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Table of Contents

 
 
FORM 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2011
or
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 0-10140
CVB FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
     
California
(State or other jurisdiction of incorporation
or organization)
  95-3629339
(I.R.S. Employer Identification No.)
     
701 North Haven Ave, Suite 350, Ontario, California
(Address of Principal Executive Offices)
  91764
(Zip Code)
(Registrant’s telephone number, including area code) (909) 980-4030
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer, non-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 þ   Accelerated filer o   Non-accelerated filer o   Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
Number of shares of common stock of the registrant: 106,080,055 outstanding as of April 29, 2011.
 
 

 

 


 

CVB FINANCIAL CORP.
2011 QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
         
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 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT

 

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GENERAL
Forward Looking Statements
Certain statements in this Report on Form 10-Q, including, but not limited to, statements under the heading “Management Discussion and Analysis of Financial Condition and Results of Operations” constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995, including but not limited to, statements about anticipated future operating and financial performance, financial position and liquidity, business prospects, strategic alternatives, business strategies, regulatory and competitive outlook, capital and financing needs and availability, acquisition and divestiture opportunities, investment and expenditure plans, plans and objectives of management for future operations and other similar forecasts and statements of expectations of assumptions underlying any of the foregoing. Words such as “will likely result, “aims”, “anticipates”, “believes”, “could”, “estimates”, “expects”, “hopes”, “intends”, “may”, “plans”, “projects”, “seeks”, “should”, “will” and variations of these words and similar expressions are intended to identify these forward looking statements, which involve risks and uncertainties. Our actual results may differ significantly from the results discussed in such forward-looking statements. Factors that might cause such a difference include, but are not limited to, local, regional, national and international economic conditions and events and the impact they may have on us and our customers; ability to attract deposits and other sources of liquidity; oversupply of inventory and continued deterioration in values of California real estate, both residential and commercial; a prolonged slowdown in construction activity; changes in the financial performance and/or condition of our borrowers; changes in the level of non-performing assets and charge-offs; the effect of acquisitions we may make; the effect of changes in laws and regulations (including laws and regulations concerning financial reform, taxes, banking, securities, executive compensation and insurance) with which we and our subsidiaries must comply; changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements; inflation, interest rate, securities market and monetary fluctuations; political instability; acts of war or terrorism, or natural disasters, such as earthquakes, or the effects of pandemic flu; the timely development and acceptance of new banking products and services and perceived overall value of these products and services by users; changes in consumer spending, borrowing and savings habits; technological changes; the ability to increase market share and control expenses; changes in the competitive environment among financial and bank holding companies and other financial service providers; continued volatility in the credit and equity markets and its effect on the general economy; the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters; changes in our organization, management, compensation and benefit plans; the costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquiries, including, but not limited to, the current investigation by the Securities and Exchange Commission and the related class-action lawsuits filed against us, and the results of regulatory examinations or reviews. The Company cautions that the foregoing factors are not exclusive. For additional information concerning these factors and other factors which may cause actual results to differ from the results discussed in our forward-looking statements, see the periodic filings the Company makes with the Securities and Exchange Commission, and, in particular, the information set forth in Item 1A herein and in “Item 1A. Risk Factors” contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. The Company does not undertake, and specifically disclaims, any obligation to update any forward-looking statements to reflect the occurrence of events or circumstances after the date of such statements except as required by law.

 

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PART I — FINANCIAL INFORMATION (UNAUDITED)
ITEM 1. FINANCIAL STATEMENTS
CVB FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
Dollar amounts in thousands, except share data
                 
    March 31,     December 31,  
    2011     2010  
ASSETS
               
Cash and due from banks
  $ 348,773     $ 354,048  
Interest-bearing balances due from depository institutions
    50,287       50,227  
 
           
Total cash and cash equivalents
    399,060       404,275  
 
               
Interest-bearing balances due from depository institutions
    50,190       50,190  
Investment securities available-for-sale
    2,017,528       1,791,558  
Investment securities held-to-maturity
    3,039       3,143  
Investment in stock of Federal Home Loan Bank (FHLB)
    83,310       86,744  
 
               
Loans held-for-sale
    3,505       2,954  
 
               
Loans and lease finance receivables
    3,598,447       3,747,740  
Allowance for credit losses
    (101,067 )     (105,259 )
 
           
Net Loans and lease finance receivables
    3,497,380       3,642,481  
 
           
 
               
Premises and equipment, net
    39,431       40,921  
Bank owned life insurance
    113,605       112,901  
Accrued interest receivable
    23,263       23,647  
Intangibles
    8,128       9,029  
Goodwill
    55,097       55,097  
FDIC loss sharing asset
    81,133       101,461  
Deferred tax asset
    60,998       52,559  
Other assets
    62,685       59,731  
 
           
TOTAL ASSETS
  $ 6,498,352     $ 6,436,691  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Liabilities:
               
Deposits:
               
Noninterest-bearing
  $ 1,817,951     $ 1,701,523  
Interest-bearing
    2,667,738       2,817,305  
 
           
Total deposits
    4,485,689       4,518,828  
Demand Note to U.S. Treasury
    2,966       1,917  
Customer repurchase agreements
    578,009       542,188  
Borrowings
    553,458       553,390  
Accrued interest payable
    4,626       4,985  
Deferred compensation
    9,212       9,221  
Junior subordinated debentures
    115,055       115,055  
Other liabilities
    94,733       47,252  
 
           
TOTAL LIABILITIES
    5,843,748       5,792,836  
 
           
 
               
COMMITMENTS AND CONTINGENCIES
               
 
               
Stockholders’ Equity:
               
Preferred stock, authorized, 20,000,000 shares without par; none issued or outstanding
           
Common stock, authorized, 225,000,000 shares without par; issued and outstanding 106,078,253 (2011) and 106,075,576 (2010)
    490,837       490,226  
Retained earnings
    155,027       147,444  
Accumulated other comprehensive income, net of tax
    8,740       6,185  
 
           
Total stockholders’ equity
    654,604       643,855  
 
           
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 6,498,352     $ 6,436,691  
 
           
See accompanying notes to the consolidated financial statements

 

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CVB FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(unaudited)
Dollar amounts in thousands, except per share
                 
    For the Three Months  
    Ended March 31,  
    2011     2010  
Interest income:
               
Loans, including fees
  $ 51,315     $ 67,768  
Investment securities:
               
Taxable
    8,839       16,084  
Tax-preferred
    5,919       6,532  
 
           
Total investment income
    14,758       22,616  
Dividends from FHLB stock
    65       66  
Federal funds sold and Interest bearing deposits with other institutions
    374       102  
 
           
Total interest income
    66,512       90,552  
Interest expense:
               
Deposits
    2,788       5,288  
Borrowings
    5,796       11,120  
Junior subordinated debentures
    819       805  
 
           
Total interest expense
    9,403       17,213  
 
           
Net interest income before provision for credit losses
    57,109       73,339  
Provision for credit losses
    7,068       12,200  
 
           
Net interest income after provision for credit losses
    50,041       61,139  
 
           
Other operating income:
               
Impairment loss on investment securities
          (98 )
Plus: Reclassification of credit-related impairment loss from other comprehensive income
          (587 )
 
           
Net impairment loss on investment securities recognized in earnings
          (685 )
Service charges on deposit accounts
    3,723       4,264  
Trust and Investment Services
    2,152       2,118  
Bankcard services
    708       640  
BOLI income
    707       845  
Increase (reduction) in FDIC loss sharing asset
    1,415       (10,583 )
Other
    1,273       1,190  
 
           
Total other operating income (expense)
    9,978       (2,211 )
 
           
Other operating expenses:
               
Salaries and employee benefits
    17,660       18,073  
Occupancy and Equipment
    4,321       5,052  
Professional services
    3,610       2,807  
Amortization of intangibles
    901       950  
Other
    9,813       9,040  
 
           
Total other operating expenses
    36,305       35,922  
 
           
Earnings before income taxes
    23,714       23,006  
Income taxes
    7,114       6,887  
 
           
Net earnings
  $ 16,600     $ 16,119  
Earnings allocated to restricted stock
    66       54  
 
           
Net earnings allocated to common shareholders
  $ 16,534     $ 16,065  
 
           
 
               
Comprehensive income
  $ 19,155     $ 22,853  
 
           
 
               
Basic earnings per common share
  $ 0.16     $ 0.15  
 
           
Diluted earnings per common share
  $ 0.16     $ 0.15  
 
           
 
               
Cash dividends per common share
  $ 0.085     $ 0.085  
 
           
See accompanying notes to the consolidated financial statements

 

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CVB FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME
(Unaudited)
Amounts and shares in thousands
                                                 
                            Accumulated              
    Common                     Other              
    Shares     Common     Retained     Comprehensive     Comprehensive        
    Outstanding     Stock     Earnings     Income     Income     Total  
 
 
Balance January 1, 2011
    106,076     $ 490,226     $ 147,444     $ 6,185             $ 643,855  
Proceeds from exercise of stock options
    2       19                               19  
Tax benefit from exercise of stock options
            2                               2  
Stock-based Compensation Expense
            590                               590  
Cash dividends declared
                                               
Common ($0.085 per share)
                    (9,017 )                     (9,017 )
Comprehensive income:
                                               
Net earnings
                    16,600             $ 16,600       16,600  
Other comprehensive gain:
                                               
Unrealized gain on securities available-for-sale, net
                            2,555       2,555       2,555  
 
                                             
Comprehensive income
                                  $ 19,155          
 
                                   
Balance March 31, 2011
    106,078     $ 490,837     $ 155,027     $ 8,740             $ 654,604  
 
                                     
 
                                               
Balance January 1, 2010
    106,263     $ 491,226     $ 120,612     $ 26,390             $ 638,228  
Proceeds from exercise of stock options
    30       152                               152  
Tax benefit from exercise of stock options
            35                               35  
Stock-based Compensation Expense
            532                               532  
Cash dividends declared
                                               
Common ($0.085 per share)
                    (9,035 )                     (9,035 )
Comprehensive income:
                                               
Net earnings
                    16,119             $ 16,119       16,119  
Other comprehensive gain:
                                               
Unrealized gain on securities available-for-sale, net
                            6,394       6,394       6,394  
Portion of impairment loss on investment securities reclassified in the current year, net
                            340       340       340  
 
                                             
Comprehensive income
                                  $ 22,853          
 
                                   
Balance March 31, 2010
    106,293     $ 491,945     $ 127,696     $ 33,124             $ 652,765  
 
                                     
                 
    At March 31,  
    2011     2010  
 
 
Disclosure of reclassification amount
               
Unrealized gain on securities arising during the period
  $ 4,291     $ 11,610  
Tax benefit
    (1,736 )     (4,876 )
 
           
Net unrealized gain on securities
  $ 2,555     $ 6,734  
 
           
See accompanying notes to the consolidated financial statements

 

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CVB FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Dollar amounts in thousands
                 
    For the Three Months  
    Ended March 31,  
    2011     2010  
CASH FLOWS FROM OPERATING ACTIVITIES:
               
Interest and dividends received
  $ 67,948     $ 78,809  
Service charges and other fees received
    8,446       8,177  
Interest paid
    (9,695 )     (17,736 )
Cash paid to vendors and employees
    (33,942 )     (27,384 )
Income taxes paid
    (27,000 )      
 
           
Net cash provided by operating activities
    5,757       41,866  
 
           
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Proceeds from repayment of investment securities
    86,684       72,514  
Proceeds from redemption of FHLB stock
    3,434        
Proceeds from maturity of investment securities
    25,055       30,845  
Purchases of investment securities
    (280,623 )     (57,854 )
Net decrease in loans and lease finance receivables
    136,380       116,375  
Proceeds from sales of premises and equipment
    147       12  
Proceeds from sales of other real estate owned
    1,789       1,874  
Proceeds from FDIC shared-loss agreements
    21,734        
Purchase of premises and equipment
    (309 )     (1,734 )
Other, net
    (1 )     (10 )
 
           
Net cash (used in) provided by investing activities
    (5,710 )     162,022  
 
           
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net increase in transaction deposits
    95,328       50,129  
Net (decrease)/increase in time deposits
    (128,464 )     29,930  
Repayment of advances from Federal Home Loan Bank
          (100,000 )
Net increase in other borrowings
    1,049       1,807  
Net increase in customer repurchase agreements
    35,821       50,082  
Cash dividends on common stock
    (9,017 )     (9,035 )
Proceeds from exercise of stock options
    19       152  
Tax benefit related to exercise of stock options
    2       35  
 
           
Net cash (used in) provided by financing activities
    (5,262 )     23,100  
 
           
 
               
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
    (5,215 )     226,988  
CASH AND CASH EQUIVALENTS, beginning of period
    404,275       104,480  
 
           
CASH AND CASH EQUIVALENTS, end of period
  $ 399,060     $ 331,468  
 
           
See accompanying notes to the consolidated financial statements

 

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CVB FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(unaudited)
Dollar amounts in thousands
                 
    For the Three Months  
    Ended March 31,  
    2011     2010  
RECONCILIATION OF NET EARNINGS TO NET CASH PROVIDED BY OPERATING ACTIVITIES:
               
Net earnings
  $ 16,600     $ 16,119  
Adjustments to reconcile net earnings to net cash provided by operating activities:
               
(Gain) loss on sales of premises and equipment
    (7 )     9  
(Gain) on sale of other real estate owned
    (74 )     (185 )
Increase from bank owned life insurance
    (707 )     (845 )
Net amortization of premiums on investment securities
    3,212       998  
Accretion of SJB Discount
    (1,951 )     (13,378 )
Provisions for credit losses
    7,068       12,200  
Provisions for revaluation of other real estate owned
    820        
(Increase)/decrease in FDIC Loss Sharing Asset
    (1,415 )     10,583  
Stock-based compensation
    590       532  
Depreciation and amortization
    2,560       2,588  
Change in accrued interest receivable
    384       1,250  
Change in accrued interest payable
    (359 )     (475 )
Change in other assets and liabilities
    (20,964 )     12,470  
 
           
Total adjustments
    (10,843 )     25,747  
 
           
NET CASH PROVIDED BY OPERATING ACTIVITIES
  $ 5,757     $ 41,866  
 
           
 
               
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES
               
Securities purchased and not settled
  $ 55,791     $  
Transfer from loans to other real estate owned
  $ 3,669     $ 17,397  
See accompanying notes to the consolidated financial statements

 

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CVB FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
For the three months ended March 31, 2011 and 2010
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying condensed consolidated unaudited financial statements and notes thereto have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission for Form 10-Q and conform to practices within the banking industry and include all of the information and disclosures required by accounting principles generally accepted in the United States of America for interim financial reporting. The results of operations for the three months ended March 31, 2011 are not necessarily indicative of the results for the full year. These financial statements should be read in conjunction with the financial statements, accounting policies and financial notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010 filed with the Securities and Exchange Commission. In the opinion of management, the accompanying condensed consolidated unaudited financial statements reflect all adjustments (consisting only of normal recurring adjustments), which are necessary for a fair presentation of financial results for the interim periods presented. A summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows.
Principles of Consolidation — The consolidated financial statements include the accounts of CVB Financial Corp. (the “Company”) and its wholly owned subsidiary: Citizens Business Bank (the “Bank”) after elimination of all intercompany transactions and balances. The Company also has three inactive subsidiaries: CVB Ventures, Inc.; Chino Valley Bancorp; and ONB Bancorp. The Company is also the common stockholder of CVB Statutory Trust I, CVB Statutory Trust II, CVB Statutory Trust III and FCB Trust II. CVB Statutory Trusts I and II were created in December 2003 and CVB Statutory Trust III was created in January 2006 to issue trust preferred securities in order to raise capital for the Company. The Company acquired FCB Trust II through the acquisition of First Coastal Bancshares (“FCB”). These trusts do not meet the criteria for consolidation.
Nature of Operations — The Company’s primary operations are related to traditional banking activities, including the acceptance of deposits and the lending and investing of money through the operations of the Bank. The Bank also provides automobile and equipment leasing to customers through its Citizens Financial Services Group and trust and investment-related services to customers through its CitizensTrust Division. The Bank’s customers consist primarily of small to mid-sized businesses and individuals located in San Bernardino County, Riverside County, Orange County, Los Angeles County, Madera County, Fresno County, Tulare County, Kern County and San Joaquin County. The Bank operates 43 Business Financial Centers, five Commercial Banking Centers, and three wealth management offices with its headquarters located in the city of Ontario.
The Company’s operating business units have been divided into two main segments: (i) Business Financial and Commercial Banking Centers and (ii) Treasury. Business Financial and Commercial Banking Centers (branches) are comprised of loans, deposits, and products and services the Bank offers to the majority of its customers. The other segment is Treasury, which manages the investment portfolio of the Company. The Company’s remaining centralized functions and eliminations of inter-segment amounts have been aggregated and included in “Other.”
The internal reporting of the Company considers all business units. Funds are allocated to each business unit based on its need to fund assets (use of funds) or its need to invest funds (source of funds). Net income is determined based on the actual net income of the business unit plus the allocated income or expense based on the sources and uses of funds for each business unit. Non-interest income and non-interest expense are those items directly attributable to a business unit.

 

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Cash and due from banks — Cash on hand, cash items in the process of collection, and amounts due from correspondent banks, the Federal Reserve Bank and interest-bearing balances due from depository institutions, with initial terms of ninety days or less, are included in Cash and due from banks.
Investment Securities — The Company classifies as held-to-maturity those debt securities that the Company has the positive intent and ability to hold to maturity. Securities classified as trading are those securities that are bought and held principally for the purpose of selling them in the near term. All other debt and equity securities are classified as available-for-sale. Securities held-to-maturity are accounted for at cost and adjusted for amortization of premiums and accretion of discounts. Trading securities are accounted for at fair value with the unrealized gains and losses being included in current earnings. Available-for-sale securities are accounted for at fair value, with the net unrealized gains and losses, net of income tax effects, presented as a separate component of stockholders’ equity. Realized gains and losses on sales of securities are recognized in earnings at the time of sale and are determined on a specific-identification basis. Purchase premiums and discounts are recognized in interest income using the effective-yield method over the terms of the securities. For mortgage-backed securities (“MBS”), the amortization or accretion is based on estimated average lives of the securities. The lives of these securities can fluctuate based on the amount of prepayments received on the underlying collateral of the securities. The Company’s investment in Federal Home Loan Bank (“FHLB”) stock is carried at cost.
At each reporting date, securities are assessed to determine whether there is an other-than-temporary impairment. Other-than-temporary impairment on investment securities is recognized in earnings when there are credit losses on a debt security for which management does not intend to sell and for which it is more-likely-than-not that the Company will not have to sell prior to recovery of the noncredit impairment. In those situations, the portion of the total impairment that is attributable to the credit loss would be recognized in earnings, and the remaining difference between the debt security’s amortized cost and its fair value would be included in other comprehensive income.
Loans and Lease Finance Receivables - Loans and lease finance receivables are reported at the principal amount outstanding, less deferred net loan origination fees. Interest on loans and lease finance receivables is credited to income based on the principal amount outstanding. Interest income is not recognized on loans and lease finance receivables when collection of interest is deemed by management to be doubtful. In the ordinary course of business, the Company enters into commitments to extend credit to its customers. These commitments are not reflected in the accompanying consolidated financial statements. As of March 31, 2011, the Company had entered into commitments with certain customers amounting to $595.8 million compared to $570.1 million at December 31, 2010. Letters of Credit at March 31, 2011 and December 31, 2010, were $68.3 million and $70.4 million, respectively.
The Bank receives collateral to support loans, lease finance receivables, and commitments to extend credit for which collateral is deemed necessary. The most significant categories of collateral are real estate, principally commercial and industrial income-producing properties, real estate mortgages, and assets utilized in dairy, livestock and agribusiness.
Nonrefundable fees and direct costs associated with the origination or purchase of loans are deferred and netted against outstanding loan balances. The deferred net loan fees and costs are recognized in interest income over the loan term using the effective-yield method.
Acquired loans for which there is deterioration in credit quality between origination and acquisition of the loans and the bank does not expect to collect all amounts due according to the loan’s contractual terms are accounted for individually or in pools of loans based on common risk characteristics. These loans are within the scope of accounting guidance for loans acquired with deteriorated credit quality. The excess of the loan’s or pool’s scheduled contractual principal and interest payments over all cash flows expected at acquisition is the nonaccretable difference. The remaining amount, representing the excess of the loan’s cash flows expected to be collected over the fair value is the accretable yield (accreted into interest income over the remaining life of the loan or pool). The Bank has also elected to account for acquired loans not within the scope of accounting guidance using this same methodology.

 

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Throughout this document, we have separated the discussion of asset quality into two sections: non-covered loans and covered loans. The non-covered loans represent the legacy Citizens Business Bank loans and exclude all loans acquired in the San Joaquin Bank (“SJB”) acquisition. The SJB loans are “covered” loans as defined in the loss sharing agreement with the FDIC.
Provision and Allowance for Credit Losses - The determination of the balance in the allowance for credit losses is based on an analysis of the loan and lease finance receivables portfolio using a systematic methodology and reflects an amount that, in management’s judgment, is adequate to provide for probable credit losses inherent in the portfolio, after giving consideration to the character of the loan portfolio, current economic conditions, past credit loss experience, and such other factors that would deserve current recognition in estimating inherent credit losses. The estimate is reviewed quarterly by the Board of Directors and management and periodically by various regulatory entities and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. The provision for credit losses is charged to expense. During the first three months of 2011, we recorded a provision for credit losses of $7.1 million. The allowance for credit losses was $101.1 million as of March 31, 2011, or 3.11% of total non-covered loans and leases.
In addition to the allowance for credit losses, the Company also has a reserve for undisbursed commitments for loans and letters of credit. This reserve is carried in the liabilities section of the balance sheet in other liabilities. Provisions to this reserve are included in other expense. For the first three months of 2011, the Company recorded an increase of $732,000 in the reserve for undisbursed commitments. As of March 31, 2011, the balance in this reserve was $11.2 million.
A loan for which collection of principal and interest according to its original terms is not probable is considered to be impaired. The Company’s policy is to record a specific valuation allowance, which is included in the allowance for credit losses, or charge off that portion of an impaired loan that exceeds its fair value less selling costs. Fair value is usually based on the value of underlying collateral.
At March 31, 2011, the Company had non-covered impaired loans of $120.1 million. Of this amount, $4.0 million consisted of non-accrual residential construction and land loans, $40.0 million in non-accrual commercial construction loans, $18.4 million of non-accrual single family mortgage loans, $35.0 million of non-accrual commercial real estate loans, $7.5 million of non-accrual commercial and industrial loans, $3.0 million in dairy and livestock loans, and $260,000 of non-accrual consumer loans. Non-covered impaired loans also include $38.4 million of loans whose terms were modified in a troubled debt restructure, of which $26.5 million are classified as non-accrual. The remaining balance of $11.9 million consists of nine loans performing according to the restructured terms. These loans had specific reserves of $1.3 million at March 31, 2011. At December 31, 2010, the Bank had classified as impaired, non-covered loans with a balance of $170.3 million.
Premises and Equipment - Premises and equipment are stated at cost, less accumulated depreciation, which is provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives using the straight-line method. Properties under capital lease and leasehold improvements are amortized over the shorter of estimated economic lives of 15 years or the initial terms of the leases. Estimated lives are 3 to 5 years for computer equipment, 5 to 7 years for furniture, fixtures and equipment, and 15 to 40 years for buildings and improvements. Long-lived assets are reviewed periodically for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. The existence of impairment is based on undiscounted cash flows. To the extent impairment exists, the impairment is calculated as the difference in fair value of assets and their carrying value. The impairment loss, if any, would be recorded in noninterest expense.

 

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FDIC Loss Sharing Asset The FDIC loss sharing asset was initially recorded at fair value which represents the present value of the estimated cash payments from the FDIC for future losses on covered loans. The ultimate collectability of this asset is dependent upon the performance of the underlying covered loans, the passage of time and claims paid by the FDIC.
Other Real Estate Owned — Other real estate owned (“OREO”) represents real estate acquired through foreclosure in satisfaction of commercial and real estate loans and is stated at fair value, minus estimated costs to sell (fair value at time of foreclosure). Loan balances in excess of fair value of the real estate acquired at the date of acquisition are charged against the allowance for credit losses. Any subsequent operating expenses or income, reduction in estimated values, and gains or losses on disposition of such properties are charged to current operations. OREO is recorded in other assets on the consolidated balance sheets.
Business Combinations and Intangible Assets — The Company has engaged in the acquisition of financial institutions and the assumption of deposits and purchase of assets from other financial institutions in its market area. The Company has paid premiums on certain transactions, and such premiums are recorded as intangible assets, in the form of goodwill or other intangible assets. Goodwill is not being amortized whereas identifiable intangible assets with finite lives are amortized over their useful lives. On an annual basis, the Company tests goodwill and intangible assets for impairment.
At March 31, 2011 goodwill was $55.1 million. As of March 31, 2011, intangible assets that continue to be subject to amortization include core deposit premiums of $8.1 million (net of $23.9 million of accumulated amortization). Amortization expense for such intangible assets was $901,000 for the three months ended March 31, 2011. Estimated amortization expense, for the remainder of 2011 is expected to be $2.6 million. Estimated amortization expense, for the succeeding years is $2.2 million for 2012, $1.1 million for 2013, $475,000 for 2014, $437,000 for 2015 and $1.3 million thereafter. The weighted average remaining life of intangible assets is approximately 2.2 years.
Bank Owned Life Insurance — The Bank invests in Bank-Owned Life Insurance (“BOLI”). BOLI involves the purchasing of life insurance by the Bank on a select group of employees. The Bank is the owner and beneficiary of these policies. BOLI is recorded as an asset at cash surrender value. Increases in the cash value of these policies, as well as insurance proceeds received, are recorded in other non-interest income and are not subject to income tax.
Income Taxes — Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Future realization of deferred tax assets ultimately depends on the existence of sufficient taxable income of the appropriate character (for example, ordinary income or capital gain) within the carryback or carryforward periods available under the tax law. Based on historical and future expected taxable earnings and available strategies, the Company considers the future realization of these deferred tax assets more likely than not.
The tax effects from an uncertain tax position are recognized in the financial statements only if, based on its merits, the position is more likely than not to be sustained on audit by the taxing authorities. Interest and penalties related to uncertain tax positions are recorded as part of other operating expense.

 

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Earnings per Common Share — The Company calculates earnings per common share (“EPS”) using the two-class method. The two-class method requires the Company to present EPS as if all of the earnings for the period are distributed to common shareholders and any participating securities, regardless of whether any actual dividends or distributions are made. All outstanding unvested share-based payment awards that contain rights to non-forfeitable dividends are considered participating securities. The Company grants restricted shares under the 2008 Equity Incentive Plan that qualify as participating securities. Restricted shares issued under this plan are entitled to dividends at the same rate as common stock.
Basic earnings per common share are computed by dividing income allocated to common stockholders by the weighted-average number of common shares outstanding during each period. The computation of diluted earnings per common share considers the number of tax-effected shares issuable upon the assumed exercise of outstanding common stock options. Share and per share amounts have been retroactively restated to give effect to all stock dividends and splits. The number of shares outstanding at March 31, 2011 was 106,078,253. The tables below presents the reconciliation of earnings per share for the periods indicated.
Earnings Per Share Reconciliation
(Dollars and shares in thousands, except per share amounts)
                 
    For the three months ended  
    March 31,  
    2011     2010  
Earnings per common share
               
Net earnings
  $ 16,600     $ 16,119  
Less: Dividends on preferred stock and discount amortization
           
 
           
Net earnings available to common shareholders
  $ 16,600     $ 16,119  
 
           
Less: Net earnings allocated to restricted stock
    66       54  
 
           
Net earnings allocated to common shareholders (numerator)
  $ 16,534     $ 16,065  
 
           
 
               
Weighted Average Shares Outstanding (denominator)
    105,651       105,929  
Earnings per common share
  $ 0.16     $ 0.15  
 
           
 
               
Diluted earnings per common share
               
Net income allocated to common shareholders (numerator)
  $ 16,534     $ 16,065  
 
           
Weighted Average Shares Outstanding
    105,651       105,929  
Incremental shares from assumed exercise of outstanding options
    53       192  
 
           
Diluted Weighted Average Shares Outstanding (denominator)
    105,704       106,121  
Diluted earnings per common share
  $ 0.16     $ 0.15  
 
           
Stock-Based Compensation — At March 31, 2011, the Company has three stock-based employee compensation plans, which are described more fully in Note 17 in the Company’s Annual Report on Form 10-K. The Company accounts for stock compensation using the “modified prospective” method. Under this method, awards that are granted, modified, or settled after December 31, 2005, are fair valued as of grant date and compensation costs recognized over the vesting period on a straight-lined basis. Also under this method, unvested stock awards as of January 1, 2006 are recognized over the remaining service period with no change in historical reported earnings.
Derivative Financial Instruments — All derivative instruments, including certain derivative instruments embedded in other contracts, are recognized on the consolidated balance sheet at fair value. For derivatives designated as fair value hedges, changes in the fair value of the derivative and the hedged item related to the hedged risk are recognized in earnings. Changes in fair value of derivatives designated and accounted for as cash flow hedges, to the extent they are effective as hedges, are recorded in “Other Comprehensive Income,” net of deferred taxes and are subsequently reclassified to earnings when the hedged transaction affects earnings. Any hedge ineffectiveness would be recognized in the income statement line item pertaining to the hedged item.

 

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Statement of Cash Flows — Cash and cash equivalents as reported in the statements of cash flows include cash and due from banks. Cash flows from loans and deposits are reported net.
CitizensTrust — This division provides trust, investment and brokerage related services, as well as financial, estate and business succession planning services. CitizensTrust services its clients through three offices in Southern California: Pasadena, Ontario, and Irvine. CitizensTrust has approximately $2.2 billion in assets under administration, including $1.2 billion in assets under management. The amount of these funds and the related liability have not been recorded in the accompanying consolidated balance sheets because they are not assets or liabilities of the Bank or Company, with the exception of any funds held on deposit with the Bank.
Use of Estimates in the Preparation of Financial Statements — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for credit losses. Other significant estimates which may be subject to change include fair value determininations and disclosures, impairment of investments, goodwill, loans, determining the amount and the realization of the FDIC loss sharing asset, and valuation of deferred tax assets, other intangibles and OREO.
Other Contingencies — In the ordinary course of business, the Company becomes involved in litigation. Based upon the Company’s internal records and discussions with legal counsel, the Company records reserves for estimates of the probable outcome of all cases brought against them. Except as discussed in Part II — Other Information Item 1, “Legal Proceedings,” at March 31, 2011 the Company does not have any litigation reserves and is not aware of any material pending legal action or complaints asserted against the Company.
Recent Accounting Pronouncements — In April, 2011 the FASB issued ASU 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The update provides additional guidance for creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. The provisions of this standard are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to restructurings occurring on or after January 1, 2011. The Company is currently assessing the impact of this guidance on its financial statements.

 

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2. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities are shown below. The majority of securities held are publicly traded, and the estimated fair values were obtained from an independent pricing service based upon market quotes.
                                         
    March 31, 2011  
            Gross     Gross                
            Unrealized     Unrealized                
    Amortized     Holding     Holding             Total  
    Cost     Gain     Loss     Fair Value     Percent  
    (Amounts in thousands)  
Investment Securities Available-for-Sale:
                                       
Government agency & government-sponsored enterprises
  $ 86,297     $ 77     $ (404 )   $ 85,970       4.26 %
Mortgage-backed securities
    887,201       12,140       (6,846 )     892,495       44.24 %
CMO’s / REMIC’s
    415,831       4,458       (1,402 )     418,887       20.76 %
Municipal bonds
    612,843       13,309       (5,976 )     620,176       30.74 %
 
                             
Total Investment Securities
  $ 2,002,172     $ 29,984     $ (14,628 )   $ 2,017,528       100.00 %
 
                             
                                         
    December 31, 2010  
            Gross     Gross                
            Unrealized     Unrealized                
    Amortized     Holding     Holding             Total  
    Cost     Gain     Loss     Fair Value     Percent  
    (Amounts in thousands)  
Investment Securities Available-for-Sale:
                                       
Government agency & government-sponsored enterprises
  $ 106,368     $ 119     $ (214 )   $ 106,273       5.93 %
Mortgage-backed securities
    801,370       13,405       (6,366 )     808,409       45.12 %
CMO’s / REMIC’s
    267,556       4,300       (1,379 )     270,477       15.10 %
Municipal bonds
    605,199       10,943       (9,743 )     606,399       33.85 %
 
                             
Total Investment Securities
  $ 1,780,493     $ 28,767     $ (17,702 )   $ 1,791,558       100.00 %
 
                             
Approximately 69% of the available-for-sale portfolio, at March 31, 2011, represents securities issued by the U.S government or U.S. government-sponsored enterprises, which guarantee payment of principal and interest.
The remaining CMO/REMICs are backed by agency-pooled collateral or whole loan collateral. All non-agency available-for-sale CMO/REMIC issues held are rated investment grade or better by either Standard & Poor’s or Moody’s, as of March 31, 2011 and December 31, 2010.

 

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Composition of the Fair Value and Gross Unrealized of Securities:
                                                 
    March 31, 2011  
    Less than 12 months     12 months or longer     Total  
            Gross             Gross             Gross  
            Unrealized             Unrealized             Unrealized  
            Holding             Holding             Holding  
Description of Securities   Fair Value     Losses     Fair Value     Losses     Fair Value     Losses  
    (amounts in thousands)  
 
                                               
Held-To-Maturity
                                               
CMO
  $     $     $ 3,039     $ 288     $ 3,039     $ 288  
 
                                   
Available-for-Sale
                                               
Government agency
  $ 79,440     $ 404     $     $     $ 79,440     $ 404  
Mortgage-backed securities
    453,643       6,846                   453,643       6,846  
CMO/REMICs
    162,094       1,402                   162,094       1,402  
Municipal bonds
    168,299       5,088       5,599       888       173,898       5,976  
 
                                   
 
  $ 863,476     $ 13,740     $ 5,599     $ 888     $ 869,075     $ 14,628  
 
                                   
                                                 
    December 31, 2010  
    Less than 12 months     12 months or longer     Total  
            Gross             Gross             Gross  
            Unrealized             Unrealized             Unrealized  
            Holding             Holding             Holding  
Description of Securities   Fair Value     Losses     Fair Value     Losses     Fair Value     Losses  
    (amounts in thousands)  
 
                                               
Held-To-Maturity
                                               
CMO (1)
  $     $     $ 3,143     $ 401     $ 3,143     $ 401  
 
                                   
Available-for-Sale
                                               
Government agency
  $ 79,635     $ 214     $     $     $ 79,635     $ 214  
Mortgage-backed securities
    449,806       6,366                   449,806       6,366  
CMO/REMICs
    144,234       1,379                   144,234       1,379  
Municipal bonds
    225,928       8,844       5,585       899       231,513       9,743  
 
                                   
 
  $ 899,603     $ 16,803     $ 5,585     $ 899     $ 905,188     $ 17,702  
 
                                   
     
(1)  
For 2010, the Company recorded a $587,000 charge, on a pre-tax basis, of the non-credit portion of OTTI for this security in other comprehensive income, which is included as gross unrealized losses.
The tables above show the Company’s investment securities’ gross unrealized losses and fair value by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2011 and December 31, 2010. The Company has reviewed individual securities to determine whether a decline in fair value below the amortized cost is other-than-temporary.
The following summarizes our analysis of these securities and the unrealized losses. This assessment was based on the following factors: i) the length of the time and the extent to which the fair value has been less than amortized cost; ii) adverse condition specifically related to the security, an industry, or a geographic area and whether or not the Company expects to recover the entire amortized cost, iii) historical and implied volatility of the fair value of the security; iv) the payment structure of the security and the likelihood of the issuer being able to make payments in the future; v) failure of the issuer of the security to make scheduled interest or principal payments, vi) any changes to the rating of the security by a rating agency, and vii) recoveries or additional declines in fair value subsequent to the balance sheet date.
CMO Held-to-Maturity — We have one investment security classified as held-to-maturity. This security was issued by Countrywide Financial and is collateralized by Alt-A mortgages. The mortgages are primarily fixed-rate, 30-year loans, originated in early 2006 with average FICO scores of 715 and an average LTV of 71% at origination. The security was a senior security in the securitization, was rated AAA at origination and was supported by subordinate securities. This security is classified as held-to-maturity as we have both the intent and ability to hold this debt security to maturity as the amount of the security, $3.0 million, is not significant to our liquidity needs. We acquired this security in February 2008 at a price of 98.25%. The significant decline in the fair value of the security first appeared in August 2008 as the current financial crisis in the markets occurred and the market for securities collateralized by Alt-A mortgages diminished.

 

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As of March 31, 2011, the unrealized loss on this security was $288,000 and the fair value on the security was 66% of the current par value. The security is rated non-investment grade. We evaluated the security for an other-than-temporary decline in fair value as of March 31, 2011. We assess for credit impairment using a cash flow model. The key assumptions include default rates, severities and prepayment rates. This security was determined to have additional credit impairment during the first quarter 2010 due to continued degradation in expected cash flows primarily due to higher loss forecasts. We determined the amount of the credit impairment by discounting the expected future cash flows of the underlying collateral. We recognized no other-than-temporary impairment loss in the first quarter of 2011 and $685,000 in the first quarter of 2010.
The following table provides a roll-forward of credit-related other-than-temporary impairment recognized in earnings for the three months ended March 31, 2011.
         
    For the three months  
    ended  
    March 31, 2011  
    (in thousands)  
Balance, beginning of the period
  $ 1,227  
Addition of OTTI that was not previously recognized
     
Reduction for securities sold during the period
     
 
       
Reduction for securities with OTTI recognized in earnings because the security might be sold before recovery of its amortized cost basis
     
 
       
Addition of OTTI that was previously recognized because the security might not be sold before recovery of its amortized cost basis
     
Reduction for increases in cash flows expected to be collected that are recognized over the remaining life of the security
     
 
     
Balance, end of the period
  $ 1,227  
 
     
Government Agency — The government agency bonds are backed by the full faith and credit of Agencies of the U.S. Government. These securities are bullet securities, that is, they have a defined maturity date on which the principal is paid. The contractual term of these investments provides that the Bank will receive the face value of the bond at maturity which will equal the amortized cost of the bond. Interest is received throughout the life of the security. There was no loss greater than 12 months on these securities at March 31, 2011.
Mortgaged-Backed Securities and CMO/REMICs — Almost all of the available-for-sale mortgage-backed and CMO/REMICs securities are issued by the government-sponsored enterprises such as Ginnie Mae, Fannie Mae and Freddie Mac. These securities are collateralized or backed by the underlying residential mortgages. All available-for-sale mortgage-backed securities are rated investment grade with a weighted average life of approximately 3.5 years. The contractual cash flows of 99.33% of these investments are guaranteed by U.S. government-sponsored agencies. The remaining 0.67% are issued by banks. Accordingly, it is expected the securities would not be settled at a price less than the amortized cost of the bonds. There was no loss greater than 12 months on these securities at March 31, 2011.
Municipal Bonds — Ninety-eight percent of our $620.2 million municipal bond portfolio contains securities which have an underlying rating of investment grade. The majority of our municipal bonds are insured by the largest bond insurance companies with an average remaining maturity of approximately 10.12 years. The unrealized loss greater than 12 months on these securities at March 31, 2011 was $888,000. The Bank diversifies its holdings by owning selections of securities from different issuers and by holding securities from geographically diversified municipal issuers, thus reducing the Bank’s exposure to any single adverse event. Because we believe the decline in fair value is attributable to the changes in interest rates and not credit quality and because the Bank does not intend to sell the investments and it is more likely than not that the Bank will not be required to sell the investments before recovery of their amortized costs, which may be at maturity, management does not consider these investments to be other-than-temporarily impaired at March 31, 2011.

 

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We are continually monitoring the quality of our municipal bond portfolio in light of the current financial problems exhibited by certain monoline insurance companies. Many of the securities that would not be rated without insurance are pre-refunded and/or are general obligation bonds. Based on our monitoring of the municipal marketplace, to our knowledge, none of the municipalities are exhibiting financial problems that would lead us to believe there is a loss in any given security.
At March 31, 2011 and December 31, 2010, investment securities having an amortized cost of approximately $1.88 billion and $1.74 billion respectively, were pledged to secure public deposits, short and long-term borrowings, and for other purposes as required or permitted by law.
The amortized cost and fair value of debt securities at March 31, 2011, by contractual maturity, are shown below. Although mortgage-backed securities and CMO/REMICs have contractual maturities through 2029, expected maturities will differ from contractual maturities because borrowers may have the right to prepay such obligations without penalty. Mortgage-backed securities and CMO/REMICs are included in maturity categories based upon estimated prepayment speeds.
                         
    Available-for-sale  
                    Weighted-  
    Amortized     Fair     Average  
    Cost     Value     Yield  
    (amounts in thousands)  
Due in one year or less
  $ 107,396     $ 109,487       3.60 %
Due after one year through five years
    1,450,540       1,461,952       3.01 %
Due after five years through ten years
    270,816       277,399       4.05 %
Due after ten years
    173,420       168,690       3.88 %
 
                   
 
  $ 2,002,172     $ 2,017,528       3.25 %
 
                   
The investment in FHLB stock is periodically evaluated for impairment based on, among other things, the capital adequacy of the FHLB and its overall financial condition. No impairment losses have been recorded through March 31, 2011.

 

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3. LOAN AND LEASE FINANCE RECEIVABLES
The following is a summary of the components of loan and lease finance receivables (dollars in thousands):
                         
    March 31, 2011  
    Non-Covered              
    Loans     Covered Loans     Total  
Commercial and Industrial
  $ 456,040     $ 34,276     $ 490,316  
Real Estate:
                       
Construction
    109,540       60,022       169,562  
Commercial Real Estate
    1,966,589       288,658       2,255,247  
SFR Mortgage
    205,583       4,862       210,445  
Consumer
    51,818       9,804       61,622  
Municipal lease finance receivables
    122,422       475       122,897  
Auto and equipment leases, net of unearned discount
    17,399             17,399  
Dairy and Livestock
    325,052             325,052  
Agribusiness
    885       48,779       49,664  
 
                 
Gross Loans
  $ 3,255,328     $ 446,876     $ 3,702,204  
 
                       
Less: Purchase Accounting Discount
          (98,117 )     (98,117 )
Less: Deferred net loan fees
    (5,640 )           (5,640 )
 
                 
Gross loans, net of deferred loan fees
  $ 3,249,688     $ 348,759     $ 3,598,447  
Less: Allowance for credit losses
    (101,067 )           (101,067 )
 
                 
Net Loans
  $ 3,148,621     $ 348,759     $ 3,497,380  
 
                 
                         
    December 31, 2010  
    Non-Covered              
    Loans     Covered Loans     Total  
Commercial and Industrial
  $ 460,399     $ 39,587     $ 499,986  
Real Estate:
                       
Construction
    138,980       84,498       223,478  
Commercial Real Estate
    1,980,256       292,014       2,272,270  
SFR Mortgage
    218,467       5,858       224,325  
Consumer
    56,747       10,624       67,371  
Municipal lease finance receivables
    128,552       576       129,128  
Auto and equipment leases, net of unearned discount
    17,982             17,982  
Dairy and Livestock
    376,143             376,143  
Agribusiness
    1,686       55,618       57,304  
 
                 
Gross Loans
  $ 3,379,212     $ 488,775     $ 3,867,987  
 
                       
Less: Purchase Accounting Discount
          (114,763 )     (114,763 )
Less: Deferred net loan fees
    (5,484 )           (5,484 )
 
                 
Gross loans, net of deferred loan fees
  $ 3,373,728     $ 374,012     $ 3,747,740  
Less: Allowance for credit losses
    (105,259 )           (105,259 )
 
                 
Net Loans
  $ 3,268,469     $ 374,012     $ 3,642,481  
 
                 
At March 31, 2011, the Company held approximately $1.35 billion of fixed rate loans. As of March 31, 2011, 60.9% of the loan portfolio consisted of commercial real estate loans, 4.6% of the loan portfolio consisted of construction loans and 5.7% of the loan portfolio consisted of SFR mortgages. Substantially all of the Company’s real estate loans and construction loans are secured by real properties located in California.

 

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4. ALLOWANCE FOR CREDIT LOSSES AND OTHER REAL ESTATE OWNED (NON-COVERED LOANS)
The Bank’s Credit Management Division is responsible for regularly reviewing the allowance for credit losses (“ALLL”) methodology, including loss factors and economic risk factors. The Bank’s Director Loan Committee provides Board oversight of the ALLL process and approves the ALLL methodology on a quarterly basis.
Our methodology for assessing the appropriateness of the allowance is conducted on a regular basis and considers all loans. The systematic methodology consists of two major elements.
The first major element includes a detailed analysis of the loan portfolio in two phases. In the first phase, individual loans are reviewed to identify loans for impairment. A loan is impaired when principal and interest are deemed uncollectible in accordance with the original contractual terms of the loan. Impairment is measured as either the expected future cash flows discounted at each loan’s effective interest rate, the fair value of the loan’s collateral if the loan is collateral dependent, or an observable market price of the loan (if one exists). If we determine that the value of the impaired loan is less than the recorded investment of the loan, we either recognize an impairment reserve as a Specific Allowance to be provided for in the allowance for credit losses or charge-off the impaired balance if it determined that such amount represents a confirmed loss. Loans determined to be impaired are excluded from the formulae allowance so as not to double-count the loss exposure.
Central to the first phase and our credit risk management is our loan risk rating system. The originating credit officer assigns borrowers an initial risk rating, which is reviewed and possibly changed by Credit Management, which is based primarily on a thorough analysis of each borrower’s financial capacity in conjunction with industry and economic trends. Approvals are made based upon the amount of inherent credit risk specific to the transaction and are reviewed for appropriateness by senior line and credit management personnel. Credits are monitored by line and credit management personnel for deterioration in a borrower’s financial condition, which would impact the ability of the borrower to perform under the contract. Risk ratings are adjusted as necessary.
Loans are risk rated into the following categories: Loss, Doubtful, Substandard, Special Mention and Pass. Each of these groups is assessed for the proper amount to be used in determining the adequacy of our allowance for losses. The Impaired and Doubtful loans are analyzed on an individual basis for allowance amounts. The other categories have formulae used to determine the needed allowance amount.
The second phase is conducted by evaluating or segmenting the remainder of the loan portfolio into groups or pools of loans with similar characteristics. In this second phase, groups or pools of homogeneous loans are reviewed to determine a portfolio formula allowance. In the case of the portfolio formula allowance, homogeneous portfolios, such as small business loans, consumer loans, agricultural loans, and real estate loans, are aggregated or pooled in determining the appropriate allowance. The risk assessment process in this case emphasizes trends in the different portfolios for delinquency, loss, and other-behavioral characteristics of the subject portfolios.

 

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The second major element in our methodology for assessing the appropriateness of the allowance consists of our considerations of qualitative factors, including, all known relevant internal and external factors that may affect the collectability of a loan. This includes our estimates of the amounts necessary for concentrations, economic uncertainties, the volatility of the market value of collateral, and other relevant factors. The relationship of the two major elements of the allowance to the total allowance may fluctuate from period to period. These qualitative factors are used to adjust the historical loan loss rates for each pool of loans to determine the probable credit losses inherent in the portfolio.
The Bank’s methodology is consistently applied across all the portfolio segments taken into account the applicable historical loss rates and the qualitative factors applicable to each pool of loans. There have been no significant changes to the methodology or policies in the periods presented.
The allowance for off-balance sheet credit exposure relates to commitments to extend credit, letters of credit and undisbursed funds on lines of credit. The Bank evaluates credit risk associated with the loan and lease portfolio at the same time it evaluates credit risk associated with the off-balance sheet commitments. The Bank recorded an increase of $732,000 and $1.3 million in the reserve for undisbursed commitments for the first quarters of 2011 and 2010, respectively. As of March 31, 2011, the balance in this reserve was $11.2 million compared to a balance of $10.5 million as of December 31, 2010.
Management believes that the ALLL was adequate at March 31, 2011. No assurance can be given that economic conditions which adversely affect the Bank’s service areas or other circumstances will not be reflected in increased provisions for credit losses in the future.

 

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The following table presents the balance and activity in the allowance for loan losses, and the recorded investment in held-for-investment loans by portfolio segment and its evaluation based on impairment method as of March 31, 2011, December 31, 2010 and March 31, 2010:
Allowance for Credit Losses and Recorded Investment in Financing Receivables
(Dollars in thousands)
                                                                         
                            Municipal                                
                            Lease     Dairy                          
    Commercial                     Finance     &     Consumer,     Covered              
    and Industrial     Construction     Real Estate     Receivables     Livestock     Auto & Other     Loans (1)     Unallocated     Total  
Three Months Ended March 31, 2011
                                                                       
Allowance for Credit Losses:
                                                                       
 
                                                                       
Beginning balance
  $ 11,472     $ 10,188     $ 43,529     $ 2,172     $ 36,061     $ 1,034     $ 0     $ 803     $ 105,259  
Charge-offs
    (689 )     (6,160 )     (2,471 )           (2,204 )     (120 )     (394 )           (12,038 )
Recoveries
    142             581                   52       3             778  
Provision
    (482 )     2,350       1,151       639       (430 )     707       391       2,742       7,068  
 
                                                     
Ending balance
  $ 10,443     $ 6,378     $ 42,790     $ 2,811     $ 33,427     $ 1,673     $     $ 3,545     $ 101,067  
 
                                                     
Ending balance: Individually evaluated for impairment
  $ 364     $     $ 885     $     $     $ 37     $     $     $ 1,286  
 
                                                     
Ending balance: Collectively evaluated for impairment
  $ 10,079     $ 6,378     $ 41,905     $ 2,811     $ 33,427     $ 1,636     $     $ 3,545     $ 99,781  
 
                                                     
 
                                                                       
Financing receivables:
                                                                       
Ending balance
  $ 456,925     $ 109,540     $ 2,172,172     $ 122,422     $ 325,052     $ 69,217     $ 348,759     $     $ 3,604,087  
 
                                                     
Ending balance: Individually evaluated for impairment
  $ 10,136     $ 42,320     $ 62,707     $     $ 2,996     $ 260     $ 14,965     $     $ 133,384  
 
                                                     
Ending balance: Collectively evaluated for impairment
  $ 446,789     $ 67,220     $ 2,109,465     $ 122,422     $ 322,056     $ 68,957     $ 333,794     $     $ 3,470,703  
 
                                                     
 
                                                                       
Twelve Months Ended December 31, 2010
                                                                       
Allowance for Credit Losses:
                                                                       
 
                                                                       
Beginning balance
  $ 7,530     $ 21,222     $ 42,215     $ 1,724     $ 31,051     $ 1,004     $     $ 4,178     $ 108,924  
Charge-offs
    (6,290 )     (15,648 )     (41,356 )     (13 )     (1,205 )     (627 )     (385 )           (65,524 )
Recoveries
    242       291       35                   76       15             659  
Provision
    9,990       4,323       42,635       461       6,215       581       370       (3,375 )     61,200  
 
                                                     
Ending balance
  $ 11,472     $ 10,188     $ 43,529     $ 2,172     $ 36,061     $ 1,034     $     $ 803     $ 105,259  
 
                                                     
Ending balance: Individually evaluated for impairment
  $ 50     $ 3,300     $ 681     $     $     $ 28     $     $     $ 4,059  
 
                                                     
Ending balance: Collectively evaluated for impairment
  $ 11,422     $ 6,888     $ 42,848     $ 2,172     $ 36,061     $ 1,006     $     $ 803     $ 101,200  
 
                                                     
 
                                                                       
Financing receivables:
                                                                       
Ending balance
  $ 462,085     $ 138,980     $ 2,198,723     $ 128,552     $ 376,143     $ 74,729     $ 374,012     $     $ 3,753,224  
 
                                                     
Ending balance: Individually evaluated for impairment
  $ 9,404     $ 63,025     $ 90,416     $     $ 5,207     $ 586     $ 15,879     $     $ 184,517  
 
                                                     
Ending balance: Collectively evaluated for impairment
  $ 452,681     $ 75,955     $ 2,108,307     $ 128,552     $ 370,936     $ 74,143     $ 358,133     $     $ 3,568,707  
 
                                                     
 
                                                                       
Three Months Ended March 31, 2010
                                                                       
Allowance for Credit Losses:
                                                                       
 
                                                                       
Beginning balance
  $ 7,530     $ 21,222     $ 42,215     $ 1,724     $ 31,051     $ 1,004     $     $ 4,178     $ 108,924  
Charge-offs
    (2,569 )     (4,685 )     (1,580 )                 (97 )                 (8,931 )
Recoveries
    119             1                   8                   128  
Provision
    2,865       2,532       3,140       347       1,533       862             921       12,200  
 
                                                     
Ending balance
  $ 7,945     $ 19,069     $ 43,776     $ 2,071     $ 32,584     $ 1,777     $     $ 5,099     $ 112,321  
 
                                                     
Ending balance: Individually evaluated for impairment
  $ 225     $ 7     $ 1,359     $     $     $ 73     $     $     $ 1,664  
 
                                                     
Ending balance: Collectively evaluated for impairment
  $ 7,720     $ 19,062     $ 42,417     $ 2,071     $ 32,584     $ 1,704     $     $ 5,099     $ 110,657  
 
                                                     
 
                                                                       
Financing receivables:
                                                                       
Ending balance
  $ 408,554     $ 221,130     $ 2,247,732     $ 155,511     $ 391,668     $ 90,025     $ 438,539     $     $ 3,953,159  
 
                                                     
Ending balance: Individually evaluated for impairment
  $ 6,393     $ 41,028     $ 35,767     $     $     $ 609     $ 24,071     $     $ 107,868  
 
                                                     
Ending balance: Collectively evaluated for impairment
  $ 402,161     $ 180,102     $ 2,211,965     $ 155,511     $ 391,668     $ 89,416     $ 414,468     $     $ 3,845,291  
 
                                                     
     
(1)  
Net of purchase accounting discount

 

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Asset Quality and Non-Performing Loans
We manage asset quality and control credit risk through diversification of the non-covered loan portfolio and the application of policies designed to promote sound underwriting and loan monitoring practices. The Bank’s Credit Management Division is charged with monitoring asset quality, establishing credit policies and procedures and enforcing the consistent application of these policies and procedures across the Bank. Reviews of non-performing, past due non-covered loans and larger credits, designed to identify potential charges to the allowance for loan and lease losses, and to determine the adequacy of the allowance, are conducted on an ongoing basis. These reviews consider such factors as the financial strength of borrowers, the value of the applicable collateral, loan loss experience, estimated loan losses, growth in the loan portfolio, prevailing economic conditions and other factors.
A loan is considered impaired when based on current information and events, we determine it is probable that we will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. Generally, when loans are identified as impaired they are moved to our Special Assets Department. When we identify a loan as impaired, we measure the loan for potential impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of collateral, less selling costs. The starting point for determining the fair value of collateral is through obtaining external appraisals.
Loans are reported as restructured when the Bank grants a concession(s) to a borrower experiencing financial difficulties that it would not otherwise consider. Examples of such concessions include forgiveness of principal or accrued interest, extending the maturity date(s) or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, restructured loans are impaired as the Bank will not collect all amounts due, both principal and interest, in accordance with the terms of the original loan agreement. Impairment reserves on non-collateral dependent restructured loans are measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s carrying value. These impairment reserves are recognized as a specific component to be provided for in the allowance for loan and lease losses.
The accrual of interest on loans is discontinued when the loan becomes 90 days past due, or when the full collection of principal and interest is no longer probable. When an asset is placed on non-accrual status, previously accrued but unpaid interest is reversed against income. Subsequent collections of cash are applied as reductions to the principal balance unless the loan is returned to accrual status. Non-accrual loans may be restored to accrual status when principal and interest become current and full payment of principal and interest is expected. Had non-accrual loans for which interest was no longer accruing complied with the original terms and conditions of their notes, interest income would have been $831,000 and $1.0 million greater for the first quarters of 2011 and 2010, respectively.

 

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The following table presents the recorded investment in held-for-investment and held-for-sale, non-covered, non-accrual loans and loans past due by class of loans as of March 31, 2011, December 31, 2010 and March 31, 2010:
(Dollars in Thousands)
                                                         
                    Greater Than                                
                    90 Days Past                             Total  
    30-59 Days     60-89 Days     Due and     Total Past                     Financing  
March 31, 2011   Past Due     Past Due     Accruing     Due     Nonaccrual     Current     Receivables  
Commercial & Industrial
  $ 72     $     $     $ 72     $ 7,542     $ 449,311     $ 456,925  
Construction — Speculative
                            34,656       58,393       93,049  
Construction — Non-Speculative
    1,492                   1,492       9,320       7,335       18,147  
Commercial Real Estate — Owner-Occupied
    366                   366       1,511       698,980       700,857  
Commercial Real Estate — Non-Owner-Occupied
          532             532       33,440       1,231,760       1,265,732  
Residential Real Estate (SFR 1-4)
    993                   993       18,425       188,014       207,432  
Dairy & Livestock
                            2,996       322,056       325,052  
Municipal Lease Finance Receivables
                                  122,422       122,422  
Consumer
    9                   9       259       51,550       51,818  
Auto & Equipment Leases
    139       28             167       1       17,231       17,399  
 
                                         
Total
  $ 3,071     $ 560     $     $ 3,631     $ 108,150     $ 3,147,052     $ 3,258,833  
 
                                         
                                                         
                    Greater Than                                
                    90 Days Past                             Total  
    30-59 Days     60-89 Days     Due and     Total Past                     Financing  
December 31, 2010   Past Due     Past Due     Accruing     Due     Nonaccrual     Current     Receivables  
 
                                                       
Commercial & Industrial
  $ 2,177     $ 1,036     $       3,213     $ 3,887     $ 454,985     $ 462,085  
Construction — Speculative
                            55,208       66,343       121,551  
Construction — Non-Speculative
                            9,473       9,612       19,085  
Commercial Real Estate — Owner-Occupied
    62                   62       5,457       545,073       550,592  
Commercial Real Estate — Non-Owner-Occupied
    3,132                   3,132       59,402       1,367,130       1,429,664  
Residential Real Estate (SFR 1-4)
    1,473       1,124             2,597       17,800       199,368       219,765  
Dairy & Livestock
                            5,207       370,936       376,143  
Municipal Lease Finance Receivables
                                  128,552       128,552  
Consumer
          29             29       537       56,181       56,747  
Auto & Equipment Leases
    93       14             107       49       17,826       17,982  
 
                                         
Total
  $ 6,937     $ 2,203     $     $ 9,140     $ 157,020     $ 3,216,006     $ 3,382,166  
 
                                         
                                                         
                    Greater Than                                
                    90 Days Past                             Total  
    30-59 Days     60-89 Days     Due and     Total Past                     Financing  
March 31, 2010   Past Due     Past Due     Accruing     Due     Nonaccrual     Current     Receivables  
Commercial & Industrial
  $ 679     $ 1,670     $     $ 2,349     $ 6,393     $ 399,812     $ 408,554  
Construction — Speculative
    8,143                   8,143       24,142       165,671       197,956  
Construction — Non-Speculative
                            9,929       15,765       25,694  
Commercial Real Estate — Owner-Occupied
    130                   130       1,906       738,847       740,883  
Commercial Real Estate — Non-Owner-Occupied
    3,156                   3,156       20,135       1,230,248       1,253,539  
Residential Real Estate (SFR 1-4)
    3,199       547             3,746       13,726       238,459       255,931  
Dairy & Livestock
                                  391,668       391,668  
Municipal Lease Finance Receivables
                                  155,511       155,511  
Consumer
          28             28       123       62,328       62,479  
Auto & Equipment Leases
    276       89             365       486       26,695       27,546  
 
                                         
Total
  $ 15,583     $ 2,334     $     $ 17,917     $ 76,840     $ 3,425,004     $ 3,519,761  
 
                                         

 

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Credit Quality Indicators
The Company’s risk rating methodology assigns risk ratings generally described by the following groupings:
Pass — These loans range from minimal credit risk to lower than average, but still acceptable, credit risk.
Watch List —Watch list loans usually require more than normal management attention. Loans which qualify for the Watch List may involve borrowers with adverse financial trends, higher debt/equity ratios, or weaker liquidity positions, but not to the degree of being considered a defined weakness or problem loan where risk of loss may be apparent.
Special Mention — Loans assigned to this category are currently protected but are weak. Although concerns exist, the bank is currently protected and loss is unlikely. They have potential weaknesses that may, if not checked or corrected, weaken the asset or inadequately protect the Bank’s credit position at some future date.
Substandard — Loans classified as substandard include poor liquidity, high leverage, and erratic earnings or losses. The primary source of repayment is no longer realistic, and asset or collateral liquidation may be the only source of repayment. Loans are marginal and require continuing and close supervision by credit management. Substandard loans have the distinct possibility that the Bank will sustain some loss if deficiencies are not corrected.
Doubtful — Loans classified doubtful have all the weaknesses inherent in those classified substandard with the added provision that the weaknesses make collection or the liquidation, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonable specific pending factors which may work to the advantage and strengthening of the assets, their classifications as losses are deferred until their more exact status may be determined.
Loss — Loans classified as Loss are considered uncollectible and of such little value that their continuance as active assets of the Bank is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.
Impaired — Loans are classified as Impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due, in accordance with the terms of the original loan agreement, without unreasonable delay. This generally includes all loans classified as non-accrual and troubled debt restructurings.

 

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The following table summarizes our internal risk grouping by loan class as of March 31, 2011, December 31, 2010 and March 31, 2010 for non-covered, held-for-investment loans:
Credit Quality Indicators
As of March 31, 2011, December 31, 2010 and March 31, 2010
(Amounts in Thousands)
Credit Risk Profile by Internally Assigned Grade
                                                 
    March 31, 2011  
                    Special             Doubtful &        
    Pass     Watch List     Mention     Sub-Standard     Loss     Total  
Commercial & Industrial
  $ 310,233     $ 76,268     $ 37,395     $ 32,996     $ 33     $ 456,925  
Construction — Speculative
    796       8,251       24,522       57,824             91,393  
Construction — Non-Speculative
    606       3,784       2,005       11,752             18,147  
Commercial Real Estate — Owner-Occupied
    367,139       105,493       93,386       134,839             700,857  
 
                                               
Commercial Real Estate — Non-Owner-Occupied
    862,262       208,533       74,732       120,205             1,265,732  
Residential Real Estate (SFR 1-4)
    175,636       11,926       701       17,320             205,583  
Dairy & Livestock
    911       2,164       123,034       198,943             325,052  
Municipal Lease Finance Receivables
    85,275       13,515       13,559       10,073             122,422  
Consumer
    42,841       3,854       2,707       2,332       84       51,818  
Auto & Equipment Leases
    10,818       3,426       893       2,262             17,399  
 
                                   
Total Non-covered Loans
    1,856,517       437,214       372,934       588,546       117       3,255,328  
Covered Loans
    130,726       47,967       29,108       238,367       708       446,876  
 
                                   
Total Gross Loans
  $ 1,987,243     $ 485,181     $ 402,042     $ 826,913     $ 825     $ 3,702,204  
 
                                   
                                                 
    December 31, 2010  
                    Special             Doubtful &        
    Pass     Watch List     Mention     Sub-Standard     Loss     Total  
Commercial & Industrial
  $ 311,303     $ 80,306     $ 35,670     $ 34,741     $ 65     $ 462,085  
Construction — Speculative
    428       16,022       24,773       78,672             119,895  
Construction — Non-Speculative
    3,168       3,422       2,346       10,149             19,085  
Commercial Real Estate — Owner-Occupied
    369,974       98,295       32,647       49,676             550,592  
 
                                               
Commercial Real Estate — Non-Owner-Occupied
    853,581       209,185       123,912       242,986             1,429,664  
Residential Real Estate (SFR 1-4)
    190,022       11,002       801       16,642             218,467  
Dairy & Livestock
    4,373       4,917       152,891       213,962             376,143  
Municipal Lease Finance Receivables
    92,064       11,540       21,746       3,202             128,552  
Consumer
    47,927       4,885       2,367       1,484       84       56,747  
Auto & Equipment Leases
    10,925       3,450       1,122       2,483       2       17,982  
 
                                   
Total Non-covered Loans
    1,883,765       443,024       398,275       653,997       151       3,379,212  
Covered Loans
    139,038       59,996       42,147       247,407       187       488,775  
 
                                   
Total Gross Loans
  $ 2,022,803     $ 503,020     $ 440,422     $ 901,404     $ 338     $ 3,867,987  
 
                                   
                                                 
    March 31, 2010  
                    Special                    
    Pass     Watch List     Mention     Sub-Standard     Doubtful     Total  
Commercial & Industrial
  $ 271,512     $ 81,143     $ 26,942     $ 28,957     $     $ 408,554  
Construction — Non-Speculative
    8,115       7,175             10,405             25,695  
Construction — Speculative
    1,473       36,038       33,372       124,342       210       195,435  
Commercial Real Estate — Owner-Occupied
    423,664       122,620       59,070       135,529             740,883  
 
                                               
Commercial Real Estate — Non-Owner-Occupied
    872,029       174,892       53,297       153,321             1,253,539  
Residential Real Estate (SFR 1-4)
    227,821       9,343       734       15,412             253,310  
Dairy & Livestock
    13,414       79,745       121,602       176,907             391,668  
Municipal Lease Finance Receivables
    127,955       11,662       12,949       2,945             155,511  
Consumer
    52,491       5,162       3,223       1,603             62,479  
Auto & Equipment Leases
    16,736       3,933       3,198       3,679             27,546  
 
                                   
Total Non-covered Loans
    2,015,210       531,713       314,387       653,100       210       3,514,620  
Covered Loans
    215,101       47,780       41,291       298,209             602,381  
 
                                   
Total Gross Loans
  $ 2,230,311     $ 579,493     $ 355,678     $ 951,309     $ 210     $ 4,117,001  
 
                                   

 

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Non-covered Impaired Loans
The following table presents held-for-investment and held-for-sale loans, individually evaluated for impairment by class of loans, as of March 31, 2011, December 31, 2010 and March 31, 2010:
Non-Covered Impaired Loans
As of March 31, 2011, December 31, 2010 and March 31, 2010
                                         
            Unpaid             Average     Interest  
    Recorded     Principal     Related     Recorded     Income  
    Investment     Balance     Allowance     Investment     Recognized  
March 31, 2011
                                       
With no related allowance recorded:
                                       
Commercial & Industrial
  $ 7,574     $ 8,691     $     $ 8,657     $ 52  
Construction — Speculative
    34,656       56,431             39,521        
Construction — Non-Speculative
    9,320       10,149             9,396        
Commercial Real Estate — Owner-Occupied
    1,511       1,721             1,648        
Commercial Real Estate — Non-Owner-Occupied
    39,880       48,014             40,138       131  
Residential Real Estate (SFR 1-4)
    17,327       20,370             17,816       8  
Dairy & Livestock
    2,996       5,777             4,654        
Municipal Lease Finance Receivables
                             
Consumer
                             
Auto & Equipment Leases
                             
 
                             
 
    113,264       151,153             121,830       191  
 
                             
With a related allowance recorded:
                                       
Commercial & Industrial
  $ 2,562     $ 2,601     $ 364     $ 2,853     $  
Construction — Speculative
                             
Construction — Non-Speculative
                             
Commercial Real Estate — Owner-Occupied
                             
Commercial Real Estate — Non-Owner-Occupied
    1,647       1,655       717       1,661        
Residential Real Estate (SFR 1-4)
    2,342       2,446       168       2,351        
Dairy & Livestock
                             
Municipal Lease Finance Receivables
                             
Consumer
    259       265       37       260        
Auto & Equipment Leases
    1       1             2        
 
                             
 
    6,811       6,968       1,286       7,127        
 
                             
Total
  $ 120,075     $ 158,121     $ 1,286     $ 128,957     $ 191  
 
                             
 
                                       
December 31, 2010
                                       
With no related allowance recorded:
                                       
Commercial & Industrial
  $ 9,060     $ 9,600     $     $ 9,972     $ 339  
Construction — Speculative
    47,328       65,121             56,610        
Construction — Non-Speculative
    9,473       10,149             9,777        
Commercial Real Estate — Owner-Occupied
    4,528       4,528             4,541        
Commercial Real Estate — Non-Owner-Occupied
    66,856       103,010             93,807       498  
Residential Real Estate (SFR 1-4)
    13,766       16,285             14,556        
Dairy & Livestock
    5,207       5,780             6,334        
Municipal Lease Finance Receivables
                             
Consumer
    334       334             336        
Auto & Equipment Leases
                             
 
                             
 
    156,552       214,807             195,933       837  
 
                             
 
                                       
With a related allowance recorded:
                                       
Commercial & Industrial
  $ 344     $ 352     $ 50     $ 371     $  
Construction — Speculative
    7,880       12,588       3,300       8,966        
Construction — Non-Speculative
                             
Commercial Real Estate — Owner-Occupied
    929       929       136       934        
Commercial Real Estate — Non-Owner-Occupied
    303       311       25       308        
Residential Real Estate (SFR 1-4)
    4,034       4,086       520       4,067        
Dairy & Livestock
                             
Municipal Lease Finance Receivables
                             
Consumer
    203       205       21       207        
Auto & Equipment Leases
    49       49       7       77        
 
                             
 
    13,742       18,520       4,059       14,930        
 
                             
Total
  $ 170,294     $ 233,327     $ 4,059     $ 210,863     $ 837  
 
                             
 
                                       
March 31, 2010
                                       
With no related allowance recorded:
                                       
Commercial & Industrial
  $ 4,370     $ 6,890     $     $ 6,451     $  
Construction — Speculative
    33,494       46,074             37,034       125  
Construction — Non-Speculative
    9,929       10,149             10,005        
Commercial Real Estate — Owner-Occupied
    500       500             500        
Commercial Real Estate — Non-Owner-Occupied
    19,817       21,135             20,654        
Residential Real Estate (SFR 1-4)
    9,967       10,897             10,343        
Dairy & Livestock
                             
Municipal Lease Finance Receivables
                             
Consumer
    40       100             85        
Auto & Equipment Leases
                             
 
                             
 
    78,117       95,745             85,072       125  
 
                             
With a related allowance recorded:
                                       
Commercial & Industrial
  $ 2,023     $ 2,031     $ 225     $ 2,028     $  
Construction — Speculative
    125       127       7       125        
Construction — Non-Speculative
                             
Commercial Real Estate — Owner-Occupied
    1,406       1,404       582       1,408        
Commercial Real Estate — Non-Owner-Occupied
    318       323       36       320        
Residential Real Estate (SFR 1-4)
    3,759       3,794       741       3,786        
Dairy & Livestock
                             
Municipal Lease Finance Receivables
                             
Consumer
    83       83       12       83        
Auto & Equipment Leases
    486       486       61       497        
 
                             
 
    8,200       8,248       1,664       8,247        
 
                             
Total
  $ 86,317     $ 103,993     $ 1,664     $ 93,319     $ 125  
 
                             

 

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Loans with no related allowance reported generally represent non-accrual loans. The Bank recognizes the charge-off of impairment reserves on impaired loans in the period it arises for collateral dependent loans. Therefore, the majority of the non-accrual loans as of March 31, 2011 have already been written-down to their estimated net realizable value. The impaired loans with a related allowance recorded are on non-accrual loans where a charge-off is not yet processed, on non-accrual SFR loans where there is a potential modification in process, on smaller balance non-collateral dependent loans and impairment reserves on performing restructured loans.
At March 31, 2011 and December 31, 2010, impaired loans of $11.9 million and $13.3 million were classified as accruing restructured loans, respectively. The restructurings were granted in response to borrower financial difficulty, and generally provide for a modification of loan repayment terms. The restructured loans on accrual status represent the only impaired loans accruing interest at each respective date. A performing restructured loan is reasonably assured of repayment, is performing according to the modified terms and the restructured loan is well secured.
5. FAIR VALUE INFORMATION
The following disclosure provides fair value information for financial assets and liabilities as of March 31, 2011 and December 31, 2010. The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels (Level 1, Level 2, and Level 3).
   
Level 1 — Valuation is based upon quoted prices for identical instruments traded in active markets.
   
Level 2 — Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
   
Level 3 — Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flows and similar techniques.
Determination of Fair Value
The following is a description of valuation methodologies used for assets and liabilities recorded at fair value and for estimating fair value for financial instruments not recorded at fair value.
Cash — The carrying amount of cash and cash equivalents is considered to be a reasonable estimate of fair value.
Investment securities available-for-sale — Investment securities available-for-sale are valued based upon quotes obtained from reputable third-party pricing services. These services use evaluated pricing applications and model processes. Market inputs, such as, benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data are considered as part of the evaluation. The inputs are related directly to the security being evaluated, or indirectly to a similarly situated security. Market assumptions and market data are utilized in the valuation models. Accordingly, the Company categorized its investment portfolio as a Level 2 valuation.
Investment security held-to-maturity — Investment security held-to-maturity is carried at amortized cost-basis on the balance sheet. The fair value is determined using the same process described above for available-for-sale securities.

 

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Non-covered Loans — The carrying amount of loans and lease finance receivables is their contractual amounts outstanding, reduced by deferred net loan origination fees and the allocable portion of the allowance for credit losses.
The fair value of loans, other than loans on non-accrual status, was estimated by discounting the remaining contractual cash flows using the estimated current rate at which similar loans would be made to borrowers with similar credit risk characteristics and for the same remaining maturities, reduced by deferred net loan origination fees and the allocable portion of the allowance for credit losses. Accordingly, in determining the estimated current rate for discounting purposes, no adjustment has been made for any change in borrowers’ credit risks since the origination of such loans. Rather, the allocable portion of the allowance for credit losses is considered to provide for such changes in estimating fair value. As a result, this fair value is not necessarily the value which would be derived using an exit price.
Non-covered Impaired loans and OREO are generally measured using the fair value of the underlying collateral, which is determined based on the most recent appraisal information received, less costs to sell. Appraised values may be adjusted based on factors such as the changes in market conditions from the time of valuation or discounted cash flows of the property. As such, these loans fall within Level 3 of the fair value hierarchy.
The fair value of commitments to extend credit and standby letters of credit were not significant at either March 31, 2011 or December 31, 2010, as these instruments predominantly have adjustable terms and are of a short-term nature.
Covered Loans — Covered loans were measured at fair value on the date of acquisition. Thereafter, covered loans are not measured at fair value on a recurring basis. The above valuation discussion for non-covered loans is applicable to covered loans following their acquisition date.
Swaps — The fair value of the interest rate swap contracts are provided by our counterparty using a system that constructs a yield curve based on cash LIBOR rates, Eurodollar futures contracts, and 3-year through 30-year swap rates. The yield curve determines the valuations of the interest rate swaps. Accordingly, the swap is categorized as a Level 2 valuation.
Deposits & Borrowings — The amounts payable to depositors for demand, savings, and money market accounts, and the demand note to the U.S. Treasury, and short-term borrowings are considered to be stated at fair value. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value of long-term borrowings and junior subordinated debentures is estimated using the rates currently offered for borrowings of similar remaining maturities.
Accrued Interest Receivable/Payable — The amounts of accrued interest receivable on loans and lease finance receivables and investments and accrued interest payable on deposits and borrowings are considered to be stated at fair value.

 

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The table below presents the balances of assets and liabilities measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010.
Assets & Liabilities Measured at Fair Value on a Recurring Basis
                                 
            Quoted Prices in     Significant        
            Active Markets     Other     Significant  
            for Identical     Observable     Unobservable  
    Carrying Value at     Assets     Inputs     Inputs  
(in thousands)   March 31, 2011     (Level 1)     (Level 2)     (Level 3)  
Description of Assets
                               
Mortgage-backed securities
  $ 892,495     $     $ 892,495     $  
CMO’s / REMIC’s
    418,887             418,887        
Government agency
    85,970             85,970        
Municipal bonds
    620,176             620,176        
 
                       
Investment Securities-AFS
    2,017,528             2,017,528        
Interest Rate Swaps
    5,847             5,847        
 
                       
Total Assets
  $ 2,023,375     $     $ 2,023,375     $  
 
                       
 
                               
Description of Liability
                               
Interest Rate Swaps
  $ 5,847     $     $ 5,847     $  
Assets & Liabilities Measured at Fair Value on a Recurring Basis
                                 
            Quoted Prices in     Significant        
            Active Markets     Other     Significant  
            for Identical     Observable     Unobservable  
    Carrying Value at     Assets     Inputs     Inputs  
(in thousands)   December 31, 2010     (Level 1)     (Level 2)     (Level 3)  
Description of Assets
                               
Mortgage-backed securities
  $ 808,409     $     $ 808,409     $  
CMO’s / REMIC’s
    270,477             270,477        
Government agency
    106,273             106,273        
Municipal bonds
    606,399             606,399        
 
                       
Investment Securities-AFS
    1,791,558             1,791,558        
Interest Rate Swaps
    9,127             9,127        
 
                       
Total Assets
  $ 1,800,685     $     $ 1,800,685     $  
 
                       
 
                               
Description of Liability
                               
Interest Rate Swaps
  $ 9,127     $     $ 9,127     $  
We may be required to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets. For assets measured at fair value on a nonrecurring basis that were still held in the balance sheet at March 31, 2011 and December 31, 2010, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related assets.

 

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Assets & Liabilities Measured at Fair Value on a Non-Recurring Basis
                                         
            Quoted Prices in     Significant             For the three  
            Active Markets     Other     Significant     months ended  
            for Identical     Observable     Unobservable     March 31,  
    Carrying Value at     Assets     Inputs     Inputs     2011  
(in thousands)   March 31, 2011     (Level 1)     (Level 2)     (Level 3)     Total Losses  
Description of Assets
                                       
Investment Security-HTM
  $ 3,039     $     $     $ 3,039     $  
Impaired Loans-Noncovered
  $ 120,075     $     $     $ 120,075     $ (11,644 )
OREO-Noncovered
  $ 6,240     $     $     $ 6,240     $ (18 )
OREO-Covered
  $ 11,490     $     $     $ 11,490     $ (802 )
Assets & Liabilities Measured at Fair Value on a Non-Recurring Basis
                                         
            Quoted Prices in     Significant             For the year  
            Active Markets     Other     Significant     ended  
            for Identical     Observable     Unobservable     December 31,  
    Carrying Value at     Assets     Inputs     Inputs     2010  
(in thousands)   December 31, 2010     (Level 1)     (Level 2)     (Level 3)     Total Losses  
Description of Assets
                                       
Investment Security-HTM
  $ 3,143     $     $     $ 3,143     $ (904 )
Impaired Loans-Noncovered
  $ 170,294     $     $     $ 170,294     $ (65,524 )
OREO-Noncovered
  $ 5,290     $     $     $ 5,290     $ (4,578 )
OREO-Covered
  $ 11,305     $     $     $ 11,305     $ (2,912 )
The following table presents estimated fair value of financial instruments. The estimated fair value amounts have been determined by the Bank using available market information and appropriate valuation methodologies. However, considerable judgment is required to develop the estimates of fair value. Accordingly, the estimates presented below are not necessarily indicative of the amounts the Bank could have realized in a current market exchange as of March 31, 2011 and December 31, 2010. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
                                 
    March 31, 2011     December 31, 2010  
    Carrying     Estimated     Carrying     Estimated  
    Amount     Fair Value     Amount     Fair Value  
    (amounts in thousands)  
Assets
                               
Total cash and cash equivalents
  $ 399,060     $ 399,060     $ 404,275     $ 404,275  
Interest-bearing balances due from depository institutions
    50,190       50,190       50,190       50,190  
FHLB Stock
    83,310       83,310       86,744       86,744  
Investment securities available-for-sale
    2,017,528       2,017,528       1,791,558       1,791,558  
Investment securities held-to-maturity
    3,039       3,039       3,143       3,143  
Loans held-for-sale
    3,505       3,505       2,954       2,954  
Total Loans, net of allowance for credit losses
    3,497,380       3,559,924       3,642,481       3,729,296  
Accrued interest receivable
    23,263       23,263       23,647       23,647  
Swaps
    5,847       5,847       9,127       9,127  
 
                               
Liabilities
                               
Deposits:
                               
Noninterest-bearing
  $ 1,817,951     $ 1,817,951     $ 1,701,523     $ 1,701,523  
Interest-bearing
    2,667,738       2,668,688       2,817,305       2,818,390  
Demand note to U.S. Treasury
    2,966       2,966       1,917       1,917  
Borrowings
    1,131,467       1,161,575       1,095,578       1,128,562  
Junior subordinated debentures
    115,055       115,803       115,055       115,823  
Accrued interest payable
    4,626       4,626       4,985       4,985  
Swaps
    5,847       5,847       9,127       9,127  

 

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The fair value estimates presented herein are based on pertinent information available to management as of March 31, 2011 and December 31, 2010. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date, and therefore, current estimates of fair value may differ significantly from the amounts presented above.
6. BUSINESS SEGMENTS
The Company has identified two principal reportable segments: Business Financial and Commercial Banking Centers and the Treasury Department. The Company’s subsidiary bank has 43 Business Financial Centers and 5 Commercial Banking Centers (branches), organized in 5 geographic regions, which are the focal points for customer sales and services. The Company utilizes an internal reporting system to measure the performance of various operating segments within the Bank which is the basis for determining the Bank’s reportable segments. The Chief Operating Decision Maker (currently our CEO) regularly reviews the financial information of these segments in deciding how to allocate resources and assessing performance. The Bank’s Business Financial and Commercial Banking Centers are considered one operating segment as their products and services are similar and are sold to similar types of customers, have similar production and distribution processes, have similar economic characteristics, and have similar reporting and organizational structures. The Treasury Department’s primary focus is managing the Bank’s investments, liquidity, and interest rate risk. Information related to the Company’s remaining operating segments which include construction lending, dairy and livestock lending, SBA lending, leasing, and centralized functions have been aggregated and included in “Other.” In addition, the Company allocates internal funds transfer pricing to the segments using a methodology that charges users of funds interest expense and credits providers of funds interest income with the net effect of this allocation being recorded in administration.
The following table represents the selected financial information for these two business segments. Accounting principles generally accepted in the United States of America do not have an authoritative body of knowledge regarding the management accounting used in presenting segment financial information. The accounting policies for each of the business units is the same as those policies identified for the consolidated Company and identified in the footnote on the summary of significant accounting policies. The income numbers represent the actual income and expenses of each business unit. In addition, each segment has allocated income and expenses based on management’s internal reporting system, which allows management to determine the performance of each of its business units. Loan fees, included in the “Business Financial and Commercial Banking Centers” category are the actual loan fees paid to the Bank by its customers. These fees are eliminated and deferred in the “Other” category, resulting in deferred loan fees for the consolidated financial statements. All income and expense items not directly associated with the two business segments are grouped in the “Other” category. Future changes in the Company’s management structure or reporting methodologies may result in changes in the measurement of operating segment results.

 

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The following tables present the operating results and other key financial measures for the individual reportable segments for the three months ended March 31, 2011 and 2010 (dollar amounts in thousands):
                                         
    Three Months Ended March 31, 2011  
    Business                          
    Financial                          
    Centers     Treasury     Other     Eliminations     Total  
 
                                       
Interest income, including loan fees
  $ 39,439     $ 15,221     $ 11,852     $     $ 66,512  
Credit for funds provided (1)
    6,026             2,688       (8,714 )      
 
                             
Total interest income
    45,465       15,221       14,540       (8,714 )     66,512  
 
                             
 
Interest expense
    3,268       5,291       844             9,403  
Charge for funds used (1)
    1,286       8,302       (874 )     (8,714 )      
 
                             
Total interest expense
    4,554       13,593       (30 )     (8,714 )     9,403  
 
                             
 
Net interest income
    40,911       1,628       14,570             57,109  
 
                             
Provision for credit losses
                7,068               7,068  
 
                             
Net interest income after provision for credit losses
  $ 40,911     $ 1,628     $ 7,502     $     $ 50,041  
 
                             
 
Non-interest income
    5,212             4,766             9,978  
Non-interest expense
    12,631       216       23,458             36,305  
 
                             
 
Segment pretax profit (loss)
  $ 33,492     $ 1,412     $ (11,190 )   $     $ 23,714  
 
                             
 
                                       
Segment assets as of March 31, 2011
  $ 4,903,546     $ 2,540,188     $ 724,182     $ (1,669,564 )   $ 6,498,352  
 
                             
                                         
    Three Months Ended March 31, 2010  
    Business                          
    Financial                          
    Centers     Treasury     Other     Eliminations     Total  
 
                                       
Interest income, including loan fees
  $ 42,752     $ 22,804     $ 24,996     $     $ 90,552  
Credit for funds provided (1)
    16,823             7,016       (23,839 )      
 
                             
Total interest income
    59,575       22,804       32,012       (23,839 )     90,552  
 
                             
 
Interest expense
    6,636       9,907       670             17,213  
Charge for funds used (1)
    3,521       8,856       11,462       (23,839 )      
 
                             
Total interest expense
    10,157       18,763       12,132       (23,839 )     17,213  
 
                             
 
Net interest income
    49,418       4,041       19,880             73,339  
 
                             
Provision for credit losses
                12,200               12,200  
 
                             
Net interest income after provision for credit losses
  $ 49,418     $ 4,041     $ 7,680     $     $ 61,139  
 
                             
 
Non-interest income
    5,604       (685 )     (7,130 )           (2,211 )
Non-interest expense
    13,132       380       22,410             35,922  
 
                             
 
                                       
Segment pretax profit (loss)
  $ 41,890     $ 2,976     $ (21,860 )   $     $ 23,006  
 
                             
 
                                       
Segment assets as of March 31, 2010
  $ 4,825,482     $ 2,476,423     $ 769,487     $ (1,282,740 )   $ 6,788,652  
 
                             
     
(1)  
Credit for funds provided and charge for funds used is eliminated in the consolidated presentation.
7. DERIVATIVE FINANCIAL INSTRUMENTS
The Bank is exposed to certain risks relating to its ongoing business operations. The primary risks managed by using derivative instruments are market risk and interest rate risk. As of March 31, 2011, the Bank entered into 57 interest-rate swap agreements with customers and 57 with a counterparty bank. The swaps are not designated as hedging instruments. The purpose of entering into offsetting derivatives not designated as a hedging instrument is to provide the Bank a variable-rate loan receivable and provide the customer the financial effects of a fixed-rate loan without creating volatility in the bank’s earnings.
The structure of the swaps is as follows. The Bank enters into a swap with its customers to allow them to convert variable rate loans to fixed rate loans, and at the same time, the Bank enters into a swap with the counterparty bank to allow the Bank to pass on the interest-rate risk associated with fixed rate loans. The net effect of the transaction allows the Bank to receive interest on the loan from the customer at a variable rate based on LIBOR plus a spread. The changes in the market value of the swaps primarily offset each other and therefore do not have a significant impact on the Company’s results of operations.

 

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As of March 31, 2011, the total notional amount of the Bank’s swaps was $173.6 million. The following tables present the location of the asset and liability and the amount of gain recognized as of and for the three months ended March 31, 2011.
Fair Value of Derivative Instruments
                         
    Asset Derivatives     Liability Derivatives  
    March 31, 2011     March 31, 2011  
    (amounts in thousands)  
    Balance Sheet           Balance Sheet      
    Location   Fair Value     Location   Fair Value  
Derivatives Not Designated as Hedging Instruments
                       
 
                       
Interest Rate Swaps
  Other Assets   $ 5,847     Other Liabilities   $ 5,847  
                     
 
                       
Total Derivatives
      $ 5,847         $ 5,847  
                     
The Effect of Derivative Instruments on the Consolidated Statement of Earnings for
three months ended March 31, 2011

(amounts in thousands)
             
        Amount of Gain  
    Location of Gain   Recognized in Income  
Derivatives Not Designated as   Recognized in   on Derivative  
Hedging Instruments   Income on Derivative   March 31, 2011  
Interest Rate Swaps
  Other Income   $ 101  
           
Total
      $ 101  
           

 

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ITEM 2.  
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
We are a bank holding company with one bank subsidiary, Citizens Business Bank. We have three other inactive subsidiaries: CVB Ventures, Inc.; Chino Valley Bancorp and ONB Bancorp. We are also the common stockholder of CVB Statutory Trust I, CVB Statutory Trust II and CVB Statutory Trust III, statutory trusts which were formed to issue trust preferred securities in order to increase the capital of the Company. Through our acquisition of FCB in June 2007, we acquired FCB Capital Trust II, another statutory trust. We are headquartered in Ontario, California in what is known as the “Inland Empire” of California. Our geographical market area encompasses the City of Stockton in the center of California to the City of Laguna Beach (in Orange County) in the southern portion of California. Our mission is to offer the finest financial products and services to professionals and businesses in our market area while maintaining a strong capital base and prudent loan loss reserves. We intend to grow our business through targeted efforts at our existing customers and by attracting new associates who bring customer relationships with them and acquisitions.
Our primary source of income is from the interest earned on our loans and investments and our primary area of expense is the interest paid on deposits, borrowings, and salaries and benefits. As such our net income is subject to fluctuations in interest rates and their impact on our income statement. We are also subject to competition from other financial institutions, which may affect our pricing of products and services, and the fees and interest rates we can charge on them.
Economic conditions in our California service area impact our business. We have seen a significant decline in the housing market resulting in slower growth in construction loans. Unemployment is high in our market areas and areas of our marketplace have been significantly impacted by adverse economic conditions, both nationally and in California. Approximately 17.6% of our total loan portfolio of $3.60 billion is located in the Inland Empire region of California. The balance of the portfolio is from outside of this region. We continue to see the impact of deteriorating economic conditions on our loan portfolio. Continued weaknesses in the local and state economy could adversely affect us through diminished loan demand, credit quality deterioration, and increases in provisions for credit losses, loan delinquencies and defaults.
Over the past few years, we have been active in acquisitions and we will continue to consider acquisition targets, including FDIC-assisted acquisitions, which will enable us to meet our business objectives and enhance shareholder value, along with organic growth. Since 2000, we have acquired five banks and a leasing company, and we have opened four de novo branches: Bakersfield, Fresno, Madera and Stockton, California. We also opened five Commercial Banking Centers since 2008.
Our net income increased to $16.6 million for the first three months of 2011 compared with $16.1 million for the first three months of 2010, an increase of $481,000 million, or 2.98%. Diluted earnings per share increased to $0.16 per share for 2011, from $0.15 per share for 2010. Operating results for the first three months of 2011 include a $7.1 million provision for credit losses, $2.0 million in interest income from accelerated accretion on loans from our FDIC assisted acquisition of San Joaquin Bank (SJB), and $1.4 million in income from the increase in the FDIC loss sharing asset.
During the first quarter of 2011, the Bank sold six of seven notes previously held in connection with its former largest borrowing relationship. The six notes, with a bank carrying value of $42.9 million (and a legal principal balance of $78.1 million), were sold for $41.0 million, resulting in a $1.9 million charge-off.

 

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The operating results for the first quarter 2011 were impacted by the accounting treatment of credit-related transactions from the SJB loan portfolio. For further discussion, see “Analysis of the Results of Operations” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.
CRITICAL ACCOUNTING ESTIMATES
Critical accounting estimates are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We believe that our most critical accounting estimates upon which our financial condition depends, and which involve the most complex or subjective decisions or assessments are as follows:
Allowance for Credit Losses: Arriving at an appropriate level of allowance for credit losses involves a high degree of judgment. Our allowance for credit losses provides for probable losses based upon evaluations of known and inherent risks in the loan portfolio. The determination of the balance in the allowance for credit losses is based on an analysis of the loan and lease finance receivables portfolio using a systematic methodology and reflects an amount that, in our judgment, is adequate to provide for probable credit losses inherent in the portfolio, after giving consideration to the character of the loan portfolio, current economic conditions, past credit loss experience, and such other factors as deserve current recognition in estimating inherent credit losses. The provision for credit losses is charged to expense. For a full discussion of our methodology of assessing the adequacy of the allowance for credit losses, see the “Risk Management” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Investment Portfolio: The investment portfolio is an integral part of our financial performance. We invest primarily in fixed income securities. Accounting estimates are used in the presentation of the investment portfolio and these estimates do impact the presentation of our financial condition and results of operations. We classify securities as held-to-maturity those debt securities that we have the positive intent and ability to hold to maturity. Securities classified as trading are those securities that are bought and held principally for the purpose of selling them in the near term. All other debt and equity securities are classified as available-for-sale. Securities held-to-maturity are accounted for at cost and adjusted for amortization of premiums and accretion of discounts. Trading securities are accounted for at fair value with the unrealized holding gains and losses being included in current earnings. Securities available-for-sale are accounted for at fair value, with the net unrealized gains and losses, net of income tax effects, presented as a separate component of stockholders’ equity. At each reporting date, securities are assessed to determine whether there is an other-than-temporary impairment. Such impairment, if any, is required to be recognized in current earnings rather than as a separate component of stockholders’ equity. Realized gains and losses on sales of securities are recognized in earnings at the time of sale and are determined on a specific-identification basis. Purchase premiums and discounts are recognized in interest income using the effective-yield method over the terms of the securities. Our investment in Federal Home Loan Bank (“FHLB”) stock is carried at cost.
Income Taxes: We account for income taxes using the asset and liability method by deferring income taxes based on estimated future tax effects of differences between the tax and book basis of assets and liabilities considering the provisions of enacted tax laws. These differences result in deferred tax assets and liabilities, which are included in our balance sheets. We must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and establish a valuation allowance for those assets determined to not likely be recoverable. Our judgment is required in determining the amount and timing of recognition of the resulting deferred tax assets and liabilities, including projections of future taxable income. Although we have determined a valuation allowance is not required for any of our deferred tax assets, there is no guarantee that these assets are recoverable.

 

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Covered Other Real Estate Owned: All other real estate owned acquired in the FDIC-assisted acquisition of SJB are included in a FDIC shared-loss agreement and are referred to as covered other real estate owned. Covered other real estate owned is reported exclusive of expected reimbursement cash flows from the FDIC. Upon transferring covered loan collateral to covered other real estate owned status, acquisition date fair value discounts on the related loan are also transferred to covered other real estate owned. Fair value adjustments on covered other real estate owned result in a reduction of the covered other real estate carrying amount and a corresponding increase in the estimated FDIC reimbursement, with the estimated net loss to the Bank charged against earnings.
FDIC Loss Sharing Asset: In conjunction with the FDIC-assisted acquisition of San Joaquin Bank, the Company entered into a shared-loss agreement with the FDIC for amounts receivable under the shared-loss agreement. At the date of the acquisition the Company elected to account for amounts receivable under the shared-loss agreement as a loss sharing asset in accordance with ASC 805. Subsequent to the acquisition the loss sharing asset is adjusted for payments received and changes in estimates of expected losses and is not being accounted for under fair value. The loss estimates used in calculating the FDIC loss sharing asset are determined on the same basis as the related covered loans and is the present value of the cash flows the Company expects to collect from the FDIC under the shared-loss agreement. The difference between the present value and the undiscounted cash flow the Company expects to collect from the FDIC is accreted into noninterest income over the life of the FDIC indemnification asset. The FDIC indemnification asset is adjusted for any changes in expected cash flows based on the loan performance. Any increases in cash flow of the loans over those expected will reduce the FDIC indemnification asset and any decreases in cash flow of the loans over those expected will increase the FDIC indemnification asset. Increase and decreases to the FDIC indemnification asset are recorded as adjustments to other operating income.
Other Real Estate Owned: Other real estate owned (“OREO”) represents properties acquired through foreclosure or through full or partial satisfaction of loans, is considered held for sale, and is recorded at the lower of cost or estimated fair value at the time of foreclosure. Loan balances in excess of fair value of the real estate acquired at the date of foreclosure are charged against the allowance for credit losses. After foreclosure, valuations are periodically performed as deemed necessary by management and the real estate is carried at the lower of carrying value or fair value less costs to sell. Subsequent declines in the fair value of the OREO below the carrying value are recorded through the use of a valuation allowance by charges to other operating expense. Any subsequent operating expenses or income of such properties are charged to other operating expense or income, respectively. Any declines in value after foreclosure are recorded as OREO expense. Revenue recognition upon disposition of a property is dependent on the sale having met certain criteria relating to the buyer’s initial investment in the property sold.
The Bank is able and willing to provide financing for entities purchasing loans or OREO assets from the Bank. Our general guideline is to seek an adequate down payment (as a percentage of the purchase price) from the buyer. We will consider lower down payments when this is not possible; however, accounting rules require certain minimum down payments in order to record the profit on sale, if any. The minimum down payment varies by the type of underlying real estate collateral.
Goodwill and Intangible Assets: We have acquired entire banks and branches of banks. Those acquisitions accounted for under the purchase method of accounting have given rise to goodwill and intangible assets. We record the assets acquired and liabilities assumed at their fair value. These fair values are arrived at by use of internal and external valuation techniques. The excess purchase price is allocated to assets and liabilities respectively, resulting in identified intangibles. Any excess purchase price after this allocation results in goodwill. Goodwill is not being amortized whereas identifiable intangible assets with finite lives are amortized over their useful lives. On an annual basis, the Company tests goodwill and intangible assets for impairment.

 

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Acquired Loans: Loans acquired from SJB were recorded at fair value as of the acquisition date. In estimating the fair value, the portfolio was segregated into two groups: credit-impaired covered loans and other covered loans. Credit-impaired loans are those loans showing evidence of credit deterioration since origination and it is probable, at the date of acquisition, that the Company will not collect all contractually required principal and interest payments. For the credit-impaired loans, the fair value was estimated by using observable market data for similar types of loans. For the other covered loans, the fair value was estimated by calculating the undiscounted expected cash flows based on estimated levels of prepayments, default factors, and loss severities and discounting the expected cash flows at a market rate. Significant estimates are used in calculating the fair value of acquired loans; as a result, actual results may be different than estimates.
Fair Value of Financial Instruments: We use fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. Investment securities available-for-sale and interest-rate swaps are financial instruments recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other financial assets on a non-recurring basis, such as impaired loans and OREO. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets. Further, we include in the Notes to Financial Statements information about the extent to which fair value is used to measure assets and liabilities, the valuation methodologies used and its impact to earnings. Additionally, for financial instruments not recorded at fair value we disclose the estimate of their fair value.
ANALYSIS OF THE RESULTS OF OPERATIONS
Earnings
For the quarter ended March 31, 2011, our net earnings were $16.6 million. This represents an increase of $481,000, or 2.98%, from net earnings of $16.1 million for the first quarter of 2010. Basic and diluted earnings per common share increased to $0.16 per share for the first quarter of 2011 compared to $0.15 per share for the first quarter of 2010. The annualized return on average assets was 1.03% and 0.96% for the first quarter of 2011 and 2010, respectively. The annualized return on average equity was 10.33% and 10.07% for the first quarter of 2011 and 2010, respectively.
Net Interest Income
The principal component of our earnings is net interest income, which is the difference between the interest and fees earned on loans and investments (earning assets) and the interest paid on deposits and borrowed funds (interest-bearing liabilities). Net interest margin is the taxable-equivalent of net interest income as a percentage of average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and net interest margin. The net interest spread is the yield on average earning assets minus the cost of average interest-bearing liabilities. Our net interest income, interest spread, and net interest margin are sensitive to general business and economic conditions. These conditions include short-term and long-term interest rates, inflation, monetary supply, and the strength of the economy, in general, and the local economies in which we conduct business. Our ability to manage the net interest income during changing interest rate environments will have a significant impact on our overall performance. We manage net interest income by affecting changes in the mix of earning assets as well as the mix of interest-bearing liabilities, changes in the level of interest-bearing liabilities in proportion to earning assets, and in the growth of earning assets.

 

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For the first quarter ended March 31, 2011, our net interest income, before provision for credit losses, totaled $57.1 million. This represented a decrease of $16.2 million, or 22.13%, over net interest income of $73.3 million for the same period in 2010. The decrease in net interest income was due to a decrease in interest expense of $7.8 million offset by a decrease in interest income of $24.0 million.
Interest income totaled $66.5 million for the first quarter of 2011. This represented a decrease of $24.0 million, or 26.55%, compared to total interest income of $90.6 million for the same period last year. Interest income on loans decreased by $16.5 million for the first quarter of 2011 compared to the same period last year. Included in first quarter of 2011 interest income is $1.9 million discount accretion on covered loans acquired from SJB, compared to $13.4 million for the first quarter of 2010. Interest income on investment securities also decreased by $7.9 million for the first quarter of 2011 compared to the same period last year.
Interest expense totaled $9.4 million for the first quarter of 2011. This represented a decrease of $7.8 million or 45.37%, from total interest expense of $17.2 million for the same period last year. The decrease in interest expense was due to the decrease in average borrowings of $406.0 million, or 26.35%. The average rate paid on interest-bearing liabilities decreased to 0.94% for the first quarter ending March 31, 2011 from 1.52% for the same period in 2010 or 58 basis points. The average cost of deposits decreased to 0.25% for the first quarter ending March 31, 2011 from 0.48% for the same period in 2010, or 23 basis points.
Table 1 shows the average balances of assets, liabilities, and stockholders’ equity and the related interest income, expense, and yields/rates for the three-month periods ended March 31, 2011 and 2010. Yields for tax-preferenced investments are shown on a taxable equivalent basis using a 35% tax rate.

 

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TABLE 1 — Distribution of Average Assets, Liabilities, and Stockholders’ Equity; Interest Rates and Interest Differentials
                                                 
    Three-month period ended March 31,  
    2011     2010  
    Average             Average     Average             Average  
    Balance     Interest     Yield/Rate     Balance     Interest     Yield/Rate  
    (dollar amounts in thousands)  
ASSETS
                                               
 
Investment Securities
                                               
Taxable
  $ 1,249,471     $ 8,839       2.84 %   $ 1,428,338     $ 16,084       4.50 %
Tax preferenced (1)
    609,993       5,919       5.50 %     659,980       6,532       5.59 %
Investment in FHLB stock
    86,591       65       0.30 %     97,582       66       0.27 %
Federal Funds Sold & Interest Bearing
                                               
Deposits with other institutions (5)
    431,439       374       0.35 %     181,421       102       0.22 %
Loans HFS
    3,460       20       2.34 %     2,143       18       3.41 %
Loans (2) (3)
    3,791,540       49,344       5.28 %     4,200,708       54,372       5.25 %
Yield adjustment to interest income from discount accretion
    (112,953 )     1,951             (188,812 )     13,378        
 
                                   
Total Earning Assets (5)
    6,059,541       66,512       4.60 %     6,381,360       90,552       5.90 %
Total Non Earning Assets
    462,025                       456,367                  
 
                                           
Total Assets
  $ 6,521,566                     $ 6,837,727                  
 
                                           
 
                                               
LIABILITIES AND STOCKHOLDERS’ EQUITY
                                               
 
                                               
Savings Deposits (4)
  $ 1,745,660     $ 1,636       0.38 %   $ 1,664,774     $ 2,730       0.67 %
Time Deposits
    1,027,962       1,152       0.45 %     1,240,528       2,558       0.84 %
 
                                       
Total Deposits
    2,773,622       2,788       0.41 %     2,905,302       5,288       0.74 %
Other Borrowings
    1,249,571       6,615       2.12 %     1,655,551       11,925       2.88 %
 
                                       
Interest Bearing Liabilities
    4,023,193       9,403       0.94 %     4,560,853       17,213       1.52 %
 
                                       
Non-interest bearing deposits
    1,790,839                       1,574,633                  
Other Liabilities
    55,690                       53,150                  
Stockholders’ Equity
    651,844                       649,091                  
 
                                           
Total Liabilities and Stockholders’ Equity
  $ 6,521,566                     $ 6,837,727                  
 
                                           
 
                                               
Net interest income
          $ 57,109                     $ 73,339          
 
                                           
Net interest income excluding discount
            55,158                       59,961          
 
                                           
 
                                               
Net interest spread — tax equivalent
                    3.66 %                     4.38 %
Net interest spread — tax equivalent excluding discount
                    3.45 %                     3.39 %
Net interest margin
                    3.82 %                     4.65 %
Net interest margin — tax equivalent
                    3.98 %                     4.82 %
Net interest margin — tax equivalent excluding discount
                    3.78 %                     3.86 %
Net interest margin excluding loan fees
                    3.78 %                     4.60 %
Net interest margin excluding loan fees — tax equivalent
                    3.94 %                     4.77 %
 
     
(1)  
Non tax-equivalent rate was 3.17% for 2011, 4.33% for 2010
 
(2)  
Loan fees are included in total interest income as follows, (000)s omitted: 2011, $524; 2010, $752
 
(3)  
Non-performing, non-covered loans are included in net loans as follows: 2011, $108.2 million; 2010, $76.8 million (4) Includes interest bearing demand and money market accounts
 
(5)  
For the three month periods ended March 31, 2011 through September 30, 2009, Federal Funds Sold and Interest Bearing Deposits with Other Institutions as well as Total Earning Assets were revised to include the average amount of the interest bearing balances due from the Federal Reserve. As a result, all previously reported net interest spread and net interest margin ratios were revised as follows:
                                                 
                                    Net Interest Margin  
    Net Interest Spread     Net Interest Margin     (TE) excluding  
    (TE)     (TE)     discount  
    Prior     Revised     Prior     Revised     Prior     Revised  
Three months ended 03/31/11
    3.66 %     3.66 %     3.98 %     3.98 %     3.78 %     3.78 %
Three months ended 12/31/10
    3.92 %     3.68 %     4.24 %     4.03 %     3.84 %     3.66 %
Three months ended 09/30/10
    3.98 %     3.72 %     4.32 %     4.11 %     3.92 %     3.73 %
Three months ended 06/30/10
    4.03 %     3.76 %     4.39 %     4.18 %     3.99 %     3.80 %
Three months ended 03/31/10
    4.54 %     4.38 %     4.95 %     4.82 %     3.96 %     3.86 %
Three months ended 12/31/09
    3.28 %     3.18 %     3.80 %     3.73 %     3.80 %     3.73 %
Three months ended 09/30/09
    3.22 %     3.17 %     3.75 %     3.72 %     3.75 %     3.72 %
As stated above, the net interest margin measures net interest income as a percentage of average earning assets. Our tax effected (TE) net interest margin for the first quarter of 2011 was 3.98%, compared to 4.82% for the first quarter of 2010. The decrease in the net interest margin over the same period last year is primarily the result of changes in the mix of assets and liabilities as discussed in the following paragraphs plus $11.4 million decrease in discount accretion on covered SJB loans which impacted interest income on loans. Generally, our net interest margin improves in a decreasing interest rate environment as our deposits and borrowings reprice much faster than our loans and securities.

 

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The net interest spread is the difference between the yield on average earning assets and the cost of average interest-bearing liabilities. The net interest spread is an indication of our ability to manage rates received on loans and investments and rates paid on deposits and borrowings in a competitive and changing interest rate environment. For the first quarter of 2011, the Company’s net interest spread (TE) was 3.66% as compared to 4.38% for the same period last year. The decrease in net interest spread for the first quarter ended March 31, 2011 resulted from a 130 basis point decrease in yield on earning assets and a 58 basis point decrease in the cost of interest-bearing liabilities, thus generating a 72 basis point decrease in the net interest spread from the same period last year.
The net interest spread was negatively impacted by the $11.4 million decrease in discount accretion on covered SJB loans recognized as a yield adjustment to interest income.
For the first quarter of 2011, the yield (TE) on earning assets decreased to 4.60%, from 5.90% for the same period last year. The cost of average interest-bearing liabilities decreased to 0.94% for the first quarter of 2011 as compared to 1.52% for the same period in 2010. The changes reflect the decreasing interest rate environment and change in mix of earning assets and interest-bearing liabilities, reflecting similar trends as described above.
Table 2 presents a comparison of interest income and interest expense resulting from changes in the volumes and rates on average earning assets and average interest-bearing liabilities for the periods indicated. Changes in interest income or expense attributable to volume changes are calculated by multiplying the change in volume by the initial average interest rate. The change in interest income or expense attributable to changes in interest rates is calculated by multiplying the change in interest rate by the initial volume. The changes attributable to both interest rate and volume changes are calculated by multiplying the change in rate times the change in volume.
TABLE 2 —  
Rate and Volume Analysis for Changes in Interest Income, Interest Expense and Net Interest Income
                                 
    Comparison of three months ended March 31,  
    2011 Compared to 2010  
    Increase (Decrease) Due to  
                    Rate/        
    Volume     Rate     Volume     Total  
    (amounts in thousands)  
Interest Income:
                               
Taxable investment securities
  $ (2,070 )   $ (5,928 )   $ 753     $ (7,245 )
Tax-advantaged securities
    (699 )     66       20       (613 )
Fed funds sold & interest-bearing deposits with other institutions
    138       59       75       272  
Investment in FHLB stock
    (7 )     7       (1 )     (1 )
Loans HFS
    11       (6 )     (3 )     2  
Loans
    (5,297 )     311       (42 )     (5,028 )
Yield adjustment to interest income from discount accretion
    (5,376 )     (10,117 )     4,066       (11,427 )
 
                       
Total interest on earning assets
    (13,300 )     (15,608 )     4,868       (24,040 )
 
                       
 
                               
Interest Expense:
                               
Savings deposits
    134       (1,190 )     (38 )     (1,094 )
Time deposits
    (440 )     (1,193 )     227       (1,406 )
Other borrowings
    (2,923 )     (3,146 )     759       (5,310 )
 
                       
Total interest on interest-bearing liabilities
    (3,229 )     (5,529 )     948       (7,810 )
 
                       
 
                               
Net Interest Income
  $ (10,071 )   $ (10,079 )   $ 3,920     $ (16,230 )
 
                       

 

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Interest and Fees on Loans
Our major source of revenue and primary component of interest income is interest and fees on loans. Interest and fees on loans totaled $51.3 million for the first three months of 2011. This represented a decrease of $16.5 million, or 24.28%, from interest and fees on loans of $67.8 million for the same period in 2010. The decrease in interest on loans was primarily due to a decrease in the average loans outstanding, and a decrease in accelerated discount accretion on covered loans acquired from SJB. Average loans decreased $333.3 million, or 8.31%, from $4.01 billion for the first three months of 2010 to $3.68 billion for the first three months of 2011. In addition, the discount accretion on covered loans acquired from SJB was $2.0 million in the first quarter of 2011 compared to $13.4 million for the same period in 2010. This amount represents the discount recognized from accelerated principal payments on SJB loans. It is recorded as a yield adjustment to interest income. As a result, the yield on loans decreased to 5.65% for the first three months of 2011, compared to 6.85% for the same period in 2010.
In general, we stop accruing interest on a loan after its principal or interest becomes 90 days or more past due. When a loan is placed on nonaccrual, all interest previously accrued but not collected is charged against earnings. There was no interest income that was accrued and not reversed on non-performing non-covered loans at March 31, 2011 and 2010.
Fees collected on loans are an integral part of the loan pricing decision. Loan fees and the direct costs associated with the origination of loans are deferred and deducted from the loan balance. Deferred net loan fees are recognized in interest income over the term of the loan using the effective-yield method. We recognized loan fee income of $524,000 for the first three months of 2011, as compared to $752,000 for the same period in 2010, a decrease of $228,000 or 30.40%.
Interest on Investments
The second most important component of interest income is interest on investments, which totaled $14.8 million for the first three months of 2011. This represented a decrease of $7.9 million, or 34.74%, from interest on investments of $22.6 million for the same period in 2010. The decrease in interest on investments for the three months of 2011 from the same period last year was the result of a decrease in yield on investments and a decrease in average investments. The interest rate environment and the investment strategies we employ directly affect the yield on the investment portfolio. We continually adjust our investment strategies in response to the changing interest rate environment in order to maximize the rate of total return consistent within prudent risk parameters, and to minimize the overall interest rate risk of the Company. The total yield (TE) on investments decreased to 3.72% for the first three months of 2011 compared to 4.85% for the first three months of 2010. Average investment balances for the first three months for 2011 decreased $228.9 million, or 10.96% from the same period last year.
Interest on Deposits
For the first quarter of 2011, interest on deposits totaled $2.8 million. This represented a decrease of $2.5 million, or 47.28%, from interest on deposits of $5.3 million for the same period in 2010. The decrease is due to the decrease in interest rates on deposits plus a decrease in average interest-bearing deposits of $131.7 million, or 4.53%, from the same period last year. The cost of interest-bearing deposits decreased to 0.41% for the first quarter of 2011 from 0.74% for the first quarter of 2010. The cost of total deposits decreased to 0.25% for the first quarter of 2011 from 0.48% for the first quarter of 2010.

 

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Interest on Borrowings
For the first quarter of 2011, interest on borrowings totaled $6.6 million. This represented a decrease of $5.3 million, or 44.53%, from interest on borrowings of $11.9 million for the same period of 2010. The decrease is due to the decrease in interest rates paid on borrowings and a decrease in average borrowings. Interest rates on borrowings decreased 76 basis points, from 2.88% for the first quarter of 2010 to 2.12% for the first quarter of 2011. Average borrowings decreased $406.0 million, or 24.52%.
Provision for Credit Losses
We maintain an allowance for inherent credit losses that is increased by a provision for credit losses charged against operating results. The provision for credit losses is determined by management as the amount to be added to the allowance for probable credit losses after net charge-offs have been deducted to bring the allowance to an adequate level which, in management’s best estimate, is necessary to absorb probable credit losses within the existing loan portfolio.
We made a provision for credit losses of $7.1 million during the first three months of 2011 and $12.2 million during the same period in 2010. We continue to make provisions for credit losses based on historical losses and current economic indicators. We believe the allowance is appropriate as of the end of the period covered by this report. We continually assess the quality of our portfolio to determine whether additional provision for credit losses is necessary. We anticipate future provisions will be required to account for probable credit losses. The ratio of the allowance for credit losses to total non-covered loans as of March 31, 2011 and 2010 was 3.11% and 3.20%, respectively.
No assurance can be given that economic conditions which adversely affect the Company’s service areas, past credit loss experience, the characteristics of our loan portfolio or other circumstances will not be reflected in increased provisions for credit losses in the future. The nature of this process requires considerable judgment. Net charge-offs totaled $11.3 million for the first three months of 2011 and $8.8 million during the same period of 2010. See “Risk Management — Credit Risk” herein.
Other Operating Income
Other operating income for the Company includes income derived from special services offered by the Bank, such as CitizensTrust, merchant card, international banking, and other business services. Also included in other operating income are service charges and fees, primarily from deposit accounts; gains (net of losses) from the sale of investment securities, other real estate owned, and fixed assets; and other revenues not included as interest on earning assets.
We reported other operating income of $10.0 million for the first three months of 2011, compared to other operating income of $(2.2) million during the same period of 2010. This represents an increase of $12.2 million, primarily due to a $10.6 million reduction in the FDIC loss sharing asset during the first three months of 2010.
During the first three months of 2011, we reported increases in trust and investment services income and bankcard services income compared to the same period last year. Service charge fee income of $3.7 million for the three months ended March 31, 2011 decreased $541,000, or 12.69%, from service charge fee income of $4.3 million for the same period last year. Trust and investment services income of $2.2 million during the first three months of 2011 increased $34,000, or 1.61%, over trust and investment service income of $2.1 million during the first three months of 2010, and a $1.4 million increase in the FDIC loss sharing asset.

 

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Other Operating Expenses
Other operating expenses for the Company include expenses for salaries and benefits, occupancy, equipment, stationary and supplies, professional services, amortization of intangibles, and other expenses. Other operating expenses totaled $36.3 million for the first three months of 2011. This represents an increase of $383,000 million, or 1.07% over other operating expenses of $35.9 million for the same period in 2010. We also had a decrease in salaries and employee expenses of $413,000, or 2.29%. In addition, professional services expenses were up $803,000, or 28.61%, compared to the same period last year, primarily due to legal expenses related to the management and collection of credit-impaired loans acquired from the acquisition of SJB, the management and collection of CBB legacy non-accrual loans, and legal expenses related to the SEC investigation.
At March 31, 2011, we employed 763 full-time equivalent employees, compared to 740 full-time equivalent employees at March 31, 2010.
For the most part, other operating expenses reflect the direct expenses and related administrative expenses associated with staffing, maintaining, promoting, and operating branch facilities. Our ability to control other operating expenses in relation to asset growth can be measured in terms of other operating expenses as a percentage of average assets. Operating expenses measured as a percentage of average assets was 2.26% and 2.13% for the first three months of 2011 and 2010, respectively.
Our ability to control other operating expenses in relation to the level of net revenue (net interest income after provision for credit losses plus other operating income) is measured by the efficiency ratio and indicates the percentage of net revenue that is used to cover expenses. For the first three months of 2011, the efficiency ratio was 60.49%, compared to a ratio of 60.96% for the same period in 2010. The efficiency ratio, before the provision for credit losses, was 54.12% for the first three months of 2011 and 50.50% for the first three months of 2010. The increase in the efficiency ratio was primarily due higher other operating income partially offset by lower net interest income (after provision).
Income Taxes
The Company’s effective tax rate for the three months of 2011 was 30.00%, compared to 29.94% for the same period in 2010. The effective tax rates are below the nominal combined Federal and State tax rates as a result of the tax-preferenced income from certain investments and municipal loans/leases as a percentage of total income for each period. The majority of tax preferenced income is derived from municipal securities.
RESULTS BY BUSINESS SEGMENTS
We have two reportable business segments: Business Financial and Commercial Banking Centers, and Treasury. The results of these two segments are included in the reconciliation between business segment totals and our consolidated total. Our business segments do not include the results of administration units that do not meet the definition of an operating segment.

 

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Business Financial and Commercial Banking Centers
Key measures we use to evaluate the Business Financial and Commercial Banking Center’s performance are included in the following table for the three months ended March 31, 2011 and 2010. The table also provides additional significant segment measures useful to understanding the performance of this segment.
                 
    Three months ended  
    March 31,  
    2011     2010  
    (amounts in thousands)  
Key Measures:
               
Statement of Operations
               
Interest income
  $ 45,465     $ 59,575  
Interest expense
    4,554       10,157  
 
           
Net Interest Income
  $ 40,911     $ 49,418  
 
           
Non-interest income
    5,212       5,604  
Non-interest expense
    12,631       13,132  
 
           
Segment pretax profit
  $ 33,492     $ 41,890  
 
           
Balance Sheet
               
Average loans
  $ 2,698,124     $ 2,857,110  
Average interest-bearing deposits and customer repos
  $ 3,109,420     $ 3,172,430  
Yield on loans
    5.93 %     6.01 %
Rate paid on interest-bearing deposits and customer repos
    0.43 %     0.85 %
     
(1)  
Interest income and interest expense include credit for funds provided and charge for funds used, respectively. These are eliminated in the consolidated presentation.
 
(2)  
Yield on loans excludes SJB discount accretion as this is accounted for at the Corporate level.
For the three months ended March 31, 2011, segment profit decreased by $8.4 million, or 20.05%, compared to the same period last year. This was primarily due to the decrease in net interest income of $8.5 million, or 17.21%, due to decreases in loan balances. Average loan balances decreased $159.0 million or 5.56%, from the same period last year. This decrease also included a decrease in loan yield of 8 basis points. Rates paid on deposits decreased 42 basis points, while average interest-bearing deposits and customer repos decreased $63.0 million, or 1.99%. Non-interest income decreased by $392,000, or 7.00%, compared to the first three months of 2010. Non-interest expense decreased $501,000, or 3.82%, compared to the same period last year. Certain average loans and deposits in the quarter ended March 31, 2010 were reclassified between segments to be consistent with the quarter ended March 31, 2011 presentation.

 

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Treasury
Key measures we use to evaluate the Treasury’s performance are included in the following table for the three months ended March 31, 2011 and 2010. The table also provides additional significant segment measures useful to understanding the performance of this segment.
                 
    Three months ended  
    March 31,  
    2011     2010  
    (amounts in thousands)  
Key Measures:
               
Statement of Operations
               
Interest income
  $ 15,221     $ 22,804  
Interest expense
    13,593       18,763  
 
           
Net Interest Income
  $ 1,628     $ 4,041  
 
           
Non-interest income (expense)
          (685 )
Non-interest expense
    216       380  
 
           
Segment pretax profit
  $ 1,412     $ 2,976  
 
           
Balance Sheet
               
Average investments
  $ 2,377,494     $ 2,367,321  
Average interest-bearing deposits
  $ 240,001     $ 238,612  
Average borrowings
  $ 1,134,516     $ 1,540,496  
Yield on investments-TE
    3.72 %     4.85 %
Non-tax equivalent yield
    3.17 %     4.33 %
Rate paid on borrowings
    2.04 %     2.89 %
For the quarter ended March 31, 2011, segment profit decreased by $1.6 million over the same period last year. This was primarily due to a decrease in net interest income of $2.4 million, or 59.71%, from $4.0 million as of March 31, 2010. Certain average loans and deposits in the quarter ended March 31, 2010 were reclassified between segments to be consistent with the quarter ended March 31, 2011 presentation.
There are no provisions for credit losses or taxes in the segments as these are accounted for at the corporate level.
Other
                 
    Three months ended  
    March 31,  
    2011     2010  
    (amounts in thousands)  
Key Measures:
               
Statement of Operations
               
Interest income
  $ 14,540     $ 32,012  
Interest (income) expense
    (30 )     12,132  
 
           
Net interest income
  $ 14,570     $ 19,880  
 
           
Provision for Credit Losses
    7,068       12,200  
Non-interest income (expense)
    4,766       (7,130 )
Non-interest expense
    23,458       22,410  
 
           
Pre-tax loss
  $ (11,190 )   $ (21,860 )
 
           
 
               
Balance Sheet
               
Average loans
  $ 983,923     $ 1,156,929  
Average interest-bearing deposits and customer repos
  $ 522     $ 63,401  
Yield on loans
    4.89 %     8.92 %
The Company’s administration and other operating departments reported pre-tax loss of $11.2 million for the first three months of 2011. This represents a decrease of pre-tax loss of $10.7 million or 48.81%, from a pre-tax loss of $21.9 million for the same period in 2010. The decrease in pre-tax loss is primarily attributed to a decrease in net interest income of $5.3 million which is primarily due to the $11.4 million decrease in discount accretion on SJB loans plus non-interest expense also increased $1.0 million primarily due to higher legal expenses as discussed above. This was partially offset by increase in non-interest income of $11.9 million which is primarily due to the increase in the FDIC loss sharing asset of $12.0 million. Certain average loans and deposits in the quarter ended March 31, 2010 were reclassified between segments to be consistent with the quarter ended March 31, 2011 presentation.

 

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ANALYSIS OF FINANCIAL CONDITION
The Company reported total assets of $6.50 billion at March 31, 2011. This represented an increase of $61.7 million, or 0.96%, from total assets of $6.44 billion at December 31, 2010. This increase was primarily due to a an increase in investment securities of $225.9 million, partially offset by a decrease in loans of $149.3 million and a $20.3 million decrease in the FDIC loss sharing asset. Earning assets totaled $5.76 billion at March 31, 2011. This represented an increase of $73.7 million, or 1.30%, from total earning assets of $5.68 billion at December 31, 2010, due to an increase in investments partially offset by a decrease in loans. Total liabilities were $5.84 billion at March 31, 2011, an increase of $50.9 million, or 0.88%, over total liabilities of $5.79 billion at December 31, 2010. Total equity increased $10.7 million, or 1.67%, to $654.6 million at March 31, 2011, compared with total equity of $643.9 million at December 31, 2010.
Investment Securities
The Company reported total investment securities of $2.02 billion at March 31, 2011. This represented an increase of $225.9 million, or 12.59%, from total investment securities of $1.79 billion at December 31, 2010. Investment securities comprise 35.10% of the Company’s total earning assets at March 31, 2011.
Securities held as “available-for-sale” are reported at fair value for financial reporting purposes. The related unrealized gains or losses, net of income taxes, are recorded in stockholders’ equity. At March 31, 2011, securities held as available-for-sale had a fair value of $2.02 billion, representing 99.85% of total investment securities, with an amortized cost of $2.00 billion. At March 31, 2011, the net unrealized holding gain on securities available-for-sale was $15.4 million and that resulted in accumulated other comprehensive income of $8.7 million (net of $6.7 million in deferred taxes). At December 31, 2010, the Company reported net unrealized gain on investment securities available-for-sale of $11.1 million and accumulated other comprehensive income of $6.2 million (net of deferred taxes of $4.9 million).
Table 3 sets forth investment securities available-for-sale at March 31, 2011 and December 31, 2010.
Table 3 — Composition of Investment Securities
(amounts in thousands)
                                 
    March 31, 2011     December 31, 2010  
                  Total  
    Fair Value     Total Percent     Fair Value     Percent  
Investment Securities Available-for-Sale:
                               
Mortgage-backed securities
  $ 892,495       44.24 %   $ 808,409       45.12 %
CMO’s / REMIC’s
    418,887       20.76 %     270,477       15.10 %
Government agency
    85,970       4.26 %     106,273       5.93 %
Municipal bonds
    620,176       30.74 %     606,399       33.85 %
 
                       
Total Investment Securities
  $ 2,017,528       100.00 %   $ 1,791,558       100.00 %
 
                       
The weighted-average yield (TE) on the investment portfolio at March 31, 2011 was 3.72% with a weighted-average life of 4.3 years. This compares to a yield of 3.62% at December 31, 2010 with a weighted-average life of 4.6 years and a yield of 4.85% at March 31, 2010 with a weighted-average life of 4.7 years. The weighted average life is the average number of years that each dollar of unpaid principal due remains outstanding. Average life is computed as the weighted-average time to the receipt of all future cash flows, using as the weights the dollar amounts of the principal paydowns.

 

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Approximately 69% of the available-for-sale portfolio represents securities issued by the U.S government or U.S. government-sponsored enterprises, which guarantee payment of principal and interest.
The remaining CMO/REMICs are backed by agency-pooled collateral or whole loan collateral. All non-agency available-for-sale CMO/REMIC issues held are rated investment grade or better by either Standard & Poor’s or Moody’s, as of March 31, 2011 and December 31, 2010.
Composition of the Fair Value and Gross Unrealized Losses of Securities:
                                                 
    March 31, 2011  
    Less than 12 months     12 months or longer     Total  
            Gross             Gross             Gross  
            Unrealized             Unrealized             Unrealized  
            Holding             Holding             Holding  
Description of Securities   Fair Value     Losses     Fair Value     Losses     Fair Value     Losses  
    (amounts in thousands)  
Held-To-Maturity
                                               
CMO
  $     $     $ 3,039     $ 288     $ 3,039     $ 288  
 
                                   
Available-for-Sale
                                               
Government agency
  $ 79,440     $ 404     $     $     $ 79,440     $ 404  
Mortgage-backed securities
    453,643       6,846                   453,643       6,846  
CMO/REMICs
    162,094       1,402                   162,094       1,402  
Municipal bonds
    168,299       5,088       5,599       888       173,898       5,976  
 
                                   
 
  $ 863,476     $ 13,740     $ 5,599     $ 888     $ 869,075     $ 14,628  
 
                                   
                                                 
    December 31, 2010  
    Less than 12 months     12 months or longer     Total  
            Gross             Gross             Gross  
            Unrealized             Unrealized             Unrealized  
            Holding             Holding             Holding  
Description of Securities   Fair Value     Losses     Fair Value     Losses     Fair Value     Losses  
    (amounts in thousands)  
Held-To-Maturity
                                               
CMO (1)
  $     $     $ 3,143     $ 401     $ 3,143     $ 401  
 
                                   
Available-for-Sale
                                               
Government agency
  $ 79,635     $ 214     $     $     $ 79,635     $ 214  
Mortgage-backed securities
    449,806       6,366                   449,806       6,366  
CMO/REMICs
    144,234       1,379                   144,234       1,379  
Municipal bonds
    225,928       8,844       5,585       899       231,513       9,743  
 
                                   
 
  $ 899,603     $ 16,803     $ 5,585     $ 899     $ 905,188     $ 17,702  
 
                                   
     
(1)  
For 2010, the Company recorded a $587,000 charge, on a pre-tax basis, of the non-credit portion of OTTI for this security in other comprehensive income, which is included as gross unrealized losses.
The tables above show the Company’s investment securities’ gross unrealized losses and fair value by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2011 and December 31, 2010. The Company has reviewed the individual securities to determine whether a decline in fair value below the amortized cost basis is other-than-temporary. A summary of our analysis of these securities and the unrealized losses is described more fully in Note 2 — Investment Securities in the notes to the consolidated financial statements. Economic trends may adversely affect the value of the portfolio of investment securities that we hold.
During the first three months of 2010, the Company recognized an other-than-temporary impairment on the held-to-maturity investment security. The credit-impairment loss of $685,000 was recognized as an offset to other operating income. We recognized no other-than-temporary impairment loss in the first quarter of 2011.

 

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Loans
At March 31, 2011, we reported total loans, net of deferred loan fees, of $3.60 billion. This represents a decrease of $149.3 million, or 3.98%, from total loans, net of deferred loan fees, of $3.75 billion at December 31, 2010. We attribute a significant portion of the decrease to the following:
   
$51.9 million to the non-covered dairy and livestock portfolio. Historically, dairies tend to seasonally draw down on available lines of credit in the fourth quarter and repay these advances in the first quarter.
   
$42.9 million in note sales related to our former largest borrower.
   
$25.3 million from working down problem assets acquired from SJB.
We also experienced a $15.4 million decline in non-covered construction loans and a $11.3 million decline in purchased mortgage pool loans. These two areas are considered non-core lending niches. Our core lending strategy is focused on commercial & industrial business lending, dairy/livestock/agribusiness lending and commercial real estate loans.
We continue to see moderate loan demand in our market areas as a result of the weakness in the state and local economies. Many of our business owner clients are hesitating to invest in new equipment, buildings, or employees until they see stronger signs of economic recovery and stability.
Total loans, net of deferred loan fees, comprise 62.53% of our total earning assets. The following tables present our loan portfolio, excluding held for sale loans, segregated into covered versus non-covered loans, by category as of March 31, 2011 and December 31, 2010.
Table 4 — Distribution of Loan Portfolio by Type (Dollar amounts in thousands)
                         
    March 31, 2011  
    Non-Covered              
    Loans     Covered Loans     Total  
Commercial and Industrial
  $ 456,040     $ 34,276     $ 490,316  
Real Estate:
                       
Construction
    109,540       60,022       169,562  
Commercial Real Estate
    1,966,589       288,658       2,255,247  
SFR Mortgage
    205,583       4,862       210,445  
Consumer
    51,818       9,804       61,622  
Municipal lease finance receivables
    122,422       475       122,897  
Auto and equipment leases, net of unearned discount
    17,399             17,399  
Dairy and Livestock
    325,052             325,052  
Agribusiness
    885       48,779       49,664  
 
                 
Gross Loans
  $ 3,255,328     $ 446,876     $ 3,702,204  
 
                       
Less: Purchase Accounting Discount
          (98,117 )     (98,117 )
Less: Deferred net loan fees
    (5,640 )           (5,640 )
 
                 
Gross loans, net of deferred loan fees
  $ 3,249,688     $ 348,759     $ 3,598,447  
Less: Allowance for credit losses
    (101,067 )           (101,067 )
 
                 
Net Loans
  $ 3,148,621     $ 348,759     $ 3,497,380  
 
                 
 
                       
Allowance for Credit Losses as a % of Loans, net of deferred loan fees
    3.11 %                

 

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    December 31, 2010  
    Non-Covered              
    Loans     Covered Loans     Total  
Commercial and Industrial
  $ 460,399     $ 39,587     $ 499,986  
Real Estate:
                       
Construction
    138,980       84,498       223,478  
Commercial Real Estate
    1,980,256       292,014       2,272,270  
SFR Mortgage
    218,467       5,858       224,325  
Consumer
    56,747       10,624       67,371  
Municipal lease finance receivables
    128,552       576       129,128  
Auto and equipment leases, net of unearned discount
    17,982             17,982  
Dairy and Livestock/Agribusiness
    376,143             376,143  
Agribusiness
    1,686       55,618       57,304  
 
                 
Gross Loans
  $ 3,379,212     $ 488,775     $ 3,867,987  
 
                       
Less: Purchase Accounting Discount
          (114,763 )     (114,763 )
Less: Deferred net loan fees
    (5,484 )           (5,484 )
 
                 
Gross loans, net of deferred loan fees
  $ 3,373,728     $ 374,012     $ 3,747,740  
Less: Allowance for credit losses
    (105,259 )           (105,259 )
 
                 
Net Loans
  $ 3,268,469     $ 374,012     $ 3,642,481  
 
                 
 
                       
Allowance for Credit Losses as a % of Loans, net of deferred loan fees
    3.12 %                
Commercial and industrial loans are primarily loans and leases to commercial entities to finance capital purchases or improvements, or to provide cash flow for operations. Real estate loans are loans secured by trust deeds on real property, including property under construction, commercial property and single family and multifamily residences. Consumer loans include installment loans to consumers as well as home equity loans and other loans secured by junior liens on real property. Municipal lease finance receivables provide financing to municipalities, school districts, and other special districts. Auto and equipment leases provide financing to both commercial entities as well as consumers. Dairy and livestock/agribusiness loans are loans to finance the operating needs of wholesale dairy farm operations, cattle feeders, livestock raisers, and farmers.
Our loan portfolio is from a variety of areas throughout our marketplace. The following is the breakdown of our total non-covered loans and commercial real estate loans by region as of March 31, 2011.
                                 
    March 31, 2011  
                    Non-Covered  
Non-Covered                   Commercial  
Loans by Market Area   Total Non-Covered Loans     Real Estate Loans  
    (amounts in thousands)  
Los Angeles County
  $ 1,102,224       33.9 %   $ 704,905       35.8 %
Inland Empire
    648,417       19.9 %     550,713       28.0 %
Central Valley
    573,659       17.6 %     328,728       16.7 %
Orange County
    504,638       15.5 %     208,141       10.6 %
Other Areas
    426,390       13.1 %     174,102       8.9 %
 
                       
 
  $ 3,255,328       100.0 %   $ 1,966,589       100.0 %
 
                       

 

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    March 31, 2011  
Covered Loans                   Covered Commercial  
Loans by Market Area   Total Covered Loans     Real Estate Loans  
    (amounts in thousands)  
Los Angeles County
  $ 16,531       3.7 %   $ 3,011       1.0 %
Inland Empire
    2,943       0.6 %     174       0.1 %
Central Valley
    342,598       76.7 %     224,467       77.8 %
Orange County
    2,584       0.6 %           0.0 %
Other Areas (1)
    82,220       18.4 %     61,006       21.1 %
 
                       
 
  $ 446,876       100.0 %   $ 288,658       100.0 %
 
                       
     
(1)  
Other areas include church and hotel loans that are out-of-state or in other areas of California
Of particular concern in the current credit and economic environments is our real estate and real estate construction loans. Our real estate loans are comprised of single-family residences, multifamily residences, industrial, office and retail. We strive to have a maximum loan-to-value ratio of 65-75% at loan origination. This table breaks down our real estate portfolio, with the exception of construction loans, which are discussed in greater detail below.
                                 
    March 31, 2011  
                    Percent     Average  
Non-Covered Real Estate Loans                   Owner-     Loan  
(amounts in thousands)   Loan Balance     Percent     Occupied (1)     Balance  
Single Family-Direct
  $ 46,716       2.2 %     100.0 %   $ 349  
Single Family-Mortgage Pools
    158,867       7.3 %     100.0 %     303  
Multifamily
    115,851       5.3 %     0.0 %     1,044  
Industrial
    639,884       29.5 %     35.4 %     880  
Office
    371,297       17.1 %     25.4 %     964  
Retail
    272,465       12.5 %     11.6 %     1,206  
Medical
    141,235       6.5 %     38.2 %     1,811  
Secured by Farmland
    161,506       7.4 %     100.0 %     2,153  
Other
    264,351       12.2 %     53.0 %     1,041  
 
                           
 
  $ 2,172,172       100.0 %     42.1 %     864  
 
                           
     
(1)  
Represents percentage of owner-occupied in each real estate loan category
In the table above, Single Family-Direct represents those single-family residence loans that we have made directly to our customers. These loans totaled $46.7 million at March 31, 2011. In addition, we have purchased pools of owner-occupied single-family loans from real estate lenders totaling $158.9 million at March 31, 2011. These loans were purchased with FICO scores predominantly ranging from 700 to over 800 and original loan-to-value ratios of 60% to 80%. These pools were purchased to diversify our loan portfolio since we make few single-family loans. Due to market conditions, we have not purchased any mortgage pools since August 2007.

 

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The table below provides a breakdown of our covered real estate loans, with the exception of construction loans, which are discussed in greater detail below.
                         
    March 31, 2011  
Covered Real Estate Loans                   Average Loan  
(amounts in thousands)   Loan Balance     Percent     Balance  
Single Family-Direct
  $ 4,862       1.7 %   $ 270  
Multifamily
    7,697       2.6 %     962  
Industrial
    54,806       18.7 %     751  
Office
    27,743       9.5 %     495  
Retail
    37,962       12.9 %     904  
Medical
    27,385       9.3 %     1,191  
Secured by Farmland
    1,460       0.5 %     292  
Secured by Hotels
    49,557       16.9 %     3,097  
Church Loans
    42,197       14.4 %     1,563  
Other
    39,851       13.5 %     569  
 
                 
 
  $ 293,520       100.0 %     868  
 
                 
As of March 31, 2011, the Company had $169.6 million in construction loans, both non-covered and covered. This represents 4.6% of gross loans outstanding of $3.70 billion. The following table presents a break-down of our non-covered construction loans by county and type.
                                                 
    March 31, 2011  
Non-Covered   SFR & Multifamily  
Construction Loans   Land                                      
(amounts in thousands)   Development             Construction             Total          
Inland Empire
  $     0.0 %   $       0.0 %   $       0.0 %
Los Angeles
        0.0 %     9,477       75.4 %     9,477       58.5 %
Central Valley
    1,095       30.1 %     556       4.4 %     1,651       10.2 %
Orange
    135       3.7 %           0.0 %     135       0.8 %
San Diego
    2,408       66.2 %     2,541       20.2 %     4,949       30.5 %
 
                                   
 
  $ 3,638       100.0 %   $ 12,574       100.0 %   $ 16,212       100.0 %
 
                                   
 
                                               
Total Non-Performing
  $ 2,345       64.5 %   $     0.0%     $ 2,345       14.5 %
 
                                   
                                                 
    Commercial  
    Land                                      
    Development             Construction             Total          
Inland Empire
  $ 3,008       18.7 %   $ 26,298       34.0 %   $ 29,306       31.4 %
Los Angeles
    1,559       9.7 %     31,341       40.6 %     32,900       35.2 %
Central Valley
    4,571       28.3 %     5,862       7.6 %     10,433       11.2 %
Orange
          0.0 %           0.0 %           0.0 %
San Diego
          0.0 %           0.0 %           0.0 %
Other (includes out-of-state)
    6,977       43.3 %     13,712       17.8 %     20,689       22.2 %
 
                                   
 
  $ 16,115       100.0 %   $ 77,213       100.0 %   $ 93,328       100.0 %
 
                                   
 
                                               
Total Non-Performing
  $ 14,016       87.0 %   $ 25,960       33.6 %   $ 39,976       42.8 %
 
                                   
Of the $109.5 million in non-covered construction loans, $42.3 million, or 38.64% is non-performing. Approximately 14.80%, or $16.2 million, were loans for single-family residences (“SFR”), residential land loans, and multi-family land development loans. The remaining construction loans, totaling $93.3 million, were related to commercial construction. The average balance of any single construction loan is approximately $2.7 million. Our construction loans are located throughout our marketplace as can be seen in the table above.

 

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The following table presents a break-down of our covered construction loans by county and type.
                                                 
    March 31, 2011  
Covered   SFR & Multifamily  
Construction Loans   Land                                      
(amounts in thousands)   Development             Construction             Total          
Central Valley
  $ 14,955       78.7 %   $ 7,652       80.1 %   $ 22,607       79.2 %
Other (includes out-of-state)
    4,048       21.3 %     1,897       19.9 %     5,945       20.8 %
 
                                   
 
  $ 19,003       100.0 %   $ 9,549       100.0 %   $ 28,552       100.0 %
 
                                   
                                                 
    Commercial  
    Land                                      
    Development             Construction             Total          
Central Valley
  $ 5,612       100.0 %   $ 25,858       100.0 %   $ 31,470       100.0 %
 
                                   
 
  $ 5,612       100.0 %   $ 25,858       100.0 %   $ 31,470       100.0 %
 
                                   
Allowance for Credit Losses
The allowance for credit losses was $101.1 million as of March 31, 2011. This represents a decrease of $4.2 million, or 3.98%, compared to allowance for credit losses of $105.3 million as of December 31, 2010. Activity in the allowance for credit losses was as follows for the first three months of 2011 and for the year ended December 31, 2010.
                 
    March 31,     December 31,  
    2011     2010  
    (amounts in thousands)  
Balance, beginning of year
  $ 105,259     $ 108,924  
Provision charged to operations
    7,068       61,200  
Loans charged off (1)
    (12,038 )     (65,524 )
Recoveries on loans previously charged off
    778       659  
 
           
Balance, end of period
  $ 101,067     $ 105,259  
 
           
Non-performing Assets (Non-Covered)
We had non-covered non-performing assets of $114.4 million at March 31, 2011. Non-performing assets represent 3.52% of total loans and OREO and 1.77% of total assets at March 31, 2011. We had non-performing assets of $162.3 million at December 31, 2010. Non-performing assets include non-accrual loans plus other real estate owned (foreclosed property).
TABLE 5 - Non-Performing Assets
(Non-covered)
                 
  March 31,     December 31,  
  2011     2010  
    (Amounts in thousands)  
Non-accrual loans
  $ 81,687     $ 84,050  
Restructured loans (non-performing)
    26,463       72,970  
Other real estate owned (OREO), net
    6,240       5,290  
 
           
Total non-performing assets
  $ 114,390     $ 162,310  
 
           
 
               
Restructured loans (performing)
  $ 11,925     $ 13,274  
 
Percentage of non-performing assets to total loans outstanding & OREO
    3.51 %     4.80 %
 
               
Percentage of non-performing assets to total assets
    1.76 %     2.52 %

 

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We had loans with a balance of $120.1 million classified as impaired at March 31, 2011. This balance includes the non-performing loans of $108.2 million and loans which were restructured in a troubled debt restructuring with a balance of $38.4 million, of which $26.5 million are non-performing and $11.9 million are performing, as of March 31, 2011. The decrease in impaired loans of $50.2 million over December 31, 2010 is primarily due to the sale of loans related to our former largest borrowing relationship. At December 31, 2010, we had impaired loans with a balance of $170.3 million. Impaired loans were 3.69% of total non-covered loans as of March 31, 2011.
As of March 31, 2011, we had $6.2 million in non-covered OREO compared to $5.3 million as of December 31, 2010, an increase of $950,000. During the first three months of 2011, we added two properties for a total of $1.0 million to OREO. We sold one property with an OREO value of $119,000 for cash proceeds of $101,000. We now have four OREO properties. During the first three months of 2011, the Bank incurred expenses of $1.1 million related to the holding of OREO.
The table below provides trends in our non-covered non-performing assets and delinquencies over the past year.
Non-Performing Assets & Delinquency Trends
(Non-Covered Loans)
                                         
    March 31,     December 31,     September 30,     June 30,     March 31,  
    2011     2010     2010     2010     2010  
Non-Performing Loans
                                       
Residential Construction and Land
  $ 4,001     $ 4,090     $ 5,085     $ 2,789     $ 2,855  
Commercial Construction
    39,976       60,591       71,428       39,114       31,216  
Residential Mortgage
    18,425       17,800       14,543       12,638       13,726  
Commercial Real Estate
    34,950       64,859       56,330       20,639       22,041  
Commercial and Industrial
    7,542       3,936       6,067       7,527       6,879  
Dairy & Livestock
    2,996       5,207       5,176              
Consumer
    260       537       242       143       123  
 
                             
Total
  $ 108,150     $ 157,020     $ 158,871     $ 82,850     $ 76,840  
 
                             
 
                                       
% of Total Loans
    3.33 %     4.65 %     4.65 %     2.36 %     2.19 %
 
                                       
Past Due 30-89 Days
                                       
Residential Construction and Land
  $     $     $     $     $  
Commercial Construction
    1,492                   9,093       8,143  
Residential Mortgage
    993       2,597       2,779       2,552       3,746  
Commercial Real Estate
    898       3,194       1,234       1,966       3,286  
Commercial and Industrial
    239       3,320       2,333       634       2,714  
Dairy & Livestock
                1,406              
Consumer
    9       29       494       139       28  
 
                             
Total
  $ 3,631     $ 9,140     $ 8,246     $ 14,384     $ 17,917  
 
                             
 
                                       
% of Total Loans
    0.11 %     0.27 %     0.24 %     0.41 %     0.51 %
 
                                       
OREO
                                       
Residential Construction and Land
  $     $     $ 11,113     $ 11,113     $ 11,113  
Commercial Construction
    2,709       2,709       2,709              
Commercial Real Estate
    3,322       2,581       3,220       3,220       3,746  
Commercial and Industrial
    209                   668        
Residential Mortgage
                345             319  
Consumer
                             
 
                             
Total
  $ 6,240     $ 5,290     $ 17,387     $ 15,001     $ 15,178  
 
                             
 
                                       
Total Non-Performing, Past Due & OREO
  $ 118,021     $ 171,450     $ 184,504     $ 112,235     $ 109,935  
 
                             
 
                                       
% of Total Loans
    3.63 %     5.08 %     5.40 %     3.20 %     3.13 %
We had $108.2 million in non-covered non-performing loans at March 31, 2011, or 3.33% of total non-covered loans. This compares to $157.0 million in non-performing loans at December 31, 2010 and $76.8 million in non-performing loans at March 31, 2010. During the first quarter of 2011 we sold loans related to our former largest borrower with a carrying value of $42.9 million.
The economic downturn has had an impact on our market area and on our loan portfolio. The dairy industry and the commercial real estate industry are under stress. We continually monitor these conditions in determining our estimates of needed reserves. We anticipate that there will be some additional losses in the loan portfolio given the current state of the economy. However, we cannot predict the extent to which the deterioration in general economic conditions, real estate values, increase in general rates of interest, change in the financial conditions or business of a borrower may adversely affect a borrower’s ability to pay. See “Risk Management — Credit Risk” herein.

 

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Covered Loans and OREO
Loans acquired through the SJB acquisition are accounted for under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”). Covered loans accounted for under ASC 310-30 are generally considered accruing and performing loans as the loans accrete interest income over the estimated life of the loan when cash flows are reasonably estimable. Accordingly, acquired impaired loans that are contractually past due are still considered to be accruing and performing loans. If the timing and amount of future cash flows is not reasonably estimable, the loans may be classified as non-performing loans and interest income is not recognized until the timing and amount of future cash flows can be reasonably estimated. As of March 31, 2011, there are no non-performing covered loans. We have sixteen properties in covered OREO totaling $11.5 million as of March 31, 2011 compared to seventeen properties totaling $11.3 million at December 31, 2010.
Deposits
The primary source of funds to support earning assets (loans and investments) is the generation of deposits from our customer base. The ability to grow the customer base and subsequently deposits is a crucial element in the performance of the Company.
At March 31, 2011, total deposits were $4.49 billion, representing a decrease of $33.1 million, or 0.73%, from total deposits of $4.52 billion at December 31, 2010. The composition of deposits is as follows:
                                 
    March 31, 2011     December 31, 2010  
    (Amounts in thousands)  
 
Non-interest bearing deposits
                               
Demand deposits
  $ 1,817,951       40.6 %   $ 1,701,523       37.7 %
Interest bearing deposits
                               
Savings Deposits
    1,706,329       38.0 %     1,727,432       38.2 %
Time deposits
    961,409       21.4 %     1,089,873       24.1 %
 
                       
Total deposits
  $ 4,485,689       100.0 %   $ 4,518,828       100.0 %
 
                       
The amount of non-interest-bearing demand deposits in relation to total deposits is an integral element in achieving a low cost of funds. Demand deposits totaled $1.82 billion at March 31, 2011, representing an increase of $116.4 million, or 6.84%, over total demand deposits of $1.70 billion at December 31, 2010. Non-interest-bearing demand deposits represented 40.6% of total deposits as of March 31, 2011 and 37.7% of total deposits as of December 31, 2010.
Savings deposits, which include savings, interest-bearing demand, and money market accounts, totaled $1.71 billion at March 31, 2011, representing a decrease of $21.1 million, or 1.22%, from savings deposits of $1.73 billion at December 31, 2010.
Time deposits totaled $961.4 million at March 31, 2011. This represented a decrease of $128.5 million, or 11.79%, from total time deposits of $1.09 billion at December 31, 2010.

 

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Other Borrowed Funds
To achieve the desired growth in earning assets and to fully utilize our capital, we first pursue non-interest-bearing deposits (the lowest cost of funds to the Company). Next, we pursue interest-bearing deposits and finally we supplement the growth in deposits with borrowed funds. Average borrowed funds, as a percent of average total funding (total deposits plus demand notes plus borrowed funds) was 19.91% for the quarter ending March 31, 2011, as compared to 23.11% for the quarter ending December 31, 2010.
In June 2006, the Company purchased securities totaling $250.0 million. This purchase was funded by a repurchase agreement with J.P. Morgan of $250.0 million, with a double cap embedded in the repurchase agreement. The interest rate on this agreement was fixed at 4.95% and the maturity was September 30, 2011. During the first nine months of 2010, we prepaid this structured repurchase agreement. The transaction resulted in a $13.3 million prepayment charge recorded in other operating expense.
In November 2006, we began a repurchase agreement product with our customers. This product, known as Citizens Sweep Manager, sells our investment securities overnight to our customers under an agreement to repurchase them the next day. These repurchase agreements are with customers who have other banking relationships with us. As of March 31, 2011 and December 31, 2010, total customer repurchases were $578.0 million and $542.2 million, respectively, with weighted average interest rates of 0.36% and 0.55%, respectively.
We entered into long-term borrowing agreements (borrowings with original maturities of one year or longer) with the Federal Home Loan Bank (“FHLB”). We had outstanding balances of $548.5 million under these agreements at March 31, 2011 and $548.4 million at December 31, 2010. The weighted average interest rate was 3.71% at both March 31, 2011 and December 31, 2010. The FHLB holds certain investment securities and loans of the Bank as collateral for these borrowings.
The Bank has an agreement, known as the Treasury Tax & Loan (“TT&L”) Note Option Program, with the Federal Reserve Bank and the U.S. Department of Treasury in which federal tax deposits made by depositors can be held by the Bank until called (withdrawn) by the U.S. Department of Treasury. The maximum amount of accumulated federal tax deposits allowable to be held by the Bank, as set forth in the agreement, is $15.0 million. On March 31, 2011 and December 31, 2010 the amounts held by the Bank in the TT&L Note Option Program were $3.0 million and $1.9 million, collateralized by securities, respectively. Amounts are payable on demand.
Through the acquisition of FCB in June 2007, the Bank acquired $5 million in junior subordinated debt.
At March 31, 2011, borrowed funds totaled $1.13 billion, representing an increase of $36.9 million, or 3.37%, from total borrowed funds of $1.10 billion at December 31, 2010.

 

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Aggregate Contractual Obligations
The following table summarizes our contractual commitments as of March 31, 2011:
                                         
            Maturity by Period  
            Less Than     One Year     Four Year     After  
            One     to Three     to Five     Five  
    Total     Year     Years     Years     Years  
    (amounts in thousands)  
 
                                       
Deposits
  $ 4,485,689     $ 3,538,942     $ 941,515     $ 1,665     $ 3,567  
Customer Repurchase Agreements
    578,009       578,009                    
FHLB and Other Borrowings
    556,424       2,966       100,000       255,000       198,458  
Junior Subordinated Debentures
    115,055                         115,055  
Deferred Compensation
    9,212       809       1,599       1,432       5,372  
Operating Leases
    23,885       5,579       8,193       5,101       5,012  
Advertising Agreements
    8,616       1,561       2,750       1,856       2,449  
 
                             
Total
  $ 5,776,890     $ 4,127,866     $ 1,054,057     $ 265,054     $ 329,913  
 
                             
Deposits represent non-interest bearing, money market, savings, NOW, certificates of deposits, brokered and all other deposits held by the Company.
Repurchase agreements represent amounts due to customers.
FHLB borrowings represent the amounts that are due to the Federal Home Loan Bank. These borrowings have fixed maturity dates. Other borrowings represent the amounts on subordinated debt and TT&L.
Junior subordinated debentures represent the amounts that are due from the Company to CVB Statutory Trust I, CVB Statutory Trust II & CVB Statutory Trust III. The debentures have the same maturity as the Trust Preferred Securities. CVB Statutory Trust I, which matures in 2033, became callable in whole or in part in December 2008. CVB Statutory Trust II, which matures in 2034, became callable in whole or in part in January 2009. CVB Statutory Trust III, which matures in 2036, will become callable in whole or in part in 2011. It also represents FCB Capital Trust II which matures in 2033 and became callable in 2008. We have not called any of our debentures as of March 31, 2011.
Deferred compensation primarily represents the amounts that are due to current employees’ salary deferral agreements and former employees’ salary continuation agreements as a result of acquisitions. Operating leases represent the total minimum lease payments under noncancelable operating leases. Advertising agreements represent the amounts that are due on various agreements that provide advertising benefits to the Company.
Off-Balance Sheet Arrangements
At March 31, 2011, we had commitments to extend credit of approximately $595.8 million and obligations under letters of credit of $68.3 million and available lines of credit totaling $1.29 billion from certain institutions. Commitments to extend credit are agreements to lend to customers, provided 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. Commitments are generally variable rate, and many of these commitments are expected to expire without being drawn upon. As such, the total commitment amounts do not necessarily represent future cash requirements. The Bank uses the same credit underwriting policies in granting or accepting such commitments or contingent obligations as it does for on-balance-sheet instruments, which consist of evaluating customers’ creditworthiness individually. The Company has a reserve for undisbursed commitments of $11.2 million as of March 31, 2011 and $10.5 million as of December 31, 2010.
Standby letters of credit written are conditional commitments issued by the Bank to guarantee the financial performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. When deemed necessary, the Bank holds appropriate collateral supporting those commitments.

 

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The following table summarizes the off-balance sheet arrangements at March 31, 2011:
                                         
            Maturity by Period  
            Less Than     One Year     Four Year     After  
            One     to Three     to Five     Five  
    Total     Year     Years     Years     Years  
    (Amounts in thousands)  
Commitment to extend credit
  $ 595,821     $ 450,121     $ 68,895     $ 20,820     $ 55,985  
Obligations under letters of credit
    68,267       58,248       9,819       200        
 
                             
Total
  $ 664,088     $ 508,369     $ 78,714     $ 21,020     $ 55,985  
 
                             
Liquidity and Cash Flow
Since the primary sources and uses of funds for the Bank are deposits and loans, the relationship between gross loans and total deposits provides a useful measure of the Bank’s liquidity. Typically, the closer the ratio of loans to deposits is to 100%, the more reliant the Bank is on its loan portfolio to provide for short-term liquidity needs. Since repayment of loans tends to be less predictable than the maturity of investments and other liquid resources, the higher the loan to deposit ratio the less liquid are the Bank’s assets. For the first three months of 2011, the Bank’s loan to deposit ratio averaged 80.59%, compared to an average ratio of 89.55% for the same period in 2010. The Bank’s ratio of loans to deposits and customer repurchases averaged 71.56% for the first three months of 2011 and 79.46% for the same period in 2010.
CVB is a company separate and apart from the Bank that must provide for its own liquidity and must service its own obligations. Substantially all of CVB’s revenues are obtained from dividends declared and paid by the Bank. There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to CVB. In addition, our regulators could limit the ability of the Bank or the Company to pay dividends or make other distributions. At March 31, 2011, approximately $105.1 million of the Bank’s equity was unrestricted and available to be paid as dividends to CVB. Management of CVB believes that such restrictions will not have an impact on the ability of CVB to meet its ongoing cash obligations.
For the Bank, sources of funds normally include principal and interest payments on loans and investments, other borrowed funds, and growth in deposits. Uses of funds include withdrawal of deposits, interest paid on deposits, increased loan balances, purchases, and other operating expenses.
Net cash provided by operating activities totaled $5.8 million for the first three months of 2011, compared to $41.9 million for the same period last year. The decrease in cash provided by operating activities is primarily attributed to an increase in cash paid to vendors and employees and an increase in income taxes paid and a decrease in interest and dividends received, offset by a decrease in interest paid on deposits.
Net cash used in investing activities totaled $5.7 million for the first three months of 2011, compared to net cash provided by investing activities of $162.0 million for the same period in 2010. The cash used in investing activities was primarily the result of sales, purchases, repayments and maturities of investment securities partially offset by a decrease in loans and net proceeds from the FDIC shared-loss agreement during the first three months of 2011.
Net cash used in financing activities totaled $5.3 million for the first three months of 2011, compared to net cash provided by financing activities of $23.1 million for the same period last year. The cash used in financing activities during the first three months of 2011 was primarily due to the net decrease in time deposits and payment of dividends, partially offset by net increases in transaction accounts and customer repurchase agreements.

 

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At March 31, 2011, cash and cash equivalents totaled $399.1 million. This represented an increase of $67.6 million, or 20.39%, over a total of $331.5 million at March 31, 2010 and a decrease of $5.2 million, or 1.29%, from a total of $404.3 million at December 31, 2010.
Capital Resources
Historically, our primary source of capital has been the retention of operating earnings. In order to ensure adequate levels of capital, we conduct an ongoing assessment of projected sources, needs and uses of capital in conjunction with projected increases in assets and the level of risk. As part of this ongoing assessment, the Board of Directors reviews the various components of capital. Based on the Board of Directors analysis of our capital needs (including any capital needs arising out of our financial condition and results of operations or from any acquisitions we may make) and the input of our regulators, we could determine or, our regulators could require us, to raise additional capital.
Regulatory risk-based capital standards require the achievement of a minimum ratio of total capital to risk-weighted assets of 8.0% (of which at least 4.0% must be Tier 1 capital). In addition, the regulatory authorities require the highest rated institutions to maintain a minimum leverage ratio of 4.0%. To be considered “well-capitalized” for bank regulatory purposes, it is necessary for the Bank and the Company to achieve a Tier 1 risk-based capital ratio equal to or greater than 6%, a total risk-based capital ratio equal to or greater than 10% and a Tier 1 leverage ratio equal to or greater than 5%. At March 31, 2011, the Bank and the Company exceeded the minimum risk-based capital ratios and leverage ratios required to be considered “well-capitalized” for regulatory purposes.
The Company’s equity capital was $654.6 million at March 31, 2011. This represented an increase of $10.7 million, or 1.67%, over equity capital of $643.9 million at December 31, 2010. The Company’s 2010 Annual Report on Form 10-K (Management’s Discussion and Analysis and Note 18 of the accompanying financial statements) describes the regulatory capital requirements of the Company and the Bank.
During the first three months of 2011, the Board of Directors of the Company declared quarterly common stock cash dividends that totaled $0.085 per share. Dividends are payable at the discretion of the Board of Directors and there can be no assurance that the Board of Directors will continue to pay dividends at the same rate, or at all, in the future. CVB’s ability to pay cash dividends to its shareholders is subject to restrictions under federal and California law, including restrictions imposed by the FRB and covenants set forth in various agreements we are a party to including covenants set forth in our junior subordinated debentures.
The table below presents the Company’s and the Bank’s risk-based and leverage capital ratios as of March 31, 2011, and December 31, 2010.
                                                 
    Adequately     Well              
    Capitalized     Capitalized     March 31, 2011     December 31, 2010  
Capital Ratios   Ratios     Ratios     Company     Bank     Company     Bank  
Risk-based capital ratios:
                                               
Tier I
    4.0 %     6.0 %     17.0 %     17.0 %     16.6 %     16.6 %
Total
    8.0 %     10.0 %     18.4 %     18.2 %     18.0 %     17.8 %
Leverage ratio
    4.0 %     5.0 %     10.8 %     10.7 %     10.6 %     10.5 %
Tangible Capital Ratio
                    9.2 %     10.9 %     9.1 %     10.8 %

 

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RISK MANAGEMENT
We have adopted a Risk Management Plan to ensure the proper control and management of all risk factors inherent in the operation of the Company and the Bank. Specifically, credit risk, counterparty risk, interest rate risk, liquidity risk, transaction risk, compliance risk, strategic risk, reputation risk, price risk and foreign exchange risk, can all affect the market risk exposure of the Company. These specific risk factors are not mutually exclusive. It is recognized that any product or service offered by us may expose the Bank to one or more of these risks. Our Risk Management Committee and Risk Management Department monitors these risks to minimize exposure to the Company.
Credit Risk
Credit risk is defined as the risk to earnings or capital arising from an obligor’s failure to meet the terms of any contract or otherwise fail to perform as agreed. Credit risk is found in all activities where success depends on counter party, issuer, or borrower performance. Credit risk arises through the extension of loans and leases, certain securities, and letters of credit.
Credit risk in the investment portfolio and correspondent bank accounts is addressed through defined limits in the Bank’s policy statements. In addition, certain securities carry insurance to enhance credit quality of the bond. Limitations on industry concentration, aggregate customer borrowings, geographic boundaries and standards on loan quality also are designed to reduce loan credit risk. Senior Management, Directors’ Committees, and the Board of Directors are provided with information to appropriately identify, measure, control and monitor the credit risk of the Bank.
Implicit in lending activities is the risk that losses will occur and that the amount of such losses will vary over time. Consequently, we maintain an allowance for credit losses by charging a provision for credit losses to earnings. Loans determined to be losses are charged against the allowance for credit losses. Our allowance for credit losses is maintained at a level considered by us to be adequate to provide for estimated probable losses inherent in the existing portfolio.
The allowance for credit losses is based upon estimates of probable losses inherent in the loan and lease portfolio. The nature of the process by which we determine the appropriate allowance for credit losses requires the exercise of considerable judgment. The amount actually observed in respect of these losses can vary significantly from the estimated amounts. We employ a systematic methodology that is intended to reduce the differences between estimated and actual losses.
Our methodology for assessing the appropriateness of the allowance is conducted on a regular basis and considers all loans. The systematic methodology consists of two major elements.
The first major element includes a detailed analysis of the loan portfolio in two phases. In the first phase, individual loans are reviewed to identify loans for impairment. A loan is impaired when principal and interest are deemed uncollectible in accordance with the original contractual terms of the loan. Impairment is measured as either the expected future cash flows discounted at each loan’s effective interest rate, the fair value of the loan’s collateral if the loan is collateral dependent, or an observable market price of the loan (if one exists). Upon measuring the impairment, we will ensure an appropriate level of allowance is present or established.
Central to the first phase of our credit risk management is its loan risk rating system. The originating credit officer assigns borrowers an initial risk rating, which is reviewed and possibly changed by Credit Management. The risk rating is based primarily on a thorough analysis of each borrower’s financial capacity in conjunction with industry and economic trends. Credit approvals are made based upon the amount of inherent credit risk specific to the transaction and are reviewed for appropriateness by senior line and Credit Management personnel. Credits are monitored by line and Credit Management personnel for deterioration in a borrower’s financial condition, which would impact the ability of the borrower to perform under the contract. Risk ratings are adjusted as necessary.

 

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Loans are risk rated into the following categories: Pass, Special Mention, Substandard, Doubtful, and Loss. Each of these groups is assessed and appropriate amounts used in determining the adequacy of our allowance for losses. The Impaired and Doubtful loans are analyzed on an individual basis for allowance amounts. The other categories have formulae used to determine the needed allowance amount.
The Bank obtains a quarterly independent credit review by engaging an outside party to review our loans. The primary purpose of this review is to evaluate our existing loan ratings and provide an assessment as to the effectiveness of our allowance process.
Based on the risk rating system, specific allowances are established in cases where we have identified significant conditions or circumstances related to a credit that we believe indicates the probability that a loss has been incurred. We perform a detailed analysis of these loans, including, but not limited to, cash flows, appraisals of the collateral, conditions of the marketplace for liquidating the collateral and assessment of the guarantors. We then determine the inherent loss potential and allocate a portion of the allowance for losses as a specific allowance for each of these credits.
The second phase is conducted by evaluating or segmenting the remainder of the loan portfolio into groups or pools of loans with similar characteristics in accordance with ASC No. 450-10, “Contingencies.” In this second phase, groups or pools of homogeneous loans are reviewed to determine a portfolio formula allowance. In the case of the portfolio formula allowance, homogeneous portfolios, such as small business loans, consumer loans, agricultural loans, and real estate loans, are aggregated or pooled in determining the appropriate allowance. The risk assessment process in this case emphasizes trends in the different portfolios for delinquency, loss, and other-behavioral characteristics of the subject portfolios.
The second major element in our methodology for assessing the appropriateness of the allowance consists of our considerations of all known relevant internal and external factors that may affect a loan’s collectability. This includes our estimates of the amounts necessary for concentrations, economic uncertainties, the volatility of the market value of collateral, and other relevant factors. The relationship of the two major elements of the allowance to the total allowance may fluctuate from period to period.
In the second major element of the analysis which considers all known relevant internal and external factors that may affect a loan’s collectability, we perform an evaluation of various conditions, the effects of which are not directly measured in the determination of the formula and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with the second element of the analysis of the allowance include, but are not limited to the following conditions that existed as of the balance sheet date:
• then-existing general economic and business conditions affecting the key lending areas of the Company,
• then-existing economic and business conditions of areas outside the lending areas, such as other sections of the United States
• credit quality trends (including trends in non-performing loans expected to result from existing conditions),
• collateral values
• loan volumes and concentrations,
• specific industry conditions within portfolio segments,
• recent loss experience in particular segments of the portfolio,
• duration of the current business cycle,
• bank regulatory examination results and
• findings of the Company’s external credit examiners.

 

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We review these conditions in discussion with our senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, our estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, our evaluation of the inherent loss related to such condition is reflected in the second major element of the allowance. Although we have allocated a portion of the allowance to specific loan categories, the adequacy of the allowance must be considered in its entirety.
Table 7 presents a comparison of net credit losses, the provision for credit losses (including adjustments incidental to mergers), and the resulting allowance for credit losses for the three months ended March 31, 2011 and 2010.
TABLE 7 — Summary of Credit Loss Experience