Loans

6 Months Ended

Jun. 30, 2011

Loans

Loans

Note 3.  Loans

The following table provides a summary of outstanding loan balances as of June 30, 2011 compared to December 31, 2010:

	June 30,		December 31,
(dollars in thousands)	2011		2010
Real Estate Secured
Multi-family residential	$	16,287	$	17,637
Residential 1 to 4 family	19,310		21,804
Home equity lines of credit	31,532		30,801
Commercial	368,583		348,583
Farmland	11,129		15,136
Total real estate secured	446,841		433,961
Commercial
Commercial and industrial	140,084		145,811
Agriculture	16,092		15,168
Other	113		153
Total commercial	156,289		161,132
Construction
Single family residential	11,110		11,525
Single family residential - Spec.	500		2,391
Multi-family	1,704		2,218
Commercial	11,124		27,785
Total construction	24,438		43,919
Land	29,802		30,685
Installment loans to individuals	6,748		7,392
All other loans (including overdrafts)	213		214
Total gross loans	664,331		677,303
Deferred loan fees	1,167		1,613
Allowance for loan losses	21,700		24,940
Total net loans	$	641,464	$	650,750
Loans held for sale	$	3,662	$	11,008

Concentration of Credit Risk

At June 30, 2011 and December 31, 2010, $501.1 million and $508.6 million, respectively, of the Company’s loan portfolio were collateralized by various forms of real estate.  Such loans are generally made to borrowers located in the counties of San Luis Obispo and Santa Barbara.  The Company attempts to reduce its concentration of credit risk by making loans which are diversified by project type.  While Management believes that the collateral presently securing this portfolio is adequate, there can be no assurances that further deterioration in the California real estate market would not expose the Company to significantly greater credit risk.

At June 30, 2011, the Company was contingently liable for financial and performance standby letters of credit to its customers totaling approximately $14.8 million and un-disbursed loan commitments in the amount of $132.3 million, exclusive of letters of credit. The Company makes commitments to extend credit in the normal course of business to meet the financing needs of its customers. Commitments to extend credit are agreements to lend to a customer, as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total outstanding commitment amount does not necessarily represent future cash requirements. Letters of credit written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as those involved in extending loan facilities to customers. The Company currently anticipates no losses as a result of such transactions.

Impaired Loans

The following table provides a summary of the Company’s investment in impaired loans as of June 30, 2011:

			Unpaid		Impaired Loans					Specific		Average		Interest
	Recorded		Principal			With Specific		Without Specific		Allowance for		Recorded		Income
(dollar amounts in thousands)	Investment		Balance			Allowance		Allowance		Impaired Loans		Investment		Recognized
Real Estate Secured
Residential 1 to 4 family	$	671	$	744		$	160	$	511	$	160	$	522	$	-
Home equity lines of credit	1,376		316			-		1,376		-		1,033		-
Commercial	11,778		14,462			5,590		6,188		757		13,103		-
Farmland	857		914			-		857		-		866		-
Commercial
Commercial and industrial	3,194		4,571			931		2,263		471		3,171		1
Agriculture	1,199		1,349			134		1,065		134		720		-
Construction
Single family residential	1,293		1,293			-		1,293		-		1,293		-
Land	3,729		4,367			1,380		2,349		102		3,899		-
Installment loans to individuals	12		12			-		12		-		6		-
Totals	$	24,109	$	28,028		$	8,195	$	15,914	$	1,624	$	24,613	$	1

The following table summarizes impaired loan balances as of December 31, 2010:

			Unpaid		Impaired Loans					Specific		Average		Interest
	Recorded		Principal			With Specific		Without Specific		Allowance for		Recorded		Income
(dollar amounts in thousands)	Investment		Balance			Allowance		Allowance		Impaired Loans		Investment		Recognized
Real Estate Secured
Residential 1 to 4 family	$	748	$	896		$	-	$	748	$	-	$	988	$	-
Home equity lines of credit	1,019		1,019			-		1,019		-		508		-
Commercial	18,322		20,539			4,706		13,616		1,085		18,890		67
Farmland	2,626		2,773			-		2,626		-		2,745		-
Commercial
Commercial and industrial	5,858		6,474			903		4,955		461		8,010		150
Agriculture	246		384			-		246		-		1,294		-
Construction
Single family residential	1,311		1,310			952		359		476		945		-
Single family residential - Spec.	1,250		1,250			-		1,250		-		1,108		-
Tract	-		-			-		-		-		311		-
Multi-family	479		896			-		479		-		481		-
Commercial	-		100			-		-		-		245		-
Land	3,371		3,771			1,478		1,893		235		6,935		-
Installment loans to individuals	370		502			-		370		-		396		17
Totals	$	35,600	$	39,913		$	8,039	$	27,561	$	2,257	$	42,855	$	234

The Company considers a loan impaired when, based on certain information and events surrounding a borrower, it is determined that the likelihood of the Company receiving all scheduled payments, including interest, when due is remote.

The Company classifies non-accruing loans, loans 90 days or more past due and still accruing, and loans recently classified as troubled debt restructurings as impaired loans.  When loans are placed on non-accrual status, all accrued but uncollected interest is reversed from earnings.  Once on non-accrual status, payments received on such loans are generally applied as a reduction of the loan principal balance.  Interest on such loans is only recognized on a cash basis, and is generally not recognized on specific impaired loans unless the likelihood of further loss is remote.  Loans may be returned to accruing status if the Company believes that all remaining principal and interest is fully collectible and there has been at least six months of sustained repayment performance since the loan was placed on non-accrual.  The Company did not record income from the receipt of cash payments related to non-accruing loans during the three and six month periods ended June 30, 2011 and 2010.  Interest income recognized on impaired loans in the table above, if any, represents interest the Company recognized on performing troubled debt restructurings.

The provisions of U.S. GAAP permit the valuation allowances reported in the table above to be determined on a loan-by-loan basis or by aggregating loans with similar risk characteristics.  Because substantially all of the loans currently identified as impaired have unique risk characteristics, a significant majority of valuation allowances for loans the Company recorded were determined on a loan-by-loan basis.  It should be noted that a significant portion of the Company’s impaired loans were carried at fair value as of June 30, 2011 and December 31, 2010, resulting in large part from the charge-off of loan balances following the receipt of appraisal information on the underlying collateral.

Total forgone interest related to impaired loans, includes (1) the initial accrued interest reversal when a loan is transferred to non-accrual status and (2) interest lost prospectively for the period of time a loan is on non-accrual status.  Total foregone interest was $0.5 million and $1.1 million for the three month periods ended June 30, 2011 and 2010, respectively, and $1.1 million and $1.7 million for the six months ended June 30, 2011 and 2010, respectively.  In addition to foregone interest, the Company lost interest related to rate concessions on certain TDRs of $23 thousand and $35 thousand for the three months ended June 30, 2011 and 2010, respectively, and $49 thousand and $77 thousand for the six months ended June 30, 2011 and 2010, respectively.  As of June 30, 2011, the Company was not committed to lend any additional funds to borrowers whose obligations to the Company were classified as TDRs.

Credit Quality and Credit Risk Management

The Company manages credit risk not only through extensive risk analyses performed prior to a loan’s funding, but also through the ongoing monitoring of loans within the portfolio, and more specifically certain types of loans that generally involve a greater degree of risk, such as commercial real estate, commercial lines of credit, and construction/land loans.  The Company monitors loans in the portfolio through an exhaustive internal process, at least quarterly, as well as with the assistance of a semi-annual independent loan review.  These reviews generally not only focus on problem loans, but also pass credits within certain pools of loans that may be expected to experience stress due to economic conditions.

This process allows the Company to validate credit ratings, underwriting structure, and the Company’s estimated exposure in the current economic environment as well as enhance communications with borrowers where necessary in an effort to mitigate potential future losses.

The Company conducts an analysis on all significant problem loans at least quarterly, in order to properly estimate its potential exposure to loss associated with such credits in a timely manner.  Pursuant to the Company’s lending policy, all loans in the portfolio are assigned a risk rating, which allows Management, among other things, to identify the risk associated with each credit in the portfolio, and to provide a basis for estimating credit losses inherent in the portfolio.  Risk grades are generally assigned based on information concerning the borrower and the strength of the collateral.  Risk grades are reviewed regularly by the Company’s credit committee and are scrutinized by independent loan reviews performed semi-annually, as well as by regulatory agencies during scheduled examinations.

The following provides brief definitions for credit ratings assigned to loans in the portfolio:

· Pass – strong credit quality with adequate collateral or secondary source of repayment and little existing or known weaknesses.  However, pass may include credits with exposure to certain potential factors that may adversely impact the credit, if they materialize, resulting in these credits being put on a watch list to monitor more closely than other pass rated credits.  Such factors may be credit / relationship specific or general to an entire industry.

· Special Mention – credits that have potential weaknesses that deserve Management’s close attention.  If not corrected, these potential weaknesses may result in deterioration of the repayment prospects for the credit at some future date.

· Substandard – credits that have a defined weakness or weaknesses which may jeopardize the orderly liquidation of the loan through cash flows, making it likely that repayment may have to come from some other source, such as the liquidation of collateral.  The Company is more likely to incur losses on substandard credits if the weakness or weaknesses identified in the credit are not corrected.

· Doubtful – credits that possess the characteristics of a substandard credit, but because of certain existing deficiencies related to the credit, full collection is highly questionable.  The probability of incurring some loss on such credits is high, but because of certain important and reasonably specific pending factors which may work to the advantage of strengthening the credit, charge-off is deferred until such time the Company becomes reasonably certain that certain pending factors related to the credit will no longer provide some form of benefit.

Loans typically move to non-accruing status from the Company’s substandard risk grade.  When a loan is first classified as substandard, the Company obtains financial information in order to determine if any evidence of impairment exists.  If impairment is determined to exist, the Company obtains updated appraisal information on the underlying collateral. Once the updated appraisal is obtained and analyzed by Management, a valuation allowance, if necessary, is established against such loan or a loss is recognized by a charge to the allowance for loan losses, if Management believes that the full amount of the Company’s recorded investment in the loan is no longer collectable.  Therefore, at the time a loan moves into non-accruing status, a valuation allowance typically has already been established or balances deemed uncollectable on such loan have been charged-off.  If upon a loan’s migration to non-accruing status, the appraisals obtained while the loan was classified as substandard are deemed to be out dated, the Company typically orders new appraisals on underlying collateral in order to have the most current indication of fair value.  If a complete appraisal is expected to take a significant amount of time to complete, the Company may also rely on a broker’s price opinion or other meaningful market data, such as comparable sales, in order to derive its best estimate of a property’s fair value, while waiting for an appraisal at the time of the decision to classify the loan as substandard and/or non-accruing.  Once a loan is placed on non-accruing status an analysis of the underlying collateral is performed at least quarterly, and corresponding changes in any related valuation allowance are made or balances deemed to be fully uncollectable are charged-off.

The Company typically moves to charge-off loan balances when, based on various evidence, it believes those balances are no longer collectable.  Such evidence may include updated information related to a borrower’s financial condition or updated information related to collateral securing such loans.  Such loans are monitored internally on a regular basis by the Special Assets department, which is responsible for obtaining updated periodic appraisal information for collateral securing problem loans.  If a loan’s credit quality deteriorates to the point that collection of principal through traditional means is believed by Management to be doubtful, and the value of collateral securing the obligation is sufficient, the Company generally takes steps to protect and liquidate the collateral.  Any loss resulting from the difference between the Company’s recorded investment in the loan and the fair market value of the collateral obtained through repossession is recognized by a charge to the allowance for loan losses.  In those cases where Management has determined that it is in the best interests of the Bank to attempt to broker a troubled loan rather than to continue to hold it in its portfolio, additional charges-offs have been realized as investment firms that typically purchase these types of loans tend to require a higher rate of return than would be built into the Company’s traditional hold to maturity model, resulting in the sales price for these loans being less than the adjusted carrying cost.

The following table stratifies the loan portfolio by the Company’s internal risk grading system as well as certain other information concerning the credit quality of the loan portfolio as of June 30, 2011:

			Credit Risk Grades								Days Past Due
	Total Gross				Special										90+ and Still		Non-		Accruing
(dollar amounts in thousands)	Loans		Pass		Mention		Substandard		Doubtful		30-59		60-89		Accruing		Accruing		TDR
Real Estate Secured
Multi-family residential	$	16,287	$	16,287	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Residential 1 to 4 family	19,310		18,637		-		673		-		-		-		-		672		-
Home equity lines of credit	31,532		29,435		32		2,065		-		129		-		-		1,379		-
Commercial	368,583		317,470		25,587		25,526		-		-		-		-		10,988		-
Farmland	11,129		7,039		561		3,529		-		-		-		-		857		-
Commercial
Commercial and industrial	140,084		129,590		2,999		7,495		-		393		183		-		3,194		-
Agriculture	16,092		12,824		550		2,718		-		-		-		-		1,199		-
Other	113		113		-		-		-		-		-		-		-		-
Construction
Single family residential	11,110		8,932		886		1,292		-		-		-		-		1,293		-
Single family residential - Spec.	500		-		-		500		-		-		-		-		-		-
Multi-family	1,704		-		-		1,704		-		-		-		-		-		-
Commercial	11,124		10,630		494		-		-		-		-		-		-		-
Land	29,802		18,766		-		11,036		-		-		-		-		3,724		-
Installment loans to individuals	6,748		6,458		269		21		-		54		6		-		11		-
All other loans (including overdrafts)	213		207		-		6		-		-		-		-		-		-
Totals	$	664,331	$	576,388	$	31,378	$	56,565	$	-	$	576	$	189	$	-	$	23,317	$	-

The following table stratifies the loan portfolio by the Company’s internal risk grading system as well as certain other information concerning the credit quality of the loan portfolio as of December 31, 2010:

			Credit Risk Grades								Days Past Due
	Total Gross				Special										90+ and Still		Non-		Accruing
(dollar amounts in thousands)	Loans		Pass		Mention		Substandard		Doubtful		30-59		60-89		Accruing		Accruing		TDR
Real Estate Secured
Multi-family residential	$	17,637	$	17,637	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Residential 1 to 4 family	21,804		20,054		282		1,468		-		-		-		-		748		-
Home equity lines of credit	30,801		29,575		89		1,137		-		40		24		-		1,019		-
Commercial	348,583		266,232		33,786		47,000		1,565		1,212		-		-		17,752		570
Farmland	15,136		8,980		2,693		3,463		-		-		-		-		2,626		-
Commercial
Commercial and industrial	145,811		131,594		2,166		10,835		1,216		284		26		-		3,921		1,937
Agriculture	15,168		12,062		2,555		551		-		-		-		-		246		-
Other	153		153		-		-		-		-		-		-		-		-
Construction
Single family residential	11,525		9,399		816		1,310		-		-		-		-		1,311		-
Single family residential - Spec.	2,391		-		1,141		1,250		-		-		-		-		1,250		-
Tract	-		-		-		-		-		-		-		-		-		-
Multi-family	2,218		-		1,739		-		479		-		-		-		479		-
Hospitality	-		-		-		-		-		-		-		-		-		-
Commercial	27,785		27,287		498		-		-		-		-		-		-		-
Land	30,685		16,618		9,213		4,854		-		-		-		-		3,371		-
Installment loans to individuals	7,392		7,009		8		375		-		10		-		-		96		274
All other loans (including overdrafts)	214		214		-		-		-		-		-		-		-		-
Totals	$	677,303	$	546,814	$	54,986	$	72,243	$	3,260	$	1,546	$	50	$	-	$	32,819	$	2,781