ITEM 1. BUSINESS
Forward-Looking Statements: Certain matters discussed or incorporated by reference in this Annual Report on Form 10-K including, but not limited to, matters described in “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations,” are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. Such forward-looking statements may contain words related to future projections including, but not limited to, words such as “believe,” “expect,” “anticipate,” “intend,” “may,” “will,” “should,” “could,” “would,” and variations of those words and similar words that are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those projected. Factors that could cause or contribute to such differences include, but are not limited to, the following: (1) variances in the actual versus projected growth in assets; (2) return on assets; (3) loan and lease losses; (4) expenses; (5) changes in the interest rate environment including interest rates charged on loans, earned on securities investments and paid on deposits; (6) competition effects; (7) fee and other noninterest income earned; (8) general economic conditions nationally, regionally, and in the operating market areas of the Company and its subsidiary, including State and local issues being addressed in California; (9) changes in the regulatory environment; (10) changes in business conditions and inflation; (11) changes in securities markets; (12) data processing problems; (13) a further decline in real estate values in the Company’s operating market areas; (14) the effects of terrorism, the threat of terrorism or the impact of the current military conflicts in Iraq and Afghanistan, and the conduct of the war on terrorism by the United States and its allies, worsening financial and economic conditions, natural disasters, and disruption of power supplies and communications; and (15) changes in accounting standards, tax laws or regulations and interpretations of such standards, laws or regulations, as well as other factors. The factors set forth under “Item 1A
ITEM 1A. RISK FACTORS
In addition to the risks associated with the business of banking generally, as described above under Item 1 (Description of Business), the Company’s business, financial condition, operating results, future prospects and stock price can be adversely impacted by certain risk factors, as set forth below, any of which could cause the Company’s actual results to vary materially from recent results or from the Company’s anticipated future results.
Extensive Regulation of Banking. The Company’s operations are subject to extensive regulation by Federal, state and local governmental authorities and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of its operations. The Company believes that it is in substantial compliance in all material respects with laws, rules and regulations applicable to the conduct of its business. Because the Company’s business is highly regulated, the laws, rules and regulations applicable to it are subject to regular modification and change. There can be no assurance that these laws, rules and regulations, or any other laws, rules or regulations, will not be adopted in the future, which could make compliance much more difficult or expensive, restrict the Company’s ability to originate, broker or sell loans, further limit or restrict the amount of commissions, interest or other charges earned on loans originated or sold by the Company, or otherwise adversely affect the Company’s results of operations, financial condition, or future prospects.
Regulatory Agreements. On May 10, 2010, in connection with a regularly scheduled examination of the Bank by the OCC, the Bank entered into an informal Memorandum of Agreement (“Bank MOU”) with the OCC, covering actions to be taken by the Board of Directors and management to (i) reduce a high level of problem and non-performing assets, (ii) to enhance procedures for managing the risks associated with a concentration of credit in commercial real estate loans, and (iii) to maintain an adequate allowance for loan and lease losses. The Bank MOU also restricts the ability of the Bank to declare dividends and requires the formation of a Compliance Committee to monitor compliance with the MOU and submit quarterly progress reports to the OCC. Also, by letter dated June 9, 2010, the OCC notified the Board of Directors of its determination that the Bank must maintain, on an ongoing basis, a minimum ratio of Tier 1 capital to adjusted total assets of 9% and a minimum ratio of total risk-based capital to risk-weighted assets of 12%.
On June 23, 2010, the Company entered into a Memorandum of Understanding (“Company MOU”) with the Federal Reserve Bank of San Francisco (the “Reserve Bank”), agreeing that, without prior approval of the Reserve Bank, the Company would not (a) receive dividends or any other reduction of capital from the Bank; (b) pay any dividends (including TARP dividends) or make any other capital distributions; (c) incur, renew, increase or guarantee any debt; (d) issue any trust preferred securities; (e) purchase, redeem or otherwise acquire any of its stock; (f) appoint any new director or senior executive officer; or (g) make or agree to make any indemnification or severance payments in the nature of a “golden parachute.”
We believe the Bank and the Company are currently in full compliance with all terms and conditions of the Bank MOU (and the minimum capital ratios) and the Company MOU. In the event of noncompliance, the Bank and the Company would be subject to such administrative action or sanctions as the OCC and the Reserve Bank consider appropriate, which could have a material adverse effect on the Bank and the Company. See Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report for more information regarding these regulatory agreements.
Governmental Fiscal and Monetary Policies. The business of banking is affected significantly by the fiscal and monetary policies of the federal government and its agencies. Such policies are beyond the control of the Company. The Company is particularly affected by the policies established by the Board of Governors of the Federal Reserve Bank in relation to the supply of money and credit in the United States, and the target federal funds rate. The instruments of monetary policy available to the Board of Governors can be used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits, and this can and does have a material effect on the Company’s business, results of operations and financial condition. Federal monetary policy may also affect the longer-term inflation rate which directly affects the national and local economy.
The Effects of Legislation in Response to Current Credit Conditions. Legislation passed at the federal level and/or by the State of California in response to current conditions affecting credit markets could cause the Company to experience higher credit losses if such legislation reduces the amount that borrowers are otherwise contractually required to pay under existing loan contracts with the Bank. Such legislation could also result in the imposition of limitations upon the Bank’s ability to foreclose on property or other collateral or make foreclosure less economically feasible. Such events could result in increased loan losses and require a material increase in the allowance for loan losses and thereby adversely affect the Company’s results of operations, financial condition, future prospects, profitability and stock price.
Geographic Concentration. All of the banking offices of the Company are located in the Northern California Counties of San Mateo and San Francisco. The Company and the Bank conduct business primarily in the San Francisco Bay area. As a result, our financial condition, results of operations and cash flows are subject to changes in the economic conditions in this area. Our success depends upon the business activity, population, income levels, deposits and real estate activity in these markets, and adverse economic conditions could reduce our growth rate, or affect the ability of our customers to repay their loans, and generally impact our financial condition and results of operations. Economic conditions in the State of California are subject to various uncertainties at this time, including the budgetary and fiscal difficulties facing the State government. The Company can provide no assurance that conditions in the California economy will not deteriorate further or that such deterioration will not adversely affect the Company.
Competition. Increased competition in the market of the Bank may result in reduced loans and deposits. Ultimately, the Bank may not be able to compete successfully against current and future bank and non bank competitors. Many competitors offer the banking services that are offered by the Bank in its service area. These competitors include national and super-regional banks, finance companies, investment banking and brokerage firms, credit unions, government-assisted farm credit programs, other community banks and technology-oriented financial institutions offering online services. In particular, the Bank’s competitors include several major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns. Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the credit needs of larger customers. Areas of competition include interest rates for loans and deposits, efforts to obtain deposits, and range and quality of products and services provided, including new technology-driven products and services. Technological innovation continues to contribute to greater competition in domestic and international financial services markets as technological advances, such as Internet-based banking services that cross traditional geographic bounds, enable more companies to provide financial services. If the Bank is unable to attract and retain banking customers, it may be unable to continue its loan growth and level of deposits, which may adversely affect its and the Company’s results of operations, financial condition and future prospects.
The Effects of Changes to FDIC Insurance Coverage Limits and Assessments. These changes are uncertain and increased premiums may adversely affect the Company. The FDIC charges insured financial institutions premiums to maintain the Deposit Insurance Fund. Current economic conditions have increased expectations for bank failures. In such event, the FDIC would take control of failed banks and guarantee payment of deposits up to applicable insured limits from the Deposit Insurance Fund. Insurance premium assessments to insured financial institutions may increase as necessary to maintain adequate funding of the Deposit Insurance Fund.
The Emergency Economic Stabilization Act of 2008 included a provision for an increase in the amount of deposits insured by the FDIC to $250,000. On October 24, 2008, the FDIC announced the Temporary Liquidity Guarantee Program that provides unlimited deposit insurance on funds in noninterest-bearing transaction deposit accounts not otherwise covered by the existing deposit insurance limit of $250,000. All eligible institutions will be covered under the program for the first 30 days without incurring any costs. After the initial period, participating institutions will be assessed a 10 basis point surcharge on the additional insured deposits through the scheduled end of the program. Increased premiums will negatively impact the Company’s earnings.
FDIC Final Rule of Assessments, Dividends, Assessment Base and Large Bank pricing dated February 7, 2011. The Board of Directors of the Federal Deposit Insurance Corporation (“FDIC”) approved a final rule on Assessments, Dividends, Assessment Base and Large Bank Pricing. The rule implements changes to the deposit insurance assessment system mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act and revises the assessment system applicable to large banks to eliminate reliance on debt issuer ratings and make it more forward looking. Dodd-Frank required that the base on which deposit insurance assessments are charged be revised from one based on domestic deposits to one based on assets.
In November, 2010, the FDIC approved a proposed rule to change the assessment base from adjusted domestic deposits to average consolidated assets minus average tangible equity and reissued a proposed rule revising the deposit insurance assessment system for large institutions that was approved by the FDIC in April 2010. The FDIC approved a proposed rule on Assessments, Dividends, Assessment Rates and the Designated Reserve Ratio in October 2010. The final rule encompasses both of these proposed rules.
It is not clear how depositors may respond regarding the increase in insurance coverage. Despite the increase, some depositors may reduce the amount of deposits held at the Bank if concerns regarding bank failures persist, which could affect the level and composition of the Bank’s deposit portfolio and thereby directly impact the Bank’s funding costs and net interest margin. The Bank’s funding costs may also be adversely affected in the event that activities of the Federal Reserve Board and the U.S. Treasury to provide liquidity for the banking system and improvement in capital markets are curtailed or are unsuccessful. Such events could reduce liquidity in the markets, thereby increasing funding costs to the Bank or reducing the availability of funds to the Bank to finance its existing operations and thereby adversely affect the Company’s results of operations, financial condition, future prospects, profitability and stock price.
We are Subject to Interest Rate Risk. Our earnings and cash flows are largely dependent upon our net interest income. Net interest income is the difference between interest income earned on interest-earning assets, such as loans and securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are sensitive to many factors outside our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System, which regulates the supply of money and credit in the United States. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and interest we pay on deposits and borrowings, but could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, and (iii) the average duration of our mortgage-backed securities portfolio. Our portfolio of securities is subject to interest rate risk and will generally decline in value if market interest rates increase, and generally increase in value if market interest rates decline.
We Rely on Technology and Continually Encounter Technological Change. The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology will enable efficiency and meeting customer’s changing needs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to retain and compete for customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact of the long-term aspect our business and, in turn, our financial condition and results of operations.
Dependence on Key Officers and Employees. We are dependent on the successful recruitment and retention of highly qualified personnel. Our ability to implement our business strategies is closely tied to the strengths of our executive officers who have extensive experience in the banking industry but who are not easily replaced. In addition, business banking, one of the Company’s principal lines of business, is dependent on relationship banking, in which the Bank personnel develop professional relationships with small business owners and officers of larger business customers who are responsible for the financial management of the companies they represent. If these employees were to leave the Bank and become employed by a local competing bank, we could potentially lose business customers. In addition, we rely on our customer service staff to effectively serve the needs of our consumer customers. We actively recruit for all open positions and management believes that its relations with employees are good.
Growth strategy. We have pursued and continue to pursue a growth strategy which depends primarily on generating an increasing level of loans and deposits at acceptable risk levels. We may not be able to sustain this growth strategy without establishing new branches or new products. We may attempt to expand in our current market by opening or acquiring branch offices or other financial institutions or branch offices or through a purchase, in whole or in part, of other financial institutions. This expansion may require significant investments in equipment, technology, personnel and site locations. We cannot assure you of our success in implementing our growth strategy either through expansion of our existing branch system or through mergers and acquisitions, and there may be significant increases in our noninterest expenses, without any corresponding balance sheet growth.
Commercial loans. As of December 31, 2010, approximately 12.7% of our loan portfolio consisted of commercial business loans, which could have a higher degree of risk than other types of loans. Commercial lending is dependent on borrowers making payments on their loans and lines of credit in accordance with the terms of their notes. Our current economic recession has made it difficult for many commercial borrowers to make their required loan payments. This credit risk is increased when there is a concentration of principal in a limited number of loans and borrowers, the mobility of collateral, the effect of general economic conditions and the increased difficulty of evaluating and monitoring these types of loans. The availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself and the general economic environment. If the cash flow from business operations is reduced, the borrower’s ability to repay the loan may be impaired. In addition, unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. If the Bank is required to repossess equipment or pursue collection efforts under personal guarantees, there could be a substantial decrease in value of collateral, if any, increased legal costs, and an increased risk of loss on the amount outstanding.
Real Estate Values. A large portion of the loan portfolio of the Company is dependent on the performance of our real estate portfolio. At December 31, 2010, real estate (including construction loans) served as the principal source of collateral with respect to approximately 86.8% of the Company’s loan portfolio. The current substantial decline in the economy in general, coupled with a continued decline in real estate values in the Company’s primary operating market areas could have an adverse effect on the demand for new loans, the ability of borrowers to repay outstanding loans, and the value of real estate and other collateral securing loans. Real estate values have declined, due in part to reduced construction lending, tighter underwriting requirements, and reduced borrower ability to make payments. Real estate loans may pose collection problems, resulting in increased collection expenses, and delays in the ultimate collection of these loans.
In addition, acts of nature, including fires, earthquakes and floods, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact the Company’s financial condition.
Allowance for Loan and Lease Losses. The Company maintains an allowance for loan losses to provide for loan defaults and non-performance, but its allowance for loan losses may not be adequate to cover actual loan and lease losses. In addition, future provisions for loan and lease losses could materially and adversely affect the Company and therefore the Company’s operating results. The Company’s allowance for loan and lease losses is based on prior experience, as well as an evaluation of the risks in the current portfolio. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond the Company’s control, and these losses current estimates. Federal regulatory agencies, as an integral part of their examination process, review the Company’s loans and the allowance for loan and lease losses. Although we believe that the Company’s allowance for loan and lease losses is adequate to cover current losses, we cannot assure you that it will not further increase the allowance for loan and lease losses or that the regulators will not require it to increase this allowance. Either of these occurrences could materially and adversely affect the Company’s earnings.
Other Real Estate Owned (“OREO”). Real estate acquired through, or in lieu of, loan foreclosures is expected to be sold and is recorded at its fair value less estimated costs to sell (fair value). The amount, if any, by which the recorded amount of the loan exceeds the fair value (less estimated costs to sell) are charged to the allowance for loan or lease losses, if necessary. The Company’s earnings could be materially and adversely affected by various expenses associated with OREO, including legal expenses, personnel costs, insurance and taxes, completion and repair costs, valuation adjustments, and other expenses associated with property ownership. Also, any further decrease in market prices of real estate in our market areas may lead to additional OREO write downs, with a corresponding expense in our income statement. At December 31, 2010, 2009 and 2008, our OREO totaled $6,680,000, $7,320,000 and $3,557,000, respectively
Environmental Liabilities. In the course of our business, we may foreclose and take title to real estate, and could become subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigations or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we could become subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business prospects, financial condition, liquidity, results of operations and stock price could be materially and adversely affected.
Dilution of Common Stock. Shares of the Company’s common stock eligible for future sale could have a dilutive effect on the market for common stock and could adversely affect the market price.
The Articles of Incorporation of the Company authorize the issuance of 10,000,000 shares of common stock, of which approximately 3,341,049 were outstanding at December 31, 2010. Pursuant to its 1997, 2002 and 2008 Stock Option Plans, at December 31, 2010, the Company had outstanding options to purchase a total of 427,089 shares of common stock. As of December 31, 2010, 286,849 shares of common stock remained available for grants under the 2008 Stock Option Plan as well as an additional 44,823 shares under the 2002 Stock Option Plan. The issuance of substantial amounts of the Company’s newly issued common stock in the public market could adversely affect the market price of the Company’s common stock. The market for the Company’s common stock is limited. The ability to raise funds in the future through a stock offering could be difficult.
Operating Losses. The Company is subject to certain operations risks, including, but not limited to, data processing system failures and errors and customer or employee fraud. The Company maintains a system of internal controls to mitigate against such occurrences and maintains insurance coverage for such risks, but should such an event occur that is not prevented or detected by the Company’s internal controls, uninsured or in excess of applicable insurance limits, it could have a significant adverse impact on the Company’s business, financial condition or results of operations. Additionally, the Company is dependent on network and computer systems. If these systems and their back-up systems were to fail or were breached, the Company could be adversely affected.
Business Confidence Uncertainty. Terrorist activities in the future and the actions taken by the United States and its allies in combating terrorism on a worldwide basis could adversely impact the Company and the extent of such impact is uncertain. Even more so, the problems in the mortgage and credit markets, the government conservatorship of Fannie Mae and Freddie Mac, the failure of investment firms such as Bear Stearns and Lehman Brothers, and the bailout of AIG Inc., the insurance giant, as well as large write-offs at some major financial institutions have had a ripple effect on the entire financial services industry, and may continue to do so for some time. Such events have had and may continue to have an adverse effect on the economy in the Company’s market areas. Such continued economic deterioration could adversely affect the Company’s future results of operations by, among other matters, reducing the demand for loans and the amounts required to be reserved for loan losses, reducing the value of collateral held as security for the Company’s loans, and causing a decline in the Company’s stock price.
Restrictions in Purchase Agreement with U.S. Treasury. The Purchase Agreement between the Company and the U.S. Treasury dated February 27, 2009, pursuant to which the Company sold $12 million of the Company’s Series A Preferred Stock and issued 600 shares of the Company’s Series B Preferred Stock (upon exercise of the Warrant issued to the U.S. Treasury), provides that prior to the earlier of (1) February 27, 2012 and (2) the date on which all of the shares of the U.S. Treasury Preferred Stock have been redeemed by the Company or transferred by the U.S. Treasury to third parties, the Company may not, without the consent of the Treasury, (a) declare or pay any dividend or make any distribution on capital stock or other equity securities of any kind of the Company other than (i) regular quarterly cash dividends of not more than the amount of the last quarterly cash dividend per share declared, or (ii) dividends payable solely in shares of common stock, or (b) subject to limited exceptions, redeem, repurchase or otherwise acquire shares of the Company’s common stock or preferred stock other than the U.S. Treasury Preferred Stock. In addition, the Company is unable to pay any dividends on the Company’s common stock unless the Company is current in the Company’s dividend payments on the U.S. Treasury Preferred Stock. These restrictions could have a negative effect on the value of the Company’s common stock. Dividends paid by the Company on the shares of U.S. Treasury Preferred Stock will reduce the net income available to the holders of Company common stock and the Company’s earnings per common share. The holders of the Company’s common stock are entitled to receive dividends only when, as and if declared by the Company’s Board of Directors. Although the Company has historically paid stock and cash dividends on the Company’s common stock, the Company is not required to do so and the Company’s Board of Directors could reduce or eliminate these common stock dividends in the future, depending on the circumstances.
The U.S. Treasury Preferred Stock will also receive preferential treatment in the event of liquidation, dissolution or winding up of the Company.
Restrictions on Executive Compensation. Pursuant to the terms of the Purchase Agreement, the Company adopted certain standards for executive compensation and corporate governance. These standards generally apply to the Company’s Chief Executive Officer, the Chief Financial Officer and the three next most highly compensated senior executive officers. The standards (1) ensure that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) require “clawback” of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibit making golden parachute payments to senior executives; and (4) confirm agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive. Pursuant to the American Recovery and Reinvestment Act of 2009, further compensation restrictions, including significant limitations on incentive compensation and “golden parachute” payments, have been imposed on the Company’s most highly compensated employees, which could, in the future, make it more difficult for the Company to retain and recruit qualified personnel.
Federal Home Loan Bank Risk. The failure of the Federal Home Loan Bank (“FHLB”) of San Francisco or the national Federal Home Loan Bank System may have a material negative impact on our earnings and liquidity.
Even though the FHLB of San Francisco has announced it does not anticipate that additional capital is immediately necessary, nor does it believe that its capital level is inadequate to support realized losses in the future, the FHLB of San Francisco could require its members, including the Bank, to contribute additional capital in order to return the FHLB of San Francisco to compliance with capital guidelines.
At December 31, 2010, we held $4.1 million of common stock in the FHLB of San Francisco. Should the FHLB of San Francisco fail, we anticipate that our investment in the FHLB’s common stock would be “other than temporarily” impaired and may have no value.
At December 31, 2010, we maintained a line of credit with the FHLB of San Francisco equal to approximately 30% of total assets to the extent the Bank provides qualifying collateral and holds sufficient FHLB stock. At December 31, 2010, we were in compliance with collateral requirements. The Company also maintained a Line of Credit available with the Federal Reserve Bank of San Francisco (“FRB”) of $49,195,000 as of December 31, 2010 that was secured by commercial and construction loans. In addition, we have an unsecured Federal Funds line of up to $45,000,000 at year end. We are highly dependent on the FHLB of San Francisco to provide the primary source of wholesale funding for immediate liquidity and borrowing needs. The failure of the FHLB of San Francisco or the FHLB system in general, may materially impair our ability to meet our growth plans or to meet short and long term liquidity demands.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
The Company does not own any real property. Since its incorporation on February 28, 2001, the Company has conducted its operations at the administrative offices of the Bank, located at 975 El Camino Real, South San Francisco, California 94080.
The Bank owns the land and building at 975 El Camino Real, South San Francisco, California 94080. The premises consist of a modern, three-story building of approximately 15,000 square feet and off-street parking for employees and customers of approximately 45 vehicles.
The Buri Buri Branch Office of the Bank is located on the ground floor of this three-story building and administrative offices, including the offices of senior management and credit administration, occupy the second and third floors.
The Bank owns the land and two-story building occupied by the Daly City Branch Office (6600 Mission Street, Daly City, CA 94014); the land and two-story building occupied by the Colma Branch Office (1300 El Camino Real, Colma, CA 94014); the land and two-story building occupied by the South San Francisco Branch Office (211 Airport Boulevard, South San Francisco, CA 94080); the land and two-story building occupied by the Redwood City Branch Office (700 El Camino Real, Redwood City, CA 94063); the land and two-story building occupied by the Millbrae Branch Office (1551 El Camino Real, Millbrae, CA 94030); the land and single-story building occupied by the Half Moon Bay Branch Office (756 Main Street, Half Moon Bay, CA 94019); and the land and two-story building occupied by the Pescadero Branch Office (239 Stage Road, Pescadero, CA 94060). All properties include adequate vehicle parking for customers and employees.
The Bank owns approximately 30,900 square feet of land and an approximately 5,100 square foot one story building located at 425 South Mathilda Avenue, Sunnyvale, CA 94086 for the purpose of a future loan production office. The building has been unoccupied since its purchase in 2010.
The Bank leases premises at 1450 Linda Mar Shopping Center, Pacifica, California 94044, for its Linda Mar Branch Office. This ground floor space is approximately 4,100 square feet. The original lease term was 10 years and expired on September 1, 2009. The lease has been renewed for a further ten years and will expire on August 31, 2019.
The Bank leases premises at 65 Post Street, San Francisco, CA 94104, for its Financial District Office. The current lease term expires April 30, 2013, with one 5-year option to extend the lease remaining. The location consists of approximately 2,826 square feet of street level, 1,322 square feet of basement, and 1,077 square feet of mezzanine space.
The Bank leases premises at 6599 Portola Drive, San Francisco, CA 94127, for its Portola Office. The current lease expires June 30, 2012, and has a remaining 2-year option to extend the lease to June 30, 2014. The location consists of approximately 1,325 square feet of street level space.
The Bank subleases premises at 2197 Chestnut Street, San Francisco, CA consisting of 2,150 square feet at street level and approximately 2,000 square feet on the second floor. The sublease ends on July 15, 2024.
The Bank leases premises at 150 East Third Avenue, San Mateo, CA 94401, for its San Mateo Branch Office. The current lease term, expires July 31, 2013. It has one remaining five-year option to extend the lease. The location consists of approximately 4,000 square feet of ground floor usable commercial space.
The Bank leases a warehouse facility at 450 Cabot Road, South San Francisco, CA 94080. The lease term is for 5 years and one half month, and will expire February 28, 2011. The facility consists of approximately 7,600 square feet of office/warehouse space. Management intends to continue to occupy this property and is in the process of negotiating a new lease contract.
The foregoing summary descriptions of leased premises are qualified in their entirety by reference to the full text of the lease agreements listed as exhibits to this report.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings adverse to the Company or the Bank to which any director, officer, affiliate of the Company, or 5% shareholder of the Company, or any associate of any such director, officer, affiliate or 5% shareholder of the Company are a party, and none of the foregoing persons has a material interest adverse to the Company or the Bank.
From time to time, the Company and/or the Bank are a party to claims and legal proceedings arising in the ordinary course of business. The Company’s management is not aware of any material pending legal proceedings to which either it or the Bank may be a party or has recently been a party, which will have a material adverse effect on the financial condition or results of operations of the Company and the Bank, taken as a whole.
ITEM 4.
ITEM 4. (REMOVED AND RESERVED)
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Since March 18, 2002, the common stock of the Company has been quoted on the OTC Bulletin Board under the trading symbol, “FNBG.” There has been limited trading in the shares of common stock of the Company. On February 28, 2011, the Company had approximately 700 shareholders of common stock of record.
The following table summarizes sales of the Common Stock of the Company during the periods indicated of which management has knowledge, including the approximate high and low bid prices during such periods and the per share cash dividends declared for the periods indicated. All information has been adjusted to reflect 5% stock dividends effected on December 15, 2009 and on December 20, 2010. The prices indicated below reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
See Item 1, “Limitations on Dividends,” above (following the “Additional Regulations” sub section, for a description of the limitations applicable to the payment of dividends by the Company.
STOCK PERFORMANCE GRAPH
Set forth below is a line graph comparing the annual percentage change in the cumulative total return on the Company’s Common Stock with the cumulative total return of the SNL Securities Index of Pink Banks (asset size of over $500 million) and the Russell 2000 Index as of the end of each of the last five fiscal years.
The graph assumes that $100.00 was invested on December 31, 2005 in the Company’s Common Stock and each index, and that all dividends were reinvested. Returns have been adjusted for any stock dividends and stock splits declared by the Company. Shareholder returns over the indicated period should not be considered indicative of future shareholder returns.
ISSUER PURCHASES OF EQUITY SECURITIES
On August 24, 2007, the Board of Directors of the Company authorized a stock repurchase program which calls for the repurchase of up to five percent (5%) of the Company’s then outstanding 2,863,635 shares of Common Stock, or 143,182 shares. There were no repurchases during the quarter and year ended December 31, 2010 and 2009. There were 10,457 shares remaining that may be purchased under this Plan as of December 31, 2010. Effective February 27, 2009, based on the Purchase Agreement with the U. S. Treasury, the Company may not repurchase Company common stock so long as the Treasury’s Preferred Stock investment is outstanding.
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
The following table presents a summary of selected financial information that should be read in conjunction with the Company’s consolidated financial statements and notes thereto included under Item 8 - “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.”
(1) per share data has been adjusted for stock dividends.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF FNB BANCORP AND SUBSIDIARY
Critical Accounting Policies And Estimates
Management’s discussion and analysis of its financial condition and results of operations are based upon the Company’s financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to its loans and allowance for loan losses. The Company bases its estimates on current market conditions, historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. All adjustments that, in the opinion of management, are necessary for a fair presentation for the periods presented have been reflected as required by Regulation S-X, Rule 10-01. The Company believes the following critical accounting policies requires significant judgments and estimates used in the preparation of the consolidated financial statements.
Allowance for Loan Losses
The allowance for loan losses is periodically evaluated for adequacy by management. Factors considered include the Company’s loan loss experience, known and inherent risks in the portfolio, current economic conditions, known adverse situations that may affect the borrower’s ability to repay, regulatory policies, and the estimated value of underlying collateral. The evaluation of the adequacy of the allowance is based on the above factors along with prevailing and anticipated economic conditions that may impact our borrowers’ ability to repay their loans. Determination of the allowance is based upon objective and subjective judgments by management from the information currently available. Adverse changes in information could result in higher charge-offs and loan loss provisions.
Goodwill
Goodwill arises when the Company’s purchase price exceeds the fair value of net assets of an acquired business. Goodwill represents the value attributable to intangible elements acquired. The value of goodwill is supported ultimately by profit from the acquired business. A decline in earnings could lead to impairment, which would be recorded as a write-down in the Company’s consolidated statements of earnings. Events that may indicate goodwill impairment include significant or adverse changes in results of operations of the acquired business or asset, economic or political climate; an adverse action or assessment by a regulator; unanticipated competition; and a more-likely-than-not expectation that a reporting unit will be sold or disposed of at a loss.
Other Than Temporary Impairment
Other than temporary impairment (“OTTI”) is triggered if the Company has the intent to sell the security, it is likely that it will be required to sell the security before recovery, or if the Company does not expect to recover the entire amortized cost basis of the security. If the Company intends to sell the security or it is likely it will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If the Company does not intend to sell the security and it is not likely that the Company will be required to sell the security but the Company does not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings as an OTTI. The credit loss is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected of a security. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment loss related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, would be recognized as a charge to other comprehensive income (“OCI”). Impairment losses related to all other factors are to be presented as a separate category within OCI. For investment securities held to maturity, this amount is accreted over the remaining life of the debt security prospectively based on the amount and timing of future estimated cash flows. The accretion of the OTTI amount recorded in OCI will increase the carrying value of the investment, and would not affect earnings. If there is an indication of additional credit losses the security is re-evaluated accordingly based on the procedures described above.
Provision for and Deferred Income Taxes
The Company is subject to income tax laws of the United States, its states, and municipalities in which it operates. The Company considers its income tax provision methodology to be critical, as the determination of current and deferred taxes based on complex analyses of many factors including interpretation of federal and state laws, the difference between tax and financial reporting bases of assets and liabilities (temporary differences), estimates of amounts due or owed, the timing of reversals of temporary differences and current financial standards. Actual results could differ significantly from the estimates due to tax law interpretations used in determining the current and deferred income tax liabilities. Additionally, there can be no assurances that estimates and interpretations used in determining income tax liabilities may not be challenged by federal and state taxing authorities.
Fair Values of Financial Instruments
Certain assets and liabilities are either carried at fair value on a recurring or non-recurring basis or are required to be disclosed at fair value. Accounting principles have established a fair value measurement model which establishes a framework that quantifies fair value estimates by the level of pricing precision. The degree of judgment utilized in measuring the fair value of assets generally correlates to the level of pricing precision. Financial instruments rarely traded or not quoted will generally have a higher degree of judgment utilized in measuring fair value. Pricing precision is impacted by a number of factors including the type of asset, the availability of the asset, the market demand for the asset, and other conditions that were considered at the time of the valuation.
Recent Accounting Pronouncements
In January, 2010, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No. 2010-06, to improve disclosure requirements related to “Fair Value Measurements and Disclosures-Overall Subtopic (Subtopic 820-10)” of the FASB Accounting Standards Codification, which was originally issued as FASB Statement No. 157, Fair Value Measurements. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009 except for the disclosures about purchases, sales, issuances and settlements in the rollforward activity in Level 3 fair value measurements. The new disclosures require separate disclosures regarding transfers in and out of Levels 1 and 2 fair value measurements, and to describe the reasons for the transfers. As to activity in Level 3, a reporting entity is required to present separate information about purchases, sales, issuances and settlements (on a gross basis rather than as one net number).This required first quarter of 2010 implementation so that investments shown by class and changes or transfers in levels were disclosed. The Company only measures investment securities, impaired loans and real estate owned at fair value. Our adoption of this standard update did not have an impact on our financial condition or results of operations.
In February 2010, the FASB issued ASU No. 2010-09, “Subsequent Events (Topic 855)-Amendments to Certain Recognition and disclosure Requirements.” This ASU eliminates the requirement to disclose the date through which a Company has evaluated subsequent events and refines the scope of the disclosure requirements for reissued financial statements. This ASU was effective for the first quarter of 2010. This ASU did not have an impact on the Company’s consolidated financial statements, since it is not applicable to public companies.
In March 2010, the FASB issued ASU No. 2010-11, “Derivatives and Hedging (Topic 815)-Scope Exception Related to Embedded Credit Derivatives.” The ASU eliminates the scope exception for bifurcation of embedded credit derivatives in interests in securitized financial assets, unless they are created solely by subordination of one financial instrument to another. The ASU was effective the first quarter beginning after June 15, 2010. This ASU did not have a material impact on the Company’s consolidated financial statements.
In April 2010, the FASB issued ASU No. 2010-18, “Receivables (Topic 310)-Effect of a Loan Modification When the Loan Is Part of a Pool That is Accounted for as a Single Asset”. This ASU clarifies that modifications of loans that are accounted for within a pool under Topic 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. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. No additional disclosures are required with this ASU. The amendments in this ASU were effective for modifications of loans accounted for within pools under Topic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. The amendments are to be applied prospectively and early application is permitted. Upon initial adoption of the guidance in this ASU, an entity may make a onetime election to terminate accounting for loans as a pool under Topic 310-30. This election may be applied on a pool-by-pool basis and does not preclude an entity from applying pool accounting to subsequent acquisitions of loans with credit deterioration. The Company has evaluated the impact of adoption and it did not have a material impact on the Company’s consolidated financial statements.
In July 2010, the FASB issued ASU No. 2010-20, “Receivables (Topic 310)-Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The objective of the amendments in this Update is for an entity to provide disclosures that facilitate financial statement users’ evaluation of the following:
1.
The nature of credit risk inherent in the entity’s portfolio of financing receivables.
2.
How that risk is analyzed and assessed in arriving at the allowance for credit losses.
3.
The changes and reasons for those changes in the allowance for credit losses.
The disclosures about activity that occurs during a reporting period were effective for interim and annual reports beginning on or after December 15, 2010.
In December 2010, the FASB issued ASU No. 2010-28, Intangibles-Goodwill and Other (Topic 350)-When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. The amendments in this update modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. The amendments become effective for public entities for fiscal years beginning after December 15, 2010. Early adoption is not permitted. The Company does not have goodwill with a zero or negative carrying amount.
In December, 2010, the FASB issued ASU No. 2010-29, Business Combinations (Topic 805). The amendments in this Update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current yearhad occurred as of the beginning of the comparable prior annual reporting period.
In January, 2011, the FASB issued ASU No. 2011-01, Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. The amendments in this Update temporarily delay the effective date of the disclosures about troubled debt restructurings in Update 2010-20 for public entities. The delay is intended to allow the Board time to complete its deliberations on what constitutes a troubled debt restructuring. Currently, the guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011.
Earnings Analysis
Net earnings in 2010 were $3,665,000, a $3,072,000 or a 518.0% increase from 2009 net earnings of $593,000. Net earnings for the year 2009 decreased $3,370,000 or 85.0% from year 2008 net earnings of $3,963,000. Net earnings (loss) available to common stockholders were $2,812,000 in 2010, ($39,000) in 2009, and $3,963,000 in 2008. The principal source of income is interest income on loans. The level of interest income can be affected by changes in interest rate, volume of loans outstanding, and the quality of the Bank’s loan portfolio. Loans that are 90 days or more past due are placed on non-accrual status. Income on such loans is then recognized only to the extent that cash is received, and where the future collection of principal is probable. All other loans accrue interest at the stated contract rate.
Basic earnings (loss) per share were $0.84 in 2010, ($0.01) in 2009, and $1.17 in 2008. Diluted earnings (loss) per share were $0.84 in 2010, ($0.01) in 2009, and $1.15 in 2008.
Net interest income for 2010 was $29,045,000, an increase of $2,239,000, or 8.4% from 2009. In 2009, net interest income was $26,806,000, a decrease of $1,114,000 or 4.0% from 2008. Interest income was $34,428,000 in 2010, a decrease of $1,389,000 or 3.9% from 2009. Interest income was $35,817,000 in 2009, a decrease of $3,610,000 or 9.2% from 2008. Interest income on deposits at the Federal Reserve Bank of San Francisco were $136,000 in 2010, $42,000 in 2009 and none in 2008. The increase in net interest income during 2010 was caused primarily by a decrease in the interest rate paid on interest bearing liabilities which exceeded the decrease in the interest rate earned on interest earning assets. Most of the interest earning assets are tied to the prime lending rate, which has seen no change during 2010. During 2009, the net interest income reduction from 2008 levels was primarily caused by a decline in interest earned on interest earning assets that was greater than the decline in interest expense on interest bearing liabilities. Total nonaccrual loans were $16,712,000 and $25,592,000 as of December 31, 2010 and 2009, respectively. Payments received for loans on nonaccrual status, where principal is believed to be fully collectible, are credited to interest income when they are received. Average interest earning assets totaled $613,553,000 in 2010, an increase of $5,231,000 or 0.9% over 2009. They averaged $608,322,000 in 2009, an increase of $9,923,000 or 1.7% over 2008. The yield on interest earning assets decreased 27 basis points in 2010 compared to 2009. They decreased 72 basis points in 2009 compared to 2008. The principal earning assets were loans, and average loans outstanding decreased $10,648,000 in 2010 versus 2009, but increased $4,707,000 in 2009 versus 2008. Their yield decreased 13 basis points in 2010 compared to 2009, and 63 basis points in 2009 compared to 2008. Loan origination volumes in 2010 were significantly lower than in 2009 and 2008. These lower origination volumes coupled with loan prepayments caused our average 2010 loans outstanding to decrease and contributed to the decline in our 2010 loan interest income from 2009 levels.
Interest expense for 2010 was $5,383,000 compared to $9,011,000 for 2009, a decrease of $3,628,000 or 40.3%. In 2009 interest expense was $9,011,000 compared to $11,507,000 for 2008, a decrease of $2,496,000, or 21.7%. The decrease in interest expense during 2010, 2009 and 2008 was caused primarily by rate decreases on deposits, as rates followed the declines in prevailing short term market interest rates. During 2010, the Federal Open Market Committee (“FOMC”) federal funds rate was maintained at a target rate between 0% and 0.25%. A new consumer product, the Money Market Maximizer, was created during 2009, and reached $122,594,000 in deposit balances by the end of 2010. Average interest bearing liabilities were $511,277,000 in 2010, $482,900,000 in 2009, and $463,546,000 in 2008 . This represented an increase of $28,377,000 in 2010 over 2009, and an increase of $19,354,000 in 2009 over 2008. The cost of these liabilities decreased 82 basis points in 2010 compared to 2009, and decreased 61 basis points in 2009 compared to 2008. Time deposit costs decreased 76 basis points in 2010 compared to 2009, and decreased 130 basis points in 2009 compared to 2008. The Bank generally lowered rates paid on interest bearing liabilities throughout 2009 and accelerated these rate reductions during 2010. Management believes that further rate reductions on interest bearing liabilities will be difficult to achieve given the low absolute levels of existing market interest rates.
Net Interest Income
Net interest income is the difference between interest yield generated by earning assets and the interest expense associated with the funding of those assets. Net interest income is affected by the interest rate earned or paid and by volume changes in loans, investment securities, deposits and borrowed funds.
(1)
Interest on non-accrual loans is recognized into income on a cash received basis if the loan has demonstrated performance and full collection is considered probable.
(2)
Amounts of interest earned include loan fees of $1,075,000, $1,249,000 and $1,425,000 for the years ended December 31, 2010, 2009 and 2008, respectively.
(3)
Tax equivalent adjustments recorded at the statutory rate of 34% that are included in the nontaxable securities portfolio are $401,000, $392,000, and $481,000 for the years ended December 31, 2010, 2009 and 2008, respectively, and were derived from nontaxable municipal interest income.
(4)
The annualized net interest margin is computed by dividing net interest income by total average interest earning assets.
The following table analyzes the dollar amount of change in interest income and expense and the changes in dollar amounts attributable to (a) changes in volume (changes in volume at the current year rate), (b) changes in rate (changes in rate times the prior year’s volume) and (c) changes in rate/volume (changes in rate times changes in volume). In this table, the dollar change in rate/volume is prorated to volume and rate proportionately.
Note (1) Nontaxable securities in this Table are shown on a taxable equivalent basis.
Note (2) Increases (decreases) shown are in relation to their effect on net interest income.
The net interest margin on average earning assets was 4.80% in 2010 compared to 4.47% in 2009 and 4.75% in 2008. The average rate earned on interest earning assets was 5.68% in 2010, 5.95% in 2009 and 6.67% in 2008. The average cost for interest-bearing liabilities was 1.05% in 2010 compared to 1.87% in 2009 and 2.48% in 2008. The improvement in net interest margin in 2010 was related to an overall market rate decline that allowed the Bank to lower deposit rates faster than the corresponding decline in the earning rate on interest earning assets.
Yield on average loans was 6.38% in 2010, 6.51% in 2009 and 7.14% in 2008. Interest on average taxable securities was 2.09% in 2010, 3.05% in 2009 and 4.22% in 2008. Interest on average nontaxable securities on a tax equivalent basis was 4.64% in 2010, 4.75% in 2009 and 4.77% in 2008. Interest on average federal funds sold was 0.58% in 2009, 2.24% in 2008. There were minimal federal funds sold during 2010. Interest on average total interest earning assets was 5.68% in 2010, 5.95% in 2009 and 6.67% in 2008. On the expense side, the market decline in income on interest bearing assets was also followed by declines in competitive market rates offered on interest-bearing liabilities.
Allowance For Loan Losses
The Board of Directors, with help from senior executive management, has the ultimate responsibility of assessing the overall risks in the Company’s loan portfolio, assessing the specific loss expectancy, and determining the adequacy of the loan loss reserve. The level of reserves is determined by internally generated credit quality ratings, a review of the local economic conditions in the Bank’s market area, and consideration of the Bank’s historical loan loss experience. The Bank is committed to maintaining adequate reserves, identifying credit weaknesses through frequent loan reviews, and updating loan risk ratings and changing those risk ratings in a timely manner as circumstances change.
Real estate loans outstanding increased by $6,383,000 in 2010 compared to 2009, and increased by $33,519,000 in 2009 compared to 2008. Bank management maintained conservative underwriting standards during 2010 and 2009 , which generally required borrowers to maintain at most a loan-to-value ratio of 70%; maintain a debt service coverage ratio of at least 1.25; and required borrowers to make monthly mortgage payments out of documented cash flows.
During 2010 and 2009, we priced our loans competitively, but did not discount our loans in order to attract new business. The reserve allocated to our loans was increased in 2009 and again in 2010, at levels designed to accurately reflect the credit risk involved in the our loan portfolio. We experienced increased loan charge-offs and non-accrual loans during 2009 compared to 2008 levels, which subsequently decreased during 2010. The credit quality of our underlying collateral also deteriorated during 2009, but showed signs of improvement during 2010, necessitating an increased provision for loan losses in 2009 compared to 2008 and 2010 levels.
The allowance for loan losses totaled $9,524,000, $9,829,000 and $7,075,000 at December 31, 2010, 2009 and 2008, respectively. This represented 1.97%, 1.95% and 1.40% of total loans outstanding on those dates. These balances reflect amounts that, in management’s judgment, are adequate to provide for probable loan losses based on the considerations listed above. During 2010, the provision for loan losses was $1,854,000, and the net charge-offs were $2,159,000. During 2009, the provision for loan losses was $4,596,000, and the net charge-offs were $1,842,000. During 2008, the provision for loan losses was $3,045,000, and the net charge-offs were $1,608,000. Management performs stress testing of our loan portfolio to gain a better understanding of the portfolio effects of additional declines in real estate values and expected cash values. Management also evaluates all commercial loans, secured and unsecured, at least annually.
Table 4 summarizes transactions in the allowance for loan losses and details the charge-offs, recoveries and net loan losses by loan category for each of the last five fiscal years ended December 31, 2010. The amount added to the provision and charged to operating expenses for each period is based on the risk profile of the loan portfolio.
The increase in charge-offs during 2008, 2009 and 2010 was primarily attributable to problems that were identified with specific borrowers rather than problems with a particular segment of the loan portfolio. In particular, borrowers who had exposure to real estate projects outside of San Mateo and San Francisco counties were identified as having a relatively higher risk profile than those operating solely within these two counties. Additionally, there was a high default rate related to purchased single family loans that were serviced by outside third parties during 2009. These loan purchase programs have been terminated and the servicing of these loans is now performed by the Bank. Problem asset resolution efforts during 2010 helped to keep problem loan levels below 2009 levels. If real estate values or lease rates continue to decline in the future, additional increases in our allowance for loan losses may be warranted.
Nonperforming Assets.
Nonperforming assets consist of nonaccrual loans, foreclosed assets, and loans that are 90 days or more past due but are still accruing interest. The accrual of interest on non-accrual loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. For the years ended December 31, 2010, 2009 and 2008, had non-accrual loans performed as agreed, approximately $625,000, $759,000 and $692,000, respectively, would have been recognized in additional interest income.
Table 5 provides a summary of nonperforming assets for the most recent five years. Nonperforming loans were 3.5% of total loans at December 31, 2010, 5.1% of total loans at December 31, 2009 and 2.8% of total loans at December 31, 2008. Management believes the current list of past due loans are collectible and does not anticipate significant losses. Nonperforming loans at December 31, 2010 include sixteen real estate secured loans compared to fifteen real estate secured loans at December 31, 2009, but the dollar amounts of the loans decreased, and to a large extent, these loans were not the same borrowers in both years.
There was no commitment to lend additional funds to any customer whose loan was classified as nonperforming at December 31, 2010, 2009 or 2008.
Nonaccrual loans at December 31, 2010 consist of several single family residence loans, commercial loans and some commercial real estate secured loans. The Bank is working with its borrowers to develop strategies that can give the borrowers time to work through their financial difficulties. The other real estate owned properties consist of two construction loans related to single-family home construction, a four-unit apartment building, a retail commercial real estate loan, and a land development parcel. The Bank is actively marketing these properties. However, given current market conditions, there can be no assurance that these properties can be sold in the near future.
A troubled debt restructuring occurs when the Bank offers, at favorable terms, a modification of loan terms and conditions because management believes the borrower may not be able to make payments at their original note rate and terms. At December 31, 2010, the Bank had thirteen loans totaling $19,409,000 that were considered troubled debt restructurings. These 13 loans consist of four commercial real estate loans totaling $4,598,000, two multi family real estate loans totaling $9,774,000, three commercial loans totaling $2,416,000; and four single family residence loans totaling $2,621,000.
As a result of a 2010 scheduled Office of the Comptroller of the Currency (“OCC”) examination, management informally agreed with the OCC to take actions to further strengthen and improve asset quality including, among other things: to increase our capital levels and restrict our ability to pay dividends as the risk contained in the Bank’s loan portfolio increases (including the risks related to the concentration of commercial real estate (“CRE”) loans within our portfolio), to strengthen our loan policies related to analyzing the risk within the Bank’s CRE portfolio, to reduce the level of our classified assets over an agreed upon timetable, to maintain certain levels of minimum capital above “well capitalized” levels as defined by current regulation, and to address other criticisms from the examination. Management is already developing strategies and taking actions to address these issues.
Noninterest Income
The following table sets forth the principal components of noninterest income:
Total noninterest income consists mainly of service charges on deposits. Noninterest income in 2009 and 2008 included $316,000 and $760,000, respectively, in proceeds from a life insurance contract related to death benefits received from a policy that was placed on the life of an executive who is now deceased. Gain or loss on sale or impairment of securities available for sale was a gain of $619,000 in 2010, $997,000 in 2009, and a loss of $290,000 in 2008. The gain on sale during 2010 was derived primarily from the sale of U.S. Treasury and mortgage backed scurities; the gain in 2009 and the loss in 2008 were derived primarily from the sale of available for sale municipal securities and mortgage backed securities within our investment portfolio.
The principal source of other income was policy dividends on Officers’ Life Insurance, which was $329,000, $315,000 and $404,000 in the years 2010, 2009 and 2008, respectively, which reflected an increased investment in these policies during 2008, and a decline in the policies during 2009 and 2010 due to the payout of the death benefit on one policy. Policy dividend rates were negatively affected by downward market interest rate levels during 2008, 2009 and 2010.
Noninterest Expenses
The following table sets forth the various components of noninterest expense:
Total noninterest expense for the year ended December 31, 2010 was $27,005,000 compared to $27,585,000 and $25,346,000 for the years ended December 31, 2009 and 2008. Salaries and employee benefits were $13,603,000 in 2010, $13,359,000 in 2009 and $14,335,000 in 2008. Salaries and employee benefits represented 50%, 48% and 57% of noninterest expense for the years 2010, 2009 and 2008, respectively. During the third quarter of 2008, a Call Center was established; there were also support staff increases in the loan area during 2008. The reduction in salaries and employee benefits in 2009 was primarily the result of a decrease in full time equivalent employees that resulted from the elimination of the Call Center and other positions during the fourth quarter of 2008. During 2010, the Bank closed our Eureka Square and our Colma branch offices. The increase in salary and benefits costs during 2010 was primarily attributable to normal salary progression and an increase in medical and dental costs offset in large part by employee reductions net of relocation of staff from closed branches. The loss on impairment of other real estate owned expense was recorded primarily to reflect the decrease in valuation of the real estate owned properties since their value on the foreclosure date. Another significant expense which has been steadily increasing are the Bank’s FDIC deposit insurance assessments, which were $435,000 in 2008, $1,128,000 in 2009 and $1,350,000 in 2010. These assessments are expected to remain high until such time as the FDIC is able to build their deposit fund reserve to their targeted levels established by the FDIC. At December 31, 2010, the FDIC insurance reserves were significantly below targeted levels.
Provision for Loan Losses
There was a provision for loan losses of $1,854,000 for the year ended December 31, 2010 compared to a provision for loan losses of $4,596,000 for the year ended December 31, 2009. The allowance for loan losses was $9,524,000 or 1.97% of total gross loans at December 31, 2010, compared to $9,829,000 or 1.95% of total gross loans at December 31, 2009. The allowance for loan losses is maintained at a level considered adequate for management to provide for probable loan losses inherent in the loan portfolio. During 2010, nonaccrual loans and delinquent loans steadily decreased throughout the year. During 2009, nonaccrual and delinquent loans steadily increased during the first three quarters of the year. The level of nonperforming assets peaked during the fourth quarter of 2009. Management is taking the steps necessary to work with borrowers and has granted modified loan terms to borrowers willing to make payments on their loans secured by their primary residence, even though they were delinquent and/or the value of their home had declined substantially.
Balance Sheet Analysis
Total assets of the Company at December 31, 2010 were $714,639,000, compared to $708,309,000 at December 31, 2009, and $660,957,000 at December 31, 2008. Assets averaged $729,309,000 in 2010, compared to $683,829,000 in 2009 and $658,108,000 in 2008. Average earning assets represented 84.1% of total average assets in 2010 and 89.0% in 2009.
Loans
The loan portfolio is the principal earning asset of the Bank. Gross loans outstanding (net of loan fees) at December 31, 2010 decreased by $19,826,000 or 3.9% from December 31, 2009. At December 31, 2009, they decreased by $881,000 or 0.2% from December 31, 2008. The loan portfolio experienced higher nonperforming loan levels in 2009 when compared to 2008 or 2010 levels. During 2010, new loan origination volumes decreased from 2009 and 2008 levels due to the additional time spent working to reduce our nonperforming assets and decreased demand for credit by our borrowers. In addition, the effect of the economic recession was a reduction in the applications received for credit during 2010. New credit worthy borrowers were difficult to identify during 2010, and existing clients were not seeking additional loans.
Commercial real estate loans increased by $4,885,000 or 1.8% in 2010 compared to 2009. They increased by $25,658,000 or 10.3% in 2009 compared to 2008. During 2009, the Bank purchased approximately $19,000,000 in performing real estate loans from another community bank. Real estate construction loans decreased by $19,612,000 and $18,458,000 in 2010 and 2009, respectively. Real estate multi-family loans decreased by $15,291,00 in 2010 compared to 2009, but increased by $5,829,000 or 11.2% in 2009 compared to 2008. Real estate 1 to 4 family increased by $16,789,00 or 30.7% in 2010 compared to 2009, and by $2,032,000 or 3.9% in 2009 over 2008. These changes occurred due to a tightening in our underwriting standards, and a reflection of current economic conditions, as a reduced number of new construction projects were being started. Commercial and industrial loans decreased by $6,484,000 and $15,465,000 in 2010 and 2009, respectively. Consumer loans represent a nominal portion of total loans. They increased by $28,000 in 2010 and dereased by $475,000 in 2009.
Table 8 presents a detailed analysis of loans outstanding at December 31, 2006 through December 31, 2010.
Loans that are not guaranteed by the U. S. Government contain some level of risk repayment. Real estate and loans that contain UCC filing requirements contain less risk of loss than unsecured loans. By securing loans with various types of collateral, the Bank is able to better assure repayment from either the collateral or the borrower. For commercial loans, both secured and unsecured, the Bank will generally require personal guarantees from our borrowers. These financial guarantees allow the Bank to initiate collection activity from the borrowers individually if the liquidation of collateral is insufficient to repay the loan. The underwriting policies of the Bank require our borrowers to document the source of repayment for their loans, maintain equity positions in any secured financings, and provide ongoing financial statement information. Current appraisals, financial statements, and tax returns allow Bank management to evaluate our borrower’s repayment ability on at least an annual basis. Commercial loans are generally variable rate in nature. Real estate loans more than five years to maturity generally contain variable interest rates. Loans that mature in five years or less may be either fixed or variable rate in nature, with fixed rate loans containing initial rates that are higher than those with variable rates. Borrower’s preference and interest rate risk tolerance will generally dictate whether they utilize fixed or viariable rate financing.
The following table shows the Bank’s loan maturities and sensitivities to changes in interest rates as of December 31, 2010.
Investment Portfolio
Investments at December 31, 2010 were $126,189,000, an increase of $29,001,000 or 29.8% over December 31, 2009. At December 31, 2009, they were $97,188,000, a decrease of $2,033,000 or 2.1% over December 31, 2008.
The primary purpose of the Bank’s investment portfolio is to insure the Bank has sufficient available funds to fund loans, or pay down our liabilities. The Company’s primary source of funds is the deposit base. If more funds are needed, investment maturities, calls and sales from the investment portfolio may be used. The Bank’s investment portfolio is composed primarily of debt securities of U. S. Government Agencies, mortgage-backed securities that have their principal guaranteed by U. S. Government Agencies, and in obligations of States and their political subdivisions. The Bank believes this provides for an appropriate liquidity level and minimal credit risk.
The following table sets forth the maturity distribution and interest rate sensitivity of investment securities at December 31, 2010:
The following table shows the securities portfolio mix at December 31, 2010, 2009 and 2008.
Deposits
During 2010, average deposits were $628,758,000, an increase of $78,771,000 or 14.3% over 2009. During 2009, average deposits were $549,987,000, an increase of $41,964,000 or 8.3% over 2008. The prime lending rate was 3.25% on December 16, 2008, and has remained unchanged through December 31, 2010. Time deposits lagged the prime rate changes because their rates changed only as certificates matured or new certificates were issued. Thus, interest-bearing demand costs averaged 0.6% in 2008, 0.5% in 2009 and 0.3% in 2010. Money market deposit costs averaged 2.3% in 2008, 2.0% in 2009 and 1.1% in 2010. Savings rates averaged 0.3% in 2008, 0.3% in 2009 and 0.3% in 2010. Average rates on time certificates of deposit of $100,000 or more was 3.6% in 2008, 2.0% in 2009 and 0.9% in 2010. On certificates under $100,000, average rates were 2.8% in 2008, 2.0% in 2009 and 1.2% in 2010. During 2009, the Bank introduced a money market account that carried an interest rate that was linked to the number of products the customer utilized. This product was the primary driver of the Bank’s deposit growth during 2009 and 2010.
The following table summarizes the distribution of average deposits and the average rates paid for them in the periods indicated:
The following table indicates the maturity schedule of time deposits of $100,000 or more:
Capital
At December 31, 2010, stockholders’ equity of the Company was $80,924,000, an increase of $2,059,000 or 2.6% over 2009. At December 31, 2009, stockholders’ equity of the Company was $78,865,000, an increase of $10,716,000 or 15.7% over 2008. During 2009, the primary reason for the increase in capital was the issuance of $12,600,000 of liquidation value preferred stock to the U. S. Treasury in conjunction with the U. S. Treasury’s Capital Purchase Program (“CPP”). The increases in retained earnings were primarily attributable to retention of net income less cash dividends on preferred stock of $654,000 in 2010 and $469,000 in 2009; and cash dividends on common stock of $645,000 in 2010, $916,000 in 2009, and $2,226,000 in 2008.
In February of 2009, a total of $12,600,000 in equity securities were issued to the U.S. Treasury as part of the Treasury’s Capital Purchase Program. These securities were issued in the form of Series A Preferred Stock with a 5% annual dividend rate, paid quarterly, and Series B Preferred Stock with a 9% annual dividend rate, paid quarterly which accounted for the major part of the 2008-2009 variance.
Under regulatory capital guidelines, qualifying capital is classified into two tiers, referred to as Tier 1 (core) and Tier 2 (supplementary) capital. The Company’s Tier 1 capital consists of common shareholders’ equity and preferred stock issued to the U.S. Treasury during 2009. The Company’s Tier 2 capital consists of eligible reserves for possible loan losses. Total capital is the sum of Tier 1 plus Tier 2 capital. Risk-weighted assets are calculated by applying risk percentages specified by the FDIC to categories of both balance sheet assets and off-balance sheet obligations. At year-end 1990, the FDIC also adopted a leverage ratio requirement. This ratio supplements the risk-based capital ratios and is defined as Tier 1 capital divided by quarterly average assets during the reporting period. This requirement established a minimum leverage ratio of 3.0% for the highest rated banks and ratios of 100 to 200 basis points higher for most other banks. To qualify as “well-capitalized” as defined by regulation, financial institutions must maintain risk-based Tier 1 and total capital ratios of at least 6.0% and 10.0% respectively. “Well-capitalized” financial institutions must also maintain a leverage ratio equal to or exceeding 5.0%.
As mentioned under “Capital Standards under Item 1 ‘Business’ above,” the Office of the Comptroller of the Currency (“the OCC”) on June 9, 2010 notified the Bank that our Individual Minimum Capital Ratios (“IMCR”) had been established and required the Bank to maintain IMCRs as follows: a Tier 1 leverage ratio of at least 9% and a total risk-based capital ratio of at least 12%.
During the fourth quarter of 2010, the U.S. Treasury established the Small Business Lending Fund. This fund provided $30 billion in funding capital designated to be invested in Community Banks with assets less than $10 billion who intended to increase their small business lending efforts. The Company applied to refinance its existing $12.6 million in liquidation value preferred stock received under the U.S. Treasury’s TARP program plus requested $5.4 million in additional capital invested in the issuance of additional preferred shares during the first quarter of 2011 from the Small Business Lending Fund. Our application is subject to review by the OCC and the U.S. Treasury. To date, the Company has not yet received a response to our application.
The following table shows the risk-based capital ratios and the leverage ratios at December 31, 2010, 2009 and 2008 for the Bank. The Company’s capital ratios are substantially equivalent to those of the Bank.
Liquidity
The Company’s primary source of liquidity on a stand-alone basisee the discussion under “Limitation on Dividends”s is dividends from the Bank. The payment of dividends by the Bank is subject to regulatory restrictions. See the discussion under “Limitation on Dividends” in “Item 1 - ” Business” above.
Liquidity is a measure of the Company’s ability to convert assets into cash. Liquidity consists of cash and due from other banks accounts, including time deposits, federal funds sold, and securities available for sale. The Company’s policy is to maintain a liquidity ratio of 5% or greater of total assets. As of December 31, 2010, the Company’s primary liquidity was 26.18%, compared to 22.59% in 2009, and 17.26% in 2008. Total Liquid Assets were $187,063,000 in 2010, $160,041,000 in 2009 and $114,086,000 in 2008. The objective of liquidity management is to ensure that the Company has funds available to meet all present and future financial obligations and to take advantage of business opportunities as they occur. Financial obligations arise from withdrawals of deposits, repayment on maturity of purchased funds, extension of loans or other forms of credit, payment of operating expenses and payments of dividends.
Core deposits, which consist of all deposits other than time deposits, have provided the Company with a sizeable source of relatively stable low-cost funds. The Company’s average core deposits represented 77.7% of average total liabilities of $648,600,000 for the year ended December 31, 2010, 68.7% of average total liabilities of $606,462,000 for the year ended December 31, 2009 and 61.8% of average total liabilities of $590,620,000 for the year ended December 31, 2008.
As of December 31, 2010, the Company had salary continuation agreements and other commercial commitments totaling approximately $97,781,000. The following table sets forth the Company’s contractual obligations and other commercial commitments as of December 31, 2010. These obligations and commitments can be funded from other loan repayments, the Company’s liquidity sources such as cash and due from other banks, federal funds sold, securities available for sale, as well as from the Bank’s line of credit with the Federal Home Loan Bank of San Francisco and the Federal Reserve Bank.
The largest component of the Company’s earnings is net interest income, which can fluctuate widely when significant interest rate movements occur. The prime lending rate was 3.25% at the end of 2008. It remained the same through December 31, 2009 and 2010. Net interest ncome increases during 2010 were primarily the result of aggressive reductions to the Bank’s deposit product rates. Reductions in 2009 net interest income occurred because rates earned on interest earning assets decreased faster than the rates we paid on interst bearing liabilities.
The Company’s management is responsible for minimizing the Bank’s exposure to interest rate risk and assuring an adequate level of liquidity. This is accomplished by developing objectives, goals and strategies designed to enhance profitability and performance.
In order to ensure that sufficient funds are available for loan growth and deposit withdrawals, as well as to provide for general needs, the Company must maintain an adequate level of liquidity. Asset liquidity comes from the Company’s ability to convert short-term investments into cash and from the maturity and repayment of loans and investment securities. Liability liquidity is provided by the Company’s ability to attract deposits and obtain short term credit through established borrowing lines. The primary source of liability liquidity is the Bank’s customer base, which provides core deposit growth. The overall liquidity position of the Company is closely monitored and evaluated regularly. The Company has federal fund borrowing facilities for a total of $30,000,000, a Federal Home Loan Bank line of credit of up to 30% of total assets, and a Federal Reserve Bank borrowing facility of approximately $49,195,000. Management believes the Company’s liquidity sources at December 31, 2010 are adequate to meet its operating needs in 2011 and into the foreseeable future. In February, 2009, the Company received $12,000,000 in net proceeds from an investment in Company Preferred Stock by the U. S. Department of the Treasury. This investment was then contributed to the Bank as an additional capital contribution. These funds are being used to fund loan workout programs and to bolster lending activity of the Bank.
Effect of Changing Prices
The results of operations and financial conditions presented in this report are based on historical cost information and are not adjusted for the effects of inflation. Since the assets and liabilities of banks are primarily monetary in nature (payable in fixed, determinable amounts), the performance of the Company is affected more by changes in interest rates than by inflation. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not be the same.
The effect of inflation on banks is normally not as significant as its influence on those businesses that have large investments in plant and inventories. During periods of high inflation, there are normally corresponding increases in the money supply, and banks will normally experience above average growth in assets, loans and deposits. Also, increases in the price of goods and services will result in increased operating expenses.
The following table includes key ratios, including returns on average assets and equity.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
Closely related to the concept of liquidity is the concept of interest rate sensitivity (i. e., the extent to which assets and liabilities are sensitive to changes in interest rates). Management uses an asset/liability model that considers the relative sensitivities of the balance sheet, including the effect of interest rate caps on adjustable rate mortgages and the relatively stable aspects of core deposits. As such, management can model a net interest income simulation that is designed to address the probability of interest rate changes and behavioral response of the balance sheet to those changes. Market value of portfolio equity represents the fair value of the net present value of assets, liabilities and off-balance sheet items. The starting point (or “base case”) for the following table is the Company’s net portfolio at December 31, 2010, using current discount rates, and an estimate of net interest income for 2011 assuming that both interest rates and the Company’s interest-sensitive assets and liabilities remain at December 31, 2010 levels. The “rate shock” information in the table shows estimates of net portfolio value at December 31, 2010 and net interest income for 2011 assuming fluctuations or “rate shocks” of minus 100 and 200 basis points and plus 100 and 200 basis points. Rate shocks assume that current interest rates change immediately. The information set forth in the following table is based on significant estimates and assumptions, and constitutes a forward-looking statement within the meaning of that term set forth in Rule 175 under the Securities Act of 1933 and Rule 3b-6(c) of the Securities Exchange Act of 1934.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
FNB Bancorp
We have audited the accompanying consolidated balance sheets of FNB Bancorp and subsidiary (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of earnings, changes in stockholders’ equity and comprehensive earnings, and cash flows for each of the years in the three-year period ended December 31, 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of FNB Bancorp and subsidiary as of December 31, 2010 and 2009, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.
/s/ Moss Adams LLP
Portland, Oregon
March 28, 2011
FNB BANCORP AND SUBSIDIARY
Consolidated Balance Sheets
December 31, 2010 and 2009
See accompanying notes to consolidated financial statements.
FNB BANCORP AND SUBSIDIARY
Consolidated Statements of Earnings
Years ended December 31, 2010, 2009 and 2008
FNB BANCORP AND SUBSIDIARY
Consolidated Statement of Changes in Stockholders’ Equity and Comprehensive Earnings
Years ended December 31, 2010, 2009 and 2008
See accompanying notes to consolidated financial statements.
FNB BANCORP AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended December 31, 2010, 2009 and 2008
See accompanying notes to consolidated financial statements.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(1)
The Company and Summary of Significant Accounting Policies
FNB Bancorp (the “Company”) is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Company was incorporated under the laws of the State of California on February 28, 2001. The consolidated financial statements include the accounts of FNB Bancorp and its wholly-owned subsidiary, First National Bank of Northern California (the “Bank”). The Bank provides traditional banking services in San Mateo and San Francisco counties.
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenue and expenses during the reporting period. Actual results could differ from those estimates. For the Bank, the significant accounting estimates are the allowance for loan losses, the valuation of goodwill, the valuation of the allowance for deferred tax assets and fair value determinations such as OREO and impaired loans. A summary of the significant accounting policies applied in the preparation of the accompanying consolidated financial statements follows.
(a)
Basis of Presentation
The accounting and reporting policies of the Company and its wholly-owned subsidiary are in accordance with accounting principles generally accepted in the United States of America. All intercompany balances and transactions have been eliminated.
(b)
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Generally, federal funds are sold for one-day periods. The cash equivalents are readily convertible to known amounts of cash and present insignificant risk of changes in value due to original maturity dates of 90 days or less. Included in cash and cash equivalents are restricted balances at the Federal Reserve Bank which relate to a minimum cash reserve requirement of approximately $829,000 and $855,000 at December 31, 2010 and 2009, respectively.
(c)
Investment Securities
Investment securities consist of U.S. Treasury securities, U.S. agency securities, obligations of states and political subdivisions, obligations of U.S. corporations, mortgage-backed securities and other securities. At the time of purchase of a security, the Company designates the security as held-to-maturity or available-for-sale, based on its investment objectives, operational needs, and intent to hold. The Company classifies securities as held to maturity only if and when it has the positive intent and ability to hold the security to maturity. The Company does not purchase securities with the intent to engage in trading activity. Held to maturity securities are recorded at amortized cost, adjusted for amortization of premiums or accretion of discounts. The Company did not have any investments in the held-to-maturity portfolio at December 31, 2010 or 2009.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Securities available-for-sale are recorded at fair value with unrealized holding gains or losses, net of the related tax effect, reported as a separate component of stockholders’ equity until realized.
An impairment charge would also be recorded if the Company has the intent to sell a security that is currently in an unrealized loss position or where the Company may be required to sell a security that is currently in an unrealized loss position. A decline in the market value of any security available-for-sale or held-to-maturity below cost that is deemed other than temporary results in a charge to earnings and the corresponding establishment of a new cost basis for the security. Amortization of premiums and accretion of discounts on debt securities are included in interest income over the life of the related security held-to-maturity or available-for-sale using the effective interest method. Dividend and interest income are recognized when earned. Realized gains and losses for securities classified as available-for-sale and held-to-maturity are included in earnings and are derived using the specific identification method for determining the cost of securities sold.
Investments with fair values that are less than amortized cost are considered impaired. Impairment may result from either a decline in the financial condition of the issuing entity or, in the case of fixed interest rate investments, from rising interest rates. At each consolidated financial statement date, management assesses each investment to determine if impaired investments are temporarily impaired or if the impairment is other than temporary. This assessment includes a determination of whether the Company intends to sell the security, or if it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are considered other than temporarily impaired and that the Company does not intend to sell and will not be required to sell prior to recovery of the amortized cost basis, the amount of impairment is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is calculated as the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of the future expected cash flows is deemed to be due to factors that are not credit related and is recognized in other comprehensive income.
(d)
Derivatives
All derivatives contracts are recognized as either assets or liabilities in the balance sheet and measured at fair value. The Company did not hold any derivative contracts at December 31, 2010 or 2009.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(e)
Loans
Loans are reported at the principal amount outstanding, net of deferred loan fees and the allowance for loan losses. A loan is considered 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, including scheduled interest payments. For a loan that has been restructured, the contractual terms of the loan agreement refer to the contractual terms specified by the original loan agreement, not the contractual terms specified by the restructuring agreement. An impaired loan is measured based upon the present value of future cash flows discounted at the loan’s effective rate, the loan’s observable market price, or the fair value of collateral if the loan is collateral dependent. Interest on impaired loans is recognized on a cash basis. If the measurement of the impaired loan is less than the recorded investment in the loan, an impairment is recognized by a charge to the allowance for loan losses. An unearned discount on installment loans is recognized as income over the terms of the loans by the interest method. Interest on other loans is calculated by using the simple interest method on the daily balance of the principal amount outstanding.
Loan fees net of certain direct costs of origination, which represent an adjustment to interest yield, are deferred and amortized over the contractual term of the loan using the interest method.
Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Accrual of interest on loans is discontinued either when reasonable doubt exists as to the full and timely collection of interest or principal when a loan becomes contractually past due by 90 days or more with respect to interest or principal. When a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest. Restructured loans are loans on which concessions in terms have been granted because of the borrowers’ financial difficulties. Interest is generally accrued on such loans in accordance with the new terms, once the borrower has demonstrated a history of at least six months repayment. A loan is considered to be a troubled debt restructuring when the Bank, for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor that makes it easier for the debtor to make their required loan payments. The concession may take the form of a temporary reduction in the interest rate or monthly payment amount due or may extend the maturity date of the loan. Other financial concessions may be agreed to as conditions warrant.
(f)
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged off against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb probable losses inherent in existing loans, standby letters of credit, overdrafts, and commitments to extend credit based on evaluations of collectibility and prior loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the portfolio, overall portfolio quality, loan concentrations, specific problem loans and current and anticipated economic conditions that may affect the borrowers’ ability to pay. While management uses these evaluations to determine the level of the allowance for loan losses, future provisions may be necessary based on changes in the factors used in the evaluations. Material estimates relating to the determination of the allowance for loan losses are particularly susceptible to significant change in the near term. Management believes that the allowance for loan losses is adequate as of December 31, 2010. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions, and our borrowers’ ability to pay. In addition, the banking regulators, as an integral part of its examination process, periodically review the Bank’s allowance for loan losses. The banking regulators may require the Bank to recognize additions to the allowance based on their judgment about information available to them at the time of their examination.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(g)
Premises and Equipment
Premises and equipment are reported at cost less accumulated depreciation using the straight-line method over the estimated service lives of related assets ranging from 3 to 50 years. Leasehold improvements are amortized over the estimated lives of the respective leases or the service lives of the improvements, whichever is shorter.
(h)
Other Real Estate Owned
Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at the lower of the carrying amount of the loan or fair value of the property at the date of foreclosure less selling costs. Subsequent to foreclosure, valuations are periodically performed, and any subsequent revisions in the estimate of fair value are reported as an adjustment to the carrying value of the real estate, provided the adjusted carrying amount does not exceed the original amount at foreclosure. Revenues and expenses from operations and changes in the valuation allowance are included in other operating expenses. The Company may make loans to facilitate the sale of foreclosed real estate. Gains and losses on financed sales are recorded in accordance with the appropriate accounting standard, taking into account the buyer’s initial and continuing investment in the property, potential subordination and transfer of ownership.
(i)
Goodwill and Other Intangible Assets
Goodwill is recognized in a business acquisition transaction when the acquisition purchase price exceeds the fair market value of identified tangible and intangible assets and liabilities. Goodwill is subsequently evaluated for possible impairment at least annually. If impairment is determined to exist, it is recorded in the period it is identified. The Company evaluated goodwill at December 31, 2010, and found no impairment.
Other intangible assets consist of core deposit and customer intangible assets that are initially recorded at fair value and subsequently amortized over their estimated useful lives, usually no longer than a seven year period.
(j)
Cash Dividends
The Company’s ability to pay cash dividends is subject to restrictions set forth in the California General Corporation Law. Funds for payment of any cash dividends by the Company would be obtained from its investments as well as dividends and/or management fees from the Bank. The Bank’s ability to pay cash dividends is also subject to restrictions imposed under the National Bank Act and regulations promulgated by the Office of the Comptroller of the Currency.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(k)
Stock Dividend
On November 19, 2010, the Company announced that its Board of Directors had declared a five percent (5%) stock dividend resulting in approximately 159,086 shares, payable at the rate of one share of Common Stock for every twenty (20) shares of Common Stock owned. The stock dividend was paid on December 20, 2010, to stockholders of record on December 3, 2010. The earnings per share data for all periods presented has been adjusted for stock dividends, except for the Consolidated Statement of Changes in Stockholders’ Equity and Comprehensive Earnings, which shows the historical rollforward of stock dividends declared.
(l)
Income Taxes
Deferred income taxes are determined using the asset and liability method. Under this method, the net deferred tax asset or liability is recognized for tax consequences of temporary differences by applying current tax rates to differences between the financial reporting and the tax basis of existing assets and liabilities. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. A valuation allowance is established through the provision for income taxes for any deferred tax assets where the utilization of the asset is in doubt. During 2010, the Company recorded an addition to the deferred tax asset valuation allowance of $254,000 for tax credit carryforwards from the Bank’s investment in low income housing real estate partnerships, and since it is uncertain if the benefit will be eligible to offset future income tax liabilities. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
The Company had unrecognized tax benefits of $415,000 and $375,000 as of December 31, 2010 and 2009, respectively. These unrecognized tax benefits are related to income tax uncertainties surrounding the Bank’s Enterprise Zone net interest deduction. The Bank is currently being audited by the Franchise Tax Board for the years ended December 31, 2005 through 2008, and the outcome is uncertain.
The Company recognizes interest accrued and penalties related to unrecognized tax benefits in tax expense. During the years ended December 31, 2010 and 2009, the Company believes that any penalties and interest penalties that may exist are not material and the Company has not accrued for them.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(m)
Earnings per Share
Basic earnings per share is computed by dividing net income by the weighted average common shares outstanding. Diluted earnings per share reflects potential dilution from outstanding stock options, using the treasury stock method. There were 363,241, 342,889, and 305,258 antidilutive shares in the years ended December 31, 2010, 2009 and 2008, respectively, which were not included in the calculation. Reconciliation of weighted average shares used in computing basic and diluted earnings (loss) per share is as follows:
(n)
Stock Option Plans
Measurement of the cost of stock options granted is based on the grant-date fair value of each stock option granted using the Black-Scholes valuation model. The cost is then amortized to expense on a straight-line basis over each option’s requisite service period. The amortized expense of the stock option’s fair value has been included in salaries and employee benefits expense for the three years ended December 31, 2010, 2009 and 2008. The expected term of options granted is derived from the output of the option valuation model and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U. S. Treasury yield curve in effect at the time of the grant. The Company’s stock has limited liquidity and limited trading activity. Volatility was calculated using historical price changes on a monthly basis over the expected life of the option.
(o)
Fair Values of Financial Instruments
The accounting standards provide for a fair value measurement framework that quantifies fair value estimates by the level of pricing precision. The degree of judgment utilized in measuring the fair value of assets generally correlates to the level of pricing precision. Financial instruments rarely traded or not quoted will generally have a higher degree of judgment utilized in measuring fair value. Pricing precision is impacted by a number of factors including the type of asset, the availability of the asset, the market demand for the asset, and other conditions that were considered at the time of the valuation.
In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(p)
Income Tax Credits
At December 31, 2010, the Bank had a $2,026,000 investment in five partnerships, which own low-income affordable housing projects that generate tax benefits in the form of federal and state housing tax credits. As a limited partner investor in these partnerships, the Company receives tax benefits in the form of tax deductions from partnership operating losses and federal and state income tax credits. The federal and state income tax credits are earned over a 10-year period as a result of the investment properties meeting certain criteria and are subject to recapture for noncompliance with such criteria over a 15-year period. The expected benefit resulting from the low-income housing tax credits is recognized in the period for which the tax benefit is recognized in the Company’s consolidated tax returns. These investments are accounted for using the historical cost method less depreciation and amortization and are recorded in other assets on the balance sheet. The Company recognizes tax credits as they are allocated and amortizes the initial cost of the investments over the period that tax credits are allocated to the Company.
There is no residual value for the investment at the end of the tax credit allocation period. Cash received from operations of the limited partnership or sale of the properties, if any, will be included in earnings when realized.
(q)
Bank Owned Life Insurance
The Company purchased insurance on the lives of certain executives. The policies accumulate asset values to meet future liabilities including the payment of employee benefits such as the deferred compensation plan. Increases in the cash surrender value are recorded as other noninterest income in the consolidated statements of earnings. The cash surrender value of bank owned life insurance is reflected in other assets on the consolidated balance sheets in the amount of $9,195,000 and $8,866,000 at December 31, 2010 and 2009, respectively. During 2009 and 2008, the Company realized $316,000 and $760,000, respectively, in death benefits from a life insurance contract covering a former executive of the Company.
(r)
Federal Home Loan Bank Borrowings
The Bank maintains a collateralized line of credit with the Federal Home Loan Bank (“FHLB”) of San Francisco. Under this line, the Bank may borrow on a short term or a long term (over one year) basis. FHLB advances are recorded and carried at their historical cost. FHLB advances are not transferable and may contain prepayment penalties. In addition to the collateral pledged, the Company is required to hold prescribed amounts of FHLB stock that vary with the usage of FHLB credits.
(s)
Reclassifications
Certain prior year information has been reclassified to conform to current year presentation. The reclassifications had no impact on consolidated net earnings or retained earnings.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(t)
Recently Issued Accounting Pronouncements
In January, 2010, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No. 2010-06, to improve disclosure requirements related to “Fair Value Measurements and Disclosures-Overall Subtopic (Subtopic 820-10)” of the FASB Accounting Standards Codification, which was originally issued as FASB Statement No. 157, Fair Value Measurements. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009 except for the disclosures about purchases, sales, issuances and settlements in the rollforward activity in Level 3 fair value measurements. The new disclosures require separate disclosures regarding transfers in and out of Levels 1 and 2 fair value measurements, and to describe the reasons for the transfers. As to activity in Level 3, a reporting entity is required to present separate information about purchases, sales, issuances and settlements (on a gross basis rather than as one net number). This requires first quarter of 2010 implementation so that investments shown by class and changes or transfers in levels disclosed. The Company only measures investment securities owned at fair value. Impaired loans and other real estate owned are measured and recorded at the lower of historical cost or fair value. Our adoption of this standard update did not have an impact on our financial condition or results of operations.
In February 2010, the FASB issued ASU No. 2010-09, “Subsequent Events (Topic 855)-Amendments to Certain Recognition and Disclosure Requirements.” This ASU eliminates the requirement to disclose the date through which a Company has evaluated subsequent events and refines the scope of the disclosure requirements for reissued financial statements. This ASU is effective for the first quarter of 2010. This ASU did not have a material impact on the Company’s consolidated financial statements, since it is not applicable to public companies.
In March, the FASB issued ASU No. 2010-11, “Derivatives and Hedging (Topic 815)-Scope Exception Related to Embedded Credit Derivatives.” The ASU eliminates the scope exception for bifurcation of embedded credit derivatives in interests in securitized financial assets, unless they are created solely by subordination of one financial instrument to another. The ASU is effective the first quarter beginning after June 15, 2010. The Company has evaluated the impact of adoption and the ASU did not have a material impact on the Company’s consolidated financial statements.
In April, the FASB issued ASU No. 2010-18, “Receivables (Topic 310)-Effect of a Loan Modification When the Loan Is Part of a Pool That is Accounted for as a Single Asset.” This ASU clarifies that modifications of loans that are accounted for within a pool under Topic 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. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. No additional disclosures are required with this ASU. The amendments in this ASU are effective for modifications of loans accounted for within pools under Topic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. The amendments are to be applied prospectively and early application is permitted. Upon initial adoption of the guidance in this ASU, an entity may make a onetime election to terminate accounting for loans as a pool under Topic 310-30. This election may be applied on a pool-by-pool basis and does not preclude an entity from applying pool accounting to subsequent acquisitions of loans with credit deterioration. The Company has evaluated the impact of adoption and the ASU did not have a material impact on the Company’s consolidated financial statements.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
In July 2010, the FASB issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This update amends Topic 310 to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. The amendments in this update apply to all entities, both public and nonpublic. The amendments in this update affect all entities with financing receivables, excluding short-term trade accounts receivable or receivables measured at fair value or lower of cost or fair value. For public entities, the disclosures required by this update as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. For nonpublic entities, the disclosures are effective for annual reporting periods ending on or after December 15, 2011. The amendments in this update encourage, but do not require, comparative disclosures for earlier reporting periods that ended before initial adoption. However, an entity should provide comparative disclosures for those reporting periods ending after initial adoption. As this ASU is disclosure-related only, the adoption of this ASU did not impact the Bank’s financial condition or results of operations.
In December 2010, the FASB issued ASU No. 2010-28, Intangibles-Goodwill and Other (Topic 350)-When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. The amendments in this update modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. The amendments become effective for public entities for fiscal years beginning after December 15, 2010. Early adoption is not permitted. The Company does not have goodwill with a zero or negative carrying amount.
In December, 2010, the FASB issued ASU No. 2010-29, Business Combinations (Topic 805). The amendments in this Update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current yearhad occurred as of the beginning of the comparable prior annual reporting period.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
An analysis of gross unrealized losses within the available-for-sale investment securities portfolio as of December 31, 2010 and December 31, 2009 follows:
At December 31, 2010, there were no securities in an unrealized loss position for greater than 12 consecutive months. Management periodically evaluates each security in an unrealized loss position to determine if the impairment is temporary or other-than-temporary. Management has determined that no investment security is other-than-temporarily impaired at December 31, 2010. The unrealized losses are due solely to interest rate changes, and the Company does not intend to sell nor expects it will be required to sell investment securities identified with impairments resulting from interest rate declines prior to the earliest of forecasted recovery or the maturity of the underlying investment security.
The amortized cost and carrying value of debt securities as of December 31, 2010, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
At December 31, 2010 and 2009, securities with an amortized cost of $87,064,000 and $87,854,000, and fair value of $87,755,000 and $88,791,000, respectively, were pledged as collateral for public deposits and for other purposes required by law.
As of December 31, 2010 and 2009, the Bank had investments in Federal Reserve Bank stock classified as other assets in the accompanying balance sheets of $1,062,000. These investments in Federal Reserve Bank stock are carried at cost, and evaluated periodically for impairment. Federal home Loan Bank and Federal Reserve Bank stock can be redeemed at par by the governmrent agencies. These securities cannot be sold to other investors. Management reviews the financial statements, credit rating and other pertinent financial information of these entities in order to determine if other than temporary impairment has occurred. So long as there is sufficient evidence to support the ability of these entities to continue to redeem their stock, then management believes these securities are not impaired. .As of December 31, 2010 and 2009, the Bank had investments in Federal Home Loan Bank stock classified as other assets in the accompanying balance sheets of $3,939,000 and $4,432,000, respectively. These investments in Federal Home Loan Bank stock are carried at cost, and periodically evaluated for impairment.
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Loans
Loans are summarized as follows at December 31:
The Bank had total impaired loans of $27,302,000 and $26,532,000 at December 31, 2010 and 2009, respectively. The allowance for loan losses related to the impaired loans was $1,469,000 and $2,875,000 as of December 31, 2010 and 2009, respectively. The amount of the recorded investment in impaired loans for which there is no related allowance is $8,949,000 and $11,918,000 as of December 31, 2010 and 2009. The average recorded investment in impaired loans during 2010, 2009 and 2008 was $24,481,000, $20,338,000 and $12,193,000, respectively.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Nonaccrual loans totaled $16,712,000 and $25,592,000 as of December 31, 2010 and 2009. The single largest nonaccrual loan that was added in 2009 was for a multifamily residential loan that totaled $8,718,000 as of December 31, 2009. Subsequent to December 31, 2009, Bank management and the borrower have agreed to the following: the borrower made a substantial loan repayment, the Bank agreed to waive a significant amount of nonaccrual interest related to this loan, and a loan modification arrangement was entered whereby the borrower agreed to make payments according to the modified loan terms in 2010 that were based on prevailing market rates at that time. If the borrower performs under the modified loan terms, this credit will be returned to accrual status. The difference between impaired loans and nonaccrual loans represents loans that are restructured, are performing under modified agreements, and interest is accrued.
The carrying amounts of loans include $16,712,000 and $25,592,000 of nonaccrual loans (loans that are not accruing interest) at December 31, 2010 and 2009, respectively.
The following aggregate information is provided at December 31, about the contractual provisions of these loans:
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Interest income on impaired loans of $810,000, $467,000 and $64,000 was recognized for cash payments received in 2010, 2009, and 2008, respectively. The amount of interest on impaired loans not collected in 2010, 2009 and 2008, was $290,000, $759,000 and $692,000, respectively. The cumulative amount of unpaid interest on impaired loans was $1,095,000, $806,000 and $1,022,000 at December 31, 2010, 2009 and 2008, respectively. During 2010, Bank management was able to come to agreement regarding the restructure of 13 loans with borrowers that were having difficulties making their loan payments. Total loan principal of troubled debt restructurings during 2010 was $19,409,000, of which $2,416,000 was commercial loans, $2,621,000 was residential loans, $4,598,000 was commercial real estate loans, and $9,774,000 was multi-family real estate loans. The troubled debt restructurings were made at current market rates, with loan terms that allow the borrowers to make interest-only payments, reduced principal reductions, or other modifications that helped these borrowers reduce their loan payments.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Risk rating system
Loans to borrowers graded as pass or pooled loans represent loans to borrowers of acceptable or better credit quality. They demonstrate sound financial positions, repayment capacity and credit history. They have an identifiable and stable source of repayment.
Special mention loans have potential weaknesses that deserve management’s attention. If left uncorrected these potential weaknesses may result in a deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. These assets are “not adversely classified” and do not expose the Bank to sufficient risk to warrant adverse classification.
Substandard loans are inadequately protected by current sound net worth, paying capacity of the borrower, or pledged collateral. Loans are normally classified as Substandard when there are unsatisfactory characteristics causing more than acceptable levels of risk. A substandard loan normally has one or more well-defined weakness that could jeopardize the repayment of the debt. For example, a) cash flow deficiency, which may jeopardize future payments; b) sale of non-collateral assets has become primary source of repayment; c) the borrower is bankrupt; or d) for any other reason, future repayment is dependent on court action.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Doubtful loans represent credits with weakness inherent in the Substandard classification and where collection or liquidation in full is highly questionable. To be classified Doubtful, there must be specific pending factors which prevent the Loan Review Officer from determining the amount of loss contained in the credit. When the amount of loss can be reasonably estimated, that amount is classified as “loss” and the remainder is classified as Substandard.
Commercial Real Estate Loans
Our commercial real estate loans are made primarily to investors or small businesses where our primary source of repayment is from cash flows generated by the properties, either through rent collection or business profits. The borrower’s promissory notes are secured with recorded liens on the underlying property. The borrowers would normally also be required to personally guarantee repayment of the loan. The bank uses conservative underwriting standards in reviewing applications for credit. Generally, our borrowers have multiple sources of income, so if cash flow generated from the property declines, at least in the short term, the borrowers can normally cover these short term cash flow deficiencies from their available cash reserves. Risk of loss to the Bank is increased when there are cash flow decreases sufficiently large and for such a prolonged period of time that loan payments can no longer be made by the borrowers.
Our real estate construction loans are generally made to borrowers who are rehabilitating a building, converting a building use from one type of use to another, or developing land and building residential or commercial structures for sale or lease. The borrower’s promissory notes are secured with recorded liens on the underlying property. The borrowers would normally also be required to personally guarantee repayment of the loan. The bank uses conservative underwriting standards in reviewing applications for credit. Generally, our borrowers have sufficient resources to make the required construction loan payments during the construction and absorption or lease-up period. After construction is complete, the loans are normally paid off from proceeds from the sale of the building or through a refinance to a commercial real estate loan. Risk of loss to the Bank is increased when there are material construction cost overruns, significant delays in the time to complete the project and/or there has been a material drop in the value of the projects in the marketplace since the inception of the loan.
Commercial and Industrial Loans
Our commercial and industrial loans are generally made to small businesses to provide them with at least some of the working capital necessary to fund their daily business operations. These loans are generally either unsecured or secured by fixed assets, accounts receivable and/or inventory. The borrowers would normally also be required to personally guarantee repayment of the loan. The Bank uses conservative underwriting standards in reviewing applications for credit. Risk of loss to the Bank is increased when our small business customers experience a significant business downturn, incur significant financial losses, or file for relief from creditors through bankruptcy proceedings.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Residential Real Estate Loans
Our residential real estate loans are generally made to borrowers who are buying or refinancing their primary personal residence or a rental property of 1-4 singe family residential units. The Bank uses conservative underwriting standards in reviewing applications for credit. Risk of loss to the Bank is increased when borrowers loose their primary source of income and/or property values decline significantly.
Consumer and installment Loans
Our consumer and installment loans generally consist of personal loans, credit card loans, automobile loans or other loans secured by personal property. The Bank uses conservative underwriting standards in reviewing applications for credit. Risk of loss to the Bank is increased when borrowers loose their primary source of income, or file for relief from creditors through bankruptcy proceedings.
(5)
Allowance for Loan Losses
Changes in the allowance for loan losses are summarized as follows for the years ended December 31:
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
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Foreclosed Assets
A summary of the activity in the balance of foreclosed assets follows (in thousands):
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
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Related Party Transactions
In the ordinary course of business, the Bank made loans and advances under lines of credit to directors, officers, and their related interests. The Bank’s policies require that all such loans be made at substantially the same terms as those prevailing at the time for comparable transactions with unrelated parties and do not involve more than normal risk or unfavorable features. The following summarizes activities of loans to such parties at December 31:
(8)
Bank Premises, Equipment, and Leasehold Improvements
Bank premises, equipment and leasehold improvements are stated at cost, less accumulated depreciation and amortization, and are summarized as follows at December 31:
Depreciation and amortization expense for the years ended December 31, 2010, 2009, and 2008 was $1,509,000, $1,554,000 and $1,597,000, respectively.
(9)
Deposits
The aggregate amount of jumbo time certificates, each with a minimum denomination of $100,000 or more, was $82,364,000 and $79,662,000 at December 31, 2010 and 2009, respectively.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
At December 31, 2010, the scheduled maturities of all time certificates of deposit are as follows:
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Federal Home Loan Bank Advances
As of December 31, 2010, there were no Federal Home Loan Bank (“FHLB”) advances. As of December 31, 2009, FHLB advances consisted of $20,000,000 in short-term advances due in one year or less, and $5,000,000 in long-term advances due in more than one year. The interest rate on total advances ranged from 1.84% to 4.62% at year end December 31, 2009. Average FHLB advances were $11,575,000 and $49,857,000 in 2010 and 2009, respectively. Weighted average rates were 3.20% and 3.88% in 2010 and 2009, respectively. Including prepayment penalties in 2010, the weighted average rate was 4.76%. The maximum amount borrowed during 2010 and 2009 was $25,000,000 and $86,100,000, respectively.
At December 31, 2010, the Bank had a maximum borrowing capacity under Federal Home Loan Bank advances of $162,515,000, of which the entire amount was available. The Federal Home Loan Bank advances are secured by a blanket collateral agreement pledge of FHLB stock and certain other qualifying collateral, such as commercial and mortgage loans.
(11)
Commitments and Contingencies
Operating Lease Commitments
The Bank leases a portion of its facilities and equipment under noncancelable operating leases expiring at various dates through 2019. Some of these leases provide that the Bank pay taxes, maintenance, insurance, and other occupancy expenses applicable to leased premises. Generally, the leases provide for renewal for various periods at stipulated rates.
The minimum rental commitments under the operating leases as of December 31, 2010 are as follows:
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Total rent expense for operating leases was $641,000, $669,000 and $630,000, in 2010, 2009, and 2008, respectively.
Legal Commitments
The Bank is engaged in various lawsuits either as plaintiff or defendant in the ordinary course of business and, in the opinion of management, based upon the advice of counsel, the ultimate outcome of these lawsuits does not expect to have a material effect on the Bank’s financial condition or results of operations.
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Salary Deferral Plan
The Bank maintains a salary deferral 401(k) plan covering substantially all employees, known as the FNB Bancorp Savings Plan (the “Plan”). The Plan allows employees to make contributions to the Plan up to a maximum allowed by law, and the Bank’s contribution is discretionary. Beginning in 2008, the Board approved a safe harbor election related to the Plan which requires the Company to contribute 3% of qualifying employees wages as a profit sharing contribution. The Bank’s contribution to the Plan for the years ended December 31, 2010, 2009, and 2008 was $294,000, $310,000 and $400,000, respectively.
(13)
Salary Continuation and Deferred Compensation Plans
The Bank maintains a Salary Continuation Plan for certain Bank officers. Officers participating in the Salary Continuation Plan are entitled to receive a monthly payment for a period of fifteen to twenty years upon retirement. The Company accrues such post-retirement benefits over the individual’s employment period. The Salary Continuation Plan expense for the years ended December 31, 2010, 2009, and 2008 was $212,000, $197,000 and $238,000, respectively. Accrued compensation payable under the salary continuation plan totaled $1,698,000 and $1,616,000 at December 31, 2010 and 2009, respectively. The Deferred Compensation Plan allows eligible officers to defer annually their compensation up to a maximum 80% of their base salary and 100% of their cash bonus. The officers are entitled to receive distribution upon reaching a specified age, passage of at least five years or termination of employment. As of December 31, 2010 and 2009, the related liability included in accrued expenses and other liabilities was $644,000 and $711,000, respectively.
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Preferred Stock
Preferred Stock was issued to the U. S. Treasury as part of the Treasury’s Capital Purchase Program. The Preferred Stock consists of two issues, Series A and Series B. The Series A and Series B Preferred Stock are both carried at liquidation value less discounts received plus premiums paid that are amortized over the expected timeframe that the Preferred Shares will be outstanding using the level yield method. The Series A and Series B Preferred Stock must be redeemed after ten years. The Series A Preferred Stock carries a dividend yield of 5% for the first five years. Beginning in year six, the dividend increases to 9% and continues at this rate until repaid. The Series B Preferred Stock pays a 9% dividend until repaid. Allocation of proceeds between the two issues was done in such a manner that the blended level yield of both issues would be 6.83% to the expected repayment date, which is currently anticipated to be three years from the date of issue. Operating restrictions related to the preferred stock are documented on the U. S. Department of the Treasury’s website and include restrictions on dividend payments and executive compensation, the establishment of the requirement that the Preferred Stock be repaid first with the proceeds from any future capital offering before any other use of the proceeds is allowed, establishment of additional reporting requirements related to lending activity of the Bank during the time the Preferred Stock is outstanding, and the execution of documents that allow the U. S. Department of the Treasury to add or change the conditions related to the issuance of the Preferred Stock unilaterally, at their discretion. In addition, beginning in the second quarter of 2010, the Company must obtain regulatory approval from the Office of the Comptroller of the Currency before TARP dividends can be paid. As of December 31, 2010, all dividend payments on our Preferred Stock have been paid in accordance with the Treasury’s Capital Purchase Program.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(15)
Income Taxes
The provision (benefit) for income taxes for the years ended December 31, consists of the following:
The reason for the differences between the statutory federal income tax rate and the effective tax rates for the years ending December 31, are summarized as follows:
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Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The tax effect of temporary differences giving rise to the Bank’s net deferred tax asset are as follows:
Management believes that it is more likely than not that the deferred tax assets will be realized through recovery of taxes previously paid and/or future taxable income, with the exception of a portion of low income housing credit carryforwards. The Bank has federal net operating loss carryforwards resulting from the acquisition of Sequoia National Bank which expire in various tax years ending on December 31, 2013 through December 31, 2020, totaling $1,670,000 as of December 31, 2010. These losses are limited to approximately $468,000 per year under IRS regulations. All operating loss carryforwards are expected to be utilized prior to their expiration.
In assessing the Company’s ability to realize the tax benefits of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the recorded benefits of these deductible differences, with the possible exception of our low income housing tax credit carryforwards. The Company owns investments in low income housing tax credit (“LIHTC”) that had a book value of $2,026,000 as of December 31, 2010. LIHTC investments are expected to have a fifteen year life and no residual value. The LIHTC investments are expected to generate operating losses of $2,026,000 and federal tax credits of $764,000 over the next eight years. These tax benefits have value to the Company only to the extent that they offset income taxes created from otherwise taxable earnings generated by the Company. In the opinion of management, a valuation allowance of $886,000 and $632,000 was necessary as of December 31, 2010 and 2009, respectively. The valuation allowance is equivalent to 100% of the low income housing credit carryforwards that existed as of December 31, 2010 and 2009.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
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Financial Instruments
The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business. These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the balance sheet. The Bank’s exposure to credit loss is represented by the contractual amount of those instruments and is usually limited to amounts funded or drawn. The contract or notional amounts of these agreements, which are not included in the balance sheets, are an indicator of the Bank’s credit exposure. Commitments to extend credit generally carry variable interest rates and are subject to the same credit standards used in the lending process for on-balance-sheet instruments. Additionally, the Bank periodically reassesses the customer’s creditworthiness through ongoing credit reviews. The Bank generally requires collateral or other security to support commitments to extend credit. The following table provides summary information on financial instruments whose contract amounts represent credit risk as of December 31:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis, following normal lending policies. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial and residential properties. Equity reserves and unused credit card lines are additional commitments to extend credit. Many of these customers are not expected to draw down their total lines of credit, and therefore, the total contract amount of these lines does not necessarily represent future cash requirements.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank issues both financial and performance standby letters of credit. The financial standby letters of credit are primarily to guarantee payment to third parties. As of December 31, 2010, there were $1,980,000 issued in financial standby letters of credit. The performance standby letters of credit are typically issued to municipalities as specific performance bonds. As of December 31, 2010 there were $87,000 issued in performance standby letters of credit. The terms of the guarantees will expire in 2011. The Bank has experienced no draws on these letters of credit, and does not expect to in the future. However, should a triggering event occur, the Bank either has collateral in excess of the letters of credit or embedded agreements of recourse from the customer.
The following tables present information about the Company’s assets and liabilities measured at fair value as of December 31, 2010 and 2009, and indicates the fair value techniques used by the Company to determine such fair value.
Fair values established for available-for-sale investment securities are based on estimates of fair values quoted for similar types of securities with similar maturities, risk and yield characteristics.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The following table presents the recorded amount of assets measured at fair value on a non-recurring basis:
The Bank does not record loans at fair value. However, from time to time, if a loan is considered impaired, and a specific allowance for loan losses is established, loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement, are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with the Financial Accounting Standards Board Accounting Standards Codification Section 820. In accordance with this guidance, impaired loans that have a specific allowance established based on the fair value of collateral require classification in the fair value hierarchy. If the fair value of the collateral is based on an observable market price, the Bank records the impaired loans as nonrecurring Level 3. When management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Bank records the fair value of the impaired loans using nonrecurring Level 3 valuation inputs.
The following methods and assumptions were used by the Company in estimating the fair value disclosures for financial instruments:
Cash and Cash Equivalents.
The carrying amounts reported in the balance sheet for cash and short-term instruments are a reasonable estimate of fair value, which will approximate their historical cost.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Securities Available-for-Sale.
Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
Federal Home Loan Bank and Federal Reserve Bank stock.
Federal Home Loan Bank and Federal Reserve Bank stock can only be issued and redeemed at par by these entities. These securities cannot be sold in open market transactions. They are valued at cost.
Loans Receivable.
For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. For fixed rate loans, fair values are based on discounted cash flows, credit risk factors, and liquidity factors.
Bank Owned Life Insurance.
The fair value of bank owned life insurance is the cash surrender value of the policies, net of expenses.
Deposit liabilities.
The fair values disclosed for demand deposits (e.g., interest and non-interest checking, savings, and money market accounts) are, by definition, equal to the amount payable on demand at reporting date (i.e., their carrying amounts). The fair values for fixed-rate certificates of deposit are based on discounted cash flows.
Federal Home Loan Bank Advances.
The fair values of Federal Home Loan Bank Advances were based on discounted cash flows.
Undisbursed loan commitments, lines of credit, Mastercard line and standby letters of credit.
The fair value of these off-balance sheet items are based on discounted cash flows of expected fundings.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The following table provides summary information on the estimated fair value of financial instruments at December 31, 2010:
The following table provides summary information on the estimated fair value of financial instruments at December 31, 2009:
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
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Significant Group Concentrations of Credit Risk
Most of the Bank’s business activity is with customers located within San Mateo and San Francisco counties. Generally, loans are secured by assets of the borrowers. Loans are expected to be repaid from cash flows or proceeds from the sale of selected assets of the borrowers. The Bank does not have significant concentrations of loans to any one industry, but does have loan concentrations in commercial real estate loans that are considered high by regulatory standards. The Bank has mitigated this concentration to a large extent by utilizing underwriting standards that are more conservative than regulatory guidelines, and performing stress testing on this segment of the portfolio to insure that the commercial real estate loan portfolio will perform within management expectations given an additional downturn in commercial lease rates and commercial real estate valuations. The distribution of commitments to extend credit approximates the distribution of loans outstanding. Commercial and standby letters of credit were granted primarily to commercial borrowers. The contractual amounts of credit-related financial instruments such as commitments to extend credit, credit-card arrangements, and letters of credit represent the amounts of potential accounting loss should the contract be fully drawn upon, the customer default, and the value of any existing collateral become worthless.
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Regulatory matters
The Company, as a bank holding company, is subject to regulation by the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956, as amended. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements.
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 the Company’s and the Bank’s assets, liabilities and certain off balance-sheet items as calculated under regulatory accounting practices.
The capital amounts and classification are also subject to qualitative judgments by the regulators about asset groupings, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2010, that the Company and the Bank have met all regulatory capital requirements.
As of December 31, 2010, the most recent notification from the regulatory agencies 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 as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank’s categories.
As of December 31, 2010, the Bank was also in compliance with an Individual Mandatory Capital Requirement imposed by the OCC on the Bank, which requires the Bank to maintain capital ratios of at least 9% Tier 1 Capital Ratio and a 12% Risk-based Capital Ratio.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The consolidated actual capital amounts and ratios of the Company and the Bank are also presented in the following table:
(19)
Stock Option Plans
In 1997, the Board of Directors of the Bank adopted the First National Bank of Northern California 1997 stock option plan approved by the shareholders of First National Bank at the 1997 Annual Meeting on October 15, 1997. Pursuant to the holding company reorganization effective March 15, 2002, the Bank stock option plan became the FNB Bancorp stock option Plan. In 2002, the Company adopted an incentive employee stock option plan known as the 2002 FNB Bancorp plan. In 2008, the Company adopted an incentive employee stock option plan known as the 2008 FNB Bancorp stock option plan. The plans allow the Company as of December 31, 2010 to grant options to employees covering 331,672 shares.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Incentive stock options currently outstanding become exercisable in one to five years from the grant date, based on a vesting schedule of 20% per year and expire 10 years after the grant date. Nonqualified options to directors become vested on the date of grant. The options exercise price is the fair value of the per share price of the underlying stock options at the grant date.
The amount of compensation expense for options recorded in the years ended December 31, 2010, December 31, 2009, and December 31 2008 was $168,000, $157,000 and $171,000, respectively. The income tax benefit related to stock option exercises was $0 for 2010, $0 for 2009 and $8,000 for 2008.
The amount of total unrecognized compensation expense related to non-vested options at December 31, 2010 was $423,000, and the weighted average period it will be amortized over is 2.1 years.
The assumptions for options granted in 2009 were as follows: dividend yield of 2.68% for the year; risk-free interest rate of 3.20%; expected volatility of 60.59%; expected life of 8.8 years. This resulted in a weighted average fair value of $3.77 per share. The assumptions for grants in 2008 were as follows: dividend yield of 4.86% for the year; risk-free interest rate of 3.51%; expected volatility of 50.92%; and expected life of 8.8 years. This resulted in a weighted average fair value of $4.22 per share.
A summary of option activity under the 2008 FNB Bancorp Plan as of December 31, 2010 and changes during the year then ended is presented below.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
The following supplemental information applies to the three years ended December 31:
A summary of option activity under the 2002 FNB Bancorp Plan as of December 31, 2010 and changes during the year then ended is presented below.
The following supplemental information applies to the three years ended December 31:
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
A summary of option activity under the 1997 FNB Bancorp Plan as of December 31, 2010 and changes during the year then ended is presented below.
The following supplemental information applies to the three years ended December 31:
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(20)
Quarterly Data (Unaudited)
There may be rounding differences between the sum of the four quarters presented and the annual amounts used throughout the annual report.
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
(21)
Condensed Financial Information of Parent Company
The parent company-only condensed balance sheets, condensed statements of income, and condensed statements of cash flows information are presented as of and for the years ended December 31, as follows:
FNB BANCORP AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures. Disclosure controls and procedures are designed with the objective of ensuring that information required to be disclosed in reports filed by the Company under the Exchange Act, such as this Annual Report, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Disclosure controls and procedures are also designed with the objective of ensuring that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Evaluation of Disclosure Controls and Procedures and Internal Control over Financial Reporting. The Company’s management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of December 31, 2010. Based on this evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective. There was no change in the Company’s internal control over financial reporting that occurred during the quarter ended December 31, 2010 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting. Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. As defined in Rule 13a-15(f) under the Exchange Act, internal control over financial reporting is a process designed by, or under the supervision of, a company’s principal executive and principal financial officers and effected by a company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. It includes those policies and procedures that:
a)
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of a company;
b)
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of a company are being made only in accordance with authorizations of management and the board of directors of the company, and
c)
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of a company’s assets that could have a material effect on its financial statements.
Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s management has used the criteria established in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) to evaluate the effectiveness of the Company’s internal control over financial reporting. Management has selected the COSO framework for its evaluation as it is a control framework recognized by the SEC and the Public Company Accounting Oversight Board, that is free from bias, permits reasonably consistent qualitative and quantitative measurement of the Company’s internal controls, is sufficiently complete so that relevant controls are not omitted and is relevant to an evaluation of internal controls over financial reporting.
Based on our assessment, management has concluded that our internal control over financial reporting, based on criteria established in “Internal Control-Integrated Framework” issued by COSO was effective as of December 31, 2010.
Date: March 28, 2011
/s/ Thomas C. Mc Graw
/s/ David A. Curtis
Thomas C. Mc Graw
David A. Curtis
Chief Executive Officer
Chief Financial Officer
This annual report does not include an attestation report of the cmopany’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Inherent Limitations on Effectiveness of Controls
The Company’s management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Item 10 of Form 10-K is incorporated by reference to the applicable information contained in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 of Form 10-K is incorporated by reference to the applicable information contained in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
The information required by Item 12 of Form 10-K is incorporated by reference to the applicable information contained in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by Item 13 of Form 10-K is incorporated by reference to the applicable information contained in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by Item 14 of Form 10-K is incorporated by reference to the applicable information contained in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES
(a)(1) Financial Statements. Listed and included in Part II, Item 8.
(2)
Financial Statement Schedules. All schedules have been omitted since the required information is not present in amounts sufficient to require submission of the schedule or because the information required is included in the Financial Statements or notes thereto.
(3) Exhibits.
Exhibit
Number
Document Description
**2.1
(deleted)
2.2
Acquisition Agreement dated November 5, 2004, signed among First National Bank of Northern California, Sequoia National Bank and Hemisphere National Bank (incorporated by reference from Exhibit 2.2 to the Company’s Current Report on Form 8-K filed with the Commission on November 9, 2004).
2.3
First Addendum to Acquisition Agreement, dated December 13, 2004, signed among First National Bank of Northern California, Sequoia National Bank, Hemisphere National Bank and Privee Financial, Inc. (incorporated by reference from Exhibit 2.5 to the Company’s Current Report on Form 8-K filed with the Commission on December 17, 2004)
2.4
Second Addendum to Acquisition Agreement. Dated as of April 15, 2005, signed among First National Bank Of Northern California, Sequoia National Bank, Hemisphere National Bank and Privee Financial, Inc. (incorporated by reference from Exhibit 2.4 to the Company’s Current Report on Form 8-K filed with the Commission on May 2, 2005)
**3.1
Articles of Incorporation of FNB Bancorp
3.2
Certificate of Determination of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”), of FNB Bancorp (incorporated by reference from Exhibit 3.1 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
3.3
Certificate of Determination of Fixed Rate Cumulative Perpetual Preferred Stock, Series B (“Series B Preferred Stock”), of FNB Bancorp (incorporated by reference from Exhibit 3.2 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
3.4
Bylaws of FNB Bancorp (as amended through February 27, 2009).
**4.1
Specimen of the Registrant’s common stock certificate.
4.2
Form of Certificate for the Series A Preferred Stock (incorporated by reference from Exhibit 4.1 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
4.3
Warrant for Purchase of Shares of Series B Preferred Stock (“Warrant”) (incorporated by reference from Exhibit 4.2 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
4.4
Form of Certificate for the Series B Preferred Stock (incorporated by reference from Exhibit 4.3 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
**10.1
Lease agreement dated April 24, 1995, as amended, for Eureka Square Branch Office of First National Bank of Northern California at Eureka Square Shopping Center, Pacifica, California
**10.2
(deleted)
10.3
(deleted)
10.4
(deleted)
10.5
(deleted)
10.6
(deleted)
10.7
(deleted)
10.8(a)
(deleted)
10.8(b)
(deleted)
**10.9
First National Bank Profit Sharing and 401(k) Plan dated August 26, 1969.*
**10.10
First National Bank Deferred compensation Plan dated November 1, 1997.*
**10.11
Salary Continuation Agreement between First National Bank of Northern California and Michael R. Wyman, dated December 20, 1996.*
**10.12
Salary Continuation Agreement between First National Bank of Northern California and Paul B. Hogan dated December 20, 1996.*
**10.13
Salary Continuation Agreement between First National Bank of Northern California and James B. Ramsey, dated December 23, 1999.*
**10.14
Form of Management Continuity Agreement signed on July 20, 2000, between First National Bank of Northern California and Jim D. Black, Charles R. Key and Anthony J. Clifford.*
10.15
(deleted)
**10.16
Communications Site Lease Agreement as amended dated March 30, 1999, between First National Bank of Northern California, as Lessor and Nextel of California, Inc., as Lessee, with respect to Redwood City Branch Office.
10.17
(deleted)
**10.18
Separation Agreement between First National Bank of Northern California and Paul B. Hogan, dated December 5, 2001.*
***10.19
First Amendment to Separation Agreement between First National Bank of Northern California and Paul B. Hogan, dated March 22, 2002.*
****10.20
FNB Bancorp Stock Option Plan (effective March 15, 2002).*
****10.21
FNB Bancorp Stock Option Plan, Form of Incentive Stock Option Agreement.*
****10.22
FNB Bancorp Stock Option Plan, Form of Nonstatutory Stock Option Agreement.*
*****10.23
FNB Bancorp 2002 Stock option Plan (adopted June 28, 2002).*
*****10.24
FNB Bancorp 2002 Stock Option Plan, Form of Incentive Stock Option Agreement.*
*****10.25
FNB Bancorp 2002 Stock Option Plan, Form of Nonstatutory Stock option Agreement.*
******10.26
Lease Agreement dated August 13, 2003, for San Mateo Branch Office of First National Bank of Northern California, located at 150 East Third Avenue, San Mateo, California.
10.27
Salary Continuation Agreement and Split-Dollar Agreement for Jim D. Black (incorporated by reference from Exhibit 10.27 to the Company’s Current Report on Form 8-K filed with the Commission on September 10, 2004).*
10.28
Salary Continuation Agreement and Split-Dollar Agreement for Anthony J. Clifford (incorporated by reference from Exhibit 10.28 to the Company’s Current Report on Form 8-K filed with the Commission on September 10, 2004).*
10.29
Amended and Restated Salary Continuation and Split-Dollar Agreement for James B. Ramsey (incorporated by reference from Exhibit 10.29 o the company’s current Report on Form 8-K filed with the Commission on September 10, 2004).*
*******10.30
Lease Agreement dated May 1, 2003 as amended by Assignment, Assumption and Consent Agreement for the Financial District Branch of First National Bank of Northern California located at 65 Post Street, San Francisco, California.
*******10.31
Lease Agreement dated July 1, 1999, as amended by Assignment, Assumption and Consent for the Portola Branch Office of First National Bank of Northern California located at 699 Portola Drive, San Francisco, California.
10.32
Amendment to Salary Continuation Agreement for Jim D. Black (incorporated by reference from Exhibit 99.37 to the Company’s Current Report on Form 8-K filed with the Commission on July 26, 2006).*
10.33
Amendment to Salary Continuation Agreement for Anthony J. Clifford (incorporated by reference from Exhibit 99.38 to the Company’s Current Report on Form 8-K filed with the Commission on July 26, 2006).*
10.34
Amendment to Amended and Restated Salary Continuation Agreement for James B. Ramsey (incorporated by reference from Exhibit 99.39 to the Company’s Current report on Form 8-K filed with the Commission on July 26, 2006).*
10.35
Lease Agreement dated February 3, 2006, for warehouse facility of First National Bank of Northern California (incorporated by reference from Exhibit 10.35 to the company’s Annual Report on Form 10-K filed with the Commission on March 13, 2008).
10.36
First National Bank Deferred Compensation Plan dated December 1, 2007 (incorporated by reference from Exhibit 10.36 to the Company’s Annual Report on Form 10-K filed with the Commission on March 13, 2008).*
10.37
Amendment No. 5 to the First National Bank Profit Sharing and 401(k) Plan dated December 1, 2007 (incorporated by reference from Exhibit 10.37 to the Company’s Annual Report on Form 10-K filed with the Commission on March 13, 2008).*
10.38
Executive Supplemental Compensation Agreement between First National Bank of Northern California and David A. Curtis dated March 3, 2008 (incorporated by reference from Exhibit 10.38 to the Company’s Current Report on Form 8-K filed with the Commission on March 6, 2008).*
10.39
Split-Dollar Life Insurance Agreement between First National Bank of Northern California and David A. Curtis dated March 3, 2008 (incorporated by reference from Exhibit 10.39 to the Company’s Current Report on Form 8-K filed with the Commission on March 6, 2008).*
********10.40
FNB Bancorp 2008 Stock option Plan (adopted February 22, 2008).*
10.41
Second 409A Amendment to the Salary Continuation Agreement for Jim D. Black (incorporated by reference from Exhibit 99.66 to the Company’s Current Report on Form 8-K filed with the Commission on December 22, 2008).*
10.42
Second 409A Amendment to the Salary Continuation Agreement for Anthony J. Clifford (incorporated by reference from Exhibit 99.67 to the Company’s Current Report on Form 8-K filed with the Commission on December 22, 2008).*
10.43
Amendment to the Executive Supplemental Compensation Agreement for David A. Curtis (incorporated by reference from Exhibit 99.68 to the Company’s Current Report on Form 8-K filed with the Commission on December 22, 2008).*
10.44
Letter Agreement dated February 27, 2009, between FNB Bancorp and United States Department of the Treasury pertaining to the election of directors by the holder(s) of the Series A and Series B Preferred Stock (incorporated by reference from Exhibit 4.4 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
10.45
Letter Agreement, including Schedule A and Securities Purchase Agreement Standard Terms, dated February 27, 2009, between FNB Bancorp and United States Department of the Treasury, with respect to to the issuance and sale of the Series A and Series B Preferred Stock and the Warrant (incorporated by reference from Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
10.46
Letter Agreement dated February 27, 2009, between FNB Bancorp and United States Department of the Treasury pertaining to the American Recovery and Reinvestment Act of 2009 (incorporated by reference from Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
10.47
Letter Agreement dated February 27, 2009, between FNB Bancorp and United States Department of the Treasury amending certain sections of the Securities Purchase Agreement Standard Terms (incorporated by reference from Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009)
10.48
Form of Compensation Modification Agreement and Waiver, dated February 27, 2009, executed by each of:
Thomas C. McGraw
Chief Executive Officer
FNB Bancorp and First National Bank of Northern California
Jim D. Black, President
FNB Bancorp and First National Bank of Northern California
Anthony J. Clifford
Executive Vice President and Chief Operating Officer
FNB Bancorp and First National Bank of Northern California
David A. Curtis
Senior Vice President and Chief Financial Officer
FNB Bancorp and First National Bank of Northern California
Randy R. Brugioni
Senior Vice President and Senior Loan Officer
FNB Bancorp and First National Bank of Northern California
(incorporated by reference from Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the Commission on February 27, 2009).
10.49
Lease agreement dated June 8, 1999, as amended August 18, 2009, for Linda Mar Branch Office of First National Bank of Northern California at Linda Mar Shopping Center, Pacifica, California
10.50
Sublease agreement dated as of September 20, 2010, between Wells Fargo Bank, N. A. as Sublandlord, and First National Bank of Northern California as Subtenant, for Chestnut Street Branch of First National Bank of Northern California
******14.0
Code of Ethics
21.1
The Registrant has one subsidiary, First National Bank of Northern California
23.1
Consent of Moss Adams LLP
31.1
Rule 13a-14(a)/15d-14(a) Certification (principal executive officer)
31.2
Rule 13a-14(a)/15d-14(a) Certification (principal financial officer)
32.0
Section 1350 Certifications
*
Denotes management contracts, compensatory plans or arrangements.
**
Incorporated by reference to registrant’s Quarterly Report on Form 10-Q filed with the Commission on May 15, 2002.
***
Incorporated by reference to registrant’s Annual Report on Form 10-K filed with the Commission on March 31, 2002.
****
Incorporated by reference to registrant’s Statement on Form S-8 (No. 333-91596) filed with the Commission on July 1, 2002.
*****
Incorporated by reference to the registrant’s Registration Statement on Form S-8 (No. 333-98293) filed with the Commission on August 16, 2002.
******
Incorporated by reference to registrant’s Annual Report on Form 10-K filed with the Commission on March 30, 2003.
*******
Incorporated by reference to registrant’s Annual Report on Form 10-K filed with the Commission on March 29, 2006.
********
Incorporated by reference from Appendix A to the Registrant’s Definitive Proxy Statement for its 2008 Annual Meeting of Shareholders, filed with the Commission on April 21, 2008.
An Annual Report for the fiscal year ended December 31, 2010, and Notice of Annual Meeting and Proxy Statement for the Company’s 2011 Annual Meeting will be mailed to security holders subsequent to the date of filing this report. Copies of said materials will be furnished to the Commission in accordance with the Commission’s Rules and Regulations.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
FNB BANCORP
Dated: March 28, 2011
By:
/s/ Thomas C. McGraw
Thomas C. McGraw
Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Lisa Angelot
Chairwoman of the Board
March 28, 2011
Lisa Angelot
of Directors
/s/ Thomas C. McGraw
Director, Chief Executive
March 28, 2011
Thomas C. McGraw
Officer and Secretary
/s/ David A. Curtis
Senior Vice President
March 28, 2011
David A. Curtis
and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)
/s/ Thomas G. Atwood
Director
March 28, 2011
Thomas G. Atwood, D. D. S.
/s/ Ronald R. Barels
Director
March 28, 2011
Ronald R. Barels, D.D.S.
/s/ Merrie Turner Lightner
Director
March 28, 2011
Merrie Turner Lightner
/s/ Michael Pacelli
Director
March 28, 2011
Michael Pacelli
/s/ Edward J. Watson
Director
March 28, 2011
Edward J. Watson
/s/ Jim D. Black
Director and President
March 28, 2011
Jim D. Black
/s/ Anthony J. Clifford
Director and Executive
March 28, 2011
Anthony J. Clifford
Vice President and Chief
Operating Officer