UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

(Mark One)

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

FOR THE QUARTERLY PERIOD ENDED June 30, 2013

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

FOR THE TRANSITION PERIOD FROM                        TO

COMMISSION FILE NUMBER: 000—31977

CENTRAL VALLEY COMMUNITY BANCORP

(Exact name of registrant as specified in its charter)

California	77-0539125
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

7100 N. Financial Dr, Suite 101, Fresno, California	93720
(Address of principal executive offices)	(Zip code)

Registrant’s telephone number (559) 298-1775

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ý  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  ý  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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o	Accelerated filer o
Non-accelerated filer o	Smaller reporting company x
(Do not check if a smaller reporting company)

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

As of August 08, 2013 there were 10,912,735 shares of the registrant’s common stock outstanding.

1

CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY

2013 QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

PART 1	FINANCIAL INFORMATION	2
ITEM 1	FINANCIAL STATEMENTS	3
ITEM 2	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	30
ITEM 4	CONTROLS AND PROCEDURES	58
PART II	OTHER INFORMATION	58
ITEM 1	LEGAL PROCEEDINGS	58
ITEM 1A	RISK FACTORS	58
ITEM 2	CHANGES IN SECURITIES AND USE OF PROCEEDS	58
ITEM 3	DEFAULTS UPON SENIOR SECURITIES	58
ITEM 4	MINE SAFETY DISCLOSURES	58
ITEM 5	OTHER INFORMATION	59
ITEM 6	EXHIBITS	59
SIGNATURES		59

2

PART 1: FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)	June 30, 2013			December 31, 2012
	(Unaudited)
ASSETS
Cash and due from banks	$	16,492		$	22,405
Interest-earning deposits in other banks	20,929			30,123
Federal funds sold	30			428
Total cash and cash equivalents	37,451			52,956
Available-for-sale investment securities (Amortized cost of $377,074 at June 30, 2013 and $381,074 at December 31, 2012)	374,840			393,965
Loans, less allowance for credit losses of $9,601 at June 30, 2013 and $10,133 at December 31, 2012	395,343			385,185
Bank premises and equipment, net	6,370			6,252
Bank owned life insurance	12,356			12,163
Federal Home Loan Bank stock	3,802			3,850
Goodwill	23,577			23,577
Core deposit intangibles	483			583
Accrued interest receivable and other assets	17,150			11,697
Total assets	$	871,372		$	890,228
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Non-interest bearing	$	222,181		$	240,169
Interest bearing	516,216			511,263
Total deposits	738,397			751,432
Short-term borrowings	—			4,000
Junior subordinated deferrable interest debentures	5,155			5,155
Accrued interest payable and other liabilities	16,278			11,976
Total liabilities	759,830			772,563
Commitments and contingencies (Note 9)
Shareholders’ equity:
Preferred stock, no par value, $1,000 per share liquidation preference; 10,000,000 shares authorized, Series C, issued and outstanding: 7,000 shares at June 30, 2013 and December 31, 2012	7,000			7,000
Common stock, no par value; 80,000,000 shares authorized; issued and outstanding: 9,649,600 at June 30, 2013 and 9,558,746 at December 31, 2012	41,422			40,583
Retained earnings	64,435			62,496
Accumulated other comprehensive (loss) income, net of tax	(1,315		)	7,586
Total shareholders’ equity	111,542			117,665
Total liabilities and shareholders’ equity	$	871,372		$	890,228

See notes to unaudited consolidated financial statements.

3

CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	For the Three Months Ended June 30,				For the Six Months Ended June 30,
(In thousands, except share and per share amounts)	2013		2012		2013		2012
INTEREST INCOME:
Interest and fees on loans	$	5,435	$	6,053	$	10,846	$	12,137
Interest on deposits in other banks	29		16		59		34
Interest on Federal funds sold	—		1		—		1
Interest and dividends on investment securities:
Taxable	352		880		753		1,953
Exempt from Federal income taxes	1,398		1,078		2,736		2,115
Total interest income	7,214		8,028		14,394		16,240
INTEREST EXPENSE:
Interest on deposits	312		455		605		936
Interest on junior subordinated deferrable interest debentures	24		26		49		55
Other	—		37		17		73
Total interest expense	336		518		671		1,064
Net interest income before provision for credit losses	6,878		7,510		13,723		15,176
PROVISION FOR CREDIT LOSSES	—		100		—		500
Net interest income after provision for credit losses	6,878		7,410		13,723		14,676
NON-INTEREST INCOME:
Service charges	673		676		1,371		1,365
Appreciation in cash surrender value of bank owned life insurance	97		96		193		190
Loan placement fees	214		99		379		227
Net realized gain on sale of assets	1		4		1		4
Net gain on disposal of other real estate owned	—		14		—		12
Net realized gains on sales of investment securities	320		97		1,133		444
Federal Home Loan Bank dividends	32		3		54		7
Other income	491		482		923		880
Total non-interest income	1,828		1,471		4,054		3,129
NON-INTEREST EXPENSES:
Salaries and employee benefits	3,974		3,957		7,868		8,086
Occupancy and equipment	901		877		1,802		1,758
Regulatory assessments	154		169		297		325
Data processing expense	289		283		592		577
Advertising	80		140		222		280
Audit and accounting fees	136		125		271		253
Legal fees	71		54		102		82
Merger expenses	380		—		513		—
Other real estate owned, net	—		9		—		72
Amortization of core deposit intangibles	50		50		100		100
Other expense	1,189		1,054		2,390		2,103
Total non-interest expenses	7,224		6,718		14,157		13,636
Income before provision for income taxes	1,482		2,163		3,620		4,169
Provision for income taxes	195		454		550		747
Net income	$	1,287	$	1,709	$	3,070	$	3,422
Preferred stock dividends and accretion	88		87		175		175
Net income available to common shareholders	$	1,199	$	1,622	$	2,895	$	3,247
Net income per common share:
Basic earnings per share	$	0.13	$	0.17	$	0.30	$	0.34
Weighted average common shares used in basic computation	9,587,376		9,592,045		9,573,257		9,581,172
Diluted earnings per share	$	0.12	$	0.17	$	0.30	$	0.34
Weighted average common shares used in diluted computation	9,644,938		9,618,976		9,629,771		9,604,056
Cash dividend per common share	$	0.05	$	—	$	0.10	$	—

See notes to unaudited consolidated financial statements.

4

CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
(In thousands)	2013			2012			2013			2012
Net income	$	1,287		$	1,709		$	3,070		$	3,422
Other Comprehensive Income (Loss):
Unrealized gains (losses) on securities:
Unrealized holdings gains (losses)	(11,921		)	1,602			(13,992		)	4,192
Less: reclassification for net gains included in net income	320			97			1,133			444
Other comprehensive income (loss), before tax	(12,241		)	1,505			(15,125		)	3,748
Tax benefit (expense) related to items of other comprehensive income	5,037			(620		)	6,224			(1,543		)
Total other comprehensive income (loss)	(7,204		)	885			(8,901		)	2,205
Comprehensive income (loss)	$	(5,917	)	$	2,594		$	(5,831	)	$	5,627

See notes to unaudited consolidated financial statements.

5

CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	For the Six Months Ended June 30,
(In thousands)	2013			2012
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	3,070		$	3,422
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Net (decrease) increase in deferred loan fees	(162		)	170
Depreciation	501			486
Accretion	(385		)	(346		)
Amortization	4,675			3,376
Stock-based compensation	50			64
Tax benefit from exercise of stock options	(16		)	(20		)
Provision for credit losses	—			500
Net realized gains on sales of available-for-sale investment securities	(1,133		)	(444		)
Net gain on sale and disposal of equipment	(1		)	(4		)
Net gain on sale of other real estate owned	—			(12		)
Increase in bank owned life insurance, net of expenses	(193		)	(190		)
Net (increase) decrease in accrued interest receivable and other assets	(205		)	14
Net decrease in prepaid FDIC assessments	1,542			257
Net decrease in accrued interest payable and other liabilities	(124		)	(8,521		)
(Benefit from) provision for deferred income taxes	(548		)	261
Net cash provided by (used in) operating activities	7,071			(987		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of available-for-sale investment securities	(75,306		)	(41,120		)
Proceeds from sales or calls of available-for-sale investment securities	35,853			7,499
Proceeds from maturity and principal repayments of available-for-sale investment securities	44,822			40,365
Net (increase) decrease in loans	(9,997		)	8,790
Proceeds from sale of other real estate owned	—			251
Purchases of premises and equipment	(620		)	(900		)
Purchases of bank owned life insurance	—			(116		)
FHLB stock redeemed (purchased)	48			(957		)
Proceeds from sale of premises and equipment	1			4
Net cash provided by (used in) investing activities	(5,199		)	13,816
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in demand, interest bearing and savings deposits	(18,308		)	(5,105		)
Net increase (decrease) in time deposits	5,273			(5,130		)
Repayments of short-term borrowings to Federal Home Loan Bank	(4,000		)	—
Proceeds from exercise of stock options	773			241
Excess tax benefit from exercise of stock options	16			20
Cash dividend payments on common stock	(956		)	—
Cash dividend payments on preferred stock	(175		)	(175		)
Net cash used in financing activities	(17,377		)	(10,149		)
(Decrease) increase in cash and cash equivalents	(15,505		)	2,680
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD	52,956			44,804
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	37,451		$	47,484
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION:
Cash paid during the period for:
Interest	$	750		$	1,089
Income taxes	$	940		$	760
Non-cash investing and financing activities:
Transfer of loans to other real estate owned	$	—		$	2,337
Purchases of Available-for-sale investment securities, not yet settled	$	4,425		$	—
Accrued preferred stock dividends	$	87		$	87

See notes to unaudited consolidated financial statements.

6

Note 1.  Basis of Presentation

The interim unaudited consolidated financial statements of Central Valley Community Bancorp and subsidiary have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC). These interim consolidated financial statements include the accounts of Central Valley Community Bancorp and its wholly owned subsidiary Central Valley Community Bank (the Bank) (collectively, the Company). All significant intercompany accounts and transactions have been eliminated in consolidation.  Certain information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) have been omitted. The Company believes that the disclosures are adequate to make the information presented not misleading. These interim consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s 2012 Annual Report to Shareholders on Form 10-K. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the Company’s financial position at June 30, 2013, and the results of its operations and its cash flows for the three and six month interim periods ended June 30, 2013 and 2012 have been included. Certain reclassifications have been made to prior year amounts to conform to the 2013 presentation. Reclassifications had no effect on prior period net income or shareholders’ equity. The results of operations for interim periods are not necessarily indicative of results for the full year.

The preparation of these 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

    Management has determined that since all of the banking products and services offered by the Company are available in each branch of the Bank, 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 the Bank branches and report them as a single operating segment. No customer accounts for more than 10 percent of revenues for the Company or the Bank.

Impact of New Financial Accounting Standards

Presentation of Comprehensive Income

In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (“Topic 220”) - Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“ASU 2013-02”). This ASU requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about those amounts. ASU 2013-02 is effective prospectively for annual and interim periods beginning after December 15, 2012. The Company adopted this standard on January 1, 2013. The adoption of this ASU did not have a material impact on the Company’s financial position, results of operations, or cash flows.

Note 2.  Share-Based Compensation

For the six month periods ended June 30, 2013 and 2012, share-based compensation cost recognized was $50,000 and $64,000, respectively. For the three month periods ended June 30, 2013 and 2012, share-based compensation cost recognized was $25,000 and $14,000 , respectively. The recognized tax benefits for stock option compensation expense were $9,000 and $11,000, respectively, for the six month periods ended June 30, 2013 and 2012. For the quarter ended June 30, 2013 and 2012,the recognized tax benefits for stock option compensation expense were $5,000 and $2,000, respectively. 

The Company bases the fair value of the options granted on the date of grant using a Black-Scholes Merton option pricing model that uses assumptions based on expected option life and the level of estimated forfeitures, expected stock volatility, risk free interest rate, and dividend yield.  The expected term and level of estimated forfeitures of the Company’s options are based on the Company’s own historical experience.  Stock volatility is based on the historical volatility of the Company’s stock.  The risk-free rate is based on the U. S. Treasury yield curve for the periods within the contractual life of the options in effect at the time of grant.  The compensation cost for options granted is based on the weighted average grant date fair value per share.

7

     No options to purchase shares of the Company’s common stock were issued in the first six months of 2013 and 2012 from either of the Company’s stock based compensation plans. 

A summary of the combined activity of the Company’s Stock Based Compensation Plans for the six month period ended June 30, 2013 follows:

	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value (In thousands)
Options outstanding at January 1, 2013	499,289		$	8.78
Options exercised	(90,854	)	$	8.51
Options forfeited	(21,380	)	$	8.83
Options outstanding at June 30, 2013	387,055		$	8.84	5.19	$	879
Options vested or expected to vest at June 30, 2013	379,784		$	8.87	5.13	$	333
Options exercisable at June 30, 2013	251,555		$	9.70	3.42	$	493

The total intrinsic value of 90,854 options exercised in the six months ended June 30, 2013 was $73,000.

     Cash received from options exercised for the six months ended June 30, 2013 and 2012 was $773,000 and $241,000, respectively.  The actual tax benefit realized for the tax deductions from options exercised totaled $16,000 and $20,000 for the six months ended June 30, 2013 and 2012, respectively.

     As of June 30, 2013, there was $318,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under both plans.  The cost is expected to be recognized over a weighted average period of 3.56 years.

Note 3. Earnings Per Share

Basic earnings per share (EPS), which excludes dilution, is computed by dividing income 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, stock appreciation rights settled in stock or restricted stock awards, result in the issuance of common stock which shares in the earnings of the Company. 

     A reconciliation of the numerators and denominators of the basic and diluted EPS computations is as follows:

Basic Earnings Per Share	For the Three Months Ended June 30,						For the Six Months Ended June 30,
(In thousands, except share and per share amounts)	2013			2012			2013			2012
Net Income	$	1,287		$	1,709		$	3,070		$	3,422
Less: Preferred stock dividends and accretion	(88		)	(87		)	(175		)	(175		)
Income available to common shareholders	$	1,199		$	1,622		$	2,895		$	3,247
Weighted average shares outstanding	9,587,376			9,592,045			9,573,257			9,581,172
Basic earnings per share	$	0.13		$	0.17		$	0.30		$	0.34

8

Diluted Earnings Per Share	For the Three Months Ended June 30,						For the Six Months Ended June 30,
(In thousands, except share and per share amounts)	2013			2012			2013			2012
Net Income	$	1,287		$	1,709		$	3,070		$	3,422
Less: Preferred stock dividends and accretion	(88		)	(87		)	(175		)	(175		)
Income available to common shareholders	$	1,199		$	1,622		$	2,895		$	3,247
Weighted average shares outstanding	9,587,376			9,592,045			9,573,257			9,581,172
Effect of dilutive stock options	57,562			26,931			56,514			22,884
Weighted average shares of common stock and common stock equivalents	9,644,938			9,618,976			9,629,771			9,604,056
Diluted earnings per share	$	0.12		$	0.17		$	0.30		$	0.34

During the six month periods ended June 30, 2013 and 2012, options to purchase 206,085 and 377,129 shares of common stock, respectively, were not factored into the calculation of dilutive stock options because they were anti-dilutive. 

Note 4.  Investments

The investment portfolio consists primarily of U.S. Government sponsored entity and agency securities collateralized by residential mortgage obligations, private label residential mortgage backed securities (PLRMBS), and obligations of states and political subdivisions securities, all of which are classified as available-for-sale.  As of June 30, 2013, $102,764,000 of these securities were held as collateral for borrowing arrangements, public funds, and for other purposes.

     The fair value of the available-for-sale investment portfolio reflected a net unrealized loss of $2,234,000 at June 30, 2013 compared to an unrealized gain of $12,891,000 at December 31, 2012.

     The following table sets forth the carrying values and estimated fair values of our investment securities portfolio at the dates indicated (in thousands): 

	June 30, 2013
Available-for-Sale Securities	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Debt securities:
U.S. Government agencies	$	14,621	$	235	$	(3	)	$	14,853
Obligations of states and political subdivisions	170,005		4,362		(6,476		)	167,891
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations	179,620		828		(2,076		)	178,372
Private label residential mortgage backed securities	5,232		859		(4		)	6,087
Other equity securities	7,596		41		—			7,637
	$	377,074	$	6,325	$	(8,559	)	$	374,840

	December 31, 2012
Available-for-Sale Securities	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Debt securities:
U.S. Government agencies	$	9,443	$	34	$	(23	)	$	9,454
Obligations of states and political subdivisions	151,312		10,751		(385		)	161,678
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations	206,465		3,152		(1,107		)	208,510
Private label residential mortgage backed securities	6,258		323		(206		)	6,375
Other equity securities	7,596		352		—			7,948
	$	381,074	$	14,612	$	(1,721	)	$	393,965

9

Proceeds and gross realized gains (losses) from the sales or calls of investment securities for the periods ended June 30, 2013 and 2012 are shown below (in thousands):

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
Available-for-Sale Securities	2013			2012			2013			2012
Proceeds from sales or calls	$	13,696		$	3,107		$	35,853		$	7,499
Gross realized gains from sales or calls	395			157			1,401			566
Gross realized losses from sales or calls	(75		)	(60		)	(268		)	(122		)

The provision for income taxes includes $466,000 and $183,000 income tax impact from the reclassification of unrealized net gains on available-for-sale securities to realized net gains on available-for-sale securities for the six months ended June 30, 2013 and 2012. The provision for income taxes includes $132,000 and $40,000 income tax impact from the reclassification of unrealized net gains on available-for-sale securities to realized net gains on available-for-sale securities for the three months ended June 30, 2013 and 2012.

Investment securities with unrealized losses as of the dates indicated are summarized and classified according to the duration of the loss period as follows (in thousands): 

	June 30, 2013
	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
Available-for-Sale Securities	Value		Losses			Value		Losses			Value		Losses
Debt securities:
U.S. Government agencies	$	1,100	$	(3	)	$	—	$	—		$	1,100	$	(3	)
Obligations of states and political subdivisions	93,119		(6,476		)	—		—			93,119		(6,476		)
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations	111,634		(1,868		)	14,626		(208		)	126,260		(2,076		)
Private label residential mortgage backed securities	—		—			231		(4		)	231		(4		)
	$	205,853	$	(8,347	)	$	14,857	$	(212	)	$	220,710	$	(8,559	)

	December 31, 2012
	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
Available-for-Sale Securities	Value		Losses			Value		Losses			Value		Losses
Debt securities:
U.S. Government agencies	$	3,590	$	(23	)	$	—	$	—		$	3,590	$	(23	)
Obligations of states and political subdivisions	30,572		(385		)	—		—			30,572		(385		)
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations	76,764		(809		)	18,024		(298		)	94,788		(1,107		)
Private label residential mortgage backed securities	—		—			2,886		(206		)	2,886		(206		)
	$	110,926	$	(1,217	)	$	20,910	$	(504	)	$	131,836	$	(1,721	)

We periodically evaluate each investment security for other-than-temporary impairment, relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations.  Under ASC 320-10, the portion of the impairment that is attributable to a shortage in the present value of expected future cash flows relative to the amortized cost should be recorded as a current period charge to earnings.  The discount rate in this analysis is the original yield expected at time of purchase.

As of June 30, 2013, the Company performed an analysis of the investment portfolio to determine whether any of the investments held in the portfolio had an other-than-temporary impairment (OTTI). Management evaluated all available-for-sale investment securities with an unrealized loss at June 30, 2013 and identified those that had an unrealized loss for at least a

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consecutive 12 month period, which had an unrealized loss at June 30, 2013 greater than 10% of the recorded book value on that date, or which had an unrealized loss of more than $10,000.  Management also analyzed any securities that may have been downgraded by credit rating agencies.  Management retained the services of a third party in June 2013 to provide independent valuation and OTTI analysis on certain PLRMBS.

For those bonds that met the evaluation criteria, management obtained and reviewed the most recently published national credit ratings for those bonds.  For those bonds that were municipal debt securities with an investment grade rating by the rating agencies, management also evaluated the financial condition of the municipality and any applicable municipal bond insurance provider and concluded that no credit related impairment existed.

The evaluation for PLRMBS includes estimating projected cash flows that the Company is likely to collect based on an assessment of all available information about the applicable security on an individual basis, the structure of the security, and certain assumptions, such as the remaining payment terms for the security, prepayment speeds, default rates, loss severity on the collateral supporting the security based on underlying loan-level borrower and loan characteristics, expected housing price changes, and interest rate assumptions, to determine whether the Company will recover the entire amortized cost basis of the security.  In performing a detailed cash flow analysis, the Company identified the best estimate of the cash flows expected to be collected.  If this estimate results in a present value of expected cash flows (discounted at the security’s original yield) that is less than the amortized cost basis of the security, an OTTI is considered to have occurred.

To assess whether it expects to recover the entire amortized cost basis of its PLRMBS, the Company performed a cash flow analysis for all of its PLRMBS as of June 30, 2013.  In performing the cash flow analysis for each security, the Company uses a third-party model. The model considers borrower characteristics and the particular attributes of the loans underlying the Company’s securities, in conjunction with assumptions about future changes in home prices and other assumptions, to project prepayments, default rates, and loss severities.

The month-by-month projections of future loan performance are allocated to the various security classes in each securitization structure in accordance with the structure’s prescribed cash flow and loss allocation rules.  When the credit enhancement for the senior securities in a securitization is derived from the presence of subordinated securities, losses are allocated first to the subordinated securities until their principal balance is reduced to zero.  The projected cash flows are based on a number of assumptions and expectations, and the results of these models can vary significantly with changes in assumptions and expectations.  The scenario of cash flows determined based on the model approach described above reflects a best-estimate scenario.

At each quarter end, the Company compares the present value of the cash flows expected to be collected on its PLRMBS to the amortized cost basis of the securities to determine whether a credit loss exists.

The unrealized losses associated with PLRMBS are primarily driven by projected collateral losses, credit spreads, and changes in interest rates.  The Company assesses for credit impairment using a discounted cash flow model.  The key assumptions include default rates, severities, discount rates and prepayment rates.  Losses are estimated by forecasting the performance of the underlying mortgage loans for each security.  The forecasted loan performance is used to project cash flows to the various tranches in the structure.  Based upon management’s assessment of the expected credit losses of these securities given the performance of the underlying collateral compared with our credit enhancement (which occurs as a result of credit loss protection provided by subordinated tranches), the Company expects to recover the entire amortized cost basis of these securities, with the exception of certain securities for which OTTI was previously recorded.

U.S. Government Agencies

At June 30, 2013, the Company held five U.S. Government agency securities, of which one was in a loss position for less than 12 months and none were in a loss position nor had been in a loss position for 12 months or more. The unrealized losses on the Company’s investments in direct obligations of U.S. government agencies were caused by interest rate changes. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized costs of the investment. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2013.

Obligations of States and Political Subdivisions

At June 30, 2013, the Company held 199 obligations of states and political subdivision securities of which 72 were in a loss position for less than 12 months and none were in a loss position nor had been in a loss position for 12 months or more. The unrealized losses on the Company’s investments in obligations of states and political subdivision securities were caused by interest rate changes. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell, and it is more likely than not that it will not be required to sell those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2013.

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U.S. Government Sponsored Entities and Agencies Collateralized by Residential Mortgage Obligations

At June 30, 2013, the Company held 182 U.S. Government sponsored entity and agency securities collateralized by residential mortgage obligations of which 58 were in a loss position for less than 12 months and 19 have been in a loss position for more than 12 months. The unrealized losses on the Company’s investments in U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations were caused by interest rate changes. The contractual cash flows of those investments are guaranteed by an agency or sponsored entity of the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of the Company’s investment. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell, and it is more likely than not that it will not be required to sell those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2013.

Private Label Residential Mortgage Backed Securities

At June 30, 2013, the Company had a total of 22 PLRMBS with a remaining principal balance of $5,232,000 and a net unrealized gain of approximately $855,000.  One of these securities accounted for $4,000 of unrealized loss at June 30, 2013 offset by 21 of these securities with gains totaling $859,000.  Eight of these PLRMBS with a remaining principal balance of $4,068,000 had credit ratings below investment grade.  The Company continues to perform extensive analyses on these securities. No credit related OTTI charges related to PLRMBS were recorded during the six month period ended June 30, 2013.

     PLRMBS as of June 30, 2013 with credit ratings below investment grade are summarized in the table below (dollars in thousands):

Description	Book Value		Market Value		Unrealized Gain (Loss)			Rating	Agency	12 Month Historical Prepayment Rates %	Projected Default Rates %	Projected Severity Rates %	Original Purchase Price %	Current Credit Enhancement %
PHHAM	$	1,585	1,781		$	196		D	Fitch	16.85	20.23	51.00	97.25	—
CWALT 1	552		608		56			D	Fitch	14.99	24.05	47.15	100.73	—
CWALT 2	236		232		(4		)	D	Fitch	17.71	23.11	55.38	101.38	(1.24	)
FHAMS	1,430		1,753		323			D	Fitch	14.70	18.83	53.90	95.00	(0.96	)
BAALT	23		28		5			C	Fitch	13.39	11.65	57.09	97.24	1.41
ABFS	147		284		137			D	S&P	8.99	40.55	46.75	97.46	—
CWALT 3	57		61		4			B1	Moodys	21.17	11.15	28.12	94.47	10.54
CONHE	38		59		21			Caa2	Moodys	4.10	6.92	46.75	86.39	—
	$	4,068	$	4,806	$	738

The following tables provide a roll forward for the three and six month periods ended June 30, 2013 and 2012 of investment securities credit losses recorded in earnings. The beginning balance represents the credit loss component for which OTTI occurred on debt securities in prior periods.  Additions represent the first time a debt security was credit impaired or when subsequent credit impairments have occurred on securities for which OTTI credit losses have been previously recognized.

	For the Three Months Ended June 30,				For the Six Months Ended June 30,
(In thousands)	2013		2012		2013		2012
Beginning balance	$	800	$	783	$	783	$	783
Amounts related to credit loss for which an OTTI charge was not previously recognized	—		—		17		—
Increases to the amount related to credit loss for which OTTI was previously recognized	—		—		—		—
Realized losses for securities sold	—		—		—		—
Ending balance	$	800	$	783	$	800	$	783

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The amortized cost and estimated fair value of investment securities at June 30, 2013 by contractual maturity is shown below (in thousands).  Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.

June 30, 2013	Amortized Cost		Estimated Fair Value
Within one year	$	150	$	150
After one year through five years	12,688		13,578
After five years through ten years	23,314		24,187
After ten years	133,853		129,976
	170,005		167,891
Investment securities not due at a single maturity date:
U.S. Government agencies	14,621		14,853
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations	179,620		178,372
Private label residential mortgage backed securities	5,232		6,087
Other equity securities	7,596		7,637
	$	377,074	$	374,840

Note 5.  Fair Value Measurements

Fair Value Hierarchy

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. In accordance with applicable guidance, 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.  Valuations within these levels are based upon:

Level 1 — Quoted market prices (unadjusted) for identical instruments traded in active exchange markets that the Company has the ability to access as of the measurement date.

Level 2 — Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable or can be corroborated by observable market data.

Level 3 — Model-based techniques that use at least one significant assumption not observable in the market.  These unobservable assumptions reflect the Company’s estimates of assumptions that market participants would use on pricing the asset or liability.  Valuation techniques include management judgment and estimation which may be significant.

Management monitors the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy. Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one fair value level to another. In such instances, we report the transfer at the beginning of the reporting period.

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

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	June 30, 2013
	Carrying Amount		Fair Value
(In thousands)			Level 1		Level 2		Level 3		Total
Financial assets:
Cash and due from banks	$	16,492	$	16,492	$	—	$	—	$	16,492
Interest-earning deposits in other banks	20,929		20,929		—		—		20,929
Federal funds sold	30		30		—		—		30
Available-for-sale investment securities	374,840		7,637		367,203		—		374,840
Loans, net	395,343		—		—		397,401		397,401
Federal Home Loan Bank stock	3,802		N/A		N/A		N/A		N/A
Accrued interest receivable	4,496		20		2,737		1,739		4,496
Financial liabilities:
Deposits	738,397		596,249		142,303		—		738,552
Junior subordinated deferrable interest debentures	5,155		—		—		2,487		2,487
Accrued interest payable	120		—		96		24		120

	December 31, 2012
	Carrying Amount		Fair Value
(In thousands)			Level 1		Level 2		Level 3		Total
Financial assets:
Cash and due from banks	$	22,405	$	22,405	$	—	$	—	$	22,405
Interest-earning deposits in other banks	30,123		30,123		—		—		30,123
Federal funds sold	428		428		—		—		428
Available-for-sale investment securities	393,965		7,948		386,017		—		393,965
Loans, net	385,185		—		—		388,834		388,834
Federal Home Loan Bank stock	3,850		N/A		N/A		N/A		N/A
Accrued interest receivable	4,267		22		2,395		1,850		4,267
Financial liabilities:
Deposits	751,432		614,556		137,401		—		751,957
Short-term borrowings	4,000		—		4,016		—		4,016
Junior subordinated deferrable interest debentures	5,155		—		—		2,990		2,990
Accrued interest payable	174		—		149		25		174

These estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments.  In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.

These estimates are made at a specific point in time based on relevant market data and information about the financial instruments.  Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors.  These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision.  Changes in assumptions could significantly affect the fair values presented.

The methods and assumptions used to estimate fair values are described as follows:

(a) Cash and Cash Equivalents— The carrying amounts of cash and due from banks, interest-earning deposits in other banks, and Federal funds sold approximate fair values and are classified as Level 1.

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(b) Available-for-Sale Investment Securities — Available-for-sale investment securities in Level 1 are mutual funds and fair values are based on quoted market prices for identical instruments traded in active markets. Fair values for available-for-sale investment securities classified in Level 2 are based on quoted market prices for similar securities in active markets. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators.

(c) Loans — Fair values of 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 initially valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for loan losses. For collateral dependent loans, fair value is commonly 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. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management's historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

(d) FHLB Stock — It is not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability.

(e) Deposits — Fair value of demand deposit, 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 resulting in a Level 1 classification. Fair value for fixed and variable rate certificates of deposit are estimated using discounted cash flow analyses using interest rates offered at each reporting date by the Company for certificates with similar remaining maturities resulting in a Level 2 classification.

(f) Short-Term Borrowings — The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification.

(g) Other Borrowings — The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

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.

(h) Accrued Interest Receivable/Payable — The fair value of accrued interest receivable and payable is based on the fair value hierarchy of the related asset or liability.

(i) Off-Balance Sheet Instruments — Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.

Assets Recorded at Fair Value

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of June 30, 2013:

Recurring Basis

The Company is required or permitted to record the following assets at fair value on a recurring basis under other accounting pronouncements as of June 30, 2013 (in thousands).

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Description	Fair Value		Level 1		Level 2		Level 3
Available-for-sale securities
Debt Securities:
U.S. Government agencies	$	14,853	$	—	$	14,853	$	—
Obligations of states and political subdivisions	167,891		—		167,891		—
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations	178,372		—		178,372		—
Private label residential mortgage backed securities	6,087		—		6,087		—
Other equity securities	7,637		7,637		—		—
Total assets measured at fair value on a recurring basis	$	374,840	$	7,637	$	367,203	$	—

Securities in Level 1 are mutual funds and fair values are based on quoted market prices for identical instruments traded in active markets.  Fair values for available-for-sale investment securities in Level 2 are based on quoted market prices for similar securities in active markets. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators.

Management evaluates the significance of transfers between levels based upon the nature of the financial instrument and size of the transfer relative to total assets, total liabilities or total earnings. During the six months ended June 30, 2013, no transfers between levels occurred.

There were no Level 3 assets measured at fair value on a recurring basis at June 30, 2013. Also there were no liabilities measured at fair value on a recurring basis at June 30, 2013.

Non-recurring Basis

The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a non-recurring basis. These include assets and liabilities that are measured at the lower of cost or fair value that were recognized at fair value which was below cost at June 30, 2013 (in thousands).

Description	Fair Value		Level 1		Level 2		Level 3
Impaired loans:
Commercial:
Commercial and industrial	$	929	$	—	$	—	$	929
Agricultural production	—		—		—		—
Total commercial	929		—		—		929
Real estate:
Owner occupied	—		—		—		—
Real estate-construction and other land loans	—		—		—		—
Commercial real estate	—		—		—		—
Agricultural real estate	—		—		—		—
Other	—		—		—		—
Total real estate	—		—		—		—
Consumer:
Equity loans and lines of credit	78		—		—		78
Consumer and installment	—		—		—		—
Total consumer	78		—		—		78
Lease financing receivable	—		—		—		—
Total impaired loans	1,007		—		—		1,007
Other real estate owned	—		—		—		—
Total assets measured at fair value on a non-recurring basis	$	1,007	$	—	$	—	$	1,007

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At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for loan losses. For collateral dependent loans, fair value is commonly 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. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. The fair value of impaired loans is based on the fair value of the collateral. Impaired loans were determined to be collateral dependent and categorized as Level 3 due to ongoing real estate market conditions resulting in inactive market date, which in turn required the use of unobservable inputs and assumptions in fair value measurements. Impaired loans evaluated under the discounted cash flow method are excluded from the table above. The discounted cash flow methods as prescribed by topic 310 is not a fair value measurement since the discount rate utilized is the loan's effective interest rate which is not a market rate. There were no changes in valuation techniques used during the six months period ended June 30, 2013.

Appraisals for collateral-dependent impaired loans are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value is compared with independent data sources such as recent market data or industry-wide statistics.    

Impaired loans that are measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal balance of $1,451,000 with a valuation allowance of $444,000 at June 30, 2013, resulting in no provision for credit losses for the period ended June 30, 2013, down to their fair value of $1,007,000.  The valuation allowance represents specific allocations for the allowance for credit losses for impaired loans.

The following tables present information about the Company's assets and liabilities measured at fair value on a recurring and nonrecurring basis as of December 31, 2012:

Recurring Basis

The Company is required or permitted to record the following assets at fair value on a recurring basis under other accounting pronouncements (in thousands).

Description	Fair Value		Level 1		Level 2		Level 3
Available-for-sale securities
Debt Securities:
U.S. Government agencies	$	9,454	$	—	$	9,454	$	—
Obligations of states and political subdivisions	161,678		—		161,678		—
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations	208,510		—		208,510		—
Private label residential mortgage backed securities	6,375		—		6,375		—
Other equity securities	7,948		7,948		—		—
Total assets measured at fair value on a recurring basis	$	393,965	$	7,948	$	386,017	$	—

Securities in Level 1 are mutual funds and fair values are based on quoted market prices for identical instruments traded in active markets.  Fair values for available-for-sale investment securities in Level 2 are based on quoted market prices for similar securities in active markets. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators.

     Management evaluates the significance of transfers between levels based upon the nature of the financial instrument and size of the transfer relative to total assets, total liabilities or total earnings. During the year ended December 31, 2012, no transfers between levels occurred.

There were no Level 3 assets measured at fair value on a recurring basis at December 31, 2012. Also there were no liabilities measured at fair value on a recurring basis at December 31, 2012.

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Non-recurring Basis

The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a non-recurring basis.  These include assets and liabilities that are measured at the lower of cost or fair value that were recognized at fair value which was below cost at December 31, 2012 (in thousands).

Description	Fair Value		Level 1		Level 2		Level 3
Impaired loans:
Commercial:
Commercial and industrial	$	—	$	—	$	—	$	—
Agricultural production	—		—		—		—
Total commercial	—		—		—		—
Real estate:
Owner occupied	194		—		—		194
Real estate-construction and other land loans	4,863		—		—		4,863
Commercial real estate	—		—		—		—
Agricultural real estate	—		—		—		—
Other	—		—		—		—
Total real estate	5,057		—		—		5,057
Consumer:
Equity loans and lines of credit	233		—		—		233
Consumer and installment	—		—		—		—
Total consumer	233		—		—		233
Lease financing receivable	—		—		—		—
Total impaired loans