f10q_080211.htm
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)
R  
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2011
 
or
£  
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________.
 
Commission file number: 001-09383
WESTAMERICA BANCORPORATION
(Exact Name of Registrant as Specified in Its Charter)

CALIFORNIA
(State or Other Jurisdiction of Incorporation or Organization)

94-2156203
(I.R.S. Employer Identification No.)
 
1108 FIFTH AVENUE, SAN RAFAEL, CALIFORNIA 94901
(Address of Principal Executive Offices)
(Zip Code)
 
Registrant's Telephone Number, Including Area Code (707) 863-6000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes R                      No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes R                                                                                                 No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer R
Accelerated filer £
Non-accelerated filer £
Smaller reporting company £
 
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes £                      No R

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date:
 
Title of Class
Shares outstanding as of July 25, 2011
   
Common Stock,
No Par Value
28,523,000
 
 
 

 
TABLE OF CONTENTS


 
Page
Forward Looking Statements
 3
PART I - FINANCIAL INFORMATION   
Item 1         Financial Statement
 4
Notes to Unaudited Condensed Consolidated Financial Statements
 8
Financial Summary
30
Item 2         Management's Discussion and Analysis of Financial Condition and Results of Operations
31
Item 3         Quantitative and Qualitative Disclosures about Market Risk
50
Item 4         Controls and Procedures
50
PART II - OTHER INFORMATION
 
Item 1         Legal Proceedings
50
Item 1ARisk Factors
50
Item 2         Unregistered Sales of Equity Securities and Use of Proceeds
51
Item 3         Defaults upon Senior Securities
51
Item 4         Reserved
51
Item 5         Other Information
51
Item 6         Exhibits
51
Signatures
52
Exhibit Index
53
Exhibit 31.1 - Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a)
54
Exhibit 31.2 - Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a)
55
Exhibit 32.1 - Certification of Chief Executive Officer Required by 18 U.S.C. Section 1350
56
Exhibit 32.2 - Certification of Chief Financial Officer Required by 18 U.S.C. Section 1350
57

 
- 2 -

 
FORWARD-LOOKING STATEMENTS
 
This report on Form 10-Q contains forward-looking statements about Westamerica Bancorporation for which it claims the protection of the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of the Company or its management or board of directors, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements.  Words such as "believes", "anticipates", "expects", "intends", "targeted", "projected", "continue", "remain", "will", "should", "may" and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

These forward-looking statements are based on Management’s current knowledge and belief and include information concerning the Company’s possible or assumed future financial condition and results of operations. A number of factors, some of which are beyond the Company’s ability to predict or control, could cause future results to differ materially from those contemplated. These factors include but are not limited to (1) the length and severity of current and potential future difficulties in the national and California economies and the effects of federal government efforts to address those difficulties; (2) liquidity levels in capital markets; (3) fluctuations in asset prices including, but not limited to stocks, bonds, real estate, and commodities; (4) the effect of acquisitions and integration of acquired businesses; (5) economic uncertainty created by terrorist threats and attacks on the United States, the actions taken in response, and the uncertain effect of these events on the national and regional economies; (6) changes in the interest rate environment; (7) changes in the regulatory environment; (8) competitive pressure in the banking industry; (9) operational risks including data processing system failures or fraud; (10) volatility of interest rate sensitive loans, deposits and investments; (11) asset/liability management risks and liquidity risks; (12) the effect of natural disasters, including earthquakes, fire, and other disasters, on the uninsured value of loan collateral, the financial condition of debtors and issuers of investment securities, the economic conditions affecting the Company’s market place, and commodities and asset values, and (13) changes in the securities markets. The Company undertakes no obligation to update any forward-looking statements in this report. The reader is directed to the Company's annual report on Form 10-K for the year ended December 31, 2010, for further discussion of factors which could affect the Company's business and cause actual results to differ materially from those expressed in any forward-looking statement made in this report. The Company undertakes no obligation to update any forward-looking statements in this report.
 
 
- 3 -

 
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements

WESTAMERICA BANCORPORATION
 
CONSOLIDATED BALANCE SHEETS
 
(unaudited)
 
             
   
At June 30,
   
At December 31,
 
   
2011
   
2010
 
   
(In thousands)
 
Assets:
           
Cash and due from banks
  $ 320,119     $ 338,793  
Money market assets
    -       392  
Investment securities available for sale
    705,078       671,484  
Investment securities held to maturity,
with fair values of:
$687,326 at June 30, 2011, $594,711 at December 31, 2010
    669,452       580,728  
Purchased covered loans
    622,727       692,972  
Purchased non-covered loans
    164,844       199,571  
Originated loans
    1,963,642       2,029,541  
Allowance for loan losses
    (33,008 )     (35,636 )
Total loans
    2,718,205       2,886,448  
Non-covered other real estate owned
    16,637       13,620  
Covered other real estate owned
    24,348       21,791  
Premises and equipment, net
    35,015       36,278  
Identifiable intangibles, net
    31,576       34,604  
Goodwill
    121,673       121,673  
Other assets
    234,628       225,713  
Total Assets
  $ 4,876,731     $ 4,931,524  
                 
Liabilities:
               
Deposits
               
Noninterest bearing deposits
  $ 1,446,973     $ 1,454,663  
Interest bearing deposits
    2,641,412       2,678,298  
Total deposits
    4,088,385       4,132,961  
Short-term borrowed funds
    106,727       107,385  
Federal Home Loan Bank advances
    46,351       61,698  
Debt financing and notes payable
    25,853       26,363  
Other liabilities
    60,075       57,830  
Total Liabilities
    4,327,391       4,386,237  
                 
Shareholders' Equity:
               
Common stock (no par value), authorized - 150,000 shares
Issued and outstanding:
28,540 at June 30, 2011, 29,090 at December 31, 2010
    375,277       378,885  
Deferred compensation
    3,060       2,724  
Accumulated other comprehensive income
    8,251       159  
Retained earnings
    162,752       163,519  
Total Shareholders' Equity
    549,340       545,287  
Total Liabilities and  Shareholders' Equity
  $ 4,876,731     $ 4,931,524  
 
See accompanying notes to unaudited condensed consolidated financial statements.

 
- 4 -

 
WESTAMERICA BANCORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
   
Three months ended
 
Six months ended
 
   
June 30,
 
June 30,
 
   
2011
 
2010
 
2011
 
2010
 
   
(In thousands, except per share data)
Interest and Fee Income:
                 
Loans
  $ 41,272   $ 44,060   $ 82,635   $ 88,762  
Money market assets and funds sold
    -     -     -     1  
Investment securities available for sale
    5,684     4,026     10,902     7,921  
Investment securities held to maturity
    6,132     6,992     12,045     14,397  
Total Interest and Fee Income
    53,088     55,078     105,582     111,081  
Interest Expense:
                         
Deposits
    1,777     2,180     3,667     4,668  
Short-term borrowed funds
    47     491     109     1,028  
Federal Home Loan Bank advances
    128     52     279     136  
Debt financing and notes payable
    201     422     401     847  
Total Interest Expense
    2,153     3,145     4,456     6,679  
Net Interest Income
    50,935     51,933     101,126     104,402  
Provision for Loan Losses
    2,800     2,800     5,600     5,600  
Net Interest Income After Provision For Loan Losses
    48,135     49,133     95,526     98,802  
Noninterest Income:
                         
   Service charges on deposit accounts
    7,577     8,629     15,098     17,371  
   Merchant processing services
    2,391     2,176     4,562     4,397  
   Debit card fees
    1,283     1,245     2,484     2,419  
   ATM processing fees
    997     1,021     1,932     1,912  
   Trust fees
    482     448     975     829  
   Financial services commissions
    117     223     146     372  
   Other
    2,445     2,028     4,838     3,940  
Total Noninterest Income
    15,292     15,770     30,035     31,240  
Noninterest Expense:
                         
   Salaries and related benefits
    14,913     15,476     29,988     31,368  
   Occupancy
    4,050     3,822     8,075     7,599  
   Outsourced data processing services
    2,122     2,202     4,578     4,442  
   Settlements
    2,100     -     2,100     23  
   Amortization of identifiable intangibles
    1,480     1,540     3,028     3,138  
   Professional fees
    1,453     867     2,303     1,530  
   Furniture and equipment
    1,038     1,116     1,971     2,167  
   Courier service
    852     903     1,695     1,810  
   FDIC insurance assessments
    740     1,260     1,960     2,580  
   Other
    5,561     4,909     9,934     9,469  
Total Noninterest Expense
    34,309     32,095     65,632     64,126  
Income Before Income Taxes
    29,118     32,808     59,929     65,916  
   Provision for income taxes
    7,849     9,247     16,278     18,779  
Net Income
  $ 21,269   $ 23,561   $ 43,651   $ 47,137  
                           
Average Common Shares Outstanding
    28,771     29,207     28,895     29,217  
Diluted Average Common Shares Outstanding
    28,923     29,568     29,073     29,582  
Per Common Share Data:
                         
   Basic earnings
  $ 0.74   $ 0.81   $ 1.51   $ 1.61  
   Diluted earnings
    0.74     0.80     1.50     1.59  
   Dividends paid
    0.36     0.36     0.72     0.72  
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
 
- 5 -

 
WESTAMERICA BANCORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(unaudited)

   
Common
     
Accumulated
             
   
Shares
 
Common
 
Deferred
 
Comprehensive
 
Retained
     
   
Outstanding
 
Stock
 
Compensation
 
Income
 
Earnings
 
Total
 
   
(In thousands)
                           
Balance, December 31, 2009
    29,208   $ 366,247   $ 2,485   $ 3,714   $ 133,002   $ 505,448  
Comprehensive income
                                     
     Net income for the period
                            47,137     47,137  
     Other comprehensive income,
           net of tax:
                                     
        Increase in net unrealized gains
           on securities available for sale
                      2,582           2,582  
        Post-retirement benefit transition
           obligation amortization
                      18           18  
Total comprehensive income
                                  49,737  
Exercise of stock options
    210     8,783                       8,783  
Stock option tax benefits
          796                       796  
Restricted stock activity
    7     194     239                 433  
Stock based compensation
          720                       720  
Stock awarded to employees
    1     77                       77  
Purchase and retirement of stock
    (308 )   (3,828 )               (13,392 )   (17,220 )
Dividends
                            (21,093 )   (21,093 )
Balance, June 30, 2010
    29,118   $ 372,989   $ 2,724   $ 6,314   $ 145,654   $ 527,681  
                                       
Balance, December 31, 2010
    29,090   $ 378,885   $ 2,724   $ 159   $ 163,519   $ 545,287  
Comprehensive income
                                     
     Net income for the period
                            43,651     43,651  
     Other comprehensive income,
        net of tax:
                                     
        Increase in net unrealized gains
           on securities available for sale
                      8,074           8,074  
        Post-retirement benefit transition
           obligation amortization
                      18           18  
Total comprehensive income
                                  51,743  
Exercise of stock options
    74     3,273                       3,273  
Stock option tax benefits
          28                       28  
Restricted stock activity
    15     455     336                 791  
Stock based compensation
          720                       720  
Stock awarded to employees
    1     58                       58  
Purchase and retirement of stock
    (640 )   (8,142 )               (23,542 )   (31,684 )
Dividends
                            (20,876 )   (20,876 )
Balance, June 30, 2011
    28,540   $ 375,277   $ 3,060   $ 8,251   $ 162,752   $ 549,340  
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
 
- 6 -

 
WESTAMERICA BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
   
For the six months
 
   
ended June 30,
 
   
2011
   
2010
 
   
(In thousands)
 
Operating Activities:
           
Net income
  $ 43,651     $ 47,137  
Adjustments to reconcile net income to net cash
  provided by operating activities:
               
Depreciation and amortization
    6,943       7,589  
Loan loss provision
    5,600       5,600  
Net amortization of deferred loan (fees) cost
    (190 )     28  
(Increase) decrease in interest income receivable
    (161 )     657  
Decrease in other assets
    1,685       403  
Increase in income taxes payable
    212       2,899  
Increase in net deferred tax asset
    (571 )     (11,275 )
Decrease in interest expense payable
    (328 )     (1 )
Increase (decrease) in other liabilities
    4,581       (13,866 )
Stock option compensation expense
    720       720  
Stock option tax benefits
    (28 )     (796 )
Gain on sale of other assets
    (800 )     (608 )
Net gain on sale of premises and equipment
    (127 )     (447 )
Originations of mortgage loans for resale
    (90 )     (277 )
Net proceeds from sale of mortgage loans originated for resale
    93       288  
Net gain on sale of foreclosed assets
    (193 )     (478 )
Write-down of foreclosed assets
    845       399  
Net Cash Provided by Operating Activities
    61,842       37,972  
                 
Investing Activities:
               
Net repayments of loans
    146,387       145,389  
Proceeds from FDIC loss-sharing indemnification
    5,265       29,841  
Purchases of investment securities available for sale
    (152,998 )     (149,493 )
Purchases of investment securities held to maturity
    (128,294 )     -  
Proceeds from maturity/calls of securities available for sale
    122,645       73,064  
Proceeds from maturity/calls of securities held to maturity
    41,749       73,977  
Net change in FRB/FHLB* securities
    (13,158 )     3,121  
Proceeds from sale of foreclosed assets
    6,734       8,071  
Purchases of premises and equipment
    (250 )     (448 )
Proceeds from sale of premises and equipment
    169       603  
Net Cash Provided by Investing Activities
    28,249       184,125  
                 
Financing Activities:
               
Net change in deposits
    (43,848 )     (168,106 )
Net change in short-term borrowings and FHLB advances
    (15,658 )     (92,152 )
Exercise of stock options
    3,273       8,783  
Stock option tax benefits
    28       796  
Repurchases/retirement of stock
    (31,684 )     (17,220 )
Dividends paid
    (20,876 )     (21,093 )
Net Cash Used in Financing Activities
    (108,765 )     (288,992 )
Net Change In Cash and Due from Banks
    (18,674 )     (66,895 )
Cash and Due from Banks at Beginning of Period
    338,793       361,135  
Cash and Due from Banks at End of Period
  $ 320,119     $ 294,240  
                 
Supplemental Cash Flow Disclosures:
               
Supplemental disclosure of non cash activities:
               
   Loan collateral transferred to other real estate owned
  $ 14,637     $ 13,749  
Supplemental disclosure of cash flow activities:
               
   Interest paid for the period
    6,299       8,058  
   Income tax payments for the period
    16,638       27,257  
 
See accompanying notes to unaudited condensed consolidated financial statements.
* Federal Reserve Bank/Federal Home Loan Bank ("FRB/FHLB")
 
- 7 -

 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1: Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. The results of operations reflect interim adjustments, all of which are of a normal recurring nature and which, in the opinion of Management, are necessary for a fair presentation of the results for the interim periods presented. The interim results for the three and six months ended June 30, 2011 and 2010 are not necessarily indicative of the results expected for the full year. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes as well as other information included in the Company's Annual Report on Form 10-K for the year ended December 31, 2010.

The Company has evaluated events and transactions subsequent to the balance sheet date. Based on this evaluation, the Company is not aware of any events or transactions that occurred subsequent to the balance sheet date but prior to filing that would require recognition or disclosure in its consolidated financial statements.

Note 2: Accounting Policies

The Company’s accounting policies are discussed in Note 1 to the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.  Certain amounts in prior periods have been reclassified to conform to the current presentation.

Nonmarketable Equity Securities.  Nonmarketable equity securities include securities that are not publicly traded and securities acquired for various purposes, such as to meet regulatory requirements (for example, Federal Home Loan Bank and Federal Reserve stock).  These securities are accounted for under the cost method and are included in other assets.  The Company reviews those assets accounted for under the cost method at least quarterly for possible declines in value that are considered “other than temporary”.  The Company’s review typically includes an analysis of the facts and circumstances of each investment, the expectations for the investment’s cash flows and capital needs, the viability of its business model and exit strategy.  The asset value is reduced when a decline in value is considered to be other than temporary.  The Company recognizes the estimated loss as a loss from equity investments in noninterest income.

Certain accounting policies underlying the preparation of these financial statements require Management to make estimates and judgments. These estimates and judgments may significantly affect reported amounts of assets and liabilities, revenues and expenses, and disclosures of contingent assets and liabilities. Management exercises judgment to estimate the appropriate level of the allowance for credit losses and the acquisition date fair value of purchased loans, which are discussed in the Company’s accounting policies.

As described in Note 3 below, Westamerica Bank (“Bank”) acquired assets and assumed liabilities of the former Sonoma Valley Bank (“Sonoma”) on August 20, 2010. The acquired assets and assumed liabilities were measured at estimated fair values, as required by Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 805, Business Combinations. Management made significant estimates and exercised significant judgment in accounting for the acquisition. Management judgmentally measured loan fair values based on loan file reviews (including borrower financial statements and tax returns), appraised collateral values, expected cash flows, and historical loss factors. Repossessed loan collateral was primarily valued based upon appraised collateral values. The Bank also recorded an identifiable intangible asset representing the value of the core deposit customer base of Sonoma based on Management’s evaluation of the cost of such deposits relative to alternative funding sources. In determining the value of the identifiable intangible asset, Management used significant estimates including average lives of depository accounts, future interest rate levels, the cost of servicing various depository products, and other significant estimates. Management used quoted market prices to determine the fair value of investment securities and FHLB advances.

The acquired assets of Sonoma include loans; such loans are not indemnified by the Federal Deposit Insurance Corporation (FDIC).  However, on February 6, 2009, the Bank acquired loans in a business combination that are indemnified by the FDIC, as described in Note 2 to the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.  Pursuant to acquisition accounting, the loans in each business combination were measured at their estimated fair value at the respective acquisition date.  This method of measuring the carrying value of purchased loans differs from loans originated by the Company, and as such, the Company identifies purchased loans not indemnified by the FDIC as “Purchased Non-covered Loans” and purchased loans indemnified by the FDIC as “Purchased Covered Loans.”

 
- 8 -

 
Loans originated by the Company are measured at the principal amount outstanding, net of unearned discount and unamortized deferred fees and costs.  These loans are identified as “Originated Loans.”

Recently Adopted Accounting Standards

FASB Accounting Standards Update (ASU) 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring, was issued April 2011 providing additional guidance for creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring.  The provisions of this standard are effective for the first interim or annual period beginning on or after June 15, 2011 with early adoption permissible, and should be applied retrospectively to the beginning of the annual period of adoption. The Company early adopted the provisions of this standard effective April 1, 2011 with retrospective application to January 1, 2011. One troubled debt restructuring was identified as a result of the adoption of this Update as disclosed in Note 5.

FASB ASU 2011-01, Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20 (Topic 310), was issued January 2011 deferring the new disclosure requirements (paragraphs 310-10-50-31 through 50-34 of the FASB Accounting Standards Codification) about troubled debt restructurings to be concurrent with the effective date of the guidance for determining what constitutes a troubled debt restructuring, as presented in proposed Accounting Standards Update, Receivables (Topic 310): Clarifications to Accounting for Troubled Debt Restructurings by Creditors. As a result of the issuance of Update 2011-02, the provisions of Update 2011-01 are effective for the first interim or annual period beginning on or after June 15, 2011 or July 1, 2011 for the Company, and should be applied retrospectively to the beginning of the annual period of adoption. The Company adopted the Update concurrent with ASU 2011-02.

Recently Issued Accounting Standards

FASB ASU 2011-03, Reconsideration of Effective Control for Repurchase Agreements, was issued April 2011 addressing the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity.  The amendments remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion.  The provisions of this Update are effective for the first interim or annual period beginning on or after December 15, 2011, and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date.  Management does not expect the adoption of the Update to have a material effect on the Company’s financial statements at the date of adoption.

 FASB ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, was issued May 2011 as a result of the FASB and International Accounting Standards Board’s (IASB) goal to develop common requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. generally accepted accounting principles and International Financial Reporting Standards. The provisions of this Update are effective during the interim or annual periods beginning after December 15, 2011, and are to be applied prospectively.  Management does not expect the adoption of the Update to have a material effect on the Company’s financial statements at the date of adoption.

FASB ASU 2011-05, Presentation of Comprehensive Income, was issued June 2011 requiring that all nonowner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  This Update also requires that reclassification adjustments for items that are reclassified from other comprehensive income to net income be presented on the face of the financial statements.  The provisions of this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, and are to be applied retrospectively.  Early adoption is permitted.  Management does not expect the adoption of the Update to have a material effect on the Company’s financial statements at the date of adoption.

 
- 9 -

 
Note 3:  Acquisition

On August 20, 2010, the Bank purchased substantially all the assets and assumed substantially all the liabilities of Sonoma from the FDIC, as Receiver of Sonoma. Sonoma operated 3 commercial banking branches within Sonoma County, California. The FDIC took Sonoma under receivership upon Sonoma’s closure by the California Department of Financial Institutions at the close of business August 20, 2010. Westamerica Bank purchased substantially all of Sonoma’s net assets at a discount of $43,000 thousand and paid a $5,008 thousand deposit premium.

The Sonoma acquisition was accounted for under the purchase method of accounting in accordance with FASB ASC 805, Business Combinations. The statement of net assets acquired as of August 20, 2010 and the resulting bargain purchase gain are presented in the following table. The purchased assets and assumed liabilities were recorded at their respective acquisition date fair values, and identifiable intangible assets were recorded at fair value. Fair values are preliminary and subject to refinement for up to one year after the closing date of a merger as information relative to closing date fair values becomes available. A “bargain purchase” gain totaling $178 thousand resulted from the acquisition and is included as a component of noninterest income on the statement of income. The amount of the gain is equal to the amount by which the fair value of assets purchased exceeded the fair value of liabilities assumed. Sonoma’s results of operations prior to the acquisition are not included in Westamerica’s statement of income.

Statement of Net Assets Acquired (at fair value)
     
   
At
 
   
August 20, 2010
 
   
(In thousands)
 
Assets
     
Cash and due from banks
  $ 57,895  
Money market assets
    26,050  
Securities
    7,223  
Loans
    213,664  
Other real estate owned
    2,916  
Core deposit intangible
    5,270  
Other assets
    2,065  
Total Assets
  $ 315,083  
         
Liabilities
       
Deposits
    252,563  
Federal Home Loan Bank advances
    61,872  
Other liabilities
    470  
Total Liabilities
    314,905  
         
Net assets acquired
  $ 178  
 
Statement of Net Assets Acquired (at fair value)
     
   
At
 
   
August 20, 2010
 
   
(In thousands)
 
       
Sonoma Valley Bank tangible shareholder's equity
  $ 13,923  
Adjustments to reflect assets acquired and
  liabilities assumed at fair value:
       
    Cash payment from FDIC
    21,270  
    Loans and leases, net
    (34,562 )
    Other real estate owned
    (1,491 )
    Other assets
    (811 )
    Core deposit intangible
    5,270  
    Deposits
    (1,233 )
    Federal Home Loan Bank advances
    (1,872 )
    Other liabilities
    (316 )
Gain on acquisition
  $ 178  

 
- 10 -

 
Note 4:  Investment Securities

The amortized cost, unrealized gains and losses accumulated in other comprehensive income, and fair value of the available for sale investment securities portfolio follows:

   
Investment securities available for sale
 
   
At June 30, 2011
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
Value
 
   
(In thousands)
U.S. Treasury securities
  $ 3,546     $ 27     $ -     $ 3,573  
Securities of U.S. Government sponsored entities
    167,028       390       (554 )     166,864  
Residential mortgage-backed securities
    100,150       5,045       (16 )     105,179  
Commercial mortgage-backed securities
    4,827       12       (8 )     4,831  
Obligations of States and political subdivisions
    265,340       4,628       (1,607 )     268,361  
Residential collateralized mortgage obligations
    54,248       1,527       -       55,775  
Asset-backed securities
    8,305       -       (281 )     8,024  
FHLMC and FNMA stock
    824       3,410       (4 )     4,230  
Corporate securities
    83,776       377       (247 )     83,906  
Other securities
    2,397       1,988       (50 )     4,335  
Total
  $ 690,441     $ 17,404     $ (2,767 )   $ 705,078  
 
The amortized cost, unrealized gains and losses, and fair value of the held to maturity investment securities portfolio  follows:

   
Investment securities held to maturity
   
At June 30, 2011
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
Value
 
   
(In thousands)
 
Residential mortgage-backed securities
  $ 33,139     $ 1,702     $ -     $ 34,841  
Obligations of States and political subdivisions
    503,039       16,618       (629 )     519,028  
Residential collateralized mortgage obligations
    133,274       2,274       (2,091 )     133,457  
Total
  $ 669,452     $ 20,594     $ (2,720 )   $ 687,326  
 
The amortized cost, unrealized gains and losses accumulated in other comprehensive income, and fair value of the available for sale investment securities portfolio follows:

   
Investment securities available for sale
 
   
At December 31, 2010
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
Value
 
   
(In thousands)
 
U.S. Treasury securities
  $ 3,554     $ -     $ (12 )   $ 3,542  
Securities of U.S. Government sponsored entities
    175,080       162       (2,365 )     172,877  
Residential mortgage-backed securities
    105,702       4,142       (15 )     109,829  
Commercial mortgage-backed securities
    5,081       7       (23 )     5,065  
Obligations of States and political subdivisions
    264,757       2,423       (6,047 )     261,133  
Residential collateralized mortgage obligations
    24,709       894       -       25,603  
Asset-backed securities
    9,060       -       (774 )     8,286  
FHLMC and FNMA stock
    824       42       (211 )     655  
Corporate securities
    79,356       200       (365 )     79,191  
Other securities
    2,655       2,699       (51 )     5,303  
Total
  $ 670,778     $ 10,569     $ (9,863 )   $ 671,484  
 
- 11 -

 
The amortized cost, unrealized gains and losses, and fair value of the held to maturity investment securities portfolio  follows:
 
   
Investment securities held to maturity
 
   
At December 31, 2010
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
Value
 
   
(In thousands)
 
Residential mortgage-backed securities
  $ 40,531     $ 1,797     $ -     $ 42,328  
Obligations of States and political subdivisions
    455,372       13,142       (1,142 )     467,372  
Residential collateralized mortgage obligations
    84,825       2,198       (2,012 )     85,011  
Total
  $ 580,728     $ 17,137     $ (3,154 )   $ 594,711  
 
The amortized cost and fair value of securities by contractual maturity are shown in the following table:

   
At June 30, 2011
   
Securities Available
 
Securities Held
   
for Sale
 
to Maturity
   
Amortized
   
Fair
   
Amortized
   
Fair
 
   
Cost
   
Value
   
Cost
   
Value
 
   
(In thousands)
Maturity in years:
                       
1 year or less
  $ 14,162     $ 14,230     $ 9,574     $ 9,590  
Over 1 to 5 years
    304,588       305,523       123,233       126,678  
Over 5 to 10 years
    62,451       63,277       325,489       337,477  
Over 10 years
    146,794       147,698       44,743       45,283  
Subtotal
    527,995       530,728       503,039       519,028  
Mortgage-backed securities and residential
collateralized mortgage obligations
    159,225       165,785       166,413       168,298  
Other securities
    3,221       8,565       -       -  
Total
  $ 690,441     $ 705,078     $ 669,452     $ 687,326  
 
The amortized cost and fair value of securities by contractual maturity are shown in the following table:

   
At December 31, 2010
   
Securities Available
 
Securities Held
   
for Sale
 
to Maturity
   
Amortized
   
Fair
   
Amortized
   
Fair
 
   
Cost
   
Value
   
Cost
   
Value
 
   
(In thousands)
 
Maturity in years:
                       
1 year or less
  $ 21,362     $ 21,460     $ 6,057     $ 6,103  
Over 1 to 5 years
    315,777       314,605       92,837       95,608  
Over 5 to 10 years
    64,565       64,804       351,407       360,602  
Over 10 years
    130,103       124,160       5,071       5,059  
Subtotal
    531,807       525,029       455,372       467,372  
Mortgage-backed securities and residential
collateralized mortgage obligations
    135,492       140,497       125,356       127,339  
Other securities
    3,479       5,958       -       -  
Total
  $ 670,778     $ 671,484     $ 580,728     $ 594,711  
 
Expected maturities of mortgage-backed securities can differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties. In addition, such factors as prepayments and interest rates may affect the yield on the carrying value of mortgage-backed securities.

 
- 12 -

 
An analysis of gross unrealized losses on the available for sale investment securiteis portfolio follows:
 
   
Investment securities available for sale
   
At June 30, 2011
 
   
Less than 12 months
 
12 months or longer
 
Total
         
Unrealized
         
Unrealized
         
Unrealized
 
   
Fair Value
   
Losses
   
Fair Value
   
Losses
   
Fair Value
   
Losses
 
   
(In thousands)
 
Securities of U.S. Government sponsored entities
  $ 66,561     $ (554 )   $ -     $ -     $ 66,561     $ (554 )
Residential mortgage-backed securities
    -       -       974       (16 )     974       (16 )
Commercial mortgage-backed securities
    -       -       1,384       (8 )     1,384       (8 )
Obligations of States and political subdivisions
    58,597       (1,187 )     12,956       (420 )     71,553       (1,607 )
Asset-backed securities
    -       -       8,024       (281 )     8,024       (281 )
FHLMC and FNMA stock
    -       -       1       (4 )     1       (4 )
Corporate securities
    39,753       (247 )     -       -       39,753       (247 )
Other securities
    -       -       1,950       (50 )     1,950       (50 )
Total
  $ 164,911     $ (1,988 )   $ 25,289     $ (779 )   $ 190,200     $ (2,767 )
 
An analysis of gross unrealized losses of the available for sale investment securities portfolio follows:

   
Investment securities held to maturity
   
At June 30, 2011
   
Less than 12 months
 
12 months or longer
 
Total
         
Unrealized
         
Unrealized
         
Unrealized
 
   
Fair Value
   
Losses
   
Fair Value
   
Losses
   
Fair Value
   
Losses
 
   
(In thousands)
 
Obligations of States and political subdivisions
  $ 34,115     $ (334 )   $ 9,821     $ (295 )   $ 43,936     $ (629 )
                                                 
Residential collateralized mortgage obligations
    22,259       (97 )     16,856       (1,994 )     39,115       (2,091 )
Total
  $ 56,374     $ (431 )   $ 26,677     $ (2,289 )   $ 83,051     $ (2,720 )

The unrealized losses on the Company’s investments in mortgage obligations and asset backed securities were caused by market conditions for these types of investments.  The Company evaluates these securities on a quarterly basis including changes in security ratings issued by rating agencies, delinquency and loss information with respect to the underlying collateral, changes in the levels of subordination for the Company’s particular position within the repayment structure, and remaining credit enhancement as compared to expected credit losses of the security.

The unrealized losses on the Company’s investments in obligations of states and political subdivisions were caused by conditions in the municipal securities market.  The Company’s investments in obligations of states and political subdivisions primarily finance essential community services such as school districts, water delivery systems, hospitals and fire protection services. Further, these bonds are primarily “bank qualified” issues whereby the issuing authority’s total debt issued in any one year does not exceed $30 million, thereby qualifying the bonds for tax-exempt status for federal income tax purposes. The Company evaluates these securities quarterly to determine if a change in security rating has occurred or the municipality has experienced financial difficulties.  Substantially all of these securities continue to be investment grade rated.

The Company does not intend to sell any investments and has concluded that it is more likely than not that it will not be required to sell the investments prior to recovery of the amortized cost basis. Therefore, the Company does not consider these investments to be other-than-temporarily impaired as of June 30, 2011.

The fair values of the investment securities could decline in the future if the issuers’ financial condition deteriorates, general economy deteriorates, credit ratings decline, or the liquidity for securities is low.  As a result, other than temporary impairments may occur in the future.

 
- 13 -

 
An analysis of gross unrealized losses of the available for sale investment securities portfolio follows:

   
Investment securities available for sale
   
At December 31, 2010
   
Less than 12 months
   
12 months or longer
 
Total
         
Unrealized
         
Unrealized
         
Unrealized
 
   
Fair Value
   
Losses
   
Fair Value
   
Losses
   
Fair Value
   
Losses
 
   
(In thousands)
 
U.S. Treasury securities
  $ 3,542     $ (12 )   $ -     $ -     $ 3,542     $ (12 )
Securities of U.S. Government sponsored entities
    146,083       (2,365 )     -       -       146,083       (2,365 )
Residential mortgage-backed securities
    1,534       (15 )     -       -       1,534       (15 )
Commercial mortgage-backed securities
    3,028       (23 )     -       -       3,028       (23 )
Obligations of States and political subdivisions
    132,014       (5,505 )     10,341       (542 )     142,355       (6,047 )
Asset-backed securities
    -       -       8,286       (774 )     8,286       (774 )
FHLMC and FNMA stock
    550       (211 )     -       -       550       (211 )
Corporate securities
    44,752       (365 )     -       -       44,752       (365 )
Other securities
    1       -       1,948       (51 )     1,949       (51 )
Total
  $ 331,504     $ (8,496 )   $ 20,575     $ (1,367 )   $ 352,079     $ (9,863 )

An analysis of gross unrealized losses of the held to maturity investment securities portfolio follows:

   
Investment securities held to maturity
 
   
At December 31, 2010
 
   
Less than 12 months
   
12 months or longer
 
Total
         
Unrealized
         
Unrealized
         
Unrealized
 
   
Fair Value
   
Losses
   
Fair Value
   
Losses
   
Fair Value
   
Losses
 
   
(In thousands)
 
Obligations of States and political subdivisions
  $ 22,157     $ (382 )   $ 18,663     $ (760 )   $ 40,820     $ (1,142 )
Residential collateralized mortgage obligations
    -       -       20,182       (2,012 )     20,182       (2,012 )
Total
  $ 22,157     $ (382 )   $ 38,845     $ (2,772 )   $ 61,002     $ (3,154 )

The following table provides information about the amount of interest income from taxable and non-taxable investment securities:

   
For the three months
 
For the six months
   
ended June 30,
 
ended June 30,
   
2011
   
2010
   
2011
   
2010
 
   
(In thousands)
 
Taxable
  $ 4,223     $ 4,199     $ 7,980     $ 8,628  
Tax-exempt
    7,593       6,819       14,967       13,690  
Total interest income from investment securities
  $ 11,816     $ 11,018     $ 22,947     $ 22,318  

 
- 14 -

 
Note 5: Loans and Allowance for Credit Losses

A summary of the major categories of originated loans outstanding is shown in the following table:
 
   
At June 30,
   
At December 31,
 
   
2011
   
2010
 
   
(In thousands)
Originated loans:
           
Commercial
  $ 429,033     $ 474,183  
Commercial real estate
    734,811       757,140  
Construction
    25,698       26,145  
Residential real estate
    293,771       310,196  
Consumer installment & other
    480,329       461,877  
Total
  $ 1,963,642     $ 2,029,541  

A summary of the major categories of purchased covered loans is shown in the following table:
 
   
As of June 30, 2011
 
As of December 31, 2010
   
Impaired
Purchased
Covered Loans
   
Non Impaired
Purchased
Covered Loans
   
Total Purchased
Covered Loans
   
Impaired
Purchased
Covered Loans
   
Non Impaired
Purchased
Covered Loans
   
Total Purchased
Covered Loans
 
    (In thousands) (In thousands)  
Purchased covered loans:
                                   
Commercial
  $ 6,593     $ 125,530     $ 132,123     $ 10,014     $ 158,971     $ 168,985  
Commercial real estate
    12,507       364,661       377,168       14,079       376,603       390,682  
Construction
    5,997       11,709       17,706       9,073       19,307       28,380  
Residential real estate
    138       13,724       13,862       138       18,236       18,374  
Consumer installment & other
    244       81,624       81,868       252       86,299       86,551  
    Total
  $ 25,479     $ 597,248     $ 622,727     $ 33,556     $ 659,416     $ 692,972  

Changes in the carrying amount of impaired purchased covered loans were as follows:
 
   
Six months ended
   
Year ended
 
   
June 30, 2011
   
December 31, 2010
 
   
(In thousands)
 
Carrying amount at the beginning of the period
  $ 33,556     $ 43,196  
Reductions during the period
    (8,077 )     (9,640 )
Carrying amount at the end of the period
  $ 25,479     $ 33,556  
 
Impaired purchased covered loans had an unpaid principal balance (less prior charge-offs) of $34,517 thousand and $48,471 thousand at June 30, 2011 and December 31, 2010, respectively.

A summary of the major categories of purchased non-covered loans is shown in the following table. Re-classification of some purchased non-covered loans occurred in the first quarter 2011 upon conversion of such loans to the Company’s accounting systems.
 
   
At June 30, 2011
 
At December 31, 2010
 
   
Impaired
Purchased Non-
covered Loans
   
Non Impaired
Purchased Non-
covered Loans
   
Total Purchased
Non-covered
Loans
   
Impaired
Purchased Non-
covered Loans
   
Non Impaired
Purchased Non-
covered Loans
   
Total Purchased
Non-covered
Loans
 
   
(In thousands)
   
(In thousands)
 
Purchased non-covered loans:
                                   
Commercial
  $ 1,294     $ 14,121     $ 15,415     $ 415     $ 15,005     $ 15,420  
Commercial real estate
    15,876       85,516       101,392       22,988       99,900       122,888  
Construction
    4,001       10,844       14,845       6,514       15,106       21,620  
Residential real estate
    311       5,970       6,281       311       6,744       7,055  
Consumer installment & other
    459       26,452       26,911       1,790       30,798       32,588  
Total
  $ 21,941     $ 142,903     $ 164,844     $ 32,018     $ 167,553     $ 199,571  

 
- 15 -

 
The following table represents the non impaired purchased non-covered loans receivable at the acquisition date of August 20, 2010. The amounts include principal only and do not reflect accrued interest as of the date of acquisition or beyond:

Non impaired purchased non-covered loans receivable
 
 
  At August 20, 2010  
    (In thousands)  
       
Gross contractual loan principal payment receivable
  $ 188,206  
Estimate of contractual principal not expected to be collected
    (15,058 )
Fair value of non impaired purchased loans receivable
  $ 175,922  

The Company applied the cost recovery method to impaired purchased non-covered loans at the acquisition date of August 20, 2010 due to the uncertainty as to the timing of expected cash flows as reflected in the following table:

Impaired purchased non-covered loans
     
   
At August 20, 2010
 
   
(In thousands)
 
Contractually required payments receivable (including interest)
  $ 70,882  
Nonaccretable difference
    (33,140 )
Cash flows expected to be collected
    37,742  
Accretable difference
    -  
Fair value of loans acquired
  $ 37,742  
 
Changes in the carrying amount of impaired purchased non-covered loans were as follows for the periods indicated below from August 20, 2010 (acquisition date) through June 30, 2011:

         
August 20, 2010
 
   
Six months ended
   
through
 
   
June 30, 2011
   
December 31, 2010
 
   
Impaired purchased non-covered loans
 
   
(In thousands)
 
Carrying amount at the beginning of the period
  $ 32,018     $ 37,742  
Reductions during the period
    (10,077 )     (5,724 )
Carrying amount at the end of the period
  $ 21,941     $ 32,018  

Impaired purchased non-covered loans had an unpaid principal balance (less prior charge-offs) of $33,642 thousand, $50,875 thousand and $59,662 thousand at June 30, 2011, December 31, 2010 and August 20, 2010, respectively.
 
 
- 16 -

 
The following summarizes activity in the allowance for credit losses:
 
   
Allowance for Credit Losses
   
For the Six Months Ended June 30, 2011
         
Commercial
         
Residential
                   
   
Commercial
   
Real Estate
   
Construction
   
Real Estate
   
Consumer
   
Unallocated
   
Total
 
   
(In thousands)
Allowance for credit losses:
                                         
Beginning balance
  $ 9,878     $ 9,607     $ 3,559     $ 617     $ 6,982     $ 7,686     $ 38,329  
    Charge-offs
    (4,987 )     -       (1,475 )     (527 )     (3,475 )     -       (10,464 )
    Recoveries
    643       -       -       -       1,593       -       2,236  
    Provision
    2,967       667       1,980       376       (1,431 )     1,041       5,600  
Ending balance
  $ 8,501     $ 10,274     $ 4,064     $ 466     $ 3,669     $ 8,727     $ 35,701  
Components:
                                                       
    Allowance for loan losses
  $ 6,729     $ 10,241     $ 3,959     $ 466     $ 3,522     $ 8,091     $ 33,008  
    Liability for off-balance sheet
      credit exposure
    1,772       33       105       -       147       636       2,693  
    Total
  $ 8,501     $ 10,274     $ 4,064     $ 466     $ 3,669     $ 8,727     $ 35,701  
Ending balance: individually evaluated for impairment
  $ -     $ 399     $ 1,514     $ -     $ -     $ -     $ 1,913  
Ending balance: collectively evaluated for impairment
  $ 8,501     $ 9,875     $ 2,550     $ 466     $ 3,669     $ 8,727     $ 33,788  
Ending balance: loans acquired with deteriorated quality
  $ -     $ -     $ -     $ -     $ -     $ -     $ -  
 
   
Allowance for Credit Losses
   
At December 31, 2010
         
Commercial
         
Residential
                   
   
Commercial
   
Real Estate
   
Construction
   
Real Estate
   
Consumer
   
Unallocated
   
Total
 
   
(In thousands)
Allowance for credit losses
                                         
Components:
                                         
    Allowance for loan losses
  $ 8,094     $ 9,607     $ 3,260     $ 617     $ 6,372     $ 7,686     $ 35,636  
Liability for off-balance sheet credit exposure
    1,784       -       299       -       610       -       2,693  
    Total
  $ 9,878     $ 9,607     $ 3,559     $ 617     $ 6,982     $ 7,686     $ 38,329  
Ending balance: individually evaluated for impairment
  $ -     $ -     $ 1,365     $ -     $ -     $ -     $ 1,365  
Ending balance: collectively evaluated for impairment
  $ 9,878     $ 9,607     $ 2,194     $ 617     $ 6,982     $ 7,686     $ 36,964  
Ending balance: loans acquired with deteriorated quality
  $ -     $ -     $ -     $ -     $ -     $ -     $ -  

 
- 17 -

 
The recorded investment in loans related to the allowance for credit losses was as follows:
 
   
At June 30, 2011
         
Commercial
         
Residential
                   
   
Commercial
   
Real Estate
   
Construction
   
Real Estate
   
Consumer
   
Unallocated
   
Total
 
   
(In thousands)
Purchased loans principal balance
  $ 176,566     $ 513,345     $ 39,501     $ 21,134     $ 114,630     $ -     $ 865,176  
Default risk purchase discount
    (29,028 )     (34,785 )     (6,950 )     (991 )     (5,851 )     -       (77,605 )
Purchased loans recorded investment
    147,538       478,560       32,551       20,143       108,779       -       787,571  
Originated loans
    429,033       734,811       25,698       293,771       480,329       -       1,963,642  
Ending balance
  $ 576,571     $ 1,213,371     $ 58,249     $ 313,914     $ 589,108     $ -     $ 2,751,213  
 
   
At December 31, 2010
         
Commercial
         
Residential
                   
   
Commercial
   
Real Estate
   
Construction
   
Real Estate
   
Consumer
   
Unallocated
   
Total
 
   
(In thousands)
Purchased loans principal balance
  $ 215,728     $ 554,619     $ 60,983     $ 26,420     $ 128,959     $ -     $ 986,709  
Default risk purchase discount
    (31,323 )     (41,049 )     (10,983 )     (991 )     (9,820 )     -       (94,166 )
Purchased loans recorded investment
    184,405       513,570       50,000       25,429       119,139       -       892,543  
Originated loans
    474,183       757,140       26,145       310,196       461,877       -       2,029,541  
Ending balance
  $ 658,588     $ 1,270,710     $ 76,145     $ 335,625     $ 581,016     $ -     $ 2,922,084  

The recorded investment in loans was evaluated for impairment as follows:
 
   
At June 30, 2011
         
Commercial
         
Residential
                   
   
Commercial
   
Real Estate
   
Construction
   
Real Estate
   
Consumer
   
Unallocated
   
Total
 
   
(In thousands)
Individually  evaluated for impairment
  $ 4,958     $ 5,669     $ 15,000     $ -     $ 1,271     $ -     $ 26,898  
Collectively evaluated for impairment
  $ 563,726     $ 1,179,319     $ 33,251     $ 313,465     $ 587,134     $ -     $ 2,676,895  
Loans acquired with deteriorated quality
  $ 7,887     $ 28,383     $ 9,998     $ 449     $ 703     $ -     $ 47,420  
 
   
At December 31, 2010
         
Commercial
         
Residential
                   
   
Commercial
   
Real Estate
   
Construction
   
Real Estate
   
Consumer
   
Unallocated
   
Total
 
   
(In thousands)
Individually evaluated for impairment
  $ 11,947     $ 7,004     $ 7,421     $ -     $ -     $ -     $ 26,372  
Collectively evaluated for impairment
  $ 636,212     $ 1,226,639     $ 53,137     $ 335,176     $ 578,974     $ -     $ 2,830,138  
Loans acquired with deteriorated quality
  $ 10,429     $ 37,067     $ 15,587     $ 449     $ 2,042     $ -     $ 65,574  
 
The Bank’s customers are small businesses, professionals and consumers. Given the scale of these borrowers, corporate credit rating agencies do not evaluate the borrowers’ financial condition. The Bank maintains a Loan Review Department which reports directly to the Board of Directors. The Loan Review Department performs independent evaluations of loans and assigns credit risk grades to evaluated loans using grading standards employed by bank regulatory agencies. Loans judged to carry lower-risk attributes are assigned a “pass” grade, with a minimal likelihood of loss. Loans judged to carry higher-risk attributes are referred to as “classified loans,” and are further disaggregated, with increasing expectations for loss recognition, as “substandard,” “doubtful,” and “loss.” If the Bank becomes aware of deterioration in a borrower’s performance or financial condition between Loan Review examinations, assigned risk grades will be re-evaluated promptly. Credit risk grades assigned by the Loan Review Department are subject to review by the Bank’s regulatory authority during regulatory examinations.
 
 
- 18 -

 
The following summarizes the credit risk profile by internally assigned grade:

   
Originated Loans
 
   
At June 30, 2011
 
                                       
Total
 
         
Commercial
         
Residential
   
Indirect
   
Other
   
Originated
 
   
Commercial
   
Real Estate
   
Construction
   
Real Estate
   
Automobile
   
consumer
   
Loans
 
   
(In thousands)
 
Grade:
                                         
Pass
  $ 386,926     $ 691,531     $ 14,218     $ 289,703     $ 416,265     $ 61,802     $ 1,860,445  
Special mention
    22,517       17,322       341       1,737       -       450       42,367  
Substandard
    18,690       25,958       11,139       2,331       399       907       59,424  
Doubtful
    900       -       -       -       19       35       954  
Loss
    -       -       -       -       452       -       452  
       Total
  $ 429,033     $ 734,811     $ 25,698     $ 293,771     $ 417,135     $ 63,194     $ 1,963,642  
 
   
Originated Loans
 
   
At December 31, 2010
 
                                       
Total
 
         
Commercial
         
Residential
   
Indirect
   
Other
   
Originated
 
   
Commercial
   
Real Estate
   
Construction
   
Real Estate
   
Automobile
   
consumer
   
Loans
 
   
(In thousands)
 
Grade:
                                         
Pass
  $ 427,878     $ 718,124     $ 18,073     $ 305,433     $ 398,805     $ 59,984     $ 1,928,297  
Special mention
    17,731       19,216       -       1,749       -       568       39,264  
Substandard
    27,801       19,800       8,072       3,014       311       1,481       60,479  
Doubtful
    773       -       -       -       61       28       862  
Loss
    -       -       -       -       636       3       639  
       Total
  $ 474,183     $ 757,140     $ 26,145     $ 310,196     $ 399,813     $ 62,064     $ 2,029,541  
 
   
Purchased Covered Loans
 
   
At June 30, 2011
 
                                       
Total
 
                                       
Purchased
 
         
Commercial
         
Residential
   
Indirect
   
Other
   
Covered
 
   
Commercial
   
Real Estate
   
Construction
   
Real Estate
   
Automobile
   
consumer
   
Loans
 
   
(In thousands)
 
Grade:
                                         
Pass
  $ 70,063     $ 257,709     $ 1,914     $ 10,911     $ -     $ 82,752     $ 423,349  
Special mention
    14,797       40,650       605       -       -       95       56,147  
Substandard
    73,541       99,450       6,200       3,475       -       1,475       184,141  
Doubtful
    1,520       1,085       11,925       -       -       87       14,617  
Loss
    -       -       -       -       -       -       0  
Default risk purchase discount
    (27,798 )     (21,726 )     (2,938 )     (524 )     -       (2,541 )     (55,527 )
       Total
  $ 132,123     $ 377,168     $ 17,706     $ 13,862     $ -     $ 81,868     $ 622,727  
 
   
Purchased Covered Loans
 
   
At December 31, 2010
 
                                       
Total
 
                                       
Purchased
 
         
Commercial
         
Residential
   
Indirect
   
Other
   
Covered
 
   
Commercial
   
Real Estate
   
Construction
   
Real Estate
   
Automobile
   
consumer
   
Loans
 
   
(In thousands)
 
Grade:
                                         
Pass
  $ 97,652     $ 281,679     $ 1,721     $ 12,688     $ -     $ 88,733     $ 482,473  
Special mention
    17,485       44,355       615       -       -       -       62,455  
Substandard
    82,657       86,720       30,890       5,345       -       1,034       206,646  
Doubtful
    430       1,105       345       865       -       2       2,747  
Loss
    -       -       -       -       -       435       435  
Default risk purchase discount
    (29,239 )     (23,177 )     (5,191 )     (524 )     -       (3,653 )     (61,784 )
       Total
  $ 168,985     $ 390,682     $ 28,380     $ 18,374     $ -     $ 86,551     $ 692,972  

 
- 19 -

 
   
Purchased Non-covered Loans
 
   
At June 30, 2011
 
                                       
Total
 
                                       
Purchased
 
         
Commercial
         
Residential
   
Indirect
   
Other
   
Non-covered
 
   
Commercial
   
Real Estate
   
Construction
   
Real Estate
   
Automobile
   
consumer
   
Loans
 
   
(In thousands)
 
Grade:
                                         
Pass
  $ 13,493     $ 45,140     $ 1,581     $ 4,481     $ -     $ 21,363     $ 86,058  
Special mention
    599       20,931       -       344       -       2,748       24,622  
Substandard
    2,348       39,890       16,717       1,923       -       5,872       66,750  
Doubtful
    205       8,490       559       -       -       238       9,492  
Loss
    -       -       -       -       -       -       -  
Default risk purchase discount
    (1,230 )     (13,059 )     (4,012 )     (467 )     -       (3,310 )     (22,078 )
       Total
  $ 15,415     $ 101,392     $ 14,845     $ 6,281     $ -     $ 26,911     $ 164,844  
 
   
Purchased Non-covered Loans
 
   
At December 31, 2010
 
                                       
Total
 
                                       
Purchased
 
         
Commercial
         
Residential
   
Indirect
   
Other
   
Non-covered
 
   
Commercial
   
Real Estate
   
Construction
   
Real Estate
   
Automobile
   
consumer
   
Loans
 
   
(In thousands)
 
Grade:
                                         
Pass
  $ 12,748     $ 78,899     $ 5,335     $ 6,157     $ -     $ 25,184     $ 128,323  
Special mention
    2,282       15,589       4,604       -       -       2,748       25,223  
Substandard
    1,980       33,796       15,110       1,365       -       9,690       61,941  
Doubtful
    494       12,476       2,363       -       -       1,132       16,465  
Loss
    -       -       -       -       -       1       1  
Default risk purchase discount
    (2,084 )     (17,872 )     (5,792 )     (467 )     -       (6,167 )     (32,382 )
       Total
  $ 15,420     $ 122,888     $ 21,620     $ 7,055     $ -     $ 32,588     $ 199,571  

The following tables summarize loans by delinquency and nonaccrual status:
 
   
Originated Loans
 
   
At June 30, 2011
 
         
Past Due
                         
   
30-89 Days
   
90 days
   
Total Past
               
Total
 
   
Past Due
   
or More
   
Due
   
Current
         
Originated
 
   
and Accruing
   
and Accruing
   
and Accruing
   
and Accruing
   
Nonaccrual
   
Loans
 
   
(In thousands)
 
Commercial
  $ 6,254     $ -     $ 6,254     $ 420,791     $ 1,988     $ 429,033  
Commercial Real Estate
    14,466       -       14,466       713,627       6,718       734,811  
Construction
    -       -       -       14,559       11,139       25,698  
Residential Real Estate
    3,899       -       3,899       289,019       853       293,771  
Indirect Automobile
    4,447       522       4,969       412,165       -       417,134  
Other Consumer
    354       33       387       62,591       217       63,195  
    Total
  $ 29,420     $ 555     $ 29,975     $ 1,912,752     $ 20,915     $ 1,963,642  
 
 
- 20 -

 
   
Originated Loans
 
   
At December 31, 2010
 
         
Past Due
                         
   
30-89 Days
   
90 days
   
Total Past
               
Total
 
   
Past Due
   
or More
   
Due
   
Current
         
Originated
 
   
and Accruing
   
and Accruing
   
and Accruing
   
and Accruing
   
Nonaccrual
   
Loans
 
   
(In thousands)
 
Commercial
  $ 7,274     $ -     $ 7,274     $ 458,061     $ 8,848     $ 474,183  
Commercial Real Estate
    14,037       -       14,037       737,167       5,936       757,140  
Construction
    4,022       -       4,022       18,073       4,050       26,145  
Residential Real Estate
    2,552       -       2,552       305,709       1,935       310,196  
Indirect Automobile
    6,382       647       7,029       392,784       -       399,813  
Other Consumer
    488       119       607       61,358       99       62,064  
    Total
  $ 34,755     $ 766     $ 35,521     $ 1,973,152     $ 20,868     $ 2,029,541  
 
   
Purchased Covered Loans
 
   
At June 30, 2011
 
         
Past Due
                     
Total
 
   
30-89 Days
   
90 days
   
Total Past
               
Purchased
 
   
Past Due
   
or More
   
Due
   
Current
         
Covered
 
   
and Accruing
   
and Accruing
   
and Accruing
   
and Accruing
   
Nonaccrual
   
Loans
 
   
(In thousands)
 
Commercial
  $ 2,720     $ -     $ 2,720     $ 118,879     $ 10,524     $ 132,123  
Commercial Real Estate
    26,102       -       26,102       343,498       7,568       377,168  
Construction
    305       -       305       8,578       8,823       17,706  
Residential Real Estate
    -       -       -       13,724       138       13,862  
Other Consumer
    940       472       1,412       79,918       538       81,868  
    Total
  $ 30,067     $ 472     $ 30,539     $ 564,597     $ 27,591     $ 622,727  
 
   
Purchased Covered Loans
 
   
At December 31, 2010
 
         
Past Due
                     
Total
 
   
30-89 Days
   
90 days
   
Total Past
               
Purchased
 
   
Past Due
   
or More
   
Due
   
Current
         
Covered
 
   
and Accruing
   
and Accruing
   
and Accruing
   
and Accruing
   
Nonaccrual
   
Loans
 
   
(In thousands)
 
Commercial
  $ 12,692     $ -     $ 12,692     $ 144,307     $ 11,986     $ 168,985  
Commercial Real Estate
    12,413       -       12,413       355,518       22,751       390,682  
Construction
    415       -       415       17,508       10,457       28,380  
Residential Real Estate
    128       -       128       16,568       1,678       18,374  
Other Consumer
    2,200       355       2,555       83,723       273       86,551  
    Total
  $ 27,848     $ 355     $ 28,203     $ 617,624     $ 47,145     $ 692,972  
 
   
Purchased Non-covered Loans
 
   
At June 30, 2011
 
         
Past Due
                         
   
30-89 Days
   
90 days
   
Total Past
               
Total Purchased
 
   
Past Due
   
or More
   
Due
   
Current
         
Non-covered
 
   
and Accruing
   
and Accruing
   
and Accruing
   
and Accruing
   
Nonaccrual
   
Loans
 
   
(In thousands)
 
Commercial
  $ 23     $ -     $ 23     $ 15,107     $ 285     $ 15,415  
Commercial Real Estate
    3,324       -       3,324       74,739       23,329       101,392  
Construction
    -       -       -       7,563       7,282       14,845  
Residential Real Estate
    562       -       562       5,408       311       6,281  
Other Consumer
    1,896       159       2,055       22,612       2,244       26,911  
    Total
  $ 5,805     $ 159     $ 5,964     $ 125,429     $ 33,451     $ 164,844  

 
- 21 -

 
   
Purchased Non-covered Loans
 
   
At December 31, 2010
 
         
Past Due
                         
   
30-89 Days
   
90 days
   
Total Past
               
Total Purchased
 
   
Past Due
   
or More
   
Due
   
Current
         
Non-covered
 
   
and Accruing
   
and Accruing
   
and Accruing
   
and Accruing
   
Nonaccrual
   
Loans
 
   
(In thousands)
 
Commercial
  $ 1,089     $ -     $ 1,089     $ 13,969     $ 362     $ 15,420  
Commercial Real Estate
    2,860       -       2,860       93,384       26,644       122,888  
Construction
    -       -       -       13,390       8,230       21,620  
Residential Real Estate
    3,336       -       3,336       3,408       311       7,055  
Other Consumer
    1,503       1       1,504       27,468       3,616       32,588  
    Total
  $ 8,788     $ 1     $ 8,789     $ 151,619     $ 39,163     $ 199,571  
 
There were no commitments to lend additional funds to borrowers whose loans were on nonaccrual status at June 30, 2011 and December 31, 2010.

The following summarizes impaired loans:

   
Impaired Loans
 
   
At June 30, 2011
 
         
Unpaid
       
   
Recorded
   
Principal
   
Related
 
   
Investment
   
Balance
   
Allowance
 
   
(In thousands)
 
Impaired loans with no related allowance recorded:
                 
    Commercial
  $ 12,845     $ 22,026     $ -  
    Commercial Real Estate
    32,195       55,568       -  
    Construction
    20,330       33,994       -  
    Residential Real Estate
    449       451       -  
    Other Consumer
    1,974       2,708       -  
                         
Impaired loans with an allowance recorded:
                       
    Commercial Real Estate
    1,857       1,857       399  
    Construction
    4,668       5,608       1,514  
                         
Total:
                       
    Commercial
  $ 12,845     $ 22,026     $ -  
    Commercial Real Estate
    34,052       57,425       399  
    Construction
    24,998       39,602       1,514  
    Residential Real Estate
    449       451       -  
    Other Consumer
    1,974       2,708       -  

   
Impaired Loans
 
   
For the three months ended
   
For the six months ended
 
   
June 30, 2011
   
June 30, 2011
 
   
Average
   
Recognized
   
Average
   
Recognized
 
   
Recorded
   
Interest
   
Recorded
   
Interest
 
   
Investment
   
Income
   
Investment
   
Income
 
   
(In thousands)
 
Commercial
  $ 17,135     $ 179     $ 17,373     $ 509  
Commercial Real Estate
    38,402       414       38,732       729  
Construction
    25,141       89       24,572       173  
Residential Real Estate
    449       -       449       -  
Other Consumer
    2,374       13       2,191       17  
  Total Impaired Loans
  $ 83,501     $ 695     $ 83,317     $ 1,428  

 
- 22 -

 
   
Impaired Loans
 
   
At December 31, 2010
 
         
Unpaid
       
   
Recorded
   
Principal
   
Related
 
   
Investment
   
Balance
   
Allowance
 
   
(In thousands)
 
Impaired loans with no related allowance recorded:
                 
    Commercial
  $ 22,376     $ 35,027     $ -  
    Commercial Real Estate
    44,071       67,905       -  
    Construction
    19,308       36,244       -  
    Residential Real Estate
    449       451       -  
    Other Consumer
    2,042       3,077       -  
                         
Impaired loans with an allowance recorded:
                       
    Construction
    3,700       3,700       1,365  
                         
Total:
                       
    Commercial
  $ 22,376     $ 35,027     $ -  
    Commercial Real Estate
    44,071       67,905       -  
    Construction
    23,008       39,944       1,365  
    Residential Real Estate
    449       451       -  
    Other Consumer
    2,042       3,077       -  

The Company had one troubled debt restructuring with an outstanding recorded investment of $3,183 thousand pre-and post-modification at June 30, 2011 and no troubled debt restructurings at December 31, 2010.

The Company pledges loans to secure borrowings from the Federal Home Loan Bank (FHLB). At June 30, 2011, loans pledged to secure borrowing totaled $99,944 thousand compared with $137,954 thousand at December 31, 2010. The FHLB does not have the right to sell or repledge such loans.

There were no loans held for sale at June 30, 2011 and December 31, 2010.
 
Note 6: Concentration of Credit Risk

The Company’s business activity is with customers in Northern and Central California. The loan portfolio is well diversified within the Company’s geographic market, although the Company has significant credit arrangements that are secured by real estate collateral. In addition to real estate loans outstanding as disclosed in Note 5, the Company had loan commitments and standby letters of credit related to real estate loans of $10,025 thousand and $13,048 thousand at June 30, 2011 and December 31, 2010, respectively. The Company requires collateral on all real estate loans with loan-to-value ratios generally no greater than 75% on commercial real estate loans and no greater than 80% on residential real estate loans at origination.
 
Note 7: Goodwill and Identifiable Intangible Assets

The Company has recorded goodwill and other identifiable intangibles associated with purchase business combinations. Goodwill is not amortized, but is periodically evaluated for impairment. The Company did not recognize impairment during the six months ended June 30, 2011.

The carrying values of goodwill were (in thousands):
 
December 31, 2010   $ 121,673  
June 30, 2011   $ 121,673  
 
Identifiable intangibles are amortized to their estimated residual values over their expected useful lives. Such lives and residual values are also periodically reassessed to determine if any amortization period adjustments are indicated. During the six months ended June 30, 2011, no such adjustments were recorded.
 
 
- 23 -

 
The gross carrying amount of identifiable intangible assets and accumulated amortization was:

   
At June 30,
   
At December 31,
 
   
2011
   
2010
 
   
(In thousands)
 
   
Gross
         
Gross
       
   
Carrying
   
Accumulated
   
Carrying
   
Accumulated
 
   
Amount
   
Amortization
   
Amount
   
Amortization
 
                         
Core Deposit Intangibles
  $ 56,808     $ (27,423 )   $ 56,808     $ (24,719 )
Merchant Draft Processing Intangible
    10,300       (8,109 )     10,300       (7,785 )
Total Identifiable Intangible Assets
  $ 67,108     $ (35,532 )   $ 67,108     $ (32,504 )
 
As of June 30, 2011, the current year and estimated future amortization expense for identifiable intangible assets was:
 
   
At June 30, 2011
 
         
Merchant
       
   
Core
   
Draft
       
   
Deposit
   
Processing
       
   
Intangibles
   
Intangible
   
Total
 
   
(In thousands)
 
Six months ended June 30, 2011 (actual)
  $ 2,704     $ 324     $ 3,028  
Estimate for year ended December 31, 2011
    5,351       624       5,975  
     2012
    4,868       500       5,368  
     2013
    4,304       400       4,704  
     2014
    3,946       324       4,270  
     2015
    3,594       262       3,856  
     2016
    3,292       212       3,504  
 
Note 8: Commitments and Contingent Liabilities

Loan commitments are agreements to lend to a customer provided there is no violation of any condition established in the agreement. Commitments generally have fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future funding requirements. Loan commitments are subject to the Company’s normal credit policies and collateral requirements. Unfunded loan commitments were $385,199 thousand and $422,677 thousand at June 30, 2011 and December 31, 2010, respectively. Standby letters of credit commit the Company to make payments on behalf of customers when certain specified future events occur. Standby letters of credit are primarily issued to support customers’ short-term financing requirements and must meet the Company’s normal credit policies and collateral requirements. Standby letters of credit outstanding totaled $25,643 thousand and $25,458 thousand at June 30, 2011 and December 31, 2010, respectively. The Company also had commitments for commercial and similar letters of credit of $2,954 thousand and $3,351 thousand at June 30, 2011 and December 31, 2010, respectively.

Due to the nature of its business, the Company is subject to various threatened or filed legal cases resulting from loan collection efforts, transaction processing for deposit accounts including the order of posting transactions and the assessment of overdraft fees, and employment practices. Like many banks, the Bank is a defendant in a lawsuit alleging it improperly assessed overdraft fees on deposit accounts due to the order in which it processed payments against such deposit accounts. The Bank has reached a preliminary mediated settlement of this matter which is subject to court approval. The Company establishes a liability for contingent litigation losses for any legal matter when payments associated with the claims become probable and the costs can be reasonably estimated. The Bank has accrued a liability for the preliminary mediated settlement. Legal costs related to covered assets are eighty percent indemnified under loss-sharing agreements with the FDIC if certain conditions are met.
 
 
- 24 -

 
Note 9:  Fair Value Measurements

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.  Available for sale investment securities are recorded at fair value on a recurring basis.  Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as certain loans held for investment and other assets.  These nonrecurring fair value adjustments typically involve the lower-of-cost-or-fair value accounting or impairment or write-down of individual assets.

In accordance with the Fair Value Measurement and Disclosure topic of the Codification, the Company bases its fair values on the price that would be received to sell an asset or paid to transfer a liability in the principal market or most advantageous market for an asset or liability in an orderly transaction between market participants on the measurement date.  A fair value measurement reflects all of the assumptions that market participants would use in pricing the asset or liability, including assumptions about the risk inherent in a particular valuation technique, the effect of a restriction on the sale or use of an asset, and the risk of nonperformance.

The Company groups its assets and liabilities measured at fair value into a three-level hierarchy, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active exchange markets, such as the New York Stock Exchange.  Level 1 includes U.S. Treasury and federal agency securities, which are traded by dealers or brokers in active markets.  Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 2 includes mortgage-backed securities, municipal bonds and residential collateralized mortgage obligations as well as other real estate owned and impaired loans collateralized by real property where the fair value is generally based upon independent market prices or appraised values of the collateral.

Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques. Level 3 includes those impaired loans collateralized by business assets where the expected cash flow has been used in determining the fair value.
 
 
- 25 -

 
Assets Recorded at Fair Value on a Recurring Basis
The table below presents assets measured at fair value on a recurring basis.

   
At June 30, 2011
 
   
Fair Value
   
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2 )
   
Significant
Unobservable
Inputs
(Level 3 )
 
   
(In thousands)
 
U.S. Treasury securities
  $ 3,573     $ 3,573     $ -     $ -  
Securities of U.S. Government sponsored entities
    166,864       166,864       -       -  
Municipal bonds:
                               
Federally Tax-exempt - California
    84,983       -       84,983       -  
Federally Tax-exempt - 29 other states
    175,534       -       175,534       -  
Taxable - California
    2,030       -       2,030       -  
Taxable - 2 other states
    5,814       -       5,814       -  
Residential mortgage-backed securities ("MBS"):
                               
Guaranteed by GNMA
    39,970       -       39,970       -  
Issued by FNMA and FHLMC
    65,209       -       65,209       -  
Residential collateralized mortgage obligations:
                               
Issued or guaranteed by FNMA, FHLMC, or GNMA
    49,604       -       49,604       -  
All other
    6,171       -       6,171       -  
Commercial mortgage-backed securities
    4,831       -       4,831       -  
Asset-backed securities - government guaranteed student loans
    8,024       -       8,024       -  
FHLMC and FNMA stock
    4,230       4,230       -       -  
Corporate securities
    83,906       -       83,906       -  
Other securities
    4,335       2,385       1,950       -  
Total securities available for sale
  $ 705,078     $ 177,052     $ 528,026     $ -  
 
There were no significant transfers in or out of Levels 1 and 2 for the six months ended June 30, 2011.

   
At December 31, 2010
 
   
Fair Value
   
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2 )
   
Significant
Unobservable
Inputs
(Level 3 )
 
   
(In thousands)
 
U.S. Treasury securities
  $ 3,542     $ 3,542     $ -     $ -  
Securities of U.S. Government sponsored entities
    172,877       172,877       -       -  
Municipal bonds:
                               
Federally Tax-exempt - California
    83,616       -       83,616       -  
Federally Tax-exempt - 29 other states
    170,741       -       170,741       -  
Taxable - California
    6,276       -       6,276       -  
Taxable - 1 other state
    500       -       500       -  
Residential mortgage-backed securities ("MBS"):
                               
Guaranteed by GNMA
    43,557       -       43,557       -  
Issued by FNMA and FHLMC
    66,272       -       66,272       -  
Residential collateralized mortgage obligations:
                               
Issued or guaranteed by FNMA, FHLMC, or GNMA
    18,010       -       18,010       -  
All other
    7,593       -       7,593       -  
Commercial mortgage-backed securities
    5,065       -       5,065       -  
Asset-backed securities - government guaranteed student loans
    8,286       -       8,286       -  
FHLMC and FNMA stock
    655       655       -       -  
Corporate securities
    79,191       -       79,191       -  
Other securities
    5,303       3,342       1,961       -  
Total securities available for sale
  $ 671,484     $ 180,416     $ 491,068     $ -  

 
- 26 -

 
Assets Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets. For assets measured at fair value on a nonrecurring basis that were still held in the balance sheet at June 30, 2011 and December 31, 2010, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related assets at period end.

   
At June 30, 2011
 
   
Fair Value
   
Level 1
   
Level 2
   
Level 3
   
Total losses
 
   
(In thousands)
 
Non-covered other real estate owned (1)
  $ 5,632     $ -     $ 5,632     $ -     $ (623 )
Covered other real estate owned (2)
    7,511       -       7,511       -       (449 )
Originated impaired loans (3)
    5,352       -       5,352       -       (1,475 )
Total assets measured at fair value on a nonrecurring basis
  $ 18,495     $ -     $ 18,495     $ -     $ (2,547 )
 
   
At December 31, 2010
 
   
Fair Value
   
Level 1
   
Level 2
   
Level 3
   
Total losses
 
   
(In thousands)
 
Non-covered other real estate owned (1)
  $ 1,863     $ -     $ 1,863     $ -     $ (664 )
Originated impaired loans (3)
    4,780       -       4,780       -       (829 )
Total assets measured at fair value on a nonrecurring basis
  $ 6,643     $ -     $ 6,643     $ -     $ (1,493 )

(1) Represents the fair value of foreclosed real estate owned that was measured at fair value subsequent to their initial classification as foreclosed assets.
 
(2) Represents the fair value of foreclosed real estate owned that is covered by the Indemnification Agreement with the FDIC where the real estate was written down subsequent to its initial classification as foreclosed assets. Total losses are reduced by the 80% indemnified loss percentage.

(3) Represents carrying value of loans for which adjustments are predominantly based on the appraised value of the collateral and loans considered impaired under FASB ASC 310-10-35, Subsequent Measurement of Receivables, where a specific reserve has been established or a chargeoff has been recorded.

Disclosures about Fair Value of Financial Instruments

The following section describes the valuation methodologies used by the Company for estimating fair value of financial instruments not recorded at fair value.

Cash and Due from Banks  The carrying amount of cash and amounts due from banks approximate fair value due to the relatively short period of time between their origination and their expected realization.

Money Market Assets  The carrying amount of money market assets approximate fair value due to the relatively short period of time between their origination and their expected realization.

Investment Securities Held to Maturity The fair values of investment securities were estimated using quoted prices as described above for Level 1 and Level 2 valuation.

Loans  Loans were separated into two groups for valuation. Variable rate loans, except for those described below, which reprice frequently with changes in market rates were valued using historical cost. Fixed rate loans and variable rate loans that have reached their minimum contractual interest rates were valued by discounting the future cash flows expected to be received from the loans using current interest rates charged on loans with similar characteristics. Additionally, the allowance for loan losses of $33,008 thousand at June 30, 2011 and $35,636 thousand at December 31, 2010 and the fair value discount due to credit default risk associated with purchased covered and purchased non-covered loans of $55,527 thousand and $22,078 thousand, respectively at June 30, 2011 and $61,784 thousand and $32,382 thousand, respectively at December 31, 2010 were applied against the estimated fair values to recognize estimated future defaults of contractual cash flows. The Company does not consider these values to be a liquidation price for the loans.

 
- 27 -

 
FDIC Receivable  The fair value of the FDIC receivable recorded in Other Assets was estimated by discounting estimated future cash flows using current market rates for financial instruments with similar characteristics.

Deposit Liabilities  The carrying amount of checking accounts, savings accounts and money market accounts approximates fair value due to the relatively short period of time between their origination and their expected realization.  The fair values of time deposits were estimated by discounting estimated future cash flows related to these financial instruments using current market rates for financial instruments with similar characteristics.

Short-Term Borrowed Funds  The carrying amount of securities sold under agreement to repurchase and other short-term borrowed funds approximate fair value due to the relatively short period of time between their origination and their expected realization.  The fair values of term repurchase agreements were estimated by using interpolated yields for financial instruments with similar characteristics.

Federal Home Loan Bank Advances  The fair values of FHLB advances were estimated by using interpolated yields for financial instruments with similar characteristics.

Debt Financing and Notes Payable  The fair values of debt financing and notes payable were estimated by using interpolated yields for financial instruments with similar characteristics.

Restricted Performance Share Grants The fair value of liabilities for unvested restricted performance share grants recorded in Other Liabilities were estimated using quoted prices as described above for Level 1 valuation.

The table below is a summary of fair value estimates for financial instruments, excluding financial instruments recorded at fair value on a recurring basis. The values assigned do not necessarily represent amounts which ultimately may be realized. In addition, these values do not give effect to discounts to fair value which may occur when financial instruments are sold in larger quantities.  The carrying amounts in the following table are recorded in the balance sheet under the indicated captions.

The Company has not included assets and liabilities that are not financial instruments, such as goodwill, long-term relationships with deposit, merchant processing and trust customers, other purchased intangibles, premises and equipment, deferred taxes and other assets and liabilities. The total estimated fair values do not represent, and should not be construed to represent, the underlying value of the Company.

   
At June 30, 2011
   
At December 31, 2010
 
   
Carrying
Amount
   
Estimated
Fair Value
   
Carrying
Amount
   
Estimated
Fair Value
 
   
(In thousands)
 
Financial Assets
                       
Cash and due from banks
  $ 320,119     $ 320,119     $ 338,793     $ 338,793  
Money market assets
    -       -       392       392  
Investment securities held to maturity
    669,452       687,326       580,728       594,711  
Loans
    2,718,205       2,752,643       2,886,448       2,923,612  
Other assets - FDIC receivable
    41,152       40,987       44,738       44,353  
                                 
Financial Liabilities
                               
Deposits
    4,088,385       4,089,138       4,132,961       4,135,113  
Short-term borrowed funds
    106,727       106,727       107,385       107,385  
Federal Home Loan Bank Advances
    46,351       46,757       61,698       61,833  
Debt financing and notes payable
    25,853       27,742       26,363       26,811  
Other liabilities - restricted performance share grants
    1,506       1,506       2,259       2,259  

The majority of the Company’s standby letters of credit and other commitments to extend credit carry current market interest rates if converted to loans. No premium or discount was ascribed to these commitments because virtually all funding would be at current market rates.

 
- 28 -

 
Note 10: Borrowed Funds

Debt financing and notes payable were as follows:
 
   
At June 30,
2011
   
At December 31,
2010
 
   
(In thousands)
 
Senior fixed-rate note (1)
  $ 15,000     $ 15,000  
Subordinated fixed-rate note (2)
    10,853       11,363  
Total debt financing and notes payable - Parent
  $ 25,853     $ 26,363  
 
(1)
Senior note, issued by Westamerica Bancorporation, originated in October 2003 and maturing October 31, 2013. Interest of 5.31% per annum is payable semiannually on April 30 and October 31, with original principal payment due at maturity.
(2)
Subordinated debt, assumed by Westamerica Bancorporation March 1, 2005, originated February 22, 2001. Par amount $10,000 thousand, interest of 10.2% per annum, payable semiannually. Matures February 22, 2031, redeemable February 22, 2011 at a premium and February 22, 2021 at par.

The subordinated note is currently callable by the Company at a premium. The Company intends to redeem the subordinated note in August 2011, and has adjusted the premium amortization accordingly. The call premium will approximate 5 percent of the $10,000 thousand principal amount.


Note 11: Earnings Per Common Share

The table below shows earnings per common share and diluted earnings per common share. Basic earnings per common share are computed by dividing net income applicable to common equity by the average number of common shares outstanding during the period. Diluted earnings per common share are computed by dividing net income applicable to common equity by the average number of common shares outstanding during the period plus the impact of common stock equivalents.

   
 
   
 
 
   
For the three months ended
June 30,
   
For the six months ended
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
(In thousands, except per share data)
   
(In thousands, except per share data)
 
Net income applicable to common equity (numerator)
  $ 21,269     $ 23,561     $ 43,651     $ 47,137  
Basic earnings per common share
                               
Weighted average number of common shares outstanding - basic
    (denominator)
    28,771       29,207       28,895       29,217  
Basic earnings per common share
  $ 0.74     $ 0.81     $ 1.51     $ 1.61  
Diluted earnings per common share
                               
Weighted average number of common shares outstanding - basic
    28,771       29,207       28,895       29,217  
Add exercise of options reduced by the number of shares that could
    have been purchased with the proceeds of such exercise
    152       361       178       365  
Weighted average number of common shares outstanding - diluted
    (denominator)
    28,923       29,568       29,073       29,582  
Diluted earnings per common share
  $ 0.74     $ 0.80     $ 1.50     $ 1.59  

For the three months ended June 30, 2011, stock options and warrants to purchase 1,149 thousand and 247 thousand shares of common stock, respectively, were outstanding but not included in the computation of diluted net income per share because the option exercise price exceeded the fair value of the stock such that their inclusion would have had an anti-dilutive effect. For the six months ended June 30, 2011, stock options and warrants to purchase 962 thousand and 247 thousand shares of common stock, respectively, were outstanding but not included in the computation of diluted net income per share because their inclusion would have had an anti-dilutive effect. For the three months and six months ended June 30, 2010, options to purchase 287 thousand and 290 thousand shares of common stock, respectively, were outstanding but not included in the computation of diluted net income per share because their inclusion would have had an anti-dilutive effect.

 
- 29 -

 
WESTAMERICA BANCORPORATION
 
FINANCIAL SUMMARY
 
                         
   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
(In thousands, except per share data)
 
Net Interest Income (FTE)*
  $ 55,837     $ 56,573     $ 110,830     $ 113,602  
Provision for Loan Losses
    2,800       2,800       5,600       5,600  
Noninterest Income
    15,292       15,770       30,035       31,240  
Noninterest Expense:
                               
  Settlements
    2,100       -       2,100       23  
  Other noninterest expense
    32,209       32,095       63,532       64,103  
Total Noninterest Expense
    34,309       32,095       65,632       64,126  
Income Before Income Taxes (FTE)*
    34,020       37,448       69,633       75,116  
Income Tax Provision (FTE)*
    12,751       13,887       25,982       27,979  
Net Income
  $ 21,269     $ 23,561     $ 43,651     $ 47,137  
                                 
Average Common Shares Outstanding
    28,771       29,207       28,895       29,217  
Diluted Average Common Shares Outstanding
    28,923       29,568       29,073       29,582  
Common Shares Outstanding at Period End
    28,540       29,118       28,540       29,118  
                                 
As Reported:
                               
  Basic Earnings Per Common Share
  $ 0.74     $ 0.81     $ 1.51     $ 1.61  
  Diluted Earnings Per Common Share
    0.74       0.80       1.50       1.59  
  Return On Assets
    1.73 %     2.00 %     1.78 %     1.99 %
  Return On Common Equity
    15.64 %     18.24 %     16.14 %     18.54 %
  Net Interest Margin (FTE)*
    5.38 %     5.62 %     5.37 %     5.61 %
  Net Loan Losses to Average Gross Originated Loans
    0.83 %     0.64 %     0.83 %     0.65 %
  Efficiency Ratio**
    48.2 %     44.4 %     46.6 %     44.3 %
                                 
Average Balances:
                               
  Total Assets
  $ 4,927,849     $ 4,731,270     $ 4,934,387     $ 4,771,872  
  Total Earning Assets
    4,156,226       4,033,831       4,154,676       4,072,374  
  Originated Loans
    1,978,155       2,136,407       1,990,042       2,150,857  
  Purchased Covered Loans
    644,555       788,108       659,597       809,515  
  Purchased Non-covered Loans
    178,384       -       185,870       -  
  Total Deposits
    4,143,749       3,895,671       4,141,288       3,925,321  
  Shareholders' Equity
    545,637       518,128       545,421       512,796  
                                 
Balances at Period End:
                               
  Total Assets
  $ 4,876,731     $ 4,727,086                  
  Total Earning Assets
    4,125,743       4,007,989                  
  Originated Loans
    1,963,642       2,124,570                  
  Purchased Covered Loans
    622,727       763,619                  
  Purchased Non-covered Loans
    164,844       -                  
  Total Deposits
    4,088,385       3,890,560                  
  Shareholders' Equity
    549,340       527,681                  
                                 
Financial Ratios at Period End:
                               
  Allowance for Loan Losses to Originated Loans
    1.68 %     1.87 %                
  Book Value Per Common Share
  $ 19.25     $ 18.12                  
  Equity to Assets
    11.26 %     11.16 %                
  Total Capital to Risk Adjusted Assets
    15.72 %     15.72 %                
                                 
Dividends Paid Per Common Share
  $ 0.36     $ 0.36     $ 0.72     $ 0.72  
Common Dividend Payout Ratio
    49 %     45 %     48 %     45 %
 
The above financial summary has been derived from the Company's unaudited consolidated financial statements. This information should be read in conjunction with those statements, notes and the other information included elsewhere herein. Percentages under the heading "As Reported" are annualized with the exception of the efficiency ratio.
 
* Yields on securities and certain loans have been adjusted upward to a "fully taxable equivalent" ("FTE") basis, which is a non-GAAP financial measure, in order to reflect the effect of income which is exempt from federal income taxation at the current statutory tax rate.
 
** The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income on an FTE basis, which is a non-GAAP financial measure, and noninterest income).

 
- 30 -

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

Westamerica Bancorporation and subsidiaries (the “Company”) reported net income of $21.3 million or $0.74 diluted earnings per common share for the second quarter 2011 and net income of $43.7 million or $1.50 diluted earnings per common share for the six months ended June 30, 2011. The second quarter of 2011 included $2.1 million in litigation settlement accruals which decreased net income by $1.2 million and earnings per diluted common shares by $0.04. First six months ended June 30, 2011 included expenses related to the integration of the former Sonoma Valley Bank (“Sonoma”) of $393 thousand after tax in addition to the settlement accruals, equivalent to $0.06 diluted earnings per share. These results compare to net income of $23.6 million or $0.80 diluted earnings per common share for the second quarter of 2010 and net income of $47.1 million or $1.59 diluted earnings per common share for the first half of 2010.
 
Acquisition

Westamerica Bank (“Bank”) acquired assets and assumed liabilities of the former Sonoma on August 20, 2010. The acquired assets and assumed liabilities were measured at estimated fair values, as required by FASB ASC 805, Business Combinations. Management made significant estimates and exercised significant judgment in accounting for the acquisition. Management judgmentally measured loan fair values based on loan file reviews (including borrower financial statements and tax returns), appraised collateral values, expected cash flows, and historical loss factors. Repossessed loan collateral was primarily valued based upon appraised collateral values. The Bank also recorded an identifiable intangible asset representing the value of the assumed core deposit customer base of Sonoma based on Management’s evaluation of the cost of such deposits relative to alternative funding sources. In determining the value of the identifiable intangible asset, Management used significant estimates including average lives of depository accounts, future interest rate levels, the cost of servicing various depository products, and other significant estimates. Management used quoted market prices to determine the fair value of investment securities, Federal Home Loan Bank (“FHLB”) advances and other borrowings which were purchased and assumed. The acquired Sonoma operations were fully integrated into the Company’s traditional operating systems and practices in February 2011.

Net Income

Following is a summary of the components of net income for the periods indicated:

   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
(In thousands, except per share data)
 
Net interest income (FTE)
  $ 55,837     $ 56,573     $ 110,830     $ 113,602  
Provision for loan losses
    (2,800 )     (2,800 )     (5,600 )     (5,600 )
Noninterest income
    15,292       15,770       30,035       31,240  
Noninterest expense
    (34,309 )     (32,095 )     (65,632 )     (64,126 )
Income  before taxes (FTE)
    34,020       37,448       69,633       75,116  
Income tax provision (FTE)
    (12,751 )     (13,887 )     (25,982 )     (27,979 )
Net income
  $ 21,269     $ 23,561     $ 43,651     $ 47,137  
                                 
Average diluted common shares
    28,923       29,568       29,073       29,582  
Diluted earnings per common share
  $ 0.74     $ 0.80     $ 1.50     $ 1.59  
                                 
Average total assets
  $ 4,927,849     $ 4,731,270     $ 4,934,387     $ 4,771,872  
Net income to average total assets (annualized)
    1.73 %     2.00 %     1.78 %     1.99 %
Net income to average common stockholders' equity (annualized)
    15.64 %     18.24 %     16.14 %     18.54 %

Net income for the second quarter of 2011 was $2.3 million or 9.7% less than the same quarter of 2010, the net result of declines in net interest income (FTE) and noninterest income and the $2.1 million settlement accrual, partially offset by lower income tax provision (FTE). A $736 thousand or 1.3% decrease in net interest income (FTE) was mostly attributed to lower yields on earning assets and lower average balances of loans, partially offset by higher average balances of investments and lower rates paid on interest-bearing liabilities. The provision for loan losses remained the same, reflecting Management's evaluation of losses inherent in the loan portfolio not covered by loss-sharing agreements with the Federal Deposit Insurance Corporation (“FDIC”) and purchased loan credit-default discounts. Noninterest income decreased $478 thousand mainly due to lower service charges on deposit accounts. Noninterest expense increased $2.2 million mostly due to the $2.1 million settlement accrual.
 
 
- 31 -

 
Comparing the first half of 2011 to the first half of 2010, net income decreased $3.5 million or 7.4%, primarily due to lower net interest income (FTE), lower noninterest income and the $2.1 million settlement accrual, partially offset by a decrease in income tax provision (FTE). The lower net interest income (FTE) was primarily caused by lower yields on interest earning assets, a lower average volume of loans and higher average balances of interest-bearing liabilities, partially offset by higher average balances of investments and lower rates paid on interest-bearing liabilities. The provision for loan losses remained the same, reflecting Management's evaluation of losses inherent in the loan portfolio not covered by loss-sharing agreements with the FDIC and purchased loan credit-default discounts. Noninterest income decreased $1.2 million largely due to lower service charges on deposit accounts. Noninterest expense increased $1.5 million mostly due to the $2.1 million settlement accrual.
 
Net Interest Income

Following is a summary of the components of net interest income for the periods indicated:

   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
 
 
2011
   
2010
   
2011
   
2010
 
   
(In thousands)
 
Interest and fee income
  $ 53,088     $ 55,078     $ 105,582     $ 111,081  
Interest expense
    (2,153 )     (3,145 )     (4,456 )     (6,679 )
FTE adjustment
    4,902       4,640       9,704       9,200  
  Net interest income (FTE)
  $ 55,837     $ 56,573     $ 110,830     $ 113,602  
                                 
Average earning assets
  $ 4,156,226     $ 4,033,831     $ 4,154,676     $ 4,072,374  
Net interest margin (FTE) (annualized)
    5.38 %     5.62 %     5.37 %     5.61 %

Net interest income (FTE) decreased during the second quarter of 2011 by $736 thousand or 1.3% from the same period in 2010 to $55.8 million, mainly due to lower yields on earning assets (down 0.34%) and lower average balances of loans (down $123 million), partially offset by higher average balances of investments (up $246 million) and lower rates paid on interest-bearing liabilities (down 0.16%).

Comparing the first half of 2011 with the first half of 2010, net interest income (FTE) decreased $2.8 million or 2.4%, primarily due to lower yields on interest earning assets (down 0.35%), a lower average volume of loans (down $125 million) and higher average balances of interest-bearing liabilities (up $62 million), partially offset by higher average balances of investments (up $207 million) and lower rates paid on interest-bearing liabilities (down 0.17%).

Yields on interest-earning assets have declined due to relatively low interest rates prevailing in the market. Economic conditions and deleveraging by businesses and individuals have reduced loan volumes, placing greater reliance on lower-yielding investment securities. Rates on interest-bearing deposits and borrowings have declined to offset some of the decline in asset yields.

At June 30, 2011, purchased FDIC covered loans represented 23 percent of the Company’s loan portfolio. Under the terms of the FDIC loss-sharing agreements, the FDIC is obligated to reimburse the Bank 80 percent of loan interest income foregone on covered loans. Such reimbursements are limited to the lesser of 90 days contractual interest or actual unpaid contractual interest at the time a principal loss is recognized in respect to the underlying loan. The term of the loss-sharing agreement on residential real estate assets is ten years, while the term for loss-sharing on non-residential real estate assets is five years with respect to losses and eight years with respect to loss recoveries.
 
Interest and Fee Income

Interest and fee income (FTE) for the second quarter of 2011 decreased $1.7 million or 2.9% from the same period in 2010. The decrease was caused by lower average balances of loans and lower yields on earning assets, partially offset by higher average balances of investments. The total average balances of loans declined due to decreases in the average balances of taxable commercial loans (down $88 million), residential real estate loans (down $40 million) and tax-exempt commercial loans (down $21 million), partially offset by increases in the average balances of personal credit lines (up $19 million) and construction loans (up $10 million). The average investment portfolio increased largely due to higher average balances of U.S. Government sponsored entities (up $119 million), municipal securities (up $105 million) and corporate securities (up

 
- 32 -

 
$73 million), partially offset by declines in the average balances of collateralized mortgage obligations (down $10 million) and residential mortgage backed securities (down $46 million). The average yield on the Company's earning assets decreased from 5.93% in the second quarter of 2010 to 5.59% in the corresponding period of 2011. The composite yield on loans declined 0.15% to 6.03% in the second quarter 2011 compared to the corresponding period of 2010. Nonperforming loans are included in average loan volumes used to compute loan yields; fluctuations in nonaccrual loan volumes impact loan yields. The loan portfolio yield fell due to declines in yields on construction loans (down 1.29%), residential real estate loans (down 0.51%), indirect auto loans (down 0.66%), tax-exempt commercial loans (down 0.4%) and commercial real estate loans (down 0.06%), partially offset by increases in yields on taxable commercial loans (up 0.43%) and personal credit lines (up 0.53%). The investment portfolio yield decreased 0.6% to 4.68%. Decreases in yields on collateralized mortgage obligations (down 0.75%), residential mortgage backed securities (down 0.26%), municipal securities (down 0.19%) were partially offset by increases in yields on corporate securities (up 0.61%) and U.S. government sponsored entities (up 0.12%). The decline in loan and investment yields is primarily due to relatively low market rates and competitive loan pricing.
 
Comparing the first half of 2011 with the first half of 2010, interest and fee income (FTE) was down $5.0 million or 4.2%. The decrease resulted from a lower average volume of loans and lower yields on interest earning assets, partially offset by higher average balances of investments. A lower average balance of the loan portfolio was mostly attributable to decreases in average balances of taxable commercial loans (down $80 million), residential real estate loans (down $44 million), tax-exempt commercial loans (down $20 million) and indirect auto loans (down $12 million), partially offset by a $19 million increase in the average balance of personal credit lines. The average investment portfolio increased mostly due to higher average balances of U.S. government sponsored entity obligations (up $131 million), municipal securities (up $87 million) and corporate securities (up $74 million), partially offset by decreases in collateralized mortgage obligations (down $38 million) and residential mortgage backed securities (down $51 million). The average yield on earning assets for the first half of 2011 was 5.59% compared with 5.94% in the first half of 2010. The loan portfolio yield for the first half of 2011 decreased 0.18% compared with the first half of 2010 primarily due to lower yields on construction loans (down 0.85%), residential real estate loans (down 0.51%), indirect auto loans (down 0.58%) and commercial real estate loans (down 0.13%), partially offset by increases in yields on taxable commercial loans (up 0.18%) and personal credit lines (up 0.36%). The investment portfolio yield declined from 5.32% in the first half of 2010 to 4.69% in the first half of 2011 mainly due to decreases in yields on collateralized mortgage obligations (down 0.46%), residential mortgage backed securities (down 0.28%) and municipal securities (down 0.17%), partially offset by corporate securities (up 0.5%)
 
Interest Expense

Interest expense in the second quarter of 2011 decreased $992 thousand or 31.5% compared with the same period in 2010. The decrease was attributable to lower rates paid on interest-bearing liabilities (down 0.16%) and a shift from higher costing term repurchase agreements and time deposits less than $100 thousand to low-cost checking and savings accounts. Such deposits represented 79% of total deposits in the second quarter 2011 compared with 77% in the second quarter 2010. Lower average balances of short-term borrowed funds (down $103 million) and time deposits less than $100 thousand (down $33 million) were partially offset by higher average balances of Federal Home Loan Bank advances (up $38 million), preferred money market savings (up $66 million), money market savings (up $54 million), money market checking accounts (up $39 million) and regular savings (up $37 million). Lower average balances of short-term borrowed funds were attributable to repayment of term repurchase agreements of $100 million in December of 2010. The average rate paid on interest-bearing liabilities decreased from 0.46% in the second quarter of 2010 to 0.3% in the same quarter of 2011. Rates on interest-bearing deposits decreased 0.08% to 0.27% primarily due to decreases in rates paid on time deposits $100 thousand or more (down 0.2%) and preferred money market savings (down 0.31%), partially offset by higher rates paid on time deposits less than $100 thousand (up 0.18%). Rates on short-term borrowed funds decreased 0.76%. Rates on Federal Home Loan Bank advances also declined 0.95%. Rates on debt financing payable declined 3.3% due to the adjustment of the premium amortization on a $10 million subordinated note, which the Company intends to redeem in August 2011. The redemption premium will approximate 5 percent of the $10 million principal amount.

Comparing the first half of 2011 with the first half of 2010, interest expense declined $2.2 million or 33.3%, due to lower rates paid on interest-bearing liabilities, partially offset by higher average balances of interest-bearing liabilities. Higher average balances of Federal Home Loan Bank advances (up $36 million), money market savings (up $57 million), preferred money market savings (up $48 million), money market checking accounts (up $46 million) and regular savings (up $30 million) were partially offset by lower average balances of short-term borrowed funds (down $106 million) and time deposits less than $100 thousand (down $44 million). Lower average balances of short-term borrowed funds were attributable to repayment of term repurchase agreements of $100 million in December of 2010.

Rates paid on interest-bearing liabilities averaged 0.31% during the first half of 2011 compared with 0.48% for the first half of 2010 mainly due to lower rates on time deposits over $100 thousand (down 0.17%), money market savings (down 0.16%),

 
- 33 -

 
preferred money market savings (down 0.32%), short-term borrowed funds (down 0.76%), Federal Home Loan Bank advances (down 0.51%) and debt financing and notes payable (down 3.34%), partially offset by a 0.06% increase in rates on time deposits less than $100 thousand. Rates on debt financing payable declined due to the adjusted premium amortization described in the preceding paragraph.
 
Net Interest Margin (FTE)

The following summarizes the components of the Company's net interest margin for the periods indicated:

   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
 
 
2011
   
2010
   
2011
   
2010
 
                         
Yield on earning assets (FTE)
    5.59 %     5.93 %     5.59 %     5.94 %
Rate paid on interest-bearing liabilities
    0.30 %     0.46 %     0.31 %     0.48 %
  Net interest spread (FTE)
    5.29 %     5.47 %     5.28 %     5.46 %
Impact of noninterest bearing demand deposits
    0.09 %     0.15 %     0.09 %     0.15 %
    Net interest margin (FTE)
    5.38 %     5.62 %     5.37 %     5.61 %
                                 
 
During the second quarter of 2011, the net interest margin (FTE) decreased 0.24% compared with the same period in 2010. Yields on interest-earning assets have declined due to relatively low interest rates prevailing in the market. Economic conditions and deleveraging by businesses and individuals have reduced loan volumes, placing greater reliance on lower-yielding investment securities. Rates on interest-bearing deposits and borrowings have declined to offset some of the decline in asset yields. Lower yields on earning assets were partially offset by lower rates paid on interest-bearing liabilities and resulted in a 0.18% decrease in net interest spread (FTE). The net interest margin contribution of noninterest-bearing demand deposits increased the net interest margin (FTE) to 5.38%. The net interest margin (FTE) in the first half of 2011 was 5.37% compared with 5.61% in the first half of 2010, the net result of a 0.35% decrease in earning asset yields, partially offset by lower cost of interest-bearing liabilities (down 0.17%). The margin contribution from noninterest bearing demand deposits declined from 0.15% in the first half of 2010 to 0.09% in the first half of 2011.




 


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- 34 -

 
Summary of Average Balances, Yields/Rates and Interest Differential

The following tables present, for the periods indicated, information regarding the Company's consolidated average assets, liabilities and shareholders' equity, the amount of interest income from average earning assets and the resulting annualized yields, and the amount of interest expense paid on average interest-bearing liabilities and the resulting annualized rate paid. Average loan balances include nonperforming loans. Interest income includes proceeds from loans on nonaccrual status only to the extent cash payments have been received and applied as interest income. Yields on securities and certain loans have been adjusted upward to reflect the effect of income which is exempt from federal income taxation at the current statutory tax rate (FTE).

   
For the three months ended
 
   
June 30, 2011
 
               
Yields
 
         
Interest
   
Earned/
 
   
Average
   
Income/
   
Rates
 
   
Balance
   
Expense
   
Paid
 
   
(In thousands)
 
Assets:
                 
Money market assets and funds sold
  $ 205     $ -       - %
Investment securities:
                       
  Available for sale
                       
    Taxable
    467,322       2,914       2.49 %
    Tax-exempt (1)
    271,889       4,242       6.24 %
  Held to maturity
                       
    Taxable
    139,411       1,309       3.76 %
    Tax-exempt (1)
    476,305       7,405       6.22 %
Loans:
                       
  Commercial:
                       
    Taxable
    457,659       7,619       6.68 %
    Tax-exempt (1)
    149,459       2,436       6.54 %
  Commercial real estate
    1,222,393       20,017       6.57 %
  Real estate construction
    67,323       771       4.59 %
  Real estate residential
    319,323       3,171       3.97 %
  Consumer
    584,937       8,106       5.56 %
    Total loans (1)
    2,801,094       42,120       6.03 %
        Total Interest earning assets (1)
    4,156,226     $ 57,990       5.59 %
Other assets
    771,623                  
    Total assets
  $ 4,927,849                  
                         
Liabilities and shareholders' equity
                       
Deposits:
                       
  Noninterest bearing demand
  $ 1,466,754     $ -       - %
  Savings and interest-bearing transaction
    1,815,513       647       0.14 %
  Time less than $100,000
    318,235       548       0.69 %
  Time $100,000 or more
    543,247       582       0.43 %
     Total interest-bearing deposits
    2,676,995       1,777       0.27 %
Short-term borrowed funds
    103,177       47       0.18 %
Federal Home Loan Bank advances
    48,248       128       1.05 %
Debt financing and notes payable
    26,007       201       3.08 %
    Total interest-bearing liabilities
    2,854,427     $ 2,153       0.30 %
Other liabilities
    61,031                  
Shareholders' equity
    545,637                  
    Total liabilities and shareholders' equity
  $ 4,927,849                  
Net interest spread (1) (2)
                    5.29 %
Net interest income and interest margin (1) (3)
          $ 55,837       5.38 %
 
(1) Interest and rates calculated on a fully taxable equivalent basis using the current statutory federal tax rate.
(2) Net interest spread represents the average yield earned on earning assets minus the average rate paid on interest-bearing liabilities.
(3) Net interest margin is computed by calculating the difference between interest income and expense (annualized), divided by the average balance of earning assets.
 
 
- 35 -

 
 
   
For the three months ended
 
   
June 30, 2010
 
               
Yields
 
         
Interest
   
Earned/
 
   
Average
   
Income/
   
Rates
 
   
Balance
   
Expense
   
Paid
 
   
(In thousands)
 
Assets:
                 
Money market assets and funds sold
  $ 703     $ -       - %
Investment securities:
                       
  Available for sale
                       
    Taxable
    266,180       2,156       3.24 %
    Tax-exempt (1)
    169,137       2,800       6.62 %
  Held to maturity
                       
    Taxable
    186,367       2,043       4.38 %
    Tax-exempt (1)
    486,929       7,636       6.27 %
Loans:
                       
  Commercial:
                       
    Taxable
    545,959       8,511       6.25 %
    Tax-exempt (1)
    170,341       2,948       6.94 %
  Commercial real estate
    1,224,442       20,240       6.63 %
  Real estate construction
    57,514       843       5.88 %
  Real estate residential
    358,887       4,016       4.48 %
  Consumer
    567,372       8,525       6.03 %
    Total loans (1)
    2,924,515       45,083       6.18 %
    Total earning assets (1)
    4,033,831     $ 59,718       5.93 %
Other assets
    697,439                  
 
                       
    Total assets
  $ 4,731,270                  
                         
Liabilities and shareholders' equity
                       
Deposits:
                       
  Noninterest bearing demand
  $ 1,384,249     $ -       - %
  Savings and interest-bearing
                       
    transaction
    1,619,319       877       0.22 %
  Time less than $100,000
    350,890       449       0.51 %
  Time $100,000 or more
    541,213       854       0.63 %
     Total interest-bearing deposits
    2,511,422       2,180       0.35 %
Short-term borrowed funds
    206,313       491       0.94 %
Federal Home Loan Bank advances
    10,273       52       2.00 %
Debt financing and notes payable
    26,450       422       6.38 %
    Total interest-bearing liabilities
    2,754,458     $ 3,145       0.46 %
Other liabilities
    74,435                  
Shareholders' equity
    518,128                  
                         
    Total liabilities and shareholders' equity
  $ 4,731,270                  
                         
Net interest spread (1) (2)
                    5.47 %
                         
Net interest income and interest margin (1) (3)
          $ 56,573       5.62 %
 
(1) Interest and rates calculated on a fully taxable equivalent basis using the current statutory federal tax rate.
(2) Net interest spread represents the average yield earned on earning assets minus the average rate paid on interest-bearing liabilities.
(3) Net interest margin is computed by calculating the difference between interest income and expense (annualized), divided by the average balance of earning assets.

 
- 36 -

 
 
   
For the six months ended
 
   
June 30, 2011
 
               
Yields
 
         
Interest
   
Earned/
 
   
Average
   
Income/
   
Rates
 
   
Balance
   
Expense
   
Paid
 
   
(In thousands)
 
Assets:
                 
Money market assets and funds sold
  $ 440     $ -       - %
Investment securities:
                       
  Available for sale
                       
    Taxable
    451,994       5,379       2.38 %
    Tax-exempt (1)
    270,490       8,455       6.25 %
  Held to maturity
                       
    Taxable
    131,087       2,601       3.97 %
    Tax-exempt (1)
    465,156       14,498       6.23 %
Loans:
                       
  Commercial:
                       
    Taxable
    471,256       15,084       6.45 %
    Tax-exempt (1)
    151,648       4,936       6.56 %
  Commercial real estate
    1,236,921       39,945       6.51 %
  Real estate construction
    71,197       1,717       4.86 %
  Real estate residential
    323,296       6,527       4.04 %
  Consumer
    581,191       16,144       5.60 %
    Total loans (1)
    2,835,509       84,353       6.00 %
    Total earning assets (1)
    4,154,676     $ 115,286       5.59 %
Other assets
    779,711                  
    Total assets
  $ 4,934,387                  
                         
Liabilities and shareholders' equity
                       
Deposits:
                       
  Noninterest bearing demand
  $ 1,464,925     $ -       - %
  Savings and interest-bearing transaction
    1,804,475       1,318       0.15 %
  Time less than $100,000
    326,159       1,040       0.64 %
  Time $100,000 or more
    545,729       1,309       0.48 %
     Total interest-bearing deposits
    2,676,363       3,667       0.28 %
Short-term borrowed funds
    106,991       109       0.20 %
Federal Home Loan Bank advances
    52,983       279       1.05 %
Debt financing and notes payable
    26,161       401       3.06 %
    Total interest-bearing liabilities
    2,862,498     $ 4,456       0.31 %
Other liabilities
    61,543                  
Shareholders' equity
    545,421                  
    Total liabilities and shareholders' equity
  $ 4,934,387                  
Net interest spread (1) (2)
                    5.28 %
Net interest income and interest margin (1) (3)
          $ 110,830       5.37 %
 
(1) Interest and rates calculated on a fully taxable equivalent basis using the current statutory federal tax rate.
(2) Net interest spread represents the average yield earned on earning assets minus the average rate paid on interest-bearing liabilities.
(3) Net interest margin is computed by calculating the difference between interest income and expense (annualized), divided by the average balance of earning assets.

 
- 37 -

 

   
For the six months ended
 
   
June 30, 2010
 
         
Interest
   
Rates
 
   
Average
   
Income/
   
Earned/
 
   
Balance
   
Expense
   
Paid
 
   
(In thousands)
 
Assets:
                 
Money market assets and funds sold
  $ 672     $ 1       0.30 %
Investment securities:
                       
  Available for sale
                       
    Taxable
    256,874       4,307       3.35 %
    Tax-exempt (1)
    162,846       5,404       6.64 %
  Held to maturity
                       
    Taxable
    196,350       4,321       4.40 %
    Tax-exempt (1)
    495,260       15,541       6.28 %
Loans:
                       
  Commercial:
                       
    Taxable
    550,923       17,127       6.27 %
    Tax-exempt (1)
    171,588       5,612       6.60 %
  Commercial real estate
    1,231,354       40,534       6.64 %
  Real estate construction
    62,459       1,769       5.71 %
  Real estate residential
    367,523       8,360       4.55 %
  Consumer
    576,525       17,305       6.05 %
    Total loans (1)
    2,960,372       90,707       6.18 %
    Total earning assets (1)
    4,072,374     $ 120,281       5.94 %
Other assets
    699,498                  
 
                       
    Total assets
  $ 4,771,872                  
                         
Liabilities and shareholders' equity
                       
Deposits:
                       
  Noninterest bearing demand
  $ 1,382,036     $ -       - %
  Savings and interest-bearing
                       
    transaction
    1,624,137       1,833       0.23 %
  Time less than $100,000
    370,611       1,066       0.58 %
  Time $100,000 or more
    548,537       1,769       0.65 %
     Total interest-bearing deposits
    2,543,285       4,668       0.37 %
Short-term borrowed funds
    212,898       1,028       0.96 %
Federal Home Loan Bank advances
    17,397       136       1.56 %
Debt financing and notes payable
    26,467       847       6.40 %
    Total interest-bearing liabilities
    2,800,047     $ 6,679       0.48 %
Other liabilities
    76,993                  
Shareholders' equity
    512,796                  
                         
    Total liabilities and shareholders' equity
  $ 4,771,872                  
                         
Net interest spread (1) (2)
                    5.46 %
                         
Net interest income and interest margin (1) (3)
          $ 113,602       5.61 %
 
(1) Interest and rates calculated on a fully taxable equivalent basis using the current statutory federal tax rate.
(2) Net interest spread represents the average yield earned on earning assets minus the average rate paid on interest-bearing liabilities.
(3) Net interest margin is computed by calculating the difference between interest income and expense (annualized), divided by the average balance of earning assets.
 
 
- 38 -

 
Summary of Changes in Interest Income and Expense due to Changes in Average Asset & Liability Balances and Yields Earned & Rates Paid

The following tables set forth a summary of the changes in interest income and interest expense due to changes in average asset and liability balances (volume) and changes in average interest rates for the periods indicated. Changes not solely attributable to volume or rates have been allocated in proportion to the respective volume and rate components.

   
Three months ended June 30, 2011
 
   
compared with
 
   
Three months ended June 30, 2010
 
   
Volume
   
Rate
   
Total
 
   
(In thousands)
 
Interest and fee income:
                 
Money market assets and funds sold
  $ -     $ -     $ -  
Investment securities:
                       
  Available for sale
                       
    Taxable
    1,340       (582 )     758  
    Tax-exempt (1)
    1,611       (169 )     1,442  
  Held to maturity
                       
    Taxable
    (468 )     (266 )     (734 )
    Tax-exempt (1)
    (166 )     (65 )     (231 )
Loans:
                       
  Commercial:
                       
    Taxable
    (1,442 )     550       (892 )
    Tax-exempt (1)
    (347 )     (165 )     (512 )
  Commercial real estate
    (34 )     (189 )     (223 )
  Real estate construction
    130       (202 )     (72 )
  Real estate residential
    (418 )     (427 )     (845 )
  Consumer
    258       (677 )     (419 )
    Total loans (1)
    (1,853 )     (1,110 )     (2,963 )
    Total increase (decrease) in interest and fee income (1)
    464       (2,192 )     (1,728 )
                         
Interest expense:
                       
Deposits:
                       
  Savings and interest-bearing
                       
    transaction
    97       (327 )     (230 )
  Time less than $100,000
    (45 )     144       99  
  Time $100,000 or more
    3       (275 )     (272 )
     Total interest-bearing deposits
    55       (458 )     (403 )
Short-term borrowed funds
    (170 )     (274 )     (444 )
Federal Home Loan Bank advances
    111       (35 )     76  
Debt financing and notes payable
    (7 )     (214 )     (221 )
   Total decrease in interest expense
    (11 )     (981 )     (992 )
Increase (decrease) in Net Interest Income (1)
  $ 475     $ (1,211 )   $ (736 )
 
(1) Amounts calculated on a fully taxable equivalent basis using the current statutory federal tax rate.
 
 
- 39 -

 
 
   
Six months ended June 30, 2011
 
   
compared with
 
   
Six months ended June 30, 2010
 
   
Volume
   
Rate
   
Total
 
   
(In thousands)
 
Interest and fee income:
                 
Money market assets and funds sold
  $ -     $ (1 )   $ (1 )
Investment securities:
                       
  Available for sale
                       
    Taxable
    2,570       (1,498 )     1,072  
    Tax-exempt (1)
    3,377       (326 )     3,051  
  Held to maturity
                       
    Taxable
    (1,327 )     (393 )     (1,720 )
    Tax-exempt (1)
    (939 )     (104 )     (1,043 )
Loans:
                       
  Commercial:
                       
    Taxable
    (2,538 )     495       (2,043 )
    Tax-exempt (1)
    (649 )     (27 )     (676 )
  Commercial real estate
    183       (772 )     (589 )
  Real estate construction
    230       (282 )     (52 )
  Real estate residential
    (948 )     (885 )     (1,833 )
  Consumer
    139       (1,300 )     (1,161 )
    Total loans (1)
    (3,583 )     (2,771 )     (6,354 )
Total increase (decrease) in interest and fee income (1)
    98       (5,093 )     (4,995 )
                         
Interest expense:
                       
Deposits:
                       
  Savings and interest-bearing
                       
    transaction
    186       (701 )     (515 )
  Time less than $100,000
    (135 )     109       (26 )
  Time $100,000 or more
    (9 )     (451 )     (460 )
     Total interest-bearing deposits
    42       (1,043 )     (1,001 )
Short-term borrowed funds
    (355 )     (564 )     (919 )
Federal Home Loan Bank advances
    576       (433 )     143  
Debt financing and notes payable
    (10 )     (436 )     (446 )
   Total increase (decrease) in interest expense
    253       (2,476 )     (2,223 )
Decrease in Net Interest Income (1)
  $ (155 )   $ (2,617 )   $ (2,772 )
 
(1) Amounts calculated on a fully taxable equivalent basis using the current statutory federal tax rate.

Provision for Loan Losses

The Company manages credit costs by consistently enforcing conservative underwriting and administration procedures and aggressively pursuing collection efforts with troubled debtors. The Company recorded the purchased County loans at estimated fair value upon acquisition as of February 6, 2009. Further, County loans purchased from the FDIC are “covered” by loss-sharing agreements the Company entered with the FDIC. Due to the loss-sharing agreements and fair value recognition, the Company did not record a provision for loan losses during the first six months of 2011 related to such loans covered by the FDIC loss-sharing agreements. The Company recorded purchased Sonoma loans at estimated fair value upon acquisition as of August 20, 2010. Due to the fair value recognition, the Company did not record a provision for loan losses during the first six months of 2011 related to purchased Sonoma loans. In Management’s judgment, the acquisition date loan fair value discounts remaining at June 30, 2011 represent appropriate loss estimates for default risk inherent in the purchased loans. The Company provided $2.8 million and $5.6 million for loan losses related to originated loans in the first quarter and first half of 2011, respectively, unchanged from comparable periods in 2010. The provision reflects Management's assessment of credit risk in the originated loan portfolio for each of the periods presented. For further information regarding credit risk, the FDIC loss-sharing agreements, net credit losses and the allowance for loan losses, see Note 5 and the “Loan Portfolio Credit Risk” and “Allowance for Credit Losses” sections of this report.
 
 
- 40 -

 
Noninterest Income

The following table summarizes the components of noninterest income for the periods indicated.
 
   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
 
 
2011
   
2010
   
2011
   
2010
 
 
 
(In thousands)
 
                         
Service charges on deposit accounts
  $ 7,577     $ 8,629     $ 15,098     $ 17,371  
Merchant processing services
    2,391       2,176       4,562       4,397  
Debit card
    1,283       1,245       2,484       2,419  
ATM processing fees
    997       1,021       1,932       1,912  
Other service fees
    721       600       1,411       1,235  
Trust fees
    482       448       975       829  
Check sale income
    212       224       432       454  
Safe deposit rental
    168       164       337       326  
Financial services commissions
    117       223       146       372  
Other
    1,344       1,040       2,658       1,925  
  Total
  $ 15,292     $ 15,770     $ 30,035     $ 31,240  
 
Noninterest income for the second quarter of 2011 declined by $478 thousand or 3.0% from the same period in 2010. Service charges on deposits decreased $1.1 million or 12.2% primarily due to declines in fees charged on overdrawn and insufficient funds accounts (down $929 thousand) and deficit fees charged on analyzed accounts (down $114 thousand). New regulations over overdraft fees were adopted July 1, 2010 and limited the Bank’s ability to assess overdraft fees. Financial services commissions decreased $106 thousand. Other categories of noninterest income contributed to partially offset the decrease. Merchant processing services income increased $215 thousand mainly due to increased transaction volumes. Other noninterest income rose $304 thousand mostly due to ACH service fee income and an increase in letters of credit fee income.

In the first half of 2011, noninterest income decreased $1.2 million or 3.9% compared with the first half of 2010. Service charges on deposits decreased $2.3 million or 13.1% due to declines in fees charged on overdrawn and insufficient funds accounts (down $1.9 million) and deficit fees charged on analyzed accounts (down $346 thousand). Financial services commissions decreased $226 thousand due to the transition to a new provider for sales of mutual funds and annuities. Other categories of noninterest income contributed to partially offset the decrease. Merchant processing services income increased $165 thousand mainly due to higher transaction volumes. Other noninterest income increased $733 thousand primarily due to increases in income from recoveries of charged-off purchased loans and ACH service fee income.





 
 
- 41 -

 
Noninterest Expense

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

   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
(In thousands)
 
                         
Salaries and related benefits
  $ 14,913     $ 15,476     $ 29,988     $ 31,368  
Occupancy
    4,050       3,822       8,075       7,599  
Outsourced data processing services
    2,122       2,202       4,578       4,442  
Settlements
    2,100       -       2,100       23  
Amortization of identifiable intangibles
    1,480       1,540       3,028       3,138  
Professional fees
    1,453       867       2,303       1,530  
Equipment
    1,038       1,116       1,971       2,167  
OREO expense
    990       314       1,135       464  
Courier service
    852       903       1,695       1,810  
FDIC insurance assessments
    740       1,260       1,960       2,580  
Loan expense
    544       475       938       893  
Telephone
    428       406       863       795  
Postage
    363       454       731       929  
Operational losses
    341       158       589       378  
Stationery and supplies
    323       330       646       680  
In-house meetings
    178       184       361       359  
Customer checks
    167       162       343       333  
Advertising and public relations
    161       266       332       476  
Correspondent service charges
    32       136       62       238  
Other noninterest expense
    2,034       2,024       3,934       3,924  
Total
  $ 34,309     $ 32,095     $ 65,632     $ 64,126  
                                 
Average full time equivalent staff
    987       1,018       994       1,025  
Noninterest expense to revenues (FTE)
    48.23 %     44.37 %     46.59 %     44.27 %
 
Noninterest expense increased $2.2 million or 6.9% in the second quarter 2011 compared with the same period in 2010 primarily due to the $2.1 million in litigation settlement accruals. OREO expenses were $676 thousand higher in the three months ended June 30, 2011 due to payment of delinquent property taxes on real estate repossessed during the period and recognition of declines in value based on recent appraisals. Professional fees increased $586 thousand due to legal fees related to nonperforming assets and general corporate matters. Occupancy expense increased $228 thousand primarily due to a $256 thousand increase in rental of bank premises net of sublease income. Operational losses increased $183 thousand due to increased branch robberies and fraudulent deposit account and debit card activity. Other categories of noninterest expense contributed to offset the increase. Salaries and related benefits decreased $563 thousand primarily due to a reduction in salaries attributable to fewer employees, decreases in incentives and other benefits partially offset by higher group health insurance costs and annual merit increases in salaries. FDIC insurance assessments declined $520 thousand due to new assessment rules effective April 1, 2011. Advertising and public relations expense decreased $105 thousand due to cost control.

Noninterest expense increased $1.5 million or 2.3% in the first half of 2011 compared with the same period in 2010 primarily due to the $2.1 million in litigation settlement accruals. The first half of 2011 results also included $679 thousand related to pre-integration costs for the acquired Sonoma, primarily outsourced data processing and personnel costs. Sonoma operations were fully integrated in February 2011. Professional fees increased $773 thousand due to legal fees related to nonperforming assets and general corporate matters. OREO expenses were $671 thousand higher in the six months ended June 30, 2011 due to payment of delinquent property taxes on real estate repossessed during the period and recognition of declines in value based on recent appraisals. Occupancy expense increased $476 thousand primarily due to a $533 thousand increase in rental of bank premises net of sublease income. Outsourced data processing services expense increased $136 thousand mainly due to merger deconversion costs for Sonoma operations. Other categories of noninterest expense contributed to offset the increase. Salaries and related benefits decreased $1.4 million primarily due to a reduction in regular salaries attributable to fewer employees, decreases in incentives, bonuses and other benefits partially offset by SVB pre-integration costs, higher

 
- 42 -

 
payroll taxes, higher group health insurance costs and annual merit increases in salaries. FDIC insurance assessments declined $620 thousand due to new assessment rules effective April 1, 2011 and a decline in the assessment base. Postage decreased $198 thousand. Equipment expense declined $196 thousand primarily due to lower repairs and maintenance expenses. Advertising/public relations expense decreased $144 thousand due to cost control. Courier service expense declined $115 thousand. Amortization of identifiable intangible assets declined $110 thousand as intangible assets are amortized on a declining balance method.

Provision for Income Tax

During the second quarter of 2011, the Company recorded income tax expense (FTE) of $12.8 million compared with $13.9 million for the second quarter of 2010. The current quarter provision represents an effective tax rate (FTE) of 37.5%, compared with 37.1% for the second quarter of 2010.

The income tax provision (FTE) was $26.0 million for the first six months of 2011 compared with $28.0 million for the corresponding period of 2010. The first half of 2011 effective tax rate was 37.3% compared to 37.2% for the same period of 2010.
 
Loan Portfolio Credit Risk

The risk that loan customers do not repay loans granted by the Bank is the most significant risk to the Company. The Company closely monitors the markets in which it conducts its lending operations and follows a strategy to control exposure to loans with high credit risk. The Bank’s organization structure separates the functions of business development and loan underwriting; Management believes this segregation of duties avoids inherent conflicts of combining business development and loan approval. In measuring and managing credit risk, the Company adheres to the following practices.

·  
The Bank maintains a Loan Review Department which reports directly to the Board of Directors. The Loan Review Department performs independent evaluations of loans and assigns credit risk grades to evaluated loans using grading standards employed by bank regulatory agencies. Those loans judged to carry higher risk attributes are referred to as “classified loans.” Classified loans receive elevated management attention to maximize collection.
 
·  
The Bank maintains two loan administration offices whose sole responsibility is to manage and collect classified loans.
 
Classified loans with higher levels of credit risk are further designated as “nonaccrual loans.” Management places loans on nonaccrual status when full collection of contractual interest and principal payments is in doubt. Interest previously accrued on loans placed on nonaccrual status is charged against interest income, net of estimated FDIC reimbursements under loss- sharing agreements. The Company does not accrue interest income on nonaccrual loans. Interest payments received on nonaccrual loans are applied to reduce the carrying amount of the loan unless the carrying amount is well secured by loan collateral or covered by FDIC loss-sharing agreements. “Nonperforming assets” include nonaccrual loans, loans 90 or more days past due and still accruing, and repossessed loan collateral.

On February 6, 2009, the Bank purchased loans and repossessed loan collateral of the former County Bank from the FDIC. This purchase transaction included loss-sharing agreements with the FDIC wherein the FDIC and the Bank share losses on the purchased assets. The loss-sharing agreements significantly reduce the credit risk of these purchased assets. In evaluating credit risk, Management separates the Bank’s total loan portfolio between those loans qualifying under the FDIC loss-sharing agreements (referred to as “purchased covered loans”) and loans not qualifying under the FDIC loss-sharing agreements (referred to as “purchased non-covered loans” and “originated loans”). At June 30, 2011, purchased covered loans totaled $623 million, or 23 percent of total loans, originated loans totaled $2.0 billion, or 71 percent of total loans and purchased non-covered loans totaled $165 million, or 6 percent of total loans.

The amount of gross interest income that would have been recorded if all nonaccrual purchased covered loans had been current in accordance with their original terms while outstanding was $608 thousand and $1.3 million in the second quarter and first half of 2011, respectively, compared with $1.1 million and $2.4 million for the second quarter and first half of 2010, respectively. The amount of interest income that was recognized on nonaccrual purchased covered loans from all cash payments made during the three and six months ended June 30, 2011, totaled $1.4 million and $1.9 million, respectively, compared with $1.5 million and $3.0 million for the second quarter and first half of 2010, respectively. There were no cash payments received that were applied against the book balance of  nonaccrual purchased covered loans outstanding at June 30,

 
- 43 -

 
2011 in the second quarter and first half of 2011. Similarly, there were no cash payments received that were applied against the book balance of  nonaccrual purchased covered loans outstanding at June 30, 2010 in the second quarter and first half of 2010.
 
The amount of gross interest income that would have been recorded if all nonaccrual purchased non-covered loans had been current in accordance with their original terms while outstanding was $639 thousand and $1.3 million in the second quarter and first half of 2011, respectively. The amount of interest income that was recognized on nonaccrual purchased non-covered loans from cash payments made in the second quarter and first half of 2011 was $374 thousand and $659 thousand for the second and first half of 2011, respectively. There were no cash payments received that were applied against the book balance of nonaccrual purchased non-covered loans outstanding at June 30, 2011 in the second quarter and first half of 2011.

The amount of gross interest income that would have been recorded if all nonaccrual originated loans had been current in accordance with their original terms while outstanding was $341 thousand and $651 thousand in the second quarter and first half of 2011, respectively, compared with $315 thousand and $613 thousand for the second quarter and first half of 2010, respectively. The amount of interest income that was recognized on nonaccrual originated loans from all cash payments made during the three and six months ended June 30, 2011, totaled $297 thousand and $361 thousand, respectively, compared with $301 thousand and $432 thousand, respectively, for the second quarter and first half of 2010, respectively. There were no cash payments received that were applied against the book balance of nonaccrual originated loans outstanding at June 30, 2011 in the second quarter and first half of 2011. Similarly, there were no cash payments received that were applied against the book balance of nonaccrual originated loans outstanding at June 30, 2010 in the second quarter and first half of 2010.

The Company had one restructured construction loan of $3.2 million as of June 30, 2011 which was on nonaccrual status. The Company had no restructured loans as of December 31, 2010. Management believes the overall credit quality of the loan portfolio is reasonably stable; however, nonperforming assets could fluctuate from period to period. The performance of any individual loan can be affected by external factors such as the interest rate environment, economic conditions, and collateral values or factors particular to the borrower. No assurance can be given that additional increases in nonaccrual and delinquent loans will not occur in the future.

Purchased Covered Loans and Repossessed Loan Collateral (Purchased Covered Assets)

Purchased covered loans and repossessed loan collateral qualify under loss-sharing agreements with the FDIC. Under the terms of the loss-sharing agreements, the FDIC absorbs 80 percent of losses and shares in 80 percent of loss recoveries on the first $269 million in losses on purchased covered assets (“First Tier”), and absorbs 95 percent of losses and shares in 95 percent of loss recoveries if losses on purchased covered assets exceed $269 million (“Second Tier”). The term of the loss-sharing agreement on residential real estate assets is ten years, while the term for loss-sharing on non-residential real estate assets is five years with respect to losses and eight years with respect to loss recoveries.

The purchased covered assets are primarily located in the California Central Valley, including Merced County. This geographic area currently has some of the weakest economic conditions within California and has experienced significant declines in real estate values. Management expects higher loss rates on purchased covered assets than on originated assets.

The Bank recorded purchased covered assets at estimated fair value on the February 6, 2009 acquisition date. The credit risk discount ascribed to the $1.2 billion acquired loan and repossessed loan collateral portfolio was $161 million representing estimated losses inherent in the assets at the acquisition date. The Bank also recorded a related receivable from the FDIC in the amount of $129 million representing estimated FDIC reimbursements under the loss-sharing agreements.

The maximum risk to future earnings if First Tier losses exceed Management’s estimated $161 million in recognized losses under the FDIC loss-sharing agreements follows (dollars in thousands):
 
First Tier Loss Coverage
  $ 269,000  
Less: Recognized credit risk discount
    161,203  
Exposure to under-estimated risk within First Tier
    107,797  
Bank loss-sharing percentage
 
20 percent
 
First Tier risk to Bank, pre-tax
  $ 21,559  
First Tier risk to Bank, after-tax
  $ 12,494  

Management has judged the likelihood of experiencing losses of a magnitude to trigger Second Tier FDIC reimbursement as remote. The Bank’s maximum after-tax exposure to Second Tier losses is $16 million as of June 30, 2011, which would be realized only if all covered assets at June 30, 2011 generated no future cash flows.

 
- 44 -

 
Purchased covered assets have declined since the acquisition date, and losses have been offset against the estimated credit risk discount. Purchased covered assets totaled $647 million at June 30, 2011, net of a credit risk discount of $56 million, compared to $715 million at December 31, 2010, net of a credit risk discount of $62 million. Purchased covered assets are evaluated for risk classification without regard to FDIC indemnification such that Management can identify purchased covered assets with potential payment problems and devote appropriate credit administration practices to maximize collections. Purchased covered assets classified without regard to FDIC indemnification totaled $192 million and $195 million at June 30, 2011 and December 31, 2010, respectively. FDIC indemnification limits the Company’s loss exposure to covered classified assets.
 
Allowance for Credit Losses

The Company’s allowance for credit losses represents Management’s estimate of credit losses inherent in the loan portfolio. In evaluating credit risk for loans, Management measures loss potential of the carrying value of loans. As described above, payments on nonaccrual loans may be applied against the principal balance of the loans until such time as full collection of the remaining recorded balance is expected. Further, the carrying value of purchased loans includes fair value discounts assigned at the time of purchase under the provisions of FASB ASC 805, Business Combinations, and FASB ASC 310-30, Loans or Debt Securities with Deteriorated Credit Quality. Management determined the credit default fair value discounts assigned to purchased loans remained adequate as an estimate of credit losses inherent in purchased loans as of June 30, 2011. The allowance for credit losses represents Management’s estimate of credit losses in excess of these principal reductions.

The Company's allowance for credit losses is maintained at a level considered appropriate to provide for losses that can be estimated based upon specific and general conditions. These include conditions unique to individual borrowers, as well as overall credit loss experience, the amount of past due, nonperforming loans and classified loans, FDIC loss-sharing indemnification, recommendations of regulatory authorities, prevailing economic conditions and other factors. A portion of the allowance is specifically allocated to impaired loans whose full collectibility is uncertain. Such allocations are determined by Management based on loan-by-loan analyses. A second allocation is based in part on quantitative analyses of historical credit loss experience, in which criticized and classified credit balances identified through an independent internal credit review process are analyzed using a linear regression model to determine standard loss rates. The results of this analysis are applied to current criticized and classified loan balances to allocate the allowance to the respective segments of the loan portfolio. In addition, loans with similar characteristics not usually criticized using regulatory guidelines are analyzed based on the historical loss rates and delinquency trends, grouped by the number of days the payments on these loans are delinquent. Given currently weak economic conditions, Management is applying further analysis to consumer loans. Current levels of indirect automobile loan losses are compared to initial allowance allocations and, based on Management judgment, additional allocations are applied, if needed, to estimate losses. For residential real estate loans, Management is comparing ultimate loss rates on foreclosed residential real estate properties and applying such loss rates to nonaccrual residential real estate loans. Based on this analysis, Management exercises judgment in allocating additional allowance if deemed appropriate to estimate losses on residential real estate loans. Last, allocations are made to non-criticized and non-classified commercial and commercial real estate loans based on historical loss rates and other statistical data.

The remainder of the allowance is considered to be unallocated. The unallocated allowance is established to provide for probable losses that have been incurred as of the reporting date but not reflected in the allocated allowance. It addresses additional qualitative factors consistent with Management's analysis of the level of risks inherent in the loan portfolio, which are related to the risks of the Company's general lending activity. Included in the unallocated allowance is the risk of losses that are attributable to national or local economic or industry trends which have occurred but have not yet been recognized in  loan charge-off history (external factors). The external factors evaluated by the Company include: economic and business conditions, external competitive issues, and other factors. Also included in the unallocated allowance is the risk of losses attributable to general attributes of the Company's loan portfolio and credit administration (internal factors). The internal factors evaluated by the Company include: loan review system, adequacy of lending Management and staff, loan policies and procedures, problem loan trends, concentrations of credit, and other factors. By their nature, these risks are not readily allocable to any specific loan category in a statistically meaningful manner and are difficult to quantify with a specific number. Management assigns a range of estimated risk to the qualitative risk factors described above based on Management's judgment as to the level of risk, and assigns a quantitative risk factor from the range of loss estimates to determine the appropriate level of the unallocated portion of the allowance. Management considers the $35.7 million allowance for credit losses to be adequate as a reserve against credit losses inherent in the loan portfolio as of June 30, 2011.

 
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The following table presents the allocation of the allowance for credit losses:

   
At June 30,
   
At December 31,
 
   
2011
   
2010
 
   
(In thousands)
 
         
Originated Loans
         
Originated Loans
 
   
Allocation of the
   
as Percent of Total
   
Allocation of the
   
as Percent of Total
 
   
Allowance Balance
   
Originated Loans
   
Allowance Balance
   
Originated Loans
 
Commercial
  $ 8,501       22 %   $ 9,878       23 %
Commercial real estate
    10,274       38 %     9,607       38 %
Real estate construction
    4,064       1 %     3,559       1 %
Real estate residential
    466       15 %     617       15 %
Consumer
    3,669       24 %     6,982       23 %
Unallocated portion
    8,727       --       7,686       --  
Total
  $ 35,701       100 %   $ 38,329       100 %
 
The allocation to loan portfolio segments changed from December 31, 2010 to June 30, 2011. The decrease in allocation for originated commercial loans was substantially attributable to a decrease in classified originated loans. The increase in allocation for originated commercial real estate loans was substantially attributable to increases in classified originated loans and impaired originated loans. The increase in allocation to originated real estate construction loans was substantially attributable to increases in classified originated loans and impaired originated loans. The decrease in allocation to originated consumer loans was substantially attributable to Management’s judgment regarding the appropriate allocation based on anticipated levels of originated consumer loan chargeoffs and delinquency trends. The unallocated portion of the allowance for credit losses increased $1.0 million from December 31, 2010 to June 30, 2011.

The unallocated allowance is established to provide for probable losses that have been incurred, but not reflected in the allocated allowance. At June 30, 2011 and December 31, 2010, Management's evaluations of the unallocated portion of the allowance for credit losses attributed significant risk levels to developing economic and business conditions ($1.7 million and $1.2 million, respectively), external competitive issues ($0.7 million and $0.6 million, respectively), internal credit administration considerations ($1.5 million and $1.2 million, respectively), and delinquency and problem loan trends ($2.6 million and $2.5 million, respectively). The change in the amounts allocated to the above qualitative risk factors was based upon Management's judgment, review of trends in its originated loan portfolio, extent of migration of previously non-criticized originated loans to criticized status, levels of the allowance allocated to portfolio segments, and current economic conditions in its marketplace. Based on Management's analysis and judgment, the amount of the unallocated portion of the allowance for credit losses was $8.7 million at June 30, 2011, compared to $7.7 million at December 31, 2010.
 
Asset/Liability and Market Risk Management

Asset/liability management involves the evaluation, monitoring and management of interest rate risk, market risk, liquidity and funding. The fundamental objective of the Company's management of assets and liabilities is to maximize its economic value while maintaining adequate liquidity and a conservative level of interest rate risk.

Interest Rate Risk

Interest rate risk is a significant market risk affecting the Company. Interest rate risk results from many factors. Assets and liabilities may mature or reprice at different times. Assets and liabilities may reprice at the same time but by different amounts. Short-term and long-term market interest rates may change by different amounts. The timing and amount of cash flows of various assets or liabilities may shorten or lengthen as interest rates change. In addition, interest rates may have an impact on loan demand, demand for various deposit products, credit losses, and other elements of earnings such as account analysis fees on commercial deposit accounts and correspondent bank service charges.

In adjusting the Company's asset/liability position, Management attempts to manage interest rate risk while enhancing the net interest margin and net interest income. At times, depending on expected increases or decreases in general interest rates, the relationship between long and short term interest rates, market conditions and competitive factors, Management may adjust the Company's interest rate risk position in order to manage its net interest margin and net interest income. The Company's results of operations and net portfolio values remain subject to changes in interest rates and to fluctuations in the difference between long and short term interest rates.

 
- 46 -

 
The Company’s asset and liability position ranged from “neutral” to slightly “asset sensitive” at June 30, 2011, depending on the interest rate assumptions applied to the simulation model employed by Management to measure interest rate risk. A “neutral” position results in similar amounts of change in interest income and interest expense resulting from application of assumed interest rate changes. A slightly “asset sensitive” position results in a slightly larger increase in interest income than in interest expense resulting from application of assumed interest rate changes. Management’s simulation modeling is currently biased toward rising interest rates. Management continues to monitor the interest rate environment as well as economic conditions and other factors it deems relevant in managing the Company's exposure to interest rate risk.

Management assesses interest rate risk by comparing the Company's most likely earnings plan with various earnings models using many interest rate scenarios that differ in the direction of interest rate changes, the degree of change over time, the speed of change and the projected shape of the yield curve. For example, using the current composition of the Company's balance sheet and assuming no change in the federal funds rate and no change in the 10 year Constant Maturity Treasury Bond yield during the same period, earnings are not estimated to change by a meaningful amount compared to the Company's most likely net income plan for the twelve months ending June 30, 2012. Using the current composition of the Company's balance sheet and assuming an increase of 100 basis points (“bp”) in the federal funds rate and an increase of 60 bp in the 10 year Constant Maturity Treasury Bond yield during the same period, earnings are not estimated to change by a meaningful amount compared to the Company's most likely net income plan for the twelve months ending June 30, 2012. Simulation estimates depend on, and will change with, the size and mix of the actual and projected balance sheet at the time of each simulation. In the current operating environment, Management’s objective is to maintain a “neutral” to slightly “asset sensitive” interest rate risk position. The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk, even though such activities may be permitted with the approval of the Company's Board of Directors.
 
Market Risk - Equity Markets

Equity price risk can affect the Company. As an example, any preferred or common stock holdings, as permitted by banking regulations, can fluctuate in value. Management regularly assesses the extent and duration of any declines in market value, the causes of such declines, the likelihood of a recovery in market value, and its intent to hold securities until a recovery in value occurs. Declines in value of preferred or common stock holdings that are deemed “other than temporary” could result in loss recognition in the Company's income statement.

Fluctuations in the Company's common stock price can impact the Company's financial results in several ways. First, the Company has regularly repurchased and retired its common stock; the market price paid to retire the Company's common stock can affect the level of the Company's shareholders' equity, cash flows and shares outstanding for purposes of computing earnings per share. Second, the Company's common stock price impacts the number of dilutive equivalent shares used to compute diluted earnings per share. Third, fluctuations in the Company's common stock price can motivate holders of options to purchase Company common stock through the exercise of such options thereby increasing the number of shares outstanding. Finally, the amount of compensation expense associated with share based compensation fluctuates with changes in and the volatility of the Company's common stock price.

Market Risk - Other

Market values of loan collateral can directly impact the level of loan charge-offs and the provision for loan losses. Other types of market risk, such as foreign currency exchange risk and commodity price risk, are not significant in the normal course of the Company's business activities.
 
Liquidity and Funding

The Company's routine sources of liquidity are operating earnings, investment securities, consumer and other loans, deposits, and other borrowed funds. During the first half of 2011, the Company’s operating activities generated $61.8 million in liquidity providing most of the funds to pay common shareholders $20.9 million in dividends, fund $31.7 million in stock repurchases and reduce short-term borrowings by $15.7 million. During the first half of 2010, operating cash flows provided $38.0 million. The Company paid $21.1 million in common shareholder dividends and used $17.2 million to repurchase and retire common stock.

During the first half of 2011, investment securities provided $164.8 million in liquidity from paydowns and maturities, and loans provided $146.4 million in liquidity from scheduled payments and maturities, net of loan fundings. First half of 2011 liquidity provided most of the funds to purchase securities of $294.9 million and to meet a net reduction in deposits totaling

 
- 47 -

 
$43.8 million. During the first half of 2010, investment securities provided $147.0 million in liquidity from paydowns and maturities to purchase securities of $149.5 million, and loans provided $145.4 million in liquidity from scheduled payments and maturities, net of loan fundings. First half of 2010 liquidity provided funds to meet a net reduction in deposits totaling $168.1 million and a reduction in short-term borrowed funds, primarily FHLB advances which declined $75.2 million. During the first half of 2011, other sources of cash from investing activities include proceeds of $5.3 million under FDIC loss-sharing agreements compared with $29.8 million in the first half of 2010.
 
The Company projects $44.5 million in additional liquidity from investment security paydowns and maturities during the three months ending September 30, 2011. At June 30, 2011, $327.4 million in residential collateralized mortgage obligations (“CMOs”) and residential mortgage backed securities (“MBSs”) were held in the Company's investment portfolios. None of the CMOs or MBSs are backed by sub-prime mortgages. The residential CMOs and MBSs provided $20.7 million in liquidity from paydowns during the three months ended June 30, 2011. At June 30, 2011, indirect automobile loans totaled $417.1 million, which were experiencing stable monthly principal payments of approximately $16.3 million during the second quarter of 2011.

The Company held $1.4 billion in total investment securities at June 30, 2011. Under certain deposit, borrowing and other arrangements, the Company must hold and pledge investment securities as collateral. At June 30, 2011, such collateral requirements totaled approximately $880.6 million. At June 30, 2011, $705.1 million of the Company's investment securities were classified as “available-for-sale”, and as such, could provide additional liquidity if sold, subject to the Company's ability to meet continuing collateral requirements.

In addition, at June 30, 2011, the Company had customary lines for overnight borrowings from other financial institutions in excess of $700 million, under none was outstanding. Additionally, the Company has access to borrowing from the Federal Reserve. The Company's short-term debt rating from Fitch Ratings is F1. The Company's long-term debt rating from Fitch Ratings is A with a stable outlook. Management expects the Company could access additional long-term debt financing if desired. In Management's judgment, the Company's liquidity position is strong and asset liquidations or additional long-term debt are considered unnecessary to meet the ongoing liquidity needs of the Company.

The Company’s short-term borrowed funds primarily represent customer depository funds transferred to borrowings under repurchase agreements the Bank enters with its customers who desire additional yield. Such repurchase agreements are collateralized with the Bank’s investment securities. Fluctuations in the balance of short-term borrowings is affected by Bank customers’ liquidity levels, rates offered by the Bank on repurchase agreements relative to competitive financial instruments, and other factors. Short-term borrowed funds averaged $107 million during the six months ended June 30, 2011.

The Company anticipates maintaining its cash levels in the remainder of 2011. Loan demand from credit-worthy borrowers  will be dictated by economic and competitive conditions in the remainder of 2011. The Company aggressively solicits non-interest bearing demand deposits and money market checking deposits, which are the least sensitive to changes in interest rates. The growth of deposit balances is subject to heightened competition, the success of the Company's sales efforts, delivery of superior customer service, new regulations and market conditions. Changes in interest rates, most notably rising interest rates, could impact deposit volumes in the future. Depending on economic conditions, interest rate levels, and a variety of other conditions, deposit growth may be used to fund loans, to reduce borrowings or purchase investment securities. However, due to concerns such as uncertainty in the general economic environment, competition and political uncertainty, loan demand and levels of customer deposits are not certain. Shareholder dividends are expected to continue subject to the Board's discretion and continuing evaluation of capital levels, earnings, asset quality and other factors.

Westamerica Bancorporation ("Parent Company") is a separate entity and apart from Westamerica Bank (“Bank”) and must provide for its own liquidity. In addition to its operating expenses, the Parent Company is responsible for the payment of dividends declared for its shareholders, and interest and principal on outstanding debt. Substantially all of the Parent Company's revenues are obtained from subsidiary dividends and service fees. Payment of dividends to the Parent Company by the Bank is limited under California law. The amount that can be paid in any calendar year, without prior approval from the state regulatory agency, cannot exceed the net profits (as defined) for the preceding three calendar years less distributions in that period. The Company believes that such restriction will not have an impact on the Parent Company's ability to meet its ongoing cash obligations.

Capital Resources

The Company has historically generated high levels of earnings, which provides a means of raising capital. The Company's net income as a percentage of average common equity (“return on common equity” or “ROE”) was 16.1% (annualized) in the first half of 2011, 18.1% in 2010 and 25.8% in 2009. The Company also raises capital as employees exercise stock options, which are awarded as a part of the Company's executive compensation programs to reinforce shareholders' interests in the

 
- 48 -

 
Management of the Company. Capital raised through the exercise of stock options totaled $3.3 million in the first half of 2011, $16.7 million in 2010 and $9.6 million in 2009.
 
The Company paid dividends totaling $20.9 million in the first half of 2011, $42.1 million in 2010 and $41.1 million in 2009, which represent dividends per share of $0.72, $1.44 and $1.41, respectively. The Company's earnings have historically exceeded dividends paid to shareholders. The amount of earnings in excess of dividends gives the Company resources to finance growth and maintain appropriate levels of shareholders' equity. In the absence of profitable growth opportunities, the Company has repurchased and retired its common stock as another means to return capital to shareholders. The Company repurchased and retired 640 thousand shares of common stock valued at $31.7 million in the first half of 2011, 533 thousand shares valued at $28.7 million in 2010 and 42 thousand shares valued at $2.0 million in 2009. Share repurchases were restricted to amounts conducted in coordination with employee benefit programs under the terms of the February 13, 2009 issuance of preferred stock to the Treasury; such restrictions were removed with full redemption of the preferred stock in November 2009.

The Company's primary capital resource is shareholders' equity, which increased $4.1 million or 0.7% during the first half of 2011 primarily due to $43.7 million in net income, $3.3 million in issuance of stock in connection with exercises of employee stock options and an $8.1 million increase in unrealized gains on securities available for sale, offset by $20.9 million in dividends paid and $31.7 million in stock repurchases.

Capital to Risk-Adjusted Assets

The following summarizes the regulatory ratios of capital to risk-adjusted assets for the Company on the dates indicated:

                     
Minimum
   
Well-capitalized
 
   
At June 30,
   
At December 31,
   
Regulatory
   
by Regulatory
 
   
2011
   
2010
   
2010
   
Requirement
   
Definition
 
                               
Tier I Capital
    14.58 %     14.42 %     14.21 %     4.00 %     6.00 %
Total Capital
    15.88 %     15.72 %     15.50 %     8.00 %     10.00 %
Leverage ratio
    8.57 %     8.53 %     8.44 %     4.00 %     5.00 %

The Company’s regulatory capital ratios declined from June 30, 2010 to December 31, 2010 as the Bank utilized excess capital to finance the acquisition of Sonoma assets on August 20, 2010. The Company’s regulatory capital ratios increased from December 31, 2010 to June 30, 2011 due to a decline in risk-weighted assets. As described in Note 10, the Company intends to retire a $10 million subordinated note in August 2011. Such debt qualifies as regulatory capital. Management intends to use cash earnings to retire the debt. FDIC-covered assets are included in the 20% risk-weight category until the loss-sharing agreements terminate; the residential loss-sharing agreement expires February 6, 2019 and the non-residential loss-sharing agreement expires (as to losses) February 6, 2014.

The following summarizes the regulatory ratios of capital to risk-adjusted assets for the Bank on the dates indicated:

                     
Minimum
   
Well-capitalized
 
   
At June 30,
   
At December 31,
   
Regulatory
   
by Regulatory
 
   
2011
   
2010
   
2010
   
Requirement
   
Definition
 
                               
Tier I Capital
    14.23 %     13.90 %     13.87 %     4.00 %     6.00 %
Total Capital
    15.75 %     15.38 %     15.33 %     8.00 %     10.00 %
Leverage ratio
    8.32 %     8.17 %     8.19 %     4.00 %     5.00 %

The Bank’s regulatory capital ratios remained steady from June 30, 2010 to December 31, 2010; the Bank retained its earnings from the third quarter 2010, rather than paying a dividend to the Company, and utilized the increased capital to finance the acquisition of Sonoma assets on August 20, 2010. The Bank’s regulatory capital ratios increased from December 31, 2010 to June 30, 2011 due to a decline in risk-weighted assets.

The Company and the Bank intend to maintain regulatory capital in excess of the highest regulatory standard, referred to as “well capitalized.” The Company and the Bank routinely project capital levels by analyzing forecasted earnings, credit quality, securities valuations, shareholder dividends, asset volumes, share repurchase activity, stock option exercise proceeds, and other factors. Based on current capital projections, the Company and the Bank expect to maintain regulatory capital

 
- 49 -

 
levels exceeding the “well capitalized” standard and pay quarterly dividends to shareholders. No assurance can be given that changes in capital management plans will not occur.
 
Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk, even though such activities may be undertaken with the approval of the Company's Board of Directors. Interest rate risk as discussed above is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange risk, equity price risk and commodity price risk, are not significant in the normal course of the Company's business activities.

Item 4. Controls and Procedures

The Company's principal executive officer and principal financial officer have evaluated the effectiveness of the Company's “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended, as of June 30, 2011. Based upon their evaluation, the principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission’s rules and forms and are effective in ensuring that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to Management, including the chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. The evaluation did not identify any change in the Company's internal control over financial reporting that occurred during the quarter ended June 30, 2011 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
 
PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Due to the nature of its business, the Company is subject to various threatened or filed legal cases resulting from loan collection efforts, transaction processing for deposit accounts including the order of posting transactions and the assessment of overdraft fees, and employment practices. Like many banks, the Bank is a defendant in a lawsuit alleging it improperly assessed  overdraft fees on deposit accounts due to the order in which it processed payments against such deposit accounts. The Bank has reached a preliminary mediated settlement of this matter which is subject to court approval. The Company establishes a liability for contingent litigation losses for any legal matter when payments associated with the claims become probable and the costs can be reasonably estimated. The Bank has accrued a liability for the preliminary mediated settlement. Legal costs related to covered assets are eighty percent indemnified under loss-sharing agreements with the FDIC if certain conditions are met.

Item 1A. Risk Factors

The Company’s Form 10-K as of December 31, 2010 includes detailed disclosure about the risks faced by the Company’s business; such risks have not materially changed since the Form 10-K was filed, except as described below:

Japanese Disaster

During the first quarter 2011, Japan experienced a devastating earthquake and resultant tsunami. The tsunami reached the California coastline, but caused limited damage. The Company’s loan customers are generally small businesses and professionals whose business activities are primarily located in Northern and Central California. These customers in the aggregate have some, but not a significant amount of reliance on trade with Asian countries. Management does not expect any significant impact on the Company’s financial results due to this disaster. However, additional shocks could occur, including, but not limited to harmful radiation from the damaged nuclear power plants. Further, economic imbalances are likely to exist such as heightened demand for non-nuclear sources of energy for Japan, supply chain disruptions affecting international manufacturing processes, food shortages, demand for liquidity, and other possible repercussions. These imbalances could affect asset values such as, but not limited to, investment securities, energy and commodities. Significant changes in assets values could impact the financial condition of the Company.

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

(a) Previously reported on Form 8-K.
(b) None
(c) Issuer Purchases of Equity Securities

The table below sets forth the information with respect to purchases made by or on behalf of the Company or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of common stock during the quarter ended June 30, 2011.
 
Period
(a)
Total Number of
Shares Purchased
(b)
Average Price
Paid per Share
(c)
Total Number
of Shares
Purchased as Part of
Publicly Announced
Plans or Programs*
(d)
Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans
or Programs
(In thousands, except per share data)
 
       
April 1
through
April 30
71
$50.27
71
1,557
May 1
through
May 31
128
49.80
128
1,429
June 1
through
June 30
202
48.07
202
1,227
Total
401
$49.01
401
1,227
 
* Includes 4 thousand, 5 thousand and 8 thousand shares purchased in April, May and June, respectively, by the Company in private transactions with the independent administrator of the Company's Tax Deferred Savings/Retirement Plan (ESOP). The Company includes the shares purchased in such transactions within the total number of shares authorized for purchase pursuant to the currently existing publicly announced program.

The Company repurchases shares of its common stock in the open market to optimize the Company’s use of equity capital and enhance shareholder value and with the intention of lessening the dilutive impact of issuing new shares to meet stock performance, option plans, and other ongoing requirements.

Shares were repurchased during the second quarter of 2011 pursuant to a program approved by the Board of Directors on August 26, 2010, authorizing the purchase of up to 2 million shares of the Company’s common stock from time to time prior to September 1, 2011.

Item 3. Defaults upon Senior Securities

None

Item 4. Reserved

Item 5. Other Information

In light of the vote of shareholders on the issue at the 2011 annual meeting, on July 28, 2011, the Company’s Board of Directors adopted a resolution to include an annual non-binding shareholder vote regarding compensation for named executive officers in the Company’s annual proxy.

Item 6. Exhibits

The exhibit list required by this item is incorporated by reference to the Exhibit Index filed with this report.
 
 
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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

WESTAMERICA BANCORPORATION
(Registrant)



/s/ JOHN "ROBERT" THORSON
John "Robert" Thorson
Senior Vice President and Chief Financial Officer
(Chief Financial and Accounting Officer)

Date: August 2, 2011

 
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EXHIBIT INDEX

Exhibit 31.1:  Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a)

Exhibit 31.2:  Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a)

Exhibit 32.1: Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit 32.2:  Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



 
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