B A N K I N G F O R A L L G E N E R A T I O N S
O a k V a l l e y B a n c Or p
|
2 0 1 2 A n n u Al R e p oR
t
S E L E C T E D F I N A N C I A L D A T A F I V E - Y E A R S U M M A R Y
(Dollars in thousands except for per share amounts)
Year Ended December 31,
2012
2011
2010
2009
2008
Interest income
Interest expense
Net interest income before
provisions for loan losses
Provision for loan losses
Net interest income
Non-interest income
Non-interest expense
Income taxes
Net income
Preferred stock dividends & accretion
Net income available to common
shareholders
Per common share net earnings (basic)
Per common share cash dividends declared
Cash dividends declared
Weighted average common
shares outstanding
Year End Balance Sheet
Total assets
Total earning assets
Net loans
Cash and cash equivalents
Investment securities
Total deposits
Non-interest bearing deposits
Interest bearing deposits
Total stockholder’s equity
$ 25,982
1,137
24,845
1,150
23,695
3,149
18,249
2,814
5,781
(452)
$ 5,329
$ 26,828
$ 27,926
$ 29,283
$ 29,247
1,648
25,180
1,500
23,680
2,751
17,394
3,176
5,861
(1,161)
2,919
25,007
4,020
20,987
2,770
16,776
2,353
4,628
(842)
$ 4,700
$ 3,786
5,641
23,642
5,862
17,780
2,641
18,218
203
2,000
(842)
$ 1,158
8,732
20,515
2,188
18,327
2,522
17,865
822
2,162
(64)
$ 2,098
$ 0.69
-
-
7,740,990
$ 0.61
-
-
7,708,853
$ 0.49
-
-
7,689,760
$ 0.15
$ 0.025
$ 192
$ 0.27
$ 0.075
$ 574
7,668,562
7,642,775
$ 660,581
605,275
382,411
141,335
103,866
$ 586,993
163,991
423,002
69,969
$ 612,172
$ 552,396
$ 524,722
$ 508,203
557,784
386,958
101,085
89,695
518,845
395,206
68,937
53,268
485,704
417,796
21,649
50,765
470,428
421,573
9,838
41,449
$ 536,204
$ 476,739
$ 429,210
$ 378,248
130,143
406,061
70,402
102,422
374,317
64,658
69,647
359,563
60,692
64,277
313,971
57,986
We continue
to deliver the
perfect blend of
old-fashioned
service and
modern
technology
to meet every
need.
Dear Customers,
Shareholders
and Friends:
This marked the fourth consecutive year
in which either the Company or one of our
Commercial Loan Officers was recognized with
the “Most Active” Small Business Association
504 lender designation by SCEDCO, one of our
business and economic development partners.
As we reflect upon another successful
year and contemplate the one ahead, we are
We are pleased to congratulate Mr. Peter Brown
on receiving the 2012 honor, an award which
pleased to report the Company has achieved
exemplifies the culture we have created and
a new earnings milestone for net income
sustained based on a lending team with the
available to shareholders. It’s no surprise to
knowledge and appetite for SBA lending.
us, as we’ve always known that our success is
An individual’s desire to stay connected
rooted in our conservative approach to growth
to their money is now stronger than ever.
and focus on customer relationships.
Gone are the days when a weekly or daily trip
For the fiscal year ended December 31,
to the bank served as a sufficient means of
2012, net income totaled $5.8 million compared
managing one’s finances. That’s why we have
to $5.9 million for 2011. After adjustment for
increased our emphasis on the electronic
preferred stock dividends and accretion, net
banking channel to enable continuous remote
income available to common shareholders
account access. Mobile Banking already allows
was $5.3 million, or $0.69 per diluted share,
customers to make payments on the go.
compared to net income of $4.7 million, or
Remote Deposit Capture allows businesses to
$0.61 per diluted common share, in 2011. This
deposit checks without leaving the office. And,
represented a 13.4% increase in net income
by the end of summer, our personal banking
available to common shareholders and marked
and small business clients will be able to make
record earnings for the Company.
deposits with a mobile phone or tablet. We
Total assets grew to $660.6 million for the
continue to deliver the perfect blend of old-
year ended December 31, 2012, an increase of
fashioned service and modern technology to
$48.4 million, or 7.9% increase over December
meet every need.
31, 2011. Deposits increased to $587.0 million,
As we continue to nurture the growth
an increase of $50.8 million, or 9.5% over the
and development of the Company, the
prior year. Gross loans at year end totaled
mighty oak planted back in 1991, we extend
$391.0 million, reflecting a decrease of $5.2
our appreciation to all of our shareholders,
million, or 1.3%, from 2011.
customers and friends for their support and
Steadied by strong deposit growth
loyalty. As announced earlier this year, I will be
and credit quality, we’re keenly focused on
retiring as Chief Executive Officer during the
increasing lending in the communities we
summer of 2013. After twenty-one incredible
serve as we begin to see signs of activity in
years, I cannot emphasize my gratitude enough.
the commercial arena. The market for quality
Without all of you, your patience and your
business loans is highly competitive. Now, more
vision, we wouldn’t be where we are today. You
than ever, we need to reaffirm our commitment
are the true roots of our success.
to crafting custom-tailored lending solutions
Sincerely, Ronald C. Martin
that make sense for the client and provide
long-term value to the Company and our
shareholders. As always, credit quality will
remain at the core of every lending decision.
service. That means customers still reach a
live, friendly person on the other end of
the phone, and when they visit one of our
branches, there’s a good chance that our entire
staff knows them by name. It’s why people
from all generations bank with Oak Valley
Community Bank and why they always will.
A tradition of leadership
Another reason for our loyal and growing
customer base is security. When people bank
with Oak Valley, they trust our long history
of leadership and financial strength. They
know we’ll be here tomorrow, weathering any
economic storm, because we stay true to
our core values and uphold prudent lending
practices, ensuring high standards of credit
quality. By staying the course with proven
fundamentals, it benefits the bank, our
shareholders and our customers.
As a result, we’ve grown deposits to the
highest level ever. With continued re-balancing
of our portfolio and restructuring of our
balance sheets, we’ve maintained a solid
financial foundation.
Seizing new opportunities on the Horizon
We can see the light at the end of the tunnel
now, and are poised to take advantage of
the economic rebound, stronger than ever.
With more than half of our branches still
relatively new, we see tremendous upside
potential. We’re armed with a knowledgeable
"The number of
mobile banking users
will grow to 530
million by 2013...
there were just more
than 300 million
users in 2011."
"Smartphone
ownership in the
United States
nearly doubled
between 2010-2012,
increasing from 63
million to
125 million users."
Connecting
Through Innovation
Sierra Pacific officers
Ken Sauls, Michelle
VanArtsdalen, Chris
Murphy and Gary
Fox pictured at their
Modesto facility.
Our generation is witnessing
the fulfillment of a promise
made long ago
Mobile Banking the oak Valley Way
Based on mobile device usage patterns and
mobile banking adoption rates, it’s becoming
evident that the mobile trend spans across
by both financial services industry leaders
all generations, with applications that benefit
and technology pioneers: anytime, anywhere
the personal and business banking user. Just
banking. Thanks to modern digital platforms
as we have supported many other banking
and new business models, banks are offering
innovations, Oak Valley will always adopt
customers ubiquitous access to their money
technology that enhances our ability to
like never before.
serve our customers and improves their
banking experience.
To keep our deposits
working for us, we
utilize Oak Valley’s
Cash Management
eBanker to
manage cash flow
and receivables
efficiently.
—Chris Murphy, Sierra
Pacific Warehouse Group
Like the big banks, we provide a diverse,
management team and the best group of
high-level product line featuring the latest
lenders the Company has ever seen. We’ve
electronic banking products. But as a
streamlined our business processes and kept
community bank offering the perfect blend of
overhead low during the past four years,
traditional values and progressive products, we
enabling us to offer quality products at a lower
do it a little differently.
cost to increase our profitability now and for
the long term.
Winning with personalized Service
What makes our approach to virtual banking
unique is that we support our products and
services with old-fashioned, personalized
Banking for the
Way You Live
& Work
In today’s busy, fast-
paced world, we know how
important it is for customers
to feel in control of their
funds wherever they are.
of these products without the
hassles typically associated
with changing financial services
platforms. Our high-touch
approach to technology helps
ease the transition for many of
We’ve created solid digital financial products
our traditional customers, while
as a logical extension of our service-focused
giving our tech-savvy account
approach to give our customers the comfort,
holders a jump-start to maximize
control and convenience they desire in
the benefits of these products.
managing their money. So customers can bank
via their smartphones, online and on the go!
Mobile Banking—Mobile Banking
is a secure, easy-to-use tool
In business, convenient access to funds is just
allowing customers to access their
as important for our commercial customers.
money and financial information
All of our eBanking products are suitable for
whenever and wherever they are,
any business, from an entrepreneur to a large
at work and at play. Customers
company. Our business customers, because of
can bank just the way they want:
their sizable investment in the bank, desire our
via text message, through our
Drs. William Marweg
and Thomas Bianchi,
pictured with Office
Manager, Stephanie
Sadberry
hallmark brand of personalized service to help
website, or by using the OVCB Mobile app.
them manage their money in the most efficient
Whichever method of mobile banking they
and effective ways.
choose, they’ll have 24/7 secure access, backed
with our personalized customer service.
High touch eBanking
What differentiates Oak Valley’s brand of
Remote Deposit Capture—Remote Deposit
Since joining Oak
Valley Community
Bank, we’ve
discovered that
technology is only a
real benefit when you
gives customers the freedom to manage their
can provide additional options for customers
finances more efficiently and make funds
without relaxing our credit standards. We even
available sooner than ever.
have a “No Closing Cost Loan Program,” which
Mortgage lending Comes Home
more people than ever before. Best of all, we
This year we teamed up with an additional
can offer this wide variety of loans through our
can bring home ownership that much closer to
eBanking is the customer service we provide
Capture is one of the newest innovations in the
can still count on a
lending partner to expand our mortgage
lending partners for less than it would cost the
to ensure that our customers reap the rewards
banking industry, offering an unprecedented
personalized touch.
product line, enabling us to offer a wider variety
bank to provide these services alone, so it’s a
level of convenience for our commercial
customers who can now make deposits
without ever leaving their place of business.
Scanning checks and making digital deposits
—Dr. Thomas Bianchi,
Delta Endodontics
of fixed rate conventional loans, ARMs, and
win-win for Oak Valley and our customers!
FHA loans, as well as more versatility on non-
owner occupied and multi-family dwellings.
Armed with a more robust loan offering, we
We’ve been using
Remote Deposit
Capture for more
than a year now, and
couldn’t be happier!
It’s highly convenient
and saves so much
time in our day-
to-day business. Its
report generation
capabilities are a
valuable bonus: it
itemizes all of our
checks, records daily
deposits and even
cross-references
with our collection
reconciliation
software. Oak Valley
has gone above and
beyond the call of
duty to create a great
product and provide
the support to make it
easy to use.
—Stephanie Sadberry
Office Manager
Delta Endodontics
The United Way
provides so many
opportunities for
us to contribute
our time, money
and expertise.
Knowing that
we’re helping
families achieve
financial stability
is our greatest
reward.
opportunities for low- to moderate-income
families, seniors, and individuals. The
organization has built more than 1,000 units of
rental housing and 500 single-family homes
from Sacramento to Fresno. Oak Valley is
providing families with resources for down
payment and closing costs, instructing clients
on how to improve financial management skills,
and educating consumers about the home
buying process.
Inyo Mono Advocates for
Community Action, Inc. (IMACA)
IMACA is a private, non-profit corporation that
works with and serves low-income residents
of Inyo, Mono, and Alpine Counties in California
with the goal of empowering them to advocate
for their needs and to find and maintain a
healthy lifestyle by breaking the cycle of
poverty. Oak Valley’s support is enabling
IMACA to deliver services such as Energy
Conservation and Assistance, Weatherization,
Eviction Prevention, Emergency Food and
Shelter, Affordable Housing Management and
Development, Head Start Programs, and
much more.
the parent Resource Center
We also help the Parent Resource Center
fulfill its mission of building stronger, healthier
families through education, mentoring
and supportive services to empower and
strengthen our community. The Center
supports parents by offering in-home volunteer
organization. This being the inaugural year
mentoring and on-site parenting education
for Bank On Stanislaus, we assisted with the
classes to decrease the risk of child abuse,
development of their brochures and posters, as
neglect and family violence. Oak Valley provides
well as teaching financial literacy classes.
funding, supports events and serves on their
board of directors.
Visionary Home Builders
We proudly support Visionary Homebuilders,
which creates and advocates for healthy,
vibrant, safe communities by developing
affordable housing and educational
Investing in Our
Communities
Oak Valley Community
Bank takes special pride in
serving our communities,
financial institutions, and local nonprofit
organizations, which sets residents on the
path to financial stability by providing a low-
cost starter bank account and the education
giving our hearts, efforts and funds to support
to manage it successfully. The program is an
worthwhile causes throughout the region:
adaptation of the Money Smart curriculum
Bank on Stanislaus County
Bank on Stanislaus County is a joint effort by
Oak Valley supports the United Way with
the United Way of Stanislaus County, select
monetary contributions, volunteerism, and
developed by the FDIC.
By supporting our
community partners,
Oak Valley helps
people buy homes,
learn important skills,
and grow healthy
families.
board membership. Every November, we hold
a United Way Campaign and annual Bowl-a-
Thon that raises thousands of dollars for the
ADVISoRS
founDeRS
Steve Benak, MD
Andrea Boston-Gilbert
Gordon A. and Yvonne
Brown
Robert and Beverly Brunker
William D. and Joyce
A.Compton
Hal and Chrys Copp
Betty Dallas
Ramon A. Esslinger
Donald Fagundes
Richard A. and Susan J.
Franco
Joel W. Geddes, Jr.
Harrison Gibbs
James Lawrence Gilbert
Thomas A. and Julia D.
Haidlen
Mr. and Mrs. Walter H.
Heckendorf
Barbara Heckendorf
Mrs. Beverly Haidlen
Holloway
Leonard B. and Betty M.
Jackson
Barry M. and Betty-Lynn
Jett
Henry Kamps, Jr.
Arne and Birgitta Knudsen
Soren and Sharon Knudsen
Steven Knudsen
Joe and Joyce Martin
Della Messner
Bill and Sharon Morris
James A. Morrison III
Ben and Judy Mullins
Dr. and Mrs. J. Patrick
Mulrooney
Thomas W. and Marsha
L. Orr
Willem Postma
Mike Reed
Roger M. and Delsie
Schrimp
Romain and Janette
Schonhoff
Ralph P. and Margitta R.
Sikkema, DVM
Richard D. and Ola L.
Stokes
George and Ruth Thoukis
Danny L. and Suzette Titus
DeWayne F. Titus
Lynda Vaughan
Richard J. Vaughan
Jack Watkins
Gilbert O. Wymond III
Debbie Armstrong
Nelson Bahler
Joseph Barlupo
Bruce Baron
Gary Barton
Tony Benites
Jennifer Bethel
David Bhakta
Dennis Bitters
Candido Borges
Roy Brown Jr.
Larry Buehner
Wendy Coddington
Hal Copp
Susan Creedon
Ron Day
Jim Devenport
Herb Dompe
John Ellsworth
Charlie Evans
Robert Fores
Paula Frago
Arlene Francis
Richard Gilton
Richard Gonzales
Anthony Guida
Dick Hagerty
Stephen Haycock
John Hooper
Don Hoy
Bob Hoyt
Gary Huff
Marge Imfeld
Trevor Irish
Mike Kline
Brad Klump
Steven Knudsen
Daniel Lee
Gary Linhares
Chaitanya Mahida
Tim Martin
David Martini
Maggie Mejia
Adan Mendoza
Jeff Mika
Carol Ornelas
Robert Ott
Ray Perez
Scott Piercy
Joel Pluim
Marc Robinson
Frank Rocha
Kathy Rocha
David Rogers
Mike Ruddy Sr.
Jeff Sceville
Jodi Sceville
Ward Schemper
Rick Schiltz
Collin Schut
Dave Silva
Tom Spadini
Bob Spengler
Jim Stevens
Bob Summers
Niniv Tamimi
Robbie Tani
Bruce Thompson
Phil Tilbury
Willie Traina
Tom Vermeulen
Arlon Waterson
Tirzah Woodward
InDepenDent AuDItoRS
Moss-Adams LLP
3121 West March Lane,
Suite 100
Stockton, CA 95219-2303
legAl CounSel
Matteo G. Daste
Squire Sanders
275 Battery Street, 26th
Floor
San Francisco, CA 94111
CoRRe SponDent B Ank
Union Bank, N.A.
400 California Street
San Francisco, CA 94104
Pacific Coast Bankers’ Bank
340 Pine Street, Suite 401
San Francisco, CA 94104
tRAnSfeR Agent
AnD RegIStRAR
Computershare
250 Royall Street
Canton, MA 02021
(800) 962-4284
MARket MAkeRS
John Cavender
Raymond James &
Associates
(415) 616-8935
Joey Warmenhoven
McAdams Wright Ragen
(503) 922-4888
DIReCtoRS
offICeRS
Ronald C. Martin
Chief Executive Officer
Christopher M. Courtney
President
Rick McCarty
Executive Vice President
Chief Administration Officer
Chief Financial Officer
Corporate Secretary
Wendy Burth
Executive Vice President
Retail Banking Group
Dave Harvey
Executive Vice President
Commercial Banking Group
Mike Rodrigues
Executive Vice President
Chief Credit Officer
Cathy Ghan
Senior Vice President
Commercial Real Estate
Janis Powers
Senior Vice President
Risk Management Officer
Russell Stahl
Senior Vice President
Information Technology
Gary Stephens
Senior Vice President
Credit Administrator
James L. Gilbert
Chairman of the Board
Chairman Nominating
Committee
Feed and Seed Business
Thomas A. Haidlen
Vice Chairman of the Board
Automobile Dealer
Donald L. Barton
Chairman Loan Committee
Agribusinessman
Christopher M. Courtney
President
Oak Valley
Community Bank
Michael Q. Jones
General Contracting, Land
Development and General
Real Estate
Daniel J. Leonard
Chairman Investment
Committee
Winery Executive
Ronald C. Martin
Chief Executive Officer
Oak Valley
Community Bank
Roger M. Schrimp
Chairman Audit Committee
Chairman Compensation
Committee
Attorney and Cattle
Rancher
Danny L. Titus
Chairman CRA Committee
Real Estate and
Investments
Richard J. Vaughan
Agribusinessman
DIRe CtoRS eMeRItuS
Barry M. Jett
Real Estate Investor
In Memoriam:
Romain J. Schonhoff
CPA and Farmer
Arne J. Knudsen
Wholesale Nurseryman
D e e p R o o t s ~ S t r o n g B r a n c h e s
eastern sierra
COmmunity Bank
BRIDgepoR t
166 Main Street
Bridgeport, CA 93517
(760) 932-7926
MAMMotH lAke S
307 Old Mammoth Road
Mammoth Lakes, CA 93546
(760) 924-0990
BISHop
351 North Main Street
Bishop, CA 93514
(760) 874-BANK (2265)
www.escbank.com
atm Only lOC atiOns:
Crowley Lake General Store
Crowley Lake, CA
Bishop Creek Lodge
Bishop, CA
United States Marine Corps
Marine Housing Exchange
Coleville, CA
United States Marine Corps
Mountain Warfare
Training Center
Bridgeport, CA
Inyo Shell
Bishop, CA
Pearsonville Shell
Pearsonville, CA
Mammoth Shell
Mammoth Lakes, CA
B r a nCh e s
Oak Valley
COmmunity Bank
oAkDAle
125 North Third Avenue
Oakdale, CA 95361
(209) 848-BANK (2265)
SonoRA
14580 Mono Way
Sonora, CA 95370
(209) 532-7100
MoDe Sto-12tH & I
1200 I Street
Modesto, CA 95354
(209) 549-BANK (2265)
MoDe Sto-D Ale
4120 B Dale Road
Modesto, CA 95356
(209) 758-8000
MoDe Sto-MCHenR y
3508 McHenry Avenue
Modesto, CA 95356
(209) 579-3360
tuRloCk
2001 Geer Road
Turlock, CA 95382
(209) 633-2850
StoCkton
2935 West March Lane
Stockton, CA 95219
(209) 320-7850
pAtteRSon
20 Plaza
Patterson, CA 95363
(209) 892-5757
RIpon
150 North Wilma Avenue
Ripon, CA 95366
(209) 599-9430
eSCAlon
1910 McHenry Avenue
Escalon, CA 95320
(209) 821-3070
MAnte CA
191 W. North Street
Manteca, CA 95336
(209) 249-7360
www.ovcb.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2012
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
OAK VALLEY BANCORP
(Exact name of registrant as specified in its charter)
California
(State or other jurisdiction
of incorporation or organization)
125 North Third Avenue
Oakdale, California
(Address of principal executive offices)
26-2326676
(I.R.S. Employer
Identification No.)
95361
(Zip Code)
(209) 848-2265
(Registrant’s telephone number including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Stock
Name of each exchange on which registered
The NASDAQ Stock Market, LLC
Securities registered pursuant to Section 12(g) of the Act:
None
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange
Act.
Yes
No
No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter during the preceding 12 months (or for
such shorter period that the registrant was required to submit and post such files). Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.
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
Smaller reporting company
Accelerated filer
Non-accelerated filer
(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
No
As of December 31, 2012, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant, based upon
the closing price per share of the registrant’s common stock as reported by the NASDAQ, was approximately $50 million. As of March 19, 2013,
there were 7,914,730 shares of common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement for the Annual Meeting of Shareholders to be held on June 4, 2013 are incorporated by reference into
Part III.
TABLE OF CONTENTS
BUSINESS
RISK FACTORS
UNRESOLVED STAFF COMMENTS
PROPERTIES
LEGAL PROCEEDINGS
MINE SAFETY DISCLOSURES
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
SELECTED FINANCIAL DATA
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
CONTROLS AND PROCEDURES
OTHER INFORMATION
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
EXECUTIVE COMPENSATION
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
PRINCIPAL ACCOUNTANT FEES AND SERVICES
EXHIBITS AND FINANCIAL STATEMENTS
PART I
ITEM 1 -
ITEM 1A -
ITEM 1B -
ITEM 2 -
ITEM 3 -
ITEM 4 -
PART II
ITEM 5 -
ITEM 6 -
ITEM 7-
ITEM 7A -
ITEM 8 -
ITEM 9 -
ITEM 9A -
ITEM 9B-
PART III
ITEM 10 -
ITEM 11 -
ITEM 12 -
ITEM 13 -
ITEM 14 -
PART IV
ITEM 15 -
SIGNATURES
EXHIBIT INDEX
3
16
16
17
17
17
18
19
19
50
50
50
50
51
52
52
52
52
52
53
54
2
ITEM 1. BUSINESS OF OAK VALLEY BANCORP
Overview of the Business
PART I
Oak Valley Bancorp. Oak Valley Bancorp (the “Company”) was incorporated on April 1, 2008 in California for the purpose of
becoming Oak Valley Community Bank’s parent bank holding company. Effective July 3, 2008, Oak Valley Bancorp acquired all of
the outstanding capital stock of Oak Valley Community Bank (the “Bank”) (from time to time, the Bank and the Company may be
generally referred to as “we”, “us” or “our”). The principal office of Oak Valley Bancorp is located at 125 North Third Avenue,
Oakdale, California 95361 and its principal telephone is (209) 848-2265.
The Company is authorized to issue 50,000,000 shares of common stock, without par value, of which 7,907,780 are issued and
outstanding at December 31, 2012, and 10,000,000 shares of preferred stock, without par value, of which 6,750 Series B preferred
stock shares are issued and outstanding.
The Company is the holding company of the Bank, and its only asset is the outstanding capital stock of the Bank, which the
Company wholly owns.
Oak Valley Community Bank. The Bank commenced operations in May 1991. The Bank is an insured bank under the Federal
Deposit Insurance Act and is a member of the Federal Reserve. The Bank is subject to regulation, supervision and regular
examination by the California Department of Financial Institutions (DFI), the Federal Deposit Insurance Commission (FDIC) and the
Federal Reserve Board (FRB). Since its formation, the Bank has provided basic banking services to individuals and business
enterprises in Oakdale, California and the surrounding areas. The focus of the Bank is to offer a range of commercial banking services
designed for both individuals and small to medium-sized businesses in the two main areas of service of the Bank: the Central Valley
and the Eastern Sierras.
The Bank offers a complement of business checking and savings accounts for its business customers. The Bank also offers
commercial and real estate loans, as well as lines of credit. Real estate loans are generally of a short-term nature for both residential
and commercial lending purposes. Longer-term real estate loans are generally made with adjustable interest rates and contain
customary provisions for acceleration. Traditional residential mortgages are available to Bank customers through a third party.
The Bank offers other services for both individuals and businesses including online banking, remote deposit capture, mobile
banking, merchant services, night depository, extended hours, wire transfer of funds, note collection, and automated teller machines in
a national network. The Bank does not currently offer international banking or trust services although the Bank may make such
services available to the Bank’s customers through financial institutions with which the Bank has correspondent banking
relationships. The Bank does not offer stock transfer services nor does it directly issue credit cards.
Expansion
Branch Expansion. Over the past few years, our network of branches and loan production offices have been expanded
geographically. As of December 31, 2012, we maintained fourteen full-service branch offices (in addition to our corporate
headquarters). Beginning in October 1995, we started our geographic expansion outside of Oakdale, by opening a Loan Production
Office in Sonora, California. We subsequently opened a branch in Sonora and two branches in Modesto. In September 2000, we
expanded into the Eastern Sierra, opening a branch in Bridgeport, California under the name Eastern Sierra Community Bank. Since
that time we have added branches in Mammoth Lakes and Bishop. During 2005 and 2006, we aggressively increased our presence in
the Central Valley, by opening branches in Turlock, Stockton, Patterson, Ripon and Escalon. In March 2007, our corporate
headquarters expanded by adding an adjacent historical building located in downtown Oakdale to its complex. In 2011, we opened a
third branch in Modesto and a branch in Manteca. We intend to continue our growth strategy in future years through the opening of
additional branches and loan production offices as our needs and resources permit.
Bank Holding Company Reorganization. Effective July 3, 2008, we entered into a bank holding company reorganization,
whereby each outstanding share of common stock of the Bank was exchanged into a share of common stock of the Company.
Operating our banking business within a holding company structure provides, among other things, greater operating flexibility;
facilitates the potential acquisition of related businesses as opportunities may arise from time to time; improves our ability to diversify
as needed; enhances our ability to remain competitive in the future with other companies in the financial services industry that are
organized in a holding company structure; and improves our ability to raise capital to support growth.
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Business Segments
The Bank operates in two primary business segments: Retail Banking and Commercial Banking, as described in additional detail
below. These segments do not meet the quantitative thresholds for reporting as separate segments and are therefore considered one
segment for financial reporting purposes:
Retail Banking. We offer a range of checking and savings accounts, including NOW accounts, money market accounts,
overdraft protection, health savings accounts, certificates of deposit, and Individual Retirement Accounts (“IRA”). To satisfy the
lending needs of individuals in its service area, we offer real estate and home equity financing, as well as consumer, automobile, and
home improvement loans.
Commercial Banking. We offer a range of deposit and lending services to business customers. More specifically, we offer a
variety of commercial loans for virtually any business, professional, or agricultural need. These include loans for short-term working
capital, operating lines of credit, equipment purchases, leasehold improvements, construction, commercial real estate acquisitions or
refinancing. Currently, virtually all of our business relationships are with customers located in the San Joaquin, Stanislaus, Tuolumne,
Inyo and Mono Counties, of California.
Primary Market Area
We conduct business from our main office in Oakdale, a city of approximately 20,900 residents located in Stanislaus County,
California. Oakdale is approximately 15 miles from Modesto and sits at the foothills of the Sierra Nevada Mountains, at the edge of
the California Central Valley agricultural area. Through our branches, we serve customers in the Central Valley, from Fresno to
Sacramento, and in foothill locations. We also reach into the Highway 395 corridor in the Eastern Sierras and in the towns of Bishop,
Mammoth and Bridgeport. Approximately 93% of our loans and 89% of our deposits are generated from the Central Valley. The
Central Valley area includes Stanislaus, San Joaquin and Tuolumne counties and has a total population of over 3 million.
Lending Activities
General. Our loan policies set forth the basic guidelines and procedures by which we conduct our lending operations. These
policies address the types of loans available, underwriting and collateral requirements, loan terms, interest rate and yield
considerations, compliance with laws and regulations and our internal lending limits. Our Board of Directors reviews and approves
our loan policies on an annual basis. We supplement our own supervision of the loan underwriting and approval process with periodic
loan audits by experienced external loan specialists who review credit quality, loan documentation and compliance with laws and
regulations. We engage in a full complement of lending activities, including:
• commercial real estate loans,
• commercial business lending and trade finance,
• Small Business Administration lending, and
• consumer loans, including automobile loans, home mortgages, credit lines and other personal loans.
As part of our efforts to achieve long-term stable profitability and respond to a changing economic environment in the California
Central Valley, we constantly evaluate a variety of options to augment our traditional focus by broadening the services and products
we provide. Possible avenues of growth include more branch locations, expanded days and hours of operation and new types of
lending.
Loan Procedures. Loan applications may be approved by the Director Loan Committee of our Board of Directors, or by our
management or lending officers, to the extent of their loan authority. Our Board of Directors authorizes our lending limits. Our
President and Chief Credit Officer are responsible for evaluating the authority limits for individual credit officers and recommending
lending limits for all other officers to the board of directors for approval.
We grant individual lending authority to our Chief Executive Officer, President, Chief Credit Officer, Credit Administrator and
to some department managers and loan officers. Our highest management lending authority is combined administrative lending
authority for unsecured and secured lending of $2,500,000, which requires the approval of our Chief Executive Officer, President, and
either our Chief Credit Officer or our Credit Administrator. Loans for which direct and indirect borrower liability exceeds combined
administrative lending authority or 75% of the banks legal unsecured and secured lending limits are referred to our Board of Directors
Loan Committee.
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At December 31, 2012, the Bank’s authorized legal lending limits were $11.2 million for unsecured loans plus an additional
$7.5 million for specific secured loans. Legal lending limits are calculated in conformance with California law, which prohibits a bank
from lending to any one individual or entity or its related interests an aggregate amount which exceeds 15% of primary capital plus the
allowance for loan losses on an unsecured basis, plus an additional 10% on a secured basis. The Bank’s primary capital plus allowance
for loan losses at December 31, 2012 totaled $74.7 million.
We seek to mitigate the risks inherent in our loan portfolio by adhering to certain underwriting practices. The review of each loan
application includes analysis of the applicant’s prior credit history, income level, cash flow and financial condition, tax returns, cash
flow projections, and the value of any collateral to secure the loan, based upon reports of independent appraisers and audits of
accounts receivable or inventory pledged as security. In the case of real estate loans over a specified amount, the review of collateral
value includes an appraisal report prepared by an independent, Bank-approved, appraiser.
Real Estate Loans. We offer commercial real estate loans to finance the acquisition of new or the refinancing of existing
commercial properties, such as office buildings, industrial buildings, warehouses, hotels, shopping centers, automotive industry
facilities and multiple dwellings. At December 31, 2012, real estate loans constituted 87% of our loan portfolio, of which 92% were
commercial loans.
Commercial real estate loans typically have 10-year maturities with up to 25-year amortization of principal and interest and
loan-to-value ratios of not more than 75% of the appraised value or purchase price, whichever is lower. We usually impose a
prepayment penalty during the period within 3 to 5 years of the date of the loan.
Construction loans are comprised of loans on commercial, residential and income producing properties that generally have terms
of 1 year, with options to extend for additional periods to complete construction and to accommodate the lease-up period. We usually
require 15% equity capital investment by the developer and loan to value ratios of not more than 75% of anticipated completion value.
Miniperm loans finance the purchase and/or ownership of commercial properties, including owner-occupied and income
producing properties. We also offer miniperm loans as take-out financing with our construction loans. Miniperm loans are generally
made with an amortization schedule ranging from 20 to 25 years, with a lump sum balloon payment due in 3 to 5 years.
Equity lines of credit are revolving lines of credit collateralized by junior deeds of trust on residential real properties. They
generally bear a rate of interest that floats with our base rate or the prime rate, and have maturities of 10 years.
We purchase participation interests in loans made by other financial institutions from time to time. These loans are subject to the
same underwriting criteria and approval process as loans made directly by us.
Our real estate loans are typically collateralized by first or junior deeds of trust on specific commercial properties and equity
lines of credit, and are subject to corporate or individual guarantees from financially capable parties, as available. The properties
collateralizing real estate loans are principally located in our primary market areas of the California Central Valley and the Eastern
Sierra. Real estate loans typically bear an interest rate that floats with our base rate, prime rate or another established index.
Our real estate portfolio is subject to certain risks, including (i) downturns in the California economy, (ii) interest rate increases,
(iii) reduction in real estate values in the California Central Valley, (iv) increased competition in pricing and loan structure, and
(v) environmental risks, including natural disasters. As a result of the high concentration of the real estate loan in our loan portfolio,
the current difficulties in the real estate markets could cause significant increases in nonperforming loans, which would reduce our
profits. A decline in real estate values could cause some of our mortgage loans to become inadequately collateralized, which would
expose us to a greater risk of loss. Additionally, a decline in real estate values could adversely affect our portfolio of commercial real
estate loans and could result in a decline in the origination of such loans. However, we strive to reduce the exposure to such risks and
seek to continue to maintain high quality in our real estate loans by (a) reviewing each loan request and each loan renewal
individually, (b) using a dual signature approval system for the approval of each loan request for loans over a certain dollar amount,
(c) adhering to written loan policies, including, among other factors, minimum collateral requirements, maximum loan-to-value ratio
requirements, cash flow requirements and personal guarantees, (d) performing secondary appraisals from time to time, (e) conducting
external independent credit review, and (f) conducting environmental reviews, where appropriate. We review each loan request on the
basis of our ability to recover both principal and interest in view of the inherent risks. We monitor and stress test our entire portfolio,
evaluating debt coverage ratios and loan-to-value ratios, on a quarterly basis. We monitor trends and evaluate exposure derived from
simulated stressed market conditions. The portfolio is stratified by owner classification (either owner occupied or non-owner
occupied), product type, geography and size.
As of December 31, 2012, the aggregate loan-to-value of the entire commercial real estate portfolio was 52.4%. Historical data
suggests that the Company continues to maintain strong LTV, which has served as a cushion against precipitous reductions in real
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estate values. Non-owner occupied real estate comprises 47.9% of the Company’s total commitments, as of December 31, 2012. The
loan-to-value on the non-owner occupied segment was 47.5%, as of December 31, 2012. The highest concentration by product type is
office buildings, which comprised 29.6% of total CRE loan commitments outstanding, as of December 31, 2012.
Our portfolio diversity in terms of both product types and geographic distribution, combined with strong debt coverage ratios, a
low aggregate loan-to-value and a high percentage of owner-occupied properties, significantly mitigate the risks associated with
excessive commercial real estate concentration. These elements contribute strength to our overall real estate portfolio despite the
current weakness in the real estate market.
Commercial Business Lending. We offer commercial loans to sole proprietorships, partnerships and corporations, with an
emphasis on the real estate related industry. These commercial loans include business lines of credit and commercial term loans to
finance operations, to provide working capital or for specific purposes, such as to finance the purchase of assets, equipment or
inventory. Since a borrower’s cash flow from operations is generally the primary source of repayment, our policies provide specific
guidelines regarding required debt coverage and other important financial ratios.
Lines of credit are extended to businesses or individuals based on the financial strength and integrity of the borrower and are
secured primarily by real estate, accounts receivable and inventory, and have a maturity of one year or less. Such lines of credit bear
an interest rate that floats with our base rate, the prime rate, LIBOR or another established index.
Commercial term loans are typically made to finance the acquisition of fixed assets, refinance short-term debts or to finance the
purchase of businesses. Commercial term loans generally have terms from one to five years. They may be collateralized by the asset
being acquired or other available assets and bear interest rates, which either floats with the Company’s base rate, prime rate, LIBOR or
another established index or is fixed for the term of the loan.
We also provide other banking services tailored to the small business market. We have focused recently on diversifying our loan
portfolio, which has led to an increase in commercial real estate and commercial business loans to small and medium sized businesses.
Our portfolio of commercial loans is also subject to certain risks, including (i) downturns in the California economy, (ii) interest
rate increases; and (iii) the deterioration of a borrower’s or guarantor’s financial capabilities. We attempt to reduce the exposure to
such risks through (a) reviewing each loan request and renewal individually, (b) requiring a dual signature approval system, (c)
mandating strict adherence to written loan policies, and (d) performing external independent credit review. In addition, we monitor
loans based on short-term asset values on a monthly or quarterly basis. In general, during the term of the relationship, we receive and
review the financial statements of our borrowing customers on an ongoing basis, and we promptly respond to any deterioration that we
note.
Small Business Administration Lending Services. Small Business Administration, or SBA, lending, forms an important part of
our business. Our SBA lending service places an emphasis on minority-owned businesses. Our SBA market area includes the
geographic areas encompassed by our full-service banking offices in the California Central Valley and in the Eastern Sierra. Our SBA
Loan Department has attained “Preferred Lender” status, which permits us to approve SBA guaranteed loans directly. As an SBA
Preferred Lender, we provide quicker and more efficient service to our clientele, enabling them to obtain SBA loans in order to
acquire new businesses, expand existing businesses, and acquire locations in which to do business, without having to go through the
time consuming SBA approval process.
Although our participation in the SBA program is subject to the legislative power of Congress and the continued maintenance of
our approved status by the SBA, we have no reason to believe that this program (and our participation therein) will not continue,
particularly in view of the lengthy duration of the SBA program nationally.
Consumer Loans. Consumer loans include personal loans, auto loans, home improvement loans, home mortgage loans,
revolving lines of credit and other loans typically made by banks to individual borrowers. We provide consumer loan products in an
effort to diversify our product line.
Our consumer loan portfolio is subject to certain risks, including:
• amount of credit offered to consumers in the market,
• interest rate increases, and
• consumer bankruptcy laws which allow consumers to discharge certain debts.
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We attempt to reduce the exposure to such risks through the direct approval of all consumer loans by:
• reviewing each loan request and renewal individually,
• using a dual signature system of approval,
• strictly adhering to written credit policies and,
• performing external independent credit review.
Deposit Activities and Other Sources of Funds
Our primary sources of funds are deposits and loan repayments. Scheduled loan repayments are a relatively stable source of
funds, whereas deposit inflows, outflows and unscheduled loan prepayments (which are influenced significantly by general interest
rate levels, interest rates available on other investments, competition, economic conditions and other factors) are not as stable.
Customer deposits also remain a primary source of funds, but these balances may be influenced by adverse market changes in the
industry. We may resort to other borrowings, on an as needed basis, as follows:
• on a short-term basis to compensate for reductions in deposit inflows at less than projected levels, and
• on a longer-term basis to support expanded lending activities and to match the maturity of repricing intervals of assets.
We offer a variety of accounts for depositors, which are designed to attract both short-term and long-term deposits. These
accounts include certificates of deposit, or “CDs”, regular savings accounts, money market accounts, checking and negotiable order of
withdrawal, or “NOW”, accounts, savings accounts, health savings accounts and individual retirement accounts, or “IRAs”. These
accounts generally earn interest at rates established by management based on competitive market factors and management’s desire to
increase or decrease certain types or maturities of deposits. As needs arise, we augment these customer deposits with brokered
deposits. The more significant deposit accounts offered by us are described below:
Certificates of Deposit. We offer several types of CDs with a maximum maturity of five years. The substantial majority of our
CDs have a maturity of one to twelve months and pay compounded interest typically credited monthly or at maturity.
Regular Savings Accounts. We offer savings accounts that allow for unlimited ATM and in-branch deposits and withdrawals.
Interest is compounded daily and paid monthly.
Money Market Account. Money market accounts pay a variable interest rate that is tiered depending on the balance maintained
in the account. Minimum opening balances vary. Interest is compounded daily and paid monthly.
Checking and NOW Accounts. Checking and NOW accounts are generally non-interest and interest bearing accounts,
respectively, and may include service fees based on activity and balances. NOW accounts pay interest, but require a higher minimum
balance to avoid service charges.
Federal Home Loan Bank Borrowings. To supplement our deposits as a source of funds for lending or investment, we borrow
funds in the form of advances from the Federal Home Loan Bank. We regularly make use of Federal Home Loan Bank advances as
part of our interest rate risk management, primarily to extend the duration of funding to match the longer term fixed rate loans held in
the loan portfolio as part of our growth strategy.
As a member of the Federal Home Loan Bank system, we are required to invest in Federal Home Loan Bank stock based on a
predetermined formula. Federal Home Loan Bank stock is a restricted investment security that can only be sold to other Federal Home
Loan Bank members or redeemed by the Federal Home Loan Bank. As of December 31, 2012, we owned $2,371,600 in FHLB stock.
Advances from the Federal Home Loan Bank are typically secured by our entire real estate loan portfolio, which includes
residential and commercial loans. At December 31, 2012, our borrowing limit with the Federal Home Loan Bank was approximately
$163 million.
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Internet Banking
Since August 1, 2001, we have offered Internet banking service, which allows our customers to access their deposit accounts
through the Internet. Customers are able to obtain transaction history and account information, transfer funds between accounts and
make on-line bill payments. We intend to improve and develop our Internet banking products and delivery channels as the need arises
and our resources permit.
Other Services
We also offer ATMs located at branch offices as well as seven other ATMs at various off site locations, and customer access to
an ATM network.
Marketing
Our marketing relies principally upon local advertising and promotional activity and upon personal contacts by our directors,
officers and shareholders to attract business and to acquaint potential customers with our personalized services. We emphasize a high
degree of personalized client service in order to be able to provide for each customer’s banking needs. Our marketing approach
emphasizes the advantages of dealing with an independent, locally managed and state chartered bank to meet the particular needs of
consumers, professionals and business customers in the community. Our management continually evaluates all of our banking services
with regard to their profitability and efforts and makes determinations based on these evaluations whether to continue or modify our
business plan, where appropriate.
We do not currently have any plans to develop any new lines of business, which would require a material amount of capital
investment on our part.
Competition
Regional Branch Competition. We consider our primary service area to be composed of the counties of San Joaquin,
Stanislaus, Tuolumne, Inyo and Mono Counties, of California. The banking business in California generally, and in our primary
service area, specifically, is competitive with respect to both loans and deposits and is dominated by a relatively small number of
major banks which have many offices operating over wide geographic areas. These include Wells Fargo Bank, Bank of America, JP
Morgan Chase Bank and Bank of the West. We compete for deposits and loans principally with these banks, as well as with savings
and loan associations, thrift and loan associations, credit unions, mortgage companies, insurance companies, offerors of money market
accounts and other lending institutions.
Among the advantages of these institutions are their ability to finance extensive advertising campaigns and to allocate their
investment assets to regions of highest yield and demand, their ability to offer certain services, such as international banking and trust
services which are not offered directly by the Company and, the ability by virtue of their greater total capitalization, to have
substantially higher lending limits than we do. In addition, as a result of increased consolidation and the passage of interstate banking
legislation there is and will continue to be increased competition among banks, savings and loan associations and credit unions for the
deposit and loan business of individuals and businesses.
As of June 30, 2012, our primary service areas contained one hundred seventy-four (174) banking offices, with approximately
$11.0 billion in total deposits. As of June 30, 2012, we had total deposits of approximately $526 million, which represented
approximately 4.8% of the total deposits in the Bank’s primary service area. There can be no assurance that the Bank will maintain its
competitive position against current and potential competitors, especially those with greater resources than the Bank. The deposits of
the four (4) largest competing banks averaged approximately $101 million per office as of June 30, 2012.
In order to compete with major financial institutions in our primary service areas, we use to the fullest extent the flexibility that
our independent status permits. This includes an emphasis on specialized services, local promotional activity, and personal contacts
by our officers, directors and employees. In the event that there are customers whose needs exceed our lending limits, we may arrange
for such loans on a participation basis with other financial institutions. We also assist customers who require other services that we do
not offer by obtaining such services from correspondent banks. However, no assurance can be given that our continued efforts to
compete with other financial institutions will be successful.
In addition to other banks, our competitors include savings institutions, credit unions, and numerous non-banking institutions,
such as finance companies, leasing companies, insurance companies, brokerage firms, and investment banking firms. In recent years,
increased competition has also developed from specialized finance and non-finance companies that offer money market and mutual
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funds, wholesale finance, credit card, and other consumer finance services, including on-line banking services and personal finance
software. Strong competition for deposit and loan products affects the rates of those products as well as the terms on which they are
offered to customers.
Other Competitive Factors. The more general competitive trends in the industry include increased consolidation and
competition. Strong competitors, other than financial institutions, have entered banking markets with focused products targeted at
highly profitable customer segments. Many of these competitors are able to compete across geographic boundaries and provide
customers increasing access to meaningful alternatives to banking services in nearly all significant products areas. Mergers between
financial institutions have placed additional pressure on banks within the industry to streamline their operations, reduce expenses, and
increase revenues to remain competitive. Competition has also intensified due to the federal and state interstate banking laws, which
permit banking organizations to expand geographically, and the California market has been particularly attractive to out-of-state
institutions. The Financial Modernization Act, which has made it possible for full affiliations to occur between banks and securities
firms, insurance companies, and other financial companies, is also expected to intensify competitive conditions.
Technological innovations have also resulted in increased competition in the financial services industry. Such innovations have,
for example, made it possible for non-depository institutions to offer customers automated transfer payment services that were
previously considered traditional banking products. In addition, many customers now expect a choice of several delivery systems and
channels, including telephone, mail, home computer, ATMs, self-service branches and/or in-store branches.
Business Concentration. No individual or single group of related accounts is considered material in relation to our total assets
or deposits, or in relation to our overall business. However, approximately 87% of our loan portfolio held for investment at
December 31, 2012 consisted of real estate-related loans, including construction loans, miniperm loans, real estate mortgage loans and
commercial loans secured by real estate. Moreover, our business activities are currently focused primarily in Central California, with
the majority of our business concentrated in San Joaquin, Stanislaus, Tuolumne, Inyo and Mono Counties. Consequently, our results
of operations and financial condition are dependent upon the general trends in the Central California economies and, in particular, the
residential and commercial real estate markets. In addition, the concentration of our operations in Central California exposes us to
greater risk than other banking companies with a wider geographic base in the event of catastrophes, such as earthquakes, fires and
floods in this region.
Employees
As of December 31, 2012, we had 139 employees (111 full-time employees and 28 part-time employees). None of our employees
are currently represented by a union or covered by a collective bargaining agreement.
Bank Holding Company Regulation
Upon effectiveness of the bank holding company reorganization on July 2, 2008, we became subject to regulation under the Bank
Holding Company Act of 1956, as amended (“BHCA”) which subjects Oak Valley Bancorp to Federal Reserve Board reporting and
examination requirements. Under the Federal Reserve Board’s regulations, a bank holding company is required to serve as a source of
financial and managerial strength to its subsidiary banks.
The BHCA regulates the activities of holding companies including acquisitions, mergers, and consolidations and, together with
the Gramm-Leach Bliley Act of 1999, the scope of allowable banking activities.
Bank Regulation
The banking and financial services business in which we engage is highly regulated. Such regulation is intended, among other
things, to protect depositors insured by the FDIC and the entire banking system. These regulations affect our lending practices,
consumer protections, capital structure, investment practices and dividend policy.
As a state chartered bank, we are subject to regulation and examination by the DFI, We are also subject to regulation, supervision
and periodic examination by the FDIC. If, as a result of an examination of the Bank, the FDIC or the DFI should determine that the
financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of our operations are
unsatisfactory, or that we have violated any law or regulation, various remedies are available to those regulators including issuing a
consent order, restricting our growth or removing officers and directors.
The commercial banking business is also influenced by the monetary and fiscal policies of the federal government and the
policies of the Board of Governors of the Federal Reserve System, also known as the FRB. As a member of the Federal Reserve
System, we are subject to certain regulations of the Board of Governors of the Federal Reserve System. The regulations of these
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agencies govern most aspects of our business, including the filing of periodic reports, and activities relating to dividends, investments,
loans, borrowings, capital requirements, certain check-clearing activities, branching, mergers and acquisitions, reserves against
deposits, and numerous other areas. Supervision, legal action and examination of us by the FRB is generally intended to protect
depositors and is not intended for the protection of our shareholders. The Federal Reserve Board implements national monetary
policies (with objectives such as curbing inflation and combating recession) by its open-market operations in United States
Government securities, by adjusting the required level of reserves for financial intermediaries subject to its reserve requirements and
by varying the discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve Board in these
areas influence the growth of bank loans, investments and deposits and affects interest rates charged on loans and paid on deposits.
Indirectly such actions may also impact the ability of non-bank financial institutions to compete with us. The nature and impact of any
future changes in monetary policies cannot be predicted.
The laws, regulations and policies affecting financial services businesses are continuously under review by Congress and state
legislatures and federal and state regulatory agencies. From time to time, legislation is enacted which has the effect of increasing the
cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other
financial intermediaries. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding
companies and other financial intermediaries are frequently made in Congress, in the California legislature and by various bank
regulatory agencies and other professional agencies. Changes in the laws, regulations or policies that impact us cannot necessarily be
predicted, but they may have a material effect on our business and earnings.
The following discussion summarizes certain significant laws, rules and regulations affecting both the Company and the Bank.
The Bank addresses the many state and federal regulations it is subject to through a comprehensive compliance program that addresses
the various risks associated with these issues. The following discussion is not meant to cover all applicable rules and regulations and it
is qualified in its entirety by reference to such laws, rules and regulations which may change from time to time.
Capital Adequacy Requirements
The federal banking agencies have adopted risk-based minimum capital guidelines intended to provide a measure of capital that
reflects the degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as
assets and transactions which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and
credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from
0% for assets with low credit risk, such as federal banking agencies, to 100% for assets with relatively high credit risk. The higher the
category, the more risk a bank is subject to and thus the more capital that is required.
The guidelines divide a bank’s capital into two tiers. Tier I includes common equity, retained earnings, certain non-cumulative
perpetual preferred stock, and minority interests in equity accounts of consolidated subsidiaries. Goodwill and other intangible assets
(except for mortgage servicing rights and purchased credit card relationships, subject to certain limitations) are subtracted from Tier I
capital. Tier II capital includes, among other items, cumulative perpetual and long-term, limited-life preferred stock, mandatory
convertible securities, certain hybrid capital instruments, term subordinated debt and the allowance for loan losses (subject to certain
limitations). Certain items are required to be deducted from Tier II capital. Banks must maintain a total risk-based ratio of 8%, of
which at least 4% must be Tier I capital. As of December 31, 2012 and 2011, the Bank’s Total Risk-Based Capital Ratio was 16.0%
and 16.2%, and our Tier 1 Risk-Based Capital Ratio was 14.8% and 14.9%, respectively.
In addition to the risk-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount
of Tier 1 capital to total average assets, referred to as the leverage ratio. Banks that have received the highest rating of the five
categories used by regulators to rate banks and are not anticipating or experiencing any significant growth must maintain a ratio of
Tier 1 capital (net of all intangibles) to adjusted total assets, or “Leverage Capital Ratio”, of at least 3%. All other institutions are
required to maintain a leverage ratio of at least 100 to 200 basis points above the 3% minimum, for a minimum of 4% to 5%. Pursuant
to federal regulations, banks must maintain capital levels commensurate with the level of risk to which they are exposed, including the
volume and severity of problem loans. As of December 31, 2012 and 2011, the Bank’s Leverage Capital Ratios were 10.3% and
11.4%, respectively.
Federal banking regulators may set capital requirements higher than the minimums described above for financial institutions
whose circumstances warrant it. For example, a financial institution experiencing or anticipating significant growth may be expected
to maintain capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets.
10
Prompt Corrective Action Provisions
Federal law requires each federal banking agency to take prompt corrective action to resolve the problems of insured financial
institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. The federal banking
agencies have by regulation defined the following five capital categories:
• “well capitalized” (Total Risk-Based Capital Ratio of 10%; Tier 1 Risk-Based Capital Ratio of 6%; and Leverage Ratio of 5%),
• “adequately capitalized” (Total Risk-Based Capital Ratio of 8%; Tier 1 Risk-Based Capital Ratio of 4%; and Leverage Ratio of
4% or 3% if the institution receives the highest rating from its primary regulator),
• “undercapitalized” (Total Risk-Based Capital Ratio of less than 8%; Tier 1 Risk-Based Capital Ratio of less than 4%; or
Leverage Ratio of less than 4% or 3% if the institution receives the highest rating from its primary regulator),
• “significantly undercapitalized” (Total Risk-Based Capital Ratio of less than 6%; Tier 1 Risk-Based Capital Ratio of less than
3%; or Leverage Ratio less than 3%), and
• “critically undercapitalized” (tangible equity to total assets less than 2%).
The Bank is well capitalized.
A bank may be treated as though it were in the next lower capital category if, after notice and the opportunity for a hearing, the
appropriate federal agency finds an unsafe or unsound condition or practice so warrants, but no bank may be treated as “critically
undercapitalized” unless its actual capital ratio warrants such treatment.
At each successively lower capital category, an insured bank is subject to increased restrictions on its operations. For example, a
bank is generally prohibited from paying management fees to any controlling persons or from making capital distributions, if to do so
would make the Bank “undercapitalized.” Asset growth and branching restrictions apply to undercapitalized banks, which are required
to submit written capital restoration plans meeting specified requirements (including a guarantee by the parent holding company, if
any). “Significantly undercapitalized” banks are subject to broad regulatory authority, including among other things, capital directives,
forced mergers, restrictions on the rates of interest they may pay on deposits, restrictions on asset growth and activities, and
prohibitions on paying certain bonuses without FRB approval. Even more severe restrictions apply to critically undercapitalized
banks. Most importantly, except under limited circumstances, the appropriate federal banking agency is required to appoint a
conservator or receiver for an insured bank not later than 90 days after the Bank becomes critically undercapitalized.
In addition to measures taken under the prompt corrective action provisions, insured banks may be subject to potential actions by
federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any
condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the issuance
of cease and desist orders, termination of insurance of deposits (in the case of a bank), the imposition of civil money penalties, the
issuance of directives to increase capital, formal and informal agreements, or removal and prohibition orders against “institution-
affiliated” parties.
Dividends
The payment of cash dividends by the Bank to Oak Valley Bancorp is subject to restrictions set forth in the California Financial
Code (the “Code”). Prior to any distribution from the Bank to Oak Valley Bancorp, a calculation is made to ensure compliance with
the provisions of the Code and to ensure that the Bank remains within capital guidelines set forth by the DFI and the FRB. In the event
that the intended distribution from the Bank to Oak Valley Bancorp exceeds the restriction in the Code, advance approval from FRB is
required. While advance approval may be required from the FRB for up to three years after we terminated our participation in the U.S.
Treasury Capital Purchase Program in 2011, management does not believe that these regulations will limit dividends from the Bank to
meet the operating requirements of Bancorp for the foreseeable future. See Note 20 to the Consolidated Financial Statements in Item 8
of this report. Management anticipates that there will be sufficient earnings at the Bank level to provide dividends to the Company to
meet its cash requirements for 2013.
11
Safety and Soundness Standards
Federal banking agencies have also adopted guidelines establishing safety and soundness standards for all insured depository
institutions. Those guidelines relate to internal controls, information systems, internal audit systems, loan underwriting and
documentation, compensation and interest rate exposure. In general, the standards are designed to assist the federal banking agencies
in identifying and addressing problems at insured depository institutions before capital becomes impaired. If an institution fails to
meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan and institute
enforcement proceedings, if an acceptable compliance plan is not submitted.
Deposit Insurance and FDIC Insurance Assessments
Our deposits are insured by the FDIC to the maximum amount permitted by law, which is currently $250,000 per depositor. The
2010 enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) made the deposit insurance
coverage permanent at the $250,000 level retroactive to January 1, 2008.
On February 7, 2011, as required by the Dodd-Frank Act, the FDIC approved a rule that changes the FDIC insurance assessment
base from adjusted domestic deposits to a bank’s average consolidated total assets minus average tangible equity, defined as Tier 1
capital. Since the new base is larger than the current base, the new rule lowers assessment rates to between 2.5 and 9 basis points on
the broader base for banks in the lowest risk category, and 30 to 45 basis points for banks in the highest risk category. The change was
effective beginning with the second quarter of 2011. Since we have a solid core deposit base and do not rely heavily on borrowings
and brokered deposits, the benefit of the lower assessment rate (which has dropped by approximately half for us) significantly
outweighed the effect of a wider assessment base.
The Dodd-Frank act also provided depositors at all FDIC-insured institutions with unlimited deposit insurance coverage on
traditional checking accounts that do not pay interest and Interest on Lawyers Trust Accounts beginning December 31, 2010 through
the end of 2012, when this provision expired.
During 2009 and 2010, we elected to participate in the Temporary Transaction Account Guarantee Program, which provided full
deposit insurance coverage to non-interest bearing transaction accounts (including low-interest negotiable order of withdrawal
accounts and interest on lawyer trust accounts), by paying a 10 basis point surcharge on the non-interest bearing transaction accounts
over $250,000 through December 31, 2009, and a 15 basis point surcharge through December 31, 2010, when the program ended.
On November 12, 2009, the FDIC finalized a Deposit Insurance Fund restoration plan that required banks to prepay, on
December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012.
Under the plan, banks were assessed through 2010 according to the risk-based premium schedule adopted in April 2009.
Community Reinvestment Act
We are subject to certain requirements and reporting obligations involving the Community Reinvestment Act, or “CRA”. The
CRA generally requires federal banking agencies to evaluate the record of financial institutions in meeting the credit needs of local
communities, including low and moderate-income neighborhoods. The CRA further requires that a record be kept of whether a
financial institution meets its community credit needs, which record will be taken into account when evaluating applications for,
among other things, domestic branches, consummating mergers or acquisitions, or holding company formations. In measuring a
bank’s compliance with its CRA obligations, the regulators now utilize a performance-based evaluation system, which bases CRA
ratings on the Company’s actual lending service and investment performance, rather than on the extent to which the institution
conducts needs assessments, documents community outreach activities or complies with other procedural requirements. In connection
with its assessment of CRA performance, the FRB assigns a rating of “outstanding,” “satisfactory,” “needs to improve” or “substantial
noncompliance.” Our CRA performance is evaluated by the FRB under the intermediate small bank requirements. The FRB’s last
CRA performance examination was performed on us and completed in July of 2011 and we received an overall “Satisfactory” CRA
Assessment Rating.
Anti-Money Laundering Regulations
A series of banking laws and regulations beginning with the Bank Secrecy Act in 1970 require banks to prevent, detect, and
report illicit or illegal financial activities to the federal government to prevent money laundering, international drug trafficking, and
12
terrorism. Under the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct
Terrorism Act of 2001, financial institutions are subject to prohibitions against specified financial transactions and account
relationships as well as enhanced due diligence and “know your customer” standards in their dealings with high risk customers,
foreign financial institutions, and foreign individuals and entities. We have extensive controls to comply with these requirements.
Privacy and Data Security
The Gramm-Leach Bliley Act (“GLBA”) of 1999 imposed requirements on financial institutions with respect to consumer
privacy. The GLBA generally prohibits disclosure of consumer information to non-affiliated third parties unless the consumer has
been given the opportunity to object and has not objected to such disclosure. Financial institutions are further required to disclose
their privacy policies to consumers annually. The GLBA also directs federal regulators to prescribe standards for the security of
consumer information. We are subject to such standards, as well as standards for notifying consumers in the event of a security
breach. We must disclose our privacy policy to consumers and permit consumers to “opt out” of having non-public customer
information disclosed to third parties. We are required to have an information security program to safeguard the confidentiality and
security of customer information and to ensure proper disposal. Customers must be notified when unauthorized disclosure involves
sensitive customer information that may be misused.
Other Consumer Protection Laws and Regulations
Bank regulatory agencies are increasingly focusing on compliance with consumer protection laws and regulations. Examination
and enforcement has become intense, and banks have been advised to monitor compliance carefully with various consumer protection
laws and their implementing regulations. For example, the federal Interagency Task Force on Fair Lending issued a policy statement
on discrimination in home mortgage lending describing three methods that federal agencies will use to prove discrimination: overt
evidence of discrimination, evidence of disparate treatment, and evidence of disparate impact. In addition to CRA and fair lending
requirements, we are subject to numerous other federal consumer protection statutes and regulations. Due to heightened regulatory
concern related to compliance with consumer protection laws and regulations generally, we may incur additional compliance costs or
be required to expend additional funds for investments in the local communities we serve.
Restriction on Transactions between Member Banks and their Affiliates
Transactions between the Company and the Bank are quantitatively and qualitatively restricted under Sections 23A and 23B of
the Federal Reserve Act and Federal Reserve Regulation W. Section 23A places restrictions on the Bank’s “covered transactions” with
the Company, including loans and other extensions of credit, investments in the securities of, and purchases of assets from the
Company. Section 23B requires that certain transactions, including all covered transactions, be on market terms and conditions.
Federal Reserve Regulation W combines statutory restrictions on transactions between the Bank and the Company with FRB
interpretations in an effort to simplify compliance with Sections 23A and 23B.
The Sarbanes-Oxley Act of 2002
On July 30, 2002, President Bush signed into law The Sarbanes-Oxley Act of 2002, or “Sarbanes-Oxley Act”. The Sarbanes-
Oxley Act addresses accounting oversight and corporate governance matters relating to the operations of public companies. During
2003, the Commission issued a number of regulations under the directive of the Sarbanes-Oxley Act significantly increasing public
company governance-related obligations and filing requirements, including:
• the establishment of an independent public oversight of public company accounting firms by a board that will set auditing,
quality and ethical standards for and have investigative and disciplinary powers over such accounting firms,
• the enhanced regulation of the independence, responsibilities and conduct of accounting firms which provide auditing services
to public companies,
• the increase of penalties for fraud related crimes,
• the enhanced disclosure, certification, and monitoring of financial statements, internal financial controls and the audit process,
and
• the enhanced and accelerated reporting of corporate disclosures and internal governance.
13
Furthermore, in November 2003, in response to the directives of the Sarbanes-Oxley Act, Nasdaq adopted substantially expanded
corporate governance criteria for the issuers of securities quoted on the Nasdaq markets. The new Nasdaq rules govern, among other
things, the enhancement and regulation of corporate disclosure and internal governance of listed companies and of the authority, role
and responsibilities of their boards of directors and, in particular, of “independent” members of such boards of directors, in the areas
of nominations, corporate governance, compensation and the monitoring of the audit and internal financial control processes.
The Sarbanes-Oxley Act, the Commission rules promulgated thereunder, and the new Nasdaq governance requirements have
required the Company to review its current procedures and policies to determine whether they comply with the new legislation and its
implementing regulations. Oak Valley Bancorp is primarily responsible for ensuring compliance with Sarbanes-Oxley and the Nasdaq
governance rules, as applicable.
Emergency Economic Stabilization Act of 2009
Dramatic negative developments in the latter half of 2007 in the subprime mortgage market and the securitization markets for
such loans, together with volatility in oil prices and other factors, have resulted in uncertainty in the financial markets in general and a
related economic downturn, which effects continued to be felt among financial institutions through 2012.
On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted to restore confidence and
stabilize the volatility in the U.S. banking system and to encourage financial institutions to increase their lending to customers and to
each other. Through a program initially known as the Treasury Capital Purchase Program (“TCPP”) that was carved out of the
Troubled Asset Relief Program (“TARP”), the EESA authorized the United States Department of the Treasury (“U.S. Treasury”) to
purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and
certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies.
Initially, $350 billion was made immediately available to the U.S. Treasury. On January 15, 2009, the remaining $350 billion was
released to the U.S. Treasury.
Consistent with its prudent approach and attention to liquidity during a time of general market turmoil and severe limitations
in accessing the capital markets, in December 2008 the Company participated in the TCPP and issued $13.5 million of preferred stock
to the U.S. Treasury, together with a warrant to acquire 350,346 shares of common stock. Both the preferred stock and the warrant
have been repurchased by the Company. However, during the period when the Company participated in the TCPP, we were subject to
restrictions on executive compensation and limitations on dividends and stock repurchases, with which we complied with. The
compensation restrictions generally applied to the Chief Executive Officer, Chief Financial Officer and the three next most highly
compensated senior executive officers.
The American Recovery and Reinvestment Act of 2009
On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was signed into law by President
Obama. The ARRA includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure,
energy, health, and education needs. In addition, the ARRA imposes certain new executive compensation and corporate expenditure
limits on all current and future TCPP recipients, including the Company, until the institution has repaid the U.S. Treasury, which is
now permitted under the ARRA without penalty and without the need to raise new capital, subject to the U.S. Treasury’s consultation
with the recipient’s appropriate regulatory agency.
The ARRA executive compensation standards that went into effect on September 14, 2009 were more stringent than those in
effect under the TCPP. The ARRA standards include (but are not limited to); (i) prohibitions on bonuses, retention awards and other
incentive compensation, other than restricted stock grants which do not fully vest during the TCPP period up to one-third of an
employee’s total annual compensation, (ii) prohibitions on golden parachute payments for departures, (iii) an expanded clawback of
bonuses, retention awards, and incentive compensation if payment is based on materially inaccurate statements of earnings, revenues,
gains or other criteria, (iv) prohibitions on compensation plans that encourage manipulation of reported earnings, (v) retroactive
review of bonuses, retention awards and other compensation previously provided by TCPP recipients if found by the U.S. Treasury to
be inconsistent with the purposes of TCPP or otherwise contrary to public interest, (vi) required establishment of a company-wide
policy regarding “excessive or luxury expenditures,” and (vii) inclusion in a participant’s proxy statements for annual shareholder
meetings of a nonbinding “Say on Pay” shareholder vote on the compensation of executives.
14
The Dodd-Frank Wall Street Reform and Consumer Protection Act
On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act
(“Act”), a landmark financial reform bill comprised of massive volume of new rules and restrictions that will impact banks going
forward. It includes key provisions aimed at preventing a repeat of the 2008 financial crisis and a new process for winding down
failing, systemically important institutions in a manner as close to a controlled bankruptcy as possible. The Act includes other key
provisions as follows:
(1) The Act establishes a new Financial Stability Oversight Council to monitor systemic financial risks. The FRB is given
extensive new authorities to impose strict controls on large bank holding companies with total consolidated assets equal to or in excess
of $50 billion and systemically significant nonbank financial companies to limit the risk they might pose for the economy and to other
large interconnected companies. The FRB can also take direct control of troubled financial companies that are considered systemically
significant.
The Act restricts the amount of trust preferred securities (“TPS”) that may be considered as Tier 1 Capital. For bank holding
companies below $15 billion in total assets, TPS issued before May 19, 2010 will be grandfathered, so their status as Tier 1 capital
does not change. Beginning January 1, 2013, bank holding companies above $15 billion in assets will have a three-year phase-in
period to fill the capital gap caused by the disallowance of the TPS issued before May 19, 2010. However going forward, TPS will be
disallowed as Tier 1 capital.
(2) The Act creates a new process to liquidate failed financial firms in an orderly manner, including giving the FDIC broader
authority to operate or liquidate a failing financial company.
(3) The Act also establishes a new independent Federal regulatory body for consumer protection within the Federal Reserve
System known as the Bureau of Consumer Financial Protection (the "Bureau"), which will assume responsibility for most consumer
protection laws (except the Community Reinvestment Act). It will also be in charge of setting appropriate consumer banking fees and
caps. The Office of Comptroller of the Currency will continue to have authority to preempt state banking and consumer protection
laws if these laws "prevent or significantly" interfere with the business of banking.
(4) The Act effects changes in the FDIC assessment as discussed in section “FDIC Insurance Assessments” above.
(5) The Act places certain limitations on investment and other activities by depository institutions, holding companies and
their affiliates, including comprehensive regulation of all over-the-counter derivatives.
(6) The Act states that the FRB is authorized to regulate interchange fees on debit cards and certain general-use prepaid card
transactions paid to issuing banks with assets in excess of $10 billion to ensure that they are “reasonable and proportional” to the cost
of processing individual transactions, and to prohibit debit and general-use prepaid payment card networks and issuers from requiring
transactions to be processed on a single payment network. The FRB issued its final rule on June 29, 2011.
Securities Laws and Corporate Governance
The Company is subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities
Exchange Act of 1934, as amended, both as administered by the SEC. As a company listed on the NASDAQ Global Select Market,
the Company is subject to NASDAQ listing standards for listed companies.
As discussed above, we are also subject to the Sarbanes-Oxley Act of 2002, provisions of the Dodd-Frank Act, and other federal and
state laws and regulations which address, among other issues, required executive certification of financial presentations, corporate
governance requirements for board audit committees and their members, and disclosure of controls and procedures and internal
control over financial reporting, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate
information. NASDAQ has also adopted corporate governance rules, which are intended to allow shareholders and investors to more
easily and efficiently monitor the performance of companies and their directors.
Finally, the Company is subject to the provisions of the California General Corporation Law, while the Bank is also subject to the
California Financial Code provisions.
15
Environmental Regulations
In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with
respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury,
investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to
investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or
remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to
common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the
property. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity and results of
operations could be materially and adversely affected.
Other Pending and Proposed Legislation
Other legislative and regulatory initiatives which could affect us and the banking industry, in general, are pending and additional
initiatives may be proposed or introduced before the United States Congress, the California legislature and other governmental bodies
in the future. Such proposals, if enacted, may further alter the structure, regulation and competitive relationship among financial
institutions, and may subject us to increased regulation, disclosure and reporting requirements. In addition, the various banking
regulatory agencies often adopt new rules and regulations to implement and enforce existing legislation. We cannot predict whether,
or in what form, any such legislation or regulations may be enacted or the extent to which our business would be affected thereby.
Available Information
The Company maintains an Internet website at http://www.ovcb.com. The Company makes available its annual reports on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports filed or furnished pursuant
to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and other information related to the Company free of
charge, through this site as soon as reasonably practicable after it electronically files those documents with, or otherwise furnishes
them to, the SEC. The Company’s website also contains a copy of our Code of Ethics. The Company’s internet website and the
information contained therein or connected thereto are not intended to be incorporated into this annual report on Form 10-K.
In addition, copies of our filings are available by requesting them in writing or by phone from:
Corporate Secretary
Oak Valley Bancorp
125 North Third Avenue
Oakdale, California
209-844-7578
ITEM 1A. RISK FACTORS
Not applicable.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
16
ITEM 2. PROPERTIES
Our main office is located in a complex at 125 North Third Avenue, Oakdale, CA 95361, in downtown Oakdale and houses our
primary loan production, operations, and administrative offices. The building has an automated teller machine and onsite parking.
The Company’s complex occupies approximately 20,000 square feet of space.
Property Location and Address
Square
Footage
Lease
Expiration Date
Lease
Extension Options
Oakdale, 125 N. 3rd Ave.
Oakdale, 338 F Street
Sonora, 14580 Mono Way
Modesto, 12th & I Street
Bridgeport, 166 Main Street
Mammoth Lakes, 170 Mountain Blvd.
Bishop, 351 North Main Street
Modesto, 4120 Dale Road
Turlock, 2001 Geer Road
Patterson, 20 Plaza Circle
Escalon, 1910 McHenry Ave.
Ripon, 150 North Wilma Ave.
Stockton, 2935 West March Lane
Modesto, 3508 McHenry Ave.
Manteca, 191 W. North St.
* The Company owns this property.
9,600
9,860
2,500
4,500
2,875
1,856
3,680
4,500
2,400
2,100
3,500
1,800
8,000
5,400
2,800
n/a*
3/2017
4/2018
3/2016
n/a*
n/a*
8/2014
3/2015
1/2015
n/a*
4/2021
12/2015
12/2022
n/a*
5/31/2016
n/a*
three, 5-year term extensions
two, 5-year term extensions
two, 5-year term extensions
n/a*
n/a*
two, 5-year term extensions
two, 5-year term extensions
two, 5-year term extensions
n/a*
two, 5-year term extensions
one, 5-year term extension
two, 5-year term extensions
n/a*
two, 5-year term extensions
Management has determined that all of its premises are adequate for its present and anticipated level of business.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company is a party to claims and legal proceedings arising in the ordinary course of business. Our
management evaluates its exposure to these claims and proceedings individually and in the aggregate and provides for potential losses
on such litigation if the amount of the loss is estimable and the loss is probable.
To our knowledge, there are no material litigation matters pending at the current time. Although the results of any such litigation
matters and claims cannot be predicted with certainty, we believe that the final outcome of any such claims and proceedings will not
have a material adverse impact on the Company’s financial position, liquidity, or results of operations.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
17
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES.
Price Range of Common Stock
Our common stock is traded on the NASDAQ Capital Market under the symbol “OVLY.” The following table sets forth the
high and low closing bid prices (which reflect prices between dealers and do not include retail markup, markdown or commission and
may not represent actual transactions) for the current year and the two calendar years ended December 31, 2012 and 2011,
respectively. From time to time, during the periods indicated, trading activity in our common stock was infrequent. The source of the
quotes is The Nasdaq Stock Market, LLC.
For Calendar Quarter Ended
March 31, 2011
June 30, 2011
September 30, 2011
December 31, 2011
March 31, 2012
June 30, 2012
September 30, 2012
December 31, 2012
Closing Sale Price
High
6.25
6.25
6.05
6.99
8.20
7.93
8.25
8.15
$
$
$
$
$
$
$
$
Low
5.80
5.85
4.05
4.65
5.80
6.17
5.02
6.75
$
$
$
$
$
$
$
$
On March 19, 2013, the closing price of our common stock was $8.04 per share; and there were approximately 482 shareholders
of record of the common stock and 7,914,730 outstanding shares of common stock.
Dividends
Our ability to pay any cash dividends will depend not only upon our earnings during a specified period, but also on our meeting
certain capital requirements.
Furthermore, the Company participated in the U.S. Treasury Small Business Lending Fund program in August 2011, pursuant to
which we issued to the U.S. Treasury 13,500 shares of Senior Non-Cumulative Perpetual Preferred Stock, Series B. As of December
31, 2012, after redeeming half of the original shares in May of 2012, the Company had 6,750 shares outstanding and so long as any
share of Series B Preferred Stock remains outstanding, the Company may declare and pay dividends on the common stock only if (A)
after giving effect to such dividend the Company’s Tier 1 capital would be at least equal to the Tier 1 Dividend Threshold (as such
term is defined in Section 2(rr) of , the Series B Preferred Stock Certificate of Determination, which is incorporated by reference as
Exhibit 4.3) and (B) full dividends on all outstanding shares of Series B Preferred Stock for the most recently completed calendar
quarter have been or are contemporaneously declared and paid. However, on March 13, 2013, the Company fully redeemed all the
remaining 6,750 shares and, as of the current date, no shares of Senior Non-Cumulative Perpetual Preferred Stock, Series B.
Shareholders are entitled to receive dividends only when and if dividends are declared by our Board of Directors. Although we
have paid dividends in the past, it is no guarantee that we will pay cash dividends in the future. No dividends were paid for the years
ended December 31, 2012 and 2011.
18
Equity Compensation Plan Information
The following table provides information as of December 31, 2012 with respect to shares of our common stock that are issued
and currently outstanding under the Company’s 1998 Restated Stock Option Plan (the “1998 Restated Stock Option Plan”), and the
number of shares that are authorized to be issued under the Company’s 2008 Equity Plan (the “2008 Equity Plan”). Figures in the
table have been retroactively adjusted to reflect three-for-two stock splits in August 2005 and 2006.
Plan Category
Equity Compensation Plans
Approved by Shareholders
Equity Compensation Plans Not
Approved by Shareholders
Total
A
B
Number of Securities to be Issued Upon
Exercise of Outstanding Options
Weighted Average Exercise Price of
Outstanding Options
C
Number of Securities Remaining Available for
Future Issuance Under 2008 Equity Plan
(Excluding Securities Reflected in
Column A)
227,187
$
0
227,187
$
9.15
0
9.15
1,349,320
0
1,349,320
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Not applicable.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
The following discussion of financial condition as of December 31, 2012 and 2011 and results of operations for each of the years in
the two-year period ended December 31, 2012 should be read in conjunction with our consolidated financial statements and related
notes thereto, included in this report. Average balances, including balances used in calculating certain financial ratios, are generally
comprised of average daily balances.
Forward-Looking Statements
This discussion of financial results includes forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, (the “1933 Act”) and Section 21E of the Securities Exchange Act of 1934, as amended, (the
“1934 Act”). Those sections of the 1933 Act and 1934 Act provide a “safe harbor” for forward-looking statements to encourage
companies to provide prospective information about their financial performance so long as they provide meaningful, cautionary
statements identifying important factors that could cause actual results to differ significantly from projected results.
Our forward-looking statements include descriptions of plans or objectives of Management for future operations, products
or services, and forecasts of our revenues, earnings or other measures of economic performance. Forward-looking statements can be
identified by the fact that they do not relate strictly to historical or current facts. They often include the words “believe,” “expect,”
“intend,” “estimate” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could” or “may.”
Forward-looking statements are based on Management’s current expectations regarding economic, legislative, and
regulatory issues that may impact our earnings in future periods. A number of factors - many of which are beyond Management’s
control - could cause future results to vary materially from current Management’s expectations. Such factors include, but are not
limited to, general economic conditions, the current financial turmoil in the United States and abroad, changes in interest rates, deposit
flows, real estate values and industry competition; changes in accounting principles, policies or guidelines; changes in legislation or
regulation; and other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing,
products and services. Forward-looking statements speak only as of the date they are made. We do not undertake to update forward-
looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the
occurrence of unanticipated events.
19
Introduction
Our continued focus on responsible community banking fundamentals and our strong customer relationships have enabled us
to increase net income to common shareholders in 2012, and have led to higher core deposits, a key funding source for our steady
asset growth.
As of December 31, 2012, we had approximately $661 million in total assets, $391 million in total gross loans, and $587 million
in total deposits.
We believe the following were key indicators of our performance for operations during 2012:
• our total assets increased to $661 million at the end of 2012, an increase of 7.9%, from $612 million at the end of 2011.
• our total deposits increased to $587 million at the end of 2012, an increase of 9.5%, from $536 million at the end of 2011.
• our total net loans decreased to $382 million at the end of 2012, a decrease of 1.2%, from $387 million at the end of 2011.
• our ratio of total non-performing loans to total loans decreased to 1.77% at December 31, 2012 from 1.83% at
December 31, 2011. Management considers that the size of the ratio of non-performing assets to total loans is moderate
and manageable, and reserves have been taken appropriately.
• net interest income decreased $0.3 million or 1.3% in 2012 compared to 2011, mainly as a result of lower market interest
rate on loans and investment securities.
• provision for loan losses decreased $0.35 million or 23.3% to $1.15 million in 2012 compared to $1.5 million in 2011.
• total noninterest income increased to $3.1 million in 2012, an increase of 14.5%, from $2.8 million in 2011, which is
mainly attributable to our growing deposit account base.
• total noninterest expense increased from $17.4 million in 2011 to $18.2 million in 2012, reflecting the increase in
overhead costs associated with two new branch openings in 2011.
These items, as well as other factors, contributed to the increase in net income available to common shareholders for 2012
to $5.33 million from $4.70 million in 2011, which translates into $0.69 per diluted common share in 2012 and $0.61 per diluted
common share in 2011.
Over the past several years, our network of branches and loan production offices has been expanded geographically. We
currently maintain fourteen full-service offices. We intend to continue our growth strategy in future years through the opening of
additional branches and loan production offices as our needs and resources permit.
2013 Outlook
As we begin our strategic business plan for 2013, we are continuing to explore opportunities for growth in our existing
markets, as well as opportunities to expand into new markets through de novo branching. In 2013, we are continuing to focus on
loan and account growth and managing our net interest margin, while attempting to control expenses and credit losses and manage our
business to achieve our net income and other objectives. Efforts to attract new accounts and grow loans continue to be an important
strategic initiative.
As a result of market interest rates declining to historic lows in 2012, we recognized a decrease in our net interest income,
which we expect could slightly compress further in 2013 even if interest rates begin to increase. The potential compression of net
interest income and net interest margin would be a likely outcome if interest rates increase, given that our balance sheet is liability
sensitive to interest rate changes primarily due to the number of loans currently at their contractual rate floors and competitive
pressures to increase deposit rates. This could in turn result in a slower increase on the yield of earning assets compared to the cost of
deposits and other funds. Ideally, if we experience an increase in our yield on earnings assets we could then determine to increase the
interest rates we pay on our deposit accounts or change our promotional or other interest rates on new deposits in marketing activation
programs to attempt to achieve a certain net interest margin. In light of the current economic environment, it may not be possible to
manage the interest margin in this manner, as competitive pressures may dictate that we increase deposit rates at a faster rate than the
earning assets increase, thereby further compressing the net interest margin. Any increases in the rates we charge on accounts could
have an effect on our efforts to attract new customers and grow loans, particularly with the continuing competition in the commercial
20
and consumer lending industry. The economies and real estate markets in our primary market areas will continue to be significant
determinants of the quality of our assets in future periods and, thus, our results of operations, liquidity and financial condition. Current
economic indicators suggest that the national economy and the economies in our primary market areas will remain depressed but the
length and severity of the cycle is difficult to predict.
For 2013, management remains focused on the above challenges and opportunities and other factors affecting the business
similar to the factors driving 2012 results as discussed in this section.
Holding Company
Effective July 3, 2008, Oak Valley Community Bank became a subsidiary of Oak Valley Bancorp, a newly established bank
holding company. Oak Valley Bancorp operates Oak Valley Community Bank as a community bank in the general commercial
banking business, with our primary market encompassing the California Central Valley around Oakdale and Modesto, and the Eastern
Sierras. As such, unless otherwise noted, all references are about Oak Valley Bancorp.
In the bank holding company reorganization, all outstanding shares of common stock of the Bank were exchanged for an
equal number of shares of common stock of Oak Valley Bancorp, which now owns the Bank as its wholly-owned subsidiary.
Management believes that operating the Bank within a holding company structure, among other things:
• provides greater operating flexibility than is currently enjoyed by us.
• facilitates the acquisition of related businesses as opportunities arise.
• improves our ability to diversify.
• enhances our ability to remain competitive in the future with other companies in the financial services industry that are
organized in a holding company structure.
• enhances our ability to raise capital to support growth.
The financial statements and discussion thereof contained in this report for periods subsequent to the reorganization relate to
the consolidated financial statements of Oak Valley Bancorp. Periods prior to the reorganization relate to the Bank only. The
information is comparable as the sole subsidiary of Oak Valley Bancorp is the Bank.
Critical Accounting Policies
Critical accounting policies are those that are both most important to the portrayal of our financial condition and results of
operations and require management's most difficult, subjective, or complex judgments, often as a result of the need to make estimates
about the effect of matters that are inherently uncertain.
The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial
statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.
The preparation of these financial statements requires management to make estimates and judgments that effect the reported amounts
of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our financial
statements. Actual results may differ from these estimates under different assumptions or conditions. In addition, GAAP itself may
change from one previously acceptable method to another method, although the economics of our transactions would be the same.
Management has determined the following accounting policies to be critical:
Asset Impairment Judgments
Certain of our assets are carried in our consolidated balance sheets at fair value or at the lower of cost or fair value.
Valuation allowances are established when necessary to recognize impairment of such assets. We periodically perform analyses to test
for impairment of various assets. In addition to our impairment analyses related to loans, another significant impairment analysis
relates to other than temporary declines in the value of our securities.
Our available for sale portfolio is carried at estimated fair value, with any unrealized gains and losses, net of taxes, reported
as accumulated other comprehensive income in shareholders’ equity. We conduct a periodic review and evaluation of the securities
portfolio to determine if the value of any security has declined below its carrying value and whether such decline is other than
temporary. If such decline is deemed other than temporary, we would adjust the carrying amount of the security by writing down the
21
security to fair value through a charge to current period income. The fair values of our securities are significantly affected by changes
in interest rates.
In general, as interest rates rise, the fair value of fixed-rate securities will decrease; as interest rates fall, the fair value of
fixed-rate securities will increase. With significant changes in interest rates, we evaluate our intent and ability to hold the security for a
sufficient time to recover the recorded principal balance. Estimated fair values for securities are based on published or securities
dealers’ market values. Market volatility is unpredictable and may impact such values.
Allowance for Loan Losses
Credit risk is inherent in the business of lending and making commercial loans. Accounting for our allowance for loan
losses involves significant judgment and assumptions by management and is based on historical data and management’s view of the
current economic environment. At least on a quarterly basis, our management reviews the methodology and adequacy of allowance for
loan losses and reports its assessment to the Board of Directors for its review and approval.
The allowance for loan losses is an estimate of probable incurred losses with regard to our loans. Our loan loss provision
for each period is dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loans,
delinquencies, management's assessment of the quality of the loans, the valuation of problem loans and the general economic
conditions in our market area. We base our allowance for loan losses on an estimation of probable losses inherent in our loan
portfolio.
Our methodology for assessing loan loss allowances are intended to reduce the differences between estimated and actual
losses and involves a detailed analysis of our loan portfolio, in three phases:
• the specific review of individual loans,
• the segmenting and review of loan pools with similar characteristics, and
• our judgmental estimate based on various subjective factors:
The first phase of our methodology involves the specific review of individual loans to identify and measure impairment.
We evaluate each loan by use of a risk rating system, except for homogeneous loans, such as automobile loans and home mortgages.
Specific risk rated loans are deemed impaired if all amounts, including principal and interest, will likely not be collected in accordance
with the contractual terms of the related loan agreement. Impairment for commercial and real estate loans is measured either based on
the present value of the loan’s expected future cash flows or, if collection on the loan is collateral dependent, the estimated fair value
of the collateral, less selling and holding costs.
The second phase involves the segmenting of the remainder of the risk rated loan portfolio into groups or pools of loans,
together with loans with similar characteristics, for evaluation. We determine the calculated loss ratio to each loan pool based on its
historical net losses and benchmark it against the levels of other peer banks.
In the third phase, we consider relevant internal and external factors that may affect the collectability of loan portfolio and
each group of loan pool. The factors considered are, but are not limited to:
• concentration of credits,
• nature and volume of the loan portfolio,
• delinquency trends,
• non-accrual loan trend,
• problem loan trend,
• loss and recovery trend,
• quality of loan review,
• lending and management staff,
22
• lending policies and procedures,
• economic and business conditions, and
• other external factors.
Our management estimates the probable effect of such conditions based on our judgment, experience and known or
anticipated trends. Such estimation may be reflected as an additional allowance to each group of loans, if necessary. Management
reviews these conditions with our senior credit officers. To the extent that any of these conditions is evidenced by a specifically
identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may
be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a
specific, identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the inherent loss
related to such condition is reflected in the unallocated allowance.
Central to our credit risk management and our assessment of appropriate loss allowance is our loan risk rating system.
Under this system, the originating credit officer assigns borrowers an initial risk rating based on a thorough analysis of each
borrower’s financial capacity in conjunction with industry and economic trends. Approvals are made based upon the amount of
inherent credit risk specific to the transaction and are reviewed for appropriateness by senior line and credit administration personnel.
Credits are monitored by line and credit administration personnel for deterioration in a borrower’s financial condition which may
impact the ability of the borrower to perform under the contract. Although management has allocated a portion of the allowance to
specific loans, specific loan pools, and off-balance sheet credit exposures (which are reported separately as part of other liabilities), the
adequacy of the allowance is considered in its entirety.
It is the policy of management to maintain the allowance for loan losses at a level adequate for risks inherent in the overall
loan portfolio, however, the loan portfolio can be adversely affected if the State of California’s economic conditions and its real estate
market in our general market area were to further deteriorate or weaken. Additionally, further weakness of a prolonged nature in the
agricultural and general economy would have a negative impact on the local market. The effect of such economic events, although
uncertain and unpredictable at this time, could result in an increase in the levels of nonperforming loans and additional loan losses,
which could adversely affect our future growth and profitability. No assurance of the level of predicted credit losses can be given with
any certainty.
Non-Accrual Loan Policy
Interest on loans is credited to income as earned and is accrued only if deemed collectible. Accrual of interest is
discontinued when a loan is over 90 days delinquent or if management believes that collection is highly uncertain. Generally,
payments received on nonaccrual loans are recorded as principal reductions. Interest income is recognized after all principal has been
repaid or an improvement in the condition of the loan has occurred that would warrant resumption of interest accruals.
Stock-Based Compensation
The Company recognizes in the consolidated statements of income the grant-date fair value of stock options and other
equity-based forms of compensation issued to employees over the employees” requisite service period (generally the vesting period).
The Company uses straight-line recognition of expenses for awards with graded vesting. The Company utilizes a binomial pricing
model for all stock option grants. Expected volatility is based on the historical volatility of the price of the Company’s stock. The
Company uses historical data to estimate option exercise and stock option forfeiture rates within the valuation model. The expected
term of options granted for the binomial model is derived from applying a historical suboptimal exercise factor to the contractual term
of the grant. For binomial pricing, the risk-free rate for periods is equal to the U.S. Treasury yield at the time of grant and
commensurate with the contractual term of the grant. For restricted stock grants, the Company uses the market price of the stock on
the grant date and expenses the market value over the vesting period.
Income Taxes
Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of
the Company’s assets and liabilities. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to
23
the period in which the deferred tax assets or liabilities are expected to be realized or settled using the liability method. As changes in
tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
The Company files income tax returns in the U.S. federal jurisdiction, and the state of California. With few exceptions, the
Company is no longer subject to U.S. federal or state/local income tax examinations by tax authorities for years before 2008.
Deferred Compensations Plans
Future compensation under the Company’s executive salary continuation plan and director retirement plan is earned for
services rendered through retirement. The Company accrues for the salary continuation liability based on anticipated years of service
and vesting schedules provided under the plans. The Company’s current benefit liability is determined based on vesting and the
present value of the benefits at a corresponding discount rate. The discount rate used is an equivalent rate for investment-grade bonds
with lives matching those of the service periods remaining for the salary continuation contracts, which average approximately
20 years.
Fair Value Measurements
We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value
disclosures. We base our fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. Securities available for sale, derivatives, and loans held for sale, if
any, are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record certain assets at fair
value on a non-recurring basis, such as certain impaired loans held for investment and securities held to maturity that are other-than-
temporarily impaired. These non-recurring fair value adjustments typically involve write-downs of individual assets due to application
of lower-of-cost or market accounting.
We have established and documented a process for determining fair value. We maximize the use of observable inputs and
minimize the use of unobservable inputs when developing fair value measurements. Whenever there is no readily available market
data, management uses its best estimate and assumptions in determining fair value, but these estimates involve inherent uncertainties
and the application of management's judgment. As a result, if other assumptions had been used, our recorded earnings or disclosures
could have been materially different from those reflected in these financial statements. For detailed information on our use of fair
value measurements and our related valuation methodologies, see Note 17 to the Consolidated Financial Statements in Item 8 of this
Form 10-K.
Recently Issued Accounting Standards
In May 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-04 Fair Value Measurement (Topic 820)
Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The ASU
improves the comparability of fair value measurements presented and disclosed in accordance with U.S. generally accepted
accounting principles (GAAP) and International Financial Reporting Standards (IFRSs) by changing the wording used to describe
many of the requirements in U.S GAAP for measuring fair value and disclosure of information. The amendments to this ASU provide
explanation on how to measure fair value but do not require any additional fair value measurements and does not establish valuation
standards or affect valuation practices outside of financial reporting. The amendments clarify existing fair value measurements and
disclosure requirements to include application of the highest and best use and valuation premises concepts; measuring fair value of an
instrument classified in a reporting entity’s shareholders’ equity; and disclosures requirements regarding quantitative information
about unobservable inputs categorized within Level 3 of the fair value hierarchy. In addition, clarification is provided for measuring
the fair value of financial instruments that are managed in a portfolio and the application of premiums and discounts in a fair value
measurement. For public entities, ASU 2011-04 is effective during interim and annual periods beginning after December 15, 2011.
There was no significant impact on the Company’s financial position or results of operations as a result of adopting this ASU.
In June 2011, the FASB issued ASU No. 2011-05 Comprehensive Income (Topic 220) Presentation of Comprehensive Income.
The ASU improves the comparability, consistency, and transparency of financial reporting and increases the prominence of items
reported in other comprehensive income. The amendments to Topic 220, Comprehensive Income, require entities to present the total
of comprehensive income, the components of net income, and the components of other comprehensive income either in a single
continuous statement of comprehensive income or in two separate but consecutive statements. Entities are no longer permitted to
present components of other comprehensive income as part of the statement of changes in stockholders’ equity. Any adjustments for
items are that reclassified from other comprehensive income to net income are to be presented on the face of the entities financial
statement regardless the method of presentation for comprehensive income. The amendments do not change items to be reported in
comprehensive income or when an item of other comprehensive income must be reclassified to net income, nor do the amendments
24
change the option to present the components of other comprehensive income either net of related tax effects or before related tax
effects. ASU 2011-05 is effective for fiscal years, and interim periods beginning on or after December 15, 2011. The Company
adopted this ASU in the first quarter of 2012.
In December 2011, the FASB issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities. The update
requires an entity to offset, and present as a single net amount, a recognized eligible asset and a recognized eligible liability when it
has an unconditional and legally enforceable right of setoff and intends either to settle the asset and liability on a net basis or to realize
the asset and settle the liability simultaneously. The ASU requires an entity to disclose information about offsetting and related
arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The
amendments are effective for annual and interim reporting periods beginning on or after January 1, 2013. The Company is currently in
the process of evaluating the ASU but does not expect it will have a material impact on the Company’s consolidated financial
statements.
In January 2013, the FASB issued ASU No. 2013-01, Clarifying the Scope of Disclosures about Offsetting Assets and
Liabilities. The Update clarifies that ASU. 2011-11 applies only to derivatives, including bifurcated embedded derivatives, repurchase
agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset or
subject to an enforceable master netting arrangement or similar agreement. Entities with other types of financial assets and financial
liabilities subject to a master netting arrangement or similar agreement are no longer subject to the disclosure requirements in ASU.
2011-11. The amendments are effective for annual and interim reporting periods beginning on or after January 1, 2013. The Company
is currently in the process of evaluating the ASU but does not expect it will have a material impact on the Company’s consolidated
financial statements.
In February 2013, the FASB issued ASU No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other
Comprehensive Income. The Update requires an entity to provide information about the amounts reclassified out of accumulated other
comprehensive income by component and 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 to be reclassified to net income in its entirety in the same reporting period. The amendments are
effective for annual and interim reporting periods beginning on or after December 15, 2012. The Company is currently in the process
of evaluating the ASU but does not expect it will have a material impact on the Company’s consolidated financial statements.
Results of Operations
The Company earns income from two primary sources. The first is net interest income, which is interest income generated by
earning assets less interest expense on interest-bearing liabilities. The second is noninterest income, which primarily consists of
deposit service charges and fees, the increase in cash surrender value of life insurance and mortgage commissions. The majority of the
Company's noninterest expenses are operating costs that relate to providing a full range of banking services to our customers.
Overview
We recorded net income available to common shareholders for the year ended December 31, 2012 of $5,329,000 or $0.69
per diluted common share compared to $4,700,000 or $0.61 per diluted common share for the year ended December 31, 2011. The
increase in net income available to common shareholders for the year ended December 31, 2012 was primarily due to a decrease of
$350,000 in provision for loan losses, an increase in non-interest income of $398,000 and a decrease in income tax provision of
$362,000. Partially offsetting these factors was a decrease in net interest income of $335,000 and an increase of $855,000 in non-
interest expense associated with two new branch openings in 2011.
25
Highlights of the financial results are presented in the following table:
(Dollars in thousands, except per share data)
For the period:
Net income available to common shareholders
Net income per common share:
Basic
Diluted
Return on average common equity
Return on average assets
Common stock dividend payout ratio
Efficiency ratio
At period end:
Book value per common share
Total assets
Total gross loans
Total deposits
Net loan-to-deposit ratio
Net Interest Income and Net Interest Margin
As of and for the years ended December 31,
2012
2011
2010
$
$
$
$
$
$
$
5,329
$
4,700
$
3,786
$
$
0.69
0.69
8.80 %
0.95 %
0.00 %
63.83 %
$
$
0.61
0.61
8.67 %
1.02 %
0.00 %
61.28 %
0.49
0.49
7.65 %
0.88 %
0.00 %
59.62 %
7.99
660,581
390,986
586,993
$
$
$
$
65.15 %
7.37
612,172
396,202
536,204
$
$
$
$
72.17 %
6.64
552,396
404,194
476,739
82.90 %
Our primary source of revenue is net interest income, which is the difference between interest and fees derived from earning
assets and interest paid on liabilities obtained to fund those assets. Our net interest income is affected by changes in the level and mix
of interest-earning assets and interest- bearing liabilities, referred to as volume changes. Our net interest income is also affected by
changes in the yields earned on assets and rates paid on liabilities, referred to as rate changes. Interest rates charged on our loans are
affected principally by the demand for such loans, the supply of money available for lending purposes and competitive factors. Those
factors are, in turn, affected by general economic conditions and other factors beyond our control, such as federal economic policies,
the general supply of money in the economy, legislative tax policies, the governmental budgetary matters, and the actions of the
Federal Reserve Board.
26
For a detailed analysis of interest income and interest expense, see the “Average Balance Sheets” and the “Rate/Volume Analysis”
below.
Distribution, Yield and Rate Analysis of Net Income
For the Years Ended December 31,
2012
Average
Balance
Interest
Income/
Expense
Avg
Rate/
Yield
2011
Interest
Income/
Expense
Avg
Rate/
Yield
Average
Balance
Assets:
Earning assets:
Gross loans (1) (2)
$ 390,856
$ 22,459
5.75%
$ 394,130
$ 23,619
5.99%
Securities of U.S. government agencies
Other investment securities (2)
Federal funds sold
Interest-earning deposits
Total interest-earning assets
Total noninterest earning assets
Total Assets
Liabilities and Shareholders' Equity:
Interest-bearing liabilities:
Business interest DDA
Money market deposits
NOW deposits
Savings deposits
Time certificates of $100,000 or more
Other time deposits
Other borrowings
Total interest-bearing liabilities
Noninterest-bearing liabilities:
Noninterest-bearing deposits
Other liabilities
Total noninterest-bearing liabilities
Shareholders' equity
3,749
95,405
12,339
54,676
46
1.23%
3,720
3.90%
29
135
0.24%
0.25%
4,775
69,518
17,804
40,902
90
1.88%
3,274
4.71%
42
100
0.24%
0.24%
557,025
26,389
4.74%
527,129
27,125
5.15%
52,996
$ 610,021
45,774
$ 572,903
3,010
249,652
68,454
26,238
37,150
21,822
467
5
0.17%
513
103
57
322
132
0.21%
0.15%
0.22%
0.87%
0.60%
4
0.86%
0
245,815
66,157
18,389
35,172
28,755
6,484
0
767
133
64
356
260
68
0.00
0.31%
0.20%
0.35%
1.01%
0.90%
1.05%
406,793
1,136
0.28%
400,772
1,648
0.41%
130,664
3,154
133,818
69,410
101,599
2,820
104,419
67,712
Total liabilities and shareholders' equity
$ 610,021
$ 572,903
Net interest income
Net interest spread (3)
Net interest margin (4)
$ 25,253
$ 25,477
4.46%
4.53%
4.73%
4.83%
(1) Loan fees have been included in the calculation of interest income.
(2) Yields on municipal securities and loans have been adjusted to their fully-taxable equivalents (FTE), based on a federal marginal
tax rate of 34.0%.
(3) Represents the average rate earned on interest-earning assets less the average rate paid on interest-bearing liabilities.
(4) Represents net interest income as a percentage of average interest-earning assets.
27
Net interest income, on a fully tax equivalent basis (FTE), decreased $0.2 million or 0.9% to $25.3 million for the year ended
December 31, 2012, compared to $25.5 million in 2011. Net interest spread and net interest margin were 4.46% and 4.53%,
respectively, for the year ended December 31, 2012, compared to 4.73% and 4.83%, respectively, for the year ended December 31,
2011. The decrease in the net interest margin in 2012 was primarily attributable to the increased average federal funds sold and
interest earning deposits in bank balances of $8.3 million which are earning 0.24% and thus driving down the overall yield on earning
assets. Additionally, the average balance of our investment portfolio increased by $24.9 million and the yield decreased by 73 basis
points in 2012 compared to 2011.
The current low market interest rate environment has had a positive impact on net interest income in previous years because the
Company’s consolidated balance sheet is liability sensitive which typically results in our average cost of funds decreasing faster than
the average yield on interest earning assets in a declining rate environment. In 2012, we have not recognized this benefit to the same
degree, as deposit interest rates are at historic lows and have essentially reached a threshold in which they cannot reasonably be further
reduced to keep pace with the reduction of our asset yield. However, the total cost of funds did decrease 13 basis points in 2012
compared to 2011, due to moderate rate reductions across all deposit products. In addition, average non-interest-bearing demand
deposit balances increased by $29.1 million in 2012 compared to 2011, further reducing our cost of funds.
Compared to cost of funds, the decrease in earning asset yield was more significant at 41 basis points in 2012 compared to 2011.
The investment securities portfolio recognized the most significant decrease of 73 basis points in 2012, mainly because of the
Company deploying cash into investment security purchases, which have historically low yields. The yield on loans has remained
more stable, with a reduction of 24 basis points for 2012 compared to 2011, partly as a result of the significant portion of our loans
that are at their contractual rate floors. In addition, the large majority of our variable loans are tied to the U.S. Treasury Constant
Maturity Indices with repricing intervals between one and five years.
Changes in volume resulted in an increase in net interest income (FTE) of $1,087,000 for the year of 2012 compared to the year
2011, and changes in interest rates and the mix resulted in a decrease in net interest income (FTE) of $1,311,000 for the year 2012
versus the year 2011. Management closely monitors both total net interest income and the net interest margin.
Market rates are in part based on the Federal Reserve Open Market Committee ("FOMC") target Federal funds interest rate (the
interest rate banks charge each other for short-term borrowings). The change in the Federal funds sold and purchased rates is the
result of target rate changes implemented by the FOMC. In 2008, there were seven downward adjustments to the target rate totaling
325 basis points, bringing the target interest rate to a historic low with a range of 0% to 0.25% where it remained as of December
2012.
28
Rate/Volume Analysis
The following table below sets forth certain information regarding changes in interest income and interest expense of the
Company for the periods indicated. For each category of earning assets and interest bearing liabilities, information is provided on
changes attributable to (i) changes in volume (change in average volume multiplied by old rate); and (ii) changes in rates (change in
rate multiplied by old average volume). Changes in rate/volume (change in rate multiplied by the change in volume) have been
allocated to the changes due to volume and rate in proportion to the absolute value of the changes due to volume and rate prior to the
allocation.
Rate/Volume Analysis of Net Interest Income
For the Year Ended December 31,
2012 vs. 2011
Increases (Decreases)
Due to Change In
For the Year Ended December 31,
2011 vs. 2010
Increases (Decreases)
Due to Change In
Volume
Rate
Total
Volume
Rate
Total
$
(196)
$
(964)
$
(1,160)
$
(1,083)
$
(834)
$
(1,917)
(19)
1,219
(13)
34
1,025
(25)
(773)
0
1
(1,761)
$
0 $
5
$
12
5
27
20
(63)
(63)
(62)
(266)
(35)
(34)
(54)
(65)
(1)
(450)
(44)
446
(13)
35
(736)
5
(254)
(30)
(7)
(34)
(128)
(64)
(512)
(224)
19
1,190
22
58
206
62
(513)
1
0
81
677
23
58
(1,284)
(1,078)
$
0 $
0 $
0
214
20
15
(87)
(63)
(217)
(118)
(821)
(73)
(13)
(67)
(136)
(43)
(607)
(53)
2
(154)
(199)
(260)
(1,153)
(1,271)
$
324 $
(131)
$
193
Interest income:
Net loans (1)
Securities of U.S. government agencies
Other Investment securities
Federal funds sold
Interest-earning deposits
Total interest income
Interest expense:
Business interest DDA
Money market deposits
NOW deposits
Savings deposits
Time certificates of $100,000 or more
Other time deposits
Other borrowings
Total interest expense
Change in net interest income
$
1,087 $
(1,311)
$
(1) Loan fees have been included in the calculation of interest income.
Provision for Loan Losses
Credit risk is inherent in the business of making loans. The Company establishes an allowance for loan losses through charges to
earnings, which are shown in the consolidated statements of income as the provision for loan losses. Specifically identifiable and
quantifiable losses are promptly charged off against the allowance. The Company maintains the allowance for loan losses at a level
that it considers to be adequate to provide for credit losses inherent in its loan portfolio. Management determines the level of the
allowance by performing a quarterly analysis that considers concentrations of credit, past loss experience, current economic
conditions, the amount and composition of the loan portfolio (including nonperforming and potential problem loans), estimated fair
value of underlying collateral, and other information relevant to assessing the risk of loss inherent in the loan portfolio such as for
example loan growth, net charge-offs, changes in the composition of the loan portfolio, and delinquencies. As a result of
management’s analysis, a range of the potential amount of the allowance for loan losses is determined.
The provision for loan losses was $1,150,000 for the year ended December 31, 2012, compared to $1,500,000 for the year end
December 31, 2011. Nonperforming loans were $6.92 million at December 31, 2012 and $7.23 million at December 31, 2011, or
1.77% and 1.83%, respectively, of total loans. Nonperforming loans are primarily in nonperforming real estate construction and
development loans. The allowance for loan losses was $7.97 million and $8.61 million at December 31, 2012 and 2011, or 2.04% and
2.17%, respectively, of total loans. Net charge-offs were $1,784,000 in 2012 compared to $1,146,000 in 2011. The relatively high
29
level of net charge-offs for 2012 and 2011 as compared to all prior years was primarily due to prolonged effect of the stagnant
economic period.
The Company will continue to monitor the adequacy of the allowance for loan losses and make additions to the allowance in
accordance with the analysis referred to above. Because of uncertainties inherent in estimating the appropriate level of the allowance
for loan losses, actual results may differ from management’s estimate of credit losses and the related allowance.
Noninterest Income
Noninterest income was $3.15 million for the year ended December 31, 2012, compared to $2.75 million for the year 2011. In
2012, other income increased by $217,000, which was partially attributable to a $120,000 operating recovery from a prior year items
processing loss. Mortgage commissions have increased by $136,000 or 131% for the year 2012, as compared to 2011 as a result of the
escalated demand for home purchases and refinancing due in part to the current low interest rate environment. Service charge income
increased to $1.17 million for the year 2012 compared to $1.12 million for the year 2011, as a result of the increase in the aggregate
number of deposit accounts of 2.9% to 23,009 at December 31, 2012, as compared to 22,371 accounts as of December 31, 2011. The
Company continues to evaluate its deposit product offerings with the intention of continuing to expand its offerings to the consumer
and business depositors.
Noninterest Income
(Dollars in thousands)
For the Years Ended December 31,
2012
2011
(Amount)
(%)
(Amount)
(%)
1,173
424
240
1,312
3,149
37.3 % $
13.5 %
7.6 %
41.6 %
100.0 % $
1,120
432
104
1,095
2,751
40.7 %
15.7 %
3.8 %
39.8 %
100.0 %
610,021
$
572,903
0.5 %
0.5%
$
$
$
Service charges on deposit accounts
Earnings on cash surrender value of life insurance
Mortgaged commissions
Other income
Total
Average assets
Noninterest income as a % of average assets
Noninterest Expense
The following table sets forth a summary of noninterest expenses for the periods indicated:
Noninterest Expense
(Dollars in thousands)
For the Years Ended December 31,
2012
2011
(Amount)
(%)
(Amount)
(%)
Salaries and employee benefits
Occupancy expenses
Data processing fees
OREO expenses
Regulatory assessments (FDIC & DFI)
Other operating expenses
Total
Average assets
Noninterest expenses as a % of average assets
$
10,009
2,948
1,128
27
461
3,675
54.8 % $
16.2 %
6.2 %
0.1 %
2.5 %
20.2 %
9,326
2,829
1,016
389
642
3,192
18,248
100.0 % $
17,394
53.6%
16.3 %
5.8 %
2.2 %
3.7 %
18.4 %
100.0%
610,021
$
572,903
3.0 %
3.0%
$
$
30
Noninterest expense was $18,248,000 for the year ended December 31, 2012, an increase of $854,000 or 4.9% compared to
$17,394,000 for the year ended 2011.
Salaries and employee benefits increased by $683,000 in 2012 to $10,009,000 as a result of hiring staff for two new branches
opened in 2011 and additional stock based compensation expense corresponding to restricted stock awards issued to employees. The
two new branches also resulted in an increase of $119,000 in occupancy expenses in 2012 compared to 2011, primarily from building
lease expense and building depreciation, as one of the branches was leased and the other was purchased.
Data processing costs increased in 2012 over 2011 by $112,000, reflecting the additional costs that related to the increased
number of deposit accounts.
Other expenses recognized an increase in 2012 compared to 2011 of $483,000 due in part to a $75,000 insurance retention
accrual recorded in 2012, overhead expenses from our new branches and various costs associated with the expansion of products and
services.
OREO expenses decreased by $362,000 to $27,000 in 2012, compared to $389,000 in 2011. Included within these totals is a
gain on sale of an OREO property of $4,000 in 2012. There were no OREO write downs in 2012 compared to write downs of
$291,000 in 2011. The remaining expense included in OREO expenses is attributed to general overhead such as property taxes and
utilities associated with the properties classified as other real estate owned. There was one sale of an OREO property recorded in
2012 which reduced our OREO inventory from two properties as of December 31, 2011 to one property as of December 31, 2012.
The Company did not acquire any additional OREO during 2011 or 2012.
FDIC and DFI (California Department of Financial Institutions) regulatory assessments decreased by $181,000 to $461,000
in 2012 compared to $642,000 in 2011. The initial base assessment rate for financial institutions varies based on the overall risk
profile of the institution as defined by the FDIC. The decrease in 2012 is due to a lower base assessment rate as the Company has
improved its overall risk ratings. The decrease in expense was in spite of a higher deposit base in 2012 as compared to 2011, as the
FDIC assessment rates are applied to average quarterly total liabilities as the primary basis.
Management anticipates that noninterest expense will continue to increase as we continue to grow, even though management
also estimates that the Company’s administration as currently set up may be scalable to handle a larger deposit base of up to around
$1B in deposits. However, management remains committed to cost-control and efficiency, and we expect to keep these increases to a
minimum relative to growth.
Provision for Income Taxes
We reported a provision for income taxes of $2,814,000 and $3,176,000 for the years 2012 and 2011 respectively. The effective
income tax rate on income from continuing operations was 32.7% for the year ended December 31, 2012 compared to 35.1% for the
year 2011. These provisions reflect accruals for taxes at the applicable rates for federal income tax and California franchise tax based
upon reported pre-tax income, and adjusted for the effects of all permanent differences between income for tax and financial reporting
purposes (such as earnings on qualified municipal securities, BOLI and certain tax-exempt loans). The disparity between the effective
tax rates in 2012 as compared to 2011 is primarily due to tax credits from California Enterprise Zones and low income housing
projects as well as tax free-income on loans within these enterprise zones and municipal securities and loans that comprise a larger
proportion of pre-tax income in 2012 as compared to 2011. We have not been subject to an alternative minimum tax ("AMT") during
these periods.
Financial Condition
The Company’s total assets were $660.6 million at December 31, 2012 compared to $612.2 million at December 31, 2011, an
increase of $48.4 million or 7.9%. Net loans decreased $4.5 million, investments increased $14.2 million, bank premises and
equipment decreased $317,000 and interest receivable and other assets decreased $904,000, while cash and cash equivalents increased
$40.3 million for the year ended December 31, 2012 as compared to December 31, 2011.
Loans gross of the allowance for loan losses and deferred fees were $391.0 million at December 31, 2012, compared to $396.2
million at December 31, 2011, a decrease of $5.2 million or 1.3%. The decrease was primarily due to a decrease of $13.7 million or
4.2% in commercial real estate loans. This was offset by increases of $4.5 million in commercial and industrial loans, $2.6 million in
agriculture loans, and an increase of $1.3 million in consumer loans and consumer residential loans. The composition of the loan
31
portfolio categories remained relatively unchanged as a percentage of total loans, except for commercial real estate loans which
recognized the highest change from 83.3% at December 31, 2011 to 80.8% at December 31, 2012. This increase was offset by
moderate increases in all other loan categories.
Deposits increased $50.8 million or 9.5% to $587.0 million at December 31, 2012 compared to $536.2 million at December 31,
2011. Time deposits and Money Market deposits decreased by $1.9 million and $15.0 million, respectively, while Demand, NOW and
Savings each increased by $45.4 million, $11.0 million and $11.3 million, respectively, as of December 31, 2012 as compared to
December 31, 2011.
Short-term borrowings were fully paid off during 2012 to leave no outstanding balances at December 31, 2012, compared to $3.0
million at December 31, 2011. There was no long-term debt outstanding at December 31, 2012 and December 31, 2011. The decrease
in short-term borrowings was due to the deposit growth of $50.8 million. This allowed us to pay off matured FHLB advances thus
reducing our cost of funds and lowering our liquidity ratio, which has been running at a surplus in recent years. The Company uses
short-term borrowings, primarily short-term FHLB advances, to fund short-term liquidity needs and manage net interest margin.
Equity decreased $433,000 or 0.6% to $70.0 million at December 31, 2012, compared to $70.4 million at December 31, 2011.
The Company was selected to participate in the U.S. Treasury Capital Purchase Program (“TCPP”) which resulted in the issuance of
$13.5 million in preferred stock in December 2008. In August 2011, the Company repurchased these Series A preferred stock shares
and simultaneously issued $13,500,000 in Series B Preferred Stock to the U.S. Treasury under the Small Business Lending Funding
(“SBLF”) program. Subsequently, the Company fully redeemed a warrant to purchase 350,346 shares of its Common Stock, at the
exercise price of $5.78 per share that the Company had granted to the U.S. Treasury pursuant to the TCPP, for a purchase price of
$560,000, which settled in September 2011. In May 2012, the Company repurchased from the U.S. Treasury 6,750 shares of Series B
Preferred Stock for aggregate consideration of $6.75 million. Thereafter, in March 2013, the Company repurchased from the U.S.
Treasury the remaining 6,750 shares of Series B Preferred Stock for aggregate consideration of $6,817,500, reflecting $6,750,000 paid
for the repurchase, and $67,500 paid for accrued dividends. The securities issued to the Treasury were accounted for as components of
regulatory Tier 1 capital. See Notes 3 and 24 to the Consolidated Financial Statements in Item 8 of this report for further discussion
regarding our participation in the TCPP and SBLF.
Investment Activities
Investments are a key source of interest income. Management of our investment portfolio is set in accordance with
strategies developed and overseen by our Investment Committee. Investment balances, including cash equivalents and interest-bearing
deposits in other financial institutions, are subject to change over time based on our asset/liability funding needs and interest rate risk
management objectives. Our liquidity levels take into consideration anticipated future cash flows and all available sources of credits
and are maintained at levels management believes are appropriate to assure future flexibility in meeting anticipated funding needs.
Cash Equivalents and Interest-bearing Deposits in other Financial Institutions
The Company holds federal funds sold, unpledged available-for-sale securities and salable government guaranteed loans to
help meet liquidity requirements and provide temporary holdings until the funds can be otherwise deployed or invested. As of
December 31, 2012, and 2011, we had $10.5 million and $27.9 million, respectively, in federal funds sold.
Investment Securities
Management of our investment securities portfolio focuses on providing an adequate level of liquidity and establishing an
interest rate-sensitive position, while earning an adequate level of investment income without taking undue risk. Investment securities
that we intend to hold until maturity are classified as held-to-maturity securities, and all other investment securities are classified as
available-for-sale. Currently, all of our investment securities are classified as available-for-sale. The carrying values of available-for-
sale investment securities are adjusted for unrealized gains or losses as a valuation allowance and any gain or loss is reported on an
after-tax basis as a component of other comprehensive income.
Our investment securities holdings increased by $14.2 million, or 15.8%, to $103.9 million at December 31, 2012,
compared to holdings of $89.7 million at December 31, 2011. Total investment securities as a percentage of total assets increased to
15.7% as of December 31, 2012 compared to 14.7% at December 31, 2011. As of December 31, 2012, $56.5 million of the
investment securities were pledged to secure public deposits.
32
As of December 31, 2012, the total unrealized loss on securities that were in a loss position for less than 12 continuous
months was $99,000 with an aggregate fair value of $5,792,000. The total unrealized loss on securities that were in a loss position for
greater than 12 continuous months was $14,000 with an aggregate fair value of $1,281,000.
The following table summarizes the book value and market value and distribution of our investment securities as of the
dates indicated:
Investment Securities Portfolio
As of December 31, 2012
As of December 31, 2011
As of December 31, 2010
Amortized
Cost
Market
Value
Amortized
Cost
Market
Value
Amortized
Cost
Market
Value
$
52,608
$
55,518
$
52,102
$
54,809
$
28,679
$
30,190
11,698
25,323
1,178
4,669
2,875
12,604
26,992
1,178
4,706
2,868
11,366
15,660
1,236
2,000
2,759
12,095
16,972
1,237
1,814
2,768
7,947
9,871
1,517
0
2,631
8,137
10,800
1,506
0
2,635
Dollars in Thousands
Available-for-Sale:
U.S. agencies
Collateralized mortgage obligations
Municipalities
SBA Pools
Corporate debt
Mutual Fund
Total investment securities
$
98,351
$
103,866
$
85,123
$
89,695
$
50,645
$
53,268
At December 31, 2012, one SBA pool and one mutual fund make up the total amount of securities in an unrealized loss
position for greater than 12 months, and one U.S. agency, five municipalities and one corporate debt security make up the total
amount of securities in an unrealized loss position for less than 12 months. Management periodically evaluates each available-for-sale
investment security in an unrealized loss position to determine if the impairment is temporary or other than temporary. This
evaluation encompasses various factors including, the nature of the investment, the cause of the impairment, the severity and duration
of the impairment, credit ratings and other credit related factors such as third party guarantees and volatility of the security’s fair
value. Management has determined that no investment security is other than temporarily impaired. The unrealized losses are due
primarily to interest rate changes and the Bank does not intend to sell the securities and it is not likely that we will be required to sell
the securities before the earlier of the forecasted recovery or the maturity of the underlying investment security. As of December 31,
2012, we did not have any investment securities that constituted 10% or more of the stockholders’ equity of any third party issuer.
The following table summarizes the maturity and repricing schedule of our investment securities at their amortized cost and
their weighted average yields at December 31, 2012:
Investment Maturities and Repricing Schedule
(Dollars in Thousands)
Afte r O ne But
Afte r Five But
Within O ne Ye ar
Within Five Ye ar
Within Te n Ye ars
Afte r Te n Ye ars
Total
Amount
Yie ld
Amount
Yie ld
Amount
Yie ld
Amount
Yie ld
Amount
Yie ld
Available -for-sale :
Securities of U.S. government
agencies
Collateralized mortgage
obligations
$
9,668
1.02 % $
6,428
4.09 % $
9,432
4.24 % $ 27,080
3.17 % $ 52,608
3.08 %
0
0.00 %
0
0.00 %
0
0.00 %
11,698
3.32 %
11,698
3.32 %
Municipal securities
1,400
4.52 %
6,001
5.43 %
17,056
2.71 %
866
3.21 %
25,323
3.47 %
SBA Pools
Corporate debt
Mutual Fund
0
0
0
0.00 %
0
0.00 %
0.00 %
4,669
2.35 %
0.00 %
0
0.00 %
0
0
0
0.00 %
1,178
1.00 %
1,178
1.00 %
0.00 %
0
0.00 %
0.00 %
2,875
0.00 %
4,669
2,875
2.35 %
0.00 %
T otal Investment Securities
$ 11,068
1.46 % $ 17,098
3.45 % $ 26,488
3.67 % $ 43,697
2.88 % $ 98,351
3.03 %
33
Yields in the above table have not been adjusted to a fully tax equivalent basis.
Loans
The following table sets forth the amount of total loans outstanding (excluding unearned income) and the percentage distributions
in each category, as of the dates indicated.
YEARS ENDED DECEMBER 31,
2012
2011
2010
2009
2008
Commercial real estate
$
316,075
$
330,045
$
336,730
$
353,171 $
354,401
Commercial and industrial
Consumer
Consumer residential
Agriculture
Unearned income
36,529
1,096
25,659
11,628
(600)
32,018
1,213
23,871
9,056
(634)
30,756
1,242
21,844
13,622
(733)
38,160
1,351
20,117
12,828
(811)
Total Loans, net of unearned income
$
390,387
$
395,569
$
403,461
$
424,816 $
37,302
1,281
21,613
13,580
(1,035)
427,142
Participation loans sold and serviced by
the Bank
Commercial real estate:
Commercial and Industrial
Consumer
Consumer residential
Agriculture
Unearned income
Total Loans, net of unearned income
8,045
7,929
9,283
14,907
9,759
80.9%
83.5%
83.5%
83.1%
9.4%
0.3%
6.6%
3.0%
-0.2%
100.0%
8.1%
0.3%
6.0%
2.3%
-0.2%
100.0%
7.6%
0.3%
5.4%
3.4%
-0.2%
100.0%
9.0%
0.3%
4.7%
3.0%
-0.2%
100.0%
83.0%
8.7%
0.3%
5.1%
3.2%
-0.2%
100.0%
Commercial real estate loans decreased $14.0 million in 2012 as compared to 2011, as a result of the decline in demand by
qualified borrowers in our serving area. Of the commercial real estate loans at December 31, 2012, 64.2% are non-owner occupied and
35.8% are owner occupied. Our commercial real estate loan portfolio is weighted towards term loans for which the primary source of
repayment is cash flow from net operating income of the real estate property.
Commercial and industrial loans increased $4.5 million in 2012 as compared to 2011, as a result of our reassessment of the
commercial and industrial lending market, specifically asset-based lines of credit. We have historically targeted well-established local
businesses with strong guarantors that have proven to be resilient in periods of economic stress.
Our residential loan portfolio includes no sub-prime loans, nor is it our normal practice to underwrite loans commonly
referred to as "Alt-A mortgages", the characteristics of which are loans lacking full documentation, borrowers having low FICO scores
or collateral compositions reflecting high loan-to-value ratios. Substantially all of our residential loans are indexed to Treasury
Constant Maturity Rates and have provisions to reset five years after their origination dates.
34
The following table summarizes our commercial real estate loan portfolio by the geographic location in which the property
is located as of December 31, 2012 and 2011:
Commercial Real Estate Loans Outstanding by Geographic Location
$
Commercial real estate loans by
geographic location (County)
Stanislaus
San Joaquin
Tuolumne
Alameda
Mono
Sacramento
Merced
Fresno
Madera
Calaveras
Contra Costa
Marin
Inyo
Solano
Santa Clara
Tulare
Los Angeles
Other
Total
$
December 31, 2012
December 31, 2011
% of
Commercial
Real Estate
Loans
Amount
% of
Commercial
Real Estate
Loans
Amount
127,310
61,007
21,910
14,054
13,333
10,518
9,246
7,894
7,623
5,923
5,031
4,830
4,222
3,500
3,432
3,125
18
13,099
316,075
$
40.4%
19.3%
6.9%
4.4%
4.2%
3.3%
2.9%
2.5%
2.4%
1.9%
1.6%
1.5%
1.3%
1.1%
1.1%
1.0%
0.0%
4.2%
100.0%
$
140,679
60,607
23,763
14,346
14,363
11,055
7,568
8,333
7,235
6,715
5,934
3,890
9,234
0
3,674
3,503
23
9,123
330,045
42.6%
18.4%
7.2%
4.3%
4.4%
3.3%
2.3%
2.5%
2.2%
2.0%
1.8%
1.2%
2.8%
0.0%
1.1%
1.1%
0.0%
2.8%
100.0%
35
Construction and land loans are classified as commercial real estate loans and decreased $4.4 million in 2012 as compared to
2011, primarily due to the successful completion and sell-through of construction development projects booked in prior years, a slow
down in construction activity (primarily residential development), as well as a conscious effort to reduce our concentration in
construction loans. The table below shows an analysis of construction loans by type and location. Non-owner-occupied land loans of
$14.3 million at December 31, 2012 included loans for lands specified for commercial development of $5.9 million and for residential
development of $8.4 million, the majority of which are located in Stanislaus County.
(Dollars in Thousands)
December 31, 2012
December 31, 2011
$
$
$
Construction loans by type
Single family non-owner-occupied
Single family owner-occupied
Commercial non-owner-occupied
Commercial owner-occupied
Land non-owner-occupied
Total
Construction loans by
geographic location (County)
Stanislaus
San Joaquin
Mono
Merced
Inyo
Contra Costa
Madera
Calaveras
Tuolumne
Sutter
Tulare
Other
% of
Construction
Loans
Amount
% of
Construction
Loans
Amount
738
263
2,114
3,467
14,269
20,851
$
3.5%
1.3%
10.1%
16.6%
68.5%
100.0%
$
7,656
1,354
5,373
212
10,636
25,231
30.3%
5.4%
21.3%
0.8%
42.2%
100.0%
% of
Construction
Loans
Amount
% of
Construction
Loans
Amount
9,526
3,820
3,141
1,788
1,076
663
476
263
20
0
0
78
$
45.7%
18.3%
15.1%
8.6%
5.2%
3.2%
2.3%
1.2%
0.1%
0.0%
0.0%
0.3%
11,940
1,912
3,227
0
965
1,479
0
162
2,074
3,050
332
90
25,231
47.3%
7.6%
12.8%
0.0%
3.8%
5.9%
0.0%
0.6%
8.2%
12.1%
1.3%
0.4%
100.0%
Total
$
20,851
100.0%
$
36
Loan Maturities
The following table shows the contractual maturity distribution and repricing intervals of the outstanding loans in our
portfolio, as of December 31, 2012. In addition, the table shows the distribution of such loans between those with variable or floating
interest rates and those with fixed or predetermined interest rates. The large majority of the variable rate loans are tied to independent
indices (such as the Wall Street Journal prime rate or a Treasury Constant Maturity Rate). Substantially all loans with an original term
of more than five years have provisions for the fixed rates to reset, or convert to a variable rate, after one, three or five years.
(Dollars in thousands)
Commercial real estate
Commercial & Industrial
Consumer
Consumer Residential
Agriculture
Unearned income
Total loans, net of unearned income
Loans with variable (floating) interest rates
Loans with predetermined (fixed) interest rates
Loan Maturities and Repricing Schedule
At December 31, 2012
Within
One Year
After One
But Within
Five Years
After
Five Years
Total
$
$
$
$
69,491
24,449
492
5,488
9,374
(168)
109,126
95,090
14,036
$
191,509
$
9,231
543
8,353
1,294
(324)
210,606
170,928
39,678
$
$
$
$
$
$
55,075
2,849
61
11,818
960
(108)
70,655
35,079
35,576
$
316,075
36,529
1,096
25,659
11,628
(600)
390,387
301,097
89,290
$
$
$
The majority of the properties taken as collateral are located in Northern California. We employ strict guidelines regarding
the use of collateral located in less familiar market areas. The recent decline in Northern California real estate value is offset by the
low loan-to-value ratios in our commercial real estate portfolio and high percentage of owner-occupied properties.
Nonperforming Assets
Financial institutions generally have a certain level of exposure to credit quality risk, and could potentially receive less than
a full return of principal and interest if a debtor becomes unable or unwilling to repay. Since loans are the most significant assets of
the Company and generate the largest portion of its revenues, the Company's management of credit quality risk is focused primarily on
loan quality. Banks have generally suffered their most severe earnings declines as a result of customers' inability to generate sufficient
cash flow to service their debts and/or downturns in national and regional economies which have brought about declines in overall
property values. In addition, certain debt securities that the Company may purchase have the potential of declining in value if the
obligor's financial capacity to repay deteriorates.
Nonperforming assets consist of loans on non-accrual status, loans 90 days or more past due and still accruing interest,
loans restructured, where the terms of repayment have been renegotiated resulting in a reduction or deferral of interest or principal and
other real estate owned (“OREO”).
Loans are generally placed on non-accrual status when they become 90 days past due, unless management believes the loan
is adequately collateralized and in the process of collection. The past due loans may or may not be adequately collateralized, but
collection efforts are continuously pursued. Loans may be restructured by management when a borrower has experienced some
changes in financial status, causing an inability to meet the original repayment terms, and where we believe the borrower will
eventually overcome those circumstances and repay the loan in full. OREO consists of properties acquired by foreclosure or similar
means and which management intends to offer for sale.
The Company had nonperforming loans of $6.92 million at December 31, 2012, as compared to $7.23 million at
December 31, 2011, $11.48 million at December 31, 2010, $14.42 million at December 31, 2009, and $4.08 million at December 31,
37
2008. The ratio of nonperforming loans over total loans was 1.77%, 1.83%, 2.84%, 3.39% and 1.10% at December 31, 2012, 2011,
2010, 2009 and 2008, respectively.
In addition, the Company held one OREO property as of December 31, 2012, which consisted of residential land acquired
through foreclosure that was written down to a zero balance because the public utilities have not been obtainable rendering these land
lots unmarketable at this time. The Company held two properties with a market value of $0.2 million as of December 31, 2011 as
compared to three OREO properties with a market value of $0.8 million as of December 31, 2010, six properties with a market value
of $2.1 million as of December 31, 2009 and two properties with a market value of $2.7 million at December 31, 2008.
Management believes that the reserve provided for nonperforming loans, together with the tangible collateral, were
adequate as of December 31, 2012. See “Allowance for Loan Losses” below for further discussion. Except as disclosed above, as of
December 31, 2012, management was not aware of any material credit problems of borrowers that would cause it to have serious
doubts about the ability of a borrower to comply with the present loan payment terms. However, no assurance can be given that credit
problems may exist that may not have been brought to the attention of management, or that credit problems may arise.
38
The following table provides information with respect to the components of our nonperforming assets as of the dates
indicated. (The figures in the table are net of the portion guaranteed by the U.S. Government):
(Dollars in Thousands)
At December 31,
Nonperforming Assets
Nonaccrual loans(1)
Commercial real estate
Commercial and industrial
Consumer
Consumer residential
Agriculture
Total
2012
2011
2010
2009
2008
$
5,891
$
7,129
$
11,253
$
12,701
$
4,078
21
0
1,011
0
104
0
0
0
222
0
0
0
488
0
0
1,229
0
0
0
0
$
6,923
$
7,233
$
11,475
$
14,418
$
4,078
Loans 90 days or more past due and still accruing
(as to principal or interest):
Commercial real estate
Commercial and industrial
Consumer
Consumer residential
Agriculture
Total
$
$
0
0
0
0
0
0
$
0
0
0
0
0
0
$
0
0
0
0
0
0
0
0
0
0
0
0
Total nonperforming loans
6,923
7,233
11,475
14,418
Other real estate owned
Total nonperforming assets
Accruing restructured loans (2)
Commercial real estate
Commercial and industrial
Consumer
Consumer residential
Agriculture
Total
0
244
778
2,150
$
6,923
$
7,477
$
12,253
$
16,568
$
$
$
0
0
0
0
0
0
$
0
0
0
0
0
0
$
0
0
0
0
0
0
$
0
0
0
0
0
0
$
643
0
0
0
0
643
4,721
2,746
7,467
0
0
0
0
0
0
Total impaired loans
$
6,923
$
7,233
$
11,475
$
14,418
$
4,721
Nonperforming loans as a percentage of total loans
Nonperforming assets as a percentage of total loans
and other real estate owned
Allowance for loan losses as a percentage of
nonperforming loans
1.77%
1.77%
1.83%
1.89%
2.84%
3.03%
3.39%
3.88%
1.10%
1.74%
115.19%
119.03%
71.94%
48.69%
117.97%
(1) During the fiscal year ended December 31, 2012 and 2011, no interest income related to these loans was included in net income
while on nonaccrual status. Additional interest income of approximately $696,000 and $692,000 would have been recorded during the
year ended December 31, 2012 and 2011, respectively, if these loans had been paid in accordance with their original terms.
(2) A “restructured loan” is one the terms of which were renegotiated to provide a concession because of deterioration in the financial
position of the borrower.
39
Allowance for Loan Losses
In anticipation of credit risk inherent in our lending business, we set aside allowances through charges to earnings. Such
charges are not only made for the outstanding loan portfolio, but also for off-balance sheet items, such as commitments to extend
credits or letters of credit. The charges made for the outstanding loan portfolio are credited to the allowance for loan losses, whereas
charges for off-balance sheet items are credited to the reserve for off-balance sheet items, which is presented as a component of other
liabilities. The provision for loan losses is discussed in the section entitled “Provision for Loan Losses” above.
The balance of our allowance for loan losses is Management's best estimate of the remaining losses inherent in the
portfolio. The ultimate adequacy of the allowance is dependent upon a variety of factors beyond our control, including the real estate
market, changes in interest rate and economic and political environments.
Historically, over the past five years, due to the economic downturn’s effect on the financial stability of certain borrowers,
we set aside more reserves for probable loan losses. However, in 2012, amid signs of credit quality improvement, the allowance for
loan losses decreased by 7.4%, or $634,000, to $7.98 million at December 31, 2012 as compared with $8.61 million at December 31,
2011. Such allowances were $8.25 million, $7.02 million and $5.57 million at December 31, 2010, 2009 and 2008, respectively. In
2012, the allowance for loan losses as a percentage of total loans decreased corresponding to our improved credit quality and lower
non-accrual loan totals, as reflected in the ratios of 2.04%, 2.17%, 2.04%, 1.65% and 1.30%, at the end of 2012, 2011, 2010, 2009 and
2008, respectively. Based on the current conditions of the loan portfolio, management believes that the $7.98 million allowance for
loan losses at December 31, 2012 is adequate to absorb losses inherent in our loan portfolio. No assurance can be given, however, that
adverse economic conditions or other circumstances will not result in increased losses in the portfolio.
Diversification, low loan-to-values, strong credit quality and enhanced credit monitoring contribute to a reduction in the
portfolio’s overall risk, and help to offset the economic risk. The impact of the stagnant economic environment will continue to be
monitored, and adjustments to the provision for loan loss will be made accordingly. The weak business climate adversely impacted
the financial conditions of some of our clients and resulted in net loan charge-offs of $1,784,000, $1,146,000, $2,785,000, $4,411,000,
and $1,110,000 in 2012, 2011, 2010, 2009 and 2008, respectively.
Management reviews these conditions with our senior credit officers. To the extent that any of these conditions is evidenced
by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of
such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions
is not evidenced by a specific, identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of
the inherent loss related to such condition is reflected in the unallocated allowance. Although management has allocated a portion of
the allowance to specific loan categories, the adequacy of the allowance is considered in its entirety.
Although management believes the allowance at December 31, 2012 was adequate to absorb losses from any known and
inherent risks in the portfolio, no assurance can be given that economic conditions which adversely affect our service areas or other
variables will not result in increased losses in the loan portfolio in the future.
As of December 31, 2012, our allowance for loan losses consisted of amounts allocated to three phases of our methodology
for assessing loan loss allowances, as follows (see details of methodology for assessing allowance for loan losses in the section
entitled “Critical Accounting Policies”):
Phase of Methodology (Dollars in Thousands)
Specific review of individual loans
Review of pools of loans with similar characteristics
Judgmental estimate based on various subjective factors
Years Ended December 31,
2011
2010
2012
$
$
549
$
551
$
5,521
1,905
7,975
$
6,091
1,967
8,609
$
948
5,392
1,915
8,255
40
The Components of the Allowance for Loan Losses
As stated previously in "Critical Accounting Policies," the overall allowance consists of a specific allowance for individually
identified impaired loans, an allowance factor for categories of credits with similar characteristics and trends, and an allowance for
changing environmental factors.
The first component, the specific allowance, results from the analysis of identified problem credits and the evaluation of
sources of repayment including collateral, as applicable. Through Management's ongoing loan grading process, individual loans are
identified that have conditions that indicate the borrower may be unable to pay all amounts due under the contractual terms. These
loans are evaluated individually by Management and specified allowances for loan losses are established when the discounted cash
flows of future payments or collateral value of collateral-dependent loans are lower than the recorded investment in the loan.
Generally with problem credits that are collateral-dependent, we obtain appraisals of the collateral at least annually. We may obtain
appraisals more frequently if we believe the collateral value is subject to market volatility, if a specific event has occurred to the
collateral (e.g. tentative map has been filed), or if we believe foreclosure is imminent. Impaired loan balances decreased from $7.2
million at December 31, 2011 to $6.9 million at December 31, 2012. The specific allowance totaled $549,000 and $551,000 at
December 31, 2012 and 2011, respectively, as we charge off substantially all of our estimated losses related to specifically identified
impaired loans as the losses are identified.
The second component, the allowance factor, is an estimate of the probable inherent losses in each loan pool stratified by
major categories or loans with similar characteristics in our loan portfolio. This analysis encompasses segmenting and reviewing loan
grades by pool and current general economic and business conditions. Confirmation of the quality of our grading process is obtained
by independent reviews conducted by consultants specifically hired for this purpose and by various bank regulatory agencies. This
analysis covers our entire loan portfolio but excludes any loans that were analyzed individually for specific allowances as discussed
above. There are limitations to any credit risk grading process. The number of loans makes it impractical to review every loan every
quarter. Therefore, it is possible that in the future some currently performing loans not recently graded will not be as strong as their
last grading and an insufficient portion of the allowance will have been allocated to them. Grading and loan review often must be done
without knowing whether all relevant facts are at hand. Troubled borrowers may deliberately or inadvertently omit important
information from reports or conversations with lending officers regarding their financial condition and the diminished strength of
repayment sources.
The total amount allocated for the second component is determined by applying loss estimation factors to outstanding loans.
At December 31, 2012 and 2011, the allowance allocated by categories of credits totaled $5.5 million and $6.1 million, respectively.
The increase mainly related to increased allowance factors for land loans related to the construction of residential subdivisions,
commercial quick-qualifier loans and manufactured home loans, recognizing increased risk for these types of loans, as well as loan
growth.
The third component of the allowance for loan losses is an economic component that is not allocated to specific loans or
groups of loans, but rather is intended to absorb losses caused by portfolio trends, concentration of credit, growth, and economic
trends, as stated previously in "Critical Accounting Policies". At December 31, 2012 and 2011, the general valuation allowance,
including the economic component, totaled $1.9 million and $2.0 million, respectively. Starting in late 2008, we witnessed financial
difficulties experienced by borrowers in our market, where real estate sale prices have declined and holding periods have
increased. The U.S. economy is still experiencing significantly reduced business activity as a result of, among other factors,
disruptions in the financial system, dramatic declines in the housing prices, and an increasing unemployment rate. There have been
significant reductions in spending by consumers and businesses. In response to this, we have been proactive in evaluating reserve
percentages for economic and other qualitative loss factors used to determine the adequacy of the allowance for loan losses. The
increase to the third component of the allowance for loan losses reflected such evaluation.
41
The table below summarizes, for the periods indicated, loan balances at the end of each period, the daily averages during
the period, changes in the allowance for loan losses arising from loans charged off, recoveries on loans previously charged off,
additions to the allowance and certain ratios related to the allowance for loan losses:
Allowance for Loan Losses
(in thousands)
2012
2011
2010
2009
2008
Balances:
Average total loans outstanding during period
Total loans outstanding at end of period
Allowance for loan losses:
Balances at beginning of period
$
$
$
390,856
390,986
8,609
$
$
$
394,130
396,202
8,255
$
$
$
411,590
404,194
7,020
$
$
$
426,748
425,627
5,569
$
$
$
400,821
428,177
4,507
Actual charge-offs:
Commercial real estate
Commercial and Industrial
Consumer
Consumer Residential
Agriculture
Total charge-offs
Recoveries on loans previously charged off:
Commercial real estate
Commercial and Industrial
Consumer
Consumer Residential
Agriculture
Total recoveries
1,663
1,108
2,696
0
26
150
0
44
7
38
0
52
1
43
0
3,524
871
0
24
0
1,062
11
0
42
0
1,839
1,197
2,792
4,419
1,115
35
1
4
15
0
55
30
14
6
1
0
51
0
2
5
0
0
7
0
0
0
8
0
8
0
0
0
5
0
5
Net loan charge-offs/(recoveries)
1,784
1,146
2,785
4,411
1,110
Provision for loan losses
1,150
1,500
4,020
5,862
Reclassification of reserve related to off-balance-sheet
commitments
0
0
0
0
2,188
(16)
Balance at end of period
$
7,975
$
8,609
$
8,255
$
7,020
$
5,569
Ratios:
Net loan charge-offs/(recoveries) to average total loans
0.46%
0.29%
0.68%
1.03%
0.28%
Allowance for loan losses to total loans at end of period
2.04%
2.17%
2.04%
1.65%
1.30%
Net loan charge-offs (recoveries) to allowance for loan
losses at end of period
Net loan charge-offs (recoveries) to provision for loan
losses
22.37%
13.31%
33.74%
62.83%
19.93%
155.13%
76.40%
69.28%
75.25%
50.73%
42
The table below summarizes the allowance for loan loss balance by type of loan balance at the end of each period (See
“Loan Portfolio” above for a description of each type of loan balance):
Allocation of the Allowance for Loan Losses
Amount Outstanding as of December 31,
2012
2011
2010
(Dollars in Thousands)
2009
2008
Applicable to:
Commercial real estate
$
6,571
$
6,969
$
6,577
$
5,845
$
4,364
Commercial and Industrial
Consumer
Consumer Residential
Agriculture
Unallocated
Total Allowance
Other Earning Assets
474
50
384
286
210
606
65
348
363
258
686
61
375
153
403
649
44
202
142
138
732
34
193
127
119
$
7,975
$
8,609
$
8,255
$
7,020
$
5,569
For various business purposes, we make investments in earning assets other than the interest-earning securities discussed
above. Before 2007, the only other earning assets held by us were insignificant amounts of Federal Home Loan Bank stock, Federal
Reserve Bank stock and the cash surrender value on the Company Owned Life Insurances (“BOLI”).
During 2007, we invested in a low-income housing tax credit funds (“LIHTCF”) to promote our participation in CRA
activities. We committed to invest $1 million over a three year period, which was fully funded by the year 2009. We receive the
return in the form of tax credits and tax deductions which began in 2007 and are expected to continue through the year 2022. The $1
million contribution is being amortized to other expenses over a term of 15 years, commensurate with the benefits received.
The balances of other earning assets as of December 31, 2012 and December 31, 2011 were as follows:
Dollars in Thousands
Type
BOLI
LIHTCF
Federal Reserve Bank Stock
Federal Home Loan Bank Stock
Deposits and Other Sources of Funds
Deposits
Balance as of
December 31, 2012
Balance as of
December 31, 2011
$
$
$
$
11,680 $
575 $
758 $
2,372 $
11,256
636
1,162
2,832
Total deposits at December 31, 2012, and 2011 were $587.0 million, and $536.2 million, respectively, representing an
increase of $50.8 million or 9.5% in 2012. The average deposits for the years ended December 31, 2012 increased $41.1 million or
8.3% to $537.0 million compared to $495.9 million at December 31, 2011.
Deposits are the Company’s primary source of funds. Due to strategic emphasis by management, core deposits (based on
definition provided by FDIC’s Uniform Bank Performance Report) increased by 9.4% in 2012 to $574.5 million at December 31,
2012. The percentage of core deposits to total deposits remained flat at 97.9% at December 31, 2012 as compared to 98.0% at
December 31, 2011. The average rate paid on time deposits in denominations of $100,000 or more was 0.86% and 1.01% for the
years ended December 31, 2012 and 2011, respectively. The composition and cost of the Company's deposit base are important
43
components in analyzing the Company's net interest margin and balance sheet liquidity characteristics, both of which are discussed in
greater detail in other sections herein. See “Net Interest Income and Net Interest Margin” for further discussion.
The Company's liquidity is impacted by the volatility of deposits or other funding instruments or, in other words, by the
propensity of that money to leave the institution for rate-related or other reasons. Deposits can be adversely affected if economic
conditions in California and the Company's market area in particular, continue to weaken. Potentially, the most volatile deposits in a
financial institution are jumbo certificates of deposit, meaning time deposits with balances that equal or exceed $100,000, as
customers with balances of that magnitude are typically more rate-sensitive than customers with smaller balances
The following tables summarize the distribution of average daily deposits and the average daily rates paid for the periods
indicated:
Distribution of Average Daily Deposits
(Dollars in Thousands)
Dollars in Thousands
Demand
Money market
NOW
Savings
Time certificates of deposit of
$100,000 or more
Other time deposits
Total deposits
2012
2011
2010
Average
Balance
Average
Rate
Average
Balance
Average
Rate
Average
Balance
Average
Rate
$
133,674
0.00%
$
101,599
0.00%
$
76,820
249,652
68,454
26,238
37,150
21,822
0.21%
0.15%
0.22%
0.86%
0.61%
245,815
66,157
18,389
35,172
28,755
0.31%
0.20%
0.35%
1.01%
0.90%
212,621
59,617
14,963
42,352
33,383
$
536,990
0.21%
$
495,887
0.32%
$
439,756
0.00%
0.65%
0.31%
0.42%
1.20%
1.37%
0.58%
The scheduled maturities of our time deposits in denominations of $100,000 or greater at December 31, 2012 are, as
follows:
Maturities of Time Deposits of $100,000 or More
(Dollars in Thousands)
Three months or less
Over three months through six months
Over six months through twelve months
Over twelve months
Total
$
$
8,346
15,413
6,864
7,322
37,945
Because our client base is comprised primarily of commercial and industrial accounts, individual account balances are
generally higher than those of consumer-oriented banks. Eight of our clients carry deposit balances of more than 1% of our total
deposits, two of which had a deposit balance of more than 3% of total deposits at December 31, 2012.
The Company had $2.0 million and $1.4 million in brokered deposits as of December 31, 2012 and 2011, respectively. The
only brokered deposits the Company holds are from CDARS and ICS, a certificate of deposit and money market account program,
respectively, that exchanges funds with other network banks to offer full FDIC insurance coverage to the customer.
44
FHLB Borrowings
Although deposits are the primary source of funds for our lending and investment activities and for general business
purposes, we may obtain advances from the Federal Home Loan Bank of San Francisco (“FHLB”) as an alternative to retail deposit
funds. Our outstanding FHLB advances were fully paid off at year-end 2012 compared to $3.0 million outstanding as of year-end
2011. See “Liquidity Management” below for the details on the FHLB borrowings program.
The following table is a summary of FHLB borrowings for fiscal years 2012 and 2011:
Dollars in Thousands
Balance at year-end
Average balance during the year
Maximum amount outstanding at any month-end
Average interest rate during the year
Average interest rate at year-end
Return on Equity and Assets
$
$
$
2012
2011
0 $
467 $
3,000 $
0.99%
0.00%
3,000
6,479
8,000
1.05%
0.99%
The following table sets forth certain information regarding our return on equity and assets for the periods indicated:
Return on average assets
Return on average common equity
Dividend payout ratio
Equity to assets ratio
Deferred Compensation Obligations
At December 31, 2012
At December 31, 2011
0.95 %
8.80 %
0.00 %
10.59 %
1.02%
8.67%
0.00%
11.50%
We maintain a nonqualified, unfunded deferred compensation plan for certain key management personnel. Under this plan,
participating employees may defer compensation, which will entitle them to receive certain payments upon retirement, death, or
disability. The plan provides for payments commencing upon retirement and reduced benefits upon early retirement, disability, or
termination of employment. At December 31, 2012 and 2011, our aggregate payment obligations under this plan totaled $7.4 million
and $7.4 million, respectively.
Off-Balance Sheet Arrangements
During the ordinary course of business, we provide various forms of credit lines to meet the financing needs of our
customers. These commitments, which represent a credit risk to us, are not represented in any form on our balance sheets.
As of December 31, 2012, and 2011, we had commitments to extend credit of $42.2 million and $46.4 million,
respectively. Obligations under standby letters of credit were $0.5 million and $0.6 million, for 2012, and 2011, respectively, and
there were no obligations under commercial letters of credit for either period.
The effect on our revenues, expenses, cash flows and liquidity from the unused portion of the commitments to provide
credit cannot be reasonably predicted because there is no guarantee that the lines of credit will be used. For more information
regarding our off balance sheet arrangements, see Note 15- Commitments and Other Contingencies- to our 2012 year-end consolidated
financial statements located elsewhere in this report.
45
Contractual Obligations
The following chart summarizes certain contractual obligations of the Company as of December 31, 2012 (dollars in thousands):
Contractual Obligations
Operating lease obligations
Supplemental retirement plans
Time deposit maturities
Less than 1
Year
1-3 years
3-5 years
$
869 $
1,501 $
19
37,836
144
18,739
858
264
1,791
More than 5
years
$
1,623
$
1,373
0
Total
4,851
1,800
58,366
Total
$
38,724 $
20,384 $
2,913
$
2,996
$
65,017
As permitted or required under California law and to the maximum extent allowable under that law, we have certain
obligations to indemnify our current and former officers and directors for certain events or occurrences while the officer or director is,
or was serving, at our request in such capacity. These indemnification obligations are valid as long as the director or officer acted in
good faith and in a manner the person reasonably believed to be in, or not opposed to, our best interests, and with respect to any
criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful. The maximum potential amount of
future payments we could be required to make under these indemnification obligations is unlimited; however, we have a director and
officer insurance policy that mitigates our exposure and enables us to recover a portion of any future amounts paid. We believe the
estimated fair value of these indemnification obligations is minimal.
Liquidity and Asset/Liability Management
Management seeks to ascertain optimum and stable utilization of available assets and liabilities as a vehicle to attain our
overall business plans and objectives. In this regard, management focuses on measurement and control of liquidity risk, interest rate
risk and market risk, capital adequacy, operation risk and credit risk.
Liquidity
Liquidity to meet borrowers’ credit and depositors’ withdrawal demands is provided by maturing assets, short-term liquid assets
that can be converted to cash and the ability to attract funds from depositors. Additional sources of liquidity may include institutional
deposits, advances from the FHLB and other short-term borrowings, such as federal funds purchased.
Since our deposit growth strategy emphasizes core deposit growth we have avoided relying on brokered deposits as a consistent
source of funds. The only brokered deposit the Company holds are from CDARS and ICS, a certificate of deposit and money market
program, respectively, that exchanges funds with other network banks to offer full FDIC insurance coverage to the customer. The
Company had $2.0 million and $1.4 million in brokered deposits as of December 31, 2012 and 2011, respectively.
As a secondary source of liquidity, we rely on advances from the FHLB to supplement our supply of lendable funds and to meet
deposit withdrawal requirements. Advances from the FHLB are typically secured by a portion of our loan portfolio and stock issued
by the FHLB. The FHLB determines limitations on the amount of advances by assigning a percentage to each eligible loan category
that will count towards the borrowing capacity. At December 31, 2012, the Company had no FHLB advances outstanding as
compared to $3.0 million at December 31, 2011, which equaled 2% of our borrowing capacity. At December 31, 2012 and
December 31, 2011, the Company had sufficient collateral to borrow an additional $163.4 million and $130.3 million, respectively. In
addition, the Company had lines of credit with its correspondent banks to purchase overnight federal funds totaling $25 million at
December 31, 2012 and 2011. No advances were made on these lines of credit as of December 31, 2012 and December 31, 2011.
The Company’s liquidity depends primarily on dividends paid to it as sole shareholder of the Bank. The Bank’s ability to pay
dividends to the Company will depend on whether the Bank will be in a position to pay dividends based on regulatory requirements
and the performance of the Bank.
Maintenance of adequate liquidity requires that sufficient resources be available at all time to meet our cash flow
requirements. Liquidity in a banking institution is required primarily to provide for deposit withdrawals and the credit needs of its
customers and to take advantage of investment opportunities as they arise. Liquidity management involves our ability to convert assets
into cash or cash equivalents without incurring significant loss, and to raise cash or maintain funds without incurring excessive
additional cost. For this purpose, we maintain a portion of our funds in cash and cash equivalents, loans and securities available for
46
sale. Our liquid assets at December 31, 2012 and 2011 totaled approximately $200.1 million and $153.4 million, respectively. Our
liquidity level measured as the percentage of liquid assets to total assets was 30.3% and 25.1% at December 31, 2012, and 2011,
respectively.
Capital Resources and Capital Adequacy Requirements
In the past two years, our primary source of capital has been internally generated operating income through retained
earnings. At December 31, 2012, total shareholders’ equity decreased to $70.0 million, representing a decrease of $433,000 from
December 31, 2011. The decrease was due to the $6.75 million redemption of SBLF preferred stock as described below, which was
offset by the increase in retained earnings.
In December 2008, the Company was selected to participate in the U.S. Treasury Capital Purchase Program which
demonstrated the confidence the U.S. Treasury Department has in the stability of the Company. The Company issued $13.5 million in
Series A preferred stock. In August 2011, the Company repurchased these Series A preferred stock shares and simultaneously issued
$13,500,000 in Series B Preferred Stock to the U.S. Treasury under the Small Business Lending Funding (“SBLF”) program.
Subsequently, the Company fully redeemed a warrant to purchase 350,346 shares of its Common Stock, at the exercise price of $5.78
per share that the Company had granted to the U.S. Treasury pursuant to the TCPP, for a purchase price of $560,000, which settled in
September 2011. In May 2012, the Company repurchased from the U.S. Treasury 6,750 shares of Series B Preferred Stock for
aggregate consideration of $6.75 million. Thereafter, in March 2013, the Company repurchased from the U.S. Treasury the remaining
6,750 shares of Series B Preferred Stock for aggregate consideration of $6,817,500, reflecting $6,750,000 paid for the repurchase, and
$67,500 paid for accrued dividends. The securities issued to the Treasury were accounted for as components of regulatory Tier 1
capital. See Notes 3 and 24 to the Consolidated Financial Statements in Item 8 of this report for further discussion regarding our
participation in the TCPP and SBLF.
As of December 31, 2012, we had no material commitments for capital expenditures other than the Series B Preferred Stock
dividend payments due to the U.S. Treasury under the SBLF program.
We are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet
minimum capital requirements can trigger regulatory actions that could have a material adverse effect on our financial statements and
operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific
capital guidelines that rely on quantitative measures of our assets, liabilities and certain off-balance-sheet items as calculated under
regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors. (See “Description of Business-Regulation and Supervision-Capital Adequacy
Requirements” herein for exact definitions and regulatory capital requirements.)
As of December 31, 2012, we were qualified as a “well capitalized institution” under the regulatory framework for prompt
corrective action. The following table presents the regulatory standards for well-capitalized institutions, compared to the Bank’s
capital ratios as of the dates specified:
Total capital to risk-weighted assets
Tier I capital to risk-weighted assets
Tier I capital to average assets
Market Risk
Regulatory Well-
Capitalized Standards
December 31, 2012
December 31, 2011
10.0%
6.0%
5.0%
16.0 %
14.8 %
10.3 %
16.2%
14.9%
11.4%
Market risk is the risk of loss of future earnings, fair values, or future cash flows that may result from changes in the price
of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates, foreign currency
exchange rates, commodity prices, equity prices and other market changes that affect market risk sensitive instruments. Market risk is
attributed to all market risk sensitive financial instruments, including securities, loans, deposits and borrowings, as well as the
Company's role as a financial intermediary in customer-related transactions. The objective of market risk management is to avoid
excessive exposure of the Company's earnings and equity to loss and to reduce the volatility inherent in certain financial instruments.
47
Interest Rate Management
Market risk arises from changes in interest rates, exchange rates, commodity prices and equity prices. The Company's market
risk exposure is primarily that of interest rate risk, and it has established policies and procedures to monitor and limit earnings and
balance sheet exposure to changes in interest rates. The Company does not engage in the trading of financial instruments, nor does the
Company have exposure to currency exchange rates.
The principal objective of interest rate risk management (often referred to as "asset/liability management") is to manage the
financial components of the Company in a manner that will optimize the risk/reward equation for earnings and capital in relation to
changing interest rates. The Company's exposure to market risk is reviewed on a regular basis by the Asset/Liability Committee.
Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a
loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest
income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income. Management realizes
certain risks are inherent, and that the goal is to identify and manage the risks. Management uses two methodologies to manage
interest rate risk: (i) a standard GAP analysis; and (ii) an interest rate shock simulation model.
The planning of asset and liability maturities is an integral part of the management of an institution's net interest margin. To the
extent maturities of assets and liabilities do not match in a changing interest rate environment, the net interest margin may change over
time. Even with perfectly matched repricing of assets and liabilities, risks remain in the form of prepayment of loans or securities or in
the form of delays in the adjustment of rates of interest applying to either earning assets with floating rates or to interest bearing
liabilities. The Company has generally been able to control its exposure to changing interest rates by maintaining primarily floating
interest rate loans and a majority of its time certificates with relatively short maturities.
Interest rate changes do not affect all categories of assets and liabilities equally or at the same time. Varying interest rate
environments can create unexpected changes in prepayment levels of assets and liabilities, which may have a significant effect on the
net interest margin and are not reflected in the interest sensitivity analysis table. Because of these factors, an interest sensitivity gap
report may not provide a complete assessment of the exposure to changes in interest rates.
The Company uses modeling software for asset/liability management in order to simulate the effects of potential interest rate
changes on the Company's net interest margin, and to calculate the estimated fair values of the Company's financial instruments under
different interest rate scenarios. The program imports current balances, interest rates, maturity dates and repricing information for
individual financial instruments, and incorporates assumptions on the characteristics of embedded options along with pricing and
duration for new volumes to project the effects of a given interest rate change on the Company's interest income and interest expense.
Rate scenarios consisting of key rate and yield curve projections are run against the Company's investment, loan, deposit and
borrowed funds portfolios. These rate projections can be shocked (an immediate and parallel change in all base rates, up or down) and
ramped (an incremental increase or decrease in rates over a specified time period), based on current trends and econometric models or
stable economic conditions (unchanged from current actual levels).
The Company applies a market value ("MV") methodology to gauge its interest rate risk exposure as derived from its simulation
model. Generally, MV is the discounted present value of the difference between incoming cash flows on interest-earning assets and
other investments and outgoing cash flows on interest-bearing liabilities and other liabilities. The application of the methodology
attempts to quantify interest rate risk as the change in the MV which would result from a theoretical 200 basis point (1 basis point
equals 0.01%) change in market interest rates. Both a 200 basis point increase and a 200 basis point decrease in market rates are
considered.
At December 31, 2012, it was estimated that the Company's MV would decrease 19.01% in the event of an immediate 200 basis
point increase in market interest rates. The Company's MV at the same date would decrease 2.79% in the event of an immediate 200
basis point decrease in applicable interest rates.
48
Presented below, as of December 31, 2012 and 2011, is an analysis of the Company's interest rate risk as measured by changes in
MV for instantaneous and sustained parallel shifts of applicable interest rates:
December 31, 2012
December 31, 2011
Market Value as a % of
Present Value of Assets
Market Value as a % of
Present Value of Assets
$ Change
in
Market
Value
%
Change
in
Market
Value
MV
Ratio
Change
(bp)
$ Change
in
Market
Value
%
Change
in
Market
Value
MV
Ratio
Change
(bp)
(Dollars in Thousands)
Shock Scenario
+200 bp
+100 bp
0 bp
-100 bp
-200 bp
$
$
$
$
$
(13,843)
(7,963)
0
6,845
(2,034)
(19.01) %
(10.93) %
0.00 %
9.40 %
(2.79) %
9.18 %
9.86 %
10.77 %
11.51 %
10.28 %
(159)
(91)
0
74
(49)
$
$
$
$
$
(12,150)
(6,692)
0
9,306
2,813
(15.46) %
(8.52) %
0.00 %
11.84 %
3.58 %
11.14 %
11.80 %
12.55 %
13.70 %
12.70 %
(141)
(75)
0
115
15
Management believes that the MV methodology overcomes three shortcomings of the typical maturity gap methodology. First, it
does not use arbitrary repricing intervals and accounts for all expected future cash flows. Second, because the MV method projects
cash flows of each financial instrument under different interest rate environments, it can incorporate the effect of embedded options on
an institution's interest rate risk exposure. Third, it allows interest rates on different instruments to change by varying amounts in
response to a change in market interest rates, resulting in more accurate estimates of cash flows.
However, as with any method of gauging interest rate risk, there are certain shortcomings inherent to the MV methodology. The
model assumes interest rate changes are instantaneous parallel shifts in the yield curve. In reality, rate changes are rarely
instantaneous. The use of the simplifying assumption that short-term and long-term rates change by the same degree may also misstate
historic rate patterns, which rarely show parallel yield curve shifts. Further, the model assumes that certain assets and liabilities of
similar maturity or period to repricing will react in the same way to changes in rates. In reality, certain types of financial instruments
may react in advance of changes in market rates, while the reaction of other types of financial instruments may lag behind the change
in general market rates. When interest rates change, actual loan prepayments and actual early withdrawals from certificates may
deviate significantly from the assumptions used in the model. Finally, this methodology does not measure or reflect the impact that
higher rates may have on adjustable-rate loan clients' ability to service their debt. All of these factors are considered in monitoring the
Company's exposure to interest rate risk.
Impact of Inflation; Seasonality
Inflation primarily impacts us by its effect on interest rates. Our primary source of income is net interest income, which is
affected by changes in interest rates. We attempt to limit the impact of inflation on our net interest margin through management of
rate-sensitive assets and liabilities and the analysis of interest rate sensitivity. The effect of inflation on premises and equipment as
well as noninterest expenses has not been significant for the periods covered in this report. Our business is generally not seasonal.
49
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not required.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements and the Independent Auditors’ Report appear on pages F-1 through F-44 of this Report
and are incorporated into this Item 8 by reference.
INDEX TO FINANCIAL STATEMENTS
MANAGEMENT’S ASSESSMENT OF INTERNAL CONTROL OVER FINANCIAL REPORTING
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
CONSOLIDATED FINANCIAL STATEMENTS
Balance sheets
Statements of income
Statements of comprehensive income
Statements of shareholders’ equity
Statements of cash flows
Notes to financial statements
PAGE
F-1
F-2
F-3
F-4
F-5
F-6
F-7
F-9
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We conducted an evaluation under the supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, or persons performing similar functions, of the effectiveness of the design and
operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Exchange Act of 1934 (the
“Act”)) as of December 31, 2012. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that
our disclosure controls and procedures were effective as of December 31, 2012.
The term disclosure controls and procedures means controls and other procedures that are designed to ensure that information
required to be disclosed by us in the reports that we file or submit under the Act (15 U.S.C. 78a et seq.) is recorded, processed,
summarized and reported, within the time periods specified in the Commission's rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports
that we file or submit under the Act is accumulated and communicated to our Management, including our principal executive and
principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required
disclosure.
There are inherent limitations to the effectiveness of any system of disclosure controls and procedures. These limitations
include the possibility of human error, the circumvention or overriding of the controls and procedures and reasonable resource
constraints. In addition, because we have designed our system of controls based on certain assumptions, which we believe are
reasonable, about the likelihood of future events, our system of controls may not achieve its desired purpose under all possible future
50
conditions. Accordingly, our disclosure controls and procedures provide reasonable assurance, but not absolute assurance, of
achieving their objectives.
Management's Annual Report on Internal Control over Financial Reporting
Our Management’s report on Internal Control over Financial Reporting is set forth in Item 8 and is incorporated herein by
reference.
Our internal control over financial reporting is designed to provide reasonable, but not absolute, assurance regarding the
financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles. There are
inherent limitations to the effectiveness of any system of internal control over financial reporting. These limitations include the
possibility of human error, the circumvention of overriding of the system and reasonable resource constraints. Because of its inherent
limitations, our internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of
controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in
conditions or deterioration in the degree of compliance with policies or procedures.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm
regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent
registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide
only management’s report in this annual report.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting that occurred during the quarter ended December 31, 2012
that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
51
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
PART III
The information required by this Item is incorporated by reference from our Proxy Statement to be filed prior to the 2013 Annual
Meeting of Shareholders. The Company and the Company have adopted a Code of Ethics that applies to all staff including the Chief
Executive Officer, and the Chief Financial Officer. A copy of the Code of Ethics will be provided to any person, without charge, upon
written request to Corporate Secretary, Oak Valley Bancorp, 125 North Third Avenue, Oakdale, CA 95361.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires the Company’s officers and directors, and persons who own more than
10% of a registered class of the Company’s equity securities, to file reports of ownership and changes in ownership with the FDIC.
Officers, directors and greater than 10% shareholders are required by SEC regulations to furnish the Company with copies of all
Section 16(a) forms they file.
Based solely on its review of the copies of such forms received by it, or written representations from certain reporting persons that no
Forms 4 and 5 were required for those persons, the Company believes that for the 2012 fiscal year the officers and directors of the
Company complied with all applicable filing requirements, except for the two directors named in the table below:
Name
Transaction Type
Transaction Date
# of Shares
Jay Gilbert
Jay Gilbert
Jay Gilbert
Jay Gilbert
Jay Gilbert
Jay Gilbert
Daniel Leonard
Daniel Leonard
Sold
Purchased
Purchased
Purchased
Sold
Purchased
Purchased
Purchased
May 25, 2012
November 15, 2012
November 16, 2012
November 19, 2012
November 19, 2012
November 26, 2012
May 25, 2012
May 25, 2012
7,000
2,587
765
1,757
3,095
200
1,000
447
ITEM 11.
EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference from our Proxy Statement to be filed prior to the 2013 Annual
Meeting of Shareholders.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
The information required by this Item is incorporated by reference from our Proxy Statement to be filed prior to the 2013 Annual
Meeting of Shareholders.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated by reference from our Proxy Statement to be filed prior to the 2013 Annual
Meeting of Shareholders.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is incorporated by reference from our Proxy Statement to be filed prior to the 2013 Annual
Meeting of Shareholders.
52
ITEM 15 — EXHIBITS, FINANCIAL STATEMENT SCHEDULES
PART IV
Documents Filed as Part of this Report:
(a)(1) Financial Statements
The Financial Statements of the Company and the Report of Independent Registered Public Accounting Firm are set forth on
pages F-1 through F-44.
(a)(2) Financial Statement Schedules
All schedules to the Financial Statements are omitted because of the absence of the conditions under which they are required or
because the required information is included in the Financial Statements or accompanying notes.
(a)(3) Exhibits
The exhibit list required by this Item is incorporated by reference to the Exhibit Index included in this report. The warranties,
representations and covenants contained in any of the agreements included herein or which appear as exhibits hereto should not be
relied upon by buyers, sellers or holders of the Company’s securities and are not intended as warranties, representations or covenants
to any individual or entity except as specifically set forth in such agreement
53
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Oakdale, California on March 28, 2013.
SIGNATURES
OAK VALLEY BANCORP
a California corporation
By: /s/ RONALD C. MARTIN
Ronald C. Martin, Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities and on the date indicated.
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned officers and directors of the registrant hereby constitutes
and appoints Ronald C. Martin and Richard A. McCarty, and each of them, as lawful attorney-in-fact and agent for each of the
undersigned (with full power of substitution and resubstitution, for and in the name, place and stead of each of the undersigned
officers and directors), to sign and file with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as
amended, any and all amendments, supplements and exhibits to this report and any and all other documents in connection therewith,
hereby granting unto said attorneys-in-fact, and each of them, full power and authority to do and perform each and every act and thing
necessary or desirable to be done in order to effectuate the same as fully and to all intents and purposes as each of the undersigned
might or could do if personally present, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or
any of their substitutes, may do or cause to be done by virtue hereof.
Signature
Title
/s/ DONALD L. BARTON
Donald Barton
/s/ CHRISTOPHER M. COURTNEY
Christopher M. Courtney
/s/ JAMES L. GILBERT
James L. Gilbert
/s/ THOMAS A. HAIDLEN
Thomas A. Haidlen
/s/ MICHAEL Q. JONES
Michael Q. Jones
/s/ DANIEL J. LEONARD
Daniel J. Leonard
/s/ RONALD C. MARTIN
Ronald C. Martin
/s/ ROGER M. SCHRIMP
Roger M. Schrimp
/s/ DANNY L. TITUS
Danny L. Titus
/s/ RICHARD J. VAUGHAN
Richard J. Vaughan
Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
54
Date
March 26, 2013
March 26, 2013
March 26, 2013
March 26, 2013
March 26, 2013
March 26, 2013
March 26, 2013
March 26, 2013
March 26, 2013
March 26, 2013
MANAGEMENT’S ASSESSMENT OF INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting.
The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s Chief
Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of the Company’s financial statements for external purposes in accordance with U.S. generally accepted accounting
principles.
As of December 31, 2012, management assessed the effectiveness of the Company’s internal control over financial reporting based on
the criteria for effective internal control over financial reporting established in Internal Control — Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) and guidance issued by the Securities and Exchange
Commission. Based on the assessment, management determined that the Company maintained effective internal control over financial
reporting as of December 31, 2012, based on those criteria.
The Company’s management, including its Chief Executive Officer and Chief Financial Officer, does not expect that its disclosure
controls and procedures, or its internal controls will prevent all error and all fraud. A control system, no matter how well conceived
and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the
design of a control system must reflect the fact that there are resource constraints and the benefit of controls must be considered
relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute
assurance that all control issues and instances of fraud, if any, within the Company have been detected.
/s/ RONALD C. MARTIN______________________
Ronald C. Martin, Chief Executive Officer
/s/ RICHARD A. MCCARTY
Richard A. McCarty, Chief Financial Officer
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Oak Valley Bancorp
We have audited the accompanying consolidated balance sheets of Oak Valley Bancorp and subsidiary (the “Company”) as of
December 31, 2012 and 2011 and the related consolidated statements of income, comprehensive income, shareholders’ equity, and
cash flows for the years ended December 31, 2012 and 2011. These consolidated financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also
includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial
position of Oak Valley Bancorp and subsidiary as of December 31, 2012 and 2011, and the consolidated results of their operations and
their cash flows for the years ended December 31, 2012 and 2011 in conformity with accounting principles generally accepted in the
United States of America.
/s/ Moss Adams LLP
Stockton, California
March 28, 2013
F-2
OAK VALLEY BANCORP
CONSOLIDATED BALANCE SHEETS
ASSETS
Cash and due from banks
Federal funds sold
Cash and cash equivalents
Securities available for sale
Loans, net of allowance for loan loss of $7,974,975 and $8,609,174
at December 31, 2012 and 2011, respectively
Bank premises and equipment, net
Other real estate owned
Interest receivable and other assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Federal Home Loan Bank advances
Interest payable and other liabilities
Total liabilities
Commitments and contingencies
$
$
$
December 31,
2012
December 31,
2011
130,799,998 $
10,535,000
141,334,998
73,189,775
27,895,000
101,084,775
103,865,881
89,694,859
382,411,361
13,182,451
0
19,786,065
386,958,076
13,499,285
244,375
20,690,288
660,580,756 $
612,171,658
586,992,650 $
0
3,619,382
590,612,032
536,204,003
3,000,000
2,565,649
541,769,652
Shareholders’ equity
Series B Preferred stock, no par value; $1,000 per share liquidation
preference, 10,000,000 shares authorized, 6,750 and 13,500 shares issued
and outstanding at December 31, 2012 and 2011, respectively
Common stock, no par value; 50,000,000 shares authorized,
7,907,780 and 7,718,469 shares issued and outstanding at
December 31, 2012 and 2011, respectively
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income, net of tax
6,750,000
13,500,000
23,673,210
2,341,814
33,958,737
3,244,963
23,453,443
2,128,700
28,629,757
2,690,106
Total shareholders’ equity
69,968,724
70,402,006
$
660,580,756 $
612,171,658
See accompanying notes
F-3
OAK VALLEY BANCORP
CONSOLIDATED STATEMENTS OF INCOME
INTEREST INCOME
Interest and fees on loans
Interest on securities available for sale
Interest on federal funds sold
Interest on deposits with banks
Total interest income
INTEREST EXPENSE
Deposits
FHLB advances
Federal funds purchased
Total interest expense
Net interest income
PROVISION FOR LOAN LOSSES
YEAR ENDED DECEMBER 31,
2011
2012
$ 22,449,274
3,368,924
28,565
135,260
25,982,023
$ 23,608,833
3,076,575
41,884
100,249
26,827,541
1,132,513
4,707
-
1,137,220
1,579,877
68,081
51
1,648,009
24,844,803
1,150,000
25,179,532
1,500,000
Net interest income after provision for loan losses
23,694,803
23,679,532
OTHER INCOME
Service charges on deposits
Earnings on cash surrender value of life insurance
Mortgage commissions
Other
Total non-interest income
OTHER EXPENSES
Salaries and employee benefits
Occupancy expenses
Data processing fees
OREO expenses
Regulatory assessments (FDIC & DFI)
Other operating expenses
Total non-interest expense
1,173,088
423,757
239,538
1,312,294
3,148,677
1,120,035
432,234
103,935
1,094,930
2,751,134
10,008,829
2,947,769
1,128,377
26,949
461,000
3,675,545
18,248,469
9,325,812
2,829,468
1,016,132
389,124
642,000
3,191,229
17,393,765
Net income before provision for income taxes
8,595,011
9,036,901
PROVISION FOR INCOME TAXES
NET INCOME
2,814,156
3,176,306
$ 5,780,855
$ 5,860,595
Preferred stock dividends and accretion
451,875
1,161,056
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS
$ 5,328,980
$ 4,699,539
NET INCOME PER COMMON SHARE
$ 0.69
$ 0.61
NET INCOME PER DILUTED COMMON SHARE
$ 0.69
$ 0.61
See accompanying notes
F-4
OAK VALLEY BANCORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Net income
Available for sale securities:
Gross unrealized gain arising during the year
Reclassification adjustment for gains realized in net income
Income tax expense
Other comprehensive income
Comprehensive income
See accompanying notes
YEAR ENDED DECEMBER 31,
2012
2011
$
5,780,855
$
5,860,595
1,034,532
(91,700)
(387,975)
554,857
2,029,446
(81,184)
(801,710)
1,146,552
$
6,335,712
$
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S
OAK VALLEY BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income
Adjustments to reconcile net earnings to net cash from operating activities:
Provision for loan losses
Decrease in deferred fees/costs, net
Depreciation
Amortization of investment securities, net
Stock based compensation
Excess tax benefits from stock-based payment arrangements
Gain on sale of premises and equipment
OREO write downs and (gain)/losses on sale
Gain on called available for sale securities
Earnings on cash surrender value of life insurance
(Increase) decrease in deferred tax asset
Increase (decrease) in interest payable and other liabilities
Decrease (increase) in interest receivable
Decrease in other assets
Net cash from operating activities
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of available for sale securities
Proceeds from maturities, calls, and principal
paydowns of securities available for sale
Net decrease in loans
Purchase of FRB Stock
Redemption of FRB Stock
Redemption of FHLB stock
Proceeds from sale of OREO
Proceeds from sales of premises and equipment
Net purchases of premises and equipment
YEARS ENDED DECEMBER 31,
2012
2011
$
5,780,855 $
5,860,595
1,150,000
(34,582)
1,138,185
241,862
175,896
(37,218)
(22,498)
(3,548)
(91,700)
(423,757)
(100,825)
1,053,733
48,983
165,015
9,040,401
1,500,000
(98,579)
998,014
36,407
48,482
0
0
290,609
(81,184)
(432,234)
205,224
(434,187)
(61,595)
2,283,773
10,115,325
(43,742,857)
(54,574,719)
30,364,505
3,431,297
(1,450)
405,000
460,500
247,923
22,498
(821,351)
20,140,881
6,846,711
(2,450)
0
548,600
243,190
450
(4,323,927)
Net cash (used in) investing activities
(9,633,935)
(31,121,264)
CASH FLOWS FROM FINANCING ACTIVITIES:
FHLB payments
Repurchase of Series A Preferred Stock
Proceeds from Series B Preferred Stock issued
Preferred stock dividend payment
Payment to repurchase U.S. Treasury Warrant
Repurchase of Series B preferred stock
Net increase in demand deposits and savings accounts
Net decrease in time deposits
Excess tax benefits from stock-based payment arrangements
Proceeds from sale of common stock and exercise of stock options
Net cash from financing activities
(3,000,000)
0
0
(451,875)
0
(6,750,000)
52,690,752
(1,902,105)
37,218
219,767
40,843,757
(5,000,000)
(13,500,000)
13,500,000
(761,249)
(560,000)
0
72,401,862
(12,936,709)
0
9,894
53,153,798
NET INCREASE IN CASH AND CASH EQUIVALENTS
40,250,223
32,147,859
CASH AND CASH EQUIVALENTS, beginning of period
101,084,775
68,936,916
F-7
CASH AND CASH EQUIVALENTS, end of period
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest
Income taxes
NON-CASH INVESTING ACTIVITIES:
Change in unrealized gain on available-for-sale securities
NON-CASH FINANCING ACTIVITIES:
Accretion of preferred stock
$
$
$
$
$
141,334,998 $
101,084,775
1,198,534 $
1,745,000 $
1,686,014
3,961,119
942,832 $
1,948,262
0 $
486,055
See accompanying notes
F-8
OAK VALLEY BANCORP
NOTES TO FINANCIAL STATEMENTS
NOTE 1 — SUMMARY OF ACCOUNTING POLICIES
Introductory Explanation
On July 3, 2008 (the “Effective Date”), a bank holding company reorganization was completed whereby Oak Valley Bancorp
(“Bancorp”) became the parent holding company for Oak Valley Community Bank ( the “Bank”). On the Effective Date, a tax-free
exchange was completed whereby each outstanding share of the Company was converted into one share of Bancorp and the Company
became the sole wholly-owned subsidiary of the holding company.
The consolidated financial statements include the accounts of Bancorp and its wholly-owned bank subsidiary. All material
intercompany transactions have been eliminated. In the opinion of Management, the consolidated financial statements contain all
adjustments necessary to present fairly the financial position, results of operations, changes in shareholders’ equity and cash
flows. All adjustments are of a normal, recurring nature.
Oak Valley Community Bank is a California State chartered bank. The Company was incorporated under the laws of the state of
California on May 31, 1990, and began operations in Oakdale on May 28, 1991. The Company operates branches in Oakdale, Sonora,
Bridgeport, Bishop, Mammoth Lakes, Modesto, Manteca, Patterson, Turlock, Ripon, Stockton, and Escalon, California. The
Bridgeport, Mammoth Lakes, and Bishop branches operate as a separate division, Eastern Sierra Community Bank. The Company’s
primary source of revenue is providing loans to customers who are predominantly middle-market businesses.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions. 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.
Significant accounting estimates reflected in the Company’s consolidated financial statements include the allowance for loan losses,
accounting for income taxes, other-than-temporary impairment of investment securities, the fair value of stock options, the fair value
measurements and the determination, deferred compensation plans, recognition and measurement of impaired loans. Actual results
could differ from these estimates.
A summary of the significant accounting policies applied in the preparation of the accompanying consolidated financial statements
follows.
Cash and cash equivalents — The Company has defined cash and cash equivalents to include cash, due from banks, certificates of
deposit with maturities of three months or less, and federal funds sold. Generally, federal funds are sold for one-day periods. At times
throughout the year, balances can exceed FDIC insurance limits. Management believes the risk of loss is remote as these amounts are
held by major financial institutions and management monitors their financial condition.
Securities available for sale — Available-for-sale securities consist of bonds, notes, and debentures not classified as trading
securities or held-to-maturity securities. Available-for-sale securities with unrealized holding gains and losses, net of tax, are reported
as a net amount in a separate component of shareholders’ equity, accumulated other comprehensive income, until realized. Gains and
losses on the sale of available-for-sale securities are determined using the specific identification method. The amortization of
premiums and accretion of discounts are recognized as adjustments to interest income over the period to maturity.
Investments with fair values that are less than amortized cost are considered impaired. Impairment may result from either a decline in
the financial condition of the issuing entity or, in the case of fixed interest rate investments, from rising interest rates. At each
consolidated financial statement date, management assesses each investment to determine if impaired investments are temporarily
impaired or if the impairment is other than temporary. This assessment includes a determination of whether the Company intends to
sell the security, or if it is more likely than not that the Company will be required to sell the security before recovery of its amortized
cost basis less any current-period credit losses. For debt securities that are considered other than temporarily impaired and that the
Company does not intend to sell and will not be required to sell prior to recovery of the amortized cost basis, the amount of
impairment is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The
credit loss component is recognized in earnings and is calculated as the difference between the security’s amortized cost basis and the
present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of the
future expected cash flows is deemed to be due to factors that are not credit related and is recognized in other comprehensive income.
Other real estate owned — Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially
F-9
recorded at fair value of the property at the date of foreclosure less estimated selling costs. Subsequent to foreclosure, valuations are
periodically performed and any subject revisions in the estimate of fair value are reported as adjustment to the carrying value of the
real estate, provided the adjusted carrying amount does not exceed the original amount at foreclosure. Revenues and expenses from
operations and changes in the valuation allowance are included in other operating expenses.
Loans and allowance for loan losses — Loans are reported at the principal amount outstanding, net of unearned income, deferred
loan fees, and the allowance for loan losses. Unearned discounts on installment loans are recognized as income over the terms of the
loans. Interest on other loans is calculated by using the simple interest method on the daily balance of the principal amount
outstanding.
Loan fees net of certain direct costs of origination are deferred and amortized, as an adjustment to interest yield, over the estimated life
of the loan.
Loans on which the accrual of interest has been discontinued are designated as non-accrual 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 ninety days or more with respect to interest or principal. When a loan is placed on non-accrual 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 only when they are brought fully current with respect to interest and principal and when, in the judgment of
management, the loans are estimated to be fully collectible as to both principal and interest.
The allowance for loan losses is established through a provision for loan losses charged to operations. Loans are charged against the
allowance for loan losses when management believes that the collectability of the principal is unlikely. Subsequent recoveries of
previously charged off amounts, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based on management’s periodic review of the
collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may
affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This
evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes
available.
In addition, various 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 additional allowance based on their judgment about information
available to them at the time of their examination.
The allowance consists of specific, general, and unallocated components. The specific component relates to loans that are classified as
impaired. Impaired loans, as defined, are measured based on the present value of expected future cash flows discounted at the loan’s
effective interest rate or the fair value of the collateral if the loan is collateral dependent. The general component relates to non-
impaired loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to
cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects
the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses
in the portfolio.
The Company considers a loan impaired when it is probable that all amounts of principal and interest due, according to the contractual
terms of the loan agreement, will not be collected. Interest income is recognized on impaired loans in the same manner as non-accrual
loans. Factors considered by management in determining impairment include payment status, collateral value, and the probability of
collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment
shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls
on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length
of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal
and interest owed.
The method for calculating the allowance for unfunded loan commitments is based on an allowance percentage which is less than
other outstanding loan types because they are at a lower risk level. This allowance percentage is evaluated by management
periodically and is applied to the total undisbursed loan commitment balance to calculate the allowance for off-balance-sheet
commitments.
The Company considers a loan to be a troubled debt restructure (“TDR”) when the Company has granted a concession and the
borrower is experiencing financial difficulty. In order to determine whether a borrower is experiencing financial difficulty, an
evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future
F-10
without the modification. This evaluation is performed under the Company’s internal underwriting policy. A TDR loan is kept on
non-accrual status until the borrower has paid for six consecutive months with no payment defaults, at which time the TDR is placed
back on accrual status.
Premises and equipment — Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation
and amortization are provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated
service lives using the straight-line basis. The estimated lives used in determining depreciation are:
Building
Equipment
31.5
years
3 – 12 years
Furniture and fixtures
3 – 7 years
Leasehold improvements
5 – 15 years
Automobiles
3 – 5 years
Leasehold improvements are amortized over the lesser of the useful life of the asset or the remaining term of the lease. The straight-
line method of depreciation is followed for all assets for financial reporting purposes, but accelerated methods are used for tax
purposes. Deferred income taxes have been provided for the resulting temporary differences.
Income taxes — Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax
basis of the Company’s assets and liabilities. Deferred tax assets and liabilities are reflected at currently enacted income tax rates
applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled using the liability method.
As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
The Company files income tax returns in the U.S. federal jurisdiction, and the state of California. With few exceptions, the Company
is no longer subject to U.S. federal or state/local income tax examinations by tax authorities for years before 2008.
Transfers of financial assets — Transfers of financial assets are accounted for as sales when control over the assets has been
surrendered. Control over transferred assets is deemed to be surrendered when: (1) the assets have been isolated from the Company,
(2) the transferee obtains the right (free of conditions that contain it from taking advantage of that right) to pledge or exchange the
transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to
repurchase them before their maturity.
Advertising costs — The Company expenses marketing costs as they are incurred. Advertising expense was $166,000 and $160,000
for the years ended December 31, 2012 and 2011, respectively.
Comprehensive income — Comprehensive income is comprised of net income and other comprehensive income. Other
comprehensive income includes items previously recorded directly to equity, such as unrealized gains and losses on securities
available for sale. Comprehensive income is presented in the statements of comprehensive income and as a component of
shareholders’ equity. For the years ended December 31, 2012 and 2011, $54,000 and $48,000 net of tax, respectively, was reclassified
from comprehensive income into net income related to gains on called available for sale securities.
Investment in limited partnership — During 2007 the Company acquired limited interests in a private limited partnership that
acquires affordable housing properties in California that generate Low Income Housing Tax Credits under Section 42 of the Internal
Revenue Code of 1986, as amended. The Company’s limited partnership investment is accounted for under the equity method. The
Company’s noninterest expense associated with the utilization of these tax credits for the year ended December 31, 2012 and 2011
was $64,000 and $67,000, respectively. The limited partnership investment is expected to generate a total tax benefit of
approximately $1.16 million over the life of the investment for the combination of the tax credits and deductions on noninterest
expense. The tax credits expire between 2013 and 2022. In 2011, a tax benefit of $98,000 was utilized for income tax purposes and
an estimated amount of $90,000 will be utilized in 2012. The recorded investment in limited partnerships totaled $575,000 and
$636,000 at December 31, 2012 and 2011, respectively, and is reflected as a component of interest receivable and other assets on the
consolidated balance sheets.
Federal Reserve Bank Stock — Federal Reserve Bank stock represents the Company’s investment in the stock of the Federal Reserve
Bank (“FRB”) and is carried at par value, which reasonably approximates its fair value. While technically these are considered equity
securities, there is no market for the FRB stock. Therefore, the shares are considered as restricted investment securities. Management
periodically evaluates FRB stock for other-than-temporary impairment. Management’s determination of whether these investments are
impaired is based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. The
F-11
determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (1) the significance of any
decline in net assets of the FRB as compared to the capital stock amount for the FRB and the length of time this situation has persisted,
(2) commitments by the FRB to make payments required by law or regulation and the level of such payments in relation to the operating
performance of the FRB, (3) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FRB,
and (4) the liquidity position of the FRB. This investment is reflected as a component of interest receivable and other assets on the
consolidated balance sheets.
Federal Home Loan Bank Stock — Federal Home Loan Bank stock represents the Company’s investment in the stock of the Federal
Home Loan Bank of San Francisco (“FHLB”) and is carried at par value, which reasonably approximates its fair value. While technically
these are considered equity securities, there is no market for the FHLB stock. Therefore, the shares are considered as restricted investment
securities. Management periodically evaluates FHLB stock for other-than-temporary impairment. Management’s determination of whether
these investments are impaired is based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines
in value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (1) the
significance of any decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this
situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in
relation to the operating performance of the FHLB, (3) the impact of legislative and regulatory changes on institutions and, accordingly, the
customer base of the FHLB, and (4) the liquidity position of the FHLB. This investment is reflected as a component of interest receivable and
other assets on the consolidated balance sheets.
Earnings per share (“EPS”) — EPS is based upon the weighted average number of common shares outstanding during each year.
The table in footnote 14 shows: (1) weighted average basic shares, (2) effect of dilutive securities related to stock options and non-
vested restricted stock, and (3) weighted average diluted shares. Net income available to common shareholders is calculated as net
income reduced by dividends accumulated on preferred stock. Basic EPS are calculated by dividing net income available to common
stockholders by the weighted average number of common shares outstanding during each period, excluding unvested restricted stock
awards. Diluted EPS are calculated using the weighted average diluted shares. The total dilutive shares included in annual diluted EPS
is a year-to-date weighted average of the total dilutive shares included in each quarterly diluted EPS computation under the treasury
stock method. We have two forms of outstanding common stock: common stock and unvested restricted stock awards. Holders of
restricted stock awards receive non-forfeitable dividends at the same rate as common stockholders and they both share equally in
undistributed earnings.
Stock based compensation — The Company recognizes in the consolidated statements of income the grant-date fair value of stock
options and other equity-based forms of compensation issued to employees over the employees’ requisite service period (generally the
vesting period). The Company uses the straight-line recognition of expenses for awards with graded vesting.
The fair value of each option grant is estimated as of the grant date using a binomial option-pricing model for all grants. Expected
volatility is based on the historical volatility of the price of the Company’s stock. The Company uses historical data to estimate option
exercise and stock option forfeiture rates within the valuation model. The expected term of options granted for the binomial model is
derived from applying a historical suboptimal exercise factor to the contractual term of the grant. For binomial pricing, the risk-free
rate for periods is equal to the U.S. Treasury yield at the time of grant and commensurate with the contractual term of the grant. There
were no stock options granted in 2012 or 2011.
The fair value of restricted stock awards is based on the price of the Company’s stock at the date of grant. There were 139,375 and
13,305 shares of restricted stock granted during 2012 and 2011, respectively. Stock based compensation recorded during the years
ended December 31, 2012 and 2011 totaled approximately $176,000 and $48,000, respectively.
Fair values of financial instruments — The consolidated financial statements include various estimated fair value information as of
December 31, 2012 and 2011. Such information, which pertains to the Company’s financial instruments, does not purport to represent
the aggregate net fair value of the Company. Further, the fair value estimates are based on various assumptions, methodologies, and
subjective considerations, which vary widely among different financial institutions and which are subject to change.
Fair Value Measurements — The Company uses fair value measurements to record fair value adjustments to certain assets and
liabilities and to determine fair value disclosures. The Company bases the fair values on the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Securities available
for sale, derivatives, and loans held for sale, if any, are recorded at fair value on a recurring basis. Additionally, from time to time, the
Company may be required to record certain assets at fair value on a non-recurring basis, such as certain impaired loans held for
investment and securities held to maturity that are other-than-temporarily impaired. These non-recurring fair value adjustments
typically involve write-downs of individual assets due to application of lower-of-cost or market accounting.
F-12
The Company has established and documented a process for determining fair value. The Company maximizes the use of observable
inputs and minimizes the use of unobservable inputs when developing fair value measurements. Whenever there is no readily
available market data, Management uses its best estimate and assumptions in determining fair value, but these estimates involve
inherent uncertainties and the application of Management's judgment. As a result, if other assumptions had been used, our recorded
earnings or disclosures could have been materially different from those reflected in these financial consolidated statements.
Deferred compensations plans — Future compensation under the Company’s executive salary continuation plan and director
retirement plan is earned for services rendered through retirement. The Company accrues for the salary continuation liability based on
anticipated years of service and vesting schedules provided under the plans. The Company’s current benefit liability is determined
based on vesting and the present value of the benefits at a corresponding discount rate. The discount rate used is an equivalent rate for
investment-grade bonds with lives matching those of the service periods remaining for the salary continuation contracts, which
average approximately 20 years.
Reclassifications — Certain prior year amounts have been reclassified to conform to the current year presentation. There was no
effect on net income or shareholders’ equity as a result of reclassifications.
Recently Issued Accounting Standards —
In May 2011, the FASB issued ASU No. 2011-04 Fair Value Measurement (Topic 820) Amendments to Achieve Common Fair
Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The ASU improves the comparability of fair value
measurements presented and disclosed in accordance with U.S. generally accepted accounting principles (GAAP) and International
Financial Reporting Standards (IFRSs) by changing the wording used to describe many of the requirements in U.S GAAP for
measuring fair value and disclosure of information. The amendments to this ASU provide explanation on how to measure fair value
but do not require any additional fair value measurements and does not establish valuation standards or affect valuation practices
outside of financial reporting. The amendments clarify existing fair value measurements and disclosure requirements to include
application of the highest and best use and valuation premises concepts; measuring fair value of an instrument classified in a reporting
entity’s shareholders’ equity; and disclosures requirements regarding quantitative information about unobservable inputs categorized
within Level 3 of the fair value hierarchy. In addition, clarification is provided for measuring the fair value of financial instruments
that are managed in a portfolio and the application of premiums and discounts in a fair value measurement. For public entities, ASU
2011-04 is effective during interim and annual periods beginning after December 15, 2011. There was no significant impact on the
Company’s financial position or results of operations as a result of adopting this ASU.
In June 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-05 Comprehensive Income (Topic 220)
Presentation of Comprehensive Income. The ASU improves the comparability, consistency, and transparency of financial reporting
and increases the prominence of items reported in other comprehensive income. The amendments to Topic 220, Comprehensive
Income, require entities to present the total of comprehensive income, the components of net income, and the components of other
comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive
statements. Entities are no longer permitted to present components of other comprehensive income as part of the statement of changes
in stockholders’ equity. Any adjustments for items are that reclassified from other comprehensive income to net income are to be
presented on the face of the entities financial statement regardless the method of presentation for comprehensive income. The
amendments do not change items to be reported in comprehensive income or when an item of other comprehensive income must be
reclassified to net income, nor do the amendments change the option to present the components of other comprehensive income either
net of related tax effects or before related tax effects. ASU 2011-05 is effective for fiscal years, and interim periods beginning on or
after December 15, 2011. The Company adopted this ASU in the first quarter of 2012.
In December 2011, the FASB issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities. The update
requires an entity to offset, and present as a single net amount, a recognized eligible asset and a recognized eligible liability when it
has an unconditional and legally enforceable right of setoff and intends either to settle the asset and liability on a net basis or to realize
the asset and settle the liability simultaneously. The ASU requires an entity to disclose information about offsetting and related
arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The
amendments are effective for annual and interim reporting periods beginning on or after January 1, 2013. The Company is currently in
the process of evaluating the ASU but does not expect it will have a material impact on the Company’s consolidated financial
statements.
In January 2013, the FASB issued ASU No. 2013-01, Clarifying the Scope of Disclosures about Offsetting Assets and
Liabilities. The Update clarifies that ASU. 2011-11 applies only to derivatives, including bifurcated embedded derivatives, repurchase
agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset or
subject to an enforceable master netting arrangement or similar agreement. Entities with other types of financial assets and financial
F-13
liabilities subject to a master netting arrangement or similar agreement are no longer subject to the disclosure requirements in ASU.
2011-11. The amendments are effective for annual and interim reporting periods beginning on or after January 1, 2013. The Company
is currently in the process of evaluating the ASU but does not expect it will have a material impact on the Company’s consolidated
financial statements.
In February 2013, the FASB issued ASU No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other
Comprehensive Income. The Update requires an entity to provide information about the amounts reclassified out of accumulated other
comprehensive income by component and 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 to be reclassified to net income in its entirety in the same reporting period. The amendments are
effective for annual and interim reporting periods beginning on or after December 15, 2012. The Company is currently in the process
of evaluating the ASU but does not expect it will have a material impact on the Company’s consolidated financial statements.
NOTE 2 — CASH AND DUE FROM BANKS
Cash and due from banks includes balances with the Federal Reserve Bank and other correspondent banks. The Company is required
to maintain specified reserves by the Federal Reserve Bank. The average reserve requirements are based on a percentage of the
Company’s deposit liabilities. In addition, the Federal Reserve Bank requires the Company to maintain a certain minimum balance at
all times. As of December 31, 2012 the Company had a balance of $85,133,000 which is more than adequate to satisfy the reserve
requirement.
NOTE 3 – PREFERRED STOCK REPURCHASE AND WARRANT REDEMPTION
In August 2011, the Company repurchased the $13,500,000 of Series A Preferred Stock originally issued to the U.S. Treasury in
December 2008 in connection with the Company’s participation in the Capital Purchase Program (“CPP”). The Company
simultaneously issued $13,500,000 in Series B Preferred Stock to the U.S. Treasury under the Small Business Lending Funding
(“SBLF”) program. Subsequently, the Company fully redeemed a warrant to purchase 350,346 shares of its Common Stock, at the
exercise price of $5.78 per share that the Company had granted to the U.S. Treasury pursuant to the CPP, for a purchase price of
$560,000, which settled in September 2011. So long as the preferred stock remains outstanding under SBLF, it will pay quarterly
cumulative dividends at a variable rate between 1% and 5% per year for the first 2.5 years depending on growth of our small business
loan portfolio. If there is no loan growth after 2.5 years, the dividend rate could increase to 7% and if the preferred stock remains
outstanding after 4.5 years, the rate increases to 9%, regardless of loan growth.
The repurchase of the original preferred stock shares under CPP resulted in preferred stock discount accretion of $389,000, the full
remaining balance of the preferred stock discount at the time of the repurchase. This entry was recorded in the third quarter of 2011
and is reflected in the Preferred stock dividends and accretion line on the consolidated statements of income.
In May 2012, the Company repurchased from the U.S. Treasury 6,750 shares of Series B Preferred Stock for aggregate consideration
of $6.75 million.
F-14
NOTE 4 — SECURITIES
The amortized cost and estimated fair values of debt securities as of December 31, 2012, are as follows:
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Market
Value
Available-for-sale securities:
U.S. agencies
$ 52,607,537
$
2,949,355
$
(39,833)
$
55,517,059
Collateralized mortgage obligations
Municipalities
SBA Pools
Corporate debt
Mutual Fund
11,698,399
25,323,157
905,985
-
1,727,206
(58,075)
1,178,242
86
(20)
4,669,390
37,048
(836)
2,874,727
-
(6,487)
12,604,384
26,992,288
1,178,308
4,705,602
2,868,240
$ 98,351,452
$
5,619,680
$
(105,251)
$
103,865,881
The following tables detail the gross unrealized losses and fair values aggregated by investment category and length of time that
individual securities have been in a continuous unrealized loss position at December 31, 2012.
Description of Securities
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Less than 12 months
12 months or more
Total
U.S. agencies
$ 1,954,005
$
(39,833)
$
Collateralized mortgage obligations
—
—
3,088,970
(58,075)
—
749,164
—
(836)
2,493,512
(6,487)
294,889
—
—
$
—
—
—
—
—
—
(20)
—
—
$ 1,954,005
$
(39,833)
—
—
3,088,970
(58,075)
294,889
749,164
(20)
(836)
2,493,512
(6,487)
Municipalities
SBA Pools
Corporate debt
Mutual Fund
Total temporarily impaired securities
$ 8,285,651
$
(105,231)
$
294,889
$
(20)
$ 8,580,540
$
(105,251)
At December 31, 2012, one SBA pool was the only security in an unrealized loss position for greater than 12 months, and one U.S.
agency, five municipalities, one corporate debt and one mutual fund security make up the total amount of securities in an unrealized
loss position for less than 12 months. Management periodically evaluates each available-for-sale investment security in an unrealized
loss position to determine if the impairment is temporary or other than temporary. This evaluation encompasses various factors
including, the nature of the investment, the cause of the impairment, the severity and duration of the impairment, credit ratings and
other credit related factors such as third party guarantees and volatility of the security’s fair value. Management has determined that
no investment security is other than temporarily impaired. The unrealized losses are due primarily to interest rate changes and the
Bank does not intend to sell the securities and it is not likely that we will be required to sell the securities before the earlier of the
forecasted recovery or the maturity of the underlying investment security.
F-15
The amortized cost and estimated fair value of debt securities at December 31, 2012, by contractual maturity or call date, are shown
below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
Available-for-sale securities:
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Amortized
Cost
Fair
Value
$ 11,068,417
$
11,062,890
17,097,942
26,488,494
43,696,599
19,556,213
27,282,065
45,964,713
$ 98,351,452
$ 103,865,881
The amortized cost and estimated fair values of debt securities as of December 31, 2011, are as follows:
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Market
Value
Available-for-sale securities:
U.S. agencies
$
52,101,177
2,722,817
$
(14,686)
$
54,809,308
Collateralized mortgage obligations
Municipalities
SBA Pools
Corporate debt
Mutual Fund
11,366,368
15,660,035
1,236,366
2,000,000
2,759,316
728,104
—
1,312,377
(370)
55
—
9,016
—
(185,716)
—
12,094,472
16,972,042
1,236,421
1,814,284
2,768,332
$
85,123,262
$
4,772,369
$
(200,772)
$
89,694,859
The following tables detail the gross unrealized losses and fair values aggregated by investment category and length of time that
individual securities have been in a continuous unrealized loss position at December 31, 2011.
Description of Securities
U.S. agencies
Municipalities
Corporate debt
Less than 12 months
12 months or more
Total
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
$
2,985,314 $
(14,686) $
561,580
(370)
1,814,284
(185,716)
—
—
—
— $
2,985,314 $
(14,686)
—
—
561,580
(370)
1,814,284
(185,716)
Total temporarily impaired securities
$
5,361,178 $
(200,772) $
— $
— $
5,361,178 $
(200,772)
At December 31, 2011, there were no securities in an unrealized loss position for greater than 12 months and one U.S. agency, one
municipality and one corporate debt security make up the total amount of securities in an unrealized loss position for less than 12
months. Management periodically evaluates each available-for-sale investment security in an unrealized loss position to determine if
the impairment is temporary or other than temporary. This evaluation encompasses various factors including, the nature of the
investment, the cause of the impairment, the severity and duration of the impairment, credit ratings and other credit related factors
such as third party guarantees and volatility of the security’s fair value. Management has determined that no investment security is
other than temporarily impaired. The unrealized losses are due primarily to interest rate changes and the Bank does not intend to sell
the securities and it is not likely that we will be required to sell the securities before the earlier of the forecasted recovery or the
maturity of the underlying investment security.
F-16
Gross realized gains on called available-for-sale securities during 2012 and 2011 totaled $91,700 and $81,184, respectively. There
were no losses on called available-for-sale securities realized during 2012 and 2011. There were no sales of available-for-sale
securities during 2012 and 2011.
Securities carried at $56,483,620 and $53,419,019 at December 31, 2012 and 2011, respectively, were pledged to secure deposits
of public funds.
NOTE 5 — LOANS
The Company’s customers are primarily located in Stanislaus, San Joaquin, Tuolumne, Inyo, and Mono Counties. As of December
31, 2012, approximately 81% of the Company’s loans are commercial real estate loans which includes construction loans.
Approximately 9% of the Company’s loans are for general commercial uses including professional, retail, and small business.
Additionally, 7% of the Company’s loans are for residential real estate and other consumer loans. The remaining 3% are agriculture
loans.
Loan totals were as follows:
YEAR ENDED DECEMBER 31,
2012
2011
Commercial real estate:
Commercial real estate- construction
$
6,581,854
$
Commercial real estate- mortgages
Land
Farmland
Commercial and industrial
Consumer
Consumer residential
Agriculture
Total loans
Less:
278,766,279
14,269,477
16,456,921
36,528,505
1,095,801
25,659,090
11,628,260
14,595,324
284,263,685
10,635,954
20,549,849
32,017,744
1,212,986
23,870,519
9,055,622
390,986,187
396,201,683
Deferred loan fees and costs, net
Allowance for loan losses
(599,851)
(7,974,975)
(634,433)
(8,609,174)
Net loans
$
382,411,361
$
386,958,076
Loan Origination/Risk Management. The Company has certain lending policies and procedures in place that are designed to
maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a
regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan
production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification
in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.
Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably
and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional
banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s
management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed.
Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the
underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral
securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other
business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans
may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of
these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
F-17
Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in
addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real
estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally
largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the
loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy.
The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. This
diversity helps reduce the Company’s exposure to adverse economic events that affect any single market or industry. Management
monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the
Company avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. The Company
also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting market areas it serves.
In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At
December 31, 2012, approximately 35.8% of the outstanding principal balance of the Company’s commercial real estate loans were
secured by owner-occupied properties.
With respect to loans to developers and builders that are secured by non-owner occupied properties that the Company may
originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and
have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews,
sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are
generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate.
Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the
ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term
lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These
loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their
ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and
the availability of long-term financing.
The Company originates consumer loans utilizing a computer-based credit scoring analysis to supplement the underwriting
process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line
and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers,
minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for
home equity loans follow bank policy, which include, but are not limited to, a maximum loan-to-value percentage of 80%, a maximum
housing and total debt ratio of 36% and 42%, respectively and other specified credit and documentation requirements.
The Company maintains an independent loan review department that reviews and validates the credit risk program on a periodic
basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk
identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.
Non-Accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been
received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower
may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be
placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all
unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess
of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current
and future payments are reasonably assured.
F-18
Year-end non-accrual loans, segregated by class of loans, were as follows:
YEAR ENDED DECEMBER 31,
2012
2011
Commercial real estate:
Commercial real estate- construction
$
126,427 $
Commercial real estate- mortgages
Land
Farmland
Commercial and industrial
Consumer
Consumer residential
Agriculture
Total non-accrual loans
3,345,098
2,419,223
0
21,311
0
1,010,998
0
179,262
3,671,693
3,277,463
0
104,481
0
0
0
$
6,923,057 $
7,232,899
Had non-accrual loans performed in accordance with their original contract terms, the Company would have recognized additional
interest income of approximately $696,000 in 2012 and $692,000 in 2011.
The following table analyzes past due loans including the non-accrual loans in the above table, segregated by class of loans, as of
December 31, 2012:
Greater
Than 90
Days Past
Due and
Still
Accruing
0
0
0
0
0
0
0
0
0
December 31, 2012
Commercial real estate:
Commercial R.E. -
construction
Commercial R.E. -
mortgages
Land
Farmland
30-59
Days Past
Due
60-89
Days Past
Due
Greater
Than 90
Days Past
Due
Total Past
Due
Current
Total
$
0 $
0
$
126,427
$
126,427
$
6,455,427 $
6,581,854
$
Commercial and industrial
16,138
Consumer
Consumer residential
Agriculture
0
0
0
55,089
0
0
623,118
54,427
2,386,688
2,364,797
3,064,895
2,419,224
0
16,138
0
0
0
0
1,010,998
1,010,998
0
0
275,701,384
278,766,279
11,850,253
16,456,921
36,512,367
1,095,801
24,648,092
11,628,260
14,269,477
16,456,921
36,528,505
1,095,801
25,659,090
11,628,260
0
0
0
0
0
Total
$
71,227 $
677,545
$
5,888,910
$
6,637,682
$
384,348,505 $
390,986,187
$
F-19
The following table analyzes past due loans including the non-accrual loans in the above table, segregated by class of loans, as of
December 31, 2011:
30-59
Days Past
Due
60-89
Days
Past Due
Greater
Than 90
Days Past
Due
Total Past
Due
Current
Total
December 31, 2011
Commercial real estate:
Commercial R.E. -
construction
Commercial R.E. -
mortgages
Land
Farmland
Commercial and industrial
Consumer
Consumer residential
Agriculture
$
0
$
0
$
179,263
$
179,263
$
14,416,061 $
14,595,324
$
424,683
0
0
0
16,419
0
0
0
0
0
79,059
0
0
0
3,671,693
2,580,231
0
0
0
0
0
4,096,376
2,580,231
0
79,059
16,419
0
0
280,167,309
284,263,685
8,055,723
20,549,849
31,938,685
1,196,567
23,870,519
9,055,622
10,635,954
20,549,849
32,017,744
1,212,986
23,870,519
9,055,622
Total
$
441,102 $
79,059
$
6,431,187
$
6,951,348
$
389,250,335 $
396,201,683
$
Greater
Than 90
Days Past
Due and
Still
Accruing
0
0
0
0
0
0
0
0
0
Impaired Loans. Loans are considered impaired when, based on current information and events, it is probable the Company will be
unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled
principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual
loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported
net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is
expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the
principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are
charged off when deemed uncollectible.
Impaired loans by class as of December 31, 2012 and 2011 are set forth in the following tables. No interest income was recognized on
impaired loans subsequent to their classification as impaired during 2012 and 2011.
December 31, 2012
Commercial real estate:
Commercial R.E. -
construction
Commercial R.E. -
mortgages
Land
Farmland
Commercial and Industrial
Consumer
Consumer residential
Agriculture
Total
Unpaid
Contractual
Principal
Balance
Recorded
Investment
With No
Allowance
Recorded
Investment
With
Allowance
Total
Recorded
Investment
Related
Allowance
Average
Recorded
Investment
$
193,027 $
0 $
126,427 $
126,427 $
2,872 $
222,757
5,728,716
6,866,869
0
27,812
0
1,034,884
0
1,875,320
663,232
0
21,311
0
1,010,999
0
1,469,777
1,755,991
0
0
0
0
0
3,345,097
2,419,223
0
21,311
0
1,010,999
0
136,015
409,656
0
0
0
0
0
$
13,851,308 $
3,570,862 $
3,352,195 $
6,923,057 $
548,543 $
3,093,523
2,833,250
0
52,822
0
534,578
0
6,736,930
F-20
Unpaid
Contractual
Principal
Balance
Recorded
Investment
With No
Allowance
Recorded
Investment
With
Allowance
Total
Recorded
Investment
Related
Allowance
Average
Recorded
Investment
$
245,862 $
0 $
179,262 $
179,262 $
5,984 $
1,177,407
4,469,681
7,659,990
0
116,867
0
0
0
3,671,693
697,232
0
104,481
0
0
0
0
2,580,231
0
0
0
0
0
3,671,693
3,277,463
0
104,481
0
0
0
0
544,630
0
0
0
0
0
$
12,492,400 $
4,473,406 $
2,759,493 $
7,232,899 $
550,614 $
4,111,549
3,329,784
0
36,655
0
0
0
8,655,395
December 31, 2011
Commercial real estate:
Commercial R.E. -
construction
Commercial R.E. -
mortgages
Land
Farmland
Commercial and Industrial
Consumer
Consumer residential
Agriculture
Total
Troubled Debt Restructurings – In order to determine whether a borrower is experiencing financial difficulty, an evaluation is
performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the
modification. This evaluation is performed under the Company’s internal underwriting policy.
At December 31, 2012, there were 6 loans and leases that were considered to be troubled debt restructurings, all of which are
considered nonaccrual totaling $2,567,000. At December 31, 2011, there were 5 loans and leases that were considered to be troubled
debt restructurings, all of which are considered nonaccrual totaling $3,482,000. At December 31, 2012 and 2011, there were unfunded
commitments of $1,697,000 and $1,644,000, respectively, on one loan classified as a troubled debt restructure because of an
agreement with a borrower to continue advancing funds and covering overhead costs on a residential development project. The
Company will receive proceeds to pay down the principal as the residential properties sell.
During the year ended December 31, 2012, the terms of two loans were modified as troubled debt restructurings. During the year
ended December 31, 2011, the terms of six loans were modified as troubled debt restructurings. 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; or a temporary payment modification in which the payment amount allocated towards principal was reduced. In some cases, a
permanent reduction of the accrued interest on the loan was conceded.
F-21
The following table presents loans by class modified as troubled debt restructurings that occurred during the years ended December
31, 2012 and 2011:
2012
Pre-
Modification
Outstanding
Recorded
Investment
Number
of
Loans
Year Ended December 31,
Post-
Modification
Outstanding
Recorded
Investment
Number
of
Loans
2011
Pre-
Modification
Outstanding
Recorded
Investment
Post-
Modification
Outstanding
Recorded
Investment
Commercial real estate:
Commercial R.E. - construction
0 $
Commercial R.E. - mortgages
Land
Farmland
Commercial and Industrial
Consumer
Consumer residential
Agriculture
Total
0
1
0
1
0
0
0
0 $
0
58,261
0
23,111
0
0
0
0
0
58,261
0
23,111
0
0
0
2 $
2,298,577 $
2,298,577
0
3
0
1
0
0
0
0
0
3,328,512
3,328,512
0
26,322
0
0
0
0
26,322
0
0
0
2 $
81,372 $
81,372
6 $
5,653,411 $
5,653,411
The troubled debt restructurings during the years ended December 31, 2012 and 2011 did not increase the allowance for loan losses as
a result of the loan modification and there were no charge offs as a result of the loan modifications.
The following table presents loans by class modified as troubled debt restructurings for which there was a payment default within
twelve months following the modification during the years ended December 31, 2012 and 2011.
Year Ended
December 31, 2012
Year Ended
December 31, 2011
Number
of Loans
Recorded
Investment
Number
of Loans
Recorded
Investment
0
0
0
0
0
0
0
0
0
$
$
0
0
0
0
0
0
0
0
0
1
0
2
0
0
0
0
0
3
$
179,262
0
2,580,231
0
0
0
0
0
$
2,759,493
Commercial real estate:
Commercial R.E. - construction
Commercial R.E. - mortgages
Land
Farmland
Commercial and Industrial
Consumer
Consumer residential
Agriculture
Total
A loan is considered to be in payment default once it is ninety days contractually past due under the modified terms.
F-22
The troubled debt restructurings that subsequently defaulted above did not result in an increase to the allowance for loan losses or a
charge-off during the years ended December 31, 2012 and 2011.
Quality ratings (Risk Grades) are assigned to all commitments and stand-alone notes. Risk grades define the basic characteristics of
commitments or stand-alone note in relation to their risk. All loans are graded using a system that maximizes the loan quality
information contained in loan review grades, while ensuring that the system is compatible with the grades used by bank examiners.
We grade loans using the following letter system:
1 Exceptional Loan
2 Quality Loan
3A Better Than Acceptable Loan
3B Acceptable Loan
3C Marginally Acceptable Loan
4 (W) Watch Acceptable Loan
5 Other Loans Especially Mentioned
6 Substandard Loan
7 Doubtful Loan
8 Loss
1. Exceptional Loan - Loans with A+ credits that contain very little, if any, risk. Grade 1 loans are considered Pass. To qualify for this
rating, the following characteristics must be present:
-A high level of liquidity and whose debt-servicing capacity exceeds expected obligations by a substantial margin.
-Where leverage is below average for the industry and earnings are consistent or growing without severe vulnerability to
economic cycles.
-Also included in this rating (but not mandatory unless one or more of the preceding characteristics are missing) are loans that are
fully secured and properly margined by our own time instruments or U.S. blue chip securities. To be properly margined cash
collateral must be equal to, or greater than, 110% of the loan amount.
2. Quality Loan - Loans with excellent sources of repayment that conform in all respects to bank policy and regulatory requirements.
These are also loans for which little repayment risk has been identified. No credit or collateral exceptions. Grade 2 loans are
considered Pass. Other factors include:
-Unquestionable debt-servicing capacity to cover all obligations in the ordinary course of business from well-defined primary
and secondary sources.
-Consistent strong earnings.
-A solid equity base.
3A. Better than Acceptable Loan - In the interest of better delineating the loan portfolio’s true credit risk for reserve allocation, further
granularity has been sought by splitting the grade 3 category into three classifications. The distinction between the three are bank-
defined guidelines and represent a further refinement of the regulatory definition of a pass, or grade 3 loan. Grade 3A is the stronger
third of the pass category, but is not strong enough to be a grade 2 and is characterized by:
-Strong earnings with no loss in last three years and ample cash flow to service all debt well above policy guidelines.
-Long term experienced management with depth and defined management succession.
-The loan has no exceptions to policy.
-Loan-to-value on real estate secured transactions is 10% to 20% less than policy guidelines.
-Very liquid balance sheet that may have cash available to pay off our loan completely.
-Little to no debt on balance sheet.
3B. Acceptable Loan - 3B loans are simply defined as all loans that are less qualified than 3A loans and are stronger than 3C loans.
These loans are characterized by acceptable sources of repayment that conform to bank policy and regulatory requirements.
Repayment risks are acceptable for these loans. Credit or collateral exceptions are minimal, are in the process of correction, and do not
represent repayment risk. These loans:
-Are those where the borrower has average financial strengths, a history of profitable operations and experienced management.
-Are those where the borrower can be expected to handle normal credit needs in a satisfactory manner.
3C. Marginally Acceptable - 3C loans have similar characteristics as that of 3Bs with the following additional characteristics:
Requires collateral. A credit facility where the borrower has average financial strengths, but usually lacks reliable secondary sources
of repayment other than the subject collateral. Other common characteristics can include some or all of the following: minimal
F-23
background experience of management, lacking continuity of management, a start-up operation, erratic historical profitability
(acceptable reasons-well identified), lack of or marginal sponsorship of guarantor, and government guaranteed loans.
4W Watch Acceptable - Watch grade will be assigned to any credit that is adequately secured and performing but monitored for a
number of indicators. These characteristics may include any unexpected short-term adverse financial performance from budgeted
projections or prior period’s results (i.e., declining profits, sales, margins, cash flow, or increased reliance on leverage, including
adverse balance sheet ratios, trade debt issues, etc.). Additionally, any managerial or personal problems of company management,
decline in the entire industry or local economic conditions failure to provide financial information or other documentation as
requested; issues regarding delinquency, overdrafts, or renewals; and any other issues that cause concern for the company. Loans to
individuals or loans supported by guarantors with marginal net worth and/or marginal collateral. Weakness identified
in a Watch credit is short-term in nature. Loans in this category are usually accounts the Company would want to retain providing a
positive turnaround can be expected within a reasonable time frame. Grade 4 loans are considered Pass.
5 Other Loans Especially Mentioned (Special Mention) - A special mention extension of credit is defined as having potential
weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may, at some future date result
in the deterioration of the repayment prospects for the credit or the institution’s credit position. Extensions of credit that might be
detailed in this category include the following:
-The lending officer may be unable to properly supervise the credit because of an inadequate loan or credit agreement.
-Questions exist regarding the condition of and/or control over collateral.
-Economic or market conditions may unfavorably affect the obligor in the future.
-A declining trend in the obligor’s operations or an imbalanced position in the balance sheet exists, but not to the point that
repayment is jeopardized.
6 Substandard Loan - A “substandard” extension of credit is inadequately protected by the current sound worth and paying capacity of
the obligor or of the collateral pledged, if any. Extensions of credit so classified must have a well-defined weakness or weaknesses
that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if
the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard credits, does not have to exist
in individual extensions of credit classified substandard.
7 Doubtful Loan - An extension of credit classified “doubtful” has all the weaknesses inherent in one classified substandard, with the
added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and
values, highly questionable and improbable. The possibility of loss is extremely high but because of certain important and reasonably
specific pending factors that may work to the advantage of and strengthen the credit, its classification as an estimated loss is deferred
until its more exact status may be determined. Pending factors may include a proposed merger or acquisition, liquidation proceedings,
capital injection, perfecting liens on additional collateral or refinancing plans. The entire loan need not be classified doubtful when
collection of a specific portion appears highly probable. An example of proper use of the doubtful category is the case of a company
being liquidated, with the trustee-in-bankruptcy indicating a minimum disbursement of 40 percent and a maximum of 65 percent to
unsecured creditors, including the Company. In this situation, estimates are based on liquidation value appraisals with actual values
yet to be realized. By definition, the only portion of the credit that is doubtful is the 25 percent difference between 40 and 65 percent.
A proper classification of such a credit would show 40 percent substandard, 25 percent doubtful, and 35 percent loss. A credit
classified as doubtful should be resolved within a ‘reasonable’ period of time. Reasonable is generally defined as the period between
examinations. In other words, a credit classified doubtful at an examination should be cleared up before the next exam. However, there
may be situations that warrant continuation of the doubtful classification a while longer.
8. Loss - Extensions of credit classified “loss” are considered uncollectible and of such little value that their continuance as bankable
assets is not warranted. This classification does not mean that the credit has absolutely no recovery or salvage value, but rather that it
is not practical or desirable to defer writing off, even though partial recovery may be affected in the future. It should not be the
Company’s practice to attempt long-term recoveries while the credit remains on the books. Losses should be taken in the period in
which they surface as uncollectible.
F-24
The following table presents weighted average risk grades of our loan portfolio.
December 31, 2012
December 31, 2011
Weighted Average
Risk Grade
Weighted Average
Risk Grade
Commercial real estate:
Commercial real estate - construction
Commercial real estate - mortgages
Land
Farmland
Commercial and Industrial
Consumer
Consumer residential
Agriculture
Total gross loans
3.23
3.22
4.56
3.04
3.09
2.55
3.17
3.50
3.25
3.52
3.26
4.75
3.40
3.21
2.76
3.10
3.23
3.30
The following table presents risk grade totals by class of loans as of December 31, 2012 and 2011. Risk grades 1 through 4 have been
aggregated in the “Pass” line.
Dollars in thousands
December 31, 2012
Pass
Special mention
Substandard
Doubtful
Total loans
December 31, 2011
Pass
Special mention
Substandard
Doubtful
Total loans
Commercial R.E.
Construction
Commercial R.E.
M ortgages
Land
Farmland
Commercial and
Industrial
Consumer
Consumer
Residential
Agriculture
Total
$ 6,455,427 $ 263,567,665 $
-
126,427
-
7,832,840
7,365,774
-
8,974,864 $ 16,456,921 $
-
5,294,613
-
-
-
-
35,435,491 $ 1,079,583 $ 24,257,465 $ 10,291,678 $
280,631
812,383
-
1,336,582
-
-
-
1,401,625
-
-
16,218
-
366,519,094
9,450,053
15,017,040
-
$ 6,581,854 $ 278,766,279 $
14,269,477 $ 16,456,921 $
36,528,505 $ 1,095,801 $ 25,659,090 $ 11,628,260 $
390,986,187
$ 14,416,062 $
-
179,262
-
264,913,517
8,684,736
10,665,432
-
$
4,419,659 $ 19,188,322 $
-
6,216,295
-
-
1,361,527
-
31,000,530 $ 1,179,624 $ 23,475,447 $ 8,357,801 $
78,011
939,203
-
-
395,072
-
-
697,821
-
-
16,943
16,419
366,950,962
8,762,747
20,471,555
16,419
$ 14,595,324 $ 284,263,685 $
10,635,954 $ 20,549,849 $
32,017,744 $ 1,212,986 $ 23,870,519 $ 9,055,622 $
396,201,683
Allowance for Loan Losses. The allowance for loan losses is a reserve established through a provision for loan losses charged to
expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of
loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan
portfolio. The Company’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC
Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the
methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and
specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate
level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects
loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized
loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects the totality of actions taken on
all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance
for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among
other things, any necessary increases or decreases in required allowances for specific loans or loan pools.
F-25
The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss
experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the
current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for
any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information
available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including,
among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the
regulatory authorities toward loan classifications.
The Company’s allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance
with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with
ASC Topic 450 based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as
necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC
Topic 450 based on general economic conditions and other qualitative risk factors both internal and external to the Company.
The allowances established for probable losses on specific loans are based on a regular analysis and evaluation of problem loans.
Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability to
repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This
analysis is performed at the relationship manager level for all commercial loans. When a loan has a calculated grade of 5 or higher, a
special assets officer analyzes the loan to determine whether the loan is impaired and, if impaired, the need to specifically allocate a
portion of the allowance for loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability
to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s
industry, among other things.
Historical valuation allowances are calculated based on the historical loss experience of specific types of loans and the internal risk
grade of such loans at the time they were charged-off. The Company calculates historical loss ratios for pools of similar loans with
similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The
historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for
each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool. The
Company’s pools of similar loans include similarly risk-graded groups of commercial and industrial loans, commercial real estate
loans, consumer real estate loans and consumer and other loans.
General valuation allowances are based on general economic conditions and other qualitative risk factors both internal and external
to the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) the experience, ability
and effectiveness of the Company’s lending management and staff; (ii) the effectiveness of the Company’s loan policies, procedures
and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of
credit; (vi) the impact of competition on loan structuring and pricing; (vii) the effectiveness of the internal loan review function;
(viii) the impact of environmental risks on portfolio risks; and (ix) the impact of rising interest rates on portfolio risk. Management
evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Each
component is determined to have either a high, moderate or low degree of risk. The results are then input into a “general allocation
matrix” to determine an appropriate general valuation allowance.
Included in the general valuation allowances are allocations for groups of similar loans with risk characteristics that exceed certain
concentration limits established by management. Concentration risk limits have been established, among other things, for certain
industry concentrations, large balance and highly leveraged credit relationships that exceed specified risk grades, and loans originated
with policy exceptions that exceed specified risk grades.
Loans identified as losses by management, internal loan review and/or bank examiners are charged-off. Furthermore, consumer
loan accounts are charged-off automatically based on regulatory requirements.
F-26
The following table details activity in the allowance for loan losses by portfolio segment for the years ended December 31, 2012
and 2011. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other
categories.
Allowance for Loan Losse s
For the Ye ars Ende d De cembe r 31, 2012 and 2011
Commercial
Commercial
Real Estate
6,969,004
(1,663,314)
35,407
1,230,193
$
and Industrial
606,307
0
926
(133,506)
$
Consumer
65,060
(26,171)
3,840
7,333
$
Consumer
Residential
347,905
(149,897)
15,010
170,635
$
Agriculture
363,174
0
0
(77,440)
$
Unallocated
257,724
0
0
(47,215)
$
T otal
8,609,174
(1,839,382)
55,183
1,150,000
6,571,290
$
473,727
$
50,062
$
383,653
$
285,734
$
210,509
$
7,974,975
6,577,011
$
686,303
$
61,115
$
375,349
$
152,526
$
402,625
$
8,254,929
(1,108,037)
30,323
1,469,707
(43,784)
14,121
(50,333)
(6,559)
(38,078)
5,793
4,711
466
10,168
0
0
0
0
(1,196,458)
50,703
210,648
(144,901)
1,500,000
Year Ende d De ce mbe r 31, 2012
Beginning balance
Charge-offs
Recoveries
Provision
Ending balance
Year Ende d De ce mbe r 31, 2011
Beginning balance
$
$
$
Charge-offs
Recoveries
Provision
Ending balance
$
6,969,004
$
606,307
$
65,060
$
347,905
$
363,174
$
257,724
$
8,609,174
The following table details the allowance for loan losses and ending gross loan balances as of December 31, 2012 and 2011,
summarized by collective and individual evaluation methods of impairment.
Dece mber 31, 2012
Allowance for loan losses for loans:
Commercial
Real Estate
Commercial
and Industrial
Consumer
Consumer
Residential
Agriculture
Unallocated
T otal
Individually evaluated for impairmen$
Collectively evaluated for impairment
548,543
6,022,747
$
6,571,290
Ending gross loan balances:
Individually evaluated for impairmen$
Collectively evaluated for impairment
5,890,748
310,183,783
$
$
$
0
473,727
473,727
21,311
36,507,194
$
$
$
0
50,062
50,062
0
1,095,801
$
$
$
0
383,653
383,653
1,010,998
24,648,092
$
$
$
0
285,734
285,734
0
11,628,260
$
316,074,531
$ 36,528,505
$ 1,095,801
$ 25,659,090
$ 11,628,260
Dece mber 31, 2011
Allowance for loan losses for loans:
Individually evaluated for impairmen$
Collectively evaluated for impairment
$
550,614
6,418,390
6,969,004
$
$
0
606,307
606,307
$
$
0
65,060
65,060
$
$
0
347,905
347,905
Ending balances of loans:
Individually evaluated for impairmen$
Collectively evaluated for impairment
$
7,128,418
322,916,394
330,044,812
$
104,481
31,913,263
$ 32,017,744
$
0
1,212,986
$ 1,212,986
$
0
23,870,519
$ 23,870,519
$
$
$
$
0
363,174
363,174
0
9,055,622
9,055,622
$
$
$
$
$
$
$
$
0
210,509
210,509
0
0
0
$
$
$
548,543
7,426,432
7,974,975
6,923,057
384,063,130
$ 390,986,187
0
257,724
257,724
$
$
550,614
8,058,560
8,609,174
0
0
0
$
7,232,899
388,968,784
$ 396,201,683
F-27
Changes in the allowance off-balance-sheet commitments were as follows:
Balance, beginning of year
Provision Charged to Operations for Off Balance Sheet
Balance, end of year
YEARS ENDED DECEMBER 31,
2012
2011
$
$
119,202
$
(10,993 )
108,209
$
157,001
(37,799 )
119,202
The method for calculating the reserve for off-balance-sheet loan commitments is based on a reserve percentage which is less than
other outstanding loan types because they are at a lower risk level. This reserve percentage, based on many factors including
historical losses and existing economic conditions, is evaluated by management periodically and is applied to the total undisbursed
loan commitment balance to calculate the reserve for off-balance-sheet commitments. Reserves for off-balance-sheet commitments
are recorded in interest payable and other liabilities on the consolidated balance sheets.
At December 31, 2012 and 2011, loans carried at $390,986,187 and $396,201,683, respectively, were pledged as collateral on
advances from the Federal Home Loan Bank.
NOTE 6 — PREMISES AND EQUIPMENT
Major classifications of premises and equipment are summarized as follows:
Land
Building
Leasehold improvements
Furniture, fixtures, and equipment
Less accumulated depreciation and amortization
DECEMBER 31,
2012
2011
$
4,698,703
$
5,871,177
4,239,294
8,081,698
4,698,703
5,356,750
3,993,247
8,105,152
22,890,872
22,153,852
(9,708,421)
(8,654,567)
$
13,182,451
$
13,499,285
Depreciation expense was $1,138,185 and $998,014 for the years ended December 31, 2012 and 2011, respectively.
NOTE 7 — INTEREST RECEIVABLE AND OTHER ASSETS
Other assets are summarized as follows:
Interest income receivable on loans
Interest income receivable on investments
Net deferred tax asset
Federal Reserve Bank stock
Federal Home Loan Bank stock
Cash surrender value of life insurance
Investment in limited partnership
Prepaid expenses and other
F-28
DECEMBER 31,
2012
2011
$
1,202,181
$
1,288,107
452,293
1,670,290
758,150
2,371,600
415,350
1,957,440
1,161,700
2,832,100
11,679,634
11,255,877
575,090
1,076,827
636,099
1,143,615
$
19,786,065
$
20,690,288
NOTE 8 — DEPOSITS
Deposit totals were as follows:
Demand
NOW accounts
Money market deposit accounts
Savings
Time, under $100,000
Time, $100,000 and over
Total deposits
DECEMBER 31,
2012
2011
$
175,588,439
$
130,142,782
83,861,123
72,867,073
238,996,864
254,011,364
30,180,677
20,420,931
37,944,616
18,915,132
22,823,783
37,443,869
$
586,992,650
$
536,204,003
Certificates of deposit issued and their remaining maturities at December 31, 2012, are as follows:
Year ending December 31,
2013
2014
2015
2016
2017
$
37,836,890
9,631,638
9,106,322
621,459
1,169,238
$
58,365,547
NOTE 9 — FHLB ADVANCES
At December 31, 2012, the Company had no outstanding advances from the Federal Home Loan Bank (“FHLB”). Unused and
available advances totaled $163,406,026 at December 31, 2012. Loans carried at $390,986,187 as of December 31, 2012, were
pledged as collateral on advances from the Federal Home Loan Bank.
At December 31, 2011, the Company had advances from the Federal Home Loan Bank (“FHLB”) totaling $3,000,000. All of the total
advances outstanding were term advances due in 2012, and there were no overnight open advances. The weighted average interest rate
on these advances was 0.99% and interest payments are due monthly. Unused and available advances totaled $130,291,562 at
December 31, 2011. Loans carried at $396,201,683 as of December 31, 2011, were pledged as collateral on advances from the
Federal Home Loan Bank.
NOTE 10 — INTEREST ON DEPOSITS
Interest on deposits was comprised of the following:
Savings and other deposits
Time deposits $100,000 and over
Other time deposits
YEARS ENDED DECEMBER 31,
2012
2011
$
$
678,558
$
321,832
132,123
963,926
356,340
259,611
1,132,513
$
1,579,877
F-29
NOTE 11 — INCOME TAXES
The provision for income taxes consists of the following:
Current
Federal
State
Deferred
Federal
State
YEARS ENDED DECEMBER 31,
2012
2011
$ 2,389,351
$ 2,356,017
525,630
615,065
2,914,981
2,971,082
(87,789)
260,546
(13,036)
(55,322)
(100,825)
205,224
$ 2,814,156
$ 3,176,306
The components of the Company’s deferred tax assets and liabilities (included in accrued interest and other assets on the consolidated
balance sheets, is shown below:
Deferred tax assets:
Deferred loan fees
Allowance for loan losses
Restricted stock expense
Accrued vacation
Accrued salary continuation liability
Deferred compensation
Nonaccrual loans
Reserve for undisbursed commitments
OREO expenses
Checking cash rewards
State income tax
Holding company organization fees
Deferred tax liabilities:
Prepaid expenses
FHLB dividends
Accumulated depreciation
Deferred loan costs
Investment in limited partnership
Accrued bonus
DECEMBER 31,
2012
2011
$ 92
$ 125
3,282,053
3,486,186
63,416
47,867
740,983
102,166
360,025
44,533
240,687
35,134
178,714
41,711
5,037
42,722
622,043
87,489
400,159
49,057
150,590
41,154
209,122
45,780
5,137,381
5,139,464
(99,455)
(220,188)
(722,309)
(153,027)
(290)
(2,634)
(132,940)
(220,188)
(808,760)
(139,547)
(479)
1,103
F-30
Unrealized gain on securities available for sale
(2,269,188)
(3,467,091)
(1,881,213)
(3,182,024)
Net deferred income tax asset
$ 1,670,290
$ 1,957,440
Management has assessed the realizability of deferred tax assets and believes it is more likely than not that all deferred tax assets will
be realized in the normal course of operations. Accordingly, these assets have not been reduced by a valuation allowance.
The Company periodically reviews its income tax positions based on tax laws and regulations and financial reporting considerations,
and records adjustments as appropriate. This review takes into consideration the status of current taxing authorities’ examinations of
the Company’s tax returns, recent positions taken by the taxing authorities on similar transactions, if any, and the overall tax
environment.
As of December 31, 2012, the Company had a liability for unrecognized tax benefits of $230,000 associated with the California
Franchise Tax Board’s (“FTB”) potential exam of our 2010, 2011 and 2012 tax returns, approximately $18,000 of which relates to
interest. The Company believes the $230,000 accrued liability is an adequate reserve for the potential of an exam for the 2010, 2011
and 2012 tax returns. If recognized, the unrecognized tax benefit would have impacted the 2012 annual effective tax rate by 0.8%.
As of December 31, 2011, the Company had a liability for unrecognized tax benefits of $307,000 associated with the FTB’s exam of
our 2008 and 2009 tax return and potential exam of our 2010 and 2011 tax return, approximately $15,000 of which was due to interest.
If recognized, the unrecognized tax benefit would have impacted the 2011 annual effective tax rate by 3.4%. During 2012, the
Company agreed to the settlement terms and made a payment of $190,000 for the 2008/2009 exam, for which the final assessment
notice from FTB is pending as December 31, 2012.
Detailed below is a reconciliation of the Company’s unrecognized tax benefits, gross of any related tax benefits, for the year ended
December 31, 2012 and 2011:
Beginning balance
Payments made to State taxing authorities, net of federal deduction
Additions for prior year tax positions
Additions for current year tax positions
Ending balance
Years Ended December 31,
2012
2011
$
$
307,000
(135,000)
-
58,000
230,000
$
$
144,000
(144,000)
221,000
86,000
307,000
The effective tax rate for 2012 and 2011 differs from the current Federal statutory income tax rate as follows:
Federal statutory income tax rate
State taxes, net of federal tax benefit
Tax exempt interest on municipal securities and loans
Tax exempt earnings on bank owned life insurance
Stock based compensation
Low income housing tax credit
California enterprise zone tax credits and deductions
Other
Effective tax rate
YEARS ENDED DECEMBER 31,
2012
2011
34.0%
7.2%
(3.2)%
(2.0)%
0.1%
(0.7)%
(2.8)%
0.1%
32.7%
34.0%
7.2%
(2.2)%
(2.0)%
0.2%
(0.8)%
(2.9)%
1.6%
35.1%
F-31
Oak Valley Bancorp files a consolidated return in the U.S. Federal tax jurisdiction and a combined report in the State of California tax
jurisdiction. Prior to the formation of Bancorp in 2008, the Company filed in the U.S. Federal and California jurisdictions on a stand-
alone basis. None of the entities are subject to examination by taxing authorities for years before 2009 for U.S. Federal or for years
before 2008 for California.
NOTE 12 — STOCK OPTION PLAN
The Company currently has two equity based incentive plans, the Oak Valley Community Bank 1998 Restated Stock Option Plan and
the Oak Valley Bancorp 2008 Stock Plan. The 2008 Stock Plan provides for awards in the form of incentive stocks, non-statutory
stock options, Stock appreciation rights and restrictive stocks. Under the 2008 Plan, the Company is authorized to issue 1,500,000
shares of its common stock to key employees and directors as incentive and non-qualified stock options, respectively, at a price equal
to the fair value on the date of grant. The Plan provides that the options are exercisable in equal increments over a five-year period
from the date of grant or over any other schedule approved by the Board of Directors. All incentive stock options expire no later than
ten years from the date of grant. Future grants are not permitted under the 1998 Stock Plan and will all be issued from the 2008 Stock
Plan.
A summary of the status of the Company’s fixed stock option plan and changes during the year are presented below.
Outstanding at beginning of year
Granted
Exercised
Forfeited
Outstanding at end of year
DECEMBER 31, 2012
Weighted-
Average
Exercise
Price
8.16
0.00
4.04
0.00
9.15
Shares
281,623
0
$
$
(54,436) $
0
$
227,187 $
A summary of the status of the Company’s restricted stock and changes during the year are presented below.
DECEMBER 31, 2012
Weighted-
Average
Grant Date
Fair Value
5.73
6.74
5.73
6.74
6.67
Shares
13,305
139,375
(2,661)
(4,500)
$
$
$
$
145,519 $
Unvested at beginning of year
Granted
Vested
Cancelled
Unvested at end of year
F-32
Weighted-average fair value of options granted during the year
Intrinsic value of options exercised
Options exercisable at year end:
Weighted average exercise price
Intrinsic value
Weighted average remaining contractual life
DECEMBER 31,
2012
2011
$
$
N/A $
N/A
164,164 $
8,075
226,487
276,123
9.16 $
$
8.14
$ 22,420 $ 157,228
2.40 years
1.90 years
Options outstanding at year end:
227,187
281,623
Weighted average exercise price
Intrinsic value
Weighted average remaining contractual life
9.15 $
$
8.16
$ 22,623 $ 159,787
2.47 years
1.91 years
There were no tax benefits recorded in the consolidated statements of income during 2012 and 2011 related to the vesting of non-
qualified stock options. As of December 31, 2012, there was $1,000 of total unrecognized compensation cost related to non-vested
stock options which is expected to be recognized over a weighted-average period of 1.04 years.
For the year ended December 31, 2012, the Company received proceeds of approximately $220,000 from the exercise of stock options
and received income tax benefits of approximately $37,000 related to disqualifying dispositions in the exercise of incentive stock
options.
The Company granted 139,375 shares of restricted stock in 2012 with a weighted average fair value of $6.74 per share. For the year
ended December 31, 2012, total compensation expense recorded in the consolidated statements of income related to restricted stock
awards was $160,000, with an offsetting tax benefit of $66,000, as this expense is deductible for income tax purposes. As of
December 31, 2012, there was $765,000 of total unrecognized compensation cost related to restricted stock awards which is expected
to be recognized over a weighted-average period of 4.09 years. During 2012, shares of restricted stock awards totaling 2,661 with a
fair value of $18,000 were vested and became unrestricted.
For the year ended December 31, 2011, the Company received $9,900 from the exercise of stock options and received no income tax
benefits related to the exercise of non-qualified employee stock options and disqualifying dispositions in the exercise of incentive
stock options.
The Company granted 13,305 shares of restricted stock in 2011 with a weighted average fair value of $5.73 per share. For the year
ended December 31, 2011, total compensation expense recorded in the consolidated statement of income related to restricted stock
awards was $12,000, with an offsetting tax benefit of $5,000, as this expense is deductible for income tax purposes. As of
December 31, 2011, there was $64,000 of total unrecognized compensation cost related to restricted stock awards which is expected to
be recognized over a weighted-average period of 4.23 years. No restricted stock shares vested during 2011.
NOTE 13 — TREASURY CAPITAL PURCHASE PROGRAM
In response to the stresses in the credit markets and to protect and recapitalize the U.S. financial system, on October 3, 2008, the
Emergency Economic Stabilization Act of 2008 (“EESA”) was signed into law. EESA includes the Treasury Capital Purchase
Program (the “TCPP”), which was intended to inject liquidity into, and stabilize the financial industry. On December 1, 2008, we
received preliminary approval from the United States Department of the Treasury (the “U.S. Treasury”) to participate in the
TCPP. On December 5, 2008, the Company issued to the U.S. Treasury 13,500 shares of senior preferred stock with a zero par value
and a $1,000 per share liquidation preference, along with warrants to purchase 350,346 shares of common stock at a per share exercise
price of $5.78, in exchange for aggregate consideration of $13.5 million. The attached warrants were immediately exercisable and
expired 10 years after the issuance date. We were required to comply with restrictions on executive compensation during the period
that the U.S. Treasury held an equity position in us through the TCPP.
F-33
The proceeds of $13.5 million were allocated between the preferred stock and the warrants with $12.7 million allocated to preferred
stock and $833 thousand allocated to the warrants, based on their relative fair value at the time of issuance. The fair value of the
preferred stock was estimated using discounted cash flows with a discount rate of 9%. The fair value of the warrants was estimated
using the Binomial option pricing model with the following assumptions: 1) risk-free interest rate of 2.66% (the Treasury 10-year
yield rate as of warrant issuance date); 2) estimated life of ten years (contractual term of the warrants); 3) volatility of 37.4%; and 4)
dividend yield of 1.67%. The discount on the preferred stock (i.e., difference between the initial carrying amount and the liquidation
amount) was scheduled to be amortized over a five-year period, using effective yield method.
See Note 3 above for information regarding the Company’s repurchase of the Series A preferred shares from the TCPP, issuance of
Series B preferred stock under the SBLF and redemption of warrants in August 2011.
NOTE 14 — EARNINGS PER SHARE
Earnings per share (“EPS”) are based upon the weighted average number of common shares outstanding during each year. The
following table shows: (1) weighted average basic shares, (2) effect of dilutive securities related to stock options and non-vested
restricted stock, and (3) weighted average diluted shares. Net income available to common stockholders is calculated as net income
reduced by dividends accumulated on preferred stock. Basic EPS are calculated by dividing net income available to common
stockholders by the weighted average number of common shares outstanding during each period, excluding unvested restricted stock
awards. Diluted EPS are calculated using the weighted average diluted shares. The total dilutive shares included in annual diluted EPS
is a year-to-date weighted average of the total dilutive shares included in each quarterly diluted EPS computation under the treasury
stock method. We have two forms of outstanding common stock: common stock and unvested restricted stock awards. Holders of
restricted stock awards receive non-forfeitable dividends at the same rate as common stockholders and they both share equally in
undistributed earnings.
The Company’s calculation of earnings per share (“EPS”) including basic EPS, which does not consider the effect of common stock
equivalents and diluted EPS, which considers all dilutive common stock equivalents is as follows:
YEAR ENDED DECEMBER 31, 2012
Shares
(Denominator)
Income
(Numerator)
Per-Share
Amount
Basic EPS:
Net earnings available to common shareholders
$
5,328,980
7,740,990
$
0.69
Effect of dilutive securities:
Stock options
Non-vested restricted stock
Total dilutive shares
Diluted EPS:
—
—
9,647
16,108
25,755
Net earnings available to common shareholders plus assumed conversions
$
5,328,980
7,766,745
$
0.69
Anti-dilutive options to purchase 208,375 shares of common stock in prices ranging from $7.20 to $15.67 were outstanding during
2012. They were not included in the computation of diluted EPS because the options’ exercise price was greater than the average
market price of the common shares. These options begin to expire in 2015.
During 2012, anti-dilutive non-vested restricted stock grants of 740 weighted average shares of common stock were outstanding with
a grant date fair value price of $7.20. These shares were anti-dilutive because the fair value of the grant was higher than the average
market price of the common shares.
F-34
YEAR ENDED DECEMBER 31, 2011
Shares
(Denominator)
Income
(Numerator)
Per-Share
Amount
Basic EPS:
Net earnings available to common shareholders
$
4,699,539
7,708,853
$
0.61
Effect of dilutive securities:
Stock options
Restricted stock
Warrants
Total dilutive shares
Diluted EPS:
—
—
—
13,888
10,273
5,985
30,146
Net earnings available to common shareholders plus assumed conversions
$
4,699,539
7,738,999
$
0.61
Anti-dilutive options to purchase 219,625 shares of common stock in prices ranging from $7.00 to $15.67 were outstanding during
2011. They were not included in the computation of diluted EPS because the options’ exercise price was greater than the average
market price of the common shares. These options begin to expire in 2015. In addition, warrants issued to the U.S. Treasury related to
the Capital Purchase Program of 350,346 with a price of $5.78 were dilutive and included in EPS because the warrants’ exercise price
was less than the average market price of the common shares. The Company redeemed all of these warrants in September 2011 with a
payment to the U.S. Treasury of $560,000.
NOTE 15 — COMMITMENTS AND CONTINGENCIES
The Company is obligated for rental payments under certain operating lease agreements, some of which contain renewal options and
escalation clauses that provide for increased rentals. Total rental expense for the years ended December 31, 2012 and 2011, was
$890,000 and $884,000, respectively.
At December 31, 2012, the future minimum commitments under these operating leases are as follows:
Year ending December 31,
2013
2014
2015
2016
2017
Thereafter
$
869,241
848,214
653,087
494,301
363,436
1,623,146
$
4,851,425
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to extend credit in the form of loans or through standby
letters of credit. These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount
recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the Company has in
particular classes of financial instruments.
The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments
to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the
same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
F-35
Financial instruments at December 31, 2012 whose contract amounts represent credit risk:
Contract
Amount
Undisbursed loan commitments
$
29,584,667
Checking reserve
Equity lines
Standby letters of credit
1,206,517
10,872,517
539,942
$
42,203,643
Commitments to extend credit, including undisbursed loan commitments and equity lines, are agreements to lend to a customer as
long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn
upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s
creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of
credit, is based on management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property,
plant, equipment and income-producing commercial properties.
Checking reserves are lines of credit associated consumer deposit accounts that meet qualification standards for extension of credit if
the deposit account were to become overdraft.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third
party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to
customers.
NOTE 16 — FINANCIAL INSTRUMENTS
Fair values of financial instruments — The consolidated financial statements include various estimated fair value information as of
December 31, 2012 and 2011. Such information, which pertains to the Company’s financial instruments, does not purport to represent
the aggregate net fair value of the Company. Further, the fair value estimates are based on various assumptions, methodologies, and
subjective considerations, which vary widely among different financial institutions and which are subject to change. The following
methods and assumptions are used by the Company.
Cash and cash equivalents — The carrying amounts of cash and cash equivalents approximate their fair value.
Restricted Equity Securities— The carrying amounts of the stock the Company’s owns in FRB and FHLB approximate their fair
value and are considered a level 2 valuation.
Securities (including mortgage-backed securities) — Fair values for securities are based on quoted market prices, where available. If
quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. See Note 17 for
additional disclosure regarding fair values of securities.
Loans receivable — For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values are based
on carrying values. The fair values for other loans (e.g., real estate construction and mortgage, commercial, and installment 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. The allowance for loan losses is considered to be a reasonable estimate of loan discount due to credit risks.
Deposit liabilities — The fair values estimated for demand deposits (interest and non-interest checking, savings, and certain types of
money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e. their carrying amounts).
The carrying amounts for variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at
the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies
interest rates currently being offered on certificates to a schedule of the aggregate expected monthly maturities on time deposits.
F-36
Federal Home Loan Bank (FHLB) advances — Rates currently available to the Company for borrowings with similar terms and
remaining maturities are used to estimate the fair value of the existing debt.
Interest receivable and payable — The carrying amounts of accrued interest approximate their fair value.
Off-balance-sheet instruments — Fair values for the Company’s off-balance-sheet lending commitments are based on fees currently
charged to enter into similar agreements, taking into account the remaining terms of the agreements and the credit standing of the
counterparties.
The estimated fair values of the Company’s financial instruments at December 31, 2012 were as follows:
Financial assets:
Cash and cash equivalents
Restricted equity securities
Loans, net
Interest receivable
Financial liabilities:
Deposits
Interest payable
Off-balance-sheet assets (liabilities):
Commitments and standby letters of credit
Carrying
Amount
Fair
Value
Hierarchy
Valuation
Level
$
141,334,998
$
141,334,998
3,129,750
3,129,750
382,411,361
398,029,908
1,654,474
1,654,474
(586,992,650 )
(587,430,712)
(67,958 )
(67,958)
(422,036)
1
2
3
2
3
2
3
The estimated fair values of the Company’s financial instruments at December 31, 2011 were as follows:
Financial assets:
Cash and cash equivalents
Restricted equity securities
Loans, net
Interest receivable
Financial liabilities:
Deposits
FHLB advance
Interest payable
Off-balance-sheet assets (liabilities):
Commitments and standby letters of credit
Carrying
Amount
Fair
Value
Hierarchy
Valuation
Level
$
101,084,775
$
101,084,775
3,993,800
3,993,800
386,958,076
401,051,975
1,703,457
1,703,457
(536,204,003 )
(536,791,880)
(3,000,000 )
(129,272 )
(3,002,834)
(129,272)
(464,029)
1
2
3
2
3
2
2
3
F-37
NOTE 17 − FAIR VALUE MEASUREMENTS
ASC Topic 820, Fair Value Measurements, which the Company adopted effective January 1, 2008, defines fair value, establishes a
framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and
enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the
valuation of an asset or liability as of the measurement date. The three levels are defined as follow:
Level 1: Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2: Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets and inputs that
are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level
in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level
input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular
input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. Transfers
between levels of the fair value hierarchy are recognized on the actual date of the event or circumstance that caused the transfer, which
generally corresponds with the Company’s quarterly valuation process.
Assets and liabilities measured at fair value on a recurring and non-recurring basis for the years ended December 31, 2012 and 2011
are summarized below:
Fair Value Measurements at December 31, 2012 Using
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
December 31,
2012
Assets and liabilities measured on a recurring basis:
Available-for-sale securities
U.S. agencies
Collateralized mortgage obligations
Municipalities
SBA Pools
Corporate debt
Mutual Fund
Assets and liabilities measured on a non-recurring basis:
Impaired Loans
Other real estate owned
$
$
$
$
55,517,059
12,604,384
26,992,288
1,178,308
4,705,602
2,868,240
$
0
0
0
0
0
2,868,240
$
55,517,059
12,604,384
26,992,288
1,178,308
4,705,602
0
0
0
0
0
0
0
4,980,341
0
$
$
0
0
$
$
0
0
$
$
4,980,341
0
F-38
Fair Value Measurements at December 31, 2011 Using
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
December 31,
2011
$
$
54,809,308
12,094,472
16,972,042
1,236,421
1,814,284
2,768,332
$
0
0
0
0
0
2,768,332
$
54,809,308
12,094,472
16,972,042
1,236,421
1,814,284
0
0
0
0
0
0
0
Assets and liabilities measured on a recurring basis:
Available-for-sale securities
U.S. agencies
Collateralized mortgage obligations
Municipalities
SBA Pools
Corporate debt
Mutual Fund
Assets and liabilities measured on a non-recurring basis:
Impaired Loans
Other real estate owned
$ 4,650,738
$ 244,375
$
$
0
0
$
$
0
0
$
$
4,650,738
244,375
Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.
Available-for-sale securities - Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value
measurement is based upon quoted market prices, if available. If quoted market prices are not available, fair values are measured
using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted
for the security’s credit rating, prepayment assumptions, and other factors such as credit loss assumptions. Level 1 securities include
those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or
brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by
government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed
securities in less liquid markets.
Impaired loans - ASC Topic 820 applies to loans measured for impairment using the practical expedients permitted by ASC Topic
310, Accounting by Creditors for Impairment of a Loan. The Company does not record loans at fair value on a recurring basis.
However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is
probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are
considered impaired. Impaired loans where an allowance is established based on the fair value of collateral less the cost related to
liquidation of the collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an
observable market price or a current appraised value, the Company records the impaired loan as non-recurring Level 3. Likewise,
when an appraised value is not available or management determines the fair value of the collateral is further impaired below the
appraised value and there is no observable market price, the Company records the impaired loan as non-recurring Level 3.
Other Real Estate Owned - Other real estate assets (“OREO”) acquired through, or in lieu of, foreclosure are held-for-sale and are
initially recorded at the lower of cost or fair value, less selling costs. Any write-downs to fair value at the time of transfer to OREO
are charged to the allowance for loan losses, subsequent to foreclosure. Appraisals or evaluations are then done periodically thereafter
charging any additional write-downs or valuation allowances to the appropriate expense accounts. Values are derived from appraisals
of underlying collateral and discounted cash flow analysis. OREO is classified within Level 3 of the hierarchy.
NOTE 18 — RELATED PARTY TRANSACTIONS
The Company, in the normal course of business, makes loans and receives deposits from its directors, officers, principal shareholders,
and their associates. In management’s opinion, these transactions are on substantially the same terms as comparable transactions with
other customers of the Company. Loans to directors, officers, shareholders, and affiliates are summarized below:
F-39
Aggregate amount outstanding, beginning of year
New loans or advances during year
Repayments during year
Aggregate amount outstanding, end of year
YEARS ENDED DECEMBER 31,
2012
2011
$
$
6,178,238
5,354,389
(3,156,886 )
8,375,741
$
$
8,019,148
1,441,886
(3,282,796)
6,178,238
Related party deposits totaled $59,025,000 and $13,893,000 at December 31, 2012 and 2011, respectively.
NOTE 19 — PROFIT SHARING PLAN
The profit sharing plan to which both the Company and eligible employees contribute was established in 1995. Bank contributions are
voluntary and at the discretion of the Board of Directors. Contributions were approximately $335,000 and $283,000 for the years
ended December 31, 2012 and 2011, respectively.
NOTE 20 — RESTRICTIONS ON DIVIDENDS
Under current California State banking laws, the Bank may not pay cash dividends in an amount that exceeds the lesser of retained
earnings of the Bank or the Bank’s net earnings for its last three fiscal years (less the amount of any distributions to shareholders made
during that period). If the above requirements are not met, cash dividends may only be paid with the prior approval of the
Commissioner of the Department of Financial Institutions, in an amount not exceeding the Bank’s net earnings for its last fiscal year
or the amount of its net earnings for its current fiscal year. Accordingly, the future payment of cash dividends will depend on the
Bank’s earnings and its ability to meet its capital requirements.
NOTE 21 — OTHER POST-RETIREMENT BENEFIT PLANS
The Company has awarded certain officers a salary continuation plan (the “Plan”). Under the Plan, the participants will be provided
with a fixed annual retirement benefit for 20 years after retirement. The Company is also responsible for certain pre-retirement death
benefits under the Plan. In connection with the implementation of the Plan, the Company purchased single premium life insurance
policies on the life of each of the officers covered under the Plan. The Company is the owner and partial beneficiary of these life
insurance policies. The assets of the Plan, under Internal Revenue Service regulations, are owned by the Company and are available to
satisfy the Company’s general creditors.
During December 2001, the Company awarded its directors a director retirement plan (“DRP”). Under the DRP, the participants will
be provided with a fixed annual retirement benefit for ten years after retirement. The Company is also responsible for certain pre-
retirement death benefits under the DRP. In connection with the implementation of the DRP, the Company purchased single premium
life insurance policies on the life of each director covered under the DRP. The Company is the owner and partial beneficiary of these
life insurance policies. The assets of the DRP, under Internal Revenue Service regulations, are the property of the Company and are
available to satisfy the Company’s general creditors.
Future compensation under both plans is earned for services rendered through retirement. The Company accrues for the salary
continuation liability based on anticipated years of service and vesting schedules provided under the plans. The Company’s current
benefit liability is determined based on vesting and the present value of the benefits at a corresponding discount rate. The discount rate
used is an equivalent rate for investment-grade bonds with lives matching those of the service periods remaining for the salary
continuation contracts, which average approximately 20 years. At December 31, 2012 and 2011, $1,800,000 and $1,511,000,
respectively, has been accrued to date, and is included in other liabilities on the consolidated balance sheets.
The Company entered into split-dollar life insurance agreements with certain officers. In connection with the implementation of the
split-dollar agreements, the Company purchased single premium life insurance policies on the life of each of the officers covered by
the split-dollar life insurance agreements. The Company is the owner of the policies and the partial beneficiary in an amount equal to
the cash surrender value of the policies.
The combined cash surrender value of all Bank-owned life insurance policies was $11,679,634 and $11,255,877 at December 31,
2012 and 2011, respectively. The cash surrender value of the life insurance policies is included in other assets on the consolidated
balance sheets (Note 7).
F-40
NOTE 22 — REGULATORY MATTERS
The Bank and the Company are subject to various regulatory capital requirements administered by federal and state banking agencies.
Failure to meet minimum capital requirements can initiate certain mandatory — and possibly additional discretionary — actions by
regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve
quantitative measures of the Company’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Company’s capital amounts and classifications are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and
ratios (set forth in the table on the next page) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as
defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2012, that the
Bank and Company meets all capital adequacy requirements to which they are subject.
As of December 31, 2011, the most recent notification from the Federal Reserve Bank categorized the Bank as well capitalized under
the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total
risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. There are no conditions or events since
notification that management believes have changed the Bank’s category.
The Company and Bank’s actual capital amounts and ratios at December 31, 2012 and 2011, are presented in the following table.
Actual
For capital
adequacy purposes
To be well
capitalized under
prompt corrective
action provisions
Amount
Ratio
Amount
Ratio
Amount
Ratio
Capital ratios for Bank:
As of December 31, 2012
Total capital (to Risk- Weighted Assets)
$ 72,230,000
Tier I capital (to Risk- Weighted Assets) $ 66,570,000
Tier I capital (to Average Assets)
$ 66,570,000
As of December 31, 2011
Total capital (to Risk- Weighted Assets)
$ 73,562,000
Tier I capital (to Risk- Weighted Assets) $ 67,835,000
Tier I capital (to Average Assets)
$ 67,835,000
Capital ratios for Bancorp:
As of December 31, 2012
Total capital (to Risk- Weighted Assets)
$ 72,376,000
Tier I capital (to Risk- Weighted Assets)
$ 66,716,000
Tier I capital (to Average Assets)
$ 66,716,000
As of December 31, 2011
Total capital (to Risk- Weighted Assets)
$ 73,439,000
Tier I capital (to Risk- Weighted Assets)
$ 67,712,000
Tier I capital (to Average Assets)
$ 67,712,000
16.0%
14.8%
10.3%
16.2%
14.9%
11.4%
16.1%
14.8%
10.3%
16.2%
14.9%
11.4%
F-41
$ 36,028,000
$ 18,014,000
$ 25,848,000
>8.0%
>4.0%
>4.0%
$ 45,035,000
>10.0%
$ 27,021,000
$ 32,310,000
>6.0%
>5.0%
$ 36,384,000
$ 18,192,000
$ 23,807,000
>8.0%
>4.0%
>4.0%
$ 45,481,000
>10.0%
$ 27,288,000
$ 29,759,000
>6.0%
>5.0%
$ 36,030,000
$ 18,015,000
$ 25,850,000
>8.0%
>4.0%
>4.0%
$ 36,387,000
$ 18,193,000
$ 23,809,000
>8.0%
>4.0%
>4.0%
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
OAK VALLEY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
23. PARENT ONLY CONDENSED FINANCIAL STATEMENTS
CONDENSED BALANCE SHEETS
ASSETS
Cash
Investment in bank subsidiary
Other assets
Total Assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Other liabilities
Total liabilities
Shareholders’ equity
Series B Preferred stock, no par value; $1,000 per share liquidation
preference, 10,000,000 shares authorized, 6,750 and 13,500 issued and
outstanding at December 31, 2012 and 2011, respectively
Common stock, no par value; 50,000,000 shares authorized,
7,907,780 and 7,718,469 shares issued and outstanding at
December 31, 2012 and 2011, respectively
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income, net of tax
December 31,
2012
December 31,
2011
$
$
$
202,934
69,821,699
28,466
20,526
70,524,665
25,565
70,053,099
$
70,570,756
$
84,375 $
168,750
$
84,375
$
168,750
6,750,000
13,500,000
23,673,210
2,341,814
33,958,737
3,244,963
23,453,443
2,128,700
28,629,757
2,690,106
Total shareholders’ equity
69,968,724
70,402,006
Total liabilities and shareholders' equity
$
70,053,099
$
70,570,756
F-42
OAK VALLEY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
23. PARENT ONLY CONDENSED FINANCIAL STATEMENTS (CONTINUED)
CONDENSED STATEMENTS OF INCOME
INCOME
Dividends declared by subsidiary
Total income
EXPENSES
Salary expense
Employee benefit expense
Legal expense
Other operating expenses
Total non-interest expense
Income before equity in undistributed
income of subsidiary
Year Ended December 31,
2012
2011
$
7,286,250 $
7,286,250
1,152,500
1,152,500
71,000
175,896
43,632
119,255
409,783
70,000
0
86,224
66,587
222,811
6,876,467
929,689
Equity in undistributed net (loss) income of subsidiary
Income before income tax benefit
(1,257,823)
5,618,644
4,839,209
5,768,898
Income tax benefit
Net Income
Preferred Stock dividends and accretion
Net income available to common shareholders
162,211
91,697
5,780,855 $
5,860,595
451,875
1,161,056
5,328,980 $
4,699,539
$
$
F-43
OAK VALLEY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
23. PARENT ONLY CONDENSED FINANCIAL STATEMENTS (CONTINUED)
CONDENSED STATEMENTS OF CASHFLOWS
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income
Adjustments to reconcile net earnings to net cash from operating activities:
$
5,780,855 $
5,860,595
YEAR ENDED DECEMBER 31,
2011
2012
Undistributed net loss (income) of subsidiary
Stock based compensation
Excess tax benefits from stock-based payment arrangements
(Decrease) increase in other liabilities
Decrease (increase) in other assets
Net cash from operating activities
CASH FLOWS FROM FINANCING ACTIVITIES:
Repurchase of Series A Preferred Stock
Repurchase of Series B Preferred Stock
Proceeds from Series B Preferred Stock issued
Preferred stock dividend payment
Payment to repurchase U.S. Treasury Warrant
Proceeds from sale of common stock and exercise of stock options
Excess tax benefits from stock-based payment arrangements
Net cash used in financing activities
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS, beginning of period
1,257,823
175,896
(37,218)
(84,375)
34,317
7,127,298
0
(6,750,000)
0
(451,875)
0
219,767
37,218
(6,944,890)
182,408
20,526
(4,839,209)
0
0
168,750
(3,086)
1,187,050
(13,500,000)
0
13,500,000
(761,249)
(560,000)
9,894
0
(1,311,355)
(124,305)
144,831
CASH AND CASH EQUIVALENTS, end of period
$
202,934 $
20,526
24. SUBSEQUENT EVENTS
On March 13, 2013, Oak Valley Bancorp repurchased from the U.S. Treasury 6,750 shares of Non-Cumulative Perpetual Preferred
Stock, Series B. The aggregate consideration paid to the U.S. Treasury was $6,817,500, reflecting $6,750,000 paid for the repurchase,
and $67,500 paid for accrued dividends. Oak Valley Bancorp had originally issued 13,500 shares of Non-Cumulative Perpetual
Preferred Stock, Series B to the U.S. Treasury in September 2011 in connection with Oak Valley Bancorp’s participation in the U.S.
Treasury Small Business Lending Fund (SBLF) Program. In May 2012, however, Oak Valley Bancorp had repurchased 6,750 shares
of Non-Cumulative Perpetual Preferred Stock, Series B from the U.S. Treasury. So, no shares of Non-Cumulative Perpetual Preferred
Stock, Series B are now outstanding as a result of the current repurchase.
F-44
INDEX TO EXHIBITS
Exhibit
Number
2.1
Description
Agreement and Plan of Merger between the Registrant, Interim Oak Valley Bancorp, Inc. and Oak Valley Community
Bank*
3.1 Articles of Incorporation of Oak Valley Bancorp, Inc.*
3.2 First Amendment to Articles of Incorporation of Oak Valley Bancorp, Inc.*
3.3 Bylaws of Oak Valley Bancorp, Inc.*
3.4 First Amended and Restated Bylaws of Oak Valley Bancorp, Inc.**
3.5 Certificate of Determination of Series A Preferred Stock of Oak Valley Bancorp, Inc.**
3.6
Letter Agreement between the United States Department of the Treasury and Oak Valley Bancorp dated December 5,
2008**
3.7
Certificate of Amendment of Bylaws dated effective as of August 11, 2011****
4.1
Certificate of Determination dated December 2, 2008 filed with the California Secretary of State for Fixed Rate
Cumulative Perpetual Preferred Stock, Series A**
4.2
Warrant to Purchase Common Stock dated December 5, 2008**
4.3
Certificate of Determination dated August 11, 2011 and filed with the California Secretary of State for Senior Non-
Cumulative Perpetual Preferred Stock, Series B****
10.1 Oak Valley Community Bank 1998 Restated Stock Option Plan*
10.2 Oak Valley Community Bank Form of Director Retirement Agreement*
10.3 Oak Valley Community Bank Form of Salary Continuation Agreement*
10.4
Securities Purchase Agreement between Oak Valley Bancorp and the U.S. Treasury effective December 4, 2008**
10.5 Securities Purchase Agreement dated August 11, 2011 between the Company and the Secretary of the U.S. Treasury,
with respect to the issuance and sale of Senior Non-Cumulative Perpetual Preferred Stock, Series B.****
10.6
Warrant Redemption Letter Agreement dated September 28, 2011 between the Company and the U.S. Treasury, with
respect to the redemption of the Warrant to Purchase Common Stock dated December 5, 2008.****
14 Code of Ethics***
21 Subsidiaries of the Issuer*
23.1 Consent of Independent Registered Accounting Firm
24 Power of Attorney (included on the signature page of this report)
31.01
Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
31.02
Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
32.01
Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.01 XBLR Interactive Data File*****
* Incorporated by reference from the Form 10 filed on July 31, 2008
** Incorporated by reference from the Form 8-A filed on January 14, 2009
*** Incorporated by reference from the Form 10-K filed on March 31, 2009
**** Incorporated by reference from the Form 10-Q filed on November 14, 2011
***** As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of
the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.
EXHIBIT 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in the Registration Statement No. 333-158201 on Form S-8 of our report dated
March 28, 2013, relating to the consolidated financial statements appearing in this Annual Report on Form 10-K of Oak Valley
Bancorp for the year ended December 31, 2012.
/s/ Moss Adams LLP
Stockton, California
March 28, 2013
EXHIBIT 31.01
CERTIFICATION PURSUANT TO RULE 13a-14(a)/15d-14(a) AS ADOPTED PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002
I, Ronald C. Martin, Chief Executive Officer, certify that:
1.
I have reviewed this annual report on Form 10-K of Oak Valley Bancorp (the Registrant);
2.
3.
4.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods
presented in this report;
The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as
defined in Exchange Act Rules 13a -15(f) and 15d-15(f)) for the Registrant and have:
(a)
(b)
(c)
(d)
designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the Registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is
being prepared;
designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles;
evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by
this report based on such evaluation; and
disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during
the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial
reporting; and
5.
The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the Registrant’s auditors and the audit committee of Registrant’s Board of Directors:
(a)
(b)
all significant deficiencies and material weaknesses in the design or operation of internal control over financial
reporting, which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and
report financial information; and
any fraud, whether or not material, that involves Management or other employees who have a significant role in the
Registrant’s internal control over financial reporting.
Dated: March 26, 2013
/s/ Ronald C. Martin
Ronald C. Martin
Chief Executive Officer
EXHIBIT 31.02
CERTIFICATION PURSUANT TO RULE 13a-14(a)/15d-14(a) AS ADOPTED PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002
I, Richard A. McCarty, Chief Financial Officer, certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of Oak Valley Bancorp (the Registrant);
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods
presented in this report;
The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as
defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have:
(a)
(b)
(c)
(d)
designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the Registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during the period in which this report
is being prepared;
designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles;
evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by
this report based on such evaluation; and
disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during
the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial
reporting; and
5.
The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the Registrant’s auditors and the audit committee of Registrant’s Board of Directors:
(a)
(b)
all significant deficiencies and material weaknesses in the design or operation of internal control over financial
reporting, which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and
report financial information; and
any fraud, whether or not material, that involves Management or other employees who have a significant role in the
Registrant’s internal control over financial reporting.
Dated: March 26, 2013
/s/ Richard A. McCarty
Richard A. McCarty
Chief Financial Officer
EXHIBIT 32.01
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002
In connection with the annual report on Form 10-K of Oak Valley Bancorp (the Registrant) for the year ended December 31, 2012, as
filed with the Securities and Exchange Commission, the undersigned hereby certify pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
1)
2)
such Form 10-K fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934;
and
the information contained in such Form 10-K fairly presents, in all material respects, the financial condition and results
of operations of the Registrant.
Dated: March 26, 2013
Dated: March 26, 2013
/s/ Ronald C. Martin
Ronald C. Martin
Chief Executive Officer
/s/ Richard A. McCarty
Richard A. McCarty
Chief Financial Officer
This certification accompanies each report pursuant to section 906 of the Sarbanes Oxley Act of 2002 and shall not, except to the
extent required by the Sarbanes Oxley Act of 2002, be deemed filed by the Registrant for purposes of section 18 of the Securities and
Exchange Act of 1934, as amended.