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NOVB > SEC Filings for NOVB > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for NORTH VALLEY BANCORP

Form 10-Q for NORTH VALLEY BANCORP


13-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Certain statements in this Form 10-Q (excluding statements of fact or historical financial information) involve forward-looking information within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the "safe harbor" created by those sections. These forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Such risks and uncertainties include, but are not limited to, the following factors:
competitive pressure in banking industry increases significantly; changes in the interest rate environment reduce margins; general economic conditions, either nationally or regionally, are less favorable than expected, resulting in, among other things, a deterioration in credit quality and an increase in the provision for possible loan losses; changes in the regulatory environment; changes in business conditions, particularly in the Northern California region; volatility of rate sensitive deposits; operational risks including data processing system failures or fraud; asset/liability matching risks and liquidity risks; California state budget problems; the U.S. "war on terrorism" and military action by the U.S. in the Middle East; and changes in the securities markets.

Critical Accounting Policies

General

North Valley Bancorp's financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our financial statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. Another estimate that we use is related to the expected useful lives of our depreciable assets. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

Allowance for Loan Losses.The allowance for loan losses is an estimate of loan losses inherent in the Company's loan portfolio as of the balance-sheet date. The allowance is established through a provision for loan losses which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after loan losses and loan growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The overall allowance consists of two primary components, specific reserves related to impaired loans and general reserves for inherent losses related to non-impaired loans. Non-impaired loans are evaluated collectively for impairment as a group by loan type and common risk characteristics.

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, including principal and interest, according to the contractual terms of the original agreement. Loans determined to be impaired are individually evaluated for impairment. When a loan is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, it may measure impairment based on a loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. For further information on the allowance for loan losses, see Note 4 to the Notes to Condensed Consolidated Financial Statements in Item I above.

Allowance for Loan Losses on Off-Balance-Sheet Credit Exposures. The Company also maintains a separate allowance for off-balance-sheet commitments. Management estimates anticipated losses using historical data and utilization assumptions. The allowance for off-balance-sheet commitments is included in accrued interest payable and other liabilities on the consolidated balance sheet.

Other Real Estate Owned ("OREO"). OREO represents properties acquired through foreclosure or physical possession. Write-downs to fair value at the time of transfer to OREO are charged to allowance for loan losses. Subsequent to foreclosure, management periodically evaluate the value of OREO held for sale and record a valuation allowance for any subsequent declines in fair value less selling costs. Subsequent declines in value are charged to operations. Fair value is based on our assessment of information available to us at the end of a reporting period and depends upon a number of factors, including our historical experience, economic conditions, and issues specific to individual properties. Management's evaluation of these factors involves subjective estimates and judgments that may change.

Share Based Compensation. At September 30, 2012, the Company had two stock-based compensation plans: the 1998 Employee Stock Incentive Plan and the 2008 Stock Incentive Plan, which are described more fully in Note 9 to the Notes to Condensed Consolidated Financial Statements. Compensation cost is recognized on all share-based payments over the requisite service periods of the awards based on the grant-date fair value of the options determined using the Black-Scholes-Merton based option valuation model. Critical assumptions that are assessed in computing the fair value of share-based payments include stock price volatility, expected dividend rates, the risk free interest rate and the expected lives of such options. Compensation cost recorded is net of estimated forfeitures expected to occur prior to vesting. For further information on the computation of the fair value of share-based payments, see Note 9 to the Notes to Condensed Consolidated Financial Statements in Item I above.

Impairment of Investment Securities. An investment security is impaired when its carrying value is greater than its fair value. Investment securities that are impaired are evaluated on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether such a decline in their fair value is other than temporary. Management utilizes criteria such as the magnitude and duration of the decline and the intent and ability of the Company to retain its investment in the securities for a period of time sufficient to allow for an anticipated recovery in fair value, in addition to the reasons underlying the decline, to determine whether the loss in value is other than temporary. The term "other than temporary" is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other than temporary, and management does not intend to sell the security or it is more likely than not that the Company will not be required to sell the security before recovery, only the portion of the impairment loss representing credit exposure is recognized as a charge to earnings, with the balance recognized as a charge to other comprehensive income. If management intends to sell the security or it is more likely than not that the Company will be required to sell the security before recovering its forecasted cost, the entire impairment loss is recognized as a charge to earnings.

Accounting for Income Taxes. The Company files its income taxes on a consolidated basis with its subsidiary. The allocation of income tax expense (benefit) represents each entity's proportionate share of the consolidated provision for income taxes.

The Company applies the asset and liability method to account for income taxes. Deferred tax assets and liabilities are calculated by applying applicable tax laws to the differences between the financial statement basis and the tax basis of assets and liabilities. The effect on deferred taxes of changes in tax laws and rates is recognized in income in the period that includes the enactment date. On the consolidated balance sheet, net deferred tax assets are included in other assets.

The Company accounts for uncertainty in income taxes by recording only tax positions that met the more likely than not recognition threshold, that the tax position would be sustained in a tax examination.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

The Company evaluates deferred income tax assets for recoverability based on all available evidence. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws, our ability to successfully implement tax planning strategies, or variances between our future projected operating performance and our actual results. The Company is required to establish a valuation allowance for deferred tax assets if we determine, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In determining the more-likely-than-not criterion, we evaluate all positive and negative available evidence as of the end of each reporting period. Future adjustments to the deferred tax asset valuation allowance, if any, will be determined based upon changes in the expected realization of net deferred tax assets. The realization of deferred tax assets ultimately depends on the existence of sufficient taxable income in the carry back and carry forward periods under the tax law. Due to the Company's cumulative tax losses in 2009 and 2010, it was determined to establish a partial valuation allowance in 2010 of $4,500,000 to reflect the portion of the deferred tax assets that the Company determined to be more likely than not that it will not be realized. During the quarter ended December 31, 2011, the Company reversed the Federal portion of its valuation allowance in the amount of $223,000, and in the quarter ended September 30, 2012, the Company eliminated the remaining valuation allowance of $4,277,000.

To determine if the benefit of its net deferred tax asset will more likely than not be realized, the Company's management analyzed both positive and negative evidence that may affect the realization of the deferred tax asset. Management of the Company determined that it was more likely than not that all of its net deferred tax asset would be realized based on:

The quarter ended September 30, 2012 marked the Company's eighth consecutive quarter of positive earnings
Continued profitability is expected for the foreseeable future
At September 2012 classified loans as a percent of total loans were 5.8% as compared to 13.3% as of December 2010
At September 2012 nonaccrual loans as a percent of total loans were 2.4% as compared to 3.6% as of December 2010
Other real estate owned totaled $21,689,000 at September 2012 compared to $25,784,000 at December 2010
Effective April 2012 the supervisory agreement by and among North Valley Bancorp, North Valley Bank, and the Federal Reserve Bank of San Francisco was terminated
Implementation of various cost savings measures including reductions in the number of personnel and regulatory approval to consolidate two of its branches during the current quarter; one located in Redding, California and the other in Ukiah, California
Approval by the Federal Reserve Bank of San Francisco and the California Department of Financial Institutions allowing North Valley Bank upstream $16.5 million to the Company to pay all deferred interest on its subordinated debentures and to fully redeem its North Valley Capital Trust I subordinated notes in the amount of $10.3 million

Redemption of the Company's North Valley Capital Trust I on July 25, 2012
The length of the carryforward period in which the Company has to utilize its net operating losses and tax credits
The reduction of nonperforming assets and classified assets significantly reduces the risk associated with future financial projections.

As of September 30, 2012, the net deferred tax asset was $13,470,000. This is compared to a net deferred tax asset of $10,721,000, which included a valuation allowance of $4,227,000, as of December 31, 2011.

Business Organization

North Valley Bancorp (the "Company") is a California corporation and a bank holding company for North Valley Bank, a California state-chartered, Federal Reserve member bank ("NVB"). NVB operates out of its main office located at 300 Park Marina Circle, Redding, California 96001, with twenty-four branches, including two supermarket branches in eight counties in Northern California. As previously reported, the Board of Directors of NVB approved the filing of regulatory applications, the sending of customer notices, and all other actions required in order to close and consolidate two offices of North Valley Bank. The Bank will not extend the lease for its branch office located in Ukiah, California, due to expire in April 2013, and the Bank will close its branch office located at 2930 Bechelli Lane, Redding, California. The Bank has now received regulatory approval to proceed and the Bank plans to close both branches prior to the end of 2012. The Company views its service area as having four distinct markets: the Redding market, the Coastal market, the I-80 Corridor market and the Santa Rosa market.

The Company's principal business consists of attracting deposits from the general public and using the funds to originate commercial, real estate and installment loans to customers, who are predominately small and middle market businesses and middle income individuals. The Company's primary source of revenues is interest income from its loan and investment securities portfolios. The Company is not dependent on any single customer for more than ten percent of its revenues.

Overview



Financial Results



                                            Three months ended          Nine months ended
(in thousands except per share amounts)        September 30,              September 30,
                                             2012          2011         2012          2011
Net interest income                       $     7,713     $ 7,847     $  22,434     $ 23,811
Provision for loan losses                         700         400         2,100        2,650
Noninterest income                              4,204       4,012        12,150       10,648
Noninterest expense                             9,759       9,597        28,643       28,803
(Benefit) provision for income taxes           (3,893 )       542        (3,251 )        768
Net income                                $     5,351     $ 1,320     $   7,092     $  2,238

Per Share Amounts
Basic and Diluted Income Per Share        $      0.78     $  0.19     $    1.04     $   0.33

Annualized Return on Average Assets              2.32 %      0.58 %        1.04 %       0.33 %
Annualized Return on Average Equity             22.59 %      5.85 %       10.23 %       3.45 %

The Company had net income of $5,351,000, or $0.78 per diluted share, and $7,092,000, or $1.04 per diluted share for the three and nine months ended September 30, 2012, respectively. Net income for the three and nine months ended September 30, 2012 included a $4,277,000 elimination of the deferred tax asset valuation allowance. This compares to net income of $1,320,000, or $0.19 per diluted share, and $2,238,000, or $0.33 per diluted share for the three and nine months ended September 30, 2011. The increase in net income before taxes for three and nine months ended September 30, 2012 compared to the net income for three and nine months ended September 30, 2011 was primarily attributed to gains on sale of securities and an increase in gains on real estate loans. Noninterest expense decreased for the three and nine months ended September 30, 2012 compared to the three and nine months ended September 30, 2011 due to other real estate owned expense and FDIC assessment decreases offset by higher salaries and benefit costs.

The supervisory agreement signed on January 6, 2010 by and among North Valley Bancorp, North Valley Bank and the Federal Reserve Bank of San Francisco was terminated, effective as of April 16, 2012, and resolutions adopted by the Board of Directors of NVB at the request of the California Department of Financial Institutions were previously terminated, effective March 1, 2012.

Results of Operations

Net Interest Income and Net Interest Margin (fully taxable equivalent basis)

Net interest income is the difference between interest earned on loans and investments and interest paid on deposits and borrowings, and is the primary revenue source for the Company. Net interest margin is net interest income expressed as a percentage of average earning assets. These items have been adjusted to give effect to $67,000 and $81,000 in taxable-equivalent interest income on tax-free investments for the three month periods ended September 30, 2012 and 2011, respectively.

Net interest income for the three months ended September 30, 2012 was $7,780,000, a $148,000, or 1.9%, decrease from net interest income of $7,928,000 for the same period in 2011. Interest income decreased $825,000, or 8.9%, to $8,493,000 for the three month period ended September 30, 2012 due primarily to a decrease in yields on average investments and average loans. The Company had foregone interest income for the loans placed on nonaccrual status of $138,000 during the three months ended September 30, 2012 compared to $89,000 for the same period in 2011. The average loans outstanding during the three months ended September 30, 2012 increased $1,184,000, or 0.2%, to $475,600,000. This higher loan volume increased interest income by $18,000. The average yield earned on the loan portfolio decreased 41 basis points to 5.56% for the three months ended September 30, 2012. This decrease in yield decreased interest income by $489,000. The total decrease in interest income from the loan portfolio was $471,000. The average balance of the investment portfolio increased $29,759,000, or 10.1%, which accounted for a $179,000 increase in interest income and a decrease in average yield of the investment portfolio of 69 basis points reduced interest income by $521,000.

Interest expense for the three months ended September 30, 2012 decreased $677,000, or 48.7%, to $713,000 compared to the same period in 2011. The largest decrease to interest expense was attributed to the reduction in average balances in time deposit accounts which decreased $26,719,000 as the average rates paid on these accounts decreased 45 basis points to 0.72% and reduced interest expense by $209,000 while a decrease in the average balances of these accounts decreased interest expense by $78,000. The average rate paid on savings and money market accounts decreased 25 basis points to 0.18% for the three month period ended September 30, 2012 compared to 0.43% for the same period in 2011, resulting in a decrease in interest expense of $144,000. This decrease was offset partially by higher average balances in transaction accounts of $16,821,000, resulting in an $8,000 increase in interest expense. On July 25, 2012, the Company redeemed, in full, its North Valley Capital Trust I subordinated notes, in the amount of $10,310,000, bearing an interest rate of 10.25%. The redemption decreased interest expense by $207,000.

The net interest margin for the three months ended September 30, 2012 decreased 12 basis points to 3.78% from 3.90% for the same period in 2011 and an 11 basis point increase from the 3.67% net interest margin for the linked quarter ended June 30, 2012.

The following table sets forth the Company's consolidated condensed average daily balances and the corresponding average yields received and average rates paid of each major category of assets, liabilities, and stockholders' equity for the periods indicated:

Schedule of Average Daily Balance and Average Yields and Rates

(Dollars in thousands)



                               Three months ended September 30, 2012                 Three months ended September 30, 2011
                             Average             Yield/          Interest          Average             Yield/          Interest
                             Balance              Rate            Amount           Balance              Rate            Amount

Assets
Earning assets:
Federal funds sold       $        17,770             0.22 %     $       10     $        38,076             0.23 %     $       22
Investment securities:
Taxable                          311,736             2.06 %          1,622             279,548             2.73 %          1,924
Tax exempt (1)                    11,663             6.74 %            198              14,092             6.70 %            238
Total investments                323,399             2.23 %          1,820             293,640             2.92 %          2,162
Loans (2)(3)                     475,600             5.56 %          6,663             474,416             5.97 %          7,134
Total earning assets             816,769             4.13 %          8,493             806,132             4.59 %          9,318

Nonearning assets                107,942                                               106,699
Allowance for loan
losses                           (11,472 )                                             (14,379 )
Total nonearning
assets                            96,470                                                92,320

Total assets             $       913,239                                       $       898,452

Liabilities and
Stockholders' Equity
Interest bearing
liabilities:
Transaction accounts     $       180,431             0.05 %     $       24     $       163,610             0.18 %     $       76
Savings and money
market                           226,630             0.18 %            103             221,669             0.43 %            242
Time certificates                184,802             0.72 %            335             211,521             1.17 %            622
Other borrowed funds              35,172             2.83 %            251              31,961             5.59 %            450
Total interest bearing
liabilities                      627,035             0.45 %            713             628,761             0.88 %          1,390
Demand deposits                  168,658                                               161,939
Other liabilities                 23,589                                                18,306
Total liabilities                819,282                                               809,006
Stockholders' equity              93,957                                                89,446
Total liabilities and
stockholders' equity     $       913,239                                       $       898,452
Net interest income                                             $    7,780                                            $    7,928
Net interest spread                                  3.68 %                                                3.71 %
Net interest margin                                  3.78 %                                                3.90 %


(1) Tax-equivalent basis; non-taxable securities are exempt from federal taxation.
(2) Loans on nonaccrual status have been included in the computations of averages balances.
(3) Includes loan fees of $113 and $38 for the three months ended September 30, 2012 and 2011, respectively.

Net interest income for the nine months ended September 30, 2012 was $22,646,000, a $1,408,000, or 5.9%, decrease from net interest income of $24,054,000 for the same period in 2011. Interest income decreased $2,842,000, or 10%, to $25,667,000 for the nine months ended September 30, 2012 due primarily to a decrease in average loans. The Company had foregone interest income for the loans placed on nonaccrual status of $495,000 during the nine months ended September 30, 2012 compared to $824,000 for the same period in 2011. The average loans outstanding during the nine months ended September 30, 2012 decreased $30,866,000, or 6.3%, to $458,826,000. This lower loan volume decreased interest income by $1,385,000. The average yield earned on the loan portfolio decreased 35 basis points to 5.65% for the nine months ended September 30, 2012. This decrease in yield decreased interest income by $1,136,000. The total decrease in interest income from the loan portfolio was $2,521,000. The average balance of the investment portfolio increased $32,868,000, or 11.2%, which accounted for a $622,000 increase in interest income and a decrease in average yield of the investment portfolio of 44 basis points reduced interest income by $961,000.

Interest expense for the nine months ended September 30, 2012 decreased $1,434,000, or 32.2%, to $3,021,000 compared to the same period in 2011. The largest decrease in interest expense was in time deposit accounts which decreased $16,667,000 as the average rates paid on these accounts decreased 37 basis points to 0.88% and reduced interest expense by $552,000 while a decrease in the average balances of these accounts decreased interest expense by $156,000. The average rate paid on savings and money market accounts decreased 25 basis points to 0.22% for the nine month period ended September 30, 2012 compared to 0.47% for the same period in 2011, resulting in a decrease to interest expense of $405,000. This decrease was offset partially by higher average balances in transaction accounts of $15,585,000, resulting in a $22,000 increase in interest expense.

The net interest margin for the nine months ended September 30, 2012 decreased 30 basis points to 3.70% from 4.00% for the same period in 2011. The following table sets forth the Company's consolidated condensed average daily balances and the corresponding average yields received and average rates paid of each major category of assets, liabilities, and stockholders' equity for the periods indicated (these items have been adjusted to give effect to $212,000 and $243,000 in taxable-equivalent interest income on tax-free investments for the nine month periods ended September 30, 2012 and 2011, respectively):

Schedule of Average Daily Balance and Average Yields and Rates

(Dollars in thousands)



                              Nine months ended September 30, 2012               Nine months ended September 30, 2011
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