Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended September 30, 2011

or

 

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

For the transition period from              to             

Commission File Number: 0-10140

 

 

CVB FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

 

 

 

California   95-3629339

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

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

 

 

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

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

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

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨      Smaller reporting company   ¨

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

Number of shares of common stock of the registrant: 104,484,371 outstanding as of October 31, 2011.

 

 

 


Table of Contents

CVB FINANCIAL CORP.

2010 QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION (UNAUDITED)

     4   

ITEM 1.

 

FINANCIAL STATEMENTS

     4   

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     9   

ITEM 2.

 

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

     40   

OVERVIEW

     40   

CRITICAL ACCOUNTING ESTIMATES

     41   

ANALYSIS OF THE RESULTS OF OPERATIONS

     43   

RESULTS BY BUSINESS SEGMENTS

     53   

ANALYSIS OF FINANCIAL CONDITION

     56   

RISK MANAGEMENT

     70   

ITEM 3.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     75   

ITEM 4.

 

CONTROLS AND PROCEDURES

     79   

PART II – OTHER INFORMATION

     80   

ITEM 1.

 

LEGAL PROCEEDINGS

     80   

ITEM 1A.

 

RISK FACTORS

     81   

ITEM 2.

 

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

     82   

ITEM 3.

 

DEFAULTS UPON SENIOR SECURITIES

     82   

ITEM 4.

 

REMOVED AND RESERVED

     82   

ITEM 5.

 

OTHER INFORMATION

     82   

ITEM 6.

 

EXHIBITS

     83   

SIGNATURES

       84   

 

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Table of Contents

GENERAL

Forward Looking Statements

Certain statements in this Report on Form 10-Q, including, but not limited to, statements under the heading “Management Discussion and Analysis of Financial Condition and Results of Operations” constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995, including but not limited to, statements about anticipated future operating and financial performance, financial position and liquidity, business prospects, strategic alternatives, business strategies, regulatory and competitive outlook, capital and financing needs and availability, acquisition and divestiture opportunities, investment and expenditure plans, plans and objectives of management for future operations and other similar forecasts and statements of expectations of assumptions underlying any of the foregoing. Words such as “will likely result, “aims”, “anticipates”, “believes”, “could”, “estimates”, “expects”, “hopes”, “intends”, “may”, “plans”, “projects”, “seeks”, “should”, “will” and variations of these words and similar expressions are intended to identify these forward looking statements, which involve risks and uncertainties. Our actual results may differ significantly from the results discussed in such forward-looking statements. Factors that might cause such a difference include, but are not limited to, local, regional, national and international economic conditions and events and the impact they may have on us and our customers; ability to attract deposits and other sources of liquidity; oversupply of inventory and continued deterioration in values of California real estate, both residential and commercial; a prolonged slowdown in construction activity; changes in the financial performance and/or condition of our borrowers; changes in the level of non-performing assets and charge-offs; the effect of acquisitions we may make; the effect of changes in laws and regulations (including laws and regulations concerning financial reform, taxes, banking, securities, executive compensation and insurance) with which we and our subsidiaries must comply; changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements; inflation, interest rate, securities market and monetary fluctuations; cybersecurity breaches of our systems; political instability; acts of war or terrorism, or natural disasters, such as earthquakes, or the effects of pandemic flu; the timely development and acceptance of new banking products and services and perceived overall value of these products and services by users; changes in consumer spending, borrowing and savings habits; technological changes; the ability to increase market share and control expenses; changes in the competitive environment among financial and bank holding companies and other financial service providers; continued volatility in the credit and equity markets and its effect on the general economy; the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters; changes in our organization, management, compensation and benefit plans; the costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquiries, including, but not limited to, the current investigation by the Securities and Exchange Commission and the related class-action lawsuits filed against us, and the results of regulatory examinations or reviews. The Company cautions that the foregoing factors are not exclusive. For additional information concerning these factors and other factors which may cause actual results to differ from the results discussed in our forward-looking statements, see the periodic filings the Company makes with the Securities and Exchange Commission, and, in particular, the information set forth in Item 1A herein and in “Item 1A. Risk Factors” contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. The Company does not undertake, and specifically disclaims, any obligation to update any forward-looking statements to reflect the occurrence of events or circumstances after the date of such statements except as required by law.

 

3


Table of Contents

PART I - FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

CVB FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(unaudited)

Amounts in thousands, except share data

 

     September 30,
2011
    December 31,
2010
 
ASSETS     

Cash and due from banks

   $ 33,493      $ 67,279   

Interest-bearing balances due from Federal Reserve

     409,449        286,769   

Interest-bearing balances due from depository institutions

     —          50,227   
  

 

 

   

 

 

 

Total cash and cash equivalents

     442,942        404,275   

Interest-bearing balances due from depository institutions

     50,190        50,190   

Investment securities available-for-sale

     2,167,159        1,791,558   

Investment securities held-to-maturity

     2,574        3,143   

Investment in stock of Federal Home Loan Bank (FHLB)

     76,207        86,744   

Non-covered loans held-for-sale

     4,239        2,954   

Covered loans held-for-sale

     5,726        —     

Non-covered loans and lease finance receivables

     3,170,365        3,373,728   

Allowance for credit losses

     (95,528     (105,259
  

 

 

   

 

 

 

Net Loans and lease finance receivables

     3,074,837        3,268,469   
  

 

 

   

 

 

 

Covered loans and lease finance receivables

     280,337        374,012   

Premises and equipment, net

     36,725        40,921   

Bank owned life insurance

     115,494        112,901   

Accrued interest receivable

     23,140        23,647   

Intangibles

     6,399        9,029   

Goodwill

     55,097        55,097   

FDIC loss sharing asset

     56,452        101,461   

Non-covered other real estate owned

     15,956        5,290   

Covered other real estate owned

     14,193        11,305   

Deferred tax asset

     28,832        52,559   

Income tax receivable

     30,357        21,561   

Other assets

     43,051        21,575   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 6,529,907      $ 6,436,691   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Liabilities:

    

Deposits:

    

Noninterest-bearing

   $ 1,977,137      $ 1,701,523   

Interest-bearing

     2,612,007        2,817,305   
  

 

 

   

 

 

 

Total deposits

     4,589,144        4,518,828   

Demand Note to U.S. Treasury

     1,930        1,917   

Customer repurchase agreements

     485,273        542,188   

Borrowings

     548,594        553,390   

Accrued interest payable

     4,243        4,985   

Deferred compensation

     8,758        9,221   

Junior subordinated debentures

     115,055        115,055   

Other liabilities

     77,035        47,252   
  

 

 

   

 

 

 

TOTAL LIABILITIES

     5,830,032        5,792,836   
  

 

 

   

 

 

 

COMMITMENTS AND CONTINGENCIES

    

Stockholders’ Equity:

    

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

     —          —     

Common stock, authorized, 225,000,000 shares
without par; issued and outstanding
104,581,689 (2011) and 106,075,576 (2010)

     480,121        490,226   

Retained earnings

     180,518        147,444   

Accumulated other comprehensive income, net of tax

     39,236        6,185   
  

 

 

   

 

 

 

Total stockholders’ equity

     699,875        643,855   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 6,529,907      $ 6,436,691   
  

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements

 

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Table of Contents

CVB FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

(unaudited)

Amounts in thousands, except per share

 

     For the Three Months
Ended September 30,
    For the Nine Months
Ended September 30,
 
     2011     2010     2011     2010  

Interest income:

        

Loans, including fees

   $ 52,788      $ 58,165      $ 158,800      $ 185,105   

Investment securities:

        

Taxable

     9,407        11,461        28,397        41,938   

Tax-preferred

     5,951        6,324        17,791        19,265   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

     15,358        17,785        46,188        61,203   

Dividends from FHLB stock

     52        105        183        233   

Federal funds sold and interest bearing deposits with other institutions

     332        418        1,053        757   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     68,530        76,473        206,224        247,298   

Interest expense:

        

Deposits

     1,979        4,310        6,987        14,439   

Borrowings

     5,748        8,652        17,286        30,162   

Junior subordinated debentures

     823        896        2,467        2,529   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     8,550        13,858        26,740        47,130   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income before provision for credit losses

     59,980        62,615        179,484        200,168   

Provision for credit losses

     —          25,300        7,068        48,500   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for credit losses

     59,980        37,315        172,416        151,668   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other operating income:

        

Impairment loss on investment securities

     (25     —          (144     (98

Plus: Reclassification of credit-related impairment loss from other comprehensive income

     (402     (127     (402     (714
  

 

 

   

 

 

   

 

 

   

 

 

 

Net impairment loss on investment securities recognized in earnings

     (427     (127     (546     (812

Service charges on deposit accounts

     4021        4,225        11,773        12,686   

Trust and Investment Services

     2056        1,928        6,468        6,255   

Bankcard services

     771        760        2,295        2,110   

BOLI income

     733        813        2,589        2,394   

Reduction in FDIC loss sharing asset, net

     (844     (2,630     (1,118     (14,800

Gain on sale of securities

     —          30,119        —          38,900   

Other

     1204        1,631        2,025        3,193   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other operating income

     7,514        36,719        23,486        49,926   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other operating expenses:

        

Salaries and employee benefits

     17,579        17,311        53,459        52,863   

Occupancy and equipment

     4,152        4,807        12,554        14,641   

Professional services

     3,728        4,135        12,365        9,823   

Amortization of intangibles

     862        934        2,629        2,824   

Provision for unfunded commitments

     (1,650     450        (918     2,150   

Prepayment penalties on borrowings

     —          12,963        —          18,663   

Other

     8,187        8,718        26,229        25,723   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other operating expenses

     32,858        49,318        106,318        126,687   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings before income taxes

     34,636        24,716        89,584        74,907   

Income taxes

     12,253        6,789        29,563        21,846   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings

   $ 22,383      $ 17,927      $ 60,021      $ 53,061   

Earnings allocated to restricted stock

     81        58        229        181   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings allocated to common shareholders

   $ 22,302      $ 17,869      $ 59,792      $ 52,880   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 36,453      $ 3,439      $ 93,072      $ 55,104   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share

   $ 0.21      $ 0.17      $ 0.57      $ 0.50   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share

   $ 0.21      $ 0.17      $ 0.57      $ 0.50   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash dividends per common share

   $ 0.085      $ 0.085      $ 0.255      $ 0.255   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

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Table of Contents

CVB FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME

(Unaudited)

Amounts and shares in thousands

 

     Common
Shares
Outstanding
    Common
Stock
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income
     Comprehensive
Income
     Total  

Balance January 1, 2011

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

Repurchase of common stock

     (1,503     (11,837             (11,837

Proceeds from exercise of stock options

     9        57                57   

Tax benefit from exercise of stock options

       2                2   

Stock-based compensation expense

       1,673                1,673   

Cash dividends declared

              

Common ($0.255 per share)

         (26,947           (26,947

Comprehensive income:

              

Net earnings

         60,021         $ 60,021         60,021   

Other comprehensive gain:

              

Unrealized gain on securities available-for-sale, net

           32,818         32,818         32,818   

Portion of impairment loss on investment securities reclassified in the current year, net

           233         233         233   
           

 

 

    

Comprehensive income

            $ 93,072      
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Balance September 30, 2011

     104,582      $ 480,121      $ 180,518      $ 39,236          $ 699,875   
  

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Balance January 1, 2010

     106,263      $ 491,226      $ 120,612      $ 26,390          $ 638,228   

Repurchase of common stock

     (600     (4,768             (4,768

Proceeds from exercise of stock options

     255        1,146                1,146   

Tax benefit from exercise of stock options

       459                459   

Stock-based compensation expense

       1,676                1,676   

Cash dividends declared

              

Common ($0.255 per share)

         (27,087           (27,087

Comprehensive income:

              

Net earnings

         53,061         $ 53,061         53,061   

Other comprehensive gain:

              

Unrealized gain on securities available-for-sale, net

           1,629         1,629         1,629   

Portion of impairment loss on investment securities reclassified in the current year, net

           414         414         414   
           

 

 

    

Comprehensive income

            $ 55,104      
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Balance September 30, 2010

     105,918      $ 489,739      $ 146,586      $ 28,433          $ 664,758   
  

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

 

     At September 30,  
     2011     2010  

Disclosure of reclassification amount

    

Unrealized gain on securities arising during the period

   $ 56,582      $ 41,610   

Tax benefit

     (23,764     (17,476

Less:

    

Reclassification adjustment for net gain on securities included in net income

     402        (38,088

Add:

    

Tax expense on reclassification adjustments

     (169     15,997   
  

 

 

   

 

 

 

Net unrealized gain on securities

   $ 33,051      $ 2,043   
  

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

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Table of Contents

CVB FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

Amounts in thousands

 

     For the Nine Months
Ended September 30,
 
     2011     2010  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Interest and dividends received

   $ 203,106      $ 229,991   

Service charges and other fees received

     24,889        27,274   

Interest paid

     (27,279     (48,574

Cash paid to vendors and employees

     (91,806     (103,870

Income taxes paid

     (57,000     (35,776
  

 

 

   

 

 

 

Net cash provided by operating activities

     51,910        69,045   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Proceeds from sales of investment securities

     —          743,769   

Proceeds from repayment of investment securities

     239,791        213,130   

Proceeds from redemption of FHLB stock

     10,537        7,232   

Proceeds from maturity of investment securities

     84,410        185,789   

Purchases of investment securities

     (631,043     (907,695

Net decrease in loans and lease finance receivables

     258,064        201,976   

Proceeds from sales of premises and equipment

     180        114   

Proceeds from sales of other real estate owned

     11,917        6,972   

Proceeds from FDIC shared-loss agreements

     43,891        —     

Purchase of premises and equipment

     (679     (5,811

Other, net

     —          (329
  

 

 

   

 

 

 

Net cash provided by investing activities

     17,068        445,147   
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Net increase in transaction deposits

     315,291        87,231   

Net decrease in time deposits

     (244,975     (3,150

Repayment of advances from Federal Home Loan Bank

     —          (250,000

Repayment of FCB Subordinated Debt

     (5,000     —     

Net increase/(decrease) in other borrowings

     13        (198,673

Net (decrease)/increase in customer repurchase agreements

     (56,915     72,440   

Cash dividends on common stock

     (26,947     (27,087

Repurchase of common stock

     (11,837     (4,768

Proceeds from exercise of stock options

     57        1,146   

Tax benefit related to exercise of stock options

     2        459   
  

 

 

   

 

 

 

Net cash used in financing activities

     (30,311     (322,402
  

 

 

   

 

 

 

NET INCREASE IN CASH AND CASH EQUIVALENTS

     38,667        191,790   

CASH AND CASH EQUIVALENTS, beginning of period

     404,275        104,480   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, end of period

   $ 442,942      $ 296,270   
  

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements

 

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Table of Contents

CVB FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(unaudited)

Amounts in thousands

 

CONSOLIDATED STATEMENTS OF CASH FLOWS
     For the Nine Months
Ended September 30,
 
     2011     2010  

RECONCILIATION OF NET EARNINGS TO NET CASH PROVIDED BY OPERATING ACTIVITIES:

    

Net earnings

   $ 60,021      $ 53,061   

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

    

Gain on sale of investment securities

     —          (38,900

Loss on sales of premises and equipment

     11        64   

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

     (202     686   

Credit-related impairment loss on investment securities held-to-maturity

     546        812   

Increase from bank owned life insurance

     (2,589     (2,394

Net amortization of premiums on investment securities

     9,130        3,570   

Accretion of SJB Discount

     (11,638     (22,333

Provisions for credit losses

     7,068        48,500   

Provisions for revaluation of other real estate owned

     3,849        —     

Decrease in FDIC Loss Sharing Asset

     1,118        14,800   

Stock-based compensation

     1,673        1,676   

Depreciation and amortization

     7,313        7,965   

Change in accrued interest receivable

     507        3,142   

Change in accrued interest payable

     (742     (1,377

Change in other assets and liabilities

     (24,155     (227
  

 

 

   

 

 

 

Total adjustments

     (8,111     15,984   
  

 

 

   

 

 

 

NET CASH PROVIDED BY OPERATING ACTIVITIES

   $ 51,910      $ 69,045   
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES

    

Securities purchased and not settled

   $ 20,883      $ —     

Transfer from loans to other real estate owned

   $ 29,117      $ 25,547   

See accompanying notes to the consolidated financial statements

 

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CVB FINANCIAL CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

For the nine months ended September 30, 2011 and 2010

 

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying condensed consolidated unaudited financial statements and notes thereto have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission for Form 10-Q and conform to practices within the banking industry and include all of the information and disclosures required by accounting principles generally accepted in the United States of America for interim financial reporting. The results of operations for the nine months ended September 30, 2011 are not necessarily indicative of the results for the full year. These financial statements should be read in conjunction with the financial statements, accounting policies and financial notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010 filed with the Securities and Exchange Commission. In the opinion of management, the accompanying condensed consolidated unaudited financial statements reflect all adjustments (consisting only of normal recurring adjustments), which are necessary for a fair presentation of financial results for the interim periods presented. A summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows.

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

Nature of Operations – The Company’s primary operations are related to traditional banking activities, including the acceptance of deposits and the lending and investing of money through the operations of the Bank. The Bank also provides automobile and equipment leasing to customers through its Citizens Financial Services Group and trust and investment-related services to customers through its CitizensTrust Division. The Bank’s customers consist primarily of small to mid-sized businesses and individuals located in San Bernardino County, Riverside County, Orange County, Los Angeles County, Madera County, Fresno County, Tulare County, Kern County and San Joaquin County. The Bank operates 43 Business Financial Centers, five Commercial Banking Centers, and three wealth management offices with its headquarters located in the city of Ontario.

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

The internal reporting of the Company considers all business units. Funds are allocated to each business unit based on its need to fund assets (use of funds) or its need to invest funds (source of funds).

 

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Net income is determined based on the actual net income of the business unit plus the allocated income or expense based on the sources and uses of funds for each business unit. Non-interest income and non-interest expense are those items directly attributable to a business unit.

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

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

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

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

Loans and Lease Finance Receivables – Non-covered loans and lease finance receivables are reported at the principal amount outstanding, less deferred net loan origination fees. In the ordinary course of business, the Company enters into commitments to extend credit to its customers. These commitments are not reflected in the accompanying consolidated financial statements. As of September 30, 2011, the Company had entered into commitments with certain customers amounting to $593.4 million compared to $570.1 million at December 31, 2010. Letters of credit at September 30, 2011 and December 31, 2010, were $64.6 million and $70.4 million, respectively.

 

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

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

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

Loans are reported as a troubled debt restructuring when the Company grants a concession(s) to a borrower experiencing financial difficulties that it would not otherwise consider. Examples of such concessions include forgiveness of principal or accrued interest, reduction of the stated interest rate, or extending the maturity date(s) at a stated interest rate lower than the current market rate for new debt with similar risk. Loans modified that are not reported as a troubled debt restructuring include modifications such as certain extensions of maturity dates, insignificant changes in payment terms, or reductions of interest rates to current market rates where the modified terms are not considered concessions taken into account such items as additional payments made by the borrower to reduce the balance of the loan, additional collateral provided by the borrower, the proportion of the loan to the current liquidity and financial position of guarantors, an insignificant delay in the timing of payments, current market rates for new debt with similar risk to a borrower not in financial difficulty and other factors.

As a result of concessions on troubled debt restructured loans, these loans (both nonaccrual and accrual restructured loans) are deemed impaired. Impairment on non-collateral dependent restructured loans are measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s carrying value. The impairment amount if any is normally charged-off against the allowance for loan and lease losses.

A loan that has been placed on nonaccrual that is subsequently restructured will usually remain on nonaccrual status until the borrower is able to demonstrate repayment performance in compliance with the restructured terms for a sustained period, typically for six months. A troubled debt restructured loan may return to accrual status sooner based on other significant events or mitigating circumstances. A loan that has not been placed on nonaccrual may be restructured and such loan may remain on accrual status after such troubled debt restructuring.

 

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A loan is generally considered impaired when based on current events and information it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. A loan for which there is an insignificant delay or amount of payments is not considered an impaired loan. Generally, impaired loans include loans on nonaccrual status and performing restructured loans. Depending on a particular loan’s circumstances, we measure impairment of a loan based upon either the present value of expected future cash flows discounted at the loan’s effective interest rate, the fair value of the collateral less estimated costs to sell if the loan is collateral-dependent or an observable market price of the loan (usually only if the loan is held for sale). The Company’s policy is to record a specific valuation allowance, which is included in the allowance for credit losses, or charge off that portion of an impaired loan that exceeds its fair value less selling costs. The majority of impaired loans that are collateral dependent are charged-off down to their estimated fair value of the collateral at each reporting date. The fair value is based on current appraisals. These are typically ordered at the time the loan is transferred to our special assets group or when the loan is showing signs of weakness or concern. These appraisals are normally updated at least annually, or more frequent, if there are concerns or indications that the value of the collateral may have changed significantly since the previous appraisal. The appraisals are performed by Bank-approved third-party appraisers. A specific valuation allowance is only recorded on collateral dependent impaired loans when a current appraisal is not yet available, an appraisal is still under review or on single-family mortgage loans if the loans are currently under review for a loan modification. These valuation allowances are generally based on previous appraisals adjusted for current market conditions, based on preliminary appraisal values that are still being reviewed or for single-family loans under review for modification on an appraisal or indications of comparable home sales from external sources. Charge-offs on non-collateral dependent loans are generally recorded when the probability of collection is remote. Charge-offs of unsecured consumer loans are recorded when the loan reaches 120 days past due or sooner as circumstances dictate. Except for the charge-offs of unsecured consumer loans, the charge-off policy is applied consistently across all portfolio segments. Generally, loans that have been charged-off remain on nonaccrual unless the loan has been restructured and the borrower has demonstrated repayment performance under the modified terms for a sustained period and the company believes it will collect all principal and interest due according to the modified terms.

Impairment of single-family mortgage loans that have been modified in accordance with the various government modification programs has been measured based on the present value of the expected cash flows discounted at the loan’s pre-modification interest rate. Three such single-family mortgage loans have been returned to accrual status after demonstrating sustained repayment performance. The Company recognizes the change in present value attributable to the passage of time as interest income on such performing single-family mortgage loans and the amount of interest income recognized has been insignificant.

At September 30, 2011, the Company had non-covered impaired loans of $97.4 million. Of this amount, $989,000 consisted of non-accrual residential construction and land loans, $13.8 million in non-accrual commercial construction loans, $18.8 million of non-accrual single family mortgage loans, $25.4 million of non-accrual commercial real estate loans, $3.3 million of non-accrual commercial and industrial loans, $2.6 million of non-accrual dairy and livestock loans and $347,000 of non-accrual consumer loans. Non-covered impaired loans also include $55.7 million of loans whose terms were modified in a troubled debt restructure, of which $23.5 million are classified as non-accrual. The remaining balance of $32.2 million consists of 13 loans performing according to the restructured terms. These impaired loans had specific reserves of $3.1 million at September 30, 2011. At December 31, 2010, the Company had classified as impaired, non-covered loans with a balance of $170.3 million.

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

 

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

Provision and Allowance for Credit Losses – The determination of the balance in the allowance for credit losses is based on an analysis of the loan and lease finance receivables portfolio using a systematic methodology and reflects an amount that, in management’s judgment, is appropriate to provide for probable credit losses inherent in the portfolio, after giving consideration to the character of the loan portfolio, current economic conditions, past credit loss experience, and such other factors that would deserve current recognition in estimating inherent credit losses.

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

The Company’s methodology is consistently applied across all the portfolio segments taken into account the applicable historical loss rates and the qualitative factors applicable to each pool of loans. A key factor in the Company’s methodology is the loan risk rating (Pass, Special Mention, Substandard, Doubtful and Loss). Loan risk ratings are updated as facts related to the loan or borrower become available. In addition, all term loans in excess of $1.0 million are subject to an annual internal credit review process where all factors underlying the loan, borrower and guarantors are reviewed and may result in changes to the loan’s risk rating. There has been no significant changes to the methodology or policies in the periods presented, except for one new factor added to the allowance for credit losses methodology during the quarter ended September 30, 2011. As part of the qualitative analysis, this new factor is used to adjust the historical loan loss rates to include an adjustment for indicated volatility in the value of various types of real estate collateral in our market area. The estimate is reviewed quarterly by the Board of Directors and management and periodically by various regulatory entities and, as adjustments become necessary, they are reported in earnings in the periods in which they become known.

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

The provision for credit losses is charged to expense. During the first nine months of 2011, we recorded a provision for credit losses of $7.1 million. The allowance for credit losses was $95.5 million as of September 30, 2011, or 3.01% of total non-covered loans and leases compared to $105.3 million as of December 31, 2010, or 3.12% of total non-covered loans and leases.

Premises and Equipment – Premises and equipment are stated at cost, less accumulated depreciation, which is provided for in amounts sufficient to relate the cost of depreciable assets to operations over their

 

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

FDIC Loss Sharing Asset The FDIC loss sharing asset is initially recorded at fair value which represents the present value of the estimated cash payments from the FDIC for future losses on covered loans. The ultimate collectability of this asset is dependent upon the performance of the underlying covered loans, the passage of time and claims paid by the FDIC. The loss estimates used in calculating the FDIC loss sharing asset are determined on the same basis as the loss estimates on the related covered loans and is the present value of the cash flows the Company expects to collect from the FDIC under the shared-loss agreement. The difference between the present value and the undiscounted cash flow the Company expects to collect from the FDIC is accreted into noninterest income over the life of the FDIC indemnification asset. The FDIC indemnification asset is adjusted for any changes in expected cash flows based on the loan performance. Any increases in cash flow of the loans over those expected will reduce the FDIC indemnification asset and any decreases in cash flow of the loans over those expected will increase the FDIC indemnification asset. Increase and decreases to the FDIC indemnification asset are recorded as adjustments to other operating income.

Non-covered Other Real Estate Owned – Non-covered other real estate owned (“OREO”) represents real estate acquired through foreclosure in satisfaction of commercial and real estate loans and is stated at fair value, minus estimated costs to sell (fair value at time of foreclosure). Non-covered loan balances in excess of fair value of the real estate acquired at the date of acquisition are charged against the allowance for credit losses. Any subsequent operating expenses or income, reduction in estimated values, and gains or losses on disposition of such properties are charged to current operations.

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

Business Combinations and Intangible Assets – The Company has engaged in the acquisition of non FDIC-assisted financial institutions and the assumption of deposits and purchase of assets from other financial institutions in its market area. The Company has paid premiums on certain transactions, and such premiums are recorded as intangible assets, in the form of goodwill or other intangible assets. Goodwill is not being amortized whereas identifiable intangible assets with finite lives are amortized over their useful lives. The Company performed its annual impairment test as of July 1, 2011 to determine whether and to what extent, if any, recorded goodwill was impaired. There was no recorded impairment as of September 30, 2011.

At September 30, 2011 goodwill was $55.1 million. As of September 30, 2011, intangible assets that continue to be subject to amortization include core deposit premiums of $6.4 million (net of $25.6 million of accumulated amortization). Amortization expense for such intangible assets was $2.6 million for the nine months ended September 30, 2011. Estimated amortization expense for the remainder of 2011 is expected to be $852,000. Estimated amortization expense for the succeeding years is $2.2 million for 2012, $1.1 million for 2013, $475,000 for 2014, $437,000 for 2015 and $1.3 million for the period from 2016 to 2019. The weighted average remaining life of intangible assets is approximately 1.7 years.

 

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

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

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

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

Basic earnings per common share are computed by dividing income allocated to common stockholders by the weighted-average number of common shares outstanding during each period. The computation of diluted earnings per common share considers the number of tax-effected shares issuable upon the assumed exercise of outstanding common stock options. Share and per share amounts have been retroactively restated to give effect to all stock dividends and splits. The number of shares outstanding at September 30, 2011 was 104,581,689. The tables below presents the reconciliation of earnings per share for the periods indicated.

 

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Earnings Per Share Reconciliation

(Amounts and shares in thousands, except per share amounts)

 

     For the three months
ended September 30,
     For the nine months
ended September 30,
 
     2011      2010      2011      2010  

Earnings per common share

           

Net earnings available to common shareholders

   $ 22,383       $ 17,927       $ 60,021       $ 53,061   

Less: Net earnings allocated to restricted stock

     81         58         229         181   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net earnings allocated to common shareholders (numerator)

   $ 22,302       $ 17,869       $ 59,792       $ 52,880   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted Average Shares Outstanding (denominator)

     105,117         105,685         105,474         105,926   

Earnings per common share

   $ 0.21       $ 0.17       $ 0.57       $ 0.50   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted earnings per common share

           

Net income allocated to common shareholders (numerator)

   $ 22,302       $ 17,869       $ 59,792       $ 52,880   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted Average Shares Outstanding

     105,117         105,685         105,474         105,926   

Incremental shares from assumed exercise of outstanding options

     89         110         81         171   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted Weighted Average Shares Outstanding (denominator)

     105,206         105,795         105,555         106,097   

Diluted earnings per common share

   $ 0.21       $ 0.17       $ 0.57       $ 0.50   
  

 

 

    

 

 

    

 

 

    

 

 

 

Stock-Based Compensation – At September 30, 2011, the Company has three stock-based employee compensation plans, which are described more fully in Note 17 in the Company’s Annual Report on Form 10-K. The Company accounts for stock compensation using the “modified prospective” method. Under this method, awards that are granted, modified, or settled after December 31, 2005, are fair valued as of grant date and compensation costs recognized over the vesting period on a straight-lined basis. Also under this method, unvested stock awards as of January 1, 2006 are recognized over the remaining service period with no change in historical reported earnings.

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

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

CitizensTrust – This division provides trust, investment and brokerage related services, as well as financial, estate and business succession planning services. CitizensTrust services its clients through three offices in Southern California: Pasadena, Ontario, and Irvine. CitizensTrust has approximately $2.0 billion in assets under administration, including $1.6 billion in assets under management. The amount of these funds and the related liability have not been recorded in the accompanying consolidated balance sheets because they are not assets or liabilities of the Bank or Company, with the exception of any funds held on deposit with the Bank.

Use of Estimates in the Preparation of Financial Statements – The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from

 

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those estimates. A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for credit losses. Other significant estimates which may be subject to change include fair value determinations and disclosures, impairment of investments, goodwill, loans, determining the amount and realization of the FDIC loss sharing asset, and valuation of deferred tax assets, other intangibles and OREO.

Other Contingencies – In the ordinary course of business, the Company becomes involved in litigation. Based upon the Company’s internal records and discussions with legal counsel, the Company records reserves as appropriate, for estimates of the probable outcome of all cases brought against the Company. Except as discussed in Part II – Other Information Item 1. “Legal Proceedings,” at September 30, 2011 the Company does not have any litigation reserves and is not aware of any material pending legal action or complaints asserted against the Company.

Recent Accounting Pronouncements – In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The update provides additional guidance for creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. The provisions of this standard are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to restructurings occurring on or after January 1, 2011. The adoption of this guidance on July 1, 2011 did not have a material effect on the Company’s consolidated financial statements.

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

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

 

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2. INVESTMENT SECURITIES

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

 

     September 30, 2011  
     Amortized
Cost
     Gross
Unrealized
Holding
Gain
     Gross
Unrealized
Holding
Loss
    Fair Value      Total
Percent
 
     (Amounts in thousands)  

Investment Securities Available-for-Sale:

             

Government agency & government-sponsored enterprises

   $ 46,336       $ 275       $   —        $ 46,611         2.15

Residential mortgage-backed securities

     927,695         21,436         (511     948,620         43.77

CMO’s / REMIC’s – Residential

     516,952         13,600         (67     530,485         24.48

Municipal bonds

     608,528         33,362         (447     641,443         29.60
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total Investment Securities

   $ 2,099,511       $ 68,673       $ (1,025   $ 2,167,159         100.00
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

     December 31, 2010  
     Amortized
Cost
     Gross
Unrealized
Holding
Gain
     Gross
Unrealized
Holding
Loss
    Fair Value      Total
Percent
 
     (Amounts in thousands)  

Investment Securities Available-for-Sale:

             

Government agency & government-sponsored enterprises

   $ 106,368       $ 119       $ (214   $ 106,273         5.93

Residential mortgage-backed securities

     801,370         13,405         (6,366     808,409         45.12

CMO’s / REMIC’s – Residential

     267,556         4,300         (1,379     270,477         15.10

Municipal bonds

     605,199         10,943         (9,743     606,399         33.85
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total Investment Securities

   $ 1,780,493       $ 28,767       $ (17,702   $ 1,791,558         100.00
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Approximately 70.14% of the available-for-sale portfolio at September 30, 2011 represents securities issued by the U.S government or U.S. government-sponsored enterprises, with the implied guarantee of payment of principal and interest. The remaining CMO/REMICs are backed by agency-pooled collateral or whole loan collateral. All non-agency available-for-sale CMO/REMIC issues held are rated investment grade or better by either Standard & Poor’s or Moody’s, as of September 30, 2011 and December 31, 2010.

 

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

 

     September 30, 2011  
     Less than 12 months      12 months or longer      Total  
Description of Securities    Fair Value      Gross
Unrealized
Holding
Losses
     Fair Value      Gross
Unrealized
Holding
Losses
     Fair Value      Gross
Unrealized
Holding
Losses
 
     (Amounts in thousands)  

Held-To-Maturity

                 

CMO

   $ —         $ —         $ 2,574       $ —         $ 2,574       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-Sale

                 

Government agency

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

Residential mortgage-backed securities

     79,630         511         —           —           79,630         511   

CMO’s/REMIC’s – Residential

     22,749         67         —           —           22,749         67   

Municipal bonds

     3,898         87         13,002         360         16,900         447   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 106,277       $      665       $ 13,002       $ 360       $ 119,279       $   1,025   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2010  
     Less than 12 months      12 months or longer      Total  
Description of Securities    Fair Value      Gross
Unrealized
Holding
Losses
     Fair Value      Gross
Unrealized
Holding
Losses
     Fair Value      Gross
Unrealized
Holding
Losses
 
     (Amounts in thousands)  

Held-To-Maturity

                 

CMO

   $ —         $ —         $ 3,143       $ 401       $ 3,143       $ 401   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-Sale

                 

Government agency

   $ 79,635       $ 214       $ —         $ —         $ 79,635       $ 214   

Residential mortgage-backed securities

     449,806         6,366         —           —           449,806         6,366   

CMO’s/REMIC’s – Residential

     144,234         1,379         —           —           144,234         1,379   

Municipal bonds

     225,928         8,844         5,585         899         231,513         9,743   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 899,603       $ 16,803       $   5,585       $ 899       $ 905,188       $ 17,702   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The tables above show the Company’s investment securities’ gross unrealized losses and fair value by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2011 and December 31, 2010. The Company has reviewed individual securities to determine whether a decline in fair value below the amortized cost is other-than-temporary.

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

CMO Held-to-Maturity – We have one investment security classified as held-to-maturity. This security was issued by Countrywide Financial and is collateralized by Alt-A mortgages. The mortgages are primarily fixed-rate, 30-year loans, originated in early 2006 with average FICO scores of 715 and an average LTV of 71% at origination. The security was a senior security in the securitization, was rated AAA at origination and was supported by subordinate securities. This security is classified as held-to-maturity

 

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as we have both the intent and ability to hold this debt security to maturity as the amount of the security, $2.6 million, is not significant to our liquidity needs. We acquired this security in February 2008 at a price of 98.25%. The significant decline in the fair value of the security first appeared in August 2008 as the current financial crisis in the markets occurred and the market for securities collateralized by Alt-A mortgages diminished.

As of September 30, 2011, we had no unrealized loss on this security and the fair value on the security was 59% of the current par value. The security is rated non-investment grade. We evaluated the security for an other than temporary decline in fair value as of September 30, 2011. We assess for credit impairment using a cash flow model. The key assumptions include default rates, severities and prepayment rates. This security was determined to have additional credit impairment during the third quarter of 2011 due to continued degradation in expected cash flows primarily due to higher loss forecasts. We determined the amount of the credit impairment by discounting the expected future cash flows of the underlying collateral. We recognized an other-than-temporary impairment loss of $546,000 during the first nine months of 2011.

The following table provides a roll-forward of credit-related other-than-temporary impairment recognized in earnings for the nine months ended September 30, 2011.

 

     For the nine months  ended
September 30, 2011
 
     (Amounts in thousands)  

Balance, beginning of the period

   $ 1,227   

Addition of OTTI that was not previously recognized

     546   

Reduction for securities sold during the period

     —     

Reduction for securities with OTTI recognized in earnings because the security might be sold before recovery of its amortized cost basis

     —     

Addition of OTTI that was previously recognized because the security might not be sold before recovery of its amortized cost basis

     —     

Reduction for increases in cash flows expected to be collected that are recognized over the remaining life of the security

     —     
  

 

 

 

Balance, end of the period

   $ 1,773   
  

 

 

 

Government Agency – The government agency bonds are backed by the full faith and credit of Agencies of the U.S. Government. These securities are bullet securities, that is, they have a defined maturity date on which the principal is paid. The contractual term of these investments provides that the Company will receive the face value of the bond at maturity which will equal the amortized cost of the bond. Interest is received throughout the life of the security. There was no loss greater than 12 months on these securities at September 30, 2011.

Mortgaged-Backed Securities and CMO/REMICs – Almost all of the mortgage-backed and CMO/REMICs securities are issued by the government-sponsored enterprises such as Ginnie Mae, Fannie Mae and Freddie Mac. These securities are collateralized or backed by the underlying residential mortgages. All mortgage-backed securities are rated investment grade with an average life of approximately 3.20 years. The contractual cash flows of 99.62% of these investments have the implied guarantee of the U.S. government provided to the U.S. government-sponsored agencies. The remaining 0.38% is issued by banks. Accordingly, it is expected the securities would not be settled at a price less than the amortized cost of the bonds. There was no loss greater than 12 months on these securities at September 30, 2011.

Municipal Bonds – Ninety-nine percent of our $641.4 million municipal bond portfolio contains securities which have an underlying rating of investment grade. The majority of our municipal bonds are insured by the largest bond insurance companies with remaining maturities of approximately 6.16 years.

 

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The unrealized loss greater than 12 months on these securities at September 30, 2011 was $360,000. The Company diversifies its holdings by owning selections of securities from different issuers and by holding securities from geographically diversified municipal issuers, thus reducing the Company’s exposure to any single adverse event. Because we believe the decline in fair value is attributable to the changes in interest rates and not credit quality and because the Company does not intend to sell the investments and it is more likely than not that the Company will not be required to sell the investments before recovery of their amortized costs, which may be at maturity, management does not consider these investments to be other than temporarily impaired at September 30, 2011.

We are continually monitoring the quality of our municipal bond portfolio in light of the current financial problems exhibited by certain monoline insurance companies. Many of the securities that would not be rated without insurance are pre-refunded and/or are general obligation bonds. Based on our monitoring of the municipal marketplace, to our knowledge, none of the municipalities are exhibiting financial problems that would lead us to believe there is a loss in any given security.

At September 30, 2011 and December 31, 2010, investment securities having an amortized cost of approximately $2.08 billion and $1.74 billion respectively, were pledged to secure public deposits, short and long-term borrowings, and for other purposes as required or permitted by law.

The amortized cost and fair value of debt securities at September 30, 2011, by contractual maturity, are shown below. Although mortgage-backed securities and CMO/REMICs have contractual maturities through 2029, expected maturities will differ from contractual maturities because borrowers may have the right to prepay such obligations without penalty. Mortgage-backed securities and CMO/REMICs are included in maturity categories based upon estimated prepayment speeds.

 

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

Due in one year or less

   $ 118,285       $ 120,634         3.18

Due after one year through five years

     1,568,458         1,615,177         2.96

Due after five years through ten years

     349,878         367,200         3.71

Due after ten years

     62,890         64,148         3.94
  

 

 

    

 

 

    
   $ 2,099,511       $ 2,167,159         3.13
  

 

 

    

 

 

    

The investment in FHLB stock is periodically evaluated for impairment based on, among other things, the capital adequacy of the FHLB and its overall financial condition. No impairment losses have been recorded through September 30, 2011.

 

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3. LOAN AND LEASE FINANCE RECEIVABLES

The following is a summary of the components of held-for-investment loan and lease finance receivables (amounts in thousands):

 

     September 30, 2011  
     Non-Covered
Loans
    Covered Loans     Total  

Commercial and Industrial

   $ 475,630      $ 35,320      $ 510,950   

Real Estate:

      

Construction

     77,364        24,065        101,429   

Commercial Real Estate

     1,958,287        213,763        2,172,050   

SFR Mortgage

     188,066        3,584        191,650   

Consumer

     50,179        8,489        58,668   

Municipal lease finance receivables

     115,532        271        115,803   

Auto and equipment leases, net of unearned discount

     16,237        —          16,237   

Dairy and Livestock

     292,049        —          292,049   

Agribusiness

     2,136        46,491        48,627   
  

 

 

   

 

 

   

 

 

 

Gross Loans

   $ 3,175,480      $ 331,983      $ 3,507,463   

Less: Purchase accounting discount

     —          (51,646     (51,646

Less: Deferred net loan fees

     (5,115     —          (5,115
  

 

 

   

 

 

   

 

 

 

Gross loans, net of deferred loan fees

   $ 3,170,365      $ 280,337      $ 3,450,702   

Less: Allowance for credit losses

     (95,528     —          (95,528
  

 

 

   

 

 

   

 

 

 

Net Loans

   $ 3,074,837      $       280,337      $ 3,355,174   
  

 

 

   

 

 

   

 

 

 

 

     December 31, 2010  
     Non-Covered
Loans
    Covered Loans     Total  

Commercial and Industrial

   $ 460,399      $ 39,587      $ 499,986   

Real Estate:

      

Construction

     138,980        84,498        223,478   

Commercial Real Estate

     1,980,256        292,014        2,272,270   

SFR Mortgage

     218,467        5,858        224,325   

Consumer

     56,747        10,624        67,371   

Municipal lease finance receivables

     128,552        576        129,128   

Auto and equipment leases, net of unearned discount

     17,982        —          17,982   

Dairy and Livestock

     376,143        —          376,143   

Agribusiness

     1,686        55,618        57,304   
  

 

 

   

 

 

   

 

 

 

Gross Loans

   $ 3,379,212      $ 488,775      $ 3,867,987   

Less: Purchase accounting discount

     —          (114,763     (114,763

Less: Deferred net loan fees

     (5,484     —          (5,484
  

 

 

   

 

 

   

 

 

 

Gross loans, net of deferred loan fees

   $ 3,373,728      $ 374,012      $ 3,747,740   

Less: Allowance for credit losses

     (105,259     —          (105,259
  

 

 

   

 

 

   

 

 

 

Net Loans

   $ 3,268,469      $       374,012      $ 3,642,481   
  

 

 

   

 

 

   

 

 

 

At September 30, 2011, the Company held approximately $1.33 billion of fixed rate loans. As of September 30, 2011, 61.8% of the held-for-investment loan portfolio consisted of commercial real estate loans, 2.9% of the loan portfolio consisted of construction loans and 5.5% of the loan portfolio consisted of SFR mortgages. Substantially all of the Company’s real estate loans and construction loans are secured by real properties located in California.

 

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The following is the activity of loans held for sale for the nine months ended September 30, 2011 and 2010:

Non-Covered Loans Held for Sale Activity

(Amounts in thousands)

 

     Three months ended     Nine months ended  
     September 30,
2011
    September 30,
2010
    September 30,
2011
    September 30,
2010
 

Balance at beginning of period

   $ 7,341      $ 2,554      $ 2,954      $ 1,439   

Originations of mortage loans

     17,031        4,630        33,512        24,819   

Sales of mortgage loans

     (11,258     (4,030     (27,279     (21,038

Transfer of mortgage loans to held for investment

     (2,875     —          (3,292     (4,320

Sales of other loans

     (6,000     —          (6,000     —     

Transfers of other loans to held for sale

     —          —          6,000        2,521   

Write-down of loans held for sale

     —          —          (1,656     (267
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30

   $ 4,239      $ 3,154      $ 4,239      $ 3,154   
  

 

 

   

 

 

   

 

 

   

 

 

 

Covered Loans Held for Sale Activity

(Amounts in thousands)

 

     Three months ended      Nine months ended  
     September 30,
2011
     September 30,
2010
     September 30,
2011
     September 30,
2010
 

Balance at beginning of period

   $ —         $ —         $ —         $ —     

Originations of mortage loans

     —           —           —           —     

Sales of mortgage loans

     —           —           —           —     

Transfer of other loans to held for investment

     —           —           —           —     

Sales of other loans

           

Transfers of other loans to held for sale

     5,726         —           5,726         —     

Write-down of loans held for sale

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at September 30

   $ 5,726       $ —         $ 5,726       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

During the second quarter ended June 30, 2011, a decision was made to sell one loan and it was transferred to held for sale at a fair value of $6.0 million and resulted in a charge-off against the allowance for loan losses of $619,000 at the time of transfer. This loan was subsequently sold in July, 2011 at a small gain. Also, in the nine months ended September 30, 2011, another loan classified as held for sale with a book value of $1.7 million was written-off to zero with the write-off reported as part of non-interest income. The loan was the subject of legal proceedings regarding our lien position and a preliminary decision by the court found that our lien was not in a first priority position. After careful analysis of the preliminary court decision and valuation of the subject collateral, we wrote off the remaining carrying amount.

During the third quarter ended September 30, 2011, twelve covered loans in an aggregate carrying balance of $5.7 million were transferred to held-for-sale.

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

As a result of adopting the amendments in ASU 2011-02, the Company reassessed all restructurings that occurred on or after the beginning of the current fiscal year (January 1, 2011) for identification as troubled debt restructurings. Loans that are reported as TDRs are considered impaired and evaluated for specific reserve on an individual loan basis. The majority of restructured loans during the nine months ended September 30, 2011 are loans for which the terms of repayment have been renegotiated, resulting in a reduction in interest rate or deferral of principal.

 

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As of September, 2011, we had loans of $55.7 million classified as a troubled debt restructured, of which $23.5 million are non-performing and $32.2 million are performing. TDRs on accrual status are comprised of loans that were accruing at the time of restructuring or have demonstrated repayment performance in compliance with the restructured terms for a sustained period and for which the Company anticipates full repayment of both principal and interest. TDRs on accrual status at September 30, 2011 were mainly comprised of commercial real estate loans including construction loans.

At the end of the first interim period of adoption (September 30, 2011), there were no loans for which the allowance for credit losses was previously measured under a general allowance for credit losses methodology and are now impaired. The majority of TDRs have no specific reserves allocated as any impairment amount is normally charged-off. We have allocated $152,000 and zero specific reserves to TDRs as of September 30, 2011 and December 31, 2010.

The following are the loans modified as troubled debt restructuring for the nine and three months ended September 30, 2011:

Modifications

(Amounts in Thousands)

 

     Nine Months Ended September 30, 2011  
     Number of
Loans
     Pre-modification
Outstanding Recorded
Investment
     Post-Modification
Outstanding Recorded
Investment
     Outstanding
Recorded

Investment at
September 30,
2011
 

Troubled Debt Restructurings

           

Commercial & Industrial

     5       $ 2,253       $ 1,952       $ 1,610   

Construction - Speculative

     2         16,886         16,886         15,531   

Construction - Non-Speculative

     1         9,219         9,219         9,219   

Commercial Real Estate - Owner-Occupied

     1         2,039         2,039         1,971   

Commercial Real Estate - Non-Owner-Occupied

     3         11,707         11,707         10,272   

Residential Real Estate (SFR 1-4)

     6         2,162         2,162         2,079   

Dairy & Livestock

     2         3,380         3,380         985   

Agribusiness

     —           —           —           —     

Municipal Lease Finance Receivables

     —           —           —           —     

Consumer

     —           —           —           —     

Auto & Equipment Leases

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Non-Covered Loans

     20         47,646         47,345         41,667   

Covered Loans

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Gross Loans

               20       $                 47,646       $                 47,345       $         41,667   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Three Months Ended September 30, 2011  
     Number of
Loans
     Pre-modification
Outstanding Recorded
Investment
     Post-Modification
Outstanding Recorded
Investment
     Outstanding
Recorded
Investment at
September 30,
2011
 

Troubled Debt Restructurings

           

Commercial & Industrial

     —         $ —         $ —         $ —     

Construction - Speculative

     —           —           —           —     

Construction - Non-Speculative

     —           —           —           —     

Commercial Real Estate - Owner-Occupied

     —           —           —           —     

Commercial Real Estate - Non-Owner-Occupied

     1           1,519           1,519           1,519   

Residential Real Estate (SFR 1-4)

     4         1,552         1,552         1,488   

Dairy & Livestock

     —           —           —           —     

Agribusiness

     —           —           —           —     

Municipal Lease Finance Receivables

     —           —           —           —     

Consumer

     —           —           —           —     

Auto & Equipment Leases

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Non-Covered Loans

     5         3,071         3,071         3,007   

Covered Loans

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Gross Loans

                 5       $                   3,071       $                   3,071       $           3,007   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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As of September 30, 2011, there was one commercial and industrial loan with a recorded investment balance of $255,000 modified as troubled debt restructurings within the previous 12 months that subsequently defaulted during the nine months ended September 30, 2011.

 

4. ALLOWANCE FOR CREDIT LOSSES AND OTHER REAL ESTATE OWNED

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

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

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

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

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

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

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

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

 

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Table of Contents

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

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

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

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

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

The methodology is consistently applied across all the portfolio segments taking into account the applicable historical loss rates and the qualitative factors applicable to each pool of loans. There have been no significant changes to the methodology or policies in the periods presented, except for one new factor added to the allowance for credit losses methodology during the quarter ended September 30, 2011. As part of the qualitative analysis, this new factor is used to adjust the historical loan loss rates to include an adjustment for indicated volatility in the value of various types of real estate collateral in our market area.

The allowance for off-balance sheet credit exposure relates to commitments to extend credit, letters of credit and undisbursed funds on lines of credit. The Company evaluates credit risk associated with the loan and lease portfolio at the same time it evaluates credit risk associated with the off-balance sheet commitments. The Company recorded a decrease of $918,000 and an increase of $2.2 million in the reserve for undisbursed commitments for the first nine months of 2011 and 2010, respectively. As of September 30, 2011, the balance in this reserve was $9.6 million compared to a balance of $10.5 million as of December 31, 2010.

Management believes that the ALLL was adequate at September 30, 2011. No assurance can be given that economic conditions which adversely affect our service areas or other circumstances will not be reflected in increased provisions for credit losses in the future.

 

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Table of Contents

The following table presents the balance and activity in the allowance for loan losses; and the recorded investment in held-for-investment loans by portfolio segment and based on impairment method as of September 30, 2011 and September 30, 2010:

Allowance for Credit Losses and Recorded Investment in Financing Receivables

(Amounts in thousands)

 

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

Three and Nine Months Ended September 30, 2011

                 

Allowance for Credit Losses:

                 

Beginning balance, June 30, 2011

  $ 11,286      $ 4,338      $ 45,265      $ 2,618      $ 23,511      $ 1,608      $ —        $ 8,269      $ 96,895   

Charge-offs

    (392     (559     (562     —          —          (187     (256     —          (1,956

Recoveries

    73        343        148        —          —          23        2        —          589   

Provision

    (116     (88     5,470        (89     (5,045     144        254        (530     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance, September 30, 2011

  $ 10,851      $ 4,034      $ 50,321      $ 2,529      $ 18,466      $ 1,588      $ —        $ 7,739      $ 95,528   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Beginning balance, December 31, 2010

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

Charge-offs

    (1,275     (7,976     (4,945     —          (3,291     (439     (674     —          (18,600

Recoveries

    244        746        582        —          39        183        7        —          1,801   

Provision

    410        1,076        11,155        357        (14,343     810        667        6,936        7,068   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance, September 30, 2011

  $ 10,851      $ 4,034      $ 50,321      $ 2,529      $ 18,466      $ 1,588      $ —        $ 7,739      $ 95,528   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: Individually evaluated for impairment

  $ 415      $ —        $ 1,275      $ —        $ 1,372      $ 34      $ —        $ —        $ 3,096   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: Collectively evaluated for impairment

  $ 10,436      $ 4,034      $ 49,046      $ 2,529      $ 17,094      $ 1,554      $ —        $ 7,739      $ 92,432   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financing receivables:

                 

Ending balance, September 30, 2011

  $ 477,766      $ 77,364      $ 2,146,353      $ 115,532      $ 292,049      $ 66,416      $ 280,337      $ —        $ 3,455,817   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: Individually evaluated for impairment

  $ 6,014      $ 34,854      $ 53,782      $ —        $ 2,574      $ 197      $ 85,130      $ —        $ 182,551   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: Collectively evaluated for impairment

  $ 471,752      $   42,510      $ 2,092,571      $ 115,532      $ 289,475      $         66,219      $ 195,207      $ —        $ 3,273,266   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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

Three and Nine Months Ended September 30, 2010

                 

Allowance for Credit Losses:

                 

Beginning balance, June 30, 2010

  $ 9,260      $ 18,726      $ 54,536      $ 2,193      $ 32,367      $ 963      $ —        $ 503      $ 118,548   

Charge-offs

    (1,047     (9,705     (27,368     —          (360     (242     —          —          (38,722

Recoveries

    39        100        —          —          —          18        6        —          163   

Provision

    1,757        (1,419     19,248        590        (964     1,269        (6     4,825        25,300   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance, September 30, 2010

  $ 10,009      $ 7,702      $ 46,416      $ 2,783      $ 31,043      $ 2,008      $ —        $ 5,328      $ 105,289   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Beginning balance, December 31, 2009

  $ 7,530      $ 21,222      $ 42,215      $ 1,724      $ 31,051      $ 1,004      $ —        $ 4,178      $ 108,924   

Charge-offs

    (4,836     (16,620     (30,232     —          (360     (412     (32     —          (52,492

Recoveries

    182        100        1        —          —          65        9        —          357   

Provision

    7,133        3,000        34,432        1,059        352        1,351        23        1,150        48,500   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance, September 30, 2010

  $ 10,009      $ 7,702      $ 46,416      $ 2,783      $ 31,043      $ 2,008      $ —        $ 5,328      $ 105,289   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: Individually evaluated for impairment

  $ 506      $ —        $ 919      $ —        $ —        $ 65      $ —        $ —        $ 1,490   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: Collectively evaluated for impairment

  $ 9,503      $ 7,702      $ 45,497      $ 2,783      $ 31,043      $ 1,943      $ —        $ 5,328      $ 103,799   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financing receivables:

                 

Ending balance, September 30, 2010

  $ 459,107      $ 169,232      $ 2,204,279      $ 148,906      $ 361,160      $ 81,753      $ 403,822      $ —        $ 3,828,259   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: Individually evaluated for impairment

  $ 3,009      $ 80,531      $ 70,916      $ —        $ 5,176      $ 531      $ 14,965      $ —        $ 175,128   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: Collectively evaluated for impairment

  $ 456,098      $ 88,701      $ 2,133,363      $ 148,906      $ 355,984      $         81,222      $ 388,857      $ —        $ 3,653,131   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Net of purchase accounting discount

 

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Table of Contents

Past Due and Non-Performing Loans

The following table presents the recorded investment in held-for-investment and held-for-sale, non-covered, non-accrual loans and loans past due by class of loans as of September 30, 2011 and December 31, 2010:

Loan Aging

As of September 30, 2011 and December 31, 2010

(Amounts in Thousands)

 

September 30, 2011

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

Commercial & Industrial

  $ 890      $ 50      $ —        $ 940      $ 3,277      $ 471,413      $ 475,630   

Construction - Speculative

    —          —          —          —          14,768        51,089        65,857   

Construction - Non-Speculative

    —          —          —          —          —          11,507        11,507   

Commercial Real Estate - Owner-Occupied

    —          —          —          —          9,147        698,093        707,240   

Commercial Real Estate - Non-Owner-Occupied

    —          —          —          —          16,307        1,234,740        1,251,047   

Residential Real Estate (SFR 1-4)

    —          —          —          —          18,792        169,274        188,066   

Dairy & Livestock

    —          —          —          —          2,574        289,475        292,049   

Agribusiness

    —          —          —          —          —          2,136        2,136   

Municipal Lease Finance Receivables

    —          —          —          —          —          115,532        115,532   

Consumer

    14        —          —          14        340        49,825        50,179   

Auto & Equipment Leases

    996        1        —          997        7        15,233        16,237   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Non-covered Loans excluding Held For Sale

    1,900        51        —          1,951        65,212        3,108,317        3,175,480   

Held for Sale Construction - Speculative

    —          —          —          —          —            —     

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

    —          —          —          —          —          4,239        4,239   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $     1,900      $           51      $         —        $     1,951      $   65,212      $ 3,112,556      $ 3,179,719   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

December 31, 2010

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

Commercial & Industrial

  $ 2,177      $ 1,036      $ —          3,213      $ 3,887      $ 453,299      $ 460,399   

Construction - Speculative

    —          —          —          —          53,552        66,343        119,895   

Construction - Non-Speculative

    —          —          —          —          9,473        9,612        19,085   

Commercial Real Estate - Owner-Occupied

    62        —          —          62        5,457        706,911        712,430   

Commercial Real Estate - Non-Owner-Occupied

    3,132        —          —          3,132        59,402        1,205,292        1,267,826   

Residential Real Estate (SFR 1-4)

    1,473        1,124        —          2,597        17,800        198,070        218,467   

Dairy & Livestock

    —          —          —          —          5,207        370,936        376,143   

Agribusiness

    —          —          —          —          —          1,686        1,686   

Municipal Lease Finance Receivables

    —          —          —          —          —          128,552        128,552   

Consumer

    —          29        —          29        537        56,181        56,747   

Auto & Equipment Leases

    93        14        —          107        49        17,826        17,982   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Non-covered Loans excluding Held For Sale

    6,937        2,203        —          9,140        155,364        3,214,708        3,379,212   

Held for Sale Construction - Speculative

    —          —          —          —          1,656        —          1,656   

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

    —          —          —          —          —          1,298        1,298   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $     6,937      $     2,203      $         —        $     9,140      $ 157,020      $ 3,216,006      $ 3,382,166   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

28


Table of Contents

Credit Quality Indicators

The following table summarizes our internal risk grouping by loan class as of September 30, 2011 and December 31, 2010:

Credit Quality Indicators

As of September 30, 2011 and December 31, 2010

(Amounts in Thousands)

Credit Risk Profile by Internally Assigned Grade

 

     September 30, 2011  
     Pass      Watch List      Special
Mention
     Sub-
Standard
     Doubtful &
Loss
     Total  

Commercial & Industrial

   $ 352,438       $ 58,914       $ 39,593       $ 24,685       $ —         $ 475,630   

Construction - Speculative

     2,008         —           25,218         38,631         —           65,857   

Construction - Non-Speculative

     491         30         386         10,600         —           11,507   

Commercial Real Estate - Owner-Occupied

     394,715         146,509         89,714         76,302         —           707,240   

Commercial Real Estate - Non-Owner-Occupied

     861,811         186,413         89,359         112,625         839         1,251,047   

Residential Real Estate (SFR 1-4)

     158,053         3,963         7,258         18,792         —           188,066   

Dairy & Livestock

     33,140         68,223         128,549         62,137         —           292,049   

Agribusiness

     1,489         —           647         —           —           2,136   

Municipal Lease Finance Receivables

     67,875         21,849         16,654         9,154         —           115,532   

Consumer

     44,118         2,335         2,000         1,705         21         50,179   

Auto & Equipment Leases

     13,039         1,077         372         1,749         —           16,237   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Non-covered Loans

     1,929,177         489,313         399,750         356,380         860         3,175,480   

Covered Loans

     99,557         58,852         18,491         153,993         1,090         331,983   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Loans excluding Held For Sale

     2,028,734         548,165         418,241         510,373         1,950         3,507,463   

Non-covered loans held for sale

     4,239         —           —           —           —           4,239   

Covered loans held for sale

     —           —           —           5,726         —           5,726   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Gross Loans

   $ 2,032,973       $ 548,165       $ 418,241       $ 516,099       $ 1,950       $ 3,517,428   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2010  
     Pass      Watch List      Special
Mention
     Sub-
Standard
     Doubtful &
Loss
     Total  

Commercial & Industrial

   $ 310,207       $ 79,860       $ 35,526       $ 34,741       $ 65       $ 460,399   

Construction - Speculative

     428         16,022         24,773         78,672         —           119,895   

Construction - Non-Speculative

     3,168         3,422         2,346         10,149         —           19,085   

Commercial Real Estate - Owner-Occupied

     371,575         109,784         91,751         139,320         —           712,430   

Commercial Real Estate - Non-Owner-Occupied

     851,980         197,696         64,808         153,342         —           1,267,826   

Residential Real Estate (SFR 1-4)

     190,022         11,002         801         16,642         —           218,467   

Dairy & Livestock

     4,373         4,917         152,891         213,962         —           376,143   

Agribusiness

     1,096         446         144         —           —           1,686   

Municipal Lease Finance Receivables

     92,064         11,540         21,746         3,202         —           128,552   

Consumer

     47,927         4,885         2,367         1,484         84         56,747   

Auto & Equipment Leases

     10,925         3,450         1,122         2,483         2         17,982   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Non-covered Loans

     1,883,765         443,024         398,275         653,997         151         3,379,212   

Covered Loans

     139,038         59,996         42,147         247,407         187         488,775   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Loans excluding Held For Sale

     2,022,803         503,020         440,422         901,404         338         3,867,987   

Held For Sale Loans

     1,298         —           —           1,656         —           2,954   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Gross Loans

   $ 2,024,101       $ 503,020       $ 440,422       $ 903,060       $     338       $ 3,870,941   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

29


Table of Contents

Non-covered Impaired Loans

The following table presents held-for-investment and held-for-sale loans, individually evaluated for impairment by class of loans, as of September 30, 2011 and December 31, 2010:

Non-Covered Impaired Loans

As of September 30, 2011 and December 31, 2010

(Amounts in Thousands)

 

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

September 30, 2011

                                  

With no related allowance recorded:

              

Commercial & Industrial

   $ 3,517       $ 4,781       $ —         $ 4,260       $ 103   

Held for Sale Construction - Speculative

     —           —           —           —           —     

Construction - Speculative

     25,635         28,592         —           27,233         414   

Construction - Non-Speculative

     9,219         9,219         —           9,219         194   

Commercial Real Estate - Owner-Occupied

     5,247         5,614         —           5,535         48   

Commercial Real Estate - Non-Owner-Occupied

     24,703         33,918         —           25,942         169   

Residential Real Estate (SFR 1-4)

     15,862         19,827         —           17,147         88   

Dairy & Livestock

     1,202         2,682         —           2,227         15   

Municipal Lease Finance Receivables

     —           —           —           —           —     

Consumer

     —           —           —           —           —     

Auto & Equipment Leases

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     85,385         104,633         —           91,563         1,031   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With a related allowance recorded:

              

Commercial & Industrial

   $ 2,497       $ 2,552       $ 524       $ 3,895       $ 54   

Construction - Speculative

     —           —           —           —           —     

Construction - Non-Speculative

     —           —           —           —           —     

Commercial Real Estate - Owner-Occupied

     3,900         3,900         928         3,900         —     

Commercial Real Estate - Non-Owner-Occupied

     86         86         9         86         —     

Residential Real Estate (SFR 1-4)

     3,984         4,131         338         3,993         —     

Dairy, Livestock & Agribusiness

     1,372         3,324         1,371         1,805         —     

Municipal Lease Finance Receivables

     —           —           —           —           —     

Consumer

     190         196         33         193         —     

Auto & Equipment Leases

     7         7         1         8         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     12,036         14,196         3,204         13,880         54   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 97,421       $ 118,829       $ 3,204       $ 105,443       $ 1,085   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2010

                                  

With no related allowance recorded:

              

Commercial & Industrial

   $ 9,060       $ 9,600       $ —         $ 9,972       $ 339   

Held for Sale Construction - Speculative

     1,656         3,739         —           2,311         —     

Construction - Speculative

     45,672         61,382         —           54,299         —     

Construction - Non-Speculative

     9,473         10,149         —           9,777