Note 12 – Allowance for Loan and Lease Losses

The Company's allowance for loan and lease losses, a contra-asset, is established through a provision for loan and lease losses. The allowance 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 at least quarterly. 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, 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 TDRs, totaling $3.333 million at September 30, 2014 and $3.321 million at December 31, 2013.

Impaired Loans	September 30, 2014
(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:
Other construction/land		4,513		4,513		578		5,271		69
1-4 Family - closed-end		12,820		12,820		1,111		14,000		201
Equity lines		406		406		37		491		11
Commercial real estate- owner occupied		2,856		2,746		1,416		3,068		42
Commercial real estate- non-owner occupied		3,700		3,700		741		3,771		198
Farmland		-		-		-		-		-
Total real estate		24,295		24,185		3,883		26,601		521
Agriculture		127		127		3		335		-
Commercial and industrial		2,901		2,888		873		2,958		94
Consumer loans		2,854		2,843		422		3,104		116
		30,177		30,043		5,181		32,998		731
With no related allowance recorded
Real estate:
Other construction/land		9		9		-		18		-
1-4 family - closed-end		-		-		-		-		1
Equity lines		297		294		-		297		-
Commercial real estate- owner occupied		1,855		826		-		1,932		-
Commercial real estate- non-owner occupied		9,278		9,130		-		9,844		88
Farmland		-		-		-		-		-
Total real estate		11,439		10,259		-		12,091		89
Agriculture		-		-		-		-		-
Commercial and industrial		56		37		-		81		-
Consumer loans		257		95		-		322		-
		11,752		10,391		-		12,494		89
Total	$	41,929	$	40,434	$	5,181	$	45,492	$	820

(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, 2013
	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	$	-	$	-	$	-	$	-	$	-
Other construction/land		2,972		2,972		502		3,000		98
1-4 family - closed-end		13,522		13,522		1,324		13,630		260
Equity lines		528		528		123		530		13
Commercial real estate- owner occupied		2,047		2,047		217		2,069		135
Commercial real estate- non-owner occupied		3,715		3,715		701		3,813		238
Farmland		-		-		-		-		-
Total real estate		22,784		22,784		2,867		23,042		744
Agriculture		125		125		126		131		-
Commercial and industrial		4,580		4,345		1,925		4,496		131
Consumer loans		3,411		3,411		431		3,591		172
		30,900		30,665		5,349		31,260		1,047
With no related allowance recorded
Real estate:
1-4 family residential construction		-		-		-		-		-
Other construction/land		4,176		3,779		-		3,885		-
1-4 family - closed-end		4,655		4,376		-		4,687		1
Equity lines		565		493		-		493		-
Commercial real estate- owner occupied		7,436		5,516		-		5,568		-
Commercial real estate- non-owner occupied		10,077		9,780		-		9,820		115
Farmland		282		282		-		290		-
Total real estate		27,191		24,226		-		24,743		116
Agriculture		345		345		-		837		-
Commercial and industrial		1,249		1,099		-		1,607		57
Consumer loans		241		52		-		77		-
		29,026		25,722		-		27,264		173
Total	$	59,926	$	56,387	$	5,349	$	58,524	$	1,220

⁽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.

The specific loss allowance for an impaired loan generally represents the difference between the book value of the loan and either the fair value of underlying collateral less estimated disposition costs, or the loan's net present value as determined by a discounted cash flow analysis. The discounted cash flow approach is typically 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. However, historical loss rates may be used to determine a specific loss allowance if they indicate a higher potential reserve need than the discounted cash flow analysis. 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 required. 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 is 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 84% of the Company's impaired real estate loan balances at September 30, 2014. 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 book

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 condition of the agricultural industry and other key industries in our market areas. 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 $5.831 million at September 30, 2014.

During the three months ended September 30, 2014, changes to the methodology used to determine our allowance for loan and lease losses include extending the historical loan loss look-back period from 12 months to 24 months, with more recent periods given higher weighting, and adjusting our qualitative factors accordingly. The potential impact of drought conditions in our markets was also given greater consideration in qualitative factors. 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 DBO 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 September 30, 2014
	Real Estate			Agricultural			Commercial and Industrial			Consumer			Unallocated			Total

Allowance for credit losses:
Beginning Balance	$	7,278		$	1,353		$	1,516		$	1,463		$	24		$	11,634
Charge-offs		(1,053	)		-			(170	)		(424	)		-			(1,647	)
Recoveries		291			1			538			195			-			1,025
Provision		247			(539	)		26			288			(22	)		-

Ending Balance	$	6,763		$	815		$	1,910		$	1,522		$	2		$	11,012

	For the Nine Months Ended September 30, 2014
	Real Estate			Agricultural			Commercial and Industrial			Consumer			Unallocated			Total

Allowance for credit losses:
Beginning Balance	$	5,544		$	978		$	3,787		$	1,117		$	251		$	11,677
Charge-offs		(1,485	)		(124	)		(583	)		(1,410	)		-			(3,602	)
Recoveries		1,490			4			635			458			-			2,587
Provision		1,214			(43	)		(1,929	)		1,357			(249	)		350

Ending Balance	$	6,763		$	815		$	1,910		$	1,522		$	2		$	11,012

Reserves:
Specific	$	3,883		$	3		$	873		$	422		$	-		$	5,181
General		2,880			812			1,037			1,100		$	2			5,831

Ending Balance	$	6,763		$	815		$	1,910		$	1,522		$	2		$	11,012

Loans evaluated for impairment:
Individually	$	34,444		$	127		$	2,925		$	2,938		$	-		$	40,434
Collectively		603,576			24,494			198,693			16,478			-			843,241

Ending Balance	$	638,020		$	24,621		$	201,618		$	19,416		$	-		$	883,675

	For the Year Ended December 31, 2013
	Real Estate			Agricultural			Commercial and Industrial			Consumer			Unallocated		Total

Allowance for credit losses:
Beginning Balance	$	8,034		$	258		$	3,467		$	2,114		$	-	$	13,873
Charge-offs		(4,205	)		(473	)		(1,668	)		(1,917	)		-		(8,263	)
Recoveries		618			-			802			297			-		1,717
Provision		1,097			1,193			1,186			623			251		4,350

Ending balance	$	5,544		$	978		$	3,787		$	1,117		$	251	$	11,677

Reserves:
Specific	$	2,867		$	126		$	1,925		$	431				$	5,349
General		2,677			852			1,862			686			251		6,328

Ending balance	$	5,544		$	978		$	3,787		$	1,117		$	251	$	11,677

Loans evaluated for impairment:
Individually	$	47,010		$	470		$	5,444		$	3,463		$	-	$	56,387
Collectively		530,829			24,710			171,243			20,073			-		746,855

Ending balance	$	577,839		$	25,180		$	176,687		$	23,536		$	-	$	803,242