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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           September 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 November 2, 2016.

 
 

AMERICAN RIVER BANKSHARES

 

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

Part I.    Page
   Item 1. Financial Statements   3
   Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 27
   Item 3. Quantitative and Qualitative Disclosures About Market Risk 47
   Item 4. Controls and Procedures 48
     
Part II.    
     
   Item 1. Legal Proceedings 48
   Item 1A. Risk Factors 48
   Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 48
   Item 3. Defaults Upon Senior Securities 49
   Item 4. Mine Safety Disclosures 49
   Item 5. Other Information 49
   Item 6. Exhibits 49
     
Signatures 54
   

Exhibit Index

 

55
31.1

Certifications of Chief Executive Officer pursuant to Section 302 of

the Sarbanes-Oxley Act of 2002

 

56

31.2

Certifications of the Chief Financial Officer pursuant to Section 302

of the Sarbanes-Oxley Act of 2002

 

57

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

 

58

       
   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)   September 30,
2016
    December 31,
2015  
 
ASSETS                
Cash and due from banks   $ 43,094     $ 23,727  
Interest-bearing deposits in banks     999       750  
Investment securities:                
Available-for-sale, at fair value     253,502       273,819  
Held-to-maturity, at amortized cost     508       623  
Loans and leases, less allowance for loan and lease losses of $4,983 at September 30, 2016 and $4,975 at December 31, 2015     313,302       289,102  
Premises and equipment, net     1,259       1,407  
Federal Home Loan Bank stock     3,779       3,779  
Goodwill and other intangible assets     16,321       16,321  
Other real estate owned     653       3,551  
Bank owned life insurance     14,722       14,483  
Accrued interest receivable and other assets     5,707       7,078  
    $ 653,846     $ 634,640  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY                
                 
Deposits:                
     Noninterest bearing   $ 209,586     $ 190,548  
     Interest-bearing     336,579       340,142  
             Total deposits     546,165       530,690  
                 
Short-term borrowings     5,000       3,500  
Long-term borrowings     9,000       7,500  
Accrued interest payable and other liabilities     9,015       6,875  
                 
             Total liabilities     569,180       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 – 6,656,594 shares at September 30, 2016 and 7,343,649 shares at December 31, 2015     42,402       49,554  
Retained earnings     38,907       34,418  
Accumulated other comprehensive income, net of taxes     3,357       2,103  
                 
            Total shareholders’ equity     84,666       86,075  
    $ 653,846     $ 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 September 30,  Three months   Nine months 
   2016   2015   2016   2015 
Interest income:                    
    Interest and fees on loans:                    
Taxable  $3,617   $3,541   $10,424   $10,140 
Exempt from Federal income taxes   189    92    534    222 
    Interest on deposits in banks   2    2    5    4 
    Interest and dividends on investment securities:                    
Taxable   1,340    1,633    4,333    4,706 
        Exempt from Federal income taxes   156    190    502    571 
Dividends           11    10 
              Total interest income   5,304    5,458    15,809    15,643 
Interest expense:                    
    Interest on deposits   179    202    545    624 
    Interest on borrowings   44    38    133    108 
               Total interest expense   223    240    678    732 
                     
               Net interest income   5,081    5,218    15,131    14,911 
Provision for loan and lease losses   (668)       (668)    
                     
Net interest income after provision for loan and lease losses   5,749    5,218    15,799    14,911 
Noninterest income:                    
Service charges on deposit accounts   124    132    381    376 
Gain on sale, call, or impairment of securities    33    

33

    

314

    

251

 
Rental income from other real estate owned       87    106    248 
Other noninterest income   242    238    715    707 
Total noninterest income   399    490    1,516    1,582 
                     
Noninterest expense:                    
    Salaries and employee benefits   2,073    2,185    6,334    6,500 
    Occupancy   295    294    885    888 
    Furniture and equipment   165    171    493    527 
    Federal Deposit Insurance Corporation assessments   77    83    233    239 
    Expenses related to other real estate owned   (30)   58    330    260 
    Other expense   766    641    2,277    2,246 
                Total noninterest expense   3,346    3,432    10,552    10,660 
                     
                Income before provision for income taxes   2,802    2,276    6,763    5,833 
                     
Provision for income taxes   989    807    2,274    2,022 
                     
                 Net income  $1,813   $1,469   $4,489   $3,811 
                     
Basic earnings per share  $0.28   $0.20   $0.66   $0.50 
Diluted earnings per share  $0.27   $0.20   $0.66   $0.50 
                     
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 September 30,  Three months   Nine months 
   2016   2015   2016   2015 
Net income  $1,813   $1,469   $4,489   $3,811 
Other comprehensive income (loss):                    
(Decrease) increase in net unrealized gains on
investment securities
   (1,306)   769    2,406    1,023 
Deferred tax benefit (expense)   522    (308)   (963)   (409)
(Decrease) increase in net unrealized gains on investment securities, net of tax   (784)   461    1,443    614 
                     
Reclassification adjustment for realized gains included in net income   (33)   (33)   (314)   (251)
Tax effect   13    13    125    100 
Realized gains, net of tax   (20)   (20)   (189)   (151)
Total other comprehensive (loss) income   (804)   441    1,254    463 
Comprehensive income  $1,009   $1,910   $5,743   $4,274 

 

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             3,811         3,811 
Other comprehensive income, net of tax:                         
Net change in unrealized gains on available-for-sale investment securities                  463    463 
                          
Net restricted stock award activity and related compensation expense   45,023    175              175 
Stock option compensation expense        25              25 
Retirement of common stock   (790,989)   (7,843)             (7,843)
                          
Balance, September 30, 2015   7,343,649   $49,483   $32,961   $3,834   $86,278 
                          
Balance, January 1, 2016   7,343,649   $49,554   $34,418   $2,103   $86,075 
Net income             4,489         4,489 
Other comprehensive income, net of tax:                         
Net change in unrealized gains on available-for-sale investment securities                  1,254    1,254 
                          
Net restricted stock award activity and related compensation expense   28,342    219              219 
Stocks option exercised and compensation expense   1,500    43              43 
Retirement of common stock   (716,897)   (7,414)             (7,414)
                          
Balance, September 30, 2016   6,656,594   $42,402   $38,907   $3,357   $84,666 

See Notes to Unaudited Consolidated Financial Statements

6
 

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)

 

(dollars in thousands)        
For the nine months ended September 30,        
   2016   2015 
Cash flows from operating activities:          
Net income  $4,489   $3,811 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan and lease losses   (668)    
Increase (decrease) in deferred loan origination fees, net   27    (48)
Depreciation and amortization   326    324 
Gain on sale, call, and impairment of investment securities, net   (314)   (251)
Amortization of investment security premiums and discounts, net   2,159    2,470 
Increase in cash surrender values of life insurance policies   (239)   (239)
Stock based compensation expense   249    200 
Loss/gain on sale/write-down of other real estate owned   207    68 
Decrease in accrued interest receivable and other assets   535    27 
(Decrease) increase in accrued interest payable and other liabilities   (322)   133 
           
Net cash provided by operating activities   6,449    6,495 
           
Cash flows from investing activities:          
Proceeds from the sale of available-for-sale investment securities   12,656    23,764 
Proceeds from matured available-for-sale investment securities   600    175 
Proceeds from called available-for-sale investment securities   1,165     
Purchases of available-for-sale investment securities   (25,146)   (41,254)
Proceeds from principal repayments for available-for-sale investment securities   33,749    38,193 
Proceeds from principal repayments for held-to-maturity investment securities   115    188 
Net increase in interest-bearing deposits in banks   (249)    
Net increase in loans   (21,873)   (31,669)
Proceeds from sale of other real estate   1,005    924 
Capitalized additions to other real estate       (126)
Net increase in FHLB stock       (93)
Purchases of equipment   (178)   (241)
           
Net cash provided by (used in) investing activities   1,844   (10,139)
           
Cash flows from financing activities:          
Net increase in demand, interest-bearing and savings deposits  $17,125   $12,200 
Net decrease in time deposits   (1,650)   (1,524)
Net increase in short-term borrowings   1,500     
Net increase in long-term borrowings   1,500     
Proceeds from stock option exercise   13     
Cash paid to repurchase common stock   (7,414)   (7,843)
           
Net cash provided by financing activities  $11,074   $2,833 
           
Increase (decrease) in cash and cash equivalents   19,367    (811)
           
Cash and cash equivalents at beginning of year   23,727    22,449 
           
Cash and cash equivalents at end of period  $43,094   $21,638 

  

See Notes to Unaudited Consolidated Financial Statements

7
 

AMERICAN RIVER BANKSHARES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

September 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 September 30, 2016 and December 31, 2015, the results of its operations and statement of comprehensive income for the three-month and nine-month periods ended September 30, 2016 and 2015, its cash flows for the nine-month periods ended September 30, 2016 and 2015 and its statement of changes in shareholders’ equity for the nine months ended September 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 nine-month periods ended September 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 110,587 options remain outstanding at September 30, 2016. At September 30, 2016, under the 2010 Plan, there were 76,461 stock options and 66,692 restricted shares outstanding and the total number of authorized shares that remain available for issuance was 1,376,819. 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.

8
 

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 September 30, 2016 and 2015, the compensation cost recognized for equity compensation was $83,000 and $73,000, respectively. The recognized tax benefit for equity compensation expense was $29,000 and $25,000, respectively, for the three-month periods ended September 30, 2016 and 2015. For the nine-month periods ended September 30, 2016 and 2015, the compensation cost recognized for equity compensation was $249,000 and $200,000, respectively. The recognized tax benefit for equity compensation expense was $88,000 and $70,000, respectively, for the nine-month periods ended September 30, 2016 and 2015.

At September 30, 2016, the total compensation cost related to nonvested stock option awards not yet recorded was $109,000. This amount will be recognized over the next 3.75 years and the weighted average period of recognizing these costs is expected to be 1.8 years. At September 30, 2016, the total compensation cost related to restricted stock awards not yet recorded was $441,000. This amount will be recognized over the next 4.8 years and the weighted average period of recognizing these costs is expected to be 1.6 years.

Equity Plans Activity

Stock Options

There were no stock options awarded during the three-month and nine-month periods ended September 30, 2016 or the three-month period ended September 30, 2015. There were 26,427 stock options awarded during the nine-month period ended September 30, 2015 at a weighted average exercise price of $9.56. A summary of option activity under the Plans as of September 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   1,500    8.50         
Expired, forfeited or cancelled   59,863    22.45         
Outstanding at September 30, 2016   187,048   $12.91    3.9 years   $252 
Vested at September 30, 2016   142,805   $14.11    2.7 years   $173 
Non-vested at September 30, 2016   44,243   $9.05    8.0 years   $79 

 

Restricted Stock

 

There were no shares of restricted stock awarded during the three-month periods ended September 30, 2016 and 2015. There were 29,756 and 45,023 shares of restricted stock awarded during the nine-month periods ended September 30, 2016 and 2015, respectively. Of the 29,756 restricted shares awarded in 2016, 10,094 restricted shares will vest one year from the date of the award, 1,829 vest over five years at 20% per year from the date of the award, and 17,833 are performance based awards that must meet minimum performance criteria before they begin to vest. If the performance metrics are not met, up to 100% of the award may be forfeited and if the performance metrics are exceeded, the awards may be increased by up to 150% of the original award. Of the 45,023 restricted shares awarded in 2015, 12,552 restricted shares vested one year from the date of the award, 11,939 vest over five years at 20% per year from the date of the award, and 20,532 are performance based awards that must meet minimum performance criteria before they begin to vest. If the performance metrics are not met, up to 100% of the award may be forfeited and if the performance metrics are exceeded, the awards may be increased by up to 150% of the original award. Award date fair value is determined by the market price of the Company’s common stock on the date of award ($10.17 on February 17, 2016, $10.40 on May 19, 2016, $9.41 on March 18, 2015, and $9.56 on May 22, 2015).

9
 

There were 947 restricted share awards that were fully vested during the three-month period ended September 30, 2016 and 19,166 restricted share awards that were fully vested during the nine-month period ended September 30, 2016. There were 3,274 restricted share awards that were fully vested during the three-month period ended September 30, 2015 and 20,345 restricted share awards that were fully vested during the nine-month period ended September 30, 2015. There were 386 and 1,414 restricted share awards forfeited during the three-month and nine-month periods ended September 30, 2016, respectively, and no restricted share awards forfeited during the three-month and nine-month periods ended September 30, 2015. The intrinsic value of nonvested restricted shares at September 30, 2016 was $723,000.

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   19,166    9.10 
Less:  Expired, forfeited or cancelled   1,414    9.32 
Nonvested at September 30, 2016   66,692   $9.71 

 

Other Equity Awards

 

There were no stock appreciation rights; restricted performance stock; unrestricted Company stock; or performance units awarded during the three-month or nine-month month periods ended September 30, 2016 or 2015 or outstanding at September 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 $10.84 as of September 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 $23,697,000 and standby letters of credit of approximately $238,000 at September 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 September 30, 2016 or December 31, 2015.  

10
 

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 (6,589,125 and 6,800,016 shares for the three-month and nine-month periods ended September 30, 2016, and (7,481,529 and 7,653,109 shares for the three-month and nine-month periods ended September 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 32,515 and 28,108, respectively, dilutive shares for the three-month and nine-month periods ended September 30, 2016 and 19,930 and 14,878, respectively, dilutive shares for the three-month and nine-month periods ended September 30, 2015. For the three-month periods ended September 30, 2016 and 2015, there were 99,308 and 192,106 stock options, respectively, that were excluded from the calculation as they were considered antidilutive. For the nine-month periods ended September 30, 2016 and 2015, there were 99,308 and 192,106 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.

 

5. INVESTMENT SECURITIES

 

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

 

Available-for-Sale

   September 30, 2016 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair
Value
 
Debt securities:                    
U.S. Government Agencies and Sponsored Agencies  $224,159   $4,739   $(165)  $228,733 
Obligations of states and political subdivisions   22,197    1,017    (41)   23,173 
Corporate bonds   1,501    28        1,529 
Equity securities:                    
Corporate stock   49    18        67 
   $247,906   $5,802   $(206)  $253,502 
     
   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 $5,596,000 were recorded, net of $2,239,000 in tax liabilities, as accumulated other comprehensive income within shareholders’ equity at September 30, 2016. Proceeds and gross realized gains from the sale, call, and impairment of available-for-sale investment securities totaled $5,534,000 and $33,000, respectively, for the three-month period ended September 30, 2016 and for the nine-month period ended September 30, 2016, proceeds and gross realized gains from the sale, call, and impairment of available-for-sale investment securities totaled $13,821,000 and $314,000, respectively. There were no transfers of available-for-sale investment securities for the three-month and nine-month periods ended September 30, 2016.

11
 

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 September 30, 2015 totaled $8,381,000 and $33,000, respectively, and for the nine-month period ended September 30, 2015 totaled $23,764,000 and $251,000, respectively. There were no transfers of available-for-sale investment securities for the three-month and nine-month periods ended September 30, 2015.

Held-to-Maturity                
                 
September 30, 2016                
      Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
Debt securities:                    
U.S. Government Agencies and Sponsored Agencies  $508   $43   $   $551 
                     
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 September 30, 2016 and September 30, 2015. Investment securities with unrealized losses at September 30, 2016 and December 31, 2015 are summarized and classified according to the duration of the loss period as follows (dollars in thousands):

September 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  $18,319   $(81)   5,475    (84)  $23,794   $(165)
Obligations of states and political subdivisions   3,564    (41)           3,564    (41)
   $21,883   $(122)  $5,475   $(84)  $27,358   $(206)

 

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)
12
 

There were no held-to-maturity investment securities with unrealized losses as of September 30, 2016 or December 31, 2015.  At September 30, 2016, the Company held 215 securities of which twelve were in a loss position for less than twelve months and three were in a loss position for twelve months or more.  Of the twelve securities in a loss position for less than twelve months, nine were U.S. Government Agencies and Sponsored Agencies securities and three were obligations of states or political subdivisions and of the three securities that were in a loss position for greater than twelve months, all three 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.  

  

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 September 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  $2,577   $2,615           
After one year through five years   2,656    2,768           
After five years through ten years   12,953    13,758           
After ten years   5,512    5,561           
    23,698    24,702           
Investment securities not due at a single maturity date:                    
US Government Agencies and Sponsored Agencies   224,159    228,733   $508   $551 
Corporate stock   49    67         
   $247,906   $253,502   $508   $551 

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 September 30, 2016 and December 31, 2015, the recorded investment in nonperforming loans and leases was approximately $778,000 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 September 30, 2016, the recorded investment in loans and leases that were considered to be impaired totaled $18,357,000, which includes $753,000 in nonaccrual loans and leases and $17,604,000 in performing loans and leases. Of the total impaired loans of $18,357,000, loans totaling $11,569,000 were deemed to require no specific reserve and loans totaling $6,788,000 were deemed to require a related valuation allowance of $564,000. 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.

13
 

At September 30, 2016 and December 31, 2015, the balance in other real estate owned (“OREO”) was $653,000 and $3,551,000, respectively. At September 30, 2016, the Company did not own any residential OREO properties nor were 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 $126,000. 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. During the third quarter of 2016, the Company did not add any properties to OREO and sold one single commercial property in Amador County for a gain of $43,000. The September 30, 2016 OREO balance of $653,000 consisted of one parcel of land zoned for commercial use. Nonperforming assets at September 30, 2016 and December 31, 2015 are summarized as follows:

 

(dollars in thousands)  September 30,
2016
   December 31,
2015
 
         
Nonaccrual loans and leases that are current to terms (less than 30 days past due)  $297   $379 
Nonaccrual loans and leases that are past due   481    1,264 
Loans and leases past due 90 days and accruing interest        
Other assets   878    878 
Other real estate owned   653    3,551 
Total nonperforming assets  $2,309   $6,072 
           
Nonperforming loans and leases to total loans and leases   0.24%   0.56%
Total nonperforming assets to total assets   0.35%   0.96%

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

(dollars in thousands)  As of September 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   11,233    11,931        12,269    12,902     
Real estate-residential   336    423        338    338     
Subtotal  $11,569   $12,354   $   $12,607   $13,240   $ 
                               
With an allowance recorded:                              
                               
Commercial   $31   $31   $3   $121   $121   $25 
Real estate-commercial   4,053    4,148    366    5,597    5,693    598 
Real estate-multi-family   483    483    3    488    488    5 
Real estate-residential   1,827    1,827    139    2,114    2,201    204 
Agriculture   360    360    30    370    370    38 
Consumer   34    34    23    68    68    29 
Subtotal  $6,788   $6,883   $564   $8,758   $8,941   $899 
                               
Total:                              
                               
Commercial   $31   $31   $3   $121   $121   $25 
Real estate-commercial   15,286    16,079    366    17,866    18,595    598 
Real estate-multi-family   483    483    3    488    488    5 
Real estate-residential   2,163    2,250    139    2,452    2,539    204 
Agriculture   360    360    30    370    370    38 
Consumer   34    34    23    68    68    29 
   $18,357   $19,237   $564   $21,365   $22,181   $899 
14
 

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 nine months ended
 
   September 30,
2016
   September 30,
2015
   September 30,
2016
   September 30,
2015
 
                 
Commercial   $32   $125   $33   $145 
Real estate-commercial   15,369    19,335    15,202    19,749 
Real estate-multi-family   484    491    486    493 
Real estate-residential   2,169    2,473    2,182    2,511 
Agriculture   362    375    365    377 
Consumer   35    91    36    77 
     Total  $18,451   $22,890   $18,304   $23,352 
         
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 nine months ended
 
   September 30,
2016
   September 30,
2015
   September 30,
2016
   September 30,
2015
 
                 
Commercial   $   $2   $2   $7 
Real estate-commercial   123    259    567    728 
Real estate-multi-family   15    8    25    21 
Real estate-residential   24    14    76    69 
Agriculture   6    5    16    13 
Consumer                
     Total  $168   $288   $686   $838 

 

7. TROUBLED DEBT RESTRUCTURINGS

During the three and nine-month periods ended September 30, 2016, there were no loans that were modified as troubled debt restructurings. There were no loans modified as troubled debt restructurings during the three months ended September 30, 2015.

 

The following table presents loans by class modified as troubled debt restructurings during the nine months ended September 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    1,645    1,645 
Real estate - residential   2    416    416 
Consumer   1    23    23 
Total   6   $2,131   $2,131 

  

The troubled debt restructurings described above increased the allowance for loan and lease losses by $151,000 and resulted in no charge-offs during the nine months ended September 30, 2015.

 

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

15
 

8. ALLOWANCE FOR LOAN AND LEASE LOSSES

 

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

 

September 30, 2016  Credit Risk Profile by Internally Assigned Grade 
(dollars in thousands)      Real Estate 
   Commercial   Commercial   Multi-family   Construction   Residential 
Grade:                         
   Pass  $30,334   $169,327   $50,442   $6,684   $13,014 
   Watch   1,416    21,371    485    10,181    1,797 
   Special mention   637    3,392            717 
   Substandard   2,785    719            465 
   Doubtful                    
          Total  $35,172   $194,809   $50,927   $16,865   $15,993 
                 
   Credit Risk Profile by Internally Assigned Grade Other Credit Exposure             
   Leases   Agriculture   Consumer           Total 
Grade:                            
   Pass  $462   $1,875   $1,382           $273,520 
   Watch       360    405            36,015 
   Special mention           221            4,967 
   Substandard           62            4,031 
   Doubtful                        
          Total  $462   $2,235   $2,070           $318,533 
                             
     
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 
16
 

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

                                         
September 30, 2016      Real Estate   Other         
(dollars in thousands)  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   (769)   (64)   250    39    (53)       (13)   (97)   39    (668)
Loans charged-off       (68)                               (68)
Recoveries   658    14                        72        744 
                                                   
Ending balance, September 30, 2016  $749   $2,251   $478   $852   $266   $1   $64   $53   $269   $4,983 
                                                   
Ending balance:                                                  
Individually evaluated for impairment  $3   $365   $3   $   $140   $   $30   $23   $   $564 
                                                   
Ending balance:                                                  
Collectively evaluated for impairment  $746   $1,886   $475   $852   $126   $1   $34   $30   $269   $4,419 
                                                   
Loans                                                  
                                                   
Ending balance  $35,172   $194,809   $50,927   $16,865   $15,993   $462   $2,235   $2,070   $   $318,533 
                                                   
Ending balance:                                                  
Individually evaluated for impairment  $31   $15,286   $483   $   $2,163   $   $360   $34   $   $18,357 
                                                   
Ending balance:                                                  
Collectively evaluated for impairment  $35,141   $179,523   $50,444   $16,865   $13,830   $462   $1,875   $2,036   $   $300,176 
                                                   
Allowance for Loan and Lease Losses                                                  
                                                   
Beginning balance, June 30, 2016  $808   $2,647   $329   $725   $283   $1   $73   $60   $206   $5,132 
Provision for loan losses   (644)   (330)   149    127    (17)       (9)   (7)   63    (668)
Loans charged off       (68)                               (68)
Recoveries   585    2                                587 
                                                   
Ending balance, September 30, 2016  $749   $2,251   $478   $852   $266   $1   $64   $53   $269   $4,983 

17
 
December 31, 2015      Real Estate   Other         
(dollars in thousands)  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 
                     
September 30, 2015       Real Estate   Other         
(dollars in thousands)  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   38    (58)   27    160    (133)       14    (24)   (24)    
Loans charged off   (609)                   (1)       (6)       (616)
Recoveries   88    41            113            2        244 
                                                   
Ending balance, September 30, 2015  $947   $2,300   $157   $743   $379   $1   $76   $96   $230   $4,929 
                                                   
Allowance for Loan and Lease Losses                                                  
                                                   
Beginning balance, June 30, 2015  $1,652   $1,968   $107   $807   $385   $1   $50   $122   $267   $5,359 
Provision for loan losses   (161)   331    50    (64)   (119)       26    (26)   (37)    
Loans charged off   (609)                                   (609)
Recoveries   65    1            113                    179 
                                                   
Ending balance, September 30, 2015  $947   $2,300   $157   $743   $379   $1   $76   $96   $230   $4,929 
18
 

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

 

September 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  $   $   $   $   $35,172   $35,172       $ 
Real estate:                                        
Commercial           446    446    194,363    194,809        719 
Multi-family                   50,927    50,927         
Construction                   16,865    16,865         
Residential                   15,993    15,993         
Other:                                        
Leases                   462    462         
Agriculture                   2,235    2,235         
Consumer   36    35        71    1,999    2,070        59 
Total  $36   $35   $446   $517   $318,016   $318,533   $   $778 
                                 
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 
19
 

9. BORROWING ARRANGEMENTS

 

At September 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 September 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 $14,000,000 were outstanding from the FHLB at September 30, 2016, bearing interest rates ranging from 0.75% to 1.52% and maturing between October 31, 2016 and July 13, 2020. 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 September 30, 2016 and December 31, 2015 totaled $87,263,000 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 September 30, 2016 and December 31, 2015 were $11,698,000 and $11,371,000, respectively. There were no advances outstanding under this borrowing arrangement as of September 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 nine-month periods ended September 30, 2016 and 2015.

Federal and state income taxes for the quarter ended September 30, 2016 increased $182,000 (22.6%) from $807,000 in the third quarter of 2015 to $989,000 in the third quarter of 2016 and increased $252,000 (12.5%) from $2,022,000 in the nine months ended September 30, 2015 to $2,274,000 for the nine months ended September 30, 2016. The combined federal and state effective tax rate for the quarter ended September 30, 2016 was 35.3%, compared to 35.5% for the third quarter of 2015. For the nine months ended September 30, 2016, the combined federal and state effective tax rate was 33.6% compared to 34.7% for the nine months ended September 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 $189,000 in the third quarter of 2016 compared to $99,000 in the third quarter of 2015 and tax exempt loan interest was $534,000 in the first nine months of 2016 compared to $222,000 in the first nine months of 2015. The benefit from tax exempt loan interest was partially offset by higher taxable income in both periods as well. Taxable income was $2,802,000 in the third quarter of 2016 compared to $2,276,000 in the third quarter of 2015 and taxable income was $6,763,000 in the first nine months of 2016 compared to $5,833,000 in the first nine months of 2015.

20
 

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 September 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:     
September 30, 2016  Amount   Level 1   Level 2   Level 3   Total 
                     
Financial assets:                         
Cash and due from banks  $43,094   $43,094   $   $   $43,094 
Interest-bearing deposits in banks   999        999        999 
Available-for-sale securities   253,502    23    253,479        253,502 
Held-to-maturity securities   508        551        551 
FHLB stock   3,779    N/A    N/A    N/A    N/A 
Net loans and leases:   313,302            316,221    316,221 
Accrued interest receivable   1,792        866    926    1,792 
                          
Financial liabilities:                         
Deposits:                         
Noninterest-bearing  $209,586   $209,586   $   $   $209,586 
Savings   60,605    60,605            60,605 
Money market   131,655    131,655            131,655 
NOW accounts   61,398    61,398            61,398 
Time Deposits   82,921        83,429        83,429 
Short-term borrowings   5,000    5,000            5,000 
Long-term borrowings   9,000        9,080        9,080 
Accrued interest payable   40        40        40 
21
 
   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 September 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.

22
 

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.

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 September 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) 
                     
September 30, 2016                         
Assets and liabilities measured on a recurring basis:                         
Available-for-sale securities:                         
US Government Agencies and Sponsored Agencies  $228,733   $   $228,733   $   $ 
Obligations of states and political subdivisions   23,173        23,173         
Corporate bonds   1,529        1,529         
Corporate stock   67    23    44         
Total recurring  $253,502   $23   $253,479   $   $ 
                          
Assets and liabilities measured on a nonrecurring basis:                         
Impaired loans:                         
  Real estate:                          
Commercial  $4,271   $   $   $4,271   $ 
Residential   336            336    (68)
Other real estate owned
Land
   653            653    (376)
Total nonrecurring  $5,260   $   $   $5,260   $(444)
23
 
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 nine-month periods ended September 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%.

24
 

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.

25
 

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.

26
 

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 September 30, 2016 and its income and expense accounts for the three-month and nine-month periods ended September 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 items), 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 September 30, 2016 or 2015 or for the three-month and nine-month periods then ended.

29
 

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 99 full-time employees as of September 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 $1,813,000 for the quarter ended September 30, 2016, which was an increase of $344,000 compared to $1,469,000 reported for the same period of 2015. Diluted earnings per share for the third quarter of 2016 were $0.27 compared to $0.20 recorded in the third quarter of 2015. The return on average equity (“ROAE”) and the return on average assets (“ROAA”) for the third quarter of 2016 were 8.62% and 1.13%, respectively, as compared to 6.71% and 0.92%, respectively, for the same period in 2015.

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Net income for the nine months ended September 30, 2016 and 2015 was $4,489,000 and $3,811,000, respectively, with diluted earnings per share of $0.66 in 2016 and $0.50 in 2015. For the first nine months of 2016, ROAE was 7.12% and ROAA was 0.95% compared to 5.81% and 0.82%, respectively, for the same period in 2015.

 

Total assets of the Company increased by $19,206,000 (3.0%) from $634,460,000 at December 31, 2015 to $653,846,000 at September 30, 2016. Net loans totaled $313,302,000 at September 30, 2016, an increase of $24,200,000 (8.4%) from $289,102,000 at December 31, 2015. Deposit balances at September 30, 2016 totaled $546,165,000, an increase of $15,475,000 (2.9%) from the $530,690,000 at December 31, 2015.

 

The Company ended the third quarter of 2016 with a leverage capital ratio of 10.6%, a Tier 1 capital ratio of 18.4%, and a total risk-based capital ratio of 19.7% 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
September 30,
   For the nine months ended
September 30,
 
   2016   2015   2016   2015 
Interest income*  $5,412   $5,553   $16,152   $15,912 
Interest expense   (223)   (240)   (678)   (732)
Net interest income*   5,189    5,313    15,474    15,180 
Provision for loan and lease losses   668        668     
Noninterest income   399    490    1,516    1,582 
Noninterest expense   (3,346)   (3,432)   (10,552)   (10,660)
Provision for income taxes   (989)   (807)   (2,274)   (2,022)
Tax equivalent adjustment   (108)   (95)   (343)   (269)
Net income  $1,813   $1,469   $4,489   $3,811 
                     
Average total assets  $635,561   $630,704   $632,120   $618,551 
Net income (annualized) as a percentage of average total assets   1.13%   0.92%   0.95%   0.82%

* 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 3.65% for the three months ended September 30, 2016, 3.72% for the three months ended September 30, 2015, 3.64% for the nine months ended September 30, 2016 and 3.62% for the nine months ended September 30, 2015.

The fully taxable equivalent interest income component for the third quarter of 2016 decreased $141,000 (2.5%) to $5,412,000 compared to $5,553,000 for the three months ended September 30, 2015. The decrease in the fully taxable equivalent interest income for the third quarter of 2016 compared to the same period in 2015 is broken down by rate (down $244,000) and volume (up $103,000). The yield on earning assets decreased from 3.89% during the third quarter of 2015 to 3.81% during the third quarter of 2016. The primary driver in this rate decrease was a decrease in the yield on loans which saw a decrease from 5.07% in the third quarter of 2015 to 5.01% in the third quarter of 2016 and a decrease in the yield on investments, which saw a decrease from 2.69% in the third quarter of 2015 to 2.38% in the third quarter of 2016. While average loans increased $20,410,000 (7.1%) from $286,914,000 during the third quarter of 2015 to $307,324,000 during the third quarter of 2016, due to the overall lower interest rate environment, the new loans added were at lower yields than the existing loans. The decrease in the yield on the investment portfolio is also due primarily to the lower rate environment as principal paydowns were reinvested at lower rates. The volume increase of $103,000 was primarily from loans ($252,000) partially offset by a decrease in investment balances ($149,000). The average balance of earning assets decreased $1,652,000 (0.3%) from $566,722,000 in the third quarter of 2015 to $565,070,000 in the third quarter of 2016. When compared to the third quarter of 2015, average investment securities decreased $22,061,000 (7.9%) from $278,808,000 for the third quarter of 2015 compared to $256,747,000 for the third quarter of 2016.

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Total fully taxable equivalent interest income for the nine months ended September 30, 2016 increased $240,000 (1.5%) to $16,152,000 compared to $15,912,000 for the nine months ended September 30, 2015. The breakdown of the fully taxable equivalent interest income for the nine months ended September 30, 2016 over the same period in 2015 resulted from a decrease in rate (down $380,000) and an increase in volume (up $620,000). Average earning assets increased $8,139,000 (1.5%) from $559,936,000 during the first nine months of 2015 to $568,075,000 for the same period in 2016. During the nine month periods, the Company also experienced a decrease in interest income due to the rates earned on loans (down $258,000) and investments (down $123,000). The yield on loans decreased from 5.06% in 2015 to 4.93% in 2016 and the yield on investments decreased from 2.59% in 2015 to 2.52% in 2016. Part of this decrease in the yield on investments was related to an increase in the mortgage refinance market and the related faster amortization of the premiums paid on the mortgage related bonds, as well as, a special one-time cash dividend in 2015 from the Federal Home Loan Bank of San Francisco (the “FHLB”) in the amount of $136,000. Average loan balances increased by $26,079,000 (9.5%) from $275,566,000 during 2015 to $301,645,000 during 2016. The volume increase of $620,000 is primarily related to the above mentioned increase in loan balances from 2015 to 2016, which accounted for a $971,000 increase in interest income, which was partially offset by a decrease in average investment balances. Average investment securities decreased $17,941,000 (6.3%) from $283,377,000 for the first nine months of 2015 compared to $265,436,000 for the first nine months of 2016.

Interest expense was $17,000 (7.1%) lower in the third quarter of 2016 versus the prior year period, decreasing from $240,000 to $223,000. The average balances on interest bearing liabilities were $347,173,000 or $12,713,000 (3.5%) lower in the third quarter of 2016 compared to $359,886,000 for the same quarter in 2015. The decrease in balances caused a $15,000 reduction on the overall interest expense while the decrease in rates caused a $2,000 reduction. Rates paid on interest bearing liabilities did not change during the periods as the Company’s cost of funds was 0.26% for both quarters.

Interest expense was $54,000 (7.4%) lower in the nine-month period ended September 30, 2016 decreasing from $732,000 in 2015 to $678,000 in 2016. The decrease is related to rates (down $53,000) and volume (down $1,000). The average balances on interest-bearing liabilities were $349,503,000 (down $6,625,000 or 1.9% lower) in the nine-month period ended September 30, 2016 compared $356,128,000 in the same period in 2015. Although the average balances were lower, the decreased balances did not result in a significant decrease in interest expense as the decrease in interest bearing deposit balances (down $26,000) was offset by an increase in other borrowings which increased by $25,000. Average other borrowings increased $3,330,000 (22.8%) from $14,606,000 in the first nine months of 2015 to $17,936,000 in the first nine months of 2016. The primary decrease in interest expense relates to lower rates (down $53,000). Rates paid on interest bearing liabilities decreased 1 basis point from 0.27% 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 September 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)  $289,795   $3,617    4.97%  $275,313   $3,534    5.09%
Tax-exempt loans and leases (2)   17,529    254    5.76%   11,601    130    4.45%
  Taxable investment securities   232,858    1,340    2.29%   252,760    1,633    2.56%
  Tax-exempt investment securities (2)   23,811    199    3.32%   25,965    254    3.88%
  Corporate stock (2)   78            83         
  Federal funds sold                        
  Investments in time deposits   999    2    0.80%   1,000    2    0.79%
Total earning assets   565,070    5,412    3.81%   566,722    5,553    3.89%
Cash & due from banks   37,343              29,465           
Other assets   38,618              40,010           
Allowance for loan & lease losses   (5,470)             (5,493)          
   $635,561             $630,704           
                               
Liabilities & Shareholders’ Equity                              
Interest bearing liabilities:                              
  Interest checking and money market  $188,292    35    0.07%  $196,395    61    0.12%
  Savings   60,925    4    0.03%   58,579    6    0.04%
  Time deposits   82,771    140    0.67%   86,684    135    0.62%
  Other borrowings   15,185    44    1.15%   18,228    38    0.83%
Total interest bearing liabilities   347,173    223    0.26%   359,886    240    0.26%
Noninterest bearing demand deposits   198,655              177,737           
Other liabilities   6,031              6,253           
Total liabilities   551,859              543,876           
Shareholders’ equity   83,702              86,828           
   $635,561             $630,704           
Net interest income & margin (3)       $5,189    3.65%       $5,313    3.72%

 

(1)Loan interest includes loan fees of $102,000 and $157,000, respectively, during the three months ended September 30, 2016 and September 30, 2015. Average loan balances include nonperforming loans.
(2)Includes taxable-equivalent adjustments that primarily relate to income on certain securities that is exempt from federal income taxes. The effective federal statutory tax rate was 34% for 2016 and 2015.
(3)Net interest margin is computed by dividing net interest income by total average earning assets.
(4)Average yield is calculated based on actual days in the period (92 days) and annualized to actual days in the year (366 days in 2016 and 365 days in 2015).
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Nine Months Ended September 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)  $284,782   $10,424    4.89%  $267,256   $10,130    5.07%
Tax-exempt loans and leases (2)   16,863    716    5.67%   8,310    297    4.78%
  Taxable investment securities   241,129    4,333    2.40%   257,103    4,706    2.45%
  Tax-exempt investment securities (2)   24,233    660    3.64%   26,196    763    3.89%
  Corporate stock (2)   74    14    25.27%   78    12    20.57%
  Federal funds sold                        
  Interest-bearing deposits in banks   994    5    0.67%   993    4    0.54%
Total earning assets   568,075    16,152    3.80%   559,936    15,912    3.80%
Cash & due from banks   31,209              24,347           
Other assets   38,027              39,650           
Allowance for loan & lease losses   (5,191)             (5,382)          
   $632,120             $618,551           
                               
Liabilities & Shareholders’ Equity                              
Interest-bearing liabilities:                              
  Interest checking and money market  $188,405    110    0.08%  $195,563    192    0.13%
  Savings   59,940    14    0.03%   58,464    23    0.05%
  Time deposits   83,222    421    0.68%   87,495    409    0.62%
  Other borrowings   17,936    133    0.99%   14,606    108    0.99%
Total interest-bearing liabilities   349,503    678    0.26%   356,128    732    0.27%
Noninterest-bearing demand deposits   192,103              168,546           
Other liabilities   6,262              6,157           
Total liabilities   547,868              550,831           
Shareholders’ equity   84,252              87,720           
   $632,120             $618,551           
Net interest income & margin (3)       $15,474    3.64%       $15,180    3.62%

 

(1)Loan interest includes loan fees of $197,000 and $250,000, respectively, during the nine months ended September 30, 2016 and September 30, 2015. Average loan balances include nonperforming loans.
(2)Includes taxable-equivalent adjustments that primarily relate to income on certain securities that is exempt from federal income taxes. The effective federal statutory tax rate was 34% for 2016 and 2015.
(3)Net interest margin is computed by dividing net interest income by total average earning assets.
(4)Average yield is calculated based on actual days in the period (274 days for 2016 and 273 days for 2015) and annualized to actual days in the year (366 days for 2016 and 365 days for 2015).
34
 
Table Three:  Analysis of Volume and Rate Changes on Net Interest Income and Expenses
Three Months Ended September 30, 2016 over 2015 (dollars in thousands)
Increase (decrease) due to change in:            
   Volume   Rate (4)   Net Change 
Interest-earning assets:               
   Taxable loans and leases (1)  $186   $(103)  $83 
   Tax-exempt loans and leases (2)   66    58    124 
   Taxable investment securities   (128)   (165)   (293)
   Tax exempt investment securities (3)   (21)   (34)   (55)
   Corporate stock            
   Interest-bearing deposits in banks            
       Total   103    (244)   (141)
Interest-bearing liabilities:               
   Interest checking and money market   (3)   (23)   (26)
   Savings deposits       (2)   (2)
   Time deposits   (6)   11    5 
   Other borrowings   (6)   12    6 
       Total   (15)   (2)   (17)
Interest differential  $118   $(242)  $(124)
             
Nine Months Ended September 30, 2016 over 2015 (dollars in thousands)            
Increase (decrease) due to change in:            
   Volume   Rate (4)   Net Change 
Interest-earning assets:               
   Taxable loans and leases (1)  $665   $(371)  $294 
   Tax-exempt loans and leases (2)   306    113    419 
   Taxable investment securities   (293)   (80)   (373)
   Tax exempt investment securities (3)   (57)   (46)   (103)
   Corporate stock   (1)   3    2 
   Interest-bearing deposits in banks       1    1 
       Total   620    (380)   240 
Interest-bearing liabilities:               
   Interest checking and money market   (7)   (75)   (82)
   Savings deposits   1    (10)   (9)
   Time deposits   (20)   32    12 
   Other borrowings   25        25 
       Total   (1)   (53)   (54)
Interest differential  $621   $(327)  $294 

 

(1)The average balance of non-accruing loans is immaterial as a percentage of total loans and, as such, has been included in net loans.
(2)Loan fees of $102,000 and $157,000, respectively, during the three months ended September 30, 2016 and September 30, 2015, and loan fees of $197,000 and $250,000, respectively, during the nine months ended September 30, 2016 and September 30, 2015, have been included in the interest income computation.
(3)Includes taxable-equivalent adjustments that primarily relate to income on certain securities that is exempt from federal income taxes.  The effective federal statutory tax rate was 34% for 2016 and 2015.
(4)The rate/volume variance has been included in the rate variance.
35
 

Provision for Loan and Lease Losses

The Company experienced net loan and lease recoveries of $519,000 or 0.67% (on an annualized basis) of average loans and leases for the three months ended September 30, 2016 compared to net loan and lease losses of $430,000 or 0.59% (on an annualized basis) of average loans and leases for the three months ended September 30, 2015. As a result of the loan recoveries experienced in 2016, the Company reversed $668,000 from the allowance for loan and lease losses during the third quarter. The Company did not provide any provision for loan and lease losses for the third quarter of 2015. For the first nine months of 2016, the Company reversed $668,000 from the loan and lease loss allowance and net loan and lease recoveries were $676,000 or 0.30% (on an annualized basis) of average loans and leases outstanding in 2016 compared to net loan and lease losses of $372,000 or 0.18% (on an annualized basis) of average loans and leases outstanding in the first nine months of 2015. The Company continued to experience an overall improvement in the credit quality of the loan and lease portfolio and a reduction of credit losses. For additional information see the “Allowance for Loan and Lease Losses Activity.”

Noninterest Income

Table Four below provides a summary of the components of noninterest income for the periods indicated (dollars in thousands):

Table Four: Components of Noninterest Income

  

Three Months
Ended

September 30,

  

Nine Months
Ended

September 30,

 
   2016   2015   2016   2015 
Service charges on deposit accounts  $124   $132   $381   $376 
Gain on sale/call/impairment of securities   33    33    314    251 
Merchant fee income   98    98    277    285 
Bank owned life insurance   80    80    239    239 
Income from OREO properties       87    106    248 
Other   64    60    199    183 
           Total noninterest income  $399   $490   $1,516   $1,582 

 

Noninterest income decreased $91,000 (18.6%) to $399,000 for the three months ended September 30, 2016 compared to $490,000 for the three months ended September 30, 2015. The decrease from the third quarter of 2015 to the third quarter of 2016 was primarily related to a decrease in rental income from OREO properties which decreased $87,000 (100.0%) from $87,000 in 2015 to zero in 2016. The decrease in OREO income resulted from the sale of the Bank’s only remaining income producing OREO property in the first quarter of 2016.

 

For the nine months ended September 30, 2016, noninterest income decreased $66,000 (4.2%) from $1,582,000 to $1,516,000. The decrease from the first nine months of 2015 compared to the same period in 2016 was primarily related to the decrease in rental income from OREO properties which declined $142,000 (57.3%) from $248,000 in 2015 to $106,000 in 2016.

 

Noninterest Expense

 

Noninterest expense decreased $86,000 (2.5%) from $3,432,000 in the third quarter of 2015 to $3,346,000 in the third quarter of 2015. Salary and employee benefits expense decreased $112,000 (5.1%) from $2,185,000 during the third quarter of 2015 to $2,073,000 during the third quarter of 2016. The decrease in salaries and benefits resulted from a lower number of full time equivalent employees and the associated benefit and taxes. Average full-time equivalent employees decreased from 100 in the third quarter of 2015 to 98 in the third quarter of 2016. Occupancy expense increased $1,000 (0.3%) and furniture and equipment expense decreased $6,000 (3.5%) from the third quarter of 2015 to the third quarter of 2016. FDIC assessments decreased $6,000 (7.2%) from the third quarter of 2015 to the third quarter of 2016. OREO related expenses decreased $88,000 during the third quarter of 2016 from $58,000 in the third quarter of 2015 to a credit of $30,000 in the third quarter of 2016. The primary reason for the decrease in OREO related expenses was the reduction in OREO properties reducing carrying costs as well as a gain on sale of $43,000 recorded in the third quarter of 2016. The gain on sale was greater than the operating costs for the quarter resulting in the credit balance. Other expenses increased $125,000 (19.5%) to $766,000 in the third quarter of 2016 compared to $641,000 in the third quarter of 2015. Much of the increase is related to higher legal fees and network administration fees. Legal fees increased from $17,000 to $43,000 and is related to the resolution of a former loan relationship. The increased network administration fees increased from $69,000 to $114,000 and is related to additional work performed by the network vendor, including full hosting of the Company’s computer network. The fully taxable equivalent efficiency ratio for the third quarter of 2016 increased to 59.9% from 59.1% for the third quarter of 2015.

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Noninterest expense for the nine-month period ended September 30, 2016 was $10,552,000 compared to $10,660,000 for the same period in 2015 for a decrease of $108,000 (1.0%). Salaries and employee benefits expense decreased $166,000 (2.6%) from $6,500,000 for the nine months ended September 30, 2015 to $6,334,000 for the same period in 2016. The decrease in salaries and benefit expense is related to lower incentive accruals, which decreased $81,000 (18.0%) from $450,000 in 2015 to $369,000 in 2016, as not all of the incentive targets have been met as of September 30, 2016. In addition, fees paid to employment agencies for placement fees decreased $50,000 (69.4%) from $72,000 in the first nine months of 2015 to $22,000 in the first nine months of 2016. Occupancy expense decreased $3,000 (0.3%) and furniture and equipment expense decreased $34,000 (6.5%). FDIC assessments decreased $6,000 (2.5%). OREO related expenses increased $70,000 (26.9%) during 2016 to $330,000, from $260,000 in 2015. The increase in OREO expenses is directly related to a $376,000 property write-down partially offset by the $169,000 gain on sale from two properties sold during 2016. Other expenses increased $31,000 (1.4%) from $2,246,000 for the nine months ended September 30, 2015 to $2,277,000 for the same period in 2016. The increase in other expenses resulted from higher legal fees and network administration fees. Legal fees increased from $102,000 to $126,000 and network administration fees increased from $210,000 to $322,000. The overhead efficiency ratio (fully taxable equivalent) for the first nine months of 2016 was 62.1% as compared to 63.6% in the same period of 2015.

Provision for Income Taxes

 

Federal and state income taxes for the quarter ended September 30, 2016 increased $182,000 (22.6%) from $807,000 in the third quarter of 2015 to $989,000 in the third quarter of 2016 and increased $252,000 (12.5%) from $2,022,000 in the nine months ended September 30, 2015 to $2,274,000 for the nine months ended September 30, 2016. The combined federal and state effective tax rate for the quarter ended September 30, 2016 was 35.3%, compared to 35.5% for the third quarter of 2015. For the nine months ended September 30, 2016, the combined federal and state effective tax rate was 33.6% compared to 34.7% for the nine months ended September 30, 2015. The lower effective tax rate for 2016 compared to 2015 resulted from an increase in tax exempt loan interest. Tax exempt loan interest was $534,000 in the first nine months of 2016 compared to $222,000 in the first nine months of 2015. The higher provision for taxes in 2016 resulted from a higher level of taxable income. Taxable income increased $930,000 (15.9%) from $5,833,000 in 2015 to $6,763,000 in 2016.

Balance Sheet Analysis

 

The Company’s total assets were $653,846,000 at September 30, 2016 compared to $634,460,000 at December 31, 2015, representing an increase of $19,386,000 (3.1%). The average assets for the three months ended September 30, 2016 were $635,561,000, which represents an increase of $4,857,000 (0.8%) from the balance of $630,704,000 during the three-month period ended September 30, 2015. The average assets for the nine months ended September 30, 2016 were $632,120,000, which represents an increase of $13,569,000 (2.2%) from the average balance of $618,551,000 during the nine-month period ended September 30, 2015.

Investment Securities

The Company classifies its investment securities as available-for-sale or held-to-maturity. The Company’s intent is to hold all securities classified as held-to-maturity until maturity and management believes that it has the ability to do so. Securities available-for-sale may be sold to implement asset/liability management strategies and in response to changes in interest rates, prepayment rates and similar factors.

Table Five below summarizes the values of the Company’s investment securities held on September 30, 2016 and December 31, 2015.

Table Five: Investment Securities Composition

(dollars in thousands)

Available-for-sale (at fair value)  September 30, 2016       December 31, 2015 
Debt securities:          
U.S. Government Agencies and Sponsored Agencies  $228,733   $246,185 
Obligations of states and political subdivisions   23,173    26,013 
Corporate bonds   1,529    1,551 
Corporate stock   67    70 
Total available-for-sale investment securities  $253,502   $273,819 
           
Held-to-maturity (at amortized cost)           
Debt securities:          
U.S. Government Agencies and Sponsored Agencies  $508   $623 
Total held-to-maturity investment securities  $508   $623 
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Net unrealized gains on available-for-sale investment securities totaling $5,596,000 were recorded, net of $2,239,000 in tax liabilities, as accumulated other comprehensive income within shareholders’ equity at September 30, 2016 and 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.

 

Management periodically evaluates each investment security in a loss position for other than temporary impairment relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations. Management has the ability and intent to hold securities with established maturity dates until recovery of fair value, which may be until maturity, and believes it will be able to collect all amounts due according to the contractual terms for all of the underlying investment securities; therefore, management does not consider these investments to be other-than-temporarily impaired.

Loans and Leases

The Company’s historical lending activities have been in the following principal areas: (1) commercial; (2) commercial real estate; (3) multi-family real estate; (4) real estate construction (both commercial and residential); (5) residential real estate; (6) lease financing receivable; (7) agriculture; and (8) consumer loans. The Company’s continuing focus in our market area, new borrowers developed through the Company’s marketing efforts, and credit extensions expanded to existing borrowers resulted in the Company adding $66 million in new loans during the first nine months of 2016. This production was partially offset by normal pay downs and payoffs, but still resulted in an overall net increase in net loans and leases of $24.2 million (8.4%) from December 31, 2015. Included in the $66 million in new loans in 2016 was a $13.2 million pool of performing multi-family loans purchased from another financial institution. These purchased loans consisted of seven loans primarily in the Company’s lending footprint and two loans in San Diego County. The market in which the Company operates has begun to show demand for credit products as the continued low rate environment and expectations for economic expansion have increased refinancing as well as new loan activity. Table Six below summarizes the composition of the loan portfolio as of September 30, 2016 and December 31, 2015. 

 

Table Six: Loan and Lease Portfolio Composition

(dollars in thousands)  September 30, 2016    December 31, 2015   Change in   Percentage 
   $   %   $   %   dollars   change 
Commercial  $35,172    11%  $36,195    12%  $(1,023)   (2.8%)
Real estate                              
Commercial   194,809    61%   199,591    68%   (4,782)   (2.4%)
Multi-family   50,927    16%   23,494    8%   27,433    116.8%
Construction   16,865    5%   14,533    5%   2,332    16.0%
Residential   15,993    5%   14,200    5%   1,793    12.6%
Lease financing receivable   462    0%   732    0%   (270)   (36.9%)
Agriculture   2,235    1%   2,431    1%   (196)   (8.1%)
Consumer   2,070    1%   3,122    1%   (1,052)   (33.7%)
Total loans and leases   318,533    100%   294,298    100%   24,235    8.2%
Deferred loan and lease fees, net   (248)        (221)        (27)     
Allowance for loan and lease losses   (4,983)        (4,975)        (8)