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COMMUNITY WEST BANCSHARES / - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

August 7, 2014

This discussion is designed to provide insight into management's assessment of significant trends related to the Company's consolidated financial condition, results of operations, liquidity, capital resources and interest rate sensitivity. It should be read in conjunction with the Company's unaudited interim consolidated financial statements and notes thereto included herein and the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2013, and the other financial information appearing elsewhere in this report.



Forward Looking Statements

This report contains certain forward-looking statements, within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbor for "forward-looking statements" provided by the Private Securities Litigation Reform Act of 1995. These statements may include statements that expressly or implicitly predict future results, performance or events. Statements other than statements of historical fact are forward-looking statements. In addition, the words "anticipates," "expects," "believes," "estimates" and "intends" or the negative of these terms or other comparable terminology constitute "forward-looking statements." Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. Except as required by law, the Company disclaims any obligation to update any such forward-looking statements or to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future events or developments. Forward-looking statements contained in this Quarterly Report on Form 10-Q involve substantial risks and uncertainties, many of which are difficult to predict and are generally beyond the control of the Company and may cause our actual results to differ significantly from historical results and those expressed in any forward-looking statement. Risks and uncertainties include those set forth in our filings with the Securities and Exchange Commission and the following factors that could cause actual results to differ materially from those presented:



general economic conditions, either nationally or locally in some or all areas

in which business is conducted, or conditions in the real estate or securities

markets or the banking industry which could affect liquidity in the capital

markets, the volume of loan origination, deposit flows, real estate values, the

levels of non-interest income and the amount of loan losses;

changes in existing loan portfolio composition and credit quality, and changes

in loan loss requirements;

legislative or regulatory changes which may adversely affect the Company's

business, including but not limited to the impact of the Dodd-Frank Wall Street

Reform and Consumer Protection Act and the regulations required to be

promulgated thereunder;

the Company's success in implementing its new business initiatives, including

expanding its product line, adding new branches and successfully building its

brand image;

changes in interest rates which may reduce net interest margin and net interest

income;

increases in competitive pressure among financial institutions or non-financial

institutions;

technological changes which may be more difficult to implement or expensive

than anticipated;

changes in borrowing facilities, capital markets and investment opportunities

which may adversely affect the business;

changes in accounting principles, policies or guidelines which may cause

conditions to be perceived differently;

litigation or other matters before regulatory agencies, whether currently

existing or commencing in the future, which may delay the occurrence or

non-occurrence of events longer than anticipated;

the ability to originate and purchase loans with attractive terms and

acceptable credit quality;

the ability to attract and retain key members of management; and

the ability to realize cost efficiencies.

For additional information regarding risks that may cause our actual results to differ materially from any forward-looking statements, see "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2013 and in item 1A of Part II of this Quarterly Report.



Financial Overview and Highlights

Community West Bancshares ("CWBC") incorporated under the laws of the state of California, is a bank holding company headquartered in Goleta, California providing full service banking and lending through its wholly-owned subsidiary Community West Bank ("CWB" or the "Bank"), which has five California branch banking offices in Goleta, Santa Barbara, Santa Maria, Ventura and Westlake Village. These entities are collectively referred to herein as the "Company". 33 -------------------------------------------------------------------------------- Table of Contents Financial Result Highlights for the Second Quarter of 2014 Net income available to common shareholders of the Company of $1.5 million, or $0.18 per diluted share for the second quarter of 2014 compared to a net income available to common shareholders of $1.9 million or $0.23 per diluted share for the second quarter of 2013.



The significant factors impacting the Company's second quarter earnings performance were:

Net income of $1.7 million for the second quarter of 2014 compared to a net

income of $2.1 million for the second quarter of 2013.

Net interest margin for the second quarter of 2014 improved slightly to 4.55%

compared to 4.53% for the second quarter of 2013.

Provision for loan losses was ($1.0 million) for the second quarter of 2014

compared to ($1.1 million) for the second quarter of 2013. The Company has

been experiencing a downward trend in net charge-offs and improved credit

quality and related analytics, which resulted in a reduction of the allowance

for loan losses.



Net nonaccrual loans decreased to $15.8 million at June 30, 2014, compared to

$16.8 million at December 31, 2013 and from $20.7 million at June 30, 2013.

Allowance for loan losses was $10.5 million at June 30, 2014, or 2.48% of total

loans held for investment compared to 2.98% at December 31, 2013 and 3.14% one

year ago.



Other assets acquired through foreclosure declined to $0.6 million at June 30,

2014 from $3.8 million at December 31, 2013 and $3.8 million at June 30, 2013.

During the second quarter of 2014, the Company completed the redemption of 50%

of the Company's Series A Preferred Stock.

The impact to the Company from these items, and others of both a positive and negative nature, will be discussed in more detail as they pertain to the Company's overall comparative performance for the three and six months ended June 30, 2014 throughout the analysis sections of this report.



Critical Accounting Policies

A number of critical accounting policies are used in the preparation of the Company's consolidated financial statements. These policies relate to areas of the financial statements that involve estimates and judgments made by management. These include provision and allowance for loan losses and servicing rights. These critical accounting policies are discussed in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2013 with a description of how the estimates are determined and an indication of the consequences of an over or under estimate.



RESULTS OF OPERATIONS

A summary of our results of operations and financial condition and select metrics is included in the following table:

Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (in thousands, except per share amounts)



Net income available to common stockholders $ 1,521$ 1,864

$ 2,690$ 2,691 Basic earnings per share 0.19 0.30 0.33 0.44 Diluted earnings per share 0.18 0.23 0.33 0.35 Total assets 557,741 536,098 Gross loans 494,558 460,806 Total deposits 472,294 434,871 Total stockholders' equity 64,280 62,086 Book value per common share 6.90 5.98 Net interest margin 4.55 % 4.53 % 4.60 % 4.55 % Return on average assets 1.21 % 1.61 % 1.14 % 1.23 % Return on average stockholders' equity 9.71 % 15.33 % 9.11 % 11.97 % 34

-------------------------------------------------------------------------------- Table of Contents The following table sets forth a summary financial overview for the comparable three and six months ended June 30, 2014 and 2013: Three Months Ended Six Months Ended June 30, Increase June 30, Increase 2014 2013 (Decrease) 2014 2013 (Decrease) (in thousands, except per share amounts) Consolidated Income Statement Data: Interest income $ 7,122$ 7,044$ 78$ 14,083$ 14,020 $ 63 Interest expense 849 1,161 (312 ) 1,728 2,327 (599 ) Net interest income 6,273 5,883 390 12,355 11,693 662 Provision for credit losses (1,011 ) (1,084 ) 73 (2,382 ) (1,280 ) (1,102 ) Net interest income after provision for credit losses 7,284 6,967 317 14,737 12,973 1,764 Non-interest income 656 836 (180 ) 1,174 1,608 (434 ) Non-interest expenses 5,031 5,677 (646 ) 10,556 11,366 (810 ) Income before income taxes 2,909 2,126 783 5,355 3,215 2,140 Income taxes 1,203 - 1,203 2,207 - 2,207 Net income $ 1,706$ 2,126$ (420 )$ 3,148$ 3,215$ (67 ) Dividends and accretion on preferred stock 329 262 67 602 524 78 Discount on partial redemption of preferred stock (144 ) - (144 ) (144 ) - (144 ) Net income available to common stockholders $ 1,521$ 1,864$ (343 )$ 2,690$ 2,691 $ (1 ) Income per share - basic $ 0.19$ 0.30$ (0.11 )$ 0.33$ 0.44$ (0.09 ) Income per share - diluted $ 0.18$ 0.23$ (0.05 )$ 0.33$ 0.35$ (0.02 ) 35

-------------------------------------------------------------------------------- Table of Contents Interest Rates and Differentials



The following table illustrates average yields on interest-earning assets and average rates on interest-bearing liabilities for the periods indicated:

Three Months Ended June 30, 2014 2013 Average Average Average Average Balance Interest Yield/Cost (2) Balance Interest Yield/Cost (2) Interest-Earning Assets (in thousands) Federal funds sold and interest-earning deposits (5) $ 30,196$ 23 0.31 % $ 35,159$ 20 0.23 % Investment securities 33,119 188 2.28 % 29,049 174 2.40 % Loans (1) 489,338 6,911 5.66 % 456,783 6,850 6.01 % Total earnings assets 552,653 7,122 5.17 % 520,991 7,044 5.42 % Nonearning Assets Cash and due from banks 1,661 1,016 Allowance for loan losses (11,374 ) (13,831 ) Other assets 24,207 22,431 Total assets $ 567,147$ 530,607 Interest-Bearing Liabilities Interest-bearing demand deposits 276,010 284 0.41 % 259,035 301 0.47 % Savings deposits 15,947 54 1.36 % 16,272 75 1.85 % Time deposits 123,067 350 1.14 % 103,831 384 1.48 % Total interest-bearing deposits 415,024 688 0.66 % 379,138 760 0.80 % Convertible debentures - - 0.00 % 6,833 153 8.98 % Other borrowings 23,187 161 2.79 % 34,000 248 2.93 % Total interest-bearing liabilities 438,211 849 0.78 % 419,971 1,161 1.11 % Noninterest-Bearing Liabilities Noninterest-bearing demand deposits 54,939 51,632 Other liabilities 3,528 3,372 Stockholders' equity 70,469 55,632 Total Liabilities and Stockholders' Equity $ 567,147$ 530,607 Net interest income and margin (3) $ 6,273 4.55 % $ 5,883 4.53 % Net interest spread (4) 4.39 % 4.31 %



(1) Includes nonaccrual loans.

(2) Annualized.

(3) Net interest margin is computed by dividing net interest income by total

average earning assets.

(4) Net interest spread represents average yield earned on interest-earning

assets less the average rate paid on interest-bearing liabilities.

(5) Certain amounts have been reclassified to conform to the current year

presentation.

36



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Table of Contents Six Months Ended June 30, 2014 2013 Average Average Average Average Balance Interest Yield/Cost (2) Balance Interest Yield/Cost (2) Interest-Earning Assets (in thousands) Federal funds sold and interest-earning deposits (5) $ 26,323$ 36 0.28 % $ 31,294$ 34 0.22 % Investment securities 32,593 375 2.32 % 28,513 342 2.42 % Loans (1) 482,875 13,672 5.71 % 458,751 13,644 6.00 % Total earnings assets 541,791 14,083 5.24 % 518,558 14,020 5.45 % Nonearning Assets Cash and due from banks 1,624 1,028 Allowance for loan losses (11,746 ) (14,177 ) Other assets 24,852 22,285 Total assets $ 556,521$ 527,694 Interest-Bearing Liabilities Interest-bearing demand deposits 266,225 530 0.40 % 260,543 602 0.47 % Savings deposits 16,020 112 1.41 % 16,329 154 1.90 % Time deposits 119,834 688 1.16 % 99,837 763 1.54 % Total interest-bearing deposits 402,079 1,330 0.67 % 376,709 1,519 0.81 % Convertible debentures 485 30 12.47 % 7,314 315 8.69 % Other borrowings 26,575 368 2.79 % 34,000 493 2.92 % Total interest-bearing liabilities 429,139 1,728 0.81 % 418,023 2,327 1.12 % Noninterest-Bearing Liabilities Noninterest-bearing demand deposits 54,039 51,891 Other liabilities 3,659 3,610 Stockholders' equity 69,684 54,170 Total Liabilities and Stockholders' Equity $ 556,521$ 527,694 Net interest income and margin (3) $ 12,355 4.60 % $ 11,693 4.55 % Net interest spread (4) 4.43 % 4.33 %



(1) Includes nonaccrual loans.

(2) Annualized.

(3) Net interest margin is computed by dividing net interest income by total

average earning assets.

(4) Net interest spread represents average yield earned on interest-earning

assets less the average rate paid on interest-bearing liabilities.

(5) Certain amounts have been reclassified to conform to the current year

presentation.

37 -------------------------------------------------------------------------------- Table of Contents The table below sets forth the relative impact on net interest income of changes in the volume of earning assets and interest-bearing liabilities and changes in rates earned and paid by the Company on such assets and liabilities. For purposes of this table, nonaccrual loans have been included in the average loan balances. Three Months Ended June 30, Six Months Ended June 30, 2014 versus 2013 2014 versus 2013 Increase (Decrease) Increase (Decrease) Due to Changes in Due to Changes in Volume Rate Total

Volume Rate Total (in thousands) Loans, net $ 459$ (398 )$ 61$ 683$ (655 )$ 28 Investment securities and other (3 ) 20 17 (6 ) 41 35 Total interest income 456 (378 ) 78 677 (614 ) 63 Deposits 59 (131 ) (72 ) 84 (273 ) (189 ) Other borrowings (123 ) (117 ) (240 ) (210 ) (200 ) (410 ) Total interest expense (64 ) (248 ) (312 ) (126 ) (473 ) (599 ) Net increase (decrease) $ 520$ (130 )$ 390$ 803$ (141 )$ 662



(1) Changes due to both volume and rate have been allocated to volume changes.

Comparison of interest income, interest expense and net interest margin

The Company's primary source of revenue is interest income. Interest income for the three and six months ended June 30, 2014 was $7.1 million and $14.1 million, respectively a slight increase from the three and six months ended June 30, 2013 which were $7.0 million and $14.0 million, respectively. Total interest income benefited by increased loan originations mostly in the commercial real estate portfolio and partial recoveries of previously deferred nonaccrual interest paid. These increases were mostly offset by decreased interest income from manufactured housing loans. The loan portfolio continues to have compression in the yields on loans. The yield on interest-earning assets for the second quarter 2014 compared to 2013 decreased 25 basis points to 5.17% due to decreased yields on loans and investment securities. The yield on earning assets for the six months ended June 30 2014 compared to 2013 also declined to 5.24% from 5.45%. Interest expense for the three and six months ended June 30, 2014 compared to 2013 decreased by $0.3 million and $0.6 million, respectively. This decline for the second quarter comparable periods was primarily due to decreased interest paid on FHLB advances and convertible debentures of $0.2 million. The average cost of interest-bearing deposits also declined across all types by a total of 14 basis points to 0.66% for the three months ended June 30, 2014 compared to the same period in 2013. During the first six months of 2014 the Company's deposits grew by $36.2 million mostly in interest bearing demand deposit accounts and certificates of deposits. The average cost of other borrowings also declined for the comparable periods as $12.0 million of higher cost FHLB advances matured and the convertible debentures were converted to equity. Total cost of funds declined to 0.72% from 1.00% for the six months ended June 30, 2014 compared to the same period of 2013. The net impact of the changes in yields on interest-earning assets and the rates paid on interest-bearing liabilities was an increase in the margin from 4.53% for the second quarter of 2013 to 4.55% for the second quarter of 2014. For the first six months of 2014, the net interest margin increased to 4.60% compared to 4.55% for the first half of 2013.



Provision for loan losses

The provision for loan losses in each period is reflected as a charge against earnings in that period. The provision for loan losses is equal to the amount required to maintain the allowance for credit losses at a level that is adequate to absorb probable credit losses inherent in the loan portfolio. The provision for loan losses was ($1.0 million) for the second quarter of 2014 compared to $(1.1 million) for the second quarter of 2013. The provision benefit for the three months ended June 30, 2014 resulted primarily from net recoveries of $0.2 million, $0.7 million from reduced historical loss factors and $0.2 million from improvements in credit quality factors partially offset by $0.1 million due to loan growth and loan grade changes. The provision benefit in the second quarter of 2013 was mostly due to $1.0 million from reduced historical loss factors, $0.2 million reduction in impaired loan reserves and $0.3 million from decreased loan balances partially offset by $0.4 million of net loan charge-offs. As the result of the improvements in credit quality, historical loss rates and net recoveries the ratio of allowance for loan losses to loans held for investment decreased from 3.14% at June 30, 2013 to 2.48% at June 30, 2014. 38 -------------------------------------------------------------------------------- Table of Contents The provision for loan losses for the six months ended June 30, 2014 was ($2.4 million) compared to ($1.3 million) for the first six months of 2013. The Company has been experiencing an improvement in historical loss factors as well as increased credit quality including net recoveries on loans previously charged off.



The following schedule summarizes the provision, charge-offs (recoveries) by loan category for the three and six months ended June 30, 2014 and 2013:

For the



Three Months Ended June 30,

Manufactured Commercial Single Family Housing Real Estate Commercial SBA HELOC Real Estate Consumer Total 2014 (in thousands) Beginning balance $ 4,880$ 2,284$ 1,828$ 1,858$ 265 $ 239 $ 2$ 11,356 Charge-offs (164 ) (16 ) - - - - (180 ) Recoveries 2 192 47 86 3 1 - 331 Net charge-offs (162 ) 176 47 86 3 1 - 151 Provision 35 (475 ) (372 ) (194 ) (30 ) 25 (1,011 ) Ending balance $ 4,753$ 1,985$ 1,503$ 1,750$ 238 $ 265 $ 2$ 10,496 2013 Beginning balance $ 5,871$ 2,702$ 1,969$ 2,834$ 382 $ 191 $ 1$ 13,950 Charge-offs (282 ) - (101 ) (164 ) - (31 ) (2 ) (580 ) Recoveries 14 36 48 70 1 1 - 170 Net charge-offs (268 ) 36 (53 ) (94 ) 1 (30 ) (2 ) (410 ) Provision 88 (84 ) (387 ) (667 ) (72 ) 36 2 (1,084 ) Ending balance $ 5,691$ 2,654$ 1,529$ 2,073$ 311 $ 197 $ 1$ 12,456 Six Months Ended June 30, Manufactured Commercial Single Family Housing Real Estate Commercial SBA HELOC Real Estate Consumer Total 2014 (in thousands) Beginning balance $ 5,114$ 2,552$ 2,064$ 1,951$ 280 $ 245 $ 2$ 12,208 Charge-offs (404 ) (16 ) - (12 ) - - - (432 ) Recoveries 38 831 76 137 18 2 - 1,102 Net charge-offs (366 ) 815 76 125 18 2 - 670 Provision 5 (1,382 ) (637 ) (326 ) (60 ) 18 - (2,382 ) Ending balance $ 4,753$ 1,985$ 1,503$ 1,750$ 238 $ 265 $ 2$ 10,496 2013 Beginning balance $ 5,945$ 2,627$ 2,325$ 2,733$ 634 $ 198 $ 2$ 14,464 Charge-offs (709 ) (4 ) (117 ) (279 ) (39 ) (88 ) (31 ) (1,267 ) Recoveries 129 50 109 247 1 3 - 539 Net charge-offs (580 ) 46 (8 ) (32 ) (38 ) (85 ) (31 ) (728 ) Provision 326 (19 ) (788 ) (628 ) (285 ) 84 30 (1,280 ) Ending balance $ 5,691$ 2,654$ 1,529$ 2,073$ 311 $ 197 $ 1$ 12,456



The percentage of net non-accrual loans to the total loan portfolio has decreased to 3.19% as of June 30, 2014 from 3.55% at December 31, 2013.

The allowance for loan losses compared to net non-accrual loans has decreased slightly to 66.5% as of June 30, 2014 from 72.5% as of December 31, 2013. Total past due loans declined to $0.7 million as of June 30, 2014 from $2.6 million as of December 31, 2013. Of these past due amounts $0.4 million was guaranteed by the SBA as of December 31, 2013.



Non-Interest Income

The Company earned non-interest income primarily through fees related to services provided to loan and deposit customers, gains from loan sales, and other.

The following table summarizes the Company's non-interest income for the periods indicated:

39



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Table of Contents Three Months Ended Six Months Ended June 30, Increase June 30, Increase 2014 2013 (Decrease) 2014 2013 (Decrease) (in thousands) Other loan fees $ 266$ 385$ (119 )$ 441$ 615$ (174 ) Gains from loan sales, net 28 111 (83 ) 93 272 (179 ) Document processing fees 116 145 (29 ) 194 255 (61 ) Loan servicing, net 63 24 39 95 99 (4 ) Service charges 71 85 (14 ) 143 170 (27 ) Other 112 86 26 208 197 11 Total non-interest income $ 656$ 836$ (180 )$ 1,174$ 1,608$ (434 ) Total non-interest income decreased by $0.2 million, or 21.5%, for the second quarter of 2014 compared to 2013, primarily due to decreased other loan fees, gains from loan sales, loan document processing fees and service charges income. For the second quarter of 2014 compared to 2013, other loan fees declined mostly as a result of one-time prepayment penalties on SBA loans of $0.1 million in the second quarter of 2013. For the second quarter 2014 compared to 2013, gains from loan sales net and document processing fees declined due to the decreased volume of mortgage loan originations and sales. The slight increase in loan servicing income for the second quarter of 2014 compared to 2013 is due to a decrease in the negative fair value adjustments on the servicing asset and interest only strips in 2014 related to fewer SBA loans held for sale prepayments. Total non-interest income for the six months ended June 30, 2014 compared to 2013 declined by $0.4 million mostly the result of the decrease in new mortgage loan originations and sales and SBA loan fees. The SBA loan origination volume decreased in the first half of 2014 compared to 2013.



Non-Interest Expenses

The following table summarizes the Company's non-interest expenses for the periods indicated: Three Months Ended Six Months Ended June 30, Increase June 30, Increase 2014 2013 (Decrease) 2014 2013 (Decrease) (in thousands) Salaries and employee benefits $ 3,193$ 3,355$ (162 )$ 6,420$ 6,854$ (434 ) Occupancy expense, net 459 458 1 898 913 (15 ) Professional services 371 290 81 731 605 126 Loan servicing and collection 134 347 (213 ) 399 600 (201 ) Advertising and marketing 179 187 (8 ) 300 280 20 Data processing 109 125 (16 ) 281 275 6 Stock option expense 30 16 14 241 31 210 FDIC assessment 90 261 (171 ) 170 526 (356 ) Depreciation 81 74 7 156 148 8 Net loss on sales/write-downs of foreclosed real estate and repossessed assets (190 ) 75 (265 ) (150 ) 176 (326 ) Other 575 489 86 1,110 958 152 Total non-interest expenses $ 5,031$ 5,677$ (646 )$ 10,556$ 11,366$ (810 ) Total non-interest expenses for the second quarter of 2014 compared to 2013 decreased by $0.6 million, or 11.4% primarily due to a net gain on sales/write-downs of foreclosed real estate and repossessed assets of $0.2 million compared to a net loss in the second quarter of 2013. Loan servicing and collection expenses also declined by $0.2 million in the second quarter 2014 compared to 2013 due to improved credit quality. The FDIC insurance assessment was reduced by $0.2 million in the second quarter of 2014 compared to 2013 due to improvement in the Company and release from the regulatory agreements. Salaries and employee benefits was $0.2 million lower in the second quarter of 2014 compared to 2013 mostly from severance and commissions paid in 2013 when the SBA office in Roseville was closed. Partially offsetting these declined expenses were increased costs associated with professional services and other expenses of $0.1 million each and a slight increase in stock option expense. 40 -------------------------------------------------------------------------------- Table of Contents Total non-interest expenses for the six months ended June 30 2104 compared to 2013 decreased by $0.8 million or 7.1% mostly from decreases in salaries and benefits, net loss on sales/write-downs of foreclosed real estate and repossessed assets, FDIC assessment expense and loan servicing and collection expense. Salaries and benefits expense declined for the first six months of 2014 compared to 2013 primarily from expense incurred in 2013 of $0.2 million in deferred commissions on SBA loans held for sale of and salary and severance expense paid in 2013 for the Roseville SBA office closed in the second quarter of 2013. The FDIC assessment was reduced due to the reduction in rate as a result of the Bank's upgrade. Net loss on sales/write-downs of foreclosed real estate and repossessed assets improved by $0.3 million for the first half of 2014 compared to 2013 due to a net gain from foreclosed asset sales instead of a net loss from sales on foreclosed assets in the prior year six month period as the result of some improvements in values. Loan servicing and collection expense decreased mostly due to decreased loan collection expense of $0.2 million partially offset by a small increase in legal costs associated with foreclosed assets. These decreases were partially offset by increased other expense primarily $0.1 million related to deferred costs recognized with the call of the convertible debentures.



Income Taxes

The income tax provision for the second quarter and first six month of 2014 was $1.2 million and $2.2 million, respectively compared to no income tax expense in 2013. In the first half of 2013, the Company's deferred tax asset was fully reserved. As the Company recorded taxable income, the release of this valuation allowance offset the tax expense incurred.



Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts and their respective tax basis including operating losses and tax credit carryforwards. Net deferred tax assets are reported in the consolidated balance sheet as a component of total assets.

Accounting standards Codification Topic 740, Income Taxes, requires that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a "more likely than not" standard. The determination of whether a valuation allowance for deferred tax assets is appropriate is subject to considerable judgment and requires an evaluation of all positive and negative evidence with more weight given to evidence that can be objectively verified. Each period, management considers both positive and negative evidence and analyzes changes in near-term market conditions as well as other factors which may impact future operating results. There was no valuation allowance on deferred tax assets at June 30, 2014. The determination of whether a valuation allowance for deferred tax assets is appropriate is subject to considerable judgment and requires an evaluation of all the positive and negative evidence. The Company's deferred tax asset was $4.2 million and fully reserved at June 30, 2013. The Company evaluated the need for a valuation allowance at June 30, 2014. Based on the assessment of all the positive and negative evidence, management concluded that it is more likely than not that all of the $4.2 million net deferred tax asset will be realized based upon future taxable income. The positive evidence considered by management in arriving at the conclusion that a valuation allowance is not necessary included more than six consecutive profitable quarters beginning with the third quarter of 2012, the Company is not in a three-year cumulative loss position, the Company's strong pre-crisis earnings history and growth in pre-tax earnings and significant improvement in credit measures, which improve both the sustainability of profitability and management's ability to forecast future credit losses. The regulatory agreements have also been terminated. All these factors were given the appropriate weighting in our analysis and management concluded that such positive evidence was sufficient to overcome the weight of negative evidence related to operating losses in prior years. The Company is subject to the provisions of ASC 740, Income Taxes (ASC 740). ASC 740 prescribes a more-likely-than-not threshold for the financial statement recognition of uncertain tax positions. ASC 740 clarifies the accounting for income taxes by prescribing a minimum recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. On a quarterly basis, the Company undergoes a process to evaluate whether income tax accruals are in accordance with ASC 740 guidance on uncertain tax positions.



Balance Sheet Analysis

The ability to originate new loans and attract new deposits is essential to the Company's asset growth. Total assets increased to $557.7 million at June 30, 2014 from $539.0 million at December 31, 2013. Total gross loans including loans held for sale, increased $20.4 million to $494.6 million at June 30, 2014 from $474.2 million at December 31, 2013. Total deposits increased to $472.3 million at June 30, 2014 from $436.1 million at December 31, 2013. The book value per common share was $6.90 at June 30, 2014 compared to $6.60 at December 31, 2013. The increase was primarily due to earnings net of new stock issued upon debenture conversions at a dilutive price of $4.50 per share. 41



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