XNAS:NOVB North Valley Bancorp Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

S Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
  For the period ended June 30, 2012.

 

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

 

Commission file number 0-10652

 

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

 

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

 

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

 

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

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes S No £

 

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

 

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

 

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

Yes £ No S

 

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

 

Common Stock – 6,835,192 shares as of August 10, 2012.

 

 
 

 

INDEX

 

NORTH VALLEY BANCORP AND SUBSIDIARIES

 

PART I. FINANCIAL INFORMATION    
       
Item 1. Financial Statements (Unaudited)   3
  Condensed Consolidated Balance Sheets—June 30, 2012 and December 31, 2011   3
  Condensed Consolidated Statement of Income and Comprehensive Income—For the three and six months ended June 30, 2012 and 2011   4
  Condensed Consolidated Statements of Cash Flows—For the six months ended June 30, 2012 and 2011   6
  Notes to Condensed Consolidated Financial Statements   7
       
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   23
       
Item 3. Quantitative and Qualitative Disclosures about Market Risk   41
       
Item 4. Controls and Procedures   41
       
PART II. OTHER INFORMATION  
       
Item 1. Legal Proceedings   41
       
Item 1A. Risk Factors   41
       
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds   41
       
Item 3. Defaults Upon Senior Securities   41
       
Item 4. Mine Safety Disclosures   42
       
Item 5. Other Information   42
       
Item 6. Exhibits   42

 

SIGNATURES 42

 

2
 

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands except share data) (Unaudited)
   June 30,  December 31,
   2012  2011
ASSETS          
Cash and cash equivalents:          
Cash and due from banks  $19,037   $18,758 
Federal funds sold   53,375    40,210 
Total cash and cash equivalents   72,412    58,968 
           
Time deposits at other financial institutions   1,960    1,959 
Investment securities available-for-sale, at fair value   305,378    312,205 
Investment securities held-to-maturity, at amortized cost   6    6 
           
Loans   455,257    456,215 
Less: Allowance for loan losses   (11,732)   (12,656)
Net loans   443,525    443,559 
           
Premises and equipment, net   9,362    8,661 
Accrued interest receivable   2,370    2,557 
Other real estate owned   15,648    20,106 
FHLB and FRB stock and other nonmarketable securities   8,313    8,044 
Bank-owned life insurance policies   35,513    34,972 
Core deposit intangibles, net   328    401 
Other assets   13,296    13,528 
           
TOTAL ASSETS  $908,111   $904,966 
           
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
           
LIABILITIES:          
Deposits:          
Noninterest-bearing  $163,446   $167,506 
Interest-bearing   599,825    598,733 
Total deposits   763,271    766,239 
           
Accrued interest payable and other liabilities   19,862    17,301 
Subordinated debentures   31,961    31,961 
Total liabilities   815,094    815,501 
           
STOCKHOLDERS  EQUITY:          
Preferred stock, no par value: authorized 5,000,000 shares; no shares outstanding at June 30, 2012 and December 31, 2011        
Common stock, no par value: authorized 60,000,000 shares; outstanding 6,833,752 at June 30, 2012 and December 31, 2011, respectively   98,374    98,285 
Accumulated deficit   (8,549)   (10,290)
Accumulated other comprehensive income, net of tax   3,192    1,470 
Total stockholders  equity   93,017    89,465 
           
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY  $908,111   $904,966 
           
The accompanying notes are an integral part of these consolidated financial statements.

 

3
 

 

NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
(In thousands except per share data) (Unaudited)
   For the three months ended June 30,
   2012  2011
Interest income          
Loans, including fees  $6,324   $7,394 
Taxable securities   1,943    2,057 
Tax exempt securities   136    152 
Federal funds sold and repurchase agreements   17    7 
Total interest income   8,420    9,610 
           
Interest expense          
Deposits   604    1,012 
Subordinated debentures   487    439 
Other borrowings       1 
Total interest expense   1,091    1,452 
           
Net interest income   7,329    8,158 
           
Provision for loan losses   1,000    1,250 
           
Net interest income after provision for loan losses   6,329    6,908 
           
Noninterest income          
Service charges on deposit accounts   1,136    1,172 
Other fees and charges   1,321    1,158 
Earnings on cash surrender value of life insurance policies   359    351 
Gain on sale of loans, net   684    519 
Gain on sales or calls of securities, net   968     
Other   219    283 
Total noninterest income   4,687    3,483 
           
Noninterest expense          
Salaries and employee benefits   5,051    4,475 
Occupancy expense   620    700 
Furniture and equipment expense   227    294 
FDIC and state assessments   176    303 
Other real estate owned expense   342    1,177 
Other   2,812    2,786 
Total noninterest expenses   9,228    9,735 
           
Income before provision for income taxes   1,788    656 
           
Provision for income taxes   527    137 
           
Net income  $1,261   $519 
           
Total other comprehensive income, net of tax   718    2,840 
           
Comprehensive income  $1,979   $3,359 
           
Per share amounts          
Basic and diluted income per share  $0.18   $0.08 
           
The accompanying notes are an integral part of these consolidated financial statements.

 

4
 

 

NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
(In thousands except per share data) (Unaudited)
   For the six months ended June 30,
   2012  2011
Interest income          
Loans, including fees  $12,794   $14,844 
Taxable securities   3,910    3,851 
Tax exempt securities   280    318 
Federal funds sold and repurchase agreements   45    15 
Total interest income   17,029    19,028 
           
Interest expense          
Deposits   1,338    2,094 
Subordinated debentures   970    969 
Other borrowings       1 
Total interest expense   2,308    3,064 
           
Net interest income   14,721    15,964 
           
Provision for loan losses   1,400    2,250 
           
Net interest income after provision for loan losses   13,321    13,714 
           
Noninterest income          
Service charges on deposit accounts   2,188    2,338 
Other fees and charges   2,518    2,279 
Earnings on cash surrender value of life insurance policies   683    681 
Gain on sale of loans, net   1,089    775 
Gain (loss) on sales or calls of securities, net   959    (10)
Other   509    573 
Total noninterest income   7,946    6,636 
           
Noninterest expense          
Salaries and employee benefits   10,108    9,192 
Occupancy expense   1,260    1,392 
Furniture and equipment expense   472    590 
FDIC and state assessments   489    746 
Other real estate owned expense   976    1,629 
Other   5,579    5,657 
Total noninterest expenses   18,884    19,206 
           
Income before provision for income taxes   2,383    1,144 
           
Provision for income taxes   642    226 
           
Net income  $1,741   $918 
           
Total other comprehensive income, net of tax   1,722    3,191 
           
Comprehensive income  $3,463   $4,109 
           
Per share amounts          
Basic and diluted income per share  $0.25   $0.13 
           

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

  

5
 

 

NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands except per share data) (Unaudited)
   For the six months ended June 30,
   2012  2011
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income  $1,741   $918 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization   537    626 
Amortization of premium on securities, net   1,030    807 
Amortization of core deposit intangible   73    72 
Provision for loan losses   1,400    2,250 
Net losses on sale and write-down of other real estate owned   749    1,246 
Gain on sale of loans   (1,089)   (775)
(Gain) loss on sales or calls of securities   (959)   10 
Loss on sale of premises and equipment   1    4 
Stock-based compensation expense   89    60 
Effect of changes in:          
Accrued interest receivable   187    89 
Other assets   (1,506)   (485)
Accrued interest payable and other liabilities   2,631    1,863 
Net cash provided by operating activities   4,884    6,685 
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Purchases of time deposits at other financial institutions   (1)    
Purchases of available for sale securities   (95,172)   (50,302)
Proceeds from sales/calls of available for sale securities   78,439    6,000 
Proceeds from maturities of available-for-sale securities   26,338    18,245 
Purchases of FHLB and FRB stock and other securities   (269)   (903)
Net (increase) decrease in loans   (852)   25,750 
Proceeds from sales of other real estate owned   4,284    4,513 
Purchases of premises and equipment   (1,239)   (192)
Net cash provided by investing activities   11,528    3,111 
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
Net (decrease) increase in deposits   (2,968)   4,084 
Net cash (used in) provided by financing activities   (2,968)   4,084 
           
NET INCREASE IN CASH AND CASH EQUIVALENTS   13,444    13,880 
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD   58,968    23,634 
CASH AND CASH EQUIVALENTS, END OF PERIOD  $72,412   $37,514 
           
Supplemental Disclosures of Cash Flow Information          
Cash paid during the year for:          
Interest  $1,354   $2,078 
Income taxes paid  $122   $ 
           
Noncash investing and financing activities:          
Transfer from loans to other real estate owned  $575   $3,840 
           
The accompanying notes are an integral part of these consolidated financial statements.

 

6
 

 

NORTH VALLEY BANCORP AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

NOTE 1 - BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements of North Valley Bancorp and subsidiaries (the “Company”) have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, certain information and notes required by accounting principles generally accepted in the United States for annual financial statements are not included herein. Management believes that the disclosures are adequate to make the information not misleading. In the opinion of management, all adjustments (consisting solely of normal recurring adjustments) considered necessary for a fair presentation of the results for the interim periods presented have been included. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Operating results for the six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for any subsequent period or for the year ended December 31, 2012.

 

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries North Valley Bank, a California banking corporation (“NVB”) and North Valley Trading Company, a California corporation, which is inactive. Significant intercompany items and transactions have been eliminated in consolidation. The Company owns the common stock of four business trusts that have issued trust preferred securities fully and unconditionally guaranteed by the Company. North Valley Capital Trust I, North Valley Capital Trust II, North Valley Capital Trust III and North Valley Capital Statutory Trust IV are unconsolidated subsidiaries and have issued an aggregate of $31,961,000 in trust preferred securities, which are reflected as debt on the Company’s condensed consolidated balance sheets. On July 25, 2012, the Company redeemed, in full, the notes associated with North Valley Capital Trust I in the amount of $10,310,000. 

 

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

 

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

 

7
 

 

NOTE 2 – INVESTMENT SECURITIES

 

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

 

      Gross  Gross  Estimated
   Amortized  Unrealized  Unrealized  Fair
   Cost  Gains  Losses  Value
June 30, 2012            
Available-for-Sale:                    
Obligations of U.S. government sponsored agencies  $15,021   $120   $   $15,141 
Obligations of state and political subdivisions   11,890    634        12,524 
Government sponsored agency mortgage-backed securities   262,602    7,344    (32)   269,914 
Corporate debt securities   6,000        (1,328)   4,672 
Equity securities   3,000    127        3,127 
   $298,513   $8,225   $(1,360)  $305,378 
Held-to-Maturity:                    
Government sponsored agency mortgage-backed securities  $6   $   $   $6 
                     
December 31, 2011                    
Available-for-Sale:                    
Obligations of U.S. government sponsored agencies  $15,042   $192   $   $15,234 
Obligations of state and political subdivisions   13,811    696    (52)   14,455 
Government sponsored agency mortgage-backed securities   270,337    5,212    (345)   275,204 
Corporate debt securities   6,000        (1,768)   4,232 
Equity securities   3,000    80        3,080 
   $308,190   $6,180   $(2,165)  $312,205 
Held-to-Maturity:                    
Government sponsored agency mortgage-backed securities  $6   $   $   $6 

 

For the three months ended June 30, 2012 there were $968,000 gross realized gains on sales or calls of available for sale securities. For the three months ended June 30, 2011 there were no gross realized gains on sales or calls of available for sale securities. For the three months ended June 30, 2012 and 2011 there were no gross realized losses on sales or calls of securities categorized as available for sale securities. For the three months ended June 30, 2012 there were $76,989,000 in gross proceeds from sales or calls of available for sale securities. For the three months ended June 30, 2011 there were no gross proceeds from sales or calls of available for sale securities There were no sales or transfers of held to maturity securities for the three months ended June 30, 2012 and 2011. For the three months ended June 30, 2012 and 2011 there were no gross proceeds from maturities or calls of held to maturity securities.

 

For the six months ended June 30, 2012 there were $968,000 gross realized gains on sales or calls of available for sale securities. For the six months ended June 30, 2011 there were no gross realized gains on sales or calls of available for sale securities. For the six months ended June 30, 2012 and 2011 there were $9,000 and $10,000, respectively, in gross realized losses on sales or calls of securities categorized as available for sale securities. For the six months ended June 30, 2012 and 2011 there were $78,439,000 and $6,000,000, respectively, in gross proceeds from sales or calls of available for sale securities. There were no sales or transfers of held to maturity securities for the six months ended June 30, 2012 and 2011. For the six months ended June 30, 2012 and 2011 there were no gross proceeds from maturities or calls of held to maturity securities. Maturities of all investment securities are consistent with those reported in the December 31, 2011 Form 10-K.

 

At June 30, 2012 and December 31, 2011, securities having fair value amounts of approximately $295,364,000 and $302,852,000, respectively, were pledged to secure public deposits, short-term borrowings, treasury, tax and loan balances and for other purposes required by law or contract. Although the Company had no short-term borrowings at June 30, 2012 and December 31, 2011, the Company pledges most of its securities at the Federal Home Loan Bank (“FHLB”) to provide borrowing capacity. See “Liquidity” on page 39.

 

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

 

8
 

 

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

 

   As of June 30, 2012
   Less than 12 Months  12 Months or Longer  Total
   Estimated Fair Value  Unrealized Losses  Estimated Fair Value  Unrealized Losses  Estimated Fair Value  Unrealized Losses
Description of Securities                              
Government sponsored agency mortgage-backed securities  $20,605   $(31)  $28   $(1)  $20,633   $(32)
Corporate debt securities           4,672    (1,328)   4,672    (1,328)
Total impaired securities  $20,605   $(31)  $4,700   $(1,329)  $25,305   $(1,360)

 

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

 

As of June 30, 2012 and December 31, 2011, there were two corporate debt securities in a loss position for twelve months or more. There is a current active market for these securities and management believes that the unrealized losses on the Company’s investment in these corporate debt securities is due to the yield of the securities and is not attributable to changes in credit quality. The two corporate debt securities are each a $3,000,000 single-issuer trust preferred security issued by two separate large publicly-traded financial institutions. The securities are tied to the front-end of the yield curve, three-month LIBOR (a short-term interest rate), and have a spread over that. The Company does not intend to sell and does not believe it will be required to sell these securities and expects a full recovery of value. The Company does not consider these investments to be other-than-temporarily impaired at June 30, 2012 or December 31, 2011.

 

Management periodically evaluates each investment security for other-than-temporary impairment, relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations. Management has the ability and intent to hold securities with established maturity dates until recovery of fair value, which may be at maturity, and believes it will be able to collect all amounts due according to the contractual terms for all of the underlying investment securities; therefore, management does not consider these investments to be other-than-temporarily impaired.

 

NOTE 3 – LOANS

 

The Company originates loans for business, consumer and real estate activities. Such loans are concentrated in the Company’s market areas which consist of Yolo, Placer, Sonoma, Shasta, Humboldt, Mendocino, Trinity and Del Norte Counties and neighboring communities. Major classifications of loans were as follows (in thousands):

 

   June 30,  December 31,
   2012  2011
Commercial  $43,471   $46,160 
Real estate - commercial   282,957    276,644 
Real estate - construction   28,927    27,463 
Real estate - mortgage   45,511    47,362 
Installment   7,920    10,925 
Other   46,687    47,965 
Gross loans   455,473    456,519 
Deferred loan fees, net   (216)   (304)
Allowance for loan losses   (11,732)   (12,656)
Total loans, net  $443,525   $443,559 

  

9
 

 

Certain real estate loans receivable are pledged as collateral for available borrowings with the FHLB, FRB, and certain correspondent banks. Pledged loans totaled $126,493,000 and $137,528,000 at June 30, 2012 and December 31, 2011, respectively.

 

The Company did not recognize any interest income on impaired loans for the three and six month periods ending June 30, 2012 and the year ending December 31, 2011. The following table presents impaired loans and the related allowance for loan losses as of the dates indicated (in thousands):

 

   As of June 30, 2012  As of December 30, 2012
      Unpaid        Unpaid   
   Recorded  Principal  Related  Recorded  Principal  Related
   Investment  Balance  Allowance  Investment  Balance  Allowance
With no allocated allowance                              
Commercial  $   $   $   $   $   $ 
Real estate - commercial   5,758    6,035        1,502    1,556     
Real estate - construction   3,069    3,113        4,128    4,153     
Real estate - mortgage   660    751        643    751     
Installment   136    147        70    75     
Other   111    114        88    91     
Subtotal   9,734    10,160        6,431    6,626     
                               
With allocated allowance                              
Commercial   1,113    1,117    240    1,788    1,849    450 
Real estate - commercial   187    187    99    4,496    5,302    606 
Real estate - construction   5,312    5,312    529    5,312    5,312    504 
Real estate - mortgage   281    311    35    295    314    37 
Installment               37    39    13 
Other                        
Subtotal   6,893    6,927    903    11,928    12,816    1,610 
Total Impaired Loans  $16,627   $17,087   $903   $18,359   $19,442   $1,610 

 

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

 

   Average Recorded Investment  Average Recorded Investment
   for the three months ended  for the six months ended
   June 30,  June 30,
   2012  2011  2012  2011
             
Commercial  $1,143   $2,284   $1,173   $2,300 
Real estate - commercial   5,989    10,166    6,119    10,211 
Real estate - construction   8,388    4,257    8,394    4,260 
Real estate - mortgage   950    1,153    964    1,157 
Installment   140    23    144    23 
Other   124    50    138    50 
Total  $16,734   $17,933   $16,932   $18,001 

 

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

 

   June 30,  December 31,
   2012  2011
Nonaccrual loans  $16,627   $18,359 
Loans 90 days past due or more but still accruing interest   144    52 
Total nonperforming loans  $16,771   $18,411 
           
Nonaccrual loans to total gross loans   3.65%   4.02%
Nonperforming loans to total gross loans   3.68%   4.04%

 

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If interest on nonaccrual loans had been accrued, such income would have approximated $357,000 and $735,000 for the six months ended June 30, 2012 and 2011, respectively.

 

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

 

   As of June 30, 2012
   Accruing Interest      
   Current  30-89 Days Past Due  Greater than 90 Days
Past Due
  Nonaccrual  Total
                
Commercial  $42,212   $146   $   $1,113   $43,471 
Real estate - commercial   276,774    94    144    5,945    282,957 
Real estate - construction   20,546            8,381    28,927 
Real estate - mortgage   44,315    255        941    45,511 
Installment   7,695    89        136    7,920 
Other   46,494    82        111    46,687 
Total  $438,036   $666   $144   $16,627   $455,473 

 

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

 

During the period ending June 30, 2012, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan. The following table shows information related to Troubled Debt Restructurings for the periods indicated (in thousands):

 

   For the three months ended June 30, 2012  For the six months ended June 30, 2012
   Non Accruing TDRs  Non Accruing TDRs
      Pre-Modification  Post-Modification     Pre-Modification  Post-Modification
   Number  Outstanding  Outstanding  Number  Outstanding  Outstanding
   of  Recorded  Recorded  of  Recorded  Recorded
   Contracts  Investment  Investment  Contracts  Investment  Investment
Commercial   1   $1,076   $1,076    1   $1,076   $1,076 
Real estate - commercial   2   $278   $278    2   $278   $278 
Installment   1   $25   $25    2   $73   $73 

 

At June 30, 2012, there were $203,000 in specific reserves allocated to customers whose loan terms were modified in troubled debt restructurings. There are no commitments to lend additional amounts at June 30, 2012 to customers with outstanding loans that are classified as troubled debt restructurings. There were no loans modified as troubled debt restructurings for which there was a payment default within twelve months following the modification during the year period ending June 30, 2012.

 

There were four loans with modifications involving a reduction of the stated interest rate. There was one modification involving an extension of the maturity date for six months. The recorded investment in five loans was reduced in the aggregate amount of $9,000 during the year.

 

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NOTE 4 – ALLOWANCE FOR LOAN LOSSES

 

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

  

   For the three months ended June 30, 2012
   Commercial  Real Estate Commercial  Real Estate Construction  Real Estate Mortgage  Installment  Other  Unallocated  Total
Allowance for Loan Losses                                        
Balance March 31, 2012  $1,376   $6,847   $1,350   $1,045   $154   $811   $691   $12,274 
Charge-offs   (86)   (1,178)   (126)   (190)   (45)   (47)       (1,672)
Recoveries   14    2    37    36    41            130 
Provisions for loan losses   (44)   915    126    34    (9)   4    (26)   1,000 
Balance June 30, 2012  $1,260   $6,586   $1,387   $925   $141   $768   $665   $11,732 

 

   For the three months ended June 30, 2011
      Real Estate  Real Estate  Real Estate            
   Commercial  Commercial  Construction  Mortgage  Installment  Other  Unallocated  Total
Allowance for Loan Losses                                              
Balance March 31, 2011  $1,268   $8,987   $ 1,566    $919   $ 304    $755   $ 672    $14,471 
Charge-offs       (796)    (197 )   (81)    (124 )            (1,198)
Recoveries   128         10          85              223 
Provisions for loan losses   535    587     (40 )   177     (14 )   (10)    15     1,250 
Balance June 30, 2011  $1,931   $8,778   $ 1,339    $1,015   $ 251    $745   $ 687    $14,746 

 

   For the six months ended June 30, 2012
      Real Estate    Real Estate  Real Estate              
   Commercial  Commercial    Construction  Mortgage    Installment  Other  Unallocated  Total
Allowance for Loan Losses                                            
Balance December 31, 2011  $1,333   $7,528   $ 1,039    $935   $ 185    $736   $900   $12,656 
Charge-offs   (206)   (1,617)    (330 )   (190)    (142 )   (72)       (2,557)
Recoveries   26    63     37     36     65     6        233 
Provisions for loan losses   107    612     641     144     33     98    (235)   1,400 
Balance June 30, 2012  $1,260   $6,586   $ 1,387    $925   $ 141    $768   $665   $11,732 

  

    As of June 30, 2012
Reserve to impaired loans  $240   $99   $529   $35   $   $   $   $903 
Reserve to non-impaired loans  $1,020   $6,487   $858   $890   $141   $768   $665   $10,829 

  

   For the six months ended June 30, 2011
      Real Estate  Real Estate  Real Estate            
   Commercial  Commercial  Construction  Mortgage  Installment  Other  Unallocated  Total
Allowance for Loan Losses                                            
Balance December 31, 2010  $1,517   $8,439   $ 1,936    $956   $ 339    $666   $1,140   $14,993 
Charge-offs   (874)   (858)    (197 )   (281)    (292 )   (301)       (2,803)
Recoveries   138         10          158             306 
Provisions for loan losses   1,150    1,197     (410 )   340     46     380    (453)   2,250 
Balance June 30, 2011  $1,931   $8,778   $ 1,339    $1,015   $ 251    $745   $687   $14,746 

 

   As of June 30, 2011
Reserve to impaired loans  $835   $915   $   $130   $   $   $   $1,880 
Reserve to non-impaired loans  $1,096   $7,863   $1,339   $885   $251   $745   $687   $12,866 
                                         

 

   As of December 31, 2011
Reserve to impaired loans  $450   $606   $504   $37   $13   $   $   $1,610 
Reserve to non-impaired loans  $883   $6,922   $535   $898   $172   $736   $900   $11,046 

 

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

 

Loans  As of June 30, 2012
        Real Estate  Real Estate  Real Estate         
     Commercial  Commercial  Construction  Mortgage  Installment  Other  Total
Total Loans    $43,471   $282,957   $ 28,927  $45,511   $ 7,920  $46,687   $ 455,473
Impaired Loans    $1,113   $5,945   $ 8,381  $941   $ 136  $111   $ 16,627
Non-impaired loans    $42,358   $277,012   $ 20,546  $44,570   $ 7,784  $46,576   $ 438,846

 

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

 

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

 

   As of June 30, 2012
   Pass  Special Mention  Substandard  Doubtful  Total
Commercial  $41,779   $ -  $1,692   $   $43,471 
Real estate - commercial   260,721     3,883   18,353        282,957 
Real estate - construction   19,939     356   8,632        28,927 
Real estate - mortgage   42,910        2,601        45,511 
Installment   7,780        140        7,920 
Other   46,404        283        46,687 
Total  $419,533   $ 4,239  $31,701   $   $455,473 

 

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

 

The allowance for loan losses is established through a provision for loan losses based on management’s evaluation of the risks inherent in the loan portfolio. In determining levels of risk, management considers a variety of factors, including, but not limited to, asset classifications, economic trends, industry experience and trends, geographic concentrations, estimated collateral values, historical loan loss experience, and the Company’s underwriting policies. During the quarter ended June 30, 2012, the Company extended the loss look back period from two years to three years to expand the data range for historical loss factors. The allowance for loan losses is maintained at an amount management considers adequate to cover the probable losses in loans receivable. While management uses the best information available to make these estimates, future adjustments to allowances may be necessary due to economic, operating, regulatory, and other conditions that may be beyond the Company’s control. The Company also engages a third party credit review consultant to analyze the Company’s loan loss adequacy each calendar quarter. In addition, the regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on judgments different from those of management.

 

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

 

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

 

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

 

Unallocated Allowance. The unallocated loan loss allowance represents an amount for imprecision or uncertainty that is inherent in estimates used to determine the allowance.

 

The Company also maintains a separate allowance for off-balance-sheet commitments. A reserve for unfunded commitments is maintained at a level that, in the opinion of management, is adequate to absorb probable losses associated with commitments to lend funds under existing agreements, for example, NVB’s commitment to fund advances under lines of credit. The reserve amount for unfunded commitments is determined based on our methodologies described above with respect to the formula allowance. The allowance for off-balance-sheet commitments is included in accrued interest payable and other liabilities on the consolidated balance sheet and was $183,000 and $161,000, as of June 30, 2012 and December 31, 2011, respectively.

 

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

 

NOTE 5 – OTHER REAL ESTATE OWNED

 

The Company had $15,648,000 and $20,106,000 in other real estate owned (“OREO”) at June 30, 2012 and December 31, 2011, respectively. Below is a table with details of the changes in OREO (in thousands):

 

   June 30,  December 31,
   2012  2011
Beginning balance  $20,106   $25,784 
Properties transferred in   575    10,454 
Sales of property   (4,284)   (12,036)
Loss on sale or writedown of property   (749)   (4,096)
Total  $15,648   $20,106 

 

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

 

   Three months ended June 30,  Six months ended June 30,
   2012  2011  2012  2011
Operating expenses  $72   $297   $227   $383 
Provision for losses   165    920    561    1,431 
Net, loss(gain) on disposal   105    (40)   188    (185)
Total other real estate owned expense  $342   $1,177   $976   $1,629 

 

NOTE 6 – SUBORDINATED DEBENTURES

 

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

 

The Indentures provide generally that the payment of interest is deferrable, at the option of the Company, for up to 20 consecutive quarters (or 10 consecutive semi-annual periods). Nonpayment of interest for more than 20 consecutive quarters (or 10 semi-annual periods) is an event of default pursuant to which the payment of principal and interest may be accelerated by the Indenture Trustee. As of June 30, 2012, the Company had deferred the payment of interest for a total of eleven consecutive quarters.

 

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This series of deferrals of interest represent the first time that the Company has deferred payment of interest on the Debentures. The obligation to pay interest on the Debentures is cumulative and will continue to accrue, currently at a fixed rate of 10.25% on the 2031 Debentures, variable rate of 3.72% on the 2033 Debentures, variable rate of 3.27% on the 2034 Debentures and a variable rate of 1.80%, on the 2036 Debentures. Interest is generally set at variable rates based on the three-month LIBOR, reset and payable quarterly, plus 3.25% for the 2033 Debentures, plus 2.80% for the 2034 Debentures and plus 1.33% for the 2036 Debentures. As of June 30, 2012 and December 31, 2011, the amount of accrued interest payable on the Debentures was $5,854,000 and $4,854,000, respectively. Subject to regulatory approval, the Company may redeem some or all of the debentures earlier than their maturity dates.

 

On May 29, 2012, the Company received approval from the Federal Reserve Bank of San Francisco and on May 9, 2012, the Company received approval from the California Department of Financial Institutions to pay all deferred interest on its junior subordinated notes underlying its trust preferred securities in the amount of $5,854,000 and to fully redeem its North Valley Capital Trust I notes in the amount of $10,310,000, bearing an interest rate of 10.25%. On July 23, 2012, the Company paid all deferred interest on its junior subordinated notes and on July 25, 2012, it redeemed, in full, the notes associated with North Valley Capital Trust I. 

 

NOTE 7 – INCOME TAXES

 

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

 

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

 

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

 

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

 

Net deferred tax assets totaled $9,525,000 and $10,721,000 at June 30, 2012 and December 31, 2011, respectively. The Company evaluates deferred income tax assets for recoverability based on all available evidence. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws, our ability to successfully implement tax planning strategies, or variances between our future projected operating performance and our actual results. For purposes of establishing a deferred tax valuation allowance, the Company considers its inability to meet its financial goals in years 2011 and 2010, and its pre-tax loss in the prior year as significant, objective evidence that the Company may not be able to realize some portion of its deferred tax assets in the future. Higher than expected OREO expenses in 2011 and 2010 provided further evidence that some of the tax benefits had not met the “more likely than not” standard and may not be realized. Management also considered available tax planning strategies, the scheduled reversal of deferred tax assets and liabilities, and the nature and amount of historical and projected future taxable income that provide positive evidence that some of the tax benefits will be realizable. Accordingly, the Company established a partial valuation allowance in 2010 of $4,500,000 to reflect the portion of the deferred tax assets that the Company determined to be more likely than not that it will not be realized. During the quarter ended December 31, 2011, the Company reversed the Federal portion of its valuation allowance in the amount of $223,000, and at June 30, 2012 had a remaining valuation allowance of $4,277,000.

 

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NOTE 8 - PENSION PLAN BENEFITS

 

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

 

   Three months ended June 30,  Six months ended June 30,
Components of net periodic benefits cost:  2012  2011  2012  2011
Service cost  $151   $   $301   $ 
Interest cost   83    76    167    152 
Prior service amortization   24    8    49    16 
Recognized net actuarial loss   10    4    20    8 
Total components of net periodic cost  $268   $88   $537   $176 

 

   June 30,  December 31,
    2012    2011 
           
Total Liability of Pension Plan Benefits  $7,740   $7,397 

 

NOTE 9 – STOCK-BASED COMPENSATION

 

Stock Option Plans

 

At June 30, 2012, the Company had two shareholder approved stock-based compensation plans: the 1998 Employee Stock Incentive Plan and the 2008 Stock Incentive Plan. A total of 480,050 shares were authorized under all plans at June 30, 2012. The plans do not provide for the settlement of awards in cash and new shares are issued upon exercise of the options. The North Valley Bancorp 1998 Employee Stock Incentive Plan provides for awards in the form of options (which may constitute incentive stock options (“ISOs”) or non-statutory stock options (“NSOs”) to key employees) and also provides for the award of shares of Common Stock to outside directors. As provided in the 1998 Employee Stock Incentive Plan, the authorization to award incentive stock options terminated on February 19, 2008. Pursuant to the 1998 Employee Stock Incentive Plan there were outstanding options to purchase 66,759 shares of Common Stock at June 30, 2012. The North Valley Bancorp 2008 Stock Incentive Plan was adopted by the Company’s Board of Directors on February 27, 2008, effective that date, and was approved by the Company’s shareholders at the annual meeting, May 22, 2008. The terms of the 2008 Stock Incentive Plan are substantially the same as the North Valley Bancorp 1998 Employee Stock Incentive Plan. The 2008 Stock Incentive Plan provides for the grant to key employees of stock options, which may consist of NSOs and ISOs. Under the 2008 Stock Incentive Plan, options may not be granted at a price less than the fair market value at the date of the grant. Under all plans, options may be exercised over a ten year term. The vesting period is generally four years; however the vesting period can be modified at the discretion of the Company’s Board of Directors, and for all options granted after the fourth quarter in 2008 the vesting period is five years. The 2008 Stock Incentive Plan also provides for the grant to outside directors, and to consultants and advisers to the Company, of stock options, all of which must be NSOs. The shares of Common Stock authorized to be granted as options under the 2008 Stock Incentive Plan consist 413,291 shares of Common Stock reserved for issuance under the terms of the 2008 Stock Incentive Plan, consisting of 189,526 shares to be issued upon the exercise of options granted and still outstanding as of that date, 2,700 shares issued as stock awards and 221,065 shares reserved for future stock option grants and director stock awards at June 30, 2012. Effective January 1, 2009, and on each January 1 thereafter for the remaining term of the 2008 Stock Incentive Plan, the aggregate number of shares of Common Stock which are reserved for issuance pursuant to options granted under the terms of the 2008 Stock Incentive Plan shall be increased by a number of shares of Common Stock equal to 2% of the total number of the shares of Common Stock of the Company outstanding at the end of the most recently concluded calendar year. Any shares of Common Stock that have been reserved but not issued as options during any calendar year shall remain available for grant during any subsequent calendar year. Each outside director of the Company shall also be eligible to receive a stock award of 180 shares of Common Stock as part of his or her annual retainer paid by the Company for his or her services as a director. Each stock award shall be fully vested when granted to the outside director. The number of shares of Common Stock available as stock awards to outside directors shall equal the number of shares of Common Stock to be awarded to such outside directors. Outstanding options under the plans are exercisable until their expiration.

 

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Stock-based Compensation

 

There were 2,500 and 77,908 options granted for the three and six month periods ended June 30, 2012. There were no options granted in the three month period ended June 30, 2011 and there were 1,000 options granted in the six month period ended June 30, 2011. For the three month periods ended June 30, 2012 and 2011, the compensation cost recognized for share based compensation was $49,000 and $29,000, respectively.  For the six month periods ended June 30, 2012 and 2011, the compensation cost recognized for share based compensation was $89,000 and $60,000, respectively. At June 30, 2012, the total unrecognized compensation cost related to stock-based awards granted to employees under the Company’s stock option plans was $821,000. This cost is expected to be amortized on a straight-line basis over a weighted average period of approximately 4.3 years and will be adjusted for subsequent changes in estimated forfeitures. The weighted average grant date fair value of options granted for the three and six month periods ended June 30, 2012 was $7.08 and 6.28, respectively, based on the following assumptions used in a Black-Scholes Merton model.

 

   For three months ended  For six months ended
   June 30, 2012  June 30, 2012
       
Weighted average grant date fair value per share of options granted  $7.08   $6.28 
Significant weighted average assumptions used in calculating fair value:          
Expected term   6.61 years    6.49 years 
Expected annual volatility   58.1%   58.5%
Expected annual dividend yield   N/A    N/A 
Risk-free interest rate   1.38%   1.40%

 

A summary of outstanding stock options follows:

 

         Weighted      
      Weighted  Average      
      Average  Remaining  Exercise  Aggregate
      Exercise  Contractual  Price  Intrinsic
   Shares  Price  Term  Range  Value ($000)
                
Outstanding at January 1, 2012   184,070   $38.55    7 years   $8.99-$103.10   $185 
                          
Granted   77,908   $11.13         $9.97-$12.53   $161 
Exercised                   $ 
Expired or Forfeited   (5,693)  $44.30        $8.99-$103.10   $4 
                          
Outstanding at June 30, 2012   256,285   $30.08    7 years   $9.97-$103.10   $342 
Fully vested and exercisable at June 30, 2012   94,724   $60.46    4 years   $17.85-$103.10   $ 
Options expected to vest   161,561   $12.28    9 years   $9.97-$23.95   $342 

 

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company’s common stock as of June 30, 2012. There were no options exercised during the six months ended June 30, 2012 and 2011.

 

NOTE 10 – EARNINGS PER SHARE

 

Basic earnings per share (“EPS”), which excludes dilution, is computed by dividing income or loss available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as stock options, result in the issuance of common stock which shares in the earnings of the Company. The treasury stock method has been applied to determine the dilutive effect of stock options in computing diluted EPS. Diluted EPS are not presented when a net loss occurs because the conversion of potential common stock is antidilutive. Earnings per share are retroactively adjusted for stock dividends and stock splits for all periods presented. Stock options for 256,285 and 121,757 shares of common stock were not considered in computing diluted earnings per common share for the six months ended June 30, 2012 and 2011, respectively, because they were anti-dilutive. The weighted average common shares outstanding used in the calculation of earnings per share totaled 6,833,752 and 6,832,492 for the periods ending June 30, 2012 and 2011, respectively. There was no difference in the denominator used in the calculation of basic earnings per share and diluted earnings per share in 2012 and 2011.

 

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NOTE 11 – OTHER COMPREHENSIVE INCOME

 

At June 30, 2012 and 2011, the Company’s other comprehensive income components were as follows (in thousands):

 

   Three months ended June 30, 2012     Three months ended June 30, 2011 
   Before Tax    Tax Effect    After Tax   Before Tax    Tax Effect    After Tax 
Other comprehensive income:                              
Unrealized holding gains  $2,114   $(866)  $1,248   $4,815   $(1,975)  $2,840 
Less: reclassification adjustment for                              
realized losses included in net income   968    (397)   571             
Other comprehensive income on investment securities   1,146    (469)   677    4,815    (1,975)   2,840 
Adjustment on pension plan   70    (29)   41             
Total other comprehensive income  $1,216   $(498)  $718   $4,815   $(1,975)  $2,840 

 

   Six months ended June 30, 2012    Six months ended June 30, 2011 
   Before Tax   Tax Effect   After Tax   Before Tax   Tax Effect   After Tax 
Other comprehensive income:                               
Unrealized holding gains  $3,809   $(1,562)  $2,247   $5,398   $(2,213)  $3,185 
Less: reclassification adjustment for                              
realized losses included in net income   959    (393)   566    (10)   4    (6)
Other comprehensive income on investment                              
securities   2,850    (1,169)   1,681    5,408    (2,217)   3,191 
Adjustment on pension plan   70    (29)   41             
Total other comprehensive income  $2,920   $(1,198)  $1,722   $5,408   $(2,217)  $3,191 

 

NOTE 12 – COMMITMENTS AND CONTINGENCIES

 

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

 

The Company was contingently liable under letters of credit issued on behalf of its customers in the amount of $4,581,000 and $4,946,000 at June 30, 2012 and December 31, 2011, respectively. At June 30, 2012, commercial and consumer lines of credit and real estate loans of approximately $42,961,000 and $41,383,000, respectively, were undisbursed. At December 31, 2011, commercial and consumer lines of credit and real estate loans of approximately $45,033,000 and $41,077,000, respectively, were undisbursed.

 

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

 

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Standby letters of credit are conditional commitments written by the Company to guarantee the performance of a customer to a third party. These guarantees are issued primarily relating to real estate projects and inventory purchases by the Company’s commercial customers and such guarantees are typically short term. Credit risk is similar to that involved in extending loan commitments to customers and the Company, accordingly, uses evaluation and collateral requirements similar to those for loan commitments. Most of such commitments are collateralized. The fair value of the liability related to these standby letters of credit, which represents the fees received for issuing the guarantees, was not significant at June 30, 2012 and December 31, 2011. The Company recognizes these fees as revenues over the term of the commitment or when the commitment is used.

 

Loan commitments and standby letters of credit involve, to varying degrees, elements of credit and market risk in excess of the amounts recognized in the balance sheet and do not necessarily represent the actual amount subject to credit loss. At June 30, 2012, the Company had a reserve for unfunded commitments of $183,000.

 

A large portion of the loan portfolio of the Company is collateralized by real estate. At June 30, 2012 and December 31, 2011, real estate served as the principal source of collateral with respect to approximately 78% of the Company’s loan portfolio. At June 30, 2012, real estate construction loans totaled $28,927,000, or 6% of the total loan portfolio, commercial loans secured by real estate totaled $282,957,000, or 62% of the total loan portfolio, and real estate mortgage loans totaled $45,511,000, or 10% of the total loan portfolio. A further decline in the state and national economy, in general, combined with further deterioration in real estate values in the Company’s primary operating market areas, would have an adverse effect on the value of real estate as well as other collateral securing loans, plus the ability of certain borrowers to repay their outstanding loans and the overall demand for new loans, and this could have a material impact on the Company’s financial position, results of operations or its cash flows.

 

NOTE 13 – FAIR VALUE MEASUREMENTS

 

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

 

·Quoted prices in active markets for identical assets (Level 1): Inputs that are quoted unadjusted prices in active markets for identical assets that the Company has the ability to access at the measurement date. An active market for the asset is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.

 

Significant other observable inputs (Level 2): Inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity including quoted prices for similar assets or liabilities, quoted prices for securities in inactive markets and inputs derived principally from, or corroborated by, observable market data by correlation or other means.

 

Significant unobservable inputs (Level 3): Inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

 

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Assets Recorded at Fair Value on a Recurring Basis:

 

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

 

   As of June 30, 2012 
    Fair Value    Level 1    Level 2    Level 3 
Available-for-sale securities:                
Obligations of U.S. government sponsored agencies  $15,141   $   $15,141   $ 
Obligations of state and political subdivisions   12,524        12,524     
Government sponsored agency mortgage-backed securities   269,914        269,914     
Corporate debt securities   4,672        4,672     
Equity securities   3,127        3,127     
   $305,378   $   $305,378   $ 

 

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

 

Fair values for available-for-sale investment securities are based on quoted market prices for similar securities at June 30, 2012 and December 31, 2011. During the quarter ended June 30, 2012, there were no transfers between Levels 1 and 2.

 

Assets Recorded at Fair Value on a Nonrecurring Basis:

 

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

 

                   Total Losses/(Gains)  
   As of June 30, 2012   For three months ended For six months ended 
   Fair Value   Level 1   Level 2   Level 3   June 30, 2012   June 30, 2011   June 30, 2012   June 30, 2011 
Impaired loans:                                        
Real estate - commercial  $1,380   $   $   $1,380   $1,278   $887   $1,457   $1,335 
Real estate - construction   839            839    9        25    19 
Real estate - mortgage   416            416    70    75    70    130 
OREO:                                        
Real estate - commercial                       74        283 
Real estate - construction   1,150            1,150    87    187    133    605 
Real estate - mortgage   303            303    77    37    152    31 
Total assets measured at fair value on a nonrecurring basis  $4,088   $   $   $4,088   $1,521   $1,260   $1,837   $2,403 

 

                   Total Losses 
   As of December 31, 2011   Twelve months ended 
   Fair Value   Level 1   Level 2   Level 3   December 31, 2011 
Impaired loans:                         
Commercial  $1,338   $   $   $1,338   $324 
Real estate - commercial   4,811            4,811    1,138 
Real estate - construction   5,223            5,223    504 
Real estate - mortgage   268            268    37 
Installment   37            37    13 
OREO:                         
Real estate - commercial   1,270            1,270    253 
Real estate - construction   14,575            14,575    2,645 
Real estate - mortgage   1,276            1,276    34 
Total assets measured at fair value on a nonrecurring basis  $28,798   $   $   $28,798   $4,948 

 

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

 

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

 

The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at June 30, 2012 (in thousands)

 

    Fair Value   Valuation Techniques   Unobservable Inputs   Range (Weighted Average)
                 
Impaired loans:                
Real estate - commercial $ 1,380   Comparable sales approach   Discount adjustment for differences between comparable sales   6% to 11% (9%)
Real estate - construction   839   Comparable sales approach   Discount adjustment for differences between comparable sales   2% to 3% (3%)
Real estate - mortgage   416   Comparable sales approach   Discount adjustment for differences between comparable sales   6% to 11% (9%)
OREO:                
Real estate - construction   1,150   Comparable sales approach   Discount adjustment for differences between comparable sales   0% to 6% (6%)
Real estate - mortgage   303   Comparable sales approach   Discount adjustment for differences between comparable sales   6% to 11% (9%)

 

Disclosures about Fair Value of Financial Instruments

 

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

 

The following assumptions were used as of June 30, 2012 and December 31, 2011 to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value.

 

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

 

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

 

       Fair Value Measurements at
June 30, 2012 Using
    
   Carrying Amount   Level 1   Level 2   Level 3   Total 
FINANCIAL ASSETS                         
Cash and due from banks  $19,037   $19,037   $   $   $19,037 
Federal funds sold   53,375    53,375            53,375 
Time deposits at other financial institutions   1,960    1,960            1,960 
FHLB, FRB and other securities   8,313                N/A 
                          
Securities:                         
Available-for-sale   305,378        305,378        305,378 
Held-to-maturity   6        6        6 
Loans   443,525            461,284    461,284 
Accrued interest receivable   2,370        1,036    1,334    2,370 
                          
FINANCIAL LIABILITIES                         
Deposits:                         
Nonmaturity deposits  $567,989   $567,989   $   $   $567,989 
Time deposits   195,282        195,914        195,914 
Subordinated debentures   31,961            22,899    22,899 
Accrued interest payable   5,952    8    90    5,854    5,952 

 

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

 

NOTE 14 – NEW ACCOUNTING PRONOUNCEMENTS

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

 

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

 

NOTE 15 – SUBSEQUENT EVENTS

 

In addition to the redemption of the notes associated with North Valley Capital Trust I as discussed above, subsequent to June 30, 2012 the Board of Directors of the Company approved the filing of applications to consolidate two of its branches, subject to regulatory approval. The applications were filed with the Company’s regulators on July 30, 2012.

 

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

 

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

 

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Critical Accounting Policies

 

General

 

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

 

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

 

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

 

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

 

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

 

Share Based Compensation. At June 30, 2012, the Company had two stock-based compensation plans: the 1998 Employee Stock Incentive Plan and the 2008 Stock Incentive Plan, which are described more fully in Note 9 to the Notes to Condensed Consolidated Financial Statements. Compensation cost is recognized on all share-based payments over the requisite service periods of the awards based on the grant-date fair value of the options determined using the Black-Scholes-Merton based option valuation model. Critical assumptions that are assessed in computing the fair value of share-based payments include stock price volatility, expected dividend rates, the risk free interest rate and the expected lives of such options. Compensation cost recorded is net of estimated forfeitures expected to occur prior to vesting. For further information on the computation of the fair value of share-based payments, see Note 9 to the Notes to Condensed Consolidated Financial Statements in Item I above.

 

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

 

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

 

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

 

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

 

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

 

The Company evaluates deferred income tax assets for recoverability based on all available evidence. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws, our ability to successfully implement tax planning strategies, or variances between our future projected operating performance and our actual results. The Company is required to establish a valuation allowance for deferred tax assets if we determine, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In determining the more-likely-than-not criterion, we evaluate all positive and negative available evidence as of the end of each reporting period. Future adjustments to the deferred tax asset valuation allowance, if any, will be determined based upon changes in the expected realization of net deferred tax assets. The realization of deferred tax assets ultimately depends on the existence of sufficient taxable income in the carry back and carries forward periods under the tax law. Due to the Company’s cumulative tax losses in 2009 and 2010, it was determined to establish a partial valuation allowance in 2010 of $4,500,000 to reflect the portion of the deferred tax assets that the Company determined to be more likely than not that it will not be realized. During the quarter ended December 31, 2011, the Company reversed the Federal portion of its valuation allowance in the amount of $223,000, and at June 30, 2012 had a remaining valuation allowance of $4,277,000.

 

Business Organization

 

North Valley Bancorp (the “Company”) is a California corporation and a bank holding company for North Valley Bank, a California state-chartered, Federal Reserve member bank (“NVB”). NVB operates out of its main office located at 300 Park Marina Circle, Redding, California 96001, with twenty-four branches, including two supermarket branches in eight counties in Northern California. On July 26, 2012, the Board of Directors of the Company approved the filing of applications to consolidate two if its branches, subject to regulatory approval. The applications were filed with the Company’s regulators on July 30, 2012. The Company views its service area as having four distinct markets: the Redding market, the Coastal market, the I-80 Corridor market and the Santa Rosa market.

 

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

 

25
 

 

Overview

 

Financial Results

 

(in thousands except per share amounts)  Three months ended June 30,   Six months ended June 30, 
   2012   2011   2012   2011 
Net interest income  $7,329   $8,158   $14,721   $15,964 
Provision for loan losses   1,000    1,250    1,400    2,250 
Noninterest income   4,687    3,483    7,946    6,636 
Noninterest expense   9,228    9,735    18,884    19,206 
Provision for income taxes   527    137    642    226 
Net income  $1,261   $519   $1,741   $918 
                     
Per Share Amounts                    
Basic and Diluted Income Per Share  $0.18   $0.08   $0.25   $0.13 
                     
Annualized Return on Average Assets   0.56%   0.23%   0.38%   0.21%
Annualized Return on Average Equity   5.47%   2.42%   3.81%   2.17%

 

The Company had net income of $1,261,000, or $0.18 per diluted share, and $1,741,000, or $0.25 per diluted share for the three and six months ended June 30, 2012, respectively. This compares to net income of $519,000, or $0.08 per diluted share, and $918,000, or $0.13 per diluted share for the three and six months ended June 30, 2011. The net income for three and six months ended June 30, 2012 compared to the net income for three and six months ended June 30, 2011 was primarily attributed to gains on sale of securities and an increase in gains on real estate loans. Noninterest expense decreased for the three and six months ended June 30, 2012 compared to the three and six months ended June 30, 2011 due to other real estate owned expense and FDIC assessment decreases offset by higher salaries and benefit costs.

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

Results of Operation

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

Net interest income is the difference between interest earned on loans and investments and interest paid on deposits and borrowings, and is the primary revenue source for the Company. Net interest margin is net interest income expressed as a percentage of average earning assets. These items have been adjusted to give effect to $70,000 and $78,000 in taxable-equivalent interest income on tax-free investments for the three month periods ended June 30, 2012 and 2011, respectively.

 

Net interest income for the three months ended June 30, 2012 was $7,399,000, an $837,000, or 10.2%, decrease from net interest income of $8,236,000 for the same period in 2011. Interest income decreased $1,198,000, or 12.4%, to $8,490,000 for the three month period ended June 30, 2012 due primarily to a decrease in average loans. The Company had foregone interest income for the loans placed on nonaccrual status of $203,000 during the three months ended June 30, 2012 compared to $476,000 for the same period in 2011. The average loans outstanding during the three months ended June 30, 2012 decreased $43,321,000, or 8.8%, to $449,215,000. This lower loan volume decreased interest income by $652,000. The average yield earned on the loan portfolio decreased 37 basis points to 5.65% for the three months ended June 30, 2012. This decrease in yield decreased interest income by $418,000. The total decrease in interest income from the loan portfolio was $1,070,000. The average balance of the investment portfolio increased $34,411,000, or 11.5%, which accounted for a $231,000 increase in interest income and a decrease in average yield of the investment portfolio of 49 basis points reduced interest income by $369,000.

 

Interest expense for the three months ended June 30, 2012 decreased $361,000, or 24.9%, to $1,091,000 compared to the same period in 2011. The largest decrease to interest expense was in time deposit accounts which decreased $11,934,000 as the average rates paid on these accounts decreased 36 basis points to 0.88% and reduced interest expense by $181,000 while a decrease in the average balances of these accounts decreased interest expense by $37,000. The average rate paid on savings and money market accounts decreased 25 basis points to 0.23% for the three month period ended June 30, 2012 compared to 0.48% for the same period in 2011, resulting in a decrease in interest expense of $144,000. This decrease was offset partially by higher average balances in transaction accounts of $15,266,000, resulting in a $7,000 increase in interest expense. On July 25, 2012, the Company redeemed, in full, its North Valley Capital Trust I, in the amount of $10,310,000, bearing an interest rate of 10.25%. The Company expects this redemption to decrease interest expense by approximately $264,000 per quarter (due to the redemption occurring twenty-four days into July, interest expense will only decrease approximately $197,000 in the third quarter of 2012).

 

26
 

 

The net interest margin for the three months ended June 30, 2012 decreased 45 basis points to 3.67% from 4.12% for the same period in 2011 and a 6 basis point increase from the 3.61% net interest margin for the linked quarter ended March 31, 2012.

 

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

 

Schedule of Average Daily Balance and Average Yields and Rates

(Dollars in thousands)

 

   Three months ended June 30, 2012   Three months ended June 30, 2011 
   Average   Yield/   Interest   Average   Yield/   Interest 
   Balance   Rate   Amount   Balance   Rate   Amount 
                         
Assets                              
Earning assets:                              
Federal funds sold  $27,049    0.25%  $17   $11,634    0.24%  $7 
Investment securities:                              
Taxable   320,264    2.43%   1,943    283,680    2.91%   2,057 
Tax exempt (1)   12,229    6.76%   206    14,402    6.41%   230 
Total investments   332,493    2.59%   2,149    298,082    3.08%   2,287 
Loans (2)(3)   449,215    5.65%   6,324    492,536    6.02%   7,394 
Total earning assets   808,757    4.21%   8,490    802,252    4.84%   9,688 
                               
Nonearning assets   111,090              107,208           
Allowance for loan losses   (12,098)             (14,997)          
Total nonearning assets   98,992              92,211           
                               
Total assets  $907,749             $894,463           
                               
Liabilities and Stockholders’ Equity                              
Interest bearing liabilities:                              
Transaction accounts  $179,726    0.08%  $34   $164,460    0.19%  $79 
Savings and money market   222,669    0.23%   125    223,483    0.48%   270 
Time certificates   202,415    0.88%   445    214,349    1.24%   663 
Other borrowed funds   31,961    6.11%   487    32,166    5.49%   440 
Total interest bearing liabilities   636,771    0.69%   1,091    634,458    0.92%   1,452 
Demand deposits   157,268              156,265           
Other liabilities   21,299              17,828           
Total liabilities   815,338              808,551           
Stockholders’ equity   92,411              85,912           
Total liabilities and stockholders’ equity  $907,749             $894,463           
Net interest income            $7,399             $8,236 
Net interest spread        3.52%             3.92%     
Net interest margin        3.67%             4.12%     

 


 

(1) Tax-equivalent basis; non-taxable securities are exempt from federal taxation.
(2) Loans on nonaccrual status have been included in the computations of averages balances.
(3) Includes loan fees of $89 and $95 for the three months ended June 30, 2012 and 2011, respectively.

 

Net interest income for the six months ended June 30, 2012 was $14,865,000, a $1,262,000, or 7.8%, decrease from net interest income of $16,127,000 for the same period in 2011. Interest income decreased $2,018,000, or 10.5%, to $17,173,000 for the six month period ended June 30, 2012 due primarily to a decrease in average loans. The Company had foregone interest income for the loans placed on nonaccrual status of $357,000 during the six months ended June 30, 2012 compared to $735,000 for the same period in 2011. The average loans outstanding during the six months ended June 30, 2012 decreased $47,109,000, or 9.5%, to $450,347,000. This lower loan volume decreased interest income by $1,418,000. The average yield earned on the loan portfolio decreased 32 basis points to 5.70% for the six months ended June 30, 2012. This decrease in yield decreased interest income by $632,000. The total decrease in interest income from the loan portfolio was $2,050,000. The average balance of the investment portfolio increased $39,205,000, or 13.4%, which accounted for a $514,000 increase in interest income and a decrease in average yield of the investment portfolio of 37 basis points reduced interest income by $512,000.

27
 

 

Interest expense for the six months ended June 30, 2012 decreased $756,000, or 24.7%, to $2,308,000 compared to the same period in 2011. The largest decrease in interest expense was in time deposit accounts which decreased $11,600,000 as the average rates paid on these accounts decreased 34 basis points to .95% and reduced interest expense by $346,000 while a decrease in the average balances of these accounts decreased interest expense by $75,000. The average rate paid on savings and money market accounts decreased 24 basis points to 0.24% for the six month period ended June 30, 2012 compared to 0.48% for the same period in 2011, resulting in a decrease to interest expense of $261,000. This decrease was offset partially by higher average balances in transaction accounts of $14,962,000, resulting in a $14,000 increase in interest expense.

 

The net interest margin for the six months ended June 30, 2012 decreased 41 basis points to 3.64% from 4.05% for the same period in 2011. The following table sets forth the Company’s consolidated condensed average daily balances and the corresponding average yields received and average rates paid of each major category of assets, liabilities, and stockholders’ equity for the periods indicated (these items have been adjusted to give effect to $144,000 and $163,000 in taxable-equivalent interest income on tax-free investments for the six month periods ended June 30, 2012 and 2011, respectively):

 

Schedule of Average Daily Balance and Average Yields and Rates

(Dollars in thousands)

 

   Six months ended June 30, 2012   Six months ended June 30, 2011 
   Average   Yield/   Interest   Average   Yield/   Interest 
   Balance   Rate   Amount   Balance   Rate   Amount 
                         
Assets                              
Earning assets:                              
Federal funds sold  $38,000    0.24%  $45   $12,915    0.23%  $15 
Investment securities:                              
Taxable   318,520    2.46%   3,910    277,542    2.80%   3,852 
Tax exempt (1)   12,607    6.74%   424    14,380    6.73%   480 
Total investments   331,127    2.62%   4,334    291,922    2.99%   4,332 
Loans (2)(3)   450,347    5.70%   12,794    497,456    6.02%   14,844 
Total earning assets   819,474    4.20%   17,173    802,293    4.82%   19,191 
                               
Nonearning assets   104,851              106,907           
Allowance for loan losses   (12,363)             (14,817)          
Total nonearning assets   92,488              92,090           
                               
Total assets  $911,962             $894,383           
                               
Liabilities and Stockholders’ Equity                              
Interest bearing liabilities:                              
Transaction accounts  $177,863    0.09%  $81   $162,901    0.19%  $157 
Savings and money market   221,199    0.24%   270    220,525    0.48%   529 
Time certificates   207,657    0.95%   987    219,257    1.29%   1,408 
Other borrowed funds   31,961    6.09%   970    32,064    6.10%   970 
Total interest bearing liabilities   638,680    0.72%   2,308    634,747    0.97%   3,064 
Demand deposits   157,826              155,881           
Other liabilities   23,888              18,385           
Total liabilities   820,394              809,013           
Stockholders’ equity   91,568              85,370           
Total liabilities and stockholders’ equity  $911,962             $894,383           
Net interest income            $14,865             $16,127 
Net interest spread        3.48%             3.85%     
Net interest margin        3.64%             4.05%     

 


(1) Tax-equivalent basis; non-taxable securities are exempt from federal taxation.
(2) Loans on nonaccrual status have been included in the computations of averages balances.
(3) Includes loan fees of $127 and $155 for the six months ended June 30, 2012 and 2011, respectively.

28
 

 

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

 

Changes in Volume/Rate                     
(Dollars in thousands)  Three months ended June 30, 2012   Six months ended June 30, 2012 
   compared with   compared with 
   Three months ended June 30, 2011   Six months ended June 30, 2011 
   Average Volume   Average Yield/Rate   Total Increase (Decrease)   Average Volume   Average Yield/Rate   Total Increase (Decrease) 
Interest Income                              
Interest on Federal funds sold  $9   $1   $10   $29   $1   $30 
Interest on investments:                           
Taxable securities   266    (380)   (114)   574    (516)   58 
Tax exempt securities (1)   (35)   11    (24)   (60)   4    (56)
Total investments   231    (369)   (138)   514    (512)   2 
Interest on loans   (652)   (418)   (1,070)   (1,418)   (632)   (2,050)
Total interest income   (412)   (786)   (1,198)   (875)   (1,143)   (2,018)
                               
Interest Expense                              
Transaction accounts  $7   $(52)  $(45)  $14   $(90)  $(76)
Savings and money market   (1)   (144)   (145)   2    (261)   (259)
Time deposits   (37)   (181)   (218)   (75)   (346)   (421)
Other borrowed funds   (3)   50    47    (3)   3     
Total interest expense   (34)   (327)   (361)   (62)   (694)   (756)
                               
Total change in net interest income  $(378)  $(459)  $(837)  $(813)  $(449)  $(1,262)

 

 

(1) Taxable equivalent

 

Provision for Loan Losses

 

The provision for loan losses reflects changes in the credit quality of the entire loan portfolio. The provision for loan losses is recorded to bring the allowance for loan losses and the reserve for unfunded commitments to amounts considered appropriate by management based on factors which are discussed under “Allowance for Loan Losses” starting on page 36.

 

The Company recorded provisions for loan losses of $1,000,000 and $1,400,000 for the three and six months ended June 30, 2012, respectively, compared to provisions for loan losses of $1,250,000 and $2,250,000 for the three and six months ended June 30, 2011, respectively. The process for determining allowance adequacy and the resultant provision for loan losses includes a comprehensive analysis of the loan portfolio. Factors in the analysis include size and mix of the loan portfolio, nonperforming loan levels, charge-off/recovery activity and other qualitative factors including economic environment and activity. The decision to record the $1,400,000 provision for the six months ended June 30, 2012 reflects management’s assessment of the overall adequacy of the allowance for loan losses including the consideration of the level of nonperforming loans and the overall effect of the slowing economy, particularly in real estate. Management believes that the current level of allowance for loan losses as of June 30, 2012 of $11,732,000, or 2.6% of total loans, is adequate at this time. The allowance for loan losses was $12,656,000, or 2.8% of total loans, at December 31, 2011. For further information regarding our allowance for loan losses, see “Allowance for Loan Losses” starting on page 36.

29
 

 

Noninterest Income

 

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

 

   Three months ended June 30,   Six months ended June 30, 
   2012   2011   2012   2011 
Service charges on deposit accounts  $1,136   $1,172   $2,188   $2,338 
Other fees and charges   1,321    1,158    2,518    2,279 
Increase in cash value of life insurance   359    351    683    681 
Gain on sale of loans   684    519    1,089    775 
Gain on sales or calls of securities, net   968        959    (10)
Other   219    283    509    573 
Total  $4,687   $3,483   $7,946   $6,636 

 

Noninterest income for the quarter ended June 30, 2012 increased $1,204,000, or 34.6%, to $4,687,000 compared to $3,483,000 for the same period in 2011. The increase was primarily attributed to gain on sale of securities of $968,000. Service charges on deposits decreased by $36,000 to $1,136,000 for the second quarter of 2012 compared to $1,172,000 for the same period in 2011. All other sources of fees and charges increased by $163,000 to $1,321,000 for the second quarter of 2012 compared to $1,158,000 for the second quarter of 2011. The Company had a $684,000 gain on sale of loans for the quarter ended June 30, 2012, an increase of $165,000 compared to $519,000 for the same period in 2011. Of the $684,000 gain on sale of loans for the second quarter of 2012, the sale of mortgage loans was $621,000 and the sale of SBA loans was $63,000 compared to the sale of mortgage loans of $51,000 and the sale of SBA loans of $468,000 for the second quarter of 2011.

 

Noninterest income for the six months ended June 30, 2012 increased $1,310,000, or 19.7%, to $7,946,000 compared to $6,636,000 for the same period in 2011. The increase was primarily attributed to gain on sale of securities of $959,000. Service charges on deposits decreased by $150,000 to $2,188,000 for the period ended June 30, 2012 compared to $2,338,000 for the same period in 2011. All other sources of fees and charges increased by $239,000 to $2,518,000 for the period ended June 30, 2012 compared to $2,279,000 for the same period of 2011. The Company had a $1,089,000 gain on sale of loans for the period ended June 30, 2012, an increase of $314,000 compared to $775,000 for the same period in 2011. Of the $1,089,000 gain on sale of loans for the period ended June 30, 2012, the sale of mortgage loans was $983,000 and the sale of SBA loans was $106,000 compared to the sale of mortgage loans of $95,000 and the sale of SBA loans of $680,000 for the same period in 2011.

 

Noninterest Expense

 

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

 

   Three months ended June 30,   Six months ended June 30, 
   2012   2011   2012   2011 
Salaries and employee benefits  $5,051   $4,475   $10,108   $9,192 
Occupancy expense   620    700    1,260    1,392 
Other real estate owned expense   342    1,177    976    1,629 
Data processing   632    534    1,249    1,209 
FDIC and state assessments   176    303    489    746 
Professional services   334    283    621    608 
ATM and on-line banking   211    295    461    583 
Furniture and equipment expense   227    294    472    590 
Marketing expense   138    173    333    292 
Director expense   160    114    298    216 
Loan expense   217    99    345    224 
Printing and supplies   116    148    240    271 
Postage   123    131    244    289 
Operations expense   123    167    240    309 
Messenger   115    155    228    300 
Amortization of intangibles   37    37    73    73 
Other   606    650    1,247    1,283 
Total  $9,228   $9,735   $18,884   $19,206 

30
 

 

Noninterest expense decreased $507,000, or 5.2%, to $9,228,000 for the second quarter of 2012 from $9,735,000 for the second quarter in 2011. Salaries and employee benefits increased $576,000, for the second quarter of 2012 compared to the second quarter of 2011 due primarily due to the hiring of production personnel and the development of production incentive plans. Occupancy and furniture and equipment expense decreased $147,000 for the second quarter of 2012 compared to the second quarter of 2011 due to a decrease in depreciation and rent expense as a result of facilities consolidation initiatives completed in 2011. OREO expense decreased $835,000 to $342,000, for the second quarter of 2012 compared to $1,177,000 for the same period in 2011, and FDIC and state assessments decreased $127,000 to $176,000 for the second quarter of 2012, compared to $303,000 for the same period in 2011, as a result of the termination of the regulatory agreements previously discussed as well as a change in FDIC insurance assessment methodology, which changed the assessment base from total deposits to average total assets less tangible capital. All other expenses increased $26,000 to $2,812,000 for the second quarter 2012 compared to $2,786,000 for the same period in 2011.

 

Noninterest expense decreased $322,000, or 1.7%, to $18,884,000 for the six months ended June 30, 2012 from $19,206,000 for the same period in 2011. Salaries and employee benefits increased $916,000, for the six months ended June 30, 2012 compared to the same period in 2011 due primarily due to the hiring of production personnel and the development of production incentive plans. Occupancy and furniture and equipment expense decreased $250,000 for the six months ended June 30, 2012 compared to the same period in 2011 due to a decrease in depreciation and rent expense as a result of facilities consolidation initiatives completed in 2011. OREO expense decreased $653,000 to $976,000, for the six months ended June 30, 2012 compared to $1,629,000 for the same period in 2011, and FDIC and state assessments decreased $257,000 to $489,000 for the six months ended June 30, 2012, compared to $746,000 for the same period in 2011, as a result of the termination of the regulatory agreements previously discussed as well as a change in FDIC insurance assessment methodology, which changed the assessment base from total deposits to average total assets less tangible capital. All other expenses decreased $78,000 to $5,579,000 for the six months ended June 30, 2012 compared to $5,657,000 for the same period in 2011.

 

Income Taxes

 

The Company recorded a provision for income taxes for the quarter ended June 30, 2012 of $527,000, resulting in an effective tax rate of 29.5%, compared to a provision for income taxes of $137,000, or an effective tax rate of 20.9%, for the quarter ended June 30, 2011. The provision for income taxes for the six month period ended June 30, 2012 was $642,000, resulting in an effective tax rate of 26.9%, compared to a provision for income taxes of $226,000, or an effective tax rate of 19.8%, for the same period in 2011. The difference in the effective tax rate compared to the statutory tax rate is primarily the result of the Company’s investment in municipal securities and Company-owned life insurance policies whose income is exempt from Federal taxes. In addition, the Company receives certain tax benefits from the State of California Franchise Tax Board for operating and providing loans, as well as jobs, in designated “Enterprise Zones”.

 

Management evaluates the Company’s deferred tax assets quarterly for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including the Company’s historical profitability and projections of future taxable income. Management also considered available tax planning strategies, the scheduled reversal of deferred tax assets and liabilities, and the nature and amount of historical and projected future taxable income that provide positive evidence that some of the tax benefits will be realizable. Accordingly, the Company established a partial valuation allowance in 2010 of $4,500,000 to reflect the portion of the deferred tax assets that the Company determined to be more likely than not that it will not be realized. During the quarter ended December 31, 2011, the Company reversed the Federal portion of its valuation allowance in the amount of $223,000, and at June 30, 2012 had a remaining valuation allowance of $4,277,000.

 

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

 

Financial Condition as of June 30, 2012 As Compared to December 31, 2011

 

Overview

 

Total assets at June 30, 2012 increased $3,145,000, or 0.4%, to $908,111,000, compared to $904,966,000 at December 31, 2011. Loans, net of deferred loan fees, decreased $958,000, or 0.2%, to $455,257,000 at June 30, 2012 from $456,215,000 at December 31, 2011. Investment securities decreased $6,827,000, or 2.2%, to $305,378,000 at June 30, 2012 from $312,205,000 at December 31, 2011, and Federal funds sold increased to $53,375,000 at June 30, 2012 from $40,210,000 at December 31, 2011. The increase in Federal funds sold was due primarily to a decrease in investment securities and loans for the six months ended June 30, 2012. Deposits decreased $2,968,000, or 0.4%, from December 31, 2011 to $763,271,000 at June 30, 2012.

31
 

 

Loan Portfolio

 

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

 

Loans, the Company’s major component of earning assets, decreased $1,046,000 during the six months ended June 30, 2012 to $455,473,000 at June 30, 2012 from $456,519,000 at December 31, 2011. Real estate commercial loans increased by $6,313,000 and real estate construction loans increased by $1,464,000 while installment loans decreased by $3,005,000 and commercial loans decreased by $2,689,000. The remaining loan categories remained relatively unchanged from their December 31, 2011 balances.

 

The Company’s average loan to deposit ratio was 59.0% for the quarter ended June 30, 2012 compared to 64.9% for the quarter ended June 30, 2011. The decrease in the average loan to deposit ratio decreased in 2012 is driven by the decrease in total average loans of $43,321,000.

 

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

 

   June 30,   December 31, 
    2012    2011 
Commercial  $43,471   $46,160 
Real estate - commercial   282,957    276,644 
Real estate - construction   28,927    27,463 
Real estate - mortgage   45,511    47,362 
Installment   7,920    10,925 
Other   46,687    47,965 
Gross loans   455,473    456,519 
Deferred loan fees, net   (216)   (304)
Allowance for loan losses   (11,732)   (12,656)
Total loans, net  $443,525   $443,559 

 

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

 

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

32
 

 

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

 

   As of June 30, 2012   As of December 31, 2011 
       Unpaid           Unpaid     
   Recorded   Principal   Related   Recorded   Principal   Related 
   Investment   Balance   Allowance   Investment   Balance   Allowance 
With no allocated allowance                        
Commercial  $   $   $   $   $   $ 
Real estate - commercial   5,758    6,035        1,502    1,556     
Real estate - construction   3,069    3,113        4,128    4,153     
Real estate - mortgage   660    751        643    751     
Installment   136    147        70    75     
Other   111    114        88    91     
Subtotal   9,734    10,160        6,431    6,626     
                               
With allocated allowance                              
Commercial   1,113    1,117    240    1,788    1,849    450 
Real estate - commercial   187    187    99    4,496    5,302    606 
Real estate - construction   5,312    5,312    529    5,312    5,312    504 
Real estate - mortgage   281    311    35    295    314    37 
Installment               37    39    13 
Other                        
Subtotal   6,893    6,927    903    11,928    12,816    1,610 
Total Impaired Loans  $16,627   $17,087   $903   $18,359   $19,442   $1,610 

 

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

 

   Average Recorded Investment
for the three months ended
   Average Recorded Investment
for the six months ended
 
   June 30,   June 30, 
   2012   2011   2012   2011 
                 
Commercial  $ 1,143   $ 2,284   $ 1,173   $ 2,300 
Real estate - commercial   5,989    10,166    6,119    10,211 
Real estate - construction   8,388    4,257    8,394    4,260 
Real estate - mortgage   950    1,153    964    1,157 
Installment   140    23    144    23 
Other   124    50    138    50 
Total  $16,734   $17,933   $16,932   $18,001 

 

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

 

Nonperforming assets are summarized as follows (in thousands):

 

   June 30,   December 31, 
   2012   2011 
Nonaccrual loans  $16,627   $18,359 
Loans past due 90 days or more and still accruing interest   144    52 
Total nonperforming loans   16,771    18,411 
Other real estate owned   15,648    20,106 
Total nonperforming assets  $32,419   $38,517 
           
Nonaccrual loans to total gross loans   3.65%   4.02%
Nonperforming loans to total gross loans   3.68%   4.04%
Total nonperforming assets to total assets   3.57%   4.26%

33
 

 

At June 30, 2012 and December 31, 2011, the recorded investment in nonperforming loans (defined as nonaccrual loans and loans 90 days or more past due and still accruing interest) was approximately $16,771,000 and $18,411,000, respectively. The Company had $903,000 of specific allowance for loan losses on impaired loans of $6,893,000 at June 30, 2012 as compared to $1,610,000 of specific allowance for loan losses on impaired loans of $11,928,000 at December 31, 2011. Nonperforming assets (nonperforming loans and OREO) totaled $32,419,000 at June 30, 2012, a decrease of $6,101,000 from the total at December 31, 2011.

 

If interest on nonaccrual loans had been accrued, such income would have approximated $357,000 and $735,000, respectively for the six month periods ended June 30, 2012 and 2011.

 

At June 30, 2012 there were no commitments to lend additional funds to borrowers whose loans were classified as nonaccrual.

 

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

 

   June   March   December   September 
   2012   2012   2011   2011 
       % of       % of       % of       % of 
   Amount   total   Amount   total   Amount   total   Amount   total 
Commercial  $1,113    6.7%  $1,174    7.5%  $1,788    9.7%  $1,993    16.7%
Real estate - commercial   5,945    35.8%   4,390    28.1%   5,998    32.7%   5,068    42.4%
Real estate - construction   8,381    50.4%   8,869    56.7%   9,440    51.4%   3,387    28.3%
Real estate - mortgage   941    5.7%   905    5.8%   938    5.1%   1,281    10.7%
Installment   136    0.8%   159    1.0%   107    0.6%   111    0.9%
Other   111    0.7%   137    0.9%   88    0.5%   113    0.9%
Total nonaccrual loans  $16,627    100.0%  $15,634    100.0%  $18,359    100.0%  $11,953    100.0%

 

At June 30, 2012, nonaccrual real-estate-construction loans totaled $8,381,000, or 50.4%, of the nonaccrual loans. There are seven loans that make up the balance. Charge-offs of $2,000 have been taken on these loans and $529,000 in specific reserves have been established for these loans as of June 30, 2012. Two of these loans are residential land loans totaling $2,633,000. No charge-offs have been taken on these loans and $3,000 in specific reserves have been established. There are five loans for nonaccrual residential construction development projects totaling $5,748,000. Charge-offs of $2,000 have been taken on these loans and $526,000 in specific reserves have been established for these loans at June 30, 2012.

 

At June 30, 2012, there were ten real-estate-commercial loans totaling $5,945,000, or 35.8%, of the nonperforming loans. The largest real estate-commercial loan is for a commercial real estate building located in Sacramento County for $3,368,000. Charge-offs of $693,000 have been taken on this loan and no specific reserve has been established for this loan. The second largest is a commercial real estate loan in the amount of $910,000 for a building located in Sacramento County. This loan had a $1,178,000 charge-off and no specific reserve has been established for this loan. The third relationship consists of two commercial real estate loans in the amount of $324,000 for a building in Del Norte County. No charge offs have been taken on these loans and a specific reserve of $99,000 has been established for this relationship. The remaining six real estate-commercial loans total $1,343,000 (approximate average loan balance of $224,000). Charge-offs of $327,000 have been taken on these loans and no specific reserves have been established for these loans.

 

At June 30, 2012, net carrying value of other real estate owned decreased $4,458,000 to $15,648,000 from $20,106,000 at December 31, 2011. During the six month period ending June 30, 2012, the Company transferred three properties into OREO totaling $575,000, sold ten properties totaling $4,284,000, had write-downs of OREO of $561,000, and recorded loss on sale of OREO of $188,000. As part of the financial close process, valuations of OREO are performed by management and write-downs are recorded as warranted. At June 30, 2012, OREO was comprised of twenty properties which consisted of the following: four residential construction properties totaling $4,338,000, eleven residential land parcels totaling $9,238,000, one commercial land parcel for $382,000, one non-farm non-residential properties totaling $363,000 and three residential properties totaling $1,327,000.

34
 

 

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

 

   As of June 30, 2012 
   Accruing Interest         
       30-89 Days   Greater than 90 Days         
   Current   Past Due   Past Due   Nonaccrual   Total 
                     
Commercial  $42,212   $146   $   $1,113   $43,471 
Real estate - commercial   276,774    94    144    5,945    282,957 
Real estate - construction   20,546            8,381    28,927 
Real estate - mortgage   44,315    255        941    45,511 
Installment   7,695    89        136    7,920 
Other   46,494    82        111    46,687 
Total  $438,036   $666   $144   $16,627   $455,473 

 

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

 

During the period ending June 30, 2012, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan. The following table shows information related to Troubled Debt Restructurings for the periods indicated (in thousands):

 

   For the three months ended June 30, 2012   For the six months ended June 30, 2012 
   Non Accruing TDRs   Non Accruing TDRs 
       Pre-Modification   Post-Modification       Pre-Modification   Post-Modification 
   Number   Outstanding   Outstanding   Number   Outstanding   Outstanding 
   of   Recorded   Recorded   of   Recorded   Recorded 
   Contracts   Investment   Investment   Contracts   Investment   Investment 
Commercial   1   $1,076   $1,076    1   $1,076   $1,076 
Real estate - commercial   2   $278   $278    2   $278   $278 
Installment   1   $25   $25    2   $73   $73 

 

At June 30, 2012, there were $203,000 in specific reserves allocated to customers whose loan terms were modified in troubled debt restructurings. There are no commitments to lend additional amounts at June 30, 2012 to customers with outstanding loans that are classified as troubled debt restructurings.

 

There were four loans with modifications involving a reduction of the stated interest rate. There was one modification involving an extension of the maturity date for six months. The recorded investment in five loans was reduced in the aggregate amount of $9,000 during the year.

35
 

 

Allowance for Loan Losses

 

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

 

   For the three months ended June 30, 2012 
   Commercial   Real Estate Commercial   Real Estate Construction   Real Estate Mortgage   Installment   Other   Unallocated   Total 
Allowance for Loan Losses                                        
Balance March 31, 2012  $1,376   $6,847   $1,350   $1,045   $154   $811   $691   $12,274 
Charge-offs   (86)   (1,178)   (126)   (190)   (45)   (47)       (1,672)
Recoveries   14    2    37    36    41            130 
Provisions for loan losses   (44)   915    126    34    (9)   4    (26)   1,000 
Balance June 30, 2012  $1,260   $6,586   $1,387   $925   $141   $768   $665   $11,732 

 

 

   For the three months ended June 30, 2011 
   Commercial   Real Estate Commercial   Real Estate Construction   Real Estate Mortgage   Installment   Other   Unallocated   Total 
Allowance for Loan Losses                                        
Balance March 31, 2011  $1,268   $8,987   $1,566   $919   $304   $755   $672   $14,471 
Charge-offs       (796)   (197)   (81)   (124)           (1,198)
Recoveries   128        10        85            223 
Provisions for loan losses   535    587    (40)   177    (14)   (10)   15    1,250 
Balance June 30, 2011  $1,931   $8,778   $1,339   $1,015   $251   $745   $687   $14,746 

 

 

   For the six months ended June 30, 2012 
   Commercial   Real Estate Commercial   Real Estate Construction   Real Estate Mortgage   Installment   Other   Unallocated   Total 
Allowance for Loan Losses                                        
Balance December 31, 2011  $1,333   $7,528   $1,039   $935   $185   $736   $900   $12,656 
Charge-offs   (206)   (1,617)   (330)   (190)   (142)   (72)       (2,557)
Recoveries   26    63    37    36    65    6        233 
Provisions for loan losses   107    612    641    144    33    98    (235)   1,400 
Balance June 30, 2012  $1,260   $6,586   $1,387   $925   $141   $768   $665   $11,732 

 

 

   As of June 30, 2012 
Reserve to impaired loans  $240   $99   $529   $35   $   $   $   $903 
Reserve to non-impaired loans  $1,020   $6,487   $858   $890   $141   $768   $665   $10,829 

 

   For the six months ended June 30, 2011 
   Commercial   Real Estate Commercial   Real Estate Construction   Real Estate Mortgage   Installment   Other   Unallocated   Total 
Allowance for Loan Losses                                        
Balance December 31, 2010  $1,517   $8,439   $1,936   $956   $339   $666   $1,140   $14,993 
Charge-offs   (874)   (858)   (197)   (281)   (292)   (301)       (2,803)
Recoveries   138        10        158            306 
Provisions for loan losses   1,150    1,197    (410)   340    46    380    (453)   2,250 
Balance June 30, 2011  $1,931   $8,778   $1,339   $1,015   $251   $745   $687   $14,746 

 

 

   As of June 30, 2011 
Reserve to impaired loans  $835   $915   $   $130   $   $   $   $1,880 
Reserve to non-impaired loans  $1,096   $7,863   $1,339   $885   $251   $745   $687   $12,866 

 

 

   As of December 31, 2011 
Reserve to impaired loans  $450   $606   $504   $37   $13   $   $   $1,610 
Reserve to non-impaired loans  $883   $6,922   $535   $898   $172   $736   $900   $11,046 

 

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

 

Loans  As of June 30, 2012 
   Commercial   Real Estate Commercial   Real Estate Construction   Real Estate Mortgage   Installment   Other   Total 
Total Loans  $43,471   $282,957   $28,927   $45,511   $7,920   $46,687   $455,473 
Impaired Loans  $1,113   $5,945   $8,381   $941   $136   $111   $16,627 
Non-impaired loans  $42,358   $277,012   $20,546   $44,570   $7,784   $46,576   $438,846 

 

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

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

 

   As of June 30, 2012
   Pass  Special Mention  Substandard  Doubtful  Total
Commercial  $41,779   $—     $1,692   $—     $43,471 
Real estate - commercial   260,721    3,883    18,353    —      282,957 
Real estate - construction   19,939    356    8,632    —      28,927 
Real estate - mortgage   42,910    —      2,601    —      45,511 
Installment   7,780    —      140    —      7,920 
Other   46,404    —      283    —      46,687 
Total  $419,533   $4,239   $31,701   $—     $455,473 

 

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

 

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

 

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

 

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

 

The Company also maintains a separate allowance for off-balance-sheet commitments. A reserve for unfunded commitments is maintained at a level that, in the opinion of management, is adequate to absorb probable losses associated with commitments to lend funds under existing agreements, for example, the Bank’s commitment to fund advances under lines of credit. The reserve amount for unfunded commitments is determined based on our methodologies described above with respect to the formula allowance. The allowance for off-balance-sheet commitments is included in accrued interest payable and other liabilities on the consolidated balance sheet and was $183,000 and $161,000, as of June 30, 2012 and December 31, 2011, respectively.

37
 

 

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

 

Deposits

 

Total deposits decreased $2,968,000, or 0.4%, to $763,271,000 at June 30, 2012 compared to $766,239,000 at December 31, 2011. During the six months ended June 30, 2012, interest-bearing demand deposits increased $13,989,000, or 7.6%, and savings and money market deposits increased $4,131,000, or 1.9%, while certificates of deposit decreased $17,028,000, or 8.7% and noninterest-bearing demand deposits decreased $4,060,000, or 2.5%.

 

   June 30,   December 31, 
   2012   2011 
Noninterest-bearing demand  $163,446   $167,506 
Interest-bearing demand   184,113    170,124 
Savings and money market   220,430    216,299 
Time certificates   195,282    212,310 
Total deposits  $763,271   $766,239 

 

Capital Resources

 

The Company maintains capital to support future growth and maintain financial strength while trying to effectively manage the capital on hand. From the depositor standpoint, a greater amount of capital on hand relative to total assets is generally viewed as positive. At the same time, from the standpoint of the shareholder, a greater amount of capital on hand may not be viewed as positive because it limits the Company’s ability to earn a high rate of return on stockholders’ equity (ROE). Stockholders’ equity increased $3,552,000 to $93,017,000 as of June 30, 2012, as compared to $89,465,000 at December 31, 2011. The increase was the result of net income of $1,741,000, a change in accumulated other comprehensive income of $1,722,000 and stock based compensation expense of $89,000, during the first six months of 2012. Under current regulations, management believes that the Company meets all capital adequacy requirements. The Company suspended indefinitely the payment of quarterly cash dividends on its common stock beginning in 2009. This Board decision was made to strengthen and preserve the Company’s capital base in these challenging economic times. Future dividends will be determined by the Board of Directors after consideration of the Company’s earnings, financial condition, future capital funds, regulatory requirements and other factors as the Board of Directors may deem relevant.

 

On June 7, 2012, the federal bank regulatory agencies published notices of proposed rulemakings that would revise and replace the current capital requirements. The proposed rules implement the “Basel III” regulatory capital reforms released by the Basel Committee on Banking Supervision and changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The proposed rules are subject to a comment period through September 7, 2012. Therefore, it is uncertain whether the proposed rules will be effective in the form proposed or modified in response to comments including delay of the effective date or other changes that may have a material impact upon the proposed rules and their application to our Company and the Bank. The proposed rules include new minimum capital ratio requirements to be phased in between January 1, 2013 and January 1, 2015. The proposed rules would also establish a “capital conservation buffer,” which requires maintenance of a minimum of 2.5% of common equity Tier 1 capital to total risk weighted assets in excess of the regulatory minimum capital ratio requirements.

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

 

                   To be Well Capitalized 
           For Capital   Under Prompt Corrective 
   Actual   Adequacy Purposes   Action Provisions 
   Amount   Ratio   Minimum Amount   Minimum Ratio   Minimum Amount   Minimum Ratio 
Company                              
As of June 30, 2012:                              
Total capital (to risk weighted assets)  $110,527    18.49%  $47,821    8.00%   N/A    N/A 
Tier 1 capital (to risk weighted assets)  $102,943    17.22%  $23,912    4.00%   N/A    N/A 
Tier 1 capital (to average assets)  $102,943    11.44%  $35,994    4.00%   N/A    N/A 
                               
As of December 31, 2011:                              
Total capital (to risk weighted assets)  $116,464    19.53%  $47,707    8.00%   N/A    N/A 
Tier 1 capital (to risk weighted assets)  $107,240    17.99%  $23,844    4.00%   N/A    N/A 
Tier 1 capital (to average assets)  $107,240    11.82%  $36,291    4.00%   N/A    N/A 
                               
North Valley Bank                              
As of June 30, 2012:                              
Total capital (to risk weighted assets)  $110,027    18.43%  $47,760    8.00%  $59,700    10.00%
Tier 1 capital (to risk weighted assets)  $102,453    17.16%  $23,882    4.00%  $35,823    6.00%
Tier 1 capital (to average assets)  $102,453    11.40%  $