Business Combinations

9 Months Ended

Sep. 30, 2011

Business Combinations [Abstract]

Business Combinations

Note 2 - Business Combinations

On September 23, 2011, the California Department of Financial Institutions closed Citizens Bank of Northern California (“Citizens”), Nevada City, California and appointed the FDIC as receiver. That same date, the Bank assumed the banking operations of Citizens from the FDIC under a whole bank purchase and assumption agreement without loss sharing. With this agreement, the Bank added seven traditional bank branches, including two in Grass Valley, and one in each of Nevada City, Penn Valley, Lake of the Pines, Truckee, and Auburn, California. This acquisition is consistent with the Bank’s community banking expansion strategy and provides further opportunity to fill in the Bank’s market presence in the Northern California market.

The operations of Citizens, included in the Company’s operating results from September 23, 2011, and through September 30, 2011, added revenue of $7,891,000, including a bargain purchase gain of $7,575,000, noninterest expense of $131,000 and a provision for loan losses of $85,000, that resulted in a contribution to net income after-tax of approximately $4,448,000. Such operating results are not necessarily indicative of future operating results. Citizens’ results of operations prior to the acquisition are not included in the Company’s operating results. As of September 30, 2011, nonrecurring expenses related to the Citizens acquisition were insignificant.

The assets acquired and liabilities assumed for the Citizens acquisition have been accounted for under the acquisition method of accounting (formerly the purchase method). The assets and liabilities, both tangible and intangible, were recorded at their estimated fair values as of the acquisition date. The fair values of the assets acquired and liabilities assumed were determined based on the requirements of the Fair Value Measurements and Disclosures topic of the FASB ASC. The tax treatment of FDIC assisted acquisitions is complex and subject to interpretations that may result in future adjustments of deferred taxes as of the acquisition date. The terms of the agreement provide for the FDIC to indemnify the Bank against claims with respect to liabilities of Citizens not assumed by the Bank and certain other types of claims identified in the agreement. The application of the acquisition method of accounting resulted in the recognition of a bargain purchase gain of $7,575,000 in the Citizens acquisition.

A summary of the net assets received in the Citizens acquisition, at their estimated fair values, is presented below:

	Citizens
(in thousands)	September 23, 2011
Asset acquired:
Cash and cash equivalents	$	80,707
Securities available-for-sale		9,353
Restricted equity securities		1,926
Loans		167,484
Core deposit intangible		898
Foreclosed assets		8,412
Other assets		1,524
Total assets acquired	$	270,304
Liabilities assumed:
Deposits	$	239,899
Other borrowings		22,038
Other liabilities		792
Total liabilities assumed	$	262,729
Net assets acquired/bargain purchase gain	$	7,575

In FDIC-assisted transactions, only certain assets and liabilities are transferred to the acquirer and, depending on the nature and amount of the acquirer’s bid, the FDIC may be required to make a cash payment to the acquirer. In the Citizens acquisition, net assets with a cost basis of $26,682,000 were transferred to the Bank. In the Citizens acquisition, the Company recorded a bargain purchase gain of $7,575,000 representing the excess of the estimated fair value of the assets acquired over the estimated fair value of the liabilities assumed.

A summary of the estimated fair value adjustments resulting in the bargain purchase gain in the Citizens acquisition are presented below:

	Citizens
(in thousands)	September 23, 2011
Cost basis net assets acquired	$	26,682
Cash payment received from FDIC		44,140
Fair value adjustments:
Cash and cash equivalents		539
Loans		(57,745	)
Foreclosed assets		(5,609	)
Core deposit intangible		898
Deposits		(382	)
Borrowings		(28	)
Other		(920	)
Bargain purchase gain	$	7,575

The Bank acquired only certain assets and assumed certain liabilities of Citizens. A significant portion of Citizens’s operations, its facilities and its central operations and administrative functions were not retained by the Bank. Therefore, disclosure of supplemental pro forma financial information, especially prior period comparison is deemed neither practical nor meaningful given the troubled nature of Citizens prior to the date of acquisition. The Bank did not immediately acquire all the real estate, banking facilities, furniture or equipment of Citizens as part of the purchase and assumption agreement. However, the Bank has the option to purchase or lease the real estate and furniture and equipment from the FDIC. The term of this option expires 90 days from the acquisition date.

The Company identified the loans acquired in the Citizens acquisition as either PNCI or PCI loans. The Company identified certain of the Citizens PCI loans as having cash flows that were not reasonably estimable and elected to place these loans in nonaccrual status under the cash basis method for income recognition (“PCI – cash basis” loans). The Company elected to use the ASC 310-30 “pooled” method of accounting for all other Citizens PCI loans (“PCI – other” loans).

The following table presents a reconciliation of the undiscounted contractual cash flows, nonaccretable difference, accretable yield, fair value, purchase discount, and principal balance of loans for the various categories of Citizens PNCI and PCI loans as of the acquisition date. For PCI loans, the purchase discount does not necessarily represent cash flows to be collected as a portion of it is a nonaccretable difference:

	Citizens Loans – September 23, 2011
(in thousands)	PNCI			PCI - other			PCI - cash basis			Total
Undiscounted contractual cash flows	$	252,447		$	69,346		$	37,637		$	359,430
Undiscounted cash flows not expected to be collected (nonaccretable difference)		—			(26,846	)		(26,966	)		(53,812	)
Undiscounted cash flows expected to be collected		252,477			42,500			10,671			305,618
Accretable yield at acquisition		(127,988	)		(10,146	)		—			(138,134	)
Estimated fair value of loans acquired at acquisition		124,459			32,354			10,671			167,484
Purchase discount		20,364			23,207			14,174			57,745
Principal balance loans acquired	$	144,823		$	55,561		$	24,845		$	225,229

In estimating the fair value of Citizens PNCI loans at the acquisition date, we calculated the contractual amount and timing of undiscounted principal and interest payments on an individual loan basis and then discounted those cash flows using an appropriate market rate of interest adjusted for liquidity and credit loss risks inherent in each loan. The Citizens PNCI loans expected accretable yield above represents undiscounted interest, and along with the purchase discount, is accounted for using an effective interest method consistent with our accounting for originated loans.

In estimating the fair value of Citizens PCI – cash basis loans at the acquisition date, we calculated the contractual amount and timing of undiscounted principal and interest payments and estimated the amount of undiscounted expected principal recovery using historic loss rates or estimated collateral values if applicable. The difference between these two amounts represents the nonaccretable difference. We used our estimate of the amount of undiscounted expected principal recovery as the fair value of the Citizens PCI – cash basis loans, and placed these loans in nonaccrual status. Interest income and principal reductions on these PCI – cash basis loans are recorded only when they are received. At each financial reporting date, the carrying value of each PCI – cash basis loan is compared to an updated estimate of expected principal payment or recovery for each loan. To the extent that the loan carrying amount exceeds the updated expected principal payment or recovery, a provision for loan loss would be recorded as a charge to income and an allowance for loan loss established.

In estimating the fair value of Citizens PCI – other loans at the acquisition date, we calculated the contractual amount and timing of undiscounted principal and interest payments and estimated the amount and timing of undiscounted expected principal and interest payments. The difference between these two amounts represents the nonaccretable difference. On the acquisition date, the amount by which the undiscounted expected cash flows exceed the estimated fair value of the acquired loans is the “accretable yield”. The accretable yield is then measured at each financial reporting date and represents the difference between the remaining undiscounted expected cash flows and the current carrying value of the loans. For PCI loans the accretable yield is accreted into interest income over the life of the estimated remaining cash flows. For further information regarding the accounting for PCI – other loans, and acquired loans in general, see the discussion under the heading “Loans and Allowance for Loan Losses” in Note 1 above.

On May 28, 2010, the Office of the Comptroller of the Currency closed Granite Community Bank (“Granite”), Granite Bay, California and appointed the FDIC as receiver. That same date, the Bank assumed the banking operations of Granite from the FDIC under a whole bank purchase and assumption agreement with loss sharing. Under the terms of the loss sharing agreement, the FDIC will cover a substantial portion of any future losses on loans, related unfunded loan commitments, other real estate owned (OREO)/foreclosed assets and accrued interest on loans for up to 90 days. The FDIC will absorb 80% of losses and share in 80% of loss recoveries on the covered assets acquired from Granite. The loss sharing arrangements for non-single family residential and single family residential loans are in effect for 5 years and 10 years, respectively, and the loss recovery provisions are in effect for 8 years and 10 years, respectively, from the acquisition date. With this agreement, the Bank added one traditional bank branch in each of Granite Bay, Roseville and Auburn, California. This acquisition is consistent with the Bank’s community banking expansion strategy and provides further opportunity to fill in the Bank’s market presence in the greater Sacramento, California market.

The operations of Granite are included in the Company’s operating results from May 28, 2010, and through December 31, 2010 added revenue of $4,967,000, including a bargain purchase gain of $232,000, noninterest expense of $2,078,000 and a provision for loan losses of $1,608,000, that resulted in a contribution to net income after-tax of approximately $743,000. Such operating results are not necessarily indicative of future operating results. Granite’s results of operations prior to the acquisition are not included in the Company’s operating results. During the quarter ended September 30, 2010, the Company completed the conversion of Granite’s information and product delivery systems. As of December 31, 2010, nonrecurring expenses related to the Granite acquisition and systems conversion were approximately $250,000.

The assets acquired and liabilities assumed for the Granite acquisition have been accounted for under the acquisition method of accounting (formerly the purchase method). The assets and liabilities, both tangible and intangible, were recorded at their estimated fair values as of the acquisition dates. The fair values of the assets acquired and liabilities assumed were determined based on the requirements of the Fair Value Measurements and Disclosures topic of the FASB ASC. The tax treatment of FDIC assisted acquisitions is complex and subject to interpretations that may result in future adjustments of deferred taxes as of the acquisition date. The terms of the agreements provide for the FDIC to indemnify the Bank against claims with respect to liabilities of Granite not assumed by the Bank and certain other types of claims identified in the agreement. The application of the acquisition method of accounting resulted in the recognition of a bargain purchase gain of $232,000 in the Granite acquisition.

A summary of the net assets received in the Granite acquisition, at their estimated fair values, is presented below:

	Granite
(in thousands)	May 28, 2010
Asset acquired:
Cash and cash equivalents	$	18,764
Securities available-for-sale		2,954
Restricted equity securities		696
Covered loans		64,802
Premises and equipment		17
Core deposit intangible		562
Covered foreclosed assets		4,629
FDIC indemnification asset		7,466
Other assets		392
Total assets acquired	$	100,282
Liabilities assumed:
Deposits	$	95,001
Other borrowings		5,000
Other liabilities		49
Total liabilities assumed		100,050
Net assets acquired/bargain purchase gain	$	232

The loan portfolio and foreclosed assets acquired in the Granite acquisition are covered by a loss sharing agreement between the Bank and the FDIC, and are referred to as “covered loans” and “covered foreclosed assets”, respectively. These covered loans and covered foreclosed assets are recorded in Loans and Foreclosed assets, respectively, in the Company’s consolidated balance sheet. Collectively these balances are referred to as “covered assets”.

In FDIC-assisted transactions, only certain assets and liabilities are transferred to the acquirer and, depending on the nature and amount of the acquirer’s bid, the FDIC may be required to make a cash payment to the acquirer. In the Granite acquisition, net assets with a cost basis of $4,345,000 were transferred to the Bank. In the Granite acquisition, the Company recorded a bargain purchase gain of $232,000 representing the excess of the estimated fair value of the assets acquired over the estimated fair value of the liabilities assumed.

The Bank did not immediately acquire all the real estate, banking facilities, furniture or equipment of Granite as part of the purchase and assumption agreement. However, the Bank had the option to purchase or lease the real estate and furniture and equipment from the FDIC. During the quarter ended September 30, 2010, the Bank elected to close the Roseville branch and assume the leases for the Granite Bay and Auburn branches. The Bank purchased the existing furniture and equipment in the Granite Bay and Auburn branches from the FDIC for approximately $100,000.

A summary of the estimated fair value adjustments resulting in the bargain purchase gain in the Granite acquisition are presented below:

	Granite
(in thousands)	May 28, 2010
Cost basis net assets acquired	$	4,345
Cash payment received from FDIC		3,940
Fair value adjustments:
Securities available-for-sale		(118	)
Loans		(13,189	)
Foreclosed assets		(2,616	)
Core deposit intangible		562
FDIC indemnification asset		7,466
Deposits		(209	)
Other		51
Bargain purchase gain	$	232

Because of the significant credit discounts associated with the loans acquired in the Granite acquisition, the Company elected to account for all loans acquired in the Granite acquisition under FASB ASC Topic 310-30, and classify them all as PCI loans.

The following table reflects the estimated fair value of the acquired loans at the acquisition date:

	Granite
(in thousands)	May 28, 2010
Principal balance loans acquired	$	77,991
Discount		(13,189	)
Covered loans, net	$	64,802

In estimating the fair value of the covered loans at the acquisition date, we (a) calculated the contractual amount and timing of undiscounted principal and interest payments and (b) estimated the amount and timing of undiscounted expected principal and interest payments. The difference between these two amounts represents the nonaccretable difference.

On the acquisition date, the amount by which the undiscounted expected cash flows exceed the estimated fair value of the acquired loans is the “accretable yield”. The accretable yield is then measured at each financial reporting date and represents the difference between the remaining undiscounted expected cash flows and the current carrying value of the loans.

The following table presents a reconciliation of the undiscounted contractual cash flows, nonaccretable difference, accretable yield, and fair value of covered loans for each respective acquired loan portfolio at the acquisition dates:

	Granite
(in thousands)	May 28, 2010
Undiscounted contractual cash flows	$	99,179
Undiscounted cash flows not expected to be collected (nonaccretable difference)		(11,226	)
Undiscounted cash flows expected to be collected		87,953
Accretable yield at acquisition		(23,151	)
Estimated fair value of Loans acquired at acquisition	$	64,802