Summit State Bank
Annual Report 2010

Plain-text annual report

2010 Annual Report on Form 10-K To Our Shareholders and Friends: Although 2010 was another year of increased challenges for community banks nationwide, Summit State Bank outperformed the vast majority of California peers ($250 to $500 million in Assets) by maintaining profits, strong net interest margins, capital, and efficiency ratio. California community banks continued to be challenged with unemployment, foreclosures and bankruptcies considerably greater than the national average. Consequently, problem loans from local businesses continued to surface in 2010 as did the increased cost of collections and loan maintenance. However, Summit State Bank was able to show a profit of $1,807,000 while setting aside $3,860,000 in loan loss provisions (10 times our usual annual average) to maintain a prudent allowance for loan losses. The core operation actually generated an operating profit before loan loss provisions and income taxes of $7,043,000, which continues the momentum from 2009. While we are not happy with the impact the economy is having on our bottom line, our strong capital position and performance ratios ranked Summit State Bank with the top 20 publically traded community peer banks in the nation for 2010, and the economy is improving albeit slowly. In 2010, we were recognized for our performance by receiving the Findley Reports’ Premier Performing Bank designation for California banks; Best Business Bank in Sonoma County (Gold Medal) by the North Bay Business Journal; Best Places to Work by the North Bay Biz magazine; and Large Business of the Year by the Petaluma Chamber of Commerce. Banking relationships with local businesses and non-profits grew nicely as our relocated branch offices in Healdsburg and Rohnert Park showed a 38% and 23% increase in deposits in their first year, respectively, with the majority of the growth in relationship-based core deposits; and our de novo Petaluma branch turned profitable ahead of the usual three to five year wait. With a continuing focus on providing the best service experience for our customers, we continued to strengthen our technology and data systems with capabilities that will enhance our ability to grow and operate efficiently. We are actively involved in all communities we serve, including civic and non-profit organizations with all team members spending a day in the community through our Summit Day of Service program initiated in 2010. The local economy will flourish once again and Summit State Bank will continue among the leaders with needed support and services. As always, we will strive to manage ourselves and the Bank in a fashion most beneficial to shareholders, customers, employees and communities we serve. John C. Lewis Chairman Thomas M. Duryea CEO and President Directors: James E. Brush Business Consultant/Realtor John F. DeMeo Attorney DeMeo DeMeo & West Michael J. Donovan Attorney Richard A. Dorr Owner RAD Developers Thomas M. Duryea President & Chief Executive Officer Summit State Bank Todd R. Fry Chief Financial Officer Champion Industries, Inc. Joseph F. Helmer President Caldwell Securities, Inc. Allan J. Hemphill President Hemphill and Associates John C. Lewis Chairman Summit State Bank Ronald A. Metcalfe Principal Call & Metcalfe Certified Public Accountants, P.C. Nicholas J. Rado Vice President of Finance North Bay Construction, Inc. Marshall T. Reynolds Chairman and Chief Executive Officer Champion Industries, Inc. Eugene W. Traverso Director Summit State Bank Executive Officers: Thomas M. Duryea President & Chief Executive Officer Dennis E. Kelley Senior Vice President & Chief Financial Officer Guy C. Dana Senior Vice President & Chief Credit Officer Linda Bertauche Senior Vice President & Chief Operating Officer Company Contact Information: Phone: 707-568-6000 www.summitstatebank.com Corporate Secretary: Nancy Farber Summit State Bank P.O. Box 6188 Santa Rosa, CA 95406 Transfer Agent: Computershare 1745 Gardena Ave. Glendale, CA 91204 303-262-0780 SUMMIT STATE BANK ANNUAL REPORT ON FORM 10-K TABLE OF CONTENTS Selected Financial Data .................................................................................................................3 Management’s Discussion and Analysis of the Bank’s Financial Condition and Results of Operations Overview ..........................................................................................................................................6 Results of Operations .......................................................................................................................6 Net Income .......................................................................................................................................7 Net Interest Income and Net Interest Margin ..................................................................................7 Provision for Loan Losses .............................................................................................................10 Noninterest Income ........................................................................................................................11 Noninterest Expenses .....................................................................................................................12 Provision for Income Taxes ...........................................................................................................13 Investment Portfolio.......................................................................................................................14 Loan Portfolio ................................................................................................................................15 Non Performing Assets ..................................................................................................................16 Loan Policies and Procedures ........................................................................................................17 Allowance for Loan Losses ...........................................................................................................18 Deposits..........................................................................................................................................21 Borrowings .....................................................................................................................................22 Quantitative and Qualitative Disclosures about Market Risk ........................................................23 Liquidity and Capital Resources ....................................................................................................24 Impact of Inflation .........................................................................................................................25 Consolidated Financial Statements Report of Independent Registered Public Accounting Firm ..........................................................27 Consolidated Balance Sheets December 31, 2010 and 2009 .........................................................28 Consolidated Statements of Income for the Years Ended December 31, 2010, 2009 and 2008 ..................................................................................29 Consolidated Statements of Changes in Shareholders’ Equity For the Years Ended December 31, 2010, 2009 and 2008 ................................................................30 Consolidated Statements of Cash Flows for the Years Ended December 31, 2010, 2009 and 2008 ..................................................................................31 Notes to Consolidated Financial Statements..................................................................................33 1 Form 10-K Cover ................................................................................................................................61 Cross-Reference Index .......................................................................................................62 Disclosure Regarding Forward-Looking Statements .........................................................64 Business .............................................................................................................................64 Information about Summit State Bank ..................................................................64 Services and Financial Products ............................................................................65 Sources of Business ...............................................................................................67 Competition............................................................................................................67 Our Address, Telephone Number and Internet Website ........................................68 Regulation and Supervision ...................................................................................68 Employees ..............................................................................................................76 Risk Factors .......................................................................................................................76 Unresolved Staff Comments ..............................................................................................83 Properties ...........................................................................................................................83 Legal Proceedings ..............................................................................................................83 Submissions of Matters to a Vote of Security Holders ......................................................83 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ................................................83 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ....................................................................85 Controls and Procedures ....................................................................................................85 Other Information ..............................................................................................................86 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters .....................................................87 Exhibits, Financial Statement Schedules ...........................................................................88 2 3 (in thousands except per share data)20102009200820072006Income statement data:Interest income18,886$ 20,653$ 21,554$ 22,755$ 20,454$ Net interest income15,333 15,093 12,343 10,851 11,031 Provision for loan losses 3,860 3,650 685 749 253 Total non-interest income1,263 1,099 (1,303) 1,196 1,321 Total non-interest expense9,553 8,999 8,639 7,993 7,238 Income before income taxes3,183 3,543 1,716 3,305 4,861 Income taxes1,376 1,462 707 1,363 2,053 Net income 1,807$ 2,081$ 1,009$ 1,942$ 2,808$ Preferred dividend 552 510 4 - - Net income available to common stockholders1,255$ 1,571$ 1,005$ 1,942$ 2,808$ Selected balance sheet data:Assets347,933$ 340,400$ 364,580$ 340,193$ 312,950$ Loans, net280,398 288,277 299,645 267,067 252,860 Earning assets330,652 323,356 347,786 321,154 289,581 Deposits279,977 264,253 252,763 249,019 232,974 Federal Home Loan Bank advances12,000 20,120 55,420 42,600 31,460 Shareholders' equity55,309 55,505 55,547 47,715 47,812 Balance sheet data - averageAssets351,386$ 353,790$ 343,403$ 329,457$ 303,800$ Loans, net287,929 299,932 279,140 268,310 248,539 Earning assets336,905 337,705 326,496 310,636 284,906 Deposits278,593 260,507 242,587 238,721 235,553 Federal Home Loan Bank advances15,727 36,052 52,233 41,180 28,557 Shareholders' equity56,197 56,190 47,655 48,219 36,768 Selected per common share data:Earnings per common share - basic0.26$ 0.33$ 0.21$ 0.40$ 0.70$ Earnings per common share - diluted0.26$ 0.33$ 0.21$ 0.40$ 0.69$ Weighted average shares used to calculate earnings per common share - basic 4,745 4,7454,7454,8314,030Weighted average shares used to calculate earnings per common share - diluted 4,779 4,766 4,745 4,834 4,074 Common shares oustanding at year end 4,745 4,745 4,745 4,745 4,795 Cash dividends per share0.36$ 0.36$ 0.36$ 0.36$ 0.36$ Book value per common share9.95$ 10.01 10.05 10.06 9.97 Tangible book value per common share9.08 9.15 9.18 9.19 9.11 Selected ratios:Return on average common equity2.64%3.30%2.12%4.03%7.64%Return on average common tangible equity2.89%3.61%2.32%4.40%8.60%Return on average assets0.51%0.59%0.29%0.59%0.92%Common dividend payout ratio136.18%108.72%169.95%89.75%52.21%Net interest margin4.55%4.47%3.78%3.49%3.87%Efficiency ratio (noninterest expenses to net57.56%55.58%78.25%66.35%58.60% interest income and noninterest income)Average equity to average assets15.99%15.88%13.88%14.64%12.10%Leverage capital ratio14.62%15.13%14.76%12.98%14.29%Nonperforming assets to total assets3.87%3.44%0.30%0.14%0.76%Nonperforming loans to total loans4.70%3.98%0.34%0.17%0.93%Net charge-offs to average loans0.88%0.98%0.10%0.32%0.05%Allowance for loan losses to total loans2.11%1.62%1.32%1.34%1.46%Selected Financial DataYear Ended December 31 DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS This report contains certain statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Actual outcomes and results may differ materially from those expressed in, or implied by, our forward-looking statements. Words such as ―expects,‖ ―anticipates,‖ ―believes,‖ ―estimates‖ and other similar expressions or future or conditional verbs such as ―will,‖ ―should,‖ ―would‖ and ―could‖ are intended to identify such forward-looking statements. Readers of this annual report of the Summit State Bank (also referred to as we, us or our) should not rely solely on the forward-looking statements and should consider all uncertainties and risks throughout the report. Forward-looking statements, by their nature, are subject to risks, uncertainties and assumptions. Our future results and shareholder values may differ significantly from those expressed in these forward-looking statements. You are cautioned not to put undue reliance on any forward-looking statement. The statements are representative only as of the date they are made, and we undertake no obligation to update any forward-looking statement. However, your attention is directed to any further disclosures made on related subjects in any subsequent reports we may file with the Federal Deposit Insurance Corporation (―FDIC‖), including on Forms 10- K, 10-Q and 8-K, in the event we become required to make such filings. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion provides additional information about the financial condition of Summit State Bank (―the Bank‖) at December 31, 2010 and 2009 and results of operations for the years ended December 31, 2010, 2009 and 2008. The following analysis should be read in conjunction with the consolidated financial statements of the Bank and the notes thereto prepared in accordance with accounting principles generally accepted in the United States. Critical Accounting Policies. The discussion and analysis of the Bank’s results of operations and financial condition are based upon financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Bank’s management to make estimates and judgments that affect the reported amounts of assets and liabilities, income and expense, and the related disclosures of contingent assets and liabilities at the date of these financial statements. The Bank believes these estimates and assumptions to be reasonably accurate; however, actual results may differ from these estimates under different assumptions or circumstances. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses, consideration of goodwill impairment and consideration of ―other than temporary impairment‖ of investment securities. The allowance for loan losses is determined first and foremost by promptly identifying potential credit weaknesses that could jeopardize repayment. The Bank’s process for evaluating the adequacy of the allowance for loan losses includes determining estimated loss percentages 4 for each credit based on the Bank’s historical loss experience and other factors in the Bank’s credit grading system and accompanying risk analysis for determining an adequate level of the allowance. The risks are assessed by rating each account based upon paying habits, loan to collateral value ratio, financial condition and level of classifications. The allowance for loan losses was $6,058,000 at December 31, 2010 compared to $4,737,000 at December 31, 2009. The Bank maintains the allowance for loan losses to provide for probable incurred losses in the loan portfolio. Additions to the allowance for loan losses are established through a provision charged to expense. All loans which are judged to be uncollectible are charged against the allowance while any recoveries are credited to the allowance. The Bank’s policy is to charge off any known losses at the time of determination. Any unsecured loan more than 90 days delinquent in payment of principal or interest and not in the process of collection is charged off in total. Secured loans are evaluated on a case by case basis to determine the ultimate loss potential to us subsequent to the liquidation of collateral. In those cases where we believe we are inadequately protected, a charge-off will generally be made to reduce the loan balance to a level equal to the liquidation value of the collateral unless we believe the collateral deficiency may be overcome by borrower cash flows. The Bank’s loan policy provides procedures designed to evaluate and assess the credit risk factors associated with the loan portfolio, to enable the Bank to assess such credit risk factors prior to granting new loans and to evaluate the sufficiency of the allowance for loan losses. The Bank conducts an assessment of the allowance on a monthly basis and undertakes a more critical evaluation quarterly. At the time of the quarterly review, the Board of Directors will examine and formally approve the adequacy of the allowance. The quarterly evaluation includes an assessment of the following factors: any external loan review and any recent regulatory examination, estimated potential loss exposure on each pool of loans, concentrations of credit, value of collateral, the level of delinquent and non-accrual loans, trends in loan volume, effects of any changes in lending policies and procedures, changes in lending personnel, current economic conditions at the local, state and national level and historical losses and recoveries. We assess the carrying value of our goodwill at least annually in order to determine if this intangible asset is impaired. In reviewing the carrying value of our goodwill, we assess the recoverability of such assets by evaluating the fair value of the related business unit. If the carrying amount of goodwill exceeds its fair value, an impairment loss is recognized for the amount of the excess and the carrying value of goodwill is reduced accordingly. Any impairment would be required to be recorded during the period identified. Accounting standards require an annual evaluation of goodwill for impairment using various estimates and assumptions. The market price of the Bank’s common stock at the close of business on December 31, 2010 was $6.99 per common share compared to a book value of $9.95 per common share. The Bank believes the lower market price in relation to book value is due to the overall decline in the financial industry sector and is not specific to the Bank. Further, the Bank engaged an independent third party specialist to perform an impairment test of its goodwill. The evaluation included three approaches: 1) Multiple of tangible book value, based on recent bank acquisitions in California 2) Multiple of equity return and 3) Premium on deposits. The Bank took an average of these approaches and also considered their excess capital levels above the required leverage capital ratio. The impairment test was performed as of September 21, 2010 5 based on June 30, 2010 data and resulted in an implied fair value for the Bank sufficiently above the book value to support the current carrying value of goodwill. As the Bank’s stock price per common share is currently less than its book value per common share, it is reasonably possible that management may conclude that goodwill, totaling $4.1 million at December 31, 2010, is impaired as a result of a future assessment. If our goodwill is determined to be impaired, the related charge to earnings could be material. We are obligated to assess, at each reporting date, whether there is an ―other-than-temporary‖ impairment to our investment securities. Such impairment, if related to credit losses, must be recognized in current earnings rather than in other comprehensive income or loss, net of tax. We examine all individual securities that are in an unrealized loss position at each reporting date for other-than-temporary impairment. Specific investment level factors we examine to assess impairment include, the severity and duration of the unrealized loss, the nature, financial condition and results of operations of the issuers of the securities and whether there has been any cause for default on the securities or any adverse change in the rating of the securities by the various rating agencies, as well as whether the decline in value is credit or liquidity related. Additionally, we reexamine our financial resources and our overall intent and ability to hold the securities until their fair values recover. During 2010, 2009 and 2008, we recognized other than temporary impairment charges of $24,000, $17,000 and $2,457,000, respectively, on government sponsored agency preferred stocks, corporate bonds, and a pooled trust preferred security. We do not believe that we have any other investment securities with material unrealized losses that would be deemed to be ―other-than-temporarily impaired‖ as of December 31, 2010. Investment securities are discussed in more detail under ―Investment Portfolio‖ on page 14. Overview The Bank is a community bank serving Sonoma, Napa, San Francisco and Marin Counties in California. It operates through five offices located in Santa Rosa, Petaluma, Rohnert Park and Healdsburg. The Bank was founded as a savings and loan in 1982 under the name Summit Savings. On January 15, 1999, the Bank converted its charter to a California state-chartered commercial bank and thereby became subject to regulation, supervision and examination by the California Department of Financial Institutions and the FDIC. Results of Operations Years Ended December 31, 2010, 2009 and 2008 The Bank’s primary source of income is net interest income, which is the difference between interest income and fees derived from earning assets and interest paid on liabilities which fund those assets. Net interest income, expressed as a percentage of total average interest earning assets, is referred to as the net interest margin. The Bank’s net interest income is affected by changes in the volume and mix of interest earning assets and interest bearing liabilities. It is also affected by changes in yields earned on interest earning assets and rates paid on interest bearing deposits and other borrowed funds. The Bank also generates noninterest income, including transactional fees, service charges, office lease income, gains and losses on investment securities and gains on sold SBA guaranteed loans originated by the Bank. Noninterest expenses consist primarily of employee compensation and benefits, occupancy and equipment expenses and other 6 operating expenses. The Bank’s results of operations are also affected by its provision for loan losses. Results of operations may also be significantly affected by other factors including general economic and competitive conditions, mergers and acquisitions of other financial institutions within the Bank’s market area, changes in market interest rates, government policies, and actions of regulatory agencies. Net Income The Bank had net income of $1,807,000 and net income available for common stockholders, which deducts the preferred dividends, of $1,255,000, or $0.26 per diluted share, for the year ended December 31, 2010 compared to net income of $2,081,000 and net income available for common stockholders of $1,571,000, or $0.33 per diluted share, for the year ended December 31, 2009, and net income of $1,009,000 and net income available for common stockholders of $1,005,000, or $0.21 per diluted share, for the year ended December 31, 2008. The Return on average assets was 0.51%, 0.59% and 0.29% for the years ended December 31, 2010, 2009 and 2008, respectively. Although various factors effected the change in net income between the years which are discussed in the following sections of this Management’s Discussion and Analysis, the years 2010 and 2009 were significantly impacted by additional loan loss provisions to the allowance for loan losses and in 2008 other than temporary impairment charges (OTTI) significantly reduced net income. See ―Provision for Loan Losses‖ and ―Noninterest Income‖ below. Net Interest Income and Net Interest Margin Net interest income was $15,333,000 and the net interest margin was 4.55% for the year ended December 31, 2010, which represented a $240,000 or 1.6% increase over 2009. For the year ended December 31, 2009, net interest income was $15,093,000 and the net interest margin was 4.47%. This was an increase of $2,750,000 or 22.3% over 2008. For the year ended December 31, 2008, net interest income was $12,343,000 and the net interest margin was 3.78%. At December 31, 2010, approximately 81% of the Bank’s assets were comprised of net loans and 10% of investment securities compared to 85% of net loans and 8% of investment securities at December 31, 2009. The yield on average interest earning assets declined from 2009 to 2010 and declined from 2008 to 2009. The yield on average interest earning assets was 5.61% for the year ended December 31, 2010, 6.12% for the year ended December 31, 2009 and 6.60% for the year ended December 31, 2008. The changes in the overall yield on average earning assets between the years was primarily attributable to the changes in general economic interest rates with the changes in rates impacting the re-pricing of the Bank’s variable rate loan portfolio and calls on government agency securities. The Bank increased its liquid assets by increasing Federal funds sold in 2010 which is a lower yielding asset and this also had an impact on the decline in yields of earning assets in 2010. In 2010, average earning assets declined 0.2% and average loans declined 4.0% compared to 2009. The decline in loans was due to reductions in the portfolio from pay downs and resolution 7 of problem loans that were unable to be offset with new loan demand. In 2009, the decline in interest income resulting from lower yields was partially offset by an increase in the average earning assets over 2008. For 2009, the growth rate of average earning assets was 3.4% and the growth rate for average loans was 7.4%. For the year ended December 31, 2010, the cost of average interest bearing liabilities was 1.30% compared with a cost of average interest bearing liabilities of 1.97% for the year ended December 31, 2009 and 3.26% for the year ended December 31, 2008. The changes in cost of funds have been driven by the changing market interest rates during 2008 through 2010. In 2008 and 2009, the cost of funds was lowered, in part by utilizing brokered deposits and FHLB advances as an alternative to local time deposits as these alternative sources had a lower cost. Additionally, the Bank experienced growth in lower cost interest-bearing demand, savings and money market deposits, in 2008 through 2010. The increase in deposits from 2008 through 2010 has allowed average FHLB advances to be reduced by 70% from $52,233,000 in 2008 to $15,727,000 in 2010. The following table presents condensed average balance sheet information for the Bank, together with interest rates earned and paid on the various sources and uses of its funds for each of the periods presented. Average balances are based on daily average balances. Nonaccrual loans are included in loans with any interest collected reflected on a cash basis. 8 Average Balance Sheets and Analysis of net Interest Income (1) The net amortization of deferred fees and costs on loans included in interest income was $531,000, $499,000 and $284,000 for the years ended December 31, 2010, 2009 and 2008, respectively. (2) Net interest margin is computed by dividing net interest income by average total earning assets. (3) Net interest spread is the difference between the average rate earned on average total earning assets and the average rate paid on average total interest bearing liabilities. The following table shows the change in interest income and interest expense and the amount of change attributable to variances in volume and rates. The unallocated change in rate or volume variance has been allocated between the rate and volume variances in proportion to the absolute dollar amount in the change of each. 9 Average BalanceInterest Income/ ExpenseAverage RateAverage BalanceInterest Income/ ExpenseAverage RateAverage BalanceInterest Income/ ExpenseAverage RateAssetsInterest earning assets:Interest bearing deposits in banks3,109$ 4 0.13%134$ -$ 0.00%26$ 1$ 3.85%Taxable investment securities34,573 1,390 4.02%37,195 1,796 4.83%45,336 2,636 5.81%Federal funds sold11,294 26 0.23%444 1 0.23%1,994 69 3.46%Loans, net of unearned income (1)287,929 17,466 6.07%299,932 18,856 6.29%279,140 18,848 6.75%Total earning assets/interest income336,905 18,886 5.61%337,705 20,653 6.12%326,496 21,554 6.60%Nonearning assets20,427 20,594 20,720 Allowance for loan losses(5,946) (4,509) (3,813) Total assets351,386$ 353,790$ 343,403$ Liabilities and Shareholders' EquityInterest bearing liabilities:Deposits:Interest-bearing demand deposits24,049$ 87 0.36%18,451$ 91 0.49%13,066$ 102 0.78%Savings and money market51,951 452 0.87%43,081 535 1.24%37,919 854 2.25%Time deposits180,694 2,517 1.39%185,085 3,914 2.11%179,728 6,376 3.55%FHLB advances15,727 497 3.16%36,052 1,020 2.83%52,233 1,879 3.60%Total interest bearing liabilities/interest expense272,421 3,553 1.30%282,669 5,560 1.97%282,946 9,211 3.26%Noninterest bearing deposits21,899 13,890 11,874 Other liabilities869 1,041 928 Total liabilities295,189 297,600 295,748 Shareholders' equity56,197 56,190 47,655 Total liabilities and shareholders' equity351,386$ 353,790$ 343,403$ Net interest income and margin (2)15,333$ 4.55%15,093$ 4.47%12,343$ 3.78%Net interest spread (3)4.31%4.15%3.34%Year Ended December 31, 201020092008(in thousands) Volume and Yield/Rate Variances Provision for Loan Losses The Bank maintains an allowance for loan losses for probable incurred losses that are expected as an incidental part of the banking business. Write-offs of loans are charged against the allowance for loan losses, which is adjusted periodically to reflect changes in the volume of outstanding loans and estimated losses due to deterioration in the financial condition of borrowers or the value of property securing nonperforming loans, or changes in general economic conditions and other qualitative factors. Additions to the allowance for loan losses are made through a charge against income referred to as the ―provision for loan losses.‖ The Bank’s loan policy provides procedures designed to evaluate and assess the credit risk factors associated with its loan portfolio, to enable management to assess such credit risk factors prior to granting new loans and to evaluate the sufficiency of the allowance for loan losses. The Bank conducts an assessment of the allowance for loan losses on a monthly basis and undertakes a more critical evaluation quarterly. At the time of the quarterly review, the Board of Directors examines and formally approves the adequacy of the allowance. The quarterly evaluation includes an assessment of the following factors: any external loan review and regulatory examination, estimated potential loss exposure on each pool of loans, concentrations of credit, value of collateral, the level of delinquent and non-accruals loans, trends in loan volume, effects of any changes in the lending policies and procedures, changes in lending personnel, current economic conditions at the local, state and national level, and a migration analysis of historical losses and recoveries for the prior eight quarters. 10 VolumeRateNetVolumeRateNetInterest income:Interest bearing deposits in banks4$ -$ 4$ (1)$ -$ (1)$ Taxable investment securities(120) (286) (406) (432) (408) (840) Federal funds sold25 - 25 (31) (37) (68) Loans, net(741) (649) (1,390) 1,354 (1,346) 8 Total interest income(832) (935) (1,767) 890 (1,791) (901) Interest expense:Interest-bearing demand deposits24 (28) (4) 34 (45) (11) Savings and money market97 (180) (83) 104 (423) (319) Time deposits(91) (1,306) (1,397) 183 (2,645) (2,462) FHLB advances(631) 108 (523) (509) (350) (859) Total interest expense(601) (1,406) (2,007) (188) (3,463) (3,651) Increase (decrease) in net interest income(231)$ 471$ 240$ 1,078$ 1,672$ 2,750$ (Dollars in thousands)Change Due to2010 Compared to 2009 2009 Compared to 2008 Change Due to At December 31, 2010, the Bank’s allowance for loan losses totaled $6,058,000 or 2.11% of outstanding loans, compared with an allowance for loan losses of $4,737,000, or 1.62% of outstanding loans at December 31, 2009 and $4,016,000, or 1.32% of outstanding loans at December 31, 2008. There were $2,539,000 in net loans charged-off to the allowance for loan losses during 2010, $2,929,000 in net charge-offs to the allowance in 2009 and $290,000 in net charge-offs in 2008. For the year ended December 31, 2010, the provision for loan losses amounted to $3,860,000 and for the years ended December 31, 2009 and 2008, the provision for loan losses amounted to $3,650,000 and $685,000, respectively. The provision for loan losses is dependent on the increase in loans outstanding, the mix of types of loans within the portfolio, net charge-offs recorded against the allowance, the volumes of loans past due or on nonaccrual status and economic factors. See ―Allowance for Loan Losses‖ below. Noninterest Income Noninterest income is comprised primarily of service charges and other fees on deposit accounts and office lease income. In 2010, 2009 and 2008 noninterest income was decreased by other than temporary impairment write downs on investment securities (OTTI). In 2010 and 2009, the Bank sold various corporate bonds with a net gain of $150,000 in 2010 and $28,000 in 2009. The following table summarizes noninterest income recorded for the years indicated. Service charges on deposit accounts were $401,000 for the year ended December 31, 2010, compared to $391,000 and $404,000 for the years ended December 31, 2009 and 2008, respectively. The Bank has experienced an increase in the total demand deposits however; a corresponding increase in service charges was partially offset by commercial account earnings credits. The Bank owns its headquarters building with approximately half of the office space leased to nonaffiliated tenants. The building was occupied in 2004 and fully leased in 2005. Lease income from this office building was $528,000, $594,000 and $669,000 for the years ended December 31, 2010, 2009 and 2008, respectively. The leases have annual rent increases. The decline in lease income in between the years was attributable to lower lease rates on leases entered into in 2009. 11 (in thousands)201020092008Service charges on deposit accounts401$ 391$ 404$ Office leases 529 594 669 Net securities gains150 28 - Loan servicing, net40 58 46 Other-than-temporary impairment (loss) Total impairment loss(24) (17) (2,457) Loss recognized in other comprehensive income (loss)- - - Net impairment loss recognized in earnings(24) (17) (2,457) Other income 167 45 35 Total non-interest income1,263$ 1,099$ (1,303)$ Year Ended December 31, Management does an analysis quarterly in determining the credit quality and expected cash flows from its investment securities to determine if other than temporary impairment should be recognized. The volatile bond market and uncertainties of the financial condition of various corporate entities resulted in OTTI write downs of $24,000 during 2010, $17,000 during 2009 and $2,457,000 during 2008. The write down in 2010 was the remaining balance of government sponsored agency preferred stocks. The write down in 2009 was on a pooled trust preferred security which was written down to one dollar. In 2008, the write downs consisted of $1,256,000 on the value of government sponsored agencies’ preferred stocks, $970,000 on corporate securities and $231,000 on a security backed by trust preferred securities of financial institutions and insurance companies. Noninterest Expenses The following table summarizes noninterest expenses recorded for the years indicated. For the year ended December 31, 2010, noninterest expenses were $9,553,000 or 2.7% of average assets and 58% of total revenue (total revenue is defined as net interest income plus noninterest income, excluding securities impairment). This was a 6.2% increase over 2009 noninterest expenses of $8,999,000. The increase in expenses in 2010 was primarily attributable to increased salaries and employee benefit expenses and other expenses, partially offset with a decline in occupancy expense. Noninterest expenses increased 4.2% to $8,999,000 in 2009 compared to noninterest expenses of $8,639,000 in 2008. Noninterest expenses were 2.5% of average assets and 56% of total revenue in 2009 and 2.5% of average assets and 64% of total revenue in 2008 (total revenue is defined as net interest income plus noninterest income, excluding securities impairment). The increase in expenses in 2009 over 2008 was primarily attributable to increased FDIC insurance premiums. Salaries and employee benefits expense increased 12.2% in 2010 compared to 2009 and decreased 1.8% in 2009 compared to 2008. In 2008, salaries and employee benefits expense included $268,000 in employee termination expenses. Without these termination expenses, 2009 would have increased 4.7% over 2008. Occupancy and equipment expenses decreased 6.5% in 2010 compared to 2009 and decreased 1.4% in 2009 compared to 2008. The decrease in occupancy expenses during the years were primarily attributable to new leases related to the relocation of two of the Bank’s branches. In 12 (in thousands)201020092008Salaries and employee benefits4,788$ 4,266$ 4,343$ Occupancy and equipment 1,598 1,710 1,735 Other expenses3,167 3,023 2,561 Total9,553$ 8,999$ 8,639$ Year Ended December 31, 2009, the Bank relocated its Rohnert Park branch to a new facility and relocated its Windsor office to Healdsburg. The following table summarizes the categories of other expenses. Included in deposit and other insurance premiums are FDIC insurance premiums assessed. These premiums are assessed quarterly and were significantly offset by a credit during 2008. No credit was available during 2010 and 2009 and the FDIC has assessed higher insurance premiums along with a special assessment in 2009 to rebuild the insurance fund. FDIC insurance premiums, including the special assessment, were $413,000, $548,000 and $31,000 in 2010, 2009 and 2008, respectively. Data processing expense was higher in 2008 compared to 2010 and 2009, as the Bank converted to a new data processor in 2008 with conversion expenses of approximately $311,000 recorded. Professional fees increased in 2009 through 2010 primarily due to debt collection related expenses. Advertising and promotion expenses increased in 2010 and 2009 as the Bank increased its marketing programs. Director fees and expenses varies during the years primarily as a result of the number of Board and Board Committee meetings held during the year. Provision for Income Taxes The Bank accrues income tax expense based on the anticipated tax rates during the financial period covered. The provision for income taxes for the years ended December 31, 2010, 2009 and 2008, was $1,376,000 $1,462,000 and $707,000, respectively. The combined effective Federal and State corporate income tax rates for the years ended December 31, 2010, 2009 and 2008, were 43.2%, 41.3%, and 41.2%. The increase in the effective tax rate during 2010 was due to a $90,000, state deferred tax asset valuation allowance recorded for the write downs of preferred stocks of government sponsored agencies that are considered capital losses for California state income tax purposes and management no longer has a tax planning strategy to utilize these capital losses. 13 (in thousands)201020092008Data processing586$ 590$ 949$ Professional fees587 559 412 Director fees and expenses317 240 298 Advertising and promotion441 343 206 Deposit and other insurance premiums552 684 171 Telephone and postage90 86 91 Other expenses594 521 434 3,167$ 3,023$ 2,561$ Year Ended December 31, Investment Portfolio Securities classified as available-for-sale for accounting purposes are recorded at their fair value on the balance sheet. Securities classified as held-to-maturity, if any, are recorded at amortized cost. At December 31, 2010, investment securities comprised 9.7% of total assets and 10.4% of earning assets. At December 31, 2009, investment securities comprised 8.0% of total assets and 8.6% of earning assets. At December 31, 2010 and 2009, there were no investment securities classified as held-to-maturity. Securities classified as available-for-sale were $33,642,000 and $27,400,000 for the 2010 and 2009 respective year ends. Changes in the fair value of available-for-sale securities (e.g., unrealized holding gains or losses) are reported as ―other comprehensive tax, and carried as accumulated other comprehensive income or loss within shareholders’ equity until realized. income (loss),‖ net of The Bank utilizes the investment portfolio to manage liquidity and attract funding that requires collateralization. At December 31, 2010, investment securities with a fair value of $28,058,000, or 83% of the portfolio, were pledged to secure State of California deposits, this compares to $25,087,000, or 92% of the portfolio pledged at December 31, 2009. At December 31, 2010 and 2009, securities with a par value of $15,000,000 and $9,000,000, respectively, were callable within one year. Investment Securities The composition of the investment portfolio by major category and contracted maturities or repricing of debt investment securities at December 31, 2010 are shown below. 14 (in thousands)201020092008Available-for-sale securities: Government agencies29,308$ 23,072$ 36,143$ Mortgage-backed securities - residential4,334 1,994 2,464 Pooled trust prefereed securities- - 18 Other debt securities- 2,290 2,534 Government sponsored entities stock- 44 24 Total33,642$ 27,400$ 41,183$ December 31, Contractual Maturity or Repricing Schedule and Weighted Average Yields of Securities As of December 31, 2010 As of December 31, 2010 the Bank did not own securities of any single issuer (other than U.S. Government agencies) whose aggregate book value was in excess of 10% of the Bank’s total equity at the time of purchase. The Bank recorded other than temporary impairment charges of $24,000, $17,000 and $2,457,000 on investment securities during 2010, 2009 and 2008, respectively. The securities with impairment charges had no remaining recorded value at December 31, 2010. The securities with impairment charges were government sponsored agency preferred stocks, corporate securities and a pooled trust preferred security. Loan Portfolio The following table shows the composition of the Bank’s loan portfolio by amount and percentage of total loans for each major loan category at the dates indicated. Loans 15 (in thousands)AmountYieldAmountYieldAmountYieldAmountYieldAvailable-for-sale:Government agencies502$ 4.30%-$ 0.00%13,255$ 3.68%15,551$ 4.38%Mortgage backed securities - residential- - - - - - 4,334 4.43%502$ 4.30%-$ 0.00%13,255$ 3.68%19,885$ 4.39%Within One YearAfter One But Within Five YearsAfter Five But Within Ten YearsAfter Ten Years(in thousands)2010% 2009% 2008% 2007% 2006% Commercial & agricultural75,925$ 26.2%68,622$ 23.2%69,359$ 22.7%54,846$ 20.2%55,814$ 21.7%Real estate - commercial119,267 41.2%126,770 42.9%126,690 41.4%101,919 37.6%102,439 39.9%Real estate - construction 4,803 1.7%2,562 0.9%6,800 2.2%27,085 10.0%30,937 12.0%Real estate - single family units52,600 18.2%53,456 18.1%53,375 17.4%40,940 15.1%31,451 12.2%Real estate - multifamily21,871 7.6%22,597 7.6%23,159 7.6%20,545 7.6%14,116 5.5%Real estate - land loans7,331 2.5%12,254 4.2%14,857 4.9%12,856 4.7%10,882 4.2%Consumer5,294 1.8%5,432 1.8%5,253 1.7%5,711 2.1%4,977 1.9%Lease financing2,230 0.8%3,879 1.3%6,305 2.1%7,295 2.7%6,538 2.6%289,321 100%295,572 100%305,798 100%271,197 100%257,154 100%LESS:Allowance for Loan Losses(6,058) (4,737) (4,016) (3,621) (3,736) Deferred Loan Fees(2,865) (2,558) (2,137) (509) (558) Total Loans, Net280,398$ 288,277$ 299,645$ 267,067$ 252,860$ December 31, At December 31, 2010, the Bank had approximately $12,483,000 in undisbursed loan commitments, of which approximately $3,065,000 related to real estate construction loans. This compares with undisbursed commitments of approximately $16,143,000 at December 31, 2009, of which approximately $6,632,000 related to real estate construction loans. At December 31, 2010 and 2009, there were $209,000 and $1,847,000, respectively, in standby letters of credit outstanding. The following table shows the maturity distribution of Real Estate Construction and Commercial & Agriculture loans, including rate repricing intervals on variable rate loans, at December 31, 2010. In the following table, the term variable (generally referring to loans for which the interest rate will change immediately given a change in the underlying index) also includes loans with adjustable rates (loans for which the rate may change, but which are also limited in occurrence). Loan Portfolio Maturity Structure at December 31, 2010 Nonperforming Assets Nonperforming assets consist of nonperforming loans, investment securities with deferred interest payments and other real estate owned. Nonperforming loans are those for which the borrower fails to perform under the original terms of the obligation and consist of nonaccrual loans and accruing loans past due 90 days or more. Additionally, loans may be restructured due to deteriorating financial conditions and classified as troubled debt restructurings (TDRs). The TDR’s may or may not be the same as those listed as nonaccrual or 90 days or more past due loans. Included in nonperforming loans are loans with a balance of $4,300,000 or 32% of nonperforming loans that are secured by commercial real estate, a construction loan with a balance of $2,357,000 or 18% of nonperforming loans, loans collateralized by farmland with a balance of $3,908,000 or 29%, loans 85% guaranteed by the Small Business Administration with a balance of $445,000, or 3% and $2,462,000 or 18% of nonperforming loans that are unsecured or collateralized by real estate. 16 (in thousands)Within One YearAfter One But Within Five YearsAfter Five YearsTotalReal estate - construction4,803$ -$ -$ 4,803$ Commercial & agricultural56,417 12,608 6,900 75,925 Total61,220$ 12,608$ 6,900$ 80,728$ Loans with:Fixed interest rates24,372$ 6,800$ 175$ 31,347$ Floating interest rates36,848 5,808 6,725 49,381 Total61,220$ 12,608$ 6,900$ 80,728$ The following are the nonperforming assets for the respective periods: Nonperforming Loans and Assets At December 31, 2010 and 2009, there were $15,663,000 and $15,931,000 in potential problem loans with respect to which management had concerns as to the ability of the borrowers to comply with the present loan repayment terms that were not included in nonperforming loans. These borrowers have exhibited some deterioration as the respective year end, but were current with the loan terms and management has assessed their ability to continue performance. These loans are predominately secured by real estate. Loan Policies and Procedures The Bank’s underwriting practices include an analysis of the borrower’s management, current economic factors, the borrower’s ability to respond and adapt to economic changes outside its direct control and verification of primary and secondary sources of repayment. Risk within the loan portfolio is managed through the Bank’s loan policies and underwriting. These policies are reviewed and approved annually by the Board of Directors.  Management administers the loan policy, ensures proper loan documentation is maintained and develops the methodology for monitoring loan quality and the level of the allowance for loan losses and reports on these matters to the Board of Directors' Internal Asset Review Committee and the Board of Directors.  The Board of Directors' Internal Asset Review Committee meets regularly to evaluate problem assets and the adequacy of the allowance for loan losses. The Committee also reviews and makes recommendations to the Board of Directors regarding the adequacy of the allowance for loan losses, and is responsible for ensuring that an independent third party reviews the loan portfolio at least annually. Resultant reports are sent to this Committee and to the Audit Committee.  The Board of Directors' Loan Committee is responsible for enforcement of the loan policy and has additional responsibilities which include approving loans or loan 17 20102009200820072006Nonaccrual loans13,472$ 10,587$ 1,046$ 465$ 2,383$ Accruing loans past due 90 days or more- 1,066 - - - Total nonperforming loans13,472 11,653 1,046 465 2,383 Investment securities- 44 42 - - Total nonperforming assets13,472$ 11,697$ 1,088$ 465$ 2,383$ Nonperforming loans to total loans4.70%3.98%0.34%0.17%0.93%Nonperforming assets to total assets3.87%3.44%0.30%0.14%0.76%December 31, (in thousands) relationships for a customer that, when considered in the aggregate, exceed management's level of loan authority for that customer.  The Board of Directors' Audit Committee also engages a third party to perform a review of management's asset and liability practices to ensure compliance with the Bank's policies.  The Board of Directors retains overall responsibility for all loan functions and reviews material loan relationships. Loan approvals are granted according to established policies, and lending officers are assigned approval authorities within their levels of training and experience. Interest rates reflect the risk inherent in loans and collateral is generally taken for purchase-money financing. Collateral may consist of accounts receivable, direct assignment of contracts, inventory, equipment and real estate. Unsecured loans may be made when warranted by the financial strength of the borrower. With the exception of single-family residential mortgage loans, the maximum rate adjusting period is generally five years. The Bank has approximately $109 million in loans (38% of the gross loan portfolio at December 31, 2010) with fixed interest rates that mature in over 5 years or variable interest rates where the current interest rate is at the contractual floor rate which is above the fully indexed rate. Guarantees are generally required to help assure repayment. Management believes that pricing is commensurate with risk for both new and existing customers. Allowance for Loan Losses The Bank maintains the allowance for loan losses to provide for probable incurred losses in the loan portfolio. Additions to the allowance for loan losses are established through a provision charged to expense. All loans which are judged to be uncollectible are charged against the allowance while any recoveries are credited to the allowance. The Bank’s policy is to charge off any known losses at the time of determination. Any unsecured loan more than 90 days delinquent in payment of principal or interest and not in the process of collection is charged off in total. Secured loans are evaluated on a case by case basis to determine the ultimate loss potential to us subsequent to the liquidation of collateral. In those cases where we believe we are inadequately protected, a charge-off will generally be made to reduce the loan balance to a level equal to the liquidation value of the collateral unless we believe the collateral deficiency may be overcome by borrower cash flows. The Bank’s loan policy provides procedures designed to evaluate and assess the credit risk factors associated with the loan portfolio, to enable the Bank to assess such credit risk factors prior to granting new loans and to evaluate the sufficiency of the allowance for loan losses. The Bank conducts an assessment of the allowance on a monthly basis and undertakes a more critical evaluation quarterly. At the time of the quarterly review, the Board of Directors will examine and formally approve the adequacy of the allowance. The quarterly evaluation includes an assessment of the following factors: any external loan review and any recent regulatory examination, estimated potential loss exposure on each pool of loans, concentrations of credit, value of collateral, the level of delinquent and non-accrual loans, trends in loan volume, effects 18 of any changes in lending policies and procedures, changes in lending personnel, current economic conditions at the local, state and national level and historical losses and recoveries. The following table sets forth an analysis of the allowance for loan losses and provision for loan losses for the periods indicated. Summary of Activity in the Allowance for Loan Losses 19 201020082006Balance at beginning of period4,737$ 4,016$ 3,621$ 3,736$ 3,617$ Charge-offs:Commercial & agricultural1,987 2,747 431 331 134 Real estate--construction and land development270 - - 561 - Real estate--mortgage242 194 - - - Consumer56 44 8 - - Lease financing- - 19 - - Total loans charged-off2,555 2,985 458 892 134 Recoveries:Commercial & agricultural- 56 168 28 - Real estate--construction and land development14 - - - - Real estate--mortgage- - - - - Consumer2 - - - - Lease financing- - - - - Total recoveries16 56 168 28 - Net loans charged-off2,539 2,929 290 864 134 Provision for loan losses3,860 3,650 685 749 253 Allowance for loan losses - end of period6,058$ 4,737$ 4,016$ 3,621$ 3,736$ Loans:Average loans outstanding during period, net of unearned income287,929$ 299,932$ 279,140$ 268,310$ 248,539$ Total loans at end of period, net of unearned income286,456$ 293,014$ 303,661 270,688$ 256,596$ Ratios:Net loans charged-off to average net loans 0.88%0.98%0.10%0.32%0.05%Net loans charged-off to total loans 0.89%1.00%0.10%0.32%0.05%Allowance for loan losses to average net loans2.10%1.58%1.44%1.35%1.50%Allowance for loan losses to total loans 2.11%1.62%1.32%1.34%1.46%Net loans charged-off to beginning allowance for loan losses 53.60%72.93%8.01%23.13%3.70%Net loans charged-off to provision for loan losses65.78%80.25%42.34%115.35%52.96%2007Year Ended December 31, 2009 The following table summarizes the allocation of the allowance for loan losses by loan category and the amount of loans in each category as a percentage of total loans in each category as of the end of each year presented. The allocated and unallocated portions of the allowance for loan losses are available to the entire portfolio. Allocation of Allowance for Loan Losses The changes from year to year for the allocation by loan category are attributable to the growth of the category and management’s assessment of the quality of the individual loans within the category. The other qualitative factors allocation represents various qualitative factors in the determination of the adequacy of the allowance for loan losses. Qualitative factors included the size of individual credits, concentrations and general economic conditions. Management also considers these qualitative factors in their evaluation of the adequacy of the allowance for loan losses. The changes in the allowance allocations for the loan portfolio categories at December 31, 2010 compared to December 31, 2009 was primarily attributable to loans that were allocated a specific reserve. An unallocated allowance can arise from fluctuations in the amount of classified (―credit grades‖) and specific allocations to nonperforming loans between periods. The Internal Asset Review Committee reviews the amount and reasons for unallocated allowances and whether it has arisen due to periodic fluctuations in the credit grades or has arisen due to changes in qualitative factors or changes in lending strategies. If the unallocated allowance has arisen from other than periodic fluctuations in credit grades, then the Internal Asset Review Committee may determine that a portion of the allowance for loan losses should be reversed. The unallocated allowance represents temporary changes in allocations resulting from changes in loan volumes, types and quality, as well as other factors. Management assesses the unallocated amount to determine if the amount is due to other than temporary changes in these factors. In addition to the allowance for loan losses, the Bank maintains an allowance for losses for undisbursed loan commitments, which is reported in other liabilities on the consolidated balance sheets. This allowance was $32,000 and $27,000 at December 31, 2010 and 2009. 20 (in thousands) Allowance AllocationAmount of Category Loans to Total Loans Allowance AllocationAmount of Category Loans to Total Loans Allowance AllocationAmount of Category Loans to Total Loans Allowance AllocationAmount of Category Loans to Total Loans Allowance AllocationAmount of Category Loans to Total Loans Commercial & agricultural $ 1,485 26.2% 1,634 23.2% $ 1,024 22.7% $ 450 20.2% $ 521 21.7%Real estate - commercial 1,402 41.2% 1,094 42.9% 707 41.4% 1,156 37.6% 688 39.9%Real estate - construction 509 1.7% 8 0.9% 398 2.2% 749 10.0% 450 12.0%Real estate - single family units 63 18.2% 379 18.1% 88 17.4% 67 15.1% 58 12.2%Real estate - multifamily 87 7.6% 176 7.6% 328 7.6% 18 7.6% 99 5.5%Real estate - land loans 1,382 2.5% 86 4.2% 135 4.9% 108 4.7% 172 4.2%Consumer 38 1.8% 65 1.8% 259 1.7% 66 2.1% 36 1.9%Lease financing 22 0.8% 39 1.3% 63 2.1% 79 2.7% 69 2.6%Other qualitative factors 960 960 735 756 1,117 Unallocated 110 296 279 172 526 Total $ 6,058 100% $ 4,737 100% $ 4,016 100% $ 3,621 100% $ 3,736 100%20072006Year Ended December 31, 201020082009 Deposits Deposits are the Bank’s primary source of funds. The Bank employs business development officers to solicit commercial demand deposits. The Bank focuses on obtaining deposits from the communities it serves but occasionally may accept deposits from outside its market area or receive brokered deposits. Management concentrated on lowering its cost of funding by increasing its reliance on brokered deposits during 2010 and 2009. This enabled the Bank to avoid paying artificial high rates in the local market that were being set by troubled financial institutions operating in its market. Management is concentrating on increasing demand deposits in the local market through the use of business development officers who call on small businesses. The following table sets forth total deposits by type. The Bank offers local depositors with deposits in excess of $250,000 and who are concerned with FDIC insurance limits, a deposit placement service through a program called CDARS. Through this program amounts in excess of $250,000 can be placed in certificates of deposit at other institutions and the Bank receives reciprocal deposits from other institutions within the network. At December 31, 2010 and 2009, there were $8,238,000 and $9,437,000 in the CDARS program, respectively. Although the originating depositors are local customers of the Bank, this exchange of deposits for the purposes of FFIEC Call Reports, are classified as brokered deposits. In addition to the CDARS deposits, the Bank had $45,107,000 and $36,018,000 at December 31, 2010 and 2009 in brokered deposits. Certain time deposits are received through a program run by the Treasurer of the State of California to place public deposits with community banks. At December 31, 2010 and 2009, the State of California had $31,500,000 and $34,000,000 in time deposits with the Bank with maturities of up to six months and collateralized by investment securities, mortgage loans or letters of credit issued by the Federal Home Loan Bank. 21 Balance% of TotalBalance% of TotalDemand Accounts48,015$ 17.15%37,912$ 14.35%Savings and Money Market53,912 19.26%56,272 21.29%Time Deposits178,050 63.59%170,069 64.36%Total Deposits279,977$ 264,253$ Deposit Type (in thousands)Year Ended December 31, 20102009 The following table sets forth the average balances by deposit category and the interest cost for the periods indicated. Average Deposit Balances and Rates Paid The following table sets forth the maturities of time certificates of deposit of $100,000 or more outstanding at December 31, 2010. Maturity of Time Deposits of $100,000 or More Borrowings Borrowings were $12,000,000 and $20,120,000 at December 31, 2010 and 2009. Borrowings consisted of FHLB advances. At December 31, 2010 there was $5,000,000 due within one year, $7,000,000 with maturities greater than one year but less than three years. Management utilizes FHLB advances when the terms are deemed advantageous compared to raising time deposits and to manage over all liquidity. 22 Average BalanceAverage RateAverage BalanceAverage RateAverage BalanceAverage RateNon-interest-bearing demand deposits21,899$ 13,890$ 11,874$ Interest-bearing demand deposits24,049 0.36%18,451 0.49%13,066 0.78%Saving and money market51,951 0.87%43,081 1.24%37,919 2.25%Time certificates under $100,00072,927 1.60%80,287 2.35%79,009 2.46%Time certificates $100,000 or over107,767 1.25%104,798 1.95%100,719 4.44%Total deposits278,593$ 1.10%260,507$ 1.74%242,587$ 3.02%(in thousands)Year Ended December 31,201020092008(in thousands)December 31, 2010December 31, 2009Time deposits of $100,000 or more maturing in:Three months or less50,104$ 53,988$ Over three though six months13,467 8,458 Over six to twelve months21,743 20,918 Over twelve months27,873 14,491 Total time deposits of $100,000 or more113,187$ 97,855$ Quantitative and Qualitative Disclosures about Market Risk The Bank constantly monitors earning asset and deposit levels, developments and trends in interest rates, liquidity, capital adequacy and marketplace opportunities. Risks associated with interest rate changes and market risk is managed through the Bank’s Asset Liability and Investment Policies. These policies are reviewed and approved annually by the Board of Directors and oversight is provided by the Asset Liability and Investment committees of the Board. Management responds to all of these to protect and possibly enhance net interest income while managing risks within acceptable levels as set forth in the Bank’s policies. In addition, alternative business plans and transactions are contemplated for their potential impact. This process is known as asset/liability management and is carried out by changing the maturities and relative proportions of the various types of loans, investments, deposits and borrowings in the ways described above. The tool most commonly used to manage and analyze the interest rate sensitivity of a bank is known as a computer simulation model. To quantify the extent of risks in both the Bank’s current position and in transactions it might make in the future, the Bank uses a model to simulate the impact of different interest rate scenarios on net interest income. The hypothetical impact of both sudden (up to an immediate change in interest rates of +/- 4.00%) and smaller incremental interest rate changes are modeled at least quarterly, representing the primary means the Bank uses for interest rate risk management decisions. The Bank is liability sensitive during a one year period meaning that during one year, more liabilities will reprice than loans. Liability sensitive banks would expect an increase in the net interest margin if interest rates decline and the net interest margin to decline when rates increase. However various factors influence the change in the Bank’s margin when general economic interest rates change. These factors include, but are not limited to, the growth and mix of new assets, deposit liabilities and borrowings, the extension or contraction of maturities of new and renewed assets and liabilities, the particular shape of the general economic yield curve, and the general influence on pricing by competition in the local market for loans and deposits. Additionally, when economic rates change, there is an immediate impact from loans that are tied to a daily ―prime lending rate.‖ The repricing of liabilities to offset this change requires time for deposits to mature and renew. Based strictly on maturing time deposits and borrowings, and without the other factors listed above, it normally will take three months for the Bank to reprice liabilities to offset a prime rate change. At December 31, 2010, the computer simulation model for a +2.00% interest rate shock, results in the Bank’s net interest income for a twelve month period to decrease by 2.1% or $(321,000). As current interest rates are at low levels, no meaningful projection is made for a rate reduction. Computer simulation models use information from the Banker’s loan and deposit system at a static point in time and bases the repricing of assets and liabilities based on contractual terms and certain assumptions as to movements of various rate indexes and management decisions regarding when to reprice certain portfolios not linked to an index. The actual results experienced from interest rate changes can vary from the results of the simulation. 23 When preparing its modeling, the Bank makes significant assumptions about the lag in the rate of change and impacts of optionality in various asset and liability categories. The Bank bases its assumptions on past experience and comparisons with other banks, and tests the validity of its assumptions by reviewing actual results with past projected expectations annually. As the impact of changing interest rates depends on assumptions, actual experience can materially differ from projections. The purpose of the model is to forecast the likely impact in order for management to monitor exposures to interest rate risk. Liquidity and Capital Resources Maintenance of adequate liquidity requires that sufficient resources be available at all times to meet cash flow requirements of the Bank. Liquidity in a banking institution is required primarily to provide for deposit withdrawals and the credit needs of customers and to take advantage of lending and investment opportunities as they arise. A bank may achieve desired liquidity from both assets and liabilities. Cash and deposits held in other banks, federal funds sold, other short term investments, maturing loans and investments, payments of principal and interest on loans and investments, and potential loan sales are sources of asset liquidity. Deposit growth and access to credit lines established with correspondent banks, primarily with the FHLB, and access to brokered certificates of deposits are sources of liability liquidity. The Bank reviews its liquidity position on a regular basis based upon its current position and expected trends of loans and deposits. Management believes that the Bank maintains adequate sources of liquidity to meet its liquidity needs. The Bank’s liquid assets, defined as cash, demand deposits with banks, Federal funds sold and unpledged investment securities, totaled $18,066,000 and $5,246,000 at December 31, 2010 and December 31, 2009, respectively, and constituted 5.2% and 1.5%, respectively, of total assets on those dates. The increase in liquid assets was attributable to a decision to increase the Bank’s liquidity position in 2010. At December 31, 2010 the Bank had $89,459,000 in borrowing lines of credit from the FHLB and correspondent banks with $12,000,000 in outstanding advances from the FHLB. At December 31, 2009, these lines of credit available were $92 million with $20 million in FHLB advances outstanding. The Board of Directors recognizes that a strong capital position is vital to growth, continued profitability, and depositor and investor confidence. The policy of the Board of Directors is to maintain sufficient capital at not less than the ―well-capitalized‖ thresholds established by banking regulators. However, in the current economic and regulatory environment the Bank has maintained capital ratios in excess of regulatory requirements. Shareholders’ equity also includes the Bank’s accumulated other comprehensive income (loss), net of taxes of $98,000 at December 31, 2010 and $4,000 at December 31, 2009. Other comprehensive income (loss) reflects the fair value adjustment, net of tax, of investment securities classified as available-for-sale. This will fluctuate based on the amount of securities classified as available-for-sale and changes in market interest rates. Total shareholders’ equity was $55,309,000 at December 31, 2010, $55,505,000 at December 31, 2009. 24 Federal regulations establish guidelines for calculating ―risk-adjusted‖ capital ratios and minimum ratio requirements. Under these regulations, banks are required to maintain a total risk- based capital ratio of 8.0% and Tier 1 risk-based capital (primarily shareholders’ equity) of at least 4.0% of risk-weighted assets. The Bank had total and Tier 1 risk-based capital ratios of 19.8% and 18.6%, respectively, at December 31, 2010, and was ―well-capitalized‖ under the regulatory guidelines. The Bank’s total and Tier 1 risk-based capital ratios were 19.3% and 18.1%, respectively, at December 31, 2009. In addition, regulators have adopted a minimum leverage ratio standard for Tier 1 capital to average assets. The minimum ratio for top-rated institutions may be as low as 3%. However, regulatory agencies have stated that most institutions should maintain ratios at least 1 to 2 percentage points above the 3% minimum. As of December 31, 2010, the Bank’s leverage ratio was 14.6%, while as of December 31, 2009, the Bank’s leverage ratio was 15.1%. Capital levels for the Bank remain above established regulatory capital requirements. The Bank increased Tier 1 capital by $8,500,000 through issuance of preferred stock and a common stock warrant to the U.S. Department of the Treasury under the TARP Capital Purchase Program on December 19, 2008. See ―Regulation and Supervision – Troubled Asset Relief Program and Related Measures‖ (page 72). Quarterly dividends are paid out of retained earnings. The Bank pays $106,000 in quarterly dividends on its preferred stock and has paid $0.09 or $427,000 in quarterly dividends on common stock during 2010 and 2009. The California Financial Code restricts total dividend payment of any bank in any calendar year without permission of the California Department of Financial Institutions, to the lesser of (1) the bank’s retained earnings or (2) the bank’s net income for its last three fiscal years, less distributions made to shareholders during the same three-year period. At December 31, 2010, future dividends are subject to the foregoing restrictions and approval. Further dividend restrictions are contained in the preferred stock purchase agreement, which limits dividends to their historical levels for three years or until its redemption without obtaining the prior approval of the Treasury. Although the Bank’s regulatory capital ratios are in excess of requirements and notwithstanding the requirements of the California Financial Code, the Board of Directors reviews and declares dividends on a quarterly basis and there is no assurance that future dividends will be declared. Impact of Inflation The primary impact of inflation on the Bank is its effect on interest rates. The Bank’s primary source of income is net interest income, which is affected by changes in interest rates. The Bank attempts to limit the impact of inflation on its net interest margin through management of rate- sensitive assets and liabilities and analyses of interest rate sensitivity. The effect of inflation on premises and equipment as well as on noninterest expenses has not been significant for the periods presented. 25 SUMMIT STATE BANK AND SUBSIDIARY CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2010 AND 2009 AND FOR THE YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008 AND REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 26 Crowe Horwath LLP Independent Member Crowe Horwath International Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders Summit State Bank: We have audited the accompanying consolidated balance sheets of Summit State Bank and Subsidiary as of December 31, 2010 and 2009 and the related consolidated statements of income, changes in shareholders’ equity and cash flows for each of the three years in the period ending December 31, 2010. 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 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 audit 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 also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 financial position of Summit State Bank and Subsidiary as of December 31, 2010 and 2009 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles. South Bend, Indiana March 22, 2011 Crowe Horwath LLP 27 28 December 31,December 31,20102009Cash and due from banks4,542$ 2,933$ Federal funds sold7,940 - Total cash and cash equivalents12,482 2,933 Available-for-sale investment securities - amortized cost of$33,472 in 2010 and $27,393 in 200933,642 27,400 Loans, less allowance for loan losses of $6,058in 2010 and $4,737 in 2009280,398 288,277 Bank premises and equipment, net 7,304 7,721 Investment in Federal Home Loan Bank stock, at cost2,614 2,942 Goodwill4,119 4,119 Accrued interest receivable and other assets 7,374 7,008 Total assets347,933$ 340,400$ Deposits:Demand - non interest-bearing23,594$ 15,706$ Demand - interest-bearing24,421 22,206 Savings15,849 12,783 Money market38,063 43,489 Time deposits, $100,000 and over113,187 97,855 Other time deposits64,863 72,214 Total deposits279,977 264,253 Federal Home Loan Bank (FHLB) advances12,000 20,120 Accrued interest payable and other liabilities647 522 Total liabilities292,624 284,895 Shareholders' equity Preferred stock, no par value; 20,000,000 shares authorized;8,117 7,989 Common stock, no par value; shares authorized - 30,000,000 shares; issuedand outstanding 4,744,720 at December 31, 2010 and December 31, 200936,311 36,275 Common stock warrant622 622 Retained earnings10,161 10,615 Accumulated other comprehensive income, net of taxes of $72 and $398 4 Total shareholders' equity55,309 55,505 Total liabilities and shareholders' equity347,933$ 340,400$ SUMMIT STATE BANK AND SUBSIDIARYCONSOLIDATED BALANCE SHEETSLIABILITIES ANDSHAREHOLDERS' EQUITYASSETS$1,000 for total liquidation preference of $8,500The accompanying notes are an integralpart of these consolidated financial statements.shares issued and outstanding - 8,500 in 2010 and 2009; per share redemption of (In thousands except share and per share data) 29 (In thousands except for earnings per share data)201020092008Interest income:Interest and fees on loans17,466$ 18,856$ 18,848$ Interest on Federal funds sold26 1 69 Interest on investment securities and deposits in banks1,384 1,790 2,523 Dividends on FHLB stock10 6 114 Total interest income18,886 20,653 21,554 Interest expense:Deposits 3,056 4,540 7,332 FHLB advances 497 1,020 1,879 Total interest expense3,553 5,560 9,211 Net interest income before provision for loan losses15,333 15,093 12,343 Provision for loan losses 3,860 3,650 685 Net interest income after provision for loan losses11,473 11,443 11,658 Non-interest income:Service charges on deposit accounts401 391 404 Office leases 529 594 669 Net securities gains150 28 - Loan servicing, net40 58 46 Other-than-temporary impairment lossTotal impairment loss(44) (17) (2,457) Loss recognized in other comprehensive income (loss)20 - - Net impairment loss recognized in earnings(24) (17) (2,457) Other income 167 45 35 Total non-interest income1,263 1,099 (1,303) Non-interest expense:Salaries and employee benefits4,788 4,266 4,343 Occupancy and equipment 1,598 1,710 1,735 Other expenses3,167 3,023 2,561 Total non-interest expense9,553 8,999 8,639 Income before provision for income taxes3,183 3,543 1,716 Provision for income taxes 1,376 1,462 707 Net income1,807$ 2,081$ 1,009$ Less: preferred dividends552510 4 Net income available for common stockholders1,255$ 1,571$ 1,005$ Basic earnings per common share0.26$ 0.33$ 0.21$ Diluted earnings per common share0.26$ 0.33$ 0.21$ Basic weighted average shares of common stock outstanding4,7454,7454,745Diluted weighted average shares of common stock outstanding4,7794,7664,745SUMMIT STATE BANK AND SUBSIDIARYCONSOLIDATED STATEMENTS OF INCOMEYear Ended December 31, The accompanying notes are an integral part of these consolidated financial statements.(In thousands except per share data) 30 AccumulatedOtherTotalComprehensiveTotalCompre-RetainedIncome (Loss)Shareholders'hensive(In thousands, except per share data)AmountSharesAmountEarnings(Net of Taxes)EquityIncomeBalance, January 1, 2008-$ 4,745$ 36,244$ 11,455$ 16$ 47,715$ Comprehensive income:Net income1,009 1,009 1,009$ Other comprehensive income netof tax: Net change in unrealized gains(losses) on available-for-sale investment securities 38 38 38 Total comprehensive income1,047$ Stock-based compensation expense13 13 Preferred stock (8,500 shares) and warrants issued8,486 8,486 Stock purchases and retirements(6) (6) Accretion of preferred stock discount 4 (4) - (1,708) (1,708) Balance, December 31, 20088,4904,74536,25110,7525455,547Comprehensive income:Net income2,081 2,081 2,081$ Other comprehensive income (loss), netof tax: Net change in unrealized gains(losses) on available-for-sale investment securities (50) (50) (50) Total comprehensive income2,031$ Stock-based compensation expense24 24 Preferred stock dividend(389) (389) Accretion of preferred stock discount 121 (121) - Cash dividends - $.36 per share(1,708) (1,708) Balance, December 31, 20098,6114,74536,27510,615455,505Comprehensive income:Net income 1,807 1,807 1,807$ Other comprehensive income, netof tax: (see note 2)Net change in unrealized gains(losses) on available-for-sale investment securities 94 94 94 Total comprehensive income1,901$ Stock-based compensation expense36 36 Preferred stock dividends(424) (424) Accretion of preferred stock discount 128(128) - Cash dividends - $.36 per share(1,709) (1,709) Balance, December 31, 20108,739$ 4,745 36,311$ 10,161$ 98$ 55,309$ The accompanying notes are an integral part of these consolidated financial statements.SUMMIT STATE BANK AND SUBSIDIARYCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITYPreferred Stock and Common Stock WarrantCommon StockCash dividends - $.36 per share 31 (In thousands)201020092008Cash flows from operating activities:Net income1,807$ 2,081$ 1,009$ Adjustments to reconcile net income to netcash from operating activities:Depreciation and amortization766 809 891 Loss on disposal of bank premises and equipment- 45 9 Net increase(decrease) in deferred loan fees307 421 1,628 Provision for loan losses3,860 3,650 685 Net securities impairment loss recognized in earnings24 17 2,457 (Gain) Loss on sale of other real estate owned(11) - - Net securities gains(150) (28) - Dividends on Federal Home Loan Bank stock- - (143) Net change in accrued interestreceivable and other assets(435) (1,745) (877) Net change in accrued interestpayable and other liabilities125 (328) (9) Stock-based compensation expense36 24 13 Net cash from operating activities6,329 4,946 5,663 Cash flows from investing activities:Decrease in time deposits in banks- - 80 Purchases of available-for-sale investmentsecurities(27,577) (24,884) (24,731) Proceeds from sales of available-for-saleinvestment securities2,350 537 - Proceeds from calls and maturities of available-for-saleinvestment securities19,274 38,053 16,590 Proceeds from calls and maturities of held to maturityinvestment securities- - 5,000 Purchase of Federal Home Loan Bank stock- - (4,106) Proceeds from the redemption of FederalHome Loan Bank stock328 - 4,157 Net change in loans3,641 7,297 (34,891) Purchases of bank premises and equipment, net(349) (759) (253) Proceeds on sale of other real estate owned82 - - Net cash from investing activities(2,251) 20,244 (38,154) SUMMIT STATE BANK AND SUBSIDIARYCONSOLIDATED STATEMENTS OF CASH FLOWSYear Ended December 31,(Continued) 32 (In thousands)201020092008Cash flows from financing activities:Net increase (decrease) in demand, NOW, savingsand money market deposits7,743 33,623 (4,475) Net change in certificates of deposit7,981 (22,133) 8,219 Net change in short term FHLB advances(8,120) (24,300) 25,420 Proceeds from long term FHLB advances- - 5,000 Repayment of long term FHLB advances- (11,000) (17,600) Repurchase of common stock- - (6) Proceeds from issuance of preferred stock, net of discount- - 7,864 Proceeds from issuance of common stock warrant- - 622 Dividends paid on common stock(1,709) (1,708) (1,708) Dividends paid on preferred stock(424) (389) - Net cash from financing activities5,471 (25,907) 23,336 Net change in cash and cash equivalents9,549 (717) (9,155) Cash and cash equivalents at beginningof year2,933 3,650 12,805 Cash and cash equivalents at end of period12,482$ 2,933$ 3,650$ Supplemental disclosure of cash flowinformation:Cash paid during the period for:Interest 3,538$ 5,798$ 9,292$ Income taxes 2,060$ 2,485$ 510$ Noncash investing activities: Transfer from loans to other real estate owned71$ -$ -$ .Year Ended December 31,The accompanying notes are an integral part of these consolidated financial statements. SUMMIT STATE BANK AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES General On January 15, 1999, Summit State Bank (the ―Bank‖) received authority to transact business as a California state-chartered commercial bank and is subject to regulation, supervision and examination by the California Department of Financial Institutions and the Federal Deposit Insurance Corporation. The Bank was organized under a charter granted by the Department of Savings and Loan of the State of California under the name Summit Savings. The Bank was incorporated on December 20, 1982. The Bank converted to a federal savings bank under a charter granted by the Office of Thrift Supervision on May 24, 1990. The Bank provides a variety of banking services to individuals and businesses in its primary service area of Sonoma County, California. The Bank's branch locations include Santa Rosa, Petaluma, Rohnert Park and Healdsburg. The Bank offers depository and lending services primarily to meet the needs of its business and individual clientele. These services include a variety of transaction, money market, savings and time deposit account alternatives. The Bank's lending activities are directed primarily towards commercial real estate, construction and business loans. The Bank utilizes its subsidiary Alto Service Corporation for its deed of trust services. The accounting and reporting policies of the Bank and its subsidiary conform with accounting principles generally accepted in the United States of America and prevailing practices within the banking industry. Principles of Consolidation The consolidated financial statements include the accounts of the Bank and its wholly-owned subsidiary, Alto Service Corporation. All significant intercompany accounts and transactions have been eliminated in consolidation. Use of Estimates The preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. The allowance for loan losses, goodwill impairment and fair values of investment securities and other financial instruments are particularly subject to change. Cash and Cash Equivalents For the purpose of the consolidated statement of cash flows, the Bank considers cash and due from banks with original maturities under 90 days and Federal funds sold to be cash equivalents. Generally, Federal funds are sold for one-day periods. Net cash flows are reported for customer loan and deposit transactions, time deposits in banks and short-term borrowings with an original maturity of 90 days or less. Investment Securities Investments are classified into the following categories:  Available-for-sale securities, reported at fair value, with unrealized gains and losses excluded from earnings and reported, net of taxes, as accumulated other comprehensive 33 income (loss) within shareholders' equity.  Held-to-maturity securities, which management has the positive intent and ability to hold to maturity, reported at amortized cost, adjusted for the accretion of discounts and amortization of premiums. Management determines the appropriate classification of its investments at the time of purchase and may only change the classification in certain limited circumstances. All transfers between categories are accounted for at fair value. Gains or losses on the sale of investment securities are recorded on the trade date and are computed on the specific identification method. Interest earned on investment securities is reported in interest income, net of applicable adjustments for accretion of discounts and amortization of premiums on the level yield method. Management evaluates securities for other-than-temporary impairment (―OTTI‖) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income or loss. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. Investment in Federal Home Loan Bank Stock In order to borrow from the Federal Home Loan Bank of San Francisco (FHLB), the Bank is required to maintain an investment in the capital stock of the FHLB. The investment is carried at cost and is generally redeemable at par. Both cash and stock dividends are reported as income. Loans Held for Sale Loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Loans held for sale are generally sold with servicing rights retained. The carrying value of loans sold is reduced by the amount allocated to the servicing right. Gains and losses on loan sales are based on the difference between the selling price, net of loan discount or premium, and the carrying value of the related loans sold. The Bank has not sold any loans in 2010, 2009 or 2008. Loans Loans that management has the intent and ability to hold for the foreseeable future or until maturity are stated at principal balances outstanding, net of deferred loan origination fees and costs and the allowance for loan losses, adjusted for accretion of discounts or amortization of premiums. Interest is accrued daily based upon outstanding loan balances. However, when, in the opinion of management, loans are considered to be impaired and the future collectability of interest and principal is in serious doubt, loans are placed on nonaccrual status and the accrual of interest income is suspended. Any interest previously accrued, but unpaid, is charged against income. Payments received are applied to reduce principal to the extent necessary to ensure collection. Subsequent payments on these loans, or payments received on 34 nonaccrual loans for which the ultimate collectability of principal is not in doubt, are applied first to earned but unpaid interest and then to principal. Substantially all loan origination fees, commitment fees, direct loan origination costs and purchase premiums and discounts on loans are deferred and recognized in interest income using the level yield method, to be amortized to interest income over the contractual term of the loan. The unamortized balance of deferred fees and costs is reported as a component of net loans. Non-accrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. A loan is moved to non-accrual status in accordance with the Bank’s policy, typically after 90 days of non-payment. Allowance for Loan Losses The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the un-collectability of a loan balance is confirmed. Loans or portions of loans are charged off when there is a distinct probability of loss identified. A distinct probability of loss exists when it has been determined that any remaining sources of repayment are not sufficient to cover all outstanding principle. The probable loss is immediately calculated based on the value of the remaining sources of repayment and charged to the allowance for loan losses. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. A loan is impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Commercial & agricultural, real estate-commercial, real estate-construction, real estate-multifamily and real estate-land loans are individually evaluated for impairment. Large groups of smaller balance homogeneous loans such as real estate-single family units, consumer and lease financing are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Impaired loans are measured on the present value of expected future cash flows discounted at the loan’s original effective interest rate. As a practical expedient, impairment may be measured based on the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through an allocation of a portion of the allowance for loan losses. Loans, for which the terms have been modified granting concessions to the borrower that the Bank would not otherwise consider, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. Troubled debt restructurings are measured at the present value of estimated future cash flows using the loan’s effective interest rate at inception. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers non-impaired and non-classified loans and is based on historical loss experience adjusted for qualitative factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Bank over the most recent three years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following portfolio segments have been identified: commercial & agricultural, real estate mortgage loans, consumer and lease financing. Real estate mortgage loans have been further 35 classified according to the following risk characteristics: commercial, construction, single family units, multifamily and land loans. Commercial & Agricultural Loans- Commercial & Agricultural credit is extended to commercial customers for use in normal business operations to finance working capital needs, equipment purchases, or other projects. The majority of these borrowers are customers doing business within our geographic regions. These loans are generally underwritten individually and secured with the assets of the company and the personal guarantee of the business owners. Commercial & Agricultural loans are made based primarily on the historical and projected cash flow of the borrower and the underlying collateral provided by the borrowers. Commercial & Multifamily Real Estate Loans - Commercial & multifamily real estate loans are subject to underwriting standards and processes similar to commercial loans. These loans are viewed primarily as cash flow loans and the repayment of these loans is largely dependent on the successful operation of the property. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real estate market such as geographic location and property type. Consumer and Lease Financing Loans- Consumer and Lease Financing loans are primarily comprised of loans made directly to consumers. These loans have a specific underwriting matrix which consists of several factors including debt to income, type of collateral and loan to collateral value, credit history and relationship to the borrower. Consumer and Lease Financing lending uses risk-based pricing in the underwriting process. Single Family Residential Loans - Single family residential mortgage loans represent loans to consumers for the purchase or refinance of a residence. These loans are generally financed up to 30 years, and in most cases, are extended to borrowers to finance their primary residence. Real estate market values at the time of origination directly affect the amount of credit extended, and in the event of default, subsequent changes in these values may impact the severity of losses. The Bank is subject to periodic examinations by its federal and state regulatory examiners and may be required by such regulators to recognize additions to the allowance for loan losses based on their assessment of credit information available to them at the time of their examinations. The process of assessing the adequacy of the allowance for loan losses is necessarily subjective. Further, and particularly in times of economic downturns, it is reasonably possible that future credit losses may exceed historical loss levels and may also exceed management’s current estimates of incurred credit losses inherent within the loan portfolio. As such, there can be no assurance that future charge-offs will not exceed management’s current estimate of what constitutes a reasonable allowance for credit losses. Loan Servicing Accounting standards require separately recognized servicing assets and servicing liabilities to be initially measured at fair value, The Bank has elected to continue to amortize its servicing assets over the loan service period with periodic impairment assessment. The Bank’s servicing assets at December 31, 2010 and 2009 were $39,000 and $45,000 respectively, and consist of the servicing of loans guaranteed by the Small Business Administration (SBA) totaling $3,449,000 and $4,123,000 at December 31, 2010 and 2009, respectively. Servicing fee income which is reported on the income statement as loan servicing, net is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal; or a fixed amount per loan and are recorded as income when earned. The amortization of SBA loan servicing rights is netted against loan servicing fee income. Gross servicing fees totaled $40,000, $60,000 and $54,000 for the years ended December 31, 2010, 2009 and 2008. Late fees and ancillary fees related to loan servicing are not material. 36 Valuation of Goodwill Goodwill resulting from business combinations prior to January 1, 2009 represents the excess of the purchase price over the fair value of the net assets of businesses acquired. Goodwill resulting from business combinations after January 1, 2009 (if any) represents the future economic benefits arising from other assets acquired that are not individually identified and separately recognized. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. The Bank has selected June 30 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on our balance sheet. Management assesses the carrying value of our goodwill at least annually in order to determine if this intangible asset is impaired. In reviewing the carrying value of our goodwill, we assess the recoverability of such assets by evaluating the fair value of the related business unit. If the carrying amount of goodwill exceeds its fair value, an impairment loss is recognized for the amount of the excess and the carrying value of goodwill is reduced accordingly. Any impairment would be required to be recorded during the period identified. Accounting standards require an annual evaluation of goodwill for impairment using various estimates and assumptions. The market price of the Bank’s common stock at the close of business on December 31, 2010 was $6.99 per common share compared to a book value of $9.95 per common share. The Bank believes the lower market price in relation to book value is due to the overall decline in the financial industry sector and is not specific to the Bank. Further, the Bank engaged an independent third party specialist to perform an impairment test of its goodwill. The evaluation included three approaches: 1) Multiple of tangible book value, based on recent bank acquisitions in California 2) Multiple of equity return and 3) Premium on deposits. The Bank took an average of these approaches and also considered their excess capital levels above the required leverage capital ratio. The impairment test was performed as of September 21, 2010 based on June 30, 2010 data and resulted in an implied fair value for the Bank sufficiently above the book value to support the current carrying value of goodwill. As the Bank’s stock price per common share is currently less than its book value per common share, it is reasonably possible that management may conclude that goodwill, totaling $4.1 million at December 31, 2010, is impaired as a result of a future assessment. If our goodwill is determined to be impaired, the related charge to earnings could be material. Other Real Estate Other real estate includes real estate acquired in full or partial settlement of loan obligations. When property is acquired, any excess of the Bank's recorded investment in the loan balance and accrued interest income over the estimated fair market value of the property, less costs to sell, is charged against the allowance for loan losses. A valuation allowance for losses on other real estate, if needed, is maintained to provide for declines in value. The allowance is established through a provision for losses on other real estate which is included in other expenses. Subsequent gains or losses on sales or write-downs resulting from impairment are recorded in other income or expenses as incurred. Operating costs after acquisition are expensed. There was no other real estate owned at December 31, 2010 or 2009. Bank Premises and Equipment Land is carried at cost. Buildings, furniture, fixtures, and equipment are carried at cost less accumulated depreciation. Depreciation is determined using the straight-line method over the estimated useful lives of the related assets. The useful lives of buildings are estimated to be 39 years and furniture, fixtures and equipment are estimated to be 3 to 15 years. Leasehold improvements are amortized over the estimated useful life of the asset or the term of the related lease, whichever is shorter. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized in income for the period. The cost of maintenance and repairs is charged to expense as incurred. 37 The Bank evaluates premises and equipment for financial impairment as events or changes in circumstances indicate that the carrying amount of such assets may not be fully recoverable. Income Taxes The Bank files its income taxes on a consolidated basis with its subsidiary. The allocation of income tax expense (benefit) represents each entity's proportionate share of the consolidated provision for income taxes. Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. On the consolidated balance sheet, net deferred tax assets are included in accrued interest receivable and other assets. A tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. The Bank recognizes interest and/or penalties related to income tax matters in income tax expense. The Bank has not accrued any potential interest and penalties as of December 31, 2010 and December 31, 2009 and for the three years ended December 31, 2010 for uncertainties related to income taxes. Earnings Per Common Share Basic earnings per common share (EPS), which excludes dilution, is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if contracts to issue common stock, such as stock options, result in the issuance of common stock which shares in the earnings of the Bank. Stock options for $138,166, 108,166 and 55,666 shares of common stock were not considered in computing diluted earnings per share for 2010, 2009 and 2008 because they were anti- dilutive. The warrant for 0, 0 and 239,212 shares of common stock was not considered in computing diluted earnings per share for 2010, 2009 and 2008 because it was anti-dilutive. 38 Comprehensive Income Comprehensive income is reported in addition to net income for all periods presented. Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of other comprehensive income (loss) that historically has not been recognized in the calculation of net income. Unrealized gains and losses on the Bank's available-for-sale investment securities are included in other comprehensive income (loss), net of taxes. Total comprehensive income and the components of accumulated other comprehensive income (loss), net of taxes, are presented in the consolidated statements of changes in shareholders' equity. 39 The factors used in the earnings per common share computation follow:(in thousands except earnings per share)201020092008BasicNet income available for common shareholders1,255$ 1,571$ 1,005$ Weighted average common shares outstanding4,745 4,745 4,745 Basic earnings per common share0.26$ 0.33$ 0.21$ DilutedNet income available for common shareholders1,255$ 1,571$ 1,005$ Weighted average common shares outstanding for basic earnings per common share4,745 4,745 4,745 Add: Dilutive effects of assumed exercises of stock options and warrants34 21 - Average shares and dilutive potential common shares4,779 4,766 4,745 Diluted earnings per common share0.26$ 0.33$ 0.21$ Other comprehensive income (loss) net of related taxes were attributable to available for sale securities and were as follows: Stock Based Compensation Compensation cost is recognized for stock options granted to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. Adoption of New Accounting Standards In June 2009, the FASB issued FASB ASC Topic 860 ―Transfers and Servicing‖ (formerly SFAS No. 166 ―Accounting for Transfers of Financial Assets — an Amendment of FASB Statement No. 140‖). This standard removes the concept of a qualifying special-purpose entity and limits the circumstances in which a financial asset, or portion of a financial asset, should be derecognized when the transferor has not transferred the entire financial asset to an entity that is not consolidated with the transferor in the financial statements being presented and/or when the transferor has continuing involvement with the transferred financial asset. The adoption of this standard on January 1, 2010 did not have a material impact on our consolidated financial statements. In June 2009, the FASB issued FASB ASC Topic 810-10, ―Consolidation‖ (formerly SFAS No. 167 ―Amendments to FASB Interpretation No. 46(R)‖). The standard amends tests for variable interest entities to determine whether a variable interest entity must be consolidated. This standard requires an entity to perform an analysis to determine whether an entity’s variable interest or interests give it a controlling financial interest in a variable interest entity. This standard requires ongoing reassessments of whether an entity is the primary beneficiary of a variable interest entity and enhanced disclosures that provide more transparent information about an entity’s involvement with a variable interest entity. The adoption of this standard on January 1, 2010 did not have a material impact on our consolidated financial statements. Operating segments While the Bank’s chief decision makers monitor the revenue streams of the Bank’s various products and services, operations are managed and financial performance is evaluated on a bank-wide basis. Operating segments are aggregated into one segment as operating results for all segments are similar. 40 (In Thousands) 201020092008Net income1,807 2,081$ 1,009$ Change in securities available-for-sale:Unrealized holding gains (losses) on available-for-sale securites arising during the period289 (77) (2,384) 44 17 2,457 (150) (28) - Net unrealized gains (losses)183 (88) 73 Income tax expense (benefit)69 (38) 35 Total other comprehensive income (loss)94 (50) 38 Comprehensive income 1,901$ 2,031$ 1,047$ on available-for-sale securities associated with credit losses realized in incomeYear Ended December 31Other-than-temporary impairment on available for sale securitiesReclassification adjustment for (gains) losses realized in income 2. INVESTMENT SECURITIES The amortized costs and estimated fair value of investment securities at December 31, 2010 and 2009 consisted of the following: Net unrealized gains on available-for-sale investment securities totaling $170,000, $7,000 and $95,000 are recorded, net of $72,000, $3,000 and $40,000 in tax expense, as accumulated other comprehensive income within shareholders' equity at December 31, 2010, 2009 and 2008, respectively. Proceeds from the sale of available-for-sale securities totaled $2,350,000 and $537,000 for the years ended December 31, 2010 and 2009 with gross gains of $150,000 for 2010, and gross gains of $81,000 and gross losses of $53,000 for 2009. There were no sales of investment securities during the year ended December 31, 2008. 41 Securities available -for-sale:Government agencies29,185$ 447$ (324)$ 29,308$ Mortgage-backed securities - residential4,287 122 (75) 4,334 Total securities available -for-sale33,472$ 569$ (399)$ 33,642$ Securities available -for-sale:Government agencies23,290$ 57$ (275)$ 23,072$ Mortgage-backed securities - residential1,893 101 - 1,994 Government sponsored entities stock24 20 - 44 Other2,186 129 (25) 2,290 Total securities available -for-sale27,393$ 307$ (300)$ 27,400$ December 31, 2010(in thousands)Amortized CostGross Unrealized GainsGross Unrealized LossesEstimated Fair ValueDecember 31, 2009(in thousands)Amortized CostGross Unrealized GainsGross Unrealized LossesEstimated Fair Value Investment securities with unrealized losses at December 31, 2010 and 2009 are summarized and classified according to the duration of the loss period as follows: At December 31, 2010, the Bank held 8 investment securities which were in an unrealized loss position for less than twelve months. Management periodically evaluates each investment security for other than temporary impairment, relying primarily on industry analyst reports and observation of market conditions and interest rate fluctuations. All of the impairment appearing in the investment securities portfolio valuations is considered to be temporary, other than $24,000, $17,000 and $2,457,000 the Bank recorded in other than temporary impairment losses (OTTI) in the consolidated statements of income in 2010, 2009 and 2008 on its investments in preferred stocks of Freddie Mac and Fannie Mae, debt securities of various corporations, and an investment in pooled trust preferred securities. The measured impairment in the securities values is primarily attributable to changes in short term interest rates, market shifts of the Treasury yield curve and other variable market and economic conditions. The measured impairment in securities values did not result from any significant or persistent deterioration in the underlying credit quality of any of the investments. The securities portfolio consists primarily of debt securities with non-contingent contractual cash flows. Full realization of the principal balance is expected upon final maturity. Management has the intent and ability to hold the securities until recovery of the carrying value, which could be at the final maturity. The amortized cost and estimated fair value of investment securities at December 31, 2010 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties. 42 (in thousands)Fair ValueFair ValueFair ValueDebt Securities: Government agencies12,677$ (324)$ 12,677$ (324)$ Mortgage-backed securities - residential1,760 (75) - - 1,760 (75) 14,437$ (399)$ -$ -$ 14,437$ (399)$ (in thousands)Fair ValueFair ValueFair ValueDebt securities: Government agencies17,385$ (275)$ -$ -$ 17,385$ (275)$ Other- - 438 (25) 438 (25) 17,385$ (275)$ 438$ (25)$ 17,823$ (300)$ December 31, 2010Less than 12 Months12 Months or MoreTotalUnrealized LossesUnrealized LossesUnrealized LossesDecember 31, 2009Unrealized LossesUnrealized LossesUnrealized LossesLess than 12 Months12 Months or MoreTotal Investment securities with amortized costs totaling $27,639,000 and $25,183,000 and estimated fair values totaling $28,058,000 and $25,087,000 were pledged to secure State of California deposits at December 31, 2010 and 2009 (see Note 5). 3. LOANS 43 (in thousands)Amortized CostEstimated Fair ValueWithin one year500$ 502$ After one year through five years- - After five years through ten years13,288 13,249 After ten years15,397 15,557 29,185 29,308 Investment securities not due at a single maturity date:Mortgage-backed securities - residential4,287 4,334 33,472$ 33,642$ Available for SaleOutstanding loans are summarized as follows:(in thousands)20102009Real estate mortgage loans collateralized by:Real estate - commercial119,267$ 126,770$ Real estate - construction4,803 2,562 Real estate - single family units52,600 53,456 Real estate - multifamily21,871 22,597 Real estate - land loans7,331 12,254 Commercial & agricultural75,925 68,622 Consumer5,294 5,432 Lease financing2,230 3,879 289,321$ 295,572 Deferred loan fees, net(2,865) (2,558) Allowance for loan losses(6,058) (4,737) 280,398$ 288,277$ December 31,Changes in the allowance for loan losses were as follows:(in thousands)201020092008Balance, beginning of year4,737$ 4,016$ 3,621$ Provision charged to operations3,860 3,650 685 Losses charged to allowance(2,555) (2,985) (458) Recoveries added to allowance16 56 168 Balance, end of year6,058$ 4,737$ 4,016$ Year Ended December 31, The following table presents the balance in the allowance for loan losses and loan balances by class and based on impairment method as of December 31, 2010: The recorded investment in the aforementioned disclosure and the next several disclosures do not include accrued interest receivable and net deferred fees because such amounts are not considered material. Accrued interest receivable for the total loan portfolio was $1,171,000 and net deferred loans fees was $2,865,000 as of December 31, 2010. 44 (in thousands)Individually Evaluated for ImpairmentCollectively Evaluated for ImpairmentTotal Ending Allowance BalanceLoans Individually Evaluated for ImpairmentLoans Collectively Evaluated for ImpairmentTotal Ending Loans BalanceCommercial & agricultural78$ 1,407$ 1,485$ 3,841$ 72,084$ 75,925$ Real estate - commercial592 810 1,402 11,199 108,068 119,267 Real estate - construction487 22 509 2,357 2,446 4,803 Real estate - single family units5 58 63 1,977 50,623 52,600 Real estate - multifamily- 87 87 3,419 18,452 21,871 Real estate - land loans878 504 1,382 6,342 989 7,331 Consumer- 38 38 - 5,294 5,294 Lease financing- 22 22 - 2,230 2,230 Other qualitative factors- 960 960 - - - Unallocated- 110 110 - - - Total2,040$ 4,018$ 6,058$ 29,135$ 260,186$ 289,321$ Allowance for Loan Losses:Loans:The following table presents loans individually evaluated for impairment by class of loans as ofDecember 31, 2010:UnpaidAllowance forPrincipal RecordedLoan Lossed(in thousands)BalanceInvestmentAllocatedWith no related allowance recorded:Commercial & agricultural311$ 311$ -$ Real estate - commercial8,604 8,604 - Real estate - construction- - - Real estate - single family units1,018 1,018 - Real estate - multifamily3,419 3,419 - Real estate - land loans1,793 1,793 - Consumer- - - Lease financing- - - With an allowance recorded:Commercial & agricultural3,530 3,530 78 Real estate - commercial2,595 2,595 592 Real estate - construction2,357 2,357 487 Real estate - single family units959 959 5 Real estate - multifamily- - - Real estate - land loans4,549 4,549 878 Consumer- - - Lease financing- - - Total29,135$ 29,135$ 2,040$ The following table summarizes the Bank’s nonperforming loans at the dates indicated: 45 Loans Past Due Over 90 Days Still(in thousands)Nonaccrual AccruingCommercial & agricultural178$ -$ Real estate - commercial4,300 - Real estate - construction2,357 - Real estate - single family units295 - Real estate - multifamily - - Real estate - land loans6,342 - Consumer- - Lease financing- - Total13,472$ -$ The following table presents the recorded investment in nonaccrual loans and loans past due over 90 days still on accrual by class of loans as of December 31, 2010:(in thousands)20102009Loans past due 90 days and still accruing-$ 1,066$ Non-accrual loans13,472 10,587 Total non-performing loans13,472$ 10,653$ Impaired loans were as follows:20102009Loans with no allocated allowance for loan lossess15,145$ 10,093$ Loans with allocated allowance for loan lossess13,990 9,578 Total impaired loans29,135$ 19,671$ 20102009Amount of the allowance for loan losses allocated2,040$ 1,112$ Average impaired loans during the period13,055 7,998 Interest recognized on impaired loans902 154 Cash basis interest income recognized834 120 Year Ended December 31, Troubled Debt Restructurings From time to time, the Bank may agree to modify the contractual terms of a borrower’s loan. In cases where such modifications represent a concession to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring (―TDR‖). At December 31, 2010 and 2009, loans modified in a TDR totaled $13,164,000 and $8,715,000 which are included in the impaired loan disclosures above. The total TDRs includes $3,548,000 and $697,000 that are also included in nonperforming loans at December 31, 2010 and 2009. TDRs had specific loss allocations of $607,000 and $1,046,000 as of December 31, 2010 and 2009. Credit Quality Indicators The Bank categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Bank analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a monthly basis. The Bank uses the following definitions for risk ratings: SPECIAL MENTION- Loans in this category are considered "criticized" from a regulatory point of view but are not considered "classified" until the risk classification becomes substandard or worse. Loans in this category represent above average risk and potential weakness which may, if not corrected, weaken the loan and threaten repayment at some future date. SUBSTANDARD- Loans in this category have well defined weakness that jeopardize full repayment of the debt, although loss does not seem likely. Loss potential does not have to exist in individual loans in the Substandard classification, but will be apparent in the aggregate. Typically, these loans have not met repayment plans as agreed. The primary source of repayment may have failed to materialize; repayment may be dependent on collateral liquidation or other secondary sources. Bankrupt borrowers and those with continuously past due payments are considered substandard. DOUBTFUL- Loans in this category have all the characteristics of substandard loans with the added weakness that payment in full or liquidation in full is highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors, which may work to the strengthening of the loan, its classification as an estimated loss is deferred until the amount of the loss may be more accurately determined. PASS- Loans not meeting any of the three criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. 46 (in thousands)30 - 59 60 - 89 Greater ThanDaysDays90 DaysTotalLoans NotPast DuePast DuePast DuePast DuePast DueTotalCommercial & agricultural-$ -$ 178$ 178$ 75,747$ 75,925$ Real estate - commercial- - 4,300 4,300 114,967 119,267 Real estate - construction- - 2,357 2,357 2,446 4,803 Real estate - single family units144 70 295 509 52,091 52,600 Real estate - multifamily 223 - - 223 21,648 21,871 Real estate - land loans- - 6,342 6,342 989 7,331 Consumer- 41 - 41 5,253 5,294 Lease financing- - - - 2,230 2,230 Total367$ 111$ 13,472$ 13,950$ 275,371$ 289,321$ The following table presents the aging of the recorded investment in past due loans as of December 31, 2010 by class of loans: Based on recent analysis performed, the risk category of loans by class of loans is as follows: Salaries and employee benefits totaling $278,000, $204,000 and $280,000 have been deferred as loan origination costs for the years ended December 31, 2010, 2009 and 2008, respectively. Loans totaling $183,654,000 and $183,483,000 were pledged to secure borrowings with the Federal Home Loan Bank or State of California time deposits at December 31, 2010 and 2009, respectively (see Notes 5 and 7). 4. BANK PREMISES AND EQUIPMENT Bank premises and equipment consisted of the following: Depreciation and amortization included in occupancy and equipment expense totaled $766,000, $809,000 and $891,000 for the years ended December 31, 2010, 2009 and 2008, respectively. 5. INTEREST-BEARING DEPOSITS The aggregate amount of maturities of all time deposits is as follows: 2011 - $123,371,000; 2012 - $35,753,000; 2013 – $13,233,000; 2014 - $3,994,000; 2015 - $1,646,000; 2016 - $53,000. 47 Special (in thousands)PassMentionSubstandard DoubtfulNot RatedTotalCommercial & agricultural66,229$ 2,894$ 6,802$ -$ -$ 75,925$ Real estate - commercial99,378 6,393 13,496 - - 119,267 Real estate - construction2,446 - 2,357 - - 4,803 Real estate - single family units51,942 - 658 - - 52,600 Real estate - multifamily 18,449 - 3,422 - - 21,871 Real estate - land loans2,237 - 5,094 - - 7,331 Consumer- - 428 - 4,866 5,294 Lease financing- - - - 2,230 2,230 Total240,681$ 9,287$ 32,257$ -$ 7,096$ 289,321$ (in thousands)20102009Land1,184$ 1,184$ Building7,334 7,253 Furniture, fixtures and equipment2,741 2,540 Leasehold improvements1,144 1,077 12,403 12,054 Less accumulated depreciation and amortization(5,099) (4,333) 7,304$ 7,721$ December 31, Interest expense recognized on interest-bearing deposits were as follows: As of December 31, 2010 and 2009, time deposits, $100,000 and over included $31,500,000 and $34,000,000 of public deposits from the State of California with maturity terms of three to six months. Brokered deposits included in other time deposits were $53,345,000 and $45,455,000 at December 31, 2010 and 2009. 6. BORROWINGS Borrowing Arrangements The Bank has a total of $16,000,000 in Federal funds lines of credit with three correspondent banks at December 31, 2010. The Bank also maintains a letter of credit facility totaling $4,000,000 with a correspondent bank to guarantee international letters of credit issued to certain customers. There were guarantees of $1,749,000 and $278,000 under this facility as of December 31, 2010 and 2009, respectively. There were no borrowings outstanding under the Federal funds lines of credit as of December 31, 2010 or 2009. 7. FEDERAL HOME LOAN BANK ADVANCES Each advance is payable at its maturity date, with a prepayment penalty for fixed rate advances. The advances were collateralized by $175,606,000 and $175,010,000 of loans under a blanket lien arrangement at year-end 2010 and 2009. Based on this collateral and the Bank’s holdings of FHLB stock, the Bank was eligible to borrow up to a total of $73,459,000 and $75,220,000 of which $61,459,000 and $55,100,000 was available for additional advances as of December 31, 2010 and 2009. Advances from the Federal Home Loan Bank were $12,000,000 at December 31, 2010, with maturities from March 2011 through May 2012 and fixed rates at rates from 0.25% to 4.67%, averaging 2.83%. Advances were $20,120,000 at December 31, 2009, with maturities from January 2010 through May 2012 and fixed rates at rates from 0.04% to 6.52%, averaging 2.62%. Re-payments of FHLB advances are as follows: (In thousands) 2011 $ 5,000 2012 $ 7,000 48 (in thousands)201020092008Interest bearing demand87$ 91$ 102$ Savings79 117 181 Money market374 418 674 Time deposits2,516 3,914 6,375 3,056$ 4,540$ 7,332$ Year Ended December, 31 8. INCOME TAXES The provision for income taxes for the years ended December 31, 2010, 2009 and 2008 consisted of the following: Deferred tax assets (liabilities) are comprised of the following: A deferred tax asset valuation allowance of $90,000 has been established for capital losses from other than temporary impairment charges for California state income tax purposes as management no longer has a tax planning strategy to utilize these capital losses. 49 (in thousands)2010FederalStateChange in Valuation AllowanceTotalCurrent1,112$ 450$ -$ 1,562$ Deferred(262) (14) (276) Valuation allowance- - 90 90 Provision for income taxes850$ 436$ 90$ 1,376$ 2009FederalStateTotalCurrent1,023$ 353$ 1,376$ Deferred54 32 86 Provision for income taxes1,077$ 385$ 1,462$ 2008FederalStateTotalCurrent1,363$ 541$ 1,904$ Deferred(842) (355) (1,197) Provision for income taxes521$ 186$ 707$ 20102009Deferred tax assets:Allowance for loan losses2,015$ 1,632$ Future benefit of state tax deduction154 162 Bank premises and equipment567 466 Other than temporary impairment627 714 Other accruals108 239 Total deferred tax assets3,471 3,213 Deferred tax liabilities:Federal Home Loan Bank stock dividends(104) (119) investment securities(72) (3) Prepaid expenses and other(57) (60) Total deferred tax liabilities(233) (182) Valuation allowance(90) - Net deferred tax assets3,148$ 3,031$ December 31, (in thousands)Net unrealized gains on available-for-sale The provision for income taxes differs from amounts computed by applying the statutory Federal income tax rates to operating income before income taxes. The significant items comprising these differences for the years ended December 31, 2010, 2009 and 2008 consisted of the following: The Bank does not have any unrecognized tax benefits at December 31, 2010 and 2009. The Bank does not expect a significant change in unrecognized tax benefits in the next twelve months. The Bank and its subsidiary are subject to U.S. federal income tax as well as income tax of the State of California. The Bank is no longer subject to examination by federal taxing authorities for tax years 2006 and prior and by California taxing authorities for tax years 2005 and prior. 9. COMMITMENTS AND CONTINGENCIES Leases The Bank leases various equipment and branch offices in Santa Rosa, Rohnert Park, Petaluma and Healdsburg under non-cancelable operating leases. These leases include various renewal and termination options and rental adjustment provisions. Rental expense included in occupancy and equipment expense totaled $303,000, $317,000 and $342,000 for the years ended December 31, 2010, 2009 and 2008, respectively. Future minimum lease payments for the next five years are as follows: The Bank entered into operating leases with third parties during 2008 and 2007 for office space in its building. The leases are for periods from five to seven years and contain a provision for one five year renewal option. Rental income totaled $529,000, $594,000 and $669,000 for the years ended December 31, 2010, 2009 and 2008 respectively. Minimum future rental incomes from these operating leases are as follows: 50 (in thousands)AmountRate %AmountRate %AmountRate %Federal income tax expense, at statutory rate1,082$ 34.0%1,205$ 34.0%583$ 34.0%State franchise tax expense, net of Federal tax effect and other204 6.4%257 7.3%124 7.2%Change in deferred tax asset valuation allowance90 2.8%- 0.0%- 0.0%Total income tax expense1,376$ 43.2%1,462$ 41.3%707$ 41.2%201020092008Year EndingDecember 31,(in thousands)2011233$ 2012150 2013157 2014163 201580 783$ Federal Reserve Requirements Banks are required to maintain reserves with the Federal Reserve Bank equal to a percentage of their reservable deposits less vault cash. The reserve requirement was $1,121,000 and $0 as of December 31, 2010 and 2009. Financial Instruments with Off-Balance-Sheet Risk The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business in order to meet the financing needs of its clients and to reduce its own exposure to fluctuations in interest rates. These financial instruments consist of commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized on the consolidated balance sheets. The Bank's exposure to credit loss in the event of nonperformance by the other party for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and standby letters of credit as it does for loans included on the consolidated balance sheets. The contractual amounts of financial instruments with off-balance-sheet risk at year end were as follows: Commitments to extend credit are agreements to lend to a client as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each client's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of the credit, is based on management's credit evaluation of the borrower. Collateral held relating to these commitments varies, but may include securities, equipment, accounts receivable, inventory and deeds of trust on residential real estate and income-producing commercial properties. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a client to a third party. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loans to clients. The fair value of the liability related to these standby letters of 51 Year EndingDecember 31,2011476$ 2012286 2013224 2014- 2015- 986$ (in thousands)Fixed RateVariable RateFixed RateVariable RateCommitments to make loans-$ -$ -$ -$ Unused lines of credit288 12,195 4,299 11,844 Standby letters of credit- 209 - 1,847 December 31, (in thousands)20102009 credit, which represents the fees received for issuing the guarantees, was not significant at December 31, 2010 and 2009. The Bank recognizes these fees as revenue over the term of the commitment or when the commitment is used. At December 31, 2010, real estate loan commitments represent 32% of total commitments and are generally secured by property with a loan-to-value ratio not to exceed 80%. Commercial loan commitments represent approximately 68% of total commitments and are generally secured by collateral other than real estate or are unsecured. The majority of the Bank's commitments have variable interest rates. Concentrations of Credit Risk The Bank's business activity is primarily with clients located within Northern California. Although the Bank has a diversified loan portfolio, a significant portion of its clients' ability to repay loans is dependent upon the real estate market and various economic factors within Sonoma County. Generally, loans are secured by various forms of collateral. The Bank's loan policy requires sufficient collateral be obtained as necessary to meet the Bank's relative risk criteria for each borrower. The Bank's collateral consists primarily of real estate, accounts receivable, inventory and other financial instruments. Correspondent Banking Agreements The Bank maintains funds on deposit with other federally insured financial institutions under correspondent banking agreements. No deposits were uninsured at December 31, 2010. Contingencies The Bank is subject to legal proceedings and claims which arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability with respect to such actions will not materially affect the consolidated financial condition or results of operations of the Bank. 10. SHAREHOLDERS' EQUITY Regulatory Capital The Bank is subject to certain regulatory capital requirements administered by the Federal Deposit Insurance Corporation (FDIC). Failure to meet these 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 Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets. Each of these components is defined in the regulations. Management believes that the Bank met all its capital adequacy requirements as of December 31, 2010 and 2009. The most recent notification from the FDIC 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 1 risk-based and Tier 1 leverage ratios as set forth below. There are no conditions or events since the last notification by the FDIC that management believes have changed the Bank's category. 52 The Bank's actual and required capital amounts and ratios consisted of the following: Dividends Upon declaration by the Board of Directors, all shareholders of record will be entitled to receive dividends. The California Financial Code restricts the total dividend payment of any bank in any calendar year without permission of the California Department of Financial Institutions, to the lesser of (1) the bank's retained earnings or (2) the bank's net income for its last three fiscal years, less distributions made to shareholders during the same three-year period. At December 31, 2010, future dividends are subject to the foregoing restrictions and approval. Further dividend restrictions are contained in the Preferred Stock purchase agreement as explained below. Preferred Stock On December 19, 2008, the Bank received $8,500,000 and issued 8,500 shares of Fixed Rate Non- cumulative Perpetual Preferred Stock, Series A (the ―Preferred Stock‖) and a warrant representing the purchase rights to 239,212 shares of common stock (the ―Warrant‖) to the United States Department of the Treasury (the ―Treasury‖) as part of the Treasury’s Capital Purchase Program (CPP). The Preferred Stock was recorded net of $622,000 of value allocated to the Warrant and $14,000 in issuance costs. The Preferred Stock has a non-cumulative dividend rate of 5% per annum for 5 years and then increases to 9% per annum. The Preferred Stock may be redeemed at any time. The Warrant has a 10 year term and was immediately exercisable upon its issuance, with an exercise price of $5.33 per share of common stock. The Preferred Stock purchase agreement contains various restrictions for 3 years or until its redemption including prohibiting increasing common stock dividends in excess of historical levels without obtaining the prior approval of the Treasury, prohibiting the repurchase of common stock and limitations on executive compensation. Additionally the Bank cannot pay dividends on its common stock unless it has paid the most recent dividend accrued in the Treasury’s preferred stock. 53 (in thousands)AmountRatioAmountRatioTier 1 Leverage RatioSummit State Bank51,052$ 14.6%51,338$ 15.1%Minimum requirement for "Well-Capitalized" institution17,462$ 5.0%16,965$ 5.0%Minimum regulatory requirement13,970$ 4.0%13,572$ 4.0%Tier 1 Risk-Based Capital RatioSummit State Bank51,052$ 18.6%51,338$ 18.1%Minimum requirement for "Well-Capitalized" institution16,505$ 6.0%17,035$ 6.0%Minimum regulatory requirement11,003$ 4.0%11,357$ 4.0%Total Risk-Based Capital RatioSummit State Bank54,523$ 19.8%54,911$ 19.3%Minimum requirement for "Well-Capitalized" institution27,508$ 10.0%28,392$ 10.0%Minimum regulatory requirement22,007$ 8.0%22,713$ 8.0%20102009 Stock Options In 1999, the Bank established a stock option plan for which 100,000 shares of common stock are reserved for issuance to directors and officers under non-statutory agreements. The plan requires that the option price may not be less than the fair market value of the stock at the date the option is granted, and the stock must be paid in full at the time the option is exercised. Payment in full for the option price must be made in cash or with Bank common stock previously acquired by the optionee and held by the optionee for a period of at least six months. The options expire on dates determined by the Board of Directors, but not later than ten years from the date of grant. Options vest over a three to five year period. The 1999 stock option plan has been cancelled with the adoption of the 2007 stock option plan, except for the current options that were granted under this plan, which totaled 30,666 shares at both December 31, 2010 and December 31, 2009. The Bank’s 2007 Stock Option Plan (stock option plan or the Plan), which is shareholder-approved, permits the grant of share options to its employees for up to 150,000 shares of common stock. Option awards are generally granted with an exercise price equal to the market price of the Company’s common stock at the date of grant; those option awards have vesting periods of 5 years unless otherwise approved by the Board of Directors and have 10-year contractual terms. As of December 31, 2010, 42,500 shares remain available for future grants under this plan. The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected volatilities are based on historical volatilities of an index consisting of financial institution stocks which should approximate the future volatility of the Bank’s common stock. The Bank uses historical data to estimate option exercise and post-vesting termination behavior. Employee and management options are tracked separately. The expected term of options granted is based on historical data and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The fair value of options granted was determined using the following weighted-average assumptions as of the grant date. A summary of the activity in the stock option plan for 2010 follows: 54 201020092008Risk-free interest rate2.6%3.8%3.9%Expected term7 years7 years7 yearsExpected stock price volatility36.0841.0045.51Dividend yield5.5%7.2%5.6%SharesWeighted Average Exercise PriceWeighted Average Remaining Contractual TermAggregate Intrinsic ValueOutstanding at beginning of the year108,166 6.76$ Granted30,000 6.47Exercised - - Forfeited or expired- - Outstanding at the end of year138,166 6.70$ 5.1 years107,000$ Vested or expected to vest138,166 6.70$ 5.1 years107,000$ Exercisable at end of year56,416 7.59$ 4.8 years18,000$ Information related to the stock option plan during each year follows: As of December 31, 2010, there was $168,000 of total unrecognized compensation costs related to nonvested stock options granted under the Plan. 11. OTHER EXPENSES Other expenses consisted of the following: 12. EMPLOYEE BENEFIT PLAN 401(k) Employee Savings Plan The Bank has a 401(k) Employee Savings Plan (the "Plan"), qualified under the Internal Revenue Code (Code), whereby participants may defer a percentage of their compensation, but not in excess of the maximum allowed under the Code. Bank contributions, as determined by the Board of Directors, are discretionary and vest immediately. Contributions by the Bank totaled $77,000, $59,000 and $57,000 for the years ended December 31, 2010, 2009 and 2008, respectively. 13. RELATED PARTY TRANSACTIONS During the normal course of business, the Bank enters into loans with related parties, including executive officers and directors. Other changes are the result of changes in related parties during the year. The following is a summary of the aggregate activity involving related party borrowers during 2010: 55 201020092008Intrinsic value of options exercised-$ -$ -$ Cash received from option exercises- - - Tax benefit realized from option exercises- - - Weighted average fair value of options granted1.29 2.47 1.82 (in thousands)201020092008Data processing586$ 590$ 949$ Professional fees587 559 412 Director fees and expenses317 240 298 Advertising and promotion441 343 206 Deposit and other insurance premiums552 684 171 Telephone and postage90 86 91 Other expenses594 521 434 3,167$ 3,023$ 2,561$ Year Ended December 31, A significant shareholder of the Bank is also a significant shareholder of three other banks ("affiliated banks‖). The Bank has purchased participations in loans originated by the affiliated banks. As of December 31, 2010 and 2009, the outstanding balances of these participations purchased were approximately $5,776,000 and $8,313,000 respectively. The Bank had no sold participation interests in loans to these affiliated banks as of December 31, 2010 or 2009. 14. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS Estimated fair values are disclosed for financial instruments for which it is practicable to estimate fair value. These estimates are made at a specific point in time based on relevant market data and information about the financial instruments. These estimates do not reflect any premium or discount that could result from offering the Bank's entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates. Because no active market exists for a significant portion of the Bank's financial instruments, fair value estimates are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the fair values presented. The following methods and assumptions were used by the Bank to estimate the fair value of its financial instruments at December 31, 2010 and 2009: Cash and cash equivalents: For cash and cash equivalents consisting of cash, due from banks and federal funds sold, the carrying amount is estimated to be fair value. Investment securities: As discussed in greater detail in Note 15, for investment securities, fair values are based on quoted market prices, where available. If quoted market prices are not available, fair values are estimated using quoted market prices for similar securities and indications of value provided by brokers. The carrying amount of accrued interest receivable approximates its fair value. Loans, net of allowance: For variable-rate loans that reprice frequently with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates being offered at each reporting date for loans with similar terms to borrowers of comparable creditworthiness (without considering widening credit spreads due to market illiquidity). The allowance for loan losses is considered to be a reasonable estimate of discount for credit risk. The carrying amount of accrued interest receivable approximates its fair value. Federal Home Loan Bank stock: The fair value for Federal Home Loan Bank Stock is not determinable as there are restrictions on its transferability. 56 (in thousands)5,501$ New borrowings289 Other changes- Amounts repaid(239) Balance, December 31, 20105,551$ Undisbursed commitments to related parties, December 31, 201052$ Balance, January 1, 2010 Deposits: The fair values for demand deposits are, by definition, equal to the amount payable on demand at the reporting date represented by their carrying amount. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow analysis using interest rates being offered at each reporting date for certificates with similar remaining maturities. The carrying amount of accrued interest payable approximates its fair value. Short-term borrowings and long-term debt: The fair values of fixed rate borrowings are estimated using a discounted cash flow analysis that applies interest rates being offered on similar debt instruments. The fair values of variable rate borrowings are based on carrying value. The carrying amount of accrued interest payable approximates its fair value. Commitments to fund loans/standby letters of credit: The fair values of commitments are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. The differences between the carrying value of commitments to fund loans or standby letters of credit and their fair value are not significant and, therefore, are not included in the following table. 15. FAIR VALUE Accounting standards establish a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value: Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. The fair values of most securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used to in the industry to value debt securities without relying exclusively on quoted prices for the 57 (in thousands)Carrying AmountFair ValueCarrying AmountFair ValueFinancial assets:Cash and due from banks4,542$ 4,542$ 2,933$ 2,933$ Federal funds sold7,940 7,940 - - Investment securities33,642 33,642 27,400 27,400 Loans, net of allowance280,398 300,071 288,277 300,712 Investment in FHLB stock2,614 N/A2,942 N/AAccrued interest receivable1,342 1,342 1,600 1,600 Financial liabilities:Deposits279,977$ 281,565$ 264,253$ 265,255$ FHLB advances12,000 12,407 20,120 20,832 Accrued interest payable122 122 107 107 December 31, 2010December 31, 2009 specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Assets Measured on a Recurring Basis Assets measured at fair value on a recurring basis are summarized below: 58 Quoted Prices in Active Markets for Identical AssetsSignificant Other Observable InputsSignificant Unobservable Inputs(Level 1)(Level 2)(Level 3)December 31, 2010Assets:Government agencies29,308$ -$ 29,308$ -$ Mortgage-backed securities - residential4,334 - 4,334 - Total securities available -for-sale33,642$ -$ 33,642$ -$ Quoted Prices in Active Markets for Identical AssetsSignificant Other Observable InputsSignificant Unobservable Inputs(Level 1)(Level 2)(Level 3)December 31, 2009Assets:Government agencies23,072$ -$ 23,072$ -$ Mortgage-backed securities - residential1,994 - 1,994 - Government sponsored entities stock44 44 - - Other2,290 2,290 - - Total securities available -for-sale27,400$ 2,334$ 25,066$ -$ Fair Value Measurements at December 31, 2010(In thousands)Fair Value Measurements at December 31, 2009(In thousands) Assets Measured on a Non-Recurring Basis Assets measured at fair value on a non-recurring basis are summarized below: The following impairment charges recognized during the years ended December 31, 2010 and 2009 for assets measured at fair value on a non-recurring basis are discussed below. Impaired loans with specific loss allocations had a principal balance of $13,990,000 with a valuation allowance of $2,040,000 at December 31, 2010. Impaired loans with specific loss allocations had a principal balance of $9,578,000 with a valuation allowance of $1,112,000 at December 31, 2009. An additional provision for loan losses of $1,830,000 and $1,112,000 was recognized for impaired loans with specific loss allocations for the years ended December 31, 2010 and 2009. 16. SUBSEQUENT EVENT On January 24, 2011, the Board of Directors declared a $0.09 per common share cash dividend to shareholders of record at the close of business on February 15, 2011, to be paid on February 24, 2011 and a preferred stock cash dividend of $106,250 payable on February 15, 2011. 59 Quoted Prices in Active Markets for Identical AssetsSignificant Other Observable InputsSignificant Unobservable InputsAssets:(Level 1)(Level 2)(Level 3)December 31, 2010Commercial & agricultural $ 3,452 $ - $ - 3,452$ Real estate - commercial 2,003 - - 2,003 Real estate - construction 1,870 - - 1,870 Real estate - single family units 954 - - 954 Real estate - multifamily - - - - Real estate - land loans 3,671 - - 3,671 Consumer - - - - Lease financing - - - - Impaired loans with specific loss allocations11,950$ -$ -$ 11,950$ Quoted Prices in Active Markets for Identical AssetsSignificant Other Observable InputsSignificant Unobservable Inputs(Level 1)(Level 2)(Level 3)Assets:December 31, 2009Impaired loans with specific loss allocations8,466$ -$ -$ 8,466$ Fair Value Measurements at December 31, 2009(In thousands)Fair Value Measurements at December 31, 2010(In thousands) 17. QUARTERLY FINANCIAL DATA (Unaudited) (1) Net income for the third quarter of 2010 and for the third and fourth quarters of 2009 included the impact of higher provision for loan losses as compared to the other quarters. 60 (in thousands except EPS data)Interest IncomeNet Interest IncomeNet IncomeBasicDilutedFirst quarter4,836$ 3,880$ 540$ 0.08$ 0.08$ Second quarter4,718 3,795 506 0.08 0.08 Third quarter4,707 3,840 325 (1)0.04 0.04 Fourth quarter4,625 3,818 436 0.06 0.06 Interest IncomeNet Interest IncomeNet IncomeBasicDilutedFirst quarter5,342$ 3,702$ 847$ 0.16$ 0.16$ Second quarter5,291 3,872 713 0.12 0.12 Third quarter5,135 3,770 166 (1)0.01 0.01 Fourth quarter4,885 3,749 355 (1)0.05 0.05 2009Earnings Per Common Share2010Earnings Per Common Share FEDERAL DEPOSIT INSURANCE CORPORATION Washington, D.C. 20429 FORM 10-K [X] [ ] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the Fiscal Year Ended December 31, 2010 Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ___ to ___. FDIC Certificate Number 32203 Summit State Bank (Exact name of registrant as specified in its charter) California (State of incorporation) 94-2878925 (I.R.S. Employee Identification No.) 500 Bicentennial Way, Santa Rosa, California 95403 (Address of principal executive offices) (707) 568-6000 (registrant’s telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act:: Common Stock, no par value, registered on the NASDAQ Stock Market, LLC Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. Yes [ ] No [X] 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 and (2) has been subject to such filing requirements for the past 90 days. Yes [X] 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 or a no accelerated filer or smaller reporting company. See definition of ―large accelerated filer,‖ ―accelerated filer‖ and ―smaller reporting company‖ in Rule 12b-2 of the Exchange Act). (Check one) Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [X] Indicate by check mark if the registrant is a shell company, in Rule 12b(2) of the Exchange Act. Yes [ ] No [X] The aggregate market value of the Common Stock held by nonaffiliated was approximately $23,124,000 (based upon the closing price of shares of the registrant’s Common Stock, no par value, as reported by the NASDAQ Stock Market, LLC on June 30, 2010. The number of shares outstanding of the registrant’s common stock (no par value) at the close of business March 25, 2011 was 4,744,720. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant’s Proxy Statement for the 2011 Annual Meeting of Shareholders to be filed within 120 days of the fiscal year ended December 31, 2010 are incorporated by reference into Part III. 61 SUMMIT STATE BANK CROSS REFERENCE INDEX PART I Cover ................................................................................................................................61 Cross-Reference Index .......................................................................................................62 Item 1. Business .................................................................................................................64 Information about Summit State Bank ..................................................................64 Services and Financial Products ............................................................................65 Sources of Business ...............................................................................................67 Competition............................................................................................................67 Our, Address, Telephone Number and Internet Website .......................................68 Regulation and Supervision ...................................................................................68 Employees ..............................................................................................................76 Item 1A. Risk Factors ........................................................................................................76 Item 1B. Unresolved Staff Comments ...............................................................................83 Item 2. Properties ...............................................................................................................83 Item 3. Legal Proceedings..................................................................................................83 Item 4. Submission of Matters to a Vote on Security Holders ..........................................83 PART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ...............................................................................83 Item 6. Selected Financial Data .........................................................................................84 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations ..........................................................................................................84 Item 7A. Quantitative and Qualitative Disclosures about Market Risk .............................84 Item 8. Financial Statements and Supplementary Data .....................................................84 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..............................................................................................85 Item 9A. Controls and Procedures .....................................................................................85 Item 9B. Other Information ...............................................................................................86 PART III Item 10. Directors, Executive Officers and Corporate Governance ..................................86 Item 11. Executive Compensation .....................................................................................86 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ...............................................................................87 Item 13. Certain Relationships and Related Transactions, and Director Independence ....87 Item 14. Principal Accountant Fees and Services ..............................................................87 62 PART IV Item 15. Exhibits, Financial Statement Schedules .............................................................88 Signatures ...........................................................................................................................89 Exhibit Index ......................................................................................................................91 63 SUMMIT STATE BANK ANNUAL REPORT ON FORM 10-K PART I DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS This report contains certain statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Actual outcomes and results may differ materially from those expressed in, or implied by, our forward-looking statements. Words such as ―expects,‖ ―anticipates,‖ ―believes,‖ ―estimates‖ and other similar expressions or future or conditional verbs such as ―will,‖ ―should,‖ ―would‖ and ―could‖ are intended to identify such forward-looking statements. Readers of this annual report of the Summit State Bank (also referred to as we, us or our) should not rely solely on the forward-looking statements and should consider all uncertainties and risks throughout the report. Forward-looking statements, by their nature, are subject to risks, uncertainties and assumptions. Our future results and shareholder values may differ significantly from those expressed in these forward-looking statements. You are cautioned not to put undue reliance on any forward-looking statement. The statements are representative only as of the date they are made, and we undertake no obligation to update any forward-looking statement. However, your attention is directed to any further disclosures made on related subjects in any subsequent reports we may file with the Federal Deposit Insurance Corporation (―FDIC‖), including on Forms 10- K, 10-Q and 8-K, in the event we become required to make such filings. ITEM 1. BUSINESS INFORMATION ABOUT SUMMIT STATE BANK General Summit State Bank (the ―Bank‖) is a state-chartered commercial bank operating a traditional community banking business within our primary service area of Sonoma County in California, however we consider loans from Marin, Napa and San Francisco counties. We operate through five offices located in Santa Rosa, Rohnert Park, Healdsburg and Petaluma. The Bank was incorporated on December 20, 1982 and commenced operations as a California state-chartered savings and loan in 1982. On January 15, 1999, the Bank received authority to convert its charter to a California state-chartered commercial bank. On July 13, 2006, the Bank completed an underwritten initial public offering and listed its stock on the Nasdaq Global Market under the symbol SSBI. The Bank’s deposits are insured by the FDIC in accordance with the Federal Deposit Insurance Act and the related regulations. 64 We provide a broad array of financial services to small-to medium-sized businesses, and their owners and employees, professionals and professional associations, entrepreneurs, high net worth families, foundations, estates and to individual consumers. We believe that our principal competitive advantages are personal service, flexibility and responsiveness to customer needs. Our lending activities are primarily focused on commercial real estate, construction, and business loans to our targeted clientele. We emphasize relationship banking and we believe we offer our customers many of the management capabilities of a large financial institution, together with the resourcefulness and superior customer service of a community bank. Through our branches and the use of technology, we offer a broad array of deposit products and services for both commercial and consumer customers, including electronic banking, cash management services and electronic bill payment. We provide a comprehensive set of loan products, such as commercial loans and leases, lines of credit, commercial real estate loans, Small Business Administration, or SBA, loans, residential mortgage loans, home equity lines of credit and construction loans. We believe that local decision making ensures that our lending process is fast, efficient, and focused on maintaining our high credit quality and underwriting standards. The Bank’s only subsidiary is ALTO Service Corporation, which is a wholly owned subsidiary, incorporated in California. Its purpose is to act as trustee on the Bank’s deeds of trust and perform reconveyances. The assets of ALTO Service Corporation consist exclusively of cash on deposit with the Bank. It has no employees and its operations and balance sheet are not material to the Bank’s consolidated operating income or financial condition. Services and Financial Products Deposit Products The Bank offers a wide range of deposit accounts designed to attract commercial businesses, professionals, and residents in its primary service area. These accounts include personal and business checking accounts, money market accounts, time certificates of deposit, sweep accounts and specialized deposit accounts, including professional accounts, small business ―packaged‖ accounts, and tiered accounts designed to attract larger deposits, and Keogh and IRA accounts. Lending Products The Bank also offers a full complement of lending products designed to meet the specialized needs of its customers, including commercial and industrial lines of credit and term loans, credit lines to individuals, equipment loans, real estate and construction loans, small business loans of which a portion may be guaranteed by the SBA, and business lines of credit. The Bank has the designation of ―Preferred Lender‖ by the SBA, which allows for expedited loan approval and funding. The Bank also offers consumer loans, including auto loans, mortgage loans, home improvement loans, and home equity lines of credit. The Bank offers loans in amounts which exceed the Bank’s lending limits through participation arrangements with correspondent banks. On a selective basis, the Bank also offers loans for accounts receivable and inventory financing, loans to agriculture-related businesses, and equipment and expansion financing programs. 65 Brokered Deposits and CDARS The Bank will accept brokered deposits when it is determined to be advantageous over other time deposits through its branch system. The Bank is a member of a special network (Promontory Interfinancial Network) offering a time deposit product called CDARS. When a customer places a large deposit with the Bank as a network member, the Bank can place the funds into certificates of deposit issued by other banks in the network in increments of less than $250,000, so that both principal and interest are eligible for complete FDIC protection. Other banks do the same thing with their customer funds. The network banks exchange deposits on a dollar-for-dollar basis, bringing the full amount of the original deposit back to the originating bank. Because the originating bank comes out ―whole,‖ it can make the full amount of deposits received available for community lending purposes or other initiatives of its choosing. Deposits placed using CDARS meet the pass-through insurance coverage guidelines established by the FDIC and the depositor can obtain up to $25 million in FDIC insurance coverage. The deposits received by the Bank from other network members in exchange for the Bank’s customers’ deposits placed in the program are reported as brokered deposits for FFIEC Call Report purposes. Deposit funding raised through the CDARS product can vary significantly between financial reporting periods. CDARS and other brokered deposits totaled $40,365,000 or 14% of deposits at December 31, 2010, and $53,345,000 or 19% of deposits at December 31, 2009. State of California Approved Depository The Bank is an approved depositary for the deposit of funds of the State of California. These time deposits are placed by the Treasurer of the State of California and have maturities of three to six months, and are collateralized by investment securities, mortgage loans or letters of credit issued by the Federal Home Loan Bank (―FHLB‖). These deposits totaled $31,500,000 or 11% of deposits at December 31, 2010 and $34,000,000 or 13% of deposits at December 31, 2009. Internet and Telephone Banking Services The Bank offers a computerized internet banking system, accessible on the Internet at the Bank’s website www.summitstatebank.com, that enables its customers to view account information, access cash management services (including initiation of automated clearinghouse payments), make transfers between accounts, pay bills, make loan payments, pre- schedule deposit transfers and request loan draws, and view both the front and back of cleared deposit items. The Bank also offers telephone banking services that enable customers to obtain account information, make transfers between accounts, make stop payments, check cleared items, and pre-schedule deposit transfers and loan payments. the Other Services Other services which the Bank offers include banking by appointment, online banking services, direct payroll and social security deposits, letters of credit, access to national automated 66 teller machine networks, courier services, safe deposit boxes, night depository facilities, notary services, travelers checks, lockbox, and banking by mail. Management evaluates the Bank’s services on an ongoing basis, and adds or discontinues services based upon customer needs, competitive factors, and the financial and other capabilities of the Bank. Future services may also be significantly influenced by improvements and developments in technology and evolving state and federal regulations. Sources of Business In marketing its services, the Bank capitalizes on its identity as a local, community bank, with officers, Directors and shareholders who have business and personal ties to the community. Small to medium-sized businesses are targeted, as well as accounting, insurance, legal and medical professionals. The Bank competes with other financial institutions in its service area through localized promotional activities, personalized service, and personal contact with potential customers by Executive Officers, Directors, employees and shareholders. Promotional activities include media advertising, community advisory groups and Officer participation in community business and civic groups. Officers and Directors are active members of the community who call personally on their business contacts and acquaintances in the Sonoma County area to become customers. The Bank employs business development officers to solicit loans and deposits from local businesses and professionals. Competition The banking business in California generally, and in the Bank’s service area in particular, is highly competitive with respect to both loans and deposits and is dominated by a relatively small number of major banks that have offices operating over wide geographic areas. The Bank competes for deposits and loans with these banks as well as with savings and loan associations, credit unions, mortgage companies, money market funds, stock brokerage firms, insurance companies, and other traditional and non-traditional financial institutions. Major financial institutions with offices in the service area include Bank of America, Wells Fargo Bank, and JP Morgan Chase. Regional and independent financial institutions with offices in our service area include, among others, Sonoma Bank (part of Sterling Savings Bank), Luther Burbank Savings, Exchange Bank, and Westamerica Bank. The major banks and some of the other institutions have the ability to finance extensive advertising campaigns and to shift their resources to regions or activities of greater potential profitability. Many of the competing banks and other institutions offer diversified financial services which may not be directly offered by the Bank. The major banks also have substantially more capital and higher lending limits. 67 The Bank competes for customers’ funds with governmental and private entities issuing debt or equity securities or other forms of investments which may offer different or higher yields than those available through bank deposits. Existing and future state and federal legislation could significantly affect the Bank’s cost of doing business, its range of permissible activities, and the competitive balance among major, regional and independent banks, and other financial institutions. Management cannot predict the impact these matters may have on commercial banking in general or on the business of the Bank in particular. To compete with the financial institutions operating in the Bank’s service area, the Bank relies upon its independent status to provide flexibility and personalized service to its customers. The Bank emphasizes personal contacts with potential customers by Executive Officers, Directors and employees, develops local promotional activities, and seeks to develop specialized or streamlined services for customers. To the extent customers desire loans in excess of its lending limits or services not offered by the Bank, the Bank attempts to assist customers in obtaining such loans or other services through participations with other banks or assistance from correspondent banks. Our Address, Telephone Number and Internet Website Our principal executive offices are located at 500 Bicentennial Way, Santa Rosa, California 95403, and our telephone number is (707) 568-6000. Information about us is available at www.summitstatebank.com. The information on our website is not incorporated by reference into and does not form a part of this report. REGULATION AND SUPERVISION Overview The Bank is extensively regulated by federal and state authorities. As a California state- chartered commercial bank with deposit accounts insured by the FDIC to the maximum amount permitted by law, the Bank is regulated, supervised and examined by the Commissioner of the California Department of Financial Institutions (―the Commissioner‖) and the FDIC. The Bank must also comply with certain regulations issued by the FRB. The regulations of the Commissioner, the FRB and the FDIC govern most aspects of the Bank’s business, including the making of periodic reports by the Bank, as well as the Bank’s activities relating to dividends, investments, loans, borrowings, capital requirements, certain check-clearing activities, branching, mergers and acquisitions, reserves against deposits, the issuance of securities and numerous other areas. The Bank is also subject to the requirements and restrictions of various consumer laws and regulations, as well as applicable provisions of California law, insofar as they do not conflict with and are not preempted by federal banking laws. Supervision, legal action and examination of the Bank by the regulatory agencies are generally intended to protect depositors and are not intended for the protection of shareholders. 68 Statutes, regulations and policies affecting the banking industry are frequently under review by the U.S. Congress and state legislatures, and by the federal and state agencies charged with supervisory and examination authority over banking institutions. Changes in the banking and financial services industry can be expected to occur in the future. Some of the changes may create opportunities for the Bank to compete in financial markets with less regulation. However, these changes also may create new competitors in geographic and product markets which have historically been limited by law to insured depository institutions such as the Bank. Changes in the statutes, regulations or policies that affect the Bank cannot be predicted and may have a material effect on the Bank’s business and earnings. In addition, the regulatory agencies which have jurisdiction over the Bank have broad discretion in exercising their supervisory powers. For example, the FDIC has authority under federal law to prohibit a state bank from engaging in banking practices which it considers unsafe and unsound. The laws of the State of California affect the Bank’s business and operations. The California Financial Code provides that if the Commissioner believes that a bank is violating its articles of incorporation or state law, or is engaging in unsafe or injurious business practices, the Commissioner can order that bank to comply with the law or to cease the unsafe or injurious practices and has authority to impose civil money penalties. The Commissioner has the power to suspend or remove bank officers, directors and employees who violate any law or regulation relating to the business of the bank or breach any fiduciary duty to the bank, engage in any unsafe and unsound practices related to the business of the bank, or are charged with or convicted of a felony involving dishonesty or breach of trust. The Commissioner also has authority to take possession of and to liquidate a bank, to appoint a conservator for a bank and to appoint the FDIC as receiver for a bank. The FDIC can pursue an enforcement action against a bank for unsafe and unsound practices in conducting its business, or for violations of any law, rule or regulation or provision, any consent order with any agency, any condition imposed in writing by the agency, or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, cease-and-desist orders and written agreements, the termination of insurance of deposits, the imposition of civil money penalties and removal and prohibition orders against institution-affiliated parties. In addition to the regulation and supervision outlined above, banks must be prepared for judicial scrutiny of their lending and collection practices. For example, some banks have been found liable for exercising remedies which their loan documents authorized upon the borrower’s default. This has occurred in cases where the exercise of those remedies was determined to be inconsistent with the previous course of dealing between those banks and the borrowers. As a result, banks have had to exercise increased caution, incur greater expense and face increased exposure to liability when dealing with defaulting loans. 69 Recent Developments Dodd-Frank Wall Street Reform and Consumer Protection Act On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the ―Dodd-Frank Act‖) was signed into law. The Dodd-Frank Act is intended to effect a fundamental restructuring of federal banking regulation. Among other things, the Dodd-Frank Act creates a new Financial Stability Oversight Council to identify systemic risks in the financial system and gives federal regulators new authority to take control of and liquidate financial firms. The Dodd- Frank Act also creates a new independent federal regulator to administer federal consumer protection laws. The Dodd-Frank Act is expected to have a significant impact on our business operations as its provisions take effect. Among the provisions that are likely to affect us are the following: Deposit Insurance. The Dodd-Frank Act permanently increases the maximum deposit insurance amount for banks, savings institutions and credit unions to $250,000 per depositor, and extends unlimited deposit insurance to non-interest bearing transaction accounts through December 31, 2012. The Dodd-Frank Act also broadens the base for FDIC insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution, rather than on deposits as in the past. Assessment rates would be reduced to a range of 2½ to 9 basis points on the broader assessment base for banks in the lowest risk category (―well capitalized‖ and CAMELS I or II) up to 30 to 45 basis points for banks in the highest risk category. The Dodd-Frank Act requires the FDIC to increase the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020 and eliminates the requirement that the FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds. Effective one year from the date of enactment, the Dodd-Frank Act eliminates the federal statutory prohibition against the payment of interest on business checking accounts. Consumer Financial Protection Bureau. The Dodd-Frank Act creates a new, independent federal agency called the Consumer Financial Protection Bureau (―CFPB‖), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act and certain other statutes. The CFPB will have examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB will have authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. In addition, the Dodd-Frank Act will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a ―qualified mortgage‖ as defined by the CFPB. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations. 70 Corporate Governance. The Dodd-Frank Act will require publicly traded companies to give shareholders a non-binding vote on executive compensation at their first annual meeting taking place six months after the date of enactment and at least every three years thereafter and on so-called ―golden parachute‖ payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders. The new legislation also authorizes the SEC to promulgate rules that would allow shareholders to nominate their own candidates using a company’s proxy materials. The Dodd-Frank Act directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1.0 billion, regardless of whether the company is publicly traded or not. It also gives the SEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters. Transactions with Affiliates and Insiders. Effective one year from the date of enactment, the Dodd-Frank Act expands the definition of affiliate for purposes of quantitative and qualitative limitations of Section 23A of the Federal Reserve Act to include mutual funds advised by a depository institution or its affiliates. The Dodd-Frank Act will apply Section 23A and Section 22(h) of the Federal Reserve Act (governing transactions with insiders) to derivative transactions, repurchase agreements and securities lending and borrowing transactions that create credit exposure to an affiliate or an insider. Any such transactions with affiliates must be fully secured. The current exemption from Section 23A for transactions with financial subsidiaries will be eliminated. Holding Company Capital Requirements. The Dodd-Frank Act requires the FRB to apply consolidated capital requirements to depository institution holding companies that are no less stringent than those currently applied to depository institutions. Under these standards, trust preferred securities will be excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by a bank holding company with less than $15 billion in assets. The Dodd- Frank Act also requires capital requirements to be countercyclical so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness. Interstate Branching. The Dodd-Frank Act authorizes national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be permitted to branch. Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state. Accordingly, banks will be able to enter new markets more freely. Limits on Derivatives. Effective 18 months after enactment, the Dodd-Frank Act prohibits state-chartered banks from engaging in derivatives transactions unless the loans to one borrower limits of the state in which the bank is chartered take into consideration credit exposure to derivatives transactions. For this purpose, derivative transaction includes any contract, agreement, swap, warrant, note or option that is based in whole or in part on the value of, any interest in, or any quantitative measure or the occurrence of any event relating to, one or more commodities securities, currencies, interest or other rates, indices or other assets. 71 Troubled Asset Relief Program and Related Measures On October 3, 2008, Congress adopted the Emergency Economic Stabilization Act (―EESA‖), including a Troubled Asset Relief Program (―TARP‖). TARP gave the United States Treasury Department (―Treasury‖) authority to deploy up to $700 billion into the financial system for the purpose of improving liquidity in capital markets. On October 14, 2008, Treasury announced plans to direct $250 billion of this authority into preferred stock investments in banks and bank holding companies through a Capital Purchase Program (―CPP‖). Certain terms of this CPP are as follows:  Treasury’s preferred stock earns 5% dividends for the first five years and 9% dividends thereafter; dividends on preferred stock issued by holding companies are cumulative; dividends on preferred stock issued by banks without holding companies are non- cumulative;  No increase in common stock dividends for three years while Treasury is an investor;  Treasury’s consent is required for common stock repurchases;  Treasury receives warrants for common stock equal to 15% of Treasury’s total investment, with an exercise price based on the common stock’s market price;  Participating bank executives must agree to certain compensation restrictions and  executive compensation above $500,000 may not be claimed as a tax deduction; If an issuer fails to pay dividends for six quarters, whether or not consecutive, Treasury is entitled to appoint two persons to the issuer’s board of directors. The Bank elected to participate in the CPP by issuing $8,500,000 in non-cumulative preferred stock to Treasury and along with a warrant to purchase up to 239,212 shares of common stock at an exercise price of $5.33 per share. The transaction was completed on December 19, 2008. Under EESA, certain temporary increases in FDIC deposit insurance were approved, including full deposit insurance coverage until June 30, 2010 (now extended by the Dodd-Frank Act), for non-interest bearing deposit transaction accounts, attorney trust accounts, and NOW accounts paying not more than 50 basis points of interest regardless of dollar amount. These accounts are mainly payment-processing accounts, such as payroll accounts used by businesses. Participants will be charged a 10-basis point surcharge to current insurance assessments for this additional coverage. The Bank is participating is this program. The American Recovery and Reinvestment Act of 2009 (―ARRA‖) was signed into law on February 17, 2009. ARRA included a wide variety of programs intended to stimulate the economy. In addition, ARRA imposed new executive compensation and expenditure limits on all previous and future TARP CPP recipients, such as the Bank, and expands the class of employees to whom the limits and restrictions apply. ARRA also provided the opportunity for additional repayment flexibility for existing TARP CPP recipients. Among other things, ARRA prohibits the payment of bonuses, other incentive compensation and severance to certain of the company’s most highly paid employees (except in the form of restricted stock subject to specified limitations and conditions), and requires each TARP recipient to comply with certain other executive compensation related requirements. However, 72 both the ARRA and the existing Treasury guidelines contemplate that the Secretary of the Treasury will adopt standards to provide additional guidance regarding how the executive compensation restrictions under the ARRA and EESA will be applied. The transaction documents for the Capital Purchase Program give Treasury the unilateral right to change or add additional terms to the agreements. Treasury regulations adopted in June 2009 impose additional restrictions and requirements related to executive compensation and risk. Deposit Insurance Premiums The FDIC has developed a risk-based assessment system that provides that the assessment rate for an insured depository institution will vary according to the level of risk incurred in its activities. Effective April 1, 2009, banks pay base rates of 12 basis points to 45 basis points on deposits annually for deposit insurance, subject to adjustment down to 7 basis points and up to 77.5 basis points based on factors related to risk profile described below. The FDIC also adopted changes to the assessment system to require riskier institutions to pay a larger share of assessments. Institutions are classified into one of four risk categories. The FDIC is able to assess higher rates to institutions with a significant reliance on secured liabilities or a significant reliance on brokered deposits but, for well-managed and well-capitalized institutions, only when accompanied by rapid asset growth. The changes also provide incentives in the form of a reduction in assessment rates for institutions to hold long-term unsecured debt and, for smaller institutions, high levels of Tier 1 capital. In February 2009, the FDIC announced a proposed special emergency assessment of 20 basis points, with the possibility of an additional emergency assessment. The FDIC ultimately adopted a special assessment of 5 basis points times an institution’s assets less its Tier 1 capital, not to exceed 10 basis points times its deposit assessment base. In addition, in December 2009, the FDIC assessed an estimate of the insurance premiums for 2010, 2011 and 2012 totaling $1,347,000. This prepaid amount will be amortized to expense over 2010, 2011 and 2012. The Dodd-Frank Act resulted in additional changes in assessments for deposit insurance, including a revised range of assessment rates against a base determined by reference to assets and capital rather than to deposits. See ―Dodd-Frank Wall Street Reform and Consumer Protection Act - Deposit Insurance‖ above. Limitations on Dividends Under California law the holders of the Bank’s common stock are entitled to receive dividends out of funds legally available for the payment of dividends when and as declared by the Board of Directors, provided the conditions described below are satisfied. The payment of cash dividends by the Bank depends on various factors, including the earnings and capital requirements of the Bank and other financial conditions. California law provides that, as a state-licensed bank, the Bank may not make a cash distribution to its shareholders in excess of the lesser of the following: (a) the Bank’s retained earnings or (b) the Bank’s net income for its last three fiscal years, less the amount of any distributions made by the Bank to its 73 shareholders during that period. However, a bank such as the Bank, with the prior approval of the Commissioner, may make a distribution to its shareholders of an amount not to exceed the greater of (1) the Bank’s retained earnings, (2) the Bank’s net income for its last fiscal year, or (3) the Bank’s net income for the current fiscal year. If the Commissioner determines that the shareholders’ equity of the Bank is inadequate or that the making of a distribution by the Bank would be unsafe or unsound, the Commissioner may order the Bank to refrain from making a proposed distribution. The FDIC and the Commissioner have authority to prohibit a bank from engaging in business practices which are considered to be unsafe or unsound. Depending upon the financial condition of bank and upon other factors, the FDIC or the Commissioner could assert that payments of dividends or other payments by the Bank might be an unsafe or unsound practice. Under the terms of the preferred stock issued to Treasury in its TARP transaction on December 19, 2008, the Bank cannot pay dividends on its common stock unless it has paid the most recent dividend accrued on Treasury’s preferred stock. Further dividend restrictions are contained in the preferred stock purchase agreement which limits dividends to their historical levels for 3 years or until its redemption without obtaining the prior approval of the Treasury. Capital Adequacy Guidelines Federal bank regulatory agencies have adopted risk-based capital guidelines for insured banks. A bank’s total qualifying capital consists of two types of capital components: ―core capital elements,‖ known as Tier 1 capital, and ―supplementary capital elements,‖ known as Tier 2 capital. The Tier 1 component of a bank’s qualifying capital must represent at least 50% of total qualifying capital. Tier 1 capital consists of common equity, non-cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries. Tier 1 capital excludes goodwill and other specified intangibles, as well as the equity impact of adjusting available-for-sale securities to market value. In addition to the Tier 1 capital components, total capital also includes cumulative perpetual preferred stock, trust preferred stock, limited-life preferred stock, mandatory convertible securities, subordinated debt and general loan loss reserves up to a limit of 1.25% of risk-weighted assets. The guidelines make regulatory capital requirements sensitive to the differences in risk profiles among banking institutions, take off-balance-sheet items into account when assessing capital adequacy, and minimize disincentives to holding liquid low-risk assets. These guidelines require a minimum total risk-based capital ratio of 8% of risk-weighted assets, with at least 4% in the form of Tier 1 capital. Federal banking regulators also have instituted minimum leverage ratio guidelines for financial institutions. The leverage ratio guidelines require maintenance of a minimum ratio of 3% Tier 1 capital to adjusted quarterly average assets for the most highly rated bank holding company organizations. Less highly rated institutions and institutions that are anticipating significant growth or that face other significant risks are required to maintain capital levels ranging from 1% to 2% above the 3% minimum. In addition, all banks are generally expected to maintain capital above these minimums. 74 Federal banking agencies, including the FDIC, have adopted regulations implementing a system of prompt corrective action under the Federal Deposit Insurance Corporation Improvement Act. The regulations establish five capital categories with the following characteristics: (1) ‖Well-capitalized,‖ consisting of institutions with a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater and a leverage ratio of 5% or greater and which are not operating under an order, written agreement, capital directive or prompt corrective action directive; (2) ‖Adequately capitalized,‖ consisting of institutions with a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital of 4% or greater and a leverage ratio of 4% or greater and which do not meet the definition of a ―well-capitalized‖ institution; (3) ‖Undercapitalized,‖ consisting of institutions with a total risk-based capital ratio of less than 8%, a Tier 1 risk-based capital ratio of less than 4%, or a leverage ratio of less than 4%; (4) ‖Significantly undercapitalized,‖ consisting of institutions with a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3%, or a leverage ratio of less than 3%; and (5) ‖Critically undercapitalized,‖ consisting of institutions with a ratio of tangible equity to total assets that is equal to or less than 2%. Banks are subject to sanctions of increasing severity for failure to maintain capital ratios at well-capitalized or adequately-capitalized levels. As of December 31, 2010, the Bank was well-capitalized and had a total risk-based capital ratio of 19.8%, a Tier-1 risk-based capital ratio of 18.6% and a leverage ratio of 14.6%. Programs To Mitigate Identity Theft In November 2007, federal banking agencies together with the NCUA and FTC adopted regulations under the Fair and Accurate Credit Transactions Act of 2003 to require financial institutions and other creditors to develop and implement a written identity theft prevention program to detect, prevent and mitigate identity theft in connection with certain new and existing accounts. Covered accounts generally include consumer accounts and other accounts that present a reasonably foreseeable risk of identity theft. Each institution's program must include policies and procedures designed to: (i) identify indicators, or "red flags," of possible risk of identity theft; (ii) detect the occurrence of red flags; (iii) respond appropriately to red flags that are detected; and (iv) ensure that the program is updated periodically as appropriate to address changing circumstances. The regulations include guidelines that each institution must consider and, to the extent appropriate, include in its program. Legislation and Proposed Changes 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 institutions. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial institutions are frequently made in Congress, in the California legislature and before various bank regulatory agencies. For example, from time to time Congress has considered various proposals to eliminate the federal thrift charter, create a uniform financial institutions charter, conform holding company regulation, and abolish the Office of Thrift Supervision. Typically, the intent of this type of legislation is to strengthen the banking industry. No prediction can be 75 made as to the likelihood of any major changes or the impact that new laws or regulations might have on the Bank. Employees As of December 31, 2010, the Bank employed a total of 51 full-time and 11 part-time employees in various capacities, all located in California. The Bank’s employees are not represented by any union or covered by any collective bargaining agreement. The Bank considers its relationships with its employees to be good. ITEM 1A. RISK FACTORS The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. This report is qualified in its entirety by these risk factors. Current Market Developments May Adversely Affect Our Industry, Business and Results of Operations. Dramatic declines in the housing market during the prior years, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative securities, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Many lenders and institutional investors, concerned about the stability of the financial markets generally and the strength of counterparties, have reduced or ceased to provide funding to borrowers, including other financial institutions. The resulting lack of available credit, lack of confidence in the financial sector, increased volatility in the financial markets and reduced business activity could materially and adversely affect our business, financial condition and results of operations. There Can Be No Assurance that the Recently Enacted Emergency Economic Stabilization Act of 2008 (“EESA”) and American Recovery and Reinvestment Act (“ARRA”) Will Help Stabilize the U.S. Financial System. The Dodd-Frank Act, Emergency Economic Stabilization Act of 2008 (―EESA‖) and American Recovery and Reinvestment Act (―ARRA‖) were dramatic legislative responses to a national financial crisis. EESA evolved from the U.S. Treasury’s initial proposal in response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions. EESA was followed by the ARRA. The U.S. Treasury and banking regulators are implementing a number of programs under this legislation to address capital and liquidity issues in the banking system. Most recently, the Dodd-Frank Act’s 2,300 pages were signed into law with a focus on restructuring the regulation of the financial system. The Dodd-Frank Act alone requires various agencies to conduct 76 numerous studies and adopt new regulations affecting nearly all areas of the financial system. There can be no assurance, however, as to the actual impact that the Dodd-Frank Act, EESA or ARRA and forthcoming regulations will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced. The failure of the Dodd-Frank Act, EESA or ARRA to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock. Premiums for Federal Deposit Insurance Have Increased and May Increase More. Recent failures have caused the FDIC’s deposit insurance fund to fall below the minimum balance required by law, forcing the FDIC to consider action to rebuild the fund by raising the insurance premiums assessed member banks. The FDIC increased premiums, provided for additional increases for institutions with greater risk profiles and revised the base on which premiums are charged. It also had an additional emergency assessment as of June 30, 2009. At the end of 2009, the FDIC required banks to prepay three years of projected premiums. The amount paid will be amortized into expense by the Bank based on the actual quarterly assessment. Depending on the frequency and severity of bank failures, future increases in premiums or assessments could be significant and negatively affect our earnings. Our Share Price May Be Volatile As of December 31, 2010, there were 4,744,720 shares of our common stock issued and outstanding. The Bank’s common stock is listed on the Nasdaq Global Market under the symbol ―SSBI.‖ Factors such as announcements of developments related to the Bank’s business, announcements by competitors, fluctuations in its financial results, general conditions in the banking industry, economic conditions in the areas in which the Bank does business, fluctuations in interest rates, and other factors could cause the price of the Shares to fluctuate substantially. In addition, in recent years the stock market in general and the market for shares of small capitalization stocks and financial institutions in particular have experienced extreme price fluctuations, which have often been unrelated to the operating performance of affected companies. Such fluctuations could have a material adverse effect on the market price of the Shares. The Bank Is Highly Dependent on Real Estate and Events that Negatively Impact the Real Estate Market Could Hurt Our Business A significant portion of our loan portfolio is dependent on real estate. At December 31, 2010, real estate served as the principal source of collateral with respect to approximately 71% of our loan portfolio. Our financial condition may be adversely affected by a decline in the value of the real estate securing our loans and, while we presently hold no real estate acquired through foreclosure or other judicial proceeding, a decline in the value of real estate that may be owned by us, through foreclosure or otherwise, in the future could adversely impact our financial condition. In addition, acts of nature, including earthquakes, brush fires and floods, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also 77 negatively impact our financial condition. This is particularly significant in light of the fact that substantially all of the real estate that makes up the collateral of our real estate secured loans is located in Northern California, where earthquakes and brush fires are common. The Bank’s Business Is Highly Competitive In California generally, and in the Bank’s service area specifically, major banks and regional banks dominate the commercial banking market. By virtue of their larger capital bases, such institutions have substantially greater financial, marketing and operational resources than the Bank and offer diversified services that might not be directly offered by the Bank. The Bank competes with these larger commercial banks and other financial institutions, such as savings and loan associations and credit unions, which offer services traditionally offered only by banks. In addition, the Bank competes with other institutions such as money market funds, brokerage firms, commercial finance companies, leasing companies, and even retail stores seeking to penetrate the financial services market. No assurance can be given, however, that the Bank’s efforts to compete with other banks and financial institutions will continue to be successful. In addition, the costs of providing a high level of personal service could adversely affect the Bank’s operating results. See ―Information About Summit State Bank — Competition‖ on page 67. The Bank Depends on Loan Originations to Grow Its Business The Bank’s success depends on, among other things, its ability to originate loans. For several years, demand for loans by creditworthy borrowers has been relatively weak. The Bank’s competitors may offer better terms or better service, or respond to changing capital and other regulatory requirements better than the Bank is able to do. Some of the Bank’s competitors make loans on terms that the Bank is not willing to match. Success in competing for loans depends on such factors as: • Quality of service to borrowers, especially the time it takes to process loans; • Economic factors, such as interest rates; • Terms of the loans offered, such as rate adjustment provisions, adjustment caps, loan maturities, loan-to-value ratios and loan fees; and • Size of the loan. The Bank Is Subject to Lending Risks The Bank engages in commercial, consumer and real estate lending. All lenders face the risk that some of their borrowers will not repay their loans. The ability of borrowers to repay their obligations can be adversely affected by factors beyond the control of the Bank, including local and general economic and market conditions. A substantial portion of the Bank’s loans are secured by liens on real estate. These same factors may adversely affect the value of real estate taken as collateral. The Bank maintains the allowance for loan losses to reflect the level of probable incurred losses determined by management to be inherent in the loan portfolio. Each 78 increase made in the allowance for loan losses (―provision‖) results in a charge against the Bank’s earnings in the financial period in which the increase is made. However, the level of the allowance for loan losses and the amount of the provision are estimates based on management’s judgment, and there can be no assurance that actual losses incurred will not exceed the amount of the allowance or require substantial additional increases to the allowance. See ―Information About Summit State Bank — Services and Financial Products‖ on page 65-67. The Bank’s Business is Subject to Extensive Government Regulation and Legislation The Bank is subject to extensive state and federal regulation, supervision and legislation, and the laws that govern The Bank and its operations are subject to change from time to time. Applicable laws and regulations provide for the regular examination and supervision of institutions; affect the cost of funds through reserve requirements and assessments on deposits; limit or prohibit the payment of interest on demand deposits; limit the kinds of investments a bank or bank holding company can make and the kinds of activities in which it can engage; and grant the regulatory agencies broad enforcement authority in case of violations. The laws and regulations increase the cost of doing business and have an adverse impact on the ability of the Bank to compete efficiently with other financial services providers that are not similarly regulated. There can be no assurance that future regulation or legislation will not impose additional requirements and restrictions on the Bank in a manner that will adversely affect its results of operations, financial condition and prospects. See ―Information About Summit State Bank — ―Competition‖ and ―Regulation and Supervision‖ on pages 67-76. Limited Capital May Adversely Affect the Bank’s Ability to Do Business Under applicable government regulations, the Bank is permitted to make unsecured loans to any single borrower or group of related borrowers in an amount that will not exceed 15% of its shareholders’ equity, plus the allowance for loan losses, capital notes and debentures, and secured loans in an amount that, when combined with unsecured loans made to the same borrower or group of related borrowers, will not exceed 25% of its shareholders’ equity, plus the allowance for loan losses, capital notes and debentures (the ―Lending Limits‖). Such Lending Limits make it more difficult for the Bank to attract borrowers who have lending requirements in excess of those Lending Limits and, as a result, the future success of the Bank depends on, among other things, its ability to increase capital (and thereby the amount of the loans it will be able to make to borrowers) by selling additional common stock, preferred stock or subordinated debt. The Bank has no plans at this time to sell any such securities (except upon issuance of options to directors and employees under its stock option plan). However, if the need to do so should arise, there is no assurance that the Bank’s efforts to raise such additional capital will be successful or that the sale of additional shares will not dilute the ownership of current investors. The Bank seeks the participation of other banks and lending institutions, as co-lenders with it, for loans that exceed the Bank’s Lending Limits; however, there can be no assurance that other lending institutions will be interested in doing so. 79 The Bank’s Business May Be Adversely Affected By General Economic Conditions Including Conditions in California The banking business is affected by general economic and political conditions, both domestic and international, and by governmental monetary and fiscal policies. Conditions such as inflation, recession, unemployment, volatile interest rates, money supply, scarce natural resources, weather, natural disasters such as earthquakes, international disorders, etc., and other factors beyond the Bank’s control may adversely affect the profitability of the Bank. A substantial majority of the Bank’s assets and deposits are generated in Northern California. As a result, poor economic conditions in Northern California may cause the Bank to incur losses associated with higher default rates and decreased collateral values in its loan portfolio. Economic conditions in Northern California are subject to various uncertainties at this time, including the state’s budget deficit and the depreciation of real estate. If economic conditions in California generally and Northern California in particular decline further, the Bank recognizes that its level of problem assets could increase accordingly. Failure to Successfully Execute Our Strategy Could Adversely Affect Our Performance Along with the other factors listed herein, our financial performance and profitability depends on our ability to execute our corporate growth strategy. Continued growth may present operating and other problems that could adversely affect our business, financial condition and results of operations. Accordingly, there can be no assurance that we will be able to execute our growth strategy or maintain the level of profitability that we have recently experienced. Our Business is Subject to Liquidity Risk and Changes in Our Source of Funds May Affect Our Performance and Financial Condition Our ability to make loans is directly related to our ability to secure funding. In addition to local deposits, the Bank receives funding from FHLB advances, brokered deposits and State of California time deposits, when such alternatives are attractive compared to the cost of attracting additional local deposits. These alternative sources of funds, along with local time deposits, are sensitive to interest rates and can affect the cost of funds and net interest margin. Liquidity risk arises from the inability to meet obligations when they come due or to manage the unplanned decreases or changes in funding sources. Although we believe we can continue to successfully pursue a local deposit funding strategy, significant fluctuations in local deposit balances or if one of the alternative sources of funds becomes unavailable, an adverse effect on our financial condition and results of operations may be experienced. The Bank’s Business Is Subject to Interest Rate Sensitivity The income of the Bank depends to a great extent on the difference between the interest rates earned on its loans, securities and other interest-earning assets and the interest rates paid on its deposits and other interest-bearing liabilities. These rates are highly sensitive to many factors that are beyond the Bank’s control, including general economic conditions and the policies of various governmental and regulatory agencies, in particular the Board of Governors of the 80 Federal Reserve System (―FRB‖). A change in interest rates could have a material adverse effect on the Bank’s results of operations, financial condition and prospects by reducing the spread between income on interest earning assets and interest paid on interest bearing liabilities. See ―Management’s Discussion and Analysis of Financial Condition and Results of Operations- Liquidity and Capital Resources‖ on pages 24-25. We Are Exposed to Risk of Environmental and Other Liabilities with Respect to Properties to Which We Take Title In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental or other liabilities with respect to these properties. We may be held liable to a governmental entity or to third persons for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or we 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, in the event we become 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. The Bank’s Ability to Declare Future Dividends Is Subject to Certain Limitations The Bank’s ability to pay dividends is limited by law and regulation and by the financial condition of the Bank. There can be no assurance that the Bank will continue to pay dividends at the rate and frequency at which it has done so in the past or that any dividends will be declared and paid in the future at all. See ―Regulation and Supervision-Limitations on Dividends‖ on page 73-74. Additionally the preferred stock purchase agreement entered into with the United States Department of the Treasury prohibits the payment of common stock dividends in excess of historical levels for 3 years from December 19, 2008, without obtaining the prior approval of the Treasury and the Bank cannot pay dividends on its common stock unless it has paid the most recent dividend accrued on the Treasury’s preferred stock. The Accuracy of the Bank’s Judgments and Estimates about Financial and Accounting Matters Will Impact Operating Results and Financial Condition The Bank makes certain estimates and judgments in preparing its financial statements. The quality and accuracy of those estimates and judgments will have an impact on the Bank’s operating results and financial condition. Three items that are subject to material estimates and judgments include the consideration of other than temporary impairment of investment securities, the recorded goodwill asset of $4,119,000 and the allowance for loan losses of $6,058,000 as of December 31, 2010. Although management supports its estimates and judgments by employing third party reviews there are no assurances that regulatory reviews may result in a different conclusion or future events may occur that impact the recorded values resulting in material fluctuations of financial results. See ―MANAGEMENT’S DISCUSSION AND ANALYSIS-Critical Accounting Policies‖ beginning on page 4. 81 The Bank’s Information Systems May Experience an Interruption or Breach in Security The Bank relies heavily on communications and information systems to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Bank’s customer relationship management and systems. There can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately corrected by the Bank. The occurrence of any such failures, interruptions or security breaches could damage the Bank’s reputation, result in a loss of customer business, subject the Bank to additional regulatory scrutiny, or expose the Bank to litigation and possible financial liability, any of which could have a material adverse effect on the Bank’s financial condition and results of operations. The Bank’s Controls and Procedures May Fail or Be Circumvented Management regularly reviews and updates the Bank’s internal control over financial reporting, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls and procedures, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Bank’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Bank’s business, results of operations and financial condition. 82 ITEM 1B. UNRESOLVED STAFF COMMENTS None. ITEM 2. PROPERTIES The Bank owns its head office building located at 500 Bicentennial Way, Santa Rosa, California. The building has approximately 31,000 square feet of usable space. The Bank occupies approximately 13,000 square feet as its headquarters. The remaining 18,000 square feet are currently leased to 4 tenants, with lease terms maturing from 2011 to 2013. The Bank also leases spaces for branch offices in four shopping centers. These leases expire at various dates from 2012 through 2019 and include renewal and termination options and rental adjustment provisions. ITEM 3. LEGAL PROCEEDINGS The nature of our business causes us to be involved in routine legal proceedings from time to time. As of the date of this report, the Bank is not a party to any litigation of any kind nor is the Bank aware of any threats of any litigation or administrative proceedings affecting the Bank. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There was no submission of matters to a vote of securities holders during the quarter ended December 31, 2010. PART II ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The Bank’s common stock trades on the NASDAQ under the symbol ―SSBI.‖ The quotations shown below reflect for the periods indicated the high and low closing sales prices for our common stock as reported by NASDAQ. 83 There were 193 common stock shareholders of record at December 31, 2010. There were no issuer purchases of equity securities for the three month period ended December 31, 2010. ITEM 6. SELECTED FINANCIAL DATA Information regarding Selected Financial Data appears on page 3 under the caption ―SELECTED FINANCIAL DATA‖ and is incorporated herein by reference. ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Information regarding Management’s Discussion and Analysis of Financial Condition and Results of Operations appears on pages 4–25 under the caption ―MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS‖ and is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information regarding Quantitative and Qualitative Disclosures About Market Risk appears on page 23-24 under the caption ―QUANTITATVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK‖ and is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information regarding Financial Statements and Supplementary Data appears on pages 26-60 under the captions ―REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM, ―CONSOLIDATED BALANCE SHEETS,‖ ―CONSOLIDATED STATEMENTS OF 84 For the quarter endedHighLowCash dividends declaredDecember 31, 20106.99$ 6.10$ 0.09$ September 30, 20107.20 5.79 0.09 June 30, 20107.34 5.92 0.09 March 31, 20106.75 4.90 0.09 December 31, 20097.10 4.20 0.09 September 30, 20097.49 5.50 0.09 June 30, 20097.40 4.26 0.09 March 31, 20095.75 4.46 0.09 INCOME,‖ ―CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY,‖ ―CONSOLIDATED STATEMENTS OF CASH FLOWS‖ and ―NOTES TO CONSOLIDATED FINANCIAL STATEMENTS‖ and is incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None ITEM 9A. CONTROLS AND PROCEDURES (A) Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2010. The term ―disclosure controls and procedures,‖ as defined in Rules 13a-15(e) and 15d- 15(e) under the Securities and Exchange Act of 1934, means controls and other procedures of a Bank that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files and submits under the Exchange Act is accumulated and communicated to the Bank’s management, including its principal executive and principle financial officers, as appropriate to allow timely decisions regarding required disclosure. Based on the evaluation of our disclosure controls and procedures as of December 31, 2010, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective. The Audit Committee of the Board of Directors, which is composed solely of independent directors, meets regularly with our independent registered public accounting firm, Crowe Horwath LLP, and representatives of management to review accounting, financial reporting, internal control and audit matters, as well as the nature and extent of the audit effort. The Audit Committee is responsible for the engagement of the independent auditors. The independent auditors have free access to the Audit Committee. (B) Management’s Annual Report on Internal Control over Financial Reporting The Bank’s management is responsible for establishing and maintaining adequate control over financial reporting for the Bank, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Under the supervision and with the participation of the Bank’s management, including our principal executive and principal financial officers, the Bank conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the ―COSO Framework‖). Based on this evaluation under the COSO Framework, management concluded that its internal control over financial reporting was effective as of December 31, 2010. 85 (C) Changes in Internal Control over Financial Reporting During the quarter ended December 31, 2010, the Registrant did not make any significant changes in, nor take any corrective actions regarding, its internal control over financial reporting or other factors that has materially affected, or is reasonably likely to materially affect the registrants’ internal control over financial reporting. (D) Attestation Report of the Independent Registered Public Accounting Firm This annual report does not include an attestation report of the Bank’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Bank’s independent registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Bank to provide only management’s report in this annual report. ITEM 9B. OTHER INFORMATION None. PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE We intend to file a definitive proxy statement for the 2011 Annual Meeting of Shareholders (or ―the Proxy Statement‖) with the FDIC within 120 days of December 31, 2010. Information regarding directors of Summit State Bank will appear under the caption —Proposal 1: ―Election of Directors‖ in the Proxy Statement and is incorporated herein by reference. Information about Summit State Bank’s Audit Committee Financial Expert will appear under the caption ―The Committees of the Board—Audit Committee‖ and is incorporated herein by reference. The Bank has adopted a code of ethics applicable to all of our directors and employees, including the principal executive officer, principal financial officer and principal accounting officer. Information regarding section 16(a) filing requirements will appear under the caption ―section 16(a). ―BENEFICIAL OWNERSHIP REPORTING COMPLIANCE‖, in the Proxy Statement and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION Information regarding executive compensation will appear under the captions ―EXECUTIVE OFFICERS OF THE BANK,‖ ―EXECUTIVE COMPENSATION, EMPLOYMENT CONTRACTS‖ AND BOARD OF DIRECTS REPORT ON COMPENSATON,‖ in the Proxy Statement and is incorporated herein by reference. 86 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The following table summarizes information as of December 31, 2010 relating to equity compensation plans of Summit State Bank pursuant to which grants of options, restricted stock, or other rights to acquire shares may be granted from time to time. Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) Number of securities to be issued upon exercise of outstanding options Weighted average exercise price of outstanding options 30,666 107,500 $7.26 6.54 0 42,500 Plan category Equity compensation plans: Not approved by security holders Approved by security holders Information regarding security ownership of certain beneficial owners and management and related shareholder matters will appear under the caption ―EQUITY COMPENSATION PLAN INFORMATION,‖ ―SECURITY OWNERSHIP OF MANAGEMENT‖ AND ―PRINCIPAL SHAREHOLDERS‖ in the Proxy Statement and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE Information regarding certain relationships and related transactions will appear under the caption ―TRANSACTIONS WITH RELATED PERSONS‖ in the Proxy Statement and is incorporated herein by reference. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information regarding fees paid to our independent registered public accounting firm, will appear under the caption —Proposal 2. Ratification of Selection of Independent Public Accounts ―FEES PAID TO INDEPENDENT PUBLIC ACCOUNTANTS‖ in the Proxy Statement and is incorporated herein by reference. 87 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES (a) 1. Financial Statements The following documents are filed as part of this report: Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets at December 31, 2010 and 2009 Consolidated Statements of Income for each of the years in the three-year period ended December 31, 2010 Consolidated Statements of Changes in Shareholders’ Equity for each of the years in the three- year period ended December 31, 2010 Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2010 Notes to Consolidated Financial Statements 2. Financial Statement Schedules Not applicable 3. Exhibits (b) Exhibits Required by Item 601 of Regulation S-K Reference is made to the Exhibit Index on pages 91 through 92 for exhibits filed as part of this report. (c) Additional Financial Statements Not applicable. 88 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Summit State Bank By /s/ Dennis E. Kelley Dennis E. Kelley Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) March 22, 2011 Summit State Bank By /s/ Thomas M. Duryea Thomas M. Duryea President and Chief Executive Officer (Principal Executive Officer) March 22, 2011 89 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 in the capacities and on the dates indicated. Dated: March 22, 2011 Dated: March 22, 2011 Dated: March 22, 2011 Dated: March 22, 2011 Dated: March 22, 2011 Dated: March 22, 2011 Dated: March 22, 2011 Dated: March 22, 2011 Dated: March 22, 2011 Dated: March 22, 2011 Dated: March 22, 2011 Dated: March 22, 2011 |s| Thomas M. Duryea Thomas M. Duryea President, Chief Executive Officer (Principal Executive Officer) and Director |s| James E. Brush James E. Brush, Director |s| John F. DeMeo John F. DeMeo, Director |s| Michael J. Donovan Michael J. Donovan, Director |s| Richard A. Dorr Richard A. Dorr, Director |s| Todd R. Fry Todd R. Fry, Director |s| Allan J. Hemphill Allan J. Hemphill, Director |s| Dennis E. Kelley Dennis E. Kelley Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) |s| John C. Lewis John C. Lewis Chairman of the Board and Director |s| Ronald A. Metcalfe Ronald A. Metcalfe, Director |s| Marshall T. Reynolds Marshall T. Reynolds, Director |s| Nicholas J. Rado Nicholas J. Rado, Director Dated: March 22, 2011 |s| Eugene W. Traverso Eugene W. Traverso, Director 90 EXHIBIT NO. EXHIBIT INDEX EXHIBIT 3.1 3.2 3.3 4.1 4.2 4.3 10.1 10.2 10.3 14.1 21.1 31.1 31.2 32.1 99.1 Articles of Incorporation of the registrant (1) (2) (3) Certificate of determination of series a preferred stock (9) By-laws of the registrant Specimen of the registrant’s common stock certificate (1) (2) (3) The total amount of the registrant’s long-term debt does not exceed 10 percent of the total assets of the registrant and its subsidiaries on a consolidated basis. Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the registrant agrees to file any instrument with respect to such long-term debt upon request of the FDIC. Warrant for purchase of shares of common stock (9) 1999 Non-qualified Stock Option Plan, as amended by First Amendment dated September 25, 2002 (1) (2) (3) 2007 Stock Option Plan(6) Letter agreement dated December 19, 2008, between the Company and the United States Department of the Treasury, with respect to issuance of preferred stock and the warrant (8) Code of Ethics(7) Subsidiaries of the registrant (1) Rule 13a-14(a)/15d-14(a) Certification Rule 13a-14(a)/15d-14(a) Certification Section 1350 certifications Fiscal year certification under Troubled Asset Relief Program 91 1. Incorporated by reference from Summit State Bank’s Form 10 filed with the FDIC on June 19, 2006. 2. Incorporated by reference from Summit State Bank’s Form 10/A Amendment No. 1 filed with the FDIC on July 12, 2006. 3. Incorporated by reference from Summit State Bank’s Form 10/A Amendment No.2 filed with the FDIC on July 13, 2006. 4. Incorporated by reference from Summit State Bank’s Form 8-K filed with the FDIC on July 13, 2006. 5. Incorporated by reference from Summit State Bank’s Form 8-K filed with the FDIC on October 24, 2006. 6. 7ncorporated by reference from Summit State Bank’s Definitive Proxy Statement filed with the FDIC on April 27, 2007. 7. Incorporated by reference from Summit State Bank’s Form 10-K filed with the FDIC on March 28, 2007. 8. Incorporate by reference from Summit State Bank’s Form 8-K filed with the FDIC on December 23, 2008. 92 EXHIBIT 31.1 Certification pursuant to Rule 13a-14(a)/15d-14(a) as adopted pursuant to §302 of the Sarbanes-Oxley Act of 2002. I, Thomas M. Duryea, Chief Executive Officer, certify that: 1. I have reviewed this annual report on Form 10-K of Summit State Bank (the Registrant); 2. 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; 3. 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; 4. 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) 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; (b) 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; (c) 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 (d) 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 (or persons performing the equivalent functions): 93 (a) 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 (b) 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: 3/22/11 /s/ Thomas M. Duryea Thomas M. Duryea Chief Executive Officer 94 EXHIBIT 31.2 Certification pursuant to Rule 13a-14(a)/15d-14(a) as adopted pursuant to §302 of the Sarbanes-Oxley Act of 2002. I, Dennis E. Kelley, Chief Financial Officer, certify that: 1. I have reviewed this annual report on Form 10-K of Summit State Bank (the Registrant); 2. 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; 3. 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; 4. 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) 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; (b) 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; (c) 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 (d) 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 (or persons performing the equivalent functions): 95 (a) 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 (b) 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: 3/22/11 /s/ Dennis E. Kelley Dennis E. Kelley Chief Financial Officer 96 EXHIBIT 32.1 Certification pursuant to 18 U.S.C. §1350 In connection with the annual report on Form 10-K of Summit State Bank (the Registrant) for the year ended December 31, 2010, as filed with the Federal Deposit Insurance Corporation, the undersigned hereby certify pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that: 1) such Form 10-K fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2) 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: 3/22/11 Dated: 3/22/11 /s/ Thomas M. Duryea Thomas M. Duryea Chief Executive Officer /s/ Dennis E. Kelley Dennis E. Kelley Chief Financial Officer 97 

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