Edgar Filing: SIERRA BANCORP

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, 2014

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 þ 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 þ 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 þ
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 þ

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, 13,970,266 shares outstanding as of July 31, 2014

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 Comprehensive Income			3
		Consolidated Statements of Cash Flows			4
		Notes to Unaudited Consolidated Financial Statements			5

	Item 2. Management’s Discussion & Analysis of Financial Condition & Results of Operations				27
		Forward-Looking Statements			27
		Critical Accounting Policies			27
		Overview of the Results of Operations and Financial Condition			28
		Earnings Performance			29
			Net Interest Income and Net Interest Margin		29
			Provision for Loan and Lease Losses		33
			Non-interest Income and Non-Interest Expense		34
			Provision for Income Taxes		36
		Balance Sheet Analysis			37
			Earning Assets		37
				Investments	37
				Loan and Lease Portfolio	38
				Nonperforming Assets	39
				Allowance for Loan and Lease Losses	40
				Off-Balance Sheet Arrangements	42
			Other Assets		42
			Deposits and Interest-Bearing Liabilities		43
				Deposits	43
				Other Interest-Bearing Liabilities	44
			Other Non-Interest Bearing Liabilities		44
		Liquidity and Market Risk Management			44
		Capital Resources			46

	Item 3. Qualitative & Quantitative Disclosures about Market Risk				48

	Item 4. Controls and Procedures				48

Part II - Other Information					49
	Item 1. - Legal Proceedings				49
	Item 1A. - Risk Factors				49
	Item 2. - Unregistered Sales of Equity Securities and Use of Proceeds				49
	Item 3. - Defaults upon Senior Securities				49
	Item 4. - (Removed and Reserved)				49
	Item 5. - Other Information				49
	Item 6. - Exhibits				50

Signatures					51

PART I - FINANCIAL INFORMATION

Item 1 – Financial Statements

SIERRA BANCORP

CONSOLIDATED BALANCE SHEETS

(dollars in thousands)

	June 30, 2014			December 31, 2013
ASSETS		(unaudited)			(audited)
Cash and due from banks	$	44,796		$	51,342
Interest-bearing deposits in banks		4,028			26,664
Total cash & cash equivalents		48,824			78,006
Investment securities available for sale		459,744			425,044
Loans held for sale		-			105
Loans and leases:
Gross loans and leases		893,041			803,242
Allowance for loan and lease losses		(11,634	)		(11,677	)
Deferred loan and lease fees, net		1,393			1,522
Net loans and leases		882,800			793,087
Premises and equipment, net		20,794			20,393
Foreclosed assets		4,498			8,185
Goodwill		5,544			5,544
Other assets		75,835			79,885
TOTAL ASSETS	$	1,498,039		$	1,410,249

LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Non-interest bearing	$	351,757		$	365,997
Interest bearing		894,370			808,182
Total deposits		1,246,127			1,174,179
Federal funds purchased and repurchase agreements		6,094			5,974
Short-term borrowings		7,750			-
Junior subordinated debentures		30,928			30,928
Other liabilities		20,218			17,494
TOTAL LIABILITIES		1,311,117			1,228,575
SHAREHOLDERS' EQUITY
Common stock, no par value; 24,000,000 shares
authorized; 14,009,139 and 14,179,439 shares issued
and outstanding at June 30, 2014 and
December 31, 2013, respectively		65,310			65,780
Additional paid in capital		2,539			2,648
Retained earnings		115,580			112,817
Accumulated other comprehensive income		3,493			429
TOTAL SHAREHOLDERS' EQUITY		186,922			181,674

TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY	$	1,498,039		$	1,410,249

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)

	Three Months Ended June 30,				Six Months Ended June 30,
Interest income:	2014		2013		2014		2013
Interest and fees on loans	$	11,057	$	11,368	$	21,408	$	22,275
Interest on investment securities:
Taxable		1,876		1,034		3,701		2,196
Tax-exempt		733		672		1,474		1,291
Interest on federal funds sold and interest-bearing deposits		16		16		51		44
Total interest income		13,682		13,090		26,634		25,806

Interest expense:
Interest on deposits		553		628		1,111		1,288
Interest on short-term borrowings		4		8		9		12
Interest on long-term borrowings		-		-		-		33
Interest on mandatorily redeemable trust preferred securities		175		179		349		356
Total interest expense		732		815		1,469		1,689

Net Interest Income		12,950		12,275		25,165		24,117

Provision for loan losses		200		450		350		2,050

Net Interest Income after Provision for Loan Losses		12,750		11,825		24,815		22,067

Non-interest income:
Service charges on deposit accounts		2,039		2,215		3,925		4,288
Gains on investment securities available-for-sale		183		-		287		6
Other income, net		1,796		1,807		3,513		3,844
Total non-interest income		4,018		4,022		7,725		8,138

Non-interest expense:
Salaries and employee benefits		5,328		5,403		11,313		11,323
Occupancy expense		1,532		1,596		3,037		3,147
Other		4,148		3,718		7,386		8,068
Total non-interest expense		11,008		10,717		21,736		22,538

Income before income taxes		5,760		5,130		10,804		7,667

Provision for income taxes		1,523		1,331		2,768		1,535

Net Income	$	4,237	$	3,799	$	8,036	$	6,132

PER SHARE DATA
Book value	$	13.34	$	12.38	$	13.34	$	12.38
Cash dividends	$	0.08	$	0.06	$	0.16	$	0.12
Earnings per share basic	$	0.30	$	0.27	$	0.57	$	0.43
Earnings per share diluted	$	0.30	$	0.27	$	0.56	$	0.43
Average shares outstanding, basic		14,086,939		14,128,146		14,157,103		14,120,865
Average shares outstanding, diluted		14,212,532		14,227,335		14,291,359		14,211,910

Total shareholder equity (in thousands)	$	186,922	$	175,171	$	186,922	$	175,171
Shares outstanding		14,009,139		14,144,439		14,009,139		14,144,439
Dividends Paid	$	1,137,910	$	847,358	$	2,267,656	$	1,694,024

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

SIERRA BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in thousands, unaudited)

	Three months ended June 30,						Six months ended June 30,
	2014			2013			2014			2013

Net Income	$	4,237		$	3,799		$	8,036		$	6,132
Other comprehensive income, before tax:
Unrealized gains on securities:
Unrealized holding gains (losses) arising during period		3,927			(6,157	)		5,493			(6,242	)
Less: reclassification adjustment for gains ⁽¹⁾ included in net income		(183	)		-			(287	)		(6	)
Other comprehensive income (loss), before tax		3,744			(6,157	)		5,206			(6,248	)
Income tax expense related to items of other
comprehensive (loss) income, net of tax		(1,540	)		2,534			(2,142	)		2,571
Other comprehensive income (loss)		2,204			(3,623	)		3,064			(3,677	)

Comprehensive Income	$	6,441		$	176		$	11,100		$	2,455

⁽¹⁾ Amounts are included in net gains on investment securities available-for-sale on the Consolidated Statements of Income in non-interest revenue. Income tax expense associated with the reclassification adjustment for the three months ended June 30, 2014 and 2013 was $75 thousand and zero respectively. Income tax expense associated with the reclassification adjustment for the six months ended June 30, 2014 and 2013 was $118 thousand and $2 thousand respectively.

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,
	2014			2013
Cash flows from operating activities:
Net income	$	8,036		$	6,132
Adjustments to reconcile net income to net cash
provided by operating activities:
Gain on sales of securities		(287	)		(6	)
Gain on sales of loans		(3	)		(68	)
Gain on disposal of fixed assets		-			(15	)
(Gain) loss on sale on foreclosed assets		(469	)		269
Writedowns on foreclosed assets		223			188
Share-based compensation expense		33			150
Provision for loan losses		350			2,050
Depreciation		1,038			1,151
Net amortization on securities premiums and discounts		3,285			4,337
Increase in unearned net loan fees		(129	)		(81	)
Increase in cash surrender value of life insurance policies		(806	)		(933	)
Proceeds from sales of loans portfolio		108			2,288
Increase in loans held-for-sale		-			(2,533	)
Decrease in interest receivable and other assets		2,071			3,641
Decrease (increase) in other liabilites		2,724			(633	)
Net (Increase) decrease in FHLB stock		(190	)		438
Deferred income tax provision		833			8
Excess tax benefit from equity based compensation		-			(103	)
Net cash provided by operating activities		16,817			16,280

Cash flows from investing activities:
Maturities of securities available for sale		450			439
Proceeds from sales/calls of securities available for sale		9,210			1,221
Purchases of securities available for sale		(78,426	)		(77,966	)
Principal pay downs on securities available for sale		36,274			52,339
Net (increase) decrease in loans receivable, net		(90,117	)		63,776
Purchases of premises and equipment, net		(1,439	)		(226	)
Proceeds from sales of foreclosed assets		4,116			10,546
Net cash (used in) provided by investing activities		(119,932	)		50,129

Cash flows from financing activities:
Increase (decrease) in deposits		71,948			(19,019	)
Increase (decrease) in borrowed funds		7,750			(41,650	)
Increase in Fed funds purchased		-			544
Increase in repurchase agreements		120			-
Cash dividends paid		(2,268	)		(1,694	)
Repurchases of common stock		(4,281	)		-
Stock options exercised		664			471
Excess tax benefit from equity based compensation		-			103
Net cash provided by (used in) financing activities		73,933			(61,245	)

(Decrease) increase in cash and due from banks		(29,182	)		5,164

Cash and cash equivalents
Beginning of period		78,006			61,818
End of period	$	48,824		$	66,982

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

Sierra Bancorp

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2014

Note 1 – The Business of Sierra Bancorp

Sierra Bancorp (the “Company”) is a California corporation headquartered in Porterville, California, and is a registered bank holding company under federal banking laws. The Company was formed to serve as the holding company for Bank of the Sierra (the “Bank”), and has been the Bank’s sole shareholder since August 2001. 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 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 (TRUPS). 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 Company’s financial statements. 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 primarily to communities in the central and southern regions 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 online. In addition to our full-service branches the Bank has a real estate industries group, an agricultural credit division, an SBA lending unit, and offsite ATMs at six 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 US 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 2013 have been reclassified to be consistent with the reporting for 2014. 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, 2013, as filed with the Securities and Exchange Commission.

Note 3 – Current Accounting Developments

In January 2014, the FASB issued Accounting Standards Update (ASU) 2014-01, Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects, to provide additional flexibility with regard to accounting for investments in qualified affordable housing projects. ASU 2014-01 modifies the conditions that must be met to present the pretax impact and related tax benefits of such investments as a component of income taxes (“net” within income tax expense), to enable more investors to elect to use a “net” presentation for those investments. Investors that do not qualify for “net” presentation under the new guidance will continue to account for such investments under the equity method or cost method, which results in losses recognized in pretax income and tax benefits recognized in income taxes (“gross” presentation of investment results). For investments that qualify for the “net” presentation of investment performance, ASU 2014-01 introduces a “proportional amortization method” that can be elected to amortize the investment basis. If elected, the method is required for all eligible investments in qualified affordable housing projects. ASU 2014-01 also requires enhanced recurring disclosures for all investments in qualified affordable housing projects, regardless of the accounting method used for those investments. It is effective for interim and annual periods beginning after December 15, 2014, and early adoption is permitted. The Company currently expects to adopt ASU 2014-01 as of the first quarter of 2015. We will likely continue to account for our low-income housing tax credit investments using the equity method subsequent to our adoption of ASU 2014-01 and thus do not expect any impact on our income statement or balance sheet, but our disclosures with regard to low-income housing tax credit investments will be updated to reflect the new requirements.

In January 2014, the FASB issued ASU 2014-04, Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure, to resolve diversity in practice with respect to a creditor’s reclassification of a collateralized consumer mortgage loan to other real estate owned (OREO). Current US GAAP requires a loan to be reclassified to OREO upon a troubled debt restructuring that is “in substance a repossession or foreclosure”, where the creditor receives “physical possession” of the debtor's assets regardless of whether formal foreclosure proceedings take place. The terms “in substance a repossession or foreclosure” and “physical possession” are not defined in US GAAP; therefore, questions have arisen about when a creditor should reclassify a collateralized mortgage loan to OREO. ASU 2014-04 requires a creditor to reclassify a collateralized consumer mortgage loan to real estate property upon obtaining legal title to the real estate collateral, or when the borrower voluntarily conveys all interest in the real estate property to the lender to satisfy the loan through a deed in lieu of foreclosure or similar legal agreement. ASU 2014-04 is effective for public business entities for interim and annual periods beginning after December 15, 2014. It will be adopted by the Company for the first quarter of 2015, and we do not expect any impact upon our financial statements or operations upon adoption.

Note 4 – Supplemental Disclosure of Cash Flow Information

During the six months ended June 30, 2014 and 2013, cash paid for interest due on interest-bearing liabilities was $1.502 million and $1.794 million, respectively. There was $160,000 in cash paid for income taxes during the six months ended June 30, 2014, but no cash paid for income taxes for the six months ended June 30, 2013. Assets totaling $184,000 and $2.622 million were acquired in settlement of loans for the six months ended June 30, 2014 and June 30, 2013, respectively. We received $4.116 million in cash from the sale of foreclosed assets during the first six months of 2014 relative to $10.156 million during the first six months of 2013, which represents sales proceeds less loans extended to finance such sales.

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 123,950 shares that were granted under the 1998 Plan were still outstanding as of June 30, 2014 and remain unaffected by that plan’s 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 for issuance pursuant to awards under the 2007 Plan was initially 1,500,000 shares, although the number remaining available for grant as of June 30, 2014 was 829,920. The dilutive impact of stock options outstanding is discussed below in Note 6, Earnings per Share. No restricted stock awards have been issued by the Company.

Pursuant to FASB’s standards on stock compensation, the value of each option granted is reflected in our income statement as employee compensation or directors’ expense by amortizing the value over the vesting period of such option or by expensing it as of the grant date for immediately vested options. 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, which appears to be the preferred method for option grants with graded vesting. A pre-tax charge of $21,000 was reflected in the Company’s income statement during the second quarter of 2014 and $57,000 was charged during the second quarter of 2013, as expense related to stock options. For the first half, the charges totaled $33,000 in 2014 and $151,000 in 2013.

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 14,086,939 weighted average shares outstanding during the second quarter of 2014, and 14,128,146 during the second quarter of 2013. There were 14,157,103 weighted average shares outstanding during the first six months of 2014, and 14,120,865 during the first six months of 2013.

Diluted earnings per share include the effect of the potential issuance of common shares, which for the Company is limited to shares that would be issued on the exercise of “in-the-money” 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 2014 the dilutive effect of options outstanding calculated under the treasury stock method totaled 125,593 and 134,256, 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 2013 shares totaling 99,189 and 91,045, respectively, were added to basic weighted average shares outstanding in order to calculate diluted earnings per share.

Note 7 – Comprehensive Income

As presented in the Consolidated Statements of Comprehensive Income, comprehensive income includes net income and other comprehensive income. The Company’s only source of other comprehensive income is unrealized gains and losses on available-for-sale investment securities. Gains or losses on investment securities that were realized and included in net income of the current period, which had previously been included in other comprehensive income as unrealized holding gains or losses in the period in which they arose, are considered to be reclassification adjustments that are excluded from other comprehensive income in the current period.

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. Those financial instruments consist of unused 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 originating loans included on the balance sheet. The following financial instruments represent off-balance-sheet credit risk (dollars in thousands):

	June 30, 2014		December 31, 2013
Commitments to extend credit	$	386,378	$	420,707
Standby letters of credit	$	8,884	$	8,703
Commercial letters of credit	$	8,069	$	8,070

Commitments to extend credit consist primarily of the unused or unfunded portions of the following: home equity lines of credit; commercial real estate construction loans, where disbursements are made over the course of construction; commercial revolving lines of credit; mortgage warehouse lines of credit; unsecured personal lines of credit; and formalized (disclosed) deposit account overdraft lines. 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 unused portions of committed 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 the risk involved in extending loans to customers.

The Company is also utilizing an $88 million letter of credit issued by the Federal Home Loan Bank on the Company’s behalf as security for certain deposits. The letter of credit is backed by loans which are pledged to the Federal Home Loan Bank by the Company.

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 in their financial statement footnotes the estimated fair values of financial instruments for which it is practicable to estimate fair values. In addition to 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. FASB’s standard on financial instruments permits companies to report certain other financial assets and liabilities at fair value, but 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 values. 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, the standards establish a fair value hierarchy that encourages an entity to maximize the use of observable inputs and limit the use of unobservable inputs when measuring fair values. The standards describe three levels of inputs that may be used to measure fair values:

	·	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. The 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 realized gains and losses could have a significant effect on fair value estimates but 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. The estimates are subjective 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, 2014 and December 31, 2013:

Cash and cash equivalents and fed funds sold: The carrying amount is estimated to be fair value.

Investment securities: Fair values 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 their relationship to other benchmark quoted securities when quoted prices for 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. The carrying amount of accrued interest receivable approximates its fair value.

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 not relevant for reporting purposes. If available-for-sale loans are on our books for an extended period of time, the fair value of those loans is determined using quoted secondary-market prices.

Collateral-dependent impaired loans: Collateral-dependent impaired loans are carried at fair value when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the original loan agreement and the loan has been written down to the fair value of its underlying collateral, net of expected disposition costs where applicable.

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

Investments 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: Certain investments for which no secondary market exists are carried at cost unless an impairment analysis indicates the need for adjustments, and the carrying amount for those investments approximates their estimated fair value.

Deposits: Fair values for 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: Fair values are estimated using projected cash flows discounted at the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Subordinated debentures: Fair values 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: If funded, the carrying amounts for currently unused commitments 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 those 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 are as follows, as of the dates noted:

Fair Value of Financial Instruments
(dollars in thousands, unaudited)	June 30, 2014
			Estimated Fair Value
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Financial assets:
Cash and cash equivalents	$	48,824	$	48,824	$	-	$	-	$	48,824
Investment securities available for sale		459,744		2,487		457,257		-		459,744
Loans and leases, net held for investment		862,856		-		874,610		-		874,610
Collateral dependent impaired loans		19,944		-		19,944		-		19,944
Loans held-for-sale		-		-		-		-		-
Cash surrender value of life insurance policies		40,230		-		40,230		-		40,230
Other investments		6,122		-		6,122		-		6,122
Investment in limited partnership		7,883		-		7,883		-		7,883
Accrued interest receivable		5,196		-		5,196		-		5,196

Financial liabilities:
Deposits:
Noninterest-bearing	$	351,757	$	351,757	$	-	$	-	$	351,757
Interest-bearing		894,370		-		894,611		-		894,611
Fed funds purchased and repurchase agreements		6,094		-		6,094		-		6,094
Short-term borrowings		7,750		-		7,750		-		7,750
Long-term borrowings		-		-		-		-		-
Subordinated debentures		30,928		-		11,267		-		11,267
Limited partnership capital commitment		914		-		914		-		914
Accrued interest payable		153		-		153		-		153

		Notional Amount
Off-balance-sheet financial instruments:
Commitments to extend credit	$	386,378
Standby letters of credit		8,884
Commercial lines of credit		8,069

	December 31, 2013
			Estimated Fair Value
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Financial assets:
Cash and cash equivalents	$	78,006	$	78,006	$	-	$	-	$	78,006
Investment securities available for sale		425,044		2,456		422,588		-		425,044
Loans and leases, net held for investment		778,382		-		797,383		-		797,383
Collateral dependent impaired loans		14,705		-		14,705		-		14,705
Loans held-for-sale		105		105		-		-		105
Cash surrender value of life insurance policies		39,424		-		39,424		-		39,424
Other Investments		5,932		-		5,932		-		5,932
Investment in limited partnership		9,204		-		9,204		-		9,204
Accrued interest receivable		4,990		-		4,990		-		4,990

Financial liabilities:
Deposits:
Noninterest-bearing	$	365,997	$	365,997	$	-	$	-	$	365,997
Interest-bearing		808,182		-		808,182		-		808,182
Fed funds purchased and repurchase agreements		5,974		-		5,974		-		5,974
Short-term borrowings		-		-		-		-		-
Long-term borrowings		-		-		-		-		-
Subordinated debentures		30,928		-		11,175		-		11,175
Limited partnership capital commitment		962		-		962		-		962
Accrued interest payable		186		-		186		-		186

		Notional Amount
Off-balance-sheet financial instruments:
Commitments to extend credit	$	420,707
Standby letters of credit		8,703
Commercial lines of credit		8,070

For financial asset categories that were actually reported at fair value at June 30, 2014 and December 31, 2013, the Company used the following methods and significant assumptions:

Foreclosed assets: Repossessed real estate (OREO) and other foreclosed assets are carried at the lower of cost or fair value. Fair value is the appraised value less expected selling costs for OREO and some other assets such as mobile homes, and for any other foreclosed assets fair value is represented by the estimated sales proceeds as determined using reasonably available sources. Foreclosed assets for which appraisals can be feasibly obtained are periodically measured for impairment using updated appraisals. Fair values for other foreclosed assets are adjusted as necessary, subsequent to a periodic re-evaluation of expected cash flows and the timing of resolution. 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, 2014, using

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Investment securities
US Government agencies	$	-	$	4,672	$	-	$	4,672
Mortgage-backed securities		-		354,186		-		354,186
State and poltical subdivisions		-		98,399		-		98,399
Equity securities		2,487		-		-		2,487

Total available-for-sale securities	$	2,487	$	457,257	$	-	$	459,744

	Fair Value Measurements at December 31, 2013, using

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Investment securities
US Government agencies	$	-	$	5,304	$	-	$	5,304
Mortgage-backed securities		-		320,721		-		320,721
State and poltical subdivisions		-		96,563		-		96,563
Equity securities		2,456		-		-		2,456

Total available-for-sale securities	$	2,456	$	422,588	$	-	$	425,044

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

Fair Value Measurements - Nonrecurring
(dollars in thousands, unaudited)
	Fair Value Measurements at June 30, 2014, Using

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Collateral dependent impaired loans	$	-	$	19,944	$	-	$	19,944
Foreclosed assets	$	-	$	4,498	$	-	$	4,498

	Fair Value Measurements at December 31, 2013, using

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Collateral dependent impaired loans	$	-	$	14,705	$	-	$	14,705
Foreclosed assets	$	-	$	8,185	$	-	$	8,185

The table above includes collateral-dependent 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 Note 11 below, and in Management’s Discussion and Analysis of Financial Condition and Results of Operation in the “Nonperforming Assets” and “Allowance for Loan and Lease Losses” sections.

The unobservable inputs are based on management’s best estimates of appropriate discounts in arriving at fair market value. Increases or decreases in any of those inputs could result in a significantly lower or higher fair value measurement. For example, a change in either direction of actual loss rates would have a directionally opposite change in the calculation of the fair value of unsecured impaired loans.

Note 10 – Investments

Although the Company currently has the intent and the ability to hold the securities in its investment portfolio to maturity, the securities are all marketable and are classified as “available for sale” to allow maximum flexibility with regard to interest rate risk and liquidity management. Pursuant to FASB’s guidance on accounting for debt and equity securities, available for sale securities are carried on the Company’s financial statements at their estimated fair market values, with monthly tax-effected “mark-to-market” adjustments made vis-à-vis accumulated other comprehensive income in shareholders’ equity.

The table below summarizes the Company’s available-for-sale investment securities by type, as of the dates indicated:

Amortized Cost And Estimated Fair Value
(dollars in thousands, unaudited)
	June 30, 2014
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value

US Government agencies	$	4,743	$	7	$	(78	)	$	4,672
Mortgage-backed securities		351,139		4,411		(1,364	)		354,186
State and poltical subdivisions		96,592		2,623		(816	)		98,399
Equity securities		1,336		1,151		-			2,487
Total investment securities	$	453,810	$	8,192	$	(2,258	)	$	459,744

	December 31, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value

US Government agencies	$	5,395	$	18	$	(109	)	$	5,304
Mortgage-backed securities		320,223		3,269		(2,771	)		320,721
State and political subdivisons		97,361		1,723		(2,521	)		96,563
Equity securities		1,336		1,120		-			2,456
Total investment securities	$	424,315	$	6,130	$	(5,401	)	$	425,044

At June 30, 2014 and December 31, 2013, the Company had 158 securities and 197 securities, respectively, with unrealized losses. Management has evaluated those securities as of the respective dates, and does not believe that any of the associated unrealized losses are other than temporary. Information pertaining to our investment securities with unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous loss position, is disclosed in the table below.

Investment Portfolio - Unrealized Losses
(dollars in thousands, unaudited)	June 30, 2014
	Less than Twelve Months					Over Twelve Months
	Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value

US Government agencies	$	(20	)	$	1,707	$	(58	)	$	2,332
Mortgage-backed securities		(338	)		60,577		(1,026	)		72,589
State and political subdivisions		(44	)		5,929		(772	)		26,249
Other securities		-			-		-			-
Total investment securities	$	(402	)	$	68,213	$	(1,856	)	$	101,170

	December 31, 2013
	Less than Twelve Months					Over Twelve Months
	Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value


US Government agencies	$	(92	)	$	1,913	$	(17	)	$	1,920
Mortgage-backed securities		(642	)		21,747		(2,129	)		124,317
State and political subdivisions		(461	)		6,799		(2,060	)		38,083
Other securities		-			-		-			-
Total investment securities	$	(1,195	)	$	30,459	$	(4,206	)	$	164,320

The table below summarizes the Company’s gross realized gains and losses as well as gross proceeds from the sales of securities:

Investment Portfolio - Realized Gains/(Losses)
(dollars in thousands, unaudited)

	Three months ended June 30,					Six months ended June 30,
	2014			2013		2014			2013

Proceeds from sales of securities available for sale	$	4,995		$	-	$	8,360		$	264

Gross gains on sale of securities available for sale	$	185		$	-	$	289		$	6
Gross losses on sale of securities available for sale		(2	)		-		(2	)		-
Net gains on sale of securities available for sale	$	183		$	-	$	287		$	6

The amortized cost and estimated fair value of investment securities available-for-sale at June 30, 2014 and December 31, 2014 by contractual maturity are shown below. Expected maturities will differ from contraction maturities because the issuers of the securities may have the right to call or prepay obligations with or without penalties.

Estimated Fair Value of Contractual Maturities
(dollars in thousands, unaudited)	June 30, 2014
	Amortized Cost		Fair Value


Maturing within one year	$	3,062	$	3,077
Maturing after one year through five years		222,327		225,395
Maturing after five years through ten years		64,030		65,120
Maturing after ten years		51,477		51,642


Investment securities not due at a single maturity date:
U.S Government agencies collateralized by
mortgage obligations		111,578		112,024
Other securities		1,336		2,486
	$	453,810	$	459,744

	December 31, 2013
	Amortized Cost		Fair Value


Maturing within one year	$	2,294	$	2,316
Maturing after one year through five years		241,396		242,493
Maturing after five years through ten years		59,572		59,402
Maturing after ten years		49,674		47,737


Investment securities not due at a single maturity date:
U.S Government agencies collateralized by
mortgage obligations		70,043		70,640
Other securities		1,336		2,456
	$	424,315	$	425,044

At June 30, 2014, the Company’s investment portfolio included securities issued by 246 different government municipalities and agencies located within 27 states with a fair value of $98.4 million. The largest exposure to any single municipality or agency was a $4.5 million (fair value) bond issued for water utility improvements by the Arizona State Water Infrastructure Finance Authority, to be repaid by future water revenue.

The Company’s investments in bonds issued by states, municipalities and political subdivisions are evaluated in accordance with Supervision and Regulation Letter 12-15 (SR 12-15) issued by the Board of Governors of the Federal Reserve System, “Investing in Securities without Reliance on Nationally Recognized Statistical Rating Organization Ratings”, and other regulatory guidance. Credit ratings are considered in our analysis only as a guide to the historical default rate associated with similarly-rated bonds. There have been no significant differences in our internal analyses compared with the ratings assigned by the third party credit rating agencies.

The following table summarizes the total general obligation and revenue bonds in the Company’s investment securities portfolio at June 30, 2014, including the state in which the issuing government municipality or agency operates when such state represents an investment concentration:

Revenue and General Obligation Bonds by Location
dollars in thousands, unaudited	June 30, 2014				December 31, 2013

	Amortized		Fair Market		Amortized		Fair Market
General obligation bonds	Cost		Value		Cost		Value
State of issuance
California	$	22,103	$	23,139	$	20,638	$	21,272
Texas		12,450		12,496		11,340		11,024
Illinois		8,301		8,333		8,965		8,702
Ohio		7,646		7,669		7,659		7,485
Washington		5,997		6,087		5,487		5,340
Arizona		2,085		2,145		2,100		2,050
Other states		19,663		20,014		20,666		20,429
Total General Obligation Bonds		78,245		79,883		76,855		76,302

Revenue bonds
State of issuance
Arizona		4,645		4,482		4,700		4,341
Texas		3,294		3,362		2,762		2,719
California		2,169		2,235		2,519		2,579
Washington		1,169		1,206		1,170		1,211
Ohio		323		337		324		339
Other states		6,747		6,894		6,758		6,742
Total Revenue Bonds		18,347		18,516		18,233		17,931

Certificates of participation (All California)		-		-		2,273		2,330

Total Obligations of States
and Political Subdivisions	$	96,592	$	98,399	$	97,361	$	96,563

At June 30, 2014, the revenue bonds in the Company’s investment securities portfolios were issued by government municipalities and agencies to fund public services such as utilities (water, sewer, and power), educational facilities, and general public and economic improvements. The revenue bonds were payable from 12 different types of revenue sources. The revenue sources that represent 5% or more individually as a percent of the total revenue bonds are summarized in the following table:

Revenue Bonds by Type
dollars in thousands, unaudited	June 30, 2014				December 31, 2013

	Amortized		Fair Market		Amortized		Fair Market
Revenue bonds	Cost		Value		Cost		Value
Revenue source:
Water	$	7,350	$	7,295	$	7,409	$	7,144
College & University		2,739		2,812		2,203		2,187
Electric & Power		1,884		1,919		1,888		1,895
Sales Tax		1,673		1,713		1,673		1,688
Lease		1,356		1,337		1,155		1,063
Other sources		3,345		3,440		3,905		3,954
Total Revenue Bonds	$	18,347	$	18,516	$	18,233	$	17,931

Note 11 – Credit Quality and Nonperforming Assets

Credit Quality Classifications

The Company monitors the credit quality of loans on a continuous basis using the regulatory and accounting classifications of pass, special mention, substandard and impaired to characterize the associated credit risk. Balances classified as “loss” are immediately charged off. The Company conforms to the following definitions for risk classifications utilized:

Pass: Larger non-homogeneous loans not meeting the risk rating definitions below, and smaller homogeneous loans that are not assessed on an individual basis.

Special mention: Loans which have potential issues that deserve the close attention of management. If left uncorrected, those potential weaknesses could eventually diminish the prospects for full repayment of principal and interest according to the contractual terms of the loan agreement, or could result in deterioration of the Company’s credit position at some future date.

Substandard: Loans that have at least one clear and well-defined weakness which could jeopardize the ultimate recoverability of all principal and interest, such as a borrower displaying a highly leveraged position, unfavorable financial operating results and/or trends, uncertain repayment sources or a deteriorated financial condition.

Impaired: 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 according to the contractual terms of the loan agreement. Impaired loans include all nonperforming loans, restructured troubled debt (TDRs), and certain other loans that are still being maintained on accrual status. A TDR may be nonperforming or performing, depending on its accrual status and the demonstrated ability of the borrower to comply with restructured terms (see “Troubled Debt Restructurings” section below for additional information on TDRs).

Credit quality classifications for the Company’s loan balances were as follows, as of the dates indicated:

Credit Quality Classifications
(dollars in thousands, unaudited)
	June 30, 2014
	Pass		Special Mention		Substandard		Impaired		Total

Real Estate:
1-4 family residential construction	$	4,120	$	-	$	-	$	-	$	4,120
Other construction/land		17,967		299		10		4,878		23,154
1-4 family - closed end		97,789		927		609		14,535		113,860
Equity lines		47,591		213		1,250		2,268		51,322
Multi-family residential		6,565		423		-		-		6,988
Commercial real estate - owner occupied		177,779		21,534		3,635		4,708		207,656
Commercial real estate - non-owner occupied		89,255		3,575		228		12,945		106,003
Farmland		122,982		2,459		79		173		125,693
Total real estate		564,048		29,430		5,811		39,507		638,796

Agricultural		24,812		646		357		327		26,142
Commercial and Iindustrial		95,907		1,900		289		3,252		101,348
Mortgage Warehouse		106,157		-		-		-		106,157
Consumer loans		17,018		416		113		3,051		20,598
Total gross loans and leases	$	807,942	$	32,392	$	6,570	$	46,137	$	893,041

	December 31, 2013
	Pass		Special Mention		Substandard		Impaired		Total

Real Estate:
1-4 family residential construction	$	1,720	$	-	$	-	$	-	$	1,720
Other construction/land		18,243		334		203		6,751		25,531
1-4 family - closed end		67,051		1,305		770		17,898		87,024
Equity lines		51,019		254		1,429		1,021		53,723
Multi-family residential		8,059		426		-		-		8,485
Commercial real estate - owner occupied		158,155		17,033		3,261		7,563		186,012
Commercial real estate - non-owner occupied		89,475		3,630		240		13,495		106,840
Farmland		105,623		1,780		819		282		108,504
Total real estate		499,345		24,762		6,722		47,010		577,839

Agricultural		24,178		532		-		470		25,180
Commercial and industrial		93,224		3,358		1,236		5,444		103,262
Mortgage Warehouse		73,425		-		-		-		73,425
Consumer loans		19,387		478		208		3,463		23,536
Total gross loans and leases	$	709,559	$	29,130	$	8,166	$	56,387	$	803,242

Past Due and Nonperforming Assets

Nonperforming assets are comprised of loans for which the Company is no longer accruing interest, and foreclosed assets, including mobile homes and other real estate owned (OREO). OREO consists of properties acquired by foreclosure or similar means, which the Company is offering or will offer for sale. Nonperforming loans and leases result when reasonable doubt surfaces with regard to the ability of the Company to collect all principal and interest. At that point, we stop accruing interest on the loan or lease in question and reverse any previously-recognized interest to the extent that it is uncollected or associated with interest-reserve loans. Any asset for which principal or interest has been in default for 90 days or more is also placed on non-accrual status even if interest is still being received, unless the asset is both well secured and in the process of collection. An aging of the Company’s loan balances is presented in the following tables, by number of days past due as of the indicated dates:

Loan Portfolio Aging
(dollars in thousands, unaudited)
	June 30, 2014
	30-59 Days Past Due		60-89 Days Past Due		90 Days Or More Past Due⁽²⁾		Total Past Due		Current		Total Financing Receivables		Non-Accrual Loans⁽¹⁾

Real Estate:
1-4 family residential construction	$	-	$	7	$	-	$	7	$	4,113	$	4,120	$	-
Other construction/land		-		3,682		-		3,682		19,472		23,154		3,682
1-4 family - closed end		125		2,707		-		2,832		111,028		113,860		10,071
Equity lines		6		86		838		930		50,392		51,322		1,997
Multi-family residential		-		-		-		-		6,988		6,988		-
Commercial real estate - owner occupied		218		362		1,640		2,220		205,436		207,656		3,485
Commercial real estate - non-owner occupied		834		202		6,842		7,878		98,125		106,003		7,671
Farmland		937		-		-		937		124,756		125,693		173
Total real estate		2,120		7,046		9,320		18,486		620,310		638,796		27,079

Agricultural		159		358		327		844		25,298		26,142		327
Commercial and industrial		399		-		401		800		100,548		101,348		992
Mortgage Warehouse		-		-		-		-		106,157		106,157		-
Consumer loans		212		-		39		251		20,347		20,598		838
Total gross loans and leases	$	2,890	$	7,404	$	10,087	$	20,381	$	872,660	$	893,041	$	29,236

⁽¹⁾ Included in total financing receivables

⁽²⁾ As of June 30, 2014 there were no loans over 90 days past due and still acrruing.

	December 31, 2013
	30-59 Days Past Due		60-89 Days Past Due		90 Days Or More Past Due⁽²⁾		Total Past Due		Current		Total Financing Receivables		Non-Accrual Loans⁽¹⁾

Real Estate:
1-4 family residential construction	$	-	$	-	$	-	$	-	$	1,720	$	1,720	$	-
Other construction/land		294		-		116		410		25,121		25,531		5,528
1-4 family - closed end		2,181		300		171		2,652		84,372		87,024		13,168
Equity lines		98		-		288		386		53,337		53,723		778
Multi-family residential		-		-		-		-		8,485		8,485		-
Commercial real estate - owner occupied		1,917		144		2,011		4,072		181,940		186,012		5,516
Commercial real estate - non-owner occupied		-		-		7,667		7,667		99,173		106,840		8,058
Farmland		331		-		-		331		108,173		108,504		282
Total real estate		4,821		444		10,253		15,518		562,321		577,839		33,330

Agricultural		892		327		125		1,344		23,836		25,180		470
Commercial and industrial		1,318		587		1,298		3,203		100,059		103,262		2,622
Mortgage Warehouse		-		-		-		-		73,425		73,425		-
Consumer loans		181		-		-		181		23,355		23,536		992
Total gross loans and leases	$	7,212	$	1,358	$	11,676	$	20,246	$	782,996	$	803,242	$	37,414

⁽¹⁾ Included in total financing receivables

⁽²⁾ As of December 31, 2013 there were no loans over 90 days past due and still accruing.

Troubled Debt Restructurings

A loan that is modified for a borrower who is experiencing financial difficulty is classified as a troubled debt restructuring (TDR), if the modification constitutes a concession. At June 30, 2014, the Company had a total of $34.6 million in TDRs, including $21.4 million in TDRs that were on non-accrual status. Generally, a non-accrual loan that has been modified as a TDR remains on non-accrual status for a period of at least six months to demonstrate the borrower’s ability to comply with the modified terms. However, performance prior to the modification, or significant events that coincide with the modification, could result in a loan’s return to accrual status after a shorter performance period or even at the time of loan modification. TDRs may have the TDR designation removed in the calendar year following the restructuring, if the loan is in compliance with all modified terms and is yielding a market rate of interest. Regardless of the period of time that has elapsed, if the borrower’s ability to meet the revised payment schedule is uncertain then the loan will be kept on non-accrual status. Moreover, a TDR is generally considered to be in default when it appears that the customer will not likely be able to repay all principal and interest pursuant to the terms of the restructured agreement.

The Company may agree to different types of concessions when modifying a loan or lease. The tables below summarize TDRs which were modified during the noted periods, by type of concession:

Troubled Debt Restructurings, by Type of Loan Modification
(dollars in thousands, unaudited)
	For the six months Ended Ended June 30, 2014

	Rate Modification		Term Modification		Interest Only Modification		Rate & Term Modification		Rate & Interest Only Modification		Term & Interest Only Modification		Rate, Term & Interest Only Modification		Total

Real estate:
Other construction/land	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
1-4 family - closed-end		-		13		-		-		-		-		-		13
Equity lines		-		321		-		29		-		-		-		350
Commercial real estate - owner occupied		279		123		-		-		-		-		-		402
Total real estate loans		279		457		-		29		-		-		-		765
Commercial and industrial		-		133		-		4		-		30		-		167
Consumer loans		-		9		-		-		-		-		-		9
	$	279	$	599	$	-	$	33	$	-	$	30	$	-	$	941

	For the year ended December 31, 2013
	Rate Modification		Term Modification		Interest Only Modification		Rate & Term Modification		Rate & Interest Only Modification		Term & Interest Only Modification		Rate, Term & Interest Only Modification		Total

Real Estate:
Other construction/land	$	-	$	416	$	-	$	-	$	-	$	-	$	-	$	416
1-4 family - closed-end		-		3,338		-		238		-		-		102		3,678
Equity lines		-		-		40		-		-		-		-		40
Commercial real estate - owner occupied		-		-		-		557		-		-		-		557
Total real estate loans		-		3,754		40		795		-		-		102		4,691
Commercial and industrial		-		1,563		-		308		-		-		-		1,871
Consumer loans		-		469		-		-		-		-		92		561
	$	-	$	5,786	$	40	$	1,103	$	-	$	-	$	194	$	7,123

The following tables present, by class, additional details related to loans classified as TDRs during the referenced periods, including the recorded investment in the loan both before and after modification and balances that were modified during the period:

Troubled Debt Restructurings
(dollars in thousands, unaudited)
	For the three months Ended June 30, 2014

			Pre-Modification		Post-Modification
	Number of Loans		Outstanding Recorded Investment		Outstanding Recorded Investment		Reserve Difference⁽¹⁾		Reserve

Real Estate:
Other Construction/Land		-	$	-	$	-	$	-	$	-
1-4 family - closed-end		-		-		-		-		-
Equity Lines		3		350		350		169		205
Commercial RE- owner occupied		1		279		279		-		139
Total Real Estate Loans				629		629		169		344

Commercial and Industrial		2		53		53		29		33
Consumer loans		2		7		7		1		2
			$	689	$	689	$	199	$	379

⁽¹⁾This represents the change in the ALLL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology.


	For the six months Ended June 30, 2014

			Pre-Modification		Post-Modification
	Number of Loans		Outstanding Recorded Investment		Outstanding Recorded Investment		Reserve Difference⁽¹⁾		Reserve

Real Estate:
Other Construction/Land		-	$	-	$	-	$	-	$	-
1-4 family - closed-end		1		13		13		-		-
Equity Lines		3		350		350		169		203
Commercial RE- owner occupied		2		402		402		-		141
Total Real Estate Loans				765		765		169		344

Commercial and Industrial		5		167		167		52		43
Consumer loans		3		9		9		1		2
			$	941	$	941	$	222	$	389

⁽¹⁾ This represents the change in the ALLL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowancefor loan loss methodology.

The tables below summarize TDRs that defaulted during the periods noted, and any charge-offs on those TDRs resulting from such default.

Troubled Debt Restructurings
(dollars in thousands, unaudited)
	Subsequent default three months ended June 30, 2014
	Number of Loans		Recorded Investment		Charge-Offs

Real Estate:
Other Construction/Land		3	$	1,546	$	-
1-4 family - closed-end		2		8,305		-
Commercial real estate- owner occupied		1		222		31
Total Real Estate Loans				10,073		31
Commercial and Industrial		-		-		-
Consumer Loans		-		-		-
			$	10,073	$	31

	Subsequent default six months ended June 30, 2014

	Number of Loans		Recorded Investment		Charge-Offs
Real Estate:
Other Construction/Land		3	$	1,546	$	-
1-4 family - closed-end		2		8,305		-
Commercial real estate- owner occupied		1		222		31
Total Real Estate Loans				10,073		31
Commercial and Industrial		1		127		-
Consumer Loans		2		133		58
			$	10,333	$	89

Note 12 – Allowance for Loan and Lease Losses

The Company’s allowance for loan and lease losses, a contra-asset, is established through a provision for loan and lease losses. The allowance is maintained at a level that is considered adequate to absorb probable losses on certain specifically identified loans, as well as probable incurred losses inherent in the remaining loan portfolio. Specifically identifiable and quantifiable losses are immediately charged off against the allowance; recoveries are generally recorded only when cash payments are received subsequent to the charge off. We employ a systematic methodology, consistent with FASB guidelines on loss contingencies and impaired loans, for determining the appropriate level of the allowance for loan and lease losses and adjusting it at least quarterly. Pursuant to that methodology, impaired loans and leases are individually analyzed and a criticized asset action plan is completed specifying the financial status of the borrower and, if applicable, the characteristics and condition of collateral and any associated liquidation plan. A specific loss allowance is created for each impaired loan, if necessary.

The following tables disclose the unpaid principal balance, recorded investment (including accrued interest), average recorded investment, and interest income recognized for impaired loans on our books as of the dates indicated. Balances are shown by loan type, and are further broken out by those that required an allowance and those that did not, with the associated allowance disclosed for those that required such. Included in the valuation allowance for impaired loans shown in the tables below are specific reserves allocated to TDRs, totaling $3.878 million at June 30, 2014 and $3.321 million at December 31, 2013.

Impaired Loans	June 30, 2014
(dollars in thousands, unaudited)	Unpaid Principal Balance⁽¹⁾		Recorded Investment⁽²⁾		Related Allowance		Average Recorded Investment		Interest Income Recognized⁽³⁾


With an allowance recorded
Real Estate:
1-4 family residential construction	$	-	$	-	$	-	$	-	$	-
Other construction/land		2,904		2,903		434		3,092		47
1-4 Family - closed-end		11,055		11,055		1,214		11,918		135
Equity lines		1,867		1,702		450		1,918		6
Commercial real estate- owner occupied		2,665		2,555		1,259		2,790		26
Commercial real estate- non-owner occupied		10,423		10,424		1,079		10,896		148
Farmland		-		-		-		-		-
Total real estate		28,914		28,639		4,436		30,614		362
Agriculture		-		-		-		-		-
Commercial and industrial		3,197		3,184		807		3,185		61
Consumer loans		2,929		2,927		336		3,131		81
		35,040		34,750		5,579		36,930		504
With no related allowance recorded
Real estate:
1-4 family residential construction		-		-		-		-		-
Other construction/land		2,033		1,975		-		2,409		-
1-4 family - closed-end		3,637		3,480		-		4,339		-
Equity lines		746		566		-		759		-
Commercial real estate- owner occupied		3,483		2,153		-		3,773		-
Commercial real estate- non-owner occupied		2,669		2,521		-		2,790		58
Farmland		173		173		-		203		-
Total real estate		12,741		10,868		-		14,273		58
Agriculture		327		327		-		336		-
Commercial and industrial		93		68		-		123		-
Consumer loans		401		124		-		528		-
		13,562		11,387		-		15,260		58
Total	$	48,602	$	46,137	$	5,579	$	52,190	$	562

⁽¹⁾ Contractual principal balance due from customer.

⁽²⁾ Principal balance on Company's books, less any direct charge offs.

⁽³⁾ Interest income is recognized on performing balances on a regular accrual basis.

	December 31, 2013
	Unpaid Principal Balance⁽¹⁾		Recorded Investment⁽²⁾		Related Allowance		Average Recorded Investment		Interest Income Recognized⁽³⁾


With an allowance recorded
Real estate:
1-4 family residential construction	$	-	$	-	$	-	$	-	$	-
Other construction/land		2,972		2,972		502		3,000		98
1-4 family - closed-end		13,522		13,522		1,324		13,630		260
Equity lines		528		528		123		530		13
Commercial real estate- owner occupied		2,047		2,047		217		2,069		135
Commercial real estate- non-owner occupied		3,715		3,715		701		3,813		238
Farmland		-		-		-		-		-
Total real estate		22,784		22,784		2,867		23,042		744
Agriculture		125		125		126		131		-
Commercial and industrial		4,580		4,345		1,925		4,496		131
Consumer loans		3,411		3,411		431		3,591		172
		30,900		30,665		5,349		31,260		1,047
With no related allowance recorded
Real estate:
1-4 family residential construction		-		-		-		-		-
Other construction/land		4,176		3,779		-		3,885		-
1-4 family - closed-end		4,655		4,376		-		4,687		1
Equity lines		565		493		-		493		-
Commercial real estate- owner occupied		7,436		5,516		-		5,568		-
Commercial real estate- non-owner occupied		10,077		9,780		-		9,820		115
Farmland		282		282		-		290		-
Total real estate		27,191		24,226		-		24,743		116
Agriculture		345		345		-		837		-
Commercial and industrial		1,249		1,099		-		1,607		57
Consumer loans		241		52		-		77		-
		29,026		25,722		-		27,264		173
Total	$	59,926	$	56,387	$	5,349	$	58,524	$	1,220

⁽¹⁾ Contractual principal balance due from customer.

⁽²⁾ Principal balance on Company's books, less any direct charge offs.

⁽³⁾ Interest income is recognized on performing balances on a regular accrual basis.

The specific loss allowance for an impaired loan generally represents the difference between the face value of the loan and either the fair value of underlying collateral less estimated disposition costs, or the loan’s net present value as determined by a discounted cash flow analysis. The discounted cash flow approach is typically used to measure impairment on loans for which it is anticipated that repayment will be provided from cash flows other than those generated solely by the disposition or operation of underlying collateral. However, historical loss rates may be used to determine a specific loss allowance if they indicate a higher potential reserve need than the discounted cash flow analysis. Any change in impairment attributable to the passage of time is accommodated by adjusting the loss allowance accordingly.

For loans where repayment is expected to be provided by the disposition or operation of the underlying collateral, impairment is measured using the fair value of the collateral. If the collateral value, net of the expected costs of disposition where applicable, is less than the loan balance, then a specific loss reserve is established for the shortfall in collateral coverage. If the discounted collateral value is greater than or equal to the loan balance, no specific loss reserve is required. At the time a collateral-dependent loan is designated as nonperforming, a new appraisal is ordered and typically received within 30 to 60 days if a recent appraisal is not already available. We generally use external appraisals to determine the fair value of the underlying collateral for nonperforming real estate loans, although the Company’s licensed staff appraisers may update older appraisals based on current market conditions and property value trends. Until an updated appraisal is received, the Company uses the existing appraisal to determine the amount of the specific loss allowance that may be required, and adjusts the specific loss allowance, as necessary, once a new appraisal is received. Updated appraisals are generally ordered at least annually for collateral-dependent loans that remain impaired. Current appraisals were available for 70% of the Company’s impaired real estate loan balances at June 30, 2014. Furthermore, the Company analyzes collateral-dependent loans on at least a quarterly basis, to determine if any portion of the recorded investment in such loans can be identified as uncollectible and would therefore constitute a confirmed loss. All amounts deemed to be uncollectible are promptly charged off against the Company’s allowance for loan and lease losses, with the loan then carried at the fair value of the collateral, as appraised, less estimated costs of disposition if applicable. Once a charge-off or write-down is recorded, it will not be restored to the loan balance on the Company’s accounting books.

Our methodology also provides that a “general” allowance be established for probable incurred losses inherent in loans and leases that are not impaired. Unimpaired loan balances are segregated by credit quality, and are then evaluated in pools with common characteristics. At the present time, pools are based on the same segmentation of loan types presented in our regulatory filings. While this methodology utilizes historical loss data and other measurable information, the classification of loans and the establishment of the allowance for loan and lease losses are both to some extent based on management’s judgment and experience. Our methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan and lease losses that management believes is appropriate at each reporting date. Quantitative information includes our historical loss experience, delinquency and charge-off trends, and current collateral values. Qualitative factors include the general economic environment in our markets and, in particular, the condition of the agricultural industry and other key industries in the Central San Joaquin Valley. Lending policies and procedures (including underwriting standards), the experience and abilities of lending staff, the quality of loan review, credit concentrations (by geography, loan type, industry and collateral type), the rate of loan portfolio growth, and changes in legal or regulatory requirements are additional factors that are considered. The total general reserve established for probable incurred losses on unimpaired loans was $6.055 million at June 30, 2014.

During the three months ended June 30, 2014, there were no material changes to the methodology used to determine our allowance for loan and lease losses. As we add new products and expand our geographic coverage, and as the economic environment changes, we expect to continue to enhance our methodology to keep pace with the size and complexity of the loan and lease portfolio and respond to pressures created by external forces. We engage outside firms on a regular basis to assess our methodology and perform independent credit reviews of our loan and lease portfolio. In addition, the Company’s external auditors, the FDIC, and the California DBO review the allowance for loan and lease losses as an integral part of their audit and examination processes. Management believes that the current methodology is appropriate given our size and level of complexity.

The tables that follow detail the activity in the allowance for loan and lease losses for the periods noted:

Allowance for Credit Losses and Recorded Investment in Financing Receivables
(dollars in thousands, unaudited)
	For the Three Months Ended June 30, 2014
	Real Estate			Agricultural		Commercial and Industrial			Consumer			Unallocated			Total

Allowance for credit losses:
Beginning Balance	$	7,396		$	847	$	1,418		$	1,438		$	392		$	11,491
Charge-offs		(307	)		-		(226	)		(564	)		-			(1,097	)
Recoveries		892			1		54			93			-			1,040
Provision		(703	)		505		270			496			(368	)		200

Ending Balance	$	7,278		$	1,353	$	1,516		$	1,463		$	24		$	11,634

	For the Six Months Ended June 30, 2014
	Real Estate			Agricultural			Commercial and Industrial			Consumer			Unallocated			Total

Allowance for credit losses:
Beginning Balance	$	5,544		$	978		$	3,787		$	1,117		$	251		$	11,677
Charge-offs		(434	)		(124	)		(412	)		(985	)		-			(1,955	)
Recoveries		1,199			2			98			263			-			1,562
Provision		969			497			(1,957	)		1,068			(227	)		350

Ending Balance	$	7,278		$	1,353		$	1,516		$	1,463		$	24		$	11,634

Reserves:
Specific	$	4,436		$	-		$	807		$	336		$	-		$	5,579
General		2,842			1,353			709			1,127		$	24			6,055

Ending Balance	$	7,278		$	1,353		$	1,516		$	1,463		$	24		$	11,634

Loans evaluated for impairment:
Individually	$	39,507		$	327		$	3,252		$	3,051		$	-		$	46,137
Collectively		599,289			25,815			204,253			17,547			-			846,904

Ending Balance	$	638,796		$	26,142		$	207,505		$	20,598		$	-		$	893,041

	For the Year Ended December 31, 2013
	Real Estate			Agricultural			Commercial and Industrial			Consumer			Unallocated		Total

Allowance for credit losses:
Beginning Balance	$	8,034		$	258		$	3,467		$	2,114		$	-	$	13,873
Charge-offs		(4,205	)		(473	)		(1,668	)		(1,917	)		-		(8,263	)
Recoveries		618			-			802			297			-		1,717
Provision		1,097			1,193			1,186			623			251		4,350

Ending balance	$	5,544		$	978		$	3,787		$	1,117		$	251	$	11,677

Reserves:
Specific	$	2,867		$	126		$	1,925		$	431				$	5,349
General		2,677			852			1,862			686			251		6,328

Ending balance	$	5,544		$	978		$	3,787		$	1,117		$	251	$	11,677

Loans evaluated for impairment:
Individually	$	47,010		$	470		$	5,444		$	3,463		$	-	$	56,387
Collectively		530,829			24,710			171,243			20,073			-		746,855

Ending balance	$	577,839		$	25,180		$	176,687		$	23,536		$	-	$	803,242

Note 13 – Recent Developments

On July 17, 2014 the Company entered into a definitive agreement to acquire Santa Clara Valley Bank (OTC: SCVE) of Santa Paula, California, a community bank with approximately $125 million in assets and branches located in Santa Paula, Santa Clarita, and Fillmore, California. The agreement calls for the payment of cash consideration of $12.3 million, or $6.00 per share, to SCVE’s common shareholders and cash consideration of $3.0 million to SCVE’s preferred shareholders to retire outstanding preferred stock and associated warrants. Included in the $12.3 million payment is $700,000 that the Company will pay to cash out existing in-the-money warrants. The transaction, which is subject to customary closing conditions including required regulatory approvals and approval by the shareholders of Santa Clara Valley Bank, is expected to close in the fourth quarter of 2014.

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 Company’s potential future financial performance. They include, but are not limited to, unfavorable 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; reductions in the 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 prospective 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 Note 12 to the consolidated financial statements and 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 in Note 11 to the consolidated financial statements and in the “Nonperforming Assets” and “Allowance for Loan and Lease Losses” sections of this discussion and analysis; 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; and goodwill, which is evaluated annually for impairment based on the fair value of the Company as discussed in the “Other Assets” section of this discussion and analysis. 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 those areas.

OVERVIEW OF THE RESULTS OF OPERATIONS

AND FINANCIAL CONDITION

results of operations Summary

Second Quarter 2014 compared to Second Quarter 2013

Net income for the quarter ended June 30, 2014 was $4.237 million, representing an increase of $438,000, or 12%, relative to net income of $3.799 million for the quarter ended June 30, 2013. Basic and diluted earnings per share for the second quarter of 2014 were $0.30, compared to $0.27 for the second quarter of 2013. The Company’s annualized return on average equity was 9.13% and annualized return on average assets was 1.16% for the quarter ended June 30, 2014, compared to 8.62% and 1.09%, respectively, for the quarter ended June 30, 2013. The primary drivers behind the quarter over quarter variance in net income are as follows:

Net interest income increased $675,000, or 5%, due primarily to an $82 million increase in average interest-earning assets and a higher level of non-recurring interest income, partially offset by net interest margin compression.

Gains on securities totaled $183,000 in the second quarter of 2014, relative to no gains in the second quarter of 2013.

Service charges on deposits fell by $176,000 for the comparative quarters.

The loan loss provision was reduced by $250,000, or 56%.

Total non-interest expense increased $291,000, or 3%, primarily due to costs associated with our new core banking software that was implemented in February 2014.

First Half 2014 compared to First Half 2013

Net income for the first half of 2014 was $8.036 million, representing an increase of $1.904 million, or 31%, relative to net income of $6.132 million for the first half of 2013. Basic and diluted earnings per share for the first half of 2014 were $0.57 and $0.56, respectively, compared to $0.43 basic and diluted earnings per share for the first half of 2013. The Company’s annualized return on average equity was 8.75% and annualized return on average assets was 1.12% for the six months ended June 30, 2014, compared to a return on equity of 7.03% and return on assets of 0.89% for the six months ended June 30, 2013. The primary drivers behind the variance in year-to-date net income are as follows:

The single largest impact on the comparative year-to-date results came from a reduction of $1.700 million, or 83%, in the loan loss provision.

Net interest income increased $1.048 million, or 4%, due to a $58 million increase in average interest-earning assets and a higher level of non-recurring interest income.

Total non-interest income declined by $413,000, or 5%, in the first half of 2014 due to a drop in service charges on deposits, lower BOLI income, and a $100,000 non-recurring signing incentive received in conjunction with our conversion of merchant processing to a new vendor in the first quarter of 2013, partially offset by an increase in gains realized on the sale of investment securities.

Total non-interest expense fell by $802,000, or 4%, as higher marketing, data processing, and deposit costs were more than offset by a reduction of $1.178 million in net costs associated with foreclosed assets.

The Company’s provision for income taxes was 26% of pre-tax income for the first half of 2014, relative to 20% for the first half of 2013.

Financial Condition Summary

June 30, 2014 relative to December 31, 2013

The most significant characteristics of, and changes in, the Company’s balance sheet during the first six months of 2014 are outlined below:

The Company’s assets totaled $1.498 billion at June 30, 2014, an increase of $88 million, or 6%, relative to total assets of $1.410 billion at December 31, 2013 due to growth in loans and investments net of reductions in foreclosed assets and balances due from banks.

Gross loans increased by $90 million, or 11%, due to growth in mortgage warehouse loans, commercial real estate loans and real estate loans secured by farmland, in addition to the purchase of $33 million in residential mortgage loans in the first quarter of 2014.

Total nonperforming assets, comprised of nonperforming loans and foreclosed assets, were reduced by $12 million, or 26%, to $34 million at June 30, 2014 from $46 million at December 31, 2013.

Investment securities increased $35 million, or 8%, during the first half of 2014 but interest bearing balances held in our Federal Reserve Bank account were reduced by $23 million, or 85%, pursuant to our purchase of mortgage-backed securities as we deployed excess liquidity.

Total deposits reflect growth of $72 million, or 6%, during the six months ended June 30, 2014. Core non-maturity deposits were up $80 million, or 9%, although some of that increase appears to be seasonal.

Total capital increased by $5 million, or 3%, to $187 million at June 30, 2014, due primarily to an increase in retained earnings net of the impact of the Company’s repurchase of 270,100 shares in the first half of 2014. While still robust, our consolidated total risk-based capital ratio declined to 20.10% at June 30, 2014 from 21.67% at year-end 2013 due to growth in risk-adjusted assets. Our tier one risk-based capital ratio was 18.94% and our tier one leverage ratio was 13.87% at June 30, 2014.

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 expense is comprised of operating costs that relate to providing a full range of banking services to our customers.

Net interest income AND NET INTEREST MARGIN

In a reversal of recent adverse trends, net interest income increased by $675,000, or 5%, for the second quarter of 2014 relative to the second quarter of 2013, and by $1.048 million, or 4%, for the first half of 2014 compared to the first half of 2013. The level of net interest income recognized in any given period depends on a combination of factors including the average volume and yield for interest-earning assets, the average volume and cost of interest-bearing liabilities, and the mix of products which comprise the Company’s earning assets, deposits, and other interest-bearing liabilities. Net interest income is also impacted by the reversal of interest for loans placed on non-accrual status during the reporting period, and the recovery of interest on loans that had been on non-accrual and were paid off, sold or returned to accrual status.

The following tables show average balances for significant balance sheet categories, and the amount of interest income or interest expense associated with each applicable category for the noted periods. The tables also display the calculated yields on each major component of the Company’s investment and loan portfolios, the average rates paid on each key segment of the Company’s interest-bearing liabilities, and our net interest margin for the noted periods.

Average Balances and Rates	For the three months ended							For the three months ended
(dollars in thousands, except per share data)	Ended June 30, 2014							Ended June 30, 2013
	Average		Income/		Average Rate/			Average		Income/		Average Rate/
Assets		Balance ⁽¹⁾		Expense		Yield ⁽²⁾⁽³⁾			Balance ⁽¹⁾		Expense		Yield ⁽²⁾⁽³⁾
Investments:
Federal funds sold/due from time	$	20,561	$	16		0.31	%	$	26,115	$	16		0.24	%
Taxable		356,280		1,876		2.08	%		314,191		1,034		1.30	%
Non-taxable		97,233		733		4.52	%		86,626		672		4.65	%
Equity		2,542		-		-			2,144		-		-
Total investments		476,616		2,625		2.49	%		429,076		1,722		1.91	%
Loans and Leases:⁽⁴⁾
Real estate		629,352		8,340		5.32	%		559,098		7,848		5.63	%
Agricultural		23,667		227		3.85	%		24,219		247		4.09	%
Commercial™		96,900		1,102		4.56	%		96,893		1,249		5.17	%
Consumer		21,643		477		8.84	%		25,744		540		8.41	%
Mortgage Warehouse Lines		84,305		868		4.13	%		114,736		1,440		5.03	%
Direct financing leases		2,402		32		5.34	%		3,133		44		5.63	%
Other		303		11		14.56	%		8		-		-
Total loans and leases		858,572		11,057		5.17	%		823,831		11,368		5.53	%
Total interest earning assets ⁽⁵⁾		1,335,188		13,682		4.22	%		1,252,907		13,090		4.30	%
Other earning assets		6,072							6,168
Non-earning assets		129,437							139,815
Total assets	$	1,470,697						$	1,398,890

Liabilities and shareholders' equity
Interest bearing deposits:
Demand deposits	$	112,800	$	72		0.26	%	$	87,828	$	77		0.35	%
NOW		247,667		86		0.14	%		194,194		95		0.20	%
Savings accounts		151,938		75		0.20	%		131,341		71		0.22	%
Money market		73,337		21		0.11	%		70,607		24		0.14	%
CDAR's		13,121		7		0.21	%		13,212		7		0.21	%
Certificates of deposit<$100,000		78,582		87		0.44	%		91,450		107		0.47	%
Certificates of deposit>$100,000		200,714		183		0.37	%		212,486		210		0.40	%
Brokered deposits		5,660		22		1.56	%		10,000		37		1.48	%
Total interest bearing deposits		883,819		553		0.25	%		811,118		628		0.31	%
Borrowed Funds:
Federal funds purchased		43		-		-			2		-		-
Repurchase agreements		5,539		4		0.29	%		2,020		3		0.60	%
Short term borrowings		738		-		-			12,058		5		0.17	%
Long term borrowings		-		-		-			-		-		-
TRUPS		30,928		175		2.27	%		30,928		179