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EX-32.1 - EXHIBIT 32.1 - AMERICAN RIVER BANKSHARESex32_1.htm
EX-31.2 - EXHIBIT 31.2 - AMERICAN RIVER BANKSHARESex31_2.htm
EX-31.1 - EXHIBIT 31.1 - AMERICAN RIVER BANKSHARESex31_1.htm
 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended           June 30, 2016

 

or

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                                                                                           to    

 

Commission File Number: 0-31525

 

AMERICAN RIVER BANKSHARES
(Exact name of registrant as specified in its charter)

 

California  68-0352144
(State or other jurisdiction of incorporation or organization)  (I.R.S. Employer Identification No.)
    

 

3100 Zinfandel Drive, Suite 450, Rancho Cordova, California  95670
(Address of principal executive offices)  (Zip Code)

 

(916) 851-0123
(Registrant’s telephone number, including area code)
 
Not Applicable
(Former name, former address and former fiscal year, if changed since last report.)

 

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

Yes x No o

 

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 x No o

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

 

  Large accelerated filer o Accelerated filer o
  Non-accelerated filer x (Do not check if a smaller reporting company) Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

No par value Common Stock – 6,656,594 shares outstanding at August 8, 2016.

 
 

AMERICAN RIVER BANKSHARES

 

INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2016

Part I.    Page
   Item 1. Financial Statements   3
   Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 29
   Item 3. Quantitative and Qualitative Disclosures About Market Risk 49
   Item 4. Controls and Procedures 49
     
Part II.    
     
   Item 1. Legal Proceedings 50
   Item 1A. Risk Factors 50
   Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 50
   Item 3. Defaults Upon Senior Securities 51
   Item 4. Mine Safety Disclosures 51
   Item 5. Other Information 51
   Item 6. Exhibits 51
     
Signatures 56
   

Exhibit Index

 

57
31.1

Certifications of Chief Executive Officer pursuant to Section 302 of

the Sarbanes-Oxley Act of 2002

 

58

31.2

Certifications of the Chief Financial Officer pursuant to Section 302

of the Sarbanes-Oxley Act of 2002

 

59

32.1 Certification of American River Bankshares by its Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

60

       
   101.INS XBRL Instance Document
   101.SCH XBRL Taxonomy Extension Schema
   101.CAL XBRL Taxonomy Extension Calculation
   101.DEF XBRL Taxonomy Extension Definition
   101.LAB XBRL Taxonomy Extension Label
   101.PRE XBRL Taxonomy Extension Presentation

2
 

PART I-FINANCIAL INFORMATION

Item 1. Financial Statements.

 

AMERICAN RIVER BANKSHARES

CONSOLIDATED BALANCE SHEET

(Unaudited)

 

(dollars in thousands) 

June 30,

2016

  

December 31,

2015

 
ASSETS
          
           
Cash and due from banks  $22,671   $23,727 
Interest-bearing deposits in banks
   999    750 
Investment securities:          
Available-for-sale, at fair value   254,483    273,819 
Held-to-maturity, at amortized cost   540    623 
Loans and leases, less allowance for loan and lease losses of $5,132 at June 30, 2016 and $4,975 at December 31, 2015   305,088    289,102 
Premises and equipment, net   1,305    1,407 
Federal Home Loan Bank stock   3,779    3,779 
Goodwill and other intangible assets   16,321    16,321 
Other real estate owned   896    3,551 
Bank owned life insurance   14,643    14,483 
Accrued interest receivable and other assets   5,086    7,078 
   $625,811   $634,640 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
           
Deposits:          
Noninterest bearing   $195,903   $190,548 
Interest-bearing   330,030    340,142 
Total deposits   525,933    530,690 
           
Short-term borrowings   5,000    3,500 
Long-term borrowings   6,000    7,500 
Accrued interest payable and other liabilities   5,312    6,875 
           
Total liabilities    542,245    548,565 
           
Shareholders’ equity:          
Preferred stock, no par value; 20,000,000 shares authorized; none outstanding          
Common stock, no par value; 20,000,000 shares authorized; issued and outstanding – 6,655,980 shares at June 30, 2016 and 7,343,649 shares at December 31, 2015   42,311    49,554 
Retained earnings   37,094    34,418 
Accumulated other comprehensive income, net of taxes   4,161    2,103 
           
Total shareholders’ equity   83,566    86,075 
   $625,811   $634,640 

 

See Notes to Unaudited Consolidated Financial Statements

3
 

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF INCOME

(Unaudited)

 

(dollars in thousands, except per share data)                
For the periods ended June 30,  Three months    Six months 
   2016   2015   2016   2015 
Interest income:                    
Interest and fees on loans:                    
Taxable  $3,445   $3,339   $6,807   $6,719 
Exempt from Federal income taxes   173    85    345    123 
Interest on deposits in banks   2    1    3    2 
Interest and dividends on investment securities:                    
Taxable   1,441    1,657    2,993    3,073 
Exempt from Federal income taxes   162    191    346    381 
Dividends   6    10    11    10 
Total interest income   5,229    5,283    10,505    10,185 
Interest expense:                    
Interest on deposits   182    208    366    422 
Interest on borrowings   39    36    89    70 
Total interest expense   221    244    455    492 
                     
Net interest income   5,008    5,039    10,050    9,693 
Provision for loan and lease losses                
                     
Net interest income after provision for loan and lease losses   5,008    5,039    10,050    9,693 
Noninterest income:                    
Service charges on deposit accounts   127    127    256    244 
(Loss) gain on sale, call, or impairment of securities   (1)   51    281    218 
Rental income from other real estate owned       90    106    161 
Other noninterest income   237    239    474    469 
Total noninterest income   363    507    1,117    1,092 
                     
Noninterest expense:                    
Salaries and employee benefits   2,101    2,045    4,261    4,315 
Occupancy   292    301    590    594 
Furniture and equipment   163    179    328    356 
Federal Deposit Insurance Corporation assessments   76    76    156    156 
Expenses related to other real estate owned   20    55    360    202 
Other expense   763    759    1,511    1,605 
Total noninterest expense   3,415    3,415    7,206    7,228 
                     
Income before provision for income taxes   1,956    2,131    3,961    3,557 
                     
Provision for income taxes   652    745    1,285    1,215 
                     
Net income  $1,304   $1,386   $2,676   $2,342 
                     
Basic earnings per share  $0.19   $0.18   $0.39   $0.30 
Diluted earnings per share  $0.19   $0.18   $0.39   $0.30 
                     
Cash dividends per share  $0.00   $0.00   $0.00   $0.00 

 

 

See notes to Unaudited Consolidated Financial Statements

4
 

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(Unaudited)

 

(dollars in thousands, except per share data)                
For the periods ended June 30,  Three months   Six months 
   2016   2015   2016   2015 
                 
Net income  $1,304   $1,386   $2,676   $2,342 
Other comprehensive income (loss):                    
Increase (decrease) in net unrealized gains on investment securities   810    (1,847)   3,712    254 
Deferred tax (expense) benefit   (324)   739    (1,485)   (102)
Increase (decrease) in net unrealized gains on investment securities, net of tax   486    (1,108)   2,227    152 
                     
Reclassification adjustment for realized losses (gains) included in net income   1    (51)   (281)   (218)
Tax effect       20    112    87 
Realized losses (gains), net of tax   1    (31)   (169)   (131)
                     
Total other comprehensive gain (loss) income   487    (1,139)   2,058    21 
                     
Comprehensive income  $1,791   $247   $4,734   $2,363 

 

See Notes to Unaudited Consolidated Financial Statements

5
 

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

 

               Accumulated     
(dollars in thousands)  Common Stock       Other   Total 
           Retained   Comprehensive   Shareholders’ 
   Shares   Amount   Earnings   Income   Equity 
Balance, January 1, 2015   8,089,615    57,126    29,150    3,371    89,647 
                          
Net income             2,342         2,342 
Other comprehensive income, net of tax:                         
Net change in unrealized gains on available-for-sale investment securities                  21    21 
                          
Net restricted stock award activity and related compensation expense   45,023    111              111 
                          
Stock option compensation expense        15              15 
Retirement of common stock   (404,481)   (3,945)             (3,945)
                          
Balance, June 30, 2015   7,730,157   $53,307   $31,492   $3,392   $88,191 
                          
Balance, January 1, 2016   7,343,649    49,554    34,418    2,103    86,075 
Net income             2,676         2,676 
Other comprehensive income, net of tax:                         
Net change in unrealized gains on available-for-sale investment securities                  2,058    2,058 
                          
Net restricted stock award activity and related compensation expense   28,728    147              147 
Stocks option exercised and compensation expense   500    24              24 
Retirement of common stock   (716,897)   (7,414)             (7,414)
                          
Balance, June 30, 2016   6,655,980   $42,311   $37,094   $4,161   $83,566 

 

See Notes to Unaudited Consolidated Financial Statements

6
 

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)

 

        
(dollars in thousands)        
For the six months ended June 30,  2016   2015 
         
Cash flows from operating activities:          
Net income  $2,676   $2,342 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan and lease losses        
Increase (decrease) in deferred loan origination fees, net   26    (29)
Depreciation and amortization   220    212 
Gain on sale, call, and impairment of investment securities, net   (281)   (218)
Amortization of investment security premiums and discounts, net   1,422    1,798 
Increase in cash surrender values of life insurance policies   (160)   (159)
Stock based compensation expense   167    126 
Loss/gain on sale/write-down of other real estate owned   259    68 
Decrease in accrued interest receivable and other assets   621    162 
Decrease in accrued interest payable and other liabilities   (1,563)   (698)
           
Net cash provided by operating activities   3,387    3,503 
           
Cash flows from investing activities:          
Proceeds from the sale of available-for-sale investment securities   8,287    15,383 
Proceeds from matured available-for-sale investment securities   600     
Purchases of available-for-sale investment securities   (8,875)   (28,393)
Proceeds from principal repayments for available-for-sale investment securities   21,612    24,317 
Proceeds from principal repayments for held-to-maturity investment securities   83    122 
Net increase in interest-bearing deposits in banks   (249)    
Net increase in loans   (14,326)   (17,267)
Proceeds from sale of other real estate   710    924 
Capitalized additions to other real estate       (126)
Net increase in FHLB stock       (93)
Purchases of equipment   (118)   (155)
           
Net cash provided by (used in) investing activities   7,724    (5,288)

7
 

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
(Unaudited)

 

        
(dollars in thousands)        
For the six months ended June 30,  2016   2015 
         
Cash flows from financing activities:          
Net (decrease) increase in demand, interest-bearing and savings deposits  $(2,785)  $1,343 
Net decrease in time deposits   (1,972)   (53)
Net increase in short-term borrowings   1,500     
Net decrease in long-term borrowings   (1,500)    
Proceeds from stock option exercise   4     
Cash paid to repurchase common stock   (7,414)   (3,945)
           
Net cash used in financing activities  $(12,167)  $(2,655)
           
Decrease in cash and cash equivalents   (1,056)   (4,440)
           
Cash and cash equivalents at beginning of year   23,727    22,449 
           
Cash and cash equivalents at end of period  $22,671   $18,009 

  

See Notes to Unaudited Consolidated Financial Statements 

8
 

AMERICAN RIVER BANKSHARES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2016

 

1. CONSOLIDATED FINANCIAL STATEMENTS

 

In the opinion of management, the unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the consolidated financial position of American River Bankshares (the “Company:”) at June 30, 2016 and December 31, 2015, the results of its operations and statement of comprehensive income for the three-month and six-month periods ended June 30, 2016 and 2015, its cash flows for the six-month periods ended June 30, 2016 and 2015 and its statement of changes in shareholders’ equity for the six months ended June 30, 2016 and 2015 in conformity with accounting principles generally accepted in the United States of America.

 

Certain disclosures normally presented in the notes to the annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. The Company believes that the disclosures are adequate to make the information not misleading. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2015. The results of operations for the three-month and six-month periods ended June 30, 2016 may not necessarily be indicative of the operating results for the full year.

 

In preparing such financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant changes in the near term relate to the determination of the allowance for loan and lease losses, the provision for taxes, the valuation of goodwill and the estimated fair value of investment securities, impaired loans and other real estate owned.

 

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

 

2. STOCK-BASED COMPENSATION 

Equity Plans

On March 17, 2010, the Board of Directors adopted the 2010 Equity Incentive Plan (the “2010 Plan”). The 2010 Plan was approved by the Company’s shareholders on May 20, 2010. In 2000, the Board of Directors adopted and the Company’s shareholders approved a stock option plan (the “2000 Plan”), under which 119,237 options remain outstanding at June 30, 2016. At June 30, 2016, under the 2010 Plan, there were 76,461 stock options and 68,025 restricted shares outstanding and the total number of authorized shares that remain available for issuance was 1,377,766. The 2010 Plan provides for the following types of stock-based awards: incentive stock options; nonqualified stock options; stock appreciation rights; restricted stock; restricted performance stock; unrestricted Company stock; and performance units. Awards under the 2000 Plan were either incentive stock options or nonqualified stock options. Under the 2010 Plan, the awards may be granted to employees and directors under incentive and nonqualified option agreements, restricted stock agreements, and other awards agreements. The 2010 Plan and the 2000 Plan (collectively the “Plans”) require that the option price may not be less than the fair market value of the stock at the date the option is awarded. The option awards under the Plans expire on dates determined by the Board of Directors, but not later than ten years from the date of award. The vesting period is generally five years; however, the vesting period can be modified at the discretion of the Company’s Board of Directors. Outstanding option awards under the Plans are exercisable until their expiration, however, no new options will be awarded under the 2000 Plan. New shares are issued upon exercise of an option.

9
 

The award date fair value of awards is determined by the market price of the Company’s common stock on the date of award and is recognized ratably as compensation expense or director expense over the vesting periods. The shares of common stock awarded pursuant to such agreements vest in increments over one to five years from the date of award. The shares awarded to employees and directors under the restricted stock agreements vest on the applicable vesting dates only to the extent the recipient of the shares is then an employee or a director of the Company or one of its subsidiaries, and each recipient will forfeit all of the shares that have not vested on the date his or her employment or service is terminated.

Equity Compensation

For the three-month periods ended June 30, 2016 and 2015, the compensation cost recognized for equity compensation was $85,000 and $71,000, respectively. The recognized tax benefit for equity compensation expense was $30,000 and $25,000, respectively, for the three-month periods ended June 30, 2016 and 2015. For the six-month periods ended June 30, 2016 and 2015, the compensation cost recognized for equity compensation was $167,000 and $126,000, respectively. The recognized tax benefit for equity compensation expense was $59,000 and $45,000, respectively, for the six-month periods ended June 30, 2016 and 2015.

At June 30, 2016, the total compensation cost related to nonvested stock option awards not yet recorded was $119,000. This amount will be recognized over the next 4.0 years and the weighted average period of recognizing these costs is expected to be 2.1 years. At June 30, 2016, the total compensation cost related to restricted stock awards not yet recorded was $520,000. This amount will be recognized over the next 5.0 years and the weighted average period of recognizing these costs is expected to be 1.8 years.

Equity Plans Activity

Stock Options

There were no stock options awarded during the three-month and six-month periods ended June 30, 2016. There were 26,427 stock options awarded during the three-month and six-month periods ended June 30, 2015 at an average exercise price of $9.56. The weighted average award date fair value of options awarded for the three-month and six-month periods ended June 30, 2015 was $3.24. A summary of option activity under the Plans as of June 30, 2016 and changes during the period then ended is presented below:

Options  Shares   Weighted
Average
Exercise
Price
   Weighted
Average
Remaining
Contractual
Term
   Aggregate
Intrinsic
Value ($000)
 
Outstanding at January 1, 2016   248,411   $15.19    3.7 years   $232 
Awarded                
Exercised   500    8.50         
Expired, forfeited or cancelled   52,213    23.09         
Outstanding at June 30, 2016   195,698   $13.09    4.1 years   $190 
Vested at June 30, 2016   151,454   $14.28    2.8 years   $136 
Non-vested at June 30, 2016   44,244   $9.05    8.2 years   $54 

 

Restricted Stock

 

There were 11,923 and 29,756 shares of restricted stock awarded during the three-month and six-month periods ended June 30, 2016, respectively. There were 24,491 and 45,023 shares of restricted stock awarded during the three-month and six-month periods ended June 30, 2015, respectively.

10
 

Restricted Stock       Shares        Weighted
Average Award
Date Fair Value
 
Nonvested at January 1, 2016   57,516   $9.21 
Awarded   29,756    10.26 
Less:  Vested   18,219    9.30 
Less:  Expired, forfeited or cancelled   1,028    9.23 
Nonvested at June 30, 2016   68,025   $9.65 

 

Other Equity Awards

 

There were no stock appreciation rights; restricted performance stock; unrestricted Company stock; or performance units awarded during the three-month or six-month month periods ended June 30, 2016 or 2015 or outstanding at June 30, 2016 or December 31, 2015.

 

The intrinsic value used for stock options and restricted stock awards was derived from the market price of the Company’s common stock of $10.26 as of June 30, 2016.

 

3. COMMITMENTS AND CONTINGENCIES

 

In the normal course of business there are outstanding various commitments to extend credit which are not reflected in the financial statements, including loan commitments of approximately $25,804,000 and standby letters of credit of approximately $238,000 at June 30, 2016 and loan commitments of approximately $26,730,000 and standby letters of credit of approximately $238,000 at December 31, 2015. Such commitments relate primarily to real estate construction loans, revolving lines of credit and other commercial loans. However, all such commitments will not necessarily culminate in actual extensions of credit by the Company during 2016 as some of these are expected to expire without being fully drawn upon.

 

Standby letters of credit are commitments issued to guarantee the performance or financial obligation of a client to a third party. These guarantees are issued primarily relating to purchases of inventory, insurance programs, performance obligations to government agencies, or as security for real estate rents by commercial clients and are typically short-term in nature. Credit risk is similar to that involved in extending loan commitments to clients and accordingly, evaluation and collateral requirements similar to those for loan commitments are used. The majority of all such commitments are collateralized. The fair value of the liability related to these standby letters of credit, which represents the fees received for issuing the guarantees, was not significant at June 30, 2016 or December 31, 2015.

4. EARNINGS PER SHARE COMPUTATION

 

Basic earnings per share is computed by dividing net income by the weighted average common shares outstanding for the period (6,717,456 and 6,906,620 shares for the three-month and six-month periods ended June 30, 2016, and (7,659,883 and 7,740,320 shares for the three-month and six-month periods ended June 30, 2015). Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock, such as stock options or restricted stock, result in the issuance of common stock. Diluted earnings per share is computed by dividing net income by the weighted average common shares outstanding for the period plus the dilutive effect of stock based awards. There were 28,643 and 26,815, respectively, dilutive shares for the three-month and six-month periods ended June 30, 2016 and 14,828 and 13,999, respectively, dilutive shares for the three-month and six-month periods ended June 30, 2015. For the three-month periods ended June 30, 2016 and 2015, there were 105,844 and 214,066 stock options, respectively, that were excluded from the calculation as they were considered antidilutive. For the six-month periods ended June 30, 2016 and 2015, there were 138,549 and 214,066 stock options, respectively, that were excluded from the calculation as they were considered antidilutive. Earnings per share is retroactively adjusted for stock dividends and stock splits, if applicable, for all periods presented.

11
 

5. INVESTMENT SECURITIES

The amortized cost and estimated fair values of Available-for-Sale and Held-to-Maturity investment securities at June 30, 2016 and December 31, 2015 consisted of the following (dollars in thousands):

 

Available-for-Sale

 

   June 30, 2016 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair
Value
 
Debt securities:                    
U.S. Government Agencies and Sponsored Agencies  $223,053   $5,769   $(100)  $228,722 
Obligations of states and political subdivisions   22,945    1,204    (6)   24,143 
Corporate bonds   1,501    36        1,537 
Equity securities:                    
Corporate stock   49    32        81 
   $247,548   $7,041   $(106)  $254,483 
                     
   December 31, 2015 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair
Value
 
Debt securities:                    
U.S. Government Agencies and Sponsored Agencies  $244,056   $3,059   $(930)  $246,185 
Obligations of states and political subdivisions   24,706    1,307        26,013 
Corporate bonds   1,502    49        1,551 
Equity securities:                    
Corporate stock   51    19        70 
   $270,315   $4,434   $(930)  $273,819 

Net unrealized gains on available-for-sale investment securities totaling $6,935,000 were recorded, net of $2,774,000 in tax liabilities, as accumulated other comprehensive income within shareholders’ equity at June 30, 2016. There were no sales or calls of available-for-sale investment securities for the three-month period ended June 30, 2016, however, there was an impairment loss of one security resulting in the write-down of the remaining balance of $1,000, and for the six-month period ended June 30, 2016 proceeds and gross realized gains from the sale, call, and impairment of available-for-sale investment securities totaled $8,287,000 and $281,000, respectively. There were no transfers of available-for-sale investment securities for the three-month and six-month periods ended June 30, 2016.

Net unrealized gains on available-for-sale investment securities totaling $3,504,000 were recorded, net of $1,401,000 in tax liabilities, as accumulated other comprehensive income within shareholders’ equity at December 31, 2015. Proceeds and gross realized gains from the sale and call of available-for-sale investment securities for the three-month period ended June 30, 2015 totaled $5,473,000 and $51,000, respectively, and for the six-month period ended June 30, 2015 totaled $15,383,000 and $218,000, respectively. There were no transfers of available-for-sale investment securities for the three-month and six-month periods ended June 30, 2015.

12
 

Held-to-Maturity

June 30, 2016                
       Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
Debt securities:                    
U.S. Government Agencies and Sponsored Agencies  $540   $44   $   $584 
                 
December 31, 2015      Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
Debt securities:                    
U.S. Government Agencies and Sponsored Agencies  $623   $46   $   $669 

 

There were no sales or transfers of held-to-maturity investment securities for the periods ended June 30, 2016 and June 30, 2015. Investment securities with unrealized losses at June 30, 2016 and December 31, 2015 are summarized and classified according to the duration of the loss period as follows (dollars in thousands):

June 30, 2016  Less than 12 Months   12 Months or More   Total 
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
Available-for-Sale                             
                               
Debt securities:                              
U.S. Government Agencies and Sponsored Agencies  $2,058   $(18)   9,822    (82)  $11,880   $(100)
Obligations of states and political subdivisions   1,433    (6)           1,433    (6)
   $3,491   $(24)  $9,822   $(82)  $13,313   $(106)
             
December 31, 2015  Less than 12 Months   12 Months or More   Total 
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
Available-for-Sale                             
                               
Debt securities:                              
US Government Agencies and Sponsored Agencies  $93,265   $(813)  $5,251   $(117)  $98,516   $(930))
Obligations of states and political subdivisions                        
   $93,265   $(813)  $5,251   $(117)  $98,516   $(930)

There were no held-to-maturity investment securities with unrealized losses as of June 30, 2016 or December 31, 2015. At June 30, 2016, the Company held 213 securities of which four were in a loss position for less than twelve months and six were in a loss position for twelve months or more.  Of the four securities in a loss position for less than twelve months, two were U.S. Government Agencies and Sponsored Agencies securities and two were obligations of states or political subdivisions and of the six securities that were in a loss position for greater than twelve months, all six were U.S. Government Agencies and Sponsored Agencies securities.

 

At December 31, 2015, the Company held 223 securities of which 45 were in a loss position for less than twelve months and three were in a loss position for twelve months or more.  Of the 45 securities in a loss position for less than twelve months, all were US Government Agencies and Sponsored Agencies securities and of the three securities that were in a loss position for greater than twelve months, all were US Government Agencies and Sponsored Agencies. 

13
 

The unrealized loss on the Company’s investment securities is primarily driven by interest rates.  Because the decline in market value is attributable to a change in interest rates and not credit quality, and because the Company has the ability and intent to hold these investments until recovery of fair value, which may be until maturity, management does not consider these investments to be other-than-temporarily impaired.

The amortized cost and estimated fair values of investment securities at June 30, 2016 by contractual maturity are shown below (dollars in thousands).

   Available-for-Sale   Held-to-Maturity 
   Amortized
Cost
   Estimated
Fair
Value
   Amortized
Cost
   Estimated
Fair
Value
 
                 
Within one year  $2,430   $2,479           
After one year through five years   3,697    3,806           
After five years through ten years   11,662    12,563           
After ten years   6,657    6,832           
    24,446    25,680           
                     
Investment securities not due at a single maturity date:                    
US Government Agencies and Sponsored Agencies   223,053    228,722   $540   $584 
Corporate stock   49    81         
   $247,548   $254,483   $540   $584 

Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.

6. IMPAIRED AND NONPERFORMING LOANS AND LEASES AND OTHER REAL ESTATE OWNED

At June 30, 2016 and December 31, 2015, the recorded investment in nonperforming loans and leases was approximately $1,055,000 and $1,643,000, respectively. Nonperforming loans and leases include all such loans and leases that are either placed on nonaccrual status or are 90 days past due as to principal or interest but still accrue interest because such loans are well-secured and in the process of collection. The Company considers a loan to be impaired when, based on current information and events, it is probable that it will be unable to collect all amounts due (principal and interest) according to the contractual terms of the original loan agreement. At June 30, 2016, the recorded investment in loans and leases that were considered to be impaired totaled $20,832,000, which includes $1,029,000 in nonaccrual loans and leases and $19,803,000 in performing loans and leases. Of the total impaired loans of $20,832,000, loans totaling $11,980,000 were deemed to require no specific reserve and loans totaling $8,852,000 were deemed to require a related valuation allowance of $904,000. At December 31, 2015, the recorded investment in loans and leases that were considered to be impaired totaled $21,365,000 and had a related valuation allowance of $899,000.

At June 30, 2016 and December 31, 2015, the balance in other real estate owned (“OREO”) was $896,000 and $3,551,000, respectively. At June 30, 2016, the Company did not own any residential OREO properties nor was there any residential properties in the process of foreclosure. During the first quarter of 2016, the Company sold a single commercial property in El Dorado County for a gain of $117,000. Also, during the first quarter the Company obtained an updated appraisal on existing commercial land in Sacramento County, which resulted in a charge to expense of $376,000. The Company did not add any properties to OREO during the first quarter of 2016. During the second quarter of 2016, the Company did not add any properties to OREO or sell any OREO property.

 

The June 30, 2016 OREO balance of $896,000 consists of two properties, one of which is commercial real estate in the amount of $243,000 and the other is commercial land in the amount of $653,000. 

14
 

Nonperforming assets at June 30, 2016 and December 31, 2015 are summarized as follows:

(dollars in thousands)  June 30, 2016       December 31, 2015 
         
Nonaccrual loans and leases that are current to terms (less than 30 days past due)  $643   $379 
  Nonaccrual loans and leases that are past due   412    1,264 
  Loans and leases past due 90 days and accruing interest        
  Other assets   878    878 
  Other real estate owned   896    3,551 
Total nonperforming assets  $2,829   $6,072 
           
Nonperforming loans and leases to total loans and leases   0.34%   0.56%
Total nonperforming assets to total assets   0.45%   0.96%

Impaired loans and leases as of and for the periods ended June 30, 2016 and December 31, 2015 are summarized as follows:

(dollars in thousands)  As of June 30, 2016   As of December 31, 2015 
  

 

Recorded

Investment

  

Unpaid Principal

Balance

  

 

Related

Allowance

  

 

Recorded

Investment

  

Unpaid Principal

Balance

  

 

Related

Allowance

 
With no related allowance recorded:                              
                               
Commercial   $   $   $   $   $   $ 
Real estate-commercial   11,643    12,276        12,269    12,902     
Real estate-residential   337    424        338    338     
Subtotal  $11,980   $12,700   $   $12,607   $13,240   $ 
                               
With an allowance recorded:                              
Commercial   $91   $91   $11   $121   $121   $25 
Real estate-commercial   6,013    6,107    675    5,597    5,693    598 
Real estate-multi-family   485    485    4    488    488    5 
Real estate-residential   1,838    1,838    151    2,114    2,201    204 
Agriculture   364    364    37    370    370    38 
Consumer   61    61    26    68    68    29 
Subtotal  $8,852   $8,946   $904   $8,758   $8,941   $899 
                               
Total:                              
                               
Commercial   $91   $91   $11   $121   $121   $25 
Real estate-commercial   17,656    18,383    675    17,866    18,595    598 
Real estate-multi-family   485    485    4    488    488    5 
Real estate-residential   2,175    2,262    151    2,452    2,539    204 
Agriculture   364    364    37    370    370    38 
Consumer   61    61    26    68    68    29 
   $20,832   $21,646   $904   $21,365   $22,181   $899 

 

15
 

The following table presents the average balance related to impaired loans and leases for the periods indicated (dollars in thousands):

 

   Average Recorded Investments
for the three months ended
   Average Recorded Investments
for the six months ended
 
   June 30, 2016   June 30, 2015   June 30, 2016   June 30, 2015 
                 
Commercial   $80   $757   $100   $794 
Real estate-commercial   16,878    19,796    17,021    19,383 
Real estate-multi-family   491    492    495    494 
Real estate-residential   2,216    2,840    2,236    2,848 
Agriculture   373    377    378    378 
Consumer   76    132    77    115 
     Total  $20,114   $24,394   $20,307   $24,012 

The following table presents the interest income recognized on impaired loans and leases for the periods indicated (dollars in thousands):

   Interest Income Recognized
for the three months ended
   Interest Income Recognized
for the six months ended
 
   June 30, 2016   June 30, 2015   June 30, 2016   June 30, 2015 
                 
Commercial   $2   $3   $3   $5 
Real estate-commercial   259    216    444    472 
Real estate-multi-family   2    7    10    12 
Real estate-construction                
Real estate-residential   31    32    52    63 
Agriculture   5    5    10    8 
Consumer               1 
     Total  $299   $263   $519   $561 

 

7. TROUBLED DEBT RESTRUCTURINGS

During the three and six-month periods ended June 30, 2016, there were no loans that were modified as troubled debt restructurings.

 

The following table presents loans by class modified as troubled debt restructurings during the three months ended June 30, 2015 (dollars in thousands): 

       Pre-   Post- 
       Modification   Modification 
       Outstanding   Outstanding 
   Number   Recorded   Recorded 
   of Loans   Investment   Investment 
             
Troubled debt restructurings:               
Commercial   1   $47   $47 
Real estate – commercial   2    1,650    1,650 
Real estate – residential   1    255    255 
Consumer   1    23    23 
Total   5   $1,975   $1,975 

16
 

The following table presents loans by class modified as troubled debt restructurings during the six months ended June 30, 2015 (dollars in thousands): 

 

       Pre-   Post- 
       Modification   Modification 
       Outstanding   Outstanding 
   Number   Recorded   Recorded 
   of Loans   Investment   Investment 
             
Troubled debt restructurings:               
Commercial   1   $47   $47 
Real estate – commercial   4    2,167    2,167 
Real estate – residential   1    255    255 
Consumer   1    23    23 
Total   7   $2,492   $2,492 

 

The troubled debt restructurings described above increased the allowance for loan and lease losses by $170,000 and resulted in no charge-offs during the six months ended June 30, 2015.

 

There were no payment defaults on troubled debt restructurings within 12 months following the modification for the three-month and six-month periods ended June 30, 2015 and June 30, 2016.

 

8. ALLOWANCE FOR LOAN AND LEASE LOSSES

 

The Company’s loan and lease portfolio allocated by management’s internal risk ratings as of June 30, 2016 and December 31, 2015 are summarized below:

 

June 30, 2016  Credit Risk Profile by Internally Assigned Grade 
(dollars in thousands)      Real Estate 
   Commercial   Commercial   Multi-family   Construction   Residential 
Grade:                         
   Pass  $32,574   $175,479   $35,038   $3,917   $13,361 
   Watch   782    21,160    487    9,878    1,810 
   Special mention       6,169            385 
   Substandard   2,837    631            804 
   Doubtful                    
          Total  $36,193   $203,439   $35,525   $13,795   $16,360 
                 
   Credit Risk Profile by Internally Assigned Grade Other Credit Exposure             
   Leases   Agriculture   Consumer           Total 
Grade:                            
   Pass  $534   $1,953   $1,455           $264,311 
   Watch       364    296            34,777 
   Special mention           433            6,987 
   Substandard           120            4,392 
   Doubtful                        
          Total  $534   $2,317   $2,304           $310,467 

17
 
December 31, 2015  Credit Risk Profile by Internally Assigned Grade 
(dollars in thousands)      Real Estate 
   Commercial   Commercial   Multi-family   Construction   Residential 
Grade:                         
   Pass  $32,216   $172,755   $23,001   $6,371   $10,593 
   Watch   1,073    17,318    493    8,162    2,099 
   Special mention       8,363            697 
   Substandard   2,906    1,155            811 
   Doubtful or loss                    
          Total  $36,195   $199,591   $23,494   $14,533   $14,200 
                 
   Credit Risk Profile by Internally Assigned Grade Other Credit Exposure             
   Leases   Agriculture   Consumer           Total 
Grade:                            
   Pass  $732   $2,061   $2,136           $249,865 
   Watch       370    378            29,893 
   Special mention           433            9,493 
   Substandard           175            5,047 
   Doubtful or loss                        
          Total  $732   $2,431   $3,122           $294,298 
18
 

The allocation of the Company’s allowance for loan and lease losses and by portfolio segment and by impairment methodology are summarized below:

  

June 30, 2016                                        
(dollars in thousands)      Real Estate   Other         
   Commercial   Commercial   Multi-Family   Construction   Residential   Leases   Agriculture   Consumer   Unallocated   Total 
                                         
Allowance for Loan and Lease Losses                                                  
                                                   
Beginning balance, January 1, 2016  $860   $2,369   $228   $813   $319   $1   $77   $78   $230   $4,975 
Provision for loan losses   (125)   266    101    (88)   (36)       (4)   (90)   (24)    
Loans charged-off                                        
Recoveries   73    12                        72        157 
                                                   
Ending balance, June 30, 2016  $808   $2,647   $329   $725   $283   $1   $73   $60   $206   $5,132 
                                                   
Ending balance:                                                  
Individually evaluated for impairment  $11   $675   $4   $   $151   $   $37   $26   $   $904 
                                                   
Ending balance:                                                  
Collectively evaluated for impairment  $797   $1,972   $325   $725   $132   $1   $36   $34   $206   $4,228 
                                                   
Loans                                                  
                                                   
Ending balance  $36,193   $203,439   $35,525   $13,795   $16,360   $534   $2,317   $2,304   $   $310,467 
                                                   
Ending balance:                                                  
Individually evaluated for impairment  $91   $17,656   $485   $   $2,175   $   $364   $61   $   $20,832 
                                                   
Ending balance:                                                  
Collectively evaluated for impairment  $36,102   $185,783   $35,040   $13,795   $14,185   $534   $1,953   $2,243   $   $289,635 
                                                   
Allowance for Loan and Lease Losses                                                  
                                                   
Beginning balance, March 31, 2016  $813   $2,513   $270   $625   $298   $2   $77   $65   $419   $5,082 
Provision for loan losses   (44)   123    59    100    (15)   (1)   (4)   (5)   (213)    
Loans charged off                                        
Recoveries   39    11                                50 
                                                   
Ending balance, June 30, 2016  $808   $2,647   $329   $725   $283   $1   $73   $60   $206   $5,132 
                                                   

19
 

December 31, 2015                                        
(dollars in thousands)      Real Estate   Other         
   Commercial   Commercial   Multi-Family   Construction   Residential   Leases   Agriculture   Consumer   Unallocated   Total 
Ending balance:                                                  
Individually evaluated for impairment  $25   $598   $5   $   $204   $   $38   $29   $   $899 
                                                   
Ending balance:                                                  
Collectively evaluated for impairment  $835   $1,771   $223   $813   $115   $1   $39   $49   $230   $4,076 
                                                   
Loans                                                  
                                                   
Ending balance  $36,195   $199,591   $23,494   $14,533   $14,200   $732   $2,431   $3,122   $   $294,298 
                                                   
Ending balance:                                                  
Individually evaluated for impairment  $121   $17,866   $488   $   $2,452   $   $370   $68   $   $21,365 
                                                   
Ending balance:                                                  
Collectively evaluated for impairment  $36,074   $181,725   $23,006   $14,533   $11,748   $732   $2,061   $3,054   $   $272,933 
                                         
June 30, 2015                                        
(dollars in thousands)      Real Estate   Other         
   Commercial   Commercial   Multi-Family   Construction   Residential   Leases   Agriculture   Consumer   Unallocated   Total 
Allowance for Loan and Lease Losses                                                  
                                                   
Beginning balance, January 1, 2015  $1,430   $2,317   $130   $583   $399   $2   $62   $124   $254   $5,301 
Provision for loan losses   199    (389)   (23)   224    (14)       (12)   2    13     
Loans charged off                       (1)       (6)       (7)
Recoveries   23    40                        2        65 
Ending balance, June 30, 2015  $1,652   $1,968   $107   $807   $385   $1   $50   $122   $267   $5,359 
                                                   
Allowance for Loan and Lease Losses                                                  
                                                   
Beginning balance, March 31, 2015  $1,403   $2,284   $120   $680   $392   $1   $55   $132   $241   $5,308 
Provision for loan losses   232    (355)   (13)   127    (7)   1    (5)   (6)   26     
Loans charged off                       (1)       (4)       (5)
Recoveries   17    39                                56 
                                                   
Ending balance, June 30, 2015  $1,652   $1,968   $107   $807   $385   $1   $50   $122   $267   $5,359 
                                                   

20
 

The Company’s aging analysis of the loan and lease portfolio at June 30, 2016 and December 31, 2015 are summarized below: 

                                 
June 30, 2016
(dollars in thousands)
  30-59 Days
Past Due
   60-89 Days
Past Due
   Past Due
Greater Than
90 Days
   Total Past
Due
   Current   Total Loans   Past Due
Greater Than
90 Days and
Accruing
   Nonaccrual 
Commercial:                                        
Commercial  $   $   $   $   $36,193   $36,193       $22 
Real estate:                                        
Commercial   982    351        1,333    202,106    203,439        631 
Multi-family                   35,525    35,525         
Construction                   13,795    13,795         
Residential                   16,360    16,360        337 
Other:                                        
Leases                   534    534         
Agriculture                   2,317    2,317         
Consumer   300    36        336    1,968    2,304        65 
Total  $1,282   $387   $   $1,669   $308,798   $310,467   $   $1,055 
                                 
December 31, 2015
(dollars in thousands)
  30-59 Days
Past Due
   60-89 Days
Past Due
   Past Due
Greater Than
90 Days
   Total Past
Due
   Current   Total Loans   Past Due
Greater Than
90 Days and
Accruing
   Nonaccrual 
Commercial:                                        
Commercial  $   $   $30   $30   $36,165   $36,195   $   $30 
Real estate:                                        
Commercial       359    499    858    198,733    199,591        1,155 
Multi-family                   23,494    23,494         
Construction                   14,533    14,533         
Residential           338    338    13,862    14,200        338 
Other:                                        
Leases                   732    732         
Agriculture                   2,431    2,431         
Consumer   367            367    2,755    3,122        120 
                                         
Total  $367   $359   $867   $1,593   $292,705   $294,298   $   $1,643 

 

21
 

9. BORROWING ARRANGEMENTS

 

At June 30, 2016, the Company had $17,000,000 of unsecured short-term borrowing arrangements with two of its correspondent banks. There were no advances under the borrowing arrangements as of June 30, 2016 or December 31, 2015.

 

The Company has a line of credit available with the Federal Home Loan Bank of San Francisco (the “FHLB”) which is secured by pledged mortgage loans and investment securities. Borrowings may include overnight advances as well as loans with terms of up to thirty years. Advances (both short-term and long-term) totaling $11,000,000 were outstanding from the FHLB at June 30, 2016, bearing interest rates ranging from 0.75% to 1.91% and maturing between July 20, 2016 and July 12, 2019. Advances totaling $11,000,000 were outstanding from the FHLB at December 31, 2015, bearing interest rates ranging from 0.45% to 1.91% and maturing between January 19, 2016 and July 12, 2019. Remaining amounts available under the borrowing arrangement with the FHLB at June 30, 2016 and December 31, 2015 totaled $83,483,000 and $78,326,000, respectively. In addition, the Company has a secured borrowing agreement with the Federal Reserve Bank of San Francisco. The borrowing can be secured by pledging selected loans and investment securities. Borrowings generally are short-term including overnight advances as well as loans with terms up to ninety days. Amounts available under this borrowing arrangement at June 30, 2016 and December 31, 2015 were $12,399,000 and $11,371,000, respectively. There were no advances outstanding under this borrowing arrangement as of June 30, 2016 and December 31, 2015.

 

10. INCOME TAXES

 

The Company files its income taxes on a consolidated basis with its subsidiaries. The allocation of income tax expense (benefit) represents each entity’s proportionate share of the consolidated provision for (benefit from) income taxes.

The Company accounts for income taxes using the balance sheet method, under which deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the reported amounts of assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. On the consolidated balance sheet, net deferred tax assets are included in accrued interest receivable and other assets.

The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any.  Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above, if applicable, is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company recognizes accrued interest and penalties related to unrecognized tax benefits, if applicable, as a component of interest expense in the consolidated statement of income. There have been no unrecognized tax benefits or accrued interest and penalties for the three-month and six-month periods ended June 30, 2016 and 2015.

Federal and state income taxes for the quarter ended June 30, 2016 decreased $93,000 (12.5%) from $745,000 in the second quarter of 2015 to $652,000 in the second quarter of 2016 and increased $70,000 (5.8%) from $1,215,000 in the six months ended June 30, 2015 to $1,285,000 for the six months ended June 30, 2016. The combined federal and state effective tax rate for the quarter ended June 30, 2016 was 33.3%, compared to 35.0% for the second quarter of 2015. For the six months ended June 30, 2016, the combined federal and state effective tax rate was 32.4% compared to 34.2% for the six months ended June 30, 2015. The lower effective tax rate for both periods in 2016 compared to 2015 resulted from an increase in tax exempt loan interest. Tax exempt loan interest was $173,000 in the second quarter of 2016 compared to $85,000 in the second quarter of 2015 and tax exempt loan interest was $345,000 in the first six months of 2016 compared to $123,000 in the first six months of 2015.

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11. FAIR VALUE MEASUREMENTS

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring and nonrecurring basis as of June 30, 2016 and December 31, 2015. They indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

 

Estimated fair values are disclosed for financial instruments for which it is practicable to estimate fair value. These estimates are made at a specific point in time based on relevant market data and information about the financial instruments. These estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.

 

The carrying amounts and estimated fair values of the Company’s financial instruments are as follows (dollars in thousands):

 

   Carrying   Fair Value Measurements Using:     
June 30, 2016  Amount   Level 1   Level 2   Level 3   Total 
                     
Financial assets:                         
Cash and due from banks  $22,671   $22,671             $22,671 
Interest-bearing deposits in banks   999        $999         999 
Available-for-sale securities   254,483    36    254,447         254,483 
Held-to-maturity securities   540         584         584 
FHLB stock   3,779    N/A    N/A    N/A    N/A 
Net loans and leases:   305,088             $310,957    310,957 
Accrued interest receivable   1,728         954    774    1,728 
Financial liabilities:                         
Deposits:                         
Noninterest-bearing  $195,903   $195,903             $195,903 
Savings   59,686    59,686              59,686 
Money market   127,864    127,864              127,864 
NOW accounts   59,686    59,686              59,686 
Time Deposits   82,599        $83,034         83,034 
Short-term borrowings   5,000    5,000              5,000 
Long-term borrowings   6,000         6,049         6,049 
Accrued interest payable   40    1    39         40 

 

23
 

 

   Carrying   Fair Value Measurements Using:     
December 31, 2015
  Amount   Level 1   Level 2   Level 3   Total 
                     
Financial assets:                    
Cash and due from banks  $23,727   $23,727   $   $   $23,727 
Interest-bearing deposits in banks   750        752        752 
Available-for-sale securities   273,819    24    273,795        273,819 
Held-to-maturity securities   623        669        669 
FHLB stock   3,779    N/A    N/A    N/A    N/A 
Net loans and leases:   289,102            292,444    292,444 
Accrued interest receivable   1,885        1,077    808    1,885 
Financial liabilities:                         
Deposits:                         
Noninterest-bearing  $190,548   $190,548   $   $   $190,548 
Savings   59,061    59,061            59,061 
Money market   135,186    135,186            135,186 
NOW accounts   61,324    61,324            61,324 
Time Deposits   84,571        85,165        85,165 
Short-term borrowings   3,500    3,500            3,500 
Long-term borrowings   7,500        7,502        7,502 
Accrued interest payable   60        60        60 

  

Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the fair values presented.

 

The following methods and assumptions were used by the Company to estimate the fair values of its financial instruments at June 30, 2016 and December 31, 2015:

Cash and due from banks: The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.

Interest-bearing deposits in banks: The fair values of interest-bearing deposits in banks are estimated by discounting their future cash flows using rates at each reporting date for instruments with similar remaining maturities offered by comparable financial institutions and are classified as Level 2.

Investment securities: For investment securities, fair values are based on quoted market prices, where available, and are classified as Level 1. If quoted market prices are not available, fair values are estimated using quoted market prices for similar securities and indications of value provided by brokers and are classified as Level 2.

FHLB stock: It is not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability.

Loans and leases: Fair values of loans, excluding loans held for sale, are estimated as follows:  For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality also resulting in a Level 3 classification. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

Deposits: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. For time deposits, the fair values for fixed rate certificates of deposit are estimated using a discounted cash flow methodology that applies market interest rates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

24
 

Short-term and long-term borrowings: The fair value of short-term borrowings is estimated to be the carrying amount and is classified as Level 1. The fair value of long-term borrowings is estimated using a discounted cash flow analysis using interest rates currently available for similar debt instruments and are classified as Level 2.

Accrued interest receivable and payable: The carrying amount of accrued interest receivable approximates fair value resulting in a Level 3 classification and the carrying amount of accrued interest payable approximates fair value resulting in a Level 2 classification.

Off-balance sheet instruments: Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments was not material at June 30, 2016 and December 31, 2015.

Assets and liabilities measured at fair value on a recurring and non-recurring basis along with any related gain or loss recognized in the income statement due to fair value changes are presented in the following table:

Description      Fair Value Measurements Using   Total Gains 
(dollars in thousands)  Fair Value   Level 1   Level 2   Level 3   (Losses) 
                     
June 30, 2016                         
Assets and liabilities measured on a recurring basis:                         
Available-for-sale securities:                         
US Government Agencies and Sponsored Agencies  $228,722   $   $228,722   $   $ 
Obligations of states and political subdivisions   24,143        24,143         
Corporate bonds   1,537        1,537         
Corporate stock   81    36    45         
Total recurring  $254,483   $36   $254,447   $   $ 
                          
Assets and liabilities measured on a nonrecurring basis:                         
Impaired loans:                         
Real estate:                         
Commercial  $3,848   $   $   $3,848   $ 
Residential   337            337     
Other real estate owned                         
Commercial   243            243     
Land   653            653    (376)
Total nonrecurring  $5,081   $   $   $5,081   $(376)
25
 

 

Description      Fair Value Measurements Using   Total Gains 
(dollars in thousands)  Fair Value   Level 1   Level 2     Level 3   (Losses) 
                 
December 31, 2015
                         
Assets and liabilities measured on a recurring basis:                         
Available-for-sale securities:                         
US Government Agencies and Sponsored Agencies   $246,185   $   $246,185   $   $ 
Corporate Debt securities   1,551        1,551           
Obligations of states and political subdivisions   26,013        26,013         
Corporate stock   70    24    46         
Total recurring  $273,819   $24   $273,795   $   $ 
                          
Assets and liabilities measured on a nonrecurring basis:                         
Impaired loans:                         
Real estate:                         
Commercial  $3,900   $   $   $3,900   $(334)
                          
Other real estate owned                         
Commercial   2,522            2,522     
Land   1,029            1,029     
Total nonrecurring  $7,451   $   $   $7,451   $(334)
                          

There were no significant transfers between Levels 1 and 2 during the three-month and six-month periods ended June 30, 2016 or the twelve months ended December 31, 2015.

 

The following methods were used to estimate the fair value of each class of financial instrument above:

Available-for-sale securitiesFair values for investment securities are based on quoted market prices, if available, and are considered Level 1, or evaluated using pricing models that vary by asset class and incorporate available trade, bid and other market information and are considered Level 2. Pricing applications apply available information, as applicable, through processes such as benchmark curves, benchmarking to like securities, sector groupings and matrix pricing.

 

Impaired loans – The fair value of collateral dependent impaired loans adjusted for specific allocations of the allowance for loan losses is generally based on recent real estate appraisals and/or evaluations. These appraisals and/or evaluations may utilize a single valuation approach or a combination of approaches including comparable sales, cost and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income and other available data. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. The valuation technique used for all Level 3 nonrecurring impaired loans is the sales comparison approach less a reserve for past due taxes and selling costs ranging from 8% to 10%.

 

Other real estate owned – Certain commercial and residential real estate properties classified as OREO are measured at fair value, less costs to sell. Fair values are based on recent real estate appraisals and/or evaluations. These appraisals and/or evaluations may use a single valuation approach or a combination of approaches including comparable sales, cost and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income and other available data. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. The valuation technique used for all Level 3 nonrecurring OREO is the sales comparison approach less selling costs ranging from 8% to 10%.

26
 

12. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In January 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” This ASU addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments by making targeted improvements to GAAP as follows: (1) require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer; (2) simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value; (3) eliminate the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (4) eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (5) require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (6) require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (7) require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (8) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. ASU No. 2016-01 is effective for interim and annual reporting periods beginning after December 15, 2017. Early application is permitted as of the beginning of the fiscal year of adoption only for provisions (3) and (6) above. Early adoption of the other provisions mentioned above is not permitted. The Company has performed a preliminary evaluation of the provisions of ASU No. 2016-01. Based on this evaluation, the Company has determined that ASU No. 2016-01 is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

In February 2016, the FASB issued ASU No. 2016-02, “Leases.” Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases): 1) a lease liability, which is the present value of a lessee’s obligation to make lease payments, and 2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Lessor accounting under the new guidance remains largely unchanged as it is substantially equivalent to existing guidance for sales-type leases, direct financing leases, and operating leases. Leveraged leases have been eliminated, although lessors can continue to account for existing leveraged leases using the current accounting guidance. Other limited changes were made to align lessor accounting with the lessee accounting model and the new revenue recognition standard. All entities will classify leases to determine how to recognize lease-related revenue and expense. Quantitative and qualitative disclosures will be required by lessees and lessors to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. The intention is to require enough information to supplement the amounts recorded in the financial statements so that users can understand more about the nature of an entity’s leasing activities. ASU No. 2016-02 is effective for interim and annual reporting periods beginning after December 15, 2018; early adoption is permitted. All entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. They have the option to use certain relief; full retrospective application is prohibited. The Company is currently evaluating the provisions of ASU No. 2016-02 and will be closely monitoring developments and additional guidance to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements.

27
 

 

In March 2016, the FASB issued ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting.” This ASU includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements. Some of the key provisions of this new ASU include: (1) companies will no longer record excess tax benefits and certain tax deficiencies in additional paid-in capital (“APIC”). Instead, they will record all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement, and APIC pools will be eliminated. The guidance also eliminates the requirement that excess tax benefits be realized before companies can recognize them. In addition, the guidance requires companies to present excess tax benefits as an operating activity on the statement of cash flows rather than as a financing activity; (2) increase the amount an employer can withhold to cover income taxes on awards and still qualify for the exception to liability classification for shares used to satisfy the employer’s statutory income tax withholding obligation. The new guidance will also require an employer to classify the cash paid to a tax authority when shares are withheld to satisfy its statutory income tax withholding obligation as a financing activity on its statement of cash flows (current guidance did not specify how these cash flows should be classified); and (3) permit companies to make an accounting policy election for the impact of forfeitures on the recognition of expense for share-based payment awards. Forfeitures can be estimated, as required today, or recognized when they occur. ASU No. 2016-09 is effective for interim and annual reporting periods beginning after December 15, 2016. Early adoption is permitted, but all of the guidance must be adopted in the same period. The Company is currently evaluating the provisions of ASU No. 2016-09 to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements.

 

In June 2016, the FASB issued ASU No. 2016-13, “Measurement of Credit Losses on Financial Instruments.” This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that aren’t measured at fair value through net income. In issuing the standard, the FASB is responding to criticism that today’s guidance delays recognition of credit losses. The standard will replace today’s “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments, and financial guarantees. The CECL model does not apply to available-for-sale (“AFS”) debt securities. For AFS debt securities with unrealized losses, entities will measure credit losses in a manner similar to what they do today, except that the losses will be recognized as allowances rather than reductions in the amortized cost of the securities. As a result, entities will recognize improvements to estimated credit losses immediately in earnings rather than as interest income over time, as they do today. The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans. ASU 2016-13 also expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance for loan and lease losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. ASU No. 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019; early adoption is permitted for interim and annual reporting periods beginning after December 15, 2018. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (i.e., modified retrospective approach). The Company is currently evaluating the provisions of ASU No. 2016-13 to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements.

28
 

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

The following is management’s discussion and analysis of the significant changes in American River Bankshares’ (the “Company”) balance sheet accounts between December 31, 2015 and June 30, 2016 and its income and expense accounts for the three-month and six-month periods ended June 30, 2016 and 2015. The discussion is designed to provide a better understanding of significant trends related to the Company’s financial condition, results of operations, liquidity, capital resources and interest rate sensitivity. This discussion and supporting tables and the consolidated financial statements and related notes appearing elsewhere in this report are unaudited. Interest income and net interest income are presented on a fully taxable equivalent basis (FTE) within management’s discussion and analysis. Certain matters discussed or incorporated by reference in this Quarterly Report on Form 10-Q including, but not limited to, matters described in “Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations,” are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, Section 27A of the Securities Act of 1933, as amended, and subject to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may contain words related to future projections including, but not limited to, words such as “believe,” “expect,” “anticipate,” “intend,” “may,” “will,” “should,” “could,” “would,” and variations of those words and similar words that are subject to risks, uncertainties and other factors that could cause actual results to differ significantly from those projected. Factors that could cause or contribute to such differences include, but are not limited to, the following:

·the legislation promulgated by the United States Congress and actions taken by governmental agencies, including the United States Department of the Treasury, to deal with challenges to the U.S. financial system;
·the risks presented by economic volatility and recession, which could adversely affect credit quality, collateral values, including real estate collateral, investment values, liquidity and loan originations and loan portfolio delinquency rates;
·variances in the actual versus projected growth in assets and return on assets;
·potential loan and lease losses;
·potential expenses associated with resolving nonperforming assets as well as regulatory changes;
·changes in the interest rate environment including interest rates charged on loans, earned on securities investments and paid on deposits and other borrowed funds;
·competitive effects;
·potential declines in fee and other noninterest income earned associated with economic factors, as well as regulatory changes;
·general economic conditions nationally, regionally, and within our operating markets could be less favorable than expected or could have a more direct and pronounced effect on us than expected and adversely affect our ability to continue internal growth at historical rates and maintain the quality of our earning assets;
·changes in the regulatory environment including increased capital and regulatory compliance requirements and further government intervention in the U.S. financial system;
·changes in business conditions and inflation;
·changes in securities markets, public debt markets, and other capital markets;
·potential data processing, cybersecurity and other operational systems failures, breach or fraud;
·potential decline in real estate values in our operating markets;
·the effects of uncontrollable events such as terrorism, the threat of terrorism or the impact of military conflicts in connection with the conduct of the war on terrorism by the United States and its allies, negative financial and economic conditions, natural disasters, and disruption of power supplies and communications;
·changes in accounting standards, tax laws or regulations and interpretations of such standards, laws or regulations;
·projected business increases following any future strategic expansion could be lower than expected;
·the goodwill we have recorded in connection with acquisitions could become impaired, which may have an adverse impact on our earnings;
·the reputation of the financial services industry could experience further deterioration, which could adversely affect our ability to access markets for funding and to acquire and retain customers; and
·the efficiencies we may expect to receive from any investments in personnel and infrastructure may not be realized.
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The factors set forth under “Item 1A - Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, and other cautionary statements and information set forth in this Quarterly Report on Form 10-Q should be carefully considered and understood as being applicable to all related forward-looking statements contained in this Quarterly Report on Form 10-Q, when evaluating the business prospects of the Company and its subsidiaries.

Forward-looking statements are not guarantees of performance. By their nature, they involve risks, uncertainties and assumptions. The future results and shareholder values may differ significantly from those expressed in these forward-looking statements. You are cautioned not to put undue reliance on any forward-looking statement. Any such statement speaks only as of the date of this report, and in the case of any documents that may be incorporated by reference, as of the date of those documents. We do not undertake any obligation to update or release any revisions to any forward-looking statements, to report any new information, future event or other circumstances after the date of this report or to reflect the occurrence of unanticipated events, except as required by law. However, your attention is directed to any further disclosures made on related subjects in our subsequent reports filed with the Securities and Exchange Commission (the “SEC”) on Forms 10-K, 10-Q and 8-K.

Use of Non-GAAP Financial Measures

 

This Quarterly Report on Form 10-Q (“Form 10Q”) contains certain non-GAAP (Generally Accepted Accounting Principles) financial measures in addition to results presented in accordance with GAAP.  These measures include tangible book value and taxable equivalent basis.  Management has presented these non-GAAP financial measures in this Form 10Q because it believes that they provide useful and comparative information to assess trends in the Company’s financial position reflected in the current quarter and year-to-date results and facilitate comparison of our performance with the performance of our peers.

 

Net Interest Margin and Efficiency Ratio (non-GAAP financial measures)

 

In accordance with industry standards, certain designated net interest income amounts are presented on a

taxable equivalent basis, including the calculation of net interest margin and the efficiency ratio.  The Company believes the presentation of net interest margin on a taxable equivalent basis using a 34% effective tax rate allows comparability of net interest margin with industry peers by eliminating the effect of the differences in portfolios attributable to the proportion represented by both taxable and tax-exempt loans and investments.

 

Tangible Equity (non-GAAP financial measures)

 

Tangible common stockholders’ equity (tangible book value) excludes goodwill and other intangible assets.  The Company believes the exclusion of goodwill and other intangible assets to create “tangible equity” facilitates the comparison of results for ongoing business operations.  The Company’s management internally assesses its performance based, in part, on these non-GAAP financial measures.

 

Critical Accounting Policies

General

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

Allowance for Loan and Lease Losses

The allowance for loan and lease losses is an estimate of the probable incurred credit loss risk inherent in our loan and lease portfolio as of the balance sheet date. The allowance is based on two basic principles of accounting: (1) “Accounting for Contingencies,” which requires that losses be accrued when it is probable that a loss has occurred at the balance sheet date and such loss can be reasonably estimated; and (2) the “Receivables” topic, which requires that losses be accrued on impaired loans based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan or lease balance.

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The allowance for loan and lease losses is determined based upon estimates that can and do change when the actual risk, loss events, or changes in other factors, occur. The analysis of the allowance uses an historical loss view as an indicator of future losses and as a result could differ from the actual losses incurred in the future. If the allowance for loan and lease losses falls below that deemed adequate (by reason of loan and lease growth, actual losses, the effect of changes in risk factors, or some combination of these), the Company has a strategy for supplementing the allowance for loan and lease losses, over the short-term. For further information regarding our allowance for loan and lease losses, see “Allowance for Loan and Lease Losses Activity” discussion later in this Item 2.

Stock-Based Compensation

The Company recognizes compensation expense over the vesting period in an amount equal to the fair value of all share-based payments which consist of stock options and restricted stock awarded to directors and employees. The fair value of each stock option award is estimated on the date of the award and amortized over the service period using a Black-Scholes-Merton based option valuation model that requires the use of assumptions.  Critical assumptions that affect the estimated fair value of each award include expected stock price volatility, dividend yields, option life and the risk-free interest rate.

Goodwill  

Business combinations involving the Company’s acquisition of equity interests or net assets of another enterprise or the assumption of net liabilities in an acquisition of branches constituting a business may give rise to goodwill. Goodwill represents the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed. The value of goodwill is ultimately derived from the Company’s ability to generate net earnings after the acquisition and is not deductible for tax purposes. A decline in net earnings could be indicative of a decline in the fair value of goodwill and result in impairment. For that reason, goodwill is assessed for impairment on an annual basis. Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value. The most recent annual assessment was performed as of December 31, 2015, and at that time, the Company’s reporting unit had positive equity and the Company elected to perform a qualitative assessment to determine if it was more likely than not that the fair value of the reporting unit exceeded its carrying value, including goodwill. The qualitative assessment indicated that it was more likely than not that the fair value of the reporting unit exceeded its carrying value, resulting in no impairment.

Income Taxes

The Company files its income taxes on a consolidated basis with its subsidiaries. The allocation of income tax expense (benefit) represents each entity’s proportionate share of the consolidated provision for (benefit from) income taxes.

The Company accounts for income taxes using the balance sheet method, under which deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. On the consolidated balance sheet, net deferred tax assets are included in accrued interest receivable and other assets.

The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any.  Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is, if applicable, reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company recognizes accrued interest and penalties related to unrecognized tax benefits, if applicable, as a component of interest expense in the consolidated statement of income. There were no unrecognized tax benefits or accrued interest and penalties at June 30, 2016 or 2015 or for the three-month and six-month periods then ended.

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General Development of Business

The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Company was incorporated under the laws of the State of California in 1995. As a bank holding company, the Company is authorized to engage in the activities permitted under the Bank Holding Company Act of 1956, as amended, and regulations thereunder. Its principal office is located at 3100 Zinfandel Drive, Suite 450, Rancho Cordova, California 95670 and its telephone number is (916) 854-0123. The Company employed an equivalent of 97 full-time employees as of June 30, 2016.

The Company owns 100% of the issued and outstanding common shares of its banking subsidiary, American River Bank (the “Bank”), and American River Financial, a California corporation which has been inactive since its incorporation in 2003.

American River Bank was incorporated and commenced business in Fair Oaks, California, in 1983 and thereafter moved its headquarters to Sacramento, California in 1985. American River Bank operates five full service offices in Sacramento and Placer Counties including the main office located at 1545 River Park Drive, Suite 107, Sacramento and branch offices in Sacramento, Gold River, and Roseville; two full service offices in Sonoma County in Healdsburg and Santa Rosa; and three full service offices in Amador County in Jackson, Pioneer, and Ione.

 

In addition, American River Bank operates a loan production office in Santa Clara County, in the city of San Jose.

In 2000, the Company acquired North Coast Bank as a separate bank subsidiary. North Coast Bank was incorporated and commenced business in 1990 as Windsor Oaks National Bank in Windsor, California. In 1997, the name was changed to North Coast Bank. Effective December 31, 2003, North Coast Bank was merged with and into American River Bank. On December 3, 2004, the Company acquired Bank of Amador located in Jackson, California. Bank of Amador was merged with and into American River Bank.

The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to applicable legal limits. On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act includes a permanent increase to $250,000 as the maximum FDIC insurance limit per depositor retroactive to January 1, 2008 and the extension of unlimited FDIC insurance for noninterest-bearing transaction accounts effective December 31, 2010 through December 31, 2012. On November 9, 2010, the FDIC implemented a final rule to permanently increase the maximum insurance limit to $250,000 under the Dodd-Frank Act. The unlimited insurance coverage for noninterest bearing transaction accounts was not extended and terminated on December 31, 2012. The $250,000 maximum deposit insurance amount per depositor remains in effect.

American River Bank does not offer trust services or international banking services and does not plan to do so in the near future. American River Bank’s primary business is serving the commercial banking needs of small to mid-sized businesses within those counties listed above. American River Bank accepts checking and savings deposits, offers money market deposit accounts and certificates of deposit, makes secured and unsecured commercial, secured real estate, and other installment and term loans and offers other customary banking services. American River Bank also conducts lease financing for certain types of business equipment. American River Bank owns 100% of two inactive companies, ARBCO and American River Mortgage. ARBCO was formed in 1984 to conduct real estate development and has been inactive since 1995. American River Mortgage has been inactive since its formation in 1994. During 2015 and 2016, the Company conducted no significant activities other than holding the shares of its subsidiaries. However, it is authorized, with the prior approval of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), the Company’s principal regulator, to engage in a variety of activities which are deemed closely related to the business of banking. The common stock of the Company is registered under the Securities Exchange Act of 1934, as amended, and is listed and traded on the Nasdaq Global Select Market under the symbol “AMRB.”

Overview

The Company recorded net income of $1,304,000 for the quarter ended June 30, 2016, which was a decrease of $82,000 compared to $1,386,000 reported for the same period of 2015. Diluted earnings per share for the second quarter of 2016 were $0.19 compared to $0.18 recorded in the second quarter of 2015. The return on average equity (“ROAE”) and the return on average assets (“ROAA”) for the second quarter of 2016 were 6.29% and 0.84%, respectively, as compared to 6.31% and 0.90%, respectively, for the same period in 2015.

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Net income for the six months ended June 30, 2016 and 2015 was $2,676,000 and $2,342,000, respectively, with diluted earnings per share of $0.39 in 2016 and $0.30 in 2015. For the first six months of 2016, ROAE was 6.37% and ROAA was 0.85% compared to 5.36% and 0.77%, respectively, for the same period in 2015.

 

Total assets of the Company decreased by $8,829,000 (1.4%) from $634,460,000 at December 31, 2015 to $625,811,000 at June 30, 2016. Net loans totaled $305,088,000 at June 30, 2016, an increase of $15,986,000 (5.5%) from $289,102,000 at December 31, 2015. Deposit balances at June 30, 2016 totaled $525,933,000, a decrease of $4,757,000 (0.9%) from the $530,690,000 at December 31, 2015.

 

The Company ended the second quarter of 2016 with a leverage capital ratio of 10.4%, a Tier 1 capital ratio of 18.0%, and a total risk-based capital ratio of 19.2% compared to 11.0%, 19.3%, and 20.6%, respectively, at December 31, 2015. Table One below provides a summary of the components of net income for the periods indicated (See the “Results of Operations” section that follows for an explanation of the fluctuations in the individual components).

 

Table One: Components of Net Income

 

(dollars in thousands)  For the three months ended
June 30,
   For the six months ended
June 30,
 
   2016   2015   2016   2015 
Interest income*  $5,343   $5,386   $10,740   $10,359 
Interest expense   (221)   (244)   (455)   (492)
Net interest income*   5,122    5,142    10,285    9,867 
Provision for loan and lease losses                
Noninterest income   363    507    1,117    1,092 
Noninterest expense   (3,415)   (3,415)   (7,206)   (7,228)
Provision for income taxes   (652)   (745)   (1,285)   (1,215)
Tax equivalent adjustment   (114)   (103)   (235)   (174)
Net income  $1,304   $1,386   $2,676   $2,342 
                     
Average total assets  $625,652   $615,492   $630,364   $612,418 
Net income (annualized) as a percentage of average total assets   0.84%   0.90%   0.85%   0.77%

* Fully taxable equivalent basis (FTE)

 

Results of Operations

Net Interest Income and Net Interest Margin

Net interest income represents the excess of interest and fees earned on interest earning assets (loans and leases, securities, Federal funds sold and investments in time deposits) over the interest paid on interest-bearing deposits and borrowed funds. Net interest margin is net interest income expressed as a percentage of average earning assets. The Company’s net interest margin was 3.64% for the three months ended June 30, 2016, 3.69% for the three months ended June 30, 2015, 3.64% for the six months ended June 30, 2016 and 3.58% for the six months ended June 30, 2015.

The fully taxable equivalent interest income component for the second quarter of 2016 decreased $43,000 (0.8%) to $5,343,000 compared to $5,386,000 for the three months ended June 30, 2015. The decrease in the fully taxable equivalent interest income for the second quarter of 2016 compared to the same period in 2015 is broken down by rate (down $226,000) and volume (up $183,000). The yield on earning assets decreased from 3.87% during the second quarter of 2015 to 3.80% during the second quarter of 2016. The primary driver in this rate decrease was a decrease in the yield on loans which saw a decrease from 5.01% in the second quarter of 2015 to 4.92% in the second quarter of 2016. While average loans increased $23,452,000 (8.5%) from $276,976,000 during the second quarter of 2015 to $300,423,000 during the second quarter of 2016, due to the overall lower interest rate environment, the new loans added were at lower yields than the existing loans. The investment portfolio also experienced lower yields, decreasing from 2.75% in the second quarter of 2015 to 2.53% in the second quarter of 2016. Part of this decrease is related to a special one-time cash dividend from the Federal Home Loan Bank of San Francisco (the “FHLB”) recorded in 2015 in the amount of $136,000. The volume increase of $183,000 was primarily from loans ($300,000) partially offset by a decrease in investment balances. The average balance of earning assets increased $6,930,000 (1.2%) from $558,901,000 in the second quarter of 2015 to $565,831,000 in the second quarter of 2016. When compared to the second quarter of 2015, average investment securities decreased $16,543,000 (5.9%) from $280,952,000 for the second quarter of 2015 compared to $264,409,000 for the second quarter of 2016.

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Total fully taxable equivalent interest income for the six months ended June 30, 2016 increased $381,000 (3.7%) to $10,740,000 compared to $10,359,000 for the six months ended June 30, 2015. The breakdown of the fully taxable equivalent interest income for the six months ended June 30, 2016 over the same period in 2015 resulted from a decrease in rate (down $121,000) and an increase in volume (up $502,000). Average earning assets increased $12,098,000 (2.2%) from $556,486,000 during the first six months of 2015 to $568,584,000 for the same period in 2016. During the six month periods, the Company also experienced an increase in interest income due to the rates earned on investments (up $74,000) but this was more than offset by a reduction in rates on loans (down $199,000). The yield on investments increased from 2.54% in 2015 to 2.58% in 2016. Part of this increase is related to the slow down in the mortgage refinance market and the related slower amortization of the premiums paid on the mortgage related bonds. Average loan balances increased by $27,966,000 (10.4%) from $269,798,000 during 2015 to $297,764,000 during 2016, but the Company did experience a drop in rates on these loans from 5.05% in 2015 to 4.91% in 2016. This decrease is caused by the overall lower interest rate environment. The volume increase of $502,000 is primarily related to the above mentioned increase in loan balances from 2015 to 2016, which accounted for a $704,000 increase in interest income, which was partially offset by a decrease in average investment balances. Average investment securities decreased $15,871,000 (5.6%) from $285,699,000 for the first six months of 2015 compared to $269,828,000 for the first six months of 2016.

Interest expense was $23,000 (9.4%) lower in the second quarter of 2016 versus the prior year period, decreasing from $244,000 to $221,000. The average balances on interest bearing liabilities were $345,417,000 or $4,974,000 (1.4%) lower in the second quarter of 2016 compared to $350,391,000 for the same quarter in 2015. The decrease in balances had a slight impact on the overall interest expense as the volume decrease accounted for only a $9,000 decrease in interest expense. The primary decrease in interest expense relates to lower rates (down $14,000). Rates paid on interest bearing liabilities decreased 2 basis points from 0.28% to 0.26% for the second quarter of 2015 compared to the second quarter of 2016.

Interest expense was $37,000 (7.5%) lower in the six-month period ended June 30, 2016 decreasing from $492,000 in 2015 to $455,000 in 2016. The decrease is related to rates (down $55,000) partially offset by volume (up $18,000). The average balances on interest-bearing liabilities were $350,681,000 (down $3,537,000 or 1.0% lower) in the six-month period ended June 30, 2016 compared $354,218,000 in the same period in 2015. Although the average balances were lower, the decreased balances did not result in a decrease in interest expense as the decrease in interest bearing balances (down $18,000) was more than offset by an increase in other borrowings which increased by $36,000. Average other borrowings increased $6,562,000 (51.4%) from $12,765,000 in the first six months of 2015 to $19,327,000 in the first six months of 2016. The primary decrease in interest expense relates to lower rates (down $55,000). Rates paid on interest bearing liabilities decreased 2 basis points from 0.28% to 0.26% for 2015 compared to 2016.

Table Two, Analysis of Net Interest Margin on Earning Assets, and Table Three, Analysis of Volume and Rate Changes on Net Interest Income and Expenses, are provided to enable the reader to understand the components and trends of the Company’s interest income and expenses. Table Two provides an analysis of net interest margin on earning assets setting forth average assets, liabilities and shareholders’ equity; interest income earned and interest expense paid and average rates earned and paid; and the net interest margin on earning assets. Table Three sets forth a summary of the changes in interest income and interest expense from changes in average asset and liability balances (volume) and changes in average interest rates.

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Table Two: Analysis of Net Interest Margin on Earning Assets 
Three Months Ended June 30,  2016   2015 
(Taxable Equivalent Basis)
(dollars in thousands)
 

Avg
Balance

  

Interest

  

Avg
Yield (4)

  

Avg
Balance

  

Interest

  

Avg
Yield (4)

Assets                              
Earning assets:                              
  Taxable loans and leases (1)  $283,373   $3,445    4.89%  $267,888   $3,339    5.00%
  Tax-exempt loans and leases (2)   17,050    232    5.47%   9,073    123    5.43%
  Taxable investment securities   240,997    1,441    2.40%   254,676    1,657    2.61%
  Tax-exempt investment securities (2)   23,336    215    3.71%   26,202    255    3.90%