Edgar Filing: SIERRA BANCORP

Unassociated Document

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES

EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2011

Commission file number: 000-33063

SIERRA BANCORP

(Exact name of Registrant as specified in its charter)

California	33-0937517
(State of Incorporation)	(IRS Employer Identification No)

86 North Main Street, Porterville, California 93257

(Address of principal executive offices) (Zip Code)

(559) 782-4900

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

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

Yes R No ¨

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

Yes R 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.

Large accelerated filer ¨	Accelerated filer R
Non-accelerated filer ¨ (Do not check if a smaller reporting company)	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 R

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

Common stock, no par value, 14,046,666 shares outstanding as of August 1, 2011

FORM 10-Q

Table of Contents
		Page
Part I - Financial Information		1
	Item 1. Financial Statements (Unaudited)	1
	Consolidated Balance Sheets	1
	Consolidated Statements of Income	2
	Consolidated Statements of Cash Flows	3
	Notes to Unaudited Consolidated Financial Statements	4

	Item 2. Management’s Discussion & Analysis of Financial Condition & Results of Operations	12
	Forward-Looking Statements	12
	Critical Accounting Policies	12
	Overview of the Results of Operations and Financial Condition	13
	Earnings Performance	15
	Net Interest Income and Net Interest Margin	15
	Provision for Loan and Lease Losses	19
	Non-interest Revenue and Operating Expense	20
	Provision for Income Taxes	23
	Balance Sheet Analysis	23
	Earning Assets	23
	Investments	23
	Loan Portfolio	25
	Credit Quality and Nonperforming Assets	27
	Allowance for Loan and Lease Losses	31
	Off-Balance Sheet Arrangements	36
	Other Assets	36
	Deposits and Interest-Bearing Liabilities	37
	Deposits	37
	Other Interest-Bearing Liabilities	38
	Non-Interest Bearing Liabilities	39
	Liquidity and Market Risk Management	39
	Capital Resources	41

	Item 3. Qualitative & Quantitative Disclosures about Market Risk	43

	Item 4. Controls and Procedures	43

Part II - Other Information		44
	Item 1. - Legal Proceedings	44
	Item 1A. - Risk Factors	44
	Item 2. - Unregistered Sales of Equity Securities and Use of Proceeds	44
	Item 3. - Defaults upon Senior Securities	44
	Item 4. - (Removed and Reserved)	44
	Item 5. - Other Information	44
	Item 6. - Exhibits	45

Signatures		46

PART I - FINANCIAL INFORMATION

Item 1

SIERRA BANCORP

CONSOLIDATED BALANCE SHEETS

(dollars in thousands)

	June 30, 2011			December 31, 2010
	(unaudited)			(audited)
ASSETS
Cash and due from banks	$	49,265		$	42,110
Interest-bearing deposits in banks		19,102			325
Federal Funds Sold		-			210
Total Cash & Cash Equivalents		68,367			42,645
Investment securities available for sale		402,736			331,730
Loans and leases:
Loans held for sale		-			914
Gross loans and leases		772,551			804,626
Allowance for loan and lease losses		(20,711	)		(21,138	)
Deferred loan and lease fees, net		229			113
Net Loans and Leases		752,069			784,515
Premises and equipment, net		20,033			20,190
Operating leases, net		547			904
Foreclosed assets		18,231			20,691
Goodwill		5,544			5,544
Other assets		78,372			80,352
TOTAL ASSETS	$	1,345,899		$	1,286,571

LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Non-interest bearing	$	273,684		$	251,908
Interest bearing		842,482			800,366
Total Deposits		1,116,166			1,052,274
Federal funds purchased and repurchase agreements		3,980			-
Short-term borrowings		-			14,650
Long-term borrowings		15,000			15,000
Other liabilities		14,413			14,122
Junior subordinated debentures		30,928			30,928
TOTAL LIABILITIES		1,180,487			1,126,974
SHAREHOLDERS' EQUITY
Serial Preferred stock, no par value; 10,000,000 shares authorized; none issued		-			-
Common stock, no par value; 24,000,000 shares authorized; 14,046,666 and 13,976,741 shares issued and outstanding at June 30, 2011 and December 31, 2010, respectively		64,024			63,477
Additional paid in capital		1,760			1,652
Retained earnings		95,604			93,570
Accumulated other comprehensive income		4,024			898
TOTAL SHAREHOLDERS' EQUITY		165,412			159,597

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	1,345,899		$	1,286,571

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

SIERRA BANCORP

CONSOLIDATED STATEMENTS OF INCOME

(dollars in thousands, except per share data, unaudited)

	For the Quarter				For the Six Months
	Ended June 30,				Ended June 30,
	2011		2011		2011			2011
Interest income:
Interest and fees on loans	$	11,918	$	13,495	$	23,700		$	27,073
Interest on investment securities:
Taxable		2,285		2,043		4,201			4,150
Tax-exempt		721		673		1,437			1,318
Interest on Federal funds sold and interest-bearing deposits		25		5		33			22
Total interest income		14,949		16,216		29,371			32,563

Interest expense:
Interest on deposits		1,125		1,671		2,216			3,329
Interest on short-term borrowings		5		55		39			92
Interest on long-term borrowings		142		142		282			318
Interest on manditorily redeemable trust preferred securities		180		180		361			355
Total interest expense		1,452		2,048		2,898			4,094

Net Interest Income		13,497		14,168		26,473			28,469

Provision for loan losses		3,000		3,500		6,600			6,900

Net Interest Income after Provision for Loan Losses		10,497		10,668		19,873			21,569

Non-interest revenue:
Service charges on deposit accounts		2,446		2,887		4,701			5,590
Other income, net		1,027		1,102		2,348			2,260
Total other operating income		3,473		3,989		7,049			7,850

Other operating expense:
Salaries and employee benefits		5,201		5,151		10,911			10,930
Occupancy expense		1,625		1,819		3,200			3,559
Other		4,729		4,578		9,146			9,232
Total other operating expenses		11,555		11,548		23,257			23,721

Income before income taxes		2,415		3,109		3,665			5,698

Provision for income taxes		231		565		(48	)		814

Net Income	$	2,184	$	2,544	$	3,713		$	4,884

PER SHARE DATA
Book value	$	11.78	$	12.00	$	11.78		$	12.00
Cash dividends	$	0.06	$	0.06	$	0.12		$	0.12
Earnings per share basic	$	0.16	$	0.22	$	0.27		$	0.42
Earnings per share diluted	$	0.16	$	0.22	$	0.26		$	0.42
Average shares outstanding, basic		14,012,574		11,646,409		13,997,264			11,638,638
Average shares outstanding, diluted		14,084,997		11,749,546		14,072,974			11,723,566

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

SIERRA BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands, unaudited)

	Six Months Ended June 30,
	2011			2010
Cash flows from operating activities:
Net income	$	3,713		$	4,884
Adjustments to reconcile net income to net cash provided by operating activities:
Gain on sales of loans		(53	)		(37	)
(Gain) loss on disposal of fixed assets		(12	)		115
Loss on sale on foreclosed assets		296			337
Writedowns on foreclosed assets		1,305			653
Share-based compensation expense		117			68
Provision for loan losses		6,600			6,900
Depreciation and amortization		1,257			1,535
Net amortization on securities premiums and discounts		2,660			1,372
Increase in unearned net loan fees		(117	)		(330	)
Increase in cash surrender value of life insurance policies		(707	)		(506	)
Proceeds from sales of loans		1,725			932
Net decrease (increase) in loans held-for-sale		914			(498	)
Decrease (increase) in interest receivable and other assets		1,766			(2,004	)
Decrease in other liabilities		(1,361	)		(572	)
Net decrease in restricted stock, at cost		670			334
Deferred income tax (benefit) provision		(6	)		13
Excess tax provision (benefit) from equity based compensation		10			(12	)
Net cash provided by operating activities		18,777			13,184

Cash flows from investing activities:
Maturities of securities available for sale		408			4,960
Proceeds from sales/calls of securities available for sale		1,275			6,912
Purchases of securities available for sale		(104,699	)		(73,005	)
Principal paydowns on securities available for sale		34,638			33,589
Decrease in loans receivable, net		20,543			7,564
Purchases of premises and equipment, net		(734	)		(1,185	)
Proceeds from sales of foreclosed assets		3,434			2,911
Net cash used in investing activities		(45,135	)		(18,254	)

Cash flows from financing activities:
Increase (decrease) in deposits		63,892			(33,830	)
Decrease (increase) in borrowed funds		(14,650	)		21,900
Increase in fed funds purchased		3,980			-
Cash dividends paid		(1,679	)		(1,397	)
Payments of stock issuance costs		(23	)		-
Stock options exercised		570			225
Excess tax (benefit) provision from equity based compensation		(10	)		12
Net cash provided by (used in) financing activities		52,080			(13,090	)

Increase (decrease) in cash and due from banks		25,722			(18,160	)

Cash and Cash Equivalents
Beginning of period		42,645			66,235
End of period	$	68,367		$	48,075

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

SIERRA BANCORP

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

Note 1 – The Business of Sierra Bancorp

Sierra Bancorp (the “Company”), headquartered in Porterville, California, is a California corporation registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. The Company was incorporated in November 2000 and acquired all of the outstanding shares of Bank of the Sierra (the “Bank”) in August 2001. The Company’s principal subsidiary is the Bank, and the Company exists primarily for the purpose of holding the stock of the Bank and of such other subsidiaries it may acquire or establish. At the present time, the Company’s only other direct subsidiaries are Sierra Statutory Trust II and Sierra Capital Trust III, which were formed in March 2004 and June 2006, respectively, solely to facilitate the issuance of capital trust pass-through securities. Pursuant to the Financial Accounting Standards Board’s (FASB’s) standard on the consolidation of variable interest entities, these trusts are not reflected on a consolidated basis in the financial statements of the Company. References herein to the “Company” include Sierra Bancorp and its consolidated subsidiary, the Bank, unless the context indicates otherwise.

The Bank is a California state-chartered bank headquartered in Porterville, California, that offers a full range of retail and commercial banking services to communities in the central and southern sections of the San Joaquin Valley. Our branch footprint stretches from Fresno on the north to Bakersfield on the south, and on the southern end extends east through the Tehachapi plateau and into the northwestern tip of the Mojave Desert. The Bank was incorporated in September 1977 and opened for business in January 1978, and in the ensuing years has grown to be the largest independent bank headquartered in the South San Joaquin Valley. Our growth has primarily been organic, but includes the acquisition of Sierra National Bank in 2000. We currently operate 25 full service branch offices throughout our geographic footprint, as well as an internet branch which provides the ability to open deposit accounts and submit certain loan applications online. The Bank’s newest “brick and mortar” branches opened for business in Selma in February 2011 and Farmersville in March 2010. In January 2011 we closed our first branch ever, in Bakersfield on California Avenue due to lease issues, and we are currently searching for a suitable location to replace that branch. In addition to our full-service branches, the Bank has an agricultural credit division and an SBA lending unit with staff located at our corporate headquarters, and offsite ATM’s at eight different non-branch locations. The Bank’s deposit accounts are insured by the Federal Deposit Insurance Corporation (FDIC) up to maximum insurable amounts.

Note 2 – Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in a condensed format, and therefore do not include all of the information and footnotes required by U.S. generally accepted accounting principles (GAAP) for complete financial statements. The information furnished in these interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for such period. Such adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q. In preparing the accompanying consolidated financial statements, management has taken subsequent events into consideration and recognized them where appropriate. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for any other quarter, or for the full year. Certain amounts reported for 2010 have been reclassified to be consistent with the reporting for 2011. The interim financial information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the Securities and Exchange Commission.

Note 3 – Current Accounting Developments

In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-05, Comprehensive Income (Topic 220) - Presentation of Comprehensive Income. Current U.S. generally accepted accounting principles allow reporting entities several alternatives for displaying other comprehensive income and its components in financial statements, and ASU 2011-05 is intended to improve the consistency of this reporting issue. The amendments in this ASU require all non-owner changes in stockholders’ equity to be presented either in a single continuous statement of comprehensive income, or in two separate but consecutive statements. In a single continuous statement, the entity is required to present the components of net income and total net income, the components of other comprehensive income and a total for other comprehensive income, along with the total of comprehensive income in that statement. In the two-statement approach, an entity is required to present components of net income and total net income in the statement of net income. The statement of other comprehensive income should immediately follow the statement of net income and include the components of other comprehensive income and a total for other comprehensive income, along with a total for comprehensive income. Furthermore, the entity is required to present, on the face of the financial statements, adjustments for items that are reclassified from other comprehensive income to net income in the statements, where the components of net income and the components of other comprehensive income are presented. The amendments in the ASU do not change the following: 1) items that must be reported in other comprehensive income; 2) when an item of other comprehensive income must be reclassified to net income; 3) the option to present components of other comprehensive income either net of related tax effects or before related tax effects; or, 4) how earnings per share is calculated or presented. The amendments in ASU 2011-05 should be applied retrospectively. For public entities, such as the Company, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted. The Company’s adoption of this ASU will impact our presentation of comprehensive income, but not the calculation of such.

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, to substantially converge the fair value measurement and disclosure guidance in U.S. GAAP with International Financial Reporting Standards (“IFRS”). The amended guidance changes several aspects of current fair value measurement guidance, including the following provisions: 1) the application of the concepts of “highest and best use” and “valuation premise”; 2) the introduction of an option to measure groups of offsetting assets and liabilities on a net basis; 3) the incorporation of certain premiums and discounts in fair value measurements; and, 4) the measurement of the fair value of certain instruments classified in shareholders’ equity. In addition, the amended guidance includes several new fair value disclosure requirements, including, among other things, information about valuation techniques and unobservable inputs used in Level 3 fair value measurements and a narrative description of Level 3 measurements’ sensitivity to changes in unobservable inputs. For public entities such as the Company, the provisions of ASU 2011-04 are effective for interim and annual periods beginning after December 15, 2011, and are to be applied prospectively. The implementation of ASU 2011-04 is not expected to change fair value measurements for any of the Company’s assets or liabilities carried at fair value, and thus should not impact the Company’s statements of income and condition.

In April 2011, the FASB issued ASU No. 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring, in an effort to improve financial reporting by creating greater consistency in the way GAAP is applied for various types of debt restructurings. ASU 2011-02 is intended to assist creditors in determining whether a modification of the terms of a loan meets the criteria to be considered a troubled debt restructuring (“TDR”), both for purposes of recording an impairment loss and for disclosure of TDR’s. In evaluating whether a restructuring constitutes a TDR, a creditor must separately conclude that both of the following exist: 1) the restructuring constitutes a concession; and 2) the debtor is experiencing financial difficulties. The amendments to Topic 310 clarify the guidance on a creditor’s evaluation of whether it has granted a concession, and likewise clarify the guidance on a creditor’s evaluation of whether a debtor is experiencing financial difficulties. In addition, the amendments to Topic 310 preclude creditors from using the effective interest rate test in the debtor’s guidance on restructuring of payables (paragraph 470-60-55-10) when evaluating whether a restructuring constitutes a TDR. For public companies, such as Sierra Bancorp, the new guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. Early adoption is permitted, and the Company has adopted the provisions of ASU 2011-02 for the reporting period ended June 30, 2011. There was a total of $552,000 in loan balances that were added to performing TDR’s at June 30, 2011 as a direct result of the Company’s adoption of ASU 2011-02, with only a negligible impact on our allowance for loan and lease losses.

In July 2010, the FASB updated disclosure requirements with respect to the credit quality of financing receivables and the allowance for credit losses. According to the guidance, there are two levels of detail at which credit information must be presented - the portfolio segment level and class level. The portfolio segment level is defined as the level where financing receivables are aggregated in developing a company’s systematic method for calculating its allowance for credit losses. The class level is the second level at which credit information will be presented, and represents the categorization of financing receivables at a slightly less aggregated level than the portfolio segment level. Companies are required to provide the following disclosures as a result of this update: A roll-forward of the allowance for credit losses at the portfolio segment level, with the ending balances further categorized according to impairment method along with the balance reported in the related financing receivables at period-end; additional disclosures of nonaccrual and impaired financing receivables by class as of period-end; credit quality and past due/aging information by class as of period-end; information surrounding the nature and extent of loan modifications and troubled-debt restructurings and their effect on the allowance for credit losses during the period; and details on any significant purchases or sales of financing receivables during the period. The increased period-end disclosure requirements became effective for periods ending on or after December 15, 2010, with the exception of the additional period-end disclosures surrounding troubled-debt restructurings which were deferred in December 2010 and became effective for annual and interim reporting periods ending on or after June 15, 2011. The increased disclosures for activity within a reporting period become effective for periods beginning on or after June 15, 2011, with retrospective application to January 1, 2011. The provisions of this FASB update expanded the Company’s current disclosures with respect to our allowance for loan and lease losses and the credit quality of our financing receivables.

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This update added disclosure requirements for significant transfers into and out of Levels 1 and 2, clarified existing fair value disclosure requirements about the appropriate level of disaggregation, and clarified that a description of the valuation techniques was required for recurring and nonrecurring Level 2 and 3 fair value measurements. The Company adopted these provisions of the ASU in preparing the Consolidated Financial Statements commencing with the period ended March 31, 2010. The adoption of these provisions only affected the disclosure requirements for fair value measurements and as a result had no impact on the Company’s statements of income and condition. An additional requirement of this ASU is that activity within Level 3, including purchases, sales, issuances, and settlements, be presented on a gross basis rather than as a net number as currently permitted. This provision of the ASU became effective for the Company’s reporting period ending March 31, 2011. As this provision only amended the disclosure requirements for fair value measurements, our adoption of it had no impact on the Company’s statements of income and condition.

Note 4 – Supplemental Disclosure of Cash Flow Information

During the six months ended June 30, 2011 and 2010, cash paid for interest due on interest-bearing liabilities was $2.942 million and $4.304 million, respectively. There was $1.643 million in cash paid for income taxes during the six months ended June 30, 2011, and $5.360 million in cash paid for income taxes during the six months ended June 30, 2010. Assets totaling $2.948 million and $5.455 million were acquired in settlement of loans for the six months ended June 30, 2011 and June 30, 2010, respectively, and we received $3.268 million in cash from the sale of foreclosed assets during the first half of 2011 relative to $2.911 million during the first half of 2010. The Company extended $1.381 million in loans to finance the sale of foreclosed assets during the six months ended June 30, 2011, but none during the first six months of 2010.

Note 5 – Share Based Compensation

The 2007 Stock Incentive Plan (the “2007 Plan”) was adopted by the Company in 2007. Our 1998 Stock Option Plan (the “1998 Plan”) was concurrently terminated, although options to purchase 292,723 shares that were granted prior to the termination of the 1998 Plan were still outstanding as of June 30, 2011 and remain unaffected by the termination. The 2007 Plan provides for the issuance of both “incentive” and “nonqualified” stock options to officers and employees, and of “nonqualified” stock options to non-employee directors of the Company. The 2007 Plan also provides for the potential issuance of restricted stock awards to these same classes of eligible participants, on such terms and conditions as are established at the discretion of the Board of Directors or the Compensation Committee. The total number of shares of the Company’s authorized but unissued stock reserved and available for issuance pursuant to awards under the 2007 Plan was initially 1,500,000 shares, although options have been granted since the inception of the plan and the number remaining available for grant as of June 30, 2011 was 1,040,360. No restricted stock awards have been issued by the Company.

Pursuant to FASB’s standards on stock compensation, share-based compensation expense is reflected in our income statement for each option granted over the vesting period of such option. The Company is utilizing the Black-Scholes model to value stock options, and the “multiple option” approach is used to allocate the resulting valuation to actual expense. Under the multiple option approach, an employee’s options for each vesting period are separately valued and amortized. This appears to be the preferred method for option grants with multiple vesting periods, which is the case for most options granted by the Company. A pre-tax charge of $53,000 was reflected in the Company’s income statement during the second quarter of 2011 and $28,000 was charged during the second quarter of 2010, as compensation expense related to outstanding and unvested stock options. For the first half, these charges amounted to $118,000 in 2011 and $66,000 in 2010.

Note 6 – Earnings Per Share

The computation of earnings per share, as presented in the Consolidated Statements of Income, is based on the weighted average number of shares outstanding during each period. There were 14,012,574 weighted average shares outstanding during the second quarter of 2011, and 11,646,409 during the second quarter of 2010. There were 13,997,264 weighted average shares outstanding during the first six months of 2011, and 11,638,638 during the first six months of 2010.

Diluted earnings per share include the effect of the potential issuance of common shares, which for the Company is limited to “in-the-money” shares that would be issued on the exercise of outstanding stock options. The dilutive effect of options outstanding was calculated using the treasury stock method, excluding anti-dilutive shares and adjusting for unamortized expense and windfall tax benefits. For the second quarter and first six months of 2011, the dilutive effect of options outstanding calculated under the treasury stock method totaled 72,423 and 75,710, respectively, which were added to basic weighted average shares outstanding for purposes of calculating diluted earnings per share. Likewise, for the second quarter and first six months of 2010, shares totaling 103,137 and 84,928, respectively, were added to basic weighted average shares outstanding in order to calculate diluted earnings per share.

Note 7 – Comprehensive Income

Comprehensive income includes net income and other comprehensive income. The Company’s only source of other comprehensive income is derived from unrealized gains and losses on available-for-sale investment securities. Reclassification adjustments, resulting from gains or losses on investment securities that were realized and included in net income of the current period that also had been included in other comprehensive income as unrealized holding gains or losses in the period in which they arose, are excluded from comprehensive income of the current period. The Company’s comprehensive income was as follows:

Comprehensive Income
(dollars in thousands, unaudited)	For the Quarter				For the Six Months
	Ended June 30,				Ended June 30,
	2011		2010		2011		2010

Net Income	$	2,184	$	2,544	$	3,713	$	4,884
Other comprehensive income:
Unrealized holding gain		3,450		1,366		5,289		2,550
Less: reclassification adjustment		-		-		-		-
Pre-tax other comprehensive inc/(loss)		3,450		1,366		5,289		2,550
Less: tax impact of above		1,450		574		2,223		1,072
Net other comprehensive income		2,000		792		3,066		1,478

Comprehensive income	$	4,184	$	3,336	$	6,779	$	6,362

Note 8 – Financial Instruments with Off-Balance-Sheet Risk

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business, in order to meet the financing needs of its customers. These financial instruments consist of commitments to extend credit, and standby letters of credit. They involve, to varying degrees, elements of risk in excess of the amount recognized in the balance sheet. The Company’s exposure to credit loss in the event of nonperformance by counterparties for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and issuing letters of credit as it does for making loans included on the balance sheet. The following financial instruments represent off-balance-sheet credit risk (dollars in thousands):

	June 30, 2011		December 31, 2010
Commitments to extend credit	$	143,501	$	142,309
Standby letters of credit	$	11,380	$	7,761
Commercial letters of credit	$	9,427	$	9,435

Commitments to extend credit consist primarily of unfunded single-family residential construction loans and home equity lines of credit, and commercial real estate construction loans and commercial revolving lines of credit. Construction loans are established under standard underwriting guidelines and policies and are secured by deeds of trust, with disbursements made over the course of construction. Commercial revolving lines of credit have a high degree of industry diversification. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are generally unsecured and are issued by the Company to guarantee the performance of a customer to a third party, while commercial letters of credit represent the Company’s commitment to pay a third party on behalf of a customer upon fulfillment of contractual requirements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.

Note 9 – Fair Value Disclosures and Reporting, the Fair Value Option and Fair Value Measurements

FASB’s standards on financial instruments, and on fair value measurements and disclosures, require all entities to disclose the estimated fair value of all financial instruments for which it is practicable to estimate fair values. In addition to those footnote disclosure requirements, FASB’s standard on investments requires that our debt securities, which are classified as available for sale, and our equity securities that have readily determinable fair values, be measured and reported at fair value in our statement of financial position. Certain impaired loans are also reported at fair value, as explained in greater detail below, and foreclosed assets are carried at the lower of cost or fair value. While the fair value option outlined under FASB’s standard on financial instruments permits companies to report certain other financial assets and liabilities at fair value, we have not elected the fair value option for any additional financial assets or liabilities.

Fair value measurements and disclosure standards also establish a framework for measuring fair value. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants on the measurement date. Further, they establish a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standards describe three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the factors that market participants would likely consider in pricing an asset or liability.

Fair value estimates are made at a specific point in time based on relevant market data and information about the financial instruments. These estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any estimates. Because no market exists for a significant portion of the Company’s financial instruments, fair value disclosures are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the fair values presented. The following methods and assumptions were used by the Company to estimate the fair value of its financial instruments disclosed at June 30, 2011 and December 31, 2010:

Cash and cash equivalents and short-term borrowings: For cash and cash equivalents and short-term borrowings, the carrying amount is estimated to be fair value.

Investment securities: The fair values of investment securities are determined by obtaining quoted prices on nationally recognized securities exchanges or by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities by relying on the securities’ relationship to other benchmark quoted securities when quoted prices for the specific securities are not readily available.

Loans and leases: For variable-rate loans and leases that re-price frequently with no significant change in credit risk or interest rate spread, fair values are based on carrying values. Fair values for other loans and leases are estimated by discounting projected cash flows at interest rates being offered at each reporting date for loans and leases with similar terms, to borrowers of comparable creditworthiness. Fair values of loans held for sale are estimated using quoted market prices for similar loans or the amount that has been committed to purchase the loan. The carrying amount of accrued interest receivable approximates its fair value.

Cash surrender value of life insurance policies: The fair values are based on cash surrender values at each reporting date.

Investment in, and capital commitments to, limited partnerships: The fair values of our investments in WNC Institutional Tax Credit Fund Limited Partnerships and any other limited partnerships are estimated using quarterly indications of value provided by the general partner. The fair values of undisbursed capital commitments are assumed to be the same as their book values.

Other investments: Included in other assets are certain long-term investments carried at cost, which approximates their estimated fair value.

Deposits: Fair values for demand deposits and other non-maturity deposits are equal to the amount payable on demand at the reporting date, which is the carrying amount. Fair values for fixed-rate certificates of deposit are estimated using a cash flow analysis, discounted at interest rates being offered at each reporting date by the Bank for certificates with similar remaining maturities. The carrying amount of accrued interest payable approximates its fair value.

Short-term borrowings: The carrying amounts approximate fair values for federal funds purchased, overnight FHLB advances, borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days of the reporting dates. Fair values of other short-term borrowings are estimated by discounting projected cash flows at the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Long-term borrowings: The fair values of the Company’s long-term borrowings are estimated using projected cash flows discounted at the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Subordinated debentures: The fair values of subordinated debentures are determined based on the current market value for like instruments of a similar maturity and structure.

Commitments to extend credit and letters of credit: Commitments to extend credit are primarily for adjustable rate loans. Commitments to fund fixed rate loans and letters of credit, where such exist, are also at rates which approximate market rates at each reporting date. Thus, if funded, the carrying amounts would approximate fair values for the newly created financial assets at the funding date. However, because of the high degree of uncertainty with regard to whether or not these commitments will ultimately be funded, fair values for loan commitments and letters of credit in their current undisbursed state cannot reasonably be estimated, and only notional values are disclosed in the table below.

Estimated fair values for the Company’s financial instruments at June 30, 2011 and December 31, 2010 are as follows:

Fair Value of Financial Instruments
(dollars in thousands, unaudited)	June 30, 2011				December 31, 2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Cash and cash equivalents		68,367		68,367		42,645		42,645
Investment securities available for sale		402,736		402,736		331,730		331,730
Loans and leases, net		752,069		780,684		784,515		816,185
Cash surrender value of life insurance policies		32,298		32,298		31,591		31,591
Other investments		7,691		7,691		8,361		8,361
Investments in limited partnerships		10,198		10,198		10,899		10,899
Accrued interest receivable		5,695		5,695		5,677		5,677

Financial liabilities:
Deposits		1,116,166		1,117,063		1,052,274		1,052,085
Repurchase agreements		3,980		3,980		-		-
Overnight borrowings		-		-		9,650		9,650
Short-term borrowings		-		-		5,000		5,000
Long-term borrowings		15,000		15,529		15,000		15,736
Subordinated debentures		30,928		11,651		30,928		11,610
Limited partnership capital commitment		392		764		417		417
Accrued interest payable		722		722		678		678

	Notional Amount				Notional Amount
Off-balance-sheet financial instruments:
Commitments to extend credit		143,501				142,309
Standby letters of credit		11,380				7,761
Commercial letters of credit		9,427				9,435

For each category of financial assets that were actually reported at fair value at June 30, 2011, the Company used the following methods and significant assumptions:

Investment Securities: The fair values of trading securities and securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges or by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities by relying on the their relationship to other benchmark quoted securities.

Loans held for sale: Since loans designated by the Company as available-for-sale are typically sold shortly after making the decision to sell them, realized gains or losses are usually recognized within the same period and fluctuations in fair values are thus not relevant for reporting purposes. If available-for-sale loans stay on our books for an extended period of time, the fair value of those loans is determined using quoted secondary-market prices.

Impaired loans: Impaired loans carried at fair value are those for which it is probable that the bank will be unable to collect all amounts due (including both interest and principal) according to the original contractual terms of the loan agreement, and for which the carrying value has been written down to the fair value of the loan. The carrying value is equivalent to the fair value of the collateral, net of expected disposition costs, for collateral-dependent loans, or the present value of anticipated future cash flows for other loans.

Foreclosed assets: Repossessed real estate (OREO) and other assets are carried at the lower of cost or fair value. Fair value is appraised value less expected selling costs for OREO and some other assets such as mobile homes, and estimated sales proceeds as determined by using reasonably available sources for all other assets. Foreclosed assets for which appraisals can be feasibly obtained are periodically measured for impairment using updated appraisals. Other foreclosed assets are periodically re-evaluated by adjusting expected cash flows and timing of resolution, again using reasonably available sources. If impairment is determined to exist, the book value of a foreclosed asset is immediately written down to its estimated impaired value through the income statement, thus the carrying amount is equal to the fair value and there is no valuation allowance.

Assets reported at fair value on a recurring basis are summarized below:

Fair Value Measurements - Recurring
(dollars in thousands, unaudited)
	Fair Value Measurements at June 30, 2011, Using
	Level 1		Level 2		Level 3		Total
Investment Securities
U.S. Government agencies	$	-	$	5,028	$	-	$	5,028
Obligations of states and political subdivisions		-		73,922		-		73,922
U.S. Government agencies collateralized by mortgage obligations		-		322,171		-		322,171
Other Securities		1,615		-		-		1,615
Total availabe-for-sale securities		1,615		401,121		-		402,736

Loans Held for Sale		-		-		-		-
Total	$	1,615	$	401,121	$	-	$	402,736

	Fair Value Measurements at December 31, 2010, Using
	Level 1		Level 2		Level 3		Total
Investment Securities
U.S. Government agencies	$	-	$	5,062	$	-	$	5,062
Obligations of states and political subdivisions		-		70,102		-		70,102
U.S. Government agencies collateralized by mortgage obligations		-		255,143		-		255,143
Other Securities		1,423		-		-		1,423
Total availabe-for-sale securities		1,423		330,307		-		331,730

Loans Held for Sale		914		-		-		914
Total	$	2,337	$	330,307	$	-	$	332,644

Assets for which a nonrecurring change in fair value has been recorded are summarized below:

Fair Value Measurements - Nonrecurring
(dollars in thousands, unaudited)
	Fair Value Measurements at June 30, 2011, Using
	Level 1		Level 2		Level 3		Total
Impaired Loans	$	-	$	26,312	$	13,699	$	40,011
Foreclosed Assets	$	-	$	16,273	$	1,958	$	18,231

	Fair Value Measurements at December 31, 2010, Using
	Level 1		Level 2		Level 3		Total
Impaired Loans	$	-	$	29,482	$	6,705	$	36,187
Foreclosed Assets	$	-	$	3,123	$	17,568	$	20,691

The table above only includes impaired loan balances for which a specific reserve has been established or on which a write-down has been taken. Information on the Company’s total impaired loan balances, and specific loss reserves associated with those balances, is included in Management’s Discussion and Analysis of Financial Condition and Results of Operation, in the “Credit Quality and Nonperforming Assets” and “Allowance for Loan and Lease Losses” sections.

PART I - FINANCIAL INFORMATION

ITEM 2

MANAGEMENT’S DISCUSSION AND

ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

This Form 10-Q includes forward-looking statements that involve inherent risks and uncertainties. Words such as “expects”, “anticipates”, “believes”, “projects”, and “estimates” or variations of such words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed, forecast in, or implied by such forward-looking statements.

A variety of factors could have a material adverse impact on the Company’s financial condition or results of operations, and should be considered when evaluating the potential future financial performance of the Company. These include, but are not limited to, continued deterioration in economic conditions in the Company’s service areas; risks associated with fluctuations in interest rates; liquidity risks; increases in nonperforming assets and net credit losses that could occur, particularly in times of weak economic conditions or rising interest rates; the Company’s ability to secure buyers for foreclosed properties; the loss in market value of available-for-sale securities that could result if interest rates change substantially or an issuer has real or perceived financial difficulties; the Company’s ability to attract and retain skilled employees; the Company’s ability to successfully deploy new technology; the success of branch expansion; and risks associated with the multitude of current and future laws and regulations to which the Company is and will be subject.

CRITICAL ACCOUNTING POLICIES

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States. The financial information and disclosures contained within those statements are significantly impacted by Management’s estimates and judgments, which are based on historical experience and various other assumptions that are believed to be reasonable under current circumstances. Actual results may differ from those estimates under divergent conditions.

Critical accounting policies are those that involve the most complex and subjective decisions and assessments, and have the greatest potential impact on the Company’s stated results of operations. In Management’s opinion, the Company’s critical accounting policies deal with the following areas: the establishment of the Company’s allowance for loan and lease losses, as explained in detail in the “Provision for Loan and Lease Losses” and “Allowance for Loan and Lease Losses” sections of this discussion and analysis; the valuation of impaired loans and foreclosed assets, which is discussed under “Credit Quality and Nonperforming Assets” and “Allowance for Loan and Lease Losses”; income taxes, especially with regard to the ability of the Company to recover deferred tax assets, as discussed in the “Provision for Income Taxes” and “Other Assets” sections of this discussion and analysis; goodwill, which is evaluated annually for impairment based on the fair value of the Company and for which it has been determined that no impairment exists; and equity-based compensation, which is discussed in greater detail in Note 5 to the consolidated financial statements. Critical accounting areas are evaluated on an ongoing basis to ensure that the Company’s financial statements incorporate the most recent expectations with regard to these areas.

OVERVIEW OF THE RESULTS OF OPERATIONS

AND FINANCIAL CONDITION

RESULTS OF OPERATIONS SUMMARY

Second Quarter 2011 compared to Second Quarter 2010

Net income for the quarter ended June 30, 2011 was $2.184 million, representing a decline of $360,000, or 14%, relative to net income of $2.544 million for the quarter ended June 30, 2010. Basic and diluted earnings per share for the second quarter of 2011 were $0.16, compared to $0.22 basic and diluted earnings per share for the second quarter of 2010. The Company’s annualized return on average equity was 5.36% and annualized return on average assets was 0.65% for the quarter ended June 30, 2011, compared to a return on equity of 7.36% and return on assets of 0.77% for the quarter ended June 30, 2010. The primary drivers behind the variance in net income are as follows:

Net interest income was down $671,000, or 5%, due to a 27 basis point drop in the Company’s net interest margin, partially offset by a $15 million increase in average interest-earning assets. Negative factors impacting our net interest margin in the second quarter of 2011 include lower loan yields resulting from increased competition for quality loans, and a shift from average loan balances into lower-yielding investment balances. These negatives were partially offset by net interest recoveries in the second quarter of 2011, a reduced reliance on interest-bearing liabilities due to growth in average non-interest bearing deposits and equity, and a shift in average balances from non-deposit borrowings and CDARS deposits into lower-cost core deposit categories.

The Company’s loan loss provision was reduced by $500,000, or 14%. Thus far in 2011, our loan loss provision has been utilized to provide specific reserves for impaired loans and to replenish reserves subsequent to loan charge-offs. Net loans charged off totaled $3.753 million in the second quarter of 2011, including a $1.4 million charge-off associated with a single non-accruing loan for which we had a $1.2 million reserve already established as of year-end 2010. Net charge-offs were $2.722 million in the second quarter of 2010.

Total non-interest revenue declined by $516,000, or 13%, due primarily to a drop in overdraft income resulting from procedural changes implemented pursuant to regulatory guidance. Another unfavorable variance in non-interest income was the result of a $378,000 increase in costs associated with low-income housing tax credit investments, which are accounted for as a reduction in income. These unfavorable variances were partially offset by a higher level of debit card interchange income, higher merchant fees, an increase in income on bank-owned life insurance associated with deferred compensation plans, and gains on leased equipment subsequent to the termination of leases.

Total operating expense had a negligible variance for the quarterly comparison. Salaries and benefits increased by only $50,000, or 1%, despite the addition of staff for newer branches and a $120,000 increase in deferred compensation accruals. Occupancy expense declined by $194,000, or 11%, for the quarter, due mainly to a drop in depreciation expense, lower maintenance/repair costs, and the January 2011 closure of a branch with a relatively costly lease. Other non-interest expenses increased by an aggregate $151,000, or 3%, due in large part to a $501,000 increase in write-downs on foreclosed assets and an increase in directors deferred fee accruals, which were partially offset by favorable variances in certain other costs including those associated with online deposit accounts and internet banking, marketing expense, FDIC assessments, and sundry losses.

First Half 2011 Compared to First Half 2010

Net income for the first six months of 2011 was $3.713 million, a drop of $1.171 million, or 24%, relative to net income for the first six months of 2010. Basic and diluted earnings per share were $0.27 and $0.26, respectively, for the first six months of 2011, compared to $0.42 basic and diluted earnings per share for the first six months of 2010. The Company realized an annualized return on average equity of 4.62% for the first half of 2011 and 7.17% for the first half of 2010, and a return on assets for the same periods of 0.57% and 0.74%, respectively. The principal reasons for the first half net income variance include the following:

Net interest income declined by $1.996 million, due to a 29 basis point net interest margin decline and a $9 million drop in average interest-earning assets. The drop in our net interest margin for the comparative year-to-date periods was the result of the same circumstances discussed for the quarterly comparison.

The Company’s provision for loan losses was $6.6 million in the first half of 2011, which represents a drop of $300,000, or 4%, relative to the first half of 2010. Net charge-offs increased by $1.3 million, however, due to the charge-off of a pre-established reserve on a non-performing loan that was resolved in the second quarter of 2011.

Total non-interest income declined by $801,000, or 10%. Similar to the quarterly comparison, the largest changes in the components of non-interest income for the half include lower overdraft fee income and higher low-income housing tax credit investment costs, partially offset by an increase in income generated by deferred compensation BOLI, a higher level of debit card interchange fees, and gains realized upon the termination of equipment leases.

Total non-interest expense reflects a drop of $464,000, or 2%, for the first half of 2011. Significant reductions within this category are evident in occupancy expense, marketing costs, internet banking and online account costs, foreclosed asset operating expense, FDIC assessments, and sundry losses. These reductions were partially offset by a $692,000 increase in write-downs on foreclosed assets, and higher directors deferred fee costs.

The Company recorded a negative income tax provision of $48,000 for the first half of 2011, as compared to a provision of $814,000 for the first half of 2011 that resulted in a tax accrual rate of 14%. The income tax provision was negative for the first half of 2011 due to a high level of tax credits relative to taxable income, as adjusted for the favorable impact of tax-exempt interest income and BOLI income.

FINANCIAL CONDITION SUMMARY

June 30, 2011 relative to December 31, 2010

The most significant characteristics of, and changes in, the Company’s balance sheet during the first six months of 2011 are outlined below:

The Company’s assets totaled $1.346 billion at June 30, 2011, an increase of $59 million, or 5%, relative to total assets of $1.287 billion at December 31, 2010. Total assets increased due to growth in investment securities and an increase in cash and balances due from banks, partially offset by lower loan balances. Gross loan and lease balances declined $33 million, or 4%, due to runoff in the normal course of business, prepayments, transfers to OREO, and charge-offs. Weak loan demand from quality borrowers and aggressive competition have hindered our ability to counteract this contraction.

The $65 million balance of nonperforming assets at June 30, 2011 reflects a decline of $1 million, or 2%, since year-end 2010, and is well below its peak of $78 million reached a year earlier. In addition to nonperforming assets we had $14.3 million in performing restructured troubled debt (TDR’s) at June 30, 2011, an increase of $2 million, or 15%, relative to year-end 2010.

Our allowance for loan and lease losses was $20.7 million as of June 30, 2011, which represents a slight decline relative to the balance at year-end 2010 due primarily to the charge-off of a pre-established specific reserve that was included in the allowance at December 31, 2010. Even though the allowance for loan and lease losses fell slightly, our allowance as a percentage of total loans increased by 6 basis points, to 2.68% at June 30, 2011 from 2.62% at December 31, 2010, because loan balances fell during the first half of the year.

Total deposits increased by $64 million, or 6%. While $33 million of that growth was in core non-maturity deposits, NOW deposits dropped by $6 million, or 3%, due to runoff in our online-only accounts subsequent to interest rate adjustments. We also added $15 million in longer-term wholesale-sourced brokered deposits for interest rate risk management purposes, in order to create a more defensive posture for the eventuality of rising interest rates. Federal Home Loan Bank borrowings were reduced by $15 million during the first six months of the year, but other borrowings increased by $4 million subsequent to a customer’s transfer of $4 million from money market deposits into a non-deposit sweep account.

Total capital increased by $6 million, or 4%, to $165 million at June 30, 2011. Because capital increased and risk-adjusted assets declined, our consolidated total risk-based capital ratio increased to 21.38% at June 30, 2011 from 20.33% at year-end 2010. Further, our tier one risk-based capital ratio was 20.12% and our tier one leverage ratio was 13.75% at June 30, 2011.

EARNINGS PERFORMANCE

The Company earns income from two primary sources. The first is net interest income, which is interest income generated by earning assets less interest expense on interest-bearing liabilities. The second is non-interest income, which consists mainly of customer service charges and fees but also comes from non-customer sources such as bank-owned life insurance. The majority of the Company’s non-interest expenses are operating costs that relate to providing a full range of banking services to our customers.

NET INTEREST INCOME AND NET INTEREST MARGIN

For the second quarter of 2011 relative to the second quarter of 2010, net interest income declined by $671,000, or 5%. For the year-to-date comparison, net interest income declined by $1.996 million, or 7%. The level of net interest income depends on several factors in combination, including growth in earning assets, yields on earning assets, the cost of interest-bearing liabilities, the relative volume of earning assets and interest-bearing liabilities, and the mix of products which comprise the Company’s earning assets, deposits, and other interest-bearing liabilities. Net interest income can also be impacted by the reversal of interest for loans placed on non-accrual, and by the recovery of interest on loans that have been on non-accrual and are either sold or returned to accrual status.

The following Average Balances and Rates tables show the average balance of each significant balance sheet category, and the amount of interest income or interest expense associated with that category, for the comparative quarters and year-to-date periods. The tables also show the calculated yields on each major component of the Company’s investment and loan portfolio, the average rates paid on each key segment of the Company’s interest-bearing liabilities, and our net interest margin for the periods noted.

Average Balances and Rates	For the Quarter							For the Quarter
(dollars in thousands, except per share data)	Ended June 30, 2011 (1)(2)(3)							Ended June 30, 2010 (1)(2)(3)
	Average		Income/		Average			Average		Income/		Average
	Balance		Expense		Rate/Yield			Balance		Expense		Rate/Yield
Assets
Investments:
Federal funds sold/due from time	$	36,802	$	25		0.27	%	$	10,215	$	5		0.19	%
Taxable		312,808		2,285		2.89	%		234,371		2,043		3.45	%
Non-taxable		73,396		721		5.98	%		67,829		673		6.04	%
Equity		1,595		-		0.00	%		1,607		-		0.00	%
Total Investments		424,601		3,031		3.19	%		314,022		2,721		3.88	%

Loans and Leases:(4) (5)
Agricultural		13,886		179		5.17	%		9,719		122		5.03	%
Commercial		107,006		1,598		5.99	%		119,237		1,784		6.00	%
Real Estate		556,509		9,091		6.55	%		623,481		10,285		6.62	%
Consumer		41,031		946		9.25	%		51,286		1,139		8.91	%
Direct Financing Leases		7,117		104		5.86	%		11,484		165		5.76	%
Other		48,459		-		0.00	%		54,702		-		0.00	%
Total Loans and Leases		774,008		11,918		6.18	%		869,909		13,495		6.22	%
Total Interest Earning Assets (5)		1,198,609		14,949		5.13	%		1,183,931		16,216		5.62	%
Other Earning Assets		7,882							9,196
Non-Earning Assets		133,018							131,800
Total Assets	$	1,339,509						$	1,324,927

Liabilities and Shareholders' Equity
Interest Bearing Deposits:
NOW	$	175,621	$	205		0.47	%	$	182,036	$	530		1.17	%
Savings Accounts		83,492		50		0.24	%		69,641		41		0.24	%
Money Market		165,083		192		0.46	%		167,208		245		0.59	%
CDAR's		49,144		71		0.59	%		78,669		168		0.86	%
Certificates of Deposit<$100,000		158,083		271		0.69	%		144,702		296		0.82	%
Certificates of Deposit≥$100,000		196,870		286		0.58	%		193,209		315		0.65	%
Brokered Deposits		15,000		50		1.34	%		15,000		76		2.03	%
Total Interest Bearing Deposits		843,293		1,125		0.54	%		850,465		1,671		0.79	%
Borrowed Funds:
Federal Funds Purchased		3		-		0.00	%		-		-		0.00	%
Repurchase Agreements		1,634		5		1.23	%		-		-		0.00	%
Short Term Borrowings		1		-		0.00	%		26,676		55		0.83	%
Long Term Borrowings		15,000		142		3.80	%		15,000		142		3.80	%
TRUPS		30,928		180		2.33	%		30,928		180		2.33	%
Total Borrowed Funds		47,566		327		2.76	%		72,604		377		2.08	%
Total Interest Bearing Liabilities		890,859		1,452		0.65	%		923,069		2,048		0.89	%
Demand Deposits		269,716							248,832
Other Liabilities		15,559							14,454
Shareholders' Equity		163,375							138,572
Total Liabilities and Shareholders' Equity	$	1,339,509						$	1,324,927

Interest Income/Interest Earning Assets						5.13	%						5.62	%
Interest Expense/Interest Earning Assets						0.48	%						0.70	%
Net Interest Income and Margin(6)			$	13,497		4.65	%			$	14,168		4.92	%

(1)	Average balances are obtained from the best available daily or monthly data and are net of deferred fees and related direct costs.

(2)	Yields and net interest margin have been computed on a tax equivalent basis utilizing a 35% effective tax rate.

(3)	Annualized

(4)	Net loan costs have been included in the calculation of interest income. Net loan costs were approximately $145 thousand and $148 thousand for the quarters ended June 30, 2011 and 2010.

Loans are gross of the allowance for possible loan losses.

(5)	Non-accrual loans have been included in total loans for purposes of total earning assets.

(6)	Represents net interest income as a percentage of average interest-earning assets.

Average Balances and Rates	For the Six Months							For the Six Months
(dollars in thousands, except per share data)	Ended June 30, 2011 (1)(2)(3)							Ended June 30, 2010 (1)(2)(3)
	Average		Income/		Average			Average		Income/		Average
	Balance		Expense		Rate/Yield			Balance		Expense		Rate/Yield
Assets
Investments:
Federal funds sold/due from time	$	25,967	$	33		0.25	%	$	16,073	$	22		0.27	%
Taxable		294,874		4,201		2.83	%		228,162		4,150		3.62	%
Non-taxable		72,609		1,437		6.06	%		66,064		1,318		6.10	%
Equity		1,572		-		0.00	%		1,563		-		0.00	%
Total Investments		395,022		5,671		3.24	%		311,862		5,490		3.95	%

Loans and Leases:(4) (5)
Agricultural		12,992		331		5.14	%		9,696		242		5.03	%
Commercial		104,609		3,120		6.01	%		119,181		3,538		5.99	%
Real Estate		563,054		18,140		6.50	%		625,169		20,693		6.67	%
Consumer		42,548		1,890		8.96	%		52,990		2,263		8.61	%
Direct Financing Leases		7,530		219		5.86	%		11,832		337		5.74	%
Other		49,091		-		0.00	%		53,190		-		0.00	%
Total Loans and Leases		779,824		23,700		6.13	%		872,058		27,073		6.26	%
Total Interest Earning Assets (5)		1,174,846		29,371		5.17	%		1,183,920		32,563		5.67	%
Other Earning Assets		8,114							9,278
Non-Earning Assets		133,510							129,758
Total Assets	$	1,316,470						$	1,322,956

Liabilities and Shareholders' Equity
Interest Bearing Deposits:
NOW	$	176,358	$	420		0.48	%	$	171,352	$	914		1.08	%
Savings Accounts		80,852		96		0.24	%		67,378		77		0.23	%
Money Market		160,811		382		0.48	%		171,248		497		0.59	%
CDAR's		40,998		125		0.61	%		96,359		431		0.90	%
Certificates of Deposit<$100,000		159,727		545		0.69	%		144,648		616		0.86	%
Certificates of Deposit≥$100,000		194,093		573		0.60	%		193,754		621		0.65	%
Brokered Deposits		10,939		75		1.38	%		18,083		173		1.93	%
Total Interest Bearing Deposits		823,778		2,216		0.54	%		862,822		3,329		0.78	%
Borrowed Funds:
Federal Funds Purchased		3		-		0.00	%		2		-		0.00	%
Repurchase Agreements		821		4		0.98	%		-		-		0.00	%
Short Term Borrowings		2,538		35		2.78	%		18,084		92		1.03	%
Long Term Borrowings		15,000		282		3.79	%		17,099		318		3.75	%
TRUPS		30,928		361		2.35	%		30,928		355		2.31	%
Total Borrowed Funds		49,290		682		2.79	%		66,113		765		2.33	%
Total Interest Bearing Liabilities		873,068		2,898		0.67	%		928,935		4,094		0.89	%
Demand Deposits		265,781							243,251
Other Liabilities		15,524							13,459
Shareholders' Equity		162,097							137,311
Total Liabilities and Shareholders' Equity	$	1,316,470						$	1,322,956

Interest Income/Interest Earning Assets						5.17	%						5.67	%
Interest Expense/Interest Earning Assets						0.50	%						0.70	%
Net Interest Income and Margin(6)			$	26,473		4.68	%			$	28,469		4.97	%

(1)	Average balances are obtained from the best available daily or monthly data and are net of deferred fees and related direct costs.

(2)	Yields and net interest margin have been computed on a tax equivalent basis utilizing a 35% effective tax rate.

(3)	Annualized

(4)	Net loan costs have been included in the calculation of interest income. Net loan costs were approximately $338 thousand and $187 thousand for the six months ended June 30, 2011 and 2010.

Loans are gross of the allowance for possible loan losses.