Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

for the quarterly period ended: June 30, 2014

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: 000-10661

 

 

TriCo Bancshares

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

CALIFORNIA   94-2792841

(State or Other Jurisdiction

of Incorporation or Organization)

 

(I.R.S. Employer

Identification Number)

63 Constitution Drive

Chico, California 95973

(Address of Principal Executive Offices)(Zip Code)

(530) 898-0300

(Registrant’s Telephone Number, Including Area Code)

 

 

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.    x  Yes    ¨  No

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

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

 

Large accelerated filer   ¨    Accelerated filer   x
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    x  No

Indicate the number of shares outstanding for each of the issuer’s classes of common stock, as of the latest practical date:

Common stock, no par value: 16,133,414 shares outstanding as of August 1, 2014

 

 

 


Table of Contents

TriCo Bancshares

FORM 10-Q

TABLE OF CONTENTS

 

     Page  

Forward-Looking Statements

     1   

PART I – FINANCIAL INFORMATION

     2   

Item 1 – Financial Statements (Unaudited)

     2   

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

     46   

Item 3 – Quantitative and Qualitative Disclosures about Market Risk

     68   

Item 4 – Controls and Procedures

     68   

PART II – OTHER INFORMATION

     69   

Item 1 – Legal Proceedings

     69   

Item 1A – Risk Factors

     69   

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

     69   

Item 6 – Exhibits

     69   

Signatures

     71   

Exhibits

     71   

FORWARD-LOOKING STATEMENTS

This report on Form 10-Q contains forward-looking statements about TriCo Bancshares (the “Company”) that are subject to the protection of the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on the current knowledge and belief of the Company’s management (“Management”) and include information concerning the Company’s possible or assumed future financial condition and results of operations. When you see any of the words “believes”, “expects”, “anticipates”, “estimates”, or similar expressions, it may mean the Company is making forward-looking statements. A number of factors, some of which are beyond the Company’s ability to predict or control, could cause future results to differ materially from those contemplated. The reader is directed to the Company’s annual report on Form 10-K for the year ended December 31, 2013, and Part II, Item 1A of this report for further discussion of factors which could affect the Company’s business and cause actual results to differ materially from those suggested by any forward-looking statement made in this report. Such Form 10-K and this report should be read to put any forward-looking statements in context and to gain a more complete understanding of the risks and uncertainties involved in the Company’s business. Any forward-looking statement may turn out to be wrong and cannot be guaranteed. The Company does not intend to update any forward-looking statement after the date of this report.

 

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Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

TRICO BANCSHARES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data; unaudited)

 

     At June 30,     At December 31,  
     2014     2013  

Assets:

    

Cash and due from banks

   $ 76,104      $ 76,915   

Cash at Federal Reserve and other banks

     268,279        521,453   
  

 

 

   

 

 

 

Cash and cash equivalents

     344,383        598,368   

Investment securities:

    

Available for sale

     91,514        104,647   

Held to maturity

     422,502        240,504   

Restricted equity securities

     11,582        9,163   

Loans held for sale

     1,671        2,270   

Loans

     1,738,586        1,672,007   

Allowance for loan losses

     (39,968     (38,245
  

 

 

   

 

 

 

Total loans, net

     1,698,618        1,633,762   

Foreclosed assets, net

     5,785        6,262   

Premises and equipment, net

     31,880        31,612   

Cash value of life insurance

     53,106        52,309   

Accrued interest receivable

     7,008        6,516   

Goodwill

     15,519        15,519   

Other intangible assets, net

     779        883   

Mortgage servicing rights

     5,909        6,165   

Other assets

     34,225        36,086   
  

 

 

   

 

 

 

Total assets

   $ 2,724,481      $ 2,744,066   
  

 

 

   

 

 

 

Liabilities and Shareholders’ Equity:

    

Liabilities:

    

Deposits:

    

Noninterest-bearing demand

   $ 720,743      $ 789,458   

Interest-bearing

     1,664,453        1,621,025   
  

 

 

   

 

 

 

Total deposits

     2,385,196        2,410,483   

Accrued interest payable

     849        938   

Reserve for unfunded commitments

     2,045        2,415   

Other liabilities

     28,135        31,711   

Other borrowings

     6,075        6,335   

Junior subordinated debt

     41,238        41,238   
  

 

 

   

 

 

 

Total liabilities

     2,463,538        2,493,120   
  

 

 

   

 

 

 

Commitments and contingencies (Note 18)

    

Shareholders’ equity:

    

Common stock, no par value: 50,000,000 shares authorized; issued and outstanding:

    

16,133,414 at June 30, 2014

     92,322     

16,076,662 at December 31, 2013

       89,356   

Retained earnings

     166,433        159,733   

Accumulated other comprehensive income, net of tax

     2,188        1,857   
  

 

 

   

 

 

 

Total shareholders’ equity

     260,943        250,946   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 2,724,481      $ 2,744,066   
  

 

 

   

 

 

 

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

 

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TRICO BANCSHARES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data; unaudited)

 

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

Interest and dividend income:

           

Loans, including fees

   $ 24,433       $ 23,883       $ 48,171       $ 47,955   

Investment securities:

           

Taxable

     3,440         1,149         6,262         2,280   

Tax exempt

     117         150         253         251   

Dividends

     154         80         308         136   

Interest bearing cash at

           

Federal Reserve and other banks

     274         494         583         940   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest and dividend income

     28,418         25,756         55,577         51,562   
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest expense:

           

Deposits

     768         855         1,550         1,780   

Other borrowings

     1         1         2         2   

Junior subordinated debt

     306         311         610         622   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense

     1,075         1,167         2,162         2,404   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income

     27,343         24,589         53,415         49,158   

Provision for (benefit from) loan losses

     1,708         614         353         (494
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for (benefit from) loan losses

     25,635         23,975         53,062         49,652   
  

 

 

    

 

 

    

 

 

    

 

 

 

Noninterest income:

           

Service charges and fees

     5,519         6,693         10,981         12,622   

Gain on sale of loans

     514         1,590         978         3,884   

Commissions on sale of non-deposit investment products

     843         841         1,614         1,602   

Increase in cash value of life insurance

     400         380         797         806   

Other

     601         627         1,802         1,435   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total noninterest income

     7,877         10,131         16,172         20,349   
  

 

 

    

 

 

    

 

 

    

 

 

 

Noninterest expense:

           

Salaries and related benefits

     13,317         12,890         26,620         25,851   

Other

     11,799         10,619         21,813         19,259   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total noninterest expense

     25,116         23,509         48,433         45,110   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before income taxes

     8,396         10,597         20,801         24,891   
  

 

 

    

 

 

    

 

 

    

 

 

 

Provision for income taxes

     3,537         4,272         8,577         10,089   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income

   $ 4,859       $ 6,325       $ 12,224       $ 14,802   
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per share:

           

Basic

   $ 0.30       $ 0.39       $ 0.76       $ 0.92   

Diluted

   $ 0.30       $ 0.39       $ 0.75       $ 0.92   

See accompanying notes to unaudited condensed consolidated financial statements.

 

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TRICO BANCSHARES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands; unaudited)

 

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

Net income

   $ 4,859       $ 6,325      $ 12,224       $ 14,802   

Other comprehensive income (loss), net of tax:

          

Unrealized gains (losses) on available for sale securities arising during the period

     381         (1,489     321         (2,110

Change in minimum pension liability

     5         —          10         —     
  

 

 

    

 

 

   

 

 

    

 

 

 

Other comprehensive income (loss)

     386         (1,489     331         (2,110
  

 

 

    

 

 

   

 

 

    

 

 

 

Comprehensive income

   $ 5,245       $ 4,836      $ 12,555       $ 12,692   
  

 

 

    

 

 

   

 

 

    

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

TRICO BANCSHARES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(In thousands, except share and per share data; unaudited)

 

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

Balance at December 31, 2012

     16,000,838      $ 85,561      $ 141,639      $ 2,159      $ 229,359   

Net income

         14,802          14,802   

Other comprehensive loss

           (2,110     (2,110

Stock option vesting

       540            540   

Stock options exercised

     230,765        2,937            2,937   

Tax benefit of stock options exercised

       342            342   

Repurchase of common stock

     (166,134     (892     (2,445       (3,337

Dividends paid ($0.20 per share)

         (3,207       (3,207
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 30, 2013

     16,065,469      $ 88,488      $ 150,789      $ 49      $ 239,326   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2013

     16,076,662      $ 89,356      $ 159,733      $ 1,857      $ 250,946   

Net income

         12,224          12,224   

Other comprehensive loss

           331        331   

Stock option vesting

       534            534   

Stock options exercised

     160,020        2,786            2,786   

Tax benefit of stock options exercised

       220            220   

Repurchase of common stock

     (103,268     (574     (1,977       (2,551

Dividends paid ($0.22 per share)

         (3,547       (3,547
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 30, 2014

     16,133,414      $ 92,322      $ 166,433      $ 2,188      $ 260,943   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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TRICO BANCSHARES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands; unaudited)

 

     For the six months ended
June 30,
 
     2014     2013  

Operating activities:

    

Net income

   $ 12,224      $ 14,802   

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

    

Depreciation of premises and equipment, and amortization

     2,704        1,962   

Amortization of intangible assets

     104        105   

Provision for (benefit from) loan losses

     353        (494

Amortization of investment securities premium, net

     349        411   

Originations of loans for resale

     (31,032     (94,623

Proceeds from sale of loans originated for resale

     32,333        103,089   

Gain on sale of loans

     (978     (3,884

Change in market value of mortgage servicing rights

     532        (130

Provision for losses on foreclosed assets

     40        573   

Gain on sale of foreclosed assets

     (1,468     (1,166

(Gain) loss on disposal of fixed assets

     (70     14   

Increase in cash value of life insurance

     (797     (806

Stock option vesting expense

     534        540   

Stock option excess tax benefits

     (220     (342

Change in:

    

Reserve for unfunded commitments

     (370     (405

Interest receivable

     (492     (703

Interest payable

     (89     (92

Other assets and liabilities, net

     (2,256     (1,277
  

 

 

   

 

 

 

Net cash from operating activities

     11,401        17,574   
  

 

 

   

 

 

 

Investing activities:

    

Proceeds from maturities of securities available for sale

     13,464        31,471   

Proceeds from maturities of securities held to maturity

     9,548        218   

Purchases of securities held to maturity

     (191,673     (85,877

(Purchase) redemption of restricted equity securities

     (2,419     484   

Loan origination and principal collections, net

     (49,635     (34,239

Loans purchased

     (19,690     (62,698

Improvement of foreclosed assets

     (462     —     

Proceeds from sale of other real estate owned

     6,483        10,202   

Proceeds from sale of premises and equipment

     120        2   

Purchases of premises and equipment

     (2,483     (5,700

Life insurance proceeds

     —          706   
  

 

 

   

 

 

 

Net cash (used) provided by investing activities

     (236,747     (145,431
  

 

 

   

 

 

 

Financing activities:

    

Net decrease in deposits

     (25,287     (23,000

Net change in other borrowings

     (260     (2,622

Stock option excess tax benefits

     220        342   

Repurchase of common stock

     (292     (501

Dividends paid

     (3,547     (3,207

Exercise of stock options

     527        101   
  

 

 

   

 

 

 

Net cash used by financing activities

     (28,639     (28,887
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     (253,985     (156,744
  

 

 

   

 

 

 

Cash and cash equivalents and beginning of year

     598,368        748,899   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 344,383      $ 592,155   
  

 

 

   

 

 

 

Supplemental disclosure of noncash activities:

    

Unrealized gain (loss) on securities available for sale

   $ 553      $ (3,642

Loans transferred to foreclosed assets

   $ 4,116      $ 7,164   

Market value of shares tendered in-lieu of cash to pay for exercise of options and/or related taxes

   $ 2,259      $ 2,836   

Supplemental disclosure of cash flow activity:

    

Cash paid for interest expense

   $ 2,251      $ 2,496   

Cash paid for income taxes

   $ 11,500      $ 12,900   

See accompanying notes to unaudited condensed consolidated financial statements.

 

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Summary of Significant Accounting Policies

Description of Business and Basis of Presentation

TriCo Bancshares is a California corporation organized to act as a bank holding company for Tri Counties Bank (the “Bank”). The Bank is a state-chartered financial institution that is engaged in the general commercial banking business in the California counties of Butte, Contra Costa, Del Norte, Fresno, Glenn, Kern, Lake, Lassen, Madera, Mendocino, Merced, Napa, Nevada, Placer, Sacramento, Shasta, Siskiyou, Stanislaus, Sutter, Tehama, Tulare, Yolo and Yuba. Tri Counties Bank currently operates from 41 traditional branches and 19 in-store branches. The Company also formed two subsidiary business trusts, TriCo Capital Trust I and TriCo Capital Trust II (collectively, the Trusts), to issue trust preferred securities.

The following unaudited condensed financial statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading. In the opinion of Management, all adjustments, consisting solely of normal recurring adjustments, considered necessary for a fair presentation of results for the interim periods presented have been included. These interim condensed consolidated financial statements should be read in conjunction with the financial statements and related notes contained in the Company’s 2013 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 7, 2014.

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned financial subsidiary, Tri Counties Bank. All significant intercompany balances and transactions have been eliminated. TriCo Capital Trust I and TriCo Capital Trust II, which were formed solely for the purpose of issuing trust preferred securities, are unconsolidated subsidiaries as the Company is not the primary beneficiary of the trusts and they are not considered variable interest entities. Operating results for the three and six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. Certain amounts in the consolidated financial statements for the year ended December 31, 2013 and for the three and six months ended June 30, 2014 may have been reclassified to conform to the presentation of the condensed consolidated financial statements in 2014.

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 disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, the Company evaluates its estimates, including those related to the adequacy of the allowance for loan losses, investments, intangible assets, income taxes and contingencies. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The allowance for loan losses, indemnification asset, foreclosed assets, goodwill and other intangible assets, income taxes, fair value of assets acquired and liabilities assumed in business combinations, the valuation of securities available-for-sale, and the valuation of mortgage servicing rights are the only accounting estimates that materially affect the Company’s consolidated financial statements.

During each of 2011 and 2010, the Bank assumed the banking operations of a failed financial institution from the FDIC under whole bank purchase agreement. The acquired assets and assumed liabilities were measured at estimated fair value values under the acquisition method of accounting. The Company made significant estimates and exercised significant judgment in accounting for the acquisitions. The Company determined loan fair values based on loan file reviews, loan risk ratings, appraised collateral values, expected cash flows and historical loss factors. Foreclosed assets were primarily valued based on appraised values of the repossessed loan collateral. An identifiable intangible was also recorded representing the fair value of the core deposit customer base based on an evaluation of the cost of such deposits relative to alternative funding sources. The fair value of time deposits and borrowings were determined based on the present value of estimated future cash flows using current rates as of the acquisition date.

Significant Group Concentration of Credit Risk

The Company grants agribusiness, commercial, consumer, and residential loans to customers located throughout the northern San Joaquin Valley, the Sacramento Valley and northern mountain regions of California. The Company has a diversified loan portfolio within the business segments located in this geographical area. The Company currently classifies all its operations into one business segment that it denotes as community banking.

Cash and Cash Equivalents

For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Net cash flows are reported for loan and deposit transactions and other borrowings.

Investment Securities

The Company classifies its debt and marketable equity securities into one of three categories: trading, available for sale or held to maturity. Trading securities are bought and held principally for the purpose of selling in the near term. Held to maturity securities are those securities which the Company has the ability and intent to hold until maturity. These securities are carried at cost adjusted for amortization of premium and accretion of discount, computed by the effective interest method over their contractual lives. All other securities not included in trading or held to maturity are classified as available for sale. Available for sale securities are recorded at fair value. Unrealized gains and losses, net of the related tax effect, on available for sale securities are reported as a separate component of other accumulated comprehensive income in

 

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shareholders’ equity until realized. Premiums and discounts are amortized or accreted over the life of the related investment security as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned. Realized gains and losses are derived from the amortized cost of the security sold. During the six months ended June 30, 2014 and the year ended December 31, 2013, the Company did not have any securities classified as trading. During the three months ended March 31, 2013, the Company did not have any securities classified as held to maturity.

The Company assesses other-than-temporary impairment (“OTTI”) based on whether it intends to sell a security or if it is likely that the Company would be required to sell the security before recovery of the amortized cost basis of the investment, which may be maturity. For debt securities, if the Company intends to sell the security or it is likely that it will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If the Company does not intend to sell the security and it is not likely that it will be required to sell the security but it does not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income (“OCI”). Impairment losses related to all other factors are presented as separate categories within OCI. The accretion of the amount recorded in OCI increases the carrying value of the investment and does not affect earnings. If there is an indication of additional credit losses the security is re-evaluated according to the procedures described above. No OTTI losses were recognized during the six months ended June 30, 2014 or the year ended December 31, 2013.

Restricted Equity Securities

Restricted equity securities represent the Company’s investment in the stock of the Federal Home Loan Bank of San Francisco (“FHLB”) and are carried at par value, which reasonably approximates its fair value. While technically these are considered equity securities, there is no market for the FHLB stock. Therefore, the shares are considered as restricted investment securities. Management periodically evaluates FHLB stock for other-than-temporary impairment. Management’s determination of whether these investments are impaired is based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (1) the significance of any decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, (3) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB, and (4) the liquidity position of the FHLB.

As a member of the FHLB system, the Company is required to maintain a minimum level of investment in FHLB stock based on specific percentages of its outstanding mortgages, total assets, or FHLB advances. The Company may request redemption at par value of any stock in excess of the minimum required investment. Stock redemptions are at the discretion of the FHLB.

Loans Held for Sale

Loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by aggregate outstanding commitments from investors of current investor yield requirements. Net unrealized losses are recognized through a valuation allowance by charges to noninterest income.

Mortgage loans held for sale are generally sold with the mortgage servicing rights retained by the Company. Gains or losses on the sale of loans that are held for sale are recognized at the time of the sale and determined by the difference between net sale proceeds and the net book value of the loans less the estimated fair value of any retained mortgage servicing rights.

Loans and Allowance for Loan Losses

Loans originated by the Company, i.e., not purchased or acquired in a business combination, are referred to as originated loans. Originated loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal amount outstanding, net of deferred loan fees and costs. Loan origination and commitment fees and certain direct loan origination costs are deferred, and the net amount is amortized as an adjustment of the related loan’s yield over the actual life of the loan. Originated loans on which the accrual of interest has been discontinued are designated as nonaccrual loans.

Originated loans are placed in nonaccrual status when reasonable doubt exists as to the full, timely collection of interest or principal, or a loan becomes contractually past due by 90 days or more with respect to interest or principal and is not well secured and in the process of collection. When an originated loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of Management, the loan is estimated to be fully collectible as to both principal and interest.

An allowance for loan losses for originated loans is established through a provision for loan losses charged to expense. The allowance is maintained at a level which, in Management’s judgment, is adequate to absorb probable incurred credit losses inherent in the loan portfolio as of the balance sheet date. Originated loans and deposit related overdrafts are charged against the allowance for loan losses when Management believes that the collectability of the principal is unlikely or, with respect to consumer installment loans, according to an established delinquency schedule. The allowance is an amount that Management believes will be adequate to absorb probable incurred losses inherent in existing loans and leases, based on evaluations of the collectability, impairment and prior loss experience of loans and leases. The evaluations take into consideration such factors as changes in the nature and size of the portfolio, overall portfolio quality, loan concentrations, specific problem loans, and current economic conditions that may affect the borrower’s ability to pay. The Company defines an originated loan as impaired when it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement.

 

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Impaired originated loans are measured based on the present value of expected future cash flows discounted at the loan’s original effective interest rate. As a practical expedient, impairment may be measured based on the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance.

In situations related to originated loans where, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession for other than an insignificant period of time to the borrower that the Company would not otherwise consider, the related loan is classified as a troubled debt restructuring (TDR). The Company strives to identify borrowers in financial difficulty early and work with them to modify to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where the Company grants the borrower new terms that result in the loan being classified as a TDR, the Company measures any impairment on the restructuring as noted above for impaired loans. TDR loans are classified as impaired until they are fully paid off or charged off. Loans that are in nonaccrual status at the time they become TDR loans, remain in nonaccrual status until the borrower demonstrates a sustained period of performance which the Company generally believes to be six consecutive months of payments, or equivalent. Otherwise, TDR loans are subject to the same nonaccrual and charge-off policies as noted above with respect to their restructured principal balance.

Credit risk is inherent in the business of lending. As a result, the Company maintains an allowance for loan losses to absorb probable incurred losses inherent in the Company’s originated loan portfolio. This is maintained through periodic charges to earnings. These charges are included in the Consolidated Statements of Income as provision for loan losses. All specifically identifiable and quantifiable losses are immediately charged off against the allowance. However, for a variety of reasons, not all losses are immediately known to the Company and, of those that are known, the full extent of the loss may not be quantifiable at that point in time. The balance of the Company’s allowance for originated loan losses is meant to be an estimate of these unknown but probable losses inherent in the portfolio.

The Company formally assesses the adequacy of the allowance for originated loan losses on a quarterly basis. Determination of the adequacy is based on ongoing assessments of the probable risk in the outstanding originated loan portfolio, and to a lesser extent the Company’s originated loan commitments. These assessments include the periodic re-grading of credits based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the interest rate environment, growth of the portfolio as a whole or by segment, and other factors as warranted. Loans are initially graded when originated. They are re-graded as they are renewed, when there is a new loan to the same borrower, when identified facts demonstrate heightened risk of nonpayment, or if they become delinquent. Re-grading of larger problem loans occurs at least quarterly. Confirmation of the quality of the grading process is obtained by independent credit reviews conducted by consultants specifically hired for this purpose and by various bank regulatory agencies.

The Company’s method for assessing the appropriateness of the allowance for originated loan losses includes specific allowances for impaired originated loans and leases, formula allowance factors for pools of credits, and allowances for changing environmental factors (e.g., interest rates, growth, economic conditions, etc.). Allowance factors for loan pools were based on historical loss experience by product type and prior risk rating.

During the three months ended March 31, 2013, the Company changed the method it uses to estimate net sale proceeds from real estate collateral sales when calculating the allowance for loan losses associated with impaired real estate collateral dependent loans. Previously, the Company used the greater of fifteen percent or actual estimated selling costs. Currently, the Company uses the actual estimated selling costs, and an adjustment to appraised value based on the age of the appraisal. These changes are intended to more accurately reflect the estimated net sale proceeds from the sale of impaired collateral dependent real estate loans. This change in methodology resulted in the allowance for loan losses as of March 31, 2013 being $494,000 more than it would have been without this change in methodology.

During the three months ended June 30, 2013, the Company modified its loss migration analysis methodology used to determine the formula allowance factors. When the Company originally established its loss migration analysis methodology during the quarter ended March 31, 2012, it reviewed the loss experience of each rolling twelve month period over the previous three years in order to calculate an annualized loss rate by loan category and risk rating. The use of three years of loss experience data was originally used because that was the extent of the detailed loss data by loan category and risk rating that was available at the time. This three year historical look-back period was used through the quarter ended March 31, 2013. Starting with the quarter ended June 30, 2013, the Company reviews all available detailed loss experience data, going back to, and including, the twelve month period ended June 30, 2009, and does not limit the look-back period to the most recent three years of historical loss data. Using this data, the Company calculates loss factors for each quarter from the quarter ended June 30, 2009 to the most recent quarter. The Company then calculates a weighted average formula allowance factor for each loan category and risk rating with the most recent quarterly loss factor being weighted 125%, the quarter ended June 30, 2009 loss factor being weighted 75%, and the loss factors for all the quarters between the most recent quarter and the quarter ended June 30, 2009, being weighted on a linear scale from 75% to 125%. This change is intended to more accurately reflect the risk inherent in the loan portfolio by considering historical loss data for all years as the data for new periods becomes available. This change in methodology resulted in the allowance for loan losses as of June 30, 2013 being $1,314,000 more than it would have been without this change in methodology.

During the three months ended September 30, 2013, the Company modified its methodology used to determine the allowance for changing environmental factors. Previously, the Company compared the current value of each environmental factor to a fixed baseline value. The deviation of the current value from the baseline value was then multiplied by a conversion factor to determine the required allowance related to each environmental factor. As of September 30, 2013, the Company replaced the fixed baseline values with average baseline values derived from historical averages, and adjusted the conversion factors. This change is intended to more accurately reflect the risk inherent in the portfolio by recognizing that baseline, or normal, levels for environmental factors may change over time. This change in methodology resulted in the allowance for loan losses as of September 30, 2013 being $1,665,000 more than it would have been without this change in methodology.

 

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During the three months ended March 31, 2014, the Company modified its methodology used to determine the allowance for changing environmental factors by adding a new environmental factor based on the California Home Affordability Index (“CHAI”). The CHAI measures the percentage of households in California that can afford to purchase the median priced home in California based on current home prices and mortgage interest rates. The use of the CHAI environmental factor consists of comparing the current CHAI to its historical baseline, and allows management to consider the adverse impact that a lower than historical CHAI may have on general economic activity and the performance of our borrowers. Based on an analysis of historical data, management believes this environmental factor gives a better estimate of current economic activity compared to other environmental factors that may lag current economic activity to some extent. This change in methodology resulted in no change to the allowance for loan losses as of March 31, 2014 compared to what it would have been without this change in methodology.

During the three months ended June 30, 2014, the Company refined the method it uses to evaluate historical losses for the purpose of estimating the pool allowance for unimpaired loans. In the third quarter of 2010, the Company moved from a six point grading system (Grades A-F) to a nine point risk rating system (Risk Ratings 1-9), primarily to allow for more distinction within the “Pass” risk rating. Initially, there was not sufficient loss experience within the nine point scale to complete a migration analysis for all nine risk ratings, all loans risk rated Pass or 2-5 were grouped together, a loss rate was calculated for that group, and that loss rate was established as the loss rate for risk rating 4. The reserve ratios for risk ratings 2, 3 and 5 were then interpolated from that figure. As of June 30, 2014, the Company was able to compile twelve quarters of historical loss information for all risk ratings and use that information to calculate the loss rates for each of the nine risk ratings without interpolation. This refinement led to an increase of $1,438,000 in the reserve requirement for unimpaired loans, driven primarily by home equity lines of credit with a risk rating of 5 or “Pass-Watch.”

Loans purchased or acquired in a business combination are referred to as acquired loans. Acquired loans are valued as of the acquisition date in accordance with Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) Topic 805, Business Combinations. Loans acquired with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are referred to as purchased credit impaired (PCI) loans. PCI loans are accounted for under FASB ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. Under FASB ASC Topic 805 and FASB ASC Topic 310-30, PCI loans are recorded at fair value at acquisition date, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded as of the acquisition date. Fair value is defined as the present value of the future estimated principal and interest payments of the loan, with the discount rate used in the present value calculation representing the estimated effective yield of the loan. Default rates, loss severity, and prepayment speed assumptions are periodically reassessed and our estimate of future payments is adjusted accordingly. The difference between contractual future payments and estimated future payments is referred to as the nonaccretable difference. The difference between estimated future payments and the present value of the estimated future payments is referred to as the accretable yield. The accretable yield represents the amount that is expected to be recorded as interest income over the remaining life of the loan. If after acquisition, the Company determines that the estimated future cash flows of a PCI loan are expected to be more than originally estimated, an increase in the discount rate (effective yield) would be made such that the newly increased accretable yield would be recognized, on a level yield basis, over the remaining estimated life of the loan. If, after acquisition, the Company determines that the estimated future cash flows of a PCI loan are expected to be less than previously estimated, the discount rate would first be reduced until the present value of the reduced cash flow estimate equals the previous present value however, the discount rate may not be lowered below its original level at acquisition. If the discount rate has been lowered to its original level and the present value has not been sufficiently lowered, an allowance for loan loss would be established through a provision for loan losses charged to expense to decrease the present value to the required level. If the estimated cash flows improve after an allowance has been established for a loan, the allowance may be partially or fully reversed depending on the improvement in the estimated cash flows. Only after the allowance has been fully reversed may the discount rate be increased. PCI loans are put on nonaccrual status when cash flows cannot be reasonably estimated. PCI loans on nonaccrual status are accounted for using the cost recovery method or cash basis method of income recognition. PCI loans are charged off when evidence suggests cash flows are not recoverable. Foreclosed assets from PCI loans are recorded in foreclosed assets at fair value with the fair value at time of foreclosure representing cash flow from the loan. ASC 310-30 allows PCI loans with similar risk characteristics and acquisition time frame to be “pooled” and have their cash flows aggregated as if they were one loan. The Company elected to use the “pooled” method of ASC 310-30 for PCI – other loans in the acquisition of certain assets and liabilities of Granite Community Bank, N.A. (“Granite”) during 2010 and Citizens Bank of Northern California (“Citizens”) during 2011.

Acquired loans that are not PCI loans are referred to as purchased not credit impaired (PNCI) loans. PNCI loans are accounted for under FASB ASC Topic 310-20, Receivables – Nonrefundable Fees and Other Costs, in which interest income is accrued on a level-yield basis for performing loans. For income recognition purposes, this method assumes that all contractual cash flows will be collected, and no allowance for loan losses is established at the time of acquisition. Post-acquisition date, an allowance for loan losses may need to be established for acquired loans through a provision charged to earnings for credit losses incurred subsequent to acquisition. Under ASC 310-20, the loss would be measured based on the probable shortfall in relation to the contractual note requirements, consistent with our allowance for loan loss policy for similar loans.

Throughout these financial statements, and in particular in Note 4 and Note 5, when we refer to “Loans” or “Allowance for loan losses” we mean all categories of loans, including Originated, PNCI, PCI – cash basis, and PCI—other. When we are not referring to all categories of loans, we will indicate which we are referring to – Originated, PNCI, PCI – cash basis, or PCI—other.

When referring to PNCI and PCI loans we will use the terms “nonaccretable difference”, “accretable yield”, or “purchase discount”. Nonaccretable difference is the difference between undiscounted contractual cash flows due and undiscounted cash flows we expect to collect, or put another way, it is the undiscounted contractual cash flows we do not expect to collect. Accretable yield is the difference between undiscounted cash flows we expect to collect and the value at which we have recorded the loan on our financial statements. On the

 

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date of acquisition, all purchased loans are recorded on our consolidated financial statements at estimated fair value. Purchase discount is the difference between the estimated fair value of loans on the date of acquisition and the principal amount owed by the borrower, net of charge offs, on the date of acquisition. We may also refer to “discounts to principal balance of loans owed, net of charge-offs”. Discounts to principal balance of loans owed, net of charge-offs is the difference between principal balance of loans owed, net of charge-offs, and loans as recorded on our financial statements. Discounts to principal balance of loans owed, net of charge-offs arise from purchase discounts, and equal the purchase discount on the acquisition date.

Loans are also categorized as “covered” or “noncovered”. Covered loans refer to loans covered by a Federal Deposit Insurance Corporation (“FDIC”) loss sharing agreement. Noncovered loans refer to loans not covered by a FDIC loss sharing agreement.

Foreclosed Assets

Foreclosed assets include assets acquired through, or in lieu of, loan foreclosure. Foreclosed assets are held for sale and are initially recorded at fair value less estimated costs to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, management periodically performs valuations and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other noninterest expense. Gain or loss on sale of foreclosed assets is included in noninterest income. Foreclosed assets that are not subject to a FDIC loss-share agreement are referred to as noncovered foreclosed assets.

Foreclosed assets acquired through FDIC-assisted acquisitions that are subject to a FDIC loss-share agreement, and all assets acquired via foreclosure of covered loans are referred to as covered foreclosed assets. Covered foreclosed assets are reported exclusive of expected reimbursement cash flows from the FDIC. Foreclosed covered loan collateral is transferred into covered foreclosed assets at the loan’s carrying value, inclusive of the acquisition date fair value discount.

Covered foreclosed assets are initially recorded at estimated fair value less estimated costs to sell on the acquisition date based on similar market comparable valuations less estimated selling costs. Any subsequent valuation adjustments due to declines in fair value will be charged to noninterest expense, and will be mostly offset by noninterest income representing the corresponding increase to the FDIC indemnification asset for the offsetting loss reimbursement amount. Any recoveries of previous valuation adjustments will be credited to noninterest expense with a corresponding charge to noninterest income for the portion of the recovery that is due to the FDIC.

Premises and Equipment

Land is carried at cost. Land improvements, buildings and equipment, including those acquired under capital lease, are stated at cost less accumulated depreciation and amortization. Depreciation and amortization expenses are computed using the straight-line method over the estimated useful lives of the related assets or lease terms. Asset lives range from 3-10 years for furniture and equipment and 15-40 years for land improvements and buildings.

Goodwill and Other Intangible Assets

Goodwill represents the excess of costs over fair value of net assets of businesses acquired. Goodwill and other intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment.

The Company has an identifiable intangible asset consisting of core deposit intangibles (CDI). CDI are amortized over their respective estimated useful lives, and reviewed for impairment.

Impairment of Long-Lived Assets and Goodwill

Long-lived assets, such as premises and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the consolidated balance sheet.

As of December 31 of each year, goodwill is tested for impairment, and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. This determination is made at the reporting unit level. The Company may choose to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, the Company determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then goodwill is deemed not to be impaired. However, if the Company concludes otherwise, or if the Company elected not to first assess qualitative factors, then the Company performs the first step of a two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. Second, if the carrying amount of the reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. Currently, and historically, the Company is comprised of only one reporting unit that operates within the business segment it has identified as “community banking”. Goodwill was not impaired as of December 31, 2013 because the fair value of the reporting unit exceeded its carrying value.

 

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Mortgage Servicing Rights

Mortgage servicing rights (MSR) represent the Company’s right to a future stream of cash flows based upon the contractual servicing fee associated with servicing mortgage loans. Our MSR arise from residential mortgage loans that we originate and sell, but retain the right to service the loans. The net gain from the retention of the servicing right is included in gain on sale of loans in noninterest income when the loan is sold. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. Servicing fees are recorded in noninterest income when earned.

The Company accounts for MSR at fair value. The determination of fair value of our MSR requires management judgment because they are not actively traded. The determination of fair value for MSR requires valuation processes which combine the use of discounted cash flow models and extensive analysis of current market data to arrive at an estimate of fair value. The cash flow and prepayment assumptions used in our discounted cash flow model are based on empirical data drawn from the historical performance of our MSR, which we believe are consistent with assumptions used by market participants valuing similar MSR, and from data obtained on the performance of similar MSR. The key assumptions used in the valuation of MSR include mortgage prepayment speeds and the discount rate. These variables can, and generally will, change from quarter to quarter as market conditions and projected interest rates change. The key risks inherent with MSR are prepayment speed and changes in interest rates. The Company uses an independent third party to determine fair value of MSR.

Indemnification Asset

The Company accounts for amounts receivable or payable under its loss-share agreements entered into with the FDIC in connection with its purchase and assumption of certain assets and liabilities of Granite as indemnification assets in accordance with FASB ASC Topic 805, Business Combinations. FDIC indemnification assets are initially recorded at fair value, based on the discounted value of expected future cash flows under the loss-share agreements. The difference between the fair value and the undiscounted cash flows the Company expects to collect from the FDIC will be accreted into noninterest income over the life of the FDIC indemnification asset. FDIC indemnification assets are reviewed quarterly and adjusted for any changes in expected cash flows based on recent performance and expectations for future performance of the covered portfolios. These adjustments are measured on the same basis as the related covered loans and covered other real estate owned. Any increases in cash flow of the covered assets over those expected will reduce the FDIC indemnification asset and any decreases in cash flow of the covered assets under those expected will increase the FDIC indemnification asset. Increases and decreases to the FDIC indemnification asset are recorded as adjustments to noninterest income.

Reserve for Unfunded Commitments

The reserve for unfunded commitments is established through a provision for losses – unfunded commitments charged to noninterest expense. The reserve for unfunded commitments is an amount that Management believes will be adequate to absorb probable losses inherent in existing commitments, including unused portions of revolving lines of credits and other loans, standby letters of credits, and unused deposit account overdraft privilege. The reserve for unfunded commitments is based on evaluations of the collectability, and prior loss experience of unfunded commitments. The evaluations take into consideration such factors as changes in the nature and size of the loan portfolio, overall loan portfolio quality, loan concentrations, specific problem loans and related unfunded commitments, and current economic conditions that may affect the borrower’s or depositor’s ability to pay.

During the three months ended June 30, 2013, the Company modified the methodology employed to estimate potential losses on unfunded commitments. Similar to the Allowance for Loan Losses, the Company performs a migration analysis of historical loss experience. Prior to this quarter, the loss experience of each quarter over the previous three years was reviewed in order to calculate an annualized loss rate by loan category. Going forward, the Company has chosen to review all loss experience available since the conversion to a loss migration analysis. This change is intended to more accurately reflect the risk inherent in the unfunded commitments and appropriately consider all losses incurred in prior years. This change in methodology resulted in the reserve for unfunded commitments as of June 30, 2013 being $335,000 more than it would have been without this change in methodology.

Income Taxes

The Company’s accounting for income taxes is based on an asset and liability approach. The Company recognizes the amount of taxes payable or refundable for the current year, and deferred tax assets and liabilities for the future tax consequences that have been recognized in its financial statements or tax returns. The measurement of tax assets and liabilities is based on the provisions of enacted tax laws. A valuation allowance, if needed, reduces deferred tax assets to the expected amount most likely to be realized. Realization of deferred tax assets is dependent upon the generation of a sufficient level of future taxable income and recoverable taxes paid in prior years. Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized. Interest and/or penalties related to income taxes are reported as a component of noninterest income.

Off-Balance Sheet Credit Related Financial Instruments

In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded.

Geographical Descriptions

For the purpose of describing the geographical location of the Company’s loans, the Company has defined northern California as that area of California north of, and including, Stockton; central California as that area of the state south of Stockton, to and including, Bakersfield; and southern California as that area of the state south of Bakersfield.

 

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Reclassifications

Certain amounts reported in previous consolidated financial statements have been reclassified to conform to the presentation in this report. These reclassifications did not affect previously reported net income or total shareholders’ equity.

Recent Accounting Pronouncements

FASB issued ASU No. 2014-04, Receivables (Topic 310): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. ASU 2014-04 clarifies when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. ASU 2014-04 is effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. ASU 2014-04 is not expected to have a significant impact on the Company’s consolidated financial statements.

FASB issued ASU No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. ASU 2014-08 improves the definition of discontinued operations by limiting discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have (or will have) a major effect on an entity’s operations and financial results. ASU 2014-08 requires expanded disclosures for discontinued operations that provide users of financial statements with more information about the assets, liabilities, revenues, and expenses of discontinued operations. ASU 2014-08 also requires an entity to disclose the pretax profit or loss of an individually significant component of an entity that does not qualify for discontinued operations reporting, and provide users with information about the financial effects of significant disposals that do not qualify for discontinued operations reporting. The amendments in ASU 2014-08 include several changes to the Accounting Standards Codification to improve the organization and readability of Subtopic 205-20 and Subtopic 360-10, Property, Plant, and Equipment—Overall. ASU 2014-08 is effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. ASU 2014-08 is not expected to have a significant impact on the Company’s consolidated financial statements.

FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). The core principle of the guidance under ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 is effective for a public entity for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. ASU 2014-09 is not expected to have a significant impact on the Company’s consolidated financial statements.

FASB issued ASU No. 2014-11, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. ASU 2014-11 requires that repurchase-to-maturity transactions be accounted for as secured borrowings consistent with the accounting for other repurchase agreements. In addition, ASU 2014-11 requires separate accounting for repurchase financings, which entails the transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty. ASU 2014-11 requires entities to disclose certain information about transfers accounted for as sales in transactions that are economically similar to repurchase agreements. In addition, ASU 2014-11 requires disclosures related to collateral, remaining contractual tenor and of the potential risks associated with repurchase agreements, securities lending transactions and repurchase-to-maturity transactions. ASU 2014-11 is effective for public business entities for the first interim or annual period beginning after December 15, 2014. An entity is required to present changes in accounting for transactions outstanding on the effective date as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. Earlier application for a public business entity is prohibited. ASU 2014-11 is not expected to have a significant impact on the Company’s consolidated financial statements.

FASB issued ASU No. 2014-12, Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be achieved after the Requisite Service Period. ASU 2014-12 requires that a performance target that affects the vesting of a share-based payment award and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Topic 718 as it relates to awards with performance conditions that affect vesting to account for such awards. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. The stated vesting period (which includes the period in which the performance target could be achieved) may differ from the requisite service period. Current U.S. GAAP does not contain explicit guidance on whether to treat a performance target that could be achieved after the requisite service period as a performance condition that affects vesting or as a nonvesting condition that affects the grant-date fair value of an award. ASU 2014-12 provides explicit guidance for those awards. For all entities, ASU 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted.

 

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Note 2 – Business Combinations

On January 21, 2014, TriCo announced that it had entered into an Agreement and Plan of Merger and Reorganization under which it would acquire North Valley Bancorp. North Valley Bancorp shareholders will receive a fixed exchange ratio of 0.9433 shares of TriCo common stock for each share of North Valley Bancorp common stock, which would provide North Valley Bancorp shareholders with aggregate ownership, on a pro forma basis, of approximately 28.6% of the common stock of the combined company. Based on TriCo’s closing stock price of $27.66 on January 17, 2014, North Valley Bancorp shareholders would have received consideration valued at approximately $26.09 per share.

The merger will not be completed unless a number of customary closing conditions are met, including, among others, approval of the merger by shareholders of both companies, the registration of the offering of the TriCo common stock to the North Valley Bancorp shareholders under the Securities Act of 1933, receipt of required regulatory and other approvals and the expiration of applicable statutory waiting periods, the accuracy of specified representations and warranties of each party, the receipt of tax opinions confirming certain tax aspects of the merger, North Valley Bancorp’s satisfaction of certain financial measures shortly prior to closing, and the absence of any injunctions or other legal restraints. If the Merger Agreement is terminated, under certain circumstances, TriCo could be required to pay a termination fee to North Valley Bancorp equal to $3,800,000.

TriCo has agreed to appoint three North Valley Bancorp directors to TriCo’s board upon closing of the merger. The merger is expected to be completed in the third quarter of 2014, subject to approval of the merger by shareholders of both companies, receipt of required regulatory and other approvals and satisfaction of customary closing conditions.

North Valley Bancorp, headquartered in Redding, California, is the parent of North Valley Bank and had approximately $935 million in assets and 22 commercial banking offices in Shasta, Humboldt, Del Norte, Mendocino, Yolo, Sonoma, Placer and Trinity Counties in Northern California at June 30, 2014. In connection with the acquisition, North Valley Bank will merge into Tri Counties Bank.

 

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Note 3 – Investment Securities

The amortized cost and estimated fair values of investments in debt and equity securities are summarized in the following tables:

 

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

Securities Available for Sale

          

Obligations of U.S. government corporations and agencies

   $ 81,392       $ 4,711       $ (63   $ 86,040   

Obligations of states and political subdivisions

     3,484         76         —          3,560   

Corporate debt securities

     1,883         31         —          1,914   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total securities available for sale

   $ 86,759       $ 4,818       $ (63   $ 91,514   
  

 

 

    

 

 

    

 

 

   

 

 

 

Securities Held to Maturity

          

Obligations of U.S. government corporations and agencies

   $ 409,881       $ 6,983       $ (1,175   $ 415,689   

Obligations of states and political subdivisions

     12,621         —           (355     12,266   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total securities held to maturity

   $ 422,502       $ 6,983       $ (1,530   $ 427,955   
  

 

 

    

 

 

    

 

 

   

 

 

 
     December 31, 2013  
            Gross      Gross     Estimated  
     Amortized      Unrealized      Unrealized     Fair  
     Cost      Gains      Losses     Value  
     (in thousands)  

Securities Available for Sale

          

Obligations of U.S. government corporations and agencies

   $ 93,055       $ 4,445       $ (357   $ 97,143   

Obligations of states and political subdivisions

     5,513         77         (1     5,589   

Corporate debt securities

     1,877         38         —          1,915   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total securities available for sale

   $ 100,445       $ 4,560       $ (358   $ 104,647   
  

 

 

    

 

 

    

 

 

   

 

 

 

Securities Held to Maturity

          

Obligations of U.S. government corporations and agencies

   $ 227,864       $ 298       $ (5,540   $ 222,622   

Obligations of states and political subdivisions

     12,640         —           (1,455     11,185   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total securities held to maturity

   $ 240,504       $ 298       $ (6,995   $ 233,807   
  

 

 

    

 

 

    

 

 

   

 

 

 

No investment securities were sold during the six months ended June 30, 2014 or the year ended December 31, 2013. Investment securities with an aggregate carrying value of $56,583,000 and $62,064,000 at June 30, 2014 and December 31, 2013, respectively, were pledged as collateral for specific borrowings, lines of credit and local agency deposits.

The amortized cost and estimated fair value of debt securities at June 30, 2014 by contractual maturity are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. At June 30, 2014, obligations of U.S. government corporations and agencies with a cost basis totaling $491,273,000 consist almost entirely of mortgage-backed securities whose contractual maturity, or principal repayment, will follow the repayment of the underlying mortgages.

For purposes of the following table, the entire outstanding balance of these mortgage-backed securities issued by U.S. government corporations and agencies is categorized based on final maturity date. At June 30, 2014, the Company estimates the average remaining life of these mortgage-backed securities issued by U.S. government corporations and agencies to be approximately 5.7 years. Average remaining life is defined as the time span after which the principal balance has been reduced by half.

 

Investment Securities

   Available for Sale      Held to Maturity  
(In thousands)    Amortized      Estimated      Amortized      Estimated  
     Cost      Fair Value      Cost      Fair Value  

Due in one year

   $ 286       $ 304         —           —     

Due after one year through five years

     3,187         3,280         —           —     

Due after five years through ten years

     27,371         28,467         —           —     

Due after ten years

     55,915         59,463       $ 422,502       $ 427,955   
  

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 86,759       $ 91,514       $ 422,502       $ 427,955   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows:

 

     Less than 12 months     12 months or more     Total  
     Fair      Unrealized     Fair      Unrealized     Fair      Unrealized  
June 30, 2014    Value      Loss     Value      Loss     Value      Loss  
     (in thousands)  

Securities available for sale:

               

Obligations of U.S. government corporations and agencies

     —           —        $ 10,068       $ (63   $ 10,068       $ (63

Obligations of states and political subdivisions

     —           —          —           —          —           —     

Corporate debt securities

     —           —          —           —          —           —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total securities available for sale

     —           —        $ 10,068       $ (63   $ 10,068       $ (63
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Securities held to maturity:

               

Obligations of U.S. government corporations and agencies

   $ 3,384       $ (14   $ 57,938       $ (1,161   $ 61,322       $ (1,175

Obligations of states and political subdivisions

     477         (31     11,789         (324     12,266         (355
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total securities held to maturity

   $ 3,861       $ (45   $ 69,727       $ (1,485   $ 73,588       $ (1,530
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
     Less than 12 months     12 months or more     Total  
     Fair      Unrealized     Fair      Unrealized     Fair      Unrealized  
December 31, 2013    Value      Loss     Value      Loss     Value      Loss  
     (in thousands)  

Securities available for sale:

               

Obligations of U.S. government corporations and agencies

   $ 10,287       $ (357     —           —        $ 10,287       $ (357

Obligations of states and political subdivisions

     199         (1     —           —          199         (1

Corporate debt securities

     —           —          —           —          —           —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total securities available for sale

   $ 10,486       $ (358     —           —        $ 10,486       $ (358
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Securities held to maturity:

               

Obligations of U.S. government corporations and agencies

   $ 188,218       $ (5,540     —           —        $ 188,218       $ (5,540

Obligations of states and political subdivisions

     11,185         (1,455     —           —          11,185         (1,455
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total securities held to maturity

   $ 199,403       $ (6,995     —           —        $ 199,403       $ (6,995
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Obligations of U.S. government corporations and agencies: Unrealized losses on investments in obligations of U.S. government corporations and agencies are caused by interest rate increases. The contractual cash flows of these securities are guaranteed by U.S. Government Sponsored Entities (principally Fannie Mae and Freddie Mac). It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell and more likely than not will not be required to sell, these investments are not considered other-than-temporarily impaired. At June 30, 2014, 9 debt securities representing obligations of U.S. government corporations and agencies had unrealized losses with aggregate depreciation of 1.71% from the Company’s amortized cost basis.

Obligations of states and political subdivisions: The unrealized losses on investments in obligations of states and political subdivisions were caused by increases in required yields by investors in these types of securities. It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell and more likely than not will not be required to sell, these investments are not considered other-than-temporarily impaired. At June 30, 2014, 14 debt securities representing obligations of states and political subdivisions had unrealized losses with aggregate depreciation of 2.81% from the Company’s amortized cost basis.

Corporate debt securities: At June 30, 2014, no corporate debt securities had unrealized losses.

 

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Note 4 – Loans

A summary of loan balances follows (in thousands):

 

     June 30, 2014  
                 PCI -     PCI -        
     Originated     PNCI     Cash basis     Other     Total  

Mortgage loans on real estate:

          

Residential 1-4 family

   $ 136,690      $ 72,387        —        $ 3,843      $ 212,920   

Commercial

     872,125        52,844        —          29,967        954,936   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total mortgage loan on real estate

     1,008,815        125,231        —          33,810        1,167,856   

Consumer:

          

Home equity lines of credit

     307,964        12,866      $ 5,712        3,645        330,187   

Home equity loans

     17,129        154        126        486        17,895   

Auto Indirect

     385        —          —          —          385   

Other

     26,745        1,861        —          70        28,676   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer loans

     352,223        14,881        5,838        4,201        377,143   

Commercial

     130,848        518        11        5,964        137,341   

Construction:

          

Residential

     40,595        —          —          1,502        42,097   

Commercial

     14,084        —          —          65        14,149   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total construction

     54,679        —          —          1,567        56,246   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans, net of deferred loan fees and discounts

   $ 1,546,565      $ 140,630      $ 5,849      $ 45,542      $ 1,738,586   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total principal balance of loans owed, net of charge-offs

   $ 1,550,887      $ 147,076      $ 15,456      $ 53,192      $ 1,766,611   

Unamortized net deferred loan fees

     (4,322     —          —          —          (4,322

Discounts to principal balance of loans owed, net of charge-offs

     —          (6,446     (9,607     (7,650     (23,703
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans, net of unamortized deferred loan fees and discounts

   $ 1,546,565      $ 140,630      $ 5,849      $ 45,542      $ 1,738,586   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Noncovered loans

   $ 1,546,565      $ 140,630      $ 5,849      $ 20,137      $ 1,713,181   

Covered loans

     —          —          —          25,405        25,405   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans, net of unamortized deferred loan fees and discounts

   $ 1,546,565      $ 140,630      $ 5,849      $ 45,542      $ 1,738,586   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses

   $ 32,457      $ 3,235      $ 398      $ 3,878      $ 39,968   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Note 4 – Loans (continued)

 

A summary of loan balances follows (in thousands):

 

     December 31, 2013  
                 PCI -     PCI -        
     Originated     PNCI     Cash basis     Other     Total  

Mortgage loans on real estate:

          

Residential 1-4 family

   $ 129,882      $ 60,475        —        $ 4,656      $ 195,013   

Commercial

     824,912        57,678        —          30,260        912,850   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total mortgage loan on real estate

     954,794        118,153        —          34,916        1,107,863   

Consumer:

          

Home equity lines of credit

     316,207        13,576      $ 6,200        3,883        339,866   

Home equity loans

     13,849        253        —          486        14,588   

Auto Indirect

     946        —          —          —          946   

Other

     25,608        2,074        —          81        27,763   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer loans

     356,610        15,903        6,200        4,450        383,163   

Commercial

     124,650        693        19        6,516        131,878   

Construction:

          

Residential

     30,367        —          —          1,566        31,933   

Commercial

     17,125        —          —          45        17,170   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total construction

     47,492        —          —          1,611        49,103   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans, net of deferred loan fees and discounts

   $ 1,483,546      $ 134,749      $ 6,219      $ 47,493      $ 1,672,007   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total principal balance of loans owed, net of charge-offs

   $ 1,487,240      $ 142,786      $ 16,475      $ 56,879      $ 1,703,380   

Unamortized net deferred loan fees

     (3,694     —          —          —          (3,694

Discounts to principal balance of loans owed, net of charge-offs

     —          (8,037     (10,256     (9,386     (27,679
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans, net of unamortized deferred loan fees and discounts

   $ 1,483,546      $ 134,749      $ 6,219      $ 47,493      $ 1,672,007   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Noncovered loans

   $ 1,483,546      $ 134,749      $ 6,219      $ 19,581      $ 1,644,095   

Covered loans

     —          —          —          27,912        27,912   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans, net of unamortized deferred loan fees and discounts

   $ 1,483,546      $ 134,749      $ 6,219      $ 47,493      $ 1,672,007   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses

   $ (31,354   $ (2,850   $ (385   $ (3,656   $ (38,245
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following is a summary of the change in accretable yield for PCI – other loans during the periods indicated (in thousands):

 

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

Change in accretable yield:

        

Balance at beginning of period

   $ 17,438      $ 20,691      $ 18,232      $ 22,337   

Accretion to interest income

     (1,382     (1,568     (3,013     (3,191

Reclassification from nonaccretable difference

     242        604        1,079        581   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 16,298      $ 19,727      $ 16,298      $ 19,727   
  

 

 

   

 

 

   

 

 

   

 

 

 

Throughout these consolidated financial statements, and in particular in this Note 4 and Note 5, when we refer to “Loans” or “Allowance for loan losses” we mean all categories of loans, including Originated, PNCI, PCI – cash basis, and PCI—other. When we are not referring to all categories of loans, we will indicate which we are referring to – Originated, PNCI, PCI – cash basis, or PCI—other.

 

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Note 5 – Allowance for Loan Losses

The following tables summarize the activity in the allowance for loan losses, and ending balance of loans, net of unearned fees for the periods indicated.

 

    Allowance for Loan Losses – Three Months Ended June 30, 2014  
    RE Mortgage     Home Equity     Auto     Other           Construction        
(in thousands)   Resid.     Comm.     Lines     Loans     Indirect     Consum.     C&I     Resid.     Comm.     Total  

Beginning balance

  $ 2,980      $ 9,875      $ 16,366      $ 1,291      $ 45      $ 590      $ 4,136      $ 1,501      $ 1,538      $ 38,322   

Charge-offs

    (1     (45     (677     (11     —          (144     (151     —          —          (1,029

Recoveries

    —          299        180        25        39        119        188        97        20        967   

(Benefit) provision

    (147     (298     2,186        106        (56     (9     234        (87     (221     1,708   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $ 2,832      $ 9,831      $ 18,055      $ 1,411      $ 28      $ 556      $ 4,407      $ 1,511      $ 1,337      $ 39,968   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    Allowance for Loan Losses – Six Months Ended June 30, 2014  
    RE Mortgage     Home Equity     Auto     Other           Construction        
(in thousands)   Resid.     Comm.     Lines     Loans     Indirect     Consum.     C&I     Resid.     Comm.     Total  

Beginning balance

  $ 3,154      $ 9,700      $ 16,375      $ 1,208      $ 66      $ 589      $ 4,331      $ 1,559      $ 1,263      $ 38,245   

Charge-offs

    (136     (58     (855     (11     —          (271     (390     (4     (69     (1,794

Recoveries

    —          471        509        27        51        302        1,061        608        135        3,164   

(Benefit) provision

    (186     (282     2,026        187        (89     (64     (595     (652     8        353   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $ 2,832      $ 9,831      $ 18,055      $ 1,411      $ 28      $ 556      $ 4,407      $ 1,511      $ 1,337      $ 39,968   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance:

                   

Individ. evaluated for impairment

  $ 780      $ 392      $ 2,088      $ 211        —        $ 3      $ 405      $ 61        —        $ 3,940   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans pooled for evaluation

  $ 1,869      $ 8,605      $ 15,466      $ 1,199      $ 27      $ 553      $ 2,534      $ 720      $ 779      $ 31,752   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans acquired with deteriorated credit quality

  $ 185      $ 835      $ 499        —          —          —        $ 1,469      $ 730      $ 558      $ 4,276   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    Loans, net of unearned fees – As of June 30, 2014  
    RE Mortgage     Home Equity     Auto     Other           Construction        
(in thousands)   Resid.     Comm.     Lines     Loans     Indirect     Consum.     C&I     Resid.     Comm.     Total  

Ending balance:

                   

Total loans

  $ 212,920      $ 954,936      $ 330,187      $ 17,895      $ 385      $ 28,676      $ 137,341      $ 42,097      $ 14,149      $ 1,738,586   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Individ. evaluated for impairment

  $ 7,397      $ 52,570      $ 6,987      $ 871      $ 40      $ 77      $ 2,159      $ 2,751      $ 16      $ 72,868   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans pooled for evaluation

  $ 201,680      $ 872,399      $ 313,843      $ 16,412      $ 345      $ 28,529      $ 129,207      $ 37,844      $ 14,068      $ 1,614,327   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans acquired with deteriorated credit quality

  $ 3,843      $ 29,967      $ 9,357      $ 612        —        $ 70      $ 5,975      $ 1,502      $ 65      $ 51,391   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    Allowance for Loan Losses – Year Ended December 31, 2013  
    RE Mortgage     Home Equity     Auto     Other           Construction        
(in thousands)   Resid.     Comm.     Lines     Loans     Indirect     Consum.     C&I     Resid.     Comm.     Total  

Beginning balance

  $ 3,523      $ 8,782      $ 21,367      $ 1,155      $ 243      $ 696      $ 4,703      $ 1,400      $ 779      $ 42,648   

Charge-offs

    (46     (2,038     (2,651     (94     (68     (887     (1,599     (20     (140     (7,543

Recoveries

    345        994        1,053        41        195        759        340        63        65        3,855   

(Benefit) provision

    (668     1,962        (3,394     106        (304     21        887        116        559        (715
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $ 3,154      $ 9,700      $ 16,375      $ 1,208      $ 66      $ 589      $ 4,331      $ 1,559      $ 1,263      $ 38,245   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance:

                   

Individ. evaluated for impairment

  $ 775      $ 1,198      $ 1,140      $ 169      $ 1      $ 8      $ 585      $ 91      $ 8      $ 3,975   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans pooled for evaluation

  $ 2,039      $ 7,815      $ 14,749      $ 1,039      $ 65      $ 581      $ 2,402      $ 751      $ 789      $ 30,230   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans acquired with deteriorated credit quality

  $ 340      $ 687      $ 486        —          —          —        $ 1,344      $ 717      $ 466      $ 4,040   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

18


Table of Contents

Note 5 – Allowance for Loan Losses (continued)

 

    Loans, net of unearned fees – As of December 31, 2013  
    RE Mortgage     Home Equity     Auto     Other           Construction        
(in thousands)   Resid.     Comm.     Lines     Loans     Indirect     Consum.     C&I     Resid.     Comm.     Total  

Ending balance:

                   

Total loans

  $ 195,013      $ 912,850      $ 339,866      $ 14,588      $ 946      $ 27,763      $ 131,878      $ 31,933      $ 17,170      $ 1,672,007   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Individ. evaluated for impairment

  $ 7,342      $ 59,936      $ 6,918      $ 778      $ 60      $ 90      $ 3,177      $ 2,756      $ 178      $ 81,235   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans pooled for evaluation

  $ 183,015      $ 822,654      $ 322,865      $ 13,324      $ 886      $ 27,592      $ 122,166      $ 27,611      $ 16,947      $ 1,537,060   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans acquired with deteriorated credit quality

  $ 4,656      $ 30,260      $ 10,083      $ 486        —        $ 81      $ 6,535      $ 1,566      $ 45      $ 53,712   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    Allowance for Loan Losses – Three months ended June 30, 2013  
    RE Mortgage     Home Equity     Auto     Other           Construction        
(In thousands)   Resid.     Comm.     Lines     Loans     Indirect     Consum.     C&I     Resid.     Comm.     Total  

Beginning balance

  $ 3,343      $ 9,410      $ 19,323      $ 1,137      $ 148      $ 563      $ 4,235      $ 1,336      $ 372      $ 39,867   

Charge-offs

    (35     (886     (746     —          (33     (212     (35     —          —          (1,947

Recoveries

    191        317        215        17        61        178        66        —          20        1,065   

(Benefit) provision

    (268     (77     (82     (45     (62     38        663        (48     495        614   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $ 3,231      $ 8,764      $ 18,710      $ 1,109      $ 114      $ 567      $ 4,929      $ 1,288      $ 887      $ 39,599   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    Allowance for Loan Losses – As of and six months ended June 30, 2013  
    RE Mortgage     Home Equity     Auto     Other           Construction        
(In thousands)   Resid.     Comm.     Lines     Loans     Indirect     Consum.     C&I     Resid.     Comm.     Total  

Beginning balance

  $ 3,523      $ 8,782      $ 21,367      $ 1,155      $ 243      $ 696      $ 4,703      $ 1,400      $ 779      $ 42,648   

Charge-offs

    (42     (1,689     (1,512     (26     (58     (485     (825     (20     (61     (4,718

Recoveries

    191        670        505        26        146        402        136        61        26        2,163   

(Benefit) provision

    (441     1,001        (1,650     (46     (217     (46     915        (153     143        (494
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $ 3,231      $ 8,764      $ 18,710      $ 1,109      $ 114      $ 567      $ 4,929      $ 1,288      $ 887      $ 39,599   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance:

                   

Individ. evaluated for impairment

  $ 519      $ 1,521      $ 1,768      $ 50      $ 3      $ 7      $ 880      $ 98      $ 45      $ 4,891   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans pooled for evaluation

  $ 2,412      $ 6,965      $ 15,809      $ 992      $ 111      $ 551      $ 2,592      $ 521      $ 543      $ 30,496   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans acquired with deteriorated credit quality

  $ 300      $ 278      $ 1,133      $ 67        —        $ 9      $ 1,457      $ 669      $ 299      $ 4,212   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    Loans, net of unearned fees – As of June 30, 2013  
    RE Mortgage     Home Equity     Auto     Other           Construction        
(In thousands)   Resid.     Comm.     Lines     Loans     Indirect     Consum.     C&I     Resid.     Comm.     Total  

Ending balance:

                   

Total loans

  $ 196,910      $ 900,536      $ 342,813      $ 13,452      $ 1,965      $ 28,987      $ 128,410      $ 24,063      $ 14,904      $ 1,652,040   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Individ. evaluated for impairment

  $ 6,124      $ 68,027      $ 8,574      $ 510      $ 116      $ 86      $ 3,533      $ 3,223      $ 310      $ 90,503   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans pooled for evaluation

  $ 186,253      $ 798,979      $ 322,983      $ 12,340      $ 1,849      $ 28,818      $ 117,595      $ 18,217      $ 13,534      $ 1,500,568   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans acquired with deteriorated credit quality

  $ 4,533      $ 33,530      $ 11,256      $ 602        —        $ 83      $ 7,282      $ 2,623      $ 1,060      $ 60,969   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

19


Table of Contents

Note 5 – Allowance for Loan Losses (continued)

 

As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including, but not limited to, trends relating to (i) the level of criticized and classified loans, (ii) net charge-offs, (iii) non-performing loans, and (iv) delinquency within the portfolio.

The Company utilizes a risk grading system to assign a risk grade to each of its loans. Loans are graded on a scale ranging from Pass to Loss. A description of the general characteristics of the risk grades is as follows:

 

    Pass – This grade represents loans ranging from acceptable to very little or no credit risk. These loans typically meet most if not all policy standards in regard to: loan amount as a percentage of collateral value, debt service coverage, profitability, leverage, and working capital.

 

    Special Mention – This grade represents “Other Assets Especially Mentioned” in accordance with regulatory guidelines and includes loans that display some potential weaknesses which, if left unaddressed, may result in deterioration of the repayment prospects for the asset or may inadequately protect the Company’s position in the future. These loans warrant more than normal supervision and attention.

 

    Substandard – This grade represents “Substandard” loans in accordance with regulatory guidelines. Loans within this rating typically exhibit weaknesses that are well defined to the point that repayment is jeopardized. Loss potential is, however, not necessarily evident. The underlying collateral supporting the credit appears to have sufficient value to protect the Company from loss of principal and accrued interest, or the loan has been written down to the point where this is true. There is a definite need for a well defined workout/rehabilitation program.

 

    Doubtful – This grade represents “Doubtful” loans in accordance with regulatory guidelines. An asset classified as Doubtful has all the weaknesses inherent in a loan classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral, and financing plans.

 

    Loss – This grade represents “Loss” loans in accordance with regulatory guidelines. A loan classified as Loss is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off the loan, even though some recovery may be affected in the future. The portion of the loan that is graded loss should be charged off no later than the end of the quarter in which the loss is identified.

The following tables present ending loan balances by loan category and risk grade for the periods indicated:

 

     Credit Quality Indicators – As of June 30, 2014  
     RE Mortgage      Home Equity      Auto      Other             Construction         
(in thousands)    Resid.      Comm.      Lines      Loans      Indirect      Consum.      C&I      Resid.      Comm.      Total  

Originated loans:

                             

Pass

   $ 128,003       $ 821,814       $ 293,127       $ 15,419       $ 275       $ 26,037       $ 128,062       $ 36,055       $ 13,900       $ 1,462,692   

Special mention

     1,019         14,440         4,698         407         43         528         1,154         94         140         22,523   

Substandard

     7,668         35,871         10,137         1,303         67         180         1,632         4,446         44         61,348   

Loss

     —           —           2         —           —           —           —           —           —           2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total originated

   $ 136,690       $ 872,125       $ 307,964       $ 17,129       $ 385       $ 26,745       $ 130,848       $ 40,595       $ 14,084       $ 1,546,565   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

PNCI loans:

                             

Pass

   $ 71,787       $ 44,229       $ 11,797       $ 154         —         $ 1,823       $ 226         —           —         $ 130,016   

Special mention

     —           5,825         269         —           —           5         292         —           —           6,391   

Substandard

     600         2,790         800         —           —           33         —           —           —           4,223   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total PNCI

   $ 72,387       $ 52,844       $ 12,866       $ 154         —         $ 1,861       $ 518         —           —         $ 140,630   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

PCI loans

   $ 3,843       $ 29,967       $ 9,357       $ 612         —         $ 70       $ 5,975       $ 1,502       $ 65       $ 51,391   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 212,920       $ 954,936       $ 330,187       $ 17,895       $ 385       $ 28,676       $ 137,341       $ 42,097       $ 14,149       $ 1,738,586   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Credit Quality Indicators – As of December 31, 2013  
     RE Mortgage      Home Equity      Auto      Other             Construction         
(in thousands)    Resid.      Comm.      Lines      Loans      Indirect      Consum.      C&I      Resid.      Comm.      Total  

Originated loans:

                             

Pass

   $ 121,969       $ 768,596       $ 203,232       $ 12,284       $ 717       $ 24,653       $ 121,580       $ 25,836       $ 16,571       $ 1,394,438   

Special mention

     1,265         15,862         4,529         504         118         756         938         96         343         24,411   

Substandard

     6,648         40,454         9,446         1,061         111         196         2,122         4,435         211         64,684   

Loss

     —           —           —           —           —           3         10         —           —           13   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total originated

   $ 129,882       $ 824,912       $ 316,207       $ 13,849       $ 946       $ 25,608       $ 124,650       $ 30,367       $ 17,125       $ 1,483,546   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

PNCI loans:

                             

Pass

   $ 59,798       $ 48,548       $ 12,716       $ 253         —         $ 2,020       $ 380         —           —         $ 123,715   

Special mention

     —           5,810         195         —           —           18         313         —           —           6,336   

Substandard

     677         3,320         665         —           —           36         —           —           —           4,698   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total PNCI

   $ 60,475       $ 57,678       $ 13,576       $ 253         —         $ 2,074       $ 693         —           —         $ 134,749   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

PCI loans

   $ 4,656       $ 30,260       $ 10,083       $ 486         —         $ 81       $ 6,535       $ 1,566       $ 45       $ 53,712   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 195,013       $ 912,850       $ 339,866       $ 14,588       $ 946       $ 27,763       $ 131,878       $ 31,933       $ 17,170       $ 1,672,007   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

20


Table of Contents

Note 5 – Allowance for Loan Losses (continued)

 

Consumer loans, whether unsecured or secured by real estate, automobiles, or other personal property, are susceptible to three primary risks; non-payment due to income loss, over-extension of credit and, when the borrower is unable to pay, shortfall in collateral value. Typically non-payment is due to loss of job and will follow general economic trends in the marketplace driven primarily by rises in the unemployment rate. Loss of collateral value can be due to market demand shifts, damage to collateral itself or a combination of the two.

Problem consumer loans are generally identified by payment history of the borrower (delinquency). The Bank manages its consumer loan portfolios by monitoring delinquency and contacting borrowers to encourage repayment, suggest modifications if appropriate, and, when continued scheduled payments become unrealistic, initiate repossession or foreclosure through appropriate channels. Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, public value information (blue book values for autos), sales invoices, or other appropriate means. Appropriate valuations are obtained at initiation of the credit and periodically (every 3-12 months depending on collateral type) once repayment is questionable and the loan has been classified.

Commercial real estate loans generally fall into two categories, owner-occupied and non-owner occupied. Loans secured by owner occupied real estate are primarily susceptible to changes in the business conditions of the related business. This may be driven by, among other things, industry changes, geographic business changes, changes in the individual fortunes of the business owner, and general economic conditions and changes in business cycles. These same risks apply to commercial loans whether secured by equipment or other personal property or unsecured. Losses on loans secured by owner occupied real estate, equipment, or other personal property generally are dictated by the value of underlying collateral at the time of default and liquidation of the collateral. When default is driven by issues related specifically to the business owner, collateral values tend to provide better repayment support and may result in little or no loss. Alternatively, when default is driven by more general economic conditions, underlying collateral generally has devalued more and results in larger losses due to default. Loans secured by non-owner occupied real estate are primarily susceptible to risks associated with swings in occupancy or vacancy and related shifts in lease rates, rental rates or room rates. Most often these shifts are a result of changes in general economic or market conditions or overbuilding and resultant over-supply. Losses are dependent on value of underlying collateral at the time of default. Values are generally driven by these same factors and influenced by interest rates and required rates of return as well as changes in occupancy costs.

Construction loans, whether owner occupied or non-owner occupied commercial real estate loans or residential development loans, are not only susceptible to the related risks described above but the added risks of construction itself including cost over-runs, mismanagement of the project, or lack of demand or market changes experienced at time of completion. Again, losses are primarily related to underlying collateral value and changes therein as described above.

Problem C&I loans are generally identified by periodic review of financial information which may include financial statements, tax returns, rent rolls and payment history of the borrower (delinquency). Based on this information the Bank may decide to take any of several courses of action including demand for repayment, additional collateral or guarantors, and, when repayment becomes unlikely through borrower’s income and cash flow, repossession or foreclosure of the underlying collateral.

Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, public value information (blue book values for autos), sales invoices, or other appropriate means. Appropriate valuations are obtained at initiation of the credit and periodically (every 3-12 months depending on collateral type) once repayment is questionable and the loan has been classified.

Once a loan becomes delinquent and repayment becomes questionable, a Bank collection officer will address collateral shortfalls with the borrower and attempt to obtain additional collateral. If this is not forthcoming and payment in full is unlikely, the Bank will estimate its probable loss, using a recent valuation as appropriate to the underlying collateral less estimated costs of sale, and charge the loan down to the estimated net realizable amount. Depending on the length of time until ultimate collection, the Bank may revalue the underlying collateral and take additional charge-offs as warranted. Revaluations may occur as often as every 3-12 months depending on the underlying collateral and volatility of values. Final charge-offs or recoveries are taken when collateral is liquidated and actual loss is known. Unpaid balances on loans after or during collection and liquidation may also be pursued through lawsuit and attachment of wages or judgment liens on borrower’s other assets.

The following table shows the ending balance of current, past due, and nonaccrual originated loans by loan category as of the date indicated:

 

     Analysis of Past Due and Nonaccrual Originated Loans – As of June 30, 2014  
     RE Mortgage      Home Equity      Auto      Other             Construction         
(in thousands)    Resid.      Comm.      Lines      Loans      Indirect      Consum.      C&I      Resid.      Comm.      Total  

Originated loan balance:

                             

Past due:

                             

30-59 Days

   $ 14       $ 1,328       $ 1,928       $ 518       $ 2       $ 56       $ 140         —           —         $ 3,986   

60-89 Days

     349         —           767         46         —           2         6         —         $ 106         1,276   

> 90 Days

     903         1,731         535         138         23         6         60         —           —           3,396   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total past due

   $ 1,266       $ 3,059       $ 3,230       $ 702       $ 25       $ 64       $ 206         —         $ 106       $ 8,658   

Current

     135,424         869,066         304,734         16,427         360         26,681         130,642       $ 40,595         13,978         1,537,907   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total orig. loans

   $ 136,690       $ 872,125       $ 307,964       $ 17,129       $ 385       $ 26,745       $ 130,848       $ 40,595       $ 14,084       $ 1,546,565   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

> 90 Days and still accruing

     —           —           —           —           —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Nonaccrual loans

   $ 4,563       $ 24,308       $ 4,512       $ 813       $ 36       $ 16       $ 433       $ 2,468       $ 16       $ 37,165   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

21


Table of Contents

Note 5 – Allowance for Loan Losses (continued)

 

The following table shows the ending balance of current, past due, and nonaccrual PNCI loans by loan category as of the date indicated:

 

     Analysis of Past Due and Nonaccrual PNCI Loans – As of June 30, 2014  
     RE Mortgage      Home Equity      Auto      Other             Construction         
(in thousands)    Resid.      Comm.      Lines      Loans      Indirect      Consum.      C&I      Resid.      Comm.      Total  

PNCI loan balance:

                             

Past due:

                             

30-59 Days

     —           —           —           —           —           —         $ 10         —           —         $ 10   

60-89 Days

   $ 2,297         —           —           —           —         $ 36         —           —           —           2,333   

> 90 Days

     —           —         $ 36         —           —           —           —           —           —           36   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total past due

   $ 2,297         —         $ 36         —           —         $ 36       $ 10         —           —         $ 2,379   

Current

   $ 70,090         52,844         12,830       $ 154         —           1,825         508         —           —           138,251   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total PNCI loans

   $ 72,387       $ 52,844       $ 12,866       $ 154         —         $ 1,861       $ 518         —           —         $ 140,630   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

> 90 Days and still accruing

     —           —           —           —           —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Nonaccrual loans

   $ 193       $ 478       $ 484         —           —         $ 33         —           —           —         $ 1,188   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table shows the ending balance of current, past due, and nonaccrual originated loans by loan category as of the date indicated:

 

     Analysis of Past Due and Nonaccrual Originated Loans – As of December 31, 2013  
     RE Mortgage      Home Equity      Auto      Other             Construction         
(in thousands)    Resid.      Comm.      Lines      Loans      Indirect      Consum.      C&I      Resid.      Comm.      Total  

Originated loan balance:

                             

Past due:

                             

30-59 Days

   $ 2,272       $ 2,304       $ 3,121       $ 264       $ 24       $ 40       $ 296         —           —         $ 8,321   

60-89 Days

     284         —           1,070         16         1         16         76         —         $ 198         1,661   

> 90 Days

     447         2,213         1,050         312         33         7         749       $ 13         —           4,824   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total past due

   $ 3,003       $ 4,517       $ 5,241       $ 592       $ 58       $ 63       $ 1,121       $ 13       $ 198       $ 14,806   

Current

     126,879         820,395         310,966         13,257         888         25,545         123,529         30,354         16,927         1,468,740   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total orig. loans

   $ 129,882       $ 824,912       $ 316,207       $ 13,849       $ 946         25,608       $ 124,650       $ 30,367       $ 17,125       $ 1,483,546   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

> 90 Days and still accruing

     —           —           —           —           —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Nonaccrual loans

   $ 4,697       $ 30,732       $ 4,972       $ 719       $ 54       $ 26       $ 1,280       $ 2,473       $ 178       $ 45,131   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table shows the ending balance of current, past due, and nonaccrual PNCI loans by loan category as of the date indicated:

 

     Analysis of Past Due and Nonaccrual PNCI Loans – As of December 31, 2013  
     RE Mortgage      Home Equity      Auto      Other             Construction         
(in thousands)    Resid.      Comm.      Lines      Loans      Indirect      Consum.      C&I      Resid.      Comm.      Total  

PNCI loan balance:

                             

Past due:

                             

30-59 Days

   $ 799       $ 512       $ 313         —           —         $ 49         —           —           —         $ 1,673   

60-89 Days

     —           352         38         —           —           —           —           —           —           390   

> 90 Days

     —           217         —           —           —           —           —           —           —           217   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total past due

   $ 799       $ 1,081       $ 351         —           —         $ 49         —           —           —         $ 2,280   

Current

     59,676         56,597         13,225       $ 253         —           2,025       $ 693         —           —           132,469   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total PNCI loans

   $ 60,475       $ 57,678       $ 13,576       $ 253         —         $ 2,074       $ 693         —           —         $ 134,749   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

> 90 Days and still accruing

     —           —           —           —           —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Nonaccrual loans

   $ 262       $ 1,139       $ 429         —           —         $ 36         —           —           —         $ 1,866   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Impaired originated loans are those where management has concluded that it is probable that the borrower will be unable to pay all amounts due under the contractual terms.

 

22


Table of Contents

Note 5 – Allowance for Loan Losses (continued)

 

The following tables show the recorded investment (financial statement balance), unpaid principal balance, average recorded investment, and interest income recognized for impaired Originated and PNCI loans, segregated by those with no related allowance recorded and those with an allowance recorded for the periods indicated.

 

     Impaired Originated Loans – As of, or for the Six Months Ended, June 30, 2014  
     RE Mortgage      Home Equity      Auto      Other             Construction         
(in thousands)    Resid.      Comm.      Lines     Loans      Indirect      Consum.      C&I      Resid.      Comm.      Total  

With no related allowance recorded:

                            

Recorded investment

   $ 4,002       $ 48,781       $ 2,641      $ 626       $ 33       $ 16       $ 1,151       $ 2,468       $ 16       $ 59,734   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unpaid principal

   $ 6,227       $ 51,862       $ 5,592      $ 1,032       $ 70       $ 22       $ 1,174       $ 6,689       $ 99       $ 72,767   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Average recorded Investment

   $ 4,228       $ 54,387       $ 3,419      $ 540       $ 49       $ 21       $ 1,266       $ 1,904       $ 43       $ 65,857   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest income Recognized

   $ 23       $ 651       $ 5      $ 1         —           —         $ 31         —           —         $ 711   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

                            

Recorded investment

   $ 2,821       $ 3,163       $ 3,559      $ 245       $ 7         —         $ 998       $ 283         —         $ 11,076   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unpaid principal

   $ 2,893       $ 3,324       $ 4,231      $ 325       $ 10         —         $ 1,041       $ 283         —         $ 12,107   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Related allowance

   $ 625       $ 282       $ 1,810      $ 211         —           —         $ 405       $ 61         —         $ 3,394   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Average recorded Investment

   $ 2,594       $ 5,012       $ 3,196      $ 204       $ 5       $ 6       $ 1,524       $ 890       $ 73       $ 13,504   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest income Recognized

   $ 34       $ 76       $ 35      $ 2         —           —         $ 25       $ 9         —         $ 181   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Impaired PNCI Loans – As of, or for the Six Months Ended, June 30, 2014  
     RE Mortgage      Home Equity      Auto      Other             Construction         
(in thousands)    Resid.      Comm.      Lines     Loans      Indirect      Consum.      C&I      Resid.      Comm.      Total  

With no related allowance recorded:

                            

Recorded investment

   $ 144       $ 478       $ 320        —           —         $ 33       $ 10         —           —         $ 985   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unpaid principal

   $ 144       $ 2,648       $ 337        —           —         $ 44       $ 10         —           —         $ 3,183   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Average recorded Investment

   $ 94       $ 822       $ 291        —           —         $ 35       $ 12         —           —         $ 1,254   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest income Recognized

   $ 6         —         $ (1     —           —           —           —           —           —         $ 5   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

                            

Recorded investment

   $ 430       $ 148       $ 467        —           —         $ 28         —           —           —         $ 1,073   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unpaid principal

   $ 442       $ 148       $ 476        —           —         $ 28         —           —           —         $ 1,094   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Related allowance

   $ 155       $ 110       $ 278        —           —         $ 3         —           —           —         $ 546   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Average recorded Investment

   $ 352       $ 153       $ 260        —           —         $ 28         —           —           —         $ 793   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest income Recognized

   $ 4       $ 4       $ 8        —           —         $ 1         —           —           —         $ 17   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

23


Table of Contents

Note 5 – Allowance for Loan Losses (continued)

 

     Impaired Originated Loans – As of, or for the Year Ended, December 31, 2013  
     RE Mortgage      Home Equity      Auto      Other             Construction         
(in thousands)    Resid.      Comm.      Lines      Loans      Indirect      Consum.      C&I      Resid.      Comm.      Total  

With no related allowance recorded:

                             

Recorded investment

   $ 4,366       $ 53,352       $ 3,710       $ 552       $ 55       $ 16       $ 1,648       $ 2,473       $ 69       $ 66,241   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unpaid principal

   $ 6,489       $ 58,894       $ 7,299       $ 1,249       $ 123       $ 21       $ 1,665       $ 6,611       $ 138       $ 82,489   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Average recorded Investment

   $ 4,123       $ 58,205       $ 4,410       $ 463       $ 93       $ 18       $ 2,154       $ 1,567       $ 83       $ 71,116   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest income Recognized

   $ 336       $ 3,361       $ 352       $ 36       $ 12       $ 1       $ 113       $ 108       $ 7       $ 4,326   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

                             

Recorded investment

   $ 2,630       $ 5,296       $ 2,779       $ 226       $ 4       $ 10       $ 1,517       $ 284       $ 109       $ 12,855   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unpaid principal

   $ 2,689       $ 5,659       $ 3,053       $ 291       $ 6       $ 10       $ 1,616       $ 284       $ 288       $ 13,896   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Related allowance

   $ 648       $ 1,084       $ 968       $ 169       $ 1       $ 5       $ 585       $ 91       $ 7       $ 3,558   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Average recorded Investment

   $ 2,245       $ 6,077       $ 3,064       $ 141       $ 12       $ 7       $ 1,817       $ 1,499       $ 188       $ 15,050   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest income Recognized

   $ 124       $ 287       $ 146       $ 18       $ 1       $ 2       $ 95       $ 19       $ 15       $ 707   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Impaired PNCI Loans – As of, or for the Year Ended, December 31, 2013  
     RE Mortgage      Home Equity      Auto      Other             Construction         
(in thousands)    Resid.      Comm.      Lines      Loans      Indirect      Consum.      C&I      Resid.      Comm.      Total  

With no related allowance recorded:

                             

Recorded investment

   $ 148       $ 1,139       $ 227         —           —         $ 36       $ 12         —           —         $ 1,562   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unpaid principal

   $ 158       $ 3,323       $ 287         —           —         $ 45       $ 12         —           —         $ 3,825   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Average recorded Investment

   $ 37       $ 1,005       $ 333         —           —         $ 39       $ 7         —           —         $ 1,421   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest income Recognized

   $ 11       $ 233       $ 21         —           —         $ 5       $ 1         —           —         $ 271   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

                             

Recorded investment

   $ 198       $ 149       $ 203         —           —         $ 28         —           —           —         $ 578   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unpaid principal

   $ 207       $ 149       $ 215         —           —         $ 28         —           —           —         $ 599   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Related allowance

   $ 128       $ 114       $ 172         —           —         $ 3         —           —           —         $ 417   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Average recorded Investment

   $ 275       $ 250       $ 162         —           —         $ 29         —           —           —         $ 716   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest income Recognized

   $ 12       $ 9       $ 10         —           —         $ 1         —           —           —         $ 32   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Impaired Originated Loans – As of, or for the Six Months Ended, June 30, 2013  
     RE Mortgage      Home Equity      Auto      Other             Construction         
(in thousands)    Resid.      Comm.      Lines      Loans      Indirect      Consum.      C&I      Resid.      Comm.      Total  

With no related allowance recorded:

                             

Recorded investment

   $ 3,913       $ 60,844       $ 4,854       $ 398       $ 104       $ 15       $ 1,567       $ 510         —         $ 72,205   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unpaid principal

   $ 6,004       $ 66,568       $ 8,786       $ 1,049       $ 218       $ 27       $ 2,363       $ 1,258         —         $ 86,273   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Average recorded Investment

   $ 3,817       $ 61,360       $ 4,744       $ 406       $ 139       $ 19       $ 3,348       $ 1,587       $ 160       $ 75,580   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest income Recognized

   $ 10       $ 865       $ 14         —         $ 1         —         $ 35         —           —         $ 925   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

                             

Recorded investment

   $ 1,855       $ 6,207       $ 3,001       $ 112       $ 13       $ 4       $ 1,966       $ 2,713       $ 310       $ 16,181   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unpaid principal

   $ 1,884       $ 6,563       $ 3,366       $ 163       $ 17       $ 4       $ 2,071       $ 6,704       $ 547       $ 21,319   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Related allowance

   $ 366       $ 1,368       $ 1,562       $ 50       $ 3       $ 4       $ 880       $ 98       $ 45       $ 4,376   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Average recorded Investment

   $ 2,249       $ 5,094       $ 3,886       $ 132       $ 24       $ 13       $ 2,639       $ 1,823       $ 261       $ 16,121   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest income Recognized

   $ 42       $ 74       $ 24       $ 2         —           —         $ 37       $ 10       $ 1       $ 190   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

24


Table of Contents

Note 5 – Allowance for Loan Losses (continued)

 

     Impaired PNCI Loans – As of, or for the Six Months Ended, June 30, 2013  
     RE Mortgage      Home Equity      Auto      Other             Construction         
(in thousands)    Resid.      Comm.      Lines      Loans      Indirect      Consum.      C&I      Resid.      Comm.      Total  

With no related allowance recorded:

                             

Recorded investment

     —         $ 811       $ 512         —           —         $ 39         —           —           —         $ 1,362   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unpaid principal

     —         $ 2,881       $ 558         —           —         $ 46         —           —           —         $ 3,485   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Average recorded Investment

     —         $ 1,183       $ 393         —           —         $ 27         —           —           —         $ 1,603   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest income Recognized

     —           —         $ 5         —           —           —           —           —           —         $ 5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

                             

Recorded investment

   $ 356       $ 165       $ 205         —           —         $ 29         —           —           —         $ 755   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unpaid principal

   $ 368       $ 165       $ 214         —           —         $ 29         —           —           —         $ 776   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Related allowance

   $ 153       $ 153       $ 206         —           —         $ 3         —           —           —         $ 515   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Average recorded Investment

   $ 251       $ 335       $ 93         —           —         $ 43         —           —           —         $ 722   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest income Recognized

   $ 6       $ 4       $ 5         —           —         $ 1         —           —           —         $ 16   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At June 30, 2014, $53,476,000 of originated loans were TDRs and classified as impaired. The Company had no obligations to lend additional funds on these TDRs as of June 30, 2014. At June 30, 2014, $1,227,000 of PNCI loans were TDRs and classified as impaired. The Company had no obligations to lend additional funds on these TDRs as of June 30, 2014.

At December 31, 2013, $56,739,000 of originated loans were TDRs and classified as impaired. The Company had obligations to lend $25,000 of additional funds on these TDRs as of December 31, 2013. At December 31, 2013, $901,000 of PNCI loans were TDRs and classified as impaired. The Company had no obligations to lend additional funds on these TDRs as of December 31, 2013.

At June 30, 2013, $54,748,000 of Originated loans were TDR and classified as impaired. The Company had obligations to lend $104,000 of additional funds on these TDR as of June 30, 2013. At June 30, 2013, $1,126,000 of PNCI loans and $87,000 of PCI loans were TDR and classified as impaired. The Company had no obligations to lend additional funds on these TDR as of June 30, 2013.

Modifications classified as TDRs can include one or a combination of the following: rate modifications, term extensions, interest only modifications, either temporary or long-term, payment modifications, and collateral substitutions/additions. For all new TDRs, an impairment analysis is conducted. If the loan is determined to be collateral dependent, any additional amount of impairment will be calculated based on the difference between estimated collectible value and the current carrying balance of the loan. This difference could result in an increased provision and is typically charged off. If the asset is determined not to be collateral dependent, the impairment is measured on the net present value difference between the expected cash flows of the restructured loan and the cash flows which would have been received under the original terms. The effect of this could result in a requirement for additional provision to the reserve. The effect of these required provisions for the period are indicated above. Typically if a TDR defaults during the period, the loan is then considered collateral dependent and, if it was not already considered collateral dependent, an appropriate provision will be reserved or charge will be taken. The additional provisions required resulting from default of previously modified TDR’s are noted above.

The following tables show certain information regarding TDRs that occurred during the periods indicated:

 

     TDR Information for the Three Months Ended June 30, 2014  
     RE Mortgage      Home Equity      Auto      Other             Construction         
(in thousands)    Resid.      Comm.      Lines      Loans      Indirect      Consum.      C&I      Resid.      Comm.      Total  

Number

     1         2         1         1         —           —           2         —           —           7   

Pre-mod outstanding principal balance

   $ 112       $ 568       $ 200       $ 32         —           —         $ 34         —           —         $ 946   

Post-mod outstanding principal balance

   $ 112       $ 571       $ 212       $ 33         —           —         $ 34         —           —         $ 962   

Financial impact due to TDR taken as additional provision

     —         $ 8         —           —           —           —         $ 4         —           —         $ 12   

Number that defaulted during the period

     1         1         —           —           —           —           —           —           —           2   

Recorded investment of TDRs that defaulted during the period

   $ 152       $ 163         —           —           —           —           —           —           —         $ 315   

Financial impact due to the default of previous TDR taken as charge-offs or additional provisions

     —           —           —           —           —           —           —           —           —           —     

 

25


Table of Contents

Note 5 – Allowance for Loan Losses (continued)

 

The following tables show certain information regarding Troubled Debt Restructurings (TDRs) that occurred during the periods indicated:

 

     TDR Information for the Six Months Ended June 30,2014  
     RE Mortgage      Home Equity      Auto      Other             Construction         
(in thousands)    Resid.     Comm.      Lines      Loans      Indirect      Consum.      C&I      Resid.      Comm.      Total  

Number

     3        4         3         1         —           —           3         1         1         16   

Pre-mod outstanding principal balance

   $ 806      $ 824       $ 479       $ 32         —           —         $ 72       $ 102       $ 118       $ 2,433   

Post-mod outstanding principal balance

   $ 806      $ 830       $ 491       $ 33         —           —         $ 72       $ 85       $ 100       $ 2,417   

Financial impact due to TDR taken as additional provision

   $ 37      $ 18         —           —           —           —         $ 21         —           —         $ 76   

Number that defaulted during the period

     1        2         —           —           —           —           1         —           —           4   

Recorded investment of TDRs that defaulted during the period

   $ 152      $ 423         —           —           —           —         $ 116         —           —         $ 691   

Financial impact due to the default of previous TDR taken as charge-offs or additional provisions

                            
     TDR Information for the Three Months Ended June 30, 2013  
     RE Mortgage      Home Equity      Auto      Other             Construction         
(in thousands)    Resid.     Comm.      Lines      Loans      Indirect      Consum.      C&I      Resid.      Comm.      Total  

Number

     2        6         4         —           —           —           2         —           —           14   

Pre-mod outstanding principal balance

   $ 432      $ 4,555       $ 324         —           —           —         $ 108         —           —         $ 5,419   

Post-mod outstanding principal balance

   $ 436      $ 4,555       $ 328         —           —           —         $ 108         —           —         $ 5,427   

Financial impact due to TDR taken as additional provision

   $ 151      $ 22       $ 193         —           —           —         $ 58         —           —         $ 424   

Number that defaulted during the period

     2        4         —           —           —           —           3         1         —           10   

Recorded investment of TDRs that defaulted during the period

   $ 181      $ 931         —           —           —           —         $ 1,297       $ 73         —         $ 2,482   

Financial impact due to the default of previous TDR taken as charge-offs or additional provisions

   $ (3     —           —           —           —           —           —         $ 5         —         $ 2   
     TDR Information for the Six Months Ended June 30, 2013  
     RE Mortgage      Home Equity      Auto      Other             Construction         
(in thousands)    Resid.     Comm.      Lines      Loans      Indirect      Consum.      C&I      Resid.      Comm.      Total  

Number

     2        6         7         —           —           —           2         —           —           17   

Pre-mod outstanding principal balance

   $ 432      $ 4,555       $ 582         —           —           —         $ 108         —           —         $ 5,677   

Post-mod outstanding principal balance

   $ 436      $ 4,555       $ 588         —           —           —         $ 108         —           —         $ 5,687   

Financial impact due to TDR taken as additional provision

   $ 151      $ 22       $ 193         —           —           —         $ 58         —           —         $ 424   

Number that defaulted during the period

     2        4         —           —           —           —           3         1         —           10   

Recorded investment of TDRs that defaulted during the period

   $ 181      $ 931         —           —           —           —         $ 1,297       $ 73         —         $ 2,482   

Financial impact due to the default of previous TDR taken as charge-offs or additional provisions

   $ (3     —           —           —           —           —           —         $ 5         —         $ 2   

 

26


Table of Contents

Note 6 – Foreclosed Assets

A summary of the activity in the balance of foreclosed assets follows (in thousands):

 

     Six months ended June 30, 2014     Six months ended June 30, 2013  
     Noncovered     Covered     Total     Noncovered     Covered     Total  

Beginning balance, net

   $ 5,588      $ 674      $ 6,262      $ 5,957      $ 1,541      $ 7,498   

Additions/transfers from loans

     4,578        —          4,578        6,813        351        7,164   

Dispositions/sales

     (4,873     (142     (5,015     (8,266     (769     (9,035

Valuation adjustments

     (29     (11     (40     (492     (81     (573
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance, net

   $ 5,264      $ 521      $ 5,785      $ 4,012      $ 1,042      $ 5,054   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending valuation allowance

   $ (76   $ (11   $ (87   $ (1,250   $ (340   $ (1,590
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending number of foreclosed assets

     23        2        25        29        3        32   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Proceeds from sale of foreclosed assets

   $ 6,315      $ 168      $ 6,483      $ 9,333      $ 869      $ 10,202   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gain on sale of foreclosed assets

   $ 1,442      $ 26      $ 1,468      $ 1,066      $ 100      $ 1,166   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Note 7 – Premises and Equipment

Premises and equipment were comprised of:

 

     June 30,     December 31,  
     2014     2013  
     (In thousands)  

Land & land improvements

   $ 5,956      $ 5,975   

Buildings

     30,025        30,103   

Furniture and equipment

     28,223        27,881   
  

 

 

   

 

 

 
     64,204        63,959   

Less: Accumulated depreciation

     (32,423     (32,397
  

 

 

   

 

 

 
     31,781        31,562   

Construction in progress

     99        50   
  

 

 

   

 

 

 

Total premises and equipment

   $ 31,880      $ 31,612   
  

 

 

   

 

 

 

Depreciation expense for premises and equipment amounted to $984,000 and $734,000 for the three months ended June 30, 2014 and 2013, respectively. Depreciation expense for premises and equipment amounted to $2,165,000 and $1,475,000 for the three months ended June 30, 2014 and 2013, respectively.

Note 8 – Cash Value of Life Insurance

A summary of the activity in the balance of cash value of life insurance follows (in thousands):

 

     Six months ended
June 30,
 
     2014      2013  

Beginning balance

   $ 52,309       $ 50,582   

Increase in cash value of life insurance

     797         806   
  

 

 

    

 

 

 

Ending balance

   $ 53,106       $ 51,388   
  

 

 

    

 

 

 

End of period death benefit

   $ 95,312       $ 94,555   

Number of policies owned

     133         133   

Insurance companies used

     6         6   

Current and former employees and directors covered

     36         36   

As of June 30, 2014, the Bank was the owner and beneficiary of 133 life insurance policies, issued by six life insurance companies, covering 36 current and former employees and directors. These life insurance policies are recorded on the Company’s financial statements at their reported cash (surrender) values. As a result of current tax law and the nature of these policies, the Bank records any increase in cash value of these policies as nontaxable noninterest income. If the Bank decided to surrender any of the policies prior to the death of the insured, such surrender may result in a tax expense related to the life-to-date cumulative increase in cash value of the policy. If the Bank retains such policies until the death of the insured, the Bank would receive nontaxable proceeds from the insurance company equal to the death benefit of the policies. The Bank has entered into Joint Beneficiary Agreements (JBAs) with certain of the insured that for certain of the policies provide some level of sharing of the death benefit, less the cash surrender value, among the Bank and the beneficiaries of the insured upon the receipt of death benefits. See Note 15 of these condensed consolidated financial statements for additional information on JBAs.

 

27


Table of Contents

Note 9 – Goodwill and Other Intangible Assets

The following table summarizes the Company’s goodwill intangible as of the dates indicated.

 

     June 30,                    December 31,  
(in thousands)    2014      Additions      Reductions      2013  

Goodwill

   $ 15,519         —           —         $ 15,519   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table summarizes the Company’s core deposit intangibles as of the dates indicated.

 

     June 30,            Reductions/     Fully      December 31,  
(in thousands)    2014     Additions      Amortization     Depreciated      2013  

Core deposit intangibles

   $ 1,460        —           —          —         $ 1,460   

Accumulated amortization

     (681     —         $ (104     —           (577
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Core deposit intangibles, net

   $ 779        —         $ (104     —         $ 883   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The Company recorded additions to its core deposit intangibles of $898,000 in conjunction with the Citizens acquisition on September 23, 2011 and $562,000 in conjunction with the Granite acquisition on May 28, 2010. The following table summarizes the Company’s estimated core deposit intangible amortization excluding the impact of any future acquisitions (dollars in thousands):

 

     Estimated Core Deposit  

Years Ended

   Intangible Amortization  

2014

   $ 209   

2015

     209   

2016

     209   

2017

     209   

2018

   $ 47   

Thereafter

     —     

Note 10 – Mortgage Servicing Rights

The following tables summarize the activity in, and the main assumptions we used to determine the fair value of mortgage servicing rights (“MSRs”) for the periods indicated (dollars in thousands):

 

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

Mortgage servicing rights:

         

Balance at beginning of period

   $ 6,107      $ 4,984       $ 6,165      $ 4,552   

Additions

     153        396         276        889   

Change in fair value

     (351     191         (532     130   

Balance at end of period

   $ 5,909      $ 5,571       $ 5,909      $ 5,571   
  

 

 

   

 

 

    

 

 

   

 

 

 

Servicing, late and ancillary fees received

   $ 421      $ 429       $ 841      $ 846   
  

 

 

   

 

 

    

 

 

   

 

 

 

Balance of loans serviced at:

         

Beginning of period

   $ 672,341      $ 680,447       $ 680,197      $ 666,512   

End of period

   $ 667,969      $ 682,176       $ 667,969      $ 682,176   

Weighted-average prepayment speed (CPR)

          11.0     13.0

Discount rate

          10.0     10.0

The changes in fair value of MSRs that occurred during the three and six months ended June 30, 2014 and 2013 were mainly due to principal reductions and changes in estimated life of the MSRs.

Note 11 – Indemnification Asset

A summary of the activity in the balance of indemnification asset (included in other assets) follows (in thousands):

 

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

Beginning (payable) receivable balance

   $ (220   $ 1,807      $ 206      $ 1,997   

Effect of actual covered losses and change in estimated future covered losses

     (97     (243     (565     (278

Reimbursable expenses (revenue), net

     14        (54     73        (93

Payments made (received)

     266        (69     249        (185
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending (payable) receivable balance

   $ (37   $ 1,441      $ (37   $ 1,441   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Note 12 – Other Assets

Other assets were comprised of (in thousands):

 

     June 30,     December 31,  
     2014     2013  

Deferred tax asset, net

   $ 27,687      $ 26,781   

Prepaid expense

     1,979        2,131   

Software

     1,177        1,318   

Advanced compensation

     1,072        1,175   

TriCo Capital Trust I & II

     1,238        1,238   

Indemnification asset (Note 11)

     (37     206   

Miscellaneous other assets

     1,109        3,237   
  

 

 

   

 

 

 

Total other assets

   $ 34,225      $ 36,086   
  

 

 

   

 

 

 

Note 13 – Deposits

A summary of the balances of deposits follows (in thousands):

 

     June 30,      December 31,  
     2014      2013  

Noninterest-bearing demand

   $ 720,743       $ 789,458   

Interest-bearing demand

     547,110         533,351   

Savings

     854,127         798,986   

Time certificates, $100,000 and over

     140,852         157,647   

Other time certificates

     122,364         131,041   
  

 

 

    

 

 

 

Total deposits

   $ 2,385,196       $ 2,410,483   
  

 

 

    

 

 

 

Certificate of deposit balances of $5,000,000 from the State of California were included in time certificates, $100,000 and over, at each of June 30, 2014 and December 31, 2013. The Bank participates in a deposit program offered by the State of California whereby the State may make deposits at the Bank’s request subject to collateral and credit worthiness constraints. The negotiated rates on these State deposits are generally more favorable than other wholesale funding sources available to the Bank. Overdrawn deposit balances of $1,060,000 and $1,212,000 were classified as consumer loans at June 30, 2014 and December 31, 2013, respectively.

Note 14 – Reserve for Unfunded Commitments

The following tables summarize the activity in reserve for unfunded commitments for the periods indicated (dollars in thousands):

 

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

Balance at beginning of period

   $ 2,230      $ 3,175       $ 2,415      $ 3,615   

Provision for losses – unfunded commitments

     (185     35         (370     (405
  

 

 

   

 

 

    

 

 

   

 

 

 

Balance at end of period

   $ 2,045      $ 3,210       $ 2,045      $ 3,210   
  

 

 

   

 

 

    

 

 

   

 

 

 

Note 15 – Other Liabilities

Other liabilities were comprised of (in thousands):

 

     June 30,      December 31,  
     2014      2013  

Deferred compensation

   $ 7,213       $ 7,357   

Pension liability

     15,036         14,634   

Joint beneficiary agreements

     2,749         2,623   

Miscellaneous other liabilities

     3,137         7,097   
  

 

 

    

 

 

 

Total other liabilities

   $ 28,135       $ 31,711   
  

 

 

    

 

 

 

Note 16 – Other Borrowings

A summary of the balances of other borrowings follows:

 

     June 30,      December 31,  
     2014      2013  
     (in thousands)  

Other collateralized borrowings, fixed rate, as of June 30, 2014 of 0.05%, payable on July 1, 2014

   $ 6,075       $ 6,335   
  

 

 

    

 

 

 

Total other borrowings

   $ 6,075       $ 6,335   
  

 

 

    

 

 

 

The Company did not enter into any repurchase agreements during the six months ended June 30, 2014 or the year ended December 31, 2013.

The Company had $6,075,000 and $6,335,000 of other collateralized borrowings at June 30, 2014 and December 31, 2013, respectively. Other collateralized borrowings are generally overnight maturity borrowings from non-financial institutions that are collateralized by securities owned by the Company. As of June 30, 2014, the Company has pledged as collateral and sold under agreements to repurchase investment securities with fair value of $6,075,000 under these other collateralized borrowings.

The Company maintains a collateralized line of credit with the Federal Home Loan Bank of San Francisco. Based on the FHLB stock requirements at June 30, 2014, this line provided for maximum borrowings of $613,779,000 of which none was outstanding, leaving $613,779,000 available. As of June 30, 2014, the Company has designated loans totaling $1,130,863,000 as potential collateral under this collateralized line of credit with the FHLB.

 

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The Company maintains a collateralized line of credit with the San Francisco Federal Reserve Bank. As of June 30, 2014, this line provided for maximum borrowings of $122,913,000 of which none was outstanding, leaving $122,913,000 available. As of June 30, 2014, the Company has designated investment securities with fair value of $39,000 and loans totaling $153,219,000 as potential collateral under this collateralized line of credit with the San Francisco Federal Reserve Bank.

The Company has available unused correspondent banking lines of credit from commercial banks totaling $10,000,000 for federal funds transactions at June 30, 2014.

Note 17 – Junior Subordinated Debt

On July 31, 2003, the Company formed a subsidiary business trust, TriCo Capital Trust I, to issue trust preferred securities. Concurrently with the issuance of the trust preferred securities, the trust issued 619 shares of common stock to the Company for $1,000 per share or an aggregate of $619,000. In addition, the Company issued a Junior Subordinated Debenture to the Trust in the amount of $20,619,000. The terms of the Junior Subordinated Debenture are materially consistent with the terms of the trust preferred securities issued by TriCo Capital Trust I. Also on July 31, 2003, TriCo Capital Trust I completed an offering of 20,000 shares of cumulative trust preferred securities for cash in an aggregate amount of $20,000,000. The trust preferred securities are mandatorily redeemable upon maturity on October 7, 2033 with an interest rate that resets quarterly at three-month LIBOR plus 3.05%. TriCo Capital Trust I has the right to redeem the trust preferred securities on or after October 7, 2008. The trust preferred securities were issued through an underwriting syndicate to which the Company paid underwriting fees of $7.50 per trust preferred security or an aggregate of $150,000. The net proceeds of $19,850,000 were used to finance the opening of new branches, improve bank services and technology, repurchase shares of the Company’s common stock under its repurchase plan and increase the Company’s capital.

The $20,619,000 of junior subordinated debentures issued by TriCo Capital Trust I are reflected as junior subordinated debt in the consolidated balance sheets. The common stock issued by TriCo Capital Trust I are recorded in other assets in the consolidated balance sheets. As of June 30, 2014, The TriCo Capital Trust I debentures carried an interest rate of 3.28%.

On June 22, 2004, the Company formed a second subsidiary business trust, TriCo Capital Trust II, to issue trust preferred securities. Concurrently with the issuance of the trust preferred securities, the trust issued 619 shares of common stock to the Company for $1,000 per share or an aggregate of $619,000. In addition, the Company issued a Junior Subordinated Debenture to the Trust in the amount of $20,619,000. The terms of the Junior Subordinated Debenture are materially consistent with the terms of the trust preferred securities issued by TriCo Capital Trust II. Also on June 22, 2004, TriCo Capital Trust II completed an offering of 20,000 shares of cumulative trust preferred securities for cash in an aggregate amount of $20,000,000. The trust preferred securities are mandatorily redeemable upon maturity on July 23, 2034 with an interest rate that resets quarterly at three-month LIBOR plus 2.55%. TriCo Capital Trust II has the right to redeem the trust preferred securities on or after July 23, 2009. The trust preferred securities were issued through an underwriting syndicate to which the Company paid underwriting fees of $2.50 per trust preferred security or an aggregate of $50,000. The net proceeds of $19,950,000 were used to finance the opening of new branches, improve bank services and technology, repurchase shares of the Company’s common stock under its repurchase plan and increase the Company’s capital.

The $20,619,000 of junior subordinated debentures issued by TriCo Capital Trust II are reflected as junior subordinated debt in the consolidated balance sheets. The common stock issued by TriCo Capital Trust II is recorded in other assets in the consolidated balance sheets. As of June 30, 2014, The TriCo Capital Trust II debentures carried an interest rate of 2.78%.

The debentures issued by TriCo Capital Trust I and TriCo Capital Trust II, less the common securities of TriCo Capital Trust I and TriCo Capital Trust II, continue to qualify as Tier 1 or Tier 2 capital under interim guidance issued by the Board of Governors of the Federal Reserve System.

Note 18 – Commitments and Contingencies

Restricted Cash Balances— Reserves (in the form of deposits with the San Francisco Federal Reserve Bank) of $42,419,000 and $38,359,000 were maintained to satisfy Federal regulatory requirements at June 30, 2014 and December 31, 2013. These reserves are included in cash and due from banks in the accompanying consolidated balance sheets.

Lease Commitments— The Company leases 41 sites under non-cancelable operating leases. The leases contain various provisions for increases in rental rates, based either on changes in the published Consumer Price Index or a predetermined escalation schedule. Substantially all of the leases provide the Company with the option to extend the lease term one or more times following expiration of the initial term. The Company currently does not have any capital leases.

 

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Table of Contents

Note 18 – Commitments and Contingencies (continued)

 

At December 31, 2013, future minimum commitments under non-cancelable operating leases with initial or remaining terms of one year or more are as follows:

 

     Operating  
     Leases  
     (in thousands)  

2014

   $ 2,452   

2015

     1,706   

2016

     1,154   

2017

     791   

2018

     429   

Thereafter

     1,235   
  

 

 

 

Future minimum lease payments

   $ 7,767   
  

 

 

 

Rent expense under operating leases was $734,000 and $815,000 during the three months ended June 30, 2014 and 2013, respectively. Rent expense was offset by rent income of $54,000 and $54,000 during the three months ended June 30, 2014 and 2013, respectively. Rent expense under operating leases was $1,490,000 and $1,625,000 during the six months ended June 30, 2014 and 2013, respectively. Rent expense was offset by rent income of $109,000 and $108,000 during the six months ended June 30, 2014 and 2013, respectively.

Financial Instruments with Off-Balance-Sheet Risk— The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit, and deposit account overdraft privilege. Those instruments involve, to varying degrees, elements of risk in excess of the amount recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

The Company’s exposure to loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit written is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The Company’s exposure to loss in the event of nonperformance by the other party to the financial instrument for deposit account overdraft privilege is represented by the overdraft privilege amount disclosed to the deposit account holder.

The following table presents a summary of the Bank’s commitments and contingent liabilities:

 

     June 30,      December 31,  
(in thousands)    2014      2013  

Financial instruments whose amounts represent risk:

     

Commitments to extend credit:

     

Commercial loans

   $ 139,427       $ 136,986   

Consumer loans

     359,547         360,194   

Real estate mortgage loans

     42,389         35,309   

Real estate construction loans

     23,612         22,897   

Standby letters of credit

     4,466         2,601   

Deposit account overdraft privilege

     65,353         68,932   

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates of one year or less or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on Management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, residential properties, and income-producing commercial properties.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements. Most standby letters of credit are issued for one year or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral requirements vary, but in general follow the requirements for other loan facilities.

Deposit account overdraft privilege amount represents the unused overdraft privilege balance available to the Company’s deposit account holders who have deposit accounts covered by an overdraft privilege. The Company has established an overdraft privilege for certain of its deposit account products whereby all holders of such accounts who bring their accounts to a positive balance at least once every thirty days receive the overdraft privilege. The overdraft privilege allows depositors to overdraft their deposit account up to a predetermined level. The predetermined overdraft limit is set by the Company based on account type.

Legal Proceedings— The Bank owns 10,214 shares of Class B common stock of Visa Inc. which are convertible into Class A common stock at a conversion ratio of 0.4206 per Class A share. As of June 30, 2014, the value of the Class A shares was $210.71 per share. Utilizing the conversion ratio, the value of unredeemed Class A equivalent shares owned by the Bank was $905,000 as of June 30, 2014, and has not been

 

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reflected in the accompanying financial statements. The shares of Visa Class B common stock are restricted and may not be transferred. Visa Member Banks are required to fund an escrow account to cover settlements, resolution of pending litigation and related claims. If the funds in the escrow account are insufficient to settle all the covered litigation, Visa may sell additional Class A shares, use the proceeds to settle litigation, and further reduce the conversion ratio. If funds remain in the escrow account after all litigation is settled, the Class B conversion ratio will be increased to reflect that surplus.

On January 24, 2014, a putative shareholder class action lawsuit was filed against TriCo, North Valley Bancorp and certain other defendants in connection with TriCo entering into the merger agreement with North Valley Bancorp. The lawsuit, which was filed in the Shasta County, California Superior Court, alleges that the members of the North Valley Bancorp board of directors breached their fiduciary duties to North Valley Bancorp shareholders by approving the proposed merger for inadequate consideration; approving the transaction in order receive benefits not equally shared by other North Valley Bancorp shareholders; entering into the merger agreement containing preclusive deal protection devices; and failing to take steps to maximize the value to be paid to the North Valley Bancorp shareholders. The lawsuit alleges claims against TriCo for aiding and abetting these alleged breaches of fiduciary duties. The plaintiff seeks, among other things, declaratory and injunctive relief concerning the alleged breaches of fiduciary duties injunctive relief prohibiting consummation of the merger, rescission, attorneys’ of the merger agreement, fees and costs, and other and further relief. On July 31, 2014 the defendants entered into a memorandum of understanding with the plaintiffs regarding the settlement of this lawsuit. In connection with the settlement contemplated by the memorandum of understanding and in consideration for the full settlement and release of all claims, TriCo and North Valley Bancorp agreed to make certain additional disclosures related to the proposed merger, which are contained in a Current Report on Form 8-K filed by each of the companies. The memorandum of understanding contemplates that the parties will negotiate in good faith and use their reasonable best efforts to enter into a stipulation of settlement. The stipulation of settlement will be subject to customary conditions, including court approval following notice to North Valley Bancorp’s shareholders. In the event that the parties enter into a stipulation of settlement, a hearing will be scheduled at which the court will consider the settlement. There can be no assurance that the parties will ultimately enter into a stipulation of settlement or that the court will approve the settlement even if the parties were to enter into such stipulation. In such event, the proposed settlement as contemplated by the memorandum of understanding may be terminated.

Neither the Company nor its subsidiaries, are party to any other material pending legal proceeding, nor is their property the subject of any material pending legal proceeding, except routine legal proceedings arising in the ordinary course of their business. None of these proceedings is expected to have a material adverse impact upon the Company’s business, consolidated financial position or results of operations.

Other Commitments and Contingencies—The Company has entered into employment agreements or change of control agreements with certain officers of the Company providing severance payments and accelerated vesting of benefits under supplemental retirement agreements to the officers in the event of a change in control of the Company and termination for other than cause or after a substantial and material change in the officer’s title, compensation or responsibilities.

Mortgage loans sold to investors may be sold with servicing rights retained, with only the standard legal representations and warranties regarding recourse to the Bank. Management believes that any liabilities that may result from such recourse provisions are not significant.

Note 19 – Shareholders’ Equity

Dividends Paid

The Bank paid to the Company cash dividends in the aggregate amounts of $4,100,000 and $3,780,000 during the six months ended June 30, 2014 and 2013 respectively. The Bank is regulated by the Federal Deposit Insurance Corporation (FDIC) and the State of California Department of Business Oversight. Absent approval from the Commissioner of the Department of Business Oversight, California banking laws generally limit the Bank’s ability to pay dividends to the lesser of (1) retained earnings or (2) net income for the last three fiscal years, less cash distributions paid during such period. Under this law, at December 31, 2013, the Bank may pay dividends of $44,548,000.

Shareholders’ Rights Plan

On June 25, 2001, the Company announced that its Board of Directors adopted and entered into a Shareholder Rights Plan designed to protect and maximize shareholder value and to assist the Board of Directors in ensuring fair and equitable benefit to all shareholders in the event of a hostile bid to acquire the Company. The Company adopted this Rights Plan to protect shareholders from coercive or otherwise unfair takeover tactics. In general terms, the Rights Plan would have imposed a significant penalty upon any person or group that acquired 15% or more of the Company’s outstanding common stock without approval of the Company’s Board of Directors. The Rights Plan was not adopted in response to any known attempt to acquire control of the Company. Under the Rights Plan, a dividend of one Preferred Stock Purchase Right was declared for each common share held of record as of the close of business on July 10, 2001. No separate certificates evidencing the Rights were issued. The Rights generally would not have become exercisable unless an acquiring entity accumulated or initiated a tender offer to purchase 15% or more of the Company’s common stock. In that event, each Right entitled the holder, other than the unapproved acquirer and its affiliates, to purchase either the Company’s common stock or shares in an acquiring entity at one-half of market value.

The Rights’ initial exercise price, which was subject to adjustment, was $49.00 per Right. The Company’s Board of Directors generally was entitled to redeem the Rights at a redemption price of $.01 per Right until an acquiring entity acquired a 15% position. The Rights were scheduled to expire on July 10, 2011, but on July 8, 2011, the Company extended the expiration date to July 10, 2021.

On June 4, 2014, the Company entered into an amendment to its Rights Agreement dated June 25, 2001 with Mellon Investor Services LLC, as Rights Agent, as amended. The amendment accelerated the expiration of the Rights from July 10, 2021 to July 1, 2014 and had the effect of terminating the Rights Agreement as of that date. At the time of the termination of the Rights Agreement on July 1, 2014 at 5:00 p.m. California time, all Rights distributed to holders of the Company’s common stock pursuant to the Rights Agreement expired.

 

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Table of Contents

Stock Repurchase Plan

On August 21, 2007, the Board of Directors adopted a plan to repurchase, as conditions warrant, up to 500,000 shares of the Company’s common stock on the open market. The timing of purchases and the exact number of shares to be purchased will depend on market conditions. The 500,000 shares authorized for repurchase under this stock repurchase plan represented approximately 3.2% of the Company’s 15,814,662 outstanding common shares as of August 21, 2007. This stock repurchase plan has no expiration date. As of June 30, 2014, the Company had repurchased 166,600 shares under this plan.

Stock Repurchased Under Equity Compensation Plans

During the six months ended June 30, 2014 and 2013, employees and directors tendered 103,268 and 166,134 shares, respectively, of the Company’s common stock with market value of $2,551,000, and $3,337,000, respectively, in lieu of cash to exercise options to purchase shares of the Company’s stock and to pay income taxes related to such exercises as permitted by the Company’s shareholder-approved equity compensation plans. The tendered shares were retired. The market value of tendered shares is the last market trade price at closing on the day an option is exercised. Stock repurchased under equity incentive plans are not included in the total of stock repurchased under the stock repurchase plan announced on August 21, 2007.

Note 20 – Stock Options and Other Equity-Based Incentive Instruments

In March 2009, the Company’s Board of Directors adopted the TriCo Bancshares 2009 Equity Incentive Plan (2009 Plan) covering officers, employees, directors of, and consultants to, the Company. The 2009 Plan was approved by the Company’s shareholders in May 2009. The 2009 Plan allows for the granting of the following types of “stock awards” (Awards): incentive stock options, nonstatutory stock options, performance awards, restricted stock, restricted stock unit awards and stock appreciation rights. In May 2013, the Company’s shareholders approved an amendment to the 2009 Plan increasing the maximum aggregate number of shares of TriCo’s common stock which may be issued pursuant to or subject to Awards from 650,000 to 1,650,000. The number of shares available for issuance under the 2009 Plan is reduced by: (i) one share for each share of common stock issued pursuant to a stock option or a Stock Appreciation Right and (ii) two shares for each share of common stock issued pursuant to a Performance Award, a Restricted Stock Award or a Restricted Stock Unit Award. When Awards made under the 2009 Plan expire or are forfeited or cancelled, the underlying shares will become available for future Awards under the 2009 Plan. To the extent that a share of common stock pursuant to an Award that counted as two shares against the number of shares again becomes available for issuance under the 2009 Plan, the number of shares of common stock available for issuance under the 2009 Plan shall increase by two shares. Shares awarded and delivered under the 2009 Plan may be authorized but unissued, or reacquired shares. As of June 30, 2014, 687,500 options for the purchase of common shares were outstanding, and 937,500 remain available for grant, under the 2009 Plan.

In May 2001, the Company adopted the TriCo Bancshares 2001 Stock Option Plan (2001 Plan) covering officers, employees, directors of, and consultants to, the Company. Under the 2001 Plan, the option exercise price cannot be less than the fair market value of the Common Stock at the date of grant except in the case of substitute options. Options for the 2001 Plan expire on the tenth anniversary of the grant date. Vesting schedules under the 2001 Plan are determined individually for each grant. As of June 30, 2014, 398,850 options for the purchase of common shares were outstanding under the 2001 Plan. As of May 2009, as a result of the shareholder approval of the 2009 Plan, no new options may be granted under the 2001 Plan.

Stock option activity during the six months ended June 30, 2014 is summarized in the following table:

 

                  Weighted      Weighted  
                  Average      Average Fair  
     Number     Option Price      Exercise      Value on  
     of Shares     per Share      Price      Date of Grant  

Outstanding at December 31, 2013

     1,246,370        $12.63 to $25.91       $ 18.04      

Options granted

     —          — to —         —           —     

Options exercised

     (160,020   $ 14.54 to $20.58       $ 17.41      

Options forfeited

     —          — to —         —        

Outstanding at June 30, 2014

     1,086,350        $12.63 to $25.91       $ 18.13      

The following table shows the number, weighted-average exercise price, intrinsic value, and weighted average remaining contractual life of options exercisable, options not yet exercisable and total options outstanding as of June 30, 2014:

 

     Currently      Currently
Not
     Total  
     Exercisable      Exercisable      Outstanding  

Number of options

     788,350         298,000         1,086,350   

Weighted average exercise price

   $ 18.78       $ 16.42       $ 18.13   

Intrinsic value (in thousands)

   $ 3,571       $ 2,002       $ 5,573   

Weighted average remaining contractual term (yrs.)

     4.9         7.8         5.7   

The 298,000 options that are currently not exercisable as of June 30, 2014 are expected to vest, on a weighted-average basis, over the next 2.8 years, and the Company is expected to recognize $2,047,000 of pre-tax compensation costs related to these options as they vest. The Company did not modify any option grants during 2013 or the six months ended June 30, 2014.

 

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Note 21 – Noninterest Income and Expense

The components of other noninterest income were as follows (in thousands):

 

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

Service charges on deposit accounts

   $ 2,724      $ 3,277      $ 5,414      $ 6,417   

ATM and interchange fees

     2,192        2,233        4,205        4,108   

Other service fees

     533        562        1,053        1,121   

Mortgage banking service fees

     421        430        841        846   

Change in value of mortgage servicing rights

     (351     191        (532     130   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total service charges and fees

     5,519        6,693        10,981        12,622   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gain on sale of loans

     514        1,590        978        3,884   

Commissions on sale of non-deposit investment products

     843        841        1,614        1,602   

Increase in cash value of life insurance

     400        380        797        806   

Change in indemnification asset

     (93     (314     (505     (415

Gain (loss) on sale of foreclosed assets

     241        615        1,468        1,166   

Sale of customer checks

     98        92        199        183   

Lease brokerage income

     111        81        218        198   

Gain (loss) on disposal of fixed assets

     71        2        70        (14

Other

     173        151        352        317   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other noninterest income

     2,358        3,438        5,191        7,727   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest income

   $ 7,877      $ 10,131      $ 16,172      $ 20,349   
  

 

 

   

 

 

   

 

 

   

 

 

 

Mortgage loan servicing fees, net of change in fair value of mortgage loan servicing rights

   $ 70      $ 621      $ 309      $ 976   

The components of noninterest expense were as follows (in thousands):

 

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

Base salaries, net of deferred loan origination costs

   $ 9,008      $ 8,508       $ 17,874      $ 16,856   

Incentive compensation

     1,205        1,299         2,328        2,585   

Benefits and other compensation costs

     3,104        3,083         6,418        6,410   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total salaries and benefits expense

     13,317        12,890         26,620        25,851   
  

 

 

   

 

 

    

 

 

   

 

 

 

Occupancy

     1,802        1,753         3,764        3,412   

Equipment

     1,060        913         2,096        1,947   

Data processing and software

     1,350        1,280         2,528        2,358   

ATM network charges

     710        679         1,353        1,175   

Telecommunications

     713        587         1,293        1,112   

Postage

     221        133         448        364   

Courier service

     224        255         458        422   

Advertising

     341        415         683        740   

Assessments

     481        543         1,002        1,149   

Operational losses

     150        122         327        239   

Professional fees

     1,518        695         2,357        1,206   

Foreclosed assets expense

     151        163         309        262   

Provision for foreclosed asset losses

     4        546         40        573   

Change in reserve for unfunded commitments

     (185     35         (370     (405

Intangible amortization

     52        53         104        105   

Other

     3,207        2,448         5,421        4,600   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total other noninterest expense

     11,799        10,619         21,813        19,259   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total noninterest income

   $ 25,116      $ 23,509       $ 48,433      $ 45,110   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

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Table of Contents

Note 22 – Income Taxes

The provisions for income taxes applicable to income before taxes differ from amounts computed by applying the statutory Federal income tax rates to income before taxes. The effective tax rate and the statutory federal income tax rate are reconciled for the periods indicated as follows:

 

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

Federal statutory income tax rate

     35.0     35.0     35.0     35.0

State income taxes, net of federal tax benefit

     7.1        6.7        7.0        6.7   

Tax-exempt interest on municipal obligations

     (0.5     (0.5     (0.4     (0.3

Increase in cash value of insurance policies

     (1.7     (1.2     (1.3     (1.1

Nondeductible merger expenses

     1.2        —          0.6        —     

Other

     1.0        0.3        0.3        0.2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Effective Tax Rate

     42.1     40.3     41.2     40.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Note 23 – Earnings Per Share

Basic earnings per share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustments to income that would result from assumed issuance. Potential common shares that may be issued by the Company relate solely from outstanding stock options, and are determined using the treasury stock method. Earnings per share have been computed based on the following:

Three months ended Six months ended

 

     Three months ended      Six months ended  
     June 30,      June 30,  
(in thousands)    2014      2013      2014      2013  

Net income

   $ 4,859       $ 6,325       $ 12,224       $ 14,802   

Average number of common shares outstanding

     16,129         16,028         16,113         16,015   

Effect of dilutive stock options

     181         107         203         98   
  

 

 

    

 

 

    

 

 

    

 

 

 

Average number of common shares outstanding used to calculate diluted earnings per share

     16,310         16,135         16,316         16,113   
  

 

 

    

 

 

    

 

 

    

 

 

 

Options excluded from diluted earnings per share because the effect of these options was antidilutive

     101         604         101         731   

Note 24 – Comprehensive Income

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

The components of accumulated other comprehensive income, included in shareholders’ equity, are as follows:

 

     June 30,     December 31,  
     2014     2013  
     (in thousands)  

Net unrealized gains on available for sale securities

   $ 4,755      $ 4,202   

Tax effect

     (1,999     (1,767
  

 

 

   

 

 

 

Unrealized holding gains on available for sale securities, net of tax

     2,756        2,435   
  

 

 

   

 

 

 

Unfunded status of the supplemental retirement plans

     (769     (787

Tax effect

     323        331   
  

 

 

   

 

 

 

Unfunded status of the supplemental retirement plans, net of tax

     (446     (456
  

 

 

   

 

 

 

Joint beneficiary agreement liability

     (122     (122

Tax effect

     —          —     
  

 

 

   

 

 

 

Joint beneficiary agreement liability, net of tax

     (122     (122
  

 

 

   

 

 

 

Accumulated other comprehensive income

   $ 2,188      $ 1,857   
  

 

 

   

 

 

 

 

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Table of Contents

Note 24 – Comprehensive Income (continued)

 

The components of other comprehensive income and related tax effects are as follows:

 

     Three Months Ended     Six Months Ended  
     June 30,     June 30,  
(in thousands)    2014     2013     2014     2013  

Unrealized holding gains (losses) on available for sale securities before reclassifications

   $ 658      $ (2,569   $ 553      $ (3,642

Amounts reclassified out of accumulated other comprehensive income

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized holding gains (losses) on available for sale securities after reclassifications

     658        (2,569     553        (3,642

Tax effect

     (277     1,080        (232     1,532   
  

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized holding gains (losses) on available for sale securities, net of tax

     381        (1,489     321        (2,110
  

 

 

   

 

 

   

 

 

   

 

 

 

Change in unfunded status of the supplemental retirement plans before reclassifications

     —          —          —          —     

Amounts reclassified out of accumulated other comprehensive income:

        

Amortization of prior service cost

     5        —          10        —     

Amortization of actuarial losses

     4        —          8        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total amounts reclassified out of accumulated other comprehensive income

     9        —          18        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Change in unfunded status of the supplemental retirement plans after reclassifications

     9        —          18        —     

Tax effect

     (4     —          (8     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Change in unfunded status of the supplemental retirement plans, net of tax

     5        —          10        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Change in joint beneficiary agreement liability before reclassifications

     —          —          —          —     

Amounts reclassified out of accumulated other comprehensive income

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Change in joint beneficiary agreement liability after reclassifications

     —          —          —          —     

Tax effect

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Change in joint beneficiary agreement liability, net of tax

     —          —         
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive income (loss)

   $ 386      $ (1,489   $ 331      $ (2,110
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Note 25 – Retirement Plans

401(k) Plan

The Company sponsors a 401(k) Plan whereby substantially all employees age 21 and over with 90 days of service may participate. Participants may contribute a portion of their compensation subject to certain limits based on federal tax laws. The Company does not contribute to the 401(k) Plan. The Company did not incur any material expenses attributable to the 401(k) Plan during 2013 or the six months ended June 30, 2014.

Employee Stock Ownership Plan

Substantially all employees with at least one year of service are covered by a discretionary employee stock ownership plan (ESOP). Contributions are made to the plan at the discretion of the Board of Directors. Contributions to the plan totaling $366,000 and $667,000 during the three months ended June 30, 2014 and 2013, respectively, are included in salary expense. Contributions to the plan totaling $561,000 and $962,000 during the six months ended June 30, 2014 and 2013, respectively, are included in salary expense. Company shares owned by the ESOP are paid dividends and included in the calculation of earnings per share exactly as other common shares outstanding.

Deferred Compensation Plans

The Company has deferred compensation plans for certain directors and key executives, which allow certain directors and key executives designated by the Board of Directors of the Company to defer a portion of their compensation. The Company has purchased insurance on the lives of the participants and intends to hold these policies until death as a cost recovery of the Company’s deferred compensation obligations of $7,213,000 and $7,357,000 at June 30, 2014 and December 31, 2013, respectively. Earnings credits on deferred balances totaling $138,000 and $147,000 during the three months ended June 30, 2014 and 2013, respectively, are included in noninterest expense. Earnings credits on deferred balances totaling $290,000 and $294,000 during the six months ended June 30, 2014 and 2013, respectively, are included in noninterest expense.

Supplemental Retirement Plans

The Company has supplemental retirement plans for current and former directors and key executives. These plans are non-qualified defined benefit plans and are unsecured and unfunded. The Company has purchased insurance on the lives of the participants and intends (but is not required) to use the cash values of these policies to pay the retirement obligations. The following table sets forth the net periodic benefit cost recognized for the plans:

 

     Three months ended
June 30,
     Six months ended
June 30,
 
(in thousands)    2014      2013      2014      2013  

Net pension cost included the following components:

           

Service cost-benefits earned during the period

   $ 163       $ 185       $ 326       $ 370   

Interest cost on projected benefit obligation

     174         161         348         321   

Amortization of net obligation at transition

     1         1         1         1   

Amortization of prior service cost

     34         38         69         76   

Recognized net actuarial loss

     4         73         8         145   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net periodic pension cost

   $ 376       $ 458       $ 752       $ 913   
  

 

 

    

 

 

    

 

 

    

 

 

 

Company contributions to pension plans

   $ 376       $ 155       $ 752       $ 260   

Pension plan payouts to participants

   $ 376       $ 155       $ 752       $ 260   

For the year ending December 31, 2014, the Company expects to contribute and pay out as benefits $569,000 to participants under the plans.

Note 26 – Related Party Transactions

Certain directors, officers, and companies with which they are associated were customers of, and had banking transactions with, the Company or the Bank in the ordinary course of business.

The following table summarizes the activity in these loans for 2014 and 2013 (in thousands):

 

Balance December 31, 2012

   $ 2,368   

Advances/new loans

     1,154   

Removed/payments

     (886
  

 

 

 

Balance December 31, 2013

   $ 2,636   

Advances/new loans

     1   

Removed/payments

     (1,285
  

 

 

 

Balance June 30, 2014

   $ 1,352   
  

 

 

 

Director Chrysler is a principal owner and CEO of Modern Building Inc. Modern Building Inc. provided construction services to the Company related to new and existing Bank facilities for aggregate payments of $720,000 during the six months ended June 30, 2014 and $4,261,000 during the year ended December 31, 2013.

 

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Table of Contents

Note 27 – Fair Value Measurement

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, income approach, and/or the cost approach. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability including assumptions about the risk inherent in a particular valuation technique, the effect of a restriction on the sale or use of an asset and the risk of nonperformance. Securities available-for-sale and mortgage servicing rights are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or impairment write-downs of individual assets.

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

 

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

 

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

 

Level 3 — Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

Securities available for sale – Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. The Company had no securities classified as Level 3 during any of the periods covered in these financial statements.

Loans held for sale – Loans held for sale are carried at the lower of cost or fair value. The fair value of loans held for sale is based on what secondary markets are currently offering for loans with similar characteristics. As such, we classify those loans subjected to nonrecurring fair value adjustments as Level 2.

Impaired originated and PNCI loans – Originated and PNCI loans are not recorded at fair value on a recurring basis. However, from time to time, an originated or PNCI loan is considered impaired and an allowance for loan losses is established. Originated and PNCI loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. The fair value of an impaired originated or PNCI loan is estimated using one of several methods, including collateral value, fair value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired originated and PNCI loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. Impaired originated and PNCI loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value which uses substantially observable data, the Company records the impaired originated or PNCI loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value, or the appraised value contains a significant unobservable assumption, such as deviations from comparable sales, and there is no observable market price, the Company records the impaired originated or PNCI loan as nonrecurring Level 3.

Foreclosed assets – Foreclosed assets include assets acquired through, or in lieu of, loan foreclosure. Foreclosed assets are held for sale and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, management periodically performs valuations and the assets are carried at the lower of carrying amount or fair value less cost to sell. When the fair value of foreclosed assets is based on an observable market price or a current appraised value which uses substantially observable data, the Company records the impaired originated loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value, or the appraised value contains a significant unobservable assumption, such as deviations from comparable sales, and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3. Revenue and expenses from operations and changes in the valuation allowance are included in other noninterest expense.

Mortgage servicing rights – Mortgage servicing rights are carried at fair value. A valuation model, which utilizes a discounted cash flow analysis using a discount rate and prepayment speed assumptions is used in the computation of the fair value measurement. While the prepayment speed assumption is currently quoted for comparable instruments, the discount rate assumption currently requires a significant degree of management judgment and is therefore considered an unobservable input. As such, the Company classifies mortgage servicing rights subjected to recurring fair value adjustments as Level 3. Additional information regarding mortgage servicing rights can be found in Note 10 in the consolidated financial statements at Item 1 of this report.

 

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Table of Contents

The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis (in thousands):

 

Fair value at June 30, 2014    Total      Level 1      Level 2      Level 3  

Securities available for sale:

           

Obligations of U.S. government corporations and agencies

   $ 86,040         —         $ 86,040         —     

Obligations of states and political subdivisions

     3,560         —           3,560         —     

Corporate debt securities

     1,914         —           1,914         —     

Mortgage servicing rights

     5,909         —           —         $ 5,909   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured at fair value

   $ 97,423         —         $ 91,514       $ 5,909   
  

 

 

    

 

 

    

 

 

    

 

 

 
Fair value at December 31, 2013    Total      Level 1      Level 2      Level 3  

Securities available for sale:

           

Obligations of U.S. government corporations and agencies

   $ 97,143         —         $ 97,143         —     

Obligations of states and political subdivisions

     5,589         —           5,589         —     

Corporate debt securities

     1,915         —           1,915         —     

Mortgage servicing rights

     6,165         —           —         $ 6,165   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured at fair value

   $ 110,812         —         $ 104,647       $ 6,165   
  

 

 

    

 

 

    

 

 

    

 

 

 

Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally corresponds with the Company’s quarterly valuation process. There were no transfers between any levels during the three months ended June 30, 2014 or the year ended December 31, 2013.

The following table provides a reconciliation of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the time periods indicated. Had there been any transfer into or out of Level 3 during the time periods indicated, the amount included in the “Transfers into (out of) Level 3” column would represent the beginning balance of an item in the period (interim quarter) during which it was transferred (in thousands):

 

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

Mortgage servicing rights:

         

Balance at beginning of period

   $ 6,107      $ 4,984       $ 6,165      $ 4,552   

Issuances

     153        396         276        889   

Change included in earnings

     (351     191         (532     130   
  

 

 

   

 

 

    

 

 

   

 

 

 

Balance at end of period

   $ 5,909      $ 5,571       $ 5,909      $ 5,571   
  

 

 

   

 

 

    

 

 

   

 

 

 

The Company’s method for determining the fair value of mortgage servicing rights is described in Note 1. The key unobservable inputs used in determining the fair value of mortgage servicing rights are mortgage prepayment speeds and the discount rate used to discount cash projected cash flows. Generally, any significant increases in the mortgage prepayment speed and discount rate utilized in the fair value measurement of the mortgage servicing rights will result in a negative fair value adjustments (and decrease in the fair value measurement). Conversely, a decrease in the mortgage prepayment speed and discount rate will result in a positive fair value adjustment (and increase in the fair value measurement). Note 10 contains additional information regarding mortgage servicing rights.

The following table presents quantitative information about recurring Level 3 fair value measurements at June 30, 2014:

 

     Fair Value      Valuation    Unobservable    Range,
     (in thousands)      Technique    Inputs   

Weighted Average

Mortgage Servicing Rights

   $ 5,909       Discounted cash flow    Constant prepayment rate    5.7%-24.2%, 11.0%
         Discount rate    10.0%-12.0%, 10.0%

The following table presents quantitative information about recurring Level 3 fair value measurements at December 31, 2013:

 

     Fair Value      Valuation    Unobservable    Range,
     (in thousands)      Technique    Inputs   

Weighted Average

Mortgage Servicing Rights

   $ 6,165       Discounted cash flow    Constant prepayment rate    6.3%-33.0%, 10.3%
         Discount rate    10.0%-12.0%, 10.0%

 

39


Table of Contents

The tables below present the recorded amount of assets and liabilities measured at fair value on a nonrecurring basis, as of the dates indicated, that had a write-down or an additional allowance provided during the periods indicated; and the losses from nonrecurring fair value adjustments that occurred in the periods indicated (in thousands):

 

                                 Total  
Six months ended June 30, 2014    Total      Level 1      Level 2      Level 3      Losses  

Fair value:

              

Impaired Originated & PNCI loans

   $ 3,842         —           —         $ 3,842       $ 509   

Foreclosed assets

     566         —           —           566         16   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured at fair value

   $ 4,408         —           —         $ 4,408       $ 525   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
                                 Total  
Year ended December 31, 2013    Total      Level 1      Level 2      Level 3      Losses  

Fair value:

              

Impaired Originated & PNCI loans

   $ 20,334         —           —         $ 20,334       $ 2,539   

Foreclosed assets

     948         —           —           948         397   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured at fair value

   $ 21,282         —           —         $ 21,282       $ 2,936   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
                                 Total  
Six months ended June 30, 2013    Total      Level 1      Level 2      Level 3      Losses  

Fair value:

              

Impaired Originated & PNCI loans

   $ 21,347         —           —         $ 21,347       $ 1,886   

Foreclosed assets

     2,624         —           —           2,624         531   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured at fair value

   $ 23,971         —           —         $ 23,971       $ 2,417   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The table below presents the losses from nonrecurring fair value adjustments that occurred in the periods indicated (in thousands):

 

     Three months
ended June 30,
 
     2014      2013  

Losses from nonrecurring fair value adjustments:

     

Impaired Originated & PNCI loans

   $ 298       $ 219   

Foreclosed assets

     4         504   
  

 

 

    

 

 

 

Total losses from nonrecurring fair value adjustments

   $ 302       $ 723   
  

 

 

    

 

 

 

The impaired Originated and PNCI loan amount above represents impaired, collateral dependent loans that have been adjusted to fair value. When we identify a collateral dependent loan as impaired, we measure the impairment using the current fair value of the collateral, less selling costs. Depending on the characteristics of a loan, the fair value of collateral is generally estimated by obtaining external appraisals. If we determine that the value of the impaired loan is less than the recorded investment in the loan, we recognize this impairment and adjust the carrying value of the loan to fair value through the allowance for loan and lease losses. The loss represents charge-offs or impairments on collateral dependent loans for fair value adjustments based on the fair value of collateral. The carrying value of loans fully charged-off is zero.

The foreclosed assets amount above represents impaired real estate that has been adjusted to fair value. Foreclosed assets represent real estate which the Bank has taken control of in partial or full satisfaction of loans. At the time of foreclosure, other real estate owned is recorded at the lower of the carrying amount of the loan or fair value less costs to sell, which becomes the property’s new basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan and lease losses. After foreclosure, management periodically performs valuations such that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell. Fair value adjustments on other real estate owned are recognized within net loss on real estate owned. The loss represents impairments on non-covered other real estate owned for fair value adjustments based on the fair value of the real estate.

The Company’s property appraisals are primarily based on the sales comparison approach and income approach methodologies, which consider recent sales of comparable properties, including their income generating characteristics, and then make adjustments to reflect the general assumptions that a market participant would make when analyzing the property for purchase. These adjustments may increase or decrease an appraised value and can vary significantly depending on the location, physical characteristics and income producing potential of each property. Additionally, the quality and volume of market information available at the time of the appraisal can vary from period to period and cause significant changes to the nature and magnitude of comparable sale adjustments. Given these variations, comparable sale adjustments are generally not a reliable indicator for how fair value will increase or decrease from period to period. Under certain circumstances, management discounts are applied based on specific characteristics of an individual property.

 

40


Table of Contents

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at June 30, 2014:

 

    Fair Value     Valuation   Unobservable   Range,
    (in thousands)    

Technique

 

Inputs

 

Weighted Average

Impaired Originated & PNCI loans

  $ 3,842     

Sales comparison

approach

Income approach

 

Adjustment for differences

between comparable sales Capitalization rate

  (5.0)%-(38.0)%, (9.0)% 9.09%-9.25 %, 9.23%

Foreclosed assets

  $ 556     

Sales comparison

approach

 

Adjustment for differences

between comparable sales

  (6.0)%-(12.5)%, (9.3)%

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at December 31, 2013:

 

    Fair Value     Valuation   Unobservable   Range,
    (in thousands)     Technique   Inputs  

Weighted Average

Impaired Originated & PNCI loans

  $ 20,334      Sales comparison
approach Income
approach
  Adjustment for differences
between comparable sales
Capitalization rate
 

(5.0)%-(56.4)%, (10.4)%

7.75%-9.25 %, 8.91%

Foreclosed assets

  $ 948      Sales comparison
approach
  Adjustment for differences
between comparable sales
  (6.5)%-(16.7)%, (8.9)%

In addition to the methods and assumptions used to estimate the fair value of each class of financial instrument noted above, the following methods and assumptions were used to estimate the fair value of other classes of financial instruments for which it is practical to estimate the fair value.

Short-term Instruments – Cash and due from banks, fed funds purchased and sold, interest receivable and payable, and short-term borrowings are considered short-term instruments. For these short-term instruments their carrying amount approximates their fair value.

Securities held to maturity – The fair value of securities held to maturity is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. The Company had no securities held to maturity classified as Level 3 during any of the periods covered in these financial statements.

Restricted Equity Securities – The carrying value of restricted equity securities approximates fair value as the shares can only be redeemed by the issuing institution at par.

Originated and PNCI loans – The fair value of variable rate originated and PNCI loans is the current carrying value. The interest rates on these originated and PNCI loans are regularly adjusted to market rates. The fair value of other types of fixed rate originated and PNCI loans is estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings for the same remaining maturities. The allowance for loan losses is a reasonable estimate of the valuation allowance needed to adjust computed fair values for credit quality of certain originated and PNCI loans in the portfolio.

PCI Loans – PCI loans are measured at estimated fair value on the date of acquisition. Carrying value is calculated as the present value of expected cash flows and approximates fair value.

Deposit Liabilities – The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. These values do not consider the estimated fair value of the Company’s core deposit intangible, which is a significant unrecognized asset of the Company. The fair value of time deposits and other borrowings is based on the discounted value of contractual cash flows.

Other Borrowings – The fair value of other borrowings is calculated based on the discounted value of the contractual cash flows using current rates at which such borrowings can currently be obtained.

Junior Subordinated Debentures – The fair value of junior subordinated debentures is estimated using a discounted cash flow model. The future cash flows of these instruments are extended to the next available redemption date or maturity date as appropriate based upon the spreads of recent issuances or quotes from brokers for comparable bank holding companies compared to the contractual spread of each junior subordinated debenture measured at fair value.

Commitments to Extend Credit and Standby Letters of Credit – The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counter parties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligation with the counter parties at the reporting date.

 

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Fair values for financial instruments are management’s estimates of the values at which the instruments could be exchanged in a transaction between willing parties. These estimates are subjective and may vary significantly from amounts that would be realized in actual transactions. In addition, other significant assets are not considered financial assets including, any mortgage banking operations, deferred tax assets, and premises and equipment. Further, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on the fair value estimates and have not been considered in any of these estimates.

The estimated fair values of financial instruments that are reported at amortized cost in the Corporation’s consolidated balance sheets, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value, were as follows (in thousands):

 

     June 30, 2014      December 31, 2013  
     Carrying      Fair      Carrying      Fair  
     Amount      Value      Amount      Value  

Financial assets:

           

Level 1 inputs:

           

Cash and due from banks

   $ 76,104       $ 76,104       $ 76,915       $ 76,915   

Cash at Federal Reserve and other banks

     268,279         268,279         521,453         521,453   

Level 2 inputs:

           

Securities held to maturity

     422,502         427,954         240,504         233,807   

Restricted equity securities

     11,582         11,582         9,163         9,163   

Loans held for sale

     1,671         1,671         2,270         2,270   

Level 3 inputs:

           

Loans, net

     1,698,618         1,780,540         1,672,007         1,760,274   

Financial liabilities:

           

Level 2 inputs:

           

Deposits

     2,385,196         2,385,856         2,410,483         2,411,402   

Other borrowings

     6,075         6,075         6,335         6,335   

Junior subordinated debt

     41,238         29,485         41,238         25,774   
     Contract      Fair      Contract      Fair  
     Amount      Value      Amount      Value  

Off-balance sheet:

           

Level 3 inputs:

           

Commitments

   $ 564,975         5,650       $ 555,386       $ 5,554   

Standby letters of credit

     4,466         45         2,601         26   

Overdraft privilege commitments

     65,353         654         68,932         689   

 

 

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Note 28 – TriCo Bancshares Condensed Financial Statements (Parent Only)

Condensed Balance Sheets

 

     June 30,      December 31,  
     2014      2013  
     (In thousands)  

Assets

  

Cash and Cash equivalents

   $ 2,413       $ 2,520   

Investment in Tri Counties Bank

     298,910         288,746   

Other assets

     1,238         1,280   
  

 

 

    

 

 

 

Total assets

   $ 302,561       $ 292,546   
  

 

 

    

 

 

 

Liabilities and shareholders’ equity

     

Other liabilities

     380         362   

Junior subordinated debt

     41,238         41,238   
  

 

 

    

 

 

 

Total liabilities

     41,618         41,600   
  

 

 

    

 

 

 

Shareholders’ equity:

     

Common stock, no par value: authorized 50,000,000 shares; issued and outstanding 16,133,414 and 16,076,662 shares, respectively

     92,322         89,356   

Retained earnings

     166,433         159,733   

Accumulated other comprehensive income, net

     2,188         1,857   
  

 

 

    

 

 

 

Total shareholders’ equity

     260,943         250,946   
  

 

 

    

 

 

 

Total liabilities and shareholders’ equity

   $ 302,561       $ 292,546   
  

 

 

    

 

 

 

Statements of Income

 

     Three months ended
June 30,
    Six months ended
June 30,
 
(In thousands)    2014     2013     2014     2013  

Interest expense

   $ (306   $ (311   $ (610   $ (622

Administration expense

     (466     (232     (790     (377
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before equity in net income of Tri Counties Bank

     (772     (543     (1,400     (999

Equity in net income of Tri Counties Bank:

        

Distributed

     2,050        2,080        4,100        3,780   

(Over) under distributed

     3,400        4,560        9,079        11,601   

Income tax benefit

     181        228        445        420   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 4,859      $ 6,325      $ 12,224      $ 14,802   
  

 

 

   

 

 

   

 

 

   

 

 

 

Statements of Comprehensive Income

 

     Three months ended
June 30,
    Six months ended
June 30,
 
(In thousands)    2014      2013     2014      2013  

Net income

   $ 4,859       $ 6,325      $ 12,224       $ 14,802   

Other comprehensive income (loss), net of tax:

          

Unrealized holding gains (losses) on available for sale securities arising during the period

     381         (1,489     321         (2,110

Change in minimum pension liability

     5         —          10         —     
  

 

 

    

 

 

   

 

 

    

 

 

 

Other comprehensive income (loss)

     386         (1,489     331         (2,110
  

 

 

    

 

 

   

 

 

    

 

 

 

Comprehensive income

   $ 5,245       $ 4,836      $ 12,555       $ 12,692   
  

 

 

    

 

 

   

 

 

    

 

 

 

Statements of Cash Flows

 

     Six months ended
June 30,
 
(In thousands)    2014     2013  

Operating activities:

    

Net income

   $ 12,224      $ 14,802   

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

    

Over (under) distributed equity in earnings of Tri Counties Bank

     (9,079     (11,601

Stock option vesting expense

     534        540   

Stock option excess tax benefits

     (220     (342

Net change in other assets and liabilities

     (474     (548
  

 

 

   

 

 

 

Net cash provided by operating activities

     2,985        2,851   

Investing activities: None

    

Financing activities:

    

Issuance of common stock through option exercise

     220        101   

Stock option excess tax benefits

     527        342   

Repurchase of common stock

     (292     (501

Cash dividends paid — common

     (3,547     (3,207
  

 

 

   

 

 

 

Net cash used for financing activities

     (3,092     (3,265
  

 

 

   

 

 

 

(Decrease) increase in cash and cash equivalents

     (107     (414
  

 

 

   

 

 

 

Cash and cash equivalents at beginning of year

     2,520        2,511   
  

 

 

   

 

 

 

Cash and cash equivalents at end of year

   $ 2,413      $ 2,097   
  

 

 

   

 

 

 

 

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Note 29 – Regulatory Matters

The Company is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets. Management believes, as of June 30, 2014, that the Company meets all capital adequacy requirements to which it is subject.

As of June 30, 2014, the Bank was well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that date that Management believes have changed the institution’s category. The Bank’s actual capital amounts and ratios are also presented in the table.

 

                               Minimum  
                               To Be Well  
                               Capitalized Under  
                  Minimum     Prompt Corrective  
     Actual     Capital Requirement     Action Provisions  
     Amount      Ratio     Amount      Ratio     Amount      Ratio  
     (dollars in thousands)  

As of June 30, 2014:

               

Total Capital (to Risk Weighted Assets):

               

Consolidated

   $ 308,383         14.64   $ 168,466         8.0     N/A         N/A   

Tri Counties Bank

   $ 306,334         14.56   $ 168,366         8.0   $ 210,457         10.0

Tier 1 Capital (to Risk Weighted Assets):

               

Consolidated

   $ 281,866         13.39   $ 84,233         4.0     N/A         N/A   

Tri Counties Bank

   $ 279,833         13.30   $ 84,183         4.0   $ 126,274         6.0

Tier 1 Capital (to Average Assets):

               

Consolidated

   $ 281,866         10.36   $ 108,830         4.0     N/A         N/A   

Tri Counties Bank

   $ 279,833         10.29   $ 108,777         4.0   $ 135,971         5.0

As of December 31, 2013:

               

Total Capital (to Risk Weighted Assets):

               

Consolidated

   $ 297,429         14.77   $ 161,064         8.0     N/A         N/A   

Tri Counties Bank

   $ 295,212         14.67   $ 160,961         8.0   $ 201,201         10.0

Tier 1 Capital (to Risk Weighted Assets):

               

Consolidated

   $ 272,071         13.51   $ 80,532         4.0     N/A         N/A   

Tri Counties Bank

   $ 269,870         13.41   $ 80,480         4.0   $ 120,720         6.0

Tier 1 Capital (to Average Assets):

               

Consolidated

   $ 272,071         10.17   $ 107,017         4.0     N/A         N/A   

Tri Counties Bank

   $ 269,870         10.09   $ 106,965         4.0   $ 133,706         5.0

 

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Note 30 – Summary of Quarterly Results of Operations (unaudited)

The following table sets forth the results of operations for the periods indicated, and is unaudited; however, in the opinion of Management, it reflects all adjustments (which include only normal recurring adjustments) necessary to present fairly the summarized results for such periods.

 

     2014 Quarters Ended  
     December 31,      September 30,     June 30,      March 31,  
     (dollars in thousands, except per share data)  

Interest and dividend income:

          

Loans:

          

Discount accretion PCI – cash basis

        $ 69       $ 203   

Discount accretion PCI – other

          811         984   

Discount accretion PNCI

          624         379   

All other loan interest income

          22,929         22,172   
       

 

 

    

 

 

 

Total loan interest income

          24,433         23,738   

Debt securities, dividends and interest bearing cash at Banks (not FTE)

          3,985         3,421   
       

 

 

    

 

 

 

Total interest income

          28,418         27,159   

Interest expense

          1,075         1,087   
       

 

 

    

 

 

 

Net interest income

          27,343         26,072   

Provision for (benefit from) loan losses

          1,708         (1,355
       

 

 

    

 

 

 

Net interest income after provision for loan losses

          25,635         27,427   

Noninterest income

          7,877         8,295   

Noninterest expense

          25,116         23,317   
       

 

 

    

 

 

 

Income before income taxes

          8,396         12,405   

Income tax expense

          3,537         5,040   
       

 

 

    

 

 

 

Net income

        $ 4,859       $ 7,365   
       

 

 

    

 

 

 

Per common share:

          

Net income (diluted)

        $ 0.30       $ 0.45   
       

 

 

    

 

 

 

Dividends

        $ 0.11       $ 0.11   
       

 

 

    

 

 

 
     2013 Quarters Ended  
     December 31,      September 30,     June 30,      March 31,  
     (dollars in thousands, except per share data)  

Interest and dividend income:

          

Loans:

          

Discount accretion PCI – cash basis

   $ 255       $ 140      $ 129       $ 167   

Discount accretion PCI – other

     893         898        732         597   

Discount accretion PNCI

     568         1,115        815         766   

All other loan interest income

     22,754         22,970        22,207         22,542   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loan interest income

     24,470         25,123        23,883         24,072   

Debt securities, dividends and interest bearing cash at Banks (not FTE)

     2,992         2,413        1,873         1,734   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total interest income

     27,462         27,536        25,756         25,806   

Interest expense

     1,123         1,169        1,167         1,237   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net interest income

     26,339         26,367        24,589         24,569   

Provision for (benefit from) loan losses

     172         (393     614         (1,108
  

 

 

    

 

 

   

 

 

    

 

 

 

Net interest income after provision for loan losses

     26,167         26,760        23,975         25,677   

Noninterest income

     7,353         9,127        10,131         10,218   

Noninterest expense

     24,878         23,616        23,509         21,601   
  

 

 

    

 

 

   

 

 

    

 

 

 

Income before income taxes

     8,642         12,271        10,597         14,294   

Income tax expense

     3,406         4,910        4,272         5,817   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income

   $ 5,236       $ 7,361      $ 6,325       $ 8,477   
  

 

 

    

 

 

   

 

 

    

 

 

 

Per common share:

          

Net income (diluted)

   $ 0.32       $ 0.45      $ 0.39       $ 0.53   
  

 

 

    

 

 

   

 

 

    

 

 

 

Dividends

   $ 0.11       $ 0.11      $ 0.11       $ 0.09   
  

 

 

    

 

 

   

 

 

    

 

 

 

 

 

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Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

As TriCo Bancshares (referred to in this report as “we”, “our” or the “Company”) has not commenced any business operations independent of Tri Counties Bank (the “Bank”), the following discussion pertains primarily to the Bank. Average balances, including such balances used in calculating certain financial ratios, are generally comprised of average daily balances for the Company. Within Management’s Discussion and Analysis of Financial Condition and Results of Operations, interest income, net interest income, net interest yield, and efficiency ratio are generally presented on a fully tax-equivalent (“FTE”) basis. The Company believes the use of these non-generally accepted accounting principles (non-GAAP) measures provides additional clarity in assessing its results, and the presentation of these measures on a FTE basis is a common practice within the banking industry. Interest income and net interest income are shown on a non-FTE basis in the Part I – Financial Information section of this Form 10-Q, and a reconciliation of the FTE and non-FTE presentations is provided below in the discussion of net interest income.

Critical Accounting Policies and Estimates

There have been no changes to the Company’s critical accounting policies during the six months ended June 30, 2014, except for the changes in the Company’s accounting policies related to its allowance for loan losses noted under the heading Loans and Allowance for Loan Losses” in Note 1 in Item 1 of Part I of this report.

The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those that materially affect the financial statements and are related to the adequacy of the allowance for loan losses, investments, mortgage servicing rights, fair value measurements, retirement plans and intangible assets. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company’s policies related to estimates on the allowance for loan losses, other than temporary impairment of investments and impairment of intangible assets, can be found in Note 1 in Item 1 of Part I of this report.

On September 23, 2011, the California Department of Financial Institutions closed Citizens Bank of Northern California (“Citizens”), Nevada City, California and appointed the FDIC as receiver. That same date, the Bank assumed the banking operations of Citizens from the FDIC under a whole bank purchase and assumption agreement without loss sharing.

On May 28, 2010, the Office of the Comptroller of the Currency closed Granite Community Bank, N.A. (“Granite”), Granite Bay, California and appointed the FDIC as receiver. That same date, the Bank assumed the banking operations of Granite from the FDIC under a whole bank purchase and assumption agreement with loss sharing. Under the terms of the loss sharing agreement, the FDIC will cover a substantial portion of any future losses on loans, related unfunded loan commitments, other real estate owned (OREO)/foreclosed assets and accrued interest on loans for up to 90 days. The FDIC will absorb 80% of losses and share in 80% of loss recoveries on the covered assets acquired from Granite. The loss sharing arrangements for non-single family residential and single family residential loans are in effect for 5 years and 10 years, respectively, and the loss recovery provisions are in effect for 8 years and 10 years, respectively, from the acquisition date.

The Company refers to loans and foreclosed assets that are covered by loss sharing agreements as “covered loans” and “covered foreclosed assets”, respectively. In addition, the Company refers to loans purchased or obtained in a business combination as “purchased credit impaired” (PCI) loans, or “purchased non-credit impaired” (PNCI) loans. The Company refers to loans that it originates as “originated” loans. Additional information regarding the Citizens and Granite Bank acquisitions can be found in Note 2 in Item 1 of Part I of this report. Additional information regarding the definitions and accounting for originated, PNCI and PCI loans can be found in Notes 1, 2, 4 and 5 in Item 1 of Part I of this report, and under the heading Asset Quality and Non-Performing Assets below.

Geographical Descriptions

For the purpose of describing the geographical location of the Company’s loans, the Company has defined northern California as that area of California north of, and including, Stockton; central California as that area of the State south of Stockton, to and including, Bakersfield; and southern California as that area of the State south of Bakersfield.

 

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Table of Contents

TRICO BANCSHARES

Financial Summary

(dollars in thousands, except per share amounts; unaudited)

 

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

Net Interest Income (FTE)

   $ 27,413      $ 24,679      $ 53,567      $ 49,309   

(Provision for) benefit from loan losses

     (1,708     (614     (353     494   

Noninterest income

     7,877        10,131        16,172        20,349   

Noninterest expense

     (25,116     (23,509     (48,433     (45,110

Provision for income taxes (FTE)

     (3,607     (4,362     (8,729     (10,240
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 4,859      $ 6,325      $ 12,224      $ 14,802   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share:

        

Basic

   $ 0.30      $ 0.39      $ 0.76      $ 0.92   

Diluted

   $ 0.30      $ 0.39      $ 0.75      $ 0.92   

Per share:

        

Dividends paid

   $ 0.11      $ 0.11      $ 0.22      $ 0.20   

Book value at period end

   $ 16.17      $ 14.90       

Average common shares outstanding

     16,129        16,028        16,113        16,015   

Average diluted common shares outstanding

     16,310        16,135        16,316        16,113   

Shares outstanding at period end

     16,133        16,065       

At period end:

        

Loans, net

   $ 1,698,618      $ 1,612,441       

Total assets

   $ 2,724,481      $ 2,587,931       

Total deposits

   $ 2,385,196      $ 2,266,702       

Other borrowings

   $ 6,075      $ 6,575       

Junior subordinated debt

   $ 41,238      $ 41,238       

Shareholders’ equity

   $ 260,943      $ 239,326       

Financial Ratios:

        

During the period (annualized):

        

Return on assets

     0.71     0.98     0.89     1.14

Return on equity

     7.45     10.54     9.48     12.50

Net interest margin1

     4.28     4.07     4.19     4.06

Efficiency ratio1

     71.7     67.5     69.5     64.8

Average equity to average assets

     9.53     9.28     9.42     9.12

At period end:

        

Equity to assets

     9.58     9.25    

Total capital to risk-adjusted assets

     14.64     14.73    

 

1  Fully taxable equivalent (FTE)

 

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Table of Contents

Results of Operations

Overview

The following discussion and analysis is designed to provide a better understanding of the significant changes and trends related to the Company and the Bank’s financial condition, operating results, asset and liability management, liquidity and capital resources and should be read in conjunction with the Condensed Consolidated Financial Statements of the Company and the Notes thereto located at Item 1 of this report.

Following is a summary of the components of FTE net income for the periods indicated (dollars in thousands):

 

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

Net Interest Income (FTE)

   $ 27,413      $ 24,679      $ 53,567      $ 49,309   

(Provision for) benefit from loan losses

     (1,708     (614     (353     494   

Noninterest income

     7,877        10,131        16,172        20,349   

Noninterest expense

     (25,116     (23,509     (48,433     (45,110

Provision for income taxes (FTE)

     (3,607     (4,362     (8,729     (10,240
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 4,859      $ 6,325      $ 12,224      $ 14,802   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Interest Income

The Company’s primary source of revenue is net interest income, or the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities. Following is a summary of the components of net interest income for the periods indicated (dollars in thousands):

 

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

Interest income

   $ 28,418      $ 25,756      $ 55,577      $ 51,562   

Interest expense

     (1,075     (1,167     (2,162     (2,404

FTE adjustment

     70        90        152        151   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income (FTE)

   $ 27,413      $ 24,679      $ 53,567      $ 49,309   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest margin (FTE)

     4.28     4.07     4.19     4.06
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income (FTE) during the second quarter of 2014 increased $2,734,000 (11.1%) from the same period in 2013 to $27,413,000. The increase in net interest income (FTE) was due primarily to a $312,991,000 (172%) increase in the average balance of investments to $495,006,000, and a $105,550,000 (6.6%) increase in the average balance of loans to $1,714,061,000 that were partially offset by a 24 basis point decrease in the average yield on loans from 5.94% during the three months ended June 30, 2013 to 5.70% during the three months ended June 30, 2014. During much of 2013 and the six months ended June 30, 2014, the Company used a portion of its Fed funds sold to buy investments. The increase in average loan balances was due to organic loan growth and the purchase of $62,698,000 of single family residential real estate loans during the second quarter of 2013, and the purchase of $19,690,000 of single family residential real estate loans during the second quarter of 2014. The decrease in average loan yields is due primarily to declines in market yields on new and renewed loans compared to yields on repricing, maturing, and paid off loans. The increases in average investment and loan balances added $2,325,000 and $1,567,000 to net interest income (FTE) while the decrease in average loan yields reduced net interest income (FTE) by $1,017,000 when compared to the year-ago quarter. For more information related to loan interest income, including loan purchase discount accretion, see Note 30 to the consolidated financial statements at Part I, Item 1 of this report. As noted above, during much of 2013 and the six months ended June 30, 2014, the Company deployed some of its excess cash previously held as Federal funds sold into some higher yielding investments while maintaining an appropriate level of interest rate risk. In addition, during the three and six months ended June 30, 2014 and some of 2013, the Company noted some increase in loan demand albeit at lower yields than existing loans.

Net interest income (FTE) during the six months ended June 30, 2014 increased $4,258,000 (8.6%) from the same period in 2013 to $53,567,000. The increase in net interest income (FTE) was due primarily to a $277,949,000 (160%) increase in the average balance of investments to $451,427,000, and a $114,108,000 (7.2%) increase in the average balance of loans to $1,692,646,000 that were partially offset by a 39 basis point decrease in the average yield on loans from 6.08% during the six months ended June 30, 2013 to 5.69% during the six months ended June 30, 2014. During much of 2013 and the six months ended June 30, 2014, the Company used a portion of its Fed funds sold to buy investments. The increase in average loan balances was due to organic loan growth and the purchase of $62,698,000 of single family residential real estate loans during the second quarter of 2013, and the purchase of $19,690,000 of single family residential real estate loans during the second quarter of 2014. The decrease in average loan yields is due primarily to declines in market yields on new and renewed loans compared to yields on repricing, maturing, and paid off loans. The increases in average investment and loan balances added $4,245,000 and $3,469,000 to net interest income (FTE) while the decrease in average loan yields reduced net interest income (FTE) by $3,253,000 when compared to the six months ended June 30, 2013. For more information related to loan interest income, including loan purchase discount accretion, see Note 30 to the consolidated financial statements at Part I, Item 1 of this report. As noted above, during much of 2013 and the six months ended June 30, 2014, the Company deployed some of its excess cash previously held as Federal funds sold into some higher yielding investments while maintaining an appropriate level of interest rate risk. In addition, during the three and six months ended June 30, 2014 and some of 2013, the Company noted some increase in loan demand albeit at lower yields than existing loans.

 

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Table of Contents

Summary of Average Balances, Yields/Rates and Interest Differential

The following table presents, for the periods indicated, information regarding the Company’s consolidated average assets, liabilities and shareholders’ equity, the amounts of interest income from average interest-earning assets and resulting yields, and the amount of interest expense paid on interest-bearing liabilities. Average loan balances include nonperforming loans. Interest income includes proceeds from loans on nonaccrual loans only to the extent cash payments have been received and applied to interest income. Yields on securities and certain loans have been adjusted upward to reflect the effect of income thereon exempt from federal income taxation at the current statutory tax rate (dollars in thousands).

 

     For the three months ended  
     June 30, 2014     June 30, 2013  
            Interest      Rates            Interest      Rates  
     Average      Income/      Earned     Average      Income/      Earned  
     Balance      Expense      /Paid     Balance      Expense      /Paid  

Assets:

                

Loans

   $ 1,714,061       $ 24,433         5.70   $ 1,608,511       $ 23,883         5.94

Investment securities—taxable

     478,904         3,594         3.00     164,907         1,229         2.98

Investment securities—nontaxable

     16,102         187         4.65     17,108         240         5.61

Cash at Federal Reserve and other banks

     350,229         274         0.31     632,292         494         0.31
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total interest-earning assets

     2,559,296         28,488         4.45     2,422,818         25,846         4.27

Other assets

     178,338              161,916         
  

 

 

         

 

 

       

Total assets

   $ 2,737,634            $ 2,584,734         
  

 

 

         

 

 

       

Liabilities and shareholders’ equity:

                

Interest-bearing demand deposits

   $ 550,372         115         0.08   $ 518,961         125         0.10

Savings deposits

     853,643         263         0.12     782,339         246         0.13

Time deposits

     268,352         390         0.58     322,668         484         0.60

Other borrowings

     6,217         1         0.06     7,596         1         0.05

Junior subordinated debt

     41,238         306         2.97     41,238         311         3.02
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total interest-bearing liabilities

     1,719,822         1,075         0.25     1,672,802         1,167         0.28

Noninterest-bearing deposits

     722,779              635,503         

Other liabilities

     34,216              36,444         

Shareholders’ equity

     260,817              239,985         
  

 

 

         

 

 

       

Total liabilities and shareholders’ equity

   $ 2,737,634            $ 2,584,734         
  

 

 

         

 

 

       

Net interest spread(1)

           4.20           3.99

Net interest income and interest margin(2)

      $ 27,413         4.28      $ 24,679         4.07
     

 

 

    

 

 

      

 

 

    

 

 

 
     For the six months ended  
     June 30, 2014     June 30, 2013  
            Interest      Rates            Interest      Rates  
     Average      Income/      Earned     Average      Income/      Earned  
     Balance      Expense      /Paid     Balance      Expense      /Paid  

Assets:

                

Loans

   $ 1,692,646       $ 48,171         5.69   $ 1,578,538       $ 47,955         6.08

Investment securities—taxable

     434,567         6,570         3.02     160,482         2,416         3.01

Investment securities—nontaxable

     16,860         405         4.80     12,996         402         6.19

Cash at Federal Reserve and other banks

     412,031         583         0.28     676,858         940         0.28
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total interest-earning assets

     2,556,104         55,729         4.36     2,428,874         51,713         4.26

Other assets

     181,595              168,390         
  

 

 

         

 

 

       

Total assets

   $ 2,737,699            $ 2,597,264         
  

 

 

         

 

 

       

Liabilities and shareholders’ equity:

                

Interest-bearing demand deposits

   $ 548,685         236         0.09   $ 519,734         266         0.10

Savings deposits

     846,932         520         0.12     782,256         517         0.13

Time deposits

     274,660         794         0.58     328,112         997         0.61

Other borrowings

     6,339         2         0.06     7,892         2         0.05

Junior subordinated debt

     41,238         610         2.96     41,238         622         3.02
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total interest-bearing liabilities

     1,717,854         2,162         0.25     1,679,232         2,404         0.29

Noninterest-bearing deposits

     727,255              643,403         

Other liabilities

     34,739              37,797         

Shareholders’ equity

     257,851              236,832         
  

 

 

         

 

 

       

Total liabilities and shareholders’ equity

   $ 2,737,699            $ 2,597,264         
  

 

 

         

 

 

       

Net interest spread(1)

           4.11           3.97

Net interest income and interest margin(2)

      $ 53,567         4.19      $ 49,309         4.06
     

 

 

    

 

 

      

 

 

    

 

 

 

 

(1)  Net interest spread represents the average yield earned on interest-earning assets minus the average rate paid on interest-bearing liabilities.
(2)  Net interest margin is computed by calculating the difference between interest income and interest expense, divided by the average balance of interest-earning assets.

 

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Summary of Changes in Interest Income and Expense due to Changes in Average Asset and Liability Balances and Yields Earned and Rates Paid

The following table sets forth a summary of the changes in interest income and interest expense from changes in average asset and liability balances (volume) and changes in average interest rates for the periods indicated. Changes not solely attributable to volume or rates have been allocated in proportion to the respective volume and rate components (in thousands).

 

     Three months ended June 30, 2014  
     compared with three months  
     ended June 30, 2013  
     Volume     Rate     Total  

Increase (decrease) in interest income:

      

Loans

   $ 1,567      $ (1,017   $ 550   

Investment securities

     2,325        (13     2,312   

Cash at Federal Reserve and other banks

     (219     (1     (220
  

 

 

   

 

 

   

 

 

 

Total interest-earning assets

     3,673        (1,031     2,642   
  

 

 

   

 

 

   

 

 

 

Increase (decrease) in interest expense:

      

Interest-bearing demand deposits

     8        (18     (10

Savings deposits

     23        (6     17   

Time deposits

     (81     (13     (94

Other borrowings

     —          —          —     

Junior subordinated debt

     —          (5     (5
  

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

     (50     (42     (92
  

 

 

   

 

 

   

 

 

 

Increase (decrease) in Net Interest Income

   $ 3,723      $ (989   $ 2,734   
  

 

 

   

 

 

   

 

 

 
     Six months ended June 30, 2014  
     compared with six months  
     ended June 30, 2013  
     Volume     Rate     Total  

Increase (decrease) in interest income:

      

Loans

   $ 3,469      $ (3,253   $ 216   

Investment securities

     4,245        (88     4,157   

Cash at Federal Reserve and other banks

     (371     14        (357
  

 

 

   

 

 

   

 

 

 

Total interest-earning assets

     7,343        (3,327     4,016   
  

 

 

   

 

 

   

 

 

 

Increase (decrease) in interest expense:

      

Interest-bearing demand deposits

     14        (44     (30

Savings deposits

     42        (39     3   

Time deposits

     (163     (40     (203

Other borrowings

     —          —          —     

Junior subordinated debt

     —          (12     (12
  

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

     (107     (135     (242
  

 

 

   

 

 

   

 

 

 

Increase (decrease) in Net Interest Income

   $ 7,450      $ (3,192   $ 4,258   
  

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Provision for Loan Losses

The provision for loan losses during any period is the sum of the allowance for loan losses required at the end of the period and any loan charge offs during the period, less the allowance for loan losses required at the beginning of the period, and less any loan recoveries during the period. See the Tables labeled “Allowance for loan losses – three and six months ended June 30, 2014 and 2013” at Note 5 in Item 1 of Part I of this report for the components that make up the provision for loan losses for the three and six months ended June 30, 2014 and 2013.

The Company provided $1,708,000 for loan losses during the three months ended June 30, 2014 versus a provision of $614,000 during the three months ended June 30, 2013. As shown in the Table labeled “Allowance for Loan Losses— three months ended June 30, 2014” at Note 5 in Item 1 of Part I of this report, home equity lines of credit, home equity loans and C&I loans experienced a provision for loan losses during the three months ended June 30, 2014. All other categories of loans experienced a reversal of provision for loan losses during the three months ended June 30, 2014. The level of provision, or reversal of provision, for loan losses of each loan category during the three months ended June 30, 2014 was due primarily to a decrease in the required allowance for loan losses as of June 30, 2014 when compared to the required allowance for loan losses as of March 31, 2014 plus net recoveries during the three months ended June 30, 2014, and the effect of the refinement in the allowance methodology during the three months ended June 30, 2014 as described under the heading “Loans and Allowance for Loan Losses” at Note 1 in Item 1 of Part I of this report. All categories of loans except home equity lines of credit, home equity loans, C&I loans, and residential construction loans experienced a decrease in the required allowance for loan losses during the three months ended June 30, 2014. These decreases in required allowance for loan losses were due primarily to reduced impaired loans, improvements in estimated cash flows and collateral values for the remaining and newly impaired loans, and reductions in historical loss factors that, in part, determine the required loan loss allowance for performing loans in accordance with the Company’s allowance for loan losses methodology as described under the heading “Loans and Allowance for Loan Losses” at Note 1 in Item 1 of Part I of this report. These same factors were also present, to some extent, for home equity lines of credit, home equity loans, and C&I loans, but were more than offset by the effect of increased loan balances, changes in credit quality within the “pass” category of these loan categories, or in the case of home equity lines of credit, the refinement in the allowance methodology, resulting in net provisions for loan losses in these categories during the three months ended June 30, 2014. For details of the change in nonperforming loans during the three months ended June 30, 2014 see the Tables, and associated narratives, labeled “Changes in nonperforming assets during the three months ended June 30, 2014” under the heading “Asset Quality and Non-Performing Assets” below. Excluding the effect of the refinement in the allowance methodology during the three months ended June 30, 2014, the provision for loan losses during the three months ended June 30, 2014 would have been a provision of $270,000.

The Company provided $353,000 for loan losses during the six months ended June 30, 2014 versus a benefit of $494,000 during the six months ended June 30, 2013. As shown in the Table labeled “Allowance for Loan Losses— six months ended June 30, 2014” at Note 5 in Item 1 of Part I of this report, home equity lines of credit, home equity loans and commercial constuction loans experienced a provision for loan losses during the six months ended June 30, 2014. All other categories of loans experienced a reversal of provision for loan losses during the six months ended June 30, 2014. The level of provision, or reversal of provision, for loan losses of each loan category during the six months ended June 30, 2014 was due primarily to a decrease in the required allowance for loan losses as of June 30, 2014 when compared to the required allowance for loan losses as of December 31, 2013 plus net recoveries during the six months ended June 30, 2014, and the effect of the changes in the allowance methodology during the six months ended June 30, 2014 as described under the heading “Loans and Allowance for Loan Losses” at Note 1 in Item 1 of Part I of this report. All categories of loans except commercial real estate mortgage loans, home equity lines of credit, home equity loans, C&I loans, and commercial construction loans experienced a decrease in the required allowance for loan losses during the six months ended June 30, 2014. These decreases in required allowance for loan losses were due primarily to reduced impaired loans, improvements in estimated cash flows and collateral values for the remaining and newly impaired loans, and reductions in historical loss factors that, in part, determine the required loan loss allowance for performing loans in accordance with the Company’s allowance for loan losses methodology as described under the heading “Loans and Allowance for Loan Losses” at Note 1 in Item 1 of Part I of this report. These same factors were also present, to some extent, for home equity lines of credit, home equity loans, and commercial construction loans, but were more than offset by the effect of increased loan balances or changes in credit quality within the “pass” category of these loan categories resulting in net provisions for loan losses in these categories during the six months ended June 30, 2014. For details of the change in nonperforming loans during the six months ended June 30, 2014 see the Tables, and associated narratives, labeled “Changes in nonperforming assets during the three months ended June 30, 2014 and March 31, 2014” under the heading “Asset Quality and Non-Performing Assets” below. Excluding the effect of the changes in allowance methodology during the six months ended June 30, 2014, the provision for loan losses during the six months ended June 30, 2014 would have been a benefit of $1,085,000.

The provision for loan losses related to originated and PNCI loans is based on management’s evaluation of inherent risks in these loan portfolios and a corresponding analysis of the allowance for loan losses. The provision for loan losses related to PCI loan portfolio is based on changes in estimated cash flows expected to be collected on PCI loans. Additional discussion on loan quality, our procedures to measure loan impairment, and the allowance for loan losses is provided under the heading “Asset Quality and Non-Performing Assets” below.

Management re-evaluates the loss ratios and other assumptions used in its calculation of the allowance for loan losses for its originated and PNCI loan portfolios on a quarterly basis and makes changes as appropriate based upon, among other things, changes in loss rates experienced, collateral support for underlying loans, changes and trends in the economy, and changes in the loan mix. Management also re-evaluates expected cash flows used in its accounting for its PCI loan portfolio, including any required allowance for loan losses, on a quarterly basis and makes changes as appropriate based upon, among other things, changes in loan repayment experience, changes in loss rates experienced, and collateral support for underlying loans.

 

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Table of Contents

Noninterest Income

The following table summarizes the Company’s noninterest income for the periods indicated (in thousands):

 

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

Service charges on deposit accounts

   $ 2,724      $ 3,277      $ 5,414      $ 6,417   

ATM and interchange fees

     2,192        2,233        4,205        4,108   

Other service fees

     533        562        1,053        1,121   

Mortgage banking service fees

     421        430        841        846   

Change in value of mortgage servicing rights

     (351     191        (532     130   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total service charges and fees

     5,519        6,693        10,981        12,622   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gain on sale of loans

     514        1,590        978        3,884   

Commissions on sale of non-deposit investment products

     843        841        1,614        1,602   

Increase in cash value of life insurance

     400        380        797        806   

Change in indemnification asset

     (93     (314     (505     (415

Gain (loss) on sale of foreclosed assets

     241        615        1,468        1,166   

Sale of customer checks

     98        92        199        183   

Lease brokerage income

     111        81        218        198   

Gain (loss) on disposal of fixed assets

     71        2        70        (14

Other

     173        151        352        317   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other noninterest income

     2,358        3,438        5,191        7,727   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest income

   $ 7,877      $ 10,131      $ 16,172      $ 20,349   
  

 

 

   

 

 

   

 

 

   

 

 

 

Mortgage loan servicing fees, net of change in fair value of mortgage loan servicing rights

   $ 70      $ 621      $ 309      $ 976   

Noninterest income decreased $2,254,000 (22.2%) to $7,877,000 during the three months ended June 30, 2014 compared to the three months ended June 30, 2013. The decrease in noninterest income was due primarily to a $1,076,000 (67.7%) decrease in gain on sale of loans to $514,000, a $553,000 (16.9%) decrease in service charges on deposit accounts, a $542,000 (284%) decrease in change in value of mortgage servicing rights, and a $374,000 (60.8%) decrease in gain on sale of foreclosed assets. The decrease in gain on sale of loans was primarily due to the increase in residential real estate mortgage rates that occurred in May 2013 that resulted in a significant decrease in mortgage refinance activity, and thus a significant decrease in newly originated mortgages for the Company to sell. The decrease in service charges on deposit accounts was primarily due to reduced customer overdrafts and a resulting decrease in non-sufficient funds fees. The decrease in the change in value of mortgage servicing rights was due primarily to a decrease in the balance of mortgages serviced during the quarter ended June 30, 2014 compared to an increase in such balances during the quarter ended June 30, 2013, and a large decrease in estimated prepayment speeds of such mortgages during the three months ended June 30, 2013 versus a slight increase in estimated mortgage prepayment speeds during the three months ended June 30, 2014. An increase in prepayment speed decreases the value of mortgage servicing rights and a decrease in mortgage prepayment speed increases the value of mortgage servicing rights. Mortgage prepayment speed generally increases when market rates for mortgages decrease, and vice versa. The decrease in gain on sale of foreclosed assets was due a reduced balance of foreclosed assets and thus reduced opportunities for sale of such foreclosed assets.

Noninterest income decreased $4,177,000 (20.5%) to $16,172,000 during the six months ended June 30, 2014 when compared to the six months ended June 30, 2013. The decrease in noninterest income was due primarily to a $2,906,000 (74.8%) decrease in gain on sale of loans to $978,000, a $1,003,000 (15.6%) decrease in service charges on deposit accounts, and a $662,000 (509%) decrease in change in value of mortgage servicing rights that were partially offset by a $302,000 (25.9%) increase in gain on sale of foreclosed assets. The decrease in gain on sale of loans was primarily due to the increase in residential real estate mortgage rates that occurred in May 2013 that resulted in a significant decrease in mortgage refinance activity, and thus a significant decrease in newly originated mortgages for the Company to sell. The decrease in service charges on deposit accounts was primarily due to reduced customer overdrafts and a resulting decrease in non-sufficient funds fees. The decrease in the change in value of mortgage servicing rights was due primarily to a decrease in the balance of mortgages serviced during the six months ended June 30, 2014 compared to an increase in such balances during the six months ended June 30, 2013, and a large decrease in estimated prepayment speeds of such mortgages during the six months ended June 30, 2013 versus a slight increase in estimated mortgage prepayment speeds during the six months ended June 30, 2014. An increase in prepayment speed decreases the value of mortgage servicing rights and a decrease in mortgage prepayment speed increases the value of mortgage servicing rights. Mortgage prepayment speed generally increases when market rates for mortgages decrease, and vice versa. The increase in gain on sale of foreclosed assets was due a relatively large reduction in the balance of foreclosed assets and the resulting gain on sale during the three months ended March 31, 2014.

 

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Table of Contents

Noninterest Expense

The following table summarizes the Company’s noninterest expense for the periods indicated (dollars in thousands):

 

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

Base salaries, net of deferred loan origination costs

   $ 9,008      $ 8,508      $ 17,874      $ 16,856   

Incentive compensation

     1,205        1,299        2,328        2,585   

Benefits and other compensation costs

     3,104        3,083        6,418        6,410   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total salaries and benefits expense

     13,317        12,890        26,620        25,851   
  

 

 

   

 

 

   

 

 

   

 

 

 

Occupancy

     1,802        1,753        3,764        3,412   

Equipment

     1,060        913        2,096        1,947   

Data processing and software

     1,350        1,280        2,528        2,358   

ATM network charges

     710        679        1,353        1,175   

Telecommunications

     713        587        1,293        1,112   

Postage

     221        133        448        364   

Courier service

     224        255        458        422   

Advertising

     341        415        683        740   

Assessments

     481        543        1,002        1,149   

Operational losses

     150        122        327        239   

Professional fees

     1,518        695        2,357        1,206   

Foreclosed assets expense

     151        163        309        262   

Provision for foreclosed asset losses

     4        546        40        573   

Change in reserve for unfunded commitments

     (185     35        (370     (405

Intangible amortization

     52        53        104        105   

Other

     3,207        2,448        5,421        4,600   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other noninterest expense

     11,799        10,619        21,813        19,259   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest income

   $ 25,116      $ 23,509      $ 48,433      $ 45,110   
  

 

 

   

 

 

   

 

 

   

 

 

 

Average full time equivalent staff

     726        727        729        735   

Noninterest expense to revenue (FTE)

     71.7     67.5     69.5     64.8

Salary and benefit expenses increased $427,000 (3.3%) to $13,317,000 during the three months ended June 30, 2014 compared to the three months ended June 30, 2013. Base salaries increased $500,000 (5.9%) to $9,008,000 during the three months ended June 30, 2014 versus the year ago period despite a 0.1% decrease in the average number of full time equivalent employees from 727 to 726. The average number of full time equivalent employees decreased primarily due to the reductions in staff from the closing of six branches since December 31, 2012 that was partially offset by increases in full time equivalent back office staff and management. The salary expense attributable to the newly added back office staff and management outweighed the reduction in salary expense attributable to the branch closings. Annual salary merit increases of approximately 2.5% also contributed to the increase in base salary expense. Incentive and commission related salary expenses decreased $94,000 (7.2%) to $1,205,000 during three months ended June 30, 2014 due primarily to decreases in production related incentives tied to reduced residential real estate mortgage loan originations and sales. Benefits expense, including retirement, medical and workers’ compensation insurance, and taxes, increased $21,000 (0.7%) to $3,104,000 during the three months ended June 30, 2014.

Salary and benefit expenses increased $769,000 (3.0%) to $26,620,000 during the six months ended June 30, 2014 compared to the six months ended June 30, 2013. Base salaries increased $1,018,000 (6.0%) to $17,874,000 during the six months ended June 30, 2014 versus the year ago period despite a 0.8% decrease in the average number of full time equivalent employees from 735 to 729. The average number of full time equivalent employees decreased primarily due to the reductions in staff from the closing of six branches since December 31, 2012 that was partially offset by increases in full time equivalent back office staff and management. The salary expense attributable to the newly added back office staff and management outweighed the reduction in salary expense attributable to the branch closings. Annual salary merit increases of approximately 2.5% also contributed to the increase in base salary expense. Incentive and commission related salary expenses decreased $257,000 (9.9%) to $2,328,000 during six months ended June 30, 2014 due primarily to decreases in production related incentives tied to reduced residential real estate mortgage loan originations and sales. Benefits expense, including retirement, medical and workers’ compensation insurance, and taxes, increased $8,000 (0.1%) to $6,418,000 during the six months ended June 30, 2014.

Other noninterest expense increased $1,180,000 (11.1%) to $11,799,000 during the three months ended June 30, 2014 compared to the three months ended June 30, 2013. The increase in other noninterest expense was due primarily a $823,000 (118%) increase in professional fees to $1,518,000, a $196,000 (7.4%) increase in occupancy and equipment expenses to $2,862,000, and a $759,000 (31.0%) increase in other expenses to $3,207,000 that were partially offset by a $542,000 (99.3%) decrease in provision for foreclosed assets, and a $220,000 decrease in provision for losses on unfunded commitments. The increase in professional fees was mainly due to $536,000 consulting expense related to outside data processing, the benefit of which is expected to be realized over the next several years via lower data processing expense, and $232,000 of legal and consulting expenses related to the proposed North Valley merger. The increase in other expenses was primarily due to $175,000 of system conversion planning expenses related to the proposed North Valley merger, and $114,000 of leasehold improvement removal expenses related to two branches closed at the end of the quarter ended March 31, 2014 and one branch closed at the end of the quarter ended June 30, 2014. During the three months ended June 30, 2014, the Company incurred $407,000 of other noninterest expense related to the proposed North Valley merger.

 

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Other noninterest expense increased $2,554,000 (13.3%) to $21,813,000 during the six months ended June 30, 2014 compared to the six months ended June 30, 2013. The increase in other noninterest expense was due primarily a $1,151,000 (95.4%) increase in professional fees to $2,357,000, a $501,000 (9.4%) increase in occupancy and equipment expenses to $5,860,000, and a $820,000 (17.8%) increase in other expenses to $5,421,000 that were partially offset by a $533,000 (93.0%) decrease in provision for foreclosed assets. The increase in professional fees was mainly due to $536,000 consulting expense related to outside data processing incurred during the three months ended June 30, 2014, and noted above, and $456,000 of legal and consulting expenses related to the proposed North Valley merger. The increase in other expenses was primarily due to $175,000 of system conversion planning expenses related to the proposed North Valley merger, and $114,000 of leasehold improvement removal expenses related to two branches closed at the end of the quarter ended March 31, 2014 and one branch closed at the end of the quarter ended June 30, 2014. During the six months ended June 30, 2014, the Company incurred $631,000 of other noninterest expense related to the proposed North Valley merger.

Income Taxes

The effective combined Federal and State income tax rate on income was 42.1% and 40.3% for the three months ended June 30, 2014 and 2013, respectively. The effective combined Federal and State income tax rate was greater than the Federal statutory tax rate of 35.0% due to State income tax expense of $923,000 and $1,094,000, respectively, in these periods. Tax-exempt income of $117,000 and $150,000, respectively, from investment securities, and $401,000 and $379,000, respectively, from increase in cash value of life insurance in these periods helped to reduce the effective combined Federal and State income tax rate from the combined Federal and State statutory income tax rate of approximately 42.0%, and were partially offset by nondeductible merger expenses of $291,000 and $0, respectively, and other nondeductible expenses of $215,000 and $104,000, respectively.

The effective combined Federal and State income tax rate on income was 41.2% and 40.5% for the six months ended June 30, 2014 and 2013, respectively. The effective combined Federal and State income tax rate was greater than the Federal statutory tax rate of 35.0% due to State income tax expense of $2,234,000 and $2,582,000, respectively, in these periods. Tax-exempt income of $253,000 and $251,000, respectively, from investment securities, and $798,000 and $806,000, respectively, from increase in cash value of life insurance in these periods helped to reduce the effective combined Federal and State income tax rate from the combined Federal and State statutory income tax rate of approximately 42.0%, and were partially offset by nondeductible merger expenses of $341,000 and $0, respectively, and other nondeductible expenses of $265,000 and $195,000, respectively.

Financial Condition

Investment Securities

Investment securities available for sale decreased $13,133,000 to $91,514,000 as of June 30, 2014, as compared to December 31, 2013. This decrease is attributable to maturities of $13,464,000, a increase in fair value of investments securities available for sale of $553,000, and amortization of net purchase price premiums of $222,000.

The following table presents the available for sale investment securities portfolio by major type as of June 30, 2014 and December 31, 2013:

 

(In thousands)    June 30, 2014     December 31, 2013  
Securities available for sale:    Fair Value      %     Fair Value      %  

Obligations of U.S. government corporations and agencies

   $ 86,040         94.0   $ 97,143         92.8

Obligations of states and political subdivisions

     3,560         3.9     5,589         5.3

Corporate debt securities

     1,914         2.1     1,915         1.9
  

 

 

    

 

 

   

 

 

    

 

 

 

Total securities available for sale

   $ 91,514         100.0   $ 104,647         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Investment securities held to maturity increased $181,998,000 to $422,502,000 as of June 30, 2014, as compared to December 31, 2013. This increase is attributable to purchases of $191,673,000, maturities of $9,548,000, and amortization of net purchase price premiums of $127,000.

The following table presents the held to maturity investment securities portfolio by major type as of June 30, 2014 and December 31, 2013:

 

(In thousands)    June 30, 2014     December 31, 2013  
Securities held to maturity:    Cost Basis      %     Cost Basis      %  

Obligations of U.S. government corporations and agencies

   $ 409,881         97.0   $ 227,864         94.7

Obligations of states and political subdivisions

     12,621         3.0     12,640         5.3
  

 

 

    

 

 

   

 

 

    

 

 

 

Total securities held to maturity

   $ 422,502         100.0   $ 240,504         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Additional information about the investment portfolio is provided in Note 3 of the Notes to Unaudited Condensed Consolidated Financial Statements at Iem 1 of Part I of this report.

Restricted Equity Securities

Restricted equity securities were $11,582,000 at June 30, 2014 and $9,163,000 at December 31, 2013. The entire balance of restricted equity securities at June 30, 2014 and December 31, 2013 represent the Bank’s investment in the Federal Home Loan Bank of San Francisco (“FHLB”). Additional information about the restricted equity securities is provided in Note 1 of the Notes to Unaudited Condensed Consolidated Financial Statements at Iem 1 of Part I of this report.

 

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Loans

The Bank concentrates its lending activities in four principal areas: real estate mortgage loans (residential and commercial loans), consumer loans, commercial loans (including agricultural loans), and real estate construction loans. The interest rates charged for the loans made by the Bank vary with the degree of risk, the size and maturity of the loans, the borrower’s relationship with the Bank and prevailing money market rates indicative of the Bank’s cost of funds.

The majority of the Bank’s loans are direct loans made to individuals, farmers and local businesses. The Bank relies substantially on local promotional activity and personal contacts by bank officers, directors and employees to compete with other financial institutions. The Bank makes loans to borrowers whose applications include a sound purpose, a viable repayment source and a plan of repayment established at inception and generally backed by a secondary source of repayment.

The following table shows the Company’s loan balances, including net deferred loan costs, as of the dates indicated:

 

(In thousands)    June 30,
2014
     December 31,
2013
 

Real estate mortgage

   $ 1,167,856       $ 1,107,863   

Consumer

     377,143         383,163   

Commercial

     137,341         131,878   

Real estate construction

     56,246         49,103   
  

 

 

    

 

 

 

Total loans

   $ 1,738,586       $ 1,672,007   
  

 

 

    

 

 

 

At June 30, 2014 loans, including net deferred loan costs, totaled $1,738,586,000 which was a $66,579,000 (4.0%) increase over the balances at December 31, 2013. Included in the $66,579,000 increase in loans during the six months ended June 30, 2014 was the purchase of residential real estate mortgage loans totaling $19,690,000 during the three months ended June 30, 2014. Demand for all categories of loans was moderate during the six months ended June 30, 2014.

The following table shows the Company’s loan balances, including net deferred loan costs, as a percentage of total loans for the periods indicated:

 

     June 30,
2014
    December 31,
2013
 

Real estate mortgage

     67.2     66.3

Consumer

     21.7     22.9

Commercial

     7.9     7.9

Real estate construction

     3.2     2.9
  

 

 

   

 

 

 

Total loans

     100.0     100.0
  

 

 

   

 

 

 

Assets Quality and Nonperforming Assets

Nonperforming Assets

Loans originated by the Company, i.e., not purchased or acquired in a business combination, are referred to as originated loans. Originated loans are reported at the principal amount outstanding, net of deferred loan fees and costs. Loan origination and commitment fees and certain direct loan origination costs are deferred, and the net amount is amortized as an adjustment of the related loan’s yield over the actual life of the loan. Originated loans on which the accrual of interest has been discontinued are designated as nonaccrual loans.

Originated loans are placed in nonaccrual status when reasonable doubt exists as to the full, timely collection of interest or principal, or a loan becomes contractually past due by 90 days or more with respect to interest or principal and is not well secured and in the process of collection. When an originated loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of Management, the loan is estimated to be fully collectible as to both principal and interest.

An allowance for loan losses for originated loans is established through a provision for loan losses charged to expense. Originated loans and deposit related overdrafts are charged against the allowance for loan losses when Management believes that the collectability of the principal is unlikely or, with respect to consumer installment loans, according to an established delinquency schedule. The allowance is an amount that Management believes will be adequate to absorb probable losses inherent in existing loans and leases, based on evaluations of the collectability, impairment and prior loss experience of loans and leases. The evaluations take into consideration such factors as changes in the nature and size of the portfolio, overall portfolio quality, loan concentrations, specific problem loans, and current economic conditions that may affect the borrower’s ability to pay. The Company defines an originated loan as impaired when it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired originated loans are measured based on the present value of expected future cash flows discounted at the loan’s original effective interest rate. As a practical expedient, impairment may be measured based on the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance.

In situations related to originated loans where, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession for other than an insignificant period of time to the borrower that the Company would not otherwise consider, the related loan is classified as a troubled debt restructuring (TDR). The Company strives to identify borrowers in financial difficulty early and work with them to modify to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the

 

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collateral. In cases where the Company grants the borrower new terms that result in the loan being classified as a TDR, the Company measures any impairment on the restructuring as noted above for impaired loans. TDR loans are classified as impaired until they are fully paid off or charged off. Loans that are in nonaccrual status at the time they become TDR loans, remain in nonaccrual status until the borrower demonstrates a sustained period of performance which the Company generally believes to be six consecutive months of payments, or equivalent. Otherwise, TDR loans are subject to the same nonaccrual and charge-off policies as noted above with respect to their restructured principal balance.

Credit risk is inherent in the business of lending. As a result, the Company maintains an allowance for loan losses to absorb losses inherent in the Company’s originated loan portfolio. This is maintained through periodic charges to earnings. These charges are included in the Consolidated Statements of Income as provision for loan losses. All specifically identifiable and quantifiable losses are immediately charged off against the allowance. However, for a variety of reasons, not all losses are immediately known to the Company and, of those that are known, the full extent of the loss may not be quantifiable at that point in time. The balance of the Company’s allowance for originated loan losses is meant to be an estimate of these unknown but probable losses inherent in the portfolio.

The Company formally assesses the adequacy of the allowance for originated loan losses on a quarterly basis. Determination of the adequacy is based on ongoing assessments of the probable risk in the outstanding originated loan portfolio, and to a lesser extent the Company’s originated loan commitments. These assessments include the periodic re-grading of credits based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the interest rate environment, growth of the portfolio as a whole or by segment, and other factors as warranted. Loans are initially graded when originated. They are re-graded as they are renewed, when there is a new loan to the same borrower, when identified facts demonstrate heightened risk of nonpayment, or if they become delinquent. Re-grading of larger problem loans occurs at least quarterly. Confirmation of the quality of the grading process is obtained by independent credit reviews conducted by consultants specifically hired for this purpose and by various bank regulatory agencies.

The Company’s method for assessing the appropriateness of the allowance for originated loan losses includes specific allowances for impaired originated loans and leases, formula allowance factors for pools of credits, and allowances for changing environmental factors (e.g., interest rates, growth, economic conditions, etc.). Allowance factors for loan pools were based on historical loss experience by product type and prior risk rating.

During the three months ended March 31, 2013, the Company changed the method it uses to estimate net sale proceeds from real estate collateral sales when calculating the allowance for loan losses associated with impaired real estate collateral dependent loans. Previously, the Company used the greater of fifteen percent or actual estimated selling costs. Currently, the Company uses the actual estimated selling costs, and an adjustment to appraised value based on the age of the appraisal. These changes are intended to more accurately reflect the estimated net sale proceeds from the sale of impaired collateral dependent real estate loans. This change in methodology resulted in the allowance for loan losses as of March 31, 2013 being $494,000 more than it would have been without this change in methodology.

During the three months ended June 30, 2013, the Company modified its loss migration analysis methodology used to determine the formula allowance factors. When the Company originally established its loss migration analysis methodology during the quarter ended March 31, 2012, it reviewed the loss experience of each rolling twelve month period over the previous three years in order to calculate an annualized loss rate by loan category and risk rating. The use of three years of loss experience data was originally used because that was the extent of the detailed loss data, by loan category and risk rating that was available at the time. This three year historical look-back period was used through the quarter ended March 31, 2013. Starting with the quarter ended June 30, 2013, the Company reviews all available detailed loss experience data, going back to, and including, the twelve month period ended June 30, 2009, and does not limit the look-back period to the most recent three years of historical loss data. Using this data, the Company calculates loss factors for each quarter from the quarter ended June 30, 2009 to the most recent quarter. The Company then calculates a weighted average formula allowance factor for each loan category and risk rating with the most recent quarterly loss factor being weighted 125%, the quarter ended June 30, 2009 loss factor being weighted 75%, and the loss factors for all the quarters between the most recent quarter and the quarter ended June 30, 2009, being weighted on a linear scale from 75% to 125%. This change is intended to more accurately reflect the risk inherent in the loan portfolio by considering historical loss data for all years as the data for new periods becomes available. This change in methodology resulted in the allowance for loan losses as of June 30, 2013 being $1,314,000 more than it would have been without this change in methodology.

During the three months ended September 30, 2013, the Company modified its methodology used to determine the allowance for changing environmental factors. Previously, the Company compared the current value of each environmental factor to a fixed baseline value. The deviation of the current value from the baseline value was then multiplied by a conversion factor to determine the required allowance related to each environmental factor. As of September 30, 2013, the Company replaced the fixed baseline values with average baseline values derived from historical averages, and adjusted the conversion factors. This change is intended to more accurately reflect the risk inherent in the portfolio by recognizing that baseline, or normal, levels for environmental factors may change over time. This change in methodology resulted in the allowance for loan losses as of September 30, 2013 being $1,665,000 more than it would have been without this change in methodology.

During the three months ended March 31, 2014, the Company modified its methodology used to determine the allowance for changing environmental factors by adding a new environmental factor based on the California Home Affordability Index (“CHAI”). The CHAI measures the percentage of households in California that can afford to purchase the median priced home in California based on current home prices and mortgage interest rates. The use of the CHAI environmental factor consists of comparing the current CHAI to its historical baseline, and allows management to consider the adverse impact that a lower than historical CHAI may have on general economic activity and the performance of our borrowers. Based on an analysis of historical data, management believes this environmental factor gives a better estimate of current economic activity compared to other environmental factors that may lag current economic activity to some extent. This change in methodology resulted in no change to the allowance for loan losses as of March 31, 2014 compared to what it would have been without this change in methodology.

 

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During the three months ended June 30, 2014, the Company refined the method it uses to evaluate historical losses for the purpose of estimating the pool allowance for unimpaired loans. In the third quarter of 2010, the Company moved from a six point grading system (Grades A-F) to a nine point risk rating system (Risk Ratings 1-9), primarily to allow for more distinction within the “Pass” risk rating. Initially, there was not sufficient loss experience within the nine point scale to complete a migration analysis for all nine risk ratings, all loans risk rated Pass or 2-5 were grouped together, a loss rate was calculated for that group, and that loss rate was established as the loss rate for risk rating 4. The reserve ratios for risk ratings 2, 3 & 5 were then interpolated from that figure. As of June 30, 2014, the Company was able to compile twelve quarters of historical loss information for all risk ratings, and use that information to calculate the loss rates for each of the nine risk ratings without interpolation. This refinement led to an increase of $1,438,000 in the reserve requirement for unimpaired loans, driven primarily by home equity lines of credit with a risk rating of 5 or “Pass-Watch.”

Loans purchased or acquired in a business combination are referred to as acquired loans. Acquired loans are valued as of acquisition date in accordance with Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) Topic 805, Business Combinations. Loans acquired with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are referred to as purchased credit impaired (PCI) loans. PCI loans are accounted for under FASB ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. Under FASB ASC Topic 805 and FASB ASC Topic 310-30, PCI loans are recorded at fair value at acquisition date, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded as of the acquisition date. Fair value is defined as the present value of the future estimated principal and interest payments of the loan, with the discount rate used in the present value calculation representing the estimated effective yield of the loan. Default rates, loss severity, and prepayment speed assumptions are periodically reassessed and our estimate of future payments is adjusted accordingly. The difference between contractual future payments and estimated future payments is referred to as the nonaccretable difference. The difference between estimated future payments and the present value of the estimated future payments is referred to as the accretable yield. The accretable yield represents the amount that is expected to be recorded as interest income over the remaining life of the loan. If after acquisition, the Company determines that the estimated future cash flows of a PCI loan are expected to be more than the originally estimated, an increase in the discount rate (effective yield) would be made such that the newly increased accretable yield would be recognized, on a level yield basis, over the remaining estimated life of the loan. If, after acquisition, the Company determines that the estimated future cash flows of a PCI loan are expected to be less than the previously estimated, the discount rate would first be reduced until the present value of the reduced cash flow estimate equals the previous present value however, the discount rate may not be lowered below its original level at acquisition. If the discount rate has been lowered to its original level and the present value has not been sufficiently lowered, an allowance for loan loss would be established through a provision for loan losses charged to expense to decrease the present value to the required level. If the estimated cash flows improve after an allowance has been established for a loan, the allowance may be partially or fully reversed depending on the improvement in the estimated cash flows. Only after the allowance has been fully reversed may the discount rate be increased. PCI loans are put on nonaccrual status when cash flows cannot be reasonably estimated. PCI loans on nonaccrual status are accounted for using the cost recovery method or cash basis method of income recognition. PCI loans are charged off when evidence suggests cash flows are not recoverable. Foreclosed assets from PCI loans are recorded in foreclosed assets at fair value with the fair value at time of foreclosure representing cash flow from the loan. ASC 310-30 allows PCI loans with similar risk characteristics and acquisition time frame to be “pooled” and have their cash flows aggregated as if they were one loan. The Company elected to use the “pooled” method of ASC 310-30 for PCI – other loans in the acquisition of certain assets and liabilities of Granite and Citizens.

Acquired loans that are not PCI loans are referred to as purchased not credit impaired (PNCI) loans. PNCI loans are accounted for under FASB ASC Topic 310-20, Receivables – Nonrefundable Fees and Other Costs, in which interest income is accrued on a level-yield basis for performing loans. For income recognition purposes, this method assumes that all contractual cash flows will be collected, and no allowance for loan losses is established at the time of acquistion. Post-acquisition date, an allowance for loan losses may need to be established for acquired loans through a provision charged to earnings for credit losses incurred subsequent to acquisition. Under ASC 310-20, the loss would be measured based on the probable shortfall in relation to the contractual note requirements, consistent with our allowance for loan loss policy for similar loans.

When referring to PNCI and PCI loans we use the terms “nonaccretable difference”, “accretable yield”, or “purchase discount”. Nonaccretable difference is the difference between undiscounted contractual cash flows due and undiscounted cash flows we expect to collect, or put another way, it is the undiscounted contractual cash flows we do not expect to collect. Accretable yield is the difference between undiscounted cash flows we expect to collect and the value at which we have recorded the loan on our financial statements. On the date of acquisition, all purchased loans are recorded on our consolidated financial statements at estimated fair value. Purchase discount is the difference between the estimated fair value of loans on the date of acquisition and the principal amount owed by the borrower, net of charge offs, on the date of acquisition. We may also refer to “discounts to principal balance of loans owed, net of charge-offs”. Discounts to principal balance of loans owed, net of charge-offs is the difference between principal balance of loans owed, net of charge-offs, and loans as recorded on our financial statements. Discounts to principal balance of loans owed, net of charge-offs arise from purchase discounts, and equal the purchase discount on the acquisition date.

Loans are also categorized as “covered” or “noncovered”. Covered loans refer to loans covered by a FDIC loss sharing agreement. Noncovered loans refer to loans not covered by a FDIC loss sharing agreement.

Originated loans and PNCI loans are reviewed on an individual basis for reclassification to nonaccrual status when any one of the following occurs: the loan becomes 90 days past due as to interest or principal, the full and timely collection of additional interest or principal becomes uncertain, the loan is classified as doubtful by internal credit review or bank regulatory agencies, a portion of the principal balance has been charged off, or the Company takes possession of the collateral. Loans that are placed on nonaccrual even though the borrowers continue to repay the loans as scheduled are classified as “performing nonaccrual” and are included in total nonperforming loans. The reclassification of loans as nonaccrual does not necessarily reflect Management’s judgment as to whether they are collectible.

 

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Interest income on originated nonaccrual loans that would have been recognized during the three months ended June 30, 2014 and 2013, if all such loans had been current in accordance with their original terms, totaled $572,000 and $1,306,000, respectively. Interest income actually recognized on these originated loans during the three months ended June 30, 2014 and 2013 was $18,000 and $76,000, respectively. Interest income on PNCI nonaccrual loans that would have been recognized during the three months ended June 20, 2014 and 2013, if all such loans had been current in accordance with their original terms, totaled $50,000 and $64,000. Interest income actually recognized on these PNCI loans during the three months ended June 30, 2014 and 2013 was $(5,000) and $4,000.

Interest income on originated nonaccrual loans that would have been recognized during the six months ended June 30, 2014 and 2013, if all such loans had been current in accordance with their original terms, totaled $1,458,000 and $2,436,000, respectively. Interest income actually recognized on these originated loans during the six months ended June 30, 2014 and 2013 was $24,000 and $106,000, respectively. Interest income on PNCI nonaccrual loans that would have been recognized during the six months ended June 30, 2014 and 2013, if all such loans had been current in accordance with their original terms, totaled $118,000 and $130,000. Interest income actually recognized on these PNCI loans during the six months ended June 30, 2014 and 2013 was$(4,000) and $7,000.

The Company’s policy is to place originated loans and PNCI loans 90 days or more past due on nonaccrual status. In some instances when an originated loan is 90 days past due Management does not place it on nonaccrual status because the loan is well secured and in the process of collection. A loan is considered to be in the process of collection if, based on a probable specific event, it is expected that the loan will be repaid or brought current. Generally, this collection period would not exceed 30 days. Loans where the collateral has been repossessed are classified as foreclosed assets. Management considers both the adequacy of the collateral and the other resources of the borrower in determining the steps to be taken to collect nonaccrual loans. Alternatives that are considered are foreclosure, collecting on guarantees, restructuring the loan or collection lawsuits.

The following table sets forth the amount of the Bank’s nonperforming assets as of the dates indicated. For purposes of the following table, “PCI – other” loans that are 90 days past due and still accruing are not considered nonperforming loans. “Performing nonaccrual loans” are loans that may be current for both principal and interest payments, or are less than 90 days past due, but for which payment in full of both principal and interest is not expected, and are not well secured and in the process of collection:

 

(In thousands)    June 30,
2014
    December 31,
2013
 

Performing nonaccrual loans

   $ 40,767      $ 48,112   

Nonperforming nonaccrual loans

     3,433        5,104   
  

 

 

   

 

 

 

Total nonaccrual loans

     44,200        53,216   

Originated and PNCI loans 90 days past due and still accruing

     —          —     
  

 

 

   

 

 

 

Total nonperforming loans

     44,200        53,216   

Noncovered foreclosed assets

     5,264        5,588   

Covered foreclosed assets

     521        674   
  

 

 

   

 

 

 

Total nonperforming assets

   $ 49,985      $ 59,478   
  

 

 

   

 

 

 

U.S. government, including its agencies and its government-sponsored agencies, guaranteed portion of nonperforming loans

   $ 126      $ 101   

Indemnified portion of covered foreclosed assets

   $ 417      $ 539   

Nonperforming assets to total assets

     1.93     2.17

Nonperforming loans to total loans

     2.54     3.18

Allowance for loan losses to nonperforming loans

     90     72

Allowance for loan losses, unamortized loan fees, and discounts to loan principal balances owed

     3.88     4.09

 

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The following table set forth the amount of the Bank’s nonperforming assets as of the dates indicated. For purposes of the following table, “PCI – other” loans that are 90 days past due and still accruing are not considered nonperforming loans. “Performing nonaccrual loans” are loans that may be current for both principal and interest payments, or are less than 90 days past due, but for which payment in full of both principal and interest is not expected, and are not well secured and in the process of collection:

 

     June 30, 2014  
(dollars in thousands)    Originated     PNCI     PCI - cash basis     PCI - other     Total  

Performing nonaccrual loans

   $ 33,767      $ 1,151      $ 5,849        —        $ 40,767   

Nonperforming nonaccrual loans

     3,397        36        —          —          3,433   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonaccrual loans

     37,164        1,187        5,849        —          44,200   

Originated and PNCI loans 90 days past due and still accruing

     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     37,164        1,187        5,849        —          44,200   

Noncovered foreclosed assets

     4,805        —          —        $ 459        5,264   

Covered foreclosed assets

     —          —          —          521        521   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 41,969      $ 1,187      $ 5,849      $ 980      $ 49,985   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

U.S. government, including its agencies and its government-sponsored agencies, guaranteed portion of nonperforming loans

   $ 126            $ 126   

Indemnified portion of covered foreclosed assets

     —          —          —        $ 417      $ 417   

Nonperforming assets to total assets

     1.62     0.05     0.23     0.04     1.93

Nonperforming loans to total loans

     2.40     0.84     100.00     0.00     2.54

Allowance for loan losses to nonperforming loans

     87     273     7     n/m        90

Allowance for loan losses, unamortized loan fees, and discounts to loan principal balances owed

     2.37     6.95     64.73     21.67     3.88

n/m – not meaningful

The following table set forth the amount of the Bank’s nonperforming assets as of the dates indicated. For purposes of the following table, “PCI – other” loans that are 90 days past due and still accruing are not considered nonperforming loans. “Performing nonaccrual loans” are loans that may be current for both principal and interest payments, or are less than 90 days past due, but for which payment in full of both principal and interest is not expected, and are not well secured and in the process of collection:

 

     December 31, 2013  
(dollars in thousands)    Originated     PNCI     PCI - cash basis     PCI - other     Total  

Performing nonaccrual loans

   $ 40,294      $ 1,649      $ 6,169        —        $ 48,112   

Nonperforming nonaccrual loans

     4,837        217        50        —          5,104   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonaccrual loans

     45,131        1,866        6,219        —          53,216   

Originated and PNCI loans 90 days past due and still accruing

     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     45,131        1,866        6,219        —          53,216   

Noncovered foreclosed assets

     5,479        —          —        $ 109        5,588   

Covered foreclosed assets

     —          —          —          674        674   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 50,610      $ 1,866      $ 6,219      $ 783      $ 59,478   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

U.S. government, including its agencies and its government-sponsored agencies, guaranteed portion of nonperforming loans

   $ 101            $ 101   

Indemnified portion of covered foreclosed assets

     —          —          —        $ 539      $ 539   

Nonperforming assets to total assets

             2.30

Nonperforming loans to total loans

     3.04     1.38     100.0     —          3.18

Allowance for loan losses to nonperforming loans

     69     153     6     n/m        72

Allowance for loan losses, unamortized loan fees, and discounts to loan principal balances owed

     2.36     7.62     64.5     22.93     4.09

n/m – not meaningful

 

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Changes in nonperforming assets during the three months ended June 30, 2014

 

     Balance at             Advances/      Pay-downs           Transfers to           Balance at  
     June 30,      New      Capitalized      /Sales     Charge-offs/     Foreclosed     Category     March 31,  
(In thousands):    2014      NPA      Costs      /Upgrades     Write-downs     Assets     Changes     2014  

Real estate mortgage:

                   

Residential

   $ 4,756       $ 186       $ 24       $ (182     —          —          —        $ 4,728   

Commercial

     24,785         71         1,045         (4,643   $ (44   $ (3,287     —          31,643   

Consumer

                   

Home equity lines

     10,834         785         19         (485     (677     (116   $ (126     11,434   

Home equity loans

     813         46         —           (64     (11     —          126        716   

Auto indirect

     36         —           —           (8     —          —          —          44   

Other consumer

     49         29         —           (13     (39     —          —          72   

Commercial

     443         170         —           (377     (152     —          —          802   

Construction:

                   

Residential

     2,468         —           —           (42     —          —          —          2,510   

Commercial

     16         —           —           (3     —          —          —          19   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     44,200         1,287         1,088         (5,817     (923     (3,403     —          51,968   

Noncovered foreclosed assets

     5,264               (687     (3     3,403        —          2,551   

Covered foreclosed assets

     521         —           —           (142     (1     —          —          664   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 49,985       $ 1,287       $ 1,088       $ (6,646   $ (927     —          —        $ 55,183   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nonperforming assets decreased during the second quarter of 2014 by $5,198,000 (9.42%) to $49,985,000 at June 30, 2014 compared to $55,183,000 at March 31, 2014. The decrease in nonperforming assets during the second quarter of 2014 was primarily the result of new nonperforming loans of $1,287,000, advances on existing nonperforming loans and capitalized costs on foreclosed assets of $1,088,000, less pay-downs, sales or upgrades of nonperforming loans to performing status totaling $5,817,000, less dispositions of foreclosed assets totaling $829,000, less loan charge-offs of $923,000, and less write-downs of foreclosed assets of $4,000.

The $1,287,000 in new nonperforming loans during the second quarter of 2014 was comprised of increases of $186,000 on three residential real estate loans, $71,000 on two commercial real estate loans, $831,000 on 10 home equity lines and loans, $29,000 on eight consumer loans, and $170,000 on eight C&I loans.

Loan charge-offs during the three months ended June 30, 2014

In the second quarter of 2014, the Company recorded $923,000 in loan charge-offs and $105,000 in deposit overdraft charge-offs less $878,000 in loan recoveries and $88,000 in deposit overdraft recoveries resulting in $62,000 of net loan charge-offs. Primary causes of the loan charges taken in the second quarter of 2014 were gross charge-offs of $44,000 on four commercial real estate loans, $688,000 on 11 home equity lines and loans, $39,000 on nine other consumer loans, and $170,000 on seven C&I loans.

During the first quarter of 2014, there were no individual charges greater than $250,000. Generally losses are triggered by non-performance by the borrower and calculated based on any difference between the current loan amount and the current value of the underlying collateral less any estimated costs associated with the disposition of the collateral.

Differences between the amounts explained in this section and the total charge-offs listed for a particular category are generally made up of individual charges of less than $250,000 each. Generally losses are triggered by non-performance by the borrower and calculated based on any difference between the current loan amount and the current value of the underlying collateral less any estimated costs associated with the disposition of the collateral.

Changes in nonperforming assets during the three months ended March 31, 2014

 

     Balance at             Advances/      Pay-downs           Transfers to           Balance at  
     March 31,      New      Capitalized      /Sales     Charge-offs/     Foreclosed     Category     December 31,  
(In thousands):    2014      NPA      Costs      /Upgrades     Write-downs     Assets     Changes     2013  

Real estate mortgage:

                   

Residential

   $ 4,728       $ 72         —         $ (167   $ (136     —          —        $ 4,959   

Commercial

     31,643         860       $ 4         (1,721     (13   $ (325   $ 967        31,871   

Consumer

                   

Home equity lines

     11,434         1,232         434         (1,351     (178     (221     (83     11,601   

Home equity loans

     716         100         1         (20     —          (167     83        719   

Auto indirect

     44         —           —           (10     —          —          —          54   

Other consumer

     72         48         —           (7     (31     —          —          62   

Commercial

     802         401         417         (109     (239     —          (967     1,299   

Construction:

                   

Residential

     2,510         4         —           (9     (4     —          46        2,473   

Commercial

     19         69         —           (113     (69     —        $ (46     178   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     51,968         2,786         856         (3,507     (670     (713     —          53,216   

Noncovered foreclosed assets

     2,551         —           462         (4,186     (26   $ 713        —          5,588   

Covered foreclosed assets

     664         —           —           —          (10     —          —          674   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 55,183       $ 2,786       $ 1,318       $ (7,693   $ (706     —          —        $ 59,478   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Nonperforming assets decreased during the first quarter of 2014 by $4,295,000 (7.22%) to $55,183,000 at March 31, 2014 compared to $59,478,000 at December 31, 2013. The decrease in nonperforming assets during the first quarter of 2014 was primarily the result of new nonperforming loans of $2,786,000, advances on existing nonperforming loans and capitalized costs on foreclosed assets of $1,318,000, less pay-downs, sales or upgrades of nonperforming loans to performing status totaling $3,045,000, less dispositions of foreclosed assets totaling $4,187,000, less loan charge-offs of $670,000, and less write-downs of foreclosed assets of $36,000.

The $2,786,000 in new nonperforming loans during the first quarter of 2014 was comprised of increases of $72,000 on one residential real estate loan, $860,000 on six commercial real estate loans, $1,332,000 on 17 home equity lines and loans, $48,000 on 14 consumer loans, $401,000 on nine C&I loans, $4,000 on one residential construction loan, and $69,000 on one commercial construction loan.

The $860,000 in new nonperforming commercial real estate loans was primarily made up of two loans totaling $514,000 secured by agricultural production land in central California. Related charge-offs are discussed below.

Loan charge-offs during the three months ended March 31, 2014

In the first quarter of 2014, the Company recorded $670,000 in loan charge-offs and $96,000 in deposit overdraft charge-offs less $2,068,000 in loan recoveries and $130,000 in deposit overdraft recoveries resulting in $1,432,000 of net loan recoveries. Primary causes of the loan charges taken in the first quarter of 2014 were gross charge-offs of $136,000 on one residential real estate loan, $13,000 on one commercial real estate loan, $178,000 on 7 home equity lines and loans, $31,000 on 14 other consumer loans, $239,000 on eight C&I loans, $4,000 on one residential construction loan, and $69,000 on one commercial construction loan.

During the first quarter of 2014, there were no individual charges greater than $250,000. Generally losses are triggered by non-performance by the borrower and calculated based on any difference between the current loan amount and the current value of the underlying collateral less any estimated costs associated with the disposition of the collateral.

Differences between the amounts explained in this section and the total charge-offs listed for a particular category are generally made up of individual charges of less than $250,000 each. Generally losses are triggered by non-performance by the borrower and calculated based on any difference between the current loan amount and the current value of the underlying collateral less any estimated costs associated with the disposition of the collateral.

Allowance for Loan Losses

The Company’s allowance for loan losses is comprised of allowances for originated, PNCI and PCI loans. All such allowances are established through a provision for loan losses charged to expense.

Originated and PNCI loans, and deposit related overdrafts are charged against the allowance for originated loan losses when Management believes that the collectability of the principal is unlikely or, with respect to consumer installment loans, according to an established delinquency schedule. The allowances for originated and PNCI loan losses are amounts that Management believes will be adequate to absorb probable losses inherent in existing originated loans, based on evaluations of the collectability, impairment and prior loss experience of those loans and leases. The evaluations take into consideration such factors as changes in the nature and size of the portfolio, overall portfolio quality, loan concentrations, specific problem loans, and current economic conditions that may affect the borrower’s ability to pay. The Company defines an originated or PNCI loan as impaired when it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired originated and PNCI loans are measured based on the present value of expected future cash flows discounted at the loan’s original effective interest rate. As a practical expedient, impairment may be measured based on the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance.

In situations related to originated and PNCI loans where, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession for other than an insignificant period of time to the borrower that the Company would not otherwise consider, the related loan is classified as a troubled debt restructuring (TDR). The Company strives to identify borrowers in financial difficulty early and work with them to modify to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where the Company grants the borrower new terms that provide for a reduction of either interest or principal, the Company measures any impairment on the restructuring as noted above for impaired loans. TDR loans are classified as impaired until they are fully paid off or charged off. Loans that are in nonaccrual status at the time they become TDR loans, remain in nonaccrual status until the borrower demonstrates a sustained period of performance which the Company generally believes to be six consecutive months of payments, or equivalent. Otherwise, TDR loans are subject to the same nonaccrual and charge-off policies as noted above with respect to their restructured principal balance.

Credit risk is inherent in the business of lending. As a result, the Company maintains an allowance for loan losses to absorb losses inherent in the Company’s originated and PNCI loan portfolios. These are maintained through periodic charges to earnings. These charges are included in the Consolidated Income Statements as provision for loan losses. All specifically identifiable and quantifiable losses are immediately charged off against the allowance. However, for a variety of reasons, not all losses are immediately known to the Company and, of those that are known, the full extent of the loss may not be quantifiable at that point in time. The balance of the Company’s allowances for originated and PNCI loan losses are meant to be an estimate of these unknown but probable losses inherent in these portfolios.

The Company formally assesses the adequacy of the allowance for originated and PNCI loan losses on a quarterly basis. Determination of the adequacy is based on ongoing assessments of the probable risk in the outstanding originated and PNCI loan portfolios, and to a lesser extent the Company’s originated and PNCI loan commitments. These assessments include the periodic re-grading of credits based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors,

 

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changes in the interest rate environment, growth of the portfolio as a whole or by segment, and other factors as warranted. Loans are initially graded when originated or acquired. They are re-graded as they are renewed, when there is a new loan to the same borrower, when identified facts demonstrate heightened risk of nonpayment, or if they become delinquent. Re-grading of larger problem loans occurs at least quarterly. Confirmation of the quality of the grading process is obtained by independent credit reviews conducted by consultants specifically hired for this purpose and by various bank regulatory agencies.

The Company’s method for assessing the appropriateness of the allowance for originated and PNCI loan losses includes specific allowances for impaired loans and leases, formula allowance factors for pools of credits, and allowances for changing environmental factors (e.g., interest rates, growth, economic conditions, etc.). Allowance factors for loan pools are based on historical loss experience by product type and prior risk rating. Allowances for impaired loans are based on analysis of individual credits. Allowances for changing environmental factors are Management’s best estimate of the probable impact these changes have had on the originated or PNCI loan portfolio as a whole. The allowances for originated and PNCI loans are included in the allowance for loan losses.

As noted above, the allowances for originated and PNCI loan losses consists of a specific allowance, a formula allowance, and an allowance for environmental factors. The first component, the specific allowance, results from the analysis of identified credits that meet management’s criteria for specific evaluation. These loans are reviewed individually to determine if such loans are considered impaired. Impaired loans are those where management has concluded that it is probable that the borrower will be unable to pay all amounts due under the contractual terms. Impaired loans are specifically reviewed and evaluated individually by management for loss potential by evaluating sources of repayment, including collateral as applicable, and a specified allowance for loan losses is established where necessary.

During the three months ended March 31, 2013, the Company changed the method it uses to estimate net sale proceeds from real estate collateral sales when calculating the allowance for loan losses associated with impaired real estate collateral dependent loans. Previously, the Company used the greater of fifteen percent or actual estimated selling costs. Currently, the Company uses the actual estimated selling costs, and an adjustment to appraised value based on the age of the appraisal. These changes are intended to more accurately reflect the estimated net sale proceeds from the sale of impaired collateral dependent real estate loans. This change in methodology resulted in the allowance for loan losses as of March 31, 2013 being $494,000 more than it would have been without this change in methodology.

The second component of the allowance for originated and PNCI loan losses, the formula allowance, is an estimate of the probable losses that have occurred across the major loan categories in the Company’s originated and PNCI loan portfolios. This analysis is based on loan grades by pool and the loss history of these pools. This analysis covers the Company’s entire originated and PNCI loan portfolios including unused commitments but excludes any loans that were analyzed individually and assigned a specific allowance as discussed above. The total amount allocated for this component is determined by applying loss estimation factors to outstanding loans and loan commitments. The loss factors were previously based primarily on the Company’s historical loss experience tracked over a five-year period and adjusted as appropriate for the input of current trends and events. Because historical loss experience varies for the different categories of originated loans, the loss factors applied to each category also differed. In addition, there is a greater chance that the Company would suffer a loss from a loan that was risk rated less than satisfactory than if the loan was last graded satisfactory. Therefore, for any given category, a larger loss estimation factor was applied to less than satisfactory loans than to those that the Company last graded as satisfactory. The resulting formula allowance was the sum of the allocations determined in this manner.

During the three months ended June 30, 2013, the Company modified its loss migration analysis methodology used to determine the formula allowance factors. When the Company originally established its loss migration analysis methodology during the quarter ended March 31, 2012, it reviewed the loss experience of each quarter over the previous three years in order to calculate an annualized loss rate by loan category and risk rating. The use of three years of loss experience data was originally used because that was the extent of the detailed loss data, by loan category and risk rating that was available at the time. This three year historical look-back period was used through the quarter ended March 31, 2013. Starting with the quarter ended June 30, 2013, the Company reviews all available detailed loss experience data, going back to, and including, the quarter end June 30, 2008, and does not limit the look-back period to the most recent three years of historical loss data. Using this data, the Company calculates loss factors for each quarter from the quarter ended June 30, 2009 to the most recent quarter. The Company then calculates a weighted average formula allowance factor for each loan category and risk rating with the most recent quarterly loss factor being weighted 125%, the quarter ended June 30, 2009 loss factor being weighted 75%, and the loss factors for all the quarters between the most recent quarter and the quarter ended June 30, 2009, being weighted on a linear scale from 75% to 125%. This change is intended to more accurately reflect the risk inherent in the loan portfolio by considering historical loss data for all years as the data for new periods becomes available. This change in methodology resulted in the allowance for loan losses as of June 30, 2013 being $1,314,000 more than it would have been without this change in methodology.

During the three months ended June 30, 2014, the Company refined the method it uses to evaluate historical losses for the purpose of estimating the pool allowance for unimpaired loans. In the third quarter of 2010, the Company moved from a six point grading system (Grades A-F) to a nine point risk rating system (Risk Ratings 1-9), primarily to allow for more distinction within the “Pass” risk rating. As there was not initially sufficient loss experience within the nine point scale to complete a migration analysis for all nine risk ratings, all loans risk rated Pass or 2-5 were grouped together, a loss rate was calculated for that group, and that loss rate was established as the rate for risk rating 4. The reserve ratios for risk ratings 2, 3 & 5 were then interpolated from that figure. As of June 30, 2014, the Company was able to compile twelve quarters of historical loss information for all risk ratings, and use that information to calculate the loss rates for each of the nine risk ratings without interpolation. This refinement led to an increase of $1,438,000 in the reserve requirement for unimpaired loans, driven primarily by Consumer loans with a risk rating of 5 or “Pass-Watch.”

The third component of the allowances for originated and PNCI loan losses, the environmental factor allowance, is a component that is not allocated to specific loans or groups of loans, but rather is intended to absorb losses that may not be provided for by the other components.

 

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There are several primary reasons that the other components discussed above might not be sufficient to absorb the losses present in the originated and PNCI loan portfolios, and the environmental factor allowance is used to provide for the losses that have occurred because of them.

The first reason is that there are limitations to any credit risk grading process. The volume of originated and PNCI loans makes it impractical to re-grade every loan every quarter. Therefore, it is possible that some currently performing originated or PNCI loans not recently graded will not be as strong as their last grading and an insufficient portion of the allowance will have been allocated to them. Grading and loan review often must be done without knowing whether all relevant facts are at hand. Troubled borrowers may deliberately or inadvertently omit important information from reports or conversations with lending officers regarding their financial condition and the diminished strength of repayment sources.

The second reason is that the loss estimation factors are based primarily on historical loss totals. As such, the factors may not give sufficient weight to such considerations as the current general economic and business conditions that affect the Company’s borrowers and specific industry conditions that affect borrowers in that industry. The factors might also not give sufficient weight to other environmental factors such as changing economic conditions and interest rates, portfolio growth, entrance into new markets or products, and other characteristics as may be determined by Management.

Specifically, in assessing how much environmental factor allowance needed to be provided, management considered the following:

 

    with respect to the economy, management considered the effects of changes in GDP, unemployment, CPI, debt statistics, housing starts, housing sales, auto sales, agricultural prices, home affordability, and other economic factors which serve as indicators of economic health and trends and which may have an impact on the performance of our borrowers, and

 

    with respect to changes in the interest rate environment, management considered the recent changes in interest rates and the resultant economic impact it may have had on borrowers with high leverage and/or low profitability; and

 

    with respect to changes in energy prices, management considered the effect that increases, decreases or volatility may have on the performance of our borrowers, and

 

    with respect to loans to borrowers in new markets and growth in general, management considered the relatively short seasoning of such loans and the lack of experience with such borrowers, and

 

    with respect to loans that have not yet been identified as impaired, management considered the volume and severity of past due loans.

Each of these considerations was assigned a factor and applied to a portion or the entire originated and PNCI loan portfolios. Since these factors are not derived from experience and are applied to large non-homogeneous groups of loans, they are available for use across the portfolio as a whole.

During the three months ended September 30, 2013, the Company modified its methodology used to determine the allowance for changing environmental factors. Previously, the Company compared the current value of each environmental factor to a fixed baseline value. The deviation of the current value from the baseline value was then multiplied by a conversion factor to determine the required allowance related to each environmental factor. As of September 30, 2013, the Company replaced the fixed baseline values with average baseline values derived from historical averages, and adjusted the conversion factors. This change is intended to more accurately reflect the risk inherent in the portfolio by recognizing that baseline, or normal, levels for environmental factors may change over time. This change in methodology resulted in the allowance for loan losses as of September 30, 2013 being $1,665,000 more than it would have been without this change in methodology.

During the three months ended March 31, 2014, the Company modified its methodology used to determine the allowance for changing environmental factors by adding a new environmental factor based on the California Home Affordability Index (“CHAI”). The CHAI measures the percentage of households in California that can afford to purchase the median priced home in California based on current home prices and mortgage interest rates. The use of the CHAI environmental factor consists of comparing the current CHAI to its historical baseline, and allows management to consider the adverse impact that a lower than historical CHAI may have on general economic activity and the performance of our borrowers. Based on an analysis of historical data, management believes this environmental factor gives a better estimate of current economic activity compared to other environmental factors that may lag current economic activity to some extent. This change in methodology resulted in no change to the allowance for loan losses as of March 31, 2014 compared to what it would have been without this change in methodology.

Acquired loans are valued as of acquisition date in accordance with FASB ASC Topic 805, Business Combinations. Loans purchased with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are referred to as purchased credit impaired (PCI) loans. PCI loans are accounted for under FASB ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. In addition, because of the significant credit discounts associated with the loans acquired in the Granite acquisition, the Company elected to account for all loans acquired in the Granite acquisition under FASB ASC Topic 310-30, and classify them all as PCI loans. Under FASB ASC Topic 805 and FASB ASC Topic 310-30, PCI loans are recorded at fair value at acquisition date, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded as of the acquisition date. Fair value is defined as the present value of the future estimated principal and interest payments of the loan, with the discount rate used in the present value calculation representing the estimated effective yield of the loan. The difference between contractual future payments and estimated future payments is referred to as the nonaccretable difference. The difference between estimated future payments and the present value of the estimated future payments is referred to as the accretable yield. The accretable yield represents the amount that is expected to be recorded as interest income over the remaining life of the loan. If after acquisition, the Company determines that the future cash flows of a PCI loan are expected to be more than the originally estimated, an increase in the discount rate (effective yield) would be made such that the newly increased accretable yield would be recognized, on a level yield basis, over the remaining estimated life of the loan. If after acquisition, the Company determines that the future cash flows of a PCI loan are expected to be less than

 

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the previously estimated, the discount rate would first be reduced until the present value of the reduced cash flow estimate equals the previous present value however, the discount rate may not be lowered below its original level. If the discount rate has been lowered to its original level and the present value has not been sufficiently lowered, an allowance for loan loss would be established through a provision for loan losses charged to expense to decrease the present value to the required level. If the estimated cash flows improve after an allowance has been established for a loan, the allowance may be partially or fully reversed depending on the improvement in the estimated cash flows. Only after the allowance has been fully reversed may the discount rate be increased. PCI loans are put on nonaccrual status when cash flows cannot be reasonably estimated. PCI loans are charged off when evidence suggests cash flows are not recoverable. Foreclosed assets from PCI loans are recorded in foreclosed assets at fair value with the fair value at time of foreclosure representing cash flow from the loan. ASC 310-30 allows PCI loans with similar risk characteristics and acquisition time frame to be “pooled” and have their cash flows aggregated as if they were one loan.

The Components of the Allowance for Loan Losses

The following table sets forth the allowance for loan losses as of the dates indicated:

 

     June 30,     December 31,  
(In thousands)    2014     2013  

Allowance for originated and PNCI loan losses:

    

Specific allowance

   $ 3,940      $ 3,975   

Formula allowance

     26,189        24,611   

Environmental factors allowance

     5,563        5,619   
  

 

 

   

 

 

 

Allowance for originated and PNCI loan losses

     35,692        34,205   

Allowance for PCI loan losses

     4,276        4,040   
  

 

 

   

 

 

 

Allowance for loan losses

   $ 39,968      $ 38,245   
  

 

 

   

 

 

 

Allowance for loan losses to loans

     2.30     2.29

For additional information regarding the allowance for loan losses, including changes in specific, formula, and environmental factors allowance categories, see “Provision for Loan Losses” at “Results of Operations” and “Allowance for Loan Losses” above. Based on the current conditions of the loan portfolio, management believes that the $39,968,000 allowance for loan losses at June 30, 2014 is adequate to absorb probable losses inherent in the Bank’s loan portfolio. No assurance can be given, however, that adverse economic conditions or other circumstances will not result in increased losses in the portfolio.

The following table summarizes the allocation of the allowance for loan losses between loan types as of the dates indicated:

 

(In thousands)    June 30,
2014
     December 31,
2013
 

Real estate mortgage

   $ 12,663       $ 12,854   

Consumer

     20,050         18,238   

Commercial

     4,407         4,331   

Real estate construction

     2,848         2,822   
  

 

 

    

 

 

 

Total allowance for loan losses

   $ 39,968       $ 38,245   
  

 

 

    

 

 

 

The following table summarizes the allocation of the allowance for loan losses between loan types as a percentage of the total allowance for loan losses as of the dates indicated:

 

(In thousands)    June 30,
2014
    December 31,
2013
 

Real estate mortgage

     31.7     33.6

Consumer

     50.2     47.7

Commercial

     11.0     11.3

Real estate construction

     7.1     7.4
  

 

 

   

 

 

 

Total allowance for loan losses

     100.0     100.0
  

 

 

   

 

 

 

The following table summarizes the allocation of the allowance for loan losses as a percentage of the total loans for each loan category as of the dates indicated:

 

(In thousands)    June 30,
2014
    December 31,
2013
 

Real estate mortgage

     1.08     1.16

Consumer

     5.32     4.76

Commercial

     3.21     3.28

Real estate construction

     5.06     5.75
  

 

 

   

 

 

 

Total allowance for loan losses

     2.30     2.29
  

 

 

   

 

 

 

 

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The following tables summarize the activity in the allowance for loan losses, reserve for unfunded commitments, and allowance for losses (which is comprised of the allowance for loan losses and the reserve for unfunded commitments) for the periods indicated (in thousands):

 

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

Allowance for loan losses:

        

Balance at beginning of period

   $ 38,322      $ 39,867      $ 38,245      $ 42,648   

Provision for loan losses

     1,708        614        353        (494

Loans charged off:

        

Real estate mortgage:

        

Residential

     (1     (35     (136     (42

Commercial

     (45     (886     (58     (1,689

Consumer:

        

Home equity lines

     (677     (746     (855     (1,512

Home equity loans

     (11     —          (11     (26

Auto indirect

     —          (33     —          (58

Other consumer

     (144     (212     (271     (485

Commercial

     (151     (35     (390     (825

Construction:

        

Residential

     —          —          (4     (20

Commercial

     —          —          (69     (61
  

 

 

   

 

 

   

 

 

   

 

 

 

Total loans charged off

     (1,029     (1,947     (1,794     (4,718

Recoveries of previously charged-off loans:

        

Real estate mortgage:

        

Residential

     —          191        —          191   

Commercial

     299        317        471        670   

Consumer:

        

Home equity lines

     180        215        509        505   

Home equity loans

     25        17        27        26   

Auto indirect

     39        61        51        146   

Other consumer

     119        178        302        402   

Commercial

     188        66        1,061        136   

Construction:

        

Residential

     97        —          608        61   

Commercial

     20        20        135        26   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries of previously charged off loans

     967        1,065        3,164        2,163   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (62     (882     1,370        (2,555
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 39,968      $ 39,599      $ 39,968      $ 39,599   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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

Reserve for unfunded commitments:

        

Balance at beginning of period

   $ 2,230      $ 3,175      $ 2,415      $ 3,615   

Provision for losses –unfunded commitments

     (185     35        (370     (405
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 2,045      $ 3,210      $ 2,045      $ 3,210   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period:

        

Allowance for loan losses

       $ 39,968      $ 39,599   

Reserve for unfunded commitments

         2,045        3,210   
      

 

 

   

 

 

 

Allowance for loan losses and Reserve for unfunded commitments

       $ 42,013      $ 42,809   
      

 

 

   

 

 

 

As a percentage of total loans at end of period:

        

Allowance for loan losses

         2.30     2.40

Reserve for unfunded commitments

         0.12     0.19
      

 

 

   

 

 

 

Allowance for loan losses and Reserve for unfunded commitments

         2.42     2.59
      

 

 

   

 

 

 

Average total loans

   $ 1,714,061      $ 1,608,511      $ 1,692,646      $ 1,578,538   

Ratios (annualized):

        

Net charge-offs during period to average loans outstanding during period

     0.01     0.22     (0.16 )%      0.32

(Benefit from) provision for loan losses to average loans outstanding

     0.40     0.15     0.04     (0.06 )% 

 

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Foreclosed Assets, Net of Allowance for Losses

The following tables detail the components and summarize the activity in foreclosed assets, net of allowances for losses for the years indicated (dollars in thousands):

 

     Balance at             Advances/                                Balance at  
     June 30,      New      Capitalized            Valuation     Transfers      Category      March 31,  
(dollars in thousands):    2014      NPA      Costs      Sales     Adjustments     from Loans      Changes      2014  

Noncovered:

                     

Land & Construction

   $ 1,969         —           —         $ (453   $ (1   $ 1,845         —         $ 578   

Residential real estate

     1,526         —           —           (235     (1     116         —           1,646   

Commercial real estate

     1,769         —           —           —          —          1,442         —           327   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total noncovered

     5,264         —           —           (688     (2     3,403         —           2,551   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Covered:

                     

Land & Construction

     521         —           —           (142     (1     —           —           664   

Residential real estate

     —           —           —           —          —          —           —           —     

Commercial real estate

     —           —           —           —          —          —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total covered

     521         —           —           (142     (1     —           —           664   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total foreclosed assets

   $ 5,785         —           —         $ (830   $ (3   $ 3,403         —         $ 3,215   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 
     Balance at             Advances/                                Balance at  
     March 31,      New      Capitalized            Valuation     Transfers      Category      December 31,  
(dollars in thousands):    2014      NPA      Costs      Sales     Adjustments     from Loans      Changes      2013  

Noncovered:

                     

Land & Construction

   $ 578         —           —           —          —          —           —         $ 578   

Residential real estate

     1,646         —         $ 462       $ (1,123   $ (25   $ 388         —           1,944   

Commercial real estate

     327         —           —           (3,063     (1     325         —           3,066   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total noncovered

     2,551         —           462         (4,186     (26     713         —           5,588   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Covered:

                     

Land & Construction

     664         —           —           —          (10     —           —           674   

Residential real estate

     —           —           —           —          —          —           —           —     

Commercial real estate

     —           —           —           —          —          —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total covered

     664         —           —           —          (10     —           —           674   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total foreclosed assets

   $ 3,215         —         $ 462       $ (4,186   $ (36   $ 713         —         $ 6,262   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Premises and Equipment

Premises and equipment were comprised of:

 

     June 30,     December 31,  
(In thousands)    2014     2013  

Land & land improvements

   $ 5,956      $ 5,975   

Buildings

     30,025        30,103   

Furniture and equipment

     28,223        27,881   
  

 

 

   

 

 

 
     64,204        63,959   

Less: Accumulated depreciation

     (32,423     (32,397
  

 

 

   

 

 

 
     31,781        31,562   

Construction in progress

     99        50   
  

 

 

   

 

 

 

Total premises and equipment

   $ 31,880      $ 31,612   
  

 

 

   

 

 

 

During the six months ended June 30, 2014, premises and equipment increased $268,000 due to purchases of $2,483,000, that were partially offset by depreciation of $2,165,000 and disposals of premises and equipment with net book value of $50,000. Included in the depreciation expense of $2,165,000 during the six months ended June 30, 2014 was $238,000 of accelerated depreciation of leasehold improvements taken on two branches that were closed during the quarter ended March 31, 2014.

Intangible Assets

Intangible assets were comprised of the following as of the dates indicated:

 

     June 30,      December 31,  
(In thousands)    2014      2013  

Core-deposit intangible

   $ 779       $ 883   

Goodwill

     15,519         15,519   
  

 

 

    

 

 

 

Total intangible assets

   $ 16,298       $ 16,402   
  

 

 

    

 

 

 

The core-deposit intangible assets resulted from the Bank’s acquisitions of Citizens in 2011 and Granite in 2010. The goodwill intangible asset resulted from the North State National Bank acquisition in 2003. Amortization of core deposit intangible assets amounting to $52,000 and $53,000 were recorded during the three months ended June 30, 2014 and 2013, respectively. Amortization of core deposit intangible assets amounting to $104,000 and $105,000 were recorded during the six months ended June 30, 2014 and 2013, respectively.

 

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Deposits

Deposits at June 30, 2014 decreased $25,287,000 (1.1%) from the 2013 year-end balances to $2,385,196,000. Interest-bearing demand and savings deposits were up, while noninterest-bearing demand and time deposits down at June 30, 2014 when compared to December 31, 2013. Included in the June 30, 2014 and December 31, 2013 certificate of deposit balances are $5,000,000 from the State of California. The Bank participates in a deposit program offered by the State of California whereby the State may make deposits at the Bank’s request subject to collateral and creditworthiness constraints. The negotiated rates on these State deposits are generally more favorable than other wholesale funding sources available to the Bank.

Long-Term Debt

See Note 16 to the condensed consolidated financial statements at Item 1 of Part I of this report for information about the Company’s other borrowings, including long-term debt.

Junior Subordinated Debt

See Note 17 to the condensed consolidated financial statements at Item 1 of Part I of this report for information about the Company’s junior subordinated debt.

Off-Balance Sheet Arrangements

See Note 18 to the condensed consolidated financial statements at Item 1 of Part I of this report for information about the Company’s commitments and contingencies including off-balance-sheet arrangements.

Capital Resources

The current and projected capital position of the Company and the impact of capital plans and long-term strategies are reviewed regularly by Management.

The Company adopted and announced a stock repurchase plan on August 21, 2007 for the repurchase of up to 500,000 shares of the Company’s common stock from time to time as market conditions allow. The 500,000 shares authorized for repurchase under this plan represented approximately 3.2% of the Company’s approximately 15,815,000 common shares outstanding as of August 21, 2007. The Company did not repurchase any shares during the six months ended June 30, 2014. This plan has no stated expiration date for the repurchases. As of June 30, 2014, the Company had repurchased 166,600 shares under this plan, which left 333,400 shares available for repurchase under the plan. Shares that are repurchased in accordance with the provisions of a Company stock option plan or equity compensation plan are not counted against the number of shares repurchased under the repurchase plan adopted on August 21, 2007.

The Company’s primary capital resource is shareholders’ equity, which was $260,943,000 at June 30, 2014. This amount represents an increase of $9,997,000 (4.0%) from December 31, 2013, the net result of comprehensive income for the period of $12,555,000, and the effect of stock option vesting and tax benefits of $754,000, and the exercise of stock options of $2,786,000, that were partially offset by dividends paid of $3,547,000, and the repurchase of common stock as it was tendered in lieu of cash to exercise stock options and pay related taxes of $2,551,000. The Company’s ratio of equity to total assets was 9.58% and 9.15% as of June 30, 2014 and December 31, 2013, respectively.

The following summarizes the Company’s ratios of capital to risk-adjusted assets as of the dates indicated:

 

     As of     As     Minimum  
     June 30,     December 31,     Regulatory  
     2014     2013     Requirement  

Total Capital

     14.64     14.77     8.00

Tier I Capital

     13.39     13.51     4.00

Leverage ratio

     10.36     10.17     4.00

See Note 19 and Note 29 to the condensed consolidated financial statements at Item 1 of Part I of this report for additional information about the Company’s capital resources.

On July 2, 2013, the Federal Reserve approved final rules that substantially amend the regulatory risk-based capital rules applicable to the Company and the Bank. The FDIC has subsequently approved these rules. The final rules were adopted following the issuance of proposed rules by the Federal Reserve in June 2012, and implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. “Basel III” refers to two consultative documents released by the Basel Committee on Banking Supervision in December 2009, the rules text released in December 2010, and loss absorbency rules issued in January 2011, which include significant changes to bank capital, leverage and liquidity requirements.

The rules include new risk-based capital and leverage ratios, which would be phased in from 2015 to 2019, and would refine the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital level requirements applicable to the Company and the Bank under the final rules would be: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. The final rules also establish a “capital conservation buffer” above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital. The capital conservation buffer will be phased-in over four years beginning on January 1, 2016, as follows: the maximum buffer will be 0.625% of risk-weighted assets for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter. This will result in the following minimum ratios beginning in 2019: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. Under the final rules, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

 

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Basel III provides discretion for regulators to impose an additional buffer, the “countercyclical buffer,” of up to 2.5% of common equity Tier 1 capital to take into account the macro-financial environment and periods of excessive credit growth. However, the final rules permit the countercyclical buffer to be applied only to “advanced approach banks” ( i.e., banks with $250 billion or more in total assets or $10 billion or more in total foreign exposures), which currently excludes the Company and the Bank. The final rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses, as well as certain instruments that will no longer qualify as Tier 1 capital, some of which will be phased out over time. However, the final rules provide that small depository institution holding companies with less than $15 billion in total assets as of December 31, 2009 (which includes the Company) will be able to permanently include non-qualifying instruments that were issued and included in Tier 1 or Tier 2 capital prior to May 19, 2010 in additional Tier 1 or Tier 2 capital until they redeem such instruments or until the instruments mature.

The final rules also contain revisions to the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including the Bank, if their capital levels begin to show signs of weakness. These revisions take effect January 1, 2015. Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions will be required to meet the following increased capital level requirements in order to qualify as “well capitalized:” (i) a new common equity Tier 1 capital ratio of 6.5%; (ii) a Tier 1 capital ratio of 8% (increased from 6%); (iii) a total capital ratio of 10% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 5% (increased from 4%).

The final rules set forth certain changes for the calculation of risk-weighted assets, which the Company will be required to utilize beginning January 1, 2015. The standardized approach final rule utilizes an increased number of credit risk exposure categories and risk weights, and also addresses: (i) an alternative standard of creditworthiness consistent with Section 939A of the Dodd-Frank Act Act; (ii) revisions to recognition of credit risk mitigation; (iii) rules for risk weighting of equity exposures and past due loans; (iv) revised capital treatment for derivatives and repo-style transactions; and (v) disclosure requirements for top-tier banking organizations with $50 billion or more in total assets that are not subject to the “advance approach rules” that apply to banks with greater than $250 billion in consolidated assets. Based on the Company’s current capital composition and levels, the Company believes that it would be in compliance with the requirements as set forth in the final rules if they were presently in effect.

Liquidity

The Bank’s principal source of asset liquidity is cash at Federal Reserve and other banks and marketable investment securities available for sale. At June 30, 2014, cash at Federal Reserve and other banks in excess of reserve requirements and investment securities available for sale totaled $393,378,000, representing a decrease of $271,278,000 (40.8%) from December 31, 2013. This decrease in cash and securities available for sale is due mainly to increases in investments held to maturity and loans during the six months ended June 30, 2014. In addition, the Company generates additional liquidity from its operating activities. The Company’s profitability during the first six months of 2014 generated cash flows from operations of $11,401,000 compared to $17,574,000 during the first six months of 2013. Maturities of investment securities produced cash inflows of $23,012,000 during the six months ended June 30, 2014 compared to $31,689,000 for the six months ended June 30, 2013. During the six months ended June 30, 2014, the Company invested $193,092,000 in securities and $69,325,000 in loans net of loan principal reductions, compared to $85,393,000 invested in securities and $96,937,000 invested in loans during the six months ended June 30, 2013. Proceeds from the sale of foreclosed assets accounted for $6,483,000 and $10,202,000 of investing sources of funds during the six months ended June 30, 2014 and 2013, respectively. These changes in investment and loan balances, and proceeds from sale of foreclosed assets, contributed to net cash used by investing activities of $236,747,000 and $145,431,000 during the six months ended June 30, 2014 and 2013, respectively. Financing activities used net cash of $28,639,000 and $28,887,000 during the six months ended June 30, 2014 and 2013, respectively. Deposit balance decreases used $25,287,000 and $23,000,000 during the six months ended June 30, 2014 and 2013, respectively. Net decreases in other borrowings accounted for the use of $260,000 and $2,622,000 during the six months ended June 30, 2014 and 2013, respectively. Dividends paid used $3,547,000 and $3,207,000 of cash during the six months ended June 30, 2014 and 2013, respectively. The Company’s liquidity is dependent on dividends received from the Bank. Dividends from the Bank are subject to certain regulatory restrictions.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company’s assessment of market risk as of June 30, 2014 indicates there are no material changes in the quantitative and qualitative disclosures from those in our Annual Report on Form 10-K for the year ended December 31, 2013.

Item 4. Controls and Procedures

The Company’s management, including its Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of the Company’s disclosure controls and procedures as of June 30, 2014. Disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are controls and procedures designed to reasonably assure that information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported on a timely basis. Disclosure controls are also designed to reasonably assure that such information is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based upon their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2014.

During the six months ended June 30, 2014, there were no changes in our internal controls or in other factors that have materially affected or are reasonably likely to materially affect our internal controls over financial reporting.

 

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PART II – OTHER INFORMATION

Item 1 – Legal Proceedings

Due to the nature of our business, we are involved in legal proceedings that arise in the ordinary course of our business. While the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flows.

See Note 18 to the condensed consolidated financial statements at Item 1 of Part I of this report, for a discussion of the Company’s involvement in litigation.

Item 1A – Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed under “Part I—Item 1A—Risk Factors” in our Form 10-K for the year ended December 31, 2013 which are incorporated by reference herein. These factors could materially adversely affect our business, financial condition, liquidity, results of operations and capital position, and could cause our actual results to differ materially from our historical results or the results contemplated by the forward-looking statements contained in this report.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

The following table shows information concerning the common stock repurchased by the Company during the three months ended June 30, 2014 pursuant to the Company’s stock repurchase plan adopted on August 21, 2007, which is discussed in more detail under “Capital Resources” in this report and is incorporated herein by reference:

 

                   (c) Total number of         
                   shares purchased as      (d) Maximum number  
                   part of publicly      of shares that may yet  
     (a) Total number      (b) Average price      announced plans or      be purchased under the  

Period

   of shares purchased      paid per share      programs      plans or programs  

Apr. 1-30, 2014

     —           —           —           333,400   

May 1-31, 2014

     —           —           —           333,400   

Jun, 1-30, 2014

     —           —           —           333,400   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     —           —           —           333,400   

Item 6 – Exhibits

 

Exhibit
No.

  

Exhibit

2.1    Purchase and Assumption Agreement Whole Bank All Deposits, among the Federal Deposit Insurance Corporation, receiver of Granite Community Bank, N.A., Granite Bay, California, the Federal Deposit Insurance Corporation and Tri Counties Bank, dated as of May 28, 2010, and related addendum (incorporated by reference to Exhibit 2.1 to TriCo’s Current Report on Form 8-K filed June 3, 2010).
2.2    Purchase and Assumption Agreement Whole Bank All Deposits, among the Federal Deposit Insurance Corporation, receiver of Citizens Bank of Northern California, Nevada City, California, the Federal Deposit Insurance Corporation and Tri Counties Bank, dated as of September 23, 2011, and related addendum (incorporated by reference to Exhibit 2.1 to TriCo’s Current Report on Form 8-K filed September 27, 2011).
2.3    Agreement and Plan of Merger and Reorganization by and between TriCo and North Valley Bancorp dated January 21, 2014 (incorporated by reference to Exhibit 2.1 to TriCo’s Current Report on Form 8-K filed January 21, 2014).
3.1    Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 to TriCo’s Current Report on Form 8-K filed on March 16, 2009).
3.2    Bylaws of TriCo Bancshares, as amended (incorporated by reference to Exhibit 3.1 to TriCo’s Current Report on Form 8-K filed February 17, 2011).
4.1    Certificate of Determination of Preferences of Series AA Junior Participating Preferred Stock (incorporated by reference to Exhibit 3.3 to TriCo’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2001).
4.2    Rights Agreement dated as of June 25, 2001 between TriCo Bancshares and Mellon Investor Services LLC (incorporated by reference to Exhibit 1 to TriCo’s Registration Statement on Form 8-A filed on July 5, 2001).
4.3    Amendment to Rights Agreement dated as of July 8, 2011 between TriCo Bancshares and BNY Mellon Investor Services LLC (incorporated by reference to Exhibit 4.1 to TriCo’s Current Report on Form 8-K filed on July 8, 2011).
4.4    Amended and Restated Form of Right Certificate (incorporated by reference to Exhibit 4.2 to TriCo’s Current Report on Form 8-K filed on July 8, 2011).
4.5    Amendment to Rights Agreement dated June 4, 2014 between TriCo Bancshares and Computershare, Inc. (incorporated by reference to Exhibit 4.3 to TriCo’s Current Report on Form 8-K filed June 4, 2014).
10.2*    Form of Change of Control Agreement dated as of July 17, 2013, among TriCo, Tri Counties Bank and each of Dan Bailey, Craig Carney, Richard O’Sullivan, Thomas Reddish, and Ray Rios (incorporated by reference to Exhibit 10.2 to TriCo’s Current Report on Form 8-K filed on July 23, 2013).
10.5*    TriCo’s 1995 Incentive Stock Option Plan (incorporated by reference to Exhibit 4.1 to TriCo’s Form S-8 Registration Statement dated August 23, 1995 (No. 33-62063)).
10.6*    TriCo’s 2001 Stock Option Plan, as amended (incorporated by reference to Exhibit 10.7 to TriCo’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2005).
10.7*    TriCo’s 2009 Equity Incentive plan, as amended (incorporated by reference to Exhibit 10.2 to TriCo’s Current Report on Form 8-K filed April 3, 2013).    

 

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Item 6 – Exhibits (continued)

 

10.8*    Amended Employment Agreement between TriCo and Richard Smith dated as of March 28, 2013 (incorporated by reference to Exhibit 10.1 to TriCo’s Current Report on Form 8-K filed April 3, 2013).
10.9*    Tri Counties Bank Executive Deferred Compensation Plan restated April 1, 1992, and January 1, 2005 (incorporated by reference to Exhibit 10.9 to TriCo’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005).
10.10*    Tri Counties Bank Deferred Compensation Plan for Directors effective January 1, 2005 (incorporated by reference to Exhibit 10.10 to TriCo’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005).
10.11*    2005 Tri Counties Bank Deferred Compensation Plan for Executives and Directors effective January 1, 2005 (incorporated by reference to Exhibit 10.11 to TriCo’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005).
10.13*    Tri Counties Bank Supplemental Retirement Plan for Directors dated September 1, 1987, as restated January 1, 2001, and amended and restated January 1, 2004 (incorporated by reference to Exhibit 10.12 to TriCo’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2004).
10.14*    2004 TriCo Bancshares Supplemental Retirement Plan for Directors effective January 1, 2004 (incorporated by reference to Exhibit 10.13 to TriCo’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2004).
10.15*    Tri Counties Bank Supplemental Executive Retirement Plan effective September 1, 1987, as amended and restated January 1, 2004 (incorporated by reference to Exhibit 10.14 to TriCo’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2004).
10.16*    2004 TriCo Bancshares Supplemental Executive Retirement Plan effective January 1, 2004 (incorporated by reference to Exhibit 10.15 to TriCo’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2004).
10.17*    Form of Joint Beneficiary Agreement effective March 31, 2003 between Tri Counties Bank and each of George Barstow, Dan Bay, Ron Bee, Craig Carney, Robert Elmore, Greg Gill, Richard Miller, Richard O’Sullivan, Thomas Reddish, Jerald Sax, and Richard Smith (incorporated by reference to Exhibit 10.14 to TriCo’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003).
10.18*    Form of Joint Beneficiary Agreement effective March 31, 2003 between Tri Counties Bank and each of Don Amaral, William Casey, Craig Compton, John Hasbrook, Michael Koehnen, Donald Murphy, Carroll Taresh, and Alex Vereschagin (incorporated by reference to Exhibit 10.15 to TriCo’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003).
10.19*    Form of Tri Counties Bank Executive Long Term Care Agreement effective June 10, 2003 between Tri Counties Bank and each of Craig Carney, Richard Miller, Richard O’Sullivan, and Thomas Reddish (incorporated by reference to Exhibit 10.16 to TriCo’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003).
10.20*    Form of Tri Counties Bank Director Long Term Care Agreement effective June 10, 2003 between Tri Counties Bank and each of Don Amaral, William Casey, Craig Compton, John Hasbrook, Michael Koehnen, Donald Murphy, Carroll Taresh, and Alex Vereschagin (incorporated by reference to Exhibit 10.17 to TriCo’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003).
10.21*    Form of Indemnification Agreement between TriCo Bancshares and its directors and executive officers (incorporated by reference to Exhibit 10.1 to TriCo’s Current Report on Form 8-K filed September 10, 2013).
10.22*    Form of Indemnification Agreement between Tri Counties Bank its directors and executive officers (incorporated by reference to Exhibit 10.2 to TriCo’s Current Report on Form 8-K filed September 10, 2013).
21.1    Tri Counties Bank, a California banking corporation, TriCo Capital Trust I, a Delaware business trust, and TriCo Capital Trust II, a Delaware business trust, are the only subsidiaries of TriCo.
31.1    Rule 13a-14(a)/15d-14(a) Certification of CEO
31.2    Rule 13a-14(a)/15d-14(a) Certification of CFO
32.1    Section 1350 Certification of CEO
32.2    Section 1350 Certification of CFO
101.INS    XBRL Instance Document
101.SCH    XBRL Taxonomy Extension Schema Document
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB    XBRL Taxonomy Extension Label Linkbase Document
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document

 

* Management contract or compensatory plan or arrangement

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

 

     

TRICO BANCSHARES

(Registrant)

Date: August 8, 2014       /s/ Thomas J. Reddish
      Thomas J. Reddish
      Executive Vice President and Chief Financial Officer
      (Duly authorized officer and principal financial officer)

 

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