Note 12 – Allowance for Loan and Lease Losses

The Company's allowance for loan and lease losses, a contra-asset, is established through a provision for loan and lease losses. The allowance is maintained at a level that is considered adequate to absorb probable losses on certain specifically identified loans, as well as probable incurred losses inherent in the remaining loan portfolio. Specifically identifiable and quantifiable losses are immediately charged off against the allowance; recoveries are generally recorded only when cash payments are received subsequent to the charge off. We employ a systematic methodology, consistent with FASB guidelines on loss contingencies and impaired loans, for determining the appropriate level of the allowance for loan and lease losses and adjusting it at least quarterly. Pursuant to that methodology, impaired loans and leases are individually analyzed and a criticized asset action plan is completed specifying the financial status of the borrower and, if applicable, the characteristics and condition of collateral and any associated liquidation plan. A specific loss allowance is created for each impaired loan, if necessary.

The following tables disclose the unpaid principal balance, recorded investment, average recorded investment, and interest income recognized for impaired loans on our books as of the dates indicated. Balances are shown by loan type, and are further broken out by those that required an allowance and those that did not, with the associated allowance disclosed for those that required such. Included in the valuation allowance for impaired loans shown in the tables below are specific reserves allocated to TDRs, totaling $2.463 million at June 30, 2015 and $2.714 million at December 31, 2014.

Impaired Loans	June 30, 2015
(dollars in thousands, unaudited)	Unpaid Principal Balance⁽¹⁾		Recorded Investment⁽²⁾		Related Allowance		Average Recorded Investment		Interest Income Recognized⁽³⁾
With an allowance recorded
Real Estate:
Other construction/land	$	651	$	615	$	86	$	665	$	22
1-4 Family - closed-end		3,696		3,696		135		3,546		135
Equity lines		1,487		1,434		376		1,511		8
Multi-family residential		418		417		1		419		-
Commercial real estate- owner occupied		1,743		1,743		772		1,896		26
Commercial real estate- non-owner occupied		10,089		10,089		2,058		10,711		83
Farmland		-		-		-		-		-
Total real estate		18,084		17,994		3,428		18,748		274
Agriculture		-		-		-		-		-
Commercial and industrial		2,759		2,747		861		2,881		55
Consumer loans		2,271		2,270		362		2,488		66
		23,114		23,011		4,651		24,117		395
With no related allowance recorded
Real estate:
Other construction/land		3,106		2,993		-		3,971		17
1-4 family - closed-end		1,709		1,485		-		3,254		-
Equity lines		314		296		-		320		-
Multi-family residential		-		-		-		-		-
Commercial real estate- owner occupied		1,725		1,725		-		2,055		59
Commercial real estate- non-owner occupied		2,727		2,580		-		2,928		-
Farmland		49		49		-		51		-
Total real estate		9,630		9,128		-		12,579		76
Agriculture		-		-		-		-		-
Commercial and industrial		125		108		-		164		-
Consumer loans		222		41		-		286		-
		9,977		9,277		-		13,029		76
Total	$	33,091	$	32,288	$	4,651	$	37,146	$	471

⁽¹⁾	Contractual principal balance due from customer.
⁽²⁾	Principal balance on Company's books, less any direct charge offs.
⁽³⁾	Interest income is recognized on performing balances on a regular accrual basis.

	December 31, 2014
	Unpaid Principal Balance⁽¹⁾		Recorded Investment⁽²⁾		Related Allowance		Average Recorded Investment		Interest Income Recognized⁽³⁾

With an allowance recorded
Real estate:
Other construction/land	$	1,155	$	1,078	$	179	$	1,193	$	70
1-4 family - closed-end		4,167		4,167		288		4,276		258
Equity lines		797		797		230		878		14
Multifamily residential		171		171		51		173		-
Commercial real estate- owner occupied		2,791		2,681		1,385		3,069		60
Commercial real estate- non-owner occupied		3,463		3,463		1,731		3,545		263
Farmland		-		-		-		-		-
Total real estate		12,544		12,357		3,864		13,134		665
Commercial and industrial		2,910		2,898		916		3,046		123
Consumer loans		2,790		2,788		668		3,115		150
		18,244		18,043		5,448		19,295		938
With no related allowance recorded
Real estate:
Other construction/land		3,345		3,345		-		4,143		-
1-4 family - closed-end		2,943		2,943		-		9,186		-
Equity lines		609		570		-		611		-
Multifamily residential		-		-		-		-		-
Commercial real estate- owner occupied		2,915		1,939		-		3,046		-
Commercial real estate- non-owner occupied		9,563		9,416		-		10,306		118
Farmland		51		50		-		52		-
Total real estate		19,426		18,263		-		27,344		118
Commercial and industrial		35		18		-		81		-
Consumer loans		275		100		-		347		-
		19,736		18,381		-		27,772		118
Total	$	37,980	$	36,424	$	5,448	$	47,067	$	1,056

⁽¹⁾Contractual principal balance due from customer.

⁽²⁾Principal balance on Company's books, less any direct charge offs.

⁽³⁾Interest income is recognized on performing balances on a regular accrual basis.

The specific loss allowance for an impaired loan generally represents the difference between the book value of the loan and either the fair value of underlying collateral less estimated disposition costs, or the loan's net present value as determined by a discounted cash flow analysis. The discounted cash flow approach is typically used to measure impairment on loans for which it is anticipated that repayment will be provided from cash flows other than those generated solely by the disposition or operation of underlying collateral. However, historical loss rates may be used to determine a specific loss allowance if they indicate a higher potential reserve need than the discounted cash flow analysis. Any change in impairment attributable to the passage of time is accommodated by adjusting the loss allowance accordingly.

For loans where repayment is expected to be provided by the disposition or operation of the underlying collateral, impairment is measured using the fair value of the collateral. If the collateral value, net of the expected costs of disposition where applicable, is less than the loan balance, then a specific loss reserve is established for the shortfall in collateral coverage. If the discounted collateral value is greater than or equal to the loan balance, no specific loss reserve is required. At the time a collateral-dependent loan is designated as nonperforming, a new appraisal is ordered and typically received within 30 to 60 days if a recent appraisal is not already available. We generally use external appraisals to determine the fair value of the underlying collateral for nonperforming real estate loans, although the Company's licensed staff appraisers may update older appraisals based on current market conditions and property value trends. Until an updated appraisal is received, the Company uses the existing appraisal to determine the amount of the specific loss allowance that may be required. The specific loss allowance is adjusted, as necessary, once a new appraisal is received. Updated appraisals are generally ordered at least annually for collateral-dependent loans that remain impaired. Current appraisals were available for virtually all of the Company's impaired real estate loan balances at June 30, 2015. Furthermore, the Company analyzes collateral-dependent loans on at least a quarterly basis, to determine if any portion of the recorded investment in such loans can be identified as uncollectible and would therefore constitute a confirmed loss. All amounts deemed to be uncollectible are promptly charged off against the Company's allowance for loan and lease losses, with the loan then carried at the fair value of the collateral, as appraised, less estimated costs of disposition if applicable. Once a charge-off or write-down is recorded, it will not be restored to the loan balance on the Company's accounting books.

Our methodology also provides that a “general” allowance be established for probable incurred losses inherent in loans and leases that are not impaired. Unimpaired loan balances are segregated by credit quality, and are then evaluated in pools with common characteristics. At the present time, pools are based on the same segmentation of loan types presented in our regulatory filings. While this methodology utilizes historical loss data and other measurable information, the classification of loans and the establishment of the allowance for loan and lease losses are both to some extent based on Management's judgment and experience. Our methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan and lease losses that Management believes is appropriate at each reporting date. Quantitative information includes our historical loss experience, delinquency and charge-off trends, and current collateral values. Qualitative factors include the general economic environment in our markets and, in particular, the condition of the agricultural industry and other key industries in our market areas. Lending policies and procedures (including underwriting standards), the experience and abilities of lending staff, the quality of loan review, credit concentrations (by geography, loan type, industry and collateral type), the rate of loan portfolio growth, and changes in legal or regulatory requirements are additional factors that are considered. The total general reserve established for probable incurred losses on unimpaired loans was $5.936 million at June 30, 2015.

There were no material changes to the methodology used to determine our allowance for loan and lease losses during the three months ended June 30, 2015. We continue to consider the potential impact of drought conditions on loan losses, and for the second quarter of 2015 the possible impact of lower oil prices was also given additional weighting in qualitative factors. As we add new products and expand our geographic coverage, and as the economic environment changes, we expect to enhance our methodology to keep pace with the size and complexity of the loan and lease portfolio and respond to pressures created by external forces. We engage outside firms on a regular basis to assess our methodology and perform independent credit reviews of our loan and lease portfolio. In addition, the Company's external auditors, the FDIC, and the California DBO review the allowance for loan and lease losses as an integral part of their audit and examination processes. Management believes that the current methodology is appropriate given our size and level of complexity.

The tables that follow detail the activity in the allowance for loan and lease losses for the periods noted:

Allowance for Credit Losses and Recorded Investment in Financing Receivables

(dollars in thousands, unaudited)

	Three months ended June 30, 2015
				Agricultural			Commercial and
	Real Estate			Products			Industrial			Consumer			Unallocated			Total

Allowance for credit losses:
Beginning Balance	$	5,965		$	651		$	2,253		$	1,477		$	372		$	10,718
Charge-offs		(59	)		-			(155	)		(378	)		-			(592	)
Recoveries		177			4			44			198			-			423
Provision		(481	)		(30	)		450			107			(46	)		-

Ending Balance	$	5,602		$	625		$	2,592		$	1,404		$	326		$	10,549

	Six months ended June 30, 2015
	Real Estate			Agricultural Products			Commercial and Industrial			Consumer			Unallocated		Total

Allowance for credit losses:
Beginning Balance	$	6,243		$	986		$	1,944		$	1,765		$	310	$	11,248
Charge-offs		(686	)		-			(175	)		(791	)		-		(1,652	)
Recoveries		375			5			125			448			-		953
Provision		(330	)		(366	)		698			(18	)		16		-

Ending Balance	$	5,602		$	625		$	2,592		$	1,404		$	326	$	10,549

Reserves:
Specific	$	3,428		$	-		$	861		$	362		$	-	$	4,651
General		2,174			625			1,731			1,042			326		5,898

Ending Balance	$	5,602		$	625		$	2,592		$	1,404		$	326	$	10,549

Loans evaluated for impairment:
Individually	$	27,122		$	-		$	2,855		$	2,311		$	-	$	32,288
Collectively		706,819			31,292			288,625			14,313			-		1,041,049

Ending Balance	$	733,941		$	31,292		$	291,480		$	16,624		$	-	$	1,073,337

	Year ended December 31, 2014
	Real Estate			Agricultural Products			Commercial and Industrial			Consumer			Unallocated		Total

Allowance for credit losses:
Beginning Balance	$	5,544		$	978		$	3,787		$	1,117		$	251	$	11,677
Charge-offs		(1,629	)		(124	)		(625	)		(1,837	)		-		(4,215	)
Recoveries		1,913			6			801			716			-		3,436
Provision		415			126			(2,019	)		1,769			59		350

Ending Balance	$	6,243		$	986		$	1,944		$	1,765		$	310	$	11,248

Reserves:
Specific	$	3,864		$	-		$	916		$	668		$	-	$	5,448
General		2,379			986			1,028			1,097			310		5,800

Ending Balance	$	6,243		$	986		$	1,944		$	1,765		$	310	$	11,248

Loans evaluated for impairment:
Individually	$	30,620		$	-		$	2,916		$	2,888		$	-	$	36,424
Collectively		673,610			27,746			216,876			15,997			-		934,229

Ending Balance	$	704,230		$	27,746		$	219,792		$	18,885		$	-	$	970,653