UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C.  20549 __________________  FORM 10-Q __________________  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  For the quarterly period ended September 30, 2010  Commission file number:  000-52098 __________________  CHINO COMMERCIAL BANCORP (Exact name of registrant as specified in its charter) __________________ California
     
     20-4797048State of incorporation
     
     I.R.S. EmployerIdentification Number14345 Pipeline AvenueChino, California
     
     91710Address of Principal Executive Offices
     
     Zip Code
 (909) 393-8880 Registrants telephone number, including area code __________________  Check whether the issuer (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.þYes ̈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 ̈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. Large accelerated filer ̈Accelerated filer ̈Non-accelerated filer ̈ Smaller Reporting Companyþ Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). ̈Yes þNo On October 31, 2010, there were 749,890 shares of Chino Commercial Bancorp Common Stock outstanding.


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TABLE OF CONTENTS   PagePart I  Financial Information..........................................................................................................
     3Item 1. Financial Statements .................................................................................................
     3Consolidated Balance Sheets.....................................................................................
     3Consolidated Statements of Income...........................................................................
     4Consolidated Statements of Changes in Stockholders Equity.......................................
     5Consolidated Statements of Cash Flows.....................................................................
     6Notes to the Consolidated Financial Statements..........................................................
     7Item 2. Managements Discussion & Analysis of Financial Condition & Results of Operations..
     16Item 3. Qualitative & Quantitative Disclosures about Market Risk...........................................
     35Item 4. Controls and Procedures............................................................................................
     35Part II  Other Information.............................................................................................................
     36Item 1.  Legal Proceedings..................................................................................................
     36Item 1A.  Risk Factors........................................................................................................
     36Item 2.  Unregistered Sale of Equity Securities and Use of Proceeds.....................................
     36Item 3.  Defaults upon Senior Securities...............................................................................
     37Item 4.  (Removed and Reserved).......................................................................................
     37Item 5.  Other Information..................................................................................................
     37Item 6.  Exhibits.................................................................................................................
     37Signatures.....................................................................................................................................
     38
      2


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PART 1  FINANCIAL INFORMATION Item 1  CHINO COMMERCIAL BANCORP CONSOLIDATED BALANCE SHEETS  September 30, 2010
     
     
     
     December 31, 2009(unaudited)
     
     
     
     (audited)ASSETS:Cash and due from banks
     $
     5,291,152
     
     
     $
     3,089,300Interest-bearing deposits in other banks
     
     20,235,252
     
     
     
     25,433,602Investment securities available for sale
     
     4,923,101
     
     
     
     5,567,855Investment securities held to maturity (fair value approximates$13,403,000 at September 30, 2010 and $2,332,000 at December 31, 2009)
     
     13,111,506
     
     
     
     2,291,962Total investments
     
     38,269,859
     
     
     
     33,293,419LoansReal estate
     
     49,945,608
     
     
     
     50,931,354Commercial
     
     8,732,513
     
     
     
     9,621,310Installment
     
     618,877
     
     
     
     855,564Gross loans
     
     59,296,998
     
     
     
     61,408,228Unearned fees and discounts
     
     (20,819
     )
     
     
     (17,887
     )Loans net of unearned fees and discount
     
     59,276,179
     
     
     
     61,390,341Allowance for loan losses
     
     (1,312,397
     )
     
     
     (1,277,526
     )Net loans
     
     57,963,782
     
     
     
     60,112,815Accrued interest receivable
     
     355,727
     
     
     
     326,206Restricted stock
     
     643,350
     
     
     
     677,650Fixed assets, net
     
     5,870,079
     
     
     
     3,100,183Other real estate owned
     
     1,035,255
     
     
     
     24,861Prepaid & other assets
     
     3,276,705
     
     
     
     2,956,242Total assets
     $
     112,705,909
     
     
     $
     103,580,676LIABILITIES:DepositsNon-interest bearing
     $
     41,939,034
     
     
     $
     35,872,495Interest BearingNOW and money market
     
     35,885,849
     
     
     
     31,148,654Savings
     
     1,336,972
     
     
     
     1,003,290Time deposits less than $100,000
     
     6,626,503
     
     
     
     6,722,558Time deposits of $100,000 or greater
     
     15,956,990
     
     
     
     17,541,461Total deposits
     
     101,745,348
     
     
     
     92,288,458Accrued interest payable
     
     106,557
     
     
     
     125,823Borrowings from Federal Home Loan Bank (FHLB)
     
     0
     
     
     
     994,000Accrued expenses & other payables
     
     752,597
     
     
     
     612,667Subordinated notes payable to subsidiary trust
     
     3,093,000
     
     
     
     3,093,000Total liabilities
     
     105,697,502
     
     
     
     97,113,948STOCKHOLDERS' EQUITYCommon stock, authorized 10,000,000 shares with no par value, issuedand outstanding 749,890 shares and 699,061 shares at September 30,2010 and December 31, 2009, respectively.
     
     2,771,322
     
     
     
     2,498,664Retained earnings
     
     4,134,426
     
     
     
     3,884,907Accumulated other comprehensive income
     
     102,659
     
     
     
     83,157Total stockholders' equity
     
     7,008,407
     
     
     
     6,466,728Total liabilities & stockholders' equity
     $
     112,705,909
     
     
     $
     103,580,676The accompanying notes are an integral part of these consolidated financial statements.
  3


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CHINO COMMERCIAL BANCORP CONSOLIDATED STATEMENTS OF INCOME  (unaudited) For the three months ended
     
     
     
     For the nine months endedSeptember 30
     
     
     
     September 302010
     
     
     
     2009
     
     
     
     2010
     
     
     
     2009Interest incomeInvestment securities and due from banks
     $
     218,940
     
     
     $
     181,370
     
     
     $
     619,330
     
     
     $
     602,975Interest on Federal funds sold
     
     0
     
     
     
     46
     
     
     
     0
     
     
     
     102Interest and fee income on loans
     
     1,056,071
     
     
     
     1,124,989
     
     
     
     3,171,514
     
     
     
     2,989,001Total interest income
     
     1,275,011
     
     
     
     1,306,405
     
     
     
     3,790,844
     
     
     
     3,592,078Interest expenseDeposits
     
     218,701
     
     
     
     239,369
     
     
     
     701,966
     
     
     
     705,764Other borrowings
     
     50,963
     
     
     
     51,062
     
     
     
     153,457
     
     
     
     153,707Total interest expense
     
     269,664
     
     
     
     290,431
     
     
     
     855,423
     
     
     
     859,471Net interest income
     
     1,005,347
     
     
     
     1,015,974
     
     
     
     2,935,421
     
     
     
     2,732,607Provision for loan losses
     
     15,644
     
     
     
     287,824
     
     
     
     529,996
     
     
     
     431,705Net interest income afterprovision for loan losses
     
     989,703
     
     
     
     728,150
     
     
     
     2,405,425
     
     
     
     2,300,902Non-interest incomeService charges on deposit accounts
     
     300,166
     
     
     
     247,719
     
     
     
     862,307
     
     
     
     704,556Other miscellaneous income
     
     104,394
     
     
     
     6,889
     
     
     
     119,218
     
     
     
     13,943Dividend income from restricted stock
     
     2,961
     
     
     
     3,791
     
     
     
     4,418
     
     
     
     6,606Income from bank-owned life insurance
     
     17,468
     
     
     
     16,923
     
     
     
     51,809
     
     
     
     50,378Total non-interest income
     
     424,989
     
     
     
     275,322
     
     
     
     1,037,752
     
     
     
     775,483General and administrative expensesSalaries and employee benefits
     
     543,501
     
     
     
     450,624
     
     
     
     1,637,951
     
     
     
     1,383,099Occupancy and equipment
     
     124,668
     
     
     
     86,239
     
     
     
     316,138
     
     
     
     242,522Data and item processing
     
     91,393
     
     
     
     77,134
     
     
     
     263,233
     
     
     
     218,900Advertising and marketing
     
     16,347
     
     
     
     15,777
     
     
     
     45,228
     
     
     
     49,569Legal and professional fees
     
     107,375
     
     
     
     47,714
     
     
     
     191,818
     
     
     
     137,900Regulatory assessments
     
     56,489
     
     
     
     48,947
     
     
     
     162,239
     
     
     
     167,670Insurance
     
     9,958
     
     
     
     8,096
     
     
     
     27,950
     
     
     
     23,540Directors' fees and expenses
     
     16,541
     
     
     
     18,963
     
     
     
     50,959
     
     
     
     54,621Other expenses
     
     139,018
     
     
     
     108,101
     
     
     
     383,817
     
     
     
     368,417Total general & administrative expenses
     
     1,105,290
     
     
     
     861,595
     
     
     
     3,079,333
     
     
     
     2,646,238Income before income tax expense
     
     309,402
     
     
     
     141,877
     
     
     
     363,844
     
     
     
     430,147Income tax expense
     
     115,361
     
     
     
     46,797
     
     
     
     114,325
     
     
     
     142,269Net income
     $
     194,041
     
     
     $
     95,080
     
     
     $
     249,519
     
     
     $
     287,878Basic earnings per share
     $
     0.26
     
     
     $
     0.14
     
     
     $
     0.35
     
     
     $
     0.41Diluted earnings per share
     $
     0.26
     
     
     $
     0.13
     
     
     $
     0.35
     
     
     $
     0.39The accompanying notes are an integral part of these consolidated financial statements.
  4


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CHINO COMMERICAL BANCORP CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY  AccumulatedOtherCompre-Number of
     
     
     
     Common
     
     
     
     Retained
     
     
     
     hensiveShares
     
     
     
     Stock
     
     
     
     Earnings
     
     
     
     Income
     
     
     
     TotalBalance at December 31, 2008 (audited)
     
     708,420
     
     
     $
     2,617,542
     
     
     $
     3,534,236
     
     
     $
     28,975
     
     
     $
     6,180,753Comprehensive income:Net income
     
     
     
     
     
     
     
     
     
     350,671
     
     
     
     
     
     
     
     350,671Change in unrealized gain in securitiesavailable for sale, net of tax
     
     
     
     
     
     
     
     
     
     
     
     
     
     54,182
     
     
     
     54,182Total comprehensive income
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     404,853Exercise of stock options, includingtax benefit
     
     7,426
     
     
     
     59,622
     
     
     
     
     
     
     
     
     
     
     
     59,622Stock repurchased and retired
     
     (16,785
     )
     
     
     (178,500
     )
     
     
     
     
     
     
     
     
     
     
     (178,500
     )Balance at December 31, 2009 (audited)
     
     699,061
     
     
     
     2,498,664
     
     
     
     3,884,907
     
     
     
     83,157
     
     
     
     6,466,728Comprehensive income:Net income
     
     
     
     
     
     
     
     
     
     249,519
     
     
     
     
     
     
     
     249,519Change in unrealized income onsecurities available for sale, net of tax
     
     
     
     
     
     
     
     
     
     
     
     
     
     19,502
     
     
     
     19,502Total comprehensive income
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     269,021Exercise of stock options, includingtax benefit
     
     82,541
     
     
     
     733,195
     
     
     
     
     
     
     
     
     
     
     
     733,195Stock repurchased and retired
     
     (31,712
     )
     
     
     (460,537
     )
     
     
     
     
     
     
     
     
     
     
     (460,537
     )Balance at September 30, 2010 (unaudited)
     
     749,890
     
     
     $
     2,771,322
     
     
     $
     4,134,426
     
     
     $
     102,659
     
     
     $
     7,008,407The accompanying notes are an integral part of these consolidated financial statements.
    5


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CHINO COMMERCIAL BANCORP CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) Nine Months Ended September 30,2010
     
     
     
     2009Cash Flows from Operating ActivitiesNet income
     $
     249,519
     
     
     $
     287,878Adjustments to reconcile net income to net cash providedby operating activities:Provision for loan losses
     
     529,996
     
     
     
     431,705Depreciation and amortization
     
     131,002
     
     
     
     113,777Net amortization of securities
     
     24,447
     
     
     
     11,583Amortization of deferred loan (fees) costs
     
     2,932
     
     
     
     (72,569
     )Loss on sale of other real estate owned
     
     29,551
     
     
     
     14,219Gain on sale of other foreclosed assets
     
     (127,839
     )
     
     
     0Deferred income tax expense (benefit)
     
     (41,896
     )
     
     
     9,269Net changes in:Accrued interest receivable
     
     (29,521
     )
     
     
     (14,351
     )Other assets
     
     (119,636
     )
     
     
     (411,368
     )Accrued interest payable
     
     (19,266
     )
     
     
     49,293Other liabilities
     
     139,931
     
     
     
     11,965Net cash provided by operating activities
     
     769,220
     
     
     
     431,401Cash Flows from Investing ActivitiesNet change in interest-bearing deposits in other banks
     
     5,198,350
     
     
     
     (4,413,602
     )Activity in available for sale investment securities:Purchases
     
     0
     
     
     
     (1,414,675
     )Repayments and calls
     
     660,156
     
     
     
     3,530,644Activity in held to maturity investment securities:Repayments and calls
     
     (10,825,896
     )
     
     
     667,775Purchase of stock investments, restricted
     
     34,300
     
     
     
     0Loans purchased
     
     0
     
     
     
     (10,509,072
     )Loan originations and principal collections, net
     
     551,150
     
     
     
     (1,910,830
     )Proceeds from sale of other real estate owned
     
     25,010
     
     
     
     439,984Proceeds from sale of other foreclosed assets
     
     127,839
     
     
     
     0Purchase of premises and equipment
     
     (2,900,898
     )
     
     
     (5,034
     )Net cash used by investing activities
     
     (7,129,989
     )
     
     
     (13,614,810
     )Cash Flows from Financing ActivitiesNet increase in deposits
     
     9,456,890
     
     
     
     22,704,137Net decrease in FHLB borrowings
     
     (994,000
     )
     
     
     (2,400,000
     )Proceeds from the exercise of stock options
     
     560,268
     
     
     
     51,981Payments for stock repurchases
     
     (460,537
     )
     
     
     (144,750
     )Net cash provided by financing activities
     
     8,562,621
     
     
     
     20,211,368Net increase in cash and cash equivalents
     
     2,201,852
     
     
     
     7,027,959Cash and Cash Equivalents at Beginning of Period
     
     3,089,300
     
     
     
     3,877,897Cash and Cash Equivalents at End of Period
     $
     5,291,152
     
     
     $
     10,905,856Supplemental InformationInterest paid
     $
     874,689
     
     
     $
     810,178Income taxes paid
     $
     129,000
     
     
     $
     133,000Loans transferred to other real estate owned
     $
     1,064,955
     
     
     $
     -The accompanying notes are an integral part of these consolidated financial statements.
   6


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CHINO COMMERCIAL BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2010  Note 1  The Business of Chino Commercial Bancorp  Chino Commercial Bancorp (the Company) is a California corporation registered as a bank holding company under the Bank Holding Company Act of 1956, as amended, and is headquartered in Chino, California. The Company was incorporated in March 2006 and acquired all of the outstanding shares of Chino Commercial Bank, N.A. (the Bank) effective July 1, 2006. The Companys principal subsidiary is the Bank, and the Company exists primarily for the purpose of holding the stock of the Bank and of such other subsidiaries it may acquire or establish. The Companys principal source of income is dividends and tax equalization payments from the Bank, although supplemental sources of income may be explored in the future. The expenditures of the Company, including (but not limited to) the payment of dividends to shareholders, if and when declared by the Board of Directors, the cost of servicing debt, legal fees, audit fees, and shareholder costs will generally be paid from dividends paid to the Company by the Bank.  The Companys only other direct subsidiary is Chino Statutory Trust I, which was formed on October 25, 2006 solely to facilitate the issuance of capital trust pass-through securities. This additional regulatory capital enhances the Companys ability to maintain favorable risk-based capital ratios. Pursuant to the Accounting Standards codification 810,Consolidation,Chino Statutory Trust I is not reflected on a consolidated basis in the consolidated financial statements of the Company.  The Companys Administrative Offices are located at 14345 Pipeline Avenue, Chino, California and the telephone number is (909) 393-8880. References herein to the Company include the Company and its consolidated subsidiary, unless the context indicates otherwise.  The Bank is a national bank which was organized under the laws of the United States in December 1999 and commenced operations on September 1, 2000. The Bank operates three full-service banking offices. The Banks main branch office and administrative offices are located at 14345 Pipeline Avenue, Chino, California. On January 5, 2006 the Bank opened its Ontario branch located at 1551 South Grove Avenue, Ontario, California and on April 5, 2010 the Bank opened its Rancho Cucamonga branch located at 8229 Rochester Avenue, Rancho Cucamonga, California. As a community-oriented bank, the Bank offers a wide array of commercial and consumer services which would generally be offered by a locally-managed, independently-operated bank.  On July 2, 2010, the Company acquired property at 14245 Pipeline Avenue, Chino, California for $2.2 million to be used as its main branch and administrative offices. The renovations are estimated to be completed by end of December 2010, at which time the Bank plans to move from an approximately 6,950 square feet leased building to a permanent location with approximately 17,600 square feet.   Note 2  Basis of Presentation  The accompanying unaudited consolidated financial statements for the three and nine months ended September 30, 2010 and 2009 have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial statements. They do not, however, include all of the information and footnotes required by such accounting principles for complete financial statements. In the opinion of management, all adjustments including normal recurring accruals considered necessary for a fair presentation have been included.  Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for any other interim period or for the year as a whole. Certain prior period amounts have been reclassified to conform to current period classification. The interim financial information, which is unaudited, should be read in conjunction with the Companys Annual Report on Form 10-K for the year ended December 31, 2009 as filed with the Securities and Exchange Commission (SEC).    7


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Note 3  Critical Accounting Policies:  The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the Companys financial statements and accompanying notes. Management believes that the judgments, estimates and assumptions used in preparation of the Companys financial statements are appropriate given the factual circumstances as of September 30, 2010. Various elements of the Companys accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. Critical accounting policies are those that involve the most complex and subjective decisions and assessments and have the greatest potential impact on the Companys results of operation. In particular, management has identified two accounting policies that are critical to an understanding of the Companys financial statements due to judgments, estimates and assumptions inherent in this policy, and the sensitivity of the Companys financial statements to those judgments, estimates and assumptions.  The first critical accounting policy relates to the methodology that determines the Companys allowance for loan losses. Management has discussed the development and selection of this critical accounting policy with the Companys Audit Committee of the Board of Directors. Although Management believes the level of the allowance at September 30, 2010 is adequate to absorb losses inherent in the loan portfolio, a further decline in the regional economy may result in increasing losses that cannot reasonably be predicted at this time. For further information regarding the allowance for loan losses and related methodology see Comparison of Financial Condition at September 30, 2010 and December 31, 2009  Allowance for Loan Losses included elsewhere herein.  Another critical accounting policy relates to the valuation of other real estate owned (OREO). Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated cost to sell. Any write-down to fair value at the time of transfer to OREO is charged to the allowance for loan losses. Property is evaluated regularly to ensure that the recorded amount is supported by its current fair value and that valuation allowances to reduce the carrying amount to fair value less estimated costs to dispose are recorded as necessary. Revenue and expenses from operations of OREO and changes in the valuation allowance are included in net expenses from OREO.   Note 4  Recent Accounting Pronouncements:  In August 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2009-05,Fair Value Measurements and Disclosures (Topic 820)  Measuring Liabilities at Fair Value.This ASU provides amendments for fair value measurements of liabilities.  It provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more techniques.  ASU 2009-05 also clarifies that when estimating a fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability.  ASU 2009-05 is effective for the periods beginning after October 1, 2009.  The adoption of ASU 2009-05 did not have a material impact on the Companys consolidated financial statements.  In January 2010, the FASB issued ASU No. 2010-06,Fair Value Measurements and Disclosures (Topic 820):  Improving Disclosures about Fair Value Measurements.  ASU 2010-06 revises two disclosure requirements concerning fair value measurements and clarifies two others.  It requires separate presentation of significant transfers into and out of Levels 1 and 2 of the fair value hierarchy and disclosure of the reasons for such transfers.  It will also require the presentation of purchases, sales, issuances, and settlements within Level 3 on a gross basis rather than a net basis.  The amendments also clarify that disclosures should be disaggregated by class of asset or liability and that disclosures about inputs and valuation techniques should be provided for both recurring and non-recurring fair value measurements.   These new disclosure requirements became effective on January 1, 2010, except for the requirement concerning gross presentation of Level 3 activity, which is effective for fiscal years beginning after December 15, 2010.  There was no significant effect to the Companys financial statement disclosure upon adoption of this ASU.  8


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In June 2009, the FASB issued ASU 2009-16 (formerlyStatement of Financial Accounting Standards (SFAS) No. 166),Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140.  ASU 2009-16 amends the de-recognition accounting and disclosure guidance relating to SFAS No. 140.  ASU 2009-16 eliminates the exemption from consolidation for qualifying special purpose entities (QSPEs), and requires a transferor to evaluate all existing QSPEs to determine whether they must be consolidated in accordance with ASU 2009-16.  It also amends the sale recognition rules for sales of participating interests in loans. ASU 2009-16 is effective as of the beginning of the first annual reporting period that begins after November 15, 2009.  The adoption of ASU 2009-16 on January 1, 2010 did not have a significant impact on the Companys financial condition, results of operations, or disclosures.  In June 2009, the FASB issued ASU 2009-17 (formerly SFAS No. 167),Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities.This Statement amends ASC Topic 810,Consolidationto require an enterprise to perform an analysis and ongoing reassessments to determine whether the enterprises variable interest or interests give it a controlling financial interest in a variable interest entity, and amends certain guidance for determining whether an entity is a variable interest entity. It also requires enhanced disclosures that will provide users of financial statements with more transparent information about an enterprises involvement in a variable interest entity. This Statement, which became effective for the Company on January 1, 2010, did not have an impact on its consolidated financial statements as the Company has no interests in any variable interest entities.  In February 2010, the FASB issued ASU 2010-09,Subsequent Events (Topic 855):  Amendments to Certain Recognition and Disclosure Requirements.  The amendments remove the requirement for an SEC registrant to disclose the date through which subsequent events were evaluated, as this requirement would have potentially conflicted with SEC reporting requirements.  Removal of the disclosure requirement did not have an effect on the nature or timing of subsequent events evaluations performed by the Company.  ASU 2010-09 became effective upon issuance.  Note 5  Investment Securities  The amortized cost and fair value of investment securities at September 30, 2010 are as follows:  Gross
     
     
     
     GrossAmortized
     
     
     
     Unrealized
     
     
     
     Unrealized
     
     
     
     FairCost
     
     
     
     Gains
     
     
     
     Losses
     
     
     
     ValueSecurities available for sale:Municipal bonds
     $
     743,277
     
     
     $
     46,390
     
     
     $
     -
     
     
     $
     789,667Mortgage-backed securities
     
     4,005,383
     
     
     
     128,128
     
     
     
     (77
     )
     
     
     4,133,434$
     4,748,660
     
     
     $
     174,518
     
     
     $
     (77
     )
     
     $
     4,923,101Securities held to maturity:Municipal bonds
     $
     435,364
     
     
     $
     6,967
     
     
     $
     -
     
     
     $
     442,331Federal agency
     
     2,500,000
     
     
     
     59,368
     
     
     
     0
     
     
     
     2,559,368Mortgage-backed securities
     
     10,094,272
     
     
     
     222,423
     
     
     
     0
     
     
     
     10,316,695Corporate
     
     81,870
     
     
     
     2,338
     
     
     
     0
     
     
     
     84,208$
     13,111,506
     
     
     $
     291,096
     
     
     $
     -
     
     
     $
     13,402,602
  The amortized cost and fair value of investment securities as of September 30, 2010 by contractual maturity are shown below:  9


---



Available for Sale
     
     
     
     Held to MaturityAmortized
     
     
     
     Fair
     
     
     
     Amortized
     
     
     
     FairCost
     
     
     
     Value
     
     
     
     Cost
     
     
     
     ValueWithin 1 year
     $
     -
     
     
     $
     -
     
     
     $
     -
     
     
     $
     -After 1 year through 5 years
     
     0
     
     
     
     0
     
     
     
     81,871
     
     
     
     84,208After 5 years through 10 years
     
     0
     
     
     
     0
     
     
     
     2,601,053
     
     
     
     2,662,033After 10 years through 17 years
     
     743,277
     
     
     
     789,667
     
     
     
     334,310
     
     
     
     339,666Mortgage-backed securities
     
     4,005,383
     
     
     
     4,133,434
     
     
     
     10,094,272
     
     
     
     10,316,695$
     4,748,660
     
     
     $
     4,923,101
     
     
     $
     13,111,506
     
     
     $
     13,402,602
  Information pertaining to securities with gross unrealized losses at September 30, 2010, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:  Less than 12 Months
     
     
     
     Over 12 MonthsGross
     
     
     
     
     
     
     
     GrossUnrealized
     
     
     
     Fair
     
     
     
     Unrealized
     
     
     FairLosses
     
     
     
     Value
     
     
     
     Losses
     
     
     ValueSecurities available for saleMortgage-backed securities
     $
     77
     
     
     $
     28,295
     
     
     $
     -
     
     $
     -
  Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.  At September 30, 2010, two securities have unrealized losses with aggregate depreciation of 0.3% from the Companys amortized cost basis. These unrealized losses relate to mortgage-backed securities issued by federally sponsored agencies, which are fully secured by conforming residential loans. Since the Company has the ability to hold these securities until estimated maturity, no declines are deemed to be other than temporary.  Note 6  Subordinated Notes Payable to Subsidiary Trust  On October 25, 2006, Chino Statutory Trust I (the Trust), a newly formed Connecticutstatutory business trust and a wholly-owned subsidiary of the Company, issued an aggregate of $3.0 million of principal amount of Capital Securities (the Trust Preferred Securities) and $93,000 in Common Securities. Cohen & Company acted as placement agent in connection with the offering of the Trust Preferred Securities. The securities issued by the Trust are fully guaranteed by the Company with respect to distributions and amounts payable upon liquidation, redemption or repayment. The entire proceeds to the Trust from the sale of the Trust Preferred Securities were used by the Trust to purchase $3,000,000 in principal amount of the Junior Subordinated Deferrable Interest Debentures due December 15, 2036 issued by the Company (the Subordinated Debt Securities). The Company issued an additional $93,000 in principal amount of the Junior Subordinated Deferrable Interest Debentures due December 15, 2036, in exchange for its investment in the Trusts Common Securities. The Subordinated Debt Securities bear interest at 6.795% for the first five years from October 27, 2006 to December 15, 2011 and at a variable interest rate to be adjusted quarterly equal to LIBOR (0.291% at September 30, 2010) plus 1.68% thereafter.  During 2006 and 2007 the Company used approximately $522,000 and $2,478,000, respectively, from the proceeds of $3.0 million to repurchase and retire Company stock. There was no cost to the Trust associated with the issuance.  As of September 30, 2010, accrued interest payable to the Trust amounted to $8,494. Interest expense for Trust Preferred Securities amounted to $50,963 for each of the quarters ended September 30, 2010 and 2009 and $152,888 for each of the three quarters ended September 30, 2010 and 2009.  10


---



Note 7  Stock Based Compensation  Under the Companys stock option plan, the Company granted incentive stock options to officers and employees, and non-qualified stock options to its directors, officers and employees. The Plan terminated on July 13, 2010, and no options can be granted under the Plan thereafter, but such termination did not affect any Options previously granted. Therefore, at September 30, 2010 no shares were available for the grant of options compared to 108,405 shares were available at September 30, 2009. At September 30, 2010 and 2009, options covering 14,853 and 97,394 shares, respectively, were outstanding. The Plan provides that the exercise price of these options shall not be less than the market price of the common stock on the date granted. Incentive options begin vesting after one year from date of grant at a rate of 33% per year. Non-qualified options vest as follows: 25% on the date of the grant, and 25% per year thereafter. All options expire 10 years after the date of grant. Compensation cost relating to share-based payment transactions is recognized in the financial statements over the vesting period of the options. The most recent grant of options occurred in 2003.Thus, there was no stock-based compensation expense for the three and nine months ended September 30, 2010 and 2009.  Note 8 - Earnings per share (EPS)  Basic EPS excludes dilution and is computed by dividing earnings available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in earnings.  The weighted-average number of shares used in computing basic and diluted earnings per share is as follows:   Earnings per share CalculationFor the three months ended September 30,2010
     
     
     
     2009Weighted
     
     
     
     
     
     
     
     
     
     
     
     WeightedNet
     
     
     
     Average
     
     
     
     Per Share
     
     
     
     Net
     
     
     
     Average
     
     
     
     Per ShareIncome
     
     
     
     Shares
     
     
     
     Amount
     
     
     
     Income
     
     
     
     Shares
     
     
     
     AmountBasic earnings
     $
     194,041
     
     
     
     751,390
     
     
     $
     0.26
     
     
     $
     95,080
     
     
     
     701,311
     
     
     $
     0.14Effect of dilutive shares:assumed exercise ofoutstanding options
     
     
     
     
     
     3,062
     
     
     
     0.00
     
     
     
     
     
     
     
     38,345
     
     
     
     (0.01
     )Diluted earnings per share
     $
     194,041
     
     
     
     754,452
     
     
     $
     0.26
     
     
     $
     95,080
     
     
     
     739,656
     
     
     $
     0.13   Earnings per share CalculationFor the nine months ended September 30,2010
     
     
     
     2009Weighted
     
     
     
     
     
     
     
     
     
     
     
     WeightedNet
     
     
     
     Average
     
     
     
     Per Share
     
     
     
     Net
     
     
     
     Average
     
     
     
     Per ShareIncome
     
     
     
     Shares
     
     
     
     Amount
     
     
     
     Income
     
     
     
     Shares
     
     
     
     AmountBasic earnings
     $
     249,519
     
     
     
     717,301
     
     
     $
     0.35
     
     
     $
     287,878
     
     
     
     703,929
     
     
     $
     0.41Effect of dilutive shares:assumed exercise ofoutstanding options
     
     
     
     
     
     3,440
     
     
     
     0.00
     
     
     
     
     
     
     
     29,522
     
     
     
     (0.02
     )Diluted earnings per share
     $
     249,519
     
     
     
     720,741
     
     
     $
     0.35
     
     
     $
     287,878
     
     
     
     733,451
     
     
     $
     0.39    11


---



Note 9 - Off-Balance-Sheet Commitments  The Company is a party to credit-related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to grant loans, unadvanced lines of credit, standby letters of credit and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.  The Companys exposure to credit loss is represented by the contractual amount of these commitments. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments. At September 30, 2010 and December 31, 2009, the Company had $5.7 million and $3.8 million, respectively, of off-balance sheet commitments to extend credit. These commitments represent a credit risk to the Company. At September 30, 2010 and December 31, 2009, the Company had no unadvanced standby letters of credit.  Commitments to grant loans are agreements to lend to customers as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customers creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on managements credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, equipment, income-producing commercial properties, residential properties, and properties under construction.   Note10  Fair Value Measurement  Accounting Standards Codification 820,Fair Value Measurements(ASC 820), defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows: ·Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.  ·Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.  ·Level 3 - inputs to the valuation methodology are unobservable and significant to the fair value measurement.  Following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:  Financial assets measured at fair value on a recurring basis include the following:  Securities available for sale Where quoted prices are available for identical assets in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, securities are classified within Level 2 of the valuation hierarchy and fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow. Level 2 securities would include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation,


securities are classified within Level 3 of the valuation hierarchy. Currently, all of the Companys securities available for sale are considered to be Level 2 securities.  12


---



The following table presents the balances of securities available for sale measured at fair value on a recurring basis as of September 30, 2010 and December 31, 2009.  Quoted Prices
     
     
     Significantin Active
     
     
     OtherMarkets for
     
     
     Observable
     
     
     
     SignificantIdentical Assets
     
     
     Inputs
     
     
     
     Unobservable InputsDescription
     
     Balance
     
     
     
     (Level 1)
     
     
     (Level 2)
     
     
     
     (Level 3)Available-for-sale securitiesat September 30, 2010
     $
     4,923,101
     
     
     $
     -
     
     $
     4,923,101
     
     
     $
     -at December 31, 2009
     $
     5,567,855
     
     
     $
     -
     
     $
     5,567,855
     
     
     $
     -
  Certain financial assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets. Financial assets measured at fair value as a nonrecurring basis include the following:  Loans held for sale  Loans held for sale are required to be measured at the lower of cost or fair value. In order to determine fair value, management obtains quotes or bids on all or part of these loans directly from the purchasing financial institutions. At September 30, 2010 and December 31, 2009, there were no loans held for sale.  Impaired loans  Collateral-dependent impaired loans are carried at the fair value of the collateral less estimated costs to sell. The fair value of collateral is determined based on appraisals. In some cases, adjustments were made to the appraised values for various factors including age of the appraisal, age of comparables included in the appraisal, and known changes in the market and in the collateral. When significant adjustments were based on unobservable inputs, the resulting fair value measurement has been categorized as a Level 3 measurement. Otherwise, collateral-dependent impaired loans are categorized under Level 2.  Impaired loans that are not collateral dependent are carried at the present value of expected future cash flows discounted at the loans effective interest rate. Troubled debt restructurings are also carried at the present value of expected future cash flows. However, expected cash flows for troubled debt restructurings are discounted using the loans original effective interest rate rather than the modified interest rate. Since fair value of these loans is based on managements own projection of future cash flows, the fair value measurements are categorized as Level 3 measurements.  The following presents impaired loans measured at fair value on a non-recurring basis as of September 30, 2010 and December 31, 2009.  Quoted Prices
     
     
     Significantin Active
     
     
     OtherMarkets for
     
     
     Observable
     
     
     SignificantIdentical Assets
     
     
     Inputs
     
     
     Unobservable InputsDescription
     
     Balance
     
     
     
     (Level 1)
     
     
     (Level 2)
     
     
     (Level 3)Impaired loansat September 30, 2010
     $
     1,524,878
     
     
     $
     -
     
     $
     -
     
     $
     1,524,878at December 31, 2009
     $
     1,493,919
     
     
     $
     -
     
     $
     -
     
     $
     1,493,919
  13


---



Other Real Estate Owned  Real estate acquired through foreclosure or other proceedings (other real estate owned) is initially recorded at fair value at the date of foreclosure less estimated costs of disposal, which establishes a new cost. After foreclosure, valuations are periodically performed, and foreclosed assets held for sale are carried at the lower of cost or fair value, less estimated costs of disposal. The fair values of real properties initially are determined based on appraisals. In some cases, adjustments were made to the appraised values for various factors including age of the appraisal, age of comparables included in the appraisal, and known changes in the market or in the collateral. Subsequent valuations of the real properties are based on management estimates or on updated appraisals. Other real estate owned is categorized under Level 3 when significant adjustments are made by management to appraised values based on unobservable inputs. Otherwise, Other real estate owned is categorized under Level 2 if their values are based solely on appraisals.  The following table summarizes the Companys OREO that was measured at fair value on a nonrecurring basis as of September 30, 2010 and December 31, 2009:  Quoted Prices
     
     
     Significantin Active
     
     
     OtherMarkets for
     
     
     Observable
     
     
     SignificantIdentical Assets
     
     
     Inputs
     
     
     Unobservable InputsDescription
     
     Balance
     
     
     
     (Level 1)
     
     
     (Level 2)
     
     
     (Level 3)Other real estate owned netof valuation allowanceat September 30, 2010
     $
     1,035,255
     
     
     $
     -
     
     $
     -
     
     $
     1,035,255at December 31, 2009
     $
     24,861
     
     
     $
     -
     
     $
     -
     
     $
     24,861
  ASC 825,Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not the financial instruments are recognized in the balance sheet at fair value or historical cost. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.  The following methods and assumptions were used to estimate the fair value of financial instruments. For cash and cash equivalents, Federal Home Loan Bank stock, loans held for sale, variable-rate loans, accrued interest receivable and payable, demand deposits and savings, and short-term borrowings, the carrying amount is estimated to be fair value. For securities, fair values are based on quoted market prices, where available. If quoted market prices are not available, fair values are based in quoted market prices of comparable instruments. The fair values for fixed-rate loans are estimated using discounted cash flow analyses using interest rates currently being offered for loans with similar terms. The fair value of life insurance is based on the cash surrender value, as determined by the insurer. Fair values for deposit liabilities with a stated maturity date (time deposits) and for certificates of deposit in other banks are estimated using a discounted cash flow calculation that applies interest rates currently being offered on these accounts to a schedule of aggregated expected monthly maturities on time deposits. The fair value of long-term debt is determined utilizing the current market for like-kind instruments of a similar maturity and structure. The fair value of financial instruments with off-balance sheet risk is not considered to be material, so they are not included in the following table:    14


---



Fair Value of Financial Instruments  September 30, 2010Carrying
     
     
     
     FairFinancial assets:
     
     Amount
     
     
     
     ValueCash and due from banks
     $
     5,291,152
     
     
     $
     5,291,152Interest-bearing deposits in other banks
     
     20,235,252
     
     
     
     20,265,313Stock investments
     
     643,350
     
     
     
     643,350Investment securities AFS
     
     4,923,101
     
     
     
     4,923,101Investment securities HTM
     
     13,111,506
     
     
     
     13,402,602Loans, net
     
     57,963,782
     
     
     
     58,044,502Accrued interest receivable
     
     355,727
     
     
     
     355,727Bank owned life insurance
     
     1,731,680
     
     
     
     1,731,680Trups common securities **
     
     93,000
     
     
     
     98,607** part of Prepaid & other assetsFinancial liabilities:Deposits
     
     101,745,348
     
     
     
     101,778,757Subordinated Debenture
     
     3,093,000
     
     
     
     3,279,492Accrued interest payable
     
     106,557
     
     
     
     106,557
  15


---



Item 2 MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS  Forward Looking Information  This discussion focuses primarily on the results of operations of the Company and its consolidated subsidiary on a consolidated basis for the three months and nine months ended September 30, 2010 and 2009, and the financial condition of the Company as of September 30, 2010 and December 31, 2009.  Managements discussion and analysis is written to provide greater insight into the results of operations and the financial condition of the Company and its subsidiary.  For a more complete understanding of the Company and its operations, reference should be made to the consolidated financial statements included in this report and in the Company's 2009 Annual Report on Form 10-K.  Certain matters discussed in this report contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 (the Exchange Act), that involve substantial risks and uncertainties. When used in this report, or in the documents incorporated by reference herein, the words anticipate, believe, estimate, may, intend, expect, and similar expressions identify certain of such forward-looking statements. Actual results could differ materially from such forward-looking statements contained herein. Factors that could cause future results to vary from current expectations include, but are not limited to, the following: changes in economic conditions (both generally and more specifically in the markets in which the Company operates); increases in nonperforming assets and net credit losses that could occur, particularly in times of weak economic conditions or rising interest rates; changes in interest rates, deposit flows, loan demand, real estate values and competition; changes in accounting principles, policies or guidelines and in government legislation and regulation (which change from time to time and over which the Company has no control); other factors affecting the Companys operations, markets, products and services; and other risks detailed in this Form 10-Q and in the Companys other reports filed with the Securities and Exchange Commission (the SEC) pursuant to the SECs rules and regulations. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect managements analysis only as of the date hereof. The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date thereof.  Overview of the Results of Operations and Financial Condition  Results of Operations Summary Third quarter 2010 and 2009 comparison Net income for the quarter ended September 30, 2010 was $194,041 compared with $95,080 for the quarter ended September 30, 2009, an increase of 104.1%. Basic and diluted earnings per share for the third quarter of 2010 were both $0.26, compared to $0.14 and $0.13, respectively, for the third quarter of 2009. The Companys annualized return on average equity was 11.36% and annualized return on average assets was 0.67% for the quarter ended September 30, 2010, compared to a return on average equity of 6.16% and a return on assets of 0.39% for same quarter in 2009. The primary reasons for the change in net income during the third quarter of 2010 are as follows:  ·The provision for loan losses decreased to $15,644 during the third quarter of 2010, a decrease of $272,180 or 94.6%, as compared to $287,824 for the three months ended September 30, 2009. The Company had already provided for the increase in nonperforming loans in the first half of 2010 and experienced net charged-off loans of approximately $17,000 in the third quarter of 2010. The comparatively higher provision in the third quarter of 2009 was due to an increase of $4.5 million in outstanding loans in the third quarter of 2009. The Company has not experienced an increase in outstanding loans in the current year. ·Total non-interest income increased $149,667, or 54.4%, due to increased service charges on deposit accounts and other miscellaneous income. The increase in service charges of $52,447 was caused by an increase in the volume of deposit transactions subject to analysis charges and returned item charges. The increase in other miscellaneous income of $97,505 due to a gain on sale of repossessed equipment for


$127,839 partially offset by the recognition of the provision to the valuation allowance on OREO for $27,500.  16


---



·The Company's net interest margin declined from 4.57% to 3.92%, for the three months ended September 30, 2010 versus 2009 due principally to a drop in interest rates and the migration of deposits to higher yielding accounts. ·Salaries and employee benefits increased $92,877, or 20.6%, to $543,501 for the third quarter of 2010 compared to the same period in 2009 due principally to an increase in staff for the new Rancho Cucamonga branch. ·Occupancy and equipment expense also increased due to the opening of the new branch office. The increase was 44.4% or $38,429 to $124,668 in the third quarter of 2010. ·Legal and other professional fees increased 125.0% or $59,661 during the three months ended September 30, 2010 compared to the same period in 2009. Legal fees increased due to change in control filings and the resolution of tenant problems prior to foreclosure on what is now an OREO property.  Nine months ended September 30, 2010 and 2009 comparison Net income for the nine months ended September 30, 2010 was $249,519 compared with $287,878 for the same period of 2009, a decrease of 13.3%. Basic and diluted earnings per share for the nine months ended September 30, 2010 were $0.35, compared to $0.41 and $0.39, respectively, for the same period in 2009. Annualized return on average equity was 5.04% and a return on assets of 0.29%, compared to a return on equity of 6.20% and a return on assets of 0.42% for the same period in 2009. The primary reasons for the change in net income during the nine months ended September 30, 2010 are as follows: ·The provision for loan losses increased $98,291 or 22.8% to $529,996 for the nine months ended September 30, 2010.  The increase was due to net loan charge offs of $495,125 for the first nine months of 2010, compared to $5,318 for the comparable prior period, and an increase in nonperforming loans to $1.53 million at September 30, 2010, compared to $1.49 million at December 31, 2009 and $49,536 at September 30, 2009 (see Non Performing Assets below).  The magnitude of the increase was offset by the fact that the provision in the comparable period in 2009 was relatively high due to the increase in net loans in the third quarter of 2009, and there was no similar increase in loan levels during 2010. ·Net interest income increased $202,814, or 7.4%, from $2.7 million for the nine months ended September 30, 2009 to $2.9 million for the same period in 2010. Average earning assets increased $21.2 million, while average interest bearing liabilities increased $16.4 million. ·The Companys net interest margin declined from 4.48% to 3.94%, for the nine months ended September 30, 2010 versus 2009 due principally to a drop in interest rates and the migration of deposits to higher yielding accounts. ·Total non-interest income increased $262,269, or 33.8%, to $1.0 million for the nine months ended September 30, 2010 compared to $775,483 for the same period in 2009. Included in this increase was additional service charge income of $157,751 or 22.4% for the nine months ended September 30, 2010, due to an increase in volume of deposit transactions subject to analysis charges and returned item charges. Additionally, other miscellaneous income increased $105,275 due to a gain on sale of repossessed equipment for $127,839 partially offset by the recognition of the provision to the valuation allowance on OREO for $27,500. ·For the nine months ended September 30, 2010 salaries and benefits increased $254,852 or 18.4% as compared with the same nine months of 2009. This was due primarily to an increase in staff from 25 to 31 full-time equivalent employees which was necessary to staff and support the new Rancho Cucamonga branch. ·Occupancy and equipment and data and item processing expenses increased 30.4% and 20.3%, respectively, comparing nine months ended September 30, 2010 with the same period in the prior year due to the opening of the Rancho Cucamonga branch. Occupancy and equipment expense was $316,138 for the nine month period of 2010 compared to $242,522 in the same period of 2009. Data and item processing expenses increased from $218,900 in the nine month period of 2009 to $263,233 in the same period of 2010.  Financial Condition Summary The Companys total assets were $112.7 million at September 30, 2010, a growth of $9.1 million, or 8.8% as compared to total assets of $103.6 million at December 31, 2009. The most significant changes in the Companys balance sheet during the nine months ended September 30, 2010 are outlined below:  Total deposits increased from $92.3 million on December 31, 2009 to $101.7 million on September 30, 2010, a 10.2% increase.Total non-interest bearing deposits increased from $35.9 million at December 31, 2009 to $41.9 million at September 30, 2010, a 16.9% increase. Non-interest bearing deposits to total deposits increased from 38.9% at December 31, 2009 to 41.2% at September 30, 2010 as the Company continues to focus on attracting new customers to diversify its deposit base.  17


---



·The Company experienced an increase in interest-earning assets of $2.9 million or 3.0% to $97.5 million in the nine months of 2010. Gross loans declined from $61.4 million to $59.3 million, a 3.4% decrease, while total investments increased 14.9% to $38.3 million in the nine months ended September 30, 2010. ·Nonperforming assets were comprised of two OREO properties totaling $1.0 million; and three loans on non-accrual totaling $1.5 million, including two restructured loans totaling $1.4 million; for a total of $2.5 million in nonperforming assets at September 30, 2010, as compared to one OREO property totaling $24,861 and five loans totaling $1.5 million, for a total of $1.5 million at December 31, 2009. ·The allowance for loan losses was 2.22% of total loans at September 30, 2010 compared to 1.82% at September 30, 2009 and 2.08% at December 31, 2009. The ratio of the allowance to non-performing loans at September 20, 2010 was 86.03%, compared to 85.54% and 2304% at December 31 and September 30, 2009, respectively. ·Net fixed assets increased $2.8 million or 89.7%, from $3.1 million at December 31, 2010 to $5.9 million at September 30, 2010 resulting from the purchase of a building for relocation of the administrative departments and the main branch.  Earnings Performance  The Company earns income from two primary sources: The first is net interest income, which is interest income generated by earning assets less interest expense on interest-bearing liabilities; the second is non-interest income, which primarily consists of customer service charges and fees but also comes from non-customer sources such as bank-owned life insurance. The majority of the Companys non-interest expenses are operating costs that relate to providing a full range of banking services to the Banks customers.   Net Interest Income and Net Interest Margin  For the third quarter, net interest income decreased $10,627, or 1.0%, to $1,005,347 in 2010 from $1,015,974 in 2009. For the nine months ended September 30, 2010, net interest income increased $202,814, or 7.4%, to $2.9 million in 2010 from $2.7 million in 2009. The level of net interest income depends on several factors in combination, including growth in earning assets, yields on earning assets, the cost of interest-bearing liabilities, the relative volumes of earning assets and interest-bearing liabilities, and the mix of products which comprise the Companys earning assets, deposits, and other interest-bearing liabilities. Occasionally, net interest income is also impacted by the recovery of interest on loans that have been on non-accrual and are either sold or returned to accrual status, or by the reversal of accrued but unpaid interest for loans placed on non-accrual. The Companys net interest income, net interest margin and interest spread are sensitive to general business and economic conditions, including short-term and long-term interest rates, inflation, monetary supply, and the strength of the economy, and the local economics in which the Company conducts business. When net interest income is expressed as a percentage of average earning assets, the results is the net interest margin.  The following tables set forth certain information relating to the Company for the three and nine months ended September 30, 2010 and 2009. The yields and costs are derived by dividing income or expense by the corresponding average balances of assets or liabilities for the periods shown below. Average balances are derived from average daily balances. Yields include fees that are considered adjustments to yields.   18


---



Distribution, Yield and Rate Analysis of Net Interest Income (dollars in thousands) (unaudited) For the three months ended
     
     
     
     For the three months endedSeptember 30, 2010
     
     
     
     September 30, 2009Average
     
     
     
     Income/
     
     
     
     Average
     
     
     
     Average
     
     
     
     Income/
     
     
     
     AverageBalance
     
     
     
     Expense
     
     
     
     Yield/Rate 4
     
     
     
     Balance
     
     
     
     Expense
     
     
     
     Yield/Rate 4($ in thousands)AssetsInterest-earnings assetsLoans1
     $
     60,019
     
     
     $
     1,056
     
     
     
     6.98
     %
     
     $
     61,834
     
     
     $
     1,125
     
     
     
     7.22
     %U.S. government agencies securities
     
     2,500
     
     
     
     16
     
     
     
     2.56
     %
     
     
     0
     
     
     
     0
     
     
     
     0.00
     %Mortgage-backed securities
     
     14,992
     
     
     
     121
     
     
     
     3.19
     %
     
     
     7,110
     
     
     
     72
     
     
     
     4.02
     %Other securities & Due from banks time
     
     24,237
     
     
     
     82
     
     
     
     1.36
     %
     
     
     19,157
     
     
     
     109
     
     
     
     2.26
     %Federal funds sold
     
     0
     
     
     
     0
     
     
     
     0.00
     %
     
     
     72
     
     
     
     0
     
     
     
     0.25
     %Total interest-earning assets
     
     101,748
     
     
     $
     1,275
     
     
     
     4.97
     %
     
     
     88,173
     
     
     $
     1,306
     
     
     
     5.88
     %Non-interest earning assets
     
     14,173
     
     
     
     
     
     
     
     
     
     
     
     10,286Total assets
     $
     115,921
     
     
     
     
     
     
     
     
     
     
     $
     98,459Liabilities and Stockholders' EquityInterest-bearing liabilitiesMoney market and NOW deposits
     $
     36,967
     
     
     $
     141
     
     
     
     1.52
     %
     
     $
     30,494
     
     
     $
     132
     
     
     
     1.72
     %Savings
     
     1,392
     
     
     
     1
     
     
     
     0.29
     %
     
     
     1,051
     
     
     
     1
     
     
     
     0.23
     %Time deposits < $100,000
     
     6,871
     
     
     
     22
     
     
     
     1.29
     %
     
     
     5,112
     
     
     
     27
     
     
     
     2.13
     %Time deposits equal to or > $100,000
     
     16,771
     
     
     
     55
     
     
     
     1.28
     %
     
     
     13,964
     
     
     
     79
     
     
     
     2.24
     %Other borrowings
     
     0
     
     
     
     0
     
     
     
     0.00
     %
     
     
     171
     
     
     
     0
     
     
     
     0.23
     %Subordinated debenture
     
     3,093
     
     
     
     51
     
     
     
     6.54
     %
     
     
     3,093
     
     
     
     51
     
     
     
     6.54
     %Total interest-bearing liabilities
     
     65,094
     
     
     $
     270
     
     
     
     1.64
     %
     
     
     53,885
     
     
     $
     290
     
     
     
     2.14
     %Non-interest bearing deposits
     
     43,038
     
     
     
     
     
     
     
     
     
     
     
     37,227Non-interest bearing liabilities
     
     958
     
     
     
     
     
     
     
     
     
     
     
     1,148Stockholders' equity
     
     6,831
     
     
     
     
     
     
     
     
     
     
     
     6,199Total liabilities & stockholders' equity
     $
     115,921
     
     
     
     
     
     
     
     
     
     
     $
     98,459Net interest income
     
     
     
     
     $
     1,005
     
     
     
     
     
     
     
     
     
     
     $
     1,016Net interest spread 2
     
     
     
     
     
     
     
     
     
     3.33
     %
     
     
     
     
     
     
     
     
     
     
     3.74
     %Net interest margin 3
     
     
     
     
     
     
     
     
     
     3.92
     %
     
     
     
     
     
     
     
     
     
     
     4.57
     %
   1Net amortization of loan fees and costs have been included in the calculation of interest income. Loan fees (costs) were approximately $3,300 for the three months ended September 30, 2010 as compared to ($3,200) for the three months ended September 30, 2009. 2Represents the average rate earned on interest‐earning assets less the average rate paid on interest-bearing liabilities. 3Represents net interest income as a percentage of average interest‐earning assets. 4Average Yield/Rate is based upon actual days based on 365- and 366-day years.    19


---



Distribution, Yield and Rate Analysis of Net Interest Income (dollars in thousands) (unaudited)  For the nine months ended
     
     
     
     For the nine months endedSeptember 30, 2010
     
     
     
     September 30, 2009Average
     
     
     
     Income/
     
     
     
     Average
     
     
     
     Average
     
     
     
     Income/
     
     
     
     AverageBalance
     
     
     
     Expense
     
     
     
     Yield/Rate 4
     
     
     
     Balance
     
     
     
     Expense
     
     
     
     Yield/Rate 4($ in thousands)AssetsInterest-earnings assetsLoans1
     $
     60,651
     
     
     $
     3,171
     
     
     
     6.99
     %
     
     $
     54,670
     
     
     $
     2,989
     
     
     
     7.31
     %U.S. government agencies securities
     
     2,145
     
     
     
     27
     
     
     
     1.67
     %
     
     
     505
     
     
     
     14
     
     
     
     3.77
     %Mortgage-backed securities
     
     11,607
     
     
     
     301
     
     
     
     3.47
     %
     
     
     7,565
     
     
     
     239
     
     
     
     4.23
     %Other securities & Due from banks time
     
     25,089
     
     
     
     292
     
     
     
     1.55
     %
     
     
     18,807
     
     
     
     350
     
     
     
     2.48
     %Federal funds sold
     
     0
     
     
     
     0
     
     
     
     0.00
     %
     
     
     58
     
     
     
     0
     
     
     
     0.23
     %Total interest-earning assets
     
     99,492
     
     
     $
     3,791
     
     
     
     5.09
     %
     
     
     81,605
     
     
     $
     3,592
     
     
     
     5.89
     %Non-interest earning assets
     
     13,870
     
     
     
     
     
     
     
     
     
     
     
     9,742Total assets
     $
     113,362
     
     
     
     
     
     
     
     
     
     
     $
     91,347Liabilities and Stockholders' EquityInterest-bearing liabilitiesMoney market and NOW deposits
     $
     35,040
     
     
     $
     415
     
     
     
     1.59
     %
     
     $
     29,520
     
     
     $
     435
     
     
     
     1.97
     %Savings
     
     1,237
     
     
     
     3
     
     
     
     0.29
     %
     
     
     1,012
     
     
     
     2
     
     
     
     0.24
     %Time deposits < $100,000
     
     7,138
     
     
     
     80
     
     
     
     1.50
     %
     
     
     4,561
     
     
     
     80
     
     
     
     2.34
     %Time deposits equal to or > $100,000
     
     17,991
     
     
     
     203
     
     
     
     1.50
     %
     
     
     10,343
     
     
     
     188
     
     
     
     2.45
     %Federal funds purchased
     
     2
     
     
     
     0
     
     
     
     1.11
     %
     
     
     12
     
     
     
     0
     
     
     
     1.28
     %Other borrowings
     
     299
     
     
     
     1
     
     
     
     0.25
     %
     
     
     419
     
     
     
     1
     
     
     
     0.22
     %Subordinated debenture
     
     3,093
     
     
     
     153
     
     
     
     6.61
     %
     
     
     3,093
     
     
     
     153
     
     
     
     6.61
     %Total interest-bearing liabilities
     
     64,800
     
     
     $
     855
     
     
     
     1.76
     %
     
     
     48,960
     
     
     $
     859
     
     
     
     2.35
     %Non-interest bearing deposits
     
     40,320
     
     
     
     
     
     
     
     
     
     
     
     35,100Non-interest bearing liabilities
     
     1,660
     
     
     
     
     
     
     
     
     
     
     
     1,090Stockholders' equity
     
     6,582
     
     
     
     
     
     
     
     
     
     
     
     6,197Total liabilities & stockholders' equity
     $
     113,362
     
     
     
     
     
     
     
     
     
     
     $
     91,347Net interest income
     
     
     
     
     $
     2,936
     
     
     
     
     
     
     
     
     
     
     $
     2,733Net interest spread 2
     
     
     
     
     
     
     
     
     
     3.33
     %
     
     
     
     
     
     
     
     
     
     
     3.54
     %Net interest margin 3
     
     
     
     
     
     
     
     
     
     3.94
     %
     
     
     
     
     
     
     
     
     
     
     4.48
     %
  1Net amortization of loan fees and costs have been included in the calculation of interest income. Loan fees were approximately ($4,400) for the nine months ended September 30, 2010 as compared to $10,400 for the nine months ended September 30, 2009. Loans are net of deferred fees and related direct costs. 2Represents the average rate earned on interest‐earning assets less the average rate paid on interest-bearing liabilities. 3Represents net interest income as a percentage of average interest‐earning assets. 4Average Yield/Rate is based upon actual days based on 365- and 366-day years.   Rate/Volume Analysis  The Volume and Rate Variances table below sets forth the dollar difference in interest earned and paid for each major category of interest-earning assets and interest-bearing liabilities for the noted periods, and the amount of such change attributable to changes in average balances (volume) or changes in average interest rates. Volume variances are equal to the increase or decrease in average balance multiplied by prior period rates, and rate variances are equal to the increase or decrease in average rate times prior period average balances. Variances attributable to both rate and volume changes are calculated by multiplying the change in rate by the change in average balance, and are allocated to the rate and volume variance.  20


---



For the quarter ended
     
     
     
     For the nine months endedSeptember 30
     
     
     
     September 302010 vs. 2009
     
     
     
     2010 vs. 2009Increase (Decrease) Due to
     
     
     
     Increase (Decrease) Due to($ in thousands)
     
     
     
     ($ in thousands)Volume
     
     
     
     Rate
     
     
     
     Net
     
     
     
     Volume
     
     
     
     Rate
     
     
     
     NetInterest-earnings assetsLoans
     $
     (33
     )
     
     $
     (36
     )
     
     $
     (69
     )
     
     $
     317
     
     
     $
     (135
     )
     
     $
     182Securities of U.S. government agencies
     
     16
     
     
     
     0
     
     
     
     16
     
     
     
     23
     
     
     
     (10
     )
     
     
     13Mortgage-backed securities
     
     67
     
     
     
     (18
     )
     
     
     49
     
     
     
     111
     
     
     
     (49
     )
     
     
     62Other securities & Due from banks time
     
     23
     
     
     
     (52
     )
     
     
     (27
     )
     
     
     96
     
     
     
     (154
     )
     
     
     (58
     )Total interest-earning assets
     
     73
     
     
     
     (106
     )
     
     
     (31
     )
     
     
     547
     
     
     
     (348
     )
     
     
     199Interest-bearing liabilitiesMoney market & NOW
     
     27
     
     
     
     (18
     )
     
     
     9
     
     
     
     74
     
     
     
     (94
     )
     
     
     (20
     )Savings
     
     0
     
     
     
     0
     
     
     
     0
     
     
     
     1
     
     
     
     0
     
     
     
     1Time deposits < $100,000
     
     7
     
     
     
     (12
     )
     
     
     (5
     )
     
     
     35
     
     
     
     (35
     )
     
     
     0Time deposits equal to or > $100,000
     
     16
     
     
     
     (37
     )
     
     
     (24
     )
     
     
     103
     
     
     
     (88
     )
     
     
     15Total interest-bearing liabilities
     
     50
     
     
     
     (67
     )
     
     
     (20
     )
     
     
     213
     
     
     
     (217
     )
     
     
     (4
     )Change in net interest income
     $
     23
     
     
     $
     (39
     )
     
     $
     (11
     )
     
     $
     334
     
     
     $
     (131
     )
     
     $
     203
   As shown above, the pure volume variance positively impacted net interest income by $23,000 in the third quarter of 2010 relative to the same period of 2009, while the rate variance negatively impacted net interest income by $39,000 in the same comparative periods.  The Companys net interest income for the third quarter of 2010 was $1,005,347 compared to $1,015,974 in the third quarter of 2009, a decrease of $10,627, or 1.0%. The net interest margin decreased to 3.92% for the three months ended September 30, 2010 as compared to 4.57% for the same period in 2009 due principally to declining yields on loans and investments.  Average loans declined $1.8 million or 2.9% for the third quarter of 2010 compared with the same period of 2009. Interest and fee income on loans decreased $68,918. The decrease in average loans resulted in approximately $33,000 decrease in interest income from loans, while the decrease in interest rate resulted in approximately $36,000 decrease in income. The average yield on loans declined from 7.22% for the quarter ended September 30, 2009 to 6.98% for the quarter ended September 30, 2010.  Income from investment securities and interest-bearing balances in other banks for the quarter ended September 30, 2010 increased by $37,570 in comparison to the quarter ended September 30, 2009. The primary reason for the increased interest income was due to the increase in the average balances of approximately $15.5 million or 58.8%. The growth in average investment securities and interest-bearing balances in other banks caused an increase of interest income of approximately $106,000, while the rate decrease caused a decline in interest income of approximately $68,000 for the third quarter of 2010 as compared to the same quarter in 2009. The average yield for investment securities and interest-bearing balances in other banks declined from 2.74% for the three months ended September 30, 2009 to 2.08% for the same period in 2010.  Average interest-bearing liabilities increased $11.2 million in the third quarter of 2010 as compared to the third quarter of 2009. The increase in average interest-bearing deposits resulted in approximately a $50,000 increase in interest expense which was offset by a decrease of approximately $70,000 due to a decrease in rates in the third quarter of 2010 as compared to the third quarter of 2009.   21


---



Pure volume variances positively impacted net interest income by approximately $334,000 for the nine-month period ended September 30, 2010 relative to the same period of 2009, while the rate variance negatively impacted net interest income by approximately $131,000 in the same comparative periods.  Interest income increased $198,766 or 5.5% in the nine month period ended September 30, 2010 compared to the same period of 2009, while interest expense decreased $4,048 or 0.5%. Interest and fee income from loans increased during the nine months ended September 30, 2010 by $182,513, or 6.1% from $2,989,001 for the same period in 2009 due to an increase in average loan balances.  The average balance of investment securities and interest-bearing balances in other banks increased due to growth in average deposits. The most significant increase was in interest-bearing balances in other banks, which experienced a positive volume variance of approximately $96,000 and a negative rate variance of $154,000 for the nine months ended September 30, 2010 compared to the same period in 2009. Interest income from investment securities and interest-bearing balances in other banks increased $16,355 or 2.7% to $619,330 for the nine months ended September 30, 2010 compared to the same period of 2009.  Interest expense on deposits decreased $3,798, or 0.5% to $701,966 for the nine months ended September 30, 2010 compared to the same period of 2009. Average interest bearing deposits to average total deposits increased from 56.4% for the nine months ended September 30, 2009 to 60.4% for the same period in 2010 as new and existing deposits continue to migrate to higher yielding accounts.  The Companys net interest margin declined from 4.48% to 3.94%, for the nine months ended September 30, 2010 versus 2009 due principally to a drop in interest rates and the migration of deposits to higher yielding accounts.  Provision for Loan Losses  Provisions to the allowance for loan losses are made monthly if needed, in anticipation of future potential loan losses. The monthly provision is calculated on a predetermined methodology to ensure adequacy as the portfolio grows. The methodology utilized is composed of various components. Allowance factors are utilized in estimating the adequacy of the allowance for loan losses. The allowance is determined by assigning general reserves for non-classified loans, and specific allowances for individual classified loans. As higher allowance levels become necessary as a result of this analysis, the allowance for loan losses will be increased through the provision for loan losses. The procedures for monitoring the adequacy of the allowance, and detailed information for allowance, are included below under Allowance for Loan Losses.  The Company provided $529,996 to the allowance for loan losses during the nine months ended September 30, 2010, a 22.8% increase over the same period during 2009. The increase in the provision to the allowance for loan losses was due to net loan charge offs of $495,125 for the first nine months of 2010, compared to $5,318 for the comparable prior period, and an increase in nonperforming loans to $1.53 million at September 30, 2010, compared to $1.49 million at December 31, 2009 and $49,536 at September 30, 2009 (see Non Performing Assets below).  The magnitude of the increase was offset by the fact that the provision in the comparable period in 2009 was relatively high due to the increase in net loans in the third quarter of 2009, and there was no similar increase in loan levels during 2010.  The Company continues to pursue recovery of the loans charged off during the preceding years. The Company has not originated and does not hold sub-prime mortgage loans, or option ARM mortgages.  Non-Interest Income  Non-interest income was $424,989 for the three months ended September 30, 2010 as compared to $275,322 for the three months ended September 30, 2009, a 54.4% increase. For the nine months ended September 30, 2010, non-interest income increased 33.8% to $1,037,752 compared to $775,483 for the same period in 2009. The increases were due primarily to the increase was service charge income which was caused by an increase in the volume of deposit transactions subject to analysis charges and returned item charges. Total annualized non-interest income as a percentage of average earning assets increased to 1.7% for the three months ended September 30, 2010 compared to 1.2% for the same three months in 2009. The return on average earning assets for nine months ended September 30, 2010 increased slightly to 1.4% from 1.3% for the same period in 2009.      22


---



Non-Interest Income for the three months
     
     Non-Interest Income for the nine monthsended September 30,
     ended September 30,2010
     
     2009
     
     2010
     
     2009Amount
     
     % of Total
     
     Amount
     
     % of Total
     
     Amount
     
     % of Total
     
     Amount
     
     % of Total(Dollars in thousands)
     
     (Dollars in thousands)Service charges ondeposit accounts
     $     300
     
     70.6%
     
     $     247
     
     90.0%
     
     $     863
     
     83.1%
     
     $     704
     
     90.8%Other miscellaneousincome
     104
     
     24.6%
     
     7
     
     2.5%
     
     119
     
     11.5%
     
     14
     
     1.8%Dividend incomefrom restricted stock
     3
     
     0.7%
     
     4
     
     1.4%
     
     4
     
     0.4%
     
     7
     
     0.9%Income from bankowned life insurance
     18
     
     4.1%
     
     17
     
     6.1%
     
     52
     
     5.0%
     
     50
     
     6.5%Total non-interestincome
     $     425
     
     100.0%
     
     $     275
     
     100.0%
     
     $  1,038
     
     100.0%
     
     $     775
     
     100.0%As a percentage ofaverage earning assets
     
     
     1.7%
     
     
     
     1.2%
     
     
     
     1.4%
     
     
     
     1.3%
   Other miscellaneous income, which includes gains and losses from sale of other assets and OREO, increased $97,505 or 1415.4% in the third quarter and $105,275 or 755.0% or in the nine months ended September 30, 2010, compared to the same periods of 2009, respectively. This was due primarily to a gain on sale of repossessed equipment of $127,839 partially offset by the recognition of the provision to the valuation allowance on OREO for $27,500.  The service charges on deposit accounts, customer fees and miscellaneous income are comprised primarily of fees charged to deposit accounts and depository related services. Fees on deposit accounts consist of periodic service charges and fees that relate to specific actions, such as the return or payment of checks presented against accounts with insufficient funds. Depository related services include fees for money orders and cashiers checks, placing stop payments on checks, check-printing fees, wire transfer fees, fees for safe deposit boxes and fees for returned items or checks that were previously deposited. Service charges increased $52,447 or 21.2% to $300,166 for the three months ended September 30, 2010 and increased $157,751 or 22.4% to $862,307 for the nine months period ended September 30, 2010. The increase was primarily attributable to increased analysis charges and returned item charges. The Company periodically reviews service charges to maximize service charge income while still maintaining competitive pricing. Service charge income on deposit accounts increases with the increased number of accounts and to the extent fees are not waived. Therefore, as the number of accounts increases, the nominal service charge income is expected to increase.  Non-Interest Expense  The following table sets forth the non-interest expense for the three and nine months ended September 30, 2010 as compared to the three and nine months ended September 30, 2009:               23


---



Non-Interest Expense for the quarter ended
     
     
     
     Non-Interest Expense for the nine monthsSeptember 30
     
     
     
     September 302010
     
     
     
     2009
     
     
     
     2010
     
     
     
     2009Amount
     
     
     
     % of Total
     
     
     
     Amount
     
     
     
     % of Total
     
     
     
     Amount
     
     
     
     % of Total
     
     
     
     Amount
     
     
     
     % of Total(Dollars in thousands)
     
     
     
     (Dollars in thousands)Salaries and employee benefits
     $
     544
     
     
     
     49.4
     %
     
     $
     451
     
     
     
     52.2
     %
     
     $
     1,638
     
     
     
     53.1
     %
     
     $
     1,383
     
     
     
     52.2
     %Occupancy and equipment
     
     125
     
     
     
     11.3
     %
     
     
     86
     
     
     
     10.0
     %
     
     
     316
     
     
     
     10.3
     %
     
     
     243
     
     
     
     9.2
     %Data and item processing
     
     91
     
     
     
     8.2
     %
     
     
     77
     
     
     
     8.9
     %
     
     
     263
     
     
     
     8.5
     %
     
     
     219
     
     
     
     8.3
     %Deposit products and services
     
     27
     
     
     
     2.4
     %
     
     
     27
     
     
     
     3.1
     %
     
     
     77
     
     
     
     2.5
     %
     
     
     86
     
     
     
     3.3
     %Legal and other professional fees
     
     107
     
     
     
     9.7
     %
     
     
     48
     
     
     
     5.6
     %
     
     
     192
     
     
     
     6.2
     %
     
     
     138
     
     
     
     5.2
     %Regulatory assessments
     
     56
     
     
     
     5.1
     %
     
     
     49
     
     
     
     5.7
     %
     
     
     162
     
     
     
     5.3
     %
     
     
     168
     
     
     
     6.3
     %Advertising and marketing
     
     16
     
     
     
     1.4
     %
     
     
     16
     
     
     
     1.9
     %
     
     
     45
     
     
     
     1.5
     %
     
     
     50
     
     
     
     1.9
     %Directors fees and expenses
     
     17
     
     
     
     1.5
     %
     
     
     19
     
     
     
     2.2
     %
     
     
     51
     
     
     
     1.7
     %
     
     
     55
     
     
     
     2.1
     %Printing and supplies
     
     20
     
     
     
     1.8
     %
     
     
     11
     
     
     
     1.3
     %
     
     
     55
     
     
     
     1.8
     %
     
     
     29
     
     
     
     1.1
     %Telephone
     
     11
     
     
     
     1.0
     %
     
     
     7
     
     
     
     0.8
     %
     
     
     29
     
     
     
     0.9
     %
     
     
     21
     
     
     
     0.8
     %Insurance
     
     10
     
     
     
     0.9
     %
     
     
     8
     
     
     
     0.9
     %
     
     
     28
     
     
     
     0.9
     %
     
     
     24
     
     
     
     0.9
     %Reserve for undisbursed lines of credit
     
     (1
     )
     
     
     -0.1
     %
     
     
     (3
     )
     
     
     -0.3
     %
     
     
     5
     
     
     
     0.2
     %
     
     
     (3
     )
     
     
     -0.1
     %Other expenses
     
     82
     
     
     
     7.4
     %
     
     
     66
     
     
     
     7.7
     %
     
     
     218
     
     
     
     7.1
     %
     
     
     233
     
     
     
     8.8
     %Total non-interest expenses
     $
     1,105
     
     
     
     100.0
     %
     
     $
     862
     
     
     
     100.0
     %
     
     $
     3,079
     
     
     
     100.0
     %
     
     $
     2,646
     
     
     
     100.0
     %Non-interest expense as apercentage of average earning assets
     
     
     
     
     
     4.3
     %
     
     
     
     
     
     
     3.9
     %
     
     
     
     
     
     
     4.1
     %
     
     
     
     
     
     
     4.3
     %Efficiency ratio
     
     
     
     
     
     77.3
     %
     
     
     
     
     
     66.7
     %
     
     
     
     
     
     
     77.5
     %
     
     
     
     
     
     75.4
     %
   Total annualized non-interest expense as a percentage of average earning assets increased to 4.3% from 3.9% for the three months ended September 30, 2010 as compared to three months ended September 30, 2009. For the nine months ended September 30, 2010 and 2009, these percentages were 4.1% and 4.3%, respectively. The overhead efficiency ratio represents total operating expense divided by the sum of net interest and non-interest income, with the provision for loan losses, investment gains/losses, and other extraordinary gains/losses excluded from the equation. Because the percentage increase in net interest plus other income was smaller than the increase in total non-interest expense, the Companys overhead efficiency ratio increased to 77.3% for the third quarter of 2010 from 66.7% for the third quarter of 2009. The efficiency ratio also increased in the most recent nine month period to 77.5%, compared to 75.4% for the same period in 2009  Non-interest expenses were $1,105,290 for the three months ended September 30, 2010 as compared to $861,595 for the three months ended September 30, 2009, a 28.3% increase. Non-interest expenses increased $433,095 to $3,079,333 for the nine months ended September 30, 2010 compared to the same period in 2009. The largest component of non-interest expense was salaries and benefits expense of $543,501 for the third quarter and $1,637,951 for the nine months ended September 30, 2010 compared to $450,624 and $1,383,099 for the same periods in 2009, representing 20.6% and 18.4% increases, respectively. The increases were due to increased staffing for the new Rancho Cucamonga branch, which opened in April of this year.  Other components of non-interest expense that affected the increase were occupancy and equipment expenses which increased $38,429 and $73,616, respectively, for the three and nine month periods ended September 30, 2010 compared to the same periods in 2009, due in the opening of the Rancho Cucamonga Branch in April 2010. Data and item processing expenses also increased due to the additional branch by $14,259, or 18.5% for the comparable three month and $44,333, or 20.3% for the comparable nine month periods. Legal and other professional fees increased 125.0% and 39.1% or $59,661 and $53,918, respectively, during the three and nine months ended September 30, 2010 compared to the same periods in 2009. Legal fees increased due to change in control filings relating to the Companys CEO, and the resolution of tenant problems prior to foreclosure on what is now an OREO property.   24


---



Other expenses increased $30,917 or 28.6% in the third quarter of 2010 versus 2009 and $15,400 or 4.2% in the first nine months of 2010 versus 2009. The increase was predominately due to expenses of other real estate owned for repairs and readying the properties for sale.  Provision for Income Taxes  Income tax expenses of $115,361 and $114,325 were recorded for the third quarter and the nine months ended September 30, 2010, respectively, representing approximately 37.3% and 31.4% of pre-tax income for the third quarter and nine months ended September 30, 2010, respectively. In comparison, income tax expenses of $46,797 and $142,269 were recorded for the third quarter and the nine months ended September 30, 2009, respectively, representing approximately 33.0% and 33.1% of pre-tax income. The amount of the tax provision is determined by applying the Companys statutory income tax rates to pre-tax book income, adjusted for permanent differences between pre-tax book income and actual taxable income. Such permanent differences include but are not limited to tax-exempt interest income; increases in the cash surrender value of bank-owned life insurance, compensation expense associated with stock options and certain other expenses that are not allowed as tax deductions, and tax credits.   Financial Condition  Comparison of Financial Condition at September 30, 2010 and December 31, 2009  General  Total assets increased from $103.6 million to $112.7 million or 8.8% between December 31, 2009 and September 30, 2010, resulting from an increase in deposit balances of $9.5 million. Although approximately 12% and 11% of the deposits at December 31, 2009 and September 30, 2010, respectively, are related to a number of the Companys customers that are engaged in real estate related activities, the Companys growth in deposits was primarily from other companies and individuals not related to the real estate related industry. The Company continues to actively seek to develop alternative and supplemental business relationships with other companies and individuals in an effort to diversify its deposit base and more fully leverage the Companys capital.  Investment securities increased $10.2 million or 129.5% between December 31 2009 and September 30, 2010. The Company purchased $12.5 million of FNMA securities in April, 2010, replacing $6.2 million in lower yielding interest-bearing deposits in other banks and using cash from increased deposits. Gross loans declined $2.1 million, or 3.4%, to $59.3 million between December 31, 2009 and September 30, 2010.  Loan Portfolio  During the nine months ended September 30, 2010, the Companys loan portfolio, net of unearned loan fees, declined by $2.1 million, or 3.4%, to $59.3 million at September 30, 2010. The largest loan category at September 30, 2010 was real estate loans, which consist of commercial and consumer real estate loans none of which were construction loans. This constitutes 84.3% of the loan portfolio. In anticipation of further deterioration in economic conditions, though Management believes these credits to be properly underwritten, the Company has elected to take real estate collateral in an abundance of caution on a number of commercial loans. Though the result of this strategy may be to reflect a concentration of assets into real estate secured credits, Management believes the underlying collateral will support overall credit quality and minimize principal risk in the portfolio. The next largest loan concentration at September 30, 2010 was commercial loans constituting 14.7% of the loan portfolio. The composition of the Companys loan portfolio at September 30, 2010 and December 31, 2009 is set forth below:  September 30, 2010
     
     December 31, 2009Amount
     
     Percentage
     
     Amount
     
     PercentageReal estate
     $      49,945
     
     84.3%
     
     $      50,931
     
     82.9%Commercial
     8,733
     
     14.7%
     
     9,621
     
     15.7%Installment
     619
     
     1.0%
     
     856
     
     1.4%Gross loans
     $      59,297
     
     100.0%
     
     $      61,408
     
     100.0%
   25


---



The weighted average yield on the loan portfolio for the nine months and quarter ended September 30, 2010 was 6.99% and 6.98%, respectively and the weighted average contractual term of the loan portfolio is approximately seven years. Individual loan interest rates may require interest rate changes more frequently than at maturity due to adjustable interest rate terms incorporated into certain loans.  At September 30, 2010approximately 64.1% of loans were variable rate loans tied to adjustable rate indices such as Prime Rate. Approximately 87.9% of the variable rate loans have interest-rate floors with a weighted average yield of 7.35%.  Off-Balance Sheet Arrangements  During the ordinary course of business, the Company provides various forms of credit lines to meet the financing needs of its customers.  These commitments to provide credit represent obligations of the Company to its customers, which are not represented in any form within the balance sheets of the Company. At September 30, 2010 and December 31, 2009, the Company had $5.7 million and $3.8 million, respectively, of off-balance sheet commitments to extend credit, which includes unadvanced letters of credit. These commitments are the result of existing unused lines of credit and unfunded loan commitments. These commitments are supported by promissory notes payable upon demand of the Company. These commitments represent a credit risk to the Company.  At September 30, 2010 and at December 31, 2009, the Company had no unadvanced letters of credit.  The effect on the Companys revenues, expenses, cash flows and liquidity from the unused portion of the commitments to provide credit cannot be reasonably predicted because there is no guarantee that the lines of credit will ever be used.  Non-performing Assets  Nonperforming assets are comprised of loans for which the Company is no longer accruing interest and foreclosed assets, including other real estate owned.  OREO consists of properties acquired by foreclosure or similar means that management is offering or will offer for sale.  Nonperforming loans result when reasonable doubt exists with regard to the ability of the Company to collect all principal and interest on a loan or lease.  At that point, we stop accruing interest on the loan in question, reverse any previously-recognized interest to the extent that it is uncollected or associated with interest-reserve loans.  Any asset for which principal or interest has been in default for a period of 90 days or more is also placed on non-accrual status, even if interest is still being received, unless the asset is both well secured and in the process of collection.  Any loans where serious doubt exists with regard to the ability of borrowers to comply with repayment terms are classified as nonperforming assets and are considered to be impaired.  If the Bank grants a concession to a borrower in financial difficulty, the loan falls into the category of a troubled debt restructure (TDR).  TDRs are also deemed to be impaired loans, and are further classified as either nonperforming or performing loans depending on their accrual status.  The following table presents comparative data for the Companys nonperforming assets.       26


---



September 30
     
     
     December 31
     
     
     September 302010
     
     
     2009
     
     
     2009($ in thousands)NON-ACCRUAL LOANS:1Real estate
     $                   0
     
     
     $            1,285
     
     
     $                 49Commercial
     85
     
     
     209
     
     
     0Installment
     0
     
     
     0
     
     
     0TOTAL NON-ACCRUAL LOANS
     85
     
     
     1,494
     
     
     49LOANS 90 DAYS OR MORE PAST DUE & STILL ACCRUING:Real estate
     0
     
     
     0
     
     
     0Commercial
     0
     
     
     0
     
     
     0Installment
     0
     
     
     0
     
     
     0TOTAL LOANS 90 DAYS OR MORE PAST DUE & STILL ACCRUING
     0
     
     
     0
     
     
     0Non-Accruing TDRs2
     1,440
     
     
     0
     
     
     0TOTAL NONPERFORMING LOANS
     1,525
     
     
     1,494
     
     
     49OREO
     1,035
     
     
     25
     
     
     199TOTAL NONPERFORMING ASSETS
     $            2,560
     
     
     $            1,519
     
     
     $               248Nonperforming loans as a percentage of total loans 3
     2.57%
     
     
     2.43%
     
     
     0.08%Nonperforming assets as a percentage of total loans and OREO
     4.24%
     
     
     2.47%
     
     
     0.40%Allowance for loan losses to nonperforming loans
     86.03%
     
     
     85.54%
     
     
     2304.08%1Additional interest income of approximately $15,300 and $16,800 respectively, would have been recorded for the periods ended September 30, 2010 and December 31, 2009 if the loans had been paid or accrued in accordance with original terms.2TDRs are loans where the terms are renegotiated to provide a reduction or deferral of interest or principal due to deterioration in the financial position of the borrower. All of the Company's TDRs are on nonaccrual status.3Total loans are gross loans, which excludes the allowance for loan losses, and net of unearned loan fees.
  At September 30, 2010 the Company had two foreclosed properties (OREO) which are commercial properties, and three loans on non-accrual status, two of which are restructured loans. The Companys nonperforming assets at September 30, 2010 were 4.24% of total loans and OREO compared to 2.47% at December 31, 2009. At December 31, 2009, the Company had one foreclosed property consisting of one remaining residential unit, and five loans on non-accrual status.  Allowance for Loan Losses  The Company maintains an allowance for loan losses at a level Management considers adequate to cover the inherent risk of loss associated with its loan portfolio under prevailing and anticipated economic conditions. In determining the adequacy of the allowance for loan losses also on nonaccrual status, Management takes into consideration growth trends in the portfolio, examination by financial institution supervisory authorities, prior loan loss experience of the Companys Management, concentrations of credit risk, delinquency trends, general economic conditions, the interest rate environment, and internal and external credit reviews.  The Company formally assesses the adequacy of the allowance on a quarterly basis. This assessment is comprised of: (i) reviewing the adversely classified, delinquent or otherwise problematic loans; (ii) generating an estimate of the loss potential in each loan; (iii) adding a risk factor for industry, economic or other external factors; and (iv) evaluating the present status of each loan and the impact of potential future events.  Allowance factors are utilized in the analysis of the allowance for loan losses. Allowance factors ranging from 0.9% to 3.1% are applied to disbursed loans that are unclassified and uncriticized. Allowance factors averaging


approximately 0.03% are applied to undisbursed loans. Allowance factors are not applied to loans secured by bank deposits or to loans held for sale, which are recorded at the lower of cost or market.  27


---



The process of providing for loan losses involves judgmental discretion, and eventually losses may therefore differ from even the most recent estimates. Due to these limitations, the Company assumes that there are losses inherent in the current loan portfolio but which have not yet been identified. The Company therefore attempts to maintain the allowance at an amount sufficient to cover such unknown but inherent losses.  Management looks at a number of economic events occurring in and around the real estate industry and analyzes each credit for associated risks. Accordingly, the Company has established an allowance for loan losses which amounted to $1,312,397 at September 30, 2010, $1,277,526 at December 31, 2009, and $1,128,796 at September 30, 2009. The ratios of the allowance for loan losses to total loans at September 30, 2010, December 31, 2009, and September 30, 2009 were 2.21%, 2.08%, and 1.82% respectively.  The table below summarizes, as of and for the three and nine months ended September 30, 2010 and 2009 and the year ended December 31, 2009, the loan balances at the end of the period and the daily average loan balances during the period; changes in the allowance for loan losses arising from loan charge-offs, recoveries on loans previously charged-off, and additions to the allowance which have been charged against earnings, and certain ratios related to the allowance for loan losses.  As of and for the
     
     As of and for the
     
     As of and for theQuarter Ended
     
     Nine-Month Period Ended
     
     Year EndedSeptember 30,
     
     September 30,
     
     December 31,2010
     
     2009
     
     2010
     
     2009
     
     2009Balances:
     ($ in thousands)Average total loansoutstanding during period
     $         60,019
     
     $         61,834
     
     $         60,651
     
     $         54,670
     
     $         56,450Total loans outstandingat end of the period
     $         59,297
     
     $         62,181
     
     $         59,297
     
     $         62,181
     
     $         61,408Allowance for loan losses:Balance at the beginning of period
     $           1,313
     
     $              846
     
     $           1,278
     
     $              702
     
     $              702Provision charged to expense
     16
     
     288
     
     530
     
     432
     
     779Charge-offsReal estate loans
     21
     
     0
     
     355
     
     0
     
     0Commercial loans
     4
     
     3
     
     153
     
     3
     
     203Installment loans
     0
     
     2
     
     0
     
     2
     
     2Total
     25
     
     5
     
     508
     
     5
     
     205RecoveriesReal estate loans
     0
     
     0
     
     0
     
     0
     
     0Commercial loans
     8
     
     0
     
     12
     
     0
     
     2Installment loans
     0
     
     0
     
     0
     
     0
     
     0Total
     8
     
     0
     
     12
     
     0
     
     2Net loan charge-offs
     17
     
     5
     
     496
     
     5
     
     203Balance
     $           1,312
     
     $           1,129
     
     $           1,312
     
     $           1,129
     
     $           1,278Ratios:Net loan charge-offs to average total loans
     0.03%
     
     0.01%
     
     0.82%
     
     0.01%
     
     0.36%Allowance for loan losses to total loans at the end of the period
     2.21%
     
     1.47%
     
     2.21%
     
     1.82%
     
     2.08%Net loan charge-offs (recoveries) to allowance for loan losses at the end of the period
     1.30%
     
     0.47%
     
     37.80%
     
     0.47%
     
     15.96%Net loan charge-offs (recoveries) to Provision for loan losses
     106.25%
     
     1.85%
     
     93.58%
     
     1.85%
     
     26.18%Allowance for loan losses to non-performing loans
     86.03%
     
     2304.08%
     
     86.03%
     
     2304.08%
     
     85.52%
   Allowance for loan losses to non-performing loans decreased from 2304.08% at September 30, 2009 to 86.03% at September 30, 2010 caused principally by the migration of two loans to non performing loan status.. Included in the loans charged off during the nine months ended September 30, 2010 loans are two credits totaling $334,656 as part B of two troubled debt restructuring. The remaining balances totaling $1.4 million were placed on nonaccrual status. Also included in the outstanding balance of loans on nonaccrual status is the outstanding balance of a partially charged-off loan transferred in 2009. The three loans are paying as agreed and the Company expects no principal loss. At September 30, 2009 only one loan was on nonaccrual status and was paid in full in December 2009.  While Management believes that the amount of the allowance at September 30, 2010 was adequate, there can be no assurances that future economic or other factors will not adversely affect the Companys borrowers, or that the Companys asset quality may not deteriorate through failure to identify and monitor potential problem loans or for other reasons, thereby causing loan losses to exceed the current allowance.   28


---



Investment Portfolio  The market value of the Companys investment portfolio at September 30, 2010 was $18.3 million having a tax equivalent yield of 3.43%. This compares to an investment portfolio of $7.9 million at December 31, 2009 having a 4.32% tax equivalent yield. The primary category of investment in the portfolio at September 30, 2010 was mortgage-backed securities. In the second quarter of 2010, the Company purchased one Federal agency and four mortgage-backed securities at $2.5 million each. There were no purchases in the first and third quarters of 2010. At September 30, 2010, approximately 8% of the mortgage-backed securities were tied to adjustable rate indices such as LIBOR or Constant Maturity Treasury (CMT). Management anticipates purchasing additional short-term investment securities and interest-bearing deposits in other banks until loan demand increases.  The following table summarizes the carrying value and market value and distribution of the Companys investment securities at September 30, 2010 and December 31, 2009:  September 30, 2010
     
     December 31, 2009Carrying
     
     Fair
     
     Carrying
     
     FairValue
     
     Value
     
     Value
     
     Value($ in thousands)Held to maturity:Municipal
     $          436
     
     $          442
     
     $          437
     
     $          439Federal Agency
     2,500
     
     2,560
     
     0
     
     0Mortgage-backed securities
     10,094
     
     10,317
     
     1,725
     
     1,760Corporate bonds
     82
     
     84
     
     130
     
     133Total held to maturity
     13,112
     
     13,403
     
     2,292
     
     2,332Available for sale:Municipal
     789
     
     789
     
     754
     
     754Mortgage-backed securities
     4,134
     
     4,134
     
     4,814
     
     4,814Total available for sale
     4,923
     
     4,923
     
     5,568
     
     5,568Total
     $     18,035
     
     $     18,326
     
     $       7,860
     
     $       7,900
   There were no material changes since December 31, 2009 in the maturities or repricing of the investment securities.  Deposits  Total deposits increased $9.5 million or 10.2% to $101.7 million at September 30, 2010 from $92.3 million at December 31, 2009 due to the increases in demand deposit, NOW and money market, and savings balances. Demand deposits increased $6.1 million or 16.9% from the December 31, 2009 balance of $35.9 million to $41.9 million as of September 30, 2010. NOW and money market balances increased $4.7 million or 15.2% to $35.9 million as of September 30, 2010 from $31.1 million at December 31, 2009. Savings deposits increased $333,682 or 33.3% to $1.3 million at September 30, 2010 from $1.0 million at December 31, 2009. Increases in these accounts were offset slightly by decreased balances in time deposits. Time deposits decreased $1.7 million or 6.9% to $22.6 million at September 30, 2010 from $24.3 million at December 31, 2009. The ratio of non-interest bearing funds to total deposits was 41.2% at September 30, 2010 and 38.9% at December 31, 2009. A comparative distribution of the Companys deposits at September 30, 2010 and December 31, 2009, by outstanding balance as well as by percentage of total deposits, is presented in the following table:   Distribution of Deposits and Percentage CompositionSeptember 30, 2010
     
     December 31, 2009Amount
     
     Percentage
     
     Amount
     
     Percentage($ in thousands)Demand
     $       41,938
     
     41.2%
     
     $       35,872
     
     38.9%NOW
     1,541
     
     1.5%
     
     1,579
     
     1.7%Savings
     1,337
     
     1.3%
     
     1,003
     
     1.1%Money Market
     34,345
     
     33.8%
     
     29,570
     
     32.0%Time Deposits < $100,000
     6,627
     
     6.5%
     
     6,723
     
     7.3%Time Deposits > $100,000
     15,957
     
     15.7%
     
     17,541
     
     19.0%$     101,745
     
     100.0%
     
     $       92,288
     
     100.0%
  29


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Deposits are the Companys primary source of funds. As the Companys need for lendable funds grows, dependence on deposits increases. Information concerning the average balance and average rates paid on deposits by deposit type for the three months and nine months ended September 30, 2010 and 2009 is contained in the Distribution, Yield and Rate Analysis of Net Interest Income tables appearing in a previous section titled Net Interest Income and Net Interest Margin. At September 30, 2010 and December 31, 2009, the Company had deposits from related parties representing 5.9% and 5.5% of total deposits of the Company, respectively. Further, at September 30, 2010 and December 31, 2009, deposits from escrow companies represented 10.6% and 12.0% of the Companys total deposits, respectively. There are some escrow company deposits which are also classified as deposits from related parties.  Borrowings  At September 30, 2010 the Company had no FHLB advances or overnight borrowings outstanding, as compared to $994,000 of FHLB borrowings outstanding at December 31, 2009.On December 21, 2005, the Company entered into a stand by letter of credit with the FHLB for $800,000, which matures and renews annually, as needed. This stand-by letter of credit was issued as collateral for local agency deposits that the Company is maintaining.  Stockholders Equity  Total stockholders equity was $7.0 million at September 30, 2010 and $6.5 million at December 31, 2009. The overall increase of $541,679 was due to net income of $249,519 plus option exercises of 82,541 shares, which increased stockholders equity by $733,195, including the tax benefit of $172,927; offset by a decrease of $460,537 resulting from stock repurchases of 31,712 shares, and a $19,501 change in the unrealized loss on investment securities.  Liquidity  Maintenance of adequate liquidity requires that sufficient resources be available at all times to meet the Companys cash flow requirements. Liquidity in a banking institution is required primarily to provide for deposit withdrawals and the credit needs of its customers and to take advantage of investment opportunities as they arise. Liquidity management involves the Companys ability to convert assets into cash or cash equivalents without significant loss, and to raise cash or maintain funds without incurring excessive additional cost. The Company maintains a portion of its funds in cash, deposits in other banks, overnight investments, and securities available for sale. Liquid assets include cash and due from banks, less the federal reserve requirement; Federal funds sold; interest-bearing deposits in financial institutions, and unpledged investment securities available for sale. At September 30, 2010, the Companys liquid assets totaled approximately $30.4 million and its liquidity level, measured as the percentage of liquid assets to total assets, was 27.0%. At December 31, 2009, the Companys liquid assets totaled approximately $34.1 million and its liquidity level, measured as the percentage of liquid assets to total assets, was 32.9%. Management anticipates that liquid assets and the liquidity level will decline as the Company becomes more leveraged in the future. The Companys current policy is to maintain a minimum liquidity ratio of at least 8%.   30


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Although the Companys primary sources of liquidity include liquid assets and a stable deposit base, the Company has Fed funds lines of credit of $3.5 million at Union Bank of California and $3.5 million at Pacific Coast Bankers Bank. In addition, as a member of the FHLB, the Bank may borrow funds collateralized by the Banks securities or qualified loans up to 25% of its eligible total asset base, or $28.3 million at September 30, 2010.  Capital Resources  The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can trigger mandatory and possibly additional discretionary actions by the regulators that, if undertaken, could have a material effect on the Banks financial condition and results of operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Banks assets, liabilities, and certain off-balance sheet items as calculated under regulatory accepted accounting practices. The Banks capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings, and other factors.  Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain the following minimum ratios: Total risk-based capital ratio of at least 8%, Tier 1 Risk-based capital ratio of at least 4%, and a leverage ratio of at least 4%. Total capital is classified into two components: Tier 1 (common shareholders equity, qualifying perpetual preferred stock to certain limits, minority interests in equity accounts of consolidated subsidiaries and trust preferred securities to certain limits, less goodwill and other intangibles) and Tier 2 (supplementary capital including allowance for possible credit losses to certain limits, certain preferred stock, eligible subordinated debt, and other qualifying instruments).  As discussed in Note 6 to the consolidated financial statements herein, the Companys subordinated note represents a $3.1 million borrowing from its unconsolidated subsidiary. This subordinated note currently qualifies for inclusion as Tier 1 capital for regulatory purposes to the extent that it does not exceed 25% of total Tier 1 capital, but is classified as long-term debt in accordance with generally accepted accounting principles. On March 1, 2005, the Federal Reserve Board adopted a final rule that allows the continued inclusion of trust-preferred securities (and/or related subordinated debentures) in the Tier 1 capital of bank holding companies. Generally, the amount of junior subordinated debentures in excess of the 25% Tier 1 limitation is included in Tier 2 capital. In July 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) was signed into law which, among other things, limits the ability for certain bank holding companies to treat trust preferred security debt issuances as Tier 1 capital. Since the Company had less than $15 billion in assets at December 31, 2009, under the Dodd-Frank Act, the Company will be able to continue to include its existing trust preferred securities in Tier 1 capital consistent with the FRB rule discussed immediately above. $2.2 million of the Companys subordinated note was included in Tier 1 capital at September 30, 2010 and the remainder was included in Tier 2 capital.  The Bank had Total Risk-Based and Tier 1 Risk-Based capital ratios of 13.93% and 12.68%, respectively at September 30, 2010, as compared to 14.01% and 12.75%, respectively at December 31, 2009. At September 30, 2010 and December 31, 2009, the Banks Leverage Capital Ratios were 8.81% and 8.94%, respectively. As of September 30, 2010 and December 31, 2009, the Bank was well-capitalized. To be categorized as well-capitalized the Bank must maintain Total Risk-Based, Tier 1 Risk-Based, and Tier 1 Leverage Ratios of at least 10%, 6% and 5%, respectively.  Under the Federal Reserve Boards guidelines, Chino Commercial Bancorp is a small bank holding company, and thus qualifies for an exemption from the consolidated risk-based and leverage capital adequacy guidelines applicable to bank holding companies with assets of $500 million or more. However, while not required to do so under the Federal Reserve Banks capital adequacy guidelines, the Company still maintains levels of capital on a consolidated basis which qualify it as well capitalized. As of September 30, 2010, the Companys Total Risk-Based and Tier 1 Risk-Based Capital ratios were 14.30% and 12.06%, respectively, and its Leverage Capital ratio was 8.39%.  The following table sets forth the Companys and the Banks regulatory capital ratios as of the dates indicated:  Regulatory Capital Ratios(unaudited)Minimum RequirementSeptember 30, 2010
     December 31, 2009
     to be Well CapitalizedChino Commercial BancorpTotal capital to total risk-weighted assets
     14.36%
     14.32%
     10.00%Tier 1 capital to total risk-weighted assets
     12.06%
     11.73%
     6.00%Tier 1 leverage ratio
     8.39%
     8.23%
     5.00%Chino Commercial BankTotal capital to total risk-weighted assets
     13.93%
     14.01%
     10.00%Tier 1 capital to total risk-weighted assets
     12.68%
     12.75%
     6.00%Tier 1 leverage ratio
     8.81%
     8.94%
     5.00%
  31


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Presently, there are no outstanding commitments that would necessitate the use of material amounts of the Companys capital.  Interest Rate Risk Management  The principal objective of interest rate risk management (often referred to as asset/liability management) is to manage the financial components of the Companys balance sheet so as to optimize the risk/reward equation for earnings and capital in relation to changing interest rates. In order to identify areas of potential exposure to rate changes, the Company calculates its repricing gap on a quarterly basis. It also performs an earnings simulation analysis and market value of portfolio equity calculation on a quarterly basis to identify more dynamic interest rate exposures than those apparent in standard repricing gap analyses.  The Company manages the balance between rate-sensitive assets and rate-sensitive liabilities being repriced in any given period with the objective of stabilizing net interest income during periods of fluctuating interest rates. Rate-sensitive assets either contain a provision to adjust the interest rate periodically or mature within one year. Those assets include certain loans, certain investment securities and federal funds sold. Rate-sensitive liabilities allow for periodic interest rate changes and include time certificates, certain savings and interest-bearing demand deposits. The difference between the aggregate amount of assets and liabilities that are repricing at various time frames is called the interest rate sensitivity gap. Generally, if repricing assets exceed repricing liabilities in any given time period, the Company would be deemed to be asset-sensitive for that period, and if repricing liabilities exceed repricing assets in any given period the Company would be deemed to be liability-sensitive for that period. The Company seeks to maintain a balanced position over the period of one year in which it has no significant asset or liability sensitivity, to ensure net interest margin stability in times of volatile interest rates. This is accomplished by maintaining a significant level of loans and deposits available for repricing within one year.  The Company is generally asset sensitive, meaning that, in most cases, net interest income tends to rise as interest rates rise and decline as interest rates fall. However, as explained further on, declines in interest rates would cause a slight increase in net interest income because over 87% of the Companys variable rate loans are at their floor with a weighted average yield of 7.35%. At September 30, 2010, approximately 64.1% of loans have terms that incorporate variable interest rates. Most variable rate loans are indexed to the Banks prime rate and changes occur as the prime rate changes. Approximately 13.0% of all fixed rate loans at September 30, 2010 mature within twelve months.  Regarding the investment portfolio, a preponderance of the portfolio consists of fixed rate products with typical average lives of between three and five years. The mortgage-backed security portfolio receives monthly principal repayments which has the effect of reducing the securities average lives as principal repayment levels may exceed expected levels. Additionally, agency securities contain options by the agency to call the security, which would cause repayment prior to scheduled maturity.  Liability costs are generally based upon, but not limited to, U.S. Treasury interest rates and movements and rates paid by local competitors for similar products.  The change in net interest income may not always follow the general expectations of an asset-sensitive or liability-sensitive balance sheet during periods of changing interest rates. This possibility results from interest rates earned or paid changing by differing increments and at different time intervals for each type of interest-sensitive asset and liability. Interest rate gaps arise when assets are funded with liabilities having different repricing


intervals. Since these gaps are actively managed and change daily as adjustments are made in interest rate views and market outlook, positions at the end of any period may not reflect the Companys interest rate sensitivity in subsequent periods. The Company attempts to balance longer-term economic views against prospects for short-term interest rate changes in all repricing intervals. As of September 30, 2010, the Company had the following estimated net interest income sensitivity profile:  32


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Immediate Change in Rate-300 bp
     
     -200 bp
     
     -100 bp
     
     +100 bp
     
     +200 bp
     
     +300 bpChange in net interest income (in $000s)
     $     147
     
     $     120
     
     $     (47)
     
     $     542
     
     $  1,026
     
     $  1,438% Change
     1.77%
     
     1.44%
     
     -0.56%
     
     6.52%
     
     12.33%
     
     17.29%
   The Company uses Risk Monitor software for asset/liability management in order to simulate the effects of potential interest rate changes on the Companys net interest margin. These simulations provide static information on the projected fair market value of the Companys financial instruments under differing interest rate assumptions. The simulation program utilizes specific loan and deposit maturities, embedded options, rates and re-pricing characteristics to determine the effects of a given interest rate change on the Companys interest income and interest expense. Rate scenarios consisting of key rate and yield curve projections are run against the Companys investment, loan, deposit and borrowed funds portfolios. The rate projections can be shocked (an immediate and sustained change in rates, up or down). As of September 30, 2010, there has been no material change in interest rate risk since December 31, 2009.  If rates were at higher levels, we would likely see minimal fluctuations in either declining or rising rate scenarios. However, net interest income increases slightly as rates decline because over 87% of the Companys variable rate loans are at their floor with a weighted average yield of 7.35%. Rates will continue to slowly decrease in deposits while a majority of the loan portfolio will remain at its floor. Prepayments on fixed-rate loans tend to increase as rates decline, although our model assumptions for declining rate scenarios include a presumed floor for the Banks prime lending rate that partially offsets other negative pressures. The economic (or fair) value of financial instruments on the Companys balance sheet will also vary under the interest rate scenarios previously discussed. This is measured by simulating changes in the Companys economic value of equity (EVE), which is calculated by subtracting the estimated fair value of liabilities from the estimated fair value of assets. Fair values for financial instruments are estimated by discounting projected cash flows (principal and interest) at current replacement rates for each account type, while fair values of non-financial assets and liabilities are assumed to equal book value and do not vary with interest rate fluctuations. An economic value simulation is a static measure for balance sheet accounts at a given point in time, but this measurement can change substantially over time as the characteristics of the Companys balance sheet evolve and as interest rate and yield curve assumptions are updated. The amount of change in economic value under different interest rate scenarios depends on the characteristics of each class of financial instrument, including the stated interest rate or spread relative to current market rates or spreads, the likelihood of prepayment, whether the rate is fixed or floating, and the maturity date of the instrument. As a general rule, fixed-rate financial assets become more valuable in declining rate scenarios and less valuable in rising rate scenarios, while fixed-rate financial liabilities gain in value as interest rates rise and lose value as interest rates decline. The longer the duration of the financial instrument, the greater the impact a rate change will have on its value. In our economic value simulations, estimated prepayments are factored in for financial instruments with stated maturity dates, and decay rates for non-maturity deposits are projected based on managements best estimates. We have found that model results are highly sensitive to changes in the assumed decay rate for non-maturity deposits, in particular. If a higher deposit decay rate is used the decline in EVE becomes more severe, while the slope of the EVE simulations conforms more closely to that of our net interest income simulations if non-maturity deposits do not run off. This is because our net interest income simulations incorporate growth rather than runoff for aggregate non-maturity deposits. The table below shows estimated changes in the Companys EVE as September 30, 2010, under different interest rate scenarios relative to a base case of current interest rates:    33


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Immediate Change in Rate-300 bp
     
     -200 bp
     
     -100 bp
     
     +100 bp
     
     +200 bp
     
     +300 bpChanges in EVE (in $000's)
     $  4,220
     
     $  2,652
     
     $  1,153
     
     $   (116)
     
     $   (999)
     
     $(1,840)% Change
     45.7%
     
     28.7%
     
     12.5%
     
     -1.3%
     
     -10.8%
     
     -19.9%
  The table shows a substantial increase in EVE as interest rates decline, and a corresponding decline as interest rates increase. Changes in EVE under varying interest rate scenarios are substantially different than changes in the Companys net interest income simulations, due primarily to runoff assumptions in non-maturity deposits.    34


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Item 3. QUALITATIVE & QUANTITATIVE DISCLOSURES ABOUT MARKET RISK  Not applicable.  Item 4: CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures The Companys Chief Executive Officer and its Chief Financial Officer, after evaluating the effectiveness of the Company's disclosure controls and procedures as defined in Exchange Act Rules 13a-15(e) promulgated under the Exchange Act as of the end of the period covered by this report (the "Evaluation Date"), have concluded that as of the Evaluation Date, the Companys disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company would be made known to them by others within the Company, particularly during the period in which this report was being prepared. Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure, and that such informa­tion is recorded, processed, summarized, and reported within the time periods specified by the SEC.  Changes in Internal Controls There were no significant changes in the Company's internal controls over financial reporting or in other factors in the third quarter of 2010 that have materially affected, or are reasonably likely to materially affect, the Companys internal controls over financial reporting.   35


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PART II  Item1:   Legal ProceedingsNone   Item 1A:  Risk FactorsNot applicable   Item 2:  Unregistered Sales of Equity Securities and Use of Proceeds  Stock Repurchases  On January 18, 2010, the Board of Directors authorized an extension and expansion of its current stock repurchase program (the Repurchase Program). Under this expansion, a total of $200,000 in repurchases of the Companys common stock has been approved, and the expiration date of the Repurchase program has been extended from February 20, 2010 to February 18, 2011. This expansion was effective as of January 18, 2010. On May 20, 2010, the Board of Directors approved an additional $400,000 to be used for repurchases of the Companys common stock. The Repurchase Program is designed to improve the Company's return on equity and earnings per share, and to provide an additional outlet for shareholders interested in selling their shares. Repurchases pursuant to the program are made at the prevailing market prices from time to time in open market transactions or in privately negotiated transactions. The timing of the purchases and the number of shares to be repurchased at any given time will depend on market conditions and SEC regulations. The following table provides information concerning the Companys repurchases of its common stock during the third quarter of 2010: July
     
     August
     
     SeptemberAverage per share price
     $               -
     
     $                -
     
     $          14.75Number of shares purchased as part of  publicly announced plan or program
     -
     
     -
     
     2,000Cumulative shares repurchased under program since Janaury 1, 2010
     29,712
     
     29,712
     
     31,712
     *Maximum number of shares (or approximate dollar value) remaining for purchase under a plan or program
     $     190,403
     
     $      190,403
     
     $      160,903
  *Includes 2,149 and 2,119 shares which were repurchased in June 2010 from Linda Cooper and Jeanette Young, respectively, both of whom are directors of the Bank and the Company, in private transactions. The shares were repurchased in connection with the exercise of stock options by Ms. Cooper and Ms. Young covering 4,671 and 4,605 shares, respectively of common stock. The initial repurchase price was $14.50 per share, subject to adjustment as described immediately below in order to ensure the fairness of the price to the Company. The Company anticipates commencing a public stock offering in the first half of 2011 of up to 139,592 shares of common stock on a subscription rights basis, with the subscription rights price to be at a modest discount to the then market price of the stock, and with shares not purchased on a rights basis to be offered at the full market price on a non-rights basis.  Following the close of the stock offering, the purchase price for the shares repurchased from the above-referenced directors will be adjusted if necessary such that the ultimate repurchase price for the shares will be identical to the shareholder subscription rights price in the offering. Depending upon whether that price ends up being more or less than $14.50 per share, the adjustment will be effectuated either by the Company's issuance of additional shares to the directors, or the Company's acquisition of additional shares from such directors, in either case without additional consideration. In the event that the offering is not successfully completed, the Company will instead obtain an independent valuation of the shares, and an adjustment to the repurchase price will be made on that basis if appropriate. Based on the above, the Board concluded that the transaction was fair to the Company and in the best interests of its shareholders. The terms of the transaction were approved by the Companys Board of Directors, with the interested directors abstaining.  36


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In addition, in June 2010 the Company repurchased an aggregate of 18,344 shares from Dann H. Bowman, Chief Executive Officer and a director of the Bank and the Company, in a series of private transactions. The shares were repurchased in connection with the exercise of stock options by Mr. Bowman covering a total of 45,413 shares of common stock. The initial repurchase price was 5,977 shares at $14.50 on June 18, 2010. The remaining 12,367 shares were repurchased at the reduced purchase price $14.25 per share in late June 2010. All repurchases of Mr. Bowmans shares are subject to adjustment on the same basis as described in the previous paragraph in order to ensure the fairness of the price to the Company. Based on the same criteria as described above, the Board concluded that the transaction was fair to the Company and in the best interests of its shareholders. The terms of the transaction were approved by the Companys Board of Directors, with Mr. Bowman abstaining.   Item 3:  Default of Senior Securities- None  Item 4:  (Removed and Reserved)  Item 5:  Other Information- None  Item 6:  Exhibits  3.1           Articles of Incorporation of Chino Commercial Bancorp (1) 3.2           Bylaws of Chino Commercial Bancorp (1) 10.1Chino Commercial Bank, N.A. Salary Continuation Plan (1) 10.2Salary Continuation and Split Dollar Agreements for Dann H. Bowman (1) 10.3Salary Continuation and Split Dollar Agreements for Roger Caberto (1) 10.4Item Processing Agreement between the Bank and InterCept Group (1) 10.5Data Processing Agreement between the Bank and InterCept Group (1) 10.62000 Stock Option Plan, as amended (2) 10.7Employment Agreement for Dann H. Bowman (3) 10.8Lease between Chino Commercial Bank, N.A. and Majestic Realty Co., as amended (4) 10.9Indenture dated as of October 27, 2006 between U.S. Bank National Association, as Trustee, and Chino Commercial Bancorp, as Issuer (4) 10.10Amended and Restated Declaration of Trust of Chino Statutory Trust I, dated as of October 27, 2006 (4) 10.11Guarantee Agreement between Chino Commercial Bancorp and U.S. Bank National Association dated as of October 27, 2006 (4) 10.12Amendment to Salary Continuation Agreement for Dann H. Bowman (5) 10.13Amendment to Salary Continuation Agreement for Roger Caberto (5) 11            Statement Regarding Computation of Net Income per Share (6) 31.1Certification of Chief Executive Officer (Section 302 Certification) 31.2Certification of Chief Financial Officer (Section 302 Certification) 32            Certification of Periodic Financial Report (Section 906 Certification)  (1)Incorporated by reference to the exhibit of the same number to the Companys Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on July 5, 2006. (2)Incorporated by reference to exhibit 10.1 to the Companys Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2010. (3)Incorporated by reference to exhibit 10.4 to the Companys Form 8-K Current Report filed with the Securities and Exchange Commission on November 13, 2009. (4)Incorporated by reference to the exhibit of the same number to the Companys Quarterly Report on Form 10-QSB for the quarterly period ended September 30, 2006. (5)Incorporated by reference to the exhibit of the same number to the Companys on Form 10-K for the year ended December 31, 2008. (6)This information required by this exhibit is incorporated from Note 8 of the Companys Consolidated Financial Statements included herein    37


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SIGNATURES  Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.   Dated:  November 15, 2010CHINO COMMERCIAL BACORP   By:/s/ Dann H. Bowman Dann H. Bowman President and Chief Executive Officer   By:/s/ Sandra F. Pender Sandra F. Pender Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)          38


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