1st Century Bancshares (FCTY) 10-Q 2010 Q3 Quarterly report

 UNITED STATES

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, 2010

Commission file number 333-148302

1^st Century Bancshares, Inc.

(Exact name of registrant as specified in its charter)

Delaware	26-1169687
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

1875 Century Park East, Suite 1400

Los Angeles, California  90067

(Address of principal executive offices)

(Zip Code)

(310) 270-9500

(Registrant’s telephone number, including area code)

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

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

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 filero	Smaller reporting companyx
(Do not check if a smaller reporting company)

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

9,331,770 shares of common stock of the registrant were outstanding as of November 5, 2010.

1^st Century Bancshares, Inc.

Quarterly Report on Form 10-Q

September 30, 2010

Table of Contents

		Page
PART I.FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets — September 30, 2010 (unaudited) and December 31, 2009	4
	Unaudited Consolidated Statements of Operations — Three and nine months ended September 30, 2010 and 2009	5
	Unaudited Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income (Loss)  — Nine months ended September 30, 2010 and 2009	6
	Unaudited Consolidated Statements of Cash Flows — Nine months ended September 30, 2010 and 2009	7
	Notesto Unaudited Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	38
Item 4.	Controls and Procedures	38
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	38
Item 1A.	Risk Factors	38
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	38
Item 3.	Defaults Upon Senior Securities	39
Item 4.	Reserved	39
Item 5.	Other Information	39
Item 6.	Exhibits	39
Signatures		40

2

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995

This Quarterly Report on Form 10-Q may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  You can find many (but not all) of these statements by looking for words such as “approximates,” “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “would,” “may” and other similar expressions in this Quarterly Report on Form 10-Q.  The Company claims the protection of the safe harbor contained in the Private Securities Litigation Reform Act of 1995.  The Company cautions investors that any forward-looking statements presented in this Quarterly Report on Form 10-Q, or those that the Company may make orally or in writing from time to time, are based on the Company’s beliefs, and on assumptions made by, and information currently available to management.  The actual outcome will be affected by known and unknown risks, trends, uncertainties and factors that are beyond the Company’s control or ability to predict.  Although the Company believes that management’s assumptions are reasonable, they are not guarantees of future performance and some will inevitably prove to be incorrect.  As a result, the Company’s actual future results can be expected to differ from management’s expectations, and those differences may be material and adverse to the Company’s business, results of operations and financial condition.  Accordingly, investors should use caution in relying on forward-looking statements to anticipate future results or trends.

Some of the risks and uncertainties that may cause the Company’s actual results, performance or achievements to differ materially from those expressed include the following: the impact of changes in interest rates; a continuing decline in economic conditions; increased competition among financial service providers; the Company’s ability to attract deposit and loan customers; the quality of the Company’s earning assets; government regulation; management’s ability to manage the Company’s operations: and the other risks set forth in the Company’s reports filed with the U.S. Securities and Exchange Commission. For further discussion of these and other factors, see “Item 1A. Risk Factors” in the Company’s 2009 Annual Report on Form 10-K.

This Quarterly Report on Form 10-Q and all subsequent written and oral forward-looking statements attributable to the Company or any person acting on behalf of the Company are expressly qualified in their entirety by the cautionary statements contained or referred to in this section.  The Company does not undertake any obligation to release publicly any revisions to forward-looking statements to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q.

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PART I. FINANCIAL INFORMATION

Item 1 —Financial Statements

1^st Century Bancshares, Inc.

Consolidated Balance Sheets

(in thousands, except share and per share data)

	September 30, 2010 (unaudited)			December 31, 2009
ASSETS
Cash and due from banks	$	9,429		$	8,758
Interest earning deposits at other financial institutions	80,158			37,177
Total cash and cash equivalents	89,587			45,935
Investment securities — Available for Sale (“AFS”), at estimated fair value	38,288			43,062
Loans, net of allowance for loan losses of $4,519 and $5,478 at September 30, 2010 and December 31, 2009, respectively	164,612			176,329
Premises and equipment, net	1,052			1,108
Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”) stock	3,399			3,791
Accrued interest and other assets	1,972			1,903
Total Assets	$	298,910		$	272,128
LIABILITIES AND STOCKHOLDERS’ EQUITY
Non-interest bearing demand deposits	$	88,383		$	67,828
Interest bearing deposits:
Interest bearing checking (“NOW”)	32,693			19,874
Savings and money market	63,712			46,240
Certificates of deposit less than $100	2,577			4,584
Certificates of deposit of $100 or greater	58,262			68,848
Total deposits	245,627			207,374
Other borrowings	4,000			16,500
Accrued interest and other liabilities	2,120			1,934
Total Liabilities	251,747			225,808
Commitments and contingencies (Note 7)
Stockholders’ Equity:
Preferred stock, $0.01 par value — 10,000,000 shares authorized, none issued and outstanding at September 30, 2010 and December 31, 2009, respectively	—			—
Common stock, $0.01 par value — 50,000,000 shares authorized, 10,634,580 and 10,446,580 issued at September 30, 2010 and December 31, 2009, respectively	106			104
Additional paid-in capital	63,951			63,562
Accumulated deficit	(12,505		)	(12,903		)
Accumulated other comprehensive income	1,138			817
Treasury stock at cost — 1,298,173 and 1,227,181 shares at September 30, 2010 and December 31, 2009, respectively	(5,527		)	(5,260		)
Total Stockholders’ Equity	47,163			46,320
Total Liabilities and Stockholders’ Equity	$	298,910		$	272,128

The accompanying notes are an integral part of the unaudited consolidated financial statements.

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1^st Century Bancshares, Inc.

Unaudited Consolidated Statements ofOperations

(in thousands, except per share data)

	Three Months Ended September 30,					Nine Months Ended September 30,
	2010		2009			2010		2009
Interest and fee income on:
Loans	$	2,185	$	2,372		$	6,601	$	7,229
Investments	405		473			1,327		1,629
Other	73		32			157		84
Total interest and fee income	2,663		2,877			8,085		8,942
Interest expense on:
Deposits	189		229			560		624
Borrowings	41		119			197		372
Total interest expense	230		348			757		996
Net interest income	2,433		2,529			7,328		7,946
Provision for loan losses	100		1,707			200		2,354
Net interest income after provision for loan losses	2,333		822			7,128		5,592
Non-interest income	223		301			662		776
Non-interest expenses:
Compensation and benefits	1,230		1,180			3,905		3,790
Occupancy	232		255			688		735
Professional fees	155		235			510		563
Technology	172		124			482		372
Marketing	51		47			140		164
FDIC assessments	107		83			283		282
Other operating expenses	454		395			1,384		1,275
Total non-interest expenses	2,401		2,319			7,392		7,181
Income (loss) before income taxes	155		(1,196		)	398		(813		)
Income tax provision	—		3,362			—		3,498
Net income (loss)	$	155	$	(4,558	)	$	398	$	(4,311	)
Basic earnings (loss) per share	$	0.02	$	(0.50	)	$	0.04	$	(0.47	)
Diluted earnings (loss) per share	$	0.02	$	(0.50	)	$	0.04	$	(0.47	)

The accompanying notes are an integral part of the unaudited consolidated financial statements.

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1^st Century Bancshares, Inc.

Unaudited Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income (Loss)

(in thousands, except share data)

	Common Stock										Accumulated Other		Treasury Stock					Total
	Issued				Additional			Accumulated			Comprehensive		Number of					Stockholders’
	Shares		Amount		Paid-in Capital			Deficit			Income		Shares		Amount			Equity
Balance at December 31, 2008	10,369,298		$	103	$	63,006		$	(5,094	)	$	841	(359,400	)	$	(1,808	)	$	57,048
Restricted stock issued	100,750			1		—			—			—	—			—			1
Forfeiture of restricted stock	(73,324	)	—		(139		)	—			—		—		—			(139		)
Compensation expense associated with restricted stock awards, net of estimated forfeitures	—		—		542			—			—		—		—			542
Shares surrendered to pay taxes on vesting of restricted stock	—		—		—			—			—		(63,381	)	(260		)	(260		)
Common stock repurchased	—		—		—			—			—		(642,600	)	(2,556		)	(2,556		)
Comprehensive loss:
Net loss	—		—		—			(4,311		)	—		—		—			(4,311		)
Net change in unrealized gains on AFS investments, net of tax	—		—		—			—			253		—		—			253
Total comprehensive loss	—		—		—			(4,311		)	253		—		—			(4,058		)
Balance at September 30, 2009	10,396,724		$	104	$	63,409		$	(9,405	)	$	1,094	(1,065,381	)	$	(4,624	)	$	50,578
Balance at December 31, 2009	10,446,580		$	104	$	63,562		$	(12,903	)	$	817	(1,227,181	)	$	(5,260	)	$	46,320
Restricted stock issued	190,000		2		—			—			—		—		—			2
Forfeiture of restricted stock	(2,000	)	—		—			—			—		—		—			—
Compensation expense associated with restricted stock awards, net of estimated forfeitures	—		—		389			—			—		—		—			389
Shares surrendered to pay taxes on vesting of restricted stock	—		—		—			—			—		(35,512	)	(142		)	(142		)
Common stock repurchased	—		—		—			—			—		(35,480	)	(125		)	(125		)
Comprehensive income:
Net income	—		—		—			398			���		—		—			398
Net change in unrealized gains on AFS investments, net of tax	—		—		—			—			321		—		—			321
Total comprehensive income	—		—		—			398			321		—		—			719
Balance at September 30, 2010	10,634,580		$	106	$	63,951		$	(12,505	)	$	1,138	(1,298,173	)	$	(5,527	)	$	47,163

The accompanying notes are an integral part of the unaudited consolidated financial statements.

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1^st Century Bancshares, Inc.

Unaudited Consolidated Statements of Cash Flows

(in thousands)

	Nine Months Ended September 30,
	2010			2009
Cash flows from operating activities:
Net income (loss)	$	398		$	(4,311	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization of premises and equipment	263			286
Deferred income tax expense	—			4,263
Provision for loan losses	200			2,354
Amortization (accretion) of deferred loan costs, net of fees	109			(117		)
Non-cash stock compensation, net of forfeitures	389			403
Other, net	(39		)	(25		)
Decrease (increase) in accrued interest and other assets	244			(395		)
Decrease in accrued interest and other liabilities	(39		)	(196		)
Net cash provided by operating activities	1,525			2,262
Cash flows from investing activities:
Activities in AFS investment securities:
Purchases	(8,773		)	(10,589		)
Maturities, calls and principal reductions	10,247			9,326
Proceeds from the sale of securities	3,887			9,344
Decrease in loans, net	11,095			9,391
Purchase of premises and equipment	(207		)	(143		)
Sale of FRB stock and FHLB stock	392			211
Net cash provided by investing activities	16,641			17,540
Cash flows from financing activities:
Net increase in deposits	38,253			34,463
Net repayments of overnight FHLB borrowings	—			(32,000		)
Proceeds from long-term FHLB borrowings	—			2,000
Repayment of long-term FHLB borrowings	(12,500		)	—
Purchase of treasury stock	(267		)	(2,816		)
Net cash provided by financing activities	25,486			1,647
Increase in cash and cash equivalents	43,652			21,449
Cash and cash equivalents, beginning of period	45,935			4,153
Cash and cash equivalents, end of period	$	89,587		$	25,602
Supplemental cash flow information:
Cash paid during the period for interest	$	778		$	969
Supplemental disclosure of non-cash investing activity:
Transfer of Held to Maturity (“HTM”) securities to AFS securities	$	—		$	3,707
Transfer of real estate-residential mortgage loan to Other Real Estate Owned (“OREO”)	$	313		$	—

The accompanying notes are an integral part of the unaudited consolidated financial statements.

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1^st Century Bancshares, Inc.

Notes to Unaudited Consolidated Financial Statements

(1)

Summary of Significant Accounting Policies

Nature of Operations

1^st Century Bancshares, Inc., a Delaware corporation (“Bancshares”) is a bank holding company with one subsidiary, 1^st Century Bank, National Association (the “Bank”).  The Bank commenced operations on March 1, 2004 in the State of California operating under the laws of a National Association (“N.A.”) regulated by the Office of the Comptroller of the Currency (the “OCC”). The Bank is a commercial bank that focuses on closely held and family owned businesses and their employees, professional service firms, real estate professionals and investors, the legal, accounting and medical professions, and small and medium-sized businesses and individuals principally in Los Angeles County. The Bank provides a wide range of banking services to meet the financial needs of the local residential community, with an orientation primarily directed toward owners and employees of the Bank’s business client base. The Bank is subject to both the regulations of and periodic examinations by the OCC, which is the Bank’s federal regulatory agency. Bancshares and the Bank are collectively referred to herein as “the Company.”

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all footnotes as would be necessary for a fair presentation of financial position, results of operations, changes in stockholders’ equity and comprehensive income (loss) and cash flows in conformity with accounting principles generally accepted in the United States of America (“GAAP”). However, these interim unaudited consolidated financial statements reflect all adjustments (consisting solely of normal recurring adjustments and accruals) which, in the opinion of management, are necessary for a fair presentation of financial position, results of operations, changes in stockholders’ equity and comprehensive income (loss) and cash flows for the interim periods presented. These unaudited consolidated financial statements have been prepared on a basis consistent with, and should be read in c onjunction with, the audited consolidated financial statements as of and for the year ended December 31, 2009, and the notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC, under the Securities and Exchange Act of 1934, (the “Exchange Act”).  The unaudited consolidated financial statements include the accounts of Bancshares and the Bank.  All intercompany accounts and transactions have been eliminated.

Certain items in the 2009 unaudited consolidated financial statements have been reclassified to conform to the 2010 presentation.

The results of operations for the three and nine months ended September 30, 2010 are not necessarily indicative of the results of operations that may be expected for any other interim period or for the year ending December 31, 2010.

The Company’s accounting and reporting policies conform to GAAP and to general practices within the banking industry. A summary of the significant accounting and reporting policies consistently applied in the preparation of the accompanying unaudited consolidated financial statements follows:

Use of Estimates

Management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  Significant assumptions and estimates used by management in preparation of the unaudited consolidated financial statements include assumptions and assessments made in connection with calculating the allowance for loan losses and determining the realizability of the Company’s deferred tax assets.  It is at least reasonably possible that certain assumptions and estimates could prove to be incorrect and cause actual results to differ materially and adversely from the amounts reported in the unaudited consolidated financial statements included herewith.

Cash and Cash Equivalents

Cash and cash equivalents include cash and due from banks, interest earning deposits at other financial institutions with original maturities less than 90 days and all highly liquid investments with original maturities of less than 90 days.

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Investment Securities

Investmentsecurities are classified in three categories. Debt securities that management has a positive intent and ability to hold to maturity are classified as “Held to Maturity” or “HTM” and are recorded at amortized cost. Debt and equity securities bought and held principally for the purpose of selling in the near term are classified as “Trading” securities and are measured at fair value, with unrealized gains and losses included in earnings. Debt and equity securities not classified as “Held to Maturity” or “Trading” with readily determinable fair values are classified as “Available for Sale” or “AFS” and are recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. The Company uses estimates from third parties in arriving at fair value determinations which are derived in accordance with fair value measurement standards.

Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of investment securities below their cost that are deemed to be other-than-temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income provided that management does not have the intent to sell the securities and it is more likely than not that management will not have to sell the security before recovery of its cost basis.  In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial conditions and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of ti me sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

Federal Reserve Bank Stock and Federal Home Loan Bank Stock

The Bank is a member of the Federal Reserve System (“Fed” or “FRB”).  FRB stock is carried at cost and is considered a nonmarketable equity security.  Cash dividends from the FRB are reported as interest income.

The Bank is a member and stockholder of the capital stock of the Federal Home Loan Bank of San Francisco (“FHLB of San Francisco” or “FHLB”).  Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts.  FHLB of San Francisco stock is carried at cost and is considered a nonmarketable equity security.  Both cash and stock dividends are reported as interest income.  

Loans

Loans, net, are stated at the unpaid principal balances less the allowance for loan losses and unamortized deferred fees and costs. Loan origination fees, net of related direct costs, are deferred and accreted to interest income as an adjustment to yield over the respective maturities of the loans using the effective interest method.

Interest on loans is accrued as earned on a daily basis, except where reasonable doubt exists as to the collection of interest and principle, in which case the accrual of interest is discontinued and the loan is placed on non-accrual status.  Loans are placed on non-accrual at the time principal or interest is 90 days delinquent. Interest on non-accrual loans is accounted for on a cash-basis or cost-recovery method, until qualifying for return to accrual status. In order for a loan to return to accrual status, all principal and interest amounts owed must be brought current and future payments must be reasonably assured, or the loan must be well secured and in the process of collection.  A loan is charged-off at any time the loan is determined to be uncollectible.

Loans are considered impaired when, based upon current information and events, it is probable that the Company will be unable to collect all principal and interest amounts due according to the original contractual terms of the loan agreement on a timely basis. The Company evaluates impairment on a loan-by-loan basis. Once a loan is determined to be impaired, the impairment is measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate or by using the loan’s most recent market value or the fair value of the collateral if the loan is collateral dependent.  Loans that experience insignificant payment delays or payment shortfalls are generally not considered to be impaired.

When the measurement of an impaired loan is less than the recorded amount of the loan, a valuation allowance is established by recording a charge to the provision for loan losses. Subsequent increases or decreases in the valuation allowance for impaired loans are recorded by adjusting the existing valuation allowance for the impaired loan with a corresponding charge or credit to the provision for loan losses.  The Company’s policy for recognizing interest income on impaired loans is the same as that for non-accrual loans.  

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to operations. Loan losses are charged against the allowance when management believes that principal is uncollectible. Subsequent

9

repayments or recoveries, if any, are credited to the allowance. Management periodically assesses the adequacy of the allowance for loan losses by reference to many quantitative and qualitative factors that may be weighted differently at various times depending on prevailing conditions.  The provisions reflect management’s evaluation of the adequacy of the allowance based, in part, upon estimates from historical peer group loan loss data, the loss experience of other financial institutions, as well as the historical loss experience of the loan portfolio, augmented by the experience of management with similar assets and the Company’s independent loan review process.  Loss ratios for all categories of loans are evaluated on a quarterly basis.  Loss ratios associated with historical loss experience are determined based on a rolling migration analysis of each loan category within the portfolio.  This migration analysis estimates l oss factors based on the performance of each loan category over a two-year time period.  These loss factors are then adjusted, if necessary, for other identifiable risks specifically related to each loan category or risk grade.  Management carefully monitors changing economic conditions, the concentrations of loan categories, values of collateral, the financial condition of the borrowers, the history of the loan portfolio, and historical peer group loan loss data to determine the adequacy of the allowance for loan losses. The allowance is based on estimates and actual losses may vary from the estimates. The Company may establish a specific allowance for loan losses on certain impaired loans based on the methodologies described above. In addition, regulatory agencies, as a part of their examination process, periodically review the Bank’s allowance for loan losses, and may require the Bank to make additions to the allowance based on their judgment about information available to them at the time of their examinations.  No assurance can be given that adverse future economic conditions will not lead to increased delinquent loans, and increases in the provision for loan losses and/or charge-offs. Management believes that the allowance as of September 30, 2010 and December 31, 2009 was adequate to absorb known and inherent risks in the loan portfolio.

Other Real Estate Owned

Other real estate owned (“OREO”) represents real estate and acquired through or in lieu of foreclosure.  OREO is held for sale and is initially recorded at fair value less estimated costs of disposition at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of cost or estimated fair value less costs of disposition.  OREO are included in accrued interest and other assets within the Consolidated Balance Sheets and the net operating results, if any, from OREO are recognized as non-interest expense within the unaudited Consolidated Statements of Operations.

Furniture, Fixtures and Equipment, net

Leasehold improvements and furniture, fixtures and equipment are carried at cost, less depreciation and amortization. Furniture, fixtures and equipment are depreciated using the straight-line method over the estimated useful life of the asset (three to ten years). Leasehold improvements are depreciated using the straight-line method over the terms of the related leases or the estimated lives of the improvements, whichever is shorter.

Income Taxes

The Company files consolidated federal and combined state income tax returns. Income tax expense or benefit is the total of the current year income tax payable or refundable and the change in the deferred tax assets and liabilities (excluding deferred tax assets and liabilities related to components of other comprehensive income). Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax basis of assets and liabilities, computed using enacted tax rates.

Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in the rates and laws.  A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. The Company records a valuation allowance if it believes, based on all available evidence, that it is “more likely than not” that the future tax assets will not be realized. This assessment requires management to evaluate the Company’s ability to generate sufficient future taxable income or use eligible tax carrybacks, if any, to determine the need for a valuation allowance.

During the year ended December 31, 2009, the Company established a full valuation allowance against the deferred tax assets due to the uncertainty regarding its realizability.  At September 30, 2010, management reassessed the need for this valuation allowance and concluded that a full valuation allowance remained appropriate.  Management reached this conclusion as a result of the Company’s cumulative losses since inception, and the anticipated near term economic climate in which the Company will operate.  Management will continue to evaluate the potential realizability of the deferred tax assets and will continue to maintain a valuation allowance to the extent it is determined that it is more likely than not that these assets will not be realized. At September 30, 2010, the Company maintained a deferred tax liability of $796,000 in connection with net unrealized gains on investment securities, which is included in Accrued Interest and Other Liabilit ies within the accompanying unaudited Consolidated Balance Sheet.  The Company did not utilize this deferred tax liability to reduce its tax valuation allowance due to the fact that management does not currently intend to dispose of these investments and realize the associated gains.

At September 30, 2010 and December 31, 2009, the Company did not have any tax benefits disallowed under accounting standards for uncertainties in income taxes.  A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.  

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Comprehensive Income (Loss)

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income (loss). However, certain changes in assets and liabilities, such as unrealized gains and losses on Available for Sale securities, are reported as a separate component of the equity section of the Consolidated Balance Sheets and, along with net income (loss), are components of comprehensive income (loss).  

Earnings (Loss) per Share

The Company reports both basic and diluted earnings (loss) per share. Basic earnings (loss) per share is determined by dividing net income (loss) by the average number of shares of common stock outstanding, while diluted earnings (loss) per share is determined by dividing net income (loss) by the average number of shares of common stock outstanding adjusted for the dilutive effect of common stock equivalents. Potential dilutive common shares related to outstanding stock options and restricted stock are determined using the treasury stock method.  Diluted earnings (loss) per share are not adjusted for potentially dilutive common shares when a net loss occurs because conversion of potentially dilutive common shares is antidilutive.

	Three Months Ended September 30,
(dollars in thousands)	2010		2009
Net income (loss)	$	155	$	(4,558	)
Average number of common shares outstanding	8,921,861		9,081,213
Effect of dilution of restricted stock	95,882		—
Average number of common shares outstanding used to calculate diluted earnings (loss) per common share	9,017,743		9,081,213

	Nine Months Ended September 30,
(dollars in thousands)	2010		2009
Net income (loss)	$	398	$	(4,311	)
Average number of common shares outstanding	8,899,752		9,206,756
Effect of dilution of restricted stock	108,820		—
Average number of common shares outstanding used to calculate diluted earnings (loss) per common share	9,008,572		9,206,756

Fair Value of Financial Instruments

The Company is required to make certain disclosures about its use of fair value measurements in the preparation of its financial statements.  These standards establish a three-level hierarchy for disclosure of assets and liabilities recorded at fair value.  The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect management’s estimates about market data.

Level 1	Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 instruments include securities traded on active exchange markets, such as the New York Stock Exchange, as well as U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets.
Level 2	Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 2 instruments include securities traded in less active dealer or broker markets.

Level 3 Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

11

Stock-Based Compensation

The Company has granted restricted stock awards to directors, employees, and a vendor under the 1^st Century Bancshares 2005 Amended and Restated Equity Incentive Plan (the “Equity Incentive Plan”). The restricted stock awards are considered fixed awards as the number of shares and fair value is known at the date of grant and the fair value at the grant date is amortized over the vesting and/or service period.

Recent Accounting Pronouncements

In December 2009, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2009-16,Transfer and Servicing (“Topic 860”) –Accounting for Transfers of Financial Assets(“ASU 09-16”)which amendsASC 860-10,Transfers and Servicing-Overall (“ASC 860-10”) and adds transition paragraphs 860-10-65-3 of ASC 860-10.  ASC 860-10requires more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures.  ASC 860-10 is effective at the start of a company’s first fiscal year beginning after November 15, 2009, or January 1, 2010 for companies reporting earnings on a calendar-year basis.  The adoption of ASC 860-10 did not have a material impact on the Company’s financial position, results of operations, cash flows, or disclosures.

In December 2009, the FASB issued ASU 2009-17,Consolidation (“Topic 810”) –Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities(“ASU 09-17”) which amends ASC 810-10,Consolidations-Overall (“ASC 810-10”) and adds transition paragraphs 810-10-65-2 of ASC 810-10.  ASC 810-10changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance.  ASC 810-10 is effective at the start of a company’s first fiscal year beginning after November 15, 2009, or January 1, 2010 for companies reporting earnings on a calendar-year basis.  The adoption of ASC 810-10 did not have a material impact on the Company’s financial position, results of operations, cash flows, or disclosures.

In January 2010, the FASB issued ASU 2010-06,Fair Value Measurements and Disclosures(“Topic 820”): Improving Disclosures about Fair Value Measurements(“ASU 10-06”). ASU 10-06 revises two disclosure requirements concerning fair value measurements and clarifies two others. It requires separate presentation of significant transfers into and out of Levels 1 and 2 of the fair value hierarchy and disclosure of the reasons for such transfers. It will also require the presentation of purchases, sales, issuances and settlements within Level 3 on a gross basis rather than a net basis. The amendments also clarify that disclosures should be disaggregated by class of asset or liability and that disclosures about inputs and valuation techniques should be provided for both recurring and non-recurring fair value measurements. The Company’s disclosures about fair value measurements are presented in Note 8: Fair Value Measurements. These new dis closure requirements were adopted by the Company during the three months ended March 31, 2010, with the exception of the requirement concerning gross presentation of Level 3 activity, which is effective for fiscal years beginning after December 15, 2010.  With respect to the portions of ASU 10-06 that were adopted during the three months ended March 31, 2010, the adoption of this standard did not have a material impact on the Company’s financial position, results of operations, cash flows, or disclosures.  Management does not believe that the adoption of the remaining portion of ASU 10-06 will have a material impact on the Company’s financial position, results of operation, cash flows, or disclosures.

In February 2010, the FASB issued ASU 2010-09,Subsequent Events(“Topic 855”) –Amendments to Certain Recognition and Disclosure Requirements. The amendments remove the requirement for an SEC registrant to disclose the date through which subsequent events were evaluated as this requirement would have potentially conflicted with SEC reporting requirements. This ASU became effective upon issuance.  Removal of the disclosure requirement did not affect the nature or timing of subsequent events evaluations performed by the Company.

In April 2010, the FASB issued ASU 2010-18,Receivables  (“Topic 310”) – Effect of a Loan Modification When the Loan is Part of a Pool That is Accountedfor as a Single Asset (“ASU 10-18”) which amends ASC 310-30,Receivables—Loans and Debt Securities Acquired with Deteriorated Credit Quality(“ASC 310-30”), with a link to transition paragraph. 310-10- 65-1,  ASU 10-18 provides that modifications of loans that are accounted for within a pool under ASC 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. However, an entity needs to continue to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. ASU 10-18 is effective for qualified modifications of loans occurring in the first inte rim or annual period ending on or after July 15, 2010. Early application is permitted. With respect to this ASU that was adopted during the current period, the adoption of this standard did not have a material impact on the Company’s financial position, results of operations, cash flows, or disclosures.

In July 2010, the FASB issued ASU 2010-20,Receivables (“Topic 310”) -Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (“ASU 10-20”).  ASU 10-20 requires a company to disaggregate new and existing disclosures based on how it develops its allowance for credit losses and how it manages credit exposures.  Short-term accounts receivable, receivables measured at fair value or lower of cost or fair value, and debt securities are exempt from the ASU 10-20.  For public companies, the amendments that require disclosures as of the end of a reporting period are effective for periods ending on or after December 15, 2010 . The amendments that require disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010.  Management does not believe that the adoption of this ASU will have a material impact on the Company’s financial position, results of operation, or cash flows.

In August 2010, the FASB issued ASU 2010-21,Accounting for Technical Amendments to Various SEC Rules and Schedules - Amendments to SEC Paragraphs Pursuant to Release No. 33-9026: Technical Amendments to Rules, Forms, Schedules and Codification of Financial Reporting Policies (“ASU 10-21”).  ASU 10-21 amends various SEC paragraphs in the FASB Accounting Standards Codificationto conform to SEC Release No. 33-9026,Technical Amendments to Rules, Forms, Schedules and Codification of Financial Reporting Policies, which was effective April 23, 2009.  ASU 10-21 also proposes additions or modifications to the eXtensible Business Reporting Language (“XBRL”) taxonomy as a result of the amendments in the ASU.  With respect to this ASU that was adopted during the current period, the adoption of this standard did not have a material impact on the Company’s financial position, results of operations, cash flows, or disclo sures.

12

(2)

Investments

The following is a summary of the investments categorized as Available for Sale at September 30, 2010 and December 31, 2009:

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
(in thousands)	Cost		Gains		Losses			Value
At September 30, 2010:
Investments — Available for Sale
U.S. Gov’t and Federal Agency Securities	$	150	$	—	$	—		$	150
Residential Mortgage-Backed Securities	36,006		1,928		—			37,934
Residential Collateralized Mortgage Obligations	199		5		—			204
Total	$	36,355	$	1,933	$	—		$	38,288
At December 31, 2009:
Investments — Available for Sale
U.S. Gov’t and Federal Agency Securities	$	2,000	$	—	$	(8	)	$	1,992
Residential Mortgage-Backed Securities	39,402		1,494		(106		)	40,790
Residential Collateralized Mortgage Obligations	272		8		—			280
Total	$	41,674	$	1,502	$	(114	)	$	43,062

The Company did not have any investment securities categorized as “Held to Maturity” or “Trading” at September 30, 2010 or December 31, 2009.

The fair value of AFS securities and the weighted average yield of investment securities by contractual maturity at September 30, 2010 are as follows:

13

(dollars in thousands)

Available for Sale	1 Year or Less		Weighted Average Yield		After 1 Through 5 Years		Weighted Average Yield		After 5 Through 10 Years		Weighted Average Yield		After 10 Years		Weighted Average Yield		Total		Weighted Average Yield
U.S. Gov’t and Federal Agency Securities	$          150		0.19	%	$             —		—	%	$             —		—	%	$               —		—	%	$                  150		0.19	%
Residential Mortgage-Backed Securities	—		—		2,038		4.36		16,553		4.34		19,343		4.45		37,934		4.40
Residential Collateralized Mortgage Obligations	—		—		—		—		204		4.23		—		—		204		4.23
Total	$	150	0.19	%	$	2,038	4.36	%	$	16,757	4.33	%	$	19,343	4.45	%	$	38,288	4.38	%

There were no securities with an unrealized loss at September 30, 2010.  A total of four securities had unrealized losses at December 31, 2009.  Information pertaining to securities with gross unrealized losses aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

	Less than Twelve Months					Twelve Months or More
(in thousands)	Gross Unrealized Losses			Fair Value		Gross Unrealized Losses		Fair Value
At December 31, 2009:
Investments-Available for Sale
U.S. Gov’t and Federal Agency Securities	$	(8	)	$	1,992	$	—	$	—
Residential Mortgage-Backed Securities	(106		)	5,890		—		—
Total	$	(114	)	$	7,882	$	—	$	—

14

At September 30, 2010 and December 31, 2009, the fair value of AFS securities pledged to the State of California Treasurer’s Office to secure certificates of deposit was $38.1 million and $43.1 million, respectively.  Deposits from the State of California were $34.0 million and $39.0 million at September 30, 2010 and December 31, 2009, respectively.

The Company adopted FASB ASC 320-10-65-1, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FASB ASC 320-10-65-1”), effective April 1, 2009.  FASB ASC 320-10-65-1 (i) changed previous guidance for debt securities in determining when an impairment is other than temporary and (ii) replaced the previous requirement that the entity’s management assert it has both the intent and ability to hold an impaired security until recovery with a requirement that management assert: (a) it does not have the intent to sell the security; and (b) it is more likely than not it will not have to sell the security before recovery of its cost basis. Under FASB ASC 320-10-65-1, declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the imp airment related to other factors is recognized in other comprehensive income.  

The Company’s assessment that it has the ability to continue to hold impaired investment securities along with its evaluation of their future performance provide the basis for it to conclude that its impaired securities are not other-than-temporarily impaired.  In assessing whether it is more likely than not that the Company will be required to sell any impaired security before its anticipated recovery, which may be at their maturity, it considers the significance of each investment, the amount of impairment, as well as the Company’s liquidity position and the impact on the Company’s capital position.  As a result of its analyses, the Company determined at December 31, 2009 that the unrealized losses on its securities portfolio on which impairments had not been recognized are temporary.  As of September 30, 2010, the Company did not have any impaired investment securities.

Comprehensive income (loss), which includes net income (loss), the net change in unrealized gains (losses) on investment securities Available for Sale and the reclassification of net (gains) losses included in earnings (losses), is presented below:

15

	Three Months Ended September 30,						Nine Months Ended September 30,
(in thousands)	2010			2009			2010			2009
Net income (loss)	$	155		$	(4,558	)	$	398			$	(4,311	)
Other comprehensive income (loss):
(Decrease) increase in net unrealized gains on investment securities Available for Sale, net of tax (benefit) expense of ($82) and $242 for the three and nine months ended September 30, 2010, respectively, and net of tax expense of $234 and $177 for the three and nine months ended September 30, 2009, respectively		(117	)		334			347				254
Reclassification for net losses (gains) included in earnings (losses), net of tax expense of $18 for the nine months ended September 30, 2010, and net of tax (benefit) expense of ($6) and $0 for the three and nine months ended September 30, 2009, respectively		—			8			(26	)			(1	)
Comprehensive income (loss)	$	38		$	(4,216	)	$	719			$	(4,058	)

The Company did not sell any available for sale securities during the three months ended September 30, 2010.  The Company sold five available for sale securities totaling $5.9 million during the three months ended September 30, 2009, resulting in a realized loss of $14,000.  The realized loss of $14,000 was reported in non-interest income within the accompanying Unaudited Consolidated Statements of Operations.  The Company sold two available for sale securities totaling $3.8 million during the nine months ended September 30, 2010, resulting in a realized gain of $44,000. The realized gain was reported in non-interest income within the accompanying unaudited Consolidated Statements of Operations. The Company sold eight Available for Sale securities totaling $9.3 million during the nine months ended September 30, 2009, resulting in a realized gain of $1,000.  The realized gain of $1,000 was reported in non-interest income within the accompanying unaud ited Consolidated Statements of Operations.

16

(3)

Loans, Allowance for Loan Losses, and Non-Performing Assets

Loans

As of September 30, 2010 and December 31, 2009, gross loans outstanding totaled $169.1 million and $181.7 million, respectively, within the following loan categories:

	September 30, 2010					December 31, 2009
	Amount			Percent		Amount			Percent
(dollars in thousands)	Outstanding			of Total		Outstanding			of Total
Commercial (1)	$	68,978		40.8	%	$	84,721		46.6	%
Real estate — residential mortgage	11,948			7.1	%	1,880			1.0	%
Real estate — commercial mortgage	57,378			33.9	%	59,403			32.7	%
Real estate — land and construction	11,129			6.6	%	16,777			9.3	%
Home equity	15,781			9.3	%	12,747			7.0	%
Consumer and other (2)	3,849			2.3	%	6,180			3.4	%
Loans, gross	169,063			100.0	%	181,708			100.0	%
Net deferred loan origination costs	68					99
Less — allowance for loan losses	(4,519		)			(5,478		)
Loans, net	$	164,612				$	176,329

(1)

Unsecured commercial loan balances were $9.6 million and $17.5 million at September 30, 2010 and December 31, 2009, respectively.

(2)

Unsecured consumer and other loan balances were $1.5 million and $1.8 million at September 30, 2010 and December 31, 2009, respectively.

As of September 30, 2010, substantially all of the Company’s loan customers are located in Southern California.

Allowance for Loan Losses

The following is a summary of activities for the allowance for loan losses for the three and nine months ended September 30, 2010 and 2009:

		Three Months Ended September 30,									Nine Months Ended September 30,
(in thousands)	2010					2009				2010					2009
Beginning balance	$		4,947		$		4,733		$			5,478		$		5,171
Provision for loan losses			100				1,707					200				2,354
Charge-offs:
Commercial			(659	)			(547	)				(889	)			(547	)
Real estate-commercial mortgage			(250	)			—					(650	)			—
Consumer and other			—				(349	)				(52	)			(1,500	)
Total charge-offs			(909	)			(896	)				(1,591	)			(2,047	)
Recoveries:
Commercial			381				22					386				88
Real estate-residential mortgage			—				—					22				—
Real estate-commercial mortgage			—				—					20				—
Consumer and other			—				—					4				—
Total recoveries			381				22					432				88
Ending balance	$		4,519		$		5,566		$			4,519		$		5,566

An allowance for probable losses on undisbursed commitments to extend credit of $203,000 at both September 30, 2010 and December 31, 2009, was related to commercial/home equity lines of credit, standby/commercial letters of credit and guarantees on revolving credit limits which amounted to $65.6 million and $57.4 million at September 30, 2010 and December 31, 2009, respectively. The inherent risk associated with the undisbursed portion of the loan is evaluated at the same time the credit is extended. However, the allowance held for undisbursed commitments is reported in accrued interest and other liabilities within the accompanying Consolidated Balance Sheets, and not as part of the allowance for loan losses in the above table.

17

Non-Performing Assets

The following table sets forth non-performing assets at September 30, 2010 and December 31, 2009:

(dollars in thousands)	September 30, 2010			December 31, 2009
Non-accrual loans:
Commercial	$	940		$	3,032
Real estate-residential mortgage	876			845
Real estate-commercial mortgage	5,365			5,923
Consumer and other	—			10
Total non-accrual loans	7,181			9,810
Other real estate owned (“OREO”)	313			—
Total non-performing assets	$	7,494		$	9,810
Non-performing assets to gross loans and OREO	4.42		%	5.40		%
Non-performing assets to total assets	2.51		%	3.60		%

At September 30, 2010 and December 31, 2009, the recorded investment in impaired loans was $7.2 million and $9.8 million, respectively.  At September 30, 2010 and December 31, 2009, the Company had a $264,000 and $347,000, respectively, specific allowance for loan losses on $1.4 million and $867,000, respectively, of impaired loans.  There were $5.8 million and $8.9 million of impaired loans with no specific allowance for loan losses at September 30, 2010 and December 31, 2009, respectively.  The average recorded investment in impaired loans for the three months ended September 30, 2010 and 2009 was $8.4 million and $9.7 million, respectively.  The average recorded investment in impaired loans for the nine months ended September 30, 2010 and 2009 was $8.9 million and $6.6 million, respectively.  No interest income was recognized on these loans subsequent to their classification as impaired.  Furthermore, the Company stopped accruing intere st on these loans on the date they were classified as non-accrual, reversed any uncollected interest that had been accrued as income and began recognizing interest income only as cash interest payments are received.  There was no interest income recognized on these loans on a cash basis for the three and nine months ended September 30, 2010 and 2009.

(4)

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation and amortization. The depreciation and amortization are computed on a straight line basis over the lesser of the lease term, or the estimated useful lives of the assets, generally three to ten years.

Premises and equipment at September 30, 2010 and December 31, 2009 are comprised of the following:

(in thousands)	September 30, 2010			December 31, 2009
Leasehold improvements	$	906		$	906
Furniture & equipment	1,519			1,368
Software	508			452
Total	2,933			2,726
Accumulated depreciation	(1,881		)	(1,618		)
Premises and equipment, net	$	1,052		$	1,108

Depreciation and amortization included in occupancy expense was $91,000 and $263,000 for the three and nine months ended September 30, 2010, respectively, and $99,000 and $286,000 for the three and nine months ended September 30, 2009, respectively.

18

(5)

Deposits

The following table reflects the summary of deposit categories by dollar and percentage at September 30, 2010 and December 31, 2009:

	September 30, 2010				December 31, 2009
(dollars in thousands)	Amount		Percent of Total		Amount		Percent of Total
Non-interest bearing demand deposits	$	88,383	36.0	%	$	67,828	32.7	%
Interest bearing checking	32,693		13.3	%	19,874		9.6	%
Savings and money market	63,712		25.9	%	46,240		22.3	%
Certificates of deposit	60,839		24.8	%	73,432		35.4	%
Total	$	245,627	100.0	%	$	207,374	100.0	%

At September 30, 2010, the Company had three certificate of deposit accounts with the State of California Treasurer’s Office for a total of $34.0 million that represented 13.8% of total deposits. At December 31, 2009, the Company had six certificate of deposit accounts with the State of California Treasurer’s Office for a total of $39.0 million that represented 18.8% of total deposits. Each of these deposits outstanding at September 30, 2010 is scheduled to mature in the fourth quarter of 2010. The Company intends to renew each of these deposits at maturity.  However, given the current economic climate in the State of California, there can be no assurance that the State of California Treasurer’s Office will continue to maintain deposit accounts with the Company.  

At September 30, 2010, the Company had $11.8 million of Certificate of Deposit Accounts Registry Service (“CDARS”) reciprocal deposits, which represented 4.8% of total deposits.  At December 31, 2009, the Company had $12.0 million of CDARS reciprocal deposits, which represented 5.8% of total deposits.

The aggregate amount of certificates of deposit of $100,000 or greater at September 30, 2010 and December 31, 2009 was $58.3 million and $68.8 million, respectively.  At September 30, 2010, the maturity distribution of certificates of deposit of $100,000 or greater, including deposit accounts with the State of California Treasurer’s Office and CDARS, was as follows: $49.9 million maturing in six months or less, $4.7 million maturing in six months to one year and $3.7 million maturing in more than one year.

The table below sets forth the range of interest rates, amount and remaining maturities of the certificates of deposit at September 30, 2010.

(in thousands)	Six months and less		Greater than six months through one year		Greater than one year
0.00% to 0.99%	$	46,390	$	3,282	$	—
1.00% to 1.99%	5,176		1,458		3,933
2.00% to 2.99%	—		480		—
3.00% to 3.99%	100		—		—
4.00% to 4.99%	—		—		—
5.00% to 5.99%	20		—		—
Total	$	51,686	$	5,220	$	3,933

(6)

Other Borrowings

At September 30, 2010, the Company had a $43.0 million borrowing/credit facility secured by a blanket lien on eligible loans at the FHLB. The Company had $4.0 million of long-term borrowings and no overnight borrowings outstanding under this borrowing/credit facility with the FHLB at September 30, 2010.  At December 31, 2009, the Company had a $43.0 million borrowing/credit facility secured by a blanket lien of eligible loans at the FHLB.  The Company had $16.5 million of long-term borrowings and no overnight borrowings outstanding under this borrowing/credit facility with the FHLB at December 31, 2009.

19

The following table summarizes the outstanding long-term borrowings under the borrowing/credit facility secured by a blanket lien on eligible loans at the FHLB at September 30, 2010 and December 31, 2009 (dollars in thousands):

Maturity Date	Interest Rate		September 30, 2010		December 31, 2009
January 19, 2010	3.21	%	$	—	$	5,000
May 10, 2010	2.97	%	—		1,500
July 12, 2010	3.38	%	—		2,000
August 20, 2010	3.38	%	—		2,000
September 8, 2010	3.25	%	—		2,000
December 17, 2010	1.72	%	2,000		2,000
April 15, 2011	1.59	%	2,000		2,000
	Total		$	4,000	$	16,500

At September 30, 2010, the Company also had $27.0 million in Federal fund lines of credit available with other correspondent banks in order to disburse loan commitments and to satisfy demands for deposit withdrawals. Each of these lines of credit is subject to conditions that the Company may not be able to meet at the time when additional liquidity is needed.  The Company did not have any borrowings outstanding under these lines of credit at September 30, 2010 or December 31, 2009.

(7)

Commitments and Contingencies

Commitments to Extend Credit

The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby/commercial letters of credit and guarantees on revolving credit card limits. These instruments involve various levels and elements of credit and interest rate risk in excess of the amount recognized in the accompanying consolidated financial statements. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company had $63.4 million and $56.3 million in commitments to extend credit to customers, $2.2 million and $946,000 in standby/commercial letters of credit, and $246,000 and $223,000 in guarantees on revolving credit card limits at September 30, 2010 and December 31, 2009, respectively.  The outstanding balances on these credit cards were $58,000 and $76,000 as of September 30, 2010 and December 31, 2009, respectively.

Lease Commitments

The Company leases office premises under two operating leases that will expire in June 2014 and November 2017, respectively. Rental expense included in occupancy expense was $113,000 and $343,000 for the three and nine months ended September 30, 2010, respectively, and $115,000 and $331,000 for the three and nine months ended September 30, 2009, respectively.

The projected minimum rental payments under the term of the leases at September 30, 2010 are as follows (in thousands):

Years ending December 31,
2010 (October – December)	$	150
2011	603
2012	632
2013	639
2014	374
Thereafter	322
	$	2,720

Litigation

The Company from time to time is party to lawsuits, which arise out of the normal course of business. At September 30, 2010, the Company did not have any litigation that management believes will have a material impact on the unaudited Consolidated Balance Sheet or unaudited Consolidated Statements of Operations.

20

Restricted Stock

The following table sets forth the Company’s future restricted stock expense, net of estimated forfeitures (in thousands).

Years ending December 31,
2010 (October – December)	$	102
2011	326
2012	237
2013	119
2014	45
Thereafter	9
	$	838

(8)

Fair Value Measurements

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of September 30, 2010 and December 31, 2009, and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.  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.

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Assets Measured on a Recurring Basis

Assets measured at fair value on a recurring basis are summarized below:

			Fair Value Measurements Using
(in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
At September 30, 2010:
Investments-Available for Sale							&nbs p;
U.S. Gov’t and Federal Agency Securities	$	150	$	150	$	—		$	—
Residential Mortgage-Backed Securities		37,934		—		37,934			—
Residential Collateralized Mortgage Obligations		204		—		204			—
Total	$	38,288	$	150	$	38,138		$	—
At December 31, 2009:
Investments-Available for Sale							&nbs p;
U.S. Gov’t and Federal Agency Securities	$	1,992	$	—	$	1,992		$	—
Residential Mortgage-Backed Securities		40,790		—		40,790			—
Residential Collateralized Mortgage Obligations		280		—		280			—
Total	$	43,062	$	—	$	43,062		$	—

AFS securities— Fair values for investment securities are based on inputs other than quoted prices that are observable, either directly or indirectly.  The Company obtains quoted prices through third party brokers.  There were no transfers into or out of Level 2 measurements during the three and nine months ended September 30, 2010.

As of September 30, 2010, the Level 2 fair value of the Company’s residential mortgage-backed securities was $37.9 million.  These securities consist entirely of agency mortgage-backed securities issued by the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC).  The underlying loans for these securities are residential mortgages that were primarily originated beginning in the year of 2003 through the current period.  These loans are geographically dispersed throughout the United States.  At September 30, 2010, the weighted average rate and weighed average life of these securities were 4.40% and 3.68 years, respectively.  

The valuation for investment securities utilizing Level 2 inputs were primarily determined by quotes received from two independent pricing services using matrix pricing, which is a mathematical technique widely used in the industry to value securities without relying exclusively on quoted market prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities.  The Company compares the price estimates received from these pricing services and generally utilizes an average of the prices to calculate the estimated fair value of these securities.  

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Assets Measured on a Non-Recurring Basis

Assets measured at fair value on a non-recurring basis are summarized below:

			Fair Value Measurements Using
(in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
At September 30, 2010:
Impaired loans	$	6,917	$	—	$	—	$	6,917
Other real estate owned		313		—		—		313
Total	$	7,230	$	—	$	—	$	7,230
At December 31, 2009:
Impaired loans	$	9,463	$	—	$	—	$	9,463

Impaired loans — Loans are considered impaired when, based upon current information and events, it is probable that the Company will be unable to collect all principal and interest amounts due according to the original contractual terms of the loan agreement on a timely basis. The Company evaluates impairment on a loan-by-loan basis. Once a loan is determined to be impaired, the impairment is measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate or by using the loan’s most recent market value or the fair value of the collateral if the loan is collateral dependent.  The Company recorded  net charge-offs of $528,000 and $1.2 million on impaired loans during the three and nine months ended September 30, 2010, respectively, and net charge-offs of $874,000 and $2.0 million on impaired loans during the three and nine months ended September 30, 2009, respectively.

(9)

Estimated Fair Value Information

The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many cases, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Estimated fair value amounts have been determined by using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amounts the Company could realize in a current market exchange.

The methods and assumptions used to estimate the fair value of each class of financial instruments for which it is practicable to estimate the value are explained below.

Cash and cash equivalents

The carrying amounts are considered to be their estimated fair values because of the short-term maturity of these instruments which includes cash and due from banks and interest earning deposits at other financial institutions.

Investment securities

AFS investment securities are carried at fair value, which are based on quoted prices of exact or similar securities, or on inputs that are observable, either directly or indirectly. The Company obtains quoted prices through third party brokers.

FRB and FHLB stock

For FRB and FHLB stock, the carrying amount is equal to the par value at which the stock may be sold back to FRB or FHLB, which approximates fair value.

Loans, net

For loans, the fair value is estimated using market quotes for similar assets or the present value of future cash flows, discounted using the current rate at which similar loans would be made to borrowers with similar credit ratings and for the same maturities and giving consideration to estimated prepayment risk and credit risk.

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A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement.When a loan is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Company may measure impairment based on a loan’s observable market price, or the fair value of the collateral (net of estimated costs to sell) if the loan is collateral dependent.  

Off-balance sheet credit-related instruments

The fair values of commitments, which include standby letters of credit and commercial letters of credit, are based upon fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The related fees are not considered material to the Company’s financial statements as a whole and the fair market value of the Company’s off-balance sheet credit-related instruments cannot be readily determined.

Deposits

For demand deposits, the carrying amount approximates fair value. The fair values of interest bearing checking, savings, and money market deposits are estimated by discounting future cash flows using the interest rates currently offered for deposits of similar products.  The Company would likely receive a core deposit premium if its deposits were sold in the principal market for such deposits.

The fair values of the certificates of deposit are estimated by discounting future cash flows based on the rates currently offered for certificates of deposit with similar interest rates and remaining maturities.

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Other borrowings

The fair values of overnight FHLB advances are considered to be equivalent to the carrying amount due to the short-term maturity.  The fair values of term FHLB advances are estimated based on the rates currently offered by the FHLB for advances with similar interest rates and remaining maturities.

Accrued interest

The estimated fair value for both accrued interest receivable and accrued interest payable are considered to be equivalent to the carrying amounts.

The estimated fair value and carrying amounts of the financial instruments at September 30, 2010 and December 31, 2009 are as follows:

	September 30, 2010				December 31, 2009
	Carrying		Estimated		Carrying		Estimated
(dollars in thousands)	Amount		Fair Value		Amount		Fair Value
Assets
Cash and cash equivalents	$	89,587	$	89,587	$	45,935	$	45,935
Investment securities	38,288		38,288		43,062		43,062
FRB stock	1,289		1,289		1,511		1,511
FHLB stock	2,110		2,110		2,280		2,280
Loans, net	164,612		162,171		176,329		176,072
Accrued interest receivable	596		596		573		573
Liabilities
Non-interest bearing deposits	$	88,383	$	88,383	$	67,828	$	67,828
Interest bearing deposits	157,244		157,245		139,546		139,546
Other borrowings	4,000		4,022		16,500		16,500
Accrued interest payable	104		104		125		125

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(10)

Non-Interest Income

The following table summarizes the information regarding non-interest income for the three and nine months ended September 30, 2010 and 2009, respectively:

	Three Months Ended September 30,					Nine Months Ended September 30,
(in thousands)	2010		2009			2010	2009
Loan arrangement fees	$	163	$	219		$            413	$               506
Service charges and other operating income	60		40			205	213
Gain on sale of other real estate owned	—		56			—	56
Net gain on sale of AFS securities	—		(14		)	44	1
Total non-interest income	$	223	$	301		$            662	$               776

(11)

Stock-Based Compensation

The Company grants restricted stock awards to directors and employees under the Equity Incentive Plan.  Restricted stock awards are considered fixed awards as the number of shares and fair value is known at the date of grant and the fair value at the grant date is amortized over the requisite service period.  On May 15, 2010, the Company granted 190,000 restricted stock awards to employees with various vesting periods as follows:  50% or 95,000 awards that vest in three years, 25% or 47,500 awards that vest in four years, and 25% or 47,500 awards that vest in five years.

Non-cash stock compensation expense recognized in the unaudited Consolidated Statements of Operations related to the restricted stock awards, net of estimated forfeitures, was $109,000 and $389,000 for the three and nine months ended September 30, 2010, respectively, and $134,000 and $403,000 for the three and nine months ended September 30, 2009, respectively.

The following table reflects the activities related to restricted stock awards outstanding for the nine months ended September 30, 2010 and 2009, respectively.

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	Nine Months Ended September 30,
	2010				2009
Restricted Shares	Number of Shares		Weighted Avg Fair Value at Grant Date		Number of Shares		Weighted Avg  Fair Value at Grant Date
Beginning balance	359,710		$	5.58	366,278		$	6.90
Granted	190,000		4.05		100,750		3.95
Vested	(112,795	)	7.11		(81,060	)	8.05
Forfeited and surrendered	(2,000	)	4.71		(73,324	)	5.90
Ending balance	434,915		$	5.88	312,644		$	5.89

The Company recognizes compensation expense for stock options by amortizing the fair value at the grant date over the service, or vesting period.  

There have been no options granted, exercised or cancelled under the 2004 Founder Stock Option Plan for the nine months ended September 30, 2010 or 2009.

The remaining contractual life of the 2004 Founder Stock Options outstanding was 3.41 and 4.41 years at September 30, 2010 and 2009, respectively. All options under the 2004 Founder Stock Option Plan were exercisable at September 30, 2010 and 2009.  At September 30, 2010 and 2009, the weighted average exercise price of the 133,700 shares outstanding under the 2004 Founder Stock Option Plan is $5.00.

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The following table represents the status of all option shares and the exercise price thereof for the Director and Employee Stock Option Plan for the nine months ended September 30, 2010 and 2009.

	Nine Months Ended September 30,
	2010			2009
Director and Employee Stock Option Plan	Number of Options	Weighted Avg Exercise Price		Number of Options		Weighted Avg Exercise Price
Beginning Balance	1,045,673	$	6.05	1,105,673		$	6.01
Granted	—	—		—		—
Exercised	—	—		—		—
Cancelled	—	—		(60,000	)	5.25
Ending Balance	1,045,673	$	6.05	1,045,673		$	6.05

The remaining contractual life of the Director and Employee Stock Options outstanding was 3.89 and 4.89 years at September 30, 2010 and 2009, respectively. All options under the Directors and Employee Stock Option Plan were exercisable at September 30, 2010 and 2009.

The following tables detail the amount of shares authorized and available under all stock plans as of September 30, 2010:

	Shares Reserved	Less Shares Previously  Exercised/Vested	Less Shares  Outstanding	Total Shares  Available for  Future Issuance
2004 Founder Stock Option Plan	150,000	8,000	133,700	8,300
Director and Employee Stock Option Plan	1,434,000	216,924	1,045,673	171,403
Equity Incentive Plan	1,200,000	295,128	434,915	469,957
					& nbsp;

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(12)

Regulatory Matters

Capital

Bancshares and the Bank are subject to the various regulatory capital requirements administered by federal banking agencies.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Bancshares and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Failure to meet minimum capital requirements can initiate certain mandatory – and possibly additional discretionary – actions by regulators that, if undertaken, could have a direct material and adverse effect on the financial statements of the Company.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulation) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes that as of September 30, 2010 and December 31, 2009, the Company and the Bank met all capital adequacy requirements to which they are subject.

At December 31, 2009, the most recent notification from the OCC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios. There are no conditions or events since the notification that management believes have changed the Bank’s category.

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The Company’s and the Bank’s capital ratios as of September 30, 2010 and December 31, 2009 are presented in the table below:

	Company				Bank				For Capital  Adequacy Purposes				For the Bank to be  Well Capitalized Under  Prompt Corrective  Measures
(dollars in thousands)	Amount		Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio
September 30, 2010:
Total Risk-Based Capital Ratio	$	48,584	23.99	%	$	44,997	22.21	%	$	16,203	8.00	%	$	20,256	10.00	%
Tier 1 Risk-Based Capital Ratio	$	46,026	22.72	%	$	42,438	20.95	%	$	8,102	4.00	%	$	12,154	6.00	%
Tier 1 Leverage Ratio	$	46,026	16.15	%	$	42,438	14.88	%	$	11,400	4.00	%	$	14,261	5.00	%
December 31, 2009:
Total Risk-Based Capital Ratio	$	48,193	22.71	%	$	44,120	20.79	%	$	16,974	8.00	%	$	21,217	10.00	%
Tier 1 Risk-Based Capital Ratio	$	45,503	21.45	%	$	41,430	19.53	%	$	8,487	4.00	%	$	12,730	6.00	%
Tier 1 Leverage Ratio	$	45,503	16.89	%	$	41,430	15.33	%	$	10,784	4.00	%	$	13,514	5.00	%

Dividends

In the ordinary course of business, Bancshares is dependent upon dividends from the Bank to provide funds for the payment of dividends to stockholders and to provide for other cash requirements. Banking regulations may limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of the Bank to fall below specified minimum levels. Approval is also required if dividends declared exceed the net profits for that year combined with the retained net profits for the preceding two years.  Currently, the Bank is prohibited from paying dividends to Bancshares until such time as the accumulated deficit is eliminated.

To date, Bancshares has not paid any cash dividends.  Payment of stock or cash dividends in the future will depend upon earnings and financial condition and other factors deemed relevant by Bancshares’ Board of Directors, as well as Bancshares’ legal ability to pay dividends.  Accordingly, no assurance can be given that any cash dividends will be declared in the foreseeable future.

30

Item 2.

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

Critical Accounting Policies and Estimates

The accounting and reporting policies followed by us conform, in all material respects, to accounting principles generally accepted in the United States (“GAAP”), and to customary practices within the financial services industry.  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that effect the amounts reported in the financial statements and accompanying notes. While we base our estimates on historical experience, current information and other factors, which we deem to be relevant, actual results could differ materially and adversely from those estimates.

We consider accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain, and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on our financial statements.  Accounting polices related to the allowance for loan losses and income taxes are considered to be critical.  These critical accounting policies, and our procedures related to these policies, are described in detail below.  There have been no changes to our critical accounting policies and estimates during the three months ended September 30, 2010.

The allowance for loan losses is established through provisions for loan losses charged to operations. The provisions reflect management’s evaluation of the adequacy of the allowance based upon estimates used from and comparisons to historical peer group loan loss data, the loss experience of other financial institutions, as well as the historical loss experience of the loan portfolio, augmented by the experience of management with similar assets and the Company’s independent loan review process.  Loss ratios for all categories of loans are evaluated on a quarterly basis.  In addition, management carefully monitors qualitative factors, such as changing economic conditions, the concentrations of loan categories and collateral, to further evaluate the adequacy of the allowance for loan losses. The allowance is based on estimates, and actual losses may vary materially from the estimates. No assurance can be given that adverse future economic conditions will not lead to further increases in the provision for loan losses and/or additional charge-off of loans. See Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations –Allowance for Loan Losses” for further details considered by management in estimating the necessary level of the allowance for loan losses.

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Provision for income taxes is the amount of estimated tax due reported on our tax returns and the change in the amount of deferred tax assets and liabilities. Deferred income taxes represent the estimated net income tax expense payable (or benefits receivable) for temporary differences between the carrying amounts for financial reporting purposes and the amounts used for tax purposes.  A valuation allowance is required if it is “more likely than not” that a deferred tax asset will not be realized.  The determination of the realizability of deferred tax assets is highly subjective and dependent upon management’s evaluation of both positive and negative evidence, including historic financial performance, forecasts of future income, existence of feasible tax planning strategies, length of statutory carryforward periods, and assessments of the current and future economic and business conditions.  Management evaluates the positive and negative evidence and determines the realizability of the deferred tax asset on a quarterly basis.

Summary of the Results of Operations and Financial Condition

For the three months ended September 30, 2010 and 2009, the Company recorded net income of $155,000, or $0.02 per diluted share, and a net loss of $4.6 million, or $0.50 per diluted share, respectively.   During the three months ended September 30, 2010, net income was positively impacted by declines in provisions for loan losses and income tax provision of $1.6 million and $3.4 million, respectively, as compared to the same period last year.  These items were partially offset by declines in net interest income and non-interest income of $96,000 and $78,000, respectively, as well as an increase in total non-interest expense of $82,000, each as compared to the same period last year.  

For the nine months ended September 30, 2010 and 2009, the Company recorded net income of $398,000, or $0.04 per diluted share, and a net loss of $4.3 million, or $0.47 per diluted share, respectively.  During the nine months ended September 30, 2010, net income was positively impacted by declines in provisions for loan losses and income tax provision of $2.2 million and $3.5 million, respectively, as compared to the same period last year.  These items were partially offset by declines in net interest income and non-interest income of $618,000 and $114,000, respectively, and an increase in total non-interest expense of $211,000, each as compared to the same period last year.        

Total assets at September 30, 2010 were $298.9 million, representing an increase of approximately $26.8 million, or 9.8%, from $272.1 million reported at December 31, 2009. The increase in total assets was primarily attributable to an increase in cash and cash equivalents, partially offset by decreases in gross loans and investment securities-available for sale.  Cash and cash equivalents increased $43.7 million from $45.9 million at December 31, 2009 to $89.6 million at September 30, 2010.  The increase in cash and cash equivalents was primarily attributable to the increase in deposits generated during the nine months ended September 30, 2010, as well as the cash flows received in connection with the loan amortization and pay-downs.  Gross loans at September 30, 2010 were $169.1 million, which represents a decrease of $12.6 million, or 6.9%, from $181.7 million at December 31, 2009. The decrease in gross loans was primarily attributable to loa n amortization and pay-downs.   

Total liabilities increased by $25.9 million to $251.7 million as compared to $225.8 million at December 31, 2009.  This increase was primarily due to increases in non-interest bearing deposits, interest bearing checking and savings and money market deposits of $20.6 million, $12.8 million and $17.5 million, respectively, due to continued core deposit gathering efforts, partially offset by a $12.6 million decrease in certificates of deposit and a $12.5 million decrease in other borrowings.  Total core deposits, which include non-interest bearing demand deposits, interest bearing demand deposits and savings and money market deposits, were $184.8 million and $133.9 million at September 30, 2010 and December 31, 2009, respectively, representing an increase of $50.9 million, or 38.0%.  

Average interest earning assets increased $32.6 million from $246.0 million for the three months ended September 30, 2009 to $278.6 million for the three months ended September 30, 2010.  Average interest earning assets increased $12.3 million from $250.4 million for the nine months ended September 30, 2009 to $262.7 million for the nine months ended September 30, 2010.  The weighted average interest rate on interest earning assets decreased to 3.80% for the three months ended September 30, 2010 from 4.64% for the same period last year.  The weighted average interest rate on interest earning assets decreased to 4.11% for the nine months ended September 30, 2010 from 4.77% for the same period last year.  The declines in yields earned during the current periods as compared to the same periods last year were primarily attributable to the increase in the average balance of interest earning deposits at other financial institutions, which had average bala nces of $69.4 million and $46.1 million, respectively, and were earning approximately 29 and 26 basis points, respectively, during the three and nine months ended September 30, 2010.  During the same periods last year, the average balance of interest earning deposits at other financial institutions were $4.9 million and $1.7 million, respectively.

Set forth below are certain key financial performance ratios and other financial data for the periods indicated:

	Three months ended September 30,				Nine months ended September 30,
	2010		2009		2010		2009
Annualized return on average assets	0.22	%	(7.07)	%	0.20	%	(2.24)	%
Annualized return on average stockholders’ equity	1.31	%	(33.25)	%	1.14	%	(10.40)	%
Average stockholders’ equity to average assets	16.45	%	21.26	%	17.30	%	21.54	%
Net interest margin	3.46	%	4.08	%	3.73	%	4.24	%

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At September 30, 2010, stockholders’ equity totaled $47.2 million, or 15.8% of total assets, as compared to $46.3 million, or 17.0% of total assets at December 31, 2009.  The Company’s book value per share of common stock was $5.05 as of September 30, 2010, compared to $5.02 per share as of December 31, 2009.

Results of Operations

Net Interest Income

The management of interest income and interest expense is fundamental to the performance of the Company. Net interest income, which is the difference between interest income on interest earning assets, such as loans and investment securities, and interest expense on interest bearing liabilities, such as deposits and other borrowings, is the largest component of the Company’s total revenue. Management closely monitors both net interest income and net interest margin (net interest income divided by average earning assets).

Net interest income and net interest margin are affected by several factors including (1) the level of, and the relationship between the dollar amount of interest earning assets and interest bearing liabilities; and (2) the relationship between repricing or maturity of our variable-rate and fixed-rate loans, securities, deposits and borrowings.

The majority of the Company’s loans are indexed to the national prime rate.  Movements in the national prime rate have a direct impact on the Company’s loan yield and interest income.  The national prime rate, which generally follows the targeted federal funds rate, was 3.25% at September 30, 2010 and 2009.  There was no change in the targeted federal funds rate from September 30, 2009 to September 30, 2010, which remained at 0.00-0.25%.  Management anticipates that there will be continued pressure on the net interest margin in the current rate environment.

The Company, through its asset and liability policies and practices, seeks to maximize net interest income without exposing the Company to an excessive level of interest rate risk. Interest rate risk is managed by monitoring the pricing, maturity and repricing options of all classes of interest bearing assets and liabilities. This is discussed in more detail in Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Asset/Liability Management.”

During the three months ended September 30, 2010, net interest income was $2.4 million compared to $2.5 million for the same period last year.  The decline was primarily related to a decrease of $187,000 in interest earned in connection with our loan portfolio and a decrease of $68,000 in interest earned on our investment securities.  The fluctuation in our loan interest income was primarily related to a decrease of $27.6 million in the average balance of loans caused by loan amortization and pay-downs and, to a lesser extent, loan charge-offs. The change in interest earned on our investment portfolio was primarily due to a decline of 51 basis points in the yield earned on our residential agency mortgage-backed securities and collateralized mortgage obligations (“CMOs”).  These declines were partially offset by an increase of $48,000 in interest earned on interest earning deposits at other financial institutions, which was attributed to the inc rease in the average balance of interest earning deposits at other financial institutions, and decreases of $78,000 and $57,000 in interest paid for other borrowings and certificates of deposit, respectively, which were attributable to declines in their respective average outstanding balances, as well as a decline in the rates paid in connection with these interest bearing liabilities.

During the nine months ended September 30, 2010, net interest income was $7.3 million compared to $7.9 million for the same period a year ago.  The decline was primarily related to a decrease of $628,000 in interest earned in connection with our loan portfolio and a decrease of $302,000 in interest earned on our investment securities.  The fluctuation in our loan interest income was primarily related to a decrease of $27.3 million in the average balance of loans caused primarily by loan amortization and pay-downs and, to a lesser extent, loan charge-offs.  The change in interest earned on our investment portfolio was primarily due to a decline of 56 basis points in the yield earned on our residential agency mortgage-backed securities and CMOs, as well as a decrease of $3.9 million in its average balance.  These declines were partially offset by an increase of $86,000 in interest earned on interest earning deposits at other financial institutions, wh ich was attributed to the increase in the average balance of interest earning deposits at other financial institutions, and decreases of $175,000 and $115,000 in interest paid for other borrowings and certificates of deposit, respectively.  The decrease in interest paid on other borrowings was primarily attributable to a decline in the average outstanding balance of other borrowings, partially offset by an increase in rates paid on other borrowings, while the decrease related to certificates of deposit was primarily attributed to a decline in the rates paid on these deposits.  

The Company’s net interest spread (yield on interest earning assets less the rate paid on interest bearing liabilities) was 3.20% for the three months ended September 30, 2010 compared to 3.68% for the same period last year.  The decline in our net interest spread was primarily due to an increase of $64.5 million in the average balance of lower yielding interest earning deposits at other financial institutions.  These deposits yielded approximately 29 basis points during the three months ended September 30, 2010.  As discussed above, the increase in the average balance of interest earning deposits at other financial institutions was primarily due to excess liquidity generated by the growth in deposits, as well as cash flows from loan amortization and pay-downs.  

During the nine months ended September 30, 2010, the Company’s net interest spread was 3.43% compared to 3.89% for the same period a year ago.  The decline in our net interest spread was primarily due to an increase of $44.4 million in the average balance of lower yielding interest earning deposits at other financial institutions.  These deposits yielded approximately 26 basis points during the nine months ended September 30, 2010.  As discussed above, the increase in the average balance of interest earning deposits at other financial institutions was primarily due to excess liquidity generated by the growth in deposits, as well as cash flows from loan amortization and pay-downs.  

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The Company’s net interest margin (net interest income divided by average interest earning assets) was 3.46% and 3.73%, respectively, for the three and nine months ended September 30, 2010, compared to 4.08% and 4.24%, respectively, for the three and nine months ended September 30, 2009.  The declines of 62 and 51 basis points, respectively,  in net interest margin was primarily due to decreases in the yield on earning assets of 84 and 66 basis points, respectively, partially offset by declines of 38 and 20 basis points, respectively, in the cost of interest bearing deposits and borrowings.  As discussed above, the decrease in yield on earning assets was primarily the result of an increase in the average balance of lower yielding interest earning deposits at other financial institutions.  During the three and nine months ended September 30, 2010, the decline in our cost of interest bearing deposits was attributable to the decrease in interest r ates paid on deposit accounts during these periods, as compared to the same periods last year.  The average cost of interest bearing deposits was 0.50% and 0.54% during the three and nine months ended September 30, 2010 compared to 0.71% and 0.69% for the same periods last year.  Net interest margin was further impacted by declines in the average balance of borrowings of $9.8 million and $20.7 million during the three and nine months ended September 30, 2010, respectively, as compared to the same periods last year.  The average cost of borrowings was 2.37% and 2.64% during the three and nine months ended September 30, 2010 compared to 2.83% and 1.62% for the same periods last year.

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The following table sets forth the average balances of certain assets, interest income/expense, average yields on earning assets, average rates paid on interest bearing liabilities, net interest margins and net interest income/spread for the three months ended September 30, 2010 and 2009, respectively.

Three Months Ended September 30,

	2010						2009
	Average		Interest				Average		Interest
(dollars in thousands)	Balance		Inc/Exp		Yield		Balance		Inc/Exp		Yield
Assets
Federal funds sold	$	—	$	—	—	%	$	1,383	$	1	0.25	%
Interest earning deposits at other financial institutions	69,403		50		0.29	%	4,887		2		0.14	%
U.S. Gov’t and Federal agency securities	124		—		0.13	%	1,629		1		0.12	%
Residential mortgage-backed securities and CMO’s	39,393		405		4.12	%	40,457		472		4.63	%
Federal Reserve Bank stock	1,289		20		6.00	%	1,620		25		6.09	%
Federal Home Loan Bank stock	2,150		3		0.45	%	2,280		5		0.83	%
Loans (1) (2)	166,210		2,185		5.22	%	193,774		2,371		4.85	%
Earning assets	278,569		2,663		3.80	%	246,030		2,877		4.64	%
Other assets	8,558						9,820
Total assets	$	287,127					$	255,850
Liabilities & Equity
Interest checking (NOW)	$	27,555	15		0.22	%	$	11,682	9		0.29	%
Savings and money market deposits	61,554		98		0.63	%	50,110		87		0.69	%
CD’s	60,251		76		0.50	%	65,363		133		0.81	%
Borrowings	6,827		41		2.37	%	16,673		119		2.83	%
Total interest bearing deposits and borrowings	156,187		230		0.58	%	143,828		348		0.96	%
Demand deposits	81,604						56,243
Other liabilities	2,102						1,387
Total liabilities	239,893						201,458
Equity	47,234						54,392
Total liabilities & equity	$	287,127					$	255,850
Net interest income / spread			$	2,433	3.22	%			$	2,529	3.68	%
Net interest margin					3.46	%					4.08	%

(1)

Average loans exclude the allowance for loan losses and net deferred loan origination fees and costs.  Included in interest income from loans are net loan origination cost amortization of $39,000 and $59,000 for the three months ended September 30, 2010 and 2009, respectively.

(2)

Includes average non-accrual loans of $8.4 million and $9.7 million for the three months ended September 30, 2010 and 2009, respectively.  

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The following table sets forth the average balances of certain assets, interest income/expense, average yields on earning assets, average rates paid on interest bearing liabilities, net interest margins and net interest income/spread for the nine months ended September 30, 2010 and 2009, respectively.

Nine Months Ended September 30,

	2010						2009
	Average		Interest				Average		Interest
(dollars in thousands)	Balance		Inc/Exp		Yield		Balance		Inc/Exp		Yield
Assets
Federal funds sold	$	—	$	—	—	%	$	490	$	1	0.25	%
Interest earning deposits at other financial institutions	46,133		88		0.26	%	1,741		2		0.15	%
U.S. Gov’t and Federal agency securities	559		8		2.07	%	648		1		0.20	%
Residential mortgage-backed securities and CMO’s	41,344		1,319		4.25	%	45,237		1,628		4.81	%
Federal Reserve Bank stock	1,401		64		6.01	%	1,684		76		6.07	%
Federal Home Loan Bank stock	2,221		5		0.33	%	2,276		5		0.28	%
Loans (1) (2)	171,018		6,601		5.16	%	198,312		7,229		4.87	%
Earning assets	262,676		8,085		4.11	%	250,388		8,942		4.77	%
Other assets	8,595						6,877
Total assets	$	271,271					$	257,265
Liabilities & Equity
Interest checking (NOW)	$	23,230	39		0.23	%	$	11,196	22		0.26	%
Savings and money market deposits	53,252		271		0.68	%	48,634		237		0.65	%
CD’s	61,337		250		0.55	%	60,252		365		0.81	%
Borrowings	9,975		197		2.64	%	30,706		372		1.62	%
Total interest bearing deposits and borrowings	147,794		757		0.68	%	150,788		996		0.88	%
Demand deposits	74,633						49,848
Other liabilities	1,907						1,223
Total liabilities	224,334						201,859
Equity	46,937						55,406
Total liabilities & equity	$	271,271					$	257,265
Net interest income / spread			$	7,328	3.43	%			$	7,946	3.89	%
Net interest margin					3.73	%					4.24	%

(1)

Average loans exclude the allowance for loan losses and net deferred loan origination fees and costs.  Included in interest income from loans are net loan origination cost amortization of $102,000 and $39,000 for the nine months ended September 30, 2010 and 2009, respectively.

(2)

Includes average non-accrual loans of $8.9 million and $6.6 million for the nine months ended September 30, 2010 and 2009, respectively.  

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The Volume and Rate Variances table below sets forth the dollar difference in interest earned and paid for each major category of interest earning assets and interest bearing liabilities for the noted periods, and the amount of such change attributable to changes in average balances (volume) or changes in average interest rates. Volume variances are equal to the increase or decrease in the average balance times the prior period rate and rate variances are equal to the increase or decrease in the average rate times the prior period average balance. Variances attributable to both rate and volume changes are equal to the change in rate times the change in average balance and are included below in the average volume column.

	Three Months Ended September 30, 2010 Compared to 2009 Increase (Decrease) Due to Changes in:
(in thousands)		Volume				Rate				Total
Interest income:
Federal funds sold	$	(1		)	$	—			$	(1		)
Interest earning deposits at other financial institutions		45				3				48
U.S. Gov’t and Federal agency securities		(1		)		—				(1		)
Residential mortgage-backed securities and CMO’s		(12		)		(55		)		(67		)
Federal Reserve Bank stock		(5		)		—				(5		)
Federal Home Loan Bank stock		—				(2		)		(2		)
Loans		(354		)		168				(186		)
Total (decrease) increase in interest income		(328		)		114				(214		)
Interest expense:
Interest checking (NOW)		9				(3		)		6
Savings and money market deposits		19				(8		)		11
CD’s		(10		)		(47		)		(57		)
Borrowings		(61		)		(17		)		(78		)
Total decrease in interest expense		(43		)		(75		)		(118		)
Net (decrease) increase in net interest income	$		(285	)	$		189		$		(96	)

	Nine Months Ended September 30, 2010 Compared to 2009 Increase (Decrease) Due to Changes in:
(in thousands)		Volume				Rate				Total
Interest income:
Federal funds sold	$	(1		)	$	—			$		(1		)
Interest earning deposits at other financial institutions		84				2					86
U.S. Gov’t and Federal agency securities		—				7					7
Residential mortgage-backed securities and CMO’s		(132		)		(177		)			(309		)
Federal Reserve Bank stock		(11		)		(1		)			(12		)
Federal Home Loan Bank stock		—				—					—
Loans		(1,036		)		408					(628		)
Total (decrease) increase in interest income		(1,096		)		239					(857		)
Interest expense:
Interest checking (NOW)		21				(4		)			17
Savings and money market deposits		23				11					34
CD’s		6				(121		)			(115		)
Borrowings		(333		)		158					(175		)
Total (decrease) increase in interest expense		(283		)		44					(239		)
Net (decrease) increase in net interest income	$		(813	)	$		195		$			(618	)

Provision for Loan Losses

The provision for loan losses was $100,000 and $200,000 for the three and nine months ended September 30, 2010, and $1.7 million and $2.4 million for the three and nine months ended September 30, 2009, respectively.  During the three and nine months ended September 30, 2010, we had net charge-offs of $528,000 and $1.2 million, respectively, compared to $874,000 and $2.0 million during the same periods last year.  The provision for loan losses is recorded based on an analysis of the factors discussed in Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Allowance for Loan Losses.”  

As a percentage of our total loan portfolio, the amount of non-performing loans was 4.25% and 5.40% at September 30, 2010 and December 31, 2009, respectively.  As a percentage of our total loan portfolio and OREO, the amount of non-performing assets was 4.42% and 5.40% at September 30, 2010 and December 31, 2009, respectively.

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Non-Interest Income

Non-interest income was $223,000 for the three months ended September 30, 2010 compared to $301,000 for the three months ended September 30, 2009.  The decrease in non-interest income was primarily due to decreases in loan arrangement fees and gain on sale of other real estate owned of $56,000 and $56,000, respectively, partially offset by an increase in service charges and other operating income of $20,000 and a decline in losses incurred in connection with the sale of AFS securities of $14,000.  For the nine months ended September 30, 2010 and 2009, non-interest income was $662,000 and $776,000, respectively.  The decrease in non-interest income was primarily due to decreases in loan arrangement fees and gain on sale of other real estate owned of $93,000 and $56,000, respectively, partially offset by an increase in gain on sale of AFS securities of $43,000.  During the nine months ended September 30, 2010, the Company disposed of two agency mortga ge-backed securities with an amortized cost of $3.8 million at the time of sale and recognized a $44,000 gain in connection with this transaction.

Non-interest income primarily consists of loan arrangement fees, service charges and fees on deposit accounts, as well as other operating income, which mainly consists of wire transfer and other consumer related fees.  Loan arrangement fees are related to a college loan funding program the Company established with two student loan providers.  The Company initially funds student loans originated by the student loan providers in exchange for non-interest income.  All loans are purchased by the student loan providers within 30 days of origination.  All purchase commitments are supported by collateralized deposit accounts.  Service charges and other operating income includes service charges and fees on deposit accounts, as well as other operating income, which mainly consists of outgoing funds transfer wire fees. See Note 10 “Non-Interest Income” in Part I, Item 1.“Financial Statements”for more information regard ing non-interest income for the three and nine months ended September 30, 2010 and 2009.

Non-Interest Expense

Non-interest expense was $2.4 million and $7.4 million for the three and nine months ended September 30, 2010, respectively, compared to $2.3 million and $7.2 million for the three and nine months ended September 30, 2009, respectively, representing increases of $82,000, or 3.5%, and $211,000, or 2.9%, respectively.  

Income Tax Provision

During the three and nine months ended September 30, 2010, we did not record an income tax provision related to our pretax earnings. Tax expense that would normally arise because of the Company’s earnings during the three and nine months ended September 30, 2010 is not recorded because it is offset by a reduction in the valuation allowance on the Company’s deferred tax asset.  The income tax provision for the three and nine months ended September 30, 2009 was $3.4 million and $3.5 million, respectively.  A 100% valuation allowance was provided against the deferred tax asset at September 30, 2009.  The valuation allowance of $3.4 million was recorded as income tax expense.    

Financial Condition

Assets

Total assets at September 30, 2010 were $298.9 million, representing an increase of $26.8 million, or 9.8%, from $272.1 million reported at December 31, 2009. The increase in total assets was primarily attributable to an increase in cash and cash equivalents partially offset by a decrease in gross loans.  Gross loans at September 30, 2010 were $169.1 million, which represented a decrease of $12.6 million, or 6.9%, from $181.7 million at December 31, 2009.  The decrease in gross loans was primarily attributable to loan amortization and pay-downs.  Cash and cash equivalents increased $43.7 million from $45.9 million at December 31, 2009 to $89.6 million at September 30, 2010.

Cash and Cash Equivalents

Cash and cash equivalents totaled $89.6 million at September 30, 2010 and $45.9 million at December 31, 2009. We continued to maintain an elevated amount of cash and cash equivalents during the nine months ended September 30, 2010.  The increase in cash and cash equivalents was primarily attributable to the increase in deposits generated during the nine months ended September 30, 2010, as well as the cash flows received in connection with loan amortization and pay-offs.  Cash and cash equivalents are managed based upon liquidity needs by investing excess liquidity in higher yielding assets such as loans or investment securities. See the section “Liquidity and Asset/Liability Management” below.

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Investment Securities

The investment securities portfolio is generally the second largest component of the Company’s interest earning assets, and the structure and composition of this portfolio is important to any analysis of the financial condition of the Company. The investment

39

portfolio serves the following purposes:  (i) it can be readily reduced in size to provide liquidity for loan balance increases or deposit balance decreases; (ii) it provides a source of assets for securing certain deposits and borrowed funds, as may be required by law or by specific agreement with a depositor or lender; (iii) it can be used as an interest rate risk management tool, since it provides a large base of assets, the maturity and interest rate characteristics of which can be changed more readily than the loan portfolio to better match changes in the deposit base and other funding sources of the Company; and (iv) it is an alternative interest earning use of funds when loan demand is weak or when deposits grow more rapidly than loans.

The Company’s entire investment securities portfolio was categorized as “Available for Sale” at September 30, 2010 and December 31, 2009.

At September 30, 2010, investment securities totaled $38.3 million compared to $43.1 million at December 31, 2009.  The Company’s investment portfolio is currently primarily composed of residential mortgage-backed securities issued by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation.  As of September 30, 2010 and December 31, 2009, the weighted average life of our investment portfolio was approximately 3.63 years and 4.56 years, respectively.  The Company has not used interest rate swaps or other derivative instruments to hedge fixed rate loans or to otherwise mitigate interest rate risk.

Loans

Loans, net of the allowance for loan losses and deferred loan origination cost/unearned fees decreased 6.6%, or $11.7 million, from $176.3 million at December 31, 2009 to $164.6 million at September 30, 2010.  The decrease in the loan portfolio during the nine months ended September 30, 2010 was primarily the result of loan amortization and pay-downs and, to a lesser extent, loan charge-offs.  As of September 30, 2010 and December 31, 2009, gross loans outstanding totaled $169.1 million and $181.7 million, respectively.  Loan originations were $14.8 million and $32.7 million during the three and nine months ended September 30, 2010.  

As of September 30, 2010, substantially all of the Company’s loan customers are located in Southern California.

Non-Performing Assets

The following table sets forth non-performing assets at September 30, 2010 and December 31, 2009:

(dollars in thousands)	September 30, 2010			December 31, 2009
Non-accrual loans:
Commercial	$	940		$	3,032
Real estate-residential mortgage		876			845
Real estate-commercial mortgage	5,365			5,923
Consumer and other	—			10
Total non-accrual loans	7,181			9,810
Other real estate owned (OREO)	313			—
Total non-performing assets	$	7,494		$	9,810
Non-performing assets to total loans and OREO	4.42		%	5.40		%
Non-performing assets to total assets	2.51		%	3.60		%

Non-accrual loans totaled $7.2 million and $9.8 million at September 30, 2010 and December 31, 2009, respectively.  There were two commercial loans past due 90 days or more totaling $1.1 million that were accruing interest at September 30, 2010.  There were no accruing loans past due 90 days or more at December 31, 2009.  Gross interest income that would have been recorded on non-accrual loans had they been current in accordance with their original terms was $125,000 and $350,000 for the three and nine months ended September 30, 2010, respectively, and $172,000 and $406,000, respectively, for the same periods last year.

At September 30, 2010, non-accrual loans consisted of six commercial loans totaling $940,000, two residential real estate mortgage loans totaling $876,000, and three commercial real estate mortgage loans totaling $5.4 million.  At September 30, 2010, OREO consisted of one single family residential property.

At September 30, 2010 and December 31, 2009, the recorded investment in impaired loans was $7.2 million and $9.8 million, respectively.  At September 30, 2010 and December 31, 2009, the Company had a $264,000 and $347,000, respectively, specific allowance for loan losses on $1.4 million and $867,000, respectively, of impaired loans.  There were $5.8 million and $8.9 million of impaired loans with

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no specific allowance for loan losses at September 30, 2010 and December 31, 2009, respectively.  The average outstanding balance of impaired loans for the nine months ended September 30, 2010 and 2009 was $8.9 million and $6.6 million, respectively.  No interest income was recognized on these loans subsequent to their classification as impaired.  Furthermore, the Company stopped accruing interest on these loans on the date they were classified as non-accrual, reversed any uncollected interest that had been accrued as income and began recognizing interest income only as cash interest payments are received.  There was no interest income recognized on these loans on a cash basis for the three and nine months ended September 30, 2010 and 2009.

Allowance for Loan Losses

The allowance for loan losses (“ALL”) is established as losses are estimated to have occurred through a provision for loan losses charged to operations.  Loan losses are charged against the ALL when management believes that principal is uncollectible.  Subsequent repayments or recoveries, if any, are credited to the ALL.  Management periodically assesses the adequacy of the ALL by reference to many quantitative and qualitative factors that may be weighted differently at various times depending on prevailing conditions. These factors include, among other elements:

•

the risk characteristics of various classifications of loans;

•

general portfolio trends relative to asset and portfolio size;

•

asset categories;

•

potential credit concentrations;

•

delinquency trends within the loan portfolio;

•

changes in the volume and severity of past due and other classified loans;

•

historical loss experience and risks associated with changes in economic, social and business conditions; and

•

the underwriting standards in effect when the loan was made.

Accordingly, the calculation of the adequacy of the ALL is not based solely on the level of non-performing assets.  The quantitative factors, included above, are utilized by our management to identify two different risk groups (1) individual loans (loans with specifically identifiable risks); and (2) homogeneous loans (groups of loan with similar characteristics).  We base the allocation for individual loans on the results of our impairment analysis, which is typically based on the present value of the expected future cash flows discounted at the loan’s effective interest rate or by using the loan’s most recent market value or the fair value of the collateral, if the loan is collateral dependent.  Homogenous groups of loans are allocated reserves based on the loss ratio assigned to the pool based on its risk grade.  The loss ratio is determined based on historical peer group loan loss data, the loss experience of other financial institutio ns, as well as the historical loss experience of our loan portfolio, augmented by the experience of management with similar assets and our independent loan review process.  Loss ratios for all categories of loans are evaluated on a quarterly basis.  Loss ratios associated with historical loss experience are determined based on a rolling migration analysis of each loan category within our portfolio.  This migration analysis estimates loss factors based on the performance of each loan category over a two-year time period.  These loss factors are then adjusted, if necessary, for other identifiable risks specifically related to each loan category or risk grade.  These quantitative calculations are based on estimates and actual losses may vary materially and adversely from the estimates.  

The qualitative factors, included above, are also utilized to identify other risks inherent in the portfolio and to determine whether the estimated credit losses associated with the current portfolio might differ from historical loss trends or the loss ratios discussed above.  We estimate a range of exposure for each applicable qualitative factor and evaluate the current condition and trend of each factor.  Because of the subjective nature of these factors and the judgments required to determine the estimated ranges, the actual losses incurred may vary materially and adversely from the estimated amounts.

In addition, regulatory agencies, as a part of their examination process, periodically review the Bank’s ALL, and may require the Bank to take additional provisions to increase the ALL based on their judgment about information available to them at the time of their examinations.  No assurance can be given that adverse future economic conditions will not lead to increased delinquent loans, further provisions for loan losses and/or charge-offs. Management believes that the ALL as of September 30, 2010 and December 31, 2009 was adequate to absorb known and inherent risks in the loan portfolio.

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The following is a summary of the activity for the ALL for the three and nine months ended September 30, 2010 and 2009.

		Three Months Ended September 30,									Nine Months Ended September 30,
(in thousands)	2010					2009				2010					2009
Beginning balance	$		4,947		$		4,733		$			5,478		$		5,171
Provision for loan losses			100				1,707					200				2,354
Charge-offs:
Commercial			(659	)			(547	)				(889	)			(547	)
Real estate-commercial mortgage			(250	)			—					(650	)			—
Consumer and other			—				(349	)				(52	)			(1,500	)
Total charge-offs			(909	)			(896	)				(1,591	)			(2,047	)
Recoveries:
Commercial			381				22					386				88
Real estate-residential mortgage			—				—					22				—
Real estate-commercial mortgage			—				—					20				—
Consumer and other			—				—					4				—
Total recoveries			381				22					432				88
Ending balance	$		4,519		$		5,566		$			4,519		$		5,566

The ALL was $4.5 million, or 2.67% of our total loan portfolio, at September 30, 2010 compared to $5.5 million, or 3.01%, at December 31, 2009.  The ALL is impacted by inherent risk in the loan portfolio, including the level of our non-performing loans, as well as specific reserves and charge-off activities.  The remaining portion of our ALL is allocated to our performing loans based on the quantitative and qualitative factors discussed above.  

Deferred Tax Asset

During the year ended December 31, 2009, we established a full valuation allowance against the Company’s deferred tax assets due to uncertainty regarding its realizability.  During the three and nine months ended September 30, 2010, we reassessed the need for this valuation allowance and concluded that a full valuation allowance remained appropriate.  Management reached this conclusion as a result of the Company’s cumulative losses since inception, and the anticipated near term economic climate in which the Company will operate. Management will continue to evaluate the potential realizability of the deferred tax assets and will continue to maintain a valuation allowance to the extent it is determined that it is more likely than not that these assets will not be realized.

At September 30, 2010, the Company maintained a deferred tax liability of $796,000 in connection with net unrealized gains on investment securities, which is included in Accrued Interest and Other Liabilities within the accompanying Consolidated Balance Sheet.  We did not utilize this deferred tax liability to reduce our tax valuation allowance due to the fact that we do not currently intend to dispose of these investments and realize the associated gains.

Deposits

The Company’s activities are largely based in the Los Angeles metropolitan area. The Company’s deposit base is also primarily generated from this area.

At September 30, 2010, total deposits were $245.6 million compared to $207.4 million at December 31, 2009, representing an increase of 18.4%, or $38.2 million. This increase was primarily due to increases in non-interest bearing demand deposits, interest bearing demand deposits and savings and money market deposits of $20.6 million, $12.8 million and $17.5 million, respectively, partially offset by a decrease in certificates of deposit of $12.6 million. The decrease in certificates of deposit was primarily attributable to a decrease of $5.0 million in State of California Treasurer’s Office certificates of deposit.  The increase in non-interest bearing, as well as interest bearing demand deposits was the result of our efforts to specifically focus on growing our core deposit franchise.  Total core deposits, which include non-interest bearing demand deposits, interest bearing demand deposits and savings and money market deposits, were $184.8 million a nd $133.9 million at September 30, 2010 and December 31, 2009, respectively, representing an increase of $50.9 million, or 38.0%.

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The following table reflects a summary of deposit categories by dollar and percentage at September 30, 2010 and December 31, 2009:

	September 30, 2010				December 31, 2009
			Percent of				Percent of
(dollars in thousands)	Amount		Total		Amount		Total
Non-interest bearing demand deposits	$	88,383	36.0	%	$	67,828	32.7	%
Interest bearing demand deposits	32,693		13.3	%	19,874		9.6	%
Savings and money market deposits	63,712		25.9	%	46,240		22.3	%
Certificates of deposit	60,839		24.8	%	73,432		35.4	%
Total	$	245,627	100.0	%	$	207,374	100.0	%

At September 30, 2010, the Company had three certificates of deposit with the State of California Treasurer’s Office for a total of $34.0 million that represented 13.8% of total deposits. At December 31, 2009, the Company had six deposit accounts with the State of California Treasurer’s Office for a total of $39.0 million that represented 18.8% of total deposits. Each of these deposits outstanding at September 30, 2010 are scheduled to mature in the fourth quarter of 2010. The Company intends to renew each of these deposits at maturity.  However, given the current economic climate in the State of California, there can be no assurance that the State of California Treasurer’s Office will continue to maintain deposit accounts with the Company.  For further information on the Company’s certificates of deposit with the State of California Treasurer’s Office, see Part I, Item 1.  Financial Statements - Note 5 “Deposits.”

The aggregate amount of certificates of deposit of $100,000 or more at September 30, 2010 and December 31, 2009 was $58.3 million and $68.8 million, respectively.

Scheduled maturities of certificates of deposit in amounts of $100,000 or more at September 30, 2010, including deposit accounts with the State of California Treasurer’s Office and CDARS were as follows:

(in thousands)
Due within 3 months or less	$	46,556
Due after 3 months and within 6 months	3,347
Due after 6 months and within 12 months	4,674
Due after 12 months	3,685
Total	$	58,262

Liquidity and Asset/Liability Management

Liquidity, as it relates to banking, is the ability to meet loan commitments and to honor deposit withdrawals through either the sale or maturity of existing assets or the acquisition of additional funds through deposits or borrowing. The Company’s main sources of funds to provide liquidity are its cash and cash equivalents, cashflow generated by pay-downs and maturities of investments, loan repayments, and increases in deposits and borrowings.  The Company maintains lines of credit with the FHLB and other correspondent financial institutions.

The liquidity ratio (the sum of cash and cash equivalents and Available for Sale investments, excluding amounts required to be pledged under borrowings, lines of credit, State of California deposit relationships and operating requirements, divided by total assets) was 29.7% at September 30, 2010 and 16.7% at December 31, 2009.  At September 30, 2010, the majority of our cash and cash equivalents were earning approximately 25 basis points.

At September 30, 2010, the Company had a $43.0 million borrowing/credit facility secured by a blanket lien on eligible loans at the FHLB. The Company had $4.0 million of long-term borrowings and no overnight borrowings outstanding under this borrowing/credit facility with the FHLB at September 30, 2010.  At December 31, 2009, the Company had a $43.0 million borrowing/credit facility secured by a blanket lien of eligible loans at the FHLB.  The Company had $16.5 million of long-term borrowings and no overnight borrowings outstanding under this borrowing/credit facility with the FHLB at December 31, 2009.

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The following table summarizes the outstanding long-term borrowings under the borrowing/credit facility secured by a blanket lien on eligible loans at the FHLB at September 30, 2010 and December 31, 2009 (dollars in thousands):

Maturity Date	Interest Rate		September 30, 2010		December 31, 2009
January 19, 2010	3.21	%	$	—	$	5,000
May 10, 2010	2.97	%	—		1,500
July 12, 2010	3.38	%	—		2,000
August 20, 2010	3.38	%	—		2,000
September 8, 2010	3.25	%	—		2,000
December 17, 2010	1.72	%	2,000		2,000
April 15, 2011	1.59	%	2,000		2,000
	Total		$	4,000	$	16,500

At September 30, 2010, the Company also had $27.0 million in Federal fund lines of credit available with other correspondent banks in order to disburse loan commitments and to satisfy demands for deposit withdrawals. Each of these lines of credit is subject to conditions that the Company may not be able to meet at the time when additional liquidity is needed.  The Company did not have any borrowings outstanding under these lines of credit at September 30, 2010 or December 31, 2009.

Management believes the level of liquid assets and available credit facilities are sufficient to meet current and anticipated funding needs.  In addition, the Bank’s Asset/Liability Management Committee oversees the Company’s liquidity position by reviewing a monthly liquidity report.  Management is not aware of any trends, demands, commitments, events or uncertainties that will result or are reasonably likely to result in a material change in the Company’s liquidity.

Capital Expenditures

As of September 30, 2010, the Company was not subject to any material commitments for capital expenditures.  

Capital Resources

At September 30, 2010, the Company had total stockholders’ equity of $47.2 million, which included $106,000 in common stock, $64.0 million in additional paid-in capital, $12.5 million accumulated deficit, $1.1 million in accumulated other comprehensive income, and $5.5 million in treasury stock.

As of September 30, 2010, the Company was not subject to any material commitments for capital.  

Capital Adequacy

The Company and the Bank are subject to the various regulatory capital requirements administered by federal banking agencies.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Failure to meet minimum capital requirements can initiate certain mandatory – and possibly additional discretionary – actions by regulators that, if undertaken, could have a direct material effect on the financial statements of the Company.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulation) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes that as of September 30, 2010 and December 31, 2009, the Company and the Bank met all capital adequacy requirements to which they are subject.

At December 31, 2009, the most recent notification from the OCC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios. There are no conditions or events since the notification that management believes have changed the Bank’s category.

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The Company’s and the Bank’s capital ratios as of September 30, 2010 and December 31, 2009 are presented in the table below:

	Company				Bank				For Capital  Adequacy Purposes				For the Bank to be  Well Capitalized Under  Prompt Corrective  Measures
(dollars in thousands)	Amount		Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio
September 30, 2010:
Total Risk-Based Capital Ratio	$	48,584	23.99	%	$	44,997	22.21	%	$	16,203	8.00	%	$	20,256	10.00	%
Tier 1 Risk-Based Capital Ratio	$	46,026	22.72	%	$	42,438	20.95	%	$	8,102	4.00	%	$	12,154	6.00	%
Tier 1 Leverage Ratio	$	46,026	16.15	%	$	42,438	14.88	%	$	11,400	4.00	%	$	14,261	5.00	%
December 31, 2009:
Total Risk-Based Capital Ratio	$	48,193	22.71	%	$	44,120	20.79	%	$	16,974	8.00	%	$	21,217	10.00	%
Tier 1 Risk-Based Capital Ratio	$	45,503	21.45	%	$	41,430	19.53	%	$	8,487	4.00	%	$	12,730	6.00	%
Tier 1 Leverage Ratio	$	45,503	16.89	%	$	41,430	15.33	%	$	10,784	4.00	%	$	13,514	5.00	%

Dividends

In the ordinary course of business, the Company is dependent upon dividends from the Bank to provide funds for the payment of dividends to stockholders and to provide for other cash requirements. Banking regulations may limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of the Bank to fall below specified minimum levels. Approval is also required if dividends declared exceed the net profits for that year combined with the retained net profits for the preceding two years.  Currently, the Bank is prohibited from paying dividends to the Company until such time as the accumulated deficit is eliminated.

To date, the Company has not paid any cash dividends.  Payment of stock or cash dividends in the future will depend upon earnings and financial condition and other factors deemed relevant by the Company’s Board of Directors, as well as the Company’s legal ability to pay dividends.  Accordingly, no assurance can be given that any cash dividends will be declared in the foreseeable future.

Off-Balance Sheet Arrangements

In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and letters of credit. To varying degrees, these instruments involve elements of credit and interest rate risk in excess of the amount recognized in the statement of financial position.

(in thousands)	September 30, 2010		December 31, 2009
Commitments to extend credit	$	63,371	$	56,249
Commitments to extend credit to directors and officers (undisbursed amount)	$	2,251	$	3,190
Standby/commercial letters of credit	$	1,973	$	946
Guarantees on revolving credit card limits	$	246	$	223
Outstanding credit card balances	$	58	$	76

The Company maintains an allowance for unfunded commitments, based on the level and quality of the Company’s undisbursed loan funds, which comprises the majority of the Company’s off-balance sheet risk.  As of September 30, 2010 and December 31, 2009, the allowance for unfunded commitments was unchanged at $203,000, which represented 0.32% and 0.36% of the undisbursed loan funds, respectively.

Management is not aware of any other off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

For further information on commitments and contingencies, see Part I, Item 1.  Financial Statements- Note 7 “Commitments and Contingencies.”

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Item 3.

Quantitative and Qualitative Disclosure About Market Risk

Not applicable.

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to management, including the Principal Executive Officer and the Principal Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating th e cost-benefit relationship of possible controls and procedures.

The Company’s management, with the participation of our Principal Executive Officer and Principal Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms, and is accumulated and communicated to management, including the Principal Executive Officer and the Principal Financial Officer, as appropriate, to allow form timely decisions regarding required disclosure.

Changes in Internal Controls

There have not been any changes in the Company’s internal controls over financial reporting that occurred during the fiscal quarter ended September 30, 2010, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1.

Legal Proceedings

At present, there are no known material pending legal proceedings against the Company.

Item 1A.

Risk Factors

Management is not aware of any material changes to the risk factors discussed in Part 1, Item 1A of the Annual Report on Form 10-K for the year ended December 31, 2009, as supplemented by the risk factor discussed in Part II, Item 1A of the Quarterly Report on Form 10-Q for the three months ended June 30, 2010.  In addition to the other information set forth in this report, you should carefully consider the risk factors discussed in Part I, Item 1A of the Annual Report on Form 10-K for the year ended December 31, 2009, as supplemented by the risk factor discussed in Part II, Item 1A of the Quarterly Report on Form 10-Q for the three months ended June 30, 2010, which could materially and adversely affect the Company’s business, financial condition and results of operations. The risks described in the Annual Report on Form 10-K, as supplemented by the risk factor discussed in Part II, Item 1A of the Quarterly Report on Fo rm 10-Q for the three months ended June 30, 2010, are not the only risks facing the Company. Additional risks and uncertainties not presently known to management or that management currently believes to be immaterial may also materially and adversely affect the Company’s business, financial condition or results of operations.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Unregistered Sales of Equity Securities

Not applicable.

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Purchases of Equity Securities

The table below summarizes the Company’s monthly repurchases of equity securities during the three months ended September 30, 2010.

(dollars in thousands, except per share data)

Period	Total Number of Shares Purchased	Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1)	Approximate Dollar Value of Shares that May Yet be Purchased Under the Plans of Program (1)
July 1-31, 2010	—	$	—	—	$	—
August 1-31, 2010	31,424	3.54		31,424	1,889
September 1-30, 2010	4,056	3.55		4,056	1,875
Total	35,480	$                        3.54		35,480	$                        1,875

(1)

In August 2010, the Company’s Board of Directors authorized the purchase of up to $2.0 million of the Company’s common stock, which was announced by press release and Current Report on Form 8-K on August 16, 2010.  Under the Company’s stock repurchase program, the Company has been acquiring its common stock in the open market from time to time beginning in August 2010.  The Company’s stock repurchase program may be modified, suspended or terminated by the Board at any time without notice.

Item 3.

Defaults Upon Senior Securities

Not applicable.

Item 4.

Reserved.

Item 5.

Other Information

(a)

Additional Disclosures.  None.

(b)

Stockholder Nominations.  There have been no material changes in the procedures by which stockholders may recommend nominees to the board of directors during the three months ended September 30, 2010.  Please see the discussion of these procedures in the most recent proxy statement on Schedule 14A filed with the SEC.

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Item 6.

Exhibits

31.1

Chief Executive Officer Certification required under Section 302 of the Sarbanes—Oxley Act of 2002.

31.2

Chief Operating Officer Certification required under Section 302 of the Sarbanes—Oxley Act of 2002.

31.3

Principal Financial Officer Certification required under Section 302 of the Sarbanes—Oxley Act of 2002.

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Chief Executive Officer, Chief Operating Officer andPrincipal Financial Officer Certification required under Section 906 of the Sarbanes—Oxley Act of 2002.

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SIGNATURES

In accordance with section 13 or 15(d) of the Securities Exchange Act, as adopted by the Comptroller, the registrant caused this report to be signed on its behalf by the undersigned, thereunto authorized, on the 9th day of November, 2010.

1ST CENTURY BANCSHARES, INC.
By:	/s/ Alan I. Rothenberg.
	Alan I. Rothenberg
	Chairman and Chief Executive Officer
By:	/s/ Jason P. DiNapoli.
	Jason P. DiNapoli
	President and Chief Operating Officer
By:	/s/ Bradley S. Satenberg.
	Bradley S. Satenberg
	Executive Vice President and Chief Financial Officer

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