FNB Bancorp 10Q 2013 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, 2013

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. Yesx Noo

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). Yesx Noo

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 filero		Accelerated filero

Non-accelerated filerx		Smaller reporting companyo

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

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 7, 2013: 3,763,964 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 (Loss)	5

	Consolidated Statement of Cash Flows	6

	Notes to Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	46

Item 4T.	Controls and Procedures	46

PART II OTHER INFORMATION		46

Item 1.	Legal Proceedings	46

Item 1A.	Risk Factors	47

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47

Item 4.	Mine Safety Disclosures	47

Item 6.	Exhibits	47

SIGNATURES		48

PART I—FINANCIAL INFORMATION

Item 1. Financial Statement

FNB BANCORP AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

ASSETS

	September 30,			December 31,
(Dollar amounts in thousands)	2013			2012

Cash and due from banks	$	18,368		$	27,861
Interest-bearing time deposits with financial institutions		6,979			13,216
Securities available-for-sale, at fair value		285,610			234,945
Loans, net of allowance for loan losses of $9,748 and $9,124 on September 30, 2013 and December 31, 2012		558,164			541,563
Bank premises, equipment, and leasehold improvements, net		11,493			12,706
Premises, equipment, leasehold for sale		1,138			—
Bank owned life insurance, net		12,065			11,785
Other equity securities		5,300			5,464
Accrued interest receivable		3,855			3,760
Other real estate owned, net		6,675			6,650
Goodwill		1,841			1,841
Prepaid expenses		741			1,372
Other assets		14,822			14,177
Total assets	$	927,051		$	875,340

LIABILITIES AND STOCKHOLDERS’ EQUITY

Deposits
Demand, noninterest bearing		191,665			178,384
Demand, interest bearing		71,815			75,465
Savings and money market		387,275			343,437
Time		130,369			171,066
Total deposits		781,124			768,352

Federal Home Loan Bank advances		44,000			1,220
Accrued expenses and other liabilities		9,109			10,410
Total liabilities		834,233			779,982

Stockholders’ equity
Preferred stock - series C - no par value, authorized and outstanding 9,450 and 12,600 at September 30, 2013 and December 31, 2012, respectively (liquidation preference of $1,000 per share plus accrued dividends)		9,450			12,600
Common stock, no par value, authorized 10,000,000 shares; issued and outstanding 3,763,271 shares at September 30, 2013 and 3,698,612 shares at December 31, 2012		53,822			52,610
Retained earnings		30,218			26,280
Accumulated other comprehensive (loss) income		(672	)		3,868
Total stockholders’ equity		92,818			95,358
Total liabilities and stockholders’ equity	$	927,051		$	875,340

See accompanying notes to consolidated financial statements.

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,
	2013			2012		2013		2012
Interest income:
Interest and fees on loans	$	7,808		$	7,208	$	23,986	$	20,721
Interest on taxable securities		911			644		2,389		1,874
Interest on tax-exempt securities		505			503		1,514		1,520
Interest time deposits-other financial institutions		35			6		125		6
Total interest income		9,259			8,361		28,014		24,121
Interest expense:
Interest Federal Home Loan Bank advances		5			4		5		4
Deposits		555			659		1,876		1,996
Total interest expense		560			663		1,881		2,000
Net interest income		8,699			7,698		26,133		22,121
Provision for loan losses		225			400		1,335		1,200
Net interest income after provision for loan losses		8,474			7,298		24,798		20,921
Noninterest income:
Service charges		658			722		1,993		2,218
Credit card fees		6			114		16		422
Net gain on sale of available-for-sale securities		37			89		152		898
Bank-owned life insurance earnings		90			97		279		675
Bargain purchase gain		—			3,666		—		3,666
Other income		187			76		606		220
Total noninterest income		978			4,764		3,046		8,099
Noninterest expense:
Salaries and employee benefits		4,099			3,732		12,827		11,151
Occupancy expense		812			606		2,620		1,804
Equipment expense		387			423		1,171		1,301
Professional fees		405			325		1,212		1,296
FDIC assessment		180			160		540		496
Acquisition related expense		—			250		—		425
Telephone, postage and supplies		271			295		985		844
Operating losses		29			14		54		66
Advertising		70			81		363		256
Bankcard expenses		—			114		1		427
Data processing expense		163			110		489		386
Low income housing expense		110			69		329		208
Surety insurance		77			96		198		220
Directors expense		63			63		189		189
Gain on sale of other real estate owned		—			—		—		(4	)
Other real estate owned expense		22			5		100		56
Other expense		262			288		996		1,061
Total noninterest expense		6,950			6,631		22,074		20,182
Earnings before provision for income tax expense		2,502			5,431		5,770		8,838
(Benefit) provision for income tax expense		(629	)		490		330		1,381
Net earnings		3,131			4,941		5,440		7,457
Dividends and discount accretion on preferred stock		251			158		581		501
Net earnings available to common stockholders	$	2,880		$	4,783	$	4,859	$	6,956

Earnings per share data:
Basic	$	0.77		$	1.30	$	1.30	$	1.89
Diluted	$	0.75		$	1.27	$	1.27	$	1.86

Weighted average shares outstanding:
Basic		3,761			3,692		3,735		3,689
Diluted		3,852			3,759		3,824		3,745

See accompanying notes to consolidated financial statements.

FNB BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS (LOSS)

(UNAUDITED)


(Dollar amounts in thousands)	Three months ended						Nine months ended
	September 30,						September 30,
	2013			2012			2013			2012
Net earnings	$	3,131		$	4,941		$	5,440		$	7,457
Unrealized holding gain on available-for-sale securities net of tax of $19, ($582), $3,093 and ($664)		(27	)		837			(4,450	)		956
Reclassification adjustment for gain on available-for-salesecurities sold, net of tax of $15 and $62for three and nine months ended September 30, 2013, and $36 and $368 for three and nine months ended September 30, 2012, respectively		(22	)		(53	)		(90	)		(530	)
Total comprehensive earnings	$	3,082		$	5,725		$	900		$	7,883

See accompanying notes to consolidated financial statements.

FNB BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

(Dollar amounts in thousands)	Nine months ended
	September 30
	2013			2012
Cash flow from operating activities:
Net earnings	$	5,440		$	7,457
Adjustments to reconcile net earnings to net cash provided by operating activities:
Net gain on sale of securities available-for-sale		(152	)		(898	)
Depreciation, amortization and accretion		2,803			2,585
Gain on sale of other real estate owned		—			(4	)
Stock-based compensation expense		192			166
Earnings on bank owned life insurance		(279	)		(46	)
Provision for loan losses		1,335			1,200
Bargain purchase gain		—			(3,666	)
(Increase) decrease in accrued interest receivable		(95	)		372
Decrease in prepaid expense		631			594
Increase in other assets		(319	)		(977	)
Increase in accrued expenses and other liabilities		1,478			242
Net cash provided by operating activities		11,034			7,025

Cash flows from investing activities
Cash paid for acquisition, net of cash acquired		—			(18,374	)
Purchase of securities available-for-sale		(93,256	)		(64,866	)
Proceeds from matured/called/sold securities available-for-sale		33,180			38,136
Net investment, (redemption), in other equity securities		164			(1,280	)
Maturities of time deposits of other banks		6,237			17,096
Proceeds from sale of other real estate owned		—			832
Net investment in other real estate owned		(25	)		(13	)
Net (increase) in loans		(17,936	)		(1,835	)
Increase in bank-owned life insurance		—			(2,124	)
Purchases of bank premises, equipment, leasehold improvements		(873	)		(582	)
Proceeds from sale of equipment		13			—
Net cash used in investing activities		(72,496	)		(33,010	)

CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

	Nine months ended
	September 30
	2013			2012
Cash flows from financing activities
Net increase in demand and savings deposits		53,469			68,687
Net decrease in time deposits		(40,697	)		(6,170	)
Increase (decrease) in FHLB advances		42,780			(3,369	)
Dividends paid on common stock		(677	)		(421	)
Exercise of stock options		693			88
Redemption of preferred stock series C		(3,150	)		—
Dividends paid on preferred stock series C		(449	)		(501	)
Net cash provided by financing activities		51,969			58,314
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(9,493	)		32,329
Cash and cash equivalents at beginning of period		27,861			38,474
Cash and cash equivalents at end of period	$	18,368		$	70,803

Additional cash flow information:
Interest paid		1,977			1,868
Income taxes paid		575			1,685
Tax benefit on exercise of stock options		164			22

Non-cash investing and financing activities:
Accrued dividends		376			246
Change in unrealized gain in available for-sale securities, net of tax		(4,540	)		956

See accompanying notes to consolidated financial statements.

FNB BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2013

(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 position and results of operations for the interim periods presented.

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, 2012. 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 life, 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 quarter ended September 30, 2013 was $70,000, and $44,000 for the quarter ended September 30, 2012. There was an income tax benefit of $43,000 recognized in the statements of earnings for the quarter ended September 30, 2013, and none for the quarter ended September 30, 2012. There was an income tax benefit of $164,000 for the nine months ended September 30, 2013, and $22,000 for the nine months ended September 30, 2012, respectively. The amount of compensation expense for options recorded in the nine months ended September 30, 2013 and September 30, 2012 was $192,000 and $166,000, respectively.

The intrinsic value for options exercised during the three months ended September 30, 2013 was $6,000.The intrinsic value for options exercised during the nine months ended September 30, 2013 was $577,000.The intrinsic value for options exercisable during the nine months ended September 30, 2013 was $1,692,000. The intrinsic value for options exercised for the nine months ended September 30, 2012 was $84,000. The fair value assumptions was determined using the Black-Scholes model. The exercise price was $19.30, the expected term was derived from the output of the model, and is 8.75 years, which is the expected period of time that options granted are expected to be outstanding. The risk-free rate is based on the U.S. Treasury yield curve at the time of the grant, or 3.20% for options granted in 2013. Volatility was calculated using historical price changes on a monthly basis over the expected life of the option. The options granted estimated value was $10.44. There were 60,785 options granted for the first nine months ended September 30, 2013 and no options granted for the nine months ended September 30, 2012.

The amount of total unrecognized compensation expense related to non-vested options at September 30, 2013 was $697,000, and the weighted average period over which it will be amortized is 3.6 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,
	2013		2012		2013		2012
Net earnings	$	3,131	$	4,941	$	5,440	$	7,457
Dividends and discount accretion on preferred stock		251		158		581		501
Net earnings available to common shareholders	$	2,880	$	4,783	$	4,859	$	6,956

Average number of shares outstanding		3,761		3,692		3,735		3,689
Effect of dilutive options		91		67		88		56
Average number of shares outstanding used to calculate diluted earnings per share		3,852		3,759		3,824		3,745

Anti-dilutive options not included		132		245		198		282

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, 2013
U. S. Treasury securities	$	6,112	$	58	$	(36	)	$	6,134
Obligations of U.S. Government agencies		87,843		599		(753	)		87,689
Mortgage backed securities		82,870		549		(2,187	)		81,232
Obligations of states and political subdivisions		82,932		1,631		(1,262	)		83,301
Corporate debt		26,993		395		(134	)		27,254
	$	286,750	$	3,232	$	(4,372	)	$	285,610

(Dollar amounts in thousands)	Amortized		Unrealized		Unrealized			Carrying
	cost		gains		losses			value
December 31, 2012:
U.S. Treasury securities	$	7,145	$	135	$	—		$	7,280
Obligations of U.S. government agencies		71,061		1,206		(7	)		72,260
Mortgage-backed securities		53,934		1,383		(137	)		55,180
Obligations of states and political subdivisions		78,147		3,515		(53	)		81,609
Corporate debt		18,103		535		(22	)		18,616
	$	228,390	$	6,774	$	(219	)	$	234,945

An analysis of gross unrealized losses within the available-for-sale investment securities portfolio as of September 30, 2013 and December 31, 2012 follows.

(Dollar amounts in thousands)			Less than					12 Months
	Total		12 Months			Total		or Longer			Total		Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
September 30,2013
U.S. Treasury securities	$	2,023	$	(36	)	$	—	$	—		$	2,023	$	(36	)
Obligations of U.S. Government agencies		38,092		(753	)		—		—			38,092		(753	)
Mortgage-backed securities		54,278		(2,187	)		—		—			54,278		(2,187	)
Obligations of states and political subdivisions		31,049		(1,198	)		1,095		(64	)		32,144		(1,262	)
Corporate debt		11,063		(132	)		498		(2	)		11,561		(134	)
Total	$	136,505	$	(4,306	)	$	1,593	$	(66	)	$	138,098	$	(4,372	)

			Less than					12 Months
(Dollar amounts in thousands)	Total		12 Months			Total		or Longer			Total		Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
December 31, 2012:
Obligations of U.S. government agencies	$	4,093	$	(7	)	$	—	$	—		$	4,093	$	(7	)
Mortgage-backed securities		8,580		(137	)		—		—			8,580		(137	)
Obligations of states and political subdivisions		8,492		(53	)		—		—			8,492		(53	)
Corporate debt		—		—			478		(22	)		478		(22	)
Total	$	21,165	$	(197	)	$	478	$	(22	)	$	21,643	$	(219	)

At September 30, 2013, there were two securities in an unrealized loss position for greater than twelve consecutive months. Management periodically evaluates each security in an unrealized loss position to determine if the impairment is temporary or other-than-temporary. 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. Management has determined that no investment security is other-than-temporarily impaired at September 30, 2013 and December 31, 2012.

The amortized cost and carrying value of debt securities as of September 30, 2013, 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.

September 2013
(Dollar amounts in thousands)	Amortized		Carrying
	Cost		Value
Available-for-sale:
Due in one year or less	$	12,448	$	12,588
Due after one through five years		107,316		108,152
Due after five years through ten years		125,704		124,091
Due after ten years		41,282		40,779
	$	286,750	$	285,610

For the nine months ended September 30, 2013, gross realized gains amounted to $152,000 on the sale of $12,428,000 in securities. For the nine months ended September 30, 2012, gross realized gains amounted to $906,000 on the sale of $25,743,000 in securities. For the nine months ended September 30, 2013, there were no gross realized losses, but for the same period in 2012, gross realized losses were $8,000 on the sale of $1,968,000 in investment securities.

At September 30, 2013, securities with an amortized cost of $68,277,000 and fair value of $68,985,000 were pledged as collateral for public deposits and for other purposes required by law.

NOTE E - LOANS

Loans are summarized as follows at September 30, 2013 and December 31,2012:

(Dollar amounts in thousands)									Total
	FNB								Balance
	Bancorp								September 30,
September 30, 2013:	Originated			PNCI			PCI		2013
Commercial real estate	$	290,818		$	41,680		$	1,347	$	333,845
Real estate construction		22,966			3,033			588		26,587
Real estate multi-family		39,474			11,620			—		51,094
Real estate 1 to 4 family		97,528			10,703			—		108,231
Commercial & industrial		36,960			10,116			—		47,076
Consumer loans		1,691			—			—		1,691
Gross loans		489,437			77,152			1,935		568,524
Net deferred loan fees		(612	)		—			—		(612	)
Allowance for loan losses		(9,722	)		(26	)		—		(9,748	)
Net loans	$	479,103		$	77,126		$	1,935	$	558,164

PNCI

= purchased, non-credit impaired

PCI

= purchased, credit impaired

(Dollar amounts in thousands)								Total
	FNB							Balance
	Bancorp							December 31
December 31, 2012:	Originated			PNCI		PCI		2012
Commercial real estate	$	254,449		$	48,009	$	1,402	$	303,860
Real estate construction		14,866			3,594		486		18,946
Real estate multi-family		39,176			18,828		—		58,004
Real estate 1 to 4 family		97,329			15,390		—		112,719
Commercial & industrial		42,847			12,717		—		55,564
Consumer loans		1,824			—		—		1,824
Gross loans		450,491			98,538		1,888		550,917
Net deferred loan fees		(230	)		—		—		(230	)
Allowance for loan losses		(9,124	)		—		—		(9,124	)
Net loans	$	441,137		$	98,538	$	1,888	$	541,563

PNCI

= purchased, non-credit impaired

PCI

= purchased, credit impaired

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

Allowance for Credit Losses
For the Three Months Ended September 30, 2013

(Dollar amounts in thousands)									Real			Real
									Estate			Estate
	Commercial			Commercial			Real Estate		Multi			1 to
	& industrial			Real estate			Construction		family			4 family			Consumer			Total
Allowance for credit losses

Beginning balance	$	1,491		$	5,331		$	742	$	329		$	1,791		$	61		$	9,745
Charge-offs		(56	)		(23	)		—		—			(141	)		(5	)		(225	)
Recoveries		—			2			—		—			1			—			3
Provision		(28	)		211			9		(76	)		109			0			225
Ending balance	$	1,407		$	5,521		$	751	$	253		$	1,760		$	56		$	9,748

Ending balance: individually evaluated for impairment	$	209		$	193		$	13	$	—		$	225		$	1		$	641
Ending balance: collectively evaluated for impairment	$	1,198		$	5,328		$	738	$	253		$	1,535		$	55		$	9,107

Allowance for Credit Losses
For the Nine Months Ended September 30, 2013

(Dollar amounts in thousands)										Real		Real
										Estate		Estate
	Commercial			Commercial			Real Estate			Multi		1 to
	& industrial			Real estate			Construction			family		4 family			Consumer			Total
Allowance for credit losses

Beginning balance	$	1,876		$	4,811		$	857		$	—	$	1,516		$	64		$	9,124
Charge-offs		(56	)		(262	)		(81	)		—		(385	)		(6	)		(790	)
Recoveries		70			6			—			—		2			1			79
Provision		(483	)		966			(25	)		253		627			(3	)		1,335
Ending balance	$	1,407		$	5,521		$	751		$	253	$	1,760		$	56		$	9,748

Ending balance: individually evaluated for impairment	$	209		$	193		$	13		$	—	$	225		$	1		$	641
Ending balance: collectively evaluated for impairment	$	1,198		$	5,328		$	738		$	253	$	1,535		$	55		$	9,107

Recorded Investment in Loans at September 30, 2013

(Dollar amounts in thousands)							Real		Real
							Estate		Estate
	Commercial		Commercial		Real Estate		Multi		1 to
	& industrial		Real Estate		Construction		family		4 family		Consumer		Total

Loans:
Ending balance	$	47,076	$	333,845	$	26,587	$	51,094	$	108,231	$	1,691	$	568,524
Ending balance: individually evaluated for impairment	$	3,155	$	19,010	$	192	$	643	$	3,719	$	1	$	26,720
Ending balance: collectively evaluated for impairment	$	43,921	$	314,835	$	26,395	$	50,451	$	104,512	$	1,690	$	541,804

Note: ending balance individually evaluated for impairment of $26,720 includes the sum of Impaired Loans-Originated $21,545 and Impaired Loans-PNCI $5,175 in the detailed Recorded Investment columns on pages 16 and 17.

The collectively evaluated ending balance line includes PCI loans

Allowance for Credit Losses
For the Three Months Ended September 30, 2012

(Dollar amounts in thousands)									Real			Real
									Estate			Estate
	Commercial			Commercial		Real Estate			Multi			1 to
	& industrial			Real Estate		Construction			family			4 family			Consumer			Total
Allowance for credit losses
Beginning balance	$	1,734		$	3,752	$	834		$	49		$	2,026		$	63		$	8,458
Charge-offs		(219	)		—		—			—			(73	)		(1	)		(293	)
Recoveries		—			15		—			—			2			—			17
Provision		84			118		(257	)		(22	)		475			2			400
Ending balance	$	1,599		$	3,885	$	577		$	27		$	2,430		$	64		$	8,582
Ending balance: individually evaluated for impairment	$	330		$	470	$	74		$	22		$	292		$	—		$	1,188

Ending balance: collectively evaluated for impairment	$	1,269		$	3,415	$	503		$	5		$	2,138		$	64		$	7,394

Allowance for Credit Losses
For the Nine Months Ended September 30, 2012

(Dollar amounts in thousands)										Real			Real
										Estate			Estate
	Commercial			Commercial			Real Estate			Multi			1 to
	& industrial			Real Estate			Construction			family			4 family			Consumer			Total
Allowance for credit losses
Beginning balance	$	1,618		$	4,745		$	1,171		$	671		$	1,592		$	100		$	9,897
Charge-offs		(1,706	)		(738	)		(54	)		—			(182	)		(5	)		(2,685	)
Recoveries		1			154			—			—			11			4			170
Provision		1,686			(276	)		(540	)		(644	)		1,009			(35	)		1,200
Ending balance	$	1,599		$	3,885		$	577		$	27		$	2,430		$	64		$	8,582
Ending balance: individually evaluated for impairment	$	330		$	470		$	74		$	22		$	292		$	—		$	1,188

Ending balance: collectively evaluated for impairment	$	1,269		$	3,415		$	503		$	5		$	2,138		$	64		$	7,394

	Recorded Investment in Loans at September 30, 2012

(Dollar amounts in thousands)							Real		Real
							Estate		Estate
	Commercial		Commercial		Real Estate		Multi		1 to
	& industrial		Real Estate		Construction		family		4 family		Consumer		Total

Loans:
Ending balance	$	59,312	$	298,471	$	17,907	$	61,552	$	117,198	$	1,950	$	556,390
Ending balance: individually evaluated for impairment	$	4,309	$	9,885	$	7,210	$	3,242	$	6,366	$	—	$	31,012
Ending balance: collectively evaluated for impairment	$	55,003	$	288,586	$	10,697	$	58,310	$	110,832	$	1,950	$	525,378

	Impaired Loans-Originated
	As of and for the nine months ended September 30, 2013

			Unpaid				Average
(Dollar amounts in thousands)	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized

With no related allowance recorded
Commercial and industrial	$	1,514	$	1,687	$	—	$	1,640	$	76
Commercial real estate		8,523		8,785		—		5,178		315
Residential - 1 to 4 family		1,171		1,286		—		863		21
Total		11,208		11,758		—		7,681		412

With an allowance recorded
Commercial and industrial	$	1,641	$	2,082	$	209	$	1,677	$	12
Commercial real estate		6,147		6,147		180		5,693		197
Residential - 1 to 4 family		2,548		2,556		225		2,611		68
Consumer		1		1		1		1		—
Total		10,337		10,786		615		9,982		277

Total
Commercial and industrial	$	3,155	$	3,769	$	209	$	3,317	$	88
Commercial real estate		14,670		14,932		180		10,871		512
Residential - 1 to 4 family		3,719		3,842		225		3,474		89
Consumer		1		1		1		1		—
Grand total	$	21,545	$	22,544	$	615	$	17,663	$	689

	Impaired Loans -PNCI
	As of and for the nine months ended September 30, 2013

			Unpaid				Average
	Recorded		Principal		Related		Recorded		Income
(Dollar amounts in thousands)	Investment		Balance		Allowance		Investment		Recognized

With no related allowance recorded
Real estate-multi family	$	643	$	699	$	—	$	719	$	23
Commercial real estate		3,982		4,859		—		4,869		219
Total		4,625		5,558		—		5,588		242

With an allowance recorded
Commercial real estate	$	358	$	482	$	13	$	482	$	19
Commercial real estate construction		192		197		13		199		15
Total		550		679		26		681		34

Total
Commercial real estate construction	$	192	$	197	$	13	$	199	$	15
Real estate-multi family		643		699		—		719		23
Commercial real estate		4,340		5,341		13		5,351		238
Grand total	$	5,175	$	6,237	$	26	$	6,269	$	276

	Impaired Loans -Originated
	As of and for the year ended December 31, 2012

			Unpaid				Average
(Dollar amounts in thousands)	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized

With no related allowance recorded
Commercial and industrial	$	2,202	$	2,338	$	—	$	2,298	$	120
Commercial real estate construction		—		—		—		6,187		333
Commercial real estate		7,238		7,804		—		1,097		59
Residential - 1 to 4 family		1,052		1,147		—		1,065		55
Total		10,492		11,289		—		10,647		567

With an allowance recorded
Commercial and industrial	$	1,965	$	2,427	$	384	$	2,328	$	30
Commercial real estate		5,433		5,433		415		5,685		240
Residential - 1 to 4 family		3,719		3,722		306		3,283		150
Total		11,117		11,582		1,105		11,296		420

Total
Commercial and industrial	$	4,167	$	4,765	$	384	$	4,626	$	150
Commercial real estate construction		—		—		—		6,187		333
Commercial real estate		12,671		13,237		415		6,782		299
Residential - 1 to 4 family		4,771		4,869		306		4,348		205
Grand total	$	21,609	$	22,871	$	1,105	$	21,943	$	987

	Impaired Loans -PNCI
	As of and for the year ended December 31, 2012

			Unpaid				Average
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized

With no related allowance recorded
Commercial real estate	$	3,428	$	3,776	$	—	$	3,777	$	27
Total		3,428		3,776		—		3,777		27

With an allowance recorded
Commercial real estate construction	$	681	$	798	$	232	$	798	$	4
Total		681		798		232		798		4

Total
Commercial real estate construction	$	681	$	798	$	232	$	798	$	4
Commercial real estate		3,428		3,776		—		3,777		27
Grand total	$	4,109	$	4,574	$	232	$	4,575	$	31

Nonaccrual loans totaled $9,053,000 and $12,474,000 as of September 30, 2013 and December 31, 2012. The difference between impaired loans and nonaccrual loans represents loans that are restructured, are performing under modified agreements, and accruing interest.

	Loans on Nonaccrual Status as of
(Dollar amounts in thousands)	September 31,		December 31,
	2013		2012
Commercial and industrial	$	2,240	$	2,618
Real estate - construction		193		1,898
Commercial real estate		4,912		6,251
Real estate multi family		643		—
Real estate 1 to 4 family		1,065		1,707
Total	$	9,053	$	12,474

Interest income on impaired loans of $965,000 was recognized for cash payments received during the nine months ended September 30, 2013, and $987,000 was recognized for cash payments received during the year ended December 31, 2012. The amount of interest on impaired loans not collected for the nine months ended September 30, 2013 was $529,000, and for the year ended December 31, 2012 was $1,358,000. The cumulative amount of unpaid interest on impaired loans was $3,303,000for the nine months ended September 30, 2013, and $2,774,000 for the year ended December 31, 2012.

Total outstanding principal of troubled debt restructured loans as of September 30, 2013 was $5,574,000, of which $192,000 was real estate construction loans, $1,241,000 was residential loans, and $4,141,000 was commercial real estate loans. Total outstanding principal of troubled debt restructured loans at December 31, 2012 was $5,578,000, of which $2,723,000 was commercial loans, $1,446,000 was real estate one to four family, and $1,409,000 was commercial real estate loans.

Troubled Debt Restructurings

The Company reassessed all restructurings that occurred on or after the beginning of fiscal year 2011 for identification as troubled debt restructurings. The Company identified as troubled debt restructurings certain loans 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 loans as troubled debt restructurings, the Company also identified them as impaired under the guidance in ASC 310-10-35.

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.

As of September 30, 2013, there were no available commitments for additional funding of troubled debt restructurings.

	Modifications For the nine months ended September 30, 2013
	Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
(Dollar amounts in thousands)
Real Estate Construction		1	$	192	$	192
Real estate 1 to 4 family		3		1,241		1,241
Commercial real estate		5		4,141		4,141
Total		9	$	5,574	$	5,574

As of September 30, 2013, no loans defaulted within the previous twelve months following the date of restructure. All restructurings were a modification of interest rate and/or payment. There were no principal reductions granted.

	Modifications For the Year Ended 12/31/2012
	Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
(Dollar amounts in thousands)
Commercial and industrial		7	$	2,723	$	2,723
Real estate 1 to 4 family		3		1,446		1,446
Commercial real estate		3		1,409		1,409
Total		13	$	5,578	$	5,578

As of December 31, 2012, no loans defaulted within the previous twelve months following the date of restructure. All restructurings were a modification of interest rate and/or payment. There were no principal reductions granted.

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. These well-defined weaknesses may include 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.

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 – Multi-Family

Our multi-family commercial real estate loans are secured by multi-family properties located primarily in San Mateo and San Francisco Counties. These loans are made to investors where our primary source of repayment is from cash flows generated by the properties, through rent collections. The borrowers’ promissory notes are secured with recorded liens on the underlying properties. The borrowers would normally also be required to personally guarantee repayment of the loans. 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.

Commercial Real Estate Loans – Other

Commercial Real Estate loans consist of loans secured by non-farm, non-residential properties, including, but not limited to industrial, hotel, assisted care, retail, office and mixed use buildings. 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.

Real Estate Construction Loans

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.

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 single family residential units. The Bank uses conservative underwriting standards in reviewing applications for credit. Risk of loss to the Bank is increased when borrowers lose their primary source of income and/or property values decline significantly.

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.

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 lose their primary source of income, or file for relief from creditors through bankruptcy proceedings.

	Age Analysis of Past Due Loans
	As of September 30, 2013
(Dollar amounts in thousands)
	30-59		60-89										Recorded
	Days		Days		Over		Total						Investment >
	Past		Past		90		Past				Total		90 Days and
Originated	Due		Due		Days		Due		Current		Loans		Accruing
Commercial real estate	$	—		—		2,474		2,474		288,344		290,818		—
Real estate construction		—		—		—		—		22,966		22,966		—
Real estate multi family		—		—		—		—		39,474		39,474		—
Real estate 1 to 4 family		771		62		1,065		1,898		95,630		97,528		—
Commercial & industrial		336		11		2,240		2,587		34,373		36,960		—
Consumer		20		—		1		21		1,670		1,691		—
Total	$	1,127	$	73	$	5,780	$	6,980	$	482,457	$	489,437	$	—

													Recorded
													Investment >
Purchased													90 Days and
Not credit impaired													Accruing
Commercial real estate	$	—	$	—	$	1,098	$	1,098	$	40,582	$	41,680		—
Real estate construction		—		—		193		193		2,840		3,033		—
Real estate multi-family		—		—		643		643		10,977		11,620		—
Real estate 1 to 4 family		—		—		—		—		10,703		10,703		—
Commercial & industrial		—		—		—		—		10,116		10,116		—
Total	$	—	$	—	$	1,934	$	1,934	$	75,218	$	77,152	$	—

													Recorded
													Investment >
Purchased													90 Days and
Credit impaired													Accruing
Commercial real estate	$	—	$	—	$	1,339	$	1,339	$	8	$	1,347		—
Real estate construction		—		—		—		—		588		588		—
Total	$	—	$	—	$	1,339	$	1,339	$	596	$	1,935	$	—

	Age Analysis of Past Due Loans
	As of December 31, 2012
(Dollar amounts in thousands)
	30-59		60-89										Recorded
	Days		Days		Over		Total						Investment >
	Past		Past		90		Past				Total		90 Days and
Originated	Due		Due		Days		Due		Current		Loans		Accruing
Commercial real estate	$	3,942		—		2,525		6,467		247,982		254,449		—
Real estate construction		—		—		—		—		14,866		14,866		—
Real estate multi family		—		—		—		—		39,176		39,176		—
Real estate 1 to 4 family		806		168		1,210		2,184		95,145		97,329		—
Commercial & industrial		18		44		2,619		2,681		40,166		42,847		—
Consumer		—		—		—		—		1,824		1,824		—
Total	$	4,766	$	212	$	6,354	$	11,332	$	439,159	$	450,491	$	—

													Recorded
													Investment >
Purchased													90 Days and
Not credit impaired													Accruing
Commercial real estate	$	690	$	—	$	2,212	$	2,902	$	45,107	$	48,009		—
Real estate construction		—		—		1,411		1,411		2,183		3,594		—
Real estate multi-family		75		—		—		75		18,753		18,828		—
Real estate 1 to 4 family		—		119		—		119		15,271		15,390		—
Commercial & industrial		50		—		—		50		12,667		12,717		—
Total	$	815	$	119	$	3,623	$	4,557	$	93,981	$	98,538	$	—

														Recorded
														Investment >
Purchased			��											90 Days and
Credit impaired														Accruing
Commercial real estate	$	—		$	—	$	1402	$	1402	$	—	$	1,402		—
Real estate construction		—			—		486		486		—		486		—
Total	$	—		$	—	$	1,888	$	1,888	$	—	$	1,888	$	—

	Credit Quality Indicators
	As of September 30, 2013

(Dollar amounts in thousands)
			Special		Sub-				Total
Originated	Pass		mention		standard		Doubtful		loans
Commercial real estate	$	285,642	$	2,342	$	2,834	$	—	$	290,818
Real estate construction		21,349		573		1,044		—		22,966
Real estate multi-family		39,474		—		—		—		39,474
Real estate 1 to 4 family		96,463		—		805		260		97,528
Commercial and industrial		35,167		—		1,793		—		36,960
Consumer loans		1,690		—		—		1		1,691
Totals	$	479,785	$	2,915	$	6,476	$	261	$	489,437

Purchased
Not credit impaired
Commercial real estate	$	29,936	$	5,574	$	6,170	$	—	$	41,680
Real estate construction		1,533		—		1,500		—		3,033
Real estate multi-family		11,620		—		—		—		11,620
Real estate 1 to 4 family		10,291		—		412		—		10,703
Commercial and industrial		10,116		—		—		—		10,116
Total	$	63,496	$	5,574	$	8,082	$	—	$	77,152
Purchased
Credit impaired
Commercial real estate									$	1,347
Real estate construction										588
Total									$	1,935

	Credit Quality Indicators
	As of December 31, 2012

(Dollar amounts in thousands)
			Special		Sub-				Total
Originated	Pass		mention		standard		Doubtful		loans
Commercial real estate	$	249,991	$	2,372	$	2,086	$	—	$	254,449
Real estate construction		13,266		—		1,600		—		14,866
Real estate multi-family		39,176		—		—		—		39,176
Real estate 1 to 4 family		95,579		—		1,470		280		97,329
Commercial and industrial		39,446		—		2,564		837		42,847
Consumer loans		1,824		—		—		—		1,824
Totals	$	439,282	$	2,372	$	7,720	$	1,117	$	450,491

Purchased
Not credit impaired
Commercial real estate	$	30,600	$	7,902	$	9,507	$	—	$	48,009
Real estate construction		—		39		3,555		—		3,594
Real estate multi-family		18,828		—		—		—		18,828
Real estate 1 to 4 family		14,850		—		540		—		15,390
Commercial and industrial		12,717		—		—		—		12,717
Total	$	76,995	$	7,941	$	13,602	$	—	$	98,538
Purchased
Credit impaired
Commercial real estate									$	1,402
Real estate construction										486
Total									$	1,888

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, 2013 and December 31, 2012, 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:

(Dollar amounts in thousands)			Fair Value Measurements at September 30, 2013, Using
Description	Fair Value 9/30/2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U. S. Treasury securities	$	6,134	$	6,134	$	—	$	—
Obligations of U.S. Government agencies		87,689		—		87,689		—
Mortgage-backed securities		81,232		—		81,232		—
Obligations of states and political subdivisions		83,301		—		83,301		—
Corporate debt		27,254		—		27,254		—
Total assets measured at fair value	$	285,610	$	6,134	$	279,476	$	—

(Dollar amounts in thousands)			Fair Value Measurements at December 31, 2012, Using
Description	Fair Value 12/31/2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U. S. Treasury securities	$	7,280	$	7,280	$	—	$	—
Obligations of U.S. Government agencies		72,260		—		72,260		—
Mortgage-backed securities		55,180		—		55,180		—
Obligations of states and political subdivisions		81,609		—		81,609		—
Corporate debt		18,616		—		18,616		—
Total assets measured at fair value	$	234,945	$	7,280	$	227,665	$	—

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

(Dollar amounts in thousands)			Fair Value Measurements at September 30, 2013, Using
Description	Fair Value 9/30/2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans	$	2,299	$	—	$	—	$	2,299
Total impaired assets measured at fair value	$	2,299	$	—	$	—	$	2,299

(Dollar amounts in thousands)			Fair Value Measurements at December 31, 2012, Using
Description	Fair Value 12/31/2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans	$	2,494	$	—	$	—	$	2,494
Other real estate owned		4,710		—		—		4,710
Total impaired assets measured at fair value	$	7,204	$	—	$	—	$	7,204

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.

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 is recorded along with a corresponding reduction in the book carrying value of the property.

The Company obtains third party appraisals on its impaired loans held-for-investment and foreclosed assets to determine fair value. Generally, the third party appraisals apply the “market approach,” which is a valuation technique that uses prices and other relevant information generated by market transactions involving identical or comparable (that is, similar) assets, liabilities, or a group of assets and liabilities, such as a business. Adjustments are then made based on the type of property, age of appraisal, current status of property and other related factors to estimate the current value of collateral.

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.

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.

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.

Federal Home Loan Bank Advances.

The fair values of Federal Home Loan Bank Advances are based on discounted cash flows. The discount rate is equal to the market rate currently offered by similar products.

Accrued Interest Receivable and Payable.

The interest receivable and payable balances approximate their fair value due to the short-term nature of their settlement dates.

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 Bank has excluded non-financial assets and non-financial liabilities defined by the Codification (ASC 820-10-15-A), such as Bank premises and equipment, deferred taxes and other liabilities. In addition, the Bank has not disclosed the fair value of financial instruments specifically excluded from disclosure requirements of the Financial Instruments Topic of the Codification (ASC 825-10-50-8), such as Bank-owned life insurance policies.

The following table provides summary information on the estimated fair value of financial instruments at September 30, 2013:

(Dollar amounts in thousands)	Carrying		Fair		Fair value measurements
	amount		value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	18,368	$	18,368	$	18,368
Interest-bearing time deposits with financial institutions		6,979		7,088			$	7,088
Securities available for sale		285,610		285,610		6,134		279,476
Loans		567,912		561,036					$	561,036
Other equity securities		5,300		5,300						5,300
Accrued interest receivable		3,855		3,855				3,855

Financial liabilities:

Deposits		781,124		781,517				781,517
Federal Home Loan Bank advances		44,000		44,000				44,000
Accrued interest payable		254		254				254

Off-balance-sheet liabilities:
Undisbursed loan commitments, lines of credit, standby letters of credit and Mastercard lines of credit		—		1,419						1,419

The carrying amount of loans include $9,053,000 of nonaccrual loans (loans that are not accruing interest) as of September 30, 2013. The fair value of nonaccrual loans is based on the collateral values that secure the loans or the cash flows expected to be received.

The following table provides summary information on the estimated fair value of financial instruments at December 31, 2012:

(Dollar amounts in thousands)	Carrying		Fair		Fair value measurements
	amount		value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	27,861	$	27,861	$	27,861
Interest-bearing time deposits with financial institutions		13,216		13,216			$	13,216
Securities available for sale		234,945		234,945		7,280		227,665
Loans		550,917		547,740					$	547,740
Other equity securities		5,464		5,464						5,464
Accrued interest receivable		3,760		3,760				3,760

Financial liabilities:
Deposits		768,352		769,043				769,043
Federal Home Loan Bank advances		1,220		1,221				1,221
Accrued interest payable		349		349				349

Off-balance-sheet liabilities:
Undisbursed loan commitments, lines of credit, standby letters of credit and Mastercard lines of credit		—		1,026						1,026

The carrying amount of loans include $12,474,000 of nonaccrual loans (loans that are not accruing interest) as of December 31, 2012. The fair value of nonaccrual loans is based on the collateral values that secure the loans or the cash flows expected to be received.

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. The dividend rate at September 30, 2013 was 5%. On May 6, 2013, 25% or $3,150,000 of the original $12,600,000 was redeemed.

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.

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.

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.

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

Accounting Standards Update 2013-01 “Balance Sheet” - (Topic 210). “Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.” The amendments clarify that the scope of Update 2011-11 applies to derivatives accounted for in accordance with Topic 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with Section 210-20-45 or Section 815-10-45 or subject to an enforceable master netting arrangement or similar agreement. The amendments apply as of January 1, 2013, or fiscal years beginning after this date. This ASU had no material impact when adopted.

Accounting Standards Update 2013-02 “Comprehensive Income” - (Topic 220). “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” The objective of this Update is to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments in this Update seek to attain that objective by requiring an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. generally accepted accounting principles (GAAP) to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is reclassified to a balance sheet account (for example, inventory) instead of directly to income or expense in the same reporting period. The amendments are effective prospectively for reporting periods beginning after December 15, 2012. This ASU had no material impact when adopted.

In April 2013, the FASB issued ASU 2013-11 “Income Taxes” - (Topic 740). This ASU requires an entity to present in the financial statements an unrecognized tax benefit as a liability and the unrecognized tax benefit should not be combined with deferred tax assets to the extent that a net operating loss carry-forward, tax loss or credit carry-forward is also not available at the reporting date. The amendment is to be applied prospectively to all unrecognized tax benefits and are effective for annual and interim reporting periods beginning after December 15, 2013. The Company does not expect this ASU to have a material impact on the Company’s consolidated financial statements.

Management has reviewed the remaining Accounting Standards Updates (ASU; 2013-03 through 2013-10) and concluded that none are applicable to the Company’s current operations.

Oceanic Bank Acquisition

On September 21, 2012, FNB Bancorp completed its acquisition of all of the outstanding stock of Oceanic Bank Holding, Inc. and its wholly-owned subsidiary, Oceanic Bank, a California banking corporation. Effective the same date, Oceanic Bank was merged into First National Bank of Northern California and Oceanic Bank Holding, Inc. was merged into FNB Bancorp.

The following table presents the Oceanic Bank acquisition presented at fair value as of the acquisition date, September 21, 2012:

	September 21,
(Dollars in thousands)	2012
Assets acquired:

Cash and due from banks	$	(1,278	)
Investment securities, available for sale		13,387
Loans		103,194
Premises and equipment, net		12
Core deposit intangible		110
Other assets		2,504
Total assets acquired	$	117,929

Liabilities assumed:

Noninterest-bearing deposits	$	11,755
Interest-bearing deposits		95,914
Borrowings		6,097
Accrued expenses and other liabilities		497
Total liabilities assumed	$	114,263

Net assets acquired:	$	3,666

The Company recorded a bargain purchase gain related to this acquisition in the amount of $3,666,000. The bargain purchase gain is shown as a separate line item in the Company’s 2012 Consolidated Statement of Earnings. The consolidated operating results of the Company include those of the former Oceanic Bank from the date of acquisition or September 21, 2012.

Earnings Analysis

Net earnings for the quarter ended September 30, 2013 were $3,131,000, compared to net earnings of $4,941,000 for the quarter ended September 30, 2012, a decrease of $1,810,000,or36.6%. Cash dividend payments on the preferred shares outstanding were made as scheduled during the nine months ended September 30, 2013 and 2012, respectively. Net earnings for the nine months ended September 30, 2013 were $5,440,000 compared to net earnings of $7,457,000 for the nine months ended September 30, 2012, a decrease of $2,017,000 or 27.0%. Net earnings before income tax expense for the quarter ended September 30, 2013 were $2,502,000, compared to net earnings before income tax expense of $5,431,000 for the quarter ended September 30, 2012, a decrease of $2,929,000. Net earnings available to common stockholders for the quarter ended September 30, 2013, were $2,880,000, compared to net earnings available to common stockholders of $4,783,000 for the quarter ended September 30, 2012. Earnings before income tax expense were $5,770,000 for the nine months ended September 30, 2013 compared to net earnings before income tax expense of $8,838,000 for the nine months ended September 30, 2012, a decrease of $3,068,000. Net earnings available to common stockholders were $4,859,000 for the nine months ended September 30, 2013, compared to net earnings available to common stockholders of $6,956,000 for the nine months ended September 30, 2012. During the third quarter of 2012, a bargain purchase gain of $3,666,000 was recorded in relation to the completion of the purchase of Oceanic Holding, Inc. by FNB Bancorp on September 21, 2012.

Net interest income for the quarter ended September 30, 2013 was $8,699,000, compared to $7,698,000 for the quarter ended September 30, 2012. The increase in our net interest income was the result of a decrease in interest on interest bearing liabilities being larger than the decrease in interest earned on interest earning assets along with a significant increase in earning assets. Net interest income for the nine months ended September 30, 2013 was $26,133,000 compared to $22,121,000 for the nine months ended September 30, 2012. Our net interest income during 2013 has benefited from the fair value derived from the Oceanic Bank acquisition that closed in the third quarter of 2012. The fair value totaled $253,000 and $927,000 for the three and nine months ended September 30, 2013.

Basic earnings per share were $0.77 for the quarter ended September 30, 2013, compared to $1.30 for the same period last year. Diluted earnings per share were $0.75 for the quarter ended September 30, 2013, compared to $1.27 for the same period last year. Basic earnings per share were $1.30 for the nine months ended September 30, 2013, compared to $1.89 for the same period last year. Diluted earnings per share were $1.27 for the nine months ended September 30, 2013, compared to $1.86 for the same period last year.

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, 2013 compared to the three-and nine-month periods ended September 30, 2012.

TABLE 1	NET INTEREST INCOME AND AVERAGE BALANCES
	FNB BANCORP AND SUBSIDIARY

	Three months ended September 30,
	2013							2012
(Dollar amounts in thousands)					Annualized							Annualized
	Average				Average			Average				Average
	Balance		Interest		Yield			Balance		Interest		Yield
INTEREST EARNING ASSETS
Loans, gross (1) (2)	$	543,826	$	7,808		5.70	%	$	463,752	$	7,208		6.17	%
Taxable securities		211,858		911		1.71	%		143,704		644		1.78	%
Nontaxable securities (3)		73,079		674		3.66	%		72,552		670		3.66	%
Fed funds sold		9		—		n/a			108		—		n/a
Int time depos-other fin institutions		8,173		35		1.70	%		1,672		6		1.42	%
Total interest earning assets		836,945		9,428		4.52	%		681,788		8,528		4.96	%

NONINTEREST EARNING ASSETS:
Cash and due from banks		20,448							64,912
Premises		12,708							12,862
Other assets		33,768							27,702
Total noninterest earning assets		66,923							105,476
TOTAL ASSETS	$	903,868						$	787,264

INTEREST BEARING LIABILITIES:
Demand, int bearing	$	74,557		24		0.13	%	$	68,637		21		0.12	%
Money market		322,949		312		0.38	%		282,434		412		0.58	%
Savings		61,016		22		0.14	%		55,434		28		0.20	%
Time deposits		140,965		197		0.55	%		112,782		198		0.70	%
Fed funds borrowed		293		—		—			—		—		—
FHLB advances		12,243		5		0.16	%		409		4		3.88	%
Total interest bearing liabilities		612,023		560		0.36	%		519,696		663		0.51	%

NONINTEREST BEARING LIABILITIES:
Demand deposits		193,975							165,886
Other liabilities		8,142							11,547
Total noninterest bearing liabilities		202,117							177,433

TOTAL LIABILITIES		814,140							697,129
Stockholders’ equity		89,728							90,135

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	903,868						$	787,264

NET INTEREST INCOME AND MARGIN ON TOTAL EARNING ASSETS (4)			$	8,868		4.20	%			$	7,865		4.58	%

(1)

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

(2)

Amounts of interest earned include loan fees of $265,000 and $276,000 for the quarters ended September 30, 2013 and 2012, respectively.

(3)

Tax equivalent adjustments recorded at the statutory rate of 34% that are included in the nontaxable securities portfolio are $169,000 and $167,000 for the quarters ended September 30, 2013 and 2012, 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.

TABLE 2	NET INTEREST INCOME AND AVERAGE BALANCES
	FNB BANCORP AND SUBSIDIARY

	Nine months ended September 30,
	2013							2012
(Dollar amounts in thousands)					Annualized							Annualized
	Average				Average			Average				Average
	Balance		Interest		Yield			Balance		Interest		Yield
INTEREST EARNING ASSETS
Loans, gross (1) (2)	$	549,573	$	23,986		5.84	%	$	458,709	$	20,721		6.04	%
Taxable securities		188,059		2,389		1.70	%		133,423		1,874		1.88	%
Nontaxable securities (3)		73,925		2,018		3.65	%		72,064		2,024		3.76	%
Fed funds sold		27		—		n/a			36		—		n/a
Int time depos-other fin institutions		9,723		125		1.72	%		561		6		1.43	%
Tot interest earning assets		821,307		28,518		4.64	%		664,793		24,625		4.95	%

NONINTEREST EARNING ASSETS:
Cash and due from banks		32,446							52,004
Premises		12,725							12,979
Other assets		34,316							28,016
Tot noninterest earning assets		79,487							92,999
TOTAL ASSETS	$	900,794						$	757,792

Demand, int bearing	$	76,406		74		0.13	%	$	64,700		71		0.15	%
Money market		310,616		1,035		0.45	%		276,499		1,240		0.60	%
Savings		63,673		79		0.17	%		52,079		78		0.20	%
Time deposits		154,984		688		0.59	%		109,156		607		0.74	%
Fed funds borrowed		108		—		—			—		—		—
FHLB advances		4,530		5		0.15	%		137		4		—
Tot interest bearing liabilities		610,317		1,881		0.41	%		502,571		2,000		0.53	%

NONINTEREST BEARING LIABILITIES:
Demand deposits		187,743							155,624
Other liabilities		9,740							10,763
Tot noninterest bearing liabilities		197,483							166,387

TOTAL LIABILITIES		807,800							668,958
Stockholders’ equity		92,994							88,834

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	900,794						$	757,792

NET INTEREST INCOME AND MARGIN ON TOTAL EARNING ASSETS (4)			$	26,637		4.34	%			$	22,625		4.55	%

(1)

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

(2)

Amounts of interest earned included loan fees of $856,000 and $843,000 for the nine months ended September 30, 2013 and 2012, respectively.

(3)

Tax equivalent adjustments recorded at the statutory rate of 34% that are included in the nontaxable securities portfolio are $504,000 and $504,000 for the nine months ended September 30, 2013 and 2012, 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, 2013 and 2012. 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, 2013, average loans outstanding represented 65.6% of average earning assets. For the quarter ended September 30, 2012, they represented 68.2% of average earning assets. For the nine months ended September 30, 2013 and 2012, average loans outstanding represented 67.7% and 69.1%, respectively, of average earning assets.

The taxable equivalent yield on average interest earning assets for the quarter ended September 30, 2013 compared to the quarter ended September 30, 2012 decreased from 4.96% to 4.52%. Average loans increased by $80,074,000, quarter over quarter, while their yield declined from 6.17% to 5.70%. Interest income on total interest earning assets increased $900,000 on a fully-taxable equivalent basis.

For the three months ended September 30, 2013 compared to the three months ended September 30, 2012, the cost on total interest bearing liabilities decreased from 0.51% to 0.36%. Interest on advances from the Federal Home Loan Bank for the quarter ended September 30, 2013 was 0.13%. Time deposit interest cost decreased from 0.70% to 0.56%. The time deposit average balance outstanding increased by $28,183,000, while their expense remain the same at $198,000. Money market deposits average volume increased $40,515,000 or 14.34%, while their cost decreased from 0.58% to 0.38%.

For the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012, interest income on interest earning assets increased $3,893,000 on a fully-taxable equivalent basis, while average earning assets increased $156,514,000. Average loans increased by $90,864,000. Interest on loans increased $3,265,000, while yields decreased 20 basis points. The cost on total interest bearing liabilities decreased from 0.53% to 0.41%. Time deposit averages increased $45,828,000 and their yield decreased 15 basis points. Money market deposit average balances increased $34,117,000, and their cost decreased $205,000. For the nine months ended September 30, 2013, Federal Home Loan Bank advances averaged $4,530,000, and their interest cost was $4,000. For the nine months ended September 30, 2012, Federal Home Loan Bank advances averaged $137,000, and their interest cost was $4,000.

For the three and nine month periods ended September 30, 2013 and September 30, 2012, 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.


Table 3	FNB BANCORP AND SUBSIDIARY
	RATE/VOLUME VARIANCE ANALYSIS
	Three Months Ended September 30,
(Dollar amounts in thousands)	2013 Compared to 2012
				Variance
	Interest			Attributable to
	Income/Expense			Rate			Volume
INTEREST EARNING ASSETS
Loans	$	600		$	(550	)	$	1,150
Taxable securities		267			(26	)		293
Nontaxable securities (1)		4			(1	)		5
Int time dep-other fin institutions		29			1			28
Total	$	900		$	(576	)	$	1,476

INTEREST BEARING LIABILITIES
Demand deposits	$	(3	)	$	(1	)	$	(2	)
Money market		99			138			(39	)
Savings deposits		5			7			(2	)
Time deposits		—			50			(50	)
FHLB advances		—			116			(116	)
Total	$	101		$	310		$	(209	)
NET INTEREST INCOME	$	1,001		$	(266	)	$	1,267

(1)

Includes tax equivalent adjustment of $169,000 and $167,000 in the three months ended September 30, 2013 and September 30, 2012, respectively.

Table 4	FNB BANCORP AND SUBSIDIARY
	RATE/VOLUME VARIANCE ANALYSIS
	Nine Months Ended September 30,
(Dollar amounts in thousands)	2013 Compared to 2012
	Interest			Variance Attributable to
	Income/Expense			Rate			Volume
INTEREST EARNING ASSETS
Loans	$	3,265		$	(840	)	$	4,105
Taxable securities		515			(252	)		767
Nontaxable securities (1)		(6	)		(57	)		51
Int time dep-other fin institutions		119			21			98
Total	$	3,893		$	(1,128	)	$	5,021

INTEREST BEARING LIABILITIES
Demand deposits	$	(3	)	$	10		$	(13	)
Money market		205			358			(153	)
Savings deposits		(2	)		12			(14	)
Time deposits		(81	)		174			(255	)
Total	$	119		$	554		$	(435	)
NET INTEREST INCOME	$	4,012		$	(574	)	$	4,586

(1)

Includes tax equivalent adjustment of $504,000 and $504,000 in the nine months ended September 30, 2013 and September 30, 2012, respectively.

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)	2013		2012		Amount			Percent
Service charges	$	658	$	722	$	(64	)		-8.9	%
Credit card fees		6		114		(108	)		-94.7	%
Net gain on sale of available-for-sale of securities		37		89		(52	)		-58.4	%
Bank-owned life insurance policy earnings		90		97		(7	)		-7.2	%
Bargain purchase gain		—		3,666		(3,666	)		-100.0	%
Other income		187		76		111			146.1	%
Total noninterest income	$	978	$	4,764	$	(3,786	)		-79.5	%

	Nine months
	ended September 30,				Variance
(Dollars in thousands)	2013		2012		Amount			Percent
Service charges	$	1,993	$	2,218	$	(225	)		-10.1	%
Credit card fees		16		422		(406	)		-96.2	%
Net gain on sale of available-for-sale securities		152		898		(746	)		-83.1	%
Bank-owned life insurance policy earnings		279		675		(396	)		-58.7	%
Bargain purchase gain		—		3,666		(3,666	)		-100.0	%
Other income		606		220		386			175.5	%
Total noninterest income	$	3,046	$	8,099	$	(5,053	)		-62.4	%

Noninterest income consists mainly of service charges on deposits, credit card fees and several other types of miscellaneous income. The Bank service charges were down during the third quarter and year to date of September 30, 2013 when compared to the same period during 2012 due to primarily a decrease in our overdraft fees. The decrease in credit card fees for the three and nine months ended September 30, 2013 was related to the sale of our merchant credit card portfolio that was completed in the fourth quarter of 2012. During the nine months of 2013, the Bank sold $12,428,000 in investment securities for a pre-tax gain of $152,000. During the first quarter of 2012, the Bank recorded a one-time gain on life insurance due to the passing of Mr. Mike Wyman, the former Chairman of the Board and CEO of the Company. During the nine months of 2012, the Company sold approximately $25,743,000 in investment securities at a pre-tax net gain of $906,000, and sold approximately $1,961,000 in investment securities at a pre-tax net loss of $8,000. The sale proceeds were reinvested in a variety of investment securities during the same period. The increase in other income for the three and nine months ended September 30, 2013 was primarily related to rents received on fully rented OREO properties. Rent collections on these properties began in January of 2013.

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)	2013		2012		Amount			Percent
Salaries and employee benefits	$	4,099	$	3,732	$	367			9.8	%
Occupancy expense		812		606		206			34.0	%
Equipment expense		387		423		(36	)		-8.5	%
Professional fees		405		325		80			24.6	%
FDIC assessment		180		160		20			12.5	%
Acquisition related expense		—		250		(250	)		-100.0	%
Telephone, postage & supplies		271		295		(24	)		-8.1	%
Operating losses		29		14		15			107.1	%
Advertising expense		70		81		(11	)		-13.6	%
Bankcard expenses		—		114		(114	)		-100.0	%
Data processing expense		163		110		53			48.2	%
Low income housing expenses		110		69		41			59.4	%
Surety insurance		77		96		(19	)		-19.8	%
Directors expense		63		63		0			0.0	%
Other real estate owned expense		22		5		17			340.0	%
Other expense		262		288		(26	)		-9.0	%
Total noninterest expense	$	6,950	$	6,631	$	319			4.8	%

	NONINTEREST EXPENSE
	Nine months
	ended September 30,					Variance
(Dollars in thousands)	2013		2012			Amount			Percent
Salaries and employee benefits	$	12,827	$	11,151		$	1,676			15.0	%
Occupancy expense		2,620		1,804			816			45.2	%
Equipment expense		1,171		1,301			(130	)		-10.0	%
Professional fees		1,212		1,296			(84	)		-6.5	%
FDIC assessment		540		496			44			8.9	%
Acquisition related expense		—		425			(425	)		-100.0	%
Telephone, postage & supplies		985		844			141			16.7	%
Operating losses		54		66			(12	)		-18.2	%
Advertising		363		256			107			41.8	%
Bankcard expenses		1		427			(426	)		-99.8	%
Data processing expense		489		386			103			26.7	%
Low income housing expenses		329		208			121			58.2	%
Surety insurance		198		220			(22	)		-10.0	%
Directors expense		189		189			0			0.0	%
Other real estate owned expense		100		56			44			78.6	%
Gain on sale of other real estate owned		—		(4	)		4			-100.0	%
Other expense		996		1,061			(65	)		-6.1	%
Total noninterest expense	$	22,074	$	20,182		$	1,892			9.4	%

Noninterest expense consists mainly of salaries and employee benefits. For the three months ended September 30, 2013 compared to three months ended September 30, 2012, it represented 59.0% and 56.3% of total noninterest expenses. For the nine months ended September 30, 2013 and 2012, it was 58.1% and 55.3%, respectively, of total noninterest expenses. During the third quarter of 2012, an additional regional loan officer was added to assist our efforts in our San Francisco area branch offices. Also, the addition of personnel related to the acquisition of Oceanic Bank increased salary and benefit expenses incurred by the Bank after the acquisition date of September 21, 2012.

Provision for Loan Losses.

There was a provision for loan losses of $225,000 and $400,000 for the three months ended September 30, 2013 and 2012, respectively. There was a provision for loan losses of $1,335,000 and $1,200,000 for the nine months ended September 30, 2013 and 2012, respectively. The allowance for loan losses was $9,748,000 or 1.71% of total gross loans at September 30, 2013, compared to $8,582,000 or 1.54% of total gross loans at September 30, 2012. 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 first nine months of 2013 were significantly lower than during the same time period during 2012, reflecting the improvement in the level of problem loans within our loan portfolio on a year over year basis. A significant allocation of our allowance for loan losses exists to reflect the degree of uncertainty related to the credit risk and performance of the Oceanic Bank loan portfolio since its acquisition.

Income Taxes

The effective tax rate for the quarter ended September 30, 2013 was a benefit of 25.1% which compares to a 9.0% effective tax rate for the quarter ended September 30, 2012. The effective tax rate for the nine months ended September 30, 2013 and September 30, 2012, was an effective tax rate of 5.7% and 15.6%, respectively. During the third quarter of 2013, the Bank recorded a tax benefit of $1,334,000. This tax benefit was primarily the result of the reversal of our deferred tax valuation reserve. Taxable income levels and forecasted net income have risen to levels where management no longer believes the deferred tax valuation allowance is necessary All low income housing tax credit carry-forwards are now expected to be realized. 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. During the first quarter of 2012, the Company recognized a tax free gain on proceeds of life insurance of approximately $370,000 due to the passing of the Company’s former Chairman and CEO, Mike Wyman. During the third quarter of 2012, the effective tax rate declined due primarily to the recording of a significant bargain purchase gain related to the acquisition of Oceanic Holding, Inc. and its wholly-owned subsidiary, Oceanic Bank.

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, 2013 are adequate to meet its operating needs in 2013 and our liquidity positions are sufficient to meet our liquidity needs in the near term.

Financial Condition

Assets. Total assets increased to$927,051,000at September 30, 2013 from $875,340,000 at December 31, 2012. The increases were primarily $50,665,000 in securities available-for-sale and $16,601,000 in net loans.

Loans. Gross loans (before net loan fees) at September 30, 2013 were $568,524,000. Loans acquired from Oceanic Holding, Inc. on September 2012 were $103,194,000. During the first nine months of 2013, gross commercial real estate loans increased $29,985,000, real estate construction loans increased $7,641,000, real estate multi- family loans decreased $6,910,000, real estate loans secured by 1 to 4 family residences decreased $4,488,000, commercial and industrial loans decreased $8,488,000, and consumer loans decreased by $133,000. The portfolio breakdown was as follows:

TABLE 7	LOAN PORTFOLIO

	September 30			Percent			December 31			Percent
(Dollar amounts in thousands)	2013						2012
Commercial real estate	$	333,845			60	%	$	303,860			56	%
Real estate construction		26,587			5	%		18,946			3	%
Real estate multi family		51,094			9	%		58,004			11	%
Real estate 1 to 4 family		108,231			19	%		112,719			21	%
Commercial & industrial		47,076			8	%		55,564			10	%
Consumer loans		1,691			0	%		1,824			1	%
Gross loans		568,524			102	%		550,917			102	%
Net deferred loan fees		(612	)		0	%		(230	)		0	%
Allowance for loan losses		(9,748	)		-2	%		(9,124	)		-2	%
Total	$	558,164			100	%	$	541,563			100	%

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.

A summary of activity in the allowance for loan losses for the nine months ended September 30, 2013 and the nine months ended September 30, 2012 is as follows:

TABLE 8	ALLOWANCE FOR LOAN LOSSES
	Nine months ended September 30,
(Dollar amounts in thousands)	2013			2012
Balance, beginning of period	$	9,124		$	9,897
Provision for loan losses		1,335			1,200
Recoveries		79			170
Amounts charged off		(790	)		(2,685	)
Balance, end of period	$	9,748		$	8,582

During the nine months ended September 30, 2013, there was a provision for loan losses of $1,335,000 compared to $1,200,000 for the same period in 2012. Loan charge-off levels have declined year over year, and overall, the allowance has been increased. In management’s judgment, the allowance was adequate to absorb losses currently inherent in the loan portfolio at September 30, 2013. 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. All loans purchased in the acquisition of Oceanic Holding, Inc. were valued at fair value, with no allowance for loan losses allocated to the loans purchased.

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, 2013, there was $15,728,000 in nonperforming assets, compared to $19,124,000 at December 31, 2012. Nonaccrual loans were $9,053,000 at September 30, 2013, compared to $12,474,000 at December 31, 2012. There were no loans past due 90 days and still accruing at either date. The increase in nonperforming assets during 2012 was primarily due to the purchased nonperforming assets included in the Oceanic Bank acquisition.

There was $6,675,000 in Other Real Estate Owned at September 30, 2013. There was $6,650,000 in Other Real Estate Owned at December 31, 2012. 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. Deposits are gathered primarily from our customers in San Francisco and San Mateo counties. Although the Financial District, Sutter and Guam branches were closed in 2013, there was a modest growth in for the nine months of 2013, with deposits moving towards money market and savings, and away from time deposits. Deposits declined by $21,676,000 or 2.7% in the third quarter of 2013, primarily a decrease of $18,045,000 in time deposits. The growth in deposits during the third quarter of 2012 was primarily due to the acquisition of Oceanic Bank.

The following table sets forth the maturity schedule of the time certificates of deposit on September 30, 2013:

TABLE 9

(Dollar amounts in thousands)	Under		$100,000
Maturities	$100,000		or more		Total
Three months or less	$	10,592	$	23,168	$	33,760
Over three through six months		8,742		32,128		40,870
Over six through twelve months		9,993		16,545		26,538
Over twelve months		9,991		19,210		29,201
Total	$	39,318	$	91,051	$	130,369

Regulatory Capital. The following table shows the regulatory capital ratios and leverage ratios at September 30, 2013 and December 31, 2012 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	2013			2012				Requirements
Total Regulatory Capital Ratio		13.37	%		14.56	%	≥		10.00	%
Tier 1 Capital Ratio		12.12	%		13.31	%	≥		6.00	%
Leverage Ratios		9.44	%		9.68	%	≥		5.00	%

Liquidity. Liquidity is a measure of the Company’s ability to convert assets into cash with minimal loss. As of September 30, 2013, liquid assets were $310,957,000,or 33.5% of total assets. As of December 31, 2012, liquid assets were $276,022,000, or 31.5% 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 $30,000,000, 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, 2013, net loans were at 71.5% of deposits. On December 31, 2012, net loans were at 70.5% 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, 2013 and December 31, 2012, 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 $141,944,000 and $102,552,000 at September 30, 2013 and December 31, 2012, respectively. As a percentage of net loans, these off-balance sheet items represent 25.4% and 18.9% respectively.

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.

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, 2013. 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, 2013, 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 foregoin1g 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.

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, 2012 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. Management’s ability to effectively integrate Oceanic Holding, Inc. could have a negative impact on earnings and the financial position of the Company.

	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, 2013. There were 10,457 shares remaining that may be purchased under this Plan as of September 30, 2013.

Item 4.

Mine Safety Disclosures

Not applicable.

	Item 6.	Exhibits

		Exhibits

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

32: Section 1350 Certifications

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 14, 2013	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)

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	8th grade Avg

FNB Bancorp Inactive 10-Q2013 Q3 Quarterly report

Content analysis