Plumas Bancorp - 10-Q quarterly report FY

 

 

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s Telephone Number, Including Area Code (530) 283-7305

Indicated 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 þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule12b-2 of the Exchange Act (check one):

Large Accelerated Filer o      Accelerated Filer þ      Non-Accelerated Filer o

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of November 5, 2007; 4,919,963 shares

 

PLUMAS BANCORP
CONDENSED CONSOLIDATED BALANCE SHEET
(Unaudited)
(In thousands, except share data)

See notes to unaudited condensed consolidated financial statements.

PLUMAS BANCORP
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(Unaudited)
(In thousands, except per share data)

See notes to unaudited condensed consolidated financial statements.

PLUMAS BANCORP
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(In thousands)

Continued on next page.

PLUMAS BANCORP
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(In thousands)
(Continued)

See notes to unaudited condensed consolidated financial statements.

During 2002, Plumas Bancorp (the “Company”) was incorporated as a bank holding company for the purpose of acquiring Plumas Bank (the “Bank”) in a one bank holding company reorganization. This corporate structure gives the Company and the Bank greater flexibility in terms of operation expansion and diversification. The Company formed Plumas Statutory Trust I for the sole purpose of issuing trust preferred securities on September 26, 2002. The Company formed Plumas Statutory Trust II for the sole purpose of issuing trust preferred securities on September 28, 2005.

The Bank is a California state-chartered bank that was incorporated in July 1980 and opened for business in December 1980. The Bank operates thirteen branches in California, including branches in Alturas, Chester, Fall River Mills, Greenville, Kings Beach, Loyalton, Portola, Quincy, Redding, Susanville, Tahoe City, Truckee and Westwood. The bank also has commercial lending offices in Auburn, California and Reno, Nevada. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (FDIC) up to applicable legal limits. The Bank’s primary source of revenue is generated from providing loans to customers who are predominately small and middle market businesses and individuals residing in the surrounding areas.

The condensed consolidated financial statements include the accounts of the Company and the accounts of its wholly-owned subsidiary, Plumas Bank. Plumas Statutory Trust I and Plumas Statutory Trust II are not consolidated into the Company’s consolidated financial statements and, accordingly, are accounted for under the equity method. In the opinion of management, the unaudited condensed consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the Company’s financial position at September 30, 2007 and December 31, 2006 and its results of operations for the three-month and nine-month periods ended September 30, 2007 and 2006 and its cash flows for the nine-month periods ended September 30, 2007 and 2006. Certain reclassifications have been made to prior period’s balances to conform to classifications used in 2007.

The unaudited condensed consolidated financial statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim reporting on Form 10-Q. Accordingly, certain disclosures normally presented in the notes to the annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. The Company believes that the disclosures are adequate to make the information not misleading. These interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2006 Annual Report to Shareholders on Form 10-K. The results of operations for the three-month and nine-month periods ended September 30, 2007 and 2006 may not necessarily be indicative of future operating results. In preparing such financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the periods reported. Actual results could differ significantly from those estimates.

Management has determined that because all of the commercial banking products and services offered by the Company are available in each branch of the Bank, all branches are located within the same economic environment and management does not allocate resources based on the performance of different lending or transaction activities, it is appropriate to aggregate the Bank branches and report them as a single operating segment. No single customer accounts for more than 10% of the revenues of the Company or the Bank.

Outstanding loans are summarized below, in thousands:

The Company is party to claims and legal proceedings arising in the ordinary course of business. In the opinion of the Company’s management, the amount of ultimate liability with respect to such proceedings will not have a material adverse effect on the financial condition or result of operations of the Company taken as a whole.

In the normal course of business, there are various outstanding commitments to extend credit which are not reflected in the financial statements, including loan commitments of $92,652,000 and $101,759,000 and stand-by letters of credit of $403,000 and $564,000 at September 30, 2007 and December 31, 2006, respectively.

Of the loan commitments outstanding at September 30, 2007, $25,563,000 are real estate construction loan commitments that are expected to fund within the next twelve months. The remaining commitments primarily relate to revolving lines of credit or other commercial loans, and many of these are expected to expire without being drawn upon. Therefore, the total commitments do not necessarily represent future cash requirements. Each loan commitment and the amount and type of collateral obtained, if any, are evaluated on an individual basis. Collateral held varies, but may include real property, bank deposits, debt or equity securities or business assets.

Stand-by letters of credit are conditional commitments written to guarantee the performance of a customer to a third party. These guarantees are primarily related to the purchases of inventory by commercial customers and are typically short-term in nature. Credit risk is similar to that involved in extending loan commitments to customers and accordingly, evaluation and collateral requirements similar to those for loan commitments are used. The deferred liability related to the Company’s stand-by letters of credit was not significant at September 30, 2007 or December 31, 2006.

Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as stock options, result in the issuance of common stock which shares in the earnings of the Company. The treasury stock method has been applied to determine the dilutive effect of stock options in computing diluted earnings per share.

Stock options not included in the computation of diluted earnings per share, due to their antidilutive effect, were 276,000 and 10,000 for the three months ended September 30, 2007 and 2006, respectively and 186,000 and 10,000 for the nine months ended September 30, 2007 and 2006, respectively.

Total comprehensive income for the three months ended September 30, 2007 and 2006 totaled $1,558,000 and $1,977,000, respectively. Comprehensive income is comprised of unrealized gains, net of taxes, on available-for-sale investment securities, which were $280,000 and $581,000 for the three months ended September 30, 2007 and 2006, respectively, together with net income.

Total comprehensive income for the nine months ended September 30, 2007 and 2006 totaled $3,727,000 and $4,108,000, respectively. Comprehensive income is comprised of unrealized gains, net of taxes, on available-for-sale investment securities, which were $367,000 and $227,000 for the nine months ended September 30, 2007 and 2006, respectively, together with net income.

At September 30, 2007 and December 31, 2006, accumulated other comprehensive loss, net of taxes, totaled $325,000 and $692,000, respectively, and is reflected as a component of shareholders’ equity.

In 2001 and 1991, the Company established Stock Option Plans for which 894,860 shares of common stock remain reserved for issuance to employees and directors and 490,030 shares are available for future grants under incentive and nonstatutory agreements as of September 30, 2007. The Company granted 155,700 and 7,500 options during the nine months ended September 30, 2007 and 2006 respectively. The weighted average grant date fair value of options granted for the nine months ended September 30, 2007 and 2006 was $4.53 and $4.56 respectively. Compensation cost related to stock options recognized in operating results under SFAS No. 123R was $78,000 and $43,000 for the quarters ended September 30, 2007 and 2006, respectively. The associated future income tax benefit recognized was $7,000 and $4,000 for the quarters ended September 30, 2007 and 2006, respectively. Compensation cost related to stock options recognized in operating results under SFAS No. 123R was $209,000 and $130,000 in the nine months ended September 30, 2007 and 2006, respectively. The associated future income tax benefit recognized was $19,000 and $15,000 for the nine months ended September 30, 2007 and 2006, respectively.

The following table summarizes information about stock option activity for the nine months ended September 30, 2007:

The total intrinsic value of options (which is the amount by which the stock price exceeded the exercise price of the options on the date of exercise) exercised during the nine months ended September 30, 2007 was $84,000. During the nine months ended September 30, 2007, the amount of cash received from the exercise of stock options was $41,000.

At September 30, 2007, there was $729,000 of total unrecognized compensation cost related to non-vested stock option awards which is expected to be recognized over a weighted-average period of 3.0 years. The total fair value of options vested during the nine months ended September 30, 2007 was $12,000.

In July 2006, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standards Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 also prescribes a recognition threshold and measurement standard for the financial statement recognition and measurement of an income tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. The Company adopted FIN 48 on January 1, 2007.

The Company previously recognized income tax positions based on management’s estimate of whether it is reasonably possible that a liability has been incurred for unrecognized income tax benefits by applying FASB Statement No. 5, Accounting for Contingencies.

The provisions of FIN 48 have been applied to all tax positions of the Company as of January 1, 2007. There was no cumulative effect of applying the provisions of FIN 48 and there was no significant effect on the Company’s provision for income taxes for the nine months ended September 30, 2007. The Company recognizes interest accrued related to unrecognized tax benefits and accruals for penalties in income tax expense.

In February 2007, the FASB issued Statement No. 159 (SFAS 159), The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115. This standard permits an entity to choose to measure many financial instruments and certain other items at fair value at specified election dates. The entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option: (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments. The provisions of SFAS 159 are effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Management did not elect to early adopt SFAS 159 and has not yet completed its evaluation of the impact that SFAS 159 will have.

On October 17, 2007, the Company declared a common stock cash dividend of $0.15 per share. The dividend will be payable on November 16, 2007 to its shareholders of record on November 2, 2007.

Certain matters discussed in this Quarterly Report are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Such risks and uncertainties include, among others, (1) significant increases in competitive pressures in the financial services industry; (2) changes in the interest rate environment resulting in reduced margins; (3) general economic conditions, either nationally or regionally, maybe less favorable than expected, resulting in, among other things, a deterioration in credit quality; (4) changes in regulatory environment; (5) loss of key personnel; (6) fluctuations in the real estate market; (7) changes in business conditions and inflation; (8) operational risks including data processing systems failures or fraud; and (9) changes in securities markets. Therefore, the information set forth herein should be carefully considered when evaluating the business prospects of Plumas Bancorp.

When the Company uses in this Quarterly Report the words “anticipate”, “estimate”, “expect”, “project”, “intend”, “commit”, “believe” and similar expressions, the Company intends to identify forward-looking statements. Such statements are not guarantees of performance and are subject to certain risks, uncertainties and assumptions, including those described in this Quarterly Report. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended, committed or believed. The future results and stockholder values of the Company may differ materially from those expressed in these forward-looking statements. Many of the factors that will determine these results and values are beyond the Company’s ability to control or predict. For those statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

The following discussion and analysis sets forth certain statistical information relating to Plumas Bancorp (the “Company”) as of September 30, 2007 and December 31, 2006 and for the three and nine month periods ended September 30, 2007 and 2006. This discussion should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and the consolidated financial statements and notes thereto included in Plumas Bancorp’s Annual Report filed on Form 10-K for the year ended December 31, 2006.

Plumas Bancorp trades on The NASDAQ Capital Market under the ticker symbol “PLBC”.

On October 17, 2007, the Company declared a semi-annual common stock cash dividend of $0.15 per share. The dividend is payable on November 16, 2007 to its shareholders of record on November 2, 2007.

There have been no changes to the Company’s critical accounting policies from those disclosed in the Company’s 2006 Annual Report to Shareholders’ on Form 10-K.

This discussion should be read in conjunction with our unaudited condensed consolidated financial statements, including the notes thereto, appearing elsewhere in this report.

The Company’s net income declined by $521 thousand, or 13%, to $3.36 million for the nine months ended September 30, 2007 from $3.88 million for the same period in 2006. This decline in net income resulted from an increase in non-interest expense of $1.1 million and a decline in net interest income of $300 thousand which were partially offset by an increase in non-interest income of $142 thousand and decreases in the provision for loan losses of $400 thousand and the provision for income taxes of $337 thousand. The increase in non-interest expense included an increase of $776 thousand in salaries and employee benefit expense and $272 thousand in occupancy and equipment costs.

Total assets declined $3.5 million from $473.2 million at December 31, 2006 to $469.7 million at September 30, 2007. Net loans declined by $2.7 million from $352.0 million at December 31, 2006 to $349.3 million at September 30, 2007. A decline of $12.5 million in investment securities and an increase of $14.6 million in deposits provided funding to repay short-term borrowings which declined by $20 million with the excess funds invested in federal funds sold which increased by $8.0 million. Total shareholders’ equity increased by $1.8 million from $35.8 million at December 31, 2006 to $37.6 million at September 30, 2007.

The annualized return on average assets was 0.96% for the nine months ended September 30, 2007 down from 1.11% for the same period in 2006. The annualized return on average equity was 12.2% for the nine months ended September 30, 2007 down from 15.7% for the same period in 2006.

Net interest income before provision for loan losses. Net interest income, on a nontax-equivalent basis, was $16.4 million for the nine months ended September 30, 2007, a decrease of $300 thousand, or 2%, from $16.7 million for the same period in 2006. The decrease in net interest income was primarily attributed to increases in both the rates paid and average balances of the Company’s time certificates of deposit and an increase in the average balance of short-term borrowings. This increase in interest expense was mostly offset by an increase in interest income related to an increase in average loans outstanding and an increase in the yield on those loans.

Interest income increased $1.1 million, or 5%, to $22.8 million for the nine months ended September 30, 2007. Interest and fees on loans increased by $1.7 million from $19.2 million for the nine months ended September 30, 2006 to $20.9 million during the current nine month period. The Company’s average loan balances were $354 million for the nine months ended September 30, 2007, up $24 million, or 7%, from the $330 million during the same period in 2006. The average rate earned on the Company’s loan balances increased 11 basis points to 7.89% during the first nine months of 2007 versus 7.78% during the first nine months of 2006. The increase in yield reflects the continued effect of the Company’s decision to decrease the level of auto dealer loans which generally yield significantly less than other loans in the Company’s loan portfolio.

Interest on investment securities decreased by $527 thousand, as an increase in yield of 19 basis points was offset by a decline in average investment securities of $23.2 million. Interest earned on federal funds sold declined by $67 thousand. Average federal funds sold were $2.4 million for the nine months ended September 30, 2007, a decline of $2.3 million from $4.7 million outstanding during the same period in 2006. This decline in average balance was partially offset by an increase in yield from 4.51% during the nine months ended September 30, 2006 to 5.10% during the current nine month period.

Interest expense increased $1.4 million to $6.5 million for the nine months ended September 30, 2007, up from $5.1 million for the same period in 2006. This increase includes $1.4 million in interest on time deposits and a $357 thousand increase in interest expense on short-term borrowings. The Company has experienced increases in the average balance of its time deposits but declines in non-interest bearing demand deposit accounts, NOW, savings and money market accounts. We continue to experience significant competition for deposits from both banking and non-banking sources. Rather than increasing the rate paid on our lower yielding interest bearing transaction and money market accounts to attract deposits and thereby increasing the rate paid on the entire balance of these accounts, the Company has chosen to fund loan growth through increases in its level of short-term time deposits and to a lesser extent through short-term borrowings. This has resulted in an increase in both the volume and rate components of time deposit interest expense and the volume variance of short-term borrowings.

Average NOW account balances decreased by $2.2 million and the average rate paid decreased by 2 basis points. Included in average NOW accounts are Money Fund Plu$ balances. Money Fund Plu$ is a high interest bearing checking account designed to pay rates comparable to those available on a typical brokerage account. Average Money Fund Plu$ accounts were $41.2 million for the nine months ended September 30, 2007 compared to $38.9 million during the first nine months of 2006. The average rate paid on Money Fund Plu$ accounts declined from 3.54% during the 2006 period to 3.23% during the nine months ended September 30, 2007. The effect of the decrease in the average rate paid on Money Fund Plu$ balances on the average rate paid on NOW accounts was offset by an increase in Money Fund Plu$ account balances as a percentage of total NOW account balances.

The increase in the average rate paid on time deposits and the decrease in lower rate deposit sources as a percentage of total interest-bearing deposits has resulted in an increase in the average rate paid on the Company’s interest bearing deposits of 49 basis points from 1.99% for the nine months ended September 30, 2006 to 2.48% for the current nine month period. The average rate paid on time deposits increased 88 basis points from 3.44% during the nine months ended September 30, 2006 to 4.32% during the current nine month period. This increase includes an increase in market rates in the Company’s service area and the effect of a promotional certificate of deposit program introduced during the fourth quarter of 2006. The average rate paid on promotional certificate of deposits during the nine months ended September 30, 2007 was 5.12% and the average balance was $39 million. This product provides a higher rate of return for our more interest rate sensitive customers, whose deposits we may have lost to competition, while providing a highly competitive rate to attract new deposits.

Interest expense on money market and savings accounts declined by $397 thousand related to both a decline in the average rate paid on these accounts and a decline in the average balance. Interest on short-term borrowings increased primarily as a result of an increase in average borrowings. Interest expense paid on junior subordinated debentures fluctuates with changes in the 3-month London Interbank Offered Rate (LIBOR) rate which increased during the comparison period resulting in an increase of $28 thousand on these borrowings.

As a result of the changes noted above, the net interest margin for the nine months ended September 30, 2007 decreased slightly by 8 basis points to 5.20%, from 5.28% for the same period in 2006.

The following table presents for the nine-month periods indicated the distribution of consolidated average assets, liabilities and shareholders’ equity. It also presents the amounts of interest income from interest-earning assets and the resultant annualized yields expressed in both dollars and annualized yield percentages, as well as the amounts of interest expense on interest-bearing liabilities and the resultant cost expressed in both dollars and annualized rate percentages. Average balances are based on daily averages. Nonaccrual loans are included in the calculation of average loans while nonaccrued interest thereon is excluded from the computation of yields earned:

The following table sets forth changes in interest income and interest expense for the nine-month periods indicated and the amount of change attributable to variances in volume, rates and the combination of volume and rates based on the relative changes of volume and rates:

Provision for loan losses. The Company recorded $500 thousand in provision for loan losses for the nine months ended September 30, 2007 and $900 thousand for the nine months ended September 30, 2006. Management assesses its loan quality monthly to maintain an adequate allowance for loan losses. Based on information currently available, management believes that the allowance for loan losses is adequate to absorb potential risks in the portfolio. However, no assurance can be given that the Company may not sustain charge-offs which are in excess of the allowance in any given period. The Company’s loan portfolio composition and non-performing assets are further discussed under the financial condition section below.

Non-interest income. During the nine months ended September 30, 2007, total non-interest income increased $142 thousand, or 4%, to $4.0 million, up from $3.9 million from the comparable period in 2006. This increase was primarily related to a $50 thousand increase in gains on sales of loans, a $49 thousand increase in investment services income and a $48 thousand increase in loan commissions and serving fees. Loan serving income was lower in the 2006 period related to an increase in the amortization of servicing assets and I/O strips receivable. Investment services income has benefited in 2007 from the hiring of an investment services manager, while the gain on sale of loans varies year to year based on the volume of loan sales. Gains on sales of loans have not been a significant source of non-interest income for the Company; however with the hiring of a full time government guaranteed lender in 2007 we anticipate that income from this source will increase in 2008.

The following table describes the components of non-interest income for the nine-month periods ending September 30, 2007 and 2006, dollars in thousands:

Non-interest expenses. During the nine months ended September 30, 2007, total non-interest expense increased $1.1 million, or 8%, to $14.4 million, up from $13.3 million for the comparable period in 2006. The increase in non-interest expense was primarily the result of increases in salaries and employee benefits, occupancy and equipment costs and outside service fees.

Salaries and employee benefits increased $776 thousand, or 11%, over the same nine-month period last year. Salaries costs increased by $575 thousand which included annual merit increases as well as additional employees primarily related to the Company’s Reno, Nevada commercial real estate loan office, its recently opened Redding, California branch, its expanded Truckee, California branch and administration staffing.

During the fourth quarter of 2006 the Company completed construction and opened a new Bank branch in Truckee, California. This replaced a much smaller leased facility. Also in the fourth quarter of 2006 we opened a commercial real estate loan office in Reno, Nevada. During the second quarter of 2007 we opened a new Bank branch in Redding, California in a temporary location. Of the total increase of $575 in salary expense, $321 thousand relates to the Reno and Redding offices or 56% of the increase.

Another significant component of the increase in salaries and employee benefits was a $422 thousand reduction in the deferral of loan origination costs. The largest component of this decrease was related to a reduction in the origination volume of consumer auto loans. From 2004 through most of 2006 the Company had been aggressive in seeking out dealer auto loans. Beginning in late 2006 and continuing into 2007 we began to deemphasize our auto lending activities. In April 2007 the head of the Company’s auto lending department resigned and shortly thereafter the Company discontinued its dealer-lending program.

Stock-based compensation expense, included in salary and employee benefits, increased by $75 thousand from $94 thousand during the nine months ended September 30, 2006 to $169 thousand during the current nine-month period.

These increases in salary and employee benefit expense were partially offset by a decrease in bonus expense of $387 thousand related primarily to a reduction in net income during the 2007 nine-month period. A large portion of the Company’s bonus plan is based on the level of net income and items directly influenced by the level of net income including return on average equity, return on average assets and earnings per share.

The increase of $272 thousand in occupancy and equipment includes an increase in operating expenses of $155 thousand related to the new Truckee branch, $36 thousand in costs at our new Reno lending office and costs of $41 thousand related to the new Redding branch. Outside services increased by $44 thousand primarily related to increases in ATM processing costs which were offset by an increase in ATM income.

The following table describes the components of non-interest expense for the nine-month periods ending September 30, 2007 and 2006, dollars in thousands:

Provision for income taxes. The provision for income taxes was $2.1 million, or 38.0% of income before provision for income taxes for the nine months ended September 30, 2007. This compares to $2.4 million or 38.1% of pre-tax income during the first nine months of 2006.

Net Income. Net income decreased by $118 thousand, or 8.5% from $1.4 million during the third quarter of 2006 to $1.3 million during the three months ended September 30, 2007. This decrease in net income included a $293 thousand decline in net interest income and a $181 thousand increase in non-interest expense, partially offset by decreases of $175 thousand in the provision for loan losses and $69 thousand in the provision for income taxes and an increase of $112 thousand in non-interest income.

Net interest income before provision for loan losses. Net interest income, on a nontax-equivalent basis, was $5.4 million for the three months ended September 30, 2007, a decrease of $293 thousand, or 5%, from $5.7 million for the same period in 2006. The decline in net interest income was primarily attributable to an increase in interest expense of $261 thousand attributable to both volume and rate increases in time deposits.

Interest income declined slightly by $32 thousand as an increase in interest and fees on loans and interest on federal funds sold was offset by a decline in interest on investment securities. Interest and fees on loans increased by $61 thousand from $6.8 million for the three months ended September 30, 2006 to $6.9 million during the 2007 third quarter. The Company’s average loan balances were $350 million for the three months ended September 30, 2007, up $6 million, or 2%, from the $344 million for the same period in 2006. The average yield earned on loans decreased by 6 basis points from 7.89% during the third quarter of 2006 to 7.83% during the 2007 quarter.

A 26 basis points increase in yield on investment securities was offset by a decrease of $22 million in the average balance outstanding resulting in a decrease of $162 thousand in interest earned on investment securities. Interest on federal funds sold increased by $69 thousand related to an increase in the average balance outstanding.

Interest expense increased $261 thousand, or 14%, to $2.1 million for the three months ended September 30, 2007, up from $1.9 million for the same period in 2006. This increase includes $584 thousand in interest on time deposits partially offset by declines in both the volume and rate components of interest expense on NOW, money market and savings deposits as the mix of deposits shifted from these accounts to time deposits.

The Company has experienced declines in lower rate deposit sources such as its non interest and interest-bearing transaction accounts, money market accounts, and savings accounts. To offset these declines the Company has increased the level of short-term time deposits.

The average rate paid on time deposits increased 80 basis points from 3.64% during the three months ended September 30, 2006 to 4.44% during the third quarter of 2007. Average time deposits outstanding increased from $91 million during the quarter ended September 30, 2006 to $126 million during the current quarter. The increase in time deposits outstanding as well as the increase in average rate paid on time deposits relates to the introduction of a promotional certificate of deposit program during the fourth quarter of 2006. The average rate paid on promotional certificate of deposits during the three months ended September 30, 2007 was 5.11% and the average balance during the three-month period was $55 million.

The average balance of short-term borrowings decreased from $5.1 million during the third quarter of 2006 to $2.3 million during the three months ended September 30, 2007. The average rate paid on these borrowings decreased by 24 basis points to 5.09% during the quarter ended September 30, 2007, down from 5.33% during the third quarter of 2006.

As a result of the changes noted above, the net interest margin for the three months ended September 30, 2007 decreased 14 basis points, or 3%, to 5.20%, from 5.34% for the same period in 2006.

The following table presents for the three-month periods indicated the distribution of consolidated average assets, liabilities and shareholders’ equity. It also presents the amounts of interest income from interest-earning assets and the resultant annualized yields expressed in both dollars and annualized yield percentages, as well as, the amounts of interest expense on interest-bearing liabilities and the resultant cost expressed in both dollars and annualized rate percentages. Average balances are based on daily averages. Nonaccrual loans are included in the calculation of average loans while nonaccrued interest thereon is excluded from the computation of yields earned:

The following table sets forth changes in interest income and interest expense for the three-month periods indicated and the amount of change attributable to variances in volume, rates and the combination of volume and rates based on the relative changes of volume and rates:

Provision for loan losses. The Company recorded $125 thousand in provision for loan losses for the three months ended September 30, 2007 and $300 thousand during the quarter ended September 30, 2006. Management assesses its loan quality monthly to maintain an adequate allowance for loan losses. The Company’s loan portfolio composition and non-performing assets are further discussed under the financial condition section below.

Non-interest income. During the three months ended September 30, 2007, total non-interest income increased by $112 thousand or 8.5%, to $1.4 million, up from $1.3 million from the comparable quarter in 2006. This increase resulted from a $64 thousand increase in service charges on deposit accounts and an increase of $53 thousand in loan commission and servicing fees. Loan commission and servicing fees were lower in the 2006 quarter related to an increase in the amortization of servicing assets and I/O strips receivable.

The following table describes the components of non-interest income for the three-month periods ending September 30, 2007 and 2006, dollars in thousands:

Non-interest expenses. Non-interest expense increased by $181 thousand from $4.5 million during the third quarter of 2006 to $4.7 million during the current quarter. Consistent with the nine month comparison the increase in non-interest expense relates primarily to increases in salaries and employee benefits and occupancy and equipment costs.

Salaries and employee benefits increased by $175 thousand to $2.7 million for the third quarter of 2007 compared to $2.5 million during the three months ended September 30, 2006. This increase included an increase in salary expense of $156 thousand, a reduction in the deferral of loan origination fees of $186 thousand and an increase in stock-based compensation expense of $33 thousand. These items were partially offset by a decrease in bonus expense of $225 thousand primarily related to the reduction in net income as discussed above.

Salary expense included $142 thousand in salaries related to the new Reno commercial real estate lending office and the new Redding branch. The deferral of loan origination costs is primarily related to a reduction in the volume of consumer auto loans. Stock based compensation expense, included in salaries and related benefits, increased by $33 thousand from $31 thousand during the three months ended September 30, 2006 to $64 thousand during the current three-month period.

The increase in occupancy and equipment primarily relates to our recently opened Redding branch, and an increase in costs at the Truckee branch.

The following table describes the components of non-interest expense for the three-month periods ending September 30, 2007 and 2006, dollars in thousands:

Provision for income taxes. The provision for income taxes was $789 thousand, or 38.2% of income before provision for income taxes for the three months ended September 30, 2007. This compares to $858 thousand or 38.1% of pre-tax income during the third quarter of 2006.

Loan portfolio. Net loans declined slightly from $352 million at December 31, 2006 to $349 million at September 30, 2007. The Company continues to manage the composition of its loan portfolio consistent with its identity as a community bank serving the financing needs of all sectors of the area it serves. Although the Company offers a broad array of financing options, it continues to concentrate its focus on small- to medium-sized commercial businesses. These commercial loans are diversified as to the industries and types of businesses, thus limiting material exposure from any one industry concentration. The Company offers both fixed and floating rate loans and obtains collateral in the form of real property, business assets and deposit accounts, but looks to business and personal cash flows as its primary source of repayment. The composition of the Company’s loan portfolio has remained relatively consistent from December 31, 2006. Real estate mortgage loans increased to 34% of total gross loans at September 30, 2007 from 33% at December 31, 2006. Agricultural loans increased to 11% of total gross loans at September 30, 2007 up from 10% at December 31, 2006. Consumer loans declined to 22% of total gross loans from 26% at December 31, 2006. Commercial and real estate construction loans were 10% and 23%, respectively of total gross loans at September 30, 2007, this compares to 10% and 21% respectively, at December 31, 2006.

The Company expects the level of consumer loans to continue to decline in the future. From 2004 through most of 2006 the Company had been aggressive in seeking out dealer auto loans. Beginning in late 2006 and continuing into 2007 we began to deemphasize our auto lending activities. In April 2007 the head of the Company’s auto lending department resigned. The Company will not replace this position and has discontinued its dealer loan program. It is our expectation that the payoffs from our auto loan portfolio can be utilized to provide funding for other higher yielding loans.

Nonperforming assets. Nonperforming loans at September 30, 2007 were $2.7 million, an increase of $1.7 million over the $1.0 million balance at December 31, 2006. Nonperforming assets (which is comprised of nonperforming loans plus repossessed vehicles and foreclosed real estate) at September 30, 2007 were $3.0 million, an increase of $1.9 million over the $1.1 million balance at December 31, 2006. The increase in nonperforming loans primarily relates to an increase of $1.6 million in nonaccrual loans. The increase in nonperforming assets includes the increase in nonperforming loans as well as foreclosed real estate of $182 thousand at September 30, 2007. There was no foreclosed real estate at December 31, 2006. In addition repossessed vehicles at September 30, 2007 totaled $69 thousand compared to $47 thousand at December 31, 2006.

Nonaccrual loans are predominately well secured and the Company does not anticipate any significant losses associated with its nonaccrual loans as of September 30, 2007.

Nonperforming loans as a percentage of total loans increased to 0.78% at September 30, 2007 up from 0.29% at December 31, 2006. In addition, nonperforming assets as a percentage of total assets increased to 0.64% at September 30, 2007 up from 0.22% at December 31, 2006.

Analysis of allowance for loan losses. Net charge-offs during the nine months ended September 30, 2007 totaled $290 thousand, or 0.08% of average loans, compared to $251 thousand, or 0.08% of average loans, for the comparable period in 2006. Net charge-offs during the first nine months of 2007 were comprised of $516 thousand of charge-offs offset by $226 thousand in recoveries, compared to $475 thousand of charge-offs offset by $224 thousand in recoveries for the same period in 2006. The allowance for loan losses was 1.17% of total loans as of September 30, 2007 up from 1.10% as of December 31, 2006. Based on an evaluation of the credit quality of the loan portfolio and delinquency trends and charge-offs, management believes the allowance for loan losses to be adequate. However, no prediction of the ultimate level of loans charged off in future years can be made with any certainty.

The following table provides certain information for the nine-month period indicated with respect to the Company’s allowance for loan losses as well as charge-off and recovery activity.