FNB Bancorp 10-Q 2011 Q3 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-Q

Quarterly Report

Pursuant to Section 13 or 15(d) of

the Securities Exchange Act of 1934

For the Quarterly Period Ended September 30, 2011

FNB BANCORP

(Exact name of registrant as specified in its charter)

California

(State or other jurisdiction of incorporation)

000-49693	92-2115369
(Commission File Number)	(IRS Employer Identification No.)
975 El Camino Real, South San Francisco, California	94080
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (650) 588-6800

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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its 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).

x Yes o 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 Exchange Act. (Check one):

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o 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 as of November 3, 2011: 3,339,468 shares.

FNB BANCORP

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

		Page No
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited):
	Consolidated Balance Sheets	3
	Consolidated Statement of Earnings	4
	Consolidated Statement of Comprehensive Earnings	5
	Consolidated Statement of Cash Flows	6
	Notes to Consolidated Financial Statements	7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		29
Item 3. Quantitative and Qualitative Disclosures About Market Risk		44
Item 4T. Controls and Procedures		45
PART II OTHER INFORMATION		45
Item 1. Legal Proceedings		45
Item 1A. Risk Factors		46
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		46
Item 6. Exhibits		46
SIGNATURES		47

2

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

FNB BANCORP AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

	September 30,		December 31,
(Dollar amounts in thousands)	2011		2010
ASSETS
Cash and due from banks	$	69,273	$	60,874
Securities available-for-sale at fair value		152,376		126,189
Loans, net of allowance for loan losses of $9,646 and $9,524 on September 30, 2011 and December 31, 2010		456,106		474,828
Bank premises, equipment, and leasehold improvements, net		13,399		13,535
Other real estate owned		2,988		6,680
Goodwill		1,841		1,841
Accrued interest receivable and other assets		27,037		30,692
Total assets	$	723,020	$	714,639
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Demand, noninterest bearing		141,196		137,237
Demand, interest bearing		60,627		60,413
Savings and money market		324,321		305,390
Time		105,510		125,400
Total deposits		631,654		628,440
Accrued expenses and other liabilities		5,672		5,275
Total liabilities		637,326		633,715
Stockholders’ equity
Preferred stock - series A - no par value, authorized and outstanding 12,000 shares (liquidation preference of $1,000 per share plus accrued dividends)		—		11,747
Preferred stock - series B - no par value, authorized and outstanding 600 shares (liquidation preference of $1,000 per share plus accrued dividends)		—		615
Preferred stock - series C - no par value, authorized and outstanding 12,600 shares (liquidation preference of $1,000 per share plus accrued dividends)		12,600		—
Common stock, no par value, authorized 10,000,000 shares; issued and outstanding  3,339,468 shares at September 30, 2011 and 3,341,049 shares at December 31, 2010		46,804		46,565
Retained earnings		23,581		21,760
Accumulated other comprehensive income		2,709		237
Total stockholders’ equity		85,694		80,924
Total liabilities and stockholders’ equity	$	723,020	$	714,639

See accompanying notes to consolidated financial statements.

3

FNB BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENT OF EARNINGS

(UNAUDITED)

(Dollar amounts and average shares are in thousands, except earnings per share amounts)

	Three months ended				Nine months ended
	September 30,				September 30,
	2011		2010		2011			2010
Interest income:
Interest and fees on loans	$	7,314	$	7,799	$	22,159		$	23,735
Interest on taxable securities		513		482		1,379			1,423
Interest on tax-exempt securities		414		335		1,192			874
Total interest income		8,241		8,616		24,730			26,032
Interest expense:
Deposits		842		1,154		2,583			3,817
Federal Home Loan Bank advances		—		184		—			551
Total interest expense		842		1,338		2,583			4,368
Net interest income		7,399		7,278		22,147			21,664
Provision for loan losses		450		464		1,300			1,029
Net interest income after provision for loan losses		6,949		6,814		20,847			20,635
Noninterest income:
Service charges		817		686		2,325			2,045
Credit card fees		197		159		525			473
Gain on sale of available-for-sale securities		168		330		318			492
Bank owned life insurance earnings		83		87		248			246
Other income		102		73		353			181
Total noninterest income		1,367		1,335		3,769			3,437
Noninterest expense:
Salaries and employee benefits		3,413		3,418		10,322			10,399
Occupancy expense		593		515		1,734			1,532
Equipment expense		433		472		1,258			1,495
FDIC assessment		240		363		915			986
Professional fees		449		372		1,206			951
Telephone, postage and supplies		253		271		864			816
Operating losses		310		19		547			52
Bankcard expenses		181		147		482			436
Low income housing expense		69		69		208			208
Loss (gain) on sale of other real estate owned		—		30		(66	)		5
Loss on impairment of other real estate owned		69		85		299			732
Other real estate owned expense		55		207		316			819
Other expense		718		730		2,218			2,018
Total noninterest expense		6,783		6,698		20,303			20,449
Earnings before provision for income tax expense		1,533		1,451		4,313			3,623
Provision for income tax expense		344		426		1,141			855
Net earnings		1,189		1,025		3,172			2,768
Dividends and discount accretion on preferred stock		372		214		800			640
Net earnings available to common stockholders	$	817	$	811	$	2,372		$	2,128
Earnings per share data:
Basic	$	0.24	$	0.24	$	0.71		$	0.64
Diluted	$	0.24	$	0.24	$	0.71		$	0.64
Weighted average shares outstanding:
Basic		3,342		3,341		3,342			3,341
Diluted		3,361		3,341		3,361			3,351

See accompanying notes to consolidated financial statements.

4

FNB BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS

(UNAUDITED)

(Dollar amounts in thousands)	Three months ended						Nine months ended
	September 30,						September 30,
	2011			2010			2011			2010
Net earnings	$	1,189		$	1,025		$	3,172		$	2,768
Unrealized holding gain on available-for-sale securities		1,216			869			2,660			1,585
Reclassification adjustment for gain on available-for-sale securities sold, net of tax		(99	)		(195	)		(188	)		(290	)
Total comprehensive earnings	$	2,306		$	1,699		$	5,644		$	4,063

See accompanying notes to consolidated financial statements.

5

FNB BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(Dollar amounts in thousands)	Nine months ended
	September 30
	2011			2010
Cash flow from operating activities:
Net earnings	$	3,172		$	2,768
Adjustments to reconcile net earnings to net cash provided by operating activities:
Gain on sale of securities available-for-sale		(318	)		(492	)
Depreciation, amortization and accretion		2,041			1,828
Gain on sale of other real estate owned		(66	)		—
Stock-based compensation expense		230			126
Provision for loan losses		1,300			1,029
Decrease in accrued interest receivable and other assets		3,655			2,040
Valuation allowance on other real estate owned		299			732
(Decrease) increase in accrued expenses and other liabilities		(1,321	)		25
Net cash provided by operating activities		8,992			8,056
Cash flows from investing activities
Purchase of securities available-for-sale		(51,557	)		(105,958	)
Proceeds from matured/called/sold securities available-for-sale		28,950			74,008
Proceeds from sale of other real estate owned		4,078			3,631
Net investment in other real estate owned		—			(468	)
Net decrease in loans		16,803			14,673
Purchases of bank premises, equipment, leasehold improvements		(979	)		(1,143	)
Proceeds from sale of equipment		2			—
Net cash used in investing activities		(2,703	)		(15,257	)
Cash flows from financing activities
Net increase in demand and savings deposits		23,104			41,147
Net decrease in time deposits		(19,890	)		(1,101	)
Net decrease in Federal Home Loan Bank advances		—			(25,000	)
Dividends paid on common stock		(568	)		(477	)
Exercise of stock options		9			—
Dividends paid on preferred stock series A and B		(545	)		(490	)
Repayment of series A and B preferred stock		(12,600	)		—
Issuance of preferred stock series C		12,600			—
Net cash provided by financing activities		2,110			14,079
NET INCREASE IN CASH AND CASH EQUIVALENTS		8,399			6,878
Cash and cash equivalents at beginning of period		60,874			62,853
Cash and cash equivalents at end of period	$	69,273		$	69,731
Additional cash flow information:
Interest paid		2,581			4,630
Income taxes paid		1,640			207
Non-cash investing and financing activities:
Accrued dividends		200			159
Change in unrealized gain in available for-sale securities, net of tax		2,472			1,295
Loans transferred to other real estate owned		619			3,183
Deemed dividends on preferred stock		255			149

See accompanying notes to consolidated financial statements.

6

FNB BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

(UNAUDITED)

NOTE A – BASIS OF PRESENTATION

FNB Bancorp (the “Company”) is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Company was incorporated under the laws of the State of California on February 28, 2001. The consolidated financial statements include the accounts of FNB Bancorp and its wholly-owned subsidiary, First National Bank of Northern California (the “Bank”). The Bank provides traditional banking services in San Mateo and San Francisco counties.

All intercompany transactions and balances have been eliminated in consolidation. The financial statements include all adjustments of a normal and recurring nature, which are, in the opinion of management, necessary for a fair presentation of the financial results for the interim periods, as required by Regulation S-X, Rule 10-01.

The accompanying unaudited financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and footnotes normally included in financial statements prepared in conformity with accounting principles generally accepted in the United States of America. Accordingly, these financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2010.

Results of operations for interim periods are not necessarily indicative of results for the full year.

NOTE B – STOCK OPTION PLANS

Stock option expense is recorded based on the fair value of option contracts issued. The fair value is determined by the expected contract term, the risk free interest rate, the volatility of the Company’s stock price and the level of dividends the Company is expected to pay.

The expected term of options granted is derived from historical plan behavior and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U. S. Treasury yield curve in effect at the time of the grant.

The amount of compensation expense for options recorded in the quarters ended September 30, 2011 and September 30, 2010 was $76,000 and $41,000, respectively. There was no income tax benefit recognized in the statements of earnings for these amounts for the quarters ended September 30, 2011, and September 30, 2010, respectively. The amount of compensation expense for options recorded in the nine months ended September 30, 2011 and September 30, 2010 was $230,000 and $126,000, respectively.

7

There was no income tax benefit recognized in the statements of earnings for these amounts for the nine months ended September 30, 2011 and 2010, respectively.

There was a $183,000 intrinsic value for options exercisable and a $7,000 intrinsic value for options exercised during the nine month period ended September 30, 2011.

The amount of total unrecognized compensation expense related to non-vested options at September 30, 2011 was $433,000, and the weighted average period over which it will be amortized is 2.5 years.

NOTE C – EARNINGS PER SHARE CALCULATION

Earnings per common share (EPS) is computed based on the weighted average number of common shares outstanding during the period. Basic EPS excludes dilution and is computed by dividing net earnings available to common stockholders (after deducting dividends and related accretion on preferred stock) by the weighted average of common shares outstanding. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. All common stock equivalents are anti-dilutive when a net loss occurs.

Earnings per share have been computed based on the following :

(All amounts in thousands)	Three months ended				Nine months ended
	September 30,				September 30,
	2011		2010		2011		2010
Net earnings	$	1,189	$	1,025	$	3,172	$	2,768
Dividends and discount accretion on preferred stock		372		214		800		640
Net earnings available to common shareholders	$	817	$	811	$	2,372	$	2,128
Average number of shares outstanding		3,342		3,341		3,342		3,341
Effect of dilutive options		19		10		19		10
Average number of shares outstanding used to calculate diluted earnings per share		3,361		3,351		3,361		3,351
Anti-dilutive options not included		168		323		300		323

8

NOTE D – SECURITIES AVAILABLE FOR SALE

The amortized cost and carrying values of securities available-for-sale are as follows:

(Dollar amounts in thousands)	Amortized		Unrealized		Unrealized			Carrying
	cost		gains		losses			value
September 30, 2011
U. S. Treasury securities	$	12,405	$	261	$	—		$	12,666
Obligations of U.S. Government agencies		47,822		1,042		—			48,864
Mortgage backed securities		25,381		1,051		—			26,432
Obligations of states and political subdivisions		51,862		2,353		(47	)		54,168
Corporate debt		10,315		104		(173	)		10,246
	$	147,785	$	4,811	$	(220	)	$	152,376

(Dollar amounts in thousands)	Amortized		Unrealized		Unrealized			Carrying
	cost		gains		losses			value
December 31, 2010:
U.S. Treasury securities	$	12,440	$	2	$	(97	)	$	12,345
Obligations of U.S. Government agencies		45,941		488		(315	)		46,114
Mortgage-backed securities		18,564		521		(17	)		19,068
Obligations of states and political subdivisions		42,738		582		(864	)		42,456
Corporate debt		6,105		109		(8	)		6,206
	$	125,788	$	1,702	$	(1,301	)	$	126,189

An analysis of gross unrealized losses within the available-for-sale investment securities portfolio as of September 30, 2011 and December 31, 2010 follows.

September 30, 2011:	# of		Total		< 12 Months			Total		12 Months or >		Total		Total
(Dollar amounts	secu-		Fair		Unrealized			Fair		Unrealized		Fair		Unrealized
in thousands)	rities		Value		Losses			Value		Losses		Value		Losses
Obligations of states and political subdivisions		9	$	6,369		(47	)		—		—	$	6,369		(47	)
Corporate debt		6		4,485		(173	)		—		—		4,485		(173	)
Total		15	$	10,854	$	(220	)	$	—	$	—	$	10,854	$	(220	)

9

December 31, 2010:	# of		Total		< 12 Months			Total		12 Months or >		Total		Total
(Dollar amounts	secu-		Fair		Unrealized			Fair		Unrealized		Fair		Unrealized
in thousands)	rities		Value		Losses			Value		Losses		Value		Losses
U.S. Treasury securities		11	$	11,341	$	(97	)	$	—	$	—	$	11,341	$	(97	)
Obligations of U.S. Government agencies		19		19,983		(315	)		—		—		19,983		(315	)
Mortgage-backed securities		1		1,864		(17	)		—		—		1,864		(17	)
Obligations of states and political subdivisions		37		22,639		(864	)		—		—		22,639		(864	)
Corporate debt		2		1,437		(8	)		—		—		1,437		(8	)
Total		70	$	57,264	$	(1,301	)	$	—	$	—	$	57,264	$	(1,301	)

At September 30, 2011 and December 31, 2010, there were no securities in an unrealized loss position for greater than 12 consecutive months. Management periodically evaluates each security in an unrealized loss position to determine if the impairment is temporary or other-than-temporary. Management has determined that no investment security is other-than-temporarily impaired at September 30, 2011. The unrealized losses are due solely to interest rate changes and the Company does not intend to sell nor expects it will be required to sell investment securities identified with impairments prior to the earliest of forecasted recovery or the maturity of the underlying investment security.

The amortized cost and carrying value of debt securities as of September 30, 2011, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

(Dollar amounts in thousands)	Amortized		Carrying
	Cost		Value
Available-for-sale:
Due in one year or less	$	7,140	$	7,182
Due after one through five years		77,937		79,576
Due after five years through ten years		26,028		27,061
Due after ten years		36,680		38,557
	$	147,785	$	152,376

For the nine months ended September 30, 2011, gross realized gains amounted to $318,000 on the sale of $21,275,000 in securities. For the nine months ended September 30, 2010, gross realized gains amounted to $492,000 on the sale of $50,910,000 in securities.

At September 30, 2011, securities with an amortized cost of $130,254,000 and fair value of $134,280,000 were pledged as collateral for public deposits and for other purposes required by law.

At September 30, 2011 and December 31, 2010, the Bank had investments in Federal Reserve Bank stock classified as other assets in the accompanying balance sheet of $1,062,000. These investments in Federal Reserve Bank stock are carried at cost. At September 30, 2011 and December 31, 2010, the Bank had investments in Federal Home Loan Bank stock classified as other assets in the accompanying balance sheet of $3,460,000 and $3,939,000, respectively. These investments in Federal Home Loan Bank stock are carried at cost.

10

Both the Bank’s investment in Federal Reserve Bank and Federal Home Loan Bank stock are periodically evaluated for impairment. As of September 30, 2011, management concluded no evidence of impairment exists.

NOTE E - LOANS

Loans are summarized as follows at September 30, 2011 and December 31,2010:

	September 30,			December 31,
(Dollar amounts in thousands)	2011			2010
Commercial real estate	$	268,455		$	278,866
Commercial real estate construction		24,476			21,410
Residential 1 to 4 family construction		7,315			6,167
Real estate multi-family		37,265			42,584
Real estate 1 to 4 family		81,461			71,463
Commercial & industrial		44,612			61,493
Consumer loans		2,349			2,689
Gross loans		465,933			484,672
Net deferred loan fees		(181	)		(320	)
Allowance for loan losses		(9,646	)		(9,524	)
Net loans	$	456,106		$	474,828

A summary of impaired loans, the related allowance for loan losses, average investment and income recognized on impaired loans follows.

11

Impaired Loans

At September 30, 2011

				Unpaid
(Dollar amounts in thousands)	Recorded		��	Principal		Related
	Investment			Balance		Allowance
With no related allowance recorded
Commercial & industrial	$	3,684		$	3,813	$	—
Commercial real estate construction		6,255			6,255		—
Commercial real estate		1,476			1,578		—
Residential - 1 to 4 family		1,073			1,187		—
Total		12,488			12,833		—
With an allowance recorded
Commercial & industrial	$	4,371			5,141	$	1,506
Residential 1 to 4 family construction		1,590			1,690		142
Commercial real estate		7,187			7,654		413
Residential- 1 to 4 family		2,253			2,262		212
Total		15,401			16,747		2,273
Total
Commercial & industrial	$	8,055		$	8,954	$	1,506
Commercial real estate construction		6,255			6,255		—
Residential 1 to 4 family construction		1,590			1,690		142
Commercial real estate		8,663			9,232		413
Residential - 1 to 4 family		3,326			3,449		212
Grand total	$	27,889		$	29,580	$	2,273

Impaired Loans

	3 months ended				9 months ended
	September 30, 2011				September 30, 2011
	Average				Average
(Dollar amounts in thousands)	Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized
With no related allowance recorded
Commercial & industrial	$	3,623	$	48	$	4,666	$	148
Commercial real estate		1,840		22		1,840		51
Commercial real estate construction		6,267		22		6,278		179
Residential - 1 to 4 family		1,031		12		1,076		50
Total		12,760		104		13,860		428
With an allowance recorded
Commercial	$	4,455	$	9	$	4,547	$	35
Residential 1 to 4 family construction		1,592		14		2,111		43
Commercial real estate		6,572		30		5,787		138
Residential- 1 to 4 family		2,254		22		2,255		69
Total		14,873		75		14,700		285
Total
Commercial & industrial	$	8,077		57	$	9,213	$	183
Commercial real estate construction		7,859		36		8,388		222
Commercial real estate		8,412		52		7,627		189
Residential - 1 to 4 family		3,285		34		3,331		119
Grand total	$	27,632	$	179	$	28,559	$	713

12

Impaired Loans

For the Year Ended December 31, 2010

			Unpaid				Average
(Dollar amounts in thousands)	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded
Commercial & industrial	$	4,743	$	4,841	$	—	$	4,801	$	74
Commercial real estate		4,206		4,206		—		4,323		131
Total		8,949		9,047		—		9,124		205
With an allowance recorded
Commercial & industrial	$	2,644		3,044	$	527	$	2,945	$	31
Commercial real estate construction		6,300		6,300		15		3,150		228
Residential 1 to 4 family construction		2,631		2,631		353		2,410		75
Commercial real estate		3,474		3,474		364		3,505		171
Residential- 1 to 4 family		3,304		3,349		210		3,347		100
Total		18,353		18,798		1,469		15,357		605
Total
Commercial & industrial	$	7,387	$	7,885	$	527	$	7,746	$	105
Commercial real estate construction		6,300		6,300		15		3,150		228
Residential 1 to 4 family construction		2,631		2,631		353		2,410		75
Commercial real estate		7,680		7,680		364		7,828		302
Residential - 1 to 4 family		3,304		3,349		210		3,347		100
Grand total	$	27,302	$	27,845	$	1,469	$	24,481	$	810

The following aggregate information is provided at September 30, 2011 and December 31, 2010, about the contractual provisions of these nonaccrual loans:

	September 30			December 31
(Dollars amounts in thousands)	2011			2010
Outstanding balance	$	16,180		$	16,712
Weighted average rate		5.94	%		5.99	%
Weighted average term to maturity	70 months			94 months

	Loans on Nonaccrual Status
	As of
(Dollar amounts in thousands)	September 30,		December 31,
	2011		2010
Commercial & industrial	$	5,512	$	5,415
Commercial real estate construction		115		1,963
Residential 1 to 4 family construction		527		1,555
Commercial real estate		8,730		6,662
Real estate 1 to 4 family		1,296		1,117
Consumer		—		—
Total	$	16,180	$	16,712

Interest income on impaired loans of $179,000 and $713,000 was recognized for cash payments received during the three months and nine months ended September 30, 2011, and $810,000 was recognized for cash payments received during the year ended December 31, 2010. The amount of interest on impaired loans not collected for the three and nine months ended September 30, 2011 was $186,000, and $577,000, and for the year ended December 31, 2010 was $290,000. The cumulative amount of unpaid interest on impaired loans was $186,000 and $577,000for the three and nine months ended September 30, 2011, and $1,095,000 for the year ended December 31, 2010.

13

Troubled Debt Restructurings

The Company adopted the amendments in Accounting Standards Update No. 2011-02 during the current period ended September 30, 2011. As required, the Company reassessed all restructurings that ocurred on or after the beginning fiscal year (January 1, 2011) for identification as troubled debt restructurings. The Company identified as troubled debt restructurings certain receivables for which the allowance for credit losses had previously been measured under a general allowance for credit losses methodology (ASC 450-20). Upon identifying the reassessed receivables as troubled debt restructurings, the Company also identified them as impaired under the guidance in ASC 310-10-35. The amendments in Accounting Standards Update No. 2011-02 require prospective application of the impairment measurement guidance in Section 310-10-35 for those receivables newly identified as impaired. At the end of the first interim period of adoption for the Company (September 30,2011), the recorded investment in receivables for which the allowance for credit losses was previously measured under a general allowance for credit losses methodology and are now impaired under Section 310-10-35 was $8,711,000 (310-40-65-1(b)), and the allowance for credit losses associated with those receivables, on the basis of a current evaluation of loss, was $130,000 (310-40-65-1(b)).

Modification Categories

The Company offers a variety of modifications to borrowers. The modification categories offered can generally be described in the following categories.

Rate Modification – A modification in which the interest rate is changed.

Term modification – A modification in which the maturity date, timing of payments, or frequency of payments is changed.

Interest Only Modification – A modification in which the loan is converted to interest only payments for a period of time.

Payment Modification – A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.

14

As of September 30, 2011 and 2010, respectively, there were no available commitments for troubled debt restructurings.

(in thousands)	September 30, 2011
	Accrual		Non-Accrual		Total
	Status		Status		Modifications
Troubled Debt Restructurings:
Commercial & industrial		725		1,637		2,362
Residential 1 to 4 family		—		1,015		1,015
Commercial real estate		739		1,269		2,008
Real estate multi family		0		3,326		3,326
Total	$	1,464	$	7,247	$	8,711

(in thousands)	December 31, 2010
	Accrual		Non-Accrual		Total
	Status		Status		Modifications
Troubled Debt Restructurings:
Commercial & industrial		773		1,643		2,416
Residential 1 to 4 family		500		1,047		1,547
Commercial real estate		1,022		3,575		4,597
Real estate multi family		—		3,474		3,474
Commercial real estate construction		6,300		—		6,300
Residential 1 to 4 family construction		1,075		—		1,075
Total	$	9,670	$	9,739	$	19,409

The Bank’s policy is that loans placed on non-accrual will typically remain on non-accrual status until all principal and interest payments are brought current and the prospect for future payment in accordance with the loan agreement appear relatively certain. The Bank’s policy generally refers to six months of payment performance as sufficient to warrant a return to accrual status.

15

The following tables present newly restructured loans that occurred during the three and nine months ended September 30, 2011 and 2010, respectively. Loans that are valued using collateral and cash flows generally require higher reserves than performing loans. Troubled debt restructurings include market interest rate changes, change in loan collateral value, ability of the borrower to meet its obligations and general economic conditions.

New Troubled Debt Restructurings

(in thousands)

	Three months ended
	September 30, 2011
	Rate		Term		Interest Only		Payment		# of		Total
	Modifications		Modifications		Modifications		Modifications		Loans		Modifications
Pre-Modification Outstanding Recorded Investment
Commercial & industrial		x		—		x		x		2		105
Residential 1 to 4 family		—		—		—		—		—		—
Commercial real estate		—		—		—		—		—		—
Real estate multi family		—		—		—		—		—		—
Total		—		—		—		—		2		105

	Three months ended
	September 30, 2011
	Rate		Term		Interest Only		Payment		# of		Total
	Modifications		Modifications		Modifications		Modifications		Loans		Modifications
Post-Modification Outstanding Recorded Investment
Commercial & industrial		x		—		x		x		2		105
Residential 1 to 4 family		—		—		—		—		—		—
Commercial real estate		—		—		—		—		—		—
Real estate multi family		—		—		—		—		—		—
Total		—		—		—		—		2		105

New Troubled Debt Restructurings

(in thousands)

Three months ended

September 30, 2010

Rate

Term

Interest Only

Payment

# of

Total

Modifications

Modifications

Modifications

Modifications

Loans

Modifications

Pre-Modification Outstanding Recorded Investment

Commercial & industrial

—

—

—

—

—

—

Residential 1 to 4 family

—

—

—

—

—

—

Commercial real estate

—

—

—

—

—

—

Real estate multi family

—

—

—

—

—

—

Total

—

—

—

—

—

—

Three months ended

September 30, 2010

Rate

Term

Interest Only

Payment

# of

Total

Modifications

Modifications

Modifications

Modifications

Loans

Modifications

Post-Modification Outstanding Recorded Investment

Commercial & industrial

—

—

—

—

—

—

Residential 1 to 4 family

—

—

—

—

—

—

Commercial real estate

—

—

—

—

—

—

Real estate multi family

—

—

—

—

—

—

Total

—

—

—

—

—

—

16

New Troubled Debt Restructurings

(in thousands)

	Nine months ended
	September 30, 2011
	Rate		Term		Interest Only		Payment		# of		Total
	Modifications		Modifications		Modifications		Modifications		Loans		Modifications
Pre-Modification Outstanding Recorded Investment
Commercial & industrial		x		—		x		x		2		105
Residential 1 to 4 family		—		—		—		—		—		—
Commercial real estate		x		—		—		x		1		739
Real estate multi family		—		—		—		—		—		—
Total		—		—		—		—		3		844

	Nine months ended
	September 30, 2011
	Rate		Term		Interest Only		Payment		# of		Total
	Modifications		Modifications		Modifications		Modifications		Loans		Modifications
Post-Modification Outstanding Recorded Investment
Commercial & industrial		x		—		x		x		2		105
Residential 1 to 4 family		—		—		—		—		—		—
Commercial real estate		x		—		—		x		1		739
Real estate multi family		—		—		—		—		—		—
Total		—		—		—		—		3		844

New Troubled Debt Restructurings

(in thousands)

	Nine months ended
	September 30, 2010
	Rate		Term		Interest Only		Payment		# of		Total
	Modifications		Modifications		Modifications		Modifications		Loans		Modifications
Pre-Modification Outstanding Recorded Investment
Commercial & industrial		—		—		x		x		1		1,670
Residential 1 to 4 family		—		—		—		—		—		—
Commercial real estate		—		—		—		—		—		—
Real estate multi family		—		—		—		—		—		—
Commercial real estate construction		x		—		—		x		1		6,300
Residential 1to 4 family construction		x		—		—		x		1		1,078
Total		—		—		—		—		3		9,048

	Nine months ended
	September 30, 2010
	Rate		Term		Interest Only		Payment		# of		Total
	Modifications		Modifications		Modifications		Modifications		Loans		Modifications
Post-Modification Outstanding Recorded Investment
Commercial & industrial		—		—		x		x		1		1,670
Residential 1 to 4 family		—		—		—		—		—		—
Commercial real estate		—		—		—		—		—		—
Real estate multi family		—		—		—		—		—		—
Commercial real estate construction		x		—		—		x		1		6,300
Residential 1 to 4 family construction		x		—		—		x		1		1,078
Total		—		—		—		—		3		9,048

17

The following tables represent financing receivables modified as troubled debt restructurings and with a payment default, with the payment default occuring within 12 months of the restructure date, and the payment default occuring during the three and nine month periods ended September 30, 2011 and 2010, respectively.

(in thousands)
	Three months ended
	# of		September		# of		September
	loans		2011		loans		2010
Commercial & industrial		2		105		—		—
Real estate 1 to 4 family		—		—		—		—
Commercial real estate		—		—		—		—
Real estate multi family		—		—		—		—
Total		2	$	105		—	$	—

(in thousands)
	Nine months ended
	# of		September		# of		September
	loans		2011		loans		2010
Commercial & industrial		2		105		1		1,670
Real estate 1 to 4 family		—		—		—		—
Commercial real estate		1		739		—		—
Real estate multi family		—		—		—		—
Commercial real estate construction		—		—		2		6,300
Residential 1 to 4 family construction		—		—		1		1,078
Total		3	$	844		3	$	9,048

A summary of the number, principal amounts outstanding for troubled debt restructurings were as follows as of September 30, 2011 and December 31, 2010.

	Modifications As of September 30, 2011
			Pre-		Post-
			Modification		Modification
			Outstanding		Outstanding
	Number of		Recorded		Recorded
(Dollar amounts in thousands)	Contracts		Investment		Investment
Commercial & industrial		5	$	2,362	$	2,362
Real estate 1 to 4 family		2		1,015		1,015
Commercial real estate		4		2,008		2,008
Real estate multi family		1		3,326		3,326
Total		12		8,711		8,711

18

	Modifications
	As of December 31, 2010
			Pre-		Post-
			Modification		Modification
			Outstanding		Outstanding
	Number of		Recorded		Recorded
(Dollar amounts in thousands)	Contracts		Investment		Investment
Commercial & industrial		3	$	2,416	$	2,416
Real estate 1 to 4 family		4		2,621		2,621
Commercial real estate		4		4,598		4,598
Real estate multi family		2		9,774		9,774
Total		13		19,409		19,409

Modifications are interest only on real estate one to four family. All other troubled debt restructured loan types include rate and payment modifications.

19

The Bank has had varying degrees of success with different types of concessions. The following tables display troubled debt restructurings as of September 30, 2011 and December 31, 2010, which were performing according to agreement.

Successful Troubled  Debt Restructurings

(in thousands)

	September 30,2011
	Rate		Term		Interest Only		Payment		# of		Total
	Modifications		Modifications		Modifications		Modifications		Loans		Modifications
Commercial & industrial		x		—		—		x		3	$	2,257
Commercial real estate		x		—		—		x		2		854
Total		—		—		—		—		5	$	3,111

Successful Troubled Debt Restructurings
(in thousands)
	December 31,2010
	Rate		Term		Interest Only		Payment		# of		Total
	Modifications		Modifications		Modifications		Modifications		Loans		Modifications
Commercial & industrial		x		—		—		x		3	$	2,416
Commercial real estate		x		—		—		x		1		1,022
Real estate multi family		x		—		—		x		1		6,300
Total		—		—		—		—		5	$	9,738

Age Analysis of Past Due Loans

As of September 30, 2011

(Dollar amounts in thousands)
	30-59		60-89										Recorded
	Days		Days		Over		Total						Investment >
	Past		Past		90		Past				Total		90 Days and
	Due		Due		Days		Due		Current		Loans		Accruing
Commercial & industrial	$	330	$	—	$	651	$	981	$	43,631	$	44,612	$	—
Commercial real estate		—		—		8,040		8,040		297,680		305,720		—
Commercial real estate -construction		26		—		527		553		23,923		24,476		—
Residential 1 to 4 family -construction		—		—		—		—		7,315		7,315		—
Residential		739		74		212		1,025		80,436		81,461		—
Consumer		—		10		—		10		2,339		2,349		—
Total	$	1,095	$	84	$	9,430	$	10,609	$	455,324	$	465,933	$	—

Age Analysis of Past Due Loans

As of December 31, 2010

(Dollar amounts in thousands)
	30-59		60-89										Recorded
	Days		Days		Greater		Total						Investment >
	Past		Past		Than		Past				Total		90 Days and
	Due		Due		90 Days		Due		Current		Loans		Accruing
Commercial & industrial	$	1,216	$	250	$	1,251	$	2,717	$	58,776	$	61,493	$	—
Commercial real estate		4,138		1,705		6,051		11,894		309,556		321,450		—
Commercial real estate -construction		—		—		—		—		21,410		21,410		—
Residential 1 to 4 family -construction		—		—		1,556		1,556		4,611		6,167		—
Residential		2,830		99		70		2,999		68,464		71,463		—
Consumer		2		—		—		2		2,687		2,689		—
Total	$	8,186	$	2,054	$	8,928	$	19,168	$	465,504	$	484,672	$	—

20

Credit Quality Indicators

As of September 30, 2011

(Dollar amounts in thousands)
			Special		Sub-				Total
	Pass		mention		standard		Doubtful		loans
Commercial & industrial	$	37,012	$	—	$	7,235	$	365	$	44,612
Commercial real estate construction		15,765		—		8,711		—		24,476
Residential 1 to 4 family construction		6,788				527				7,315
Commercial real estate		295,457		—		10,263		—		305,720
Real estate 1 to 4 family		77,590		—		3,413		458		81,461
Consumer loans		2,349		—		—		—		2,349
Totals	$	434,961	$	—	$	30,149	$	823	$	465,933

Credit Quality Indicators

As of December 31, 2010

(Dollar amounts in thousands)
			Special		Sub-				Total
	Pass		mention		standard		Doubtful		loans
Commercial & industrial	$	54,726	$	175	$	6,327	$	265	$	61,493
Commercial real estate -construction		9,297		—		12,113		—		21,410
Residential 1 to 4 family -construction		4,611		—		1,556				6,167
Commercial real estate		304,869		3,913		12,668		—		321,450
Real estate 1 to 4 family		66,460		—		4,734		269		71,463
Consumer loans		2,689		—		—		—		2,689
Totals	$	442,652	$	4,088	$	37,398	$	534	$	484,672

Allowance for Credit Losses

For the Three Months Ended September 30, 2011

(Dollar amounts in thousands)
	Commercial			Commercial			Real estate			Real estate
	& industrial			Real Estate			Construction			1 to 4 family		Consumer			Total
Allowance for credit losses
Beginning balance	$	2,289		$	4,365		$	1,536		$	1,460	$	69		$	9,719
Charge-offs		(448	)		4			(100	)		—		(2	)		(546	)
Recoveries		10			3			9			—		1			23
Provision		808			(635	)		197			105		(25	)		450
Ending balance	$	2,659		$	3,737		$	1,642		$	1,565	$	43		$	9,646

21

Allowance for Credit Losses

For The Nine Months  Ended September 30, 2011

(Dollar amounts in thousands)
	Commercial			Commercial			Real estate			Real estate
	& industrial			Real Estate			Construction			1 to 4 family		Consumer			Total
Allowance for credit losses
Beginning balance	$	2,102		$	4,103		$	1,999		$	1,233	$	87		$	9,524
Charge-offs		(548	)		(521	)		(100	)		—		(55	)		(1,224	)
Recoveries		15			3			27			—		1			46
Provision		1,090			152			(284	)		332		10			1,300
Ending balance	$	2,659		$	3,737		$	1,642		$	1,565	$	43		$	9,646

Recorded Investment in Loans at September 30, 2011

(Dollar amounts in thousands)
Ending balance: individually evaluated for impairment	$	1,506	$	413	$	142	$	212	$	—	$	2,273
Ending balance: collectively evaluated for impairment	$	1,153	$	3,324	$	1,500	$	1,353	$	43	$	7,373
Loans:
Ending balance	$	44,612	$	305,720	$	31,791	$	81,461	$	2,349	$	465,933
Ending balance: individually evaluated for impairment	$	8,055	$	8,663	$	7,845	$	3,326	$	—	$	27,889
Ending balance: collectively evaluated for impairment	$	36,557	$	297,057	$	23,946	$	78,135	$	2,349	$	438,044

Allowance for Credit Losses and Recorded Investment in Loans

For the Three Months Ended September 30, 2010

(Dollar amounts in thousands)
	Commercial			Commercial		Real estate			Real estate
	& industrial			Real Estate		Construction			1 to 4 family		Consumer			Total
Allowance for credit losses
Beginning balance	$	2,750		$	3,560	$	1,458		$	1,236	$	72		$	9,076
Charge-offs		(300	)		1		—			—		(8	)		(307	)
Recoveries		3			—		9			—		5			17
Provision		149			428		(272	)		150		9			464
Ending balance	$	2,602		$	3,989	$	1,195		$	1,386	$	78			9,250

22

Allowance for Credit Losses and Recorded Investment in Loans

for the Nine months Ended September 30, 2010

(Dollar amounts in thousands)
	Commercial			Commercial			Real estate			Real estate
	& industrial			real estate			construction			1 to 4 family			Consumer			Total
Allowance for credit losses
Beginning balance	$	809		$	5,177		$	3,110		$	704		$	29		$	9,829
Charge-offs		(331	)		(87	)		(1,003	)		(217	)		(24	)		(1,662	)
Recoveries		6			—			27			14			7			54
Provision		2,118			(1,101	)		(939	)		885			66			1,029
Ending balance	$	2,602		$	3,989		$	1,195		$	1,386		$	78		$	9,250

Recorded Investment in Loans at September 30, 2010

(Dollar amounts in thousands)
Ending balance: individually evaluated for impairment	$	830	$	381	$	—	$	73	2	$	1,286
Ending balance: collectively evaluated for impairment	$	1,772	$	3,608	$	1,195	$	1,313	76	$	7,964
Loans:
Ending balance	$	58,698	$	335,218	$	26,849	$	61,884	2,363	$	485,012
Ending balance: individually evaluated for impairment	$	6,704	$	7,030	$	2,274	$	1,640	5	$	17,653
Ending balance: collectively evaluated for impairment	$	51,994	$	328,188	$	24,575	$	60,244	2,358	$	467,359

Risk rating system

Loans to borrowers graded as pass or pooled loans represent loans to borrowers of acceptable or better credit quality. They demonstrate sound financial positions, repayment capacity and credit history. They have an identifiable and stable source of repayment.

Special mention loans have potential weaknesses that deserve management’s attention. If left uncorrected these potential weaknesses may result in a deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. These assets are “not adversely classified” and do not expose the Bank to sufficient risk to warrant adverse classification.

Substandard loans are inadequately protected by current sound net worth, paying capacity of the borrower, or pledged collateral. Loans are normally classified as Substandard when there are unsatisfactory characteristics causing more than acceptable levels of risk. A substandard loan normally has one or more well-defined weakness that could jeopardize the repayment of the debt. For example, a) cash flow deficiency, which may jeopardize future payments; b) sale of non-collateral assets has become primary source of repayment; c) the borrower is bankrupt; or d) for any other reason, future repayment is dependent on court action.

23

Doubtful loans represent credits with weakness inherent in the Substandard classification and where collection or liquidation in full is highly questionable. To be classified Doubtful, there must be specific pending factors which prevent the Loan Review Officer from determining the amount of loss contained in the credit. When the amount of loss can be reasonably estimated, that amount is classified as “loss” and the remainder is classified as Substandard.

Commercial Real Estate Loans

Our commercial real estate loans are made primarily to investors or small businesses where our primary source of repayment is from cash flows generated by the properties, either through rent collection or business profits. The borrower’s promissory notes are secured with recorded liens on the underlying property. The borrowers would normally also be required to personally guarantee repayment of the loan. The bank uses conservative underwriting standards in reviewing applications for credit. Generally, our borrowers have multiple sources of income, so if cash flow generated from the property declines, at least in the short term, the borrowers can normally cover these short term cash flow deficiencies from their available cash reserves. Risk of loss to the Bank is increased when there are cash flow decreases sufficiently large and for such a prolonged period of time that loan payments can no longer be made by the borrowers.

Our real estate construction loans are generally made to borrowers who are rehabilitating a building, converting a building use from one type of use to another, or developing land and building residential or commercial structures for sale or lease. The borrower’s promissory notes are secured with recorded liens on the underlying property. The borrowers would normally also be required to personally guarantee repayment of the loan. The bank uses conservative underwriting standards in reviewing applications for credit. Generally, our borrowers have sufficient resources to make the required construction loan payments during the construction and absorption or lease-up period. After construction is complete, the loans are normally paid off from proceeds from the sale of the building or through a refinance to a commercial real estate loan. Risk of loss to the Bank is increased when there are material construction cost overruns, significant delays in the time to complete the project and/or there has been a material drop in the value of the projects in the marketplace since the inception of the loan.

Commercial and Industrial Loans

Our commercial and industrial loans are generally made to small businesses to provide them with at least some of the working capital necessary to fund their daily business operations. These loans are generally either unsecured or secured by fixed assets, accounts receivable and/or inventory. The borrowers would normally also be required to personally guarantee repayment of the loan. The Bank uses conservative underwriting standards in reviewing applications for credit. Risk of loss to the Bank is increased when our small business customers experience a significant business downturn, incur significant financial losses, or file for relief from creditors through bankruptcy proceedings.

Residential Real Estate Loans

Our residential real estate loans are generally made to borrowers who are buying or refinancing their primary personal residence or a rental property of 1-4 singe family residential units. The Bank uses conservative underwriting standards in reviewing applications for credit. Risk of loss to the Bank is increased when borrowers loose their primary source of income and/or property values decline significantly.

24

Consumer and Installment Loans

Our consumer and installment loans generally consist of personal loans, credit card loans, automobile loans or other loans secured by personal property. The Bank uses conservative underwriting standards in reviewing applications for credit. Risk of loss to the Bank is increased when borrowers loose their primary source of income, or file for relief from creditors through bankruptcy proceedings.

NOTE F – FAIR VALUE MEASUREMENT

The following tables present information about the Company’s assets and liabilities measured at fair value as of September 30, 2011 and December 31, 2010, and indicate the fair value techniques used by the Company to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

The following table presents the recorded amounts of assets measured at fair value on a recurring basis:

			Fair Value Measurements
(Dollar amounts in thousands)			at September 30, 2011, Using
			Quoted Prices
			in Active
			Markets		Other		Significant
			for Identical		Observable		Unobservable
	Fair Value		Assets		Inputs		Inputs
Description	9/30/2011		(Level 1)		(Level 2)		(Level 3)
U. S. Treasury securities	$	12,666	$	12,666	$	—	$	—
Obligations of U.S. Government agencies		48,864		—		48,864		—
Mortgage-backed securities		26,432		—		26,432		—
Obligations of states and political subdivisions		54,168		—		54,168		—
Corporate debt		10,246		—		10,246		—
Total assets measured at fair value	$	152,376	$	12,666	$	139,710	$	—

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			Fair Value Measurements
(Dollar amounts in thousands)			at December 31, 2010, Using
			Quoted Prices in
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
	Fair Value		Assets		Inputs		Inputs
Description	12/31/2010		(Level 1)		(Level 2)		(Level 3)
Available-for-sale securities:
U. S. Treasury securities	$	12,345	$	12,345	$	—	$	—
Obligations of U.S. Government agencies		46,114		—		46,114		—
Mortgage-backed securities		19,068		—		19,068		—
Obligations of states and political subdivisions		42,456		—		42,456		—
Corporate debt		6,206		—		6,206		—
Total assets measured at fair value	$	126,189	$	12,345	$	113,844	$	—

The following tables present the recorded amount of assets measured at fair value on a non-recurring basis:

			Fair Value Measurements
(Dollar amounts in thousands)			at September 30, 2011, Using
			Quoted Prices in
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable		Total
			Assets		Inputs		Inputs		gains
Description	Fair Value		(Level 1)		(Level 2)		(Level 3)		(losses)
Impaired loans *	$	7,536	$	—	$	—	$	7,536	$	(115	)
Other real estate owned		2,023		—		—		2,023		(69	)
Total impaired assets measured at fair value	$	9,559	$	—	$	—	$	9,559	$	(184	)

			Fair Value Measurements
(Dollar amounts in thousands)			at December 31, 2010, Using
			Quoted Prices
			in Active
			Markets		Other		Significant
			for Identical		Observable		Unobservable		Total
			Assets		Inputs		Inputs		gains
Description	Fair Value		(Level 1)		(Level 2)		(Level 3)		(losses)
Impaired loans *	$	10,471	$	—	$	—	$	10,471	$	(1,069	)
Other real estate owned		6,680		—		—		6,680		552
Total impaired assets measured at fair value	$	17,151	$	—	$	—	$	17,151	$	(517	)

* Represents impaired loans for which a change in the valuation occurred during the nine months period ended September 30, 2011 and the year ended December 31, 2010.

The Bank does not record loans at fair value. However, from time to time, if a loan is considered impaired, a specific allocation within the allowance for loan losses may be required.

Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and cash flows. Those impaired loans not requiring an allowance represent loans for which the value of the expected repayments or collateral exceed the recorded investments in such loans. Impaired loans where an allowance is established based on the fair value of collateral or when the impaired loan has been written down to fair value require classification in the fair value hierarchy. If the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the impaired loans as nonrecurring Level 3. When an appraised value is not available, or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Bank also records the impaired loans as nonrecurring Level 3.

26

Other real estate owned is carried at the lower of historical cost or fair market value. An appraisal (a Level 3 valuation) is obtained at the time the Company acquires property through the foreclosure process. Any loan balance outstanding that exceeds the appraised value of the property is charged off against the allowance for loan loss at the time the property is acquired. Subsequent to acquisition, the Bank updates the property’s appraised value on at least an annual basis. If the value of the property has declined during the year, a loss due to valuation impairment charge is recorded along with a corresponding reduction in the book carrying value of the property.

Fair Values of Financial Instruments.

The following methods and assumptions were used by the Company in estimating the fair value disclosures for financial instruments:

Cash and Cash Equivalents.

The carrying amounts reported in the balance sheet for cash and short-term instruments are a reasonable estimate of fair value, which will approximate their historical cost.

Securities Available-for-Sale.

Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.

Federal Home Loan Bank and Federal Reserve Bank stock.

Federal Home Loan Bank and Federal Reserve Bank stock can only be issued and redeemed at par by these entities. These securities cannot be sold in open market transactions. Fair value is estimated to be their carrying value.

Loans Receivable.

For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values and credit risk factors. For fixed rate loans, fair values are based on discounted cash flows, credit risk factors, and liquidity factors.

Bank Owned Life Insurance.

The fair value of bank owned life insurance is the cash surrender value of the policies.

27

Deposit liabilities.

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, savings, and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair values for fixed-rate certificates of deposit are based on discounted cash flows.

Undisbursed loan commitments, lines of credit, Mastercard line and standby letters of credit.

The fair value of these off-balance sheet items are based on discounted cash flows of expected fundings.

The following table provides summary information on the estimated fair value of financial instruments at September 30, 2011:

(Dollar amounts in thousands)	Carrying		Fair
	amount		value
Financial assets:
Cash and cash equivalents	$	69,273	$	69,273
Securities available for sale		152,376		152,376
Loans, net		456,106		466,101
Bank owned life insurance		9,444		9,444
Federal Home Loan Bank stock		3,460		3,460
Federal Reserve Bank stock		1,062		1,062
Financial liabilities:
Deposits		631,654		632,197
Off-balance-sheet liabilities:
Undisbursed loan commitments, lines of credit, standby letters of credit and Mastercard lines of credit		—		962

The carrying amount of loans include $16,180,000 of nonaccrual loans (loans that are not accruing interest) as of September 30, 2011. The fair value of nonaccrual loans is based on the collateral values that secure the loans or the cash flows expected to be received.

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The following table provides summary information on the estimated fair value of financial instruments at December 31, 2010:

(Dollar amounts in thousands)	Carrying		Fair
	amount		value
Financial assets:
Cash and cash equivalents	$	60,874	$	60,874
Securities available for sale		126,189		126,189
Loans, net		474,828		466,007
Bank owned life insurance		9,195		9,195
Federal Home Loan Bank stock		3,939		3,939
Federal Reserve Bank stock		1,062		1,062
Financial liabilities:
Deposits		628,440		628,983
Off-balance-sheet liabilities:
Undisbursed loan commitments, lines of credit, standby letters of credit and Mastercard lines of credit		—		3,603

NOTE G – PREFERRED STOCK

On September 15, 2011, Preferred Stock was issued to the U. S. Treasury as part of the Treasury’s Small Business Lending Fund (“SBLF”), as Preferred Stock – Series C – Non-Cumulative. The initial dividend rate is 5%. Depending on the volume of our small business lending, the dividend rate can be reduced to as low as one percent.. If lending does not increase in the first two years, the dividend rate will increase to seven percent. After 4.5 years, the dividend rate will increase to nine percent if the Company has not repaid the SBLF funding.

This program does not contain any of the various restrictions (including restrictions related to the payment of dividends to Common Stockholders) that the Treasury’s Capital Purchase Program TARP program required. The Series A and B Preferred Stock, which contained a blended yield of 6.83% to the expected repayment date, were paid off in full and canceled with the proceeds received from the U. S. Treasury’s SBLF investment.

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

Forward-Looking Information and Uncertainties Regarding Future Financial Performance.

This report, including management’s discussion below, concerning earnings and financial condition, contains “forward-looking statements.” Forward-looking statements are estimates of or statements about expectations or beliefs regarding the Company’s future financial performance or anticipated future financial condition that are based on current information and that are subject to a number of risks and uncertainties that could cause actual operating results in the future to differ significantly from those expected at the current time. Those risks and uncertainties include, although they are not limited to, the following:

Increased Competition. Increased competition from other banks and financial service businesses, mutual funds and securities brokerage and investment banking firms that offer competitive loan and investment products and competitive market pricing, which could require us to reduce interest rates and loan fees to attract new loans or to increase interest rates that we offer on time deposits, either or both of which could, in turn, reduce interest income and net interest margins. These factors could reduce our ability to attract new deposits and loans and leases.

29

Liquidity Risk. The stability of funding sources and continued availability of borrowings; our ability to raise capital or incur debt on reasonable terms.

Possible Adverse Changes in Economic Conditions. Adverse changes in national or local economic conditions could (i) reduce loan demand which could, in turn, reduce interest income and net interest margins; (ii) adversely affect the financial capability of borrowers to meet their loan obligations, which, in turn, could result in increases in loan losses and require increases in provisions for loan losses, thereby adversely affecting operating results; and (iii) lead to reductions in real property values that, due to the Company’s reliance on real property to secure many of its loans, could make it more difficult to prevent losses from being incurred on non-performing loans through the sale of such real properties.

Possible Adverse Changes in National Economic Conditions and Federal Reserve Board Monetary Policies. Changes in national economic policies, such as increases in inflation or declines in economic output often prompt changes in Federal Open Market Committee (“FOMC”) monetary policies that could reduce interest income or increase the cost of funds to the Company, either of which could result in reduced earnings. In addition, deterioration in economic conditions could result in increased loan and lease losses.

Changes in Regulatory Policies. Changes in federal and national bank regulatory policies, such as increases in capital requirements or in loan loss reserve or asset/liability ratio requirements, liquidity requirements, and the risks associated with concentration in real estate related loans could adversely affect earnings by reducing yields on earning assets or increasing operating costs.

Due to these and other possible uncertainties and risks, readers are cautioned not to place undue reliance on the forward-looking statements contained in this report, which speak only as of the date of this report, or to make predictions based solely on historical financial performance. The Company also disclaims any obligation to update forward-looking statements contained in this report.

Critical Accounting Policies And Estimates

Management’s discussion and analysis of its financial condition and results of operations are based upon the Company’s financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to its loans and allowance for loan losses. The Company bases its estimates on current market conditions, historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. All adjustments that, in the opinion of management, are necessary for a fair presentation for the periods presented have been reflected as required by Regulation S-X, Rule 10-01. The Company believes the following critical accounting policy requires significant judgments and estimates used in the preparation of the consolidated financial statements.

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Allowance for Loan Losses

The allowance for loan losses is periodically evaluated for adequacy by management. Factors considered include the Company’s historical loan loss experience, known and inherent risks in the portfolio, current economic conditions, known adverse situations that may affect the borrower’s ability to repay, regulatory policies, and the estimated value of underlying collateral. The evaluation of the adequacy of the allowance is based on the above factors along with prevailing and anticipated economic conditions that may impact our borrowers’ ability to repay their loans. Determination of the allowance is based upon objective and subjective judgments by management based on the information currently available. Adverse changes in information could result in higher than expected charge-offs and loan loss provisions.

Goodwill

Goodwill arises from the Company’s purchase price exceeding the fair value of the net assets of an acquired business. Goodwill represents the value attributable to intangible elements acquired. The value of goodwill is supported ultimately by profit from the acquired business. A decline in earnings could lead to impairment, which would be recorded as a write-down in the Company’s consolidated statements of income. Events that may indicate goodwill impairment include significant or adverse changes in results of operations of the acquired business or asset, economic or political climate; an adverse action or assessment by a regulator; unanticipated competition; and a more-likely-than-not expectation that a reporting unit will be sold or disposed of at a loss.

Other Than Temporary Impairment

Other than temporary impairment (“OTTI”) is triggered if the Company has the intent to sell the security, it is likely that it will be required to sell the security before recovery, or if the Company does not expect to recover the entire amortized cost basis of the security. If the Company intends to sell the security or it is likely it will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If the Company does not intend to sell the security and it is not likely that the Company will be required to sell the security but the Company does not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings as an OTTI. The credit loss is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected of a security. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment loss related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, would be recognized as a charge to other comprehensive income (“OCI”). Impairment losses related to all other factors are to be presented as a separate category within OCI.

For investment securities held to maturity, this amount is accreted over the remaining life of the debt security prospectively based on the amount and timing of future estimated cash flows. The accretion of the OTTI amount recorded in OCI will increase the carrying value of the investment, and would not affect earnings. If there is an indication of additional credit losses the security is re-evaluated accordingly based on the procedures described above.

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Provision for and Deferred Income Taxes

The Company is subject to income tax laws of the United States, its states, and the municipalities in which it operates. The Company considers its income tax provision methodology to be critical, as the determination of current and deferred taxes is based on complex analyses of many factors including interpretation of federal and state laws, the difference between tax and financial reporting bases of assets and liabilities (temporary differences), estimates of amounts due or owed, the timing of reversals of temporary differences and current financial standards. Actual results could differ significantly from the estimates due to tax law interpretations used in determining the current and deferred income tax liabilities. Additionally, there can be no assurances that estimates and interpretations used in determining income tax liabilities may not be challenged by federal and state taxing authorities.

Recent Accounting Pronouncements

In January, 2011, the FASB issued ASU No. 2011-01, Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. The amendments in this Update temporarily delayed the effective date of the disclosures about troubled debt restructurings in Update 2010-20 for public entities. The delay was intended to allow the Board time to complete its deliberations on what constitutes a troubled debt restructuring. However, the guidance became effective for interim and annual periods ending after June 15, 2011. As this ASU is disclosure-related only, the adoption of this ASU did not impact the Bank’s financial condition or results of operations.

In April, 2011, the FASB issued ASU No. 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The amendments in this Update apply to all creditors, both public and nonpublic, that restructure receivables that fall within the scope of Subtopic 310-40, Receivables-Troubled Debt Restructurings by Creditors.

In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist:

1.	The restructuring constitutes a concession.
2.	The debtor is experiencing financial difficulties.

For public entities, the amendments in this Update became effective for the first interim or annual period beginning on or after June 15, 2011, and have been applied retrospectively to the beginning of the annual period of adoption. As this ASU is disclosure-related only, the adoption of this ASU did not impact the Bank’s financial condition or results of operations.

In April, 2011, the FASB issued ASU No. 2011-03, Reconsideration of Effective Control for Repurchase Agreements. The amendments in this Update remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. This ASU had no material impact on the Bank’s financial condition or results of operations.

In May, 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRS. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the Board does not intend for the amendments in this Update to result in a change in the application of the requirements in Topic 820.

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Some of the amendments clarify the Board’s intent about the application of existing fair value measurements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. As this ASU is disclosure-related only, the adoption of this ASU will not impact the Bank’s financial condition or results of operations.

In June, 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220). Under the amendments to Topic 220, Comprehensive Income, in this Update an entity has the option 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. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. In a single continuous statement, the entity is required to present the components of net income and total net income, the components of other comprehensive income and a total for other comprehensive income, along with the total of comprehensive income in that statement. In the two-statement approach, an entity is required to present components of net income and total net income in the statement of net income. The statement of other comprehensive income should immediately follow the statement of net income and include the components of other comprehensive income and a total of other comprehensive income, along with a total for comprehensive income.

Regardless of whether an entity chooses to present comprehensive income in a single continuous statement 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 do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments do not change the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, with one amount shown for the aggregate income tax expense or benefit related to the total of other comprehensive income items. In both cases, the tax effect for each component must be disclosed in the notes to the financial statements or presented in the statement in which other comprehensive income is presented. The amendments do not affect how earnings per share is calculated or presented. This ASU will have no material impact on the Bank when adopted.

In September, 2011, the FASB issued ASU 2011-08, Intangibles – Goodwill and Other (Topic 350). Under the amendments in this update, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit, as described in paragraph 350-20-35-4 of the codified standards. If the carrying amount of a reporting unit exceeds its fair value, then the entity is required to perform the second step of the goodwill impairment test to measure the amount of the impairment loss, if any, as described in paragraph 350-20-35-9 of the codified standards. Under the amendments in this Update, an entity has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the two-step goodwill impairment test. An entity may resume performing the qualitative assessment in any subsequent period.

33

The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim impairments tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued, or, for nonpublic entities, have not yet been made available for issuance. The Company plans to early adopt during the fourth quarter of 2011. Management does not anticipate any financial effect due to early adoption of these amendments.

Earnings Analysis

Net earnings for the quarter ended September 30, 2011 were $1,189,000, compared to net earnings of $1,025,000 for the quarter ended September 30, 2010, an increase of $164,000, or16.00%. Cash dividend payments on the preferred shares outstanding were made as scheduled during the nine months ended September 30, 2011 and 2010, respectively. Net earnings for the nine months ended September 30, 2011 were $3,172,000 compared to net earnings of $2,768,000 for the nine months ended September 30, 2010, an improvement of $404,000. Net earnings before income tax expense for the quarter ended September 30, 2011 were $1,533,000, compared to net earnings before income tax expense of $1,451,000 for the quarter ended September 30, 2010, an increase of $82,000. Net earnings available to common stockholders for the quarter ended September 30, 2011, were $817,000, compared to net earnings available to common stockholders of $811,000 for the quarter ended September 30, 2010. Earnings before income tax expense were $4,313,000 for the nine months ended September 30, 2011 compared to net earnings before income tax expense of $3,623,000 for the nine months ended September 30, 2010, an improvement of $690,000. Net earnings available to common stockholders were $2,372,000 for the nine months ended September 30, 2011, compared to net earnings available to common stockholders of $2,128,000 for the nine months ended September 30, 2010. Earnings during the three and nine months ended September 30, 2011 were positively affected by an increase in our net interest margin on a year over year basis. The positive net interest margin in the nine month period was somewhat offset by an increase in our provision for loan losses.

Net interest income for the quarter ended September 30, 2011 was $7,399,000, compared to $7,278,000 for the quarter ended September 30, 2010, an increase of $121,000, or 2%. The increase in our net interest income was greater than the decrease in our interest from earning assets.Net interest income for the nine months ended September 30, 2011 was $22,147,000 compared to $21,664,000 for the nine months ended September 30, 2010, an increase of $483,000, or 2%.

Basic and diluted earnings per share were $0.24 for the third quarter of 2011, compared to basic and diluted earnings of $0.24 for the third quarter of 2010. Basic and diluted earnings per share were $0.71 for the nine months ended September 30, 2011 compared to basic and diluted earnings per share of $0.64 for the nine months ended September 30, 2010.

The following table presents an analysis of net interest income and average earning assets and liabilities for the three-and nine-month periods ended September 30, 2011 compared to the three-and nine-month periods ended September 30, 2010.

34

TABLE 1	NET INTEREST INCOME AND AVERAGE BALANCES
	FNB BANCORP AND SUBSIDIARY
	Three months ended September 30,
	2011							2010
(Dollar amounts in thousands)					Annualized							Annualized
	Average				Average			Average				Average
	Balance		Interest		Yield			Balance		Interest		Yield
INTEREST EARNING ASSETS
Loans, gross  (1) (2)	$	470,303	$	7,314		6.17	%	$	486,528	$	7,799		6.36	%
Taxable securities (3)		99,714		513		2.04	%		90,214		482		2.12	%
Nontaxable securities (3)		49,724		555		4.43	%		38,294		444		4.60	%
Fed funds sold		94		—		—			6		—		—
Total interest earning assets		619,835		8,382		5.37	%		615,042		8,725		5.63	%
NONINTEREST EARNING ASSETS:
Cash and due		64,708							72,113
Premises		13,582							11,947
Other assets		25,958							33,039
Total noninterest earning assets		104,248							117,099
TOTAL ASSETS	$	724,083						$	732,141
Demand, int bearing	$	61,107		31		0.20	%	$	63,064		41		0.26	%
Money market		273,284		552		0.80	%		273,334		728		1.06	%
Savings		48,143		28		0.23	%		44,342		28		0.25	%
Time deposits		106,968		231		0.86	%		123,411		357		1.15	%
FHLB advances (5)		—		—		—			6,739		184		10.83	%
Total interest bearing liabilities		489,502		842		0.68	%		510,890		1,338		1.04	%
NONINTEREST BEARING LIABILITIES:
Demand deposits		141,237							130,773
Other liabilities		8,770							8,933
Total noninterest bearing liabilities		150,007							139,706
TOTAL LIABILITIES		639,509							650,596
Stockholders’ equity		84,574							81,545
TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY	$	724,083						$	732,141
NET INTEREST INCOME AND MARGIN ON TOTAL EARNING ASSETS (4)			$	7,540		4.83	%			$	7,387		4.77	%

(1) Interest on non-accrual loans is recognized into income on a cash received basis.

(2) Amounts of interest earned include loan fees of $221,000 and $291,000 for the quarters ended September 30, 2011 and 2010, respectively.

(3) Tax equivalent adjustments recorded at the statutory rate of 34% that are included in the nontaxable securities portfolio are $141,000 and $109,000 for the quarters ended September 30, 2011 and 2010, respectively. Tax equivalent adjustments included in the nontaxable securities portfolio were derived from nontaxable municipal interest income.

(4) The annualized net interest margin is computed by dividing net interest income by total average interest earning assets and multiplied by an annualization factor.

(5) The 10.83% includes the effect of a prepayment penalty for early payoff of advances due in 2010 and the first quarter of 2011, of $139,000. Excluding this, the rate would have been 2.65%.

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TABLE 2	NET INTEREST INCOME AND AVERAGE BALANCES
	FNB BANCORP AND SUBSIDIARY
	Nine months ended September 30,
	2011							2010
(Dollar amounts in thousands)					Annualized							Annualized
	Average				Average			Average				Average
	Balance		Interest		Yield			Balance		Interest		Yield
INTEREST EARNING ASSETS
Loans, gross  (1) (2)	$	474,265	$	22,159		6.25	%	$	493,984	$	23,735		6.42	%
Taxable securities (3)		91,782		1,379		2.01	%		86,261		1,423		2.21	%
Nontaxable securities (3)		46,772		1,586		4.53	%		33,220		1,158		4.66	%
Fed funds sold		41		—		—			2		—		—
Total interest earning assets		612,860		25,124		5.48	%		613,467		26,316		5.74	%
NONINTEREST EARNING ASSETS:
Cash and due		61,016							69,777
Premises		13,558							11,852
Other assets		28,634							34,089
Total noninterest earning assets		103,208							115,718
TOTAL ASSETS	$	716,068						$	729,185
Demand, int bearing	$	61,334		101		0.22	%	$	61,038		137		0.30	%
Money market		265,057		1,633		0.82	%		270,825		2,407		1.19	%
Savings		46,716		85		0.24	%		43,256		82		0.25	%
Time deposits		112,878		764		0.90	%		123,970		1,191		1.28	%
FHLB advances		—		—		—			15,476		551		4.76	%
Fed funds purchased		—		—		—			4		—		—
Tot interest bearing liabilities		485,985		2,583		0.71	%		514,569		4,368		1.13	%
NONINTEREST BEARING LIABILITIES:
Demand deposits		139,241							126,344
Other liabilities		7,970							7,974
Total noninterest bearing liabilities		147,211							134,318
TOTAL LIABILITIES		633,196							648,887
Stockholders’ equity		82,872							80,298
TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY	$	716,068						$	729,185
NET INTEREST INCOME AND MARGIN ON TOTAL EARNING ASSETS (4)			$	22,541		4.92	%			$	21,948		4.78	%

(1) Interest on non-accrual loans is recognized into income on a cash received basis.

(2) Amounts of interest earned included loan fees of $740,000 and $821,000 for the nine months ended September 30, 2011 and 2010, respectively.

(3) Tax equivalent adjustments recorded at the statutory rate of 34% that are included in the nontaxable securities portfolio are $394,000 and $284,000 for the nine months ended September 30, 2011 and 2010, respectively. Tax equivalent adjustments included in the nontaxable securities portfolio were derived from nontaxable municipal interest income.

(4) The annualized net interest margin is computed by dividing net interest income by total average interest earning assets and multiplied by an annualization factor.

Tables 1 and 2, above, show the various components that contributed to changes in net interest income for the three and nine months ended September 30, 2011 and 2010. The principal interest earning assets are loans, from a volume as well as from a rate or yield perspective. For the quarter ended September 30, 2011, average loans outstanding represented 75.9% of average earning assets. For the quarter ended September 30, 2010, they represented 79.1% of average earning assets. For the nine months ended September 30, 2011 and 2010, average loans outstanding represented 77.4% and 80.5%, respectively, of average earning assets.

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The taxable equivalent yield on average interest earning assets for the quarter ended September 30, 2011 compared to the quarter ended September 30, 2010 decreased from 5.63% to 5.37%, or 26 basis points. Average loans decreased by $16,225,000, quarter to quarter, while their yield decreased from 6.36% to 6.17%, or 19 basis points. Interest income on total interest earning assets decreased $343,000 or 3.9% on a fully-taxable equivalent basis.

For the three months ended September 30, 2011 compared to the three months ended September 30, 2010, the cost on total interest bearing liabilities decreased from 1.04% to 0.68%, a decrease of 36 basis points. There were no advances from the Federal Home Loan Bank in 2011. Time deposit interest cost decreased from 1.15% to 0.86%. The time deposit average balance outstanding decreased by $16,443,000, or 13.3%, while their expense decreased $126,000. Money market deposits average volume decreased $50,000, or under 0.1%, while their cost decreased from 1.06% to 0.80%.

For the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010, interest income on interest earning assets decreased $1,192,000 or 4.5% on a fully-taxable equivalent basis, while average earning assets decreased $607,000, or 0.1%. Average loans decreased by $19,719,000, or 4.0%. Interest on loans decreased $1,576,000 or 6.6%, while yield decreased 17 basis points, or 2.6%. The cost on total interest bearing liabilities decreased from 1.13% to 0.71%. Time deposit averages decreased $11,092,000 or 8.9%. Their yield decreased 38 basis points, or 29.7%. Money market deposit average balances decreased $5,768,000, or 2.1%, but their cost decreased $774,000, or 32.2%. There were no Federal Home Loan Bank advances during the nine months ended September 30, 2011.

For the three and nine month periods ended September 30, 2011 and September 30, 2010, respectively, the following tables show the dollar amount of change in interest income and expense and the dollar amounts attributable to: (a) changes in volume (changes in volume at the current year rate), and b) changes in rate (changes in rate times the prior year’s volume). In this table, the dollar change in rate/volume is prorated to volume and rate proportionately.

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Table 3	FNB BANCORP AND SUBSIDIARY
	RATE/VOLUME VARIANCE ANALYSIS
	Three Months Ended September 30,
(Dollar amounts in thousands)	2011 Compared to 2010
				Variance
	Interest			Attributable to
	Income/Expense			Rate			Volume
INTEREST EARNING ASSETS
Loans	$	(485	)	$	(233	)	$	(252	)
Taxable securities		31			(18	)		49
Nontaxable securities (1)		111			(17	)		128
Total	$	(343	)	$	(268	)	$	(75	)
INTEREST BEARING LIABILITIES
Demand deposits	$	10		$	9		$	1
Money market		176			176			0
Savings deposits		0			2			(2	)
Time deposits		126			78			48
Federal Home Loan Bank advances		184			—			184
Total	$	496		$	265		$	231
NET INTEREST INCOME	$	153		$	(3	)	$	156

(1) Includes tax equivalent adjustment of $141,000 and $109,000 in the three months ended September 30, 2011 and September 30, 2010, respectively.

Table 4	FNB BANCORP AND SUBSIDIARY
	RATE/VOLUME VARIANCE ANALYSIS
	Nine Months Ended September 30,
(Dollar amounts in thousands)	2011 Compared to 2010
				Variance
	Interest			Attributable to
	Income/Expense			Rate			Volume
INTEREST EARNING ASSETS
Loans	$	(1,576	)	$	(629	)	$	(947	)
Taxable securities		(44	)		(135	)		91
Nontaxable securities (1)		428			(31	)		459
Total	$	(1,192	)	$	(795	)	$	(397	)
INTEREST BEARING LIABILITIES
Demand deposits	$	36		$	37		$	(1	)
Money market		774			723			51
Savings deposits		(3	)		3			(6	)
Time deposits		427			320			107
Federal Home Loan Bank advances		551			—			551
Total	$	1,785		$	1,083		$	702
NET INTEREST INCOME	$	593		$	288		$	305

(1) Includes tax equivalent adjustment of $394,000 and $284,000 in the nine months ended September 30, 2011 and September 30, 2010, respectively.

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Noninterest income

The following table shows the principal components of noninterest income for the periods indicated.

Table 5	NONINTEREST INCOME
	Three months
	ended September 30,				Variance
(Dollar amounts in thousands)	2011		2010		Amount			Percent
Service charges	$	817	$	686	$	131			19.1	%
Credit card fees		197		159		38			23.9	%
Gain on sale of available-for-sale of securities		168		330		(162	)		-49.1	%
Bank owned life insurance policy earnings		83		87		(4	)		-4.6	%
Other income		102		73		29			39.7	%
Total noninterest income	$	1,367	$	1,335	$	32			2.4	%

	Nine months
	ended September 30,				Variance
(Dollars in thousands)	2011		2010		Amount			Percent
Service charges	$	2,325	$	2,045	$	280			13.7	%
Credit card fees		525		473		52			11.0	%
Gain on sale of available-for-sale securities		318		492		(174	)		-35.4	%
Bank owned life insurance policy earnings		248		246		2			0.8	%
Other income		353		181		172			95.0	%
Total noninterest income	$	3,769	$	3,437	$	332			9.7	%

Noninterest income consists mainly of service charges on deposits, credit card fees and several other types of miscellaneous income. The increase in service charges is related primarily to an increase in the amount of nonsufficient funds and returned item service charges that were instituted during the first quarter of 2011.

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Noninterest expense

The following table shows the principal components of noninterest expense for the periods indicated.

Table 6	NONINTEREST EXPENSE
	Three months
	ended September 30,				Variance
(Dollar amounts in thousands)	2011		2010		Amount			Percent
Salaries and employee benefits	$	3,413	$	3,418	$	(5	)		-0.1	%
Occupancy expense		593		515		78			15.1	%
Equipment expense		433		472		(39	)		-8.3	%
Professional fees		449		372		77			20.7	%
FDIC assessment		240		363		(123	)		-33.9	%
Telephone, postage & supplies		253		271		(18	)		-6.6	%
Operating losses		310		19		291			1531.6	%
Other real estate owned expense		55		207		(152	)		-73.4	%
Bankcard expenses		181		147		34			23.1	%
Low income housing expenses		69		69		0			0.0	%
Loss on sale of other real estate owned		—		30		(30	)		-100.0	%
Loss on impairment of other real estate owned		69		85		(16	)		-18.8	%
Other expense		718		730		(12	)		-1.6	%
Total noninterest expense	$	6,783	$	6,698	$	85			1.3	%

	NONINTEREST EXPENSE
	Nine months
	ended September 30,					Variance
(Dollars in thousands)	2011			2010		Amount			Percent
Salaries and employee benefits	$	10,322		$	10,399	$	(77	)		-0.7	%
Occupancy expense		1,734			1,532		202			13.2	%
Equipment expense		1,258			1,495		(237	)		-15.9	%
Professional fees		1,206			951		255			26.8	%
FDIC assessment		915			986		(71	)		-7.2	%
Telephone, postage & supplies		864			816		48			5.9	%
Operating losses		547			52		495			951.9	%
Other real estate owned expense		316			819		(503	)		-61.4	%
Bankcard expenses		482			436		46			10.6	%
Low income housing expenses		208			208		0			0.0	%
Loss (gain) on sale of other real estate owned		(66	)		5		(71	)		-1420.0	%
Loss on impairment of other real estate owned		299			732		(433	)		-59.2	%
Other expense		2,218			2,018		200			9.9	%
Total noninterest expense	$	20,303		$	20,449	$	(146	)		-0.7	%

Noninterest expense consists mainly of salaries and employee benefits. For the three months ended September 30, 2011 compared to three months ended September 30, 2010, it represented 50.3% and 51.0% of total noninterest expenses. For the nine months ended September 30, 2011 and 2010, it was 50.8% and 50.9% respectively of total noninterest expenses. During the first quarter of 2011, the Bank experienced an operational loss of approximately $200,000 related to an unauthorized foreign wire transfer. The operational loss was increased by another $300,000 during the third quarter of 2011 when our insurance company denied coverage of our insurance reimbursement claim that had been filed. The Company disagrees with our insurance carrier’s decision to not cover the claim and intends to file suit against the insurance carrier asking the courts to force the insurance company to pay our claim. Any recoveries that may be recovered as a result of our legal remedy efforts would be recorded as other income if and when any recovery actually occurs. The reduction in other real estate owned (“OREO”) expenses was driven primarily by lower OREO holdings year over year.

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Provision for Loan Losses.

There was a provision of $450,000 and $464,000 for the three months ended September 30, 2011 and 2010, respectively. There was a provision for loan losses of $1,300,000 and $1,029,000 for the nine months ended September 30, 2011 and 2010, respectively. The allowance for loan losses was $9,646,000 or 2.07% of total gross loans at September 30, 2011, compared to $9,524,000 or 1.97% of total gross loans at December 31, 2010. The allowance for loan losses is maintained at a level considered adequate for management to provide for probable loan losses inherent in the loan portfolio. Loans charged off during the nine months ended September 30, 2011 were significantly lower than during the same period during 2010, reflecting the improvement in the level of problem loans within our loan portfolio on a year over year basis.

Income Taxes

The effective tax rate for the quarter ended September 30, 2011 was a 22.4% tax expense compared to a 29.4% tax expense for the quarter ended September 30, 2010. The effective tax rate for the nine months ended September 30, 2011 and September 30, 2010, respectively was a tax expense of 26.5% compared to a tax expense of 23.6%. Tax preference items which affect our effective tax rate include changing amounts invested in tax-advantaged securities, available Low Income Housing Credits, and amounts of interest income on qualifying loans in Enterprise Zones. Another significant cause of change in the effective tax rate provision is the change in the relative proportion of tax advantaged income in comparison to fully taxable income period over period. Also, during the third quarter of 2011, the Bank wrote off a $300,000 insurance receivable which effectively lowered our taxable income for the third quarter, 2011.

Asset and Liability Management

Ongoing management of the Company’s interest rate sensitivity limits interest rate risk through monitoring the mix and maturity of loans, investments and deposits. Management regularly reviews the Company’s position and evaluates alternative sources and uses of funds as well as changes in external factors. Various methods are used to achieve and maintain the desired rate sensitivity position including the sale or purchase of assets and product pricing.

In order to ensure that sufficient funds are available for loan growth and deposit withdrawals, as well as to provide for general needs, the Company must maintain an adequate level of liquidity. Asset liquidity comes from the Company’s ability to convert short-term investments into cash and from the maturity and repayment of loans and investment securities. Liability liquidity comes from Company’s customer base, which provides core deposit growth. The overall liquidity position of the Company is closely monitored and evaluated regularly. Management believes the Company’s liquidity sources at September 30, 2011 are adequate to meet its operating needs in 2011 and our liquidity positions are sufficient to meet our liquidity needs in the near term.

Financial Condition

Assets. Total assets increased to $723,020,000 at September 30, 2011 from $714,639,000 at December 31, 2010, an increase of $8,381,000. The principal source of this increase was $26,187,000in securities available-for-sale, partially offset by a decrease of $18,722,000 in net loans. Funding for the securities purchases was obtained from increased deposit inflows and repayment of loans. Asset growth has primarily been funded through deposit growth.

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Loans. Gross loans before deferred loan fees and cost at September 30, 2011 were $465,933,000, a decrease of $18,739,000 or 3.87% from December 31, 2010. Commercial real estate loans decreased $10,411,000, construction loans increased $4,214,000, real estate multi family decreased $5,319,000, real estate one to four family increased $9,998,000, commercial loans decreased $16,881,000 and consumer loans decreased by $340,000. The portfolio breakdown was as follows:

TABLE 7	LOAN PORTFOLIO
	September 30					December 31
(Dollar amounts in thousands)	2011			Percent		2010			Percent
Commercial real estate	$	268,455		58	%	$	278,866		56	%
Real estate construction		31,791		7	%		27,577		6	%
Real estate multi-family		37,265		8	%		42,584		9	%
Real estate 1 to 4 family		81,461		17	%		71,463		15	%
Commercial & industrial		44,612		10	%		61,493		13	%
Consumer loans		2,349		1	%		2,689		1	%
Gross loans		465,933		100	%		484,672		100	%
Net deferred loan fees		(181	)				(320	)
Total	$	465,752				$	484,352

Decreases in our loan balances are the result of our loan customer base de-leveraging their personal and business balance sheets and paying down debt.

Allowance for loan losses. Management of the Company is responsible for assessing the overall risks within the Bank’s loan portfolio, assessing the specific loss expectancy, and determining the adequacy of the allowance for loan losses. The level of the allowance is determined by internally generating credit quality ratings, historical loss experience, a review of economic conditions in the Company’s market area, and a variety of general economic factors that could affect the amount of expected losses within the Bank’s portfolio. The Company’s management considers changes in national and local economic conditions, as well as the condition of various market segments. It also reviews any changes in the nature and volume of the portfolio. Management watches for the existence and effect of any concentrations of credit, and changes in the level of such concentrations. It also reviews the effect of external factors, such as competition and legal and regulatory requirements. Finally, the Company is committed to maintaining an adequate allowance, identifying credit weaknesses by consistent review of loans, and maintaining the ratings and changing those ratings in a timely manner as circumstances change.

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

TABLE 8	ALLOWANCE FOR LOAN LOSSES
	Nine months ended
	September 30,
(Dollar amounts in thousands)	2011			2010
Balance, beginning of period	$	9,524		$	9,829
Provision for loan losses		1,300			1,029
Recoveries		46			54
Amounts charged off		(1,224	)		(1,662	)
Balance, end of period	$	9,646		$	9,250

During the nine months ended September 30, 2011, there was a provision for loan losses of $1,300,000 compared to $1,029,000 for the same period in 2010. The increase in the provision was considered necessary given the existing risk levels within the Bank’s loan portfolio. Loan charge-off levels have declined year over year, yet remain relatively high when viewed from an historical perspective.

In management’s judgment, the allowance was adequate to absorb losses currently inherent in the loan portfolio at September 30, 2011. However, changes in prevailing economic conditions in the Company’s markets or in the financial condition of its customers could result in changes in the level of nonperforming assets and charge-offs in the future and, accordingly, changes in the allowance.

The allowance is affected by a number of factors, and does not necessarily move in tandem with the level of gross loans outstanding. Management continues to monitor the factors that affect the allowance, and is prepared to make adjustments as they become necessary.

Nonperforming assets. Nonperforming assets consist of nonaccrual loans, loans that are 90 days or more past due but are still accruing interest and other real estate owned. At September 30, 2011, there was $19,168,000 in nonperforming assets, compared to $23,392,000 at December 31, 2010. Nonaccrual loans were $16,180,000 at September 30, 2011, compared to $16,712,000 at December 31, 2010. There were no loans past due 90 days and still accruing at either date.

There was $2,988,000 in Other Real Estate Owned at September 30, 2011 which consisted of three separate properties and $6,680,000 at December 31, 2010. During the first nine months of 2011, the Bank sold three properties and obtained one new commercial property through foreclosure. Management intends to aggressively market these properties. While management believes these properties will sell in the short term, there can be no assurance that these properties will sell quickly given the current real estate market, nor can the expected sales price be accurately predicted.

Deposits. Total deposits at September 30, 2011 were $631,654,000 compared to $628,440,000 on December 31, 2010. Of these totals, noninterest-bearing demand deposits were $141,196,000 or 22.4% of the total on September 30, 2011 and $137,237,000 or 21.8% on December 31, 2010. Time deposits were $105,510,000 on September 30, 2011 and $125,400,000 on December 31, 2010. Deposits are gathered primarily from our customers in San Francisco and San Mateo counties.

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The following table sets forth the maturity schedule of the time certificates of deposit on September 30, 2011:

TABLE 9
(Dollar amounts in thousands)	Under		$100,000
Maturities	$100,000		or more		Total
Three months or less	$	11,202	$	30,249	$	41,451
Over three through six months		8,004		11,177		19,181
Over six through twelve months		10,950		10,904		21,854
Over twelve months		10,490		12,534		23,024
Total	$	40,646	$	64,864	$	105,510

Regulatory Capital. The following table shows the regulatory capital ratios and leverage ratios at September 30, 2011 and December 31, 2010 for the Bank. The ratios for the Bank and the Company are essentially equivalent.

TABLE 10						Minimum “Well
	September 30,		December 31,			Capitalized”
Regulatory Capital Ratios	2011		2010			Requirements
Total Regulatory Capital Ratio	15.93	%	14.85	%	≥	10.00	%
Tier 1 Capital	14.68	%	13.60	%	≥	6.00	%
Leverage Ratios	11.02	%	10.46	%	≥	5.00	%

Liquidity. Liquidity is a measure of the Company’s ability to convert assets into cash with minimal loss. As of September 30, 2011, liquid assets were $221,649,000, or 30.7% of total assets. As of December 31, 2010, liquid assets were $187,063,000, or 26.2% of total assets. Liquidity consists of cash and due from banks, federal funds sold, and securities available-for-sale. The Company’s primary uses of funds are loans, and the primary sources of funds are deposits. The Company also has federal funds borrowing facilities totaling $45,000,000, a Federal Home Loan Bank line up to 30% of total assets, and a Federal Reserve Bank borrowing facility.

The relationship between total net loans and total deposits is a useful additional measure of liquidity. A higher loan to deposit ratio may lead to a loss of liquid assets in the future. This must be balanced against the fact that loans represent the highest interest earning assets. A lower loan to deposit ratio means lower potential income. On September 30, 2011, net loans were at 72% of deposits. On December 31, 2010, net loans were at 76% of deposits.

Off-Balance Sheet Items

The Company has certain ongoing commitments under operating leases. These commitments do not significantly impact operating results. As of September 30, 2011 and December 31, 2010, commitments to extend credit and letters of credit were the only financial instruments with off-balance sheet risk. The Company has not entered into any contracts for financial derivative instruments such as futures, swaps, options or similar instruments. Loan commitments and letters of credit were $96,182,000 and $96,083,000 at September 30, 2011 and December 31, 2010, respectively. As a percentage of net loans, these off-balance sheet items represent 21.1% and 20.2% respectively. There is no assurance that the full amount of the commitments will be drawn upon.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Market risk is the risk of loss to future earnings, to fair values of assets or to future cash flows that may result from changes in the price or value of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates and other market conditions. Market risk is attributed to all market risk sensitive financial instruments, including loans, investment securities, deposits and borrowings. The Company does not engage in trading activities or participate in foreign currency transactions for its own account. Accordingly, exposure to market risk is primarily a function of asset and liability management activities and of changes in market rates of interest. Changes in rates can cause or require increases in the rates paid on deposits that may take effect more rapidly or may be greater than the increases in the interest rates that the Company is able to charge on loans and the yields that it can realize on its investments. The extent of that market risk depends on a number of variables including the sensitivity to changes in market interest rates and the maturities of the Company’s interest earning assets and deposits.

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Item 4T. Controls and Procedures.

(a)           Disclosure Controls and Procedures: An evaluation of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and other members of the Company’s senior management as of the end of the Company’s fiscal quarter ended September 30, 2011. The Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) to allow timely decisions regarding required disclosure, and (ii) recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms.

(b)           Internal Control Over Financial Reporting: An evaluation of any changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)), that occurred during the Company’s fiscal quarter ended September 30, 2011, was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and other members of the Company’s senior management. The Company’s Chief Executive Officer and Chief Financial Officer concluded that no change identified in connection with such evaluation has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

There are no material legal proceedings adverse to the Company or First National Bank to which any director, officer, affiliate of the Company, or 5% shareholder of the Company, or any associate of any such director, officer, affiliate or 5% shareholder of the Company are a party, and none of the foregoing persons has a material interest adverse to the Company or First National Bank.

From time to time, the Company and/or First National Bank are a party to claims and legal proceedings arising in the ordinary course of business. The Company’s management is not aware of any material pending legal proceedings to which either it or First National Bank may be a party or has recently been a party, which will have a material adverse effect on the financial condition or results of operations of the Company and First National Bank, taken as a whole.

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Item 1A. Risk Factors

During the course of normal operations, the Bank and the Company manage a variety of risks including, but not limited to, credit risk, operational risk, interest rate risk and regulatory compliance risk. For a more complete discussion of the risk factors facing the Bank and the Company, please refer to the section entitled “Item 1A – Risk Factors” in the Company’s December 31, 2010 Form 10K.

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) was signed into law. The purpose of this legislation was to bring about regulatory changes and oversight that would help stop past abuses from recurring in the future. This legislation gives new powers to the FDIC and the Federal Reserve Bank that they may use in the execution of their duties as regulators and overseers of the banking industry. It also created a new federal consumer protection agency named the Consumer Financial Protection Bureau (“CFPB”). All existing consumer laws and regulations will be transferred to the CFPB. This Act is expected to enable regulators to issue numerous new banking regulations and requirements that have not yet been fully developed or promulgated. The ultimate effect the Act has on the Company’s operations will ultimately be determined by the significance of the new banking regulations that are issued as a result of the Act.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

   c) ISSUER PURCHASES OF EQUITY SECURITIES

On August 24, 2007, the Board of Directors of the Company authorized a stock repurchase program which calls for the repurchase of up to five percent (5%) of the Company’s then outstanding 2,863,635 shares of Common Stock, or 143,182 shares. There were no repurchases during the quarter ended September 30, 2011. There were 10,457 shares remaining that may be purchased under this Plan as of September 30, 2011.

On September 15, 2011, as part of the Small Business Lending Fund (“SBLF”) program established under the Small Business Jobs Act of 2010, the Company entered into and consummated a SBLF Securities Purchase Agreement with the Secretary of the Treasury, pursuant to which the Company issued and sold to Treasury a total of 12,600 shares of the Company’s Senior Non-Cumulative Perpetual Preferred Stock, Series C (the “Series C Preferred Stock”). The issuance and sale of the Series C Preferred Stock was exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”), pursuant to Section 4(2) of the Securities Act. For additional information, reference should be made to the Company’s Current Report on Form 8-K as filed with the Commission on September 19, 2011.

Item 6. Exhibits

Exhibits

      31: Rule 13a-14(a)/15d-14(a) Certifications

      32:Section 1350 Certifications

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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 hereunto duly authorized.

	FNB BANCORP
	(Registrant)
Dated: November 10, 2011
	By:	/s/ Thomas C. McGraw
		Thomas C. McGraw
		Chief Executive Officer
		(Authorized Officer)
	By:	/s/ David A. Curtis
		David A. Curtis
		Senior Vice President
		Chief Financial Officer
		(Principal Financial Officer)

47