10-Q 1 nvb_3q13.htm FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the period ended September 30, 2013.

o	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Transition Period From ______________ to ______________

Commission file number 0-10652

NORTH VALLEY BANCORP

(Exact name of registrant as specified in its charter)

California		94-2751350
(State or other jurisdiction		(IRS Employer ID Number)
of incorporation or organization)

300 Park Marina Circle, Redding, CA		96001
(Address of principal executive offices)		(Zip code)

Registrant’s telephone number, including area code (530) 226-2900

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter periods 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 o

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 o

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

Large accelerated filer	o	Accelerated filer x

Non-accelerated filer	o	Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

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

Common Stock – 6,836,632 shares as of November 8, 2013.

INDEX

NORTH VALLEY BANCORP AND SUBSIDIARIES

PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets—September 30, 2013 and December 31, 2012	3
	Condensed Consolidated Statements of Income—For the three and nine months ended September 30, 2013 and 2012	4
	Consolidated Statements of Comprehensive (Loss) Income—For the three and nine months ended September 30, 2013 and 2012	6
	Condensed Consolidated Statements of Cash Flows—For the nine months ended September 30, 2013 and 2012	7
	Notes to Condensed Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	46

Item 4.	Controls and Procedures	46

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	46

Item 1A.	Risk Factors	46

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	46

Item 3.	Defaults Upon Senior Securities	46

Item 4.	Mine Safety Disclosures	46

Item 5.	Other Information	46

Item 6.	Exhibits	47

SIGNATURES		47

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands except share data) (Unaudited)

	September 30,			December 31,
	2013			2012
ASSETS
Cash and cash equivalents:
Cash and due from banks	$	23,780		$	22,654
Federal funds sold		2,345			15,865
Total cash and cash equivalents		26,125			38,519

Time deposits at other financial institutions		2,219			2,219
Investment securities available-for-sale, at fair value		293,627			285,815
Investment securities held-to-maturity, at amortized cost		6			6

Loans		509,092			492,211
Less: Allowance for loan losses		(9,312	)		(10,458	)
Net loans		499,780			481,753

Premises and equipment, net		8,572			9,181
Accrued interest receivable		2,166			2,217
Other real estate owned		15,045			22,423
FHLB and FRB stock and other nonmarketable securities		8,402			8,313
Bank-owned life insurance policies		36,941			36,045
Core deposit intangibles, net		146			255
Other assets		19,418			15,597

TOTAL ASSETS	$	912,447		$	902,343

LIABILITIES AND STOCKHOLDERS’ EQUITY

LIABILITIES:
Deposits:
Noninterest-bearing	$	184,471		$	177,855
Interest-bearing		595,299			590,725
Total deposits		779,770			768,580

Accrued interest payable and other liabilities		15,952			15,951
Subordinated debentures		21,651			21,651
Total liabilities		817,373			806,182

Commitments and contingencies

STOCKHOLDERS’ EQUITY:
Preferred stock, no par value: authorized 5,000,000 shares; no shares outstanding at September 30, 2013 and December 31, 2012		—			—
Common stock, no par value: authorized 60,000,000 shares; outstanding 6,836,632 and 6,835,192 at September 30, 2013 and December 31, 2012, respectively		98,817			98,495
Accumulated deficit		(1,265	)		(4,000	)
Accumulated other comprehensive (loss) income, net of tax		(2,478	)		1,666
Total stockholders’ equity		95,074			96,161

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	912,447		$	902,343

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

NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands except per share data) (Unaudited)

	Three months ended September 30,
	2013		2012
Interest income
Loans, including fees	$	6,462	$	6,663
Taxable securities		1,597		1,622
Tax exempt securities		103		131
Federal funds sold and repurchase agreements		3		10
Total interest income		8,165		8,426

Interest expense
Deposits		257		462
Other borrowed funds		—		8
Subordinated debentures		134		243
Total interest expense		391		713

Net interest income		7,774		7,713

Provision for loan losses		—		700

Net interest income after provision for loan losses		7,774		7,013

Noninterest income
Service charges on deposit accounts		959		1,086
Other fees and charges		1,152		1,102
Earnings on cash surrender value of life insurance policies		343		340
Gain on sale of loans, net		596		769
Gain on sales or calls of securities, net		5		697
Other		154		210
Total noninterest income		3,209		4,204

Noninterest expense
Salaries and employee benefits		5,084		5,005
Occupancy expense		629		651
Furniture and equipment expense		223		237
FDIC and state assessments		207		212
Other real estate owned expense		1,226		817
Other		2,667		2,837
Total noninterest expenses		10,036		9,759

Income before provision (benefit) for income taxes		947		1,458

Provision (benefit) for income taxes		367		(2,546	)

Net income	$	580	$	4,004

Earnings per share
Basic and diluted income per share	$	0.08	$	0.59

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

NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands except per share data) (Unaudited)

	Nine months ended September 30,
	2013		2012
Interest income
Loans, including fees	$	19,244	$	19,457
Taxable securities		4,438		5,532
Tax exempt securities		298		411
Federal funds sold and repurchase agreements		34		55
Total interest income		24,014		25,455

Interest expense
Deposits		825		1,800
Other borrowed funds		1		8
Subordinated debentures		400		1,213
Total interest expense		1,226		3,021

Net interest income		22,788		22,434

Provision for loan losses		—		2,100

Net interest income after provision for loan losses		22,788		20,334

Noninterest income
Service charges on deposit accounts		2,882		3,274
Other fees and charges		3,380		3,620
Earnings on cash surrender value of life insurance policies		1,125		1,023
Gain on sale of loans, net		2,441		1,858
Gain on sales or calls of securities, net		548		1,656
Other		813		719
Total noninterest income		11,189		12,150

Noninterest expense
Salaries and employee benefits		15,323		15,113
Occupancy expense		1,877		1,911
Furniture and equipment expense		645		709
FDIC and state assessments		638		701
Other real estate owned expense		2,592		1,793
Other		8,785		8,416
Total noninterest expenses		29,860		28,643

Income before provision (benefit) for income taxes		4,117		3,841

Provision (benefit) for income taxes		1,382		(1,904	)

Net income	$	2,735	$	5,745

Earnings per share
Basic and diluted income per share	$	0.40	$	0.84

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

NORTH VALLEY BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS COMPREHENSIVE INCOME (LOSS)
(In thousands) (Unaudited)

	Three months ended September 30,						Nine months ended September 30,
	2013			2012			2013			2012

Net income	$	580		$	4,004		$	2,735		$	5,745
Other comprehensive income (loss):
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the period		2,674			1,471			(7,843	)		5,279
Tax effect		(1,096	)		(603	)		3,216			(2,164	)
Reclassification adjustment for gains included in gain on sales or calls of securities, net		(5	)		(697	)		(548	)		(1,656	)
Provision for income taxes		2			286			225			679
Net of tax		1,575			457			(4,950	)		2,138
Defined benefit pension plans
Net gain arising during the period		—			34			1,146			103
Tax effect		—			(14	)		(470	)		(42	)
Reclassification adjustment for amortization of prior service cost and net gain included in salaries and employee benefits		72			—			220			—
Benefit for income taxes		(30	)		—			(90	)		—
Net of tax		42			20			806			61
Total other comprehensive income (loss)		1,617			477			(4,144	)		2,199
Comprehensive income (loss)	$	2,197		$	4,481		$	(1,409	)	$	7,944

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

NORTH VALLEY BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands except per share data) (Unaudited)

	Nine months ended September 30,
	2013			2012
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	2,735		$	5,745
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		760			808
Amortization of premium on securities, net		1,320			1,616
Amortization of core deposit intangible		109			109
Provision for loan losses		—			2,100
Net losses on sale and write-down of other real estate owned		2,273			1,487
Gain on sale of loans		(2,441	)		(1,858	)
Gain on sales or calls of securities		(548	)		(1,656	)
(Gain) loss on sale of premises and equipment		(73	)		1
Stock-based compensation expense		322			158
Effect of changes in:
Accrued interest receivable		51			261
Other assets		(1,837	)		(4,634	)
Accrued interest payable and other liabilities		1,854			(1,838	)
Proceeds from sales of loan originated for sale		69,922			64,882
Loans originated for sale		(70,514	)		(65,509	)
Net cash provided by operating activities		3,933			1,672

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of time deposits at other financial institutions		—			(251	)
Purchases of available-for-sale securities		(91,054	)		(142,049	)
Proceeds from sales/calls of available-for-sale securities		18,700			110,579
Proceeds from maturities of available-for-sale securities		55,380			48,314
Purchases of FHLB and FRB stock and other securities		(89	)		(269	)
Purchases of jumbo residential mortgages		—			(33,325	)
Net increase in loans		(15,812	)		(8,688	)
Proceeds from sales of other real estate owned		5,436			4,414
Purchases of premises and equipment		(375	)		(1,451	)
Proceeds from sales of premises and equipment		297			—
Net cash used in investing activities		(27,517	)		(22,726	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits		11,190			(7,763	)
Net change in other borrowed funds		—			(10,310	)
Net cash provided by (used in) financing activities		11,190			(18,073	)

NET DECREASE IN CASH AND CASH EQUIVALENTS		(12,394	)		(39,127	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		38,519			58,968
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	26,125		$	19,841

Supplemental Disclosures of Cash Flow Information
Cash paid during the year for:
Interest	$	1,252		$	7,874
Income taxes paid	$	670		$	122

Noncash investing and financing activities:
Transfer from loans to other real estate owned	$	818		$	7,484

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

NORTH VALLEY BANCORP AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1 – BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of North Valley Bancorp and subsidiaries (the “Company”) have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, certain information and notes required by accounting principles generally accepted in the United States for annual financial statements are not included herein. Management believes that the disclosures are adequate to make the information not misleading. In the opinion of management, all adjustments (consisting solely of normal recurring adjustments) considered necessary for a fair presentation of the results for the interim periods presented have been included. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012. Operating results for the three and nine months ended September 30, 2013 are not necessarily indicative of the results that may be expected for any subsequent period or for the year ended December 31, 2013.

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries North Valley Bank, a California banking corporation (“NVB”) and North Valley Trading Company, a California corporation, which is inactive. Significant intercompany items and transactions have been eliminated in consolidation. The Company owns the common stock of three business trusts that have issued trust preferred securities fully and unconditionally guaranteed by the Company. North Valley Capital Trust II, North Valley Capital Trust III and North Valley Capital Statutory Trust IV are unconsolidated subsidiaries and have issued an aggregate of $21,651,000 in trust preferred securities, which are reflected as debt on the Company’s condensed consolidated balance sheets.

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

Management has determined that since all of the banking products and services offered by the Company are available in each branch of NVB, all branches are located within the same economic environment and management does not allocate resources based on the performance of different lending or transaction activities, it is appropriate to aggregate NVB branches and report them as a single operating segment. No single customer accounts for more than ten percent of revenues for the Company or NVB.

NOTE 2 – INVESTMENT SECURITIES

The amortized cost of securities and their approximate fair value were as follows (in thousands):

			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
September 30, 2013
Available-for-Sale:
Obligations of U.S. government sponsored agencies	$	19,669	$	—	$	(991	)	$	18,678
Obligations of state and political subdivisions		6,692		192		(31	)		6,853
Government sponsored agency mortgage-backed securities		261,085		3,566		(4,308	)		260,343
Corporate debt securities		6,000		—		(1,230	)		4,770
Equity securities		3,000		—		(17	)		2,983
	$	296,446	$	3,758	$	(6,577	)	$	293,627
Held-to-Maturity:
Government sponsored agency mortgage-backed securities	$	6	$	—	$	—		$	6

December 31, 2012
Available-for-Sale:
Obligations of U.S. government sponsored agencies	$	21,003	$	115	$	—		$	21,118
Obligations of state and political subdivisions		10,698		499		—			11,197
Government sponsored agency mortgage-backed securities		239,543		6,152		(64	)		245,631
Corporate debt securities		6,000		—		(1,244	)		4,756
Equity securities		3,000		113		—			3,113
	$	280,244	$	6,879	$	(1,308	)	$	285,815
Held-to-Maturity:
Government sponsored agency mortgage-backed securities	$	6	$	—	$	—		$	6

For the three months ended September 30, 2013 and 2012 there were $5,000 and $697,000, respectively, in gross realized gains on sales or calls of available for sale securities. For the three months ended September 30, 2013 and 2012 there were no gross realized losses on sales or calls of securities categorized as available for sale securities. For the three months ended September 30, 2013 and 2012 there were $1,615,000 and $32,140,000 in gross proceeds from sales or calls of available for sale securities. There were no sales or transfers of held to maturity securities for the three months ended September 30, 2013 and 2012. For the three months ended September 30, 2013 and 2012, there were no gross proceeds from maturities or calls of held to maturity securities.

For the nine months ended September 30, 2013 and 2012 there were $548,000 and $1,665,000, respectively, in gross realized gains on sales or calls of available for sale securities. For the nine months ended September 30, 2013 there were no gross realized losses on sales or calls of securities categorized as available for sale securities. For the nine months ended September 30, 2012 there were $9,000 in gross realized losses on sales or calls of securities categorized as available for sale securities. For the nine months ended September 30, 2013 and 2012 there were $18,700,000 and $110,579,000, respectively, in gross proceeds from sales or calls of available for sale securities. There were no sales or transfers of held to maturity securities for the nine months ended September 30, 2013 and 2012. For the nine months ended September 30, 2013 and 2012, there were no gross proceeds from maturities or calls of held to maturity securities. Expected maturities of all investment securities are consistent with those reported in the December 31, 2012 Form 10-K.

At September 30, 2013 and December 31, 2012, securities having fair value amounts of approximately $285,444,000 and $276,308,000, respectively, were pledged to secure public deposits, short-term borrowings, treasury, tax and loan balances and for other purposes required by law or contract. The Company pledges most of its securities at the Federal Home Loan Bank (“FHLB”) to provide borrowing capacity. See “Liquidity” on page 44.

Investment securities are evaluated for other-than-temporary impairment on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in their value below amortized cost is other-than-temporary. Management utilizes criteria such as the magnitude and duration of the decline and the intent and ability of the Company to retain its investment in the issues for a period of time sufficient to allow for an anticipated recovery in fair value, in addition to the reasons underlying the decline, to determine whether the loss in value is other-than-temporary. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, and management does not intend to sell the security or it is more likely than not that the Company will not be required to sell the security before recovery, only the portion of the impairment loss representing credit exposure is recognized as a charge to earnings, with the balance recognized as a charge to other comprehensive income. If management intends to sell the security or it is more likely than not that the Company will be required to sell the security before recovering its forecasted cost, the entire impairment loss is recognized as a charge to earnings. For debt securities, the credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.

A summary of investments securities in an unrealized loss for less than twelve months and twelve months or longer is as follows (in thousands).

	As of September 30, 2013
	Less than 12 Months					12 Months or Longer					Total
	Estimated		Unrealized			Estimated		Unrealized			Estimated		Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Description of Securities
Obligations of U.S. government sponsored agencies	$	18,678	$	(991	)	$	—	$	—			18,678		(991	)
Obligations of state and political subdivisions		1,151		(31	)		—		—			1,151		(31	)
Government sponsored agency mortgage-backed securities		138,511		(4,308	)		—		—			138,511		(4,308	)
Corporate debt securities		—		—			4,770		(1,230	)		4,770		(1,230	)
Equity securities		2,983		(17	)		—		—			2,983		(17	)
Total impaired securities	$	161,323	$	(5,347	)	$	4,770	$	(1,230	)	$	166,093	$	(6,577	)

	As of December 31, 2012
	Less than 12 Months					12 Months or Longer					Total
	Estimated		Unrealized			Estimated		Unrealized			Estimated		Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Description of Securities
Government sponsored agency mortgage-backed securities	$	34,878	$	(64	)	$	—	$	—		$	34,878	$	(64	)
Corporate debt securities		—		—			4,756		(1,244	)		4,756		(1,244	)
Total impaired securities	$	34,878	$	(64	)	$	4,756	$	(1,244	)	$	39,634	$	(1,308	)

As of September 30, 2013 and December 31, 2012, there were two corporate debt securities in a loss position for twelve months or more. There is a current active market for these securities and management believes that the unrealized losses on the Company’s investment in these corporate debt securities is due to the yield of the securities and is not attributable to changes in credit quality. The two corporate debt securities are each a $3,000,000 single-issuer trust preferred security issued by two separate large publicly-traded financial institutions. The securities are tied to the front-end of the yield curve, three-month LIBOR (a short-term interest rate) and have a spread over that. In addition, the payments on both of these securities have been made as agreed and are considered current. The Company does not intend to sell and does not believe it will be required to sell these securities and expects a full recovery of value. The Company did not consider these investments to be other-than-temporarily impaired at September 30, 2013 or December 31, 2012.

Management periodically evaluates each investment security for other-than-temporary impairment, relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations. Management has the ability and intent to hold securities with established maturity dates until recovery of fair value, which may be at maturity, and believes it will be able to collect all amounts due according to the contractual terms for all of the underlying investment securities; therefore, management does not consider these investments to be other-than-temporarily impaired.

NOTE 3 – LOANS

The Company originates loans for business, consumer and real estate activities and for equipment purchases. Such loans are concentrated in the Company’s market areas which consist of Yolo, Placer, Sonoma, Shasta, Humboldt, Mendocino, Trinity and Del Norte Counties and neighboring communities. Major classifications of loans were as follows (in thousands):

	September 30,			December 31,
	2013			2012
Commercial	$	48,903		$	46,078
Real estate - commercial		328,967			295,630
Real estate - construction		19,281			23,003
Real estate - mortgage		65,790			74,353
Installment		5,560			6,689
Other		40,771			45,941
Gross loans		509,272			491,694
Deferred loan (fees) costs, net		(180	)		517
Allowance for loan losses		(9,312	)		(10,458	)
Total loans, net	$	499,780		$	481,753

Certain real estate loans receivable are pledged as collateral for available borrowings with the FHLB, FRB, and certain correspondent banks. Pledged loans totaled $95,107,000 and $116,929,000 at September 30, 2013 and December 31, 2012, respectively.

The following table presents impaired loans and the related allowance for loan losses as of the dates indicated (in thousands):

	As of September 30, 2013						As of December 31, 2012
			Unpaid						Unpaid
	Recorded		Principal		Related		Recorded		Principal		Related
	Investment		Balance		Allowance		Investment		Balance		Allowance
With no allocated allowance
Commercial	$	566	$	587	$	—	$	585	$	586	$	—
Real estate - commercial		4,283		4,348		—		2,778		2,974		—
Real estate - construction		843		864		—		1,210		1,273		—
Real estate - mortgage		1,171		1,194		—		684		736		—
Installment		110		127		—		122		138		—
Other		311		326		—		111		120		—
Subtotal		7,284		7,446		—		5,490		5,827		—

With allocated allowance
Commercial		16		16		16		—		—		—
Real estate - commercial		—		—		—		184		217		171
Real estate - construction		—		—		—		161		161		18
Real estate - mortgage		164		164		164		—		—		—
Subtotal		180		180		180		345		378		189
Total Impaired Loans	$	7,464	$	7,626	$	180	$	5,835	$	6,205	$	189

The following table presents the average balance and interest income recognized related to impaired loans for the period indicated (in thousands):

	For the three months ended September 30,
	2013				2012
	Average Book		Interest Income		Average Book		Interest Income
	Balance		Recognized		Balance		Recognized

Commercial	$	372	$	—	$	938	$	—
Real estate - commercial		4,704		21		7,780		—
Real estate - construction		869		6		1,766		—
Real estate - mortgage		1,393		13		986		—
Installment		138		—		123		—
Other		327		—		277		—
Total	$	7,803	$	40	$	11,870	$	—

	For the nine months ended September 30,
	2013				2012
	Average Book		Interest Income		Average Book		Interest Income
	Balance		Recognized		Balance		Recognized

Commercial	$	430	$	—	$	1,043	$	—
Real estate - commercial		4,722		35		7,942		—
Real estate - construction		874		19		1,780		—
Real estate - mortgage		1,404		33		1,006		—
Installment		140		—		133		—
Other		330		—		287		—
Total	$	7,900	$	87	$	12,191	$	—

Nonperforming loans include all such loans that are either on nonaccrual status or are 90 days past due as to principal or interest but still accrue interest because such loans are well-secured and in the process of collection. Nonperforming loans are summarized as follows (in thousands):

	September 30,			December 31,
	2013			2012
Nonaccrual loans	$	5,216		$	5,835
Loans 90 days past due or more but still accruing interest		—			—
Total nonperforming loans	$	5,216		$	5,835

Nonaccrual loans to total gross loans		1.02	%		1.19	%
Nonperforming loans to total gross loans		1.02	%		1.19	%

If interest on nonaccrual loans had been accrued, such income would have approximated $36,000 and $138,000 for the three months ended September 30, 2013 and 2012, respectively. If interest on nonaccrual loans had been accrued, such income would have approximated $171,000 and $495,000 for the nine months ended September 30, 2013 and 2012, respectively.

The following table shows an aging analysis of the loan portfolio by the amount of time past due (in thousands):

	As of September 30, 2013
	Accruing Interest
					Greater than
			30-89 Days		90 Days
	Current		Past Due		Past Due		Nonaccrual		Total

Commercial	$	48,168	$	153	$	—	$	582	$	48,903
Real estate - commercial		325,503		73		—		3,391		328,967
Real estate - construction		18,843		—		—		438		19,281
Real estate - mortgage		64,766		612		—		412		65,790
Installment		5,469		9		—		82		5,560
Other		40,434		26		—		311		40,771
Total	$	503,183	$	873	$	—	$	5,216	$	509,272

	As of December 31, 2012
	Accruing Interest
					Greater than
			30-89 Days		90 Days
	Current		Past Due		Past Due		Nonaccrual		Total

Commercial	$	45,473	$	20	$	—	$	585	$	46,078
Real estate - commercial		292,505		163		—		2,962		295,630
Real estate - construction		21,436		196		—		1,371		23,003
Real estate - mortgage		72,907		762		—		684		74,353
Installment		6,529		38		—		122		6,689
Other		45,581		249		—		111		45,941
Total	$	484,431	$	1,428	$	—	$	5,835	$	491,694

A troubled debt restructuring (“TDRs”) is a formal modification of the terms of a loan when the lender, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan.

At September 30, 2013, accruing TDRs were $2,248,000 and nonaccrual TDRs were $952,000 compared to accruing TDRs of $2,414,000 and nonaccrual TDRs of $1,072,000 at December 31, 2012. At September 30, 2013, there were no specific reserves allocated to customers whose loan terms were modified in troubled debt restructurings. There are no commitments to lend additional amounts at September 30, 2013 to customers with outstanding loans that are classified as troubled debt restructurings. There were no TDRs that subsequently defaulted during the twelve months following the modification of terms.

The following table presents loans that were modified and recorded as TDRs for the three and nine months ended September 30, 2013 and 2012.

	Three months ended September 30, 2013						Three months ended September 30, 2012
			Pre-Modification		Post-Modification				Pre-Modification		Post-Modification
	Number		Outstanding		Outstanding		Number		Outstanding		Outstanding
	of		Recorded		Recorded		of		Recorded		Recorded
	Contracts		Investment		Investment		Contracts		Investment		Investment
Commercial		2	$	140	$	140		—	$	—	$	—
Real estate - construction		1	$	114	$	114		—	$	—	$	—
Real estate - mortgage		1	$	116	$	116		1	$	425	$	425
Other		—	$	—	$	—		1	$	26	$	26

	Nine months ended September 30, 2013						Nine months ended September 30, 2012
			Pre-Modification		Post-Modification				Pre-Modification		Post-Modification
	Number		Outstanding		Outstanding		Number		Outstanding		Outstanding
	of		Recorded		Recorded		of		Recorded		Recorded
	Contracts		Investment		Investment		Contracts		Investment		Investment
Commercial		3	$	181	$	181		1	$	800	$	800
Real estate - commercial		1	$	438	$	438		2	$	269	$	269
Real estate - construction		1	$	114	$	114		—	$	—	$	—
Real estate - mortgage		2	$	326	$	326		1	$	425	$	425
Installment		—	$	—	$	—		2	$	70	$	70
Other		1	$	47	$	47		1	$	26	$	26

A summary of TDRs by type of concession and by type of loan as of September 30, 2013 and December 31, 2012, is shown below:

	September 30, 2013
Accruing TDRs						Rate
						Reduction
	Number					and
	of	Rate		Maturity		Maturity
	Contracts	Reduction		Extension		Extension		Total
Real estate - commercial	5	$	—	$	197	$	696	$	893
Real estate - construction	2	$	—	$	405	$	—	$	405
Real estate - mortgage	3	$	—	$	294	$	628	$	922
Installment	1	$	—	$	—	$	28	$	28

	September 30, 2013
Nonaccrual TDRs						Rate
						Reduction
	Number					and
	of	Rate		Maturity		Maturity
	Contracts	Reduction		Extension		Extension		Total
Commercial	4	$	16	$	—	$	566	$	582
Real estate - commercial	—	$	—	$	—	$	—	$	—
Real estate - construction	1	$	—	$	114	$	—	$	114
Real estate - mortgage	1	$	—	$	—	$	116	$	116
Installment	3	$	—	$	—	$	70	$	70
Other	2	$	—	$	—	$	70	$	70

	December 31, 2012
Accruing TDRs						Rate
						Reduction
	Number					and
	of	Rate		Maturity		Maturity
	Contracts	Reduction		Extension		Extension		Total
Real estate - commercial	5	$	202	$	—	$	1,148	$	1,350
Real estate - construction	1	$	—	$	343	$	—	$	343
Real estate - mortgage	2	$	—	$	298	$	423	$	721

	December 31, 2012
Nonaccrual TDRs						Rate
						Reduction
	Number					and
	of	Rate		Maturity		Maturity
	Contracts	Reduction		Extension		Extension		Total
Commercial	1	$	—	$	—	$	529	$	529
Real estate-construction	2	$	327	$	71	$	—	$	398
Installment	4	$	—	$	—	$	120	$	120
Other	1	$	—	$	—	$	25	$	25

NOTE 4 – ALLOWANCE FOR LOAN LOSSES

The following table shows the changes in the allowance for loan losses (in thousands):


	For the three months ended September 30, 2013
				Real Estate			Real Estate			Real Estate
	Commercial			Commercial			Construction			Mortgage			Installment			Other			Unallocated			Total

Allowance for Loan Losses
Balance June 30, 2013	$	847		$	5,487		$	439		$	920		$	167		$	920		$	747		$	9,527
Charge-offs		(22	)		—			(20	)		(34	)		(40	)		(174	)					(290	)
Recoveries		18			48			—			1			8			—						75
Provisions for loan losses		(93	)		138			16			(23	)		15			110			(163	)		—
Balance September 30, 2013	$	750		$	5,673		$	435		$	864		$	150		$	856		$	584		$	9,312

	For the three months ended September 30, 2012
				Real Estate			Real Estate			Real Estate
	Commercial			Commercial			Construction			Mortgage			Installment			Other			Unallocated			Total

Allowance for Loan Losses
Balance June 30, 2012	$	1,260		$	6,586		$	1,387		$	925		$	141		$	768		$	665		$	11,732
Charge-offs		(250	)		(113	)		(492	)		(143	)		(48	)		(48	)					(1,094	)
Recoveries		13			—			43			1			29			3						89
Provisions for loan losses		(261	)		435			(23	)		422			—			60			67			700
Balance September 30, 2012	$	762		$	6,908		$	915		$	1,205		$	122		$	783		$	732		$	11,427

	For the nine months ended September 30, 2013
				Real Estate			Real Estate			Real Estate
	Commercial			Commercial			Construction			Mortgage			Installment			Other			Unallocated			Total

Allowance for Loan Losses
Balance December 31, 2012	$	843		$	6,295		$	690		$	982		$	98		$	721		$	829		$	10,458
Charge-offs		(131	)		(438	)		(389	)		(236	)		(68	)		(229	)					(1,491	)
Recoveries		276			46			3			3			17			—						345
Provisions for loan losses		(238	)		(230	)		131			115			103			364			(245	)		—
Balance September 30, 2013	$	750		$	5,673		$	435		$	864		$	150		$	856		$	584		$	9,312

	As of September 30, 2013
Reserve to impaired loans	$	16		$	—		$	—		$	164		$	—		$	—		$	—		$	180
Reserve to non-impaired loans	$	734		$	5,673		$	435		$	700		$	150		$	856		$	584		$	9,132

	For the nine months ended September 30, 2012
				Real Estate			Real Estate			Real Estate
	Commercial			Commercial			Construction			Mortgage			Installment			Other			Unallocated			Total

Allowance for Loan Losses
Balance December 31, 2011	$	1,333		$	7,528		$	1,039		$	935		$	185		$	736		$	900		$	12,656
Charge-offs		(456	)		(1,730	)		(822	)		(333	)		(190	)		(120	)					(3,651	)
Recoveries		39			63			80			37			94			9						322
Provisions for loan losses		(154	)		1,047			618			566			33			158			(168	)		2,100
Balance September 30, 2012	$	762		$	6,908		$	915		$	1,205		$	122		$	783		$	732		$	11,427

	As of September 30, 2012
Reserve to impaired loans	$	—		$	417		$	—		$	50		$	—		$	—					$	467
Reserve to non-impaired loans	$	762		$	6,491		$	915		$	1,155		$	122		$	783		$	732		$	10,960

	As of December 31, 2012
Reserve to impaired loans	$	—		$	171		$	18		$	—		$	—		$	—					$	189
Reserve to non-impaired loans	$	843		$	6,124		$	672		$	982		$	98		$	721		$	829		$	10,269

The following table shows the loan portfolio by segment as follows (in thousands):

	As of September 30, 2013
			Real Estate		Real Estate		Real Estate
	Commercial		Commercial		Construction		Mortgage		Installment		Other		Total

Total Loans	$	48,903	$	328,967	$	19,281	$	65,790	$	5,560	$	40,771	$	509,272
Impaired Loans	$	582	$	4,283	$	843	$	1,335	$	110	$	311	$	7,464
Non-impaired loans	$	48,321	$	324,684	$	18,438	$	64,455	$	5,450	$	40,460	$	501,808

	As of December 31, 2012
			Real Estate		Real Estate		Real Estate
	Commercial		Commercial		Construction		Mortgage		Installment		Other		Total

Total Loans	$	46,078	$	295,630	$	23,003	$	74,353	$	6,689	$	45,941	$	491,694
Impaired Loans	$	585	$	2,962	$	1,371	$	684	$	122	$	111	$	5,835
Non-impaired loans	$	45,493	$	292,668	$	21,632	$	73,669	$	6,567	$	45,830	$	485,859

The following table shows the loan portfolio allocated by management’s internal risk ratings as defined in Footnote 1 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 (in thousands):

	As of September 30, 2013
	Pass		Special Mention		Substandard		Doubtful		Total
Commercial	$	47,201	$	726	$	976	$	—	$	48,903
Real estate - commercial		315,132		3,238		10,597		—		328,967
Real estate - construction		18,843		—		438		—		19,281
Real estate - mortgage		64,750		—		1,040		—		65,790
Installment		5,448		—		112		—		5,560
Other		40,263		—		508		—		40,771
Total	$	491,637	$	3,964	$	13,671	$	—	$	509,272

	As of December 31, 2012
	Pass		Special Mention		Substandard		Doubtful		Total
Commercial	$	44,486	$	129	$	1,463	$	—	$	46,078
Real estate - commercial		278,834		—		16,796		—		295,630
Real estate - construction		21,386		—		1,617		—		23,003
Real estate - mortgage		71,973		—		2,380		—		74,353
Installment		6,562		—		127		—		6,689
Other		45,658		—		283		—		45,941
Total	$	468,899	$	129	$	22,666	$	—	$	491,694

The allowance for loan losses is established through a provision for loan losses based on management’s evaluation of the probable incurred losses in the loan portfolio. In determining levels of risk, management considers a variety of factors, including, but not limited to, asset classifications, economic trends, industry experience and trends, geographic concentrations, estimated collateral values, historical loan loss experience, and the Company’s underwriting policies. During the second quarter of 2013, there was a change in the Bank’s method of calculating the historical loss factors applied to loans identified as “homogenous segments” of the loan portfolio as follows: Losses from the past twelve quarters are applied to loan pools based on a “Migration Analysis” method. The method calculates Net Charge Offs (charge offs less corresponding recoveries) and measures them against average balances in loan pools based on the risk grade in effect on charged-off loans four quarters prior to the actual charge off date. The logic behind this four quarter “look back” is to account for management’s estimate of the typical time lapse between the recognition of the problem loan and the recognition of some or all of the loan as uncollectable. In addition, the loss ratios are calculated using “factored” logic which systematically reduces the Net Charge Off value so that charge offs occurring in older periods do not have as much weight as more recent charge offs. Management of the Company believes that, given the recent trends in historical losses and the correlation of those losses with a loans identified risk grade, that incorporation of a migration analysis in the current and future analyses was a prudent refinement of the allowance methodology. In addition, management believes that the decreases in the overall level of the allowance for loan losses over the past several quarters is directionally consistent with the improving credit quality trends of the loan portfolio. The allowance for loan losses is maintained at an amount management considers adequate to cover the probable incurred losses in loans receivable. While management uses the best information available to make these estimates, future adjustments to allowances may be necessary due to economic, operating, regulatory, and other conditions that may be beyond the Company’s control. The Company also engages a third party credit review consultant to analyze the Company’s loan loss adequacy periodically. In addition, the regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on judgments different from those of management.

The allowance for loan losses is comprised of several components including the specific, formula and unallocated allowance relating to loans in the loan portfolio. Our methodology for determining the allowance for loan losses consists of several key elements, which include:

●

Specific Allowances. A specific allowance is established when management has identified unique or particular risks that were related to a specific loan that demonstrated risk characteristics consistent with impairment. Specific allowances are established when management can estimate the amount of an impairment of a loan.

●

Formula Allowance. The formula allowance is calculated using a “Migration Analysis” method as defined above applied to homogenous pools of loans. Changes in risk grades of both performing and nonperforming loans affect the amount of the formula allowance. Loss factors are based on our historical loss experience and such other data as management believes to be pertinent. Management, also, considers a variety of subjective factors, including regional economic and business conditions that impact important segments of our portfolio, loan growth rates, the depth and skill of lending staff, the interest rate environment, and the results of bank regulatory examinations and findings of our internal credit examiners to establish the formula allowance.

●

Unallocated Allowance. The unallocated loan loss allowance represents an amount for imprecision or uncertainty that is inherent in estimates used to determine the allowance.

The Company also maintains a separate allowance for off-balance-sheet commitments. A reserve for unfunded commitments is maintained at a level that, in the opinion of management, is adequate to absorb probable losses associated with commitments to lend funds under existing agreements, for example, the Bank’s commitment to fund advances under lines of credit. The reserve amount for unfunded commitments is determined based on our methodologies described above with respect to the formula allowance. The allowance for off-balance-sheet commitments is included in accrued interest payable and other liabilities on the consolidated balance sheet and was $146,000 and $143,000 for the periods ended September 30, 2013 and December 31, 2012, respectively.

NOTE 5 – OTHER REAL ESTATE OWNED

The Company had $15,045,000 and $22,423,000 in other real estate owned (“OREO”) at September 30, 2013 and December 31, 2012, respectively. Below is a table with details of the changes in OREO (in thousands):

	September 30,			December 31,
	2013			2012
Beginning Balance	$	22,423		$	20,106
Properties transferred in		818			12,239
Sales of property		(5,923	)		(6,889	)
Loss on sale or writedown of property		(2,273	)		(3,033	)
Total	$	15,045		$	22,423

Subsequent to September 30, 2013, the Company sold eight OREO properties located in Sonoma County at their recorded value of $9,885,000 which resulted in no additional gain or loss. The transaction closed on October 29, 2013.

The following table presents the components of OREO expense (in thousands):

	Three months ended September 30,					Nine months ended September 30,
	2013		2012			2013		2012
Operating expenses	$	85	$	79		$	319	$	306
Provision for losses		1,139		749			2,023		1,310
Net, loss (gain) on disposal		2		(11	)		250		177
Total other real estate owned expense	$	1,226	$	817		$	2,592	$	1,793

NOTE 6 – SUBORDINATED DEBENTURES

The Company owns the common stock of three business trusts that have issued an aggregate of $21.0 million in trust preferred securities fully and unconditionally guaranteed by the Company. The entire proceeds of each respective issuance of trust preferred securities were invested by the separate business trusts into junior subordinated debentures issued by the Company, with identical maturity, repricing and payment terms as the respective issuance of trust preferred securities. The aggregate amount of junior subordinated debentures issued by the Company is $21,651,000, with the maturity dates for the respective debentures ranging from 2033 through 2036. Subject to regulatory approval, the Company may redeem the respective junior subordinated debentures earlier than the maturity date, based on their respective redemption dates. The respective junior subordinated debentures became redeemable in April 2008, July 2009 and March 2011.

The trust preferred securities issued by the trusts are currently included in Tier 1 capital in the amount of $21,000,000 for purposes of determining Leverage, Tier 1 and Total Risk-Based capital ratios for the periods ending September 30, 2013 and December 31, 2012.

The following table summarizes the terms of each subordinated debenture issuance for the periods ending September 30, 2013 and December 31, 2012 (dollars in thousands):

Fixed or

Date

Variable

Current

Rate

Redemption

Series

Issued

Maturity

Rate

Index

Date

Amount

North Valley Capital Trust II

4/10/03

4/24/33

Variable

3.52%

LIBOR + 3.25%

4/24/08

6,186

North Valley Capital Trust III

5/5/04

4/24/34

Variable

3.06%

LIBOR + 2.80%

7/23/09

5,155

North Valley Capital Statutory Trust IV

12/29/05

3/15/36

Variable

1.58%

LIBOR + 1.33%

3/15/11

10,310

21,651

NOTE 7 – INCOME TAXES

The Company files its income taxes on a consolidated basis with NVB. The allocation of income tax expense (benefit) represents each entity’s proportionate share of the consolidated provision for income taxes.

The Company applies the asset and liability method to account for income taxes. Deferred tax assets and liabilities are calculated by applying applicable tax laws to the differences between the financial statement basis and the tax basis of assets and liabilities. The effect on deferred taxes of changes in tax laws and rates is recognized in income in the period that includes the enactment date. On the consolidated balance sheet, net deferred tax assets are included in other assets.

The Company accounts for uncertainty in income taxes by recording only tax positions that met the more likely than not recognition threshold, that the tax position would be sustained in a tax examination.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. At September 30, 2013 and December 31, 2012, unrecognized tax benefits totaled $519,000.

During the quarter ended September 30, 2012, the Company recorded a $2,546,000 income tax benefit, which was the net result of reversing the state deferred tax asset valuation allowance of $4,277,000 less a $1,347,000 increase in federal deferred tax liabilities against the three and nine months ended September 30, 2012 current period tax expense. The deferred tax asset valuation allowance was established in 2010 due to the Company’s prior net operating losses, its inability to meet its financial projections and because of elevated levels of credit losses. To determine if the benefit of its net deferred tax asset will more likely than not be realized, the Company’s management analyzed both positive and negative evidence that may affect the realization of the deferred tax asset. Management of the Company determined that it was more likely than not that all of its net deferred tax asset would be realized.

Net deferred tax assets totaled $15,226,000 and $12,346,000 at September 30, 2013 and December 31, 2012, respectively.

NOTE 8 – PENSION PLAN BENEFITS

The Company has a supplemental retirement plan for key executives and a supplemental retirement plan for certain retired key executives and directors. These plans are nonqualified defined benefit plans and are unsecured. Total contributions paid were $63,000 for the three months ended September 30, 2013 and 2012. Components of net periodic benefit cost for the Company’s supplemental nonqualified defined benefit plans for the three and nine months ended September 30, 2013 and 2012 are presented in the following table (in thousands):

	Three months ended September 30,				Nine months ended September 30,
Components of net periodic benefits cost:	2013		2012		2013		2012
Service cost	$	171	$	150	$	512	$	451
Interest cost		93		84		279		251
Prior service amortization		25		25		74		74
Recognized net actuarial loss		48		10		146		30
Total components of net periodic cost	$	337	$	269	$	1,011	$	806

	September 30, 2013		December 31, 2012

Total Liability of Pension Plan Benefits	$	8,900	$	9,443

NOTE 9 – STOCK-BASED COMPENSATION

Stock Option Plans

At September 30, 2013, the Company had two shareholder approved stock-based compensation plans: the 1998 Employee Stock Incentive Plan and the 2008 Stock Incentive Plan. A total of 601,925 shares were authorized under all plans at September 30, 2013. The plans do not provide for the settlement of awards in cash and new shares are issued upon exercise of the options. The North Valley Bancorp 1998 Employee Stock Incentive Plan provides for awards in the form of options (which may constitute incentive stock options (“ISOs”) or non-statutory stock options (“NSOs”) to key employees) and also provides for the award of shares of Common Stock to outside directors. As provided in the 1998 Employee Stock Incentive Plan, the authorization to award incentive stock options terminated on February 19, 2008. Pursuant to the 1998 Employee Stock Incentive Plan there were outstanding options to purchase 51,930 shares of Common Stock at September 30, 2013. The North Valley Bancorp 2008 Stock Incentive Plan was adopted by the Company’s Board of Directors on February 27, 2008, effective that date, and was approved by the Company’s shareholders at the annual meeting, May 22, 2008. The terms of the 2008 Stock Incentive Plan are substantially the same as the North Valley Bancorp 1998 Employee Stock Incentive Plan. The 2008 Stock Incentive Plan provides for the grant to key employees of stock options, which may consist of NSOs and ISOs. Under the 2008 Stock Incentive Plan, options may not be granted at a price less than the fair market value at the date of the grant. Under all plans, options may be exercised over a ten year term. The vesting period is generally four years; however the vesting period can be modified at the discretion of the Company’s Board of Directors, and for all options granted after the fourth quarter in 2008 the vesting period is five years. The 2008 Stock Incentive Plan also provides for the grant to outside directors, and to consultants and advisers to the Company, of stock options, all of which must be NSOs. The shares of Common Stock authorized to be granted as options under the 2008 Stock Incentive Plan consist 549,995 shares of Common Stock reserved for issuance under the terms of the 2008 Stock Incentive Plan, consisting of 302,780 shares to be issued upon the exercise of options granted and still outstanding as of that date, 5,580 shares issued as stock awards and 241,635 shares reserved for future stock option grants and director stock awards at September 30, 2013. Effective January 1, 2009, and on each January 1 thereafter for the remaining term of the 2008 Stock Incentive Plan, the aggregate number of shares of Common Stock which are reserved for issuance pursuant to options granted under the terms of the 2008 Stock Incentive Plan shall be increased by a number of shares of Common Stock equal to 2% of the total number of the shares of Common Stock of the Company outstanding at the end of the most recently concluded calendar year. Any shares of Common Stock that have been reserved but not issued as options during any calendar year shall remain available for grant during any subsequent calendar year. Each outside director of the Company shall also be eligible to receive a stock award of 180 shares of Common Stock as part of his or her annual retainer paid by the Company for his or her services as a director. On September 18, 2013, the Board of Directors approved the 180 share stock award to each of the eight outside directors (total 1,440 shares) for the year 2013. The Company recognized director stock grant expense in the amount of $27,000 for the quarter ending September 30, 2013, relative to these 1,440 shares awarded to the eight outside directors. Each stock award shall be fully vested when granted to the outside director. The number of shares of Common Stock available as stock awards to outside directors shall equal the number of shares of Common Stock to be awarded to such outside directors. Outstanding options under the plans are exercisable until their expiration.

Stock-based Compensation

There were no options granted in the three month period ended September 30, 2013 and 2012. There were 114,234 and 77,908 options granted for the nine month periods ended September 30, 2013 and 2012, respectively. For the three month periods ended September 30, 2013 and 2012, the compensation cost recognized for share based compensation was $131,000 and $69,000, respectively. For the nine month periods ended September 30, 2013 and 2012, the compensation cost recognized for share based compensation was $322,000 and $158,000, respectively At September 30, 2013, the total unrecognized compensation cost related to stock-based awards granted to employees under the Company’s stock option plans was $1,512,000. This cost is expected to be amortized on a straight-line basis over a weighted average period of approximately 3.9 years and will be adjusted for subsequent changes in estimated forfeitures. There were no options granted for the three month periods ended September 30, 2013 and 2012. The following table summarizes the weighted average grant date fair value of options granted for the nine month periods ended September 30, 2013 and 2012, based on the following assumptions used in a Black-Scholes Merton model.

	Three months ended September 30,				Nine months ended September 30,
	2013		2012		2013			2012
Weighted average grant date fair value per share of option granted		N/A		N/A	$	9.53		$	6.28
Significant weighted average assumptions used in calculating fair value:
Expected term						6.32 years			6.49 years
Expected annual volatility						60	%		59	%
Expected annual dividend yield						N/A			N/A
Risk-free interest rate						1.38	%		1.40	%

A summary of outstanding stock options follows:

						Weighted
				Weighted		Average
				Average		Remaining		Exercise		Aggregate
				Exercise		Contractual		Price		Intrinsic
	Shares			Price		Term		Range		Value ($000)

Outstanding at January 1, 2013		248,822		$	29.40		7 years		$9.97-$103.10	$	1,160

Granted		114,234		$	16.80				$16.80	$	240
Exercised		—			—				—
Expired or Forfeited		(8,346	)	$	63.32				$23.95-$65.30

Outstanding at September 30, 2013		354,710		$	24.55		7 years		$9.97-$103.10	$	1,400
Fully vested and exercisable at September 30, 2013		130,008		$	42.10		5 years		$9.97-$103.10	$	344
Options expected to vest at September 30, 2013		224,702		$	14.39		9 years		$9.97-$23.95	$	1,056

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company’s common stock as of September 30, 2013. There were no options exercised during the three and nine month periods ended September 30, 2013 and 2012.

NOTE 10 – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

Changes in each component of accumulated other comprehensive income (loss) for the three and nine month periods ended September 30, 2013 and September 30, 2012 were as follows (in thousands):

	Net Unrealized Gains (Losses) on Securities			Adjustments Related to Defined Benefit Pension Plan			Accumulated Other Comprehensive Income (Loss)
Balance at June 30, 2013	$	(3,238	)	$	(857	)	$	(4,095	)
Net unrealized gains on securities available for sale, net of tax, $1,096		1,577			—			1,577
Reclassification adjustment for losses on securities, net of tax, $(2)		(3	)		—			(3	)
Net gains arising during the period, net of tax		—			—			—
Reclassification adjustment for amortization of prior service cost and net gain included in salaries and employee benefits, net of tax $30		—			43			43
Balance at September 30, 2013	$	(1,664	)	$	(814	)	$	(2,478	)

Balance at June 30, 2012	$	4,050		$	(858	)	$	3,192
Net unrealized gains on securities available for sale, net of tax, $603		868			—			868
Reclassification adjustment for gains on securities, net of tax, $(286)		(411	)		—			(411	)
Net gains arising during the period, net of tax $14		—			20			20
Reclassification adjustment for amortization of prior service cost and net gain included in salaries and employee benefits, net of tax		—			—			—
Balance at September 30, 2012	$	4,507		$	(838	)	$	3,669

	Net Unrealized Gains (Losses) on Securities			Adjustments Related to Defined Benefit Pension Plan			Accumulated Other Comprehensive Income (Loss)
Balance at December 31, 2012	$	3,286		$	(1,620	)	$	1,666
Net unrealized losses on securities available for sale, net of tax, $(3,215)		(4,627	)		—			(4,627	)
Reclassification adjustment for gains on securities, net of tax, $(225)		(323	)		—			(323	)
Net gains arising during the period, net of tax $470		—			676			676
Reclassification adjustment for amortization of prior service cost and net gain included in salaries and employee benefits, net of tax $90		—			130			130
Balance at September 30, 2013	$	(1,664	)	$	(814	)	$	(2,478	)

Balance at December 31, 2011	$	2,369		$	(899	)	$	1,470
Net unrealized gains on securities available for sale, net of tax, $2,165		3,115			—			3,115
Reclassification adjustment for gains on securities, net of tax, $(679)		(977	)		—			(977	)
Net gains arising during the period, net of tax $42		—			61			61
Reclassification adjustment for amortization of prior service cost and net gain included in salaries and employee benefits, net of tax		—			—			—
Balance at September 30, 2012	$	4,507		$	(838	)	$	3,669

Changes in each component of accumulated other comprehensive income were as follows (in thousands):

Three months ended September 30, 2013
Details About Accumulated Other Comprehensive Income Components	Amount Reclassified From Accumulated Other Comprehensive Income			Affected Line Item in the Statement Where Net Income is Presented
Gains on investment securities	$	5		Gain on sales or calls of securities, net
Amortization of prior service cost and net gain included in net periodic pension cost	$	(73	)	Salaries and employee benefits
		(68	)	Total before tax
		28		Benefit for income tax
	$	(40	)	Net of tax

Three months ended September 30, 2012
Details About Accumulated Other Comprehensive Income Components	Amount Reclassified From Accumulated Other Comprehensive Income			Affected Line Item in the Statement Where Net Income is Presented
Gain on investment securities	$	697		Gain on sales or calls of securities, net
Amortization of prior service cost and net gain included in net periodic pension cost		—		Salaries and employee benefits
		697		Total before tax
		(286	)	Provision for income tax
	$	411		Net of tax

Nine months ended September 30, 2013
Details About Accumulated Other Comprehensive Income Components	Amount Reclassified From Accumulated Other Comprehensive Income			Affected Line Item in the Statement Where Net Income is Presented
Gain on investment securities	$	548		Gain on sales or calls of securities, net
Amortization of prior service cost and net gain included in net periodic pension cost		(220	)	Salaries and employee benefits
		328		Total before tax
		(135	)	Provision for income tax
	$	193		Net of tax

Nine months ended September 30, 2012
Details About Accumulated Other Comprehensive Income Components	Amount Reclassified From Accumulated Other Comprehensive Income			Affected Line Item in the Statement Where Net Income is Presented
Gain on investment securities	$	1,656		Gain on sales or calls of securities, net
Amortization of prior service cost and net gain included in net periodic pension cost		—		Salaries and employee benefits
		1,656		Total before tax
		(679	)	Provision for income tax
	$	977		Net of tax

NOTE 11 – EARNINGS PER SHARE

Basic earnings per share (“EPS”), which excludes dilution, is computed by dividing income or loss available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as stock options, result in the issuance of common stock which shares in the earnings of the Company. The treasury stock method has been applied to determine the dilutive effect of stock options in computing diluted EPS. Stock options for 211,802 and 249,164 shares of common stock were not considered in computing diluted earnings per common share for the three months ended September 30, 2013 and 2012 respectively, because they were anti-dilutive. Stock options for 214,302 and 249,164 shares of common stock were not considered in computing diluted earnings per common share for the nine months ended September 30, 2013 and 2012 respectively, because they were anti-dilutive.

	Three months ended September 30,				Nine months ended September 30,
	2013		2012		2013		2012
Calculation of basic earnings per share:
Numerator - net income	$	580	$	4,004	$	2,735	$	5,745
Denominator -
Weighted average common shares outstanding		6,835		6,835		6,835		6,834
Basic earnings per share	$	0.08	$	0.59	$	0.40	$	0.84

Calculation of diluted earnings per share:
Numerator - net income	$	580	$	4,004	$	2,735	$	5,745
Denominator -
Weighted average common shares outstanding		6,835		6,835		6,835		6,834
Dilutive effect of outstanding options		26		1		18		1
Weighted average common shares outstanding and common stock equivalents		6,861		6,836		6,853		6,835
Diluted earnings per share	$	0.08	$	0.59	$	0.40	$	0.84

NOTE 12 – COMMITMENTS AND CONTINGENCIES

The Company is involved in legal actions arising from normal business activities. Management, based upon the advice of legal counsel, believes that the ultimate resolution of all pending legal actions will not have a material effect on the Company’s financial position, results of its operations or its cash flows.

The Company was contingently liable under letters of credit issued on behalf of its customers in the amount of $5,003,000 and $4,713,000 at September 30, 2013 and December 31, 2012, respectively. At September 30, 2013, commercial and consumer lines of credit and real estate loans of approximately $39,048,000 and $35,855,000, respectively, were undisbursed. At December 31, 2012, commercial and consumer lines of credit and real estate loans of approximately $47,350,000 and $31,925,000, respectively, were undisbursed.

Loan commitments are typically contingent upon the borrower meeting certain financial and other covenants and such commitments typically have fixed expiration dates and require payment of a fee. As many of these commitments are expected to expire without being drawn upon, the total commitments do not necessarily represent future cash requirements. The Company evaluates each potential borrower and the necessary collateral on an individual basis. Collateral varies, but may include real property, bank deposits, debt securities, equity securities or business or personal assets.

Standby letters of credit are conditional commitments written by the Company to guarantee the performance of a customer to a third party. These guarantees are issued primarily relating to real estate projects and inventory purchases by the Company’s commercial customers and such guarantees are typically short term. Credit risk is similar to that involved in extending loan commitments to customers and the Company, accordingly, uses evaluation and collateral requirements similar to those for loan commitments. Most of such commitments are collateralized. The fair value of the liability related to these standby letters of credit, which represents the fees received for issuing the guarantees, was not significant at September 30, 2013 and December 31, 2012. The Company recognizes these fees as revenues over the term of the commitment or when the commitment is used.

Loan commitments and standby letters of credit involve, to varying degrees, elements of credit and market risk in excess of the amounts recognized in the balance sheet and do not necessarily represent the actual amount subject to credit loss. At September 30, 2013 and December 31, 2012, the Company had a reserve for unfunded commitments of $146,000 and $143,000, respectively.

A large portion of the loan portfolio of the Company is collateralized by real estate. At September 30, 2013, real estate served as the principal source of collateral with respect to approximately 81% of the Company’s loan portfolio. At September 30, 2013, real estate construction loans totaled $19,281,000, or 4% of the total loan portfolio, commercial loans secured by real estate totaled $328,967,000, or 65% of the total loan portfolio, and real estate mortgage loans totaled $65,790,000, or 13% of the total loan portfolio. See the discussion under “Loan Portfolio” starting on page 35. A further decline in the state and national economy, in general, combined with further deterioration in real estate values in the Company’s primary operating market areas, would have an adverse effect on the value of real estate as well as other collateral securing loans, plus the ability of certain borrowers to repay their outstanding loans and the overall demand for new loans, and this could have a material impact on the Company’s financial position, results of operations or its cash flows.

As previously reported, NVB established a reserve in the amount of $1,260,000 for the settlement of criticisms identified in conjunction with a compliance examination conducted by the Federal Reserve Bank of San Francisco in 2010. During the quarter ended September 30, 2013, in accordance with the terms of an agreement reached with the Federal Reserve Bank of San Francisco, all of these funds were disbursed to the affected parties, as agreed, thereby ending the reserve. NVB continues to comply with the terms of the agreement reached to resolve criticisms raised by the Federal Reserve Bank of San Francisco.

NOTE 13 – FAIR VALUE MEASUREMENTS

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

●

Quoted prices in active markets for identical assets (Level 1): Inputs that are quoted unadjusted prices in active markets for identical assets that the Company has the ability to access at the measurement date. An active market for the asset is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.

●

Significant other observable inputs (Level 2): Inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity including quoted prices for similar assets or liabilities, quoted prices for securities in inactive markets and inputs derived principally from, or corroborated by, observable market data by correlation or other means.

●

Significant unobservable inputs (Level 3): Inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

Assets Recorded at Fair Value on a Recurring Basis:

The table below presents assets measured at fair value on a recurring basis (in thousands).

	As of September 30, 2013
	Fair Value		Level 1		Level 2		Level 3
Available-for-sale securities:
Obligations of U.S. government sponsored agencies	$	18,678	$	—	$	18,678	$	—
Obligations of state and political subdivisions		6,853		—		6,853		—
Government sponsored agency mortgage-backed securities		260,343		—		260,343		—
Corporate debt securities		4,770		—		4,770		—
Equity securities		2,983		—		2,983		—
	$	293,627	$	—	$	293,627	$	—

	At December 31, 2012
	Fair Value		Level 1		Level 2		Level 3
Available-for-sale securities:
Obligations of U.S. government sponsored agencies	$	21,118	$	—	$	21,118	$	—
Obligations of state and political subdivisions		11,197		—		11,197		—
Government sponsored agency mortgage-backed securities		245,631		—		245,631		—
Corporate debt securities		4,756		—		4,756		—
Equity securities		3,113		—		3,113		—
	$	285,815	$	—	$	285,815	$	—

Fair values for available-for-sale investment securities are based on quoted market prices for similar securities at September 30, 2013 and December 31, 2012. During the three and nine month periods ended September 30, 2013, there were no transfers between Levels 1 and 2.

Assets Recorded at Fair Value on a Nonrecurring Basis:

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. GAAP. These adjustments to fair value usually result from application of lower-of-cost-or-fair value accounting or write-downs of individual assets. For assets measured at fair value on a nonrecurring basis that were still held in the balance sheet at quarter end, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related assets at quarter end (in thousands).

									Total Losses				Total Losses
	As of September 30, 2013								Three months ended September 30,				Nine months ended September 30,
	Fair Value		Level 1		Level 2		Level 3		2013		2012		2013		2012
Impaired loans:
Commercial	$	—	$	—	$	—	$	—	$	16	$	—	$	16	$	—
Real estate - commercial		609		—		—		609		—		431		239		1,887
Real estate - construction		438		—		—		438		—		—		357		—
Real estate - mortgage		116		—		—		116		—		76		272		149
Installment		9		—		—		9		18		—		18		—
Other		171		—		—		171		34		—		71		—
OREO:
Real estate - commercial		—		—		—		—		—		92		—		92
Real estate - construction		1,644		—		—		1,644		1,100		657		1,618		790
Real estate - mortgage		219		—		—		219		39		—		39		140
Total assets measured at fair value on a nonrecurring basis	$	3,206	$	—	$	—	$	3,206	$	1,207	$	1,256	$	2,630	$	3,058

	As of December 31, 2012
	Fair Value		Level 1		Level 2		Level 3

Impaired loans:
Commercial	$	585	$	—	$	—	$	585
Real estate - commercial		2,222		—		—		2,222
Real estate - construction		143		—		—		143
Real estate - mortgage		464		—		—		464
Installment		75		—		—		75
Other		25		—		—		25
OREO:
Real estate - construction		7,360		—		—		7,360
Real estate - mortgage		184		—		—		184
Total assets measured at fair value on a nonrecurring basis	$	11,058	$	—	$	—	$	11,058

Impaired Loans – The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available, and additional discounts by management for known market factors and time since the last appraisal. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Other Real Estate Owned – Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at fair value, less costs to sell. Fair values are based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis (in thousands):

As of September 30, 2013

	Fair Value		Valuation Techniques	Unobservable Inputs	Range (Weighted Average)

Impaired loans:
Real estate - commercial	$	609	Comparable sales approach	Discount adjustment for differences between comparable sales	6% to 11% (9%)
Real estate - construction	$	438	Comparable sales approach	Discount adjustment for differences between comparable sales	2% to 3% (3%)
Real estate - mortgage	$	116	Comparable sales approach	Discount adjustment for differences between comparable sales	6% to 11% (9%)
Other	$	171	Comparable sales approach	Discount adjustment for differences between comparable sales	6% to 11% (9%)
OREO:
Real estate - construction	$	1,644	Comparable sales approach	Discount adjustment for differences between comparable sales	0% to 11% (9%)
Real estate - mortgage	$	219	Comparable sales approach	Discount adjustment for differences between comparable sales	6% to 11% (9%)

As of December 31, 2012


	Fair Value		Valuation Techniques	Unobservable Inputs	Range (Weighted Average)

Impaired loans:
Real estate - commercial	$	2,222	Comparable sales approach	Discount adjustment for differences between comparable sales	6% to 11% (9%)
Real estate - construction	$	143	Comparable sales approach	Discount adjustment for differences between comparable sales	2% to 3% (3%)
Real estate - mortgage	$	464	Comparable sales approach	Discount adjustment for differences between comparable sales	6% to 11% (9%)
OREO:
Real estate - commercial	$	7,360	Comparable sales approach	Discount adjustment for differences between comparable sales	0% to 6% (6%)
Real estate - construction	$	184	Comparable sales approach	Discount adjustment for differences between comparable sales	6% to 11% (9%)

Disclosures about Fair Value of Financial Instruments

The fair values presented represent the Company’s best estimate of fair value using the methodologies discussed below. The fair values of financial instruments which have a relatively short period of time between their origination and their expected realization were valued using historical cost. The values assigned do not necessarily represent amounts which ultimately may be realized. In addition, these values do not give effect to discounts to fair value which may occur when financial instruments are sold in larger quantities.

The following assumptions were used as of September 30, 2013 and December 31, 2012 to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value.

Cash and Due From Banks – The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.

Federal Funds Sold – The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.

Time Deposits at Other Financial Institutions – The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 2.

FHLB, FRB Stock and Other Securities – It was not practicable to determine the fair value of FHLB or FRB stock due to the restrictions placed on its transferability.

Investment Securities – The fair value of investment securities are based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Available-for-sale securities are carried at fair value.

Loans – Commercial loans, residential mortgages, construction loans and direct financing leases are segmented by fixed and adjustable rate interest terms, by maturity, and by performing and nonperforming categories.

The fair value of performing loans are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

The fair value of nonperforming loans is estimated by discounting estimated future cash flows using current interest rates with an additional risk adjustment reflecting the individual characteristics of the loans, or using the fair value of underlying collateral for collateral dependent loans as a practical expedient.

Deposits – The fair values disclosed for noninterest-bearing and interest-bearing demand deposits and savings and money market accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. Fair values for certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

Subordinated Debentures – The fair values of the Company’s Subordinated Debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

Commitments to Fund Loans/Standby Letters of Credit – The fair values of commitments are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. The differences between the carrying value of commitments to fund loans or standby letters of credit and their fair value are not significant and therefore not included in the following table.

Accrued Interest Receivable/Payable – The carrying amounts of accrued interest approximate fair value and therefore follow the same classification as the related asset or liability.

The carrying amounts and estimated fair values of the Company’s financial instruments are as follows (in thousands):

			Fair Value Measurements at
			September 30, 2013, Using
	Carrying
	Amount		Level 1		Level 2		Level 3		Total
FINANCIAL ASSETS
Cash and due from banks	$	23,780	$	23,780	$	—	$	—	$	23,780
Federal funds sold		2,345		2,345		—		—		2,345
Time deposits at other financial institutions		2,219		—		2,219		—		2,219
FHLB, FRB and other securities		8,402								N/A
Securities:
Available-for-sale		293,627		—		293,627		—		293,627
Held-to-maturity		6		—		6		—		6
Loans		499,780		—		—		513,426		513,426
Accrued interest receivable		2,166		—		736		1,430		2,166

FINANCIAL LIABILITIES
Deposits:
Nonmaturity deposits	$	626,157	$	626,157	$	—	$	—	$	626,157
Time deposits		153,613		—		153,798		—		153,798
Other borrowed funds		—		—		—		—		—
Subordinated debentures		21,651		—		—		7,927		7,927
Accrued interest payable		110		2		31		77		110

			Fair Value Measurements at
			December 31, 2012, Using
	Carrying
	Amount		Level 1		Level 2		Level 3		Total
FINANCIAL ASSETS
Cash and due from banks	$	22,654	$	22,654	$	—	$	—	$	22,654
Federal funds sold		15,865		15,865		—		—		15,865
Time deposits at other financial institutions		2,219		—		2,219		—		2,219
FHLB, FRB and other securities		8,313		—		—		—		N/A
Securities:
Available-for-sale		285,815		—		285,815		—		285,815
Held-to-maturity		6		—		6		—		6
Loans		481,753		—		—		500,689		500,689
Accrued interest receivable		2,217		—		767		1,450		2,217

FINANCIAL LIABILITIES
Deposits:
Nonmaturity deposits	$	596,204	$	596,204	$	—	$	—	$	596,204
Time deposits		172,376		—		172,805		—		172,805
Subordinated debentures		21,651		—		—		9,018		9,018
Accrued interest payable		136		2		54		80		136

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Certain statements in this Form 10-Q (excluding statements of fact or historical financial information) involve forward-looking information within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the “safe harbor” created by those sections. These forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Such risks and uncertainties include, but are not limited to, the following factors: competitive pressure in banking industry increases significantly; changes in the interest rate environment reduce margins; general economic conditions, either nationally or regionally, are less favorable than expected, resulting in, among other things, a deterioration in credit quality and an increase in the provision for possible loan losses; changes in the regulatory environment; changes in business conditions, particularly in the Northern California region; volatility of rate sensitive deposits; operational risks including data processing system failures or fraud; asset/liability matching risks and liquidity risks; California state budget problems; the U.S. “war on terrorism” and military action by the U.S. in the Middle East; and changes in the securities markets.

Critical Accounting Policies

General

North Valley Bancorp’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our financial statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the probable incurred losses that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. Another estimate that we use is related to the expected useful lives of our depreciable assets. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

Allowance for Loan Losses. The allowance for loan losses is an estimate of probable incurred loan losses in the Company’s loan portfolio as of the balance-sheet date. The allowance is established through a provision for loan losses which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after loan losses and loan growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The overall allowance consists of two primary components, specific reserves related to impaired loans and general reserves for inherent losses related to non-impaired loans. Non-impaired loans are evaluated collectively for impairment as a group by loan type and common risk characteristics.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement. Loans determined to be impaired are individually evaluated for impairment. When a loan is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, it may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. For further information on the allowance for loan losses, see Note 4 to the Notes to Condensed Consolidated Financial Statements in Item I above.

Allowance for Loan Losses on Off-Balance-Sheet Credit Exposures. The Company also maintains a separate allowance for off-balance-sheet commitments. Management estimates anticipated losses using historical data and utilization assumptions. The allowance for off-balance-sheet commitments is included in accrued interest payable and other liabilities on the consolidated balance sheet.

Other Real Estate Owned (“OREO”). OREO represents properties acquired through foreclosure or physical possession. Write-downs to fair value at the time of transfer to OREO are charged to allowance for loan losses. Subsequent to foreclosure, management periodically evaluates the value of OREO and records a valuation allowance for any subsequent declines in fair value less selling costs. Subsequent declines in value are charged to operations. The reported value of OREO is based on our assessment of information available to us at the end of a reporting period and depends upon a number of factors, including our historical experience, economic conditions, and issues specific to individual properties. Management’s evaluation of these factors involves subjective estimates and judgments that may change.

Share Based Compensation. At September 30, 2013, the Company had two stock-based compensation plans: the 1998 Employee Stock Incentive Plan and the 2008 Stock Incentive Plan, which are described more fully in Note 10 to the Notes to Condensed Consolidated Financial Statements. Compensation cost is recognized on all share-based payments over the requisite service periods of the awards based on the grant-date fair value of the options determined using the Black-Scholes-Merton based option valuation model. Critical assumptions that are assessed in computing the fair value of share-based payments include stock price volatility, expected dividend rates, the risk free interest rate and the expected lives of such options. Compensation cost recorded is net of estimated forfeitures expected to occur prior to vesting. For further information on the computation of the fair value of share-based payments, see Note 9 to the Notes to Condensed Consolidated Financial Statements on page 19.

Impairment of Investment Securities. An investment security is impaired when its carrying value is greater than its fair value. Investment securities that are impaired are evaluated on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether such a decline in their fair value is other than temporary. Management utilizes criteria such as the magnitude and duration of the decline and the intent and ability of the Company to retain its investment in the securities for a period of time sufficient to allow for an anticipated recovery in fair value, in addition to the reasons underlying the decline, to determine whether the loss in value is other than temporary. The term “other than temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other than temporary, and management does not intend to sell the security or it is more likely than not that the Company will not be required to sell the security before recovery, only the portion of the impairment loss representing credit exposure is recognized as a charge to earnings, with the balance recognized as a charge to other comprehensive income. If management intends to sell the security or it is more likely than not that the Company will be required to sell the security before recovering its forecasted cost, the entire impairment loss is recognized as a charge to earnings.

Accounting for Income Taxes. The Company files its income taxes on a consolidated basis with its subsidiary. The allocation of income tax expense (benefit) represents each entity’s proportionate share of the consolidated provision for income taxes.

The Company applies the asset and liability method to account for income taxes. Deferred tax assets and liabilities are calculated by applying applicable tax laws to the differences between the financial statement basis and the tax basis of assets and liabilities. The effect on deferred taxes of changes in tax laws and rates is recognized in operations in the period that includes the enactment date. On the consolidated balance sheet, net deferred tax assets are included in other assets.

The Company evaluates deferred income tax assets for recoverability based on all available evidence. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws, our ability to successfully implement tax planning strategies, or variances between our future projected operating performance and our actual results. The Company is required to establish a valuation allowance for deferred tax assets if we determine, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In determining the more-likely-than-not criterion, we evaluate all positive and negative available evidence as of the end of each reporting period. Future adjustments to the deferred tax asset valuation allowance, if any, will be determined based upon changes in the expected realization of net deferred tax assets. The realization of deferred tax assets ultimately depends on the existence of sufficient taxable income in the carry back and carry forward periods under the tax law. Due to the Company’s cumulative tax losses in 2009 and 2010, it was determined to establish a partial valuation allowance in 2010 of $4,500,000 to reflect the portion of the deferred tax assets that the Company determined to be more likely than not that it will not be realized. During the quarter ended December 31, 2011, the Company reversed the Federal portion of its valuation allowance in the amount of $223,000, and in the quarter ended September 30, 2012, the Company eliminated the remaining state deferred tax asset valuation allowance of $4,277,000.

Business Organization

North Valley Bancorp (the “Company”) is a California corporation and a bank holding company for North Valley Bank, a California state-chartered, Federal Reserve member bank (“NVB”). NVB operates out of its main office located at 300 Park Marina Circle, Redding, California 96001, with twenty-two branches, including two supermarket branches in eight counties in Northern California. The Company views its service area as having four distinct markets: the Redding market, the Coastal market, the I-80 Corridor market and the Santa Rosa market.

The Company’s principal business consists of attracting deposits from the general public and using the funds to originate commercial, real estate and installment loans to customers, who are predominately small and middle market businesses and middle income individuals. The Company’s primary source of revenues is interest income from its loan and investment securities portfolios. The Company is not dependent on any single customer for more than ten percent of its revenues.

Overview

Financial Results

(in thousands except per share amounts)	Three months ended September 30,						Nine months ended September 30,
	2013			2012			2013			2012
Net interest income	$	7,774		$	7,713		$	22,788		$	22,434
Provision for loan losses		—			700			—			2,100
Noninterest income		3,209			4,204			11,189			12,150
Noninterest expense		10,036			9,759			29,860			28,643
Provision (benefit) for income taxes		367			(2,546	)		1,382			(1,904	)
Net income	$	580		$	4,004		$	2,735		$	5,745

Per Share Amounts
Basic Income Per Share	$	0.08		$	0.59		$	0.40		$	0.84
Diluted Income Per Share	$	0.08		$	0.59		$	0.40		$	0.84

Annualized Return on Average Assets		0.25	%		1.74	%		0.40	%		0.84	%
Annualized Return on Average Equity		2.46	%		16.91	%		3.82	%		8.29	%

The Company had net income of $580,000, or $0.08 per diluted share, and $2,735,000, or $0.40 per diluted share, for the three and nine months ended September 30, 2013, respectively. This compares to net income of $4,004,000, or $0.59 per diluted share, and $5,745,000, or $0.84 per diluted share, for the three and nine months ended September 30, 2012. Net income for the three and nine months ended September 30, 2012 included a $2,930,000 tax benefit resulting from the reversal of a $4,277,000 state deferred tax asset valuation allowance which was partially offset by an increase in federal deferred tax liabilities of $1,347,000. The decrease in income before taxes for three months ended September 30, 2013 compared to the three months ended September 30, 2012 was primarily attributed to a decrease in gains on sale of securities, a decrease on gain on sale of loans and an increase in other real estate owned expenses partially offset by a decrease in the provision for loan losses. The Company did not record a provision for loan losses for the quarter ended September 30, 2013 compared to a provision for loan losses of $700,000 for the quarter ended September 30, 2012.

Income before taxes increased $276,000 for the nine months ended September 30, 2013, compared to the same period in 2012. The increase was primarily due to a decrease in the provision for loan losses, which was partially offset by a decrease in gains on sale of securities, and an increase in other real estate owned expenses for the nine months ended September 30, 2013 compared to the same period in 2012.

On June 26, 2013, the Company announced that its Board of Directors has authorized the repurchase of up to 5% of the Company’s outstanding common shares, or approximately 340,000 shares. During the nine month period ended September 30, 2013, there were no repurchases of common shares. Future repurchases will be made from time to time by the Company in the open market, or privately negotiated transactions, as conditions allow. All open market transactions will be structured to comply with Securities and Exchange Commission Rule 10b-18 and all shares repurchased under this program will be retired. The number, price and timing of the repurchases shall be at the Company’s sole discretion and the program will be re-evaluated from time to time depending on market conditions, liquidity needs or other factors. The Board of Directors, based on such re-evaluations, may suspend, terminate, modify or cancel the program at any time without notice.

Results of Operation

Net Interest Income and Net Interest Margin (fully taxable equivalent basis)

Net interest income is the difference between interest earned on loans, investments and other earning assets, and interest paid on deposits and borrowings, and is the primary revenue source for the Company. Net interest margin is net interest income expressed as a percentage of average earning assets. These items have been adjusted to give effect to $54,000 and $67,000 in taxable-equivalent interest income on tax-free investments for the three month periods ended September 30, 2013 and 2012, respectively.

Net interest income for the three months ended September 30, 2013 was $7,828,000, a $48,000, or 0.6%, increase from net interest income of $7,780,000 for the same period in 2012. Interest income decreased $274,000, or 3.2%, to $8,219,000 for the three month period ended September 30, 2013 compared to the same period in 2012, due primarily to both a decrease in rates earned on loans and a decrease in average securities which was partially offset by an increase in average loan balances. The Company had foregone interest income for the loans placed on nonaccrual status of $36,000 during the three months ended September 30, 2013 compared to $138,000 for the same period in 2012. Average loans outstanding during the three months ended September 30, 2013 increased $24,320,000, or 5.1%, to $499,920,000 compared to the same period in 2012. This higher loan volume increased interest income by $338,000. The average yield earned on the loan portfolio decreased 43 basis points to 5.13% for the three months ended September 30, 2013 compared to the same period in 2012. This decrease in yield decreased interest income for the three months ended September 30, 2013 by $539,000. The total decrease to interest income from the loan portfolio was $201,000 for the three months ended September 30, 2013. The average balance of the investment portfolio decreased $15,849,000, or 4.9%, which accounted for a $130,000 reduction in interest income offset by a slight increase in average yield of the investment portfolio of 3 basis points which increased interest income by $64,000.

Interest expense for the three months ended September 30, 2013 compared to the same period in 2012, decreased $322,000, or 45.2%, to $391,000. The average rate paid on other borrowed funds decreased 76 basis points to 2.07% for the quarter ended September 30, 2013 compared to 2.83% for the same period in 2012, resulting in a decrease to interest expense of $50,000 along with a decrease in average other borrowed funds of $9,508,000 which reduced interest expense by $67,000. The average rates paid on time deposits decreased 31 basis points to 0.41% and reduced interest expense by $122,000 along with a decrease in average time deposits of $29,349,000 which reduced interest expense by $53,000 for the quarter ended September 30, 2013.

The net interest margin for the three months ended September 30, 2013 increased 4 basis points to 3.82% from 3.78% for the same period in 2012 and an increase of 5 basis points from the 3.77% net interest margin for the linked quarter ended June 30, 2013.

The following table sets forth the Company’s consolidated condensed average daily balances and the corresponding average yields received and average rates paid of each major category of assets, liabilities, and stockholders’ equity for the periods indicated:

Schedule of Average Daily Balance and Average Yields and Rates
(Dollars in thousands)
	Three months ended September 30, 2013								Three months ended September 30, 2012
	Average			Yield/			Interest		Average			Yield/			Interest
	Balance			Rate			Amount		Balance			Rate			Amount

Assets
Earning assets:
Federal funds sold	$	4,645			0.26	%	$	3	$	17,770			0.22	%	$	10
Investment securities:
Taxable		299,956			2.11	%		1,598		311,736			2.06	%		1,622
Tax exempt (1)		7,594			8.15	%		156		11,663			6.74	%		198
Total investments		307,550			2.26	%		1,754		323,399			2.23	%		1,820
Loans (2)(3)		499,920			5.13	%		6,462		475,600			5.56	%		6,663
Total earning assets		812,115			4.02	%		8,219		816,769			4.13	%		8,493

Nonearning assets		104,787								107,942
Allowance for loan losses		(9,508	)							(11,472	)
Total nonearning assets		95,279								96,470

Total assets	$	907,394							$	913,239

Liabilities and Stockholders’ Equity
Interest bearing liabilities:
Transaction accounts	$	194,608			0.04	%	$	18	$	180,431			0.05	%	$	24
Savings and money market		244,571			0.13	%		79		226,630			0.18	%		103
Time certificates		155,453			0.41	%		160		184,802			0.72	%		335
Other borrowed funds		25,664			2.07	%		134		35,172			2.83	%		251
Total interest bearing liabilities		620,296			0.25	%		391		627,035			0.45	%		713
Demand deposits		177,400								168,658
Other liabilities		16,171								23,589
Total liabilities		813,867								819,282
Stockholders’ equity		93,527								93,957
Total liabilities and stockholders’ equity	$	907,394							$	913,239
Net interest income							$	7,828							$	7,780
Net interest spread					3.77	%							3.68	%
Net interest margin					3.82	%							3.78	%

(1)

Tax-equivalent basis; non-taxable securities are exempt from federal taxation.

(2)

Loans on nonaccrual status have been included in the computations of averages balances.

(3)

Includes loan (costs)/fees of $(36) and $113 for the three months ended September 30, 2013 and 2012, respectively.

Net interest income for the nine months ended September 30, 2013 was $22,942,000, a $296,000, or 1.3%, increase from net interest income of $22,646,000 for the same period in 2012. The Company had foregone interest income for the loans placed on nonaccrual status of $171,000 during the nine months ended September 30, 2013 compared to $495,000 for the same period in 2012. The average loans outstanding during the nine months ended September 30, 2013 increased $33,093,000, or 7.2%, to $491,919,000 compared to the same period in 2012. This higher loan volume increased interest income by $1,402,000. The average yield earned on the loan portfolio decreased 42 basis points to 5.23% for the nine months ended September 30, 2013 compared to the same period in 2012. This decrease in yield decreased interest income by $1,615,000. The net decrease in interest income from the loan portfolio was $213,000. The average balance of the investment portfolio decreased $28,560,000, or 8.8%, which accounted for a $626,000 decrease in interest income and a decrease in average yield of the investment portfolio of 32 basis points reduced interest income by $639,000 for the nine months ended September 30, 2013 compared to the same period in 2012.

Interest expense for the nine months ended September 30, 2013 decreased $1,795,000, or 59.4%, to $1,226,000 compared to the same period in 2012. The average rate paid on other borrowed funds decreased 265 basis points to 2.27% for the nine month period ended September 30, 2013 compared to 4.92% for the same period in 2012, resulting in a decrease to interest expense of $469,000 along with a decrease in average other borrowed funds of $9,507,000 which reduced interest expense by $351,000. These decreases were the result of the payoff of $10,310,000 in subordinated debentures in July 2012. The average rates paid on time deposits decreased 43 basis points to 0.45% and reduced interest expense by $523,000 along with a decrease in average time deposits of $39,617,000 which reduced interest expense by $261,000 for the nine month period ended September 30, 2013 compared to the same period in 2012.

The net interest margin for the nine months ended September 30, 2013 increased 9 basis points to 3.79% from 3.70% for the same period in 2012. The following table sets forth the Company’s consolidated condensed average daily balances and the corresponding average yields received and average rates paid of each major category of assets, liabilities, and stockholders’ equity for the periods indicated (these items have been adjusted to give effect to $153,000 and $212,000 in taxable-equivalent interest income on tax-free investments for the nine month periods ended September 30, 2013 and 2012, respectively):

Schedule of Average Daily Balance and Average Yields and Rates
(Dollars in thousands)
	Nine months ended September 30, 2013								Nine months ended September 30, 2012
	Average			Yield/			Interest		Average			Yield/			Interest
	Balance			Rate			Amount		Balance			Rate			Amount

Assets
Earning assets:
Federal funds sold	$	19,410			0.23	%	$	34	$	31,207			0.23	%	$	55
Investment securities:
Taxable		288,727			2.06	%		4,439		313,546			2.35	%		5,532
Tax exempt (1)		8,549			7.05	%		451		12,290			6.75	%		623
Total investments		297,276			2.20	%		4,890		325,836			2.52	%		6,155
Loans (2)(3)		491,919			5.23	%		19,244		458,826			5.65	%		19,457
Total earning assets		808,605			4.00	%		24,168		815,869			4.19	%		25,667

Nonearning assets		105,120								108,588
Allowance for loan losses		(9,858	)							(12,071	)
Total nonearning assets		95,262								96,517

Total assets	$	903,867							$	912,386

Liabilities and Stockholders’ Equity
Interest bearing liabilities:
Transaction accounts	$	192,284			0.04	%	$	54	$	178,725			0.08	%	$	105
Savings and money market		243,324			0.13	%		233		223,022			0.22	%		373
Time certificates		160,366			0.45	%		538		199,983			0.88	%		1,322
Other borrowed funds		23,569			2.27	%		401		33,076			4.92	%		1,221
Total interest bearing liabilities		619,543			0.26	%		1,226		634,806			0.63	%		3,021
Demand deposits		170,906								161,464
Other liabilities		17,694								23,751
Total liabilities		808,143								820,021
Stockholders’ equity		95,724								92,365
Total liabilities and stockholders’ equity	$	903,867							$	912,386
Net interest income							$	22,942							$	22,646
Net interest spread					3.74	%							3.56	%
Net interest margin					3.79	%							3.70	%

(1)

Tax-equivalent basis; non-taxable securities are exempt from federal taxation.

(2)

Loans on nonaccrual status have been included in the computations of averages balances.

(3)

Includes loan fees of $154 and $240 for the nine months ended September 30, 2013 and 2012, respectively.

The following table sets forth a summary of the changes in interest income and interest expense due to changes in average asset and liability balances (volume) and changes in average interest rates for the periods indicated. The change in interest due to both rate and volume has been allocated to the change in rate.

Changes in Volume/Rate
(Dollars in thousands)	Three months ended September 30, 2013									Nine months ended September 30, 2013
	compared with									compared with
	Three months ended September 30, 2012									Nine months ended September 30, 2012
							Total									Total
	Average			Average			Increase			Average			Average			Increase
	Volume			Yield/Rate			(Decrease)			Volume			Yield/Rate			(Decrease)
Interest Income
Interest on Federal funds sold	$	(7	)	$	—		$	(7	)	$	(20	)	$	(1	)	$	(21	)
Interest on investments:
Taxable securities		(61	)		37			(24	)		(437	)		(656	)		(1,093	)
Tax exempt securities (1)		(69	)		27			(42	)		(189	)		17			(172	)
Total investments		(130	)		64			(66	)		(626	)		(639	)		(1,265	)
Interest on loans		338			(539	)		(201	)		1,402			(1,615	)		(213	)
Total interest income		201			(475	)		(274	)		756			(2,255	)		(1,499	)

Interest Expense
Transaction accounts	$	2		$	(8	)	$	(6	)	$	8		$	(59	)	$	(51	)
Savings and money market		8			(32	)		(24	)		33			(173	)		(140	)
Time deposits		(53	)		(122	)		(175	)		(261	)		(523	)		(784	)
Other borrowed funds		(67	)		(50	)		(117	)		(351	)		(469	)		(820	)
Total interest expense		(110	)		(212	)		(322	)		(571	)		(1,224	)		(1,795	)

Total change in net interest income	$	311		$	(263	)	$	48		$	1,327		$	(1,031	)	$	296

(1) Taxable equivalent

Provision for Loan Losses

The provision for loan losses is recorded to bring the allowance for loan losses to a level considered appropriate by management based on factors which are discussed under “Allowance for Loan Losses” starting on page 41.

The Company did not record a provision for loan losses for the three and nine months ended September 30, 2013 compared to a provision for loan losses of $700,000 and $2,100,000 for the same periods in 2012. The process for determining allowance adequacy and the resultant provision for loan losses includes a comprehensive analysis of the loan portfolio. Factors in the analysis include size and mix of the loan portfolio, nonperforming loan levels, charge-off/recovery activity and other qualitative factors including economic environment and activity. The decision to not record a provision for the three months ended September 30, 2013 reflects management’s assessment of the overall adequacy of the allowance for loan losses including the consideration of the level of nonperforming loans, other trends in the quality and performance of our loan portfolio, and other general economic factors. Management believes that the current level of allowance for loan losses as of September 30, 2013 of $9,312,000, or 1.83% of total loans, is adequate at this time. The allowance for loan losses was $10,458,000, or 2.12% of total loans, at December 31, 2012. For further information regarding our allowance for loan losses, see “Allowance for Loan Losses” starting on page 41.

Noninterest Income

The following table is a summary of the Company’s noninterest income for the periods indicated (in thousands):

	Three months ended September 30,				Nine months ended September 30,
	2013		2012		2013		2012
Service charges on deposit accounts	$	959	$	1,086	$	2,882	$	3,274
Other fees and charges		1,152		1,102		3,380		3,620
Gain on sale of loans		596		769		2,441		1,858
Gain on sales or calls of securities, net		5		697		548		1,656
Increase in cash value of life insurance		343		340		1,125		1,023
Other		154		210		813		719
Total	$	3,209	$	4,204	$	11,189	$	12,150

Noninterest income for the three months ended September 30, 2013 decreased $995,000, or 23.7%, to $3,209,000 compared to $4,204,000 for the same period in 2012. Service charges on deposits decreased by $127,000 to $959,000 for the three months ended September 30, 2013 compared to $1,086,000 for the same period in 2012 while other fees and charges increased $50,000 to $1,152,000 for the three months ended September 30, 2013 compared to $1,102,000 for the same period in 2012. The Company had a $596,000 gain on sale of loans for the quarter ended September 30, 2013, a decrease of $173,000 compared to $769,000 for the same period in 2012. Of the $596,000 gain on sale of loans for the second quarter of 2013, the sale of mortgage loans was $574,000 and the sale of SBA loans was $22,000 compared to the sale of mortgage loans of $733,000 and the sale of SBA loans of $36,000 for the same period in 2012. The Company recorded $5,000 for gains on sale of securities for the three months ended September 30, 2013 compared to a $697,000 gain on sale of securities for the same period in 2012.

Noninterest income for the nine months ended September 30, 2013 decreased $961,000 to $11,189,000 compared to $12,150,000 for the same period in 2012. Service charges on deposits decreased by $392,000 to $2,882,000 for the nine months ended September 30, 2013 compared to $3,274,000 for the same period in 2012 and other fees and charges decreased $240,000 to $3,380,000 for the nine months ended September 30, 2013 compared to $3,620,000 for the same period in 2012. The Company had a $2,441,000 gain on sale of loans for the nine months ended September 30, 2013, an increase of $583,000 compared to $1,858,000 for the same period in 2012 due primarily to a gain on sale of mortgage loans. Of the $2,441,000 gain on sale of loans for the third quarter of 2013, the sale of mortgage loans was $2,031,000 and the sale of SBA loans was $410,000 compared to the sale of mortgage loans of $1,716,000 and the sale of SBA loans of $142,000 for the same period in 2012. The Company had a $548,000 gain on sale of securities for the nine months ended September 30, 2013, as compared to a gain on sale of securities of $1,656,000 for the same period in 2012.

Noninterest Expense

The following table is a summary of the Company’s noninterest expense for the periods indicated (in thousands):

	Three months ended September 30,				Nine months ended September 30,
	2013		2012		2013		2012
Salaries and employee benefits	$	5,084	$	5,005	$	15,323	$	15,113
Other real estate owned expense		1,226		817		2,592		1,793
Data processing		647		633		1,974		1,882
Occupancy expense		629		651		1,877		1,911
Professional services		225		331		789		952
Loan expense		237		282		791		627
Director expense		230		180		650		478
FDIC and state assessments		207		212		638		701
Furniture and equipment expense		223		237		645		709
Marketing expense		142		120		428		453
ATM and on-line banking		149		159		417		620
Operations expense		135		142		369		382
Printing and supplies		121		122		365		362
Postage		110		117		349		361
Messenger		106		112		315		340
Amortization of intangibles		36		36		109		109
Other		529		603		2,229		1,850
Total	$	10,036	$	9,759	$	29,860	$	28,643

Noninterest expense increased $277,000, or 2.8%, to $10,036,000 for the third quarter of 2013 from $9,759,000 for the third quarter of 2012. OREO expense increased $409,000 to $1,226,000, for the third quarter of 2013 compared to $817,000 for the same period in 2012. All other expenses decreased $132,000 to $8,810,000 for the third quarter of 2013 compared to $8,942,000 for the same period in 2012.

Noninterest expense increased $1,217,000, or 4.3%, to $29,860,000 for the nine months ended September 30, 2013 from $28,643,000 for the same period in 2012. OREO expense increased $799,000 to $2,592,000, for the nine months ended September 30, 2013 compared to $1,793,000 for the same period in 2012, while FDIC and state assessments decreased $63,000 to $638,000 for the nine months ended September 30, 2013, compared to $701,000 for the same period in 2012. All other expenses increased $481,000 to $26,630,000 for the nine months ended September 30, 2013 compared to $26,149,000 for the same period in 2012. As of September 30, 2013, the Company employed 321 people and had 303 full-time equivalent employees. Full-time equivalent employees at December 31, 2012 and September 30, 2012 were 316 and 323, respectively.

Income Taxes

The Company recorded a provision for income taxes of $367,000 and $1,382,000, resulting in an effective tax rate of 38.8% and 33.6% for the three and nine months ended September 30, 2013, respectively. This compares to a benefit for income taxes of $2,564,000 and $1,904,000 for the three and nine months ended September 30, 2012. The benefit for income taxes included a $2,930,000 net benefit for the three and nine month periods ended September 30, 2012, that resulted from the elimination of the $4,277,000 state deferred tax asset valuation allowance which was partially offset by an increase in federal deferred tax liabilities of $1,347,000. During the quarter ended September 30, 2013, management determined that certain available tax planning strategies would not be executed prior to December 31, 2013. As a result, management determined that certain deferred tax assets totaling approximately $205,000 would more likely than not expire prior to being utilized and therefore were charged to income tax expense. The difference in the effective tax rate compared to the statutory tax rate is primarily the result of the Company’s investment in municipal securities and Company-owned life insurance policies whose income is exempt from Federal taxes. In addition, the Company receives certain tax benefits from the State of California Franchise Tax Board for operating and providing loans, as well as jobs, in designated “Enterprise Zones”.

Management evaluates the Company’s deferred tax assets quarterly for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including the Company’s historical profitability and projections of future taxable income. Management also considered available tax planning strategies, the scheduled reversal of deferred tax assets and liabilities, and the nature and amount of historical and projected future taxable income that provide positive evidence that some of the tax benefits will be realizable.

The deferred tax assets will continue to be analyzed quarterly for changes affecting realizability and the valuation allowance may be adjusted in future periods accordingly. At September 30, 2013 and December 31, 2012, there was no valuation allowance recorded against deferred tax assets.

Financial Condition as of September 30, 2013 As Compared to December 31, 2012

Overview

Total assets at September 30, 2013 increased $10,104,000, or 1.1%, to $912,447,000, compared to $902,343,000 at December 31, 2012. Loans, net of deferred loan fees, increased $16,881,000, or 3.4%, to $509,092,000 at September 30, 2013 from $492,211,000 at December 31, 2012. Investment securities increased $7,812,000, or 2.7%, to $293,633,000 at September 30, 2013 from $285,821,000 at December 31, 2012. Fed Funds sold decreased $13,520,000 to $2,345,000 as of September 30, 2013 as compared to $15,865,000 at December 31, 2012.

Loan Portfolio

The Company originates loans for business, consumer and real estate activities for equipment purchases. Such loans are concentrated in the primary markets in which the Company operates. Substantially all loans are collateralized. Generally, real estate loans are secured by real property. Commercial and other loans are secured by bank deposits or business or personal assets and leases are generally secured by equipment. The Company’s policy for requiring collateral is through analysis of the borrower, the borrower’s industry and the economic environment in which the loan would be granted. The loans are expected to be repaid from cash flows or proceeds from the sale of selected assets of the borrower.

Loans, the Company’s primary component of earning assets, increased $16,881,000 during the nine months ended September 30, 2013 to $509,092,000 at September 30, 2013 from $492,211,000 at December 31, 2012. Commercial loans increased by $2,825,000 and real estate commercial loans increased by $33,337,000. These increases were partially offset by decreases in real estate construction loans of $3,722,000, real estate mortgage loans of $8,563,000, other loans, primarily home equity loans, of $5,170,000, and installment loans of $1,129,000.

The Company’s average loan to deposit ratio was 64.1% for the nine months ended September 30, 2013 compared to 60.8% for the year ended December 31, 2012. The increase in the Company’s average loan to deposit ratio was driven by the increase in total average loans of $27,272,000.

Major classifications of loans are summarized as follows (in thousands):

	September 30,			December 31,
	2013			2012
Commercial	$	48,903		$	46,078
Real estate - commercial		328,967			295,630
Real estate - construction		19,281			23,003
Real estate - mortgage		65,790			74,353
Installment		5,560			6,689
Other		40,771			45,941
Gross loans		509,272			491,694
Deferred loan (fees) costs, net		(180	)		517
Allowance for loan losses		(9,312	)		(10,458	)
Total loans, net	$	499,780		$	481,753

Impaired, Nonaccrual, Past Due and Restructured Loans and Other Nonperforming Assets

The Company considers a loan impaired if, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the original contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral.

The following table presents impaired loans and the related allowance for loan losses as of the dates indicated (in thousands):

	As of September 30, 2013						As of December 31, 2012
			Unpaid						Unpaid
	Recorded		Principal		Related		Recorded		Principal		Related
	Investment		Balance		Allowance		Investment		Balance		Allowance
With no allocated allowance
Commercial	$	566	$	587	$	—	$	585	$	586	$	—
Real estate - commercial		4,283		4,348		—		2,778		2,974		—
Real estate - construction		843		864		—		1,210		1,273		—
Real estate - mortgage		1,171		1,194		—		684		736		—
Installment		110		127		—		122		138		—
Other		311		326		—		111		120		—
Subtotal		7,284		7,446		—		5,490		5,827		—

With allocated allowance
Commercial		16		16		16		—		—		—
Real estate - commercial		—		—		—		184		217		171
Real estate - construction		—		—		—		161		161		18
Real estate - mortgage		164		164		164		—		—		—
Subtotal		180		180		180		345		378		189
Total Impaired Loans	$	7,464	$	7,626	$	180	$	5,835	$	6,205	$	189

The following table presents the average balance related to impaired loans for the period indicated (in thousands):

	For the three months ended September 30,
	2013				2012
	Average Book		Interest Income		Average Book		Interest Income
	Balance		Recognized		Balance		Recognized

Commercial	$	372	$	—	$	938	$	—
Real estate - commercial		4,704		21		7,780		—
Real estate - construction		869		6		1,766		—
Real estate - mortgage		1,393		13		986		—
Installment		138		—		123		—
Other		327		—		277		—
Total	$	7,803	$	40	$	11,870	$	—

	For the nine months ended September 30,
	2013				2012
	Average Book		Interest Income		Average Book		Interest Income
	Balance		Recognized		Balance		Recognized

Commercial	$	430	$	—	$	1,043	$	—
Real estate - commercial		4,722		35		7,942		—
Real estate - construction		874		19		1,780		—
Real estate - mortgage		1,404		33		1,006		—
Installment		140		—		133		—
Other		330		—		287		—
Total	$	7,900	$	87	$	12,191	$	—

Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Accrual of interest on loans is discontinued either when reasonable doubt exists as to the full and timely collection of interest or principal, or when a loan becomes contractually past due by 90 days or more with respect to interest or principal (except that when management believes a loan is well secured and in the process of collection, interest accruals are continued on loans deemed by management to be fully collectible). When a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Interest accruals are resumed on such loans when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest and borrower has made timely payments for a minimum period of six months.

Nonperforming assets are summarized as follows (in thousands):

	September 30,			December 31,
	2013			2012
Nonaccrual loans	$	5,216		$	5,835
Loans past due 90 days or more and still accruing interest		—			—
Total nonperforming loans		5,216			5,835
Other real estate owned		15,045			22,423
Total nonperforming assets	$	20,261		$	28,258

Nonaccrual loans to total gross loans		1.02	%		1.19	%
Nonperforming loans to total gross loans		1.02	%		1.19	%
Total nonperforming assets to total assets		2.22	%		3.13	%

At September 30, 2013 and December 31, 2012, the recorded investment in nonperforming loans (defined as nonaccrual loans and loans 90 days or more past due and still accruing interest) was approximately $5,216,000 and $5,835,000, respectively. The Company had $180,000 of specific allowance for loan losses on impaired loans of $180,000 at September 30, 2013 as compared to $189,000 of specific allowance for loan losses on impaired loans of $345,000 at December 31, 2012. Nonperforming assets (nonperforming loans and OREO) totaled $20,261,000 at September 30, 2013, a decrease of $7,997,000 from the total at December 31, 2012.

If interest on nonaccrual loans had been accrued, such income would have approximated $171,000 and $495,000, respectively for the nine month periods ended September 30, 2013 and 2012.

At September 30, 2013 there were no commitments to lend additional funds to borrowers whose loans were classified as nonaccrual.

The composition of nonaccrual loans as of September 30, 2013, June 30, 2013, March 31, 2013 and December 31, 2012 was as follows (in thousands):

	September					June					March					December
	2013					2013					2013					2012
			% of					% of					% of					% of
	Amount		total			Amount		total			Amount		total			Amount		total
Commercial	$	582		11.2	%	$	648		11.0	%	$	563		8.7	%	$	585		10.0	%
Real estate - commercial		3,391		65.0	%		3,669		62.5	%		4,355		67.5	%		2,962		50.8	%
Real estate - construction		438		8.4	%		450		7.7	%		770		11.9	%		1,371		23.5	%
Real estate - mortgage		412		7.9	%		622		10.6	%		513		8.0	%		684		11.7	%
Installment		82		1.6	%		89		1.5	%		93		1.4	%		122		2.1	%
Other		311		6.0	%		393		6.7	%		155		2.4	%		111		1.9	%
Total nonaccrual loans	$	5,216		100.0	%	$	5,871		100.0	%	$	6,449		100.0	%	$	5,835		100.0	%

At September 30, 2013, there were six real-estate-commercial loans on nonaccrual totaling $3,391,000, or 65.0%, of the nonaccrual loans. The largest real estate-commercial loan is for a commercial real estate property located in Sacramento County for $1,231,000. Charge-offs of $720,000 have been taken on this loan and no specific reserve has been established for this loan. The remaining five real estate-commercial loans total $2,160,000 (approximate average loan balance of $432,000). Charge-offs of $239,000 have been taken on these loans and no specific reserves have been established for these loans.

At September 30, 2013, nonaccrual real-estate-construction loans totaled $438,000, or 8.4%, of the nonaccrual loans. There are two loans that make up the balance. The first loan is a residential construction loan in Shasta County for $325,000. Charge-offs of $286,000 have been taken on this loan and no specific reserve has been established. The second loan is a commercial land loan in Yolo County totaling $113,000. Charge-offs of $71,000 have been taken on this loan and no specific reserve has been established.

At September 30, 2013, net carrying value of other real estate owned decreased $7,378,000 to $15,045,000 from $22,423,000 at December 31, 2012. During the nine month period ending September 30, 2013, the Company transferred six properties into OREO totaling $818,000, sold ten properties totaling $5,923,000, had write-downs of OREO of $2,023,000, and recorded loss on sale of OREO of $250,000. As part of the financial close process, valuations of OREO are performed by management and write-downs are recorded as warranted. At September 30, 2013, OREO was comprised of eighteen properties which consisted of the following: three residential construction properties totaling $3,064,000, nine residential land parcels totaling $10,041,000, two commercial land parcels for $343,000, one commercial construction property totaling $161,000, and three residential properties totaling $1,436,000.

The following table shows an aging analysis of the loan portfolio by the amount of time past due (in thousands):

	As of September 30, 2013
	Accruing Interest
					Greater than
			30-89 Days		90 Days
	Current		Past Due		Past Due		Nonaccrual		Total

Commercial	$	48,168	$	153	$	—	$	582	$	48,903
Real estate - commercial		325,503		73		—		3,391		328,967
Real estate - construction		18,843		—		—		438		19,281
Real estate - mortgage		64,766		612		—		412		65,790
Installment		5,469		9		—		82		5,560
Other		40,434		26		—		311		40,771
Total	$	503,183	$	873	$	—	$	5,216	$	509,272

	As of December 31, 2012
	Accruing Interest
					Greater than
			30-89 Days		90 Days
	Current		Past Due		Past Due		Nonaccrual		Total

Commercial	$	45,473	$	20	$	—	$	585	$	46,078
Real estate - commercial		292,505		163		—		2,962		295,630
Real estate - construction		21,436		196		—		1,371		23,003
Real estate - mortgage		72,907		762		—		684		74,353
Installment		6,529		38		—		122		6,689
Other		45,581		249		—		111		45,941
Total	$	484,431	$	1,428	$	—	$	5,835	$	491,694

The following table present loans that were modified and recorded as TDRs for the three and nine months ended September 30, 2013 and 2012.

	Three months ended September 30, 2013						Three months ended September 30, 2012
			Pre-Modification		Post-Modification				Pre-Modification		Post-Modification
	Number		Outstanding		Outstanding		Number		Outstanding		Outstanding
	of		Recorded		Recorded		of		Recorded		Recorded
	Contracts		Investment		Investment		Contracts		Investment		Investment
Commercial		2	$	140	$	140		—	$	—	$	—
Real estate - construction		1	$	114	$	114		—	$	—	$	—
Real estate - mortgage		1	$	116	$	116		1	$	425	$	425
Other		—	$	—	$	—		1	$	26	$	26

	Nine months ended September 30, 2013						Nine months ended September 30, 2012
			Pre-Modification		Post-Modification				Pre-Modification		Post-Modification
	Number		Outstanding		Outstanding		Number		Outstanding		Outstanding
	of		Recorded		Recorded		of		Recorded		Recorded
	Contracts		Investment		Investment		Contracts		Investment		Investment
Commercial		3	$	181	$	181		1	$	800	$	800
Real estate - commercial		1	$	438	$	438		2	$	269	$	269
Real estate - construction		1	$	114	$	114		—	$	—	$	—
Real estate - mortgage		2	$	326	$	326		1	$	425	$	425
Installment		—	$	—	$	—		2	$	70	$	70
Other		1	$	47	$	47		1	$	26	$	26

A summary of TDRs by type of concession and by type of loan as of September 30, 2013 and December 31, 2012, is shown below:

	September 30, 2013
Accruing TDRs							Rate
							Reduction
	Number						and
	of		Rate		Maturity		Maturity
	Contracts		Reduction		Extension		Extension		Total
Real estate - commercial		5	$	—	$	197	$	696	$	893
Real estate - construction		2	$	—	$	405	$	—	$	405
Real estate - mortgage		3	$	—	$	294	$	628	$	922
Installment		1	$	—	$	—	$	28	$	28

	September 30, 2013
Nonaccrual TDRs							Rate
							Reduction
	Number						and
	of		Rate		Maturity		Maturity
	Contracts		Reduction		Extension		Extension		Total
Commercial		4	$	16	$	—	$	566	$	582
Real estate - commercial		—	$	—	$	—	$	—	$	—
Real estate - construction		1	$	—	$	114	$	—	$	114
Real estate - mortgage		1	$	—	$	—	$	116	$	116
Installment		3	$	—	$	—	$	70	$	70
Other		2	$	—	$	—	$	70	$	70

	December 31, 2012
Accruing TDRs							Rate
							Reduction
	Number						and
	of		Rate		Maturity		Maturity
	Contracts		Reduction		Extension		Extension		Total
Real estate - commercial		5	$	202	$	—	$	1,148	$	1,350
Real estate - construction		1	$	—	$	343	$	—	$	343
Real estate - mortgage		2	$	—	$	298	$	423	$	721

	December 31, 2012
Nonaccrual TDRs							Rate
							Reduction
	Number						and
	of		Rate		Maturity		Maturity
	Contracts		Reduction		Extension		Extension		Total
Commercial		1	$	—	$	—	$	529	$	529
Real estate - construction		2	$	327	$	71	$	—	$	398
Installment		4	$	—	$	—	$	120	$	120
Other		1	$	—	$	—	$	25	$	25

Allowance for Loan Losses

The following table shows the changes in the allowance for loan losses were as follows (in thousands):

	For the three months ended September 30, 2013
				Real Estate			Real Estate			Real Estate
	Commercial			Commercial			Construction			Mortgage			Installment			Other			Unallocated			Total

Allowance for Loan Losses
Balance June 30, 2013	$	847		$	5,487		$	439		$	920		$	167		$	920		$	747		$	9,527
Charge-offs		(22	)		—			(20	)		(34	)		(40	)		(174	)					(290	)
Recoveries		18			48			—			1			8			—						75
Provisions for loan losses		(93	)		138			16			(23	)		15			110			(163	)		—
Balance September 30, 2013	$	750		$	5,673		$	435		$	864		$	150		$	856		$	584		$	9,312

	For the three months ended September 30, 2012
				Real Estate			Real Estate			Real Estate
	Commercial			Commercial			Construction			Mortgage			Installment			Other			Unallocated			Total

Allowance for Loan Losses
Balance June 30, 2012	$	1,260		$	6,586		$	1,387		$	925		$	141		$	768		$	665		$	11,732
Charge-offs		(250	)		(113	)		(492	)		(143	)		(48	)		(48	)					(1,094	)
Recoveries		13			—			43			1			29			3						89
Provisions for loan losses		(261	)		435			(23	)		422			—			60			67			700
Balance September 30, 2012	$	762		$	6,908		$	915		$	1,205		$	122		$	783		$	732		$	11,427

	For the nine months ended September 30, 2013
				Real Estate			Real Estate			Real Estate
	Commercial			Commercial			Construction			Mortgage			Installment			Other			Unallocated			Total

Allowance for Loan Losses
Balance December 31, 2012	$	843		$	6,295		$	690		$	982		$	98		$	721		$	829		$	10,458
Charge-offs		(131	)		(438	)		(389	)		(236	)		(68	)		(229	)					(1,491	)
Recoveries		276			46			3			3			17			—						345
Provisions for loan losses		(238	)		(230	)		131			115			103			364			(245	)		—
Balance September 30, 2013	$	750		$	5,673		$	435		$	864		$	150		$	856		$	584		$	9,312

	As of September 30, 2013
Reserve to impaired loans	$	16		$	—		$	—		$	164		$	—		$	—		$	—		$	180
Reserve to non-impaired loans	$	734		$	5,673		$	435		$	700		$	150		$	856		$	584		$	9,132

	For the nine months ended September 30, 2012
				Real Estate			Real Estate			Real Estate
	Commercial			Commercial			Construction			Mortgage			Installment			Other			Unallocated			Total

Allowance for Loan Losses
Balance December 31, 2011	$	1,333		$	7,528		$	1,039		$	935		$	185		$	736		$	900		$	12,656
Charge-offs		(456	)		(1,730	)		(822	)		(333	)		(190	)		(120	)					(3,651	)
Recoveries		39			63			80			37			94			9						322
Provisions for loan losses		(154	)		1,047			618			566			33			158			(168	)		2,100
Balance September 30, 2012	$	762		$	6,908		$	915		$	1,205		$	122		$	783		$	732		$	11,427

	As of September 30, 2012
Reserve to impaired loans	$	—		$	417		$	—		$	50		$	—		$	—					$	467
Reserve to non-impaired loans	$	762		$	6,491		$	915		$	1,155		$	122		$	783		$	732		$	10,960

	As of December 31, 2012
Reserve to impaired loans	$	—		$	171		$	18		$	—		$	—		$	—					$	189
Reserve to non-impaired loans	$	843		$	6,124		$	672		$	982		$	98		$	721		$	829		$	10,269

The following table shows the loan portfolio by segment was as follows (in thousands):

	As of September 30, 2013
			Real Estate		Real Estate		Real Estate
	Commercial		Commercial		Construction		Mortgage		Installment		Other		Total

Total Loans	$	48,903	$	328,967	$	19,281	$	65,790	$	5,560	$	40,771	$	509,272
Impaired Loans	$	582	$	4,283	$	843	$	1,335	$	110	$	311	$	7,464
Non-impaired loans	$	48,321	$	324,684	$	18,438	$	64,455	$	5,450	$	40,460	$	501,808

	As of December 31, 2012
			Real Estate		Real Estate		Real Estate
	Commercial		Commercial		Construction		Mortgage		Installment		Other		Total

Total Loans	$	46,078	$	295,630	$	23,003	$	74,353	$	6,689	$	45,941	$	491,694
Impaired Loans	$	585	$	2,962	$	1,371	$	684	$	122	$	111	$	5,835
Non-impaired loans	$	45,493	$	292,668	$	21,632	$	73,669	$	6,567	$	45,830	$	485,859

The following table shows the loan portfolio allocated by management’s internal risk ratings (in thousands):

	As of September 30, 2013
	Pass		Special Mention		Substandard		Doubtful		Total
Commercial	$	47,201	$	726	$	976	$	—	$	48,903
Real estate - commercial		315,132		3,238		10,597		—		328,967
Real estate - construction		18,843		—		438		—		19,281
Real estate - mortgage		64,750		—		1,040		—		65,790
Installment		5,448		—		112		—		5,560
Other		40,263		—		508		—		40,771
Total	$	491,637	$	3,964	$	13,671	$	—	$	509,272

	As of December 31, 2012
	Pass		Special Mention		Substandard		Doubtful		Total
Commercial	$	44,486	$	129	$	1,463	$	—	$	46,078
Real estate - commercial		278,834		—		16,796		—		295,630
Real estate - construction		21,386		—		1,617		—		23,003
Real estate - mortgage		71,973		—		2,380		—		74,353
Installment		6,562		—		127		—		6,689
Other		45,658		—		283		—		45,941
Total	$	468,899	$	129	$	22,666	$	—	$	491,694

●

Specific Allowances. A specific allowance is established when management has identified unique or particular risks that were related to a specific loan that demonstrated risk characteristics consistent with impairment. Specific allowances are established when management can estimate the amount of an impairment of a loan. As of September 30, 2013 the Company had total impaired loans of $7,464,000 of which $180,000 had $180,000 in specific allowances recorded against them. As of December 31, 2012 the Company had total impaired loans of $5,835,000 of which $345,000 had $189,000 in specific allowances recorded against them. The ratio of specific allowances to total impaired loans was 2.41% and 3.24% at September 30, 2013 and December 31, 2012, respectively.

●

Formula Allowance. The formula allowance is calculated using a “Migration Analysis” method as defined above applied to homogenous pools of loans. Changes in risk grades of both performing and nonperforming loans affect the amount of the formula allowance. Loss factors are based on our historical loss experience and such other data as management believes to be pertinent. Management, also, considers a variety of subjective factors, including regional economic and business conditions that impact important segments of our portfolio, loan growth rates, the depth and skill of lending staff, the interest rate environment, and the results of bank regulatory examinations and findings of our internal credit examiners to establish the formula allowance. As of September 30, 2013, the Company had total non-impaired loans of $501,808,000 for which a formula allowance totaling $9,132,000 was recorded. As of December 31, 2012 the Company had total non-impaired loans of $485,859,000 for which a formula allowance totaling $10,269,000 was recorded. The ratio of formula allowances to total non-impaired loans was 1.82% and 2.11% at September 30, 2013 and December 31, 2012, respectively. The decline in this ratio for the nine month period ended September 30, 2013 was due to the overall improvement in credit quality of the Company’s loan portfolio and more specifically, the decline in net charge-offs and reductions in the level of classified (substandard) loans.

●

Unallocated Allowance. The unallocated loan loss allowance represents an amount for imprecision or uncertainty that is inherent in estimates used to determine the allowance.

The Company also maintains a separate allowance for off-balance-sheet commitments. A reserve for unfunded commitments is maintained at a level that, in the opinion of management, is adequate to absorb probable losses associated with commitments to lend funds under existing agreements, for example, the Bank’s commitment to fund advances under lines of credit. The reserve amount for unfunded commitments is determined based on our methodologies described above with respect to the formula allowance. The allowance for off-balance-sheet commitments is included in accrued interest payable and other liabilities on the consolidated balance sheet and was $146,000 and $143,000 at September 30, 2013 and December 31, 2012, respectively.

Deposits

Total deposits increased $11,190,000 to $779,770,000 at September 30, 2013 compared to $768,580,000 at December 31, 2012. During the nine months ended September 30, 2013, savings and money market deposits increased $11,005,000, interest-bearing demand deposits increased $12,332,000, and noninterest-bearing demand deposits increased $6,616,000 while certificates of deposit decreased $18,763,000. There were no changes in the deposit products or deposit promotions offered by the Company during the nine months ended September 30, 2013.

	September 30,		December 31,
	2013		2012
Noninterest-bearing demand	$	184,471	$	177,855
Interest-bearing demand		197,647		185,315
Savings and money market		244,039		233,034
Time certificates		153,613		172,376
Total deposits	$	779,770	$	768,580

Capital Resources

The Company maintains capital to support future growth and maintain financial strength while trying to effectively manage the capital on hand. From the depositor standpoint, a greater amount of capital on hand relative to total assets is generally viewed as positive. At the same time, from the standpoint of the shareholder, a greater amount of capital on hand may not be viewed as positive because it limits the Company’s ability to earn a high rate of return on stockholders’ equity (ROE). Stockholders’ equity decreased $1,087,000 to $95,074,000 as of September 30, 2013, as compared to $96,161,000 at December 31, 2012. The decrease was the result of a change in accumulated other comprehensive loss of $4,144,000, which was partially offset by net income of $2,735,000 and stock based compensation expense of $322,000, all during the first nine months of 2013. Under current regulations, management believes that the Company meets all capital adequacy requirements.

On June 26, 2013, the Company announced that its Board of Directors has authorized the repurchase of up to 5% of the Company’s outstanding common shares, or approximately 340,000 shares. During the nine month period ended September 30, 2013, there were no repurchases of common stock. Future repurchases will be made from time to time by the Company in the open market, or privately negotiated transactions, as conditions allow. All open market transactions will be structured to comply with Securities and Exchange Commission Rule 10b-18 and all shares repurchased under this program will be retired. The number, price and timing of the repurchases shall be at the Company’s sole discretion and the program will be re-evaluated from time to time depending on market conditions, liquidity needs or other factors. The Board of Directors, based on such re-evaluations, may suspend, terminate, modify or cancel the program at any time without notice.

The Company’s and NVB’s capital amounts and risk-based capital ratios are presented below (in thousands).

											To be Well Capitalized
						For Capital					Under Prompt Corrective
						Adequacy Purposes					Action Provisions
	Actual					Minimum		Minimum			Minimum		Minimum
	Amount		Ratio			Amount		Ratio			Amount		Ratio
Company
As of September 30, 2013
Total capital (to risk weighted assets)	$	117,597		18.58	%	$	50,634		8.00	%		N/A		N/A
Tier 1 capital (to risk weighted assets)	$	109,665		17.32	%	$	25,327		4.00	%		N/A		N/A
Tier 1 capital (to average assets)	$	109,665		12.21	%	$	35,926		4.00	%		N/A		N/A

As of December 31, 2012:
Total capital (to risk weighted assets)	$	113,028		18.28	%	$	49,465		8.00	%		N/A		N/A
Tier 1 capital (to risk weighted assets)	$	105,211		17.01	%	$	24,741		4.00	%		N/A		N/A
Tier 1 capital (to average assets)	$	105,211		11.77	%	$	35,756		4.00	%		N/A		N/A

North Valley Bank
As of September 30, 2013:
Total capital (to risk weighted assets)	$	117,171		18.54	%	$	50,559		8.00	%	$	63,199		10.00	%
Tier 1 capital (to risk weighted assets)	$	109,252		17.29	%	$	25,275		4.00	%	$	37,913		6.00	%
Tier 1 capital (to average assets)	$	109,252		12.17	%	$	35,909		4.00	%	$	44,886		5.00	%

As of December 31, 2012:
Total capital (to risk weighted assets)	$	112,938		18.26	%	$	49,480		8.00	%	$	61,850		10.00	%
Tier 1 capital (to risk weighted assets)	$	105,122		17.00	%	$	24,735		4.00	%	$	37,102		6.00	%
Tier 1 capital (to average assets)	$	105,122		11.76	%	$	35,756		4.00	%	$	44,695		5.00	%

Liquidity

The objective of liquidity management is to ensure the continuous availability of funds to meet the demands of depositors and borrowers. Collection of principal and interest on loans, the liquidations and maturities of investment securities, deposits with other banks, customer deposits and short term borrowings, when needed, are primary sources of funds that contribute to liquidity. As of September 30, 2013, $21,651,000 was outstanding in the form of subordinated debentures issued by the Company. Unused lines of credit with correspondent banks to provide federal funds of $10,000,000 as of September 30, 2013 were also available to provide liquidity. In addition, NVB is a member of the Federal Home Loan Bank providing additional unused borrowing capacity of $269,119,000 secured by certain loans and investment securities as of September 30, 2013. The Company also has an unused line of credit with the Federal Reserve Bank of San Francisco of $2,333,000 secured by investment securities.

The Company manages both assets and liabilities by monitoring asset and liability mixes, volumes, maturities, yields and rates in order to preserve liquidity and earnings stability. Total liquid assets (cash and due from banks, Federal funds sold and available for sale investment securities) totaled $319,752,000 and $324,334,000 (or 35.0% and 35.9% of total assets) at September 30, 2013 and December 31, 2012, respectively.

Core deposits, defined as demand deposits, interest bearing demand deposits, regular savings, money market deposit accounts and time deposits of less than $100,000, continue to provide a relatively stable and low cost source of funds. Core deposits totaled $707,711,000 and $686,544,000 at September 30, 2013 and December 31, 2012, respectively.

In assessing liquidity, historical information such as seasonal loan demand, local economic cycles and the economy in general are considered along with current ratios, management goals and unique characteristics of the Company. Management believes the Company is in compliance with its policies relating to liquidity.

Interest Rate Sensitivity

Overview. The Company constantly monitors earning asset and deposit levels, developments and trends in interest rates, liquidity, capital adequacy and marketplace opportunities with the view towards maximizing shareholder value and earnings while maintaining a high quality balance sheet without exposing the Company to undue market risk. Management responds to all of these to protect and possibly enhance net interest income while managing risks within acceptable levels as set forth in the Company’s policies. In addition, alternative business plans and contemplated transactions are also analyzed for their impact. This process, known as asset/liability management is carried out by changing the maturities and relative proportions of the various types of loans, investments, deposits and other borrowings.

Market Risk. Market risk results from the fact that the market values of assets or liabilities on which the interest rate is fixed will increase or decrease with changes in market interest rates. If the Company invests in a fixed-rate, long term security and then interest rates rise, the security is worth less than a comparable security just issued because the older security pays less interest than the newly issued security. If the security had to be sold before maturity, then the Company would incur a loss on the sale. Conversely, if interest rates fall after a fixed-rate security is purchased, its value increases, because it is paying at a higher rate than newly issued securities. The fixed rate liabilities of the Company, like certificates of deposit and fixed-rate borrowings, also change in value with changes in interest rates. As rates drop, they become more valuable to the depositor and hence more costly to the Company. As rates rise, they become more valuable to the Company. Therefore, while the value changes when rates move in either direction, the adverse impacts of market risk to the Company’s fixed-rate assets are due to rising rates and for the Company’s fixed-rate liabilities, they are due to falling rates. In general, the change in market value due to changes in interest rates is greater in financial instruments that have longer remaining maturities. Therefore, the exposure to market risk of assets is lessened by managing the amount of fixed-rate assets and by keeping maturities relatively short. These steps, however, must be balanced against the need for adequate interest income because variable-rate and shorter-term assets generally yield less interest than longer-term or fixed-rate assets.

Mismatch Risk. The second interest-related risk, mismatched risk, arises from the fact that when interest rates change, the changes do not occur equally in the rates of interest earned and paid because of differences in the contractual terms of the assets and liabilities held. A difference in the contractual terms, a mismatch, can cause adverse impacts on net interest income.

The Company has a certain portion of its loan portfolio tied to the national prime rate. If these rates are lowered because of general market conditions, e.g., the prime rate decreases in response to a rate decrease by the Federal Reserve Open Market Committee (“FOMC”), these loans will be repriced. If the Company were at the same time to have a large proportion of its deposits in long-term fixed-rate certificates, interest earned on loans would decline while interest paid on the certificates would remain at higher levels for a period of time until they mature. Therefore, net interest income would decrease immediately. A decrease in net interest income could also occur with rising interest rates if the Company had a large portfolio of fixed-rate loans and securities that was funded by deposit accounts on which the rate is steadily rising.

This exposure to mismatch risk is managed by attempting to match the maturities and repricing opportunities of assets and liabilities. This may be done by varying the terms and conditions of the products that are offered to depositors and borrowers. For example, if many depositors want shorter-term certificates while most borrowers are requesting longer-term fixed rate loans, the Company will adjust the interest rates on the certificates and loans to try to match up demand for similar maturities. The Company can then partially fill in mismatches by purchasing securities or borrowing funds from the Federal Home Loan Bank with the appropriate maturity or repricing characteristics.

Basis Risk. The third interest-related risk, basis risk, arises from the fact that interest rates rarely change in a parallel or equal manner. The interest rates associated with the various assets and liabilities differ in how often they change, the extent to which they change, and whether they change sooner or later than other interest rates. For example, while the repricing of a specific asset and a specific liability may occur at roughly the same time, the interest rate on the liability may rise one percent in response to rising market rates while the asset increases only one-half percent. While the Company would appear to be evenly matched with respect to mismatch risk, it would suffer a decrease in net interest income. This exposure to basis risk is the type of interest risk least able to be managed, but is also the least dramatic. Avoiding concentrations in only a few types of assets or liabilities is the best means of increasing the chance that the average interest received and paid will move in tandem. The wider diversification means that many different rates, each with their own volatility characteristics, will come into play.

Net Interest Income and Net Economic Value Simulations. The tool used to manage and analyze the interest rate sensitivity of a financial institution is known as a simulation model and is performed with specialized software built for this specific purpose for financial institutions. This model allows management to analyze the three specific types of risks; market risk, mismatch risk, and basis risk.

To quantify the extent of all of these risks both in its current position and in transactions it might make in the future, the Company uses computer modeling to simulate the impact of different interest rate scenarios on net interest income and on net economic value. Net economic value or the market value of portfolio equity is defined as the difference between the market value of financial assets and liabilities. These hypothetical scenarios include both sudden and gradual interest rate changes, and interest rate changes in both directions. This modeling is the primary means the Company uses for interest rate risk management decisions.

The hypothetical impact of sudden interest rate shocks applied to the Company’s asset and liability balances are modeled quarterly. The results of this modeling indicate how much of the Company’s net interest income and net economic value are “at risk” (deviation from the base level) from various sudden rate changes. This exercise is valuable in identifying risk exposures. The results for the Company’s most recent simulation analysis indicate that the Company’s net interest income at risk over a one-year period and net economic value at risk from 2% shocks are within normal expectations for sudden changes and do not materially differ from those of September 30, 2013.

For this simulation analysis, the Company has made certain assumptions about the duration of its non-maturity deposits that are important to determining net economic value at risk.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In management’s opinion, there has not been a material change in the Company’s market risk profile for the nine months ended September 30, 2013 compared to December 31, 2012. Please see discussion under the caption “Interest Rate Sensitivity” on page 44.

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Disclosure controls and procedures are designed with the objective of ensuring that information required to be disclosed in reports filed by the Company under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Disclosure controls and procedures are also designed with the objective of ensuring that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Evaluation of Disclosure Controls and Procedures

The Company’s management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of September 30, 2013. Based on this evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective.

Internal Control over Financial Reporting

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. There was no change in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2013 that has materially affected or is reasonable likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

There are no material legal proceedings pending against the Company or against any of its property. The Company, because of the nature of its business, is generally subject to various legal actions, threatened or filed, which involve ordinary, routine litigation incidental to its business. Although the amount of the ultimate exposure, if any, cannot be determined at this time, the Company does not expect that the final outcome of threatened or filed suits will have a materially adverse effect on its consolidated financial position.

ITEM 1A. RISK FACTORS

There have been no material changes from risk factors as previously disclosed by the Company in its response to Item 1A of Part 1 of Form 10-K for the fiscal year ended December 31, 2012.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

31	Rule 13a-14(a) / 15d-14(a) Certifications

32	Section 1350 Certifications

101.INS	XBRL Instance Document (furnished herewith)*

101.SCH	XBRL Taxonomy Extension Schema Document (furnished herewith)*

101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document (furnished herewith)*

101.DEF	XBRL Taxonomy Extension Definition Linkbase Document (furnished herewith)*

101.LAB	XBRL Taxonomy Extension Label Linkbase Document (furnished herewith)*

101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document (furnished herewith)*

*The interactive data files listed above shall not be deemed filed for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, or Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability under those sections.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

NORTH VALLEY BANCORP

(Registrant)



Date	November 8, 2013

By:

/s/ Michael J. Cushman
Michael J. Cushman
President & Chief Executive Officer
(Principal Executive Officer)

/s/ Kevin R. Watson
Kevin R. Watson
Executive Vice President & Chief Financial Officer
(Principal Financial Officer & Principal Accounting Officer)