News Column

1ST CENTURY BANCSHARES, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 7, 2014

Introduction

Our profitability, like most banks, is primarily dependent on interest rate differentials. In general, the difference between the interest rates paid by us on interest bearing liabilities, such as deposits and other borrowings, and the interest rates received by us on our interest-earning assets, such as loans extended to our clients and securities held in our investment portfolio, comprises the major portion of our earnings. In addition, we may, from time to time, supplement our earnings by monetizing gains in our investment portfolio.



Critical Accounting Policies and Estimates

The accounting and reporting policies followed by us conform, in all material respects, to accounting principles generally accepted in the United States, or GAAP, and to general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While we base our estimates on historical experience, current information and other factors deemed by us to be relevant, actual results could differ materially and adversely from those estimates. We consider accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on our financial statements. Accounting polices related to the allowance for loan losses ("ALL") and income taxes are considered to be critical, as these policies involve considerable subjective judgment and estimation by management. Critical accounting policies, and our procedures related to these policies, are summarized below. There have been no changes to our critical accounting policies and estimates during the three months ended June 30, 2014. Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses charged to operations and represents an estimate of probable incurred losses inherent in the Company's loan portfolio that have been incurred as of the balance sheet date. Loan losses are charged against the allowance when management believes that principal is uncollectible. Subsequent repayments or recoveries, if any, are credited to the allowance. Management periodically assesses the adequacy of the allowance for loan losses by reference to many quantitative and qualitative factors that may be weighted differently at various times depending on prevailing conditions. The provisions reflect management's evaluation of the adequacy of the allowance based, in part, upon the historical loss experience of the loan portfolio, as well as estimates from historical peer group loan loss data and the loss experience of other financial institutions, augmented by management judgment. During this process, loans are separated into the following portfolio segments: commercial, commercial real estate, residential, land and construction, and consumer and other loans. The relative significance of risk considerations vary by portfolio segment. For commercial loans, commercial real estate loans and land and construction loans, the primary risk consideration is a borrower's ability to generate sufficient cash flows to repay their loan. Secondary considerations include the creditworthiness of guarantors and the valuation of collateral. In addition to the creditworthiness of a borrower, the type and location of real estate collateral is an important risk factor for commercial real estate and land and construction loans. The primary risk consideration for residential loans and consumer loans are a borrower's personal cash flow and liquidity, as well as collateral value. Loss ratios for all portfolio segments are evaluated on a quarterly basis. Loss ratios associated with historical loss experience are determined based on a rolling migration analysis of each portfolio segment within the portfolio. This migration analysis estimates loss factors based on the performance of each portfolio segment over a four and a half year time period. These loss ratios are then adjusted, if determined necessary by management, based on other factors including, but not limited to, historical peer group loan loss data and the loss experience of other financial institutions. Management carefully monitors changing economic conditions, the concentrations of loan categories, values of collateral, the financial condition of the borrowers, the history of the loan portfolio, and historical peer group loan loss data to determine the adequacy of the allowance for loan losses. As a part of this process, management typically focuses on loan-to-value ("LTV") percentages to assess the adequacy of loss ratios of collateral dependent loans within each portfolio segment discussed above, trends within each portfolio segment, as well as general economic and real estate market conditions where the collateral and borrower are located. For loans that are not collateral dependent, which generally consist of commercial and consumer and other loans, management typically focuses on general business conditions where the borrower operates, trends within the portfolio, and other external factors to evaluate the severity of loss factors. The allowance is based on estimates and actual losses may vary materially and adversely from the estimates. 29



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Table Of Contents In addition, regulatory agencies, as a part of their examination process, periodically review the Bank's allowance for loan losses, and may require the Bank to make additions to the allowance through provisioning based on their judgment about information available to them at the time of their examinations. No assurance can be given that adverse future economic conditions will not lead to increased delinquent loans, and increases in the provision for loan losses and/or charge-offs. See Part I, Item 2. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Allowance for Loan Losses" for further details considered by management in estimating the necessary level of the allowance for loan losses. Income Taxes. Provision for income taxes is the amount of estimated tax due reported on our tax returns and the change in the amount of deferred tax assets and liabilities. Deferred income taxes represent the estimated net income tax expense payable (or benefits receivable) for temporary differences between the carrying amounts for financial reporting purposes and the amounts used for tax purposes. A valuation allowance is required if it is "more likely than not" that a deferred tax asset will not be realized. The determination of the realizability of deferred tax assets is highly subjective and dependent upon management's evaluation of both positive and negative evidence, including historic financial performance, forecasts of future income, existence of feasible tax planning strategies, length of statutory carryforward period, and assessments of current and future economic and business conditions. Management evaluates the positive and negative evidence and determines the realizability of the deferred tax asset, and the corresponding need for or adequacy of a valuation allowance on a quarterly basis. See Part I, Item 2. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Deferred Tax Asset" for further discussion of our deferred tax asset and management's evaluation of the same.



Summary of Financial Condition and Results of Operations

For the three and six months ended June 30, 2014, the Company recorded net income of $779,000, or $0.08 per diluted share, and $1.2 million, or $0.12 per diluted share, respectively. During the same periods last year, the Company reported net income of $4.4 million, or $0.49 per diluted share, and $5.8 million or $0.65 per diluted share, respectively. The decline in net income during the three and six months ended June 30, 2014 as compared to the same periods last year was primarily due to the $3.2 million income tax benefit recorded in connection with the reversal of our deferred tax valuation allowance during the quarter ended June 30, 2013. Income before income taxes increased by $159,000 during the three months ended June 30, 2014 and declined by $609,000 during the six months ended June 30, 2014, as compared to the same periods last year. The increase during the three months ended June 30, 2014 was primarily related to an increase in net interest income of $641,000, partially offset by a $268,000 increase in non-interest expense, a decline in non-interest income of $114,000 and an increase of $100,000 in provision for loan losses. The decline during the quarter and six months ended June 30, 2014 was primarily related to a $1.0 million increase in non-interest expense and a $500,000 reversal of provision for loan losses that was recorded during the six months ended June 30, 2013. These declines were partially offset by an increase in net interest income of $1.1 million. Included in net income for the three and six months ended June 30, 2014 are gains in connection with the sale of securities of $533,000 and $786,000, respectively, compared to $535,000 for the same periods last year. Total assets at June 30, 2014 were $554.4 million, representing an increase of $16.3 million, or 3.0%, from $538.1 million at December 31, 2013. Cash and cash equivalents at June 30, 2014 were $60.3 million, representing an increase of $15.6 million, or 34.9%, from $44.7 million at December 31, 2013. Loans increased by $29.2 million, from $383.5 million at December 31, 2013 to $412.7 million at June 30, 2014. Loan originations were $77.0 million and $101.3 million during the three and six months ended June 30, 2014, respectively, compared to $41.1 million and $107.4 million during the same periods last year. Prepayment speeds for the three and six months ended June 30, 2014 were 11.5% and 12.9%, respectively, compared to 19.2% and 17.3% for the same periods last year. Investment securities were $78.1 million at June 30, 2014, compared to $106.3 million at December 31, 2013, representing a decline of $28.2 million, or 26.5%. During the quarter and six months ended June 30, 2014, the Company sold investment securities with an amortized cost of $28.6 million and $43.4 million, respectively, recognizing gains of $533,000 and $786,000, respectively. During the three and six months ended June 30, 2013, the Company sold $10.8 million of investment securities, recognizing a gain of $535,000. In addition, the unrealized gain on investment securities increased to $386,000 at June 30, 2014, compared to $89,000 at December 31, 2013. The weighted average life of our investment securities was 4.42 years and 3.78 years at June 30, 2014 and December 31, 2013, respectively. Total liabilities at June 30, 2014 increased by $12.5 million, or 2.6%, to $495.3 million compared to $482.8 million at December 31, 2013. This increase is primarily due to a $15.0 million increase in deposits. Total core deposits, which includes non-interest bearing demand deposits, interest bearing demand deposits and money market deposits and savings, were $426.4 million and $409.8 million at June 30, 2014 and December 31, 2013, respectively, representing an increase of $16.7 million, or 4.1%. 30



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Table Of Contents Average interest earning assets increased $50.3 million, from $492.3 million for the three months ended June 30, 2013 to $542.6 million for the three months ended June 30, 2014. The weighted average interest rate on interest earning assets was 3.47% and 3.32% for the three months ended June 30, 2014 and 2013, respectively. The improvement in this rate was primarily attributable to an increase in the average balance of loans relative to total average earning assets as compared to the same period last year, partially offset by a decline in loan yield during the current quarter as compared to the same period last year. The decrease in loan yield is primarily attributable to a general decline in interest rates, as well as competitive loan pricing conditions in our market, which have continued to intensify and compress loan yields. Average interest earning assets increased $57.2 million, from $485.2 million for the six months ended June 30, 2013 to $542.3 million for the six months ended June 30, 2014. The weighted average interest rate on interest earning assets was 3.43% and 3.39% for the six months ended June 30, 2014 and 2013, respectively. This improvement in weighted average interest rate was primarily due to an increase in the average balance of loans relative to total earning assets as compared to the same period last year, partially offset by a decline in loan yield as compared to the same period last year and a recovery of $294,000 in deferred interest income from the repayment of non-accrual and previously charged off loan balances during the six months ended June 30, 2013. The decline in loan yield was caused by a general downward trend in interest rates, as well as competitive loan pricing conditions in our market, which have continued to compress loan yields. Average interest bearing deposits and borrowings decreased $13.4 million, from $253.0 million for the three months ended June 30, 2013 to $239.5 million for the three months ended June 30, 2014. The average cost of interest bearing deposits and borrowings was 0.31% during the three months ended June 30, 2014 compared to 0.33% for the same period last year. The decline in our cost of interest bearing deposits and borrowings is primarily attributable to a decrease in interest rates paid on these accounts. Average interest bearing deposits and borrowings decreased $6.1 million, from $250.3 million for the six months ended June 30, 2013 to $244.1 million for the six months ended June 30, 2014. The average cost of interest bearing deposits and borrowings was 0.31% during the six months ended June 30, 2014 compared to 0.33% for the same period last year. The decline in our cost of interest bearing deposits and borrowings is primarily attributable to a decrease in interest rates paid on these accounts. At June 30, 2014, stockholders' equity totaled $59.2 million, or 10.7% of total assets, as compared to $55.4 million, or 10.3% of total assets at December 31, 2013. The Company's book value per share of common stock was $5.83 as of June 30, 2014, compared to $5.77 and $5.84 per share as of June 30, 2013 and December 31, 2013, respectively.



Set forth below are certain key financial performance ratios and other financial data for the period indicated:

Three months ended June 30, Six months ended June 30, 2014 2013 2014 2013 Annualized return on average assets 0.57 % 3.55 % 0.43 % 2.40 % Annualized return on average stockholders' equity 5.31 % 34.28 % 4.10 % 23.29 % Average stockholders' equity to average assets 10.71 % 10.37 % 10.59 % 10.29 % Net interest margin 3.33 % 3.15 % 3.29 % 3.22 % Results of Operations Net Interest Income The management of interest income and interest expense is fundamental to the performance of the Company. Net interest income, which is the difference between interest income on interest earning assets, such as loans and investment securities, and interest expense on interest bearing liabilities, such as deposits and other borrowings, is the largest component of the Company's total revenue. Management closely monitors both net interest income and net interest margin (net interest income divided by average earning assets). Net interest income and net interest margin are affected by several factors including (1) the level of, and the relationship between the dollar amount of interest earning assets and interest bearing liabilities; and (2) the relationship between re-pricing or maturity of our variable-rate and fixed-rate loans, securities, deposits and borrowings. 31



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Table Of Contents The majority of the Company's loans are indexed to the national prime rate. Movements in the national prime rate have a direct impact on the Company's loan yield and interest income. The national prime rate, which generally follows the targeted federal funds rate, was 3.25% at June 30, 2014 and 2013. There was no change in the targeted federal funds rate during the three and six months ended June 30, 2014 and 2013, remaining at 0.00%-0.25%. The Company, through its asset and liability management policies and practices, seeks to maximize net interest income without exposing the Company to a level of interest rate risk deemed excessive by management. Interest rate risk is managed by monitoring the pricing, maturity and re-pricing characteristics of all classes of interest bearing assets and liabilities. This is discussed in more detail in Item 2- "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Asset/Liability Management." During the quarter ended June 30, 2014, net interest income was $4.5 million compared to $3.9 million for the same period last year. The improvement in net interest income was primarily attributable to increases in the average balances of our loan portfolio during the quarter ended June 30, 2014 as compared to the same period last year. The average balances of our loan portfolio were $393.3 million during the quarter ended June 30, 2014, compared to $308.6 million for the same period last year. The additional interest earned related to the increase in the average balance of loans was partially offset by a decline in loan yield, which decreased to 4.16% during the three months ended June 30, 2014, compared to 4.30% during the same period last year. The decrease in loan yield is primarily attributable to a general decline in interest rates, as well as competitive loan pricing conditions in our market, which have continued to intensify and compress loan yields.



The Company's net interest spread was 3.16% for the three months ended June 30, 2014 compared to 2.99% for the same period last year.

The Company's net interest margin (net interest income divided by average interest earning assets) was 3.33% for the three months ended June 30, 2014, compared to 3.15% for the same period last year. The 18 basis point increase in net interest margin is primarily due to an increase in the average balance of loans relative to total average earning assets as compared to the same period last year and, to a lesser extent, a decline in the cost of our interest bearing liabilities. The percentage of average loans to total average earning assets increased to 72.5% during the quarter ended June 30, 2014, compared to 62.7% during the same period last year. The average cost of interest bearing deposits and borrowings was 0.31% during the quarter ended June 30, 2014 compared to 0.33% for the same period last year. These factors were partially offset by a general decline in the loan yields. The decline in loan yield was primarily caused by a general downward trend in interest rates, as well as competitive loan pricing conditions in our market, which have continued to compress loan yields. The following table sets forth the average balances of certain assets, interest income/expense, average yields on interest earning assets, average rates paid on interest bearing liabilities, net interest margins and net interest income/spread for the three months ended June 30, 2014 and 2013, respectively. 32



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Table Of Contents Three Months Ended June 30, 2014 2013 Average Interest Average Interest (dollars in thousands) Balance Inc/Exp Yield Balance Inc/Exp Yield Assets Interest earning deposits at other financial institutions $ 48,043$ 31 0.26 % $ 20,139$ 13 0.25 % U.S. Gov't Treasuries and agencies 5,534 30 2.15 % 2,201 18 3.35 % Corporate notes 2,662 9 1.33 % 33,827 180 2.13 % Residential mortgage-backed securities 88,326 469 2.12 % 123,248 516 1.67 % Federal Reserve Bank stock 1,599 24 6.00 % 1,428 21 6.00 % Federal Home Loan Bank stock 3,139 51 6.56 % 2,884 20 2.80 % Loans (1) (2) 393,284 4,082 4.16 % 308,575 3,307 4.30 % Earning assets 542,587 4,696 3.47 % 492,302 4,075 3.32 % Other assets 6,610 4,439 Total assets $ 549,197$ 496,741 Liabilities & Equity Interest checking (NOW) $ 23,725 8 0.14 % $ 21,454 8 0.16 % Money market deposits and savings 147,568 90 0.24 % 153,946 88 0.23 % CDs 41,826 9 0.08 % 46,867 28 0.24 % Borrowings 26,429 80 1.21 % 30,690 83 1.08 % Total interest bearing deposits and borrowings 239,548 187 0.31 % 252,957 207 0.33 % Demand deposits 248,649



189,156

Other liabilities 2,188



3,132

Total liabilities 490,385



445,245

Equity 58,812



51,496

Total liabilities & equity $ 549,197 $



496,741

Net interest income / spread $ 4,509 3.16 %



$ 3,868 2.99 %

Net interest margin 3.33 % 3.15 %



(1) Before allowance for loan losses and net deferred loan fees and costs.

Included in net interest income was net loan origination (cost amortization)

and fee accretion of ($11,000) and $11,000 for the three months ended June

30, 2014 and 2013, respectively.

(2) Includes average non-accrual loans of $734,000 and $983,000 for the three

months ended June 30, 2014 and 2013, repectively. The Volume and Rate Variances table below sets forth the dollar difference in interest earned and paid for each major category of interest earning assets and interest bearing liabilities for the noted period, and the amount of such change attributable to changes in average balances (volume) or changes in average interest rates. Volume variances are equal to the increase or decrease in the average balance times the prior period rate and rate variances are equal to the increase or decrease in the average rate times the prior period average balance. Variances attributable to both rate and volume changes are equal to the change in rate times the change in average balance and are included below in the average volume column. Three Months Ended June 30, 2014 Compared to 2013 Increase (Decrease) Due to Changes in: (in thousands) Volume Rate Total Interest income: Interest earning deposits at other financial institutions $ 18 $ - $ 18 U.S. Gov't Treasuries and agencies 20 (8 ) 12 Corporate notes (122 ) (49 ) (171 ) Residential mortgage-backed securities (166 ) 119 (47 ) Federal Reserve Bank stock 3 - 3 Federal Home Loan Bank stock 2 29 31 Loans 880 (105 ) 775 Total increase (decrease) in interest income 635 (14 ) 621 Interest expense: Interest checking (NOW) 1 (1 ) 0 Money market deposits and savings (3 ) 5 2 CDs (3 ) (16 ) (19 ) Borrowings (12 ) 9 (3 ) Total increase (decrease) in interest expense (17 ) (3 ) (20 ) Net increase (decrease) in net interest income $ 652 $ (11 ) $ 641 33



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Table Of Contents During the six months ended June 30, 2014, net interest income was $8.9 million, compared to $7.8 million for the same period last year. The increase was primarily attributable to additional interest earned in connection with our loan portfolio as compared to the same period last year. The average balances of our loan portfolio were $384.3 million and $290.8 million during the six months ended June 30, 2014 and 2013, respectively. This increase was partially offset by a decline in loan yield, which decreased to 4.17% during the six months ended June 30, 2014, compared to 4.55% during the same period last year, as well as $294,000 of additional interest income recognized during the six months ended June 30, 2013 in connection with the pay-off of non-accrual and previously charged off loans. The decrease in loan yield is primarily attributable to a general decline in interest rates, as well as competitive loan pricing conditions in our market, which have continued to intensify and compress loan yields.



The Company's net interest spread was 3.12% for the six months ended June 30, 2014 compared to 3.06% for the same period last year.

The Company's net interest margin was 3.29% for the six months ended June 30, 2014, compared to 3.22% for the same period last year. As discussed above, the improvement in our net interest margin is primarily due to an increase in the average balance of loans relative to total earning assets as compared to the same period last year, and, to a lesser extent, a decline in the cost of our interest bearing liabilities. The percentage of average loans to total average earning assets increased to 70.9% during the six months ended June 30, 2014, compared to 59.9% during the same period last year. The decline in the cost of interest bearing deposits and borrowings is primarily attributable to a decrease in interest rates paid on these accounts. The average cost of interest bearing deposits and borrowings was 0.31% during the six months ended June 30, 2014 compared to 0.33% during the same period last year. These factors were partially offset by a general decline in the loan yields and a recovery of $294,000 in deferred interest income from the repayment of non-accrual and previously charged off loan balances during the six months ended June 30, 2013. The decline in loan yield was caused by a general downward trend in interest rates, as well as competitive loan pricing conditions in our market, which have continued to compress loan yields. The following table sets forth the average balances of certain assets, interest income/expense, average yields on interest earning assets, average rates paid on interest bearing liabilities, net interest margins and net interest income/spread for the six months ended June 30, 2014 and 2013, respectively. Six Months Ended June 30, 2014 2013 Average Interest Average Interest (dollars in thousands) Balance Inc/Exp Yield Balance Inc/Exp Yield Assets Interest earning deposits at other financial institutions $ 51,368$ 65 0.25 % $ 23,135$ 29 0.25 % U.S. Gov't Treasuries 3,224 34 2.15 % 2,204 7 0.59 % Corporate notes 2,882 19 1.32 % 34,405 368 2.14 %



Residential

mortgage-backed

securities 95,866 1,016 2.12 % 130,545 1,118 1.71 % Federal Reserve Bank stock 1,585 47 6.00 % 1,395 42 6.00 % Federal Home Loan Bank stock 3,101 103 6.69 % 2,651 34 2.59 % Loans (1) (2) 384,291 7,950 4.17 % 290,826 6,565 4.55 % Earning assets 542,317 9,234 3.43 % 485,161 8,163 3.39 % Other assets 6,636 6,614 Total assets $ 548,953$ 491,775 Liabilities & Equity Interest checking (NOW) $ 21,813 16 0.14 % $ 22,477 18 0.16 % Money market deposits and savings 153,140 183 0.24 % 153,968 178 0.23 % CDs 42,201 18 0.09 % 45,934 58 0.26 % Borrowings 26,963 162 1.21 % 27,886 157 1.14 % Total interest bearing deposits and borrowings 244,117 379 0.31 % 250,265 411 0.33 % Demand deposits 244,334



187,527

Other liabilities 2,343



3,397

Total liabilities 490,794



441,189

Equity 58,159



50,586

Total liabilities & equity $ 548,953 $



491,775

Net interest income / spread $ 8,855 3.12 %



$ 7,752 3.06 %

Net interest margin 3.29 % 3.22 %



(1) Before allowance for loan losses and net deferred loan fees and costs.

Included in net interest income was net loan origination cost amortization

of $4,000 and $1,000 for the six months ended June 30, 2014 and 2013,

respectively.

(2) Includes average non-accrual loans of $735,000 and $1.1 million for the six

months ended June 30, 2014 and 2013, respectively. 34



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Table Of Contents The Volume and Rate Variances table below sets forth the dollar difference in interest earned and paid for each major category of interest earning assets and interest bearing liabilities for the noted periods, and the amount of such change attributable to changes in average balances (volume) or changes in average interest rates. Volume variances are equal to the increase or decrease in the average balance times the prior period rate and rate variances are equal to the increase or decrease in the average rate times the prior period average balance. Variances attributable to both rate and volume changes are equal to the change in rate times the change in average balance and are included below in the average volume column. Six Months Ended June 30, 2014 Compared to 2013 Increase (Decrease) Due to Changes in: (in thousands) Volume Rate Total Interest income: Interest earning deposits at other financial institutions $ 36 $ - $ 36 U.S. Gov't Treasuries and agencies 4 23 27 Corporate notes (246 ) (103 ) (349 ) Residential mortgage-backed securities (332 ) 230 (102 ) Federal Reserve Bank stock 5 - 5 Federal Home Loan Bank stock 7 62 69 Loans 1,970 (585 ) 1,385 Total increase (decrease) in interest income 1,444 (373 ) 1,071 Interest expense: Interest checking (NOW) (1 ) (1 ) (2 ) Money market deposits and savings (1 ) 6 5 CDs (4 ) (36 ) (40 ) Borrowings (5 ) 10 5 Total increase (decrease) in interest expense (11 ) (21 ) (32 ) Net increase (decrease) in net interest income $ 1,455 $ (352 ) $ 1,103 Provision for Loan Losses During the three and six months ended June 30, 2014, we recorded a provision for loan losses of $100,000, compared to none and a $500,000 reversal of provision for loan losses during the same periods last year. This reversal in provision for loan losses was primarily due to $1.1 million of net loan recoveries during the six months ended June 30, 2013, as well as the continued improvement in the level of our criticized and classified loans. These declines were partially offset by additional provisions required for the $31.1 million increase in our loan portfolio during that same period. Criticized and classified loans generally consist of special mention, substandard and doubtful loans. Special mention, substandard and doubtful loans were $152,000, $2.2 million and none, respectively, at June 30, 2014, compared to $737,000, $2.4 million and none, respectively, at June 30, 2013. We had net recoveries of $15,000 and $31,000 during the three and six months ended June 30, 2014, respectively, compared to $1,000 and $1.1 million for the same periods last year. At June 30, 2014, the ALL to total loans was 1.79% compared to 1.89% at December 31, 2013. The risks associated with the adequacy of our ALL and the decline in this ratio may have increased as a result of our loan growth. Management will continue to closely monitor the adequacy of the ALL and will make adjustments as warranted. Management believes that the ALL as of June 30, 2014 and December 31, 2013 was adequate to absorb known and inherent risks in the loan portfolio. The provision for loan losses was recorded based on an analysis of the factors discussed in Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Allowance for Loan Losses. As a percentage of our total loan portfolio, the amount of non-performing loans was 0.18% and 0.19% at June 30, 2014 and December 31, 2013, respectively. As a percentage of our total assets, the amount of non-performing assets was 0.13% and 0.15% at June 30, 2014 and December 31, 2013, respectively. Non-Interest Income Non-interest income was $723,000 and $1.1 million for the three and six months ended June 30, 2014, compared to $837,000 and $1.2 million for the same periods last year. During the quarter and six months ended June 30, 2014, the Company sold investment securities with an amortized cost of $28.6 million and $43.4 million, respectively, recognizing gains of $533,000 and $786,000, respectively. In addition, the Company recognized a gain of $47,000 in connection with the disposition of its OREO during the three months ended June 30, 2014. With the exception of these gains, non-interest income during the three and six months ended June 30, 2014 primarily consist of customer related fee income. During the quarter and six months ended June 30, 2013, the Company sold $10.8 million of investment securities, recognizing a gain of $535,000. With the exception of this gain, non-interest income for the three and six months ended June 30, 2013, primarily consists of loan arrangement fees earned in connection with our college loan funding program. During 2013, the Company terminated this program and did not report any material loan arrangement fee earnings subsequent to the second quarter of 2013. 35



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Table Of Contents Non-Interest Expense Non-interest expense was $3.8 million and $7.8 million for the three and six months ended June 30, 2014, compared to $3.5 million and $6.8 million for the same periods last year. The increases in non-interest expense during the three and six months ended June 30, 2014 as compared to the same periods last year is primarily due to the costs incurred to expand the Bank's business development and related operational support teams, as well as the additional costs incurred to address regulatory compliance matters. Income Tax Provision During the three and six months ended June 30, 2014, we recorded a tax provision of $565,000 and $875,000, respectively, compared to a tax benefit of approximately $3.2 million during the same periods last year. The tax benefit recognized during the three and six months ended June 30, 2013 was related to the full reversal of the Company's deferred tax valuation allowance that had been previously established during the year ended December 31, 2009. In making this determination, management analyzed, among other things, our recent history of earnings and cash flows, forecasts of future earnings, improvements in the credit quality of the Company's loan portfolio, the nature and timing of future deductions and benefits represented by the deferred tax assets and our cumulative earnings for the 12 quarters preceding the reversal of this valuation allowance. At June 30, 2013, no further deferred tax valuation allowance remained. Beginning in January 2014, the Company began recording tax provisions at an estimated effective tax rate of approximately 42%. Financial Condition Assets Total assets at June 30, 2014 were $554.4 million, representing an increase of $16.3 million, or 3.0%, from $538.1 million at December 31, 2013. Cash and cash equivalents at June 30, 2014 were $60.3 million, representing an increase of $15.6 million, or 34.9%, from $44.7 million at December 31, 2013. Loans increased by $29.2 million, from $383.5 million at December 31, 2013 to $412.7 million at June 30, 2014. Loan originations were $77.0 million and $101.3 million during the three and six months ended June 30, 2014, respectively, compared to $41.1 million and $107.4 million during the same periods last year. Prepayment speeds for the three and six months ended June 30, 2014 were 11.5% and 12.9%, respectively, compared to 19.2% and 17.3% for the same periods last year. Investment securities were $78.1 million at June 30, 2014, compared to $106.3 million at December 31, 2013, representing a decline of $28.2 million, or 26.5%. During the quarter and six months ended June 30, 2014, the Company sold investment securities with an amortized cost of $28.6 million and $43.4 million, respectively, recognizing gains of $533,000 and $786,000, respectively. During the quarter and six months ended June 30, 2013, the Company sold $10.8 million of investment securities, recognizing a gain of $535,000. In addition, the unrealized gain on investment securities increased to $386,000 at June 30, 2014, compared to $89,000 at December 31, 2013. The weighted average life of our investment securities was 4.42 years and 3.78 years at June 30, 2014 and December 31, 2013, respectively. Cash and Cash Equivalents Cash and cash equivalents totaled $60.3 million and $44.7 million at June 30, 2014 and December 31, 2013, respectively. The $15.6 million increase in cash and cash equivalents during the six months ended June 30, 2014 was primarily from a $15.0 million increase in deposits and the sale of $43.4 million of securities, partially offset by an increase of $29.2 million in net loan production. Cash and cash equivalents are managed based upon liquidity needs by investing excess liquidity in higher yielding assets such as loans and investment securities. See the section "Liquidity and Asset/Liability Management" below. Investment Securities The investment securities portfolio is generally the second largest component of the Company's interest earning assets, and the structure and composition of this portfolio is important to any analysis of the financial condition of the Company. The investment portfolio serves the following purposes: (i) it can be readily reduced in size to provide liquidity for loan balance increases or deposit balance decreases; (ii) it provides a source of pledged assets for securing certain deposits and borrowed funds, as may be required by law or by specific agreement with a depositor or lender; (iii) it can be used as an interest rate risk management tool, since it provides a large base of assets, the maturity and interest rate characteristics of which can be changed more readily than the loan portfolio to better match changes in the deposit base and other funding sources of the Company; and (iv) it is an alternative interest earning use of funds when loan demand is weak or when deposits grow more rapidly than loans. 36



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Table Of Contents At June 30, 2014, investment securities totaled $78.1 million compared to $106.3 million at December 31, 2013. The Company's investment portfolio is primarily composed of residential mortgage-backed securities issued by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. The underlying loans for these securities are residential mortgages that were primarily originated beginning in 2003 through the current period. These loans are geographically dispersed throughout the United States. At June 30, 2014 and December 31, 2013, the weighted average yield and weighed average life of these residential mortgage-backed securities were 2.05% and 2.12%, respectively, and 4.42 years and 3.85 years, respectively. During the quarter and six months ended June 30, 2014, the Company sold investment securities with an amortized cost of $28.6 million and $43.4 million, respectively, recognizing gains of $533,000 and $786,000, respectively. During the quarter and six months ended June 30, 2013, the Company sold $10.8 million of investment securities, recognizing a gain of $535,000. These gains were recorded in non-interest income within the unaudited Consolidated Statement of Operations and Comprehensive Income. In addition, the unrealized gain on investment securities increased to $386,000 at June 30, 2014, compared to $89,000 at December 31, 2013. We will continue to evaluate the Company's investments and liquidity needs and will adjust the amount of investment securities accordingly. Loans Loans, net of the ALL and deferred loan origination costs/unearned fees, increased 7.7%, or $29.0 million, from $376.3 million at December 31, 2013 to $405.3 million at June 30, 2014. As of June 30, 2014 and December 31, 2013, total loans outstanding totaled $412.7 million and $383.5 million, respectively. Loan originations were $77.0 million and $101.3 million during the three and six months ended June 30, 2014, respectively, compared to $41.1 million and $107.4 million during the same periods last year. Prepayment speeds for the three and six months ended June 30, 2014 were 11.5% and 12.9%, respectively, compared to 19.2% and 17.3% for the same periods last year.



As of June 30, 2014 and December 31, 2013, substantially all of the Company's loan customers were located in Southern California.

Non-Performing Assets



The following table sets forth non-accrual loans and other real estate owned at June 30, 2014 and December 31, 2013:

(dollars in thousands) June 30, 2014 December 31, 2013 Non-accrual loans: Commercial $ 702 $ 706 Consumer and other 29 29 Total non-accrual loans 731 735 Other real estate owned ("OREO") - 90 Total non-performing assets $ 731 $ 825 Non-performing assets to gross loans and OREO 0.18 % 0.22 % Non-performing assets to total assets 0.13 % 0.15 % Non-accrual loans totaled $731,000 and $735,000 at June 30, 2014 and December 31, 2013, respectively. There were no accruing loans past due 90 days or more at June 30, 2014 and December 31, 2013. Gross interest income that would have been recorded on non-accrual loans had they been current in accordance with their original terms was $10,000 and $20,000 for the three and six months ended June 30, 2014, respectively, compared to $10,000 and $25,000 for the same periods last year. At June 30, 2014, non-accrual loans consisted of two commercial loans totaling $702,000 and one consumer and other loan totaling $29,000. At December 31, 2013, non-accrual loans consisted of two commercial loans totaling $706,000 and one consumer and other loan totaling $29,000.



During the quarter ended June 30, 2014, the Bank disposed of its OREO for approximately $137,000, recognizing a gain of $47,000 in connection with this disposition. At December 31, 2013, OREO consisted of one undeveloped land property totaling $90,000. This property is located in Southern California.

At June 30, 2014 and December 31, 2013, the recorded investment in impaired loans was $927,000 and $953,000, respectively. At June 30, 2014 and December 31, 2013, the Company had a specific allowance for loan losses of $35,000 on impaired loans of $130,000 and $135,000, respectively. There were $797,000 and $818,000, respectively, of impaired loans with no specific allowance for loan losses at June 30, 2014 and December 31, 2013, respectively. The average outstanding balance of impaired loans for the six months ended June 30, 2014 was $946,000 compared to $1.4 million for the same period last year. As of June 30, 2014 and December 31, 2013, there was $731,000 and $735,000, respectively, of impaired loans on non-accrual status. During the three and six months ended June 30, 2014, interest income recognized on impaired loans subsequent to their classification as impaired was $3,000 and $5,000, respectively, compared to $2,000 and $5,000 for the same periods last year. The Company stops accruing interest on these loans on the date they are classified as non-accrual and reverses any uncollected interest that had been previously accrued as income. The Company may begin recognizing interest income on these loans as cash interest payments are received, if collection of principal is reasonably assured. 37



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Table Of Contents Allowance for Loan Losses The ALL is established through provisions for loan losses charged to operations and represents probable incurred credit losses in the Company's loan portfolio that have been incurred as of the balance sheet date. Loan losses are charged against the ALL when management believes that principal is uncollectible. Subsequent repayments or recoveries, if any, are credited to the ALL. Management periodically assesses the adequacy of the ALL by reference to many quantitative and qualitative factors that may be weighted differently at various times depending on prevailing conditions. These factors include, among others: the risk characteristics of various classifications of loans; general portfolio trends relative to asset and portfolio size; asset categories; potential credit concentrations; delinquency trends within the loan portfolio;



changes in the volume and severity of past due and other classified loans;

historical loss experience and risks associated with changes in economic,

social and business conditions; and the underwriting standards in effect when the loan was made. Accordingly, the calculation of the adequacy of the ALL is not based solely on the level of non-performing assets. The quantitative factors, included above, are utilized by our management to identify two different risk groups (1) individual loans (loans with specifically identifiable risks); and (2) homogeneous loans (groups of loan with similar characteristics). We base the allocation for individual loans on the results of our impairment analysis, which is typically based on the present value of the expected future cash flows discounted at the loan's effective interest rate or by using the loan's most recent market value or the fair value of the collateral, if the loan is collateral dependent. Homogenous groups of loans are allocated reserves based on the loss ratio assigned to the pool based on its risk grade. The loss ratio is determined based primarily on the historical loss experience of our loan portfolio. These loss ratios are then adjusted, if determined necessary by management, based on other factors including, but not limited to, historical peer group loan loss data and the loss experience of other financial institutions. Loss ratios for all categories of loans are evaluated by management on a quarterly basis. Historical loss experience is determined based on a rolling migration analysis of each loan category within our portfolio. This migration analysis estimates loss factors based on the performance of each loan category over a four and a half year time period. These quantitative calculations are based on estimates and actual losses may vary materially and adversely from the estimates. The qualitative factors, included above, are also utilized to identify other risks inherent in the portfolio and to determine whether the estimated credit losses associated with the current portfolio might differ from historical loss trends or the loss ratios discussed above. We estimate a range of exposure for each applicable qualitative factor and evaluate the current condition and trend of each factor. Because of the subjective nature of these factors, the actual losses incurred may vary materially and adversely from the estimated amounts. In addition, regulatory agencies, as a part of their examination process, periodically review the Bank's ALL, and may require the Bank to take additional provisions to increase the ALL based on their judgment about information available to them at the time of their examinations. No assurance can be given that adverse future economic conditions or other factors will not lead to increased delinquent loans, further provisions for loan losses and/or charge-offs. Management believes that the ALL as of June 30, 2014 and December 31, 2013 was adequate to absorb probable incurred credit losses inherent in the loan portfolio. 38



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The following is a summary of the activity for the ALL for the three and six months ended June 30, 2014 and 2013:

Commercial Land and Consumer (in thousands) Commercial Real Estate Residential Construction and Other Total

Three Months Ended June 30, 2014: Allowance for loan losses: Beginning balance $ 1,579$ 3,660 $ 778 $ 811 $ 424$ 7,252 Provision for loan losses 10 140 110 (120 ) (40 ) 100 Charge-offs - - - - - - Recoveries 15 - - - - 15 Ending balance $ 1,604$ 3,800 $ 888 $ 691 $ 384$ 7,367 Six Months Ended June 30, 2014: Allowance for loan losses: Beginning balance $ 1,583$ 3,660 $ 758 $ 811 $ 424$ 7,236 Provision for loan losses (10 ) 140 130 (120 ) (40 ) 100 Charge-offs - - - - - - Recoveries 31 - - - - 31 Ending balance $ 1,604$ 3,800 $ 888 $ 691 $ 384$ 7,367 Three Months Ended June 30, 2013: Allowance for loan losses: Beginning balance $ 1,631$ 3,200 $ 698 $ 741 $ 349$ 6,619 Provision for loan losses (100 ) (25 ) 50 25 50 - Charge-offs - - - - - - Recoveries 1 - - - - 1 Ending balance $ 1,532$ 3,175 $ 748 $ 766 $ 399$ 6,620 Six Months Ended June 30, 2013: Allowance for loan losses: Beginning balance $ 2,277$ 2,450 $ 508 $ 411 $ 369$ 6,015 Provision for (reduction of) loan losses (1,800 ) 725 240 355 (20 ) (500 ) Charge-offs - - - - - - Recoveries 1,055 - - - 50 1,105 Ending balance $ 1,532$ 3,175 $ 748 $ 766 $ 399$ 6,620



There were no loans acquired with deteriorated credit quality during the three and six months ended June 30, 2014 and 2013.

The ALL was $7.4 million, or 1.79% of our total loan portfolio, at June 30, 2014, compared to $7.2 million, or 1.89% of our total loan portfolio, at December 31, 2013. At June 30, 2014 and December 31, 2013, our non-performing loans were $731,000 and $735,000, respectively. The ratio of our ALL to non-performing loans was 1,008.46% and 984.26% at June 30, 2014 and December 31, 2013, respectively. In addition, our ratio of non-performing loans to total loans was 0.18% and 0.19% at June 30, 2014 and December 31, 2013, respectively. The ALL is impacted by inherent risk in the loan portfolio, including the level of our non-performing loans, as well as specific reserves and charge-off activities. The remaining portion of our ALL is allocated to our performing loans based on the quantitative and qualitative factors discussed above. Deferred Tax Asset During the year ended December 31, 2009, the Company established a full valuation allowance against the deferred tax assets due to the uncertainty regarding its realizability. During the quarter ended June 30, 2013, management reassessed the need for this valuation allowance and concluded that a valuation allowance was no longer appropriate and that it is more likely than not that these assets will be realized. As a result, management reversed the valuation allowance as an income tax benefit in the unaudited Consolidated Statements of Operations and Comprehensive Income during the quarter ended June 30, 2013. In making this determination, management analyzed, among other things, our recent history of earnings and cash flows, forecasts of future earnings, improvements in the credit quality of the Company's loan portfolio, the nature and timing of future deductions and benefits represented by the deferred tax assets and our cumulative earnings for the 12 quarters preceding the reversal of this valuation allowance. At June 30, 2014 and December 31, 2013, we had a net deferred tax asset of $2.7 million and $3.1 million, respectively. Our net deferred tax asset primarily consists of deferred tax assets related to federal and state net operating loss carryforwards and the allowance for loan losses. 39



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Table Of Contents A valuation allowance is required if it is "more likely than not" that a deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning management's evaluation of both positive and negative evidence, including historical financial performance, the forecasts of future income, existence of feasible tax planning strategies, length of statutory carryforward period, and assessments of the current and future economic and business conditions. Management evaluates the positive and negative evidence and determines the realizability of the deferred tax asset on a quarterly basis. Management may reestablish a valuation allowances in the future to the extent that it is determined that it is more likely than not that these assets will not be realized. Deposits



The Company's activities are largely based in the Los Angeles metropolitan area. The Company's deposit base is also primarily generated from this area.

At June 30, 2014, total deposits were $467.8 million compared to $452.8 million at December 31, 2013, representing an increase of 3.3%, or $15.0 million. Total core deposits, which include non-interest bearing demand deposits, interest bearing demand deposits, and money market deposits and savings, were $426.4 million and $409.8 million at June 30, 2014 and December 31, 2013, respectively. Non-interest bearing deposits represent 56.0% of total deposits at June 30, 2014, compared to 52.3% at December 31, 2013.



The following table reflects a summary of deposit categories by dollar and percentage at June 30, 2014 and December 31, 2013:

June 30, 2014 December 31, 2013 Percent of Percent of (dollars in thousands) Amount Total Amount Total Non-interest bearing demand deposits $ 261,987 56.0 % $ 236,869 52.3 % Interest bearing checking 23,594 5.1 % 21,005 4.6 % Money market deposits and savings 140,830 30.1 % 151,879 33.6 % Certificates of deposit 41,361 8.8 % 43,013 9.5 % Total $ 467,772 100.0 % $ 452,766 100.0 % At June 30, 2014, the Company had three certificates of deposit with the State of California Treasurer's Office for a total of $38.0 million, which represented 8.1% of total deposits. The deposits outstanding at June 30, 2014 are scheduled to mature in the third quarter of 2014. The Company intends to renew each of these deposits at maturity. However, there can be no assurance that the State of California Treasurer's Office will continue to maintain deposit accounts with the Company. At December 31, 2013, the Company had four certificates of deposit with the State of California Treasurer's Office for a total of $38.0 million, which represented 8.4% of total deposits. The Company was required to pledge $41.8 million of agency mortgage-backed securities at both June 30, 2014 and December 31, 2013, in connection with these certificates of deposit. For further information on the Company's certificates of deposit with the State of California Treasurer's Office, see Part I, Item 1. Financial Statements - Note 7 "Deposits."



The aggregate amount of certificates of deposit of $100,000 or more at June 30, 2014 and December 31, 2013 was $40.6 million and $42.1 million, respectively.

Scheduled maturities of certificates of deposit in amounts of $100,000 or more at June 30, 2014, including deposit accounts with the State of California Treasurer's Office and CDARS were as follows:

(in thousands) Due within 3 months or less $ 39,867



Due after 3 months and within 6 months 541 Due after 6 months and within 12 months 147 Due after 12 months

- Total $ 40,555



Liquidity and Asset/Liability Management

Liquidity, as it relates to banking, is the ability to meet loan commitments and to honor deposit withdrawals through either the sale or maturity of existing assets or the acquisition of additional funds through deposits or borrowing. The Company's main sources of funds to provide liquidity are its cash and cash equivalents, paydowns and maturities of investments, loan repayments, and increases in deposits and borrowings. The Company also maintains lines of credit with the Federal Home Loan Bank ("FHLB"), and other correspondent financial institutions. The liquidity ratio (the sum of cash and cash equivalents and available for sale investments, excluding amounts required to be pledged and operating requirements, divided by total assets) was 16.7% at June 30, 2014 and 19.4% at December 31, 2013. 40



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Table Of Contents At June 30, 2014 and December 31, 2013, the Company had a borrowing/credit facility secured by a blanket lien on eligible loans at the FHLB of $186.1 million and $169.9 million, respectively. The Company had $25.0 million and $27.5 million of long-term borrowings outstanding under this borrowing/credit facility with the FHLB at June 30, 2014 and December 31, 2013, respectively. The Company had no overnight borrowings outstanding under this borrowing/credit facility at June 30, 2014 and December 31, 2013. The following table summarizes the outstanding long-term borrowings under the borrowing/credit facility secured by a blanket lien on eligible loans at the FHLB at June 30, 2014 and December 31, 2013 (dollars in thousands): Maturity Date Interest Rate June 30, 2014 December 31, 2013 May 23, 2014 1.14% - 2,500 December 29, 2014 0.83% 5,000 5,000 December 30, 2014 0.74% 2,500 2,500 May 26, 2015 1.65% 2,500 2,500 May 23, 2016 2.07% 2,500 2,500 December 29, 2016 1.38% 5,000 5,000 December 30, 2016 1.25% 2,500 2,500 May 2, 2018 0.93% 5,000 5,000 Total $ 25,000 $ 27,500 At June 30, 2014 and December 31, 2013, the Company also had $27.0 million in Federal fund lines of credit available with other correspondent banks that could be used to disburse loan commitments and to satisfy demands for deposit withdrawals. Each of these lines of credit is subject to conditions that the Company may not be able to meet at the time when additional liquidity is needed. As of June 30, 2014 and December 31, 2013, the Company had pledged $2.6 million and $3.1 million, respectively, of corporate notes related to these lines of credit. Management believes the level of liquid assets and available credit facilities are sufficient to meet current and anticipated funding needs. In addition, the Bank's Asset/Liability Management Committee oversees the Company's liquidity position by reviewing a monthly liquidity report. Management is not aware of any trends, demands, commitments, events or uncertainties that will result or are reasonably likely to result in a material change in the Company's liquidity. Capital Expenditures



As of June 30, 2014, the Company was not subject to any material commitments for capital expenditures.

Capital Resources At June 30, 2014, the Company had total stockholders' equity of $59.2 million, which included $121,000 in common stock, $70.2 million in additional paid-in capital, $2.9 million in accumulated deficit, $227,000 in accumulated other comprehensive income, and $8.5 million in treasury stock. Capital The Company and the Bank are subject to the various regulatory capital requirements administered by federal banking agencies. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material and adverse effect on the business, results of operations and financial condition of the Company. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulation) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes that as of June 30, 2014 and December 31, 2013, the Company and the Bank met all capital adequacy requirements to which they are subject. At December 31, 2013, the most recent notification from the OCC categorized the Bank as "well-capitalized" under the regulatory framework for prompt corrective action. To generally be categorized as a "well-capitalized" financial institution, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios. There are no conditions or events since the notification that management believes have changed the Bank's categorization. 41



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The Company's and the Bank's capital ratios as of June 30, 2014 and December 31, 2013 are presented in the table below:

For the Bank to be "Well- Capitalized" Under Prompt Company Bank For Capital Adequacy Purposes Corrective Measures

(dollars in thousands) Amount Ratio Amount Ratio Amount Ratio Amount Ratio June 30, 2014: Total Risk-Based Capital Ratio $ 63,479 14.38 % $ 59,469 13.47 % $ 35,323 8.00 % $ 44,153 10.00 % Tier 1 Risk-Based Capital Ratio $ 57,934 13.12 % $ 53,923 12.21 % $ 17,661 4.00 % $ 26,492 6.00 % Tier 1 Leverage Ratio $ 57,934 10.58 % $ 53,923 9.84 % $ 21,907 4.00 % $ 27,402 5.00 % December 31, 2013: Total Risk-Based Capital Ratio $ 58,620 14.18 % $ 56,555 13.69 % $ 33,062 8.00 % $ 41,326 10.00 % Tier 1 Risk-Based Capital Ratio $ 53,425 12.93 % $ 51,361 12.43 % $ 16,531 4.00 % $ 24,796 6.00 % Tier 1 Leverage Ratio $ 53,425 9.70 % $ 51,361 9.32 % $ 22,025 4.00 % $ 27,541 5.00 % On July 2, 2013, the Federal Reserve approved the final rules implementing the Basel Committee on Banking Supervision's ("BCBS") capital guidelines for U.S. banks. Under the final rules, minimum requirements will increase for both the quantity and quality of capital held by the Company. The rules include a new common equity Tier 1 capital to risk-weighted assets ratio of 4.5%. The new rules also require a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets over each of the required capital ratios that will be phased in from 2016 to 2019 and must be met to avoid limitations on the ability of the Bank to pay dividends, repurchase shares or pay discretionary bonuses. The final rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and require a minimum leverage ratio of 4.0%. The final rules also implement strict eligibility criteria for regulatory capital instruments, excluding trust preferred securities, mortgage servicing rights and certain deferred tax assets, and including unrealized gains and losses on available for sale debt and equity securities. On July 9, 2013, the FDIC and OCC also approved, as an interim final rule, the regulatory capital requirements for U.S. banks, following the actions of the FRB. The FDIC and OCC's rules are identical in substance to the final rules issued by the FRB.



The phase-in period for the final rules will begin for the Company and the Bank on January 1, 2015, with full compliance with all of the final rule's requirements phased in over a multi-year schedule. Management is currently evaluating the provisions of the final rules and their expected impact.

Dividends In the ordinary course of business, the Company is dependent upon dividends from the Bank to provide funds for the payment of dividends to shareholders and to provide for other cash requirements. Banking regulations may limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of the Bank to fall below specified minimum levels. Approval is also required if dividends declared exceed the net profits for that year combined with the retained net profits for the preceding two years. Currently, the Bank is prohibited from paying dividends to the Company until such time as the accumulated deficit is eliminated. To date, the Company has not paid any cash dividends. Payment of stock or cash dividends in the future will depend upon earnings and financial condition and other factors deemed relevant by the Company's Board of Directors, as well as the Company's legal ability to pay dividends. Accordingly, no assurance can be given that any cash dividends will be declared in the foreseeable future. Consent Order On September 11, 2013, the Board of Directors of the Bank entered into a stipulation and consent to the issuance of a consent order with the OCC consenting to the issuance of a consent order (the "Consent Order") by the OCC, effective as of that date. The Consent Order requires the Bank to take corrective action to enhance its program and procedures for compliance with the Bank Secrecy Act and other anti-money laundering regulations. Failure to comply with the Consent Order may result in additional regulatory action, including restrictions on our operations, civil money penalties against the Bank and its officers and directors or enforcement of the Consent Order through court proceedings. 42



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Off-Balance Sheet Arrangements

In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and letters of credit. To varying degrees, these instruments involve elements of credit and interest rate risk in excess of the amount recognized in the statement of financial position. (in thousands) June 30, 2014 December 31, 2013 Commitments to extend credit $ 125,635 $ 104,330 Commitments to extend credit to directors and officers (undisbursed amount) $ 1,086 $ 1,604 Standby/commercial letters of credit $ 2,351 $ 2,616 Guarantees on revolving credit card limits $ 566 $ 574 Outstanding credit card balances $ 62 $ 73 The Company maintains an allowance for unfunded commitments, based on the level and quality of the Company's undisbursed loan funds, which comprises the majority of the Company's off-balance sheet risk. As of June 30, 2014 and December 31, 2013, the allowance for unfunded commitments was $270,000, which represented 0.21% and 0.25% of the undisbursed commitments and letters of credit, respectively. Management is not aware of any other off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, and results of operations, liquidity, capital expenditures or capital resources that is material to investors.



For further information on commitments and contingencies, see Part I, Item 1. Financial Statements - Note 9 "Commitments and Contingencies."


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Source: Edgar Glimpses


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