Pacific Continental 10-Q 2011 Q3 Quarterly report

UNITED STATES

SECURITIES & EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2011.

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from             to             .

Commission File Number: 0-30106

PACIFIC CONTINENTAL CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

OREGON	93-1269184
(State or Other Jurisdiction of	(I.R.S. Employer
Incorporation or Organization)	Identification Number)

111 West 7th Avenue

Eugene, Oregon 97401

(Address of principal executive offices) (Zip Code)

(541) 686-8685

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Act.

(Check one).

Large accelerated filer	¨	Accelerated filer	x
Non-accelerated filer	¨	Smaller reporting company	¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Common Stock outstanding as of November 1, 2011: 18,435,084

PACIFIC CONTINENTAL CORPORATION

FORM 10-Q

QUARTERLY REPORT

TABLE OF CONTENTS

		Page
Part I	Financial Information		3
Item 1	Financial Statements		3
	Consolidated Balance Sheets		3
	Consolidated Statements of Operations		4
	Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income		5
	Consolidated Statements of Cash Flows		6
	Notes to Consolidated Financial Statements		7
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations		33
Item 3	Quantitative and Qualitative Disclosures About Market Risk		53
Item 4	Controls and Procedures		53
Part II	Other Information		53
Item 1	Legal Proceedings		53
Item 1A	Risk Factors		53
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds		58
Item 3	Defaults Upon Senior Securities		58
Item 4	[Removed and Reserved]		58
Item 5	Other Information		58
Item 6	Exhibits		58

2

Part I Financial Information

Item 1 Financial Statements

Pacific Continental Corporation and Subsidiary

Consolidated Balance Sheets

(In thousands, except share amounts)

(Unaudited)

	September  30, 2011		December  31, 2010		September  30, 2010
ASSETS
Cash and due from banks	$	16,896	$	25,424	$	18,424
Interest-bearing deposits with banks		69		267		269
Total cash and cash equivalents		16,965		25,691		18,693
Securities available-for-sale		340,118		253,907		215,259
Loans held-for-sale		400		2,116		1,397
Loans, less allowance for loan losses and net deferred fees		812,525		839,815		864,604
Interest receivable		4,243		4,371		4,247
Federal Home Loan Bank stock		10,652		10,652		10,652
Property and equipment, net of accumulated depreciation		20,379		20,883		21,169
Goodwill and intangible assets		22,291		22,458		22,514
Deferred tax asset		7,428		10,188		9,749
Taxes receivable		0		0		1,460
Other real estate owned		11,663		14,293		15,422
Prepaid FDIC assessment		3,164		4,387		4,950
Other assets		1,743		1,415		1,888
Total assets	$	1,251,571	$	1,210,176	$	1,192,004
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest-bearing demand	$	279,733	$	234,331	$	220,104
Savings and interest-bearing checking		537,009		574,333		545,032
Time $100,000 and over		68,330		63,504		60,083
Other time		66,545		86,791		99,704
Total deposits		951,617		958,959		924,923
Federal funds and overnight funds purchased		8,185		0		12,380
Federal Home Loan Bank borrowings		98,500		67,000		68,500
Junior subordinated debentures		8,248		8,248		8,248
Accrued interest and other payables	��	3,951		3,731		5,374
Total liabilities		1,070,501		1,037,938		1,019,425
Shareholders’ equity
Common stock, shares authorized: 50,000,000; shares issued and outstanding: 18,433,084 at September 30, 2011, 18,415,132 at December 31, 2010 and 18,404,725 at September 30, 2010		137,660		137,062		136,845
Retained earnings		39,242		33,969		32,962
Accumulated other comprehensive income		4,168		1,207		2,772
		181,070		172,238		172,579
Total liabilities and shareholders’ equity	$	1,251,571	$	1,210,176	$	1,192,004

See accompanying notes.

3

Pacific Continental Corporation and Subsidiary

Consolidated Statements of Operations

(In thousands, except share and per share amounts)

(Unaudited)

	Three months ended				Nine months ended
	September 30,				September 30,
	2011		2010		2011		2010
Interest and dividend income
Loans	$	12,583	$	14,070	$	38,146	$	43,233
Securities		2,415		1,791		6,710		4,745
Federal funds sold & interest-bearing deposits with banks		1		3		5		6
		14,999		15,864		44,861		47,984
Interest expense
Deposits		1,628		2,395		5,325		7,069
Federal Home Loan Bank & Federal Reserve borrowings		459		563		1,412		1,788
Junior subordinated debentures		34		133		99		393
Federal funds purchased		11		15		32		39
		2,132		3,106		6,868		9,289
Net interest income		12,867		12,758		37,993		38,695
Provision for loan losses		1,750		3,750		5,900		11,750
Net interest income after provision for loan losses		11,117		9,008		32,093		26,945
Noninterest income
Service charges on deposit accounts		462		418		1,328		1,247
Other fee income, principally bankcard		402		385		1,207		1,078
Loan servicing fees		27		31		82		63
Mortgage banking income		50		69		124		144
Net gain on sale of investment securities		359		0		825		45
Impairment losses on investment securities (OTTI)		0		0		0		(226	)
Other noninterest income		431		286		981		806
		1,731		1,189		4,547		3,157
Noninterest expense
Salaries and employee benefits		4,691		4,071		14,136		13,054
Premises and equipment		861		909		2,605		2,580
Bankcard processing		155		131		472		424
Business development		350		225		1,132		931
FDIC insurance assessment		381		491		1,268		1,477
Other real estate expense		734		803		2,146		904
Other noninterest expense		1,752		1,558		5,531		4,934
		8,924		8,188		27,290		24,304
Income before provision for income taxes		3,924		2,009		9,350		5,798
Provision for income taxes		1,336		857		3,156		1,897
Net income	$	2,588	$	1,152	$	6,194	$	3,901
Earnings per share
Basic	$	0.14	$	0.06	$	0.34	$	0.21
Diluted	$	0.14	$	0.06	$	0.34	$	0.21
Weighted average shares outstanding
Basic		18,433,084		18,399,442		18,425,344		18,396,990
Common stock equivalents attributable to stock-based awards		15,871		16,161		18,637		18,620
Diluted		18,448,955		18,415,603		18,443,981		18,415,610

See accompanying notes.

4

Pacific Continental Corporation and Subsidiary

Consolidated Statements of Changes in Shareholder’s Equity and Comprehensive Income

(In thousands, except share amounts)

(Unaudited)

	Number of Shares		Common Stock		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total
Balance, December 31, 2009		18,393,773	$	136,316	$	29,613		$	(267	)	$	165,662
Net income						5,092						5,092
Other comprehensive income:
Unrealized gain on securities									2,615
less: realized losses on securities (OTTI)									(226	)
Deferred income taxes									(915	)
Other comprehensive income									1,474			1,474
Comprehensive income												6,566
Stock issuance		4,952		38								38
Stock options exercised and related tax benefit		16,407		115								115
Share-based compensation				593								593
Cash dividends						(736	)					(736	)
Balance, December 31, 2010		18,415,132		137,062		33,969			1,207			172,238
Net income						6,194						6,194
Other comprehensive income:
Unrealized gain on securities									4,800
Deferred income taxes									(1,839	)
Other comprehensive income									2,961			2,961
Comprehensive income												9,155
Stock issuance		5,952		56								56
Stock options exercised and related tax benefit		12,000		89								89
Share-based compensation				453								453
Cash dividends						(921	)					(921	)
Balance, September 30, 2011		18,433,084	$	137,660	$	39,242		$	4,168		$	181,070

See accompanying notes.

5

Pacific Continental Corporation and Subsidiary

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

	Nine months ended September 30,
	2011			2010
Cash flows from operating activities:
Net income	$	6,194		$	3,901
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization, net of accretion		4,143			3,130
Other than temporary impairment on investment securities		0			226
Valuation adjustment on foreclosed assets		1,782			762
Loss (gain) on sale of foreclosed assets		100			(47	)
Provision for loan losses		5,900			11,750
Deferred income taxes		2,760			349
Share-based compensation		439			602
Excess tax benefit of stock options exercised		(12	)		(11	)
Production of mortgage loans held-for-sale		(4,805	)		(8,086	)
Proceeds from the sale of mortgage loans held-for-sale		6,521			7,434
Change in:
Interest receivable		128			161
Deferred loan fees		115			(1,036	)
Accrued interest payable and other liabilities		(1,537	)		(2,890	)
Income taxes receivable		0			2,955
Other assets		895			1,346
Net cash provided by operating activities		22,623			20,546
Cash flows from investing activities:
Proceeds from maturities and sales of available-for-sale investment securities		73,380			32,436
Purchase of available-for-sale investment securities		(157,914	)		(77,237	)
Net loan principal collections		12,840			41,793
Purchase of loans		0			(40	)
Net purchase of property and equipment		(349	)		(2,029	)
Proceeds on sale of foreclosed assets		9,183			1,909
Purchase of energy tax credits		0			(12	)
Net cash (used) provided by investing activities		(62,860	)		(3,180	)
Cash flows from financing activities:
Change in deposits		(7,342	)		97,005
Change in federal funds purchased and FHLB short-term borrowings		47,185			(103,145	)
Proceeds from FHLB term advances originated		0			3,500
FHLB advances repayment		(7,500	)		(12,500	)
Proceeds from stock options exercised		77			38
Income tax benefit from stock options exercised		12			11
Dividends paid		(921	)		(552	)
Net cash provided (used) by financing activities		31,511			(15,643	)
Net increase (decrease) in cash and cash equivalents		(8,726	)		1,723
Cash and cash equivalents, beginning of period		25,691			16,970
Cash and cash equivalents, end of period	$	16,965		$	18,693
Supplemental information:
Noncash investing and financing activities:
Transfers of loans to foreclosed assets	$	8,435		$	13,822
Change in fair value of securities, net of deferred income taxes	$	2,961		$	3,039
Cash paid during the period for:
Income taxes	$	1,682		$	4,219
Interest	$	6,579		$	8,884

See accompanying notes.

6

Pacific Continental Corporation and Subsidiary

Notes to Consolidated Financial Statements

(Unaudited)

A complete set of Notes to Consolidated Financial Statements is a part of the Company’s 2010 Form 10-K filed March 11, 2011. The notes below are included due to material changes in the financial statements or to provide the reader with additional information not otherwise available. In preparing these financial statements, the Company has evaluated subsequent events and transactions for potential recognition or disclosure in the financial statements. All dollar amounts in the following notes are expressed in thousands, except per share amounts or where otherwise indicated.

Certain amounts contained in the prior period consolidated financial statements have been reclassified where appropriate to conform to the financial statement presentation used in the current period. These reclassifications had no effect on previously reported net income, earnings per share or retained earnings.

1. Basis of Presentation

The accompanying interim consolidated financial statements include the accounts of Pacific Continental Corporation (the “Company”), a bank holding company, and its wholly-owned subsidiary, Pacific Continental Bank (the “Bank”) and the Bank’s wholly-owned subsidiaries, PCB Services Corporation and PCB Loan Services Corporation (both of which are presently inactive). All significant intercompany accounts and transactions have been eliminated in consolidation.

The accompanying consolidated financial statements have been prepared by the Company without audit and in conformity with generally accepted accounting principles in the United States of America for interim financial information. The financial statements include all adjustments and normal accruals, which the Company considers necessary for a fair presentation of the results of operations for such interim periods. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, as of the date of the balance sheets and income and expenses for the periods. Actual results could differ from those estimates.

The balance sheet data as of December 31, 2010, was derived from audited financial statements, but does not include all disclosures contained in the Company’s 2010 Form 10-K. The interim consolidated financial statements should be read in conjunction with the December 31, 2010, consolidated financial statements, including the notes thereto, included in the Company’s 2010 Form 10-K.

7

2. Securities Available-for Sale

The amortized cost and estimated fair values of securities available-for-sale at September 30, 2011, are as follows:

										Securities in		Securities in
										Continuous		Continuous
										Unrealized		Unrealized
										Loss		Loss
			Gross		Gross			Estimated		Position For		Position For
September 30, 2011	Amortized		Unrealized		Unrealized			Fair		Less Than		12 Months
(in thousands)	Cost		Gains		Losses			Value		12 Months		or Longer
Unrealized Loss Positions
Obligations of U.S. government agencies	$	2,000	$	—	$	(17	)	$	1,983	$	1,983	$	—
Agency mortgage-backed securities		49,444		—		(367	)		49,077		48,231		846
Private-label mortgage-backed securities		6,569		—		(676	)		5,893		3,268		2,625
	$	58,013	$	—	$	(1,060	)	$	56,953	$	53,482	$	3,471
Unrealized Gain Positions
Obligations of U.S. government agencies	$	10,556	$	368	$	—		$	10,924
Obligations of states and political subdivisions		42,293		2,581		—			44,874
Agency mortgage-backed securities		213,287		4,532		—			217,819
Private-label mortgage-backed securities		9,214		334		—			9,548
		275,350		7,815		—			283,165
	$	333,363	$	7,815	$	(1,060	)	$	340,118

At September 30, 2011, there were 57 investment securities in unrealized loss positions of which 8 had been in a continuous loss position for twelve months or longer. The unrealized loss associated with the investments of $3,471 in a continuous unrealized loss position for twelve months or longer was $601. The Company has no intent, nor is it more likely than not, that it will be required to sell these securities before the recovery of carrying value.

At September 30, 2011, unrealized losses exist on certain securities classified as obligations of states and political subdivisions, agency and private-label mortgage-backed securities. The unrealized losses on obligations of states and political subdivisions are deemed to be temporary. Additionally, the unrealized losses on agency mortgage-backed securities are deemed to be temporary, as these securities retain strong credit ratings, continue to perform adequately, and are backed by various government-sponsored enterprises (“GSEs”). These decreases in fair value are associated with the changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral. The decline in value of these securities has resulted from current economic conditions. Although yields on these securities may be below market rates during the period, no loss of principal is expected.

During the third quarter 2011, management reviewed all of its private-label mortgage-backed securities for the presence of other-than-temporary impairment (“OTTI”). Management’s evaluation included the use of independently-generated third party credit surveillance reports that analyze the loans underlying each security. These reports include estimates of default rates and severities, life collateral loss rates, and static voluntary prepayment assumptions to generate estimated cash flows at the individual security level. Additionally, management considered factors such as downgraded credit ratings, severity and duration of the impairments, the stability of the issuers, and any discounts paid when the securities were purchased. At September 30, 2011, no additional OTTI was identified. Management has considered all available information related to the collectability of the impaired investment securities and believes that the estimated credit loss is appropriate.

8

Following is a tabular roll-forward of the amount of credit-related OTTI recognized in earnings during the three and nine months ended September 30, 2011, and 2010:

	Three months ended				Nine months ended
	September  30, 2011		September  30, 2010		September  30, 2011		September  30, 2010
Balance, beginning of period:	$	226	$	226	$	226	$	—
Additions:
Initial OTTI credit loss		—		—		—		226
Balance, end of period:	$	226	$	226	$	226	$	226

At September 30, 2011, twelve of the Company’s private-label mortgage-backed securities with an amortized cost of $5,095 were classified as substandard as their ratings were below investment grade. Securities with an amortized cost of $8,400 and $7,621 were classified as substandard at December 31, 2010 and September 30, 2010, respectively.

The projected average life of the securities portfolio is 3.6 years.

The amortized cost and estimated fair values of securities available-for-sale at December 31, 2010, are as follows:

December 31, 2010 (in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value		Securities in Continuous Unrealized Loss Position For Less Than 12 Months		Securities in Continuous Unrealized Loss Position For 12 Months or Longer
Unrealized Loss Positions
Obligations of states and political subdivisions	$	25,236	$	—	$	(1,247	)	$	23,989	$	23,989	$	—
Agency mortgage-backed securities		49,830		—		(608	)		49,222		49,222		—
Private-label mortgage-backed securities		6,318		—		(761	)		5,557		1,137		4,420
	$	81,384	$	—	$	(2,616	)	$	78,768	$	74,348	$	4,420
Unrealized Gain Positions
Obligations of U.S. government agencies	$	7,051	$	211	$	—		$	7,262
Obligations of states and political subdivisions		7,717		373		—			8,090
Agency mortgage-backed securities		141,891		3,392		—			145,283
Private-label mortgage-backed securities		13,908		596		—			14,504
		170,567		4,572		—			175,139
	$	251,951	$	4,572	$	(2,616	)	$	253,907

At December 31, 2010, there were 96 investment securities in unrealized loss positions of which 9 had been in a continuous loss position for twelve months or longer. The unrealized loss associated with the investments of $4,420 in a continuous unrealized loss position for twelve months or longer was $734.

9

The amortized cost and estimated fair values of securities available-for-sale at September 30, 2010, are as follows:

September 30, 2010 (in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value		Securities in Continuous Unrealized Loss Position for Less Than 12 Months		Securities in Continuous Unrealized Loss Position For 12 Months or Longer
Unrealized Loss Positions
Obligations of states and political subdivisions	$	2,796	$	—	$	(70	)	$	2,726	$	2,726	$	—
Agency mortgage-backed securities		31,869		—		(210	)		31,659		31,659		—
Private-label mortgage-backed securities		7,424		—		(936	)		6,488		1,188		5,300
	$	42,089	$	—	$	(1,216	)	$	40,873	$	35,573	$	5,300
Unrealized Gain Positions
Obligations of U.S. government agencies	$	7,054	$	338	$	—		$	7,392
Obligations of states and political subdivisions		15,290		715		—			16,005
Agency mortgage-backed securities		131,111		4,041		—			135,152
Private-label mortgage-backed securities		15,222		615		—			15,837
		168,677		5,709		—			174,386
	$	210,766	$	5,709	$	(1,216	)	$	215,259

At September 30, 2010, there were 46 investment securities in unrealized loss positions, of which 10 had been in a continuous loss position for twelve months or longer. The unrealized loss associated with the investments of $5,300 in a continuous unrealized loss position for twelve months or longer was $901.

The amortized cost and estimated fair value of securities at September 30, 2011, December 31, 2010, and September 30, 2010, by maturity are shown below. Obligations of U.S. government agencies and states and political subdivisions are shown by contractual maturity. Mortgage-backed securities are shown by projected average life.

	September 30, 2011				December 31, 2010				September 30, 2010
			Estimated				Estimated				Estimated
	Amortized		Fair		Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value		Cost		Value
Due in one year or less	$	51,790	$	52,222	$	14,947	$	15,175	$	24,815	$	24,961
Due after one year through 5 years		208,681		212,521		181,260		184,338		161,574		165,742
Due after 5 years through 10 years		48,752		50,766		53,618		52,390		21,212		21,435
Due after 10 years		24,140		24,609		2,126		2,004		3,165		3,121
	$	333,363	$	340,118	$	251,951	$	253,907	$	210,766	$	215,259

Eleven investment securities were sold during the three months ended September 30, 2011. These sales resulted in gross realized gains of $370 and gross realized losses of $11. No investment securities were sold during the three months ended September 30, 2010. Twenty-five investment securities and one investment security were sold during the nine months ended September 30, 2011, and September 30, 2010, respectively. These sales resulted in gross realized gains of $1,005 and $45, respectively, and gross realized losses of $180 and $0, respectively.

At September 30, 2011, securities with amortized costs of $57,980 (estimated market values of $59,455) were pledged to secure certain treasury and public deposits as required by law, and to secure borrowing lines.

10

3. Loans, Allowance for Loan Losses, and Credit Quality Indicators

Loans are stated at the amount of unpaid principal net of loan premiums or discounts for purchased loans, net deferred loan origination fees, discounts associated with retained portions of loans sold, and an allowance for loan losses. Interest on loans is calculated using the simple-interest method on daily balances of the principal amount outstanding. Loan origination fees, net of origination costs and discounts, are amortized over the lives of the loans as adjustments to yield.

Major classifications of period-end loans, including loans held-for-sale, are as follows:

	September 30,			% of gross			December 31,			% of gross			September 30,			% of gross
	2011			loans			2010			loans			2010			loans
Real estate secured loans:
Permanent Loans:
Multifamily residential	$	54,029			6.5	%	$	57,850			6.8	%	$	56,124			6.4	%
Residential 1-4 family		62,726			7.6	%		76,692			8.9	%		80,551			9.1	%
Owner-occupied commercial		209,702			25.3	%		201,286			23.5	%		201,075			22.8	%
Non-owner-occupied commercial		149,548			18.1	%		163,071			19.0	%		163,054			18.5	%
Other loans secured by real estate		17,421			2.1	%		23,950			2.8	%		25,013			2.8	%
Total permanent real estate loans		493,426			59.6	%		522,849			61.0	%		525,817			59.6	%
Construction Loans:
Multifamily residential		1,158			0.1	%		6,192			0.7	%		15,279			1.7	%
Residential 1-4 family		17,865			2.2	%		22,683			2.6	%		26,830			3.0	%
Commercial real estate		13,368			1.6	%		11,730			1.4	%		18,077			2.0	%
Commercial bare land and acquisition & development		24,987			3.0	%		25,587			3.0	%		26,073			3.0	%
Residential bare land and acquisition & development		13,034			1.6	%		17,263			2.0	%		18,998			2.2	%
Total construction real estate loans		70,412			8.5	%		83,455			9.7	%		105,257			11.9	%
Total real estate loans		563,838			68.1	%		606,304			70.7	%		631,074			71.5	%
Commercial loans		257,889			31.1	%		243,034			28.4	%		242,904			27.5	%
Consumer loans		5,021			0.6	%		5,900			0.7	%		6,742			0.8	%
Other loans		1,762			0.2	%		1,730			0.2	%		2,239			0.3	%
Gross loans		828,510			100.0	%		856,968			100.0	%		882,959			100.0	%
Deferred loan origination fees		(698	)					(583	)					(586	)
		827,812						856,385						882,373
Allowance for loan losses		(15,287	)					(16,570	)					(17,769	)
Total loans, net of allowance for loan losses and net deferred fees	$	812,525					$	839,815					$	864,604
Loans held-for-sale	$	400					$	2,116					$	1,397

At September 30, 2011, outstanding loans to dental professionals totaled $196,094 and represented 23.7% of total outstanding loans compared to dental professional loans of $177,229 or 20.7% at December 31, 2010, and $172,849 or 19.6% at September 30, 2010. There are no other industry concentrations in excess of 10% of the total loan portfolio. However, as of September 30, 2011, approximately 68.1% of the Company’s loan portfolio was collateralized by real estate and is, therefore, susceptible to changes in real estate market conditions. While appropriate action is taken to manage identified concentration risks, management believes that the loan portfolio is well diversified by geographic location and among industry groups.

11

Allowance for loan losses

A summary of activity in the allowance for loan losses is as follows for the three and nine months ended September 30, 2011, and 2010:

	Three months ended						Nine months ended
	September 30,						September 30,
	2011			2010			2011			2010
Balance, beginning of period	$	15,326		$	17,854		$	16,570		$	13,367
Provision charged to income		1,750			3,750			5,900			11,750
Loans charged against allowance		(2,208	)		(4,240	)		(8,085	)		(10,189	)
Recoveries credited to allowance		419			405			902			2,841
Balance, end of period	$	15,287		$	17,769		$	15,287		$	17,769

The allowance for loan losses is established as an amount that management considers adequate to absorb possible losses on existing loans within the portfolio. The allowance consists of general, specific, and unallocated components. The general component is based upon all loans collectively evaluated for impairment. The specific component is based upon all loans individually evaluated for impairment. The unallocated component represents credit losses inherent in the loan portfolio that may not have been contemplated in the general risk factors or the specific allowance analysis. Loans are charged against the allowance when management believes the collection of principal or interest is unlikely.

The Company performs regular credit reviews of the loan portfolio to determine the credit quality and adherence to underwriting standards. When loans are originated, they are assigned a risk rating that is reassessed periodically during the term of the loan through the credit review process. The Company’s internal risk rating methodology assigns risk ratings ranging from 1 to 10, where a higher rating represents higher risk. The ten point risk rating categories are a primary factor in determining an appropriate amount for the allowance for loan losses.

Estimated credit losses reflect consideration of all significant factors that affect the collectability of the loan portfolio. The historical loss rate for each group of loans with similar risk characteristics is determined based on the Company’s own loss experience in that group. Historical loss experience and recent trends in losses provides a reasonable starting point for analysis, however they do not by themselves form a sufficient basis to determine the appropriate level for the allowance for loan losses. Qualitative or environmental factors that are likely to cause estimated credit losses to differ from historical losses are also considered, including but not limited to:

• Changes in international, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;

• Changes in the nature and volume of the portfolio and in the terms of loans;

• Changes in the experience, ability, and depth of lending management and other relevant staff;

• Changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans;

• Changes in the quality of the institution’s loan review system;

• Changes in the value of underlying collateral for collateral-dependent loans;

• The existence and effect of any concentrations of credit, and changes in the level of such concentrations;

• The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the institution’s existing portfolio;

• Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses.

12

The adequacy of the allowance for loan losses and the reserve for unfunded commitments is determined using a consistent, systematic methodology and is monitored regularly based on management’s evaluation of numerous factors. For each portfolio segment, these factors include:

• The quality of the current loan portfolio;

• The trend in the migration of the loan portfolio’s risk ratings;

• The velocity of migration of losses and potential losses;

• Current economic conditions;

• Loan concentrations;

• Loan growth rates;

• Past-due and non-performing trends;

• Evaluation of specific loss estimates for all significant problem loans;

• Recovery experience;

• Peer comparison loss rates.

There have been no significant changes to the Company’s allowance for loan loss methodology or policies in the periods presented.

13

A summary of the activity in the allowance for loan losses by loan segment during the three and nine months ended September 30, 2011, follows:

Allowance for Loan Losses and Recorded Investment in Loans Receivable

	For the three months ended September 30, 2011
	Commercial and Other			Real Estate			Construction			Consumer			Unallocated		Total
Beginning balance		3,353			6,723			3,813			93			1,344		15,326
Charge-offs		(223	)		(1,585	)		(378	)		(22	)		—		(2,208	)
Recoveries		153			101			164			1			—		419
Provision		(88	)		1,763			(137	)		20			192		1,750
Ending balance		3,195			7,002			3,462			92			1,536		15,287
	For the nine months ended September 30, 2011
	Commercial and Other			Real Estate			Construction			Consumer			Unallocated		Total
Beginning balance(1)	$	2,230		$	10,042		$	3,040		$	64		$	1,194	$	16,570
Charge-offs		(1,049	)		(4,437	)		(2,556	)		(43	)		—		(8,085	)
Recoveries		249			167			482			4			—		902
Provision		1,765			1,230			2,496			67			342		5,900
Ending balance		3,195			7,002			3,462			92			1,536		15,287
	Balances as of September 30, 2011
	Commercial and Other			Real Estate			Construction			Consumer			Unallocated		Total
Ending allowance: collectively evaluated for impairment	$	2,871		$	6,797		$	3,132		$	92		$	1,536	$	14,428
Ending allowance: individually evaluated for impairment		324			205			330			—			—		859
Total ending allowance	$	3,195		$	7,002		$	3,462		$	92		$	1,536	$	15,287
Ending loan balance: collectively evaluated for impairment	$	251,868		$	479,866		$	50,156		$	5,021		$	—	$	786,911
Ending loan balance: individually evaluated for impairment		7,783			13,560			20,256			—			—		41,599
Total ending loan balance	$	259,651		$	493,426		$	70,412		$	5,021		$	—	$	828,510

⁽¹⁾  The December 31, 2010 allowance allocation has been adjusted to reallocate $5,522 from the construction loan portfolio to the realestate loan portfolio.

Management believes that the allowance for loan losses was adequate as of September 30, 2011. However, future loan losses may exceed the levels provided for in the allowance for loan losses and could possibly result in additional charges to the provision for loan losses.

14

Credit Quality Indicators

As previously noted, the Company’s risk rating methodology assigns risk ratings ranging from 1 to 10, where a higher rating represents higher risk. These risk rating categories can be summarized using the following loan grades, which are often used by regulators when assessing the credit quality of a loan portfolio:

Pass – Credit exposure in this category ranges between the highest credit quality to average credit quality. Primary repayment sources generate satisfactory debt service coverage under normal conditions. Cash flow from recurring sources is expected to continue to produce adequate debt service capacity. There are many levels of credit quality contained in the Pass definition, but none of the loans contained in this category rise to the level of special mention.

Special Mention – A special mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. The Company strictly and carefully employs the FDIC definition in assessing assets that may apply to this category. It is apparent that in many cases asset weaknesses relevant to this definition either, (1) better fit a definition of “well-defined weakness”, or (2) in our experience ultimately migrate to worse risk grade categories, such as substandard and doubtful. Consequently, management elects to downgrade most potential special mention credits to substandard or doubtful, and therefore adopts a conservative risk grade process in the use of the special mention risk grade.

Substandard – A substandard asset is inadequately protected by the current sound worth and paying capacity of the Borrower or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Loans in this category are characterized by the distinct possibility that the Company will not be repaid under contractual terms and may sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard.

Doubtful – An asset classified doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Management strives to consistently apply these definitions when allocating its loans by loan grade. The loan portfolio is continuously monitored for changes in credit quality and management takes appropriate action to update the loan risk ratings accordingly. Management has not changed the Company’s policy towards or use of credit quality indicators during the periods reported.

15

The following tables present the Company’s loan portfolio information by loan type and credit grade at September 30, 2011, and December 31, 2010:

Credit Quality Indicators

As of September 30, 2011

	Loan Grade
	Pass		Special Mention		Substandard		Doubtful		Totals
Real estate loans
Multifamily residential		52,670		—		1,359		—	$	54,029
Residential 1-4 family		52,064		—		10,662		—		62,726
Owner-occupied commercial		197,328		—		12,374		—		209,702
Nonowner-occupied commercial		146,735		—		2,813		—		149,548
Other real estate loans		16,442		—		871		108		17,421
Total real estate loans		465,239		—		28,079		108		493,426
Construction
Multifamily residential		1,158		—		—		—		1,158
Residential 1-4 family		12,647		—		5,218		—		17,865
Commercial real estate		8,962		—		4,406		—		13,368
Commercial bare land and acquisition & development		11,300		—		13,687		—		24,987
Residential bare land and acquisition & development		9,746		—		2,249		1,039		13,034
Total construction loans		43,813		—		25,560		1,039		70,412
Commercial and other		248,835		—		9,991		825		259,651
Consumer		4,935		—		86		—		5,021
Totals	$	762,822	$	—	$	63,716	$	1,972	$	828,510

Credit Quality Indicators

As of December 31, 2010

	Loan Grade
	Pass		Special Mention		Substandard		Doubtful		Totals
Real estate loans
Multifamily residential	$	55,105	$	—	$	2,745	$	—	$	57,850
Residential 1-4 family		60,544		—		15,658		490		76,692
Owner-occupied commercial		185,362		—		14,274		1,650		201,286
Nonowner-occupied commercial		153,088		—		9,983		—		163,071
Other real estate loans		20,343		—		3,607		—		23,950
Total real estate loans		474,442		—		46,267		2,140		522,849
Construction
Multifamily residential		4,206		—		1,986		—		6,192
Residential 1-4 family		19,532		—		3,151		—		22,683
Commercial real estate		7,114		—		4,616		—		11,730
Commercial bare land and acquisition & development		11,771		—		13,816		—		25,587
Residential bare land and acquisition & development		11,886		—		5,377		—		17,263
Total construction loans		54,509				28,946				83,455
Commercial and other		231,358		—		13,406		—		244,764
Consumer		5,860		—		—		40		5,900
Totals	$	766,169	$	—	$	88,619	$	2,180	$	856,968

At September 30, 2011, December 31, 2010, and September 30, 2010, the Company had $245, $16, and $203, respectively, in contingent liabilities on its classified loans.

16

Past Due and Nonaccrual Loans

The Company uses the terms “past due” and “delinquent” interchangeably. Amortizing loans are considered past due or delinquent based upon the number of contractually required payments not made as indicated in the following table:

Number of Payments Past Due	Days Delinquent
2 Payments		30 Days
3 Payments		60 Days
4 Payments		90 Days
5 Payments		120 Days
6 Payments		150 Days
7 Payments		180 Days

Delinquency status for all contractually matured loans, commercial and commercial real estate loans with non-monthly amortization, and all other extensions of credit is determined based upon the number of calendar months past due.

The following tables present an aged analysis of past due and nonaccrual loans at September 30, 2011, and December 31, 2010:

Age Analysis of Loans Receivable

As of September 30, 2011

	30-59 Days Past Due Still Accruing		60-89 Days Past Due Still Accruing		Greater Than 90 Days Still Accruing		Nonaccrual		Total Past Due and Nonaccrual		Total Current		Total Loans Receivable
Real estate loans
Multifamily residential	$	—	$	—	$	—	$	—	$	—	$	54,029	$	54,029
Residential 1-4 family		—		900		—		3,393		4,293		58,433		62,726
Owner-occupied commercial		2,502		934		—		4,704		8,140		201,562		209,702
Non owner-occupied commercial		—		—		—		1,191		1,191		148,357		149,548
Other real estate loans		—		—		—		122		122		17,299		17,421
Total real estate loans		2,502		1,834		—		9,410		13,746		479,679		493,426
Construction
Multifamily residential		—		—		—		—		—		1,158		1,158
Residential 1-4 family		—		—		—		1,596		1,596		16,269		17,865
Commercial real estate		—		—		—		1,500		1,500		11,868		13,368
Commercial bare land and acquisition & development		—		—		—		13,027		13,027		11,960		24,987
Residential bare land and acquisition & development		—		—		—		1,451		1,451		11,583		13,034
Total construction loans		—		—		—		17,574		17,574		52,838		70,412
Commercial and other		532		—		—		6,732		7,264		252,387		259,651
Consumer		16		—		—		—		16		5,005		5,021
Total	$	3,050	$	1,834	$	—	$	33,716	$	38,600	$	789,909	$	828,510

17

Age Analysis of Loans Receivable

As of December 31, 2010

	30-59 Days Past Due Still Accruing		60-89 Days Past Due Still Accruing		Greater Than 90 Days Still Accruing		Nonaccrual		Total Past Due and Nonaccrual		Total Current			Total  Loans Receivable
Real estate loans
Multifamily residential	$	2,549	$	—	$	—	$	1,010	$	3,559	$	54,291		$	57,850
Residential 1-4 family		110		366		—		6,123		6,599		70,093			76,692
Owner-occupied commercial		2,694		356		—		1,622		4,672		196,614			201,286
Non owner-occupied commercial		—		—		—		8,428		8,428		154,643			163,071
Other real estate loans		195		—		—		538		733		23,217			23,950
Total real estate loans		5,548		722		—		17,721		23,991		498,858			522,849
Construction
Multifamily residential		—		—		—		1,985		1,985		4,207			6,192
Residential 1-4 family		—		—		—		2,493		2,493		20,190			22,683
Commercial real estate		—		—		—		1,671		1,671		10,059			11,730
Commercial bare land and acquisition & development		—		—		—		91		91		25,496			25,587
Residential bare land and acquisition & development		175		—		—		1,032		1,207		16,056			17,263
Total construction loans		175		—		—		7,272		7,447		76,008			83,455
Commercial and other		102		32		—		8,033		8,167		236,597	��		244,764
Consumer		7		5		—		—		12		5,888			5,900
Total	$	5,832	$	759	$	—	$	33,026	$	39,617	$	817,351		$	856,968

Impaired Loans

Regular credit reviews of the portfolio are performed to identify loans that are considered potentially impaired. Potentially impaired loans are referred to the Asset Liability Committee (“ALCO”) for review and are included in the specific calculation of allowance for loan losses. A loan is considered impaired when, based on current information and events, the Company is unlikely to collect all principal and interest due according to the terms of the loan agreement. When the amount of the impairment represents a confirmed loss, it is charged off against the allowance for loan losses. Impaired loans are often reported net of government guarantees to the extent that the guarantees are expected to be collected. Impaired loans generally include all loans classified as nonaccrual and troubled debt restructurings.

Accrual of interest is discontinued on impaired loans when management believes, after considering economic and business conditions and collection efforts that the borrower’s financial condition is such that collection of principal or interest is doubtful. Accrued, but uncollected interest is generally reversed when loans are placed on nonaccrual status. Interest income is subsequently recognized only to the extent cash payments are received satisfying all delinquent principal and interest amounts, and the prospects for future payments in accordance with the loan agreement appear relatively certain. In accordance with GAAP, payments received on nonaccrual loans are applied to the principal balance and no interest income is recognized. Interest income may be recognized on impaired loans that are not on nonaccrual status.

18

The following tables display an analysis of the Company’s impaired loans at September 30, 2011, and December 31, 2010:

Impaired Loan Analysis

As of September 30, 2011

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded
Real estate
Multifamily residential	$	—	$	—	$	—	$	73	$	—
Residential 1-4 family		3,620		5,162		—		6,135		39
Owner-occupied commercial		6,364		6,364		—		6,188		169
Non owner-occupied commercial		1,191		1,328		—		6,469		—
Other real estate loans		323		403		—		863		24
Total real estate loans		11,498		13,257		—		19,728		232
Construction
Multifamily residential		—		—		—		182		—
Residential 1-4 family		1,596		2,208		—		1,276		—
Commercial real estate		3,143		3,314		—		3,196		87
Commercial bare land and acquisition & development		13,027		13,027		—		13,068		234
Residential bare land and acquisition & development		424		2,013		—		1,538		—
Total construction loans		18,190		20,562		—		19,260		321
Commercial and other		6,078		11,606		—		5,026		21
Consumer		—		—		—		—		—
With an allowance recorded
Real estate
Multifamily residential	$	—	$	—	$	—	$	—	$	—
Residential 1-4 family		215		248		10		390		—
Owner-occupied commercial		1,149		1,149		187		387		—
Non owner-occupied commercial		—		—		—		—		—
Other real estate loans		108		108		8		65		6
Total real estate loans		1,472		1,505		205		842		6
Construction
Multifamily residential		—		—		—		—		—
Residential 1-4 family		—		—		—		617		—
Commercial real estate		—		—		—		—		—
Commercial bare land and acquisition & development		—		—		—		—		—
Residential bare land and acquisition & development		2,066		3,539		329		1,463		38
Total construction loans		2,066		3,539		329		2,080		38
Commercial and other		677		1,116		325		1,756		13
Consumer		—		—		—		—		—
Total
Real estate
Multifamily residential	$	—	$	—	$	—	$	73	$	—
Residential 1-4 family		3,835		5,410		10		6,525		39
Owner-occupied commercial		7,513		7,513		187		6,575		169
Non owner-occupied commercial		1,191		1,328		—		6,469		—
Other real estate loans		431		511		8		928		30
Total real estate loans		12,970		14,762		205		20,570		238
Construction
Multifamily residential		—		—		—		182		—
Residential 1-4 family		1,596		2,208		—		1,893		—
Commercial real estate		3,143		3,314		—		3,196		87
Commercial bare land and acquisition & development		13,027		13,027		—		13,068		234
Residential bare land and acquisition & development		2,490		5,552		329		3,001		38
Total construction loans		20,256		24,101		329		21,340		359
Commercial and other		6,755		12,722		325		6,782		34
Consumer		—		—		—		—		—
Total impaired loans	$	39,981	$	51,585	$	859	$	48,692	$	631

19

Impaired Loan Analysis

As of December 31, 2010

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded
Real estate
Multifamily residential	$	1,009	$	1,267	$	—	$	806	$	62
Residential 1-4 family		5,698		6,793		—		4,552		279
Owner-occupied commercial		5,779		5,841		—		4,616		362
Non owner-occupied commercial		8,428		9,970		—		6,732		387
Other real estate loans		773		773		—		618		38
Total real estate loans		21,687		24,644		—		17,324		1,128
Construction
Multifamily residential		1,985		2,897		—		2,963		54
Residential 1-4 family		1,334		1,883		—		1,992		25
Commercial real estate		3,345		3,345		—		4,994		218
Commercial bare land and acquisition & development		13,156		13,378		—		19,641		795
Residential bare land and acquisition & development		1,032		2,492		—		1,540		93
Total construction loans		20,852		23,995		—		31,130		1,185
Commercial and other		7,297		13,749		—		8,055		72
Consumer		—		—		—		3		—
With an allowance recorded
Real estate
Multifamily residential	$	—	$	—	$	—	$	—	$	—
Residential 1-4 family		106		426		80		1,971		—
Owner-occupied commercial		—		—		—		—		—
Non owner-occupied commercial		—		—		—		—		—
Other real estate loans		—		—		—		—		—
Total real estate loans		106		426		80		1,971		—
Construction
Multifamily residential		—		—		—				—
Residential 1-4 family		1,159		1,331		6		1,639		—
Commercial real estate		—		—		—				—
Commercial bare land and acquisition & development		—		—		—				—
Residential bare land and acquisition & development		3,439		3,439		1,498		4,863		217
Total construction loans		4,598		4,770		1,504		6,502		217
Commercial and other		—		—		—		1,525		—
Consumer		—		—		—		—		—
Total
Real estate
Multifamily residential	$	1,009	$	1,267	$	—	$	806	$	62
Residential 1-4 family		5,804		7,219		80		6,523		279
Owner-occupied commercial		5,779		5,841		—		4,616		362
Non owner-occupied commercial		8,428		9,970		—		6,732		387
Other real estate loans		773		773		—		618		38
Total real estate loans		21,793		25,070		80		19,295		1,128
Construction
Multifamily residential		1,985		2,897		—		2,963		54
Residential 1-4 family		2,493		3,214		6		3,631		25
Commercial real estate		3,345		3,345		—		4,994		218
Commercial bare land and acquisition & development		13,156		13,378		—		19,641		795
Residential bare land and acquisition & development		4,471		5,931		1,498		6,403		310
Total construction loans		25,450		28,765		1,504		37,632		1,402
Commercial and other		7,297		13,749		—		9,580		72
Consumer		—		—		—		3		—
Total impaired loans	$	54,540	$	67,584	$	1,584	$	66,510	$	2,602

20

The impaired balances reported above are not adjusted for government guarantees of $851, $1,056 and $798 at September 30, 2011, December 31, 2010, and September 30, 2010, respectively. The recorded investment in impaired loans, net of government guarantees totaled $39,130, $53,484 and $42,540 at September 30, 2011, December 31, 2010, and September 30, 2010, respectively. The specific valuation allowance for impaired loans was $859, $1,584 and $2,231 at September 30, 2011, December 31, 2010, and September 30, 2010, respectively. The average recorded investment in impaired loans was approximately $43,646 and $67,021 during the three months ended September 30, 2011, and 2010, respectively. The average recorded investment in impaired loans was approximately $48,692 and $42,542 during the nine months ended September 30, 2011, and 2010, respectively.

Troubled Debt Restructurings

In the normal course of business, the Company may modify the terms of certain loans, attempting to protect as much of its investment as possible. Management evaluates the circumstances surrounding each modification to determine whether it is a troubled debt restructuring (“TDR”). TDRs exist when, 1) the restructuring constitutes a concession, and 2) the debtor is experiencing financial difficulties. The Company adopted the amendments of Accounting Standards Update No. 2011-02, “Receivables – A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring” during the third quarter 2011. The Update requires retrospective application to the beginning of the annual period of adoption.

For the nine months ended September 30, 2011, the Company identified 8 TDRs that are newly considered impaired for which impairment was previously measured under the Company’s general loan loss allowance methodology. The total recorded investment in such receivables was $1,650 and the associated allowance for loan losses was $32 at September 30, 2011.

The following table displays the Company’s TDRs by class at September 30, 2011:

Troubled Debt Restructurings

As of September 30, 2011

	2011
	Number of Contracts		Pre-Modification Outstanding  Recorded Investment		Post-Modification Outstanding  Recorded Investment
Real estate
Multifamily residential		—	$	—	$	—
Residential 1-4 family		9		2,562		2,372
Owner-occupied commercial		3		877		877
Non owner-occupied commercial		1		1,115		1,098
Other real estate loans		1		160		160
Total real estate loans		14		4,714		4,507
Construction
Multifamily residential		—		—		—
Residential 1-4 family		—		—		—
Commercial real estate		—		—		—
Commercial bare land and acquisition & development		—		—		—
Residential bare land and acquisition & development		4		2,701		2,701
Total construction loans		4		2,701		2,701
Commercial and other		3		1,178		1,178
Consumer		—		—		—
		21	$	8,593	$	8,386

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Virtually all of the Company’s TDRs include rate reductions, modified or deferred cash payments, and/or the extension of terms to alleviate the burden of the debtor’s near-term cash requirements. Three residential 1-4 family loans were modified through principal and accrued interest reductions and are consistent with the terms of borrowers’ bankruptcy agreements. In all cases, modifications are made to improve the Company’s likelihood of collecting the entire debt. Under all segments, loans modified as TDRs are considered impaired. As a result, each TDR is individually evaluated for impairment and if necessary, an allowance for loan losses is provided under the Company’s specific reserve methodology.

Subsequent to a loan being classified as a TDR, a borrower may become unwilling or unable to abide by the terms of the modified agreement. In such cases of default, the Company takes appropriate action to secure additional payments including the use of foreclosure proceedings. The following table presents loans receivable modified as troubled debt restructurings that subsequently defaulted:

Troubled Debt Restructurings That Subsequently Defaulted

As of September 30, 2011

	2011
	Number  of Contracts		Recorded Investment
Real estate
Multifamily residential		—	$	—
Residential 1-4 family		—		—
Owner-occupied commercial		—		—
Non owner-occupied commercial		1		1,098
Other real estate loans		—		—
Total real estate loans		1		1,098
Construction
Multifamily residential		—		—
Residential 1-4 family		—		—
Commercial real estate		—		—
Commercial bare land and acquisition & development		—		—
Residential bare land and acquisition & development		2		459
Total construction loans		2		459
Commercial and other		—		—
Consumer		—		—
		3	$	1,557

At September 30, 2011, December 31, 2010, and September 30, 2010, the Company had no commitments to lend additional funds on loans restructured as TDRs.

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4. Federal Funds and Overnight Funds Purchased:

The Company has unsecured federal funds borrowing lines with various correspondent banks totaling $88,000. At September 30, 2011, and September 30, 2010, there was $8,185 and $12,380, respectively, outstanding on these lines. At December 31, 2010, there were no outstanding borrowings on these lines.

The Company also has a secured overnight borrowing line available from the Federal Reserve Bank totaling $102,621 at September 30, 2011. The Federal Reserve Bank borrowing line is secured through the pledging of approximately $165,201 of commercial and real estate loans under the Company’s Borrower-In-Custody program. At September 30, 2011, December 31, 2010, and September 30, 2010, there were no outstanding borrowings on this line.

5. Federal Home Loan Bank Borrowings:

The Company has a borrowing limit with the FHLB equal to 30% of total assets, subject to discounted collateral and stock holdings. At September 30, 2011, the maximum borrowing line was $375,471; however, the FHLB borrowing line was limited by the lower of the amount of FHLB stock held or the discounted value of collateral pledged. At September 30, 2011, the FHLB stock held by the Company supported a total of $237,422 in borrowings. At September 30, 2011, the Company had pledged $379,671 in real estate loans and securities to the FHLB that had a discounted value of $153,090. At September 30, 2011, the borrowing line was limited to the discounted value of collateral pledged. There was $98,500 borrowed on this line at September 30, 2011.

The maximum FHLB borrowing line at December 31, 2010, was $363,053. At December 31, 2010, the Company had pledged real estate loans and securities to the FHLB that had a discounted value of $152,237. There was $67,000 borrowed on this line at December 31, 2010.

The maximum FHLB borrowing line at September 30, 2010, was $357,601. At September 30, 2010, the Company had pledged $340,051 in real estate loans and securities to the FHLB with a discounted collateral value of $226,118. There was $68,500 borrowed on this line at September 30, 2010.

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Federal Home Loan Bank borrowings by year of maturity and applicable interest rate are summarized as follows:

	Current Rates	September  30, 2011		December  31, 2010		September  30, 2010
Cash Management Advance	N/A	$	—	$	—	$	—
2010	N/A		—		—		1,500
2011	0.20%-2.39%		41,500		10,000		10,000
2012	2.02%-5.28%		16,000		16,000		16,000
2013	2.46%-4.27%		22,000		22,000		22,000
2014	2.78%-3.25%		13,500		13,500		13,500
2015	2.19%-2.86%		3,500		3,500		3,500
2016	5.05%		2,000		2,000		2,000
		$	98,500	$	67,000	$	68,500

6. Stock-based Compensation:

Prior to April 2006, incentive stock option (“ISO”) and non-qualified option awards were granted to employees and directors under the Company’s 1999 Employees’ Stock Option Plan, and the Company’s 1999 Directors’ Stock Option Plan. Subsequent to the annual shareholders’ meeting in April 2006, all shares available under these plans were deregistered and are no longer available for future grants.

At the annual shareholders’ meeting in April 2006, shareholders approved the 2006 Stock Option and Equity Compensation Plan (the “2006 SOEC Plan”). Pursuant to this plan, ISOs, nonqualified stock options, restricted stock, restricted stock units, or stock appreciation rights (“SARs”) may be awarded to attract and retain the best available personnel to the Company and its subsidiaries. Additionally, non-qualified option awards and restricted stock awards may be granted to directors under the terms of this plan. 1,050,000 shares are currently authorized under the 2006 SOEC Plan, of which 108,994 shares remain available for future issuance under the plan.

The Compensation Committee of the Board of Directors may impose any terms or conditions on the vesting of an award that it determines to be appropriate. Awards granted generally vest over four years and have a maximum life of ten years. Stock options may be granted at exercise prices of not less than 100% of the fair market value of the Company’s common stock at the grant date; provided, however, that in the case of an incentive stock option granted to an employee who immediately before the grant of such incentive stock option is a significant shareholder-employee, the incentive stock option exercise price shall be at least 110% of the fair market value of the common stock as of the date of grant of the incentive stock option. Restricted stock awards may be granted at the fair market value on the date of the grant.

SARs may be settled in common stock or cash as determined by the Company at the date of issuance. SARs to be settled in cash are recognized on the balance sheet as liability-based awards. The grant-date fair value of liability-based awards vesting in the current period, along with the change in estimated fair value of the awards during the period, are recognized as compensation expense and as an adjustment to the recorded liability. Liability-based awards (including all cash-settled SARs) have no impact on the number of shares available to be issued within the plan.

ISOs, nonqualified stock options, restricted stock, restricted stock units, and stock-settled SARs are recognized as equity-based awards and compensation expense is recorded to the income statement over the requisite vesting period based on the grant-date fair value.

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There were no liability-based awards granted or exercised during the nine months ended September 30, 2011, and 2010. For the nine months ended September 30, 2011, 5,952 restricted shares were granted and issued to directors with no restrictions imposed. Additionally, 127,192 RSU’s were granted to employees during the first nine months of 2011. The RSUs vest over four years and shares of common stock will be issued as soon as is practicable upon vesting. No other stock-based compensation was granted during the nine months ended September 30, 2011. The following table summarizes the shares and the grant-date fair market values of the equity-based awards granted during the nine months ended September 30, 2011, and 2010:

	Nine months ended September 30,
	2011				2010
	Shares		Fair Market Value		Shares		Fair Market Value
Equity-based awards:
Director restricted stock		5,952	$	56		4,952	$	56
Employee stock options		—		—		62,475		269
Employee stock SARs		—		—		130,499		529
Employee RSUs		127,192		1,040		—		—
		133,144	$	1,096		197,926	$	854

The following tables identify the compensation expense recorded and tax benefits received by the Company on its stock-based compensation plans for the three and nine months ended September 30, 2011, and 2010:

	Three months ended September 30,
	2011						2010
	Compensation Expense (Benefit)			Tax Benefit (Expense)			Compensation Expense (Benefit)			Tax Benefit (Expense)
Equity-based awards:
Director stock options	$	—		$	—		$	5		$	2
Employee stock options		42			—			66			—
Employee stock SARs		60			21			90			31
Employee RSUs		67			23			—			—
Liability-based awards:
Employee cash SARs		(75	)		(26	)		(38	)		(13	)
	$	94		$	18		$	123		$	20

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	Nine months ended September 30,
	2011						2010
	Compensation Expense			Tax Benefit			Compensation Expense		Tax Benefit
Equity-based awards:
Director restricted stock	$	56		$	20		$	56	$	20
Director stock options		1			—			13		4
Employee stock options		131			—			197		—
Employee stock SARs		188			66			243		85
Employee RSUs		134			47			—		—
Liability-based awards:
Employee cash SARs		(71	)		(25	)		93		33
	$	439		$	108		$	602	$	142

12,000 stock options were exercised during the first nine months of 2011 with a weighted average exercise price of $6.38 per share and an intrinsic value of $35. 6,000 equity awards were exercised during the first nine months of 2010 with a weighted average exercise price of $6.38 per share and an intrinsic value of $11. The fair value of equity-based awards vested during the nine months ended September 30, 2011, and 2010 was $585 and $602, respectively. The fair value of liability-based awards vested during the nine months ended September 30, 2011, and 2010 was $143 and $203, respectively.

At September 30, 2011, the Company has estimated unrecognized compensation expense of approximately $248, $405, $939, and $42 for unvested stock options, stock-settled SARs, RSUs, and cash-settled SARs, respectively. These amounts are based on forfeiture rates of 20% for all stock options and SARs and 13% for all RSUs granted to employees. The weighted-average period of time the unrecognized compensation expense will be recognized for the unvested stock options, stock-settled SARs, RSUs and cash-settled SARs is approximately 2.0, 2.1, 3.6, and 1.4 years, respectively.

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7. Fair Value

The following table presents estimated fair values of the Company’s financial instruments as of September 30, 2011, December 31, 2010, and September 30, 2010, in accordance with the provisions of FASB ASC 825 “Financial Instruments.” The use of different assumptions and estimation methods could have a significant effect on the reported fair value amounts. Accordingly, the estimates of fair value herein are not necessarily indicative of the amounts that might be realized in a current market exchange.

	September 30, 2011				December 31, 2010				September 30, 2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Cash and cash equivalents	$	16,965	$	16,965	$	25,691	$	25,691	$	18,693	$	18,693
Securities available-for-sale		340,118		340,118		253,907		253,907		215,259		215,259
Loans held-for-sale		400		400		2,116		2,116		1,397		1,397
Loans		827,812		823,188		856,385		844,838		882,373		871,318
Federal Home Loan Bank stock		10,652		10,652		10,652		10,652		10,652		10,652
Accrued interest receivable		4,243		4,243		4,371		4,371		4,247		4,247
Financial liabilities:
Deposits		951,617		952,171		958,959		959,993		924,923		927,345
Federal funds and overnight funds purchased		8,185		8,185		—		—		12,380		12,380
Federal Home Loan Bank borrowings		98,500		100,876		67,000		69,456		68,500		71,765
Junior subordinated debentures		8,248		2,015		8,248		1,927		8,248		1,908
Accrued interest payable		297		297		587		587		611		611

The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that fair value.

Cash and Cash Equivalents – The carrying amount approximates fair value.

Securities Available-for-Sale – Fair value is based on quoted market prices. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Loans Held-for-Sale – Fair value represents the anticipated proceeds from the sale of related loans.

Loans – For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. Fair value of fixed-rate loans is estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

Federal Home Loan Bank Stock – FHLB stock is valued based on the most recent redemption price.

Interest Receivable and Payable – The carrying amounts of accrued interest receivable and payable approximate their fair value.

Deposits – Fair value of demand, interest-bearing demand and savings deposits is the amount payable on demand at the reporting date. Fair value of time deposits is estimated using the interest rates currently offered for deposits of similar remaining maturities.

Federal Funds Purchased – The carrying amount is a reasonable estimate of fair value because of the short-term nature of these borrowings.

Federal Home Loan Bank and Federal Reserve Bank Borrowings – Fair value of Federal Home Loan Bank and Federal Reserve Bank borrowings are estimated by discounting future cash flows at rates currently available to the Company for debt with similar terms and remaining maturities.

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Junior Subordinated Debentures – Fair value of Junior Subordinated Debentures is estimated by discounting future cash flows at rates currently available for debt with similar credit risk, terms and remaining maturities.

Off-Balance-Sheet Financial Instruments – The carrying amount and fair value are based on fees charged for similar commitments and are not material.

The Company also adheres to the FASB guidance with regards to ASC 820, “Fair Value Measures.” This guidance defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The statement requires fair value measurement disclosure of all assets and liabilities that are carried at fair value on either a recurring or nonrecurring basis. The Company determines fair value based upon quoted prices when available or through the use of alternative approaches, such as matrix or model pricing, when market quotes are not readily accessible or available. The valuation techniques used are based on observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. These two types of inputs create the following fair value hierarchy:

Level 1 – Quoted prices for identical instruments in active markets.

Level 2 – Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3 – Unobservable inputs are used to measure fair value to the extent that observable inputs are not available. The Company’s own data used to develop unobservable inputs is adjusted for market consideration when reasonably available.

Financial instruments, measured at fair value, are broken down in the tables below by recurring and nonrecurring measurement status. Recurring assets are initially measured at fair value and are required to be remeasured at fair value in the financial statements at each reporting date. Assets measured on a nonrecurring basis are assets that, due to an event or circumstance, were required to be remeasured at fair value after initial recognition in the financial statements at some time during the reporting period.

The tables below show assets measured at fair value on a recurring basis as of September 30, 2011, December 31, 2010, and September 30, 2010:

September 30, 2011	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available-for-sale securities
Obligations of U.S. government agencies	$	12,907	$	—	$	12,907	$	—
Obligations of states and political subdivisions		44,874		—		44,874		—
Agency mortgage-backed securities		266,896		—		266,896		—
Private-label mortgage-backed securities		15,441		—		15,441		—
Total available-for-sale securities	$	340,118	$	—	$	340,118	$	—

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December 31, 2010	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available-for-sale securities
Obligations of U.S. government agencies	$	7,262	$	—	$	7,262	$	—
Obligations of states and political subdivisions		32,079		—		32,079		—
Agency mortgage-backed securities		194,505		—		194,505		—
Private-label mortgage-backed securities		20,061		—		20,061		—
Total available-for-sale securities	$	253,907	$	—	$	253,907	$	—

September 30, 2010	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available-for-sale securities
Obligations of U.S. government agencies	$	7,392	$	—	$	7,392	$	—
Obligations of states and political subdivisions		18,731		—		18,731		—
Agency mortgage-backed securities		166,811		—		166,811		—
Private-label mortgage-backed securities		22,325		—		22,325		—
Total available-for-sale securities	$	215,259	$	—	$	215,259	$	—

No transfers to or from Levels 1 and 2 occurred on assets measured at fair value on a recurring basis during the nine months ended September 30, 2011, or during the year ended December 31, 2010.

The following is a description of the inputs and valuation methodologies used for assets recorded at fair value on a recurring basis. Fair value for all classes of available-for-sale securities is estimated by obtaining quoted market prices for identical assets, where available. If such prices are not available, fair value is based on independent asset pricing services and models, the inputs of which are market-based or independently sourced market parameters, including but not limited to, yield curves, interest rates, prepayments, defaults, cumulative loss projections, and cash flows. There have been no significant changes in the valuation techniques during the periods reported.

29

The tables below show assets measured at fair value on a nonrecurring basis as of September 30, 2011, December 31, 2010, and September 30, 2010:

September 30, 2011	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Nine Months Ended September 30, 2011 Total Loss
Loans measured for impairment (net ofgovernment guarantees and specific reserves)	$	15,739	$	—	$	—	$	15,739	$	859
Other real estate owned		11,663		—		—		11,663		1,958
	$	27,402	$	—	$	—	$	27,402	$	2,817

December 31, 2010	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Twelve Months Ended December 31, 2010 Total Loss
Loans measured for impairment (net ofgovernment guarantees and specific reserves)	$	24,094	$	—	$	—	$	24,094	$	1,584
Other real estate owned		14,293		—		—		14,293		896
	$	38,387	$	—	$	—	$	38,387	$	2,480

September 30, 2010	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Nine Months Ended September 30, 2010 Total Loss
Loans measured for impairment (net ofgovernment guarantees and specific reserves)	$	33,601	$	—	$	—	$	33,601	$	2,231
Other real estate owned		15,422		—		—		15,422		909
	$	49,023	$	—	$	—	$	49,023	$	3,140

No transfers to or from Level 3 occurred on assets measured at fair value on a nonrecurring basis during the nine months ended September 30, 2011, or during the year ended December 31, 2010.

The following is a description of the inputs and valuation methodologies used for assets recorded at fair value on a nonrecurring basis.

30

Loans measured for impairment (net of government guarantees and specific reserves) include the estimated fair value of collateral-dependent loans, less collectible government guarantees, as well as certain noncollateral-dependent loans measured for impairment with an allocated specific reserve. When a collateral-dependent loan is identified as impaired, the value of the loan is measured using the current fair value of the collateral, less selling costs. The fair value of collateral is generally estimated by obtaining external appraisals which are usually updated every 6 to 12 months based on the nature of the impaired loans. Certain noncollateral-dependent loans measured for impairment with an allocated specific reserve are valued based upon the estimated net realizable value of the loan. If the estimated fair value of the impaired loan, less collectible government guarantees, is less than the recorded investment in the loan, impairment is recognized as a charge-off through the allowance for loan losses. The carrying value of the loan is adjusted to the estimated fair value. The carrying value of loans fully charged off is zero.

Other real estate owned represents real estate which the Company has taken control of in partial or full satisfaction of loans. At the time of foreclosure, other real estate owned is recorded at the lower of the carrying amount of the loan or fair value less costs to sell, which becomes the property’s new basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, management periodically orders appraisals or performs valuations to ensure that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell. Appraisals are generally updated every 6 to 12 months on other real estate owned. Fair value adjustments on other real estate owned are recognized within net loss on real estate owned. The loss represents impairments on other real estate owned for fair value adjustments based on the fair value of the real estate.

There have been no significant changes in the valuation techniques during the periods reported.

8. Regulatory Matters:

The Company and the Bank are subject to the regulations of certain federal and state agencies and receive periodic examinations by those regulatory authorities. In addition, they are subject to various regulatory capital requirements administered by federal banking agencies. 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 effect on the consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of Total and Tier I capital to risk-weighted assets and of Tier I capital to leverage assets. Management believes that, as of September 30, 2011, the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of September 30, 2011, and according to Federal Reserve and FDIC guidelines, the Company and the Bank are considered to be well-capitalized. To be categorized as well-capitalized, the Company and the Bank must maintain minimum Total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table.

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The Company’s and the Bank’s actual capital amounts and ratios are presented below:

											To Be Well
											Capitalized Under
						For Capital					Prompt Corrective
	Actual					Adequacy Purposes					Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of September 30, 2011:
Total capital (to risk weighted assets)
Bank:	$	165,931		18.00	%	$	73,740		8	%	$	92,175		10	%
Company:	$	174,164		18.89	%	$	73,763		8	%	$	92,203		10	%
Tier I capital (to risk weighted assets)
Bank:	$	154,377		16.75	%	$	36,870		4	%	$	55,305		6	%
Company:	$	162,610		17.64	%	$	36,881		4	%	$	55,322		6	%
Tier I capital (to leverage assets)
Bank:	$	154,377		12.79	%	$	48,283		4	%	$	60,353		5	%
Company:	$	162,610		13.48	%	$	48,267		4	%	$	60,334		5	%
As of December 31, 2010:
Total capital (to risk weighted assets)
Bank:	$	159,401		16.16	%	$	78,934		8	%	$	98,668		10	%
Company:	$	168,727		17.10	%	$	78,954		8	%	$	98,693		10	%
Tier I capital (to risk weighted assets)
Bank:	$	147,247		14.92	%	$	39,467		4	%	$	59,201		6	%
Company:	$	156,573		15.86	%	$	39,477		4	%	$	59,216		6	%
Tier I capital (to leverage assets)
Bank:	$	147,247		12.58	%	$	46,808		4	%	$	58,510		5	%
Company:	$	156,573		13.38	%	$	46,809		4	%	$	58,511		5	%
As of September 30, 2010:
Total capital (to risk weighted assets)
Bank:	$	157,951		16.12	%	$	78,388		8	%	$	97,984		10	%
Company:	$	167,532		17.10	%	$	78,378		8	%	$	97,972		10	%
Tier I capital (to risk weighted assets)
Bank:	$	145,712		14.87	%	$	39,196		4	%	$	58,794		6	%
Company:	$	155,293		15.85	%	$	39,191		4	%	$	58,786		6	%
Tier I capital (to leverage assets)
Bank:	$	145,712		12.59	%	$	46,295		4	%	$	57,868		5	%
Company:	$	155,293		13.34	%	$	46,565		4	%	$	58,206		5	%

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Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion contains a review of Pacific Continental Corporation’s and its wholly-owned subsidiary Pacific Continental Bank’s operating results and financial condition for the three and nine months ended September 30, 2011. When warranted, comparisons are made to the same period in 2010 and to the previous year ended December 31, 2010. The discussion should be read in conjunction with the financial statements (unaudited) and related notes contained elsewhere in this report. The reader is assumed to have access to the Company’s Form 10-K for the previous year ended December 31, 2010, which contains additional statistics and explanations. All dollar amounts, except per share data, are expressed in thousands of dollars.

In addition to historical information, this report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include but are not limited to statements about management’s plans, objectives, expectations and intentions that are not historical facts, such as statements about management’s expectations for future net interest margin, nonperforming asset levels, noninterest income and expense, loan growth, and capital levels, and other statements identified by words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “should,” “projects,” “seeks,” “estimates” or words of similar meaning. These forward-looking statements are based on current beliefs and expectations of management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. In addition to the factors set forth in (i) this report, and (ii) the sections titled “Business,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” from our 2010 Annual Report on Form 10-K, the following factors, among others, could cause actual results to differ materially from the anticipated results:

• local and national economic conditions could be less favorable than expected or could have a more direct and pronounced effect on us than expected and adversely affect our ability to continue internal growth at historical rates and maintain the quality of our earning assets;

• the local housing / real estate market could continue to decline;

• the risks presented by a continued economic downturn or slow recovery, which could adversely affect credit quality, collateral values, including real estate collateral, investment values, liquidity and loan originations and loan portfolio delinquency rates;

• interest rate changes could significantly reduce net interest income and negatively affect funding sources;

• projected business increases following any future strategic expansion or opening of new branches could be lower than expected;

• competition among financial institutions could increase significantly;

• the goodwill we have recorded in connection with acquisitions could become impaired, which may have an adverse impact on our earnings and capital;

• the reputation of the financial services industry could deteriorate, which could adversely affect our ability to access markets for funding and to acquire and retain customers;

• the efficiencies we may expect to receive from any investments in personnel, acquisitions and infrastructure may not be realized;

• the level of non-performing assets and charge-offs or changes in the estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements may increase;

• changes in laws and regulations (including laws and regulations concerning taxes, banking, securities, executive compensation and insurance) could have a material adverse effect on our business, financial condition and results of operations;

• acts of war or terrorism, or natural disasters, such as the effects of pandemic flu, may adversely impact our business;

33

• the timely development and acceptance of new banking products and services and perceived overall value of these products and services by users may adversely impact our ability to increase market share and control expenses;

• changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters may impact the results of our operations;

• the costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews may adversely impact our ability to increase market share and control expenses; and

• our success at managing the risks involved in the foregoing items will have a significant impact upon our results of operations and future prospects.

Additional factors that could cause actual results to differ materially from those expressed in the forward-looking statements are discussed in Risk Factors in Part II, Item 1A. Please take into account that forward-looking statements speak only as of the date of this report. The Company does not undertake any obligation to publicly correct or update any forward-looking statement if we later become aware that actual results differ from anticipated results.

SUMMARY OF CRITICAL ACCOUNTING POLICIES

We follow accounting standards set by the Financial Accounting Standards Board, commonly referred to as the “FASB.” The FASB sets generally accepted accounting principles (“GAAP”) that we follow to ensure we consistently report our financial condition, results of operations, and cash flows. References to GAAP issued by the FASB in this report are to the “FASB Accounting Standards Codification”, sometimes referred to as the “Codification” or “ASC”. The FASB finalized the Codification effective for periods ending on or after September 15, 2009. Prior FASB Statements, Interpretations, Positions, EITF consensuses, and AICPA Statements of Position are no longer being issued by the FASB. The Codification does not change how the Company accounts for its transactions or the nature of related disclosures made. However, when referring to guidance issued by the FASB, the Company refers to topics in the ASC rather than the specific FASB statement. We have updated references to GAAP in this report to reflect the guidance in the Codification.

The SEC defines “critical accounting policies” as those that require the application of management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. Significant accounting policies are described in Note 1 of theNotes to Consolidated Financial Statements for the year ended December 31, 2010, in Item 8 in the Company’s Form 10-K. Management believes that the following policies and those disclosed in theNotes to Consolidated Financial Statements should be considered critical under the SEC definition:

Securities

Securities are classified based on management’s intention on the date of purchase and recorded on the Consolidated Balance Sheet as of the trade date. Currently the Company has all securities classified as available-for-sale (“AFS”) and carried at fair value with net unrealized gains and losses included in accumulated other comprehensive income (“OCI”) on an after-tax basis. The Company regularly evaluates each AFS security whose value has declined below amortized cost to assess whether the decline in fair value is other-than-temporary. In determining whether an impairment is other-than-temporary, the Company considers the severity and duration of the decline in fair value, the length of time expected for recovery, the financial condition of the issuer, and other qualitative factors, as well as whether the Company either plans to sell the security or it is more-likely-than-not that it will be required to sell the security before recovery of its amortized cost. Beginning in 2009, under new accounting guidance for impairments of debt securities that are deemed to be other-than-temporary, the credit component of an other-than-temporary impairment loss is recognized in earnings and the non-credit component is recognized in accumulated OCI in situations where the Company does not intend to sell the security and it is more-likely-than-not that the Company will not be required to sell the security prior to recovery.

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Allowance for Loan Losses and Reserve for Unfunded Commitments

The allowance for outstanding loans is classified as a contra-asset account offsetting outstanding loans, and the allowance for unfunded commitments is classified as an “other” liability on the balance sheet. The allowance for loan losses is established through a provision for loan losses charged against earnings. The balances of the allowance for loan losses for outstanding loans and unfunded commitments are maintained at amounts management believes will be adequate to absorb known and inherent losses in the loan portfolio and commitments to loan funds. The appropriate balance of the allowance for loan losses is determined by applying loss factors to the credit exposure from outstanding loans and unfunded loan commitments. Estimated loss factors are based on subjective measurements including management’s assessment of the internal risk classifications, changes in the nature of the loan portfolios, industry concentrations, and the impact of current local, regional, and national economic factors on the quality of the loan portfolio. Changes in these estimates and assumptions are reasonably possible and may have a material impact on the Company’s consolidated financial statements, results of operations, or liquidity.

Goodwill and Intangible Assets

At September 30, 2011, the Company had $22,291 in goodwill and intangible assets. In accordance with financial accounting standards, assets with indefinite lives are periodically tested for impairment, at least annually. At September 30, 2011, management performed a periodic review of its goodwill and intangible assets with indefinite lives and determined that there was no impairment.

Share-based Compensation

Consistent with the provisions of FASB ASC 718,Stock Compensation, we recognize expense for the grant-date fair value of stock options and other equity-based forms of compensation issued to employees over the employees’ requisite service period (generally the vesting period). The requisite service period may be subject to performance conditions. The fair value of each option grant is estimated as of the grant date using the Black-Scholes option pricing model. Management assumptions utilized at the time of grant impact the fair value of the option calculated under the Black-Scholes methodology, and ultimately, the expense that will be recognized over the life of the option. Liability-based stock awards are re-measured at estimated fair value each reporting period. Additional information is included in Note 6 of theNotes to Consolidated Financial Statements in Item 1 of this report.

Recent Accounting Pronouncements

In April 2011, the FASB issued Accounting Standards Update No. 2011-02, “Receivables: A Creditors Determination of Whether a Restructuring is a Troubled Debt Restructuring.” This Update provides additional guidance and clarification to help creditors in determining whether a creditor has granted a concession and whether the debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. The amendments in this Update are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. The adoption of this Accounting Standards Update did not have a material impact on the Company’s consolidated financial statements. The Company did, however, expand Note 3 to include additional disclosures regarding trouble debt restructurings.

In May 2011, the FASB issued Accounting Standards Update No. 2011.04, “Fair Value Measurements.” This Update provides guidance that develops common requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRSs). The amendments in this Update explain how to measure fair value. They do not require additional fair value measurements and are not intended to establish valuation standards or affect valuation practices outside of financial reporting. The amendments in this Update should be applied prospectively and are effect during interim and annual periods beginning after December 15, 2011. The adoption of this Accounting Standards Update is not expected to have a material impact on the Company’s consolidated financial statements.

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In June 2011, the FASB issued Accounting Standards Update No. 2011-05, “Presentation of Comprehensive Income.” This Update requires that an entity elect to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. The amendments in this Update should be applied retrospectively and are effective for public companies for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this Accounting Standards Update is not expected to have a material impact on the Company’s consolidated financial statements.

In September 2011, the FASB issued Accounting Standards Update No. 2011.08, “Intangibles-Goodwill and Other: Testing Goodwill for Impairment.” This Update simplifies how entities test goodwill for impairment. The amendments of this Update permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. The adoption of this Accounting Standard Update is not expected to have a material impact on the Company’s consolidated financial statements.

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HIGHLIGHTS

	For the three months ended September 30,									For the nine months ended September 30,
	2011			2010			% Change			2011			2010			% Change
Net income	$	2,588		$	1,152			124.7	%	$	6,194		$	3,901			58.8	%
Operating revenue(1)	$	14,598		$	13,947			4.7	%	$	42,540		$	41,852			1.6	%
Earnings per share
Basic	$	0.14		$	0.06			133.3	%	$	0.34		$	0.21			61.9	%
Diluted	$	0.14		$	0.06			133.3	%	$	0.34		$	0.21			61.9	%
Assets, period-end										$	1,251,571		$	1,192,004			5.0	%
Loans, period-end(2)										$	827,812		$	882,373			-6.2	%
Core deposits, period end(3)										$	880,727		$	850,894			3.5	%
Deposits, period-end										$	951,617		$	924,923			2.9	%
Return on average assets(4)		0.83	%		0.38	%					0.68	%		0.44	%
Return on average equity(4)		5.74	%		2.66	%					4.71	%		3.07	%
Return on average tangible equity(4) (5)		6.56	%		3.06	%					5.40	%		3.54	%

⁽¹⁾  Operating revenue is defined as net interest income plus noninterest income.

⁽²⁾  Net of deferred fees; excludes loans held-for-sale, and allowance for loan losses.

⁽³⁾  Defined by the Company as demand, interest checking, money market, savings, and local non-public time deposits, including local non-public time deposits in excess of $100

⁽⁴⁾  Amounts annualized.

⁽⁵⁾  Tangible equity excludes goodwill and core deposit intangibles related to acquisitions.

The Company earned $2,588 in the third quarter 2011, an increase of $1,436 or 124.7% over third quarter 2010. The improvement in net income in third quarter 2011 was primarily due to lower provision for loan losses and increased noninterest income when compared to the same quarter last year. The third quarter 2011 provision for loan losses was $1,750 compared to $3,750 for third quarter 2010. This reduction was due to a reduction in the level of classified assets and improved credit quality of the loan portfolio. The improvement in noninterest income was primarily related to gains on the sale of securities, which totaled $359 during third quarter 2011.

A portion of the improvement in net income due to improved noninterest income and lower provision for loan losses was offset by higher noninterest expense. Noninterest expense for the third quarter 2011 was up $736 or 9.0% over the same quarter last year. The increase in noninterest expense was primarily due to increased personnel expense as the Company added staff during fourth quarter 2010 and first quarter 2011 and higher costs associated with collection of problem loans and foreclosed properties.

The net interest margin for third quarter 2011 was 4.56%, down 14 basis points from the 4.70% net interest margin reported for third quarter 2010, and down 2 basis points from the second quarter 2011 margin of 4.58%. The net interest margin for the current period and all prior periods has been adjusted to a tax-equivalent basis using a 35% tax rate. The decline in the margin on a linked-quarter basis was primarily due to lower earning asset yields, which was partially offset by a decline in the cost of funds.

Period-end assets at September 30, 2011, were $1,251,571, up $41,395 and $59,567 over December 31, 2010, and September 30, 2010, respectively. The increase in period-end assets was primarily attributable to growth in the Company’s securities portfolio as outstanding loans at September 30, 2011, were down from year-end 2010 and the same period last year. Core deposits, which are defined as demand deposits, interest checking, money market accounts, and local time deposits (including local time deposits over $100) were $880,727 and constituted 93% of September 30, 2011, outstanding deposits. Noninterest-bearing deposits (a subset of core deposits) were $279,733 or 29% of total deposits at September 30, 2011, and $234,331 or 24% at December 31, 2010, and $220,104 or 24% at September 30, 2010.

37

Reconciliation of non-GAAP financial information

Management utilizes certain non-GAAP financial measures to monitor the Company’s performance. While we believe the presentation of non-GAAP financial measures provides additional insight into our operating performance, readers of this report are urged to review the GAAP results as presented in theFinancial Statementsin Item 1 of this report.

The Company presents a computation of tangible equity along with tangible book value and return on average tangible equity. The Company defines tangible equity as total shareholders’ equity before goodwill and core deposit intangible assets. Tangible book value is calculated as tangible equity divided by total shares outstanding. Return on average tangible equity is calculated as net income divided by average tangible equity. We believe that tangible equity and certain tangible equity ratios are meaningful measures of capital adequacy which may be used when making period-to-period and company-to-company comparisons. Tangible equity and tangible equity ratios are considered to be non-GAAP financial measures and should be viewed in conjunction with total shareholders’ equity, book value and return on average equity. The following table presents a reconciliation of total shareholders’ equity to tangible equity.

	September 30,			December 31,			September 30,
	2011			2010			2010
Total shareholders’ equity	$	181,070		$	172,238		$	172,579
Subtract:
Goodwill		(22,031	)		(22,031	)		(22,031	)
Core deposit intangible assets		(260	)		(427	)		(483	)
Tangible shareholders’ equity (non-GAAP)	$	158,779		$	149,780		$	150,065
Book value per share	$	9.82		$	9.35		$	9.38
Tangible book value per share (non-GAAP)	$	8.61		$	8.13		$	8.16
Return on average equity		4.71	%		2.98	%		3.07	%
Return on average tangible equity (non-GAAP)		5.40	%		3.44	%		3.54	%

Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although we believe these non-GAAP financial measure are frequently used by stakeholders in the evaluation of a company in our industry, they have limitations as analytical tools, and should not be considered in isolation or as a substitute for analyses of results as reported under GAAP.

RESULTS OF OPERATIONS

Net Interest Income

Net interest income is the primary source of the Company’s revenue. Net interest income is the difference between interest income derived from earning assets, principally loans and securities, and interest expense associated with interest-bearing liabilities, principally deposits. The volume and mix of earning assets and funding sources, market rates of interest, demand for loans, and the availability of deposits affect net interest income.

Net interest income as a percentage of average earning assets, or net interest margin, for third quarter 2011 was 4.56%, down 14 basis points from the 4.70% margin reported for third quarter 2010, and down 2 basis points from the net interest margin reported for the second quarter 2011. The net interest margin for the current period and all prior periods has been adjusted to a tax-equivalent basis using an assumed 35% tax rate. The decline in the third quarter 2011 margin when compared to second quarter 2011 was due to a drop in earning asset yields, which was partially offset by a decline in the cost of funds. Earning asset yields in third quarter 2011 were 5.30%, down 10 basis points from the second quarter 2011 yields of 5.40%. This decline was primarily due to a lower yield on the securities portfolio as prepayment speeds on agency mortgage-backed securities increased during the quarter accelerating the amortization of premiums. Also contributing to lower earning asset yields was the continued proportional increase in the lower yielding securities portfolio relative to higher yielding loans. For the third quarter 2011, the securities portfolio averaged 28.6% of total average earning assets versus 26.2% for the second quarter 2011 and 18.6% for the third quarter 2010. The Company continued to lower its cost of funds as the cost of core deposits in third quarter 2011 were 0.80% down 16 basis points from second quarter 2011. The overall cost of interest-bearing liabilities dropped by 9 and 47 basis points, respectively, from 1.18% in second quarter 2011 and 1.56% in third quarter 2010 to 1.09% in third quarter 2011.

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Despite the change that has occurred in the mix of earning assets and the continuing elevated (but declining) levels of nonperforming loans, the Company’s net interest margin continued to remain high relative to peers. A number of factors contribute to this performance including the historically low cost of short-term funding and the Company’s longstanding practice of using floors on variable rate loans which has successfully stabilized loan yields despite the low interest rate environment. At September 30, 2011, interest rate floors were active on approximately $255,911 of prime-based variable rate loans.

Looking forward to fourth quarter 2011, the Company expects a relatively stable net interest margin with some potential for improvement. The factors that will stabilize or improve the fourth quarter 2011 margin are: 1) rate reductions on the Company’s core deposit base in line with competitor’s offerings; 2) repricing opportunities on maturing core time deposits; 3) the potential for loan growth based on monthly growth during late third quarter and improving loan pipelines; 4) lower rates on wholesale funding as higher rated brokered time deposits were called during third quarter and refinanced at lower rates; and 5) improved prospects for recoveries including recovery of prior period interest. Factors that may negatively impact the fourth quarter 2011 net interest margin include: 1) accelerated prepayments on agency mortgage-backed securities that would require faster amortization of premiums thus lowering securities portfolio yield; 2) further charges to interest expense for broker discounts as the Company may call additional brokered time deposits during the fourth quarter 2011; 3) the flatter yield curve and increased competition for new loans leading to lower yield on new production; and 4) possible additions to nonaccrual loans that could result in interest reversals.

The following table presents condensed balance sheet information, together with interest income and yields on average interest earning assets, and interest expense and rates on interest-bearing liabilities for the three months ended September 30, 2011, compared to the three months ended September 30, 2010:

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Table I

Average Balance Analysis of Net Interest Income

(dollars in thousands)

	Three Months Ended September 30, 2011								Three Months Ended September 30, 2010
			Interest			Average					Interest			Average
	Average		Income or			Yields or			Average		Income or			Yields or
	Balance		(Expense)			Rates			Balance		(Expense)			Rates
Interest earning assets
Federal funds sold and interest-bearing deposits	$	112	$	1			3.54	%	$	561		3			2.12	%
Securities available-for-sale:
Taxable		290,788		2,150			2.93	%		192,114		1,712			3.54	%
Tax-exempt(1)		33,096		408			4.89	%		9,186		122			5.27	%
Loans held-for-sale		417		4			3.81	%		556		9			6.42	%
Loans, net of deferred fees and allowance(2)		808,474		12,579			6.17	%		878,995		14,061			6.35	%
Total interest earning assets(1)		1,132,887		15,142			5.30	%		1,081,412		15,907			5.84	%
Non earning assets
Cash and due from banks		20,303								19,252
Premises and equipment		20,497								21,224
Goodwill & intangible assets		22,321								22,544
Interest receivable and other assets		38,000								46,630
Total non earning assets		101,121								109,650
Total assets	$	1,234,008							$	1,191,062
Interest-bearing liabilities
Money market and NOW accounts		505,150	$	(856	)		-0.67	%		507,423	$	(1,385	)		-1.08	%
Savings deposits		36,222		(37	)		-0.41	%		31,540		(75	)		-0.94	%
Time deposits - core (3)		71,204		(337	)		-1.88	%		88,300		(568	)		-2.55	%
Total interest-bearing core deposits		612,576		(1,230	)		-0.80	%		627,263		(2,028	)		-1.28	%
Time deposits - non-core		71,940		(398	)		-2.19	%		68,016		(367	)		-2.14	%
Federal funds purchased		8,509		(11	)		-0.51	%		11,286		(15	)		-0.53	%
FHLB & FRB borrowings		75,538		(459	)		-2.41	%		73,685		(563	)		-3.03	%
Trust preferred		8,248		(34	)		-1.64	%		8,248		(133	)		-6.40	%
Total interest-bearing wholesale funding		164,235		(902	)		-2.18	%		161,235		(1,078	)		-2.65	%
Total interest-bearing liabilities		776,811		(2,132	)		-1.09	%		788,498		(3,106	)		-1.56	%
Noninterest-bearing liabilities
Demand deposits		274,808								219,512
Interest payable and other		3,493								10,961
Total noninterest liabilities		278,301								230,473
Total liabilities		1,055,112								1,018,971
Shareholders’ equity		178,896								172,091
Total liabilities and shareholders’ equity	$	1,234,008							$	1,191,062
Net interest income			$	13,010							$	12,801
Net interest margin(1)				4.56	%							4.70	%

⁽¹⁾  Tax-exempt income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $143 and $43 for the three months ended September 30, 2011 and 2010. Net interest margin was positively impacted by five and two basis points, respectively.

⁽²⁾ Interest income includes recognized loan origination fees of $50 and $74 for the three months ended September 30, 2011 and 2010, respectively.

⁽³⁾ Defined by the Company as demand, interest checking, money market, savings and local non- public time deposits, including local non-public time deposits in excess of $100.

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Table I shows that earning asset yields declined by 54 basis points in third quarter 2011 from third quarter 2010 from 5.84% to 5.30%. This decline in earning asset yields was primarily attributable a significant change in the earning asset mix in third quarter 2011 when compared to the same quarter last year. In third quarter 2011, average securities-held-for sale with a weighted-average yield of 3.13% totaled $323,884 and represented 29% of total average earning assets and loans yielding 6.17% represented 71% of total average earning assets. This compares to third quarter 2010, when the average securities portfolio was $201,300 with a weighted average yield of 3.62% represented 19% of total average earning assets, while loans yielding 6.35% represented 81% of total average earning assets.

While earning asset yields dropped 54 basis points in third quarter 2011 compared to third quarter 2010, the cost of interest-bearing liabilities declined by 47 basis points. Table I shows that the cost of interest-bearing core deposits fell by 48 basis points from 1.28% in third quarter 2010 to 0.80% in third quarter 2011, and declines in rates are evident in all core deposit categories. The cost of wholesale funding also moved down from 2.65% in third quarter 2010 to 2.18% in third quarter 2011. The decrease in wholesale funding costs was primarily due to the decline in the cost of FHLB borrowing and trust preferred securities, which repriced effective January 1, 2011.

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The following table sets forth a summary of changes in net interest income due to changes in average asset and liability balances (volume) and changes in average rates (rate) for the three months ended September 30, 2011, and September 30, 2010.

Table II

Analysis of Changes in Interest Income and Interest Expense

(dollars in thousands)

	Three Months Ended September 30, 2011 compared to September 30, 2010 Increase (decrease) due to
	Volume			Rate			Net
Interest earned on:
Federal funds sold and interest-bearing deposits	$	(2	)	$	—		$	(2	)
Securities available-for-sale:
Taxable		879			(441	)		438
Tax-exempt(1)		318			(32	)		286
Loans held-for-sale		(2	)		(3	)		(5	)
Loans, net of deferred fees and allowance		(1,128	)		(354	)		(1,482	)
Total interest earning assets(1)		65			(830	)		(765	)
Interest paid on:
Money market and NOW accounts		(6	)��		(523	)		(529	)
Savings deposits		11			(49	)		(38	)
Time deposits - core(2)		(110	)		(121	)		(231	)
Total interest-bearing core deposits		(105	)		(693	)		(798	)
Time deposits - non-core		21			10			31
Federal funds purchased		(4	)		—			(4	)
FHLB & FRB borrowings		14			(118	)		(104	)
Trust preferred		—			(99	)		(99	)
Total interest-bearing wholesale funding		31			(207	)		(176	)
Total interest-bearing liabilities		(74	)		(900	)		(974	)
Net interest income(1)	$	139		$	70		$	209

⁽¹⁾  Tax-exempt income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $143 and $43 for the three months ended September 30, 2011, and 2010.

⁽²⁾ Defined by the Company as demand, interest checking, money market, savings and local non- public time deposits, including local non-public time deposits in excess of $100.

The rate/volume analysis shows that third quarter 2011 net interest income increased by $209 from third quarter 2010. Third quarter 2011 interest income including loan fees declined by $765 from last year with lower volumes of earning assets increasing interest income by $65, offset by an $830 decline in interest income due to lower rates. The decline in interest income was more than offset by a $974 drop in interest expense in third quarter 2011 when compared to third quarter 2010. The rate/volume analysis shows interest expense on both core deposits and wholesale funding fell by $798 and $176, respectively. Both lower volumes and changes in the mix of volumes lowered interest expense by $74, while lower rates paid on interest-bearing liabilities decreased interest expense by $900.

42

Table III

Average Balance Analysis of Net Interest Income

(dollars in thousands)

	Nine Months Ended September 30, 2011								Nine Months Ended September 30, 2010
	Average Balance		Interest Income or (Expense)			Average Yields or Rates			Average Balance		Interest Income or (Expense)			Average Yields or Rates
Interest earning assets
Federal funds sold and interest-bearing deposits	$	226	$	5			2.96	%	$	487	$	6			1.65	%
Securities available-for-sale:
Taxable		264,244		6,030			3.05	%		180,060		4,571			3.39	%
Tax-exempt(1)		27,701		1,047			5.05	%		6,633		268			5.40	%
Loans held-for-sale		433		18			5.56	%		626		23			4.91	%
Loans, net of deferred fees and allowance(2)		819,901		38,127			6.22	%		900,052		43,210			6.42	%
Total interest earning assets(1)		1,112,505		45,227			5.44	%		1,087,858		48,078			5.91	%
Non earning assets
Cash and due from banks		19,702								19,670
Premises and equipment		20,621								20,742
Goodwill & intangible assets		22,376								22,599
Interest receivable and other assets		41,064								43,786
Total non earning assets		103,763								106,797
Total assets	$	1,216,268							$	1,194,655
Interest-bearing liabilities
Money market and NOW accounts	$	507,969	$	(2,988	)		-0.79	%	$	479,493	$	(3,927	)		-1.09	%
Savings deposits		34,627		(128	)		-0.49	%		30,005		(221	)		-0.98	%
Time deposits—core (3)		79,442		(1,297	)		-2.18	%		91,372		(1,833	)		-2.68	%
Total interest-bearing core deposits		622,038		(4,413	)		-0.95	%		600,870		(5,981	)		-1.33	%
Time deposits—non-core		62,517		(912	)		-1.95	%		79,926		(1,088	)		-1.82	%
Federal funds purchased		8,204		(32	)		-0.52	%		28,321		(39	)		-0.18	%
FHLB & FRB borrowings		76,071		(1,412	)		-2.48	%		85,685		(1,788	)		-2.79	%
Trust preferred		8,248		(99	)		-1.60	%		8,248		(393	)		-6.37	%
Total interest-bearing wholesale funding		155,040		(2,455	)		-2.12	%		202,180		(3,308	)		-2.19	%
Total interest-bearing liabilities		777,078		(6,868	)		-1.18	%		803,050		(9,289	)		-1.55	%
Noninterest-bearing liabilities
Demand deposits		260,108								211,646
Interest payable and other		3,281								9,823
Total noninterest liabilities		263,389								221,469
Total liabilities		1,040,467								1,024,519
Shareholders’ equity		175,801								170,136
Total liabilities and shareholders’ equity	$	1,216,268							$	1,194,655
Net interest income			$	38,359							$	38,789
Net interest margin(1)				4.61	%							4.77	%

⁽¹⁾  Tax-exempt income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $366 and $94 for the nine months ended September 30, 2011 and 2010. Net interest margin was positively impacted by four and one basis point, respectively.

⁽²⁾ Interest income includes recognized loan origination fees of $15 and $517 for the nine months ended September 30, 2011 and 2010, respectively.

⁽³⁾ Defined by the Company as demand, interest checking, money market, savings and local non- public time deposits, including local non-public time deposits in excess of $100.

Table III shows that year-to-date September 30, 2011, earning asset yields declined by 47 basis points from year-to-date September 30, 2010, from 5.91% to 5.44%. The decline in earning asset yields was attributable to lower yields on both the Company’s securities portfolio and loan portfolio.

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Table III also shows that the yield on earning assets fell faster than rates paid on interest-bearing funding, which dropped 37 basis points from 1.55% to 1.18%. The cost of interest-bearing core deposits fell by 38 basis points, while the cost of interest-bearing wholesale funding decreased by 7 basis points. Table III also shows the impact of the significant shift in funding as average year-to-date September 30, 2011, core deposits increased allowing for a reduction in average wholesale funding of $47,140.

The following table sets forth a summary of changes in net interest income due to changes in average asset and liability balances (volume) and changes in average rates (rate) for the nine months ended September 30, 2011, and September 30, 2010.

Table IV

Analysis of Changes in Interest Income and Interest Expense

(dollars in thousands)

	Nine Months Ended September 30, 2011 Compared to September 30, 2010 Increase (decrease) due to
	Volume			Rate			Net
Interest earned on:
Federal funds sold and interest-bearing deposits	$	(3	)	$	2		$	(1	)
Securities available-for-sale:
Taxable		2,137			(678	)		1,459
Tax-exempt(1)		851			(72	)		779
Loans held-for-sale		(7	)		2			(5	)
Loans, net of deferred fees and allowance		(3,848	)		(1,235	)		(5,083	)
Total interest earning assets(1)		(870	)		(1,981	)		(2,851	)
Interest paid on:
Money market and NOW accounts		233			(1,172	)		(939	)
Savings deposits		34			(127	)		(93	)
Time deposits—core(2)		(239	)		(297	)		(536	)
Total interest-bearing core deposits		28			(1,596	)		(1,568	)
Time deposits—non-core		(237	)		61			(176	)
Federal funds purchased		(28	)		21			(7	)
FHLB & FRB borrowings		(201	)		(175	)		(376	)
Trust preferred		—			(294	)		(294	)
Total interest-bearing wholesale funding		(466	)		(387	)		(853	)
Total interest-bearing liabilities		(438	)		(1,983	)		(2,421	)
Net interest income(1)	$	(432	)	$	2		$	(430	)

⁽¹⁾  Tax-exempt income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $366 and $94 for the nine months ended September 30, 2011, and 2010.

⁽²⁾ Defined by the Company as demand, interest checking, money market, savings, and local non-public time deposits, including local non-public time deposits in excess of $100.

The year-to-date September 30, 2011, rate/volume analysis shows that net interest income decreased by $430 from the same period last year. Interest income including loan fees through September 30, 2011, declined by $2,851 from last year as lower volumes of earning assets decreased interest income by $870, combined with a $1,981 decline in interest income due to lower rates. Interest expense through September 30, 2011, was down $2,421 when compared to the same period last year. The rate/volume analysis shows interest expense on both core deposits and wholesale funding fell by $1,568 and $853, respectively. Both lower volumes and changes in the mix of volumes lowered interest expense by $438, while lower rates paid on interest-bearing liabilities decreased interest expense by $1,983.

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Loan Loss Provision and Allowance

Below is a summary of the Company’s allowance for loan losses for the periods ended September 30, 2011, and September 30, 2010:

	Three months ended September 30,						Nine months ended September 30,
	2011			2010			2011			2010
Balance, beginning of period	$	15,326		$	17,854		$	16,570		$	13,367
Provision charged to income		1,750			3,750			5,900			11,750
Loans charged against allowance		(2,208	)		(4,240	)		(8,085	)		(10,189	)
Recoveries credited to allowance		419			405			902			2,841
Balance, end of period	$	15,287		$	17,769		$	15,287		$	17,769

The year-to-date September 30, 2011, provision for loan losses was $5,900, compared to $11,750 for the same period last year. The decrease in the provision for loan losses was attributable to a decline in past due loans, and lower levels of classified assets. Classified assets, which included classified securities rated below investment grade, declined $28,796 and $45,255 from December 31, 2010, and September 30, 2010, respectively. Note 3 in theNotes to Consolidated Financial Statements in this report provide details on loan credit quality statistics at September 30, 2011.

Year-to-date September 30, 2011, net charge-offs were $7,183 or an annualized 1.15% of average loans, as compared to net charge-offs of $7,348 or an annualized 1.07% of average loans reported for the same period in 2010. Year-to-date September 30, 2010, net charge-offs included $2,841 in recoveries, primarily related to a single borrower. On a linked-quarter basis, net charge-offs for third quarter 2011 were down $112 from second quarter 2011.

The allowance for loan losses at September 30, 2011, was 1.85% of the period-end loans net of loans held-for-sale, compared to 1.93% and 2.01% at December 31, 2010, and September 30, 2010, respectively. At September 30, 2011, the unallocated portion of the allowance for loan losses was $1,536 or 10% of the total allowance. The ending allowance at September 30, 2011, includes $859 in specific allowance for impaired loans, which total $39,981. At December 31, 2010, the Company had $54,540 of impaired loans with a specific allowance of $1,584 assigned.

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The following table shows a summary of nonaccrual loans, loans past due 90 days or more, and other real estate owned for the periods covered in this report:

	September 30, 2011			December 31, 2010			September 30, 2010
NONPERFORMING ASSETS
Non-accrual loans
Real estate secured loans:
Permanent loans:
Multifamily residential	$	—		$	1,010		$	6,594
Residential 1-4 family		3,393			6,123			4,945
Owner-occupied commercial		4,704			1,622			4,306
Non-owner-occupied commercial		1,191			8,428			7,359
Other loans secured by real estate		122			538			1,379
Total permanent real estate loans		9,410			17,721			24,583
Construction loans:
Multifamily residential		—			1,985			2,033
Residential 1-4 family		1,596			2,493			3,099
Commercial real estate		1,500			1,671			4,262
Commercial bare land and acquisition & development		13,027			91			669
Residential bare land and acquisition & development		1,451			1,032			90
Other		—			—			—
Total construction real estate loans		17,574			7,272			10,153
Total real estate loans		26,984			24,993			34,736
Commercial loans		6,732			8,033			8,602
Consumer loans		—			—			—
Other loans		—			—			—
Total nonaccrual loans		33,716			33,026			43,338
90 days past due and accruing interest		—			—			—
Total nonperforming loans		33,716			33,026			43,338
Nonperforming loans guaranteed by government		(851	)		(1,056	)		(798	)
Net nonperforming loans		32,865			31,970			42,540
Other real estate owned		11,663			14,293			15,422
Total nonperforming assets, net of guaranteed loans	$	44,528		$	46,263		$	57,962
ASSET QUALITY RATIOS
Allowance for loan losses as a percentage of total loans outstanding, net of loans held for sale		1.85	%		1.93	%		2.01	%
Allowance for loan losses as a percentage of total nonperforming loans, net of government guarantees		46.51	%		51.83	%		41.77	%
Net loan charge offs as a percentage of average loans, annualized		1.15	%		1.30	%		1.07	%
Net nonperforming loans as a percentage of total loans		3.97	%		3.73	%		4.82	%
Nonperforming assets as a percentage of total assets		3.56	%		3.82	%		4.86	%
Consolidated classified asset ratio(1)		45.51	%		63.39	%		72.91	%

⁽¹⁾  Classified asset ratio is defined as the sum of all loan-related contingent liabilities and loans internally graded substandard or worse (net of government guarantees), adversely classified securities, and other real estate owned, divided by total consolidated Tier 1 capital plus the allowance for loan losses.

Total nonperforming assets, net of government guarantees, were $44,528 at September 30, 2011, or 3.56% of total assets. This compares to nonperforming assets of $46,263 or 3.82% of total assets and $57,962 or 4.86% at December 31, 2010 and September 30, 2010, respectively. The Company achieved a $2,630 reduction in other real estate owned since December 31, 2010, and a reduction of $3,759 since September 30, 2010. During the third quarter 2011, the Company completed the sale of its single largest property in other real estate owned totaling $5,773, recording a small recovery on the sale. In addition to this disposition of nonperforming assets, the Company has pending resolutions on a number of other non-performing assets that are expected to reduce the level of nonperforming assets over the next two quarters.

46

Noninterest Income

Noninterest income for the nine months ended September 30, 2011, was $4,547, up $1,390 or 44% from the same period in 2010. All categories of noninterest income showed improvement during the third quarter 2011 when compared to the same quarter last year, with the exception of loan servicing fees and mortgage banking income. Most of the increase in 2011 noninterest income was related to net gains on the sale of securities during the first nine months of 2011 totaling $825 compared to net losses of $181 during the same period in 2010, which include a $226 OTTI charge on a portion of the Company’s securities portfolio. Other fees, primarily merchant bankcard, continued to show significant improvement up $129 or 12% for the nine months ended September 30, 2011, over the same period last year as both transaction volumes and margins continued to improve. Service charges on deposit accounts and the other income category also showed increases of $81 or 6% and $175 or 22%. The increase in the other income category was primarily related to one-time rental income on other real estate owned of $140 and increased business credit card interchange.

On a linked-quarter basis, third quarter 2011 noninterest income was relatively unchanged from the prior quarter. A decline in gains on the sale of securities was largely offset by one-time rental income on other real estate owned.

Looking forward to the fourth quarter 2011, the Company expects noninterest income will return to more normal levels at approximately $1,200.

Noninterest Expense

Year-to-date September 30, 2011, noninterest expense was $27,290, up $2,986 or 12% over the same period in 2010. All categories of expense showed an increase with the exception of FDIC assessments. The largest increases in noninterest expense categories were in four categories: 1) personnel expense; 2) business development; 3) other real estate; and 4) the other expense category. The increase in personnel expense was primarily related to increased base salaries and bonus expense, combined with a decline in loan origination costs. Base salaries and bonus expense were up $576 or 5% and $108 or 10%, respectively, through September 30, 2011 while loan origination cost (a reduction to personnel expense) declined by $361 or 22% when compared to the same period last year. The increase in base salaries reflects staff additions made during 2011 and performance increases for existing staff. A portion of the increases in these categories was offset by a drop of $157 in equity-based compensation, which was lower due to reversals of prior period accruals for cash-based SAR’s. The $1,242 increase in other real estate expense resulted primarily from valuation write downs recorded during the first nine months 2011. The other noninterest expense category increase was $597 or up 12% and primarily due to increases in expenses related to problem assets, specifically legal fees and repossession and collection expense, which were up $105 and $100, respectively. Travel and training related expenses also show an increase of $43 and $28, respectively.

On a linked-quarter basis, third quarter 2011 noninterest expense was down slightly from second quarter 2011. An increase in other real estate expense in third quarter 2011 of $277 over the prior quarter was offset by declines in personnel expense and a number of other expense categories. This increase in other real estate expense was primarily related to valuation write downs.

Looking forward to the fourth quarter 2011, the Company expects noninterest expense to be relatively flat when compared with the third quarter 2011.

47

BALANCE SHEET

Loans

At September 30, 2011, gross outstanding loans were $828,510, a decline of $28,458 and $54,449 from December 31, 2010 and September 30, 2010, respectively. A summary of outstanding loans by market at September 30, 2011, December 31, 2010, and September 30, 2010, follows:

	September 30,		December 31,		September 30,
	2011		2010		2010
Eugene market gross loans, period end	$	262,469	$	257,562	$	267,098
Portland market gross loans, period end		394,469		404,965		409,702
Seattle market gross loans, period end		171,572		194,441		206,159
Total gross loans, period end	$	828,510	$	856,968	$	882,959

All three of the Company’s primary markets showed a decline in outstanding loans at September 30, 2011, when compared to September 30, 2010. The first nine months of 2011 and year-over-year decrease in outstanding loans was most pronounced in the Seattle market as this market had proportionally more real estate exposure than the other two markets. The decline in outstanding loans during the first nine months of 2011 in the Portland market was relatively modest compared to Seattle. The overall decline in loans in the markets was primarily related to a planned contraction in residential and commercial construction loans. A portion of the contraction in the markets was offset by increased commercial and industrial loans, primarily related to new loans in the health care industry, including dental related loans. Outstanding commercial and industrial loans at September 30, 2011, were up $14,985 or 6% over the same period last year. All three markets showed increased commercial and industrial loan activity. The Company believes expansion of its commercial and industrial loan activity will continue to accelerate and that contraction in loans secured by real estate will abate resulting in growth in net outstanding loans throughout the remainder of the year.

While all markets showed year-over-year declines in outstanding loans, the Eugene Market has shown growth in loans of $4,709 since December 31, 2010. The Company believes that the prospect for loan growth in future quarters is improving as the loan pipelines in all three markets are showing improvement. In addition, while outstanding loans continued to contract during the third quarter 2011 when compared to the prior quarter end, the third quarter decline of approximately $1,800 was the smallest of any of the last ten quarters. During the month of September 2011, the Company experienced its first monthly increase in outstanding loans in more than two years.

The Company continued to expand outstanding loans to dental professionals during third quarter 2011. Outstanding loans to dental professionals at September 30, 2011, totaled $196,094 and represented 23.7% of total outstanding loans compared to dental professional loans of $177,229 or 20.7% at December 31, 2010, and $172,849 or 19.6% at September 30, 2010. In addition to growth in the dental industry, growth was also experienced in the wider health care field with loans to physicians, surgeons, optometrists, family practitioners, and medical specialists.

Securities

At September 30, 2011, securities available-for-sale totaled $340,118, up $32,585 and $86,211 over June 30, 2011, and December 31, 2010, respectively, and up $124,859 over September 30, 2010. At September 30, 2011, the portfolio had an unrealized taxable gain of $6,755 compared to an unrealized taxable gain of $1,956 at December 31, 2010. During third quarter 2011, the Company purchased $59,983 in new securities, while receiving $15,075 in cash flow from the portfolio and $13,494 in proceeds from the sale of 11 securities. A net gain on sale of securities of $359 was recorded during third quarter 2011. The securities sold during the quarter consisted of 5-year bullet agencies, 5-year PAC’s, and other mortgage-backed agency securities that were susceptible to accelerated prepayments given the low interest rates. The Company determined it was advantageous to sell these groups of securities for the gain and reinvest the proceeds further up the yield curve to enhance future period income.

48

Purchases during the third quarter 2011 were high-quality agency mortgage-backed securities and longer-term tax-exempt municipals. At September 30, 2011, taxable and tax-exempt municipal securities were $44,874 and comprised 13.2% of the total portfolio. Management has exercised caution in its purchases of municipals, relying on credit surveillance reports. The municipal portion of the portfolio is diversified geographically with some areas being avoided, and the Company does not have significant exposure to any single municipality.

The third quarter 2011 purchases supported the Company’s strategy of positioning the securities portfolio to provide earnings in light of declining loan volumes and growth in core deposits and hedge the balance sheet against a rates-up scenario due to the Company’s liability sensitive position. In an unchanged rate environment, the portfolio is expected to produce cash flow of approximately $53,000 over the next 12 months, primarily from the mortgage-backed portion of the portfolio. At September 30, 2011, the portfolio had an average life of 3.6 years and duration of 3.1 years, compared to 3.8 and 3.3 year average life and duration, respectively at December 31, 2010. Going forward, the portfolio is expected to increase moderately and purchases will be dependent upon core deposit growth, loan growth, and the Company’s interest rate risk position.

At September 30, 2011, $15,411 or 4.5% of the total securities portfolio was composed of private-label mortgage-backed securities. Management reviews monthly all available information, including current and projected default rates and current and projected loss severities, related to the collectability of its potentially impaired investment securities and determined no OTTI was required during the first nine months of 2011. However, recognition of OTTI on the private-label mortgage-backed portion of the portfolio is possible in future quarters depending upon economic conditions, default rates on home mortgages, loss severities on foreclosed homes, unemployment levels, and home values.

In management’s opinion, the remaining securities in the portfolio in an unrealized loss position are considered only temporarily impaired. The Company has no intent, nor is it more likely than not, that it will be required to sell these securities before their recovery. Management believes that substantially all decreases in fair value of the remaining securities are due to changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral. The decline in value of these securities has resulted from current economic conditions. Although yields on these securities may be below market rates during the period, no loss of principal is expected.

Goodwill and Intangible Assets

At September 30, 2011, the Company had a recorded balance of $22,031 in goodwill from the November 30, 2005, acquisition of Northwest Business Financial Corporation (“NWBF”). In addition, at September 30, 2011, the Company had $260 of core deposit intangible assets resulting from the acquisition of NWBF. The core deposit intangible was determined to have an expected life of approximately seven years and is being amortized over that period using the straight-line method and has approximately 14 months remaining on the amortization schedule. In accordance with generally accepted accounting principles, the Company does not amortize goodwill or other intangible assets with indefinite lives, but instead periodically tests these assets for impairment. Management performs an impairment analysis of the intangible assets with indefinite lives at least annually. The last impairment test was performed at September 30, 2011, at which time no impairment was determined to exist.

Deposits

Core deposits, which are defined by the Company as demand, interest checking, money market, savings, and non-public local time deposits, including non-public local time deposits in excess of $100, were $880,727 and represented 93% of total deposits at September 30, 2011. Outstanding core deposits at September 30, 2011, were up $29,833 or 4% over the same period last year. The Portland and Seattle markets showed growth in core deposits over the last year, while the Eugene market core deposits were relatively flat. During the third quarter 2011, the Company experienced a decline of $11,261 in outstanding core deposits due to volatility in large depositors.

49

A summary of outstanding core deposits and average core deposits by market and other deposits classified as wholesale funding at September 30, 2011, December 31, 2010, and September 30, 2010, follows:

	September 30,		December 31,		September 30,
	2011		2010		2010
Eugene market core deposits, period end(1)	$	514,453	$	538,011	$	515,164
Portland market core deposits, period end(1)		242,341		239,991		221,407
Seattle market core deposits, period end(1)		123,933		117,836		114,323
Total core deposits, period end(1)		880,727		895,838		850,894
Other deposits, period end		70,890		63,121		74,029
Total deposits, period end	$	951,617	$	958,959	$	924,923
	Three months ended
	September 30,		December 31,		September 30,
	2011		2010		2010
Eugene market core deposits, average(1)	$	507,644	$	525,937	$	510,593
Portland market core deposits, average(1)		252,903		225,769		216,818
Seattle market core deposits, average(1)		126,837		118,597		119,364
Total core deposits, average(1)		887,384		870,303		846,775
Other deposits, average		71,940		68,663		68,016
Total deposits, average	$	959,324	$	938,966	$	914,791

⁽¹⁾  Core deposits include all demand, savings, & interest checking accounts, plus all local time deposits including local time deposits in excess of $100,000. time deposits in excess of $100.

Junior Subordinated Debentures

The Company had $8,248 in junior subordinated debentures at September 30, 2011, which were issued in conjunction with an acquisition. Effective January 1, 2011, the rate on the junior subordinated debentures changed from a fixed rate of 6.265% to a variable rate based on the three-month LIBOR plus 135 basis points. The rate on the junior subordinated debentures through September 30, 2011, was 1.60%. At September 30, 2011, the entire balance of the junior subordinated debentures qualified as Tier 1 capital under regulatory capital guidelines.

In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) was signed into law which, among other things, limits the ability of certain bank holding companies to treat trust preferred security debt issuances, such as the Company’s junior subordinated debentures, as Tier 1 capital. This law may require many banks to raise new Tier 1 capital and will effectively close the trust-preferred securities markets from offering new issuances in the future. Since the Company had less than $15 billion in assets at December 31, 2009, under the Dodd-Frank Act, the Company will be able to continue to include its existing trust preferred securities in Tier 1 capital.

Additional information regarding the terms of the junior subordinated debentures, including maturity/repricing dates and interest rate, is included in Note 10 of theNotes to Consolidated Financial Statements in the Company’s 2010 annual Form 10-K.

50

Capital Resources

Capital is the shareholders’ investment in the Company. Capital grows through the retention of earnings and the issuance of new stock whether through stock offerings or through the exercise of stock options. Capital formation allows the Company to grow assets and provides flexibility in times of adversity.

Shareholders’ equity at September 30, 2011, was $181,070, an increase of $8,832 over December 31, 2010 and an increase of $8,491 over September 30, 2010. The increase in shareholders’ equity resulted from an increase in retained earnings and the unrealized gain on the available-for-sale securities portfolio. For additional details regarding the changes in equity, review the Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income on page 5 of this report.

The Federal Reserve Board and the FDIC have in place guidelines for risk-based capital requirements applicable to U.S. bank holding companies and banks. These risk-based capital guidelines take into consideration risk factors, as defined by regulation, associated with various categories of assets, both on and off-balance sheet. Under the guidelines, capital strength is measured in three ways, first by measuring Tier 1 capital to leverage assets, followed by capital measurement in two tiers, which are used in conjunction with risk-adjusted assets to determine the risk-based capital ratios. These guidelines require a minimum of 4% Tier 1 capital to leverage assets, 4% Tier 1 capital to risk-weighted assets, and 8% total capital to risk-weighted assets. In order to be classified as well-capitalized, the highest capital rating, by the Federal Reserve and FDIC, these three ratios must be in excess of 5%, 6%, and 10%, respectively. The Company’s leverage capital ratio, Tier 1 risk-based capital ratio, and Total risk-based capital ratio were 13.48%, 17.64%, and 18.89%, respectively at September 30, 2011, all ratios being well above the minimum well-capitalized designation.

The Company pays cash dividends on a quarterly basis, typically in March, June, September and December of each year. The Board of Directors considers the dividend amount quarterly and takes a broad perspective in its dividend deliberations including a review of recent operating performance, level of classified assets, capital levels, and concentrations of loans as a percentage of capital, and growth projections. The Board also considers dividend payout ratios, dividend yield, and other financial metrics in setting the quarterly dividend.

The Board of Directors, at its February 15, and May 17, 2011, meetings, approved quarterly dividends of $0.01 per share that were paid on March 15, and June 15, 2011. On August 16, 2011, the Board of Directors approved an increase in the quarterly dividend to $0.03 per share for the third quarter 2011. The Company has sufficient liquidity to maintain this level of dividend throughout 2011 if approved by regulators and would not require any dividend from the Bank to the Company in support of this level of cash dividend to shareholders.

The Company projects that earnings retention in 2011 and existing capital will be sufficient to fund anticipated organic asset growth, while maintaining a well-capitalized designation from all regulatory agencies.

OFF-BALANCE SHEET ARRANGEMENTS AND COMMITMENTS

In the normal course of business, the Company commits to extensions of credit and issues letters of credit. The Company uses the same credit policies in making commitments to lend funds and conditional obligations as it does for other credit products. In the event of nonperformance by the customer, the Company’s exposure to credit loss is represented by the contractual amount of the instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established by the contract. Since some commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. At September 30, 2011, the Company had $112,843 in commitments to extend credit.

Letters of credit written are conditional commitments issued by the Company to guarantee performance of a customer to a third party. The credit risk involved is essentially the same as that involved in extending loan facilities to customers. At September 30, 2011, the Company had $1,258 in letters of credit and financial guarantees written.

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LIQUIDITY AND CASH FLOWS

Liquidity is the term used to define the Company’s ability to meet its financial commitments. The Company maintains sufficient liquidity to ensure funds are available for both lending needs and the withdrawal of deposit funds. The Company derives liquidity through core deposit growth, maturity of investment securities, and loan payments. Core deposits include demand, interest checking, money market, savings, and local time deposits, including local non-public time deposits in excess of $100. Additional liquidity and funding sources are provided through the sale of loans, sales of securities, access to national CD markets, and both secured and unsecured borrowings. The Company uses a number of measurements to monitor its liquidity position on a daily, weekly, and monthly basis, which includes its ability to meet both short-term and long-term obligations, and requires the Company to maintain a certain amount of liquidity on the asset side of its balance sheet. The Company also prepares quarterly projections of its liquidity position 30 days, 90 days, 180 days, and 1 year into the future. In addition, the Company prepares a Liquidity Contingency Plan at least semi-annually that is strategic in nature and forward-looking to test the ability of the Company to fund a liquidity shortfall arising from various escalating events. The Liquidity Contingency Plan is presented and reviewed by the Company’s Asset and Liability Committee.

Core deposits at September 30, 2011, were $880,727 and represented 93% of total deposits. During first nine months of 2011, outstanding core deposits have fallen by $15,111. This decline has been centered in two large depositor relationships. The Company also continued to experience a decline in outstanding loans during the current year, which offset the decline in core deposits, and led to growth in the securities portfolio and the Company’s overall liquidity position improved. Over the last year, the Company has built up significant liquidity on the asset side of the balance sheet through growth in the securities portfolio. The securities portfolio represents 27% of total assets at September 30, 2011, compared to 18% at September 30, 2010. At September 30, 2011, $59,454 of the securities portfolio was pledged to support public deposits and a portion of the Company’s secured borrowing line at the FHLB leaving $280,664 of the securities portfolio unencumbered and available-for-sale. In addition, at September 30, 2011, the Company had $39,558 of government guaranteed loans that could be sold in the secondary market to support the Company’s liquidity position.

Due to its strategic focus to market to specific segments, the Company has been successful in developing deposit relationships with several large clients, which are generally defined as deposit relationships of $1,000 or more, which are closely monitored by management and Company officers. At September 30, 2011, 36 large deposit relationships with the Company account for $311,185 or 35% of total outstanding core deposits. The single largest client represented 5.1% of outstanding core deposits at September 30, 2011. The loss of this deposit relationship or other large deposit relationships could cause an adverse effect on short-term liquidity. The Company uses a 10-point risk-rating system to evaluate each of its large depositors in order to assist management in its daily monitoring of the volatility of this portion of its core deposit base. The risk-rating system attempts to determine the stability of the deposits of each large depositor, evaluating among other things the length of time the depositor has been with the Company and the likelihood of loss of individual large depositor relationships. Risk ratings on large depositors are reviewed at least quarterly and adjusted if necessary. Company management and officers maintain close relationships and hold regular meetings with its large depositors to assist in management of these relationships. The Company expects to maintain these relationships and believes it has sufficient sources of liquidity to mitigate the loss of one or more of these clients and regularly tests its ability to mitigate the loss of multiple large depositor relationships in its Liquidity Contingency Plan.

At September 30, 2011, the Company had secured borrowing lines with the Federal Home Loan Bank of Seattle (“FHLB”) and the Federal Reserve Bank of San Francisco (“FRB”), along with unsecured borrowing lines with various correspondent banks totaling $343,711. The Company’s secured lines with the FHLB and FRB were limited by the amount of collateral pledged. At September 30, 2011, the Company had pledged $153,090 in discounted collateral value in commercial real estate loans, first and second lien single-family residential loans, multi-family loans, and securities to the FHLB. Additionally, certain commercial and commercial real estate loans with a discounted value of $102,621 were pledged to the FRB under the Company’s Borrower-In-Custody program. The Company’s unsecured correspondent bank lines were $88,000. At September 30, 2011, the Company had $98,500 in borrowings outstanding from the FHLB, $0 outstanding with the Federal Reserve Bank of San Francisco, and $8,185 outstanding on its overnight correspondent bank lines, leaving a total of $237,026 available on it secured and unsecured borrowing lines.

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As disclosed in the Consolidated Statements of Cash Flows in Item 1 of this report, net cash provided by operating activities was $22,623 during the nine months ended September 30, 2011. The difference between cash provided by operating activities and net income largely consisted of non-cash items including a $5,900 provision for loan losses. Net cash of $62,860 was used in investing activities, consisting principally of $157,914 in purchases of investment securities which was partially offset by proceeds from the maturities and sales of securities of $73,380 and net loan principal collections of $12,840. Cash provided by financing activities was $31,511 and primarily consisted of an increase in federal funds purchased and FHLB short-term borrowings of $47,185, which was partially offset by a net decrease of $7,500 in FHLB term advances and other borrowings.

Item 3 Quantitative and Qualitative Disclosures About Market Risk

There has been no material change in the Company’s exposure to market risk. Readers are referred to the Company’s Form 10-K and the Annual Report to Shareholders for the year ended December 31, 2010, for specific discussion.

Item 4 Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 240.13a-15(e) and 15d-15(e)) as of September 30, 2011, the measurement date for purposes of this quarterly report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s current disclosure controls and procedures are effective, timely providing them with material information relating to the Company required to be disclosed in the reports we file or submit under the Exchange Act.

Changes in Internal Controls

There have not been any significant changes in our internal controls or in other factors during the third quarter of 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. We are not aware of any significant deficiencies or material weaknesses in our internal controls, therefore no corrective actions were taken.

Part II Other Information

Item 1 Legal Proceedings

As of the date of this report, neither the Company nor the Bank or any of its subsidiaries is party to any material pending legal proceedings, including proceedings of governmental authorities, other than ordinary routine litigation incidental to the business of the Bank.

Item 1A Risk Factors

The continued challenging economic environment could have a material adverse effect on our future results of operations or market price of our stock.

The national economy and the financial services sector in particular, are still facing significant challenges. Substantially all of our loans are to businesses and individuals in western Washington and Oregon, markets facing many of the same challenges as the national economy, including elevated unemployment and declines in commercial and residential real estate values. Although some economic indicators are improving both nationally and in the markets we serve, unemployment remains high and there remains substantial uncertainty regarding the strength and duration of economic recovery and the possibility of another recession. A further deterioration in economic conditions in the nation as a whole or in the markets we serve could result in the following consequences, any of which could have an adverse impact, which may be material, on our business, financial condition, results of operations and prospects, and could also cause the market price of our stock to decline:

• economic conditions may worsen, increasing the likelihood of credit defaults by borrowers;

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• loan collateral values, especially as they relate to commercial and residential real estate, may decline further, thereby increasing the severity of loss in the event of loan defaults;

• demand for banking products and services may decline, including loan products and services for low cost and non-interest-bearing deposits; and

• changes and volatility in interest rates may negatively impact the yields on earning assets and the cost of interest-bearing liabilities.

Our allowance for loan losses may not be adequate to cover actual loan losses, which could adversely affect our earnings.

We maintain an allowance for loan losses in an amount that we believe is adequate to provide for losses inherent in our loan portfolio. While we strive to carefully manage and monitor credit quality and to identify loans that may be deteriorating, at any time there are loans included in the portfolio that may result in losses, but that have not yet been identified as potential problem loans. Through established credit practices, we attempt to identify deteriorating loans and adjust the loan loss reserve accordingly. However, because future events are uncertain, there may be loans that deteriorate in an accelerated time frame. As a result, future additions to the allowance at elevated levels may be necessary. Because the loan portfolio contains a number of commercial real estate loans with relatively large balances, deterioration in the credit quality of one or more of these loans may require a significant increase to the allowance for loan losses. Future additions to the allowance may also be required based on changes in the financial condition of borrowers, such as have resulted due to the current, and potentially worsening, economic conditions. Additionally, federal banking regulators, as an integral part of their supervisory function, periodically review our allowance for loan losses. These regulatory agencies may require us to recognize further loan loss provisions or charge-offs based upon their judgments, which may be different from ours. Any increase in the allowance for loan losses would have an adverse effect, which may be material, on our financial condition and results of operations.

Concentration in real estate loans and the deterioration in the real estate markets we serve could require material increases in our allowance for loan losses and adversely affect our financial condition and results of operations.

We have a high degree of concentration in loans secured by real estate (see Note 3 in theNotes to Consolidated Financial Statements included in this report). Further deterioration in the local economies we serve could have a material adverse effect on our business, financial condition and results of operations due to a weakening of our borrowers’ ability to repay these loans and a decline in the value of the collateral securing them. Our ability to recover on these loans by selling or disposing of the underlying real estate collateral is adversely impacted by declining real estate values, which increases the likelihood we will suffer losses on defaulted loans secured by real estate beyond the amounts provided for in the allowance for loan losses. This, in turn, could require material increases in our allowance for loan losses and adversely affect our financial condition and results of operations, perhaps materially.

Non-performing assets take significant time to resolve and adversely affect our results of operations and financial condition.

At September 30, 2011, our non-performing loans (which include all nonaccrual loans, net of government guarantees) were 3.97% of the loan portfolio. At September 30, 2011, our non-performing assets (which include foreclosed real estate) were 3.56% of total assets. These levels of non-performing loans and assets are at elevated levels compared to historical norms. Non-performing loans and assets adversely affect our net income in various ways. Until economic and market conditions improve, we may expect to continue to incur losses relating to non-performing assets. We generally do not record interest income on non-performing loans or other real estate owned, thereby adversely affecting our income, and increasing our loan administration costs. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, which may ultimately result in a loss. An increase in the level of non-performing assets increases our risk profile and may impact the capital levels our regulators believe are appropriate in light of the ensuing risk profile. While we reduce problem assets through loan sales, workouts, and restructurings and otherwise, decreases in the value of the underlying collateral, or in these borrowers’ performance or financial condition, whether or not due to economic and market conditions beyond our control, could adversely affect our business, results of operations and financial condition, perhaps materially. In addition, the resolution of non-performing assets requires significant commitments of time from management and our directors, which can be detrimental to the performance of their other responsibilities. Any significant future increase in non-performing assets could have a material adverse effect on our business, financial condition and results of operations.

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Tightening of credit markets and liquidity risk could adversely affect our business, financial condition and results of operations.

A tightening of the credit markets or any inability to obtain adequate funds for continued loan growth at an acceptable cost could adversely affect our asset growth and liquidity position and, therefore, our earnings capability. In addition to core deposit growth, maturity of investment securities and loan payments, the Company also relies on wholesale funding sources including unsecured borrowing lines with correspondent banks, secured borrowing lines with the Federal Home Loan Bank of Seattle and the Federal Reserve Bank of San Francisco, public time certificates of deposits and out of area and brokered time certificates of deposit. Our ability to access these sources could be impaired by deterioration in our financial condition as well as factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations for the financial services industry or serious dislocation in the general credit markets. In the event such disruption should occur, our ability to access these sources could be adversely affected, both as to price and availability, which would limit, or potentially raise the cost of, the funds available to the Company.

The FDIC has increased insurance premiums to rebuild and maintain the federal deposit insurance fund and there may be additional future premium increases and special assessments.

In 2009, the FDIC imposed a special deposit insurance assessment of five basis points on all insured institutions, and also required insured institutions to prepay estimated quarterly risk-based assessments through 2012.

The Dodd-Frank Act established 1.35% as the minimum deposit insurance fund reserve ratio. The FDIC has determined that the fund reserve ratio should be 2.0% and has adopted a plan under which it will meet the statutory minimum fund reserve ratio of 1.35% by the statutory deadline of September 30, 2020. The Dodd-Frank Act requires the FDIC to offset the effect on institutions with assets less than $10 billion of the increase in the statutory minimum fund reserve ratio to 1.35% from the former statutory minimum of 1.15%.

On February 7, 2011, the FDIC issued final rules, effective April 11, 2011, implementing changes to the assessment rules resulting from the Dodd-Frank Act. The adopted regulations: (1) modify the definition of an institution’s deposit insurance assessment base; (2) alter certain adjustments to the assessment rates; (3) revise the assessment rate schedules in light of the new assessment base and altered adjustments; and (4) provide for the automatic adjustment of the assessment rates in the future when the reserve ratio reaches certain milestones.

Despite the FDIC’s actions to restore the deposit insurance fund, the fund will suffer additional losses in the future due to failures of insured institutions. There may be additional significant deposit insurance premium increases, special assessments or prepayments in order to restore the insurance fund’s reserve ratio. Any significant premium increases or special assessments could have a material adverse effect on the Company’s financial condition and results of operations.

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We may not have the ability to continue paying dividends on our common stock at current or historic levels.

Our ability to pay dividends on our common stock depends on a variety of factors. On August 17, 2011, we announced a quarterly dividend of $0.03 per share, payable September 15, 2011, which was an increase of 300% over the prior quarter’s dividend. For the nine months ended September 30, 2011, the Company paid $0.05 per share in dividends. For the year 2010, the Company paid $0.04 per share in dividends. It is possible in the future that we may not be able to continue paying quarterly dividends commensurate with historic levels, if at all. Cash dividends will depend on sufficient earnings to support them and approval of appropriate bank regulatory authorities.

We may be required, in the future, to recognize impairment with respect to investment securities, including the FHLB stock we hold.

Our securities portfolio contains whole loan private mortgage-backed securities and municipal securities and currently includes securities with unrecognized losses. We may continue to observe volatility in the fair market value of these securities. We evaluate the securities portfolio for any other-than-temporary-impairment (“OTTI”) each reporting period, as required by generally accepted accounting principles. Future evaluations of the securities portfolio could require us to recognize impairment charges. The credit quality of securities issued by certain municipalities has deteriorated in recent quarters. Although management does not believe the credit quality of the Company’s municipal securities has similarly deteriorated, such deterioration could occur in the future.

In addition, as a condition to membership in the Federal Home Loan Bank of Seattle (“FHLB”), we are required to purchase and hold a certain amount of FHLB stock. Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB. At September 30, 2011, we had stock in the FHLB of Seattle totaling $10,652. The FHLB stock held by us is carried at cost and is subject to recoverability testing under applicable accounting standards. The FHLB has discontinued the repurchase of their stock and discontinued the distribution of dividends. As of September 30, 2011, we did not recognize an impairment charge related to our FHLB stock holdings. Future negative changes to the financial condition of the FHLB could require us to recognize an impairment charge with respect to such holdings.

If the goodwill we have recorded in connection with acquisitions becomes impaired, it could have an adverse impact on our reported earnings.

At September 30, 2011, we had $22,031 of goodwill on our balance sheet. In accordance with generally accepted accounting principles, our goodwill is not amortized but rather evaluated for impairment on an annual basis or more frequently if events or circumstances indicate that a potential impairment exists. Such evaluation is based on a variety of qualitative and quantitative factors, including macroeconomic conditions, industry and market conditions, cost factors, overall financial performance, and other relevant entity-specific events. Future evaluations of goodwill may result in findings of impairment and write-downs, which could be material. At September 30, 2011, we did not recognize an impairment charge related to our goodwill.

Recent levels of market volatility were unprecedented and we cannot predict whether they will return.

From time-to-time over the last few years, the capital and credit markets have experienced volatility and disruption at unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If similar levels of market disruption and volatility return, we could experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.

We operate in a highly regulated environment and we cannot predict the effect of recent and pending federal legislation.

As discussed more fully in the section entitled “Supervision and Regulation” in Item 1 of our Annual Report on Form 10-K for the year ended December 31, 2010, we are subject to extensive regulation, supervision and examination by federal and state banking authorities. In addition, as a publicly traded company, we are subject to regulation by the Securities and Exchange Commission. Any change in applicable regulations or federal, state or local legislation could have a substantial impact on us and our operations. Additional legislation and regulations that could significantly affect our powers, authority and operations may be enacted or adopted in the future, which could have a material adverse effect on our financial condition and results of operations.

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In that regard, sweeping financial regulatory reform legislation was enacted in July 2010. Among other provisions, the new legislation (i) creates a new Bureau of Consumer Financial Protection with broad powers to regulate consumer financial products such as credit cards and mortgages, (ii) creates a Financial Stability Oversight Council comprised of the heads of other regulatory agencies, (iii) will lead to new capital requirements from federal banking agencies, (iv) places new limits on electronic debit card interchange fees, and (v) requires the Securities and Exchange Commission and national stock exchanges to adopt significant new corporate governance and executive compensation reforms. The new legislation and regulations are likely to increase the overall costs of regulatory compliance.

Further, regulators have significant discretion and authority to prevent or remedy unsafe or unsound practices or violations of laws or regulations by financial institutions and holding companies in the performance of their supervisory and enforcement duties. Recently, these powers have been utilized more frequently due to the serious national, regional and local economic conditions we are facing. The exercise of regulatory authority may have a negative impact on our financial condition and results of operations.

We cannot accurately predict the ultimate effects of recent legislation or the various governmental, regulatory, monetary and fiscal initiatives which have been and may be enacted on the financial markets, on the Company and on the Bank. The terms and costs of these activities, or the failure of these actions to help stabilize the financial markets, asset prices, market liquidity and a continuation or worsening of current financial market and economic conditions could materially and adversely affect our business, financial condition, results of operations and the trading price of our common stock.

Fluctuating interest rates could adversely affect our profitability.

Our profitability is dependent to a large extent upon our net interest income, which is the difference between the interest earned on loans, securities and other interest-earning assets and interest paid on deposits, borrowings, and other interest-bearing liabilities. Because of the differences in maturities and repricing characteristics of our interest-earning assets and interest-bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest-earning assets and interest paid on interest-bearing liabilities. Accordingly, fluctuations in interest rates could adversely affect our net interest margin, and, in turn, our profitability. We manage our interest rate risk within established guidelines and generally seek an asset and liability structure that insulates net interest income from large deviations attributable to changes in market rates. However, our interest rate risk management practices may not be effective in a highly volatile rate environment.

We face strong competition from financial services companies and other companies that offer banking services.

Our three major markets are in Oregon and Washington. The banking and financial services businesses in our market area are highly competitive and increased competition may adversely impact the level of our loans and deposits. Ultimately, we may not be able to compete successfully against current and future competitors. These competitors include national banks, foreign banks, regional banks and other community banks. We also face competition from many other types of financial institutions, including savings and loan associations, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. In particular, our competitors include major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous locations and mount extensive promotional and advertising campaigns. Areas of competition include interest rates for loans and deposits, efforts to obtain loan and deposit customers and a range in quality of products and services provided, including new technology driven products and services. If we are unable to attract and retain banking customers, we may be unable to develop loan growth or maintain our current level of deposits, which could adversely affect our business, financial condition and results of operations.

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Future acquisitions and expansion activities may disrupt our business and adversely affect our operating results.

We regularly evaluate potential acquisitions and expansion opportunities. To the extent that we grow through acquisitions, there is a risk that we will not be able to adequately or profitably manage this growth. Acquiring other banks, branches or other assets, as well as other expansion activities, involve various risks including the risks of incorrectly assessing the credit quality of acquired assets, encountering greater than expected costs of incorporating acquired banks or branches into our Company, and being unable to profitably deploy funds acquired in an acquisition.

We may pursue additional capital in the future, which could dilute the holders of our outstanding common stock and may adversely affect the market price of our common stock.

From time-to-time, particularly in the current uncertain economic environment, we may consider alternatives for raising capital when opportunities present themselves, in order to further strengthen our capital and/or better position ourselves to take advantage of identified or potential opportunities that may arise in the future. Such alternatives may include issuance and sale of common or preferred stock, or borrowings by the Company, with proceeds contributed to the Bank. Any such capital raising alternatives could dilute the holders of our outstanding common stock and may adversely affect the market price of our common stock.

Anti-takeover provisions in our amended and restated articles of incorporation and bylaws and Oregon law could make a third party acquisition of us difficult.

Our amended and restated articles of incorporation contain provisions that could make it more difficult for a third party to acquire us (even if doing so would be beneficial to our shareholders) and for holders of our common stock to receive any related takeover premium for their common stock. We are also subject to certain provisions of Oregon law that could delay, deter or prevent a change in control of us. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock.

Item 2 Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3 Defaults Upon Senior Securities

None

Item 4 [Removed and Reserved]

Item 5 Other Information

None

Item 6 Exhibits

31.1	302 Certification, Hal Brown, Chief Executive Officer
31.2	302 Certification, Michael A. Reynolds, Executive Vice President and Chief Financial Officer
32	Certifications Pursuant to 18 U.S.C. Section 1350
101*	The following financial information from Pacific Continental Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011, is formatted in XBRL: (i) the Unaudited Consolidated Balance Sheets, (ii) the Unaudited Consolidated Statements of Operations, (iii) the Unaudited Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income, (iv) the Unaudited Consolidated Statements of Cash Flows, and (v) the Notes to Consolidated Financial Statements, tagged as blocks of text.

* Furnished herewith.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

PACIFIC CONTINENTAL CORPORATION

(Registrant)

Dated November 4, 2011	/s/ Hal Brown
	Hal Brown
	Chief Executive Officer
Dated November 4, 2011	/s/ Michael A. Reynolds
	Michael A. Reynolds
	Executive Vice President and Chief Financial Officer

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