owner-Occupied

     14,575         15,072         —           14,626         131   

Commercial Real Estate - Non-Owner-Occupied

     17,591         25,494         —           17,996         15   

Residential Real Estate (SFR 1-4)

     10,913         13,685         —           11,567         16   

Dairy & Livestock

     8,250         9,729         —           8,564         111   

Municipal Lease Finance Receivables

     —           —           —           —           —     

Consumer

     103         150         —           104         —     

Auto & Equipment Leases

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     86,470         102,909         —           88,752         583   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With a related allowance recorded:

              

Commercial & Industrial

   $ 2,136       $ 2,164       $ 421       $ 2,149       $ —     

Construction - Speculative

     —           —           —           —           —     

Construction - Non-Speculative

     —           —           —           —           —     

Commercial Real Estate - Owner-Occupied

     3,900         3,900         279         3,900         —     

Commercial Real Estate - Non-Owner-Occupied

     263         265         16         265         —     

Residential Real Estate (SFR 1-4)

     3,910         4,265         492         3,920         —     

Dairy, Livestock & Agribusiness

     221         3,324         221         796         —     

Municipal Lease Finance Receivables

     —           —           —           —           —     

Consumer

     200         208         69         201         —     

Auto & Equipment Leases

     86         91         12         89         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     10,716         14,217         1,510         11,320         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 97,186       $ 117,126       $ 1,510       $ 100,072       $ 583   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011

                                  

With no related allowance recorded:

              

Commercial & Industrial

   $ 3,566       $ 4,630       $ —         $ 4,649       $ 93   

Held for Sale Construction - Speculative

     —           —           —           —           —     

Construction - Speculative

     13,317         15,718         —           15,434         —     

Construction - Non-Speculative

     20,085         20,085         —           16,437         1,123   

Commercial Real Estate - Owner-Occupied

     13,567         14,013         —           11,941         449   

Commercial Real Estate - Non-Owner-Occupied

     16,435         23,656         —           21,096         67   

Residential Real Estate (SFR 1-4)

     14,069         17,411         —           15,120         47   

Dairy & Livestock

     8,879         10,358         —           10,535         446   

Municipal Lease Finance Receivables

     —           —           —           —           —     

Consumer

     104         150         —           127         —     

Auto & Equipment Leases

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     90,022         106,021         —           95,339         2,225   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With a related allowance recorded:

              

Commercial & Industrial

   $ 1,388       $ 1,410       $ 165       $ 1,554       $ —     

Construction - Speculative

     —           —           —           —           —     

Construction - Non-Speculative

     —           —           —           —           —     

Commercial Real Estate - Owner-Occupied

     3,900         3,900         928         3,900         —     

Commercial Real Estate - Non-Owner-Occupied

     83         85         5         86         —     

Residential Real Estate (SFR 1-4)

     4,087         4,369         406         3,967         —     

Dairy, Livestock & Agribusiness

     1,372         3,324         1,372         2,402         —     

Municipal Lease Finance Receivables

     —           —           —           —           —     

Consumer

     270         278         77         276         —     

Auto & Equipment Leases

     104         110         15         141         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     11,204         13,476         2,968         12,326         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 101,226       $ 119,497       $ 2,968       $ 107,665       $ 2,225   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The Company recognizes the charge-off of impairment allowance on impaired loans in the period it arises for collateral dependent loans. Therefore, the majority of the nonaccrual loans as of March 31, 2012 and December 31, 2011 have already been written-down to their estimated net realizable value. The impaired loans with a related allowance recorded are on nonaccrual loans where a charge-off is not yet processed, on nonaccrual SFR loans where there is a potential modification in process, or on smaller balance non-collateral dependent loans.

 

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The allowance for off-balance sheet credit exposure relates to commitments to extend credit, letters of credit and undisbursed funds on lines of credit. The Company evaluates credit risk associated with the loan and lease portfolio at the same time it evaluates credit risk associated with the off-balance sheet commitments. The Company recorded zero provision for unfunded commitments for the first three months ended March 31, 2012, compared to an increase of $732,000 in the provision for the same period of 2011. As of March 31, 2012 and December 31, 2011, the balance in this reserve was $9.6 million and was included in other liabilities.

As a result of adopting the amendments in ASU 2011-02, the Company reassessed all restructurings that occurred on or after January 1, 2011 for identification as troubled debt restructurings. Loans that are reported as TDRs are considered impaired and charged off on an individual loan basis, as deemed appropriate. The majority of restructured loans are loans for which the terms of repayment have been renegotiated, resulting in a reduction in interest rate or deferral of principal.

As of March 31, 2012, we had loans of $60.5 million classified as a troubled debt restructured, of which $18.6 million are non-performing and $41.9 million are performing. TDRs on accrual status are comprised of loans that were accruing at the time of restructuring or have demonstrated repayment performance in compliance with the restructured terms for a sustained period and for which the Company anticipates full repayment of both principal and interest. TDRs on accrual status at March 31, 2012 were mainly comprised of commercial real estate loans including construction loans.

The majority of TDRs have no specific allowance allocated as any impairment amount is normally charged-off at the time a probable loss is determined. We have allocated $20,000 and $27,000 specific allowance to TDRs as of March 31, 2012 and December 31, 2011.

The following are the loans modified as troubled debt restructuring for the three months ended March 31, 2012:

Modifications

(Dollars in thousands)

 

     Three Months Ended March 31, 2012  
     Number of
Loans
     Pre-modification
Outstanding Recorded
Investment
     Post-Modification
Outstanding  Recorded
Investment
     Outstanding
Recorded
Investment at
March 31,
2012
 

Troubled Debt Restructurings

           

Commercial & Industrial

     2       $ 2,534       $ 2,534       $ 2,532   

Construction - Speculative

     —           —           —           —     

Construction - Non-Speculative

     —           —           —           —     

Commercial Real Estate - Owner-Occupied

     1         307         307         304   

Commercial Real Estate - Non-Owner-Occupied

     1         513         513         513   

Residential Real Estate (SFR 1-4)

     —           —           —           —     

Dairy & Livestock

     —           —           —           —     

Agribusiness

     —           —           —           —     

Municipal Lease Finance Receivables

     —           —           —           —     

Consumer

     —           —           —           —     

Auto & Equipment Leases

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Non-Covered Loans

     4         3,354         3,354         3,349   

Covered Loans

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Gross Loans

     4       $ 3,354       $ 3,354       $ 3,349   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of March 31, 2012, there was one commercial and industrial loan with an outstanding balance of $1.0 million that was previously modified as a troubled debt restructuring within the previous 12 months that subsequently defaulted during the three months ended March 31, 2012.

 

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5. FAIR VALUE INFORMATION

Fair Value Hierarchy

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

The following disclosure provides the fair value information for financial assets and liabilities as of March 31, 2012. The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels (Level 1, Level 2, and Level 3).

 

   

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

 

   

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

 

   

Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flows and similar techniques.

There were no transfers in and out of Level 1 and Level 2 measurement during the three months ended March 31, 2012 and 2011.

Determination of Fair Value

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value and for estimating fair value for financial instruments not recorded at fair value.

Cash and cash equivalents - The carrying amount of cash and cash equivalents is considered to approximate fair value due to the liquidity of these instruments.

Interest-bearing balances due from depository institutions - The carrying value of due from depository institutions is considered to approximate fair value due to the short-term nature of these deposits.

FHLB stock - The carrying amount of FHLB stock approximates fair value, as the stock may be sold back to the FHLB at carrying value.

Investment securities held to maturity - Investment securities held to maturity are valued based upon quotes obtained from an independent third-party pricing service. The Company categorized its held to maturity investment as a level 3 valuation.

Investment securities available-for-sale - Investment securities available-for-sale are valued based upon quotes obtained from an independent third-party pricing service. This service uses evaluated pricing applications and model processes. Observable market inputs, such as, benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data are considered as part of the evaluation. The inputs are related directly to the security being evaluated, or indirectly to a similarly situated security. Market assumptions and market data are utilized in the valuation models. The Company reviews the market prices provided by the third-party pricing service for reasonableness based on the Company’s understanding of the market place and credit issues related to the securities. The Company has not made any adjustments to the market quotes provided by them and accordingly, the Company categorized its investment portfolio as a Level 2.

Loans held for sale - For loans held for sale, carrying value approximated fair value as the loans are recorded at the lower of cost or carrying market value (based on appraisals).

Non-covered Loans - The carrying amount of loans and lease finance receivables is their contractual amounts outstanding, reduced by deferred net loan origination fees and the allocable portion of the allowance for credit losses.

The fair value of loans, other than loans on nonaccrual status, was estimated by discounting the remaining contractual cash flows using the estimated current rate at which similar loans would be made to borrowers with similar credit risk characteristics and for the same remaining maturities, reduced by deferred net loan origination fees

 

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and the allocable portion of the allowance for credit losses. Accordingly, in determining the estimated current rate for discounting purposes, no adjustment has been made for any change in borrowers’ credit risks since the origination of such loans. Rather, the allocable portion of the allowance for credit losses is considered to provide for such changes in estimating fair value. As a result, this fair value is not necessarily the value which would be derived using an exit price. These loans are included within Level 3 of the fair value hierarchy.

Non-covered impaired loans and OREO are generally measured using the fair value of the underlying collateral, which is determined based on the most recent appraisal information received, less costs to sell (approximately 8%). Appraised values may be adjusted based on factors such as the changes in market conditions from the time of valuation or discounted cash flows of the property. As such, these loans fall within Level 3 of the fair value hierarchy.

The majority of our commitments to extend credit carry current market interest rates if converted to loans. Because these commitments are generally unassignable by either the borrower or us, they only have value to the borrower and us. The estimated fair value approximates the recorded deferred fee amounts and is excluded from the following table because it is not material.

Covered Loans - Covered loans were measured at fair value on the date of acquisition. Thereafter, covered loans are not measured at fair value on a recurring basis. The above valuation discussion for non-covered loans is applicable to covered loans following their acquisition date.

Swaps - The fair value of the interest rate swap contracts are provided by our counterparty using a system that constructs a yield curve based on cash LIBOR rates, Eurodollar futures contracts, and 3-year through 30-year swap rates. The yield curve determines the valuations of the interest rate swaps. Accordingly, the swap is categorized as a Level 2 valuation.

Deposits & Borrowings - The amounts payable to depositors for demand, savings, and money market accounts, and short-term borrowings are considered to approximate fair value. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value of long-term borrowings and junior subordinated debentures is estimated using the rates currently offered for borrowings of similar remaining maturities.

Accrued Interest Receivable/Payable - The amounts of accrued interest receivable on loans and lease finance receivables and investments and accrued interest payable on deposits and borrowings are considered to approximate fair value.

The table below presents the balances of assets and liabilities measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011.

Assets & Liabilities Measured at Fair Value on a Recurring Basis

 

(Dollars in thousands)

   Carrying Value at
March 31, 2012
     Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Description of Assets

           

Residential mortgage-backed securities

   $ 938,891       $ —         $ 938,891       $ —     

CMO’s / REMIC’s – Residential

     739,202         —           739,202         —     

Government agency

     37,362         —           37,362         —     

Municipal bonds

     646,742         —           646,742         —     

Other securities

     10,532            10,532      
  

 

 

    

 

 

    

 

 

    

 

 

 

Investment Securities-AFS

     2,372,729         —           2,372,729         —     

Interest Rate Swaps

     18,753         —           18,753         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Assets

   $ 2,391,482       $ —         $ 2,391,482       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Description of Liability

           

Interest Rate Swaps

   $ 18,753       $ —         $ 18,753       $ —     

 

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Table of Contents

(Dollars in thousands)

   Carrying Value at
December 31, 2011
     Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Description of Assets

           

Residential mortgage-backed securities

   $ 888,000       $ —         $ 888,000       $ —     

CMO’s / REMIC’s – Residential

     604,508         —           604,508         —     

Government agency

     46,507         —           46,507         —     

Municipal bonds

     652,037         —           652,037         —     

Other securities

     10,474            10,474      
  

 

 

   &nbs