10-Q 1 v326314_10q.htm FORM 10-Q

 

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 September 30, 2012

 

Commission file number: 000-52098

__________________

 

CHINO COMMERCIAL BANCORP

(Exact name of registrant as specified in its charter)

__________________

 

California   20-4797048
State of incorporation   I.R.S. Employer
Identification Number
     
14245 Pipeline Avenue
Chino, California
  91710
Address of Principal Executive Offices   Zip Code

  

(909) 393-8880

Registrant’s telephone number, including area code

__________________

 

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

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

 

Large accelerated filer ¨ Accelerated filer ¨   Non-accelerated file ¨

 

Smaller Reporting Company x

 

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

 

On October 19, 2012, there were 829,602 shares of Chino Commercial Bancorp Common Stock outstanding.

  

 
 

  

TABLE OF CONTENTS

 

  Page
Part I – Financial Information  1
Item 1. Financial Statements  1
Consolidated Balance Sheets  1
Consolidated Statements of Income  2
Consolidated Statements of Comprehensive Income  3
Consolidated Statements of Changes in Shareholders’ Equity  4
Consolidated Statements of Cash Flows  5
Notes to the Consolidated Financial Statements  6
   
Item 2. Management’s Discussion & Analysis of Financial Condition & Results of Operations 21
Forward Looking Information 21
Recent Developments 21
Overview of the Results of Operations and Financial Condition 22
Earnings Performance 25
Net Interest Income and Net Interest Margin 25
Provision for Loan Losses 29
Non-Interest Income and Non-Interest Margin 30
Provision for Income Taxes 32
Financial Condition 32
Loan Portfolio 32
Off-Balance Sheet Arrangements 33
Non-performing Assets 33
Allowance for Loan Losses 35
Investment Portfolio 36
Deposits 37
Borrowings 38
Shareholders Equity 38
Liquidity 38
Capital Resources 38
   
Item 3. Qualitative & Quantitative Disclosures about Market Risk 42
   
Item 4. Controls and Procedures 42
   
Part II – Other Information 43
Item 1 – Legal Proceedings 43
Item 1A. – Risk Factors 43
Item 2 – Unregistered Sale of Equity Securities and Use of Proceeds 43
Item 3 – Defaults upon Senior Securities 43
Item 4 – (Removed and Reserved) 43
Item 5 – Other Information 43
Item 6 – Exhibits 43
Signatures 44

  

 
 

 

PART 1 – FINANCIAL INFORMATION

Item 1

CHINO COMMERCIAL BANCORP

CONSOLIDATED BALANCE SHEETS

 

    September 30, 2012   December 31, 2011
    (unaudited)   (audited)
ASSETS:                
Cash and due from banks   $ 3,723,692     $ 3,358,177  
Federal funds sold     24,362,107       14,165,877  
Total cash and cash equivalents     28,085,799       17,524,054  
                 
Interest-bearing deposits in other banks     15,736,252       13,339,252  
Investment securities available for sale     2,463,801       2,972,420  
Investment securities held to maturity (fair value approximates                
$5,383,000 at September 30, 2012 and $9,861,000 at December 31, 2011)     5,162,608       9,652,630  
Total investments     23,362,661       25,964,302  
Loans                
Real estate     47,206,181       46,184,898  
Commercial     11,888,615       9,974,353  
Installment     343,986       643,660  
Gross loans     59,438,782       56,802,911  
Unearned fees and discounts     (137,191 )     (29,107 )
Loans net of unearned fees and discount     59,301,591       56,773,804  
Allowance for loan losses     (1,438,319 )     (1,537,963 )
 Net loans     57,863,272       55,235,841  
                 
Accrued interest receivable     254,082       275,976  
Restricted stock     623,300       667,700  
Fixed assets, net     6,309,127       6,443,753  
Foreclosed assets     0       439,317  
Prepaid & other assets     2,763,820       3,154,650  
Total assets   $ 119,262,061     $ 109,705,593  
                 
LIABILITIES:                
Deposits                
Non-interest bearing   $ 51,053,088     $ 47,188,644  
Interest bearing                
NOW and money market     37,870,150       32,241,986  
Savings     1,965,306       1,809,536  
Time deposits less than $100,000     4,379,976       4,700,126  
Time deposits of $100,000 or greater     11,509,110       12,163,266  
Total deposits     106,777,630       98,103,558  
                 
Accrued interest payable     35,314       139,646  
Accrued expenses & other payables     738,591       897,363  
Subordinated notes payable to subsidiary trust     3,093,000       3,093,000  
Total liabilities     110,644,535       102,233,567  
SHAREHOLDERS' EQUITY                
Common stock, authorized 10,000,000 shares with no par value, issued and outstanding 829,602 shares and 749,540 shares at September 30, 2012 and December 31, 2011, respectively.     3,429,254       2,760,813  
Retained earnings     5,113,579       4,631,609  
Accumulated other comprehensive income     74,693       79,604  
Total shareholders' equity     8,617,526       7,472,026  
Total liabilities & shareholders' equity   $ 119,262,061     $ 109,705,593  

 

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

 

1
 

 
CHINO COMMERCIAL BANCORP

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

 

   For the three months ended  For the nine months ended
   September 30  September 30
   2012  2011  2012  2011
Interest income                    
Investment securities and due from banks  $82,697   $133,204   $277,759   $455,931 
Interest on Federal funds sold   10,280    4,616    30,102    8,651 
Interest and fee income on loans   931,264    877,470    2,691,575    2,793,245 
Total interest income   1,024,241    1,015,290    2,999,436    3,257,827 
Interest expense                    
Deposits   83,041    94,013    248,643    307,740 
Other interest expense   0    0    0    75 
Other borrowings   17,327    50,963    52,795    152,888 
Total interest expense   100,368    144,976    301,438    460,703 
Net interest income   923,873    870,314    2,697,998    2,797,124 
Provision for loan losses   76    2,221    2,048    281,660 
Net interest income after                    
provision for loan losses   923,797    868,093    2,695,950    2,515,464 
Non-interest income                    
Service charges on deposit accounts   286,132    298,241    876,973    892,317 
Gain on sale of foreclosed assets   0    0    93,871    61,151 
Other miscellaneous income   8,415    9,299    66,164    24,805 
Dividend income from restricted stock   2,996    2,783    12,959    8,342 
Income from bank-owned life insurance   16,790    17,332    51,141    52,153 
Total non-interest income   314,333    327,655    1,101,108    1,038,768 
Non-interest expenses                    
Salaries and employee benefits   513,382    538,909    1,633,223    1,647,203 
Occupancy and equipment   111,905    98,992    318,971    325,794 
Data and item processing   92,848    86,777    265,691    277,962 
Advertising and marketing   13,919    14,947    38,824    42,183 
Legal and professional fees   76,224    108,861    212,983    311,084 
Regulatory assessments   54,872    26,051    166,195    177,418 
Insurance   12,062    10,587    36,497    30,236 
Directors' fees and expenses   27,167    17,321    80,207    54,097 
Other expenses   93,364    109,044    283,753    282,784 
Total non-interest expenses   995,743    1,011,489    3,036,344    3,148,761 
Income before income tax expense   242,387    184,259    760,714    405,471 
Income tax expense   88,571    64,146    278,744    131,997 
Net income  $153,816   $120,113   $481,970   $273,474 
Basic earnings per share  $0.19   $0.16   $0.60   $0.37 
Diluted earnings per share  $0.19   $0.16   $0.59   $0.37 

 

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

 

2
 

  

CHINO COMMERCIAL BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

 

   For the three months ended  For the nine months ended
   September 30  September 30
   2012  2011  2012  2011
             
             
Net income  $153,816   $120,113   $481,970   $273,474 
                     
Other comprehensive income (loss), net of tax effects                    
Net unrealized holding gains (losses) on securities                    
available for sale during the period (tax effects of                    
($3,887) and ($3,435) for three and nine months ended September 30,               
2012, respectively and $2,110 and $5,851 for three and                    
nine months ended September 30, 2011, respectively).   (5,561)   3,015    (4,911)   8,366 
                     
Total comprehensive income  $148,255   $123,128   $477,059   $281,840 

 

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

 

3
 

 
CHINO COMMERICAL BANCORP

CONSOLIDATED STATEMENTS OF CHANGES

IN SHAREHOLDERS’ EQUITY

 

            Accumulated   
            Other   
   Number of  Common  Retained  Comprehensive   
   Shares  Stock  Earnings  Income  Total
Balance at December 31, 2010 (audited)   748,314   $2,750,285   $4,190,208   $75,764   $7,016,257 
                          
Net income             441,401         441,401 
                          
Change in unrealized gain on securities                         
available for sale, net of tax                  3,840    3,840 
                          
Exercise of stock options, including                         
tax benefit   1,226    10,528              10,528 
Balance at December 31, 2011 (audited)   749,540    2,760,813    4,631,609    79,604    7,472,026 
                          
Net income             481,970         481,970 
                          
Change in unrealized gain on securities                         
available for sale, net of tax                  (4,911)   (4,911)
                          
Secondary stock offering   80,062    668,441              668,441 
Balance at September 30, 2012 (unaudited)   829,602   $3,429,254   $5,113,579   $74,693   $8,617,526 

 

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

 

4
 

 

CHINO COMMERCIAL BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

   Nine Months Ended September 30,
   2012  2011
Cash Flows from Operating Activities          
Net income  $481,970   $273,474 
Adjustments to reconcile net income to net cash provided          
by operating activities:          
Provision for loan losses   2,048    281,660 
Depreciation and amortization   170,965    167,895 
Net amortization of investment securities   48,130    49,669 
Amortization of deferred loan (fees) costs   108,084    (737)
Loss on disposition of equipment   204    314 
Gain on sale of foreclosed assets   (93,871)   (61,151)
Deferred income tax expense (benefit)   155,841    (59,936)
Net changes in:          
Accrued interest receivable   21,894    106,083 
Other assets   238,425    118,384 
Accrued interest payable   (104,332)   4,458 
Other liabilities   (158,772)   59,249 
Net cash provided by operating activities   870,586    939,362 
           
Cash Flows from Investing Activities          
Net change in interest-bearing deposits in other banks   (2,397,000)   7,685,000 
Activity in investment securities available for sale          
Repayments and calls   486,332    1,420,499 
Activity in  investment securities held to maturity          
Repayments and calls   4,455,831    1,630,942 
Redemption (purchases) of stock investments, restricted   44,400    (41,450)
Loan originations and principal collections, net   (2,737,563)   3,009,481 
Proceeds from sale of foreclosed assets   533,188    577,685 
Purchase of premises and equipment   (36,543)   (325,730)
Net cash provided by investing activities   348,645    13,956,427 
           
Cash Flows from Financing Activities          
Net change in deposits   8,674,072    (8,084,412)
Proceeds from stock offering, net of capital raising costs   668,442    0 
Net cash provided (used) by financing activities   9,342,514    (8,084,412)
Net increase in cash and cash equivalents   10,561,745    6,811,377 
           
Cash and Cash Equivalents at Beginning of Period   17,524,054    7,701,641 
Cash and Cash Equivalents at End of Period  $28,085,799   $14,513,018 
           
Supplemental Information          
Interest paid  $405,770   $456,245 
Income taxes paid  $133,000   $77,000 
Supplemental Disclosures of Noncash Investing and Financing Activities          
Loans transferred to other real estate owned  $—     $439,317 
Loans to facilitate the sale of foreclosed assets  $427,500   $—   

 

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

 

5
 

  

CHINO COMMERCIAL BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

 

Note 1 – The Business of Chino Commercial Bancorp

 

Chino Commercial Bancorp (the “Company”) is a California corporation headquartered in Chino, California, and is a registered bank holding company under federal banking laws. The Company was formed to serve as the holding company for Chino Commercial Bank, N.A. (the “Bank”), and has been the Bank’s sole shareholder since July 2006. The Company’s principal subsidiary is the Bank, and the Company exists primarily for the purpose of holding the stock of the Bank and of such other subsidiaries it may acquire or establish. The Company’s principal source of income is dividends and tax equalization payments from the Bank, although supplemental sources of income may be explored in the future. The expenditures of the Company, including (but not limited to) the payment of dividends to shareholders, if and when declared by the Board of Directors, the cost of servicing debt, legal fees, audit fees, and shareholder costs will generally be paid from dividends paid to the Company by the Bank.

 

The Company’s only other direct subsidiary is Chino Statutory Trust I, which was formed in 2006 solely to facilitate the issuance of capital trust pass-through securities. This additional regulatory capital enhances the Company’s ability to maintain favorable risk-based capital ratios. Pursuant to the Accounting Standards Codification (ASC) 810, Consolidation, Chino Statutory Trust I is not reflected on a consolidated basis in the consolidated financial statements of the Company.

 

The Company’s Administrative Offices are located at 14245 Pipeline Avenue, Chino, California and the telephone number is (909) 393-8880. References herein to the “Company” include Chino Commercial Bancorp and its consolidated subsidiary, unless the context indicates otherwise.

 

The Bank is a national bank which was organized under the laws of the United States in December 1999 and commenced operations on September 1, 2000. The Bank operates three full-service banking offices. The Bank’s main branch office and administrative offices are located at 14245 Pipeline Avenue, Chino, California. In January 2006 the Bank opened its Ontario branch located at 1551 South Grove Avenue, Ontario, California and in April 2010 the Bank opened its Rancho Cucamonga branch located at 8229 Rochester Avenue, Rancho Cucamonga, California. In July 2010, the Company acquired property at 14245 Pipeline Avenue, Chino, California, which became the main branch and administrative headquarters in January 2011.

 

As a community-oriented bank, the Bank offers a wide array of commercial and consumer services which would generally be offered by a locally-managed, independently-operated bank.

 

Note 2 – Basis of Presentation

 

The accompanying unaudited consolidated financial statements for the three and nine months ended September 30, 2012 and 2011 have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial statements. They do not, however, include all of the information and footnotes required by such accounting principles for complete financial statements. In the opinion of management, all adjustments including normal recurring accruals considered necessary for a fair presentation have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for any other interim period or for the year as a whole. Certain prior period amounts have been reclassified to conform to current period classification. The interim financial information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the Securities and Exchange Commission.

 

Note 3 – Critical Accounting Policies:

 

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the Company’s financial statements and accompanying notes. Various elements of the Company’s accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. Critical accounting policies are those that involve the most complex and subjective decisions and assessments and have the greatest potential impact on the Company’s results of operation. There were no significant changes to the Company’s critical accounting policies discussed in the Form 10-K for the year ended December 31, 2011.

 

6
 

 

Note 4 – Recent Accounting Pronouncements:

In December 2011, the FASB issued new guidance ASU No. 2011-11- “Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities.” This new guidance requires expanded information about financial instruments or derivatives that are either presented on a net basis in the balance sheet or subject to an enforceable master netting arrangement or similar arrangement. The new guidance does not change existing offsetting criteria in U.S. GAAP or the permitted balance sheet presentation for items meeting the criteria. The new disclosure requirements in the ASU are intended to enhance comparability between financial statements prepared using U.S. GAAP and those prepared using IFRS. The Company does not expect this guidance to have a material impact on its consolidated financial statements.

 

Note 5 – Investment Securities

    

The amortized cost and fair value of investment securities at September 30, 2012 are as follows:

 

      Gross  Gross   
   Amortized  Unrealized  Unrealized  Fair
   Cost  Gains  Losses  Value
Securities available for sale:                    
Municipal bonds  $743,487   $53,616   $—     $797,103 
Mortgage-backed securities   1,593,394    73,304    —      1,666,698 
   $2,336,881   $126,920   $—     $2,463,801 
                     
Securities held to maturity:                    
Municipal bonds  $330,000   $706   $—     $330,706 
Mortgage-backed securities   4,832,608    220,004    —      5,052,612 
   $5,162,608   $220,710   $—     $5,383,318 

  

 

The amortized cost and fair value of investment securities at December 31, 2011 are as follows:

 

      Gross  Gross   
   Amortized  Unrealized  Unrealized  Fair
   Cost  Gains  Losses  Value
Securities available for sale:                    
Municipal bonds  $743,407   $52,691   $—     $796,098 
Mortgage-backed securities   2,093,745    82,664    (87)   2,176,322 
   $2,837,152   $135,355   $(87)  $2,972,420 
                     
Securities held to maturity:                    
Municipal bonds  $431,986   $3,705   $—     $435,691 
Federal agency   2,500,000    14,528    —      2,514,528 
Mortgage-backed securities   6,690,284    188,956    —      6,879,240 
Corporate   30,360    715    —      31,075 
   $9,652,630   $207,904   $—     $9,860,534 

 

 

7
 

 

The amortized cost and fair value of investment securities as of September 30, 2012 by contractual maturity are shown below:

 

   Available for Sale  Held to Maturity
   Amortized  Fair  Amortized  Fair
   Cost  Value  Cost  Value
             
Within 1 year  $—     $—     $—     $—   
After 1 year through 5 years   —      —      —      —   
After 5 years through 10 years   400,000    428,788    330,000    330,706 
After 10 years through 17 years   343,487    368,315    —      —   
Mortgage-backed securities   1,593,394    1,666,698    4,832,608    5,052,612 
   $2,336,881   $2,463,801   $5,162,608   $5,383,318 

 

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

 

In the recent past, unrealized losses were related to mortgage-backed securities issued by federally sponsored agencies, which are fully secured by conforming residential loans. Since the Company had the ability to hold these securities until estimated maturity, no declines were deemed to be other than temporary. There were no securities with gross unrealized losses at September 30, 2012.

 

Note 6 – Loans and Allowance for Loan Losses

 

At December 31, 2011, the Company had 11 impaired loans totaling $3,605,142, all of which were on non-accrual status. Only one of those loans was past due over 30 days. At September 30, 2012, there were 10 impaired loans totaling $2,318,247, all of which were on a non-accrual status. Only one of those loans was past due over 30 days.

 

Changes in the allowance for loan losses are summarized as follows for three months ended September 30, 2012:

 

Allowance for Loan Losses (by loan segment)
For three months ended September 30, 2012

  

   One to        Commercial            
   Four  Residential  Commercial  and            
   Residential  Income  Real Estate  Industrial  Consumer  Installment  Other  Total
                         
Beginning balance                                        
July 1, 2012  $36,192   $75,343   $1,154,085   $193,508   $704   $9,370   $285   $1,469,487 
Provision for loan                                        
losses   (5,542)   (623)   36,212    (28,978)   (70)   (916)   (7)   76 
                                         
Loans charged off   —      —      (31,244)   —      —      —      —      (31,244)
                                         
Recoveries   —      —      —      —      —      —      —      —   
                                         
Ending Balance                                        
September 30, 2012  $30,650   $74,720   $1,159,053   $164,530   $634   $8,454   $278   $1,438,319 

  

8
 

 

Changes in the allowance for loan losses are summarized as follows for nine months ended September 30, 2012:

 

Allowance for Loan Losses (by loan segment)
For nine months ended September 30, 2012

 

   One to        Commercial            
   Four  Residential  Commercial  and            
   Residential  Income  Real Estate  Industrial  Consumer  Installment  Other  Total
                         
Beginning balance                                        
January 1, 2012   44,586    40,438    1,201,839    238,448    976    11,289    387    1,537,963 
Provision for loan                                        
losses   (13,936)   34,282    (11,542)   (6,090)   2,278    (2,835)   (109)   2,048 
                                         
Loans charged off   —      —      (31,244)   (67,828)   (2,720)   —      —      (101,792)
                                         
Recoveries   —      —      —      —      100    —      —      100 
                                         
Ending Balance                                        
September 30, 2012  $30,650   $74,720   $1,159,053   $164,530   $634   $8,454   $278   $1,438,319 

 

 

The following tables present loans and the allowance for loan losses by segment as of September 30, 2012 and December 31, 2011:

 

Loans and Allowance for Loan Losses (by loan segment)
As of September 30, 2012

 

   One to Four  Residential  Commercial  Commercial and            
   Residential  Income  Real Estate  Industrial  Consumer  Installment  Other  Total
                         
Loans:                                        
                                         
Balance  $2,338,286   $4,102,245   $44,867,895   $7,775,260   $25,795   $318,191   $11,110   $59,438,782 
                                         
Individually evaluated                                        
for impairment   173,464    —      3,297,444    1,416,802    —      —      —      4,887,710 
                                         
Collectively evaluated                                        
for impairment   2,164,822    4,102,245    41,570,451    6,358,458    25,795    318,191    11,110    54,551,072 
                                         
Allowance for loan losses:                                        
                                         
Balance   30,650    74,720    1,050,183    164,530    634    8,454    278    1,329,449 
                                         
Individually evaluated                                        
for impairment   4,059    —      26,903    22,791    —      —      —      53,753 
                                         
Collectively evaluated                                        
for impairment   26,591    74,720    1,023,280    141,739    634    8,454    278    1,275,696 

  

9
 

 

Loans and Allowance for Loan Losses (by loan segment)
As of December 31, 2011

 

   One to Four  Residential  Commercial  Commercial and            
   Residential  Income  Real Estate  Industrial  Consumer  Installment  Other  Total
                         
Loans:                                        
                                         
Balance  $2,368,205   $1,880,824   $43,816,693   $8,082,845   $30,737   $612,923   $10,684   $56,802,911 
                                         
Individually evaluated                                        
for impairment   656,275    —      4,839,527    1,817,734    —      —      —      7,313,536 
                                         
Collectively evaluated                                        
for impairment   1,711,930    1,880,824    38,977,166    6,265,111    30,737    612,923    10,684    49,489,375 
                                         
Allowance for loan losses:                                        
                                         
Balance   44,586    40,438    1,201,839    238,448    976    11,289    387    1,537,963 
                                         
Individually evaluated                                        
for impairment   18,835    —      49,250    40,661    —      —      —      108,746 
                                         
Collectively evaluated                                        
for impairment   25,751    40,438    1,152,589    197,787    976    11,289    387    1,429,217 

  

Management divides the loan portfolio into portfolio segments for purposes of developing and documenting a systematic method for determining its allowance for loan losses. The portfolio is segregated based on loan types and the underlying risk factors present in each loan type. Such risk factors are periodically reviewed by management and revised as deemed appropriate.

 

The Company’s loan portfolio is divided into the following portfolio segments:

 

One to Four Family Residential. This portfolio segment consists of the origination of first mortgage loans and home equity second mortgage loans secured by one-to four-family owner occupied residential properties located in the Company’s market area. The Company has experienced no foreclosures on its owner occupied loan portfolio since May 2011 and believes this is due mainly to its conservative lending strategies including its non-participation in “interest only”, “Option ARM,” “sub-prime” or “Alt-A” loans.

 

Residential Income. This portfolio segment consists of the origination of first mortgage loans secured by one-to four-family non-owner occupied residential properties in its market area. Such lending involves additional risks arising from the use of the properties by non-owners.

 

Commercial Real Estate Loans. This portfolio segment includes loans secured by commercial real estate, including multi-family dwellings. Loans secured by commercial real estate generally have larger loan balances and more credit risk than one-to four-family mortgage loans. The increased risk is the result of several factors, including the concentration of principal in a limited number of loans and borrowers, the impact of local and general economic conditions on the borrower’s ability to repay the loan, and the increased difficulty of evaluating and monitoring these types of loans.

 

Commercial and Industrial Loans. This portfolio segment includes commercial business loans secured by assignments of corporate assets and personal guarantees of the business owners. Commercial business loans generally have higher interest rates and shorter terms than one- to-four family residential loans, but they also may involve higher average balances, increased difficulty of loan monitoring and a higher risk of default since their repayment generally depends on the successful operation of the borrower’s business.

 

Consumer Loans. This portfolio segment includes loans to individuals for overdraft protection and personal lines of credit.

 

Installment Loans. This portfolio segment includes loans to individuals for personal purposes, including but not limited to automobile loans.

 

10
 

 

The following tables summarize the loan portfolio at September 30, 2012 and December 31, 2011 by credit risk profiles based on internally assigned grades. Information has been updated for each credit quality indicator as of those dates.

 

Credit Quality Indicators (by loan class)

As of September 30, 2012

 

   Grade
   Pass  Special Mention  Substandard  Doubtful  Total
                
One to four residential:                         
Closed-end  $2,164,822   $—     $173,464   $—     $2,338,286 
                          
Residential income   4,102,245    —      0    —      4,102,245 
                          
Commercial real estate:                         
Owner occupied   22,687,467    —      1,401,084    —      24,088,551 
Non-owner occupied   18,597,279    285,705    1,896,360    —      20,779,344 
                          
Commercial and industrial:                         
Secured   3,536,493    —      1,315,067    —      4,851,560 
Unsecured   2,821,965    —      101,735    —      2,923,700 
                          
Consumer   25,795    —      —      —      25,795 
                          
Installment   318,191    —      —      —      318,191 
                          
Other   11,110    —      —      —      11,110 
                          
Total  $54,265,367   $285,705   $4,887,710   $—     $59,438,782 

  

Credit Quality Indicators (by loan class)

As of December 31, 2011

 

   Grade
   Pass  Special Mention  Substandard  Doubtful  Total
                
One to four residential:                         
Closed-end  $1,711,932   $—     $656,273   $—     $2,368,205 
                          
Residential income   1,880,824    —      —      —      1,880,824 
                          
Commercial real estate:                         
Owner occupied   17,642,198    —      2,345,010    —      19,987,208 
Non-owner occupied   21,044,610    290,358    2,494,517    —      23,829,485 
                          
Commercial and industrial:                         
Secured   2,840,541    —      1,678,608    —      4,519,149 
Unsecured   3,200,770    223,798    139,128    —      3,563,696 
                          
Consumer   30,737    —      —      —      30,737 
                          
Installment   612,923    —      —      —      612,923 
                          
Other   10,684    —      —      —      10,684 
                          
Total  $48,975,219   $514,156   $7,313,536   $—     $56,802,911 

  

The Company’s policies, consistent with regulatory guidelines, provide for the classification of loans and other assets that are considered to be of lesser quality as substandard, doubtful, or loss assets. An asset is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those assets characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all of the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable, based on currently existing facts, conditions and values. Assets (or portions of assets) classified as loss are those considered uncollectible and of such little value that their continuance as assets is not warranted. Assets that do not expose the Company to risk sufficient to warrant classification in one of the aforementioned categories, but which possess potential weaknesses that deserve close attention, are required to be designated as special mention.

 

11
 

 

When assets are classified as special mention, substandard or doubtful, the Company allocates a portion of the related general loss allowances to such assets as the Company deems prudent. Assets classified as loss are charged off. Determinations as to the classification of assets and the amount of loss allowances are subject to review by regulatory agencies, which can require that we establish additional loss allowances. Management regularly reviews its asset portfolio to determine whether any assets require reclassification in accordance with applicable regulations.

The following tables set forth certain information with respect to delinquencies in the Company’s portfolio by loan class and amount as of September 30, 2012 and December 31, 2011:

 

Age Analysis of Past Due Loans (by loan class)

As of September 30, 2012

 

                     Recorded
         Greater           Investment
   30-59 Days  60-89 Days  Than  Total     Total  90 Days or more
   Past Due  Past Due  90 Days  Past Due  Current  Loans  and Accruing
                      
One to four residential:                                   
Closed-end  $—     $—     $—     $—     $2,338,286   $2,338,286   $—   
                                    
Residential income   —      —      —      —      4,102,245    4,102,245    —   
                                    
Commercial real estate:                                   
Owner occupied   0    —      128,090    128,090    23,960,461    24,088,551    —   
Non-owner occupied   —      —      —      —      20,779,344    20,779,344    —   
                                    
Commercial and industrial:                                   
Secured   —      —      —      —      4,851,560    4,851,560    —   
Unsecured   —      —      —      —      2,923,700    2,923,700    —   
                                    
Consumer   —      —      —      —      25,795    25,795    —   
                                    
Installment   9,285    —      —      9,285    308,906    318,191    —   
                                    
Other   —      —      —      —      11,110    11,110    —   
                                    
Total  $9,285   $—     $128,090   $137,375   $59,301,407   $59,438,782   $—   

  

12
 

 

Age Analysis of Past Due Loans (by loan class)

As of December 31, 2011

 

                     Recorded
         Greater           Investment
   30-59 Days  60-89 Days  Than  Total     Total  90 Days or more
   Past Due  Past Due  90 Days  Past Due  Current  Loans  and Accruing
                      
One to four residential:                                   
Closed-end  $—     $—     $—     $—     $2,368,205   $2,368,205   $—   
                                    
Residential income   —      —      —      —      1,880,824   $1,880,824    —   
                                    
Commercial real estate:                                   
Owner occupied   171,434    —      —      171,434    19,815,774    19,987,208    —   
Non-owner occupied   —      —      —      —      23,829,485    23,829,485    —   
                                    
Commercial and industrial:                                   
Secured   —      —      —      —      3,983,230    3,983,230    —   
Unsecured   —      —      —      —      4,099,615    4,099,615    —   
                                    
Consumer   —      —      —      —      30,737    30,737    —   
                                    
Installment   —      —      —      —      612,923    612,923    —   
                                    
Other   —      —      —      —      10,684    10,684    —   
                                    
Total  $171,434   $—     $—     $171,434   $56,631,477   $56,802,911   $—   

 

The following tables summarize impaired loans by loan class as of and for the period ended September 30, 2012 and December 31, 2011:

 

 

Impaired Loans (by loan class)

As of and For the Three and Nine Months Ended September 30, 2012

 

      Unpaid     Average Recorded Investment  Interest
   Recorded  Principal  Related  for three  for nine  Income
   Investment  Balance  Allowance  Months  Months  Recognized
                   
                   
With an allowance recorded:                              
One to four residential:                              
Closed-end  $173,464   $173,464   $3,313   $175,758   $320,224   $—   
                               
Commercial real estate:                              
Owner occupied   128,090    128,090    2,447    151,523    375,794    —   
Non-owner occupied   893,420    893,420    17,064    899,536    916,991    —   
                               
Commercial and industrial:                              
Secured   1,123,273    1,123,273    21,455    1,141,738    1,178,936    —   
                               
Total:                              
One to four residential  $173,464   $173,464   $3,313   $175,758   $320,224   $—   
Commercial real estate  $1,021,510   $1,021,510   $19,511   $1,051,059   $1,292,785   $—   
Commercial and industrial  $1,123,273   $1,123,273   $21,455   $1,141,738   $1,178,936   $—   

 

13
 

 

Impaired Loans (by loan class)

As of and For the Year Ended December 31, 2011

 

      Unpaid     Average  Interest
   Recorded  Principal  Related  Recorded  Income
   Investment  Balance  Allowance  Investment  Recognized
                
With an allowance recorded:                         
One to four residential:                         
Closed-end  $656,275   $656,275   $18,835   $805,914   $—   
                          
Commercial real estate:                         
Owner occupied   893,259    893,259    25,637    1,201,115    —   
Non-owner occupied   822,769    822,769    23,613    851,886    —   
                          
Commercial and industrial:                         
Secured   1,232,839    1,232,839    40,661    1,238,994    —   
                          
Total:                         
One to four residential  $656,275   $656,275   $18,835   $805,914   $—   
Commercial real estate  $1,716,028   $1,716,028   $49,250   $2,053,001   $—   
Commercial and industrial  $1,232,839   $1,232,839   $40,661   $1,238,994   $—   

  

A summary of nonaccrual loans by loan class is as follows:

 

Loans on Nonaccrual Status (by loan class)

 

   September 30, 2012  December 31, 2011
One to four residential:          
Closed-end  $173,464   $656,275 
           
Commercial real estate:          
Owner occupied   128,090    893,259 
Non-owner occupied   893,420    822,769 
           
Commercial and industrial:          
Secured   1,123,273    1,232,839 
           
Total  $2,318,247   $3,605,142 

  

No troubled debt restructuring occurred in the three months ended September 30, 2012. A summary of troubled debt restructurings that occurred in the nine-month period ended September 30, 2012 is as follows:

 

14
 

 

Modifications (by loan class)

For the nine month period ended September 30, 2012

 

          Post-    
      Pre-Modification   Modification   Recorded 
  Number   Outstanding   Outstanding   Investment
  of   Recorded   Recorded   at
  Loans   Investment   Investment   09/30/12
Troubled Debt Restructurings              
               
Commercial real estate:              
Non-owner occupied 1                      120,424    $               120,424    $      115,226
               
Commercial and industrial:              
Secured 1                      451,897                     451,897           427,938
Unsecured 1                        54,472                       54,472             30,009

  

The Company had no loans modified in troubled debt restructuring during the third quarter of 2012 and three loans that were modified in troubled debt restructurings during the first quarter of 2012 and are classified as troubled debt restructurings because they were renewed at below-market interest rates due to the borrowers’ financial difficulties at the time of the restructuring. The loans are collateral dependent and have zero impairment, thus no specific allowance has been established for these loans.

 

All loans modified in a trouble debt restructurings performed as agreed subsequent to the restructuring. The Company had no troubled debt restructurings in the three-month period ended September 30, 2011.

 

Loans serviced for others are portions of loans participated out to other banks. Loan balances are net of these participated balances. The unpaid principal balance of loans serviced for others was $1,624,460 and $1,654,001 at September 30, 2012 and December 31, 2011, respectively.

 

 

Note 7 – Subordinated Notes Payable to Subsidiary Trust

 

On October 25, 2006, Chino Statutory Trust I (the Trust), a newly formed Connecticut statutory business trust and a wholly-owned subsidiary of the Company, issued an aggregate of $3.0 million of principal amount of Capital Securities (the Trust Preferred Securities) and $93,000 in Common Securities. The securities issued by the Trust are fully guaranteed by the Company with respect to distributions and amounts payable upon liquidation, redemption or repayment. The entire proceeds to the Trust from the sale of the Trust Preferred Securities were used by the Trust to purchase $3,000,000 in principal amount of the Junior Subordinated Deferrable Interest Debentures due December 15, 2036 issued by the Company (the Subordinated Debt Securities). The Company issued an additional $93,000 in principal amount of the Junior Subordinated Deferrable Interest Debentures due December 15, 2036, in exchange for its investment in the Trust’s Common Securities.

 

The Subordinated Debt Securities bore interest at 6.795% for the first five years from October 27, 2006 to December 15, 2011. On December 15, 2011 the interest rate became a variable interest rate equal to LIBOR (adjusted quarterly) plus 1.68%. LIBOR at December 15, 2011 was 0.54625% resulting in an interest rate of 2.22625% from December 15, 2011 to March 14, 2012. LIBOR at March 15, 2012 was 0.473650% resulting in an interest rate of 2.15365% from March 15 to June 14, 2012. LIBOR at June 15, 2012 was 0.467850% resulting in an interest rate of 2.14785% from June 15 to September 14, 2012.

 

As of September 30, 2012 and 2011, accrued interest payable to the Trust amounted to $2,684 and $59,456, respectively. Interest for Trust Preferred Securities amounted to $17,327 and $50,963, respectively, for the quarters ended September 30, 2012 and 2011. Interest for the Trust Preferred Securities amounted to $52,795 and $152,888, respectively, for each of the nine months ended September 30, 2012 and 2011. The Company relies on dividends from the Bank in order to make such payments and the Bank is restricted from making dividend payments to the Company without prior supervisory non-objection from the Office of the Comptroller of the Currency (the “OCC). In addition, the Company must obtain the approval of the Federal Reserve Bank of San Francisco (the “FRB”) prior to making interest payments on the Trust Preferred Securities.  Prior to the commencement of the Company’s secondary stock offering in November 2011, the Company elected to begin deferring such interest payments pending the conclusion of the offering, commencing with the September 15, 2011 payment.  The offering has since been completed and the Company received approval from the FRB to bring all payments on the Trust Preferred Securities current together with the September 16, 2012 payment. The interest payments were made and the Company is now current.

 

15
 

 

Note 8 – Stock Based Compensation

 

The Company’s stock option plan expired on July 13, 2010. The plan allowed the board to grant incentive stock options to officers and employees and non-qualified stock options to the directors, officers and employees. At September 30, 2012 and 2011, options to purchase 12,402 and 13,628 shares, respectively, were outstanding. All outstanding options are fully vested.

 

The most recent grant of options occurred in 2003. Thus, there was no stock-based compensation expense for the three and nine months ended September 30, 2012 and 2011.

 

Note 9 - Earnings per share (EPS)

 

Basic EPS excludes dilution and is computed by dividing earnings available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in earnings.

 

The weighted-average number of shares used in computing basic and diluted earnings per share is as follows:

 

Earnings per share Calculation

For the three months ended September 30,

 

   2012  2011
      Weighted        Weighted   
   Net  Average  Per Share  Net  Average  Per Share
   Income  Shares  Amount  Income  Shares  Amount
                   
Basic earnings  $153,816    829,570   $0.19   $120,113    748,314   $0.16 
                               
Effect of dilutive shares:                              
  assumed exercise of                              
  outstanding options        0    0.00         0    0.00 
                               
Diluted earnings  $153,816    829,570   $0.19   $120,113    748,314   $0.16 

 

Earnings per share Calculation

 For the nine months ended September 30,

  

   2012  2011
      Weighted        Weighted   
   Net  Average  Per Share  Net  Average  Per Share
   Income  Shares  Amount  Income  Shares  Amount
                   
Basic earnings  $481,970    809,605   $0.60   $273,474    748,314   $0.37 
                               
Effect of dilutive shares:                              
  assumed exercise of                              
  outstanding options        488    (0.01)        0    0.00 
                               
Diluted earnings per share  $481,970    810,093   $0.59   $273,474    748,314   $0.37 

  

16
 

 

Note 10 - Off-Balance-Sheet Commitments

 

The Company is a party to credit-related 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 grant loans, unadvanced lines of credit, standby letters of credit and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets.

 

The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments. At September 30, 2012 and December 31, 2011, the Company had $3.9 million and $3.6 million, respectively, of off-balance sheet commitments to extend credit. These commitments represent a credit risk to the Company. The Company had two unadvanced standby letters of credit at September 30, 2012, for $224,612 and one unadvanced standby letter of credit at December 31, 2011, for $82,804.

 

Commitments to grant loans are agreements to lend to customers as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness 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, equipment, income-producing commercial properties, residential properties, and properties under construction.

 

Note 11 – Fair Value Measurement

 

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The tables below present information about the Company’s assets measured at fair value on a recurring and non-recurring basis as of September 30, 2012 and December 31, 2011, and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. No liabilities were measured at fair value at September 30, 2012 and December 31, 2011.

 

The fair value hierarchy is as follows:

 

·Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
·Level 2 Inputs - Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
·Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

 

The following section describes the valuation methodologies used for assets measured at fair value on a recurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy.

 

Financial assets measured at fair value on a recurring basis include the following:

 

Securities Available for Sale. The securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

 

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The following table presents the balances of securities available for sale as of September 30, 2012 and December 31, 2011.

 

      Quoted Prices  Significant   
      in Active  Other   
      Markets for  Observable  Significant
      Identical Assets  Inputs  Unobservable Inputs
Description  Balance  (Level 1)  (Level 2)  (Level 3)
Securities Available for Sale                    
at Septembere 30, 2012                    
Municipal bonds  $797,103   $—     $797,103   $—   
Mortgage-backed securities   1,666,698    —      1,666,698    —   
Total  $2,463,801   $—     $2,463,801   $—   
                     
at December 31, 2011                    
Municipal bonds  $796,098   $—     $796,098   $—   
Mortgage-backed securities   2,176,322    —      2,176,322    —   
Total  $2,972,420   $—     $2,972,420   $—   

 

Certain financial assets are measured at fair value on a nonrecurring basis in accordance with U.S. GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

 

Impaired loans  

 

Collateral-dependent impaired loans are carried at the fair value of the collateral less estimated costs to sell. The fair value of collateral is determined based on appraisals. In some cases, adjustments were made to the appraised values for various factors including age of the appraisal, age of comparables included in the appraisal, and known changes in the market and in the collateral. When significant adjustments were based on unobservable inputs, the resulting fair value measurement has been categorized as a Level 3 measurement. Otherwise, collateral-dependent impaired loans are categorized under Level 2.

 

The following presents impaired loans measured at fair value on a non-recurring basis as of September 30, 2012 and December 31, 2011.

 

      Quoted Prices  Significant   
      in Active  Other   
      Markets for  Observable  Significant
      Identical Assets  Inputs  Unobservable Inputs
Description  Balance  (Level 1)  (Level 2)  (Level 3)
Impaired loans net of ALLL            
at Septembere 30, 2012  $2,273,968   $—     $954,392   $1,319,577 
at December 31, 2011  $3,496,396   $—     $1,142,547   $2,353,849 

 

For Level 3 impaired loans, the fair value of collateral is based on appraisals that are greater than nine months old. Management has not made adjustments for the age of the appraisals based on their estimate that the values of the properties have no changed materially since the appraisal date. These estimates are based on qualitative judgments made by management on a case-by-case basis. 

  

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Other Real Estate Owned  

 

Real estate acquired through foreclosure or other proceedings (other real estate owned) is initially recorded at fair value at the date of foreclosure less estimated costs of disposal, which establishes a new cost. After foreclosure, valuations are periodically performed, and foreclosed assets held for sale are carried at the lower of cost or fair value, less estimated costs of disposal. The fair values of real properties initially are determined based on appraisals. In some cases, adjustments were made to the appraised values for various factors including age of the appraisal, age of comparables included in the appraisal, and known changes in the market or in the collateral. Subsequent valuations of the real properties are based on management estimates or on updated appraisals. Other real estate owned is categorized under Level 3 when significant adjustments are made by management to appraised values based on unobservable inputs. Otherwise, other real estate owned is categorized under Level 2 if their values are based solely on appraisals. 

  

The following table summarizes the Company’s OREO that was measured at fair value on a nonrecurring basis as of September 30, 2012 and December 31, 2011:

 

      Quoted Prices  Significant   
      in Active  Other   
      Markets for  Observable  Significant
      Identical Assets  Inputs  Unobservable Inputs
Description  Balance  (Level 1)  (Level 2)  (Level 3)
Other real estate owned net                    
of valuation allowance                    
at Septembere 30, 2012  $—     $—     $—     $—   
at December 31, 2011  $439,317   $—     $439,317   $—   

  

Disclosure of fair value information about financial instruments is required, whether or not the financial instruments are recognized in the balance sheet at fair value or historical cost. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.

 

Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

 

The following methods and assumptions were used to estimate the fair value of financial instruments for which it is practicable to estimate that value. For cash and cash equivalents, Federal Home Loan Bank stock, loans held for sale, variable-rate loans, accrued interest receivable and payable, demand deposits and savings, and short-term borrowings, the carrying amount is estimated to be fair value. For securities, fair values are based on quoted market prices, where available. If quoted market prices are not available, fair values are based in quoted market prices of comparable instruments. The fair values for fixed-rate loans are estimated using discounted cash flow analyses using interest rates currently being offered for loans with similar terms. The fair value of life insurance is based on the cash surrender value, as determined by the insurer. Fair values for deposit liabilities with a stated maturity date (time deposits) and for certificates of deposit in other banks are estimated using a discounted cash flow calculation that applies interest rates currently being offered on these accounts to a schedule of aggregated expected monthly maturities on time deposits. The fair value of non-interest bearing demand deposits is the amount payable on demand at the reporting date. The fair value of long-term debt is determined utilizing the current market for like-kind instruments of a similar maturity and structure. The fair value of financial instruments with off-balance sheet risk is not considered to be material, so they are not included in the tables below.

 

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The carrying values and estimated fair values of financial instruments at September 30, 2012 and December 31, 2011 are as follows:

 

      Fair Value Measurements at September 30, 2012 using
      Quoted Prices  Significant      
      in Active  Other  Significant   
      Markets for  Observable  Unobservable   
   Carrying  Identical Assets  Inputs  Inputs  Fair
   Value  (Level 1)  (Level 2)  (Level 3)  Value
Financial assets:                         
Cash and cash equivalents  $28,085,799   $28,085,799   $—     $—     $28,085,799 
Interest-bearing deposits with other banks   15,736,252    —      15,732,169    —      15,732,169 
Investment securities available for sale   2,463,801    —      2,463,801    —      2,463,801 
Investment securities held to maturity   5,162,608    —      5,383,318    —      5,383,318 
Stock investments   623,300    —      —      623,300    623,300 
Loans, net   57,863,272    —      954,392    55,284,079    56,238,471 
Accrued interest receivable   254,082    —      254,082    —      254,082 
Bank owned life insurance   1,870,332    —      1,870,332    —      1,870,332 
Trups common securities   93,000    —      93,000    —      93,000 
                          
Financial liabilities:                         
Deposits                         
Non-interest bearing demand deposits  $51,053,088   $51,053,088   $—     $—     $51,053,088 
Interest-bearing deposits   55,724,542    —      55,735,537    —      55,735,537 
Accrued interest payable   35,314    —      35,314    —      35,314 
Subordinated Debentures   3,093,000    —      3,093,000    —      3,093,000 

 

      Fair Value Measurements at December 31, 2011 using
      Quoted Prices  Significant      
      in Active  Other  Significant   
      Markets for  Observable  Unobservable   
   Carrying  Identical Assets  Inputs  Inputs  Fair
   Value  (Level 1)  (Level 2)  (Level 3)  Value
Financial assets:                         
Cash and cash equivalents  $17,524,054   $17,524,054   $—     $—     $17,524,054 
Interest-bearing deposits with other banks   13,339,252    —      13,345,914    —      13,345,914 
Investment securities available for sale   2,972,420    —      2,972,420    —      2,972,420 
Investment securities held to maturity   9,652,630    —      9,860,534    —      9,860,534 
Stock investments   667,700    —      —      667,700    667,700 
Loans, net   55,235,841    —      1,142,547    54,130,648    55,273,195 
Accrued interest receivable   275,976    —      275,976    —      275,976 
Bank owned life insurance   1,819,191    —      1,819,191    —      1,819,191 
Trups common securities   93,000    —      93,000    —      93,000 
                          
Financial liabilities:                         
Deposits                         
Non-interest bearing demand deposits  $47,188,644   $47,188,644   $—     $—     $47,188,644 
Interest-bearing deposits   50,914,914    —      50,926,890    —      50,926,890 
Accrued interest payable   139,646    —      139,646    —      139,646 
Subordinated Debentures   3,093,000    —      3,093,000    —      3,093,000 

 

Note 12 – Regulatory Agreements

 

On April 12, 2011, the Bank entered into a formal written agreement (the “Formal Agreement”) with the Office of the Comptroller of the Currency, the Bank’s primary regulator. (See “Item 2 – Recent Developments – Regulatory Agreements.”) The Bank has also agreed with the OCC to establishing higher minimum capital ratios for the Bank. The Bank must maintain a Leverage Capital Ratio of not less than 9.0% and a Total Risk-Based Capital Ratio of not less than 12.0%. As of September 30, 2012 the Bank’s Leverage Capital Ratio was 10.04% and its Total Risk-Based Capital Ratio was 17.05%. The Bank achieved a Leverage Capital Ratio of at least 9.0% by May 31, 2011, and continued to maintain or exceed the required ratio through September 30, 2012, by reducing higher-rate CD and money market deposits, thereby reducing average assets and to a lesser extent, in the nine months ended September 30, 2012, by increasing capital through retained earnings. The Company continues to hold a portion of the proceeds from the secondary stock offering which may be downstreamed to the Bank to further enhance capital levels.

 

On July 21, 2011, Chino Commercial Bancorp entered into a memorandum of understanding (“MOU”) with the Federal Reserve Bank of San Francisco (the “FRB”). (See “Item 2 – Recent Developments – Regulatory Agreements.”)

 

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Item 2

MANAGEMENT’S DISCUSSION AND

ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

 

Forward Looking Information

 

This discussion focuses primarily on the results of operations of the Company and its consolidated subsidiary on a consolidated basis for the three and nine months ended September 30, 2012 and 2011, and the consolidated financial condition of the Company as of September 30, 2012 and December 31, 2011.

 

Management’s discussion and analysis is written to provide greater insight into the results of operations and the financial condition of the Company and its subsidiary. For a more complete understanding of the Company and its operations, reference should be made to the consolidated financial statements included in this report and in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

 

This Form 10-Q includes forward-looking statements that may constitute forward-looking statements under Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact are forward looking statements. Words such as “expects”, “anticipates”, “believes”, “projects”, and “estimates” or variations of such words and similar expressions are intended to identify such statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed, forecast in, or implied by such forward-looking statements, and readers are cautioned not to unduly rely on such statements. Risks and uncertainties include, but are not limited to, the health of the national and California economies; the Company’s ability to attract and retain skilled employees; competition in the financial services market for both deposits and loans; the Company’s ability to increase its customer base; customers' service expectations; the Company's ability to successfully deploy new technology and gain efficiencies therefrom; the success of branch expansion; changes in interest rates; loan portfolio performance; the Company’s ability to enhance its earnings capacity; the economic and regulatory effects of the continuing war on terrorism and other events of war, including the wars in Iraq and Afghanistan; the effect of natural disasters, including earthquakes, fires and hurricanes; and regulatory risks associated with the variety of current and future regulations to which the Company is subject. All of these risks could have a material adverse impact on the Company’s financial condition, results of operations or prospects, and these risks should be considered in evaluating the Company. For additional information concerning these factors, see “Risk Factors”; and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our Form 10-K, for the year ended December 31, 2011, as supplemented by the information contained in this report.

 

Recent Developments

 

Regulatory Matters. On April 12, 2011, Chino Commercial Bank, N.A. (the “Bank”), the Company’s wholly-owned banking subsidiary, entered into a formal written agreement (the “Formal Agreement”) with the Office of the Comptroller of the Currency (the “OCC”), the Bank’s primary regulator. The Formal Agreement will remain in effect and enforceable until it is modified, waived or terminated in writing by the OCC. Entry into the Formal Agreement does not change the Bank’s “well-capitalized” status.

 

The Bank also agreed to the OCC establishing higher minimum capital ratios for the Bank. Specifically, the Bank was required to achieve by May 31, 2011, and is required thereafter to maintain, a Leverage Capital Ratio of not less than 9.0% and a Total Risk-Based Capital Ratio of not less than 12.0%. The Bank achieved the required capital ratios by May 31, 2011, and has maintained the ratio above the required minimums, thereafter. As of September 30, 2012 the Bank’s Leverage Capital Ratio was 10.04% and its Total Risk-Based Capital Ratio was 17.05%.

 

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The Formal Agreement requires the Bank to take the following actions: (i) adopt, implement and adhere to a rolling three year strategic plan and capital program, including objectives, projections and implementation strategies for the Bank’s overall risk profile, earnings performance, and various balance sheet items, as well as intended product line development and market segments; (ii) refrain from paying dividends without prior OCC non-objection; (iii) add a new independent director with banking experience, or similar accounting or regulatory experience, to the Bank Board; (iv) obtain non-objection from the OCC before adding any individual to the Bank Board or employing any senior executive officer; (v) obtain a review of insider lending compliance by an independent outside audit firm acceptable to the OCC; (vi) revise, in a manner acceptable to the OCC, the Bank’s policies or programs concerning overdrafts, insider lending compliance, credit risk management, credit risk accounting, nonaccrual recognition and concentration risk management; and thereafter implement and adhere to such policies; (vii) protect the Bank’s interest in assets criticized by the OCC and take certain actions to reduce the level of criticized assets; (viii) continue to review the adequacy of the Bank’s allowance for loan losses and maintain a program acceptable to the OCC to ensure an adequate allowance; (ix) correct each violation of law, rule or regulation cited in the most recent regulatory examination report and implement procedures to avoid future violations; and (x) submit quarterly progress reports to the OCC regarding various aspects of the foregoing actions. The Bank Board has appointed a compliance committee to submit such reports and monitor and coordinate the Bank’s performance under the Formal Agreement.

 

On July 21, 2011, Chino Commercial Bancorp entered into a memorandum of understanding (“MOU”) with the Federal Reserve Bank of San Francisco (the “FRB”). The MOU is an informal administrative agreement pursuant to which Chino Commercial Bancorp has agreed, among other things, to (i) take steps to ensure that the Bank complies with the Formal Agreement; (ii) refrain from paying cash dividends, receiving cash dividends from the Bank, increasing or guaranteeing debt, making any capital distributions or payments on trust preferred securities, redeeming or repurchasing its stock, or issuing any additional trust preferred securities, without prior FRB approval; (iii) obtain non-objection from the FRB before adding any individual to the Board or employing any senior executive officer and (iv) submit written quarterly progress reports to the FRB detailing compliance with the MOU.

 

The Boards of Directors and management of the Bank and the Company are in the process of taking all necessary actions to comply with the various provisions of the Formal Agreement and the MOU.

 

Capital Raise. On September 16, 2011, the Company filed a registration statement on Form S-1 with the SEC in connection with a rights offering to existing shareholders which commenced in the fourth quarter of 2011. Pricing for the offering was set at $10.50 per share plus certain bonus shares to be issued to holders of subscription rights for no additional consideration. The rights offering to existing shareholders expired on February 22, 2012 and the public offering was extended to and expired on July 15, 2012. The Company generated $819,158 in capital from the offering, representing gross proceeds from shareholder rights subscriptions totaling $435,068, and subscriptions from investors in the public offering totaling $384,090. Net proceeds of $668,442 after deduction of offering expenses was booked to capital. It is anticipated that a portion of the proceeds of the offering will be downstreamed to the Bank to further enhance its capital levels and enable future growth while still complying with the capital requirements to which the Bank has agreed with the OCC. See "Regulatory Matters" immediately above.

 

Overview of the Results of Operations and Financial Condition

 

Results of Operations Summary

Third quarter 2012 compared to third quarter 2011

Net income for the quarter ended September 30, 2012 was $153,816 compared with net income of $120,113 for the quarter ended September 30, 2011, an increase of 28.1%. Basic and diluted earnings per share for the third quarter of 2012 were $0.19, compared to $0.16 for the third quarter of 2011. The Company’s annualized return on average equity was 7.21% and annualized return on average assets was 0.56% for the quarter ended September 30, 2012, compared to a return on average equity of 6.80% and a return on average assets of 0.46% for same quarter in 2011. The primary factors affecting net income during the third quarter of 2012 are as follows:

 

·The Company posted net interest income of $923,873 and $870,314 for the three months ended September 30, 2012 and 2011, respectively. Interest and fee income from loans increased $53,794, or 6.1%, to $931,264 for the third quarter of 2012 compared with the third quarter of 2011. Average interest-bearing liabilities increased $588,000 or 1.1% in the third quarter of 2012 as compared to the third quarter of 2011. The increase in average interest-bearing deposits resulted in approximately a $2,000 increase in interest expense while interest rate reductions resulted in a decrease of approximately $13,000 in the third quarter of 2012 as compared to the third quarter of 2011. While there was no change in the average balance of subordinated debentures, the rate decrease resulted in a decrease of approximately $34,000.
   

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·Non-interest income totaled $314,333 for the three months ended September 30, 2012, or a 4.1% decrease from $327,655 earned during the third quarter of 2011.
·The provision for loan losses decreased to $76 during the third quarter of 2012, a decrease of $2,145 or 96.6%, as compared to $2,221 for the three months ended September 30, 2011.
·Total non-interest income decreased $13,322 or 4.1% to $314,333 for the third quarter ended September 30, 2012 as compared to $327,655 for the same period of 2011. Service charges on deposits decreased by $12,109 or 4.1% for the three months ended September 30, 2012, compared to the same periods in 2012, due to a slight decrease in volume subject to analysis charges and returned item charges.
·Non-interest expenses decreased $15,746 or 1.6% to $995,743 for the three months ended September 30, 2012 as compared to $1,011,489 for the three months ended September 30, 2011. The largest component of general and administrative expenses was salary and employee benefits expense of $513,382 for the three months ended September 30, 2012 compared to $538,909 for the same periods in 2011, representing 4.7% decrease. Legal and other professional fees decreased 30.0% or $32,637 in the three months ended September 30, 2012 compared to the same periods in 2011 as a result of certain legal fees related to regulatory maters in 2011 which did not recur in 2012. Other expenses decreased $15,680 or 14.4% to $93,364 in the third quarter of 2012 due mainly to payments for expenses of other real estate owned incurred in 2011 that were not repeated in 2012.
·Components of non-interest expenses that partially offset the decreases above were Occupancy and equipment expense, Regulatory assessments, and Directors’ fees and expenses. Occupancy and equipment expenses increased $12,913 in the three months ended September 30, 2012 compared to the same period in 2011, due mainly to an increase in property tax expense. Regulatory assessments increased $28,821 to $54,872 for the three months ended September 30, 2012 compared to the same period in 2011 due to an adjustment made in the third quarter of 2011 that was not repeated in 2012. The increase of $9,846 or 56.88% in Directors’ fees in the third quarter of 2012 was due to the addition of one director and to increases in directors’ fees compensation that was effective January 2, 2012.

Nine months ended September 30, 2012 compared to the nine months ended September 30, 2011

Net income for the nine months ended September 30, 2012 was $481,970 compared to $273,474 for the first nine months of 2011, an increase of 76.2%. Basic and diluted earnings per share for the nine months ended September 30, 2012 were $0.60 and $0.59, respectively, compared to $0.37 for both basic and diluted earnings per share for the same period in 2011. Annualized return on average equity was 7.82% and a return on assets of 0.59%, compared to a return on equity of 5.17% and a return on assets of 0.34% for the same period in 2011. The primary reasons for the change in net income during the first nine months of 2012 are as follows:

 

·For the nine months ended September 30, the Company posted net interest income of $2.7 million and $2.8 million for 2012 and 2011, respectively. The decrease in interest income from loans was $101,670, or 3.6%, comparing the nine months ended September 30, 2012 with same period in 2011. For the nine months ended September 30, 2012, investment income decreased $178,172, or 39.1%, to $277,759 as compared to the nine months ended September 30, 2011. Interest expense on deposits decreased $59,097, or 19.2% to $248,643 for the nine months ended September 30, 2012 compared to the same period of 2011. Average interest bearing deposits to average total deposits decreased from 57.0% for the nine months ended September 30, 2011 to 55.7% for the same period in 2012. While there was no change in the average balance of subordinated debentures, the rate decrease resulted in decreased interest expense of approximately $100,000.
   
23
 

   
·The Company provided $2,048 to the allowance for loan losses during the nine months ended September 30, 2012, a 99.3% decrease from $281,660 for the same period in 2011. The lower provision for the nine months ended September 30, 2012 was due to a lower level of charge-offs during the period as compared to the first half of 2011 as well as a decrease in nonperforming assets.
·Total non-interest income increased $62,340 or 6.0% to $1.1 million for the nine months ended September 30, 2012 as compared to $1.0 million for the same period of 2011. Service charges on deposits decreased by $15,344 or 1.7% for the nine months ended September 30, 2012 compared to the same periods in 2011, due to a slight decrease in volume subject to analysis charges and returned item charges. Gain on sale of foreclosed assets increased to $93,871 in the nine months ended September 30, 2012, compared to a $61,151 gain recognized in the same period of 2011. Other miscellaneous income increased to $66,164 for the nine months ended September 30, 2012, compared to $24,805 in the nine months ended September 30, 2011 due to reimbursement of certain legal expenses incurred in 2011.Dividend income from restricted stock increased $4,617, or 55.3%, in the nine months ended September 30, 2012 in comparison to the same periods in 2011, resulting from an increase in dividends received from Pacific Coast Bankers’ Bank (PCBB). No dividends were received from PCBB in 2011.
·Non-interest expenses decreased $112,417 or 3.6% to $3.0 million for the nine months ended September, 30 2012 compared to $3.1 million for the same period in 2011. The largest component of general and administrative expenses was salary and employee benefits expense of $1,633,223 for the nine months ended September 30, 2012 compared to $1,647,203 for the same periods in 2011, representing 0.8% decrease. Legal and other professional fees decreased 31.5% or $98,101 in the nine months ended September 30, 2012 compared to the same periods in 2011 as a result of certain legal fees related to regulatory maters in 2011 which did not recur in 2012. Regulatory assessments expense decreased $11,223 or 6.3% in nine months ended September 30, 2012 versus 2011 due to decreased assessment rates.
·Other components of non-interest expense that affected the changes were occupancy and equipment expenses which decreased $6,823 compared to the same periods in 2011, due to the relocation and moving expenses of the main office charged to expense in 2011. Data and item processing expenses also decreased $12,271, or 4.4% for the comparable nine month periods due to one-time licensing and moving costs amortized in 2011 and not repeated in 2012. Directors’ fees and expenses increased $26,110 or 48.3% in the nine months ended September 30, 2012 compared to the same periods of 2011 due to the addition of one additional director, an increase in the number of meetings, and increases in directors’ fees compensation effective January 1, 2012.

 

 

Financial Condition Summary

The Company’s total assets were $119.3 million at September 30, 2012, an increase of $9.6 million, or 8.7% as compared to total assets of $109.7 million at December 31, 2011. The most significant changes in the Company’s consolidated balance sheet during the nine months ended September 30, 2012 are outlined below:

 

·Total Investments decreased from $26.0 million at December 31, 2011 to $23.4 million, or 10.0%, while gross loans increased from $56.8 million to $59.4 million, and federal funds sold increased from $14.2 million to $24.4 million. Overall, earning assets increased 10.6% in the nine month period ended September 30, 2012.
·Total deposits increased by $8.7 million, or 8.8%, to $106.8 million at September 30, 2012 compared to $98.1 million December 31, 2011. Time deposits decreased $1.0 million or 5.8% to $15.9 million at September 30, 2012 from $16.9 million at December 31, 2011. This reduction was an intentional strategy to reduce higher yielding deposits. Non-interest bearing deposits increased 8.2% to $51.1 million at September 30, 2012 from $47.2 million at December 31, 2011 and NOW and money market accounts increased 17.5% to $37.9 million at September 30, 2012 from $32.2 million at December 31, 2011. The ratio of non-interest bearing deposits to total deposits decreased slightly from 48.1% at December 31, 2011 to 47.8% at September 30, 2012.
·The Bank’s asset quality improved in the nine months ended September 30, 2012 as $439,317 in OREO was sold and the level of nonperforming assets to total loans and OREO moved from 8.36% at September 31, 2011 to 7.07% at December 31, 2011 to 3.90% at September 30, 2012. Net charged-off loans were $101,692 for the nine months ended September 30, 2012 compared to $186,619 for the same period of 2011. Nonperforming loans decreased from $4.4 million at September 30, 2011 to $2.3 million at September 30, 2012. At December 31, 2011 nonperforming assets were $3.6 million.
·On September 16, 2011, the Company filed a registration statement on Form S-1 with the SEC in connection with a secondary stock offering to existing shareholders which commenced in the fourth quarter of 2011 and was extended to the general public in early 2012. The Company generated $668,442 in additional common stock from the offering. The offering closed on July 15, 2012.

 

24
 

 

Earnings Performance

 

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

 

Net Interest Income and Net Interest Margin

 

For the third quarter of 2012, net interest income increased $53,559, or 6.2%, to $923,873 in 2012 from $870,314 in 2011. For the nine months ended September 30, 2012, net interest income decreased $99,126, or 3.5%, to $2,697,998 in 2012 from $2,797,124 in 2011. The level of net interest income depends on several factors in combination, including growth in earning assets, yields on earning assets, the cost of interest-bearing liabilities, the relative volumes of earning assets and interest-bearing liabilities, and the mix of products which comprise the Company’s earning assets, deposits, and other interest-bearing liabilities. Occasionally, net interest income is also impacted by the recovery of interest on loans that have been on non-accrual and are either sold or returned to accrual status, or by the reversal of accrued but unpaid interest for loans placed on non-accrual status. The Company’s net interest income, net interest margin and interest spread are sensitive to general business and economic conditions, including short-term and long-term interest rates, inflation, monetary supply, and the strength of the economy, and the local economics in which the Company conducts business. When net interest income is expressed as a percentage of average earning assets, the results is the net interest margin.

 

The following tables set forth certain information relating to the Company for the three and nine months ended September 30, 2012 and 2011. The yields and costs are derived by dividing income or expense by the corresponding average balances of assets or liabilities for the periods shown below. Average balances are derived from average daily balances. Yields include fees that are considered adjustments to yields.

 

25
 

 

Distribution, Yield and Rate Analysis of Net Interest Income

(dollars in thousands)

(unaudited)

 

   For the three months ended  For the three months ended
   September 30, 2012  September 30, 2011
   Average  Income/  Average  Average  Income/  Average
   Balance  Expense  Yield/Rate 4  Balance  Expense  Yield/Rate 4
   ($ in thousands)
Assets                              
Interest-earnings assets                              
Loans1  $58,075   $931    6.38%  $58,679   $877    5.93%
U.S. government agencies securities   0    0    0.00%   2,500    15    2.48%
Mortgage-backed securities   6,846    46    2.65%   10,371    79    3.00%
Other securities   1,135    12    4.25%   1,257    13    4.21%
Due from Banks time   16,340    25    0.61%   11,267    26    0.91%
Federal funds sold   15,920    10    0.26%   7,215    5    0.25%
Total interest-earning assets   98,316   $1,024    4.14%   91,289   $1,015    4.41%
Non-interest earning assets   12,411              13,423           
Total assets  $110,727             $104,712           
                               
Liabilities and Stockholders' Equity                              
Interest-bearing liabilities                              
Money market and NOW deposits  $33,462   $56    0.66%  $31,298   $58    0.74%
Savings   2,081    1    0.25%   1,669    1    0.25%
Time deposits < $100,000   4,376    6    0.58%   5,186    9    0.69%
Time deposits equal to or > $100,000   11,662    20    0.67%   12,840    26    0.80%
Subordinated debenture   3,093    17    2.23%   3,093    51    6.54%
Total interest-bearing liabilities   54,674   $100    0.73%   54,086   $145    1.06%
Non-interest bearing deposits   46,653              42,516           
Other liabilities   864              1,048           
Stockholders' equity   8,536              7,062           
Total liabilities & stockholders' equity  $110,727             $104,712           
                               
Net interest income       $924             $870      
                               
Net interest spread 2             3.41%             3.35%
Net interest margin 3             3.74%             3.78%

 

1 Amortization of loan fees (costs) has been included in the calculation of interest income. Loan fees were approximately $23,100 for the three months ended September 30, 2012 as compared to ($7,000) for the three months ended September 30, 2011.

2 Represents the average rate earned on interest-earning assets less the average rate paid on interest-bearing liabilities.

3 Represents net interest income as a percentage of average interest-earning assets.

4 Average Yield/Rate is annualized.

 

26
 

 

Distribution, Yield and Rate Analysis of Net Interest Income

(dollars in thousands)

(unaudited)

 

   For the nine months ended  For the nine months ended
   September 30, 2012  September 30, 2011
   Average  Income/  Average  Average  Income/  Average
   Balance  Expense  Yield/Rate 4  Balance  Expense  Yield/Rate 4
   ($ in thousands)
Assets                              
Interest-earnings assets                              
Loans1  $56,266   $2,692    6.39%  $59,425   $2,793    6.28%
U.S. government agencies securities   1,068    20    2.52%   2,500    47    2.51%
Mortgage-backed securities   7,589    154    2.73%   11,472    266    3.10%
Other securities   1,182    37    4.15%   1,258    40    4.26%
Due from Banks time   14,238    66    0.62%   14,471    103    0.95%
Federal funds sold   15,718    30    0.26%   4,551    9    0.25%
Total interest-earning assets   96,061   $2,999    4.17%   93,677   $3,258    4.65%
Non-interest earning assets   12,690              13,815           
Total assets  $108,751             $107,492           
                               
Liabilities and Stockholders' Equity                              
Interest-bearing liabilities                              
Money market and NOW deposits  $32,337   $164    0.68%  $32,312   $179    0.74%
Savings   2,071    4    0.25%   1,901    4    0.25%
Time deposits < $100,000   4,620    20    0.57%   5,507    33    0.79%
Time deposits equal to or > $100,000   11,606    60    0.69%   13,761    92    0.90%
Other borrowings   0    0    0.00%   135    0    0.07%
Subordinated debenture   3,093    53    2.28%   3,093    153    6.61%
Total interest-bearing liabilities   53,727   $301    0.75%   56,709   $461    1.09%
Non-interest bearing deposits   45,815              42,738           
Non-interest bearing liabilities   991              993           
Stockholders' equity   8,218              7,052           
Total liabilities & stockholders' equity  $108,751             $107,492           
                               
Net interest income       $2,698             $2,797      
                               
Net interest spread 2             3.42%             3.56%
Net interest margin 3             3.75%             3.99%

  

1Amortization of loan fees (costs) has been included in the calculation of interest income. Loan fees were approximately $35,000 for the nine months ended September 30, 2012 as compared to ($4,900) for the nine months ended September 30, 2011. Loans are net of deferred fees and related direct costs.

2 Represents the average rate earned on interest-earning assets less the average rate paid on interest-bearing liabilities.

3 Represents net interest income as a percentage of average interest-earning assets.

4 Average Yield/Rate is annualized.

 

Rate/Volume Analysis

 

The Volume and Rate Variances table below sets forth the dollar difference in interest earned and paid for each major category of interest-earning assets and interest-bearing liabilities for the noted periods, and the amount of such change attributable to changes in average balances (volume) or changes in average interest rates. Volume variances are equal to the increase or decrease in average balance multiplied by prior period rates, and rate variances are equal to the increase or decrease in average rate times prior period average balances. Variances attributable to both rate and volume changes are calculated by multiplying the change in rate by the change in average balance, and are allocated to the rate and volume variance.

 

27
 

 

   For the quarter ended  For the nine months ended
   September 30  September 30
   2012 vs. 2011  2012 vs. 2011
   Increase (Decrease) Due to  Increase (Decrease) Due to
   ($ in thousands)  ($ in thousands)
   Volume  Rate  Net  Volume  Rate  Net
                   
Interest-earnings assets                              
Loans1  $(9)  $63   $54   $(153)  $52   $(101)
Securities of U.S. government agencies   (8)   (7)   (15)   (27)   0    (27)
Mortgage-backed securities   (25)   (8)   (33)   (81)   (31)   (112)
Other securities   (1)   0    (1)   (2)   (1)   (3)
Due from Banks time   10    (11)   (1)   (2)   (35)   (37)
Federal funds sold   5    0    5    23    (2)   21 
Total interest-earning assets   (28)   37    9    (242)   (17)   (259)
                               
Interest-bearing liabilities                              
Money market & NOW   4    (6)   (2)   0    (15)   (15)
Time deposits < $100,000   0    (3)   (3)   (5)   (8)   (13)
Time deposits equal to or > $100,000   (2)   (4)   (6)   (15)   (17)   (32)
Subordinated debenture   0    (34)   (34)   0    (100)   (100)
Total interest-bearing liabilities   2    (47)   (45)   (20)   (140)   (160)
Change in net interest income  $(30)  $84   $54   $(222)  $123   $(99)

  

As shown above, the pure volume variance negatively impacted net interest income by $28,000 in the third quarter of 2012 relative to the same period of 2011, while the rate variance positively impacted net interest income by $37,000 for the same comparative period.

 

Net interest income for the third quarter of 2012 was $923,873 compared to $870,314 in the third quarter of 2011, an increase of $53,559, or 6.2%. The net interest margin decreased to 3.74% for the three months ended September 30, 2012 as compared to 3.78% for the same period in 2011 due principally to a drop in the interest rates on due from banks time.

 

Average loans decreased $604,000 or 1.0% for the third quarter of 2012 compared with the same period of 2011. Interest and fee income on loans increased $53,794. The decrease in average loans resulted in approximately $9,000 in decreased interest income from loans, while the increase in interest rate resulted in approximately $63,000 in increased income. The average yield on loans increased from 5.93% for the quarter ended September 30, 2011 to 6.38% for the quarter ended September 30, 2012. The increased yield is a result of reduction in loans on non-accrual status.

 

Income from investment securities and time deposits due from banks for the quarter ended September 30, 2012 decreased by $50,507, or 37.9% in comparison to the quarter ended September 30, 2011. The primary reason for the decreased interest income was the decrease in the average balance of investment securities and due from banks of approximately $1.1 million or 4.2%. The decline in average investment securities and due from banks time balances caused a decrease of interest income of approximately $24,000, while the rate decrease caused a decline in interest income of approximately $26,000 from investment securities and due from banks time for the third quarter of 2012 as compared to the same quarter in 2011. The average yield for investment securities and due from banks time declined from 2.09% for the three months ended September 30, 2011 to 1.35% for the same period in 2012.

 

Average interest-bearing liabilities increased $588,000 or 1.1% in the third quarter of 2012 as compared to the third quarter of 2011. The increase in average interest-bearing deposits resulted in approximately a $2,000 increase in interest expense while interest rate reductions resulted in a decrease of approximately $13,000 in the third quarter of 2012 as compared to the third quarter of 2011. While there was no change in the average balance of subordinated debentures, the rate decrease resulted in a decrease of approximately $34,000.

 

28
 

 

Pure volume variances negatively impacted net interest income by approximately $222,000 for the nine-month period ended September 30, 2012 relative to the same period of 2011, while the rate variance positively impacted net interest income by approximately $123,000 in the same comparative periods.

 

Interest income decreased $258,391 or 7.9% in the nine month period ended September 30, 2012 compared to the same period of 2011, while interest expense decreased $159,265 or 34.6%. Interest and fee income from loans decreased during the nine months ended September 30, 2012 by $101,670, or 3.6% to $2,691,575 compared to same period in 2011, due to a decrease in average loan balances.

 

The average balance of investment securities and due from banks time deposits decreased due a decision to not reinvest in long-term, low-yielding investments. Average deposits declined due to the Bank’s reduction of interest rates offered on interest-bearing accounts. Investment securities and due from bank’s time experienced a negative volume variance of approximately $112,000 and a negative rate variance of $67,000 for the nine months ended September 30, 2012 compared to the same period in 2011. Interest income from investment securities and due from banks time decreased $178,172 or 39.1% to $277,759 for the nine months ended September 30, 2012 compared to the same period of 2011.

 

Interest expense on deposits decreased $59,097, or 19.2% to $248,643 for the nine months ended September 30, 2012 compared to the same period of 2011. Average interest bearing deposits to average total deposits decreased from 57.0% for the nine months ended September 30, 2011 to 55.7% for the same period in 2012. While there was no change in the average balance of subordinated debentures, the rate decrease resulted in decreased interest expense of approximately $100,000.

 

The Company’s net interest margin declined from 3.99% to 3.75% for the nine months ended September 30, 2012 versus 2011 due principally to a drop in interest rates.

 

Provision for Loan Losses

 

Provisions to the allowance for loan losses are made monthly if needed, in anticipation of future potential loan losses. The monthly provision is calculated on a predetermined formula to ensure adequacy as the portfolio grows. The formula is composed of various components. Allowance factors are utilized in estimating the adequacy of the allowance for loan losses. The allowance is determined by assigning general reserves to non-impaired loans, and specific allowances for the impaired loans as needed. As higher allowance levels become necessary as a result of this analysis, the allowance for loan losses will be increased through the provision for loan losses. The procedures for monitoring the adequacy of the allowance, and detailed information on the allowance, are included below under “Allowance for Loan Losses.”

 

The provision for loan losses decreased to $73 during the third quarter of 2012, a decrease of $2,145 or 96.6%, as compared to $2,221 for the three months ended September 30, 2011. Net loan charge-offs were $31,244 for the third quarter of 2012 compared to net recoveries of $72,838 for the third quarter of 2011.

 

The Company provided $2,048 to the allowance for loan losses during the nine months ended September 30, 2012, a 99.3% decrease from $281,660 for the same period in 2011. The lower provision for the nine months ended September 30, 2012 was due to a lower level of charge-offs during the period as compared to the first nine months of 2011 as well as a decrease in nonperforming assets. Net charge offs were $101,692 for the nine months ended September 30, 2012 compared to $186,618 for the same period of 2011. Nonperforming loans decreased from $4.4 million at September 30, 2011 to $2.3 million at September 30, 2012.

 

The Company has not originated, and has no exposure to, sub-prime mortgage loans, or option ARM mortgages.

  

Non-Interest Income

 

Non-interest income was $314,333 for the three months ended September 30, 2012 as compared to $327,655 for the three months ended September 30, 2011, a 4.1% decrease. For the nine months ended September 30, 2012, non-interest income increased 6.0% to $1.1 million compared to $1.0 million for the same period in 2011. Total annualized non-interest income as a percentage of average earning assets decreased slightly to 1.3% for the three and nine months ended September 30, 2012, compared to 1.4% for the three and nine months ended September 30, 2011. Total annualized non-interest income as a percentage of average earning assets remained at 1.5% for the nine months ended September 30, 2012 and 2011.

 

29
 

 

The following table sets forth the non-interest income for the three and nine months ended September 30, 2012 and 2011:

 

  Non-Interest Income for the three months   Non-Interest Income for the nine months
  ended September 30, ended September 30,
  2012   2011   2012 2011
  Amount   % of Total   Amount   % of Total   Amount   % of Total   Amount   % of Total
  (Dollars in thousands)   (Dollars in thousands)
                               
Service charges on deposit accounts $      286   91.0%   $      299   91.1%   $      877   79.7%   $      893   85.9%
Gain on sale of foreclosed assets 0   0.0%   0   0.0%   94   8.5%   61   5.9%
Other miscellaneous income 8   2.7%   9   2.8%   66   6.0%   25   2.4%
Dividend income from restricted stock 3   1.0%   3   0.8%   13   1.2%   8   0.8%
Income from bank owned life insurance 17   5.3%   17   5.3%   51   4.6%   52   5.0%
Total non-interest income $      314   100.0%   $      328   100.0%   $   1,101   100.0%   $   1,039   100.0%
As an annualized percentage of                              
average earning assets     1.3%       1.4%       1.5%       1.5%

 

Service charges on deposit accounts, customer fees and miscellaneous income are comprised primarily of fees charged to deposit accounts and depository related services. Fees generated from deposit accounts consist of periodic service fees and fees that relate to specific actions, such as the return or payment of checks presented against accounts with insufficient funds. Depository related services include fees for money orders and cashier’s checks, placing stop payments on checks, check-printing fees, wire transfer fees, fees for safe deposit boxes and fees for returned items or checks that were previously deposited. Service charges on deposits decreased by $12,109 or 4.1% and $15,344 or 1.7% for the three and nine months ended September 30, 2012, respectively, compared to the same periods in 2011, due to a slight decrease in volume subject to analysis charges and returned item charges. The Company periodically reviews service charges to maximize service charge income while still maintaining competitive pricing. Service charge income on deposit accounts increases with the increased number of accounts and to the extent fees are not waived.

 

Gain on sale of foreclosed assets increased to $93,871 in the nine months ended September 30, 2012, compared to a $61,151 gain recognized in the same period of 2011.

 

Other miscellaneous income increased to $66,164 for the nine months ended September 30, 2012, compared to $24,805 in the nine months ended September 30, 2011 due to reimbursement of certain legal expenses incurred in 2011.

 

Dividend income from restricted stock increased $4,617, or 55.3%, in the nine months ended September 30, 2012 in comparison to the same period in 2011, resulting from an increase in dividends received from Pacific Coast Bankers’ Bank (PCBB). No dividends were received from PCBB in 2011.

 

Non-Interest Expense

 

The following table sets forth the non-interest expense for the three and nine months ended September 30, 2012 and 2011:

 

30
 

 

   Non-Interest Expense for the quarter  Non-Interest Expense for the nine months
   ended September 30  ended September 30
   2012  2011  2012  2011
   Amount  % of Total  Amount  % of Total  Amount  % of Total  Amount  % of Total
   (Dollars in thousands)  (Dollars in thousands)
                         
Salaries and employee benefits  $513    51.7%  $539    53.2%  $1,633    53.7%  $1,647    52.2%
Occupancy and equipment   112    11.2%   99    9.8%   319    10.5%   326    10.4%
Data and item processing   93    9.3%   87    8.6%   266    8.8%   278    8.8%
Deposit products and services   16    1.6%   16    1.6%   48    1.6%   34    1.1%
Legal and other professional fees   76    7.6%   109    10.8%   213    7.0%   311    9.9%
Regulatory assessments   55    5.5%   26    2.6%   166    5.5%   177    5.6%
Advertising and marketing   14    1.4%   15    1.5%   39    1.3%   42    1.3%
Directors’ fees and expenses   27    2.7%   17    1.7%   80    2.6%   54    1.7%
Printing and supplies   14    1.4%   13    1.3%   39    1.3%   35    1.1%
Telephone   9    0.9%   9    0.9%   27    0.9%   27    0.9%
Insurance   12    1.2%   11    1.1%   36    1.2%   30    1.0%
Reserve for undisbursed lines of credit   0    0.0%   (2)   -0.2%   1    0.0%   (6)   -0.2%
Other expenses   55    5.5%   72    7.1%   169    5.6%   194    6.2%
Total non-interest expenses  $996    100.0%  $1,011    100.0%  $3,036    100.0%  $3,149    100.0%
Non-interest expense as an annualized                                        
percentage of average earning assets        4.1%        4.4%        4.2%        4.5%
Core efficiency ratio        80.4%        84.4%        81.9%        83.4%

 

Total annualized non-interest expense as a percentage of average earning assets decreased to 4.1% for the three months ended September 30, 2012 as compared to 4.4% for the three months ended September 30, 2011. For the nine months ended September 30, 2012 and 2011, these percentages were 4.2% and 4.5%, respectively. Total annualized non-interest expense as a percentage of average assets decreased due to the increase in average earning assets.

 

The core efficiency ratio represents total operating expense divided by the sum of net interest and non-interest income, with the provision for loan losses, investment gains/losses, and other extraordinary gains/losses excluded from the equation. Because of the slight decline in net interest plus other income and the decrease in total non-interest expense, the Company’s overhead efficiency ratio decreased to 80.4% for the third quarter of 2012 from 84.4% for the third quarter of 2011. The efficiency ratio decreased slightly in the most recent nine month period to 81.9%, compared to 83.4% for the same period in 2011.

 

Non-interest expenses were $995,743 for the three months ended September 30, 2012, compared to $1,011,489 for the three months ended September 30, 2011, a 1.6% decrease. Non-interest expenses decreased $112,417 to $3,036,344 for the nine months ended September, 30 2012 compared to the same period in 2011. The largest component of general and administrative expenses was salary and employee benefits expense of $513,382 for the third quarter and $1,633,223 for the nine months ended September 30, 2012 compared to $538,909 and $1,647,203 for the same periods in 2011, representing 4.7% and 0.8% decreases, respectively.

 

Legal and other professional fees decreased 30.0% and 31.5% or $32,637 and $98,101, respectively, during the three and nine months ended September 30, 2012 compared to the same periods in 2011 as a result of certain legal fees related to regulatory maters in 2011 which did not recur in 2012.

 

Regulatory assessments expense increased $28,821 or 110.6% in the third quarter of 2012 versus 2011 and decreased $11,223 or 6.3% in nine months ended September 30, 2012 versus 2011. The decrease for the nine month period resulted from decreased assessment rates due to the initial FDIC base assessment rate being 14 basis points rather than 23 basis points that was anticipated. This rate decrease would also have resulted in a decrease for the third quarter of 2012 but for the fact that assessment accruals that were made in the first and second quarters of 2011 due to anticipated increased assessment rates were reversed in the third quarter in the third quarter of 2011 as the increase did not materialize, creating an artificially low assessment expense for the third quarter of 2011.

 

Other components of non-interest expense that affected the changes were occupancy and equipment expenses which increased $12,913 in the three months ended September 30, 2012 compared to the same period in 2011, due mainly to an increase in property tax expense. In the nine months ended September 30, 2012, occupancy and equipment expenses decreased $6,823 compared to the same periods in 2011, due to the relocation and moving expenses of the main office charged to expense in 2011. Data and item processing expenses also increased in 2012 by $6,071, or 7.0% for the comparable three month due to increased processing activity and decreased $12,271, or 4.4% for the comparable nine month periods due to one-time licensing and moving costs amortized in 2011 and not repeated in 2012.

 

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Directors’ fees and expenses increased $9,846 or 56.88% in the third quarter and $26,110 or 48.3% in the nine months ended September 30, 2012 compared to the same periods of 2011 due to the addition of one additional director, an increase in the number of meetings, and increases in directors’ fees compensation effective January 1, 2012.

 

Other expenses decreased $15,680 or 14.4% to $93,364 in the third quarter of 2012 due mainly to payments for expenses of other real estate owned incurred in 2011 that were not repeated in 2012.

 

Provision for Income Taxes

 

Income tax expenses of $88,571 and $278,744 were recorded for the third quarter and the nine months ended September 30, 2012, respectively, representing approximately 36.5% and 36.6% of pre-tax income for those periods. In comparison, income tax expense of $64,146 and $131,997 were recorded for the third quarter and the nine months ended September 30, 2011, respectively, representing approximately 34.8% of pre-tax loss and 32.6% of pre-tax income for those periods.  The amount of the tax provision is determined by applying the Company’s statutory income tax rates to pre-tax book income, adjusted for permanent differences between pre-tax book income and actual taxable income. Such permanent differences include but are not limited to tax-exempt interest income; increases in the cash surrender value of bank-owned life insurance, compensation expense associated with stock options, and certain other expenses that are not allowed as tax deductions, and tax credits.

 

Financial Condition

 

Comparison of Financial Condition at September 30, 2012 and December 31, 2011

 

General

 

Total assets increased by 8.7% from $109.7 million to $119.3 million between December 31, 2011 and September 30, 2012. The Company experienced a slight increase in interest-earning assets of 10.6% to $107.2 million in the nine months ended September 30, 2012, primarily in Federal funds sold which increased to $24.4 million at September 30, 2012, compared to $14.2 million at December 31, 2011. Gross loans increased 4.6% to $59.4 million at September 30, 2012, compared to $56.8 million at December 31, 2011. Total deposits increased from $98.1 million on December 31, 2011 to $106.8 million on September 30, 2012, an 8.8% increase. Noninterest-bearing deposits increased to $51.1 million at September 30, 2012, an increase of $3.9 million or 8.2% from December 31, 2011. Total interest-bearing deposits increased from $50.9 million at December 31, 2011 to $55.7 million at September 30, 2012, a 9.4% increase in the nine months ended September 30, 2012. The ratio of non-interest bearing deposits to total deposits decreased from 48.1% at December 31, 2011 to 47.8% at September 30, 2012.

 

Loan Portfolio

 

During the nine months ended September 30, 2012, the Company’s loan portfolio, net of unearned loan fees, increased by $2.5 million to $59.3 million at September 30, 2012, compared to $56.8 million at December 31, 2011. The Company experienced moderate increases in balances of real estate and commercial loans. The largest loan category at September 30, 2012 was real estate loans, which consisted of commercial and consumer real estate loans, and represented 79.4% of the loan portfolio. In anticipation of possible further deterioration in economic conditions, though Management believes these credits to be properly underwritten, the Company has elected to take real estate collateral in an abundance of caution on a number of commercial loans. Though the result of this strategy may be to reflect a concentration of assets into real estate secured credits, Management believes the underlying collateral will support overall credit quality and minimize principal risk of the portfolio. The next largest loan concentration at September 30, 2012 was commercial loans, constituting 20.0% of the loan portfolio.

 

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The composition of the Company’s loan portfolio at September 30, 2012 and December 31, 2011 is set forth below:

 

   September 30, 2012  December 31, 2011
   Amount  Percentage  Amount  Percentage
             
Real estate  $47,206    79.4%  $46,185    81.3%
Commercial   11,889    20.0%   9,974    17.6%
Installment   344    0.6%   644    1.1%
Gross loans  $59,439    100.0%  $56,803    100.0%

  

The average yield on the loan portfolio as of September 30, 2012 was 6.39% and the weighted average contractual term of the loan portfolio is approximately seven years. Individual loan interest rates may require interest rate changes more frequently than at maturity due to adjustable interest rate terms incorporated into certain loans. At September 30, 2012, approximately 72.0% of loans were variable rate loans tied to adjustable rate indices such as Prime Rate.

 

Off-Balance Sheet Arrangements

 

During the ordinary course of business, the Company provides various forms of credit lines to meet the financing needs of its customers. These commitments to provide credit represent an obligation of the Company to its customers, which is not represented in any form within the balance sheets of the Company. At September 30, 2012 and December 31, 2011, the Company had $3.9 million and $3.6 million, respectively, of off-balance sheet commitments to extend credit. These commitments are the result of existing unused lines of credit and unfunded loan commitments. These commitments represent a credit risk to the Company. At September 30, 2012 and December 31, 2011, the Company had $224,612 and $82,807 standby letters of credit, respectively.

 

The effect on the Company’s revenues, expenses, cash flows and liquidity from the unused portion of the commitments to provide credit cannot be reasonably predicted because there is no guarantee that the lines of credit will ever be used.

 

Non-performing Assets

 

Non-performing assets are comprised of loans on non-accrual status, loans 90 days or more past due and still accruing interest, and other real estate owned (“OREO”; also referred to herein as “foreclosed assets”). Loans are generally placed on non-accrual status when they become 90 days past due unless Management believes the loan is adequately collateralized and in the process of collection. Loans may be restructured by Management when a borrower has experienced some change in financial status, causing an inability to meet the original repayment terms, and where the Company believes the borrower will eventually overcome those circumstances and repay the loan in full. Such loans are classified as "troubled debt restructurings" (TDRs) and are further classified as either performing or nonperforming depending on their accrual status.  As of September 30, 2012, all but one of the Company's TDRs were on non-accrual status. OREO consists of properties acquired by foreclosure or similar means that Management intends to offer for sale.

 

Management’s classification of a loan as non-accrual is an indication that there is a reasonable doubt as to the full collectability of principal and/or interest on the loan; at this point, the Company stops recognizing income from the interest on the loan and may reverse any uncollected interest that had been accrued but unpaid if it is determined uncollectible or the collateral is inadequate to support such accrued interest amount. These loans may or may not be collateralized, but collection efforts are continuously pursued.

 

On occasion, a well collateralized loan will be downgraded to nonaccrual status or classified as nonperforming because of the borrower’s apparent inability to continue to make payments as called for, based upon tax returns or financial statements. These downgrades may be made despite the fact that the borrower continues to make all payments as agreed.

 

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The following table presents comparative data for the Company’s nonperforming assets and performing TDRs:  

 

Nonperforming Assets and Performing TDRs

 

   September 30  December 31  September 30
   2012  2011  2011
      ($ in thousands)   
Non-accrual loans: 1               
Real estate  $1,195   $2,372   $2,955 
Commercial   1,123    1,233    1,399 
Installment   0    0    0 
                
Total non-accrual loans 2   2,318    3,605    4,354 
                
Loans 90 days or more past due & still accruing:               
Real estate   0    0    0 
Commercial   0    0    0 
Installment   0    0    0 
                
Total loans 90 days or more past due & still accruing   0    0    0 
                
Total nonperforming loans   2,318    3,605    4,354 
OREO   0    439    439 
                
Total nonperforming assets  $2,318   $4,044   $4,793 
Performing loans classified as troubled debt restructurings (TDRs) 3  $519   $—     $—   
Nonperforming loans as a percentage of total loans 4   3.90%   6.35%   7.65%
Nonperforming assets as a percentage of total loans and OREO   3.90%   7.07%   8.36%

 

 

At September 30, 2012, the Company had six nonperforming restructured loans totaling $1,941,693, one of which was partially charged off and the remaining balance of $1,610,630 is on non-accrual status. These loans are reported in the non-accrual classification of this report. Four additional loans totaling $707,617 are on non-accrual status. As of September 30, 2012, all of the Company’s nonperforming loans, whether commercial loans or real estate loans, were substantially secured by real estate, with collateral values that Management believes are sufficient to cover the debts, although no assurance can be given that such collateral values may not decline in the future. As of that same date, only one such loan was greater than 90 days past due; all other such loans were paying as agreed. At September 30, 2012, the Company had no foreclosed property (OREO). The reduction in nonperforming loan balances in the most recent twelve month period were the result of $337,417 in paydowns, $641,433 from three paid off loans, and the upgrade and return to accrual status of two loans totaling $1.2 million. While five loans were eliminated from nonperforming loans, only one was added for $117,526.

 

As shown in the table, the Company also has one restructured loan for $558,601 with a remaining book balance of $519,092 classified as performing TDRs for which we were accruing interest at September 30, 2012.

 

At December 31, 2011, the Company had one foreclosed property in the amount of $439,317 and 11 loans on non-accrual status totaling $3,605,142. At December 31, 2011, the Company had two nonperforming restructured loans totaling $1,665,444, which were partially charged off and the remaining balance of $1,294,871 is on non-accrual status. These loans are reported in the non-accrual classification of this report. The Company’s nonperforming assets at December 31, 2011 were 7.07% of the total loans and OREO.

 

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Allowance for Loan Losses

 

The Company maintains an allowance for loan losses at a level Management considers adequate to cover the inherent risk of loss associated with its loan portfolio under prevailing and anticipated economic conditions. In determining the adequacy of the allowance for loan losses, Management takes into consideration growth trends in the portfolio, examination by financial institution supervisory authorities, prior loan loss experience of the Company’s Management, concentrations of credit risk, delinquency trends, general economic conditions, the interest rate environment, and internal and external credit reviews.

 

The allowance for loan losses is evaluated on a quarterly basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

The allowance consists of general and specific components. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. In establishing the allowance for loan losses, management considers significant factors that affect the collectability of the Company’s loan portfolio. While historical loss experience provides a reasonable starting point for the analysis, such experience by itself does not form a sufficient basis to determine the appropriate level of the allowance for loan losses. Management also considers qualitative (or environmental) factors that are likely to cause estimated credit losses associated with the existing portfolio to differ from historical loss experience, including:

 

·Changes in lending policies and procedures, including changes in underwriting standards and collection;
·Changes in national, regional and local economic and business conditions and developments that affect the collectability of the portfolio;
·Changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified loans;
·Changes in the value of underlying collateral for collateral-dependent loans;
·The effect of credit concentrations; and
·The rate of defaults on loans modified as troubled debt restructurings within the previous twelve months.

 

Allowance factors ranging from 0.0% to 2.5% are applied to disbursed loans that are unclassified and uncriticized. Allowance factors averaging approximately 0.27% are applied to undisbursed loans. Allowance factors are not applied to loans secured by bank deposits or to loans held for sale, which are recorded at the lower of cost or market.

 

The process of providing for loan losses involves judgmental discretion, and ultimate losses may therefore differ from even the most recent estimates. Due to these limitations, the Company assumes that there are losses inherent in the current loan portfolio but which have not yet been identified. The Company therefore attempts to maintain the allowance at an amount sufficient to cover such unknown but inherent losses.

 

Management looks at a number of economic events occurring in and around the real estate industry and analyzes each credit for associated risks. Accordingly, the Company has established and maintains an allowance for loan losses which amounted to $1,438,319 at September 30, 2012, $1,537,963 at December 31, 2011, and $1,537,195 at September 30, 2011. The ratios of the allowance for loan losses to total loans at September 30, 2012, December 31, 2011, and September 30, 2011 were 2.42%, 2.71%, and 2.70% respectively.

 

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The table below summarizes the activity in the allowance for loan losses for the noted periods:

 

   September 30  December 31  September 30
   2012  2011  2011
      ($ in thousands)   
Non-accrual loans: 1               
Real estate  $1,195   $2,372   $2,955 
Commercial   1,123    1,233    1,399 
Installment   0    0    0 
                
Total non-accrual loans 2   2,318    3,605    4,354 
                
Loans 90 days or more past due & still accruing:               
Real estate   0    0    0 
Commercial   0    0    0 
Installment   0    0    0 
                
Total loans 90 days or more past due & still accruing   0    0    0 
                
Total nonperforming loans   2,318    3,605    4,354 
OREO   0    439    439 
                
Total nonperforming assets  $2,318   $4,044   $4,793 
Performing loans classified as troubled debt restructurings (TDRs) 3  $519   $—     $—   
Nonperforming loans as a percentage of total loans 4   3.90%   6.35%   7.65%
Nonperforming assets as a percentage of total loans and OREO   3.90%   7.07%   8.36%

 

Ratios:                  
Net loan charge-offs to average total loans 0.05%   -0.12%   0.18%   0.31%   0.32%
Provision for loan losses to average total loans 0.00%   0.00%   0.00%   0.47%   0.48%
Allowance for loan losses to total loans at the end of the period 2.42%   2.70%   2.42%   2.70%   2.71%
Allowance for loan losses to non-performing loans 62.04%   35.30%   62.04%   35.30%   42.66%
Net loan charge-offs (recoveries) to allowance                  
for loan losses at the end of the period 2.17%   4.74%   7.07%   12.14%   12.09%
Net loan charge-offs (recoveries) to provision for loan losses 41110.14%   3279.51%   4965.43%   66.26%   65.99%

 

  

 

While Management believes that the amount of the allowance at September 30, 2012 was adequate, there can be no assurances that future economic or other factors will not adversely affect the Company’s borrowers, or that the Company’s asset quality may not deteriorate through rapid growth, failure to identify and monitor potential problem loans or for other reasons, thereby causing loan losses to exceed the current allowance.

 

Investment Portfolio

 

The market value of the Company’s investment portfolio at September 30, 2012 was $7.8 million, having a tax equivalent yield of 3.23%. This compares to an investment portfolio of $12.8 million at December 31, 2011, having a 3.03% tax equivalent yield. The primary category of investment in the portfolio at September 30, 2012 was mortgage-backed securities. At September 30, 2012, approximately 12% of the mortgage-backed securities were tied to adjustable rate indices such as LIBOR or CMT. As loan demand has declined, Management anticipates purchasing additional short-term investment securities and interest-bearing deposits in other banks until loan demand increases.

 

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The following table summarizes the carrying value and market value and distribution of the Company’s investment securities at September 30, 2012 and December 31, 2011:

 

   September 30, 2012  December 31, 2011
   Carrying  Fair  Carrying  Fair
   Value  Value  Value  Value
   ($ in thousands)
Held to maturity:                    
Municipal  $330   $331   $432   $436 
Federal agency   0    0    2,500    2,515 
Mortgage-backed securities   4,833    5,053    6,690    6,879 
Corporate bonds   0    0    31    31 
Total held to maturity   5,163    5,384    9,653    9,861 
                     
Available for sale:                    
Municipal   797    797    796    796 
Mortgage-backed securities   1,667    1,667    2,176    2,176 
Total available for sale   2,464    2,464    2,972    2,972 
Total  $7,627   $7,848   $12,625   $12,833 

  

There were no material changes since December 31, 2011 in the maturities or repricing of the investment securities.

 

Deposits

 

Total deposits increased $8.7 million or 8.8% to $106.8 million at September 30, 2012 from $98.1 million at December 31, 2011. Interest-bearing deposits increased $4.8 million or 9.4% to $55.7 million at September 30, 2012 from $50.9 million at December 31, 2011. Demand deposits increased $3.9 million or 8.2% to $51.1 million at September 30, 2012 from $47.2 million at December 31, 2011. The ratio of non-interest bearing deposits to total deposits was 47.8% at September 30, 2012 and 48.1% at December 31, 2011.

A comparative distribution of the Company’s deposits at September 30, 2012 and December 31, 2011, by outstanding balance as well as by percentage of total deposits, is presented in the following table:

 

   September 30, 2012  December 31, 2011
   Amount  Percentage  Amount  Percentage
   ($ in thousands)
             
Demand  $51,053    47.8%  $47,189    48.1%
NOW   2,583    2.4%   1,835    1.9%
Savings   1,966    1.8%   1,810    1.8%
Money market   35,287    33.1%   30,407    31.0%
Time deposits < $100,000   4,380    4.1%   4,700    4.8%
Time deposits ≥ $100,000   11,509    10.8%   12,163    12.4%
Total deposits  $106,778    100.0%  $98,104    100.0%

  

Deposits are the Company’s primary source of funds. As the Company’s need for lendable funds grows, dependence on deposits increases. Information concerning the average balance and average rates paid on deposits by deposit type for the three and nine months ended September 30, 2012 and 2011 is contained in the “Distribution, Yield and Rate Analysis of Net Interest Income” table appearing in a previous section entitled “Net Interest Income and Net Interest Margin.” At September 30, 2012 and December 31, 2011, the Company had deposits from related parties representing 6.6% and 5.9% of total deposits of the Company, respectively. Further, at September 30, 2012 and December 31, 2011, deposits from escrow companies represented 11.7% and 10.1% of the Company’s total deposits, respectively. There are some escrow company deposits which are also classified as deposits from related parties.

 

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Borrowings

 

At September 30, 2012 and December 31, 2011 the Company had no FHLB advances or overnight borrowings outstanding. On December 21, 2005, the Company entered into a standby letter of credit with the FHLB for $800,000, which matures and renews annually, as needed. This standby letter of credit was issued as collateral for local agency deposits that the Company is maintaining. On July 19, 2012, the Company entered into a standby letter of credit with Zions Bank for $115,000, which matures and renews annually, as needed. This standby letter of credit was issued on behalf of a customer requiring a letter of credit from a known major bank at the request of the Royal Bank of Canada. The Company holds the customers funds on deposit as security for this transaction.

 

Shareholders’ Equity

 

Total shareholders’ equity was $8.6 million at September 30, 2012 and $7.5 million at December 31, 2011. There was an overall increase of $1.1 million due to the following: net income increased retained earnings by $481,970, net proceeds from the Company’s stock offering increased equity by $668,441 (See “Recent Development – Capital Raise”) above, and the change in the unrealized loss on investment securities available for sale decreased equity by $4,911.

 

Liquidity

 

Maintenance of adequate liquidity requires that sufficient resources be available at all times to meet the Company’s cash flow requirements. Liquidity in a banking institution is required primarily to provide for deposit withdrawals and the credit needs of its customers and to take advantage of investment opportunities as they arise. Liquidity management involves the Company’s ability to convert assets into cash or cash equivalents without significant loss, and to raise cash or maintain funds without incurring excessive additional cost. The Company maintains a portion of its funds in cash, deposits in other banks, overnight investments, and securities available for sale. Liquid assets include cash and due from banks, less the federal reserve requirement; Federal funds sold; interest-bearing deposits in financial institutions, and unpledged investment securities available for sale. At September 30, 2012, the Company’s liquid assets totaled approximately $46.3 million and its liquidity level, measured as the percentage of liquid assets to total assets, was 38.8%. At December 31, 2011, the Company’s liquid assets totaled approximately $33.8 million and its liquidity level, measured as the percentage of liquid assets to total assets, was 30.8%. Management anticipates that liquid assets and the liquidity level will decline as the Company becomes more leveraged in the future. The Company’s current policy is to maintain a minimum liquidity ratio of 8%.

 

Although the Company’s primary sources of liquidity include liquid assets and a stable deposit base, the Company has Fed funds lines of credit of $3.5 million at Pacific Coast Bankers’ Bank, and $2.0 million at Zions First National Bank. In addition, as a member of the FHLB, the Bank may borrow funds collateralized by the Bank’s securities or qualified loans up to 25% of its eligible total asset base, or $26.6 million at September 30, 2012.

 

Capital Resources

 

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can trigger mandatory and possibly additional discretionary actions by the regulators that, if undertaken, could have a material effect on the Bank’s financial statements and operations. Under capital adequacy guidelines and regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accepted accounting practices. The Bank’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 Bank to maintain the following minimum ratios: Total risk-based capital ratio of at least 8%, Tier 1 Risk-based capital ratio of at least 4%, and a leverage ratio of at least 4%. Total capital is classified into two components: Tier 1 (common shareholders equity, qualifying perpetual preferred stock to certain limits, minority interests in equity accounts of consolidated subsidiary and trust preferred securities to certain limits, less goodwill and other intangibles) and Tier 2 (supplementary capital including allowance for possible credit losses to certain limits, certain preferred stock, eligible subordinated debt, and other qualifying instruments).

 

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The Company’s subordinated note represents a $3.1 million borrowing from its unconsolidated subsidiary. This subordinated note currently qualifies for inclusion as Tier 1 capital for regulatory purposes to the extent that it does not exceed 25% of total Tier 1 capital, but is classified as long-term debt in accordance with generally accepted accounting principles. In March 2005, the Federal Reserve Board adopted a final rule allowing bank holding companies to continue to include the subordinated debt related to trust preferred securities in their Tier 1 capital. The amount that can be included is limited to 25% of core capital elements, net of goodwill less any associated deferred tax liability. Excess amounts are generally included in Tier 2 capital.  As of September 30, 2012, TRUPS related debt made up 25% of the Company’s Tier 1 capital.  In addition, since the Company had less than $15 billion in assets at December 31, 2009, under the Dodd-Frank Act the Company can continue to include this debt in Tier 1 capital to the extent permitted by FRB guidelines. Generally, the amount of junior subordinated debentures in excess of the 25% Tier 1 limitation is included in Tier 2 capital.

 

The Bank has agreed to the OCC establishing higher minimum capital ratios for the Bank, specifically that the Bank will achieve by May 31, 2011, and thereafter maintain, a Leverage Capital Ratio of not less than 9.0% and a Total Risk-Based Capital Ratio of not less than 12.0%. The Bank had Total Risk-Based and Tier 1 Risk-Based capital ratios of 17.05% and 15.78%, respectively at September 30, 2012, compared to 16.51% and 15.24%, respectively at December 31, 2011. At September 30, 2012 and December 31, 2011, the Bank’s Leverage Capital Ratios were 10.04% and 9.81%, respectively.

 

Under the Federal Reserve Bank’s guidelines, Chino Commercial Bancorp is a “small bank holding company,” and thus qualifies for an exemption from the consolidated risk-based and leverage capital adequacy guidelines applicable to bank holding companies with assets of $500 million or more. However, while not required to do so under the Federal Reserve Bank’s capital adequacy guidelines, the Company still maintains levels of capital on a consolidated basis which qualify it as “well capitalized.” As of September 30, 2012, the Company’s Total Risk-Based and Tier 1 Risk-Based Capital ratios were 17.90% and 16.28%, respectively, and its Leverage Capital ratio was 10.29%.

 

The following table sets forth the Company’s and the Bank’s regulatory capital ratios as of the dates indicated:

 

Risk Based Ratios
  (unaudited)    
      Minimum Requirement
  September 30, 2012 December 31, 2011 to be Well Capitalized
Chino Commercial Bancorp      
Total capital to total risk-weighted assets 17.90% 16.44% 10.00%
Tier 1 capital to total risk-weighted assets 16.28% 14.26% 6.00%
Tier 1 leverage ratio 10.29% 9.19% 5.00%
       
Chino Commercial Bank      
Total capital to total risk-weighted assets 17.05% 16.51% 10.00%
Tier 1 capital to total risk-weighted assets 15.78% 15.24% 6.00%
Tier 1 leverage ratio 10.04% 9.81% 5.00%

  

Presently, there are no outstanding commitments that would necessitate the use of material amounts of the Company’s capital.

 

Interest Rate Risk Management

 

The principal objective of interest rate risk management (often referred to as “asset/liability management”) is to manage the financial components of the Company’s balance sheet so as to optimize the risk/reward equation for earnings and capital in relation to changing interest rates. In order to identify areas of potential exposure to rate changes, the Company calculates its repricing gap on a quarterly basis. It also performs an earnings simulation analysis and market value of portfolio equity calculation on a quarterly basis to identify more dynamic interest rate exposures than those apparent in standard repricing gap analyses.

 

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The Company manages the balance between rate-sensitive assets and rate-sensitive liabilities being repriced in any given period with the objective of stabilizing net interest income during periods of fluctuating interest rates. Rate-sensitive assets either contain a provision to adjust the interest rate periodically or mature within one year. Those assets include certain loans, certain investment securities and federal funds sold. Rate-sensitive liabilities allow for periodic interest rate changes and include time certificates, certain savings and interest-bearing demand deposits. The difference between the aggregate amount of assets and liabilities that are repricing at various time frames is called the interest rate sensitivity “gap.” Generally, if repricing assets exceed repricing liabilities in any given time period, the Company would be deemed to be “asset-sensitive” for that period, and if repricing liabilities exceed repricing assets in any given period the Company would be deemed to be “liability-sensitive” for that period. The Company seeks to maintain a balanced position over the period of one year in which it has no significant asset or liability sensitivity, to ensure net interest margin stability in times of volatile interest rates. This is accomplished by maintaining a significant level of loans and deposits available for repricing within one year.

 

The Company is generally asset sensitive, meaning that, in most cases, net interest income tends to rise as interest rates rise and decline as interest rates fall. At September 30, 2012, approximately 72.0% of loans have terms that incorporate variable interest rates. Most variable rate loans are indexed to the Bank’s prime rate and changes occur as the prime rate changes. Approximately 28.0% of all fixed rate loans at September 30, 2012 mature within twelve months.

 

Regarding the investment portfolio, a preponderance of the portfolio consists of fixed rate products with typical average lives of between three and five years. The mortgage-backed security portfolio receives monthly principal repayments which has the effect of reducing the securities’ average lives as principal repayment levels may exceed expected levels. Additionally, agency securities contain options by the agency to call the security, which would cause repayment prior to scheduled maturity.

 

Liability costs are generally based upon, but not limited to, U.S. Treasury interest rates and movements and rates paid by local competitors for similar products.

 

The change in net interest income may not always follow the general expectations of an “asset-sensitive” or “liability-sensitive” balance sheet during periods of changing interest rates. This possibility results from interest rates earned or paid changing by differing increments and at different time intervals for each type of interest-sensitive asset and liability. The interest rate gaps reported arise when assets are funded with liabilities having different repricing intervals. Since these gaps are actively managed and change daily as adjustments are made in interest rate views and market outlook, positions at the end of any period may not reflect the Company’s interest rate sensitivity in subsequent periods. The Company attempts to balance longer-term economic views against prospects for short-term interest rate changes in all repricing intervals.

 

The table below shows the estimated impact of changes in interest rates on our net interest income as of September 30, 2012, assuming a parallel shift of 100 to 300 basis points in both directions.

 

Immediate Change in Rate
                       
  -300 bp   -200 bp   -100 bp   +100 bp   +200 bp   +300 bp
                       
Change in net interest income (in $000’s)  $     (184)    $    (153)    $    (119)    $      698    $   1,378    $   2,043
% Change -4.61%   -3.83%   -2.98%