Note 12 – Allowance for Loan and Lease Losses

The allowance for loan and lease losses, a contra-asset, is established through a provision for loan and lease losses. It is maintained at a level that is considered adequate to absorb probable losses on certain specifically identified loans, as well as probable incurred losses inherent in the remaining loan portfolio. Specifically identifiable and quantifiable losses are immediately charged off against the allowance; recoveries are generally recorded only when cash payments are received subsequent to the charge off. We employ a systematic methodology, consistent with FASB guidelines on loss contingencies and impaired loans, for determining the appropriate level of the allowance for loan and lease losses and adjusting it on at least a quarterly basis. Pursuant to that methodology, impaired loans and leases are individually analyzed and a criticized asset action plan is completed specifying the financial status of the borrower and, if applicable, the characteristics and condition of collateral and any associated liquidation plan. A specific loss allowance is created for each impaired loan, if necessary. The following tables disclose the unpaid principal balance, recorded investment (including accrued interest), average recorded investment, and interest income recognized for impaired loans on our books as of the dates indicated. Balances are shown by loan type, and are further broken out by those that required an allowance and those that did not, with the associated allowance disclosed for those that required such. Included in the valuation allowance for impaired loans shown in the tables below are specific reserves allocated to TDR’s, totaling $4.669 million at June 30, 2012 and $3.635 million at December 31, 2011.

Impaired Loans	June 30, 2012
(dollars in thousands, unaudited)	Unpaid Principal Balance⁽¹⁾		Recorded Investment⁽²⁾		Related Allowance		Average Recorded Investment		Interest Income Recognized⁽³⁾
With an Allowance Recorded
Real Estate:
1-4 family residential construction	$	352	$	352	$	46	$	352	$	-
Other Construction/Land		13,520		10,674		1,702		10,694		169
1-4 Family - closed-end		10,862		10,834		880		10,862		158
Equity Lines		377		377		131		377		3
Multifamily residential		-		-		-		-		-
Commercial RE- owner occupied		3,613		3,613		873		3,628		41
Commercial RE- non-owner occupied		12,060		12,060		1,941		12,835		173
Farmland		-		-		-		-		-
Total Real Estate		40,784		37,910		5,573		38,748		544
Agriculture		-		-		-		-		-
Commercial and Industrial		2,137		2,137		498		2,199		22
Small Business Administration		3,472		3,472		1,055		3,472		26
Direct finance leases		322		322		159		322		-
Consumer loans		3,425		3,425		386		3,473		69
		50,140		47,266		7,671		48,214		661
With no Related Allowance Recorded
Real Estate:
1-4 family residential construction	$	4,350	$	1,622	$	-	$	1,654	$	-
Other Construction/Land		785		501		-		625		7
1-4 Family - closed-end		9,061		8,778		-		8,807		51
Equity Lines		393		393		-		398		1
Multifamily residential		2,389		1,780		-		1,780		-
Commercial RE- owner occupied		6,141		5,685		-		6,107		60
Commercial RE- non-owner occupied		12,052		11,901		-		11,938		333
Farmland		1,953		1,953		-		1,963		-
Total Real Estate		37,124		32,613		-		33,272		452
Agriculture		1,676		1,676		-		1,662		-
Commercial and Industrial		702		668		-		679		1
Small Business Administration		227		227		-		227		-
Direct finance leases		-		-		-		-		-
Consumer loans		753		753		-		773		15
		40,482		35,937		-		36,613		468
Total	$	90,622	$	83,203	$	7,671	$	84,827	$	1,129

⁽¹⁾Contractual principal balance due from customer.

⁽²⁾Principal balance on Company's books, less any direct charge offs.

⁽³⁾Interest income is recognized on performing balances on a regular accrual basis.

	December 31, 2011
	Unpaid Principal Balance⁽¹⁾		Recorded Investment⁽²⁾		Related Allowance		Average Recorded Investment		Interest Income Recognized⁽³⁾
With an Allowance Recorded
Real Estate:
1-4 family residential construction	$	188	$	188	$	13	$	188	$	-
Other Construction/Land		3,477		2,906		735		2,925		89
1-4 Family - closed-end		8,086		8,057		821		8,071		222
Equity Lines		1,072		1,072		243		1,069		-
Multifamily residential		2,941		2,941		850		2,950		-
Commercial RE- owner occupied		3,628		3,628		834		3,645		24
Commercial RE- non-owner occupied		17,454		17,454		1,733		17,842		274
Farmland		-		-		-		-		-
Total Real Estate		36,846		36,246		5,229		36,690		609
Agriculture		-		-		-		-		-
Commercial and Industrial		4,135		4,106		1,481		4,197		24
Small Business Administration		3,902		3,903		1,212		3,903		2
Direct finance leases		591		591		291		591		-
Consumer loans		3,896		3,858		541		3,920		56
		49,370		48,704		8,754		49,301		691
With no Related Allowance Recorded
Real Estate:
1-4 family residential construction	$	4,784	$	2,056	$	-	$	2,069	$	-
Other Construction/Land		11,740		9,081		-		9,326		193
1-4 Family - closed-end		12,467		12,203		-		12,250		101
Equity Lines		307		307		-		318		-
Multifamily residential		-		-		-		-		-
Commercial RE- owner occupied		6,049		6,030		-		6,136		17
Commercial RE- non-owner occupied		11,818		11,666		-		12,033		190
Farmland		7,468		6,919		-		6,956		-
Total Real Estate		54,633		48,262		-		49,088		501
Agriculture		-		-		-		-		-
Commercial and Industrial		916		915		-		965		11
Small Business Administration		-		-		-		-		-
Direct finance leases		-		-		-		-		-
Consumer loans		448		448		-		462		11
		55,997		49,625		-		50,515		523
Total	$	105,367	$	98,329	$	8,754	$	99,816	$	1,214

⁽¹⁾Contractual principal balance due from customer.

⁽²⁾Principal balance on Company's books, less any direct charge offs.

⁽³⁾Interest income is recognized on performing balances on a regular accrual basis.

Similar but condensed information as of the dates noted is provided in the following table:

Impaired Loans

(dollars in thousands, unaudited)

	June 30, 2012		December 31, 2011

Impaired loans without a valuation allowance	$	35,937	$	49,625
Impaired loans with a valuation allowance		47,266		48,704
Total impaired loans ⁽¹⁾	$	83,203	$	98,329
Valuation allowance related to impaired loans	$	7,671	$	8,754
Total non-accrual loans	$	36,715	$	56,110
Total loans past-due ninety days or more and still accruing	$	-	$	48

⁽¹⁾ Principal balance on Company's books less any direct charge-off

The specific loss allowance for an impaired loan represents the difference between the face value of the loan and either its current appraised value less estimated disposition costs, or its net present value as determined by a discounted cash flow analysis. The discounted cash flow approach is used to measure impairment on loans for which it is anticipated that repayment will be provided from cash flows other than those generated solely by the disposition or operation of underlying collateral. Any change in impairment attributable to the passage of time is accommodated by adjusting the loss allowance accordingly.

For loans where repayment is expected to be provided by the disposition or operation of the underlying collateral, impairment is measured using the fair value of the collateral. If the collateral value, net of the expected costs of disposition where applicable, is less than the loan balance, then a specific loss reserve is established for the shortfall in collateral coverage. If the discounted collateral value is greater than or equal to the loan balance, no specific loss reserve is established. At the time a collateral-dependent loan is designated as nonperforming, a new appraisal is ordered and typically received within 30 to 60 days if a recent appraisal was not already available. We generally use external appraisals to determine the fair value of the underlying collateral for nonperforming real estate loans, although the Company’s licensed staff appraisers may update older appraisals based on current market conditions and property value trends. Until an updated appraisal is received, the Company uses the existing appraisal to determine the amount of the specific loss allowance that may be required, and adjusts the specific loss allowance, as necessary, once a new appraisal is received. Updated appraisals are generally ordered at least annually for collateral-dependent loans that remain impaired. Current appraisals were available for 76% of the Company’s impaired real estate loan balances at June 30, 2012. Furthermore, the Company analyzes collateral-dependent loans on at least a quarterly basis, to determine if any portion of the recorded investment in such loans can be identified as uncollectible and would therefore constitute a confirmed loss. All amounts deemed to be uncollectible are promptly charged off against the Company’s allowance for loan and lease losses, with the loan then carried at the fair value of the collateral, as appraised, less estimated costs of disposition if applicable. Once a charge-off or write-down is recorded, it will not be restored to the loan balance on the Company’s accounting books.

Our methodology also provides that a “general” allowance be established for probable incurred losses inherent in loans and leases that are not impaired. Unimpaired loan balances are segregated by credit quality, and are then evaluated in pools with common characteristics. At the present time, pools are based on the same segmentation of loan types presented in our regulatory filings. While this methodology utilizes historical loss data and other measurable information, the classification of loans and the establishment of the allowance for loan and lease losses are both to some extent based on management’s judgment and experience. Our methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan and lease losses that management believes is appropriate at each reporting date. Quantitative information includes our historical loss experience, delinquency and charge-off trends, and current collateral values. Qualitative factors include the general economic environment in our markets and, in particular, the state of the agricultural industry and other key industries in the Central San Joaquin Valley. Lending policies and procedures (including underwriting standards), the experience and abilities of lending staff, the quality of loan review, credit concentrations (by geography, loan type, industry and collateral type), the rate of loan portfolio growth, and changes in legal or regulatory requirements are additional factors that are considered. The total general reserve established for probable incurred losses on unimpaired loans was $6.2 million at June 30, 2012.

During the six months ended June 30, 2012 we adjusted certain qualitative factors used in determining our allowance for loan and lease losses pursuant to our assessment that default risk in non-impaired loans is declining, but there were no material changes made to the methodology used to determine our allowance for loan and lease losses. As we add new products and expand our geographic coverage, and as the economic environment changes, we expect to continue to enhance our methodology to keep pace with the size and complexity of the loan and lease portfolio and respond to pressures created by external forces. We engage outside firms on a regular basis to assess our methodology and perform independent credit reviews of our loan and lease portfolio. In addition, the Company’s external auditors, the FDIC, and the California DFI review the allowance for loan and lease losses as an integral part of their audit and examination processes. Management believes that the current methodology is appropriate given our size and level of complexity. The tables that follow detail the activity in the allowance for loan and lease losses for the periods noted:

Allowance for Credit Losses and Recorded Investment in Financing Receivables

(dollars in thousands, unaudited)

	For the Three Months-Ended June 30, 2012
	Real Estate			Agricultural Products		Commercial and Industrial			Small Business Administration			Direct Finance Leases		Consumer			Total

Allowance for credit losses:
Beginning Balance	$	9,900		$	18	$	3,703		$	1,397		$	174	$	2,216		$	17,408
Charge-offs		(4,446	)		-		(1,449	)		(332	)		-		(722	)		(6,949	)
Recoveries		57			-		67			47			-		73			244
Provision		2,415			-		598			53			38		56			3,160

Ending Balance	$	7,926		$	18	$	2,919		$	1,165		$	212	$	1,623		$	13,863

	For the Six Months-Ended June 30, 2012
	Real Estate			Agricultural Products			Commercial and Industrial			Small Business Administration			Direct Finance Leases			Consumer			Total

Allowance for credit losses:
Beginning Balance	$	8,260		$	19		$	4,638		$	1,447		$	311		$	2,608		$	17,283
Charge-offs		(5,400	)		-			(2,540	)		(418	)		(198	)		(1,347	)		(9,903	)
Recoveries		188			-			192			47			-			146			573
Provision		4,878			(1	)		629			89			99			216			5,910

Ending Balance	$	7,926		$	18		$	2,919		$	1,165		$	212		$	1,623		$	13,863

Reserves:
Specific	$	5,573		$	-		$	498		$	1,055		$	159		$	386		$	7,671
General		2,353			18			2,421			110			53			1,237			6,192

Ending Balance	$	7,926		$	18		$	2,919		$	1,165		$	212		$	1,623		$	13,863

Loans evaluated for impairment:
Individually	$	70,523		$	1,676		$	2,805		$	3,699		$	322		$	4,178		$	83,203
Collectively		483,969			17,556			183,361			16,968			4,922			27,621			734,397

Ending Balance	$	554,492		$	19,232		$	186,166		$	20,667		$	5,244		$	31,799		$	817,600

	For the Year Ended December 31, 2011
	Real Estate			Agricultural Products			Commercial and Industrial			Small Business Administration			Direct Finance Leases			Consumer			Total

Allowance for credit losses:
Beginning Balance	$	10,143		$	62		$	6,379		$	1,274		$	284		$	2,996		$	21,138
Charge-offs		(10,596	)		-			(3,407	)		(148	)		(82	)		(2,754	)		(16,987	)
Recoveries		418			-			323			71			57			263			1,132
Provision		8,295			(43	)		1,343			250			52			2,103			12,000

Ending Balance	$	8,260		$	19		$	4,638		$	1,447		$	311		$	2,608		$	17,283

Reserves:
Specific	$	5,229		$	-		$	1,481		$	1,212		$	291		$	541		$	8,754
General		3,031			19			3,157			235			20			2,067			8,529

Ending Balance	$	8,260		$	19		$	4,638		$	1,447		$	311		$	2,608		$	17,283

Loans evaluated for impairment:
Individually	$	84,508		$	-		$	5,021		$	3,903		$	591		$	4,306		$	98,329
Collectively		492,724			17,078			94,387			17,103			6,152			31,818			659,262

Ending Balance	$	577,232		$	17,078		$	99,408		$	21,006		$	6,743		$	36,124		$	757,591