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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)

 

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

 

For the quarterly period ended            June 30, 2018

or

 

oTRANSITION 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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

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

Emerging growth company o

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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 – 5,864,802 shares outstanding at August 9, 2018.

 
 

AMERICAN RIVER BANKSHARES

INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2018

Part I.     Page
       
Item 1. Financial Statements   3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations   29
Item 3. Quantitative and Qualitative Disclosures About Market Risk   48
Item 4. Controls and Procedures   49
       
Part II.      
       
Item 1. Legal Proceedings   49
Item 1A. Risk Factors   49
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds   49
Item 3. Defaults Upon Senior Securities   50
Item 4. Mine Safety Disclosures   50
Item 5. Other Information   50
Item 6. Exhibits   50
       
Signatures     51
       
Exhibit Index   52
       
31.1 Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002   53
31.2 Certifications of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002   54
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   55
       
101.INS XBRL Instance Document    
101.SCH XBRL Taxonomy Extension Schema    
101.CAL XBRL Taxonomy Extension Calculation    
101.DEF XBRL Taxonomy Extension Definition    
101.LAB XBRL Taxonomy Extension Label    
101.PRE XBRL Taxonomy Extension Presentation    
2
 

PART I-FINANCIAL INFORMATION

Item 1. Financial Statements.

 

AMERICAN RIVER BANKSHARES

CONSOLIDATED BALANCE SHEET

(Unaudited)

(dollars in thousands) 

June 30,

2018

  

December 31,

2017

 
ASSETS
          
Cash and due from banks  $45,068   $38,467 
Federal funds sold   8,000     
Total cash and cash equivalents   53,068    38,467 
Interest-bearing deposits in banks
   1,746    1,746 
Investment securities:          
Available-for-sale, at fair value   281,660    262,322 
Held-to-maturity, at amortized cost   330    378 
Loans and leases, less allowance for loan and lease losses of $4,492 at June 30, 2018 and $4,478 at December 31, 2017   290,552    308,713 
Premises and equipment, net   1,084    1,158 
Federal Home Loan Bank stock   3,932    3,932 
Goodwill and other intangible assets   16,321    16,321 
Other real estate owned   961    961 
Bank owned life insurance   15,273    15,122 
Accrued interest receivable and other assets   10,329    6,502 
   $675,256   $655,622 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
           
Deposits:          
     Noninterest bearing   $221,402   $215,528 
     Interest-bearing   359,914    340,552 
             Total deposits   581,316    556,080 
           
Short-term borrowings   6,500    3,500 
Long-term borrowings   9,000    12,000 
Accrued interest payable and other liabilities   6,547    7,121 
           
             Total liabilities    603,363    578,701 
           
Commitments and contingencies          
           
Shareholders’ equity:          
Preferred stock, no par value; 10,000,000 shares authorized; none outstanding        
Common stock, no par value; 20,000,000 shares authorized; issued and outstanding – 5,864,802 shares at June 30, 2018 and 6,132,362 shares at December 31, 2017   30,082    34,463 
Retained earnings   44,801    42,779 
Accumulated other comprehensive loss, net of taxes   (2,990)   (321)
           
Total shareholders’ equity   71,893    76,921 
   $675,256   $655,622 

 

See Notes to Unaudited Consolidated Financial Statements

3
 

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF INCOME

(Unaudited)

 

(dollars in thousands, except per share data)                
For the periods ended June 30,  Three months    Six months 
   2018   2017   2018   2017 
Interest income:                    
Interest and fees on loans:                    
Taxable  $3,483   $3,458   $6,811   $6,888 
Exempt from Federal income taxes   128    133    256    266 
Interest on Federal funds sold   98        148     
Interest on deposits in banks   7    3    13    5 
Interest and dividends on investment securities:                    
Taxable   1,637    1,363    3,028    2,686 
Exempt from Federal income taxes   145    159    308    316 
Dividends       5        13 
Total interest income   5,498    5,121    10,564    10,174 
Interest expense:                    
Interest on deposits   324    203    599    397 
Interest on borrowings   54    49    108    97 
Total interest expense   378    252    707    494 
                     
Net interest income   5,120    4,869    9,857    9,680 
Provision for loan and lease losses                
                     
Net interest income after provision for loan and lease losses   5,120    4,869    9,857    9,680 
Noninterest income:                    
Service charges on deposit accounts   116    114    233    231 
Gain on sale or call of investment securities   10    86    11    142 
Other noninterest income   254    239    508    485 
Total noninterest income   380    439    752    858 
                     
Noninterest expense:                    
Salaries and employee benefits   2,517    2,064    4,723    4,234 
Occupancy   262    262    524    531 
Furniture and equipment   136    147    274    298 
Federal Deposit Insurance Corporation assessments   53    52    106    105 
Expenses related to other real estate owned   (3)   12    2    32 
Other expense   863    831    1,549    1,598 
Total noninterest expense   3,828    3,368    7,178    6,798 
                     
Income before provision for income taxes   1,672    1,940    3,431    3,740 
                     
Provision for income taxes   403    643    809    1,259 
                     
Net income  $1,269   $1,297   $2,622   $2,481 
                     
Basic earnings per share  $0.22   $0.20   $0.44   $0.38 
Diluted earnings per share  $0.22   $0.20   $0.44   $0.38 
                     
Cash dividends per share  $0.05   $0.05   $0.10   $0.10 

  

See notes to Unaudited Consolidated Financial Statements

4
 

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(Unaudited)

 

(dollars in thousands, except per share data)                
For the periods ended June 30,  Three months   Six months 
   2018   2017   2018   2017 
Net income  $1,269   $1,297   $2,622   $2,481 
Other comprehensive income:                    
(Decrease) increase in net unrealized gains on investment securities   (1,150)   412    (3,862)   873 
Deferred tax benefit (expense)   367    (166)   1,200    (344)
Increase in net unrealized (losses) gains on investment securities, net of tax   (783)   246    (2,662)   529 
                     
Reclassification adjustment for realized gains included in net income   (10)   (86)   (11)   (142)
Tax effect   3    35    4    57 
Realized gains, net of tax   (7)   (51)   (7)   (85)
                   Total other comprehensive (loss) gain income   (790)   195    (2,669)   444 
Comprehensive income (loss)  $479   $1,492   $(47)  $2,925 

 

See Notes to Unaudited Consolidated Financial Statements

5
 

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

               Accumulated     
   Common Stock       Other   Total 
           Retained   Comprehensive   Shareholders' 
(dollars in thousands)  Shares   Amount   Earnings   Income (Loss)   Equity 
Balance, January 1, 2017   6,661,726   $42,484   $40,822   $544   $83,850 
Net income             2,481         2,481 
Other comprehensive income, net of tax                  444    444 
                          
Cash dividends ($0.10 per share)             (657)        (657)
Net restricted stock award activity and related compensation expense   22,032    181              181 
Stock options exercised   7,095    60              60 
Stock option compensation expense       20              20 
Retirement of common stock   (333,086)   (5,006)             (5,006)
                          
Balance, June 30, 2017   6,357,767   $37,739   $42,646   $988   $81,373 
                          
Balance, January 1, 2018   6,132,362    34,463    42,779    (321)   76,921 
Net income             2,622         2,622 
Other comprehensive loss, net of tax                  (2,669)   (2,669)
                          
Cash dividends ($0.10 per share)             (601)        (601)
Net restricted stock award activity and related compensation expense   17,859    136    1         137 
Stock options exercised   13,359    123              123 
Stock option compensation expense       14              14 
Retirement of common stock   (298,778)   (4,654)             (4,654)
                          
Balance, June 30, 2018   5,864,802   $30,082   $44,801   $(2,990)  $71,893 

 

See Notes to Unaudited Consolidated Financial Statements

6
 

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)

 

(dollars in thousands)        
For the six months ended June 30,        
   2018   2017 
Cash flows from operating activities:          
Net income  $2,622   $2,481 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan and lease losses        
Increase in deferred loan origination fees, net   93    3 
Depreciation and amortization   138    173 
Gain on sale and call of investment securities, net   (11)   (142)
Amortization of investment security premiums and discounts, net   1,491    1,648 
Increase in cash surrender values of life insurance policies   (151)   (157)
Stock based compensation expense   151    201 
Increase in accrued interest receivable and other assets   (2,604)   (98)
Decrease in accrued interest payable and other liabilities   (574)   (442)
           
Net cash provided by operating activities   1,155    3,667 
           
Cash flows from investing activities:          
Proceeds from the sale of available-for-sale investment securities   14,443    17,605 
Proceeds from matured available-for-sale investment securities       1,930 
Proceeds from called available-for-sale investment securities   1,499    145 
Purchases of available-for-sale investment securities   (61,756)   (45,419)
Proceeds from principal repayments for available-for-sale investment securities   21,105    21,513 
Proceeds from principal repayments for held-to-maturity investment securities   48    54 
Net increase in interest-bearing deposits in banks       (249)
Net decrease in loans   18,067    7,937 
Net increase in FHLB stock       (153)
Purchases of equipment   (64)   (86)
           
Net cash (used in) provided by investing activities   (6,658)   3,277 
7
 

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
(Unaudited)

 

(dollars in thousands)        
For the six months ended June 30,        
   2018   2017 
Cash flows from financing activities:          
Net increase (decrease) in demand, interest-bearing and savings deposits  $27,717   $(4,771)
Net decrease in time deposits   (2,481)   (2,155)
Net increase (decrease) in short-term borrowings   3,000    (1,500)
Net (decrease) increase in long-term borrowings   (3,000)   1,500 
Proceeds from stock option exercise   123    60 
Cash dividends paid   (601)   (657)
Cash paid to repurchase common stock   (4,654)   (5,006)
           
Net cash provided by (used in) financing activities  $20,104   $(12,529)
           
Increase (decrease) in cash and cash equivalents   14,601    (5,585)
           
Cash and cash equivalents at beginning of year   38,467    27,589 
           
Cash and cash equivalents at end of period  $53,068   $22,004 

 

See Notes to Unaudited Consolidated Financial Statements

8
 

AMERICAN RIVER BANKSHARES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2018

 

1. CONSOLIDATED FINANCIAL STATEMENTS

 

In the opinion of management, the unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the consolidated financial position of American River Bankshares (the “Company”) at June 30, 2018 and December 31, 2017, the results of its operations and statement of comprehensive income for the three-month and six-month periods ended June 30, 2018 and 2017, its cash flows for the six-month periods ended June 30, 2018 and 2017 and its statement of changes in shareholders’ equity for the six months ended June 30, 2018 and 2017 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, 2017. The results of operations for the three-month and six-month periods ended June 30, 2018 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.

 

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.

 

Adoption of New Accounting Standard: On January 1, 2018, the Company adopted ASU 2014-09 “Revenue from Contracts with Customers” and all subsequent amendments to the ASU (collectively, “ASC 606”), which (i) creates a single framework for recognizing revenue from contracts with customers that fall within its scope and (ii) revises when it is appropriate to recognize a gain (loss) from the transfer of nonfinancial assets, such as Other Real Estate Owned (“OREO”). The majority of the Company’s revenues come from interest income and other sources, including loans, leases, and securities that are outside the scope of ASC 606. The Company’s services that fall within the scope of ASC 606 are presented within Non-Interest Income and are recognized as revenue as the Company satisfies its obligation to the customer. Services within the scope of ASC 606 include deposit service charges on deposits, interchange income, and the sale of OREO. Refer to Note 13 “Revenue from Contracts with Customers” for further discussion on the Company’s accounting policies for revenue sources within the scope of ASC 606.

 

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 18,041 options remain outstanding at June 30, 2018. At June 30, 2018, under the 2010 Plan, there were 31,008 stock options and 41,457 restricted shares outstanding and the total number of authorized shares that remain available for issuance was 1,290,590. 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 unvested restricted stock under the 2010 Plan have dividend and voting rights. 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 may be awarded under the 2000 Plan. New shares are issued upon exercise of an option.

9
 

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

 

Equity Compensation

 

For the three-month periods ended June 30, 2018 and 2017, the compensation cost recognized for equity compensation was $78,000 and $100,000, respectively. The recognized tax benefit for equity compensation expense was $19,000 and $36,000, respectively, for the three-month periods ended June 30, 2018 and 2017. For the six-month periods ended June 30, 2018 and 2017, the compensation cost recognized for equity compensation was $151,000 and $201,000, respectively. The recognized tax benefit for equity compensation expense was $37,000 and $73,000, respectively, for the six-month periods ended June 30, 2018 and 2017.

At June 30, 2018, the total unrecognized pre-tax compensation cost related to nonvested stock option awards was $36,000. This amount will be recognized over the next 2.0 years and the weighted average period of recognizing these costs is expected to be 1.2 years. At June 30, 2018, the total unrecognized pre-tax compensation cost related to restricted stock awards was $458,000. This amount will be recognized over the next 3.9 years and the weighted average period of recognizing these costs is expected to be 1.2 years.

Equity Plans Activity

Stock Options

There were no stock options awarded during the three-month and six-month periods ended June 30, 2018 and June 30, 2017. A summary of option activity under the Plans as of June 30, 2018 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, 2018   97,543   $11.26    3.1 years   $419 
Awarded                
Exercised   (13,359)   9.23         
Expired, forfeited or cancelled   (35,135)   15.67         
Outstanding at June 30, 2018   49,049   $8.65    3.9 years   $353 
Vested at June 30, 2018   41,913   $8.54    3.5 years   $306 
Non-vested at June 30, 2018   7,136   $9.29    6.5 years   $47 
10
 

Restricted Stock

 

There were 10,915 and 22,514 shares of restricted stock awarded during the three-month and six-month periods ended June 30, 2018, respectively. There were 9,949 and 24,982 shares of restricted stock awarded during the three-month and six-month periods ended June 30, 2017, respectively. A summary of restricted stock award activity under the 2010 Plan as of June 30, 2018 and changes during the period then ended is presented below:

 

 

 

Restricted Stock

  Shares   Weighted
Average Award
Date Fair Value
 
Nonvested at January 1, 2018   49,053   $12.27 
Awarded   22,514    15.44 
Less:  Vested   (25,455)   10.84 
Less:  Expired, forfeited or cancelled   (4,655)   13.69 
Nonvested at June 30, 2018   41,457   $10.61 

 

Other Equity Awards

 

There were no stock appreciation rights, restricted performance stock, unrestricted Company stock, or performance units awarded during the three-month or six-month month periods ended June 30, 2018 or 2017 or outstanding at June 30, 2018 or December 31, 2017.

 

The intrinsic value used for stock options and restricted stock awards was derived from the market price of the Company’s common stock of $15.85 as of June 30, 2018.

 

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 $21,966,000 and standby letters of credit of approximately $121,000 at June 30, 2018 and loan commitments of approximately $10,923,000 and standby letters of credit of approximately $121,000 at December 31, 2017. 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 2018 as some of these are expected to expire without being fully drawn upon.

 

Standby letters of credit are commitments issued to guarantee the performance or financial obligation of a client to a third party. These guarantees are issued primarily relating to purchases of inventory, insurance programs, performance obligations to government agencies, or as security for real estate rents by commercial clients and are typically short-term in nature. Credit risk is similar to that involved in extending loan commitments to clients and accordingly, evaluation and collateral requirements similar to those for loan commitments are used. The majority of all such commitments are collateralized. The fair value of the liability related to these standby letters of credit, which represents the fees received for issuing the guarantees, was not significant at June 30, 2018 or December 31, 2017.

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 (5,843,340 and 5,919,321 shares for the three-month and six-month periods ended June 30, 2018 and 6,346,650 and 6,454,864 shares for the three-month and six-month periods ended June 30, 2017). Using the treasury stock method, 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 39,574 and 38,082, respectively, dilutive shares for the three-month and six-month periods ended June 30, 2018 and 81,372 and 85,801, respectively, dilutive shares for the three-month and six-month periods ended June 30, 2017.  For the three-month periods ended June 30, 2018 and 2017, there were zero and 32,448 stock options, respectively, that were excluded from the calculation as they were considered antidilutive.  For the six-month periods ended June 30, 2018 and 2017, there were zero and 32,448 stock options, respectively, that were excluded from the calculation as they were considered antidilutive.  Earnings per share is retroactively adjusted for stock dividends and stock splits, if applicable, for all periods presented.

11
 

5. INVESTMENT SECURITIES

The amortized cost and estimated fair values of Available-for-Sale and Held-to-Maturity investment securities at June 30, 2018 and December 31, 2017 consisted of the following (dollars in thousands):

 

Available-for-Sale

   June 30, 2018 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair
Value
 
Debt securities:                    
U.S. Government Agencies and Sponsored Entities  $260,715   $634   $(4,890)  $256,459 
Obligations of states and political subdivisions   15,851    153    (294)   15,710 
Corporate bonds   6,492    84    (70)   6,506 
U.S.  Treasury securities   2,989        (4)   2,985 
   $286,047   $871   $(5,258)  $281,660 

 

   December 31, 2017 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair
Value
 
Debt securities:                    
U.S. Government Agencies and Sponsored Entities  $233,956   $1,184   $(2,271)  $232,869 
Obligations of states and political subdivisions   22,281    528    (94)   22,715 
Corporate bonds   6,490    160    (24)   6,626 
Equity securities:                    
Corporate stock   51    61        112 
   $262,778   $1,933   $(2,389)  $262,322 

 

Net unrealized losses on available-for-sale investment securities totaling $4,387,000 were recorded, net of $1,397,000 in tax liabilities, as accumulated other comprehensive loss within shareholders’ equity at June 30, 2018. Proceeds and gross realized gains from the sale and call of available-for-sale investment securities for the three-month and six-month periods ended June 30, 2018 totaled $15,942,000 and $11,000, respectively. There were no transfers of available-for-sale investment securities for the three-month and six-month periods ended June 30, 2018.

Net unrealized losses on available-for-sale investment securities totaling $456,000 were recorded, net of $135,000 in tax liabilities, as accumulated other comprehensive income within shareholders’ equity at December 31, 2017. Proceeds and gross realized gains from the sale and call of available-for-sale investment securities for the three-month period ended June 30, 2017 totaled $9,133,000 and $86,000, respectively, and for the six-month period ended June 30, 2017 proceeds and gross realized gains from the sale and call of available-for-sale investment securities totaled $17,750,000 and $142,000, respectively. There were no transfers of available-for-sale investment securities for the three-month and six-month periods ended June 30, 2017.

12
 

Held-to-Maturity

June 30, 2018                
      Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
Debt securities:                    
U.S. Government Agencies and Sponsored Entities  $330   $19   $   $349 

 

December 31, 2017     Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
Debt securities:                    
U.S. Government Agencies and Sponsored Entities  $378   $26   $   $404 

There were no sales or transfers of held-to-maturity investment securities for the periods ended June 30, 2018 and June 30, 2017. Investment securities with unrealized losses at June 30, 2018 and December 31, 2017 are summarized and classified according to the duration of the loss period as follows (dollars in thousands):

June 30, 2018  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 Entities  $146,460   $(2,727)   59,701    (2,163)  $206,161   $(4,890)
Obligations of states and political subdivisions   1,686    (89)   4,483    (205)   6,169    (294)
Corporate bonds   2,422    (70)           2,422    (70)
U.S.  Treasury securities   2,985    (4)           2,985    (4)
   $153,553   $(2,890)  $64,184   $(2,368)  $217,737   $(5,258)

 

December 31, 2017  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 Entities  $119,455   $(1,148)  $49,258   $(1,123)  $168,713   $(2,271)
Obligations of states and political subdivisions   1,130    (9)   4,654    (85)   5,784    (94)
Corporate bonds   1,967    (24)           1,967    (24)
   $122,552   $(1,181)  $53,912   $(1,208)  $176,464   $(2,389)

 

There were no held-to-maturity investment securities with unrealized losses as of June 30, 2018 or December 31, 2017.

At June 30, 2018, the Company held 218 securities of which 87 were in a loss position for less than twelve months and 43 were in a loss position for twelve months or more.  Of the 87 securities in a loss position for less than twelve months, 80 were U.S. Government Agencies and Sponsored Entities securities, five were obligations of states or political subdivisions, and two were corporate bonds and of the 43 securities that were in a loss position for greater than twelve months, 39 were U.S. Government Agencies and Sponsored Entities securities and four was an obligation of states or political subdivisions. 

13
 

At December 31, 2017, the Company held 217 securities of which 64 were in a loss position for less than twelve months and 35 were in a loss position for twelve months or more.  Of the 35 securities in a loss position for greater than twelve months at December 31, 2017, four were municipal securities and 31 were US Government Agencies and Sponsored Agencies securities.  

  

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

The amortized cost and estimated fair values of investment securities at June 30, 2018 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  $2,989   $2,985           
After one year through five years   4,629    4,570           
After five years through ten years   12,306    12,310           
After ten years   5,408    5,336           
    25,332    25,201           
Investment securities not due at a single maturity date:                    
US Government Agencies and Sponsored Entities   260,715    256,459   $330   $349 
   $286,047   $281,660   $330   $349 

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

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

At June 30, 2018 and December 31, 2017, the recorded investment in nonperforming loans and leases was approximately $1,944,000 and $1,892,000, respectively. Nonperforming loans and leases include all such loans and leases that are either placed on nonaccrual status or are 90 days past due as to principal or interest but still accrue interest because such loans are well-secured and in the process of collection. The Company considers a loan to be impaired when, based on current information and events, it is probable that it will be unable to collect all amounts due (principal and interest) according to the contractual terms of the original loan agreement. At June 30, 2018, the recorded investment in loans and leases that were considered to be impaired totaled $11,981,000, which includes $1,944,000 in nonaccrual loans and leases and $10,037,000 in performing loans and leases. Of the total impaired loans of $11,981,000, loans totaling $6,385,000 were deemed to require no specific reserve and loans totaling $5,596,000 were deemed to require a related valuation allowance of $446,000. At December 31, 2017, the recorded investment in loans and leases that were considered to be impaired totaled $13,757,000, which includes $1,892,000 in nonaccrual loans and leases and $11,865,000 in performing loans and leases. Of the total impaired loans of $13,757,000, loans totaling $7,601,000 were deemed to require no specific reserve and loans totaling $6,156,000 were deemed to require a related valuation allowance of $355,000.

At June 30, 2018 and December 31, 2017, the recorded investment in other real estate owned (“OREO”) was $961,000. During the first and second quarters of 2018, the Company did not add any new, impair, or sell any of the OREO properties. The June 30, 2018 and December 31, 2017 OREO balance of $961,000 consisted of one commercial land property.

14
 

Nonperforming assets at June 30, 2018 and December 31, 2017 are summarized as follows:

(dollars in thousands)  June 30,
2018
   December 31,
2017
 
Nonaccrual loans and leases that are current to terms (less than 30 days past due)  $13   $1,603 
Nonaccrual loans and leases that are past due   1,931    289 
Loans and leases past due 90 days and accruing interest        
Other real estate owned   961    961 
Total nonperforming assets  $2,905   $2,853 
           
Nonperforming loans and leases to total loans and leases   0.66%   0.60%
Total nonperforming assets to total assets   0.43%   0.44%

Impaired loans and leases as of and for the periods ended June 30, 2018 and December 31, 2017 are summarized as follows:

(dollars in thousands)   As of June 30, 2018     As of December 31, 2017  
     Recorded
Investment
    Unpaid
Principal
Balance
     Related
Allowance
     Recorded
Investment
    Unpaid
Principal
Balance
     Related
Allowance
 
With no related allowance recorded:                                                
Commercial   $     $     $     $ 1,598     $ 2,671     $  
Real estate-commercial     5,990       6,223             5,674       5,907        
Real estate-residential     326       413             329       416        
Consumer     69       69                          
Subtotal   $ 6,385     $ 6,705     $     $ 7,601     $ 8,994     $  
                                                 
With an allowance recorded:                                                
Commercial   $ 1,562     $ 2,635     $ 200     $     $     $  
Real estate-commercial     2,771       2,854       171       4,396       4,483       261  
Real estate-multi-family                       474       474       21  
Real estate-residential     1,263       1,263       75       1,286       1,286       73  
Subtotal   $ 5,596     $ 6,752     $ 446     $ 6,156     $ 6,243     $ 355  
                                                 
Total:                                                
Commercial   $ 1,562     $ 2,635     $ 200     $ 1,598     $ 2,671     $  
Real estate-commercial     8,761       9,077       171       10,070       10,390       261  
Real estate-multi-family                       474       474       21  
Real estate-residential     1,589       1,676       75       1,615       1,702       73  
Consumer     69       69                          
    $ 11,981     $ 13,457     $ 446     $ 13,757     $ 15,237     $ 355  

 

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

 

   Average Recorded Investments
for the three months ended
   Average Recorded Investments
for the six months ended
 
   June 30, 2018   June 30, 2017   June 30, 2018   June 30, 2017 
Commercial   $1,562   $16   $1,580   $ 
Real estate-commercial   8,794    14,067    8,828    13,732 
Real estate-multi-family       481        478 
Real estate-residential   1,596    2,296    1,602    2,437 
Agriculture       357        351 
Consumer   69        69     
     Total  $12,021   $17,217   $12,079   $16,998 
15
 

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

   Interest Income Recognized
for the three months ended
   Interest Income Recognized
for the six months ended
 
   June 30, 2018   June 30, 2017   June 30, 2018   June 30, 2017 
                 
Commercial   $   $   $   $1 
Real estate-commercial   129    179    238    356 
Real estate-multi-family       8        16 
Real estate-residential   21    37    41    63 
Agriculture       4        9 
Consumer           2     
     Total  $150   $228   $281   $445 

 

7. TROUBLED DEBT RESTRUCTURINGS

During the three and six-month periods ended June 30, 2018 and 2017, there were no loans that were modified as troubled debt restructurings. There were no payment defaults on troubled debt restructurings within 12 months following the modification for the three-month and six-month periods ended June 30, 2018, with the exception of one commercial loan with a June 30, 2018 balance of $1,562,000. There were no payment defaults on troubled debt restructurings within 12 months following the modification for the three-month and six-month periods ended June 30, 2017. At June 30, 2018 and December 31, 2017, there were no unfunded commitments on those loans considered troubled debt restructures.

 

8. ALLOWANCE FOR LOAN AND LEASE LOSSES

The Company’s loan and lease portfolio allocated by management’s internal risk ratings as of June 30, 2018 and December 31, 2017 are summarized below:

 

June 30, 2018  Credit Risk Profile by Internally Assigned Grade 
(dollars in thousands)      Real Estate 
   Commercial   Commercial   Multi-family   Construction   Residential 
Grade:                         
   Pass  $23,308   $160,143   $62,197   $6,408   $14,976 
   Watch   125    15,854    3,871        1,848 
   Special mention       1,265             
   Substandard   31    282             
   Doubtful or loss   1,562                 
          Total  $25,026   $177,544   $66,068   $6,408   $16,824 
                 
   Credit Risk Profile by Internally Assigned Grade Other Credit Exposure             
   Leases   Agriculture   Consumer           Total 
Grade:                            
   Pass  $117   $2,603   $529           $270,281 
   Watch           150            21,848 
   Special mention           1            1,266 
   Substandard           69            382 
   Doubtful or loss                       1,562 
          Total  $117   $2,603   $749           $295,339 
16
 
December 31, 2017  Credit Risk Profile by Internally Assigned Grade 
(dollars in thousands)      Real Estate 
   Commercial   Commercial   Multi-family   Construction   Residential 
Grade:                         
   Pass  $23,617   $164,815   $73,644   $5,863   $13,767 
   Watch   96    18,083    4,381        1,507 
   Special mention   66    2,265            539 
   Substandard       289             
   Doubtful or loss   1,598                 
          Total  $25,377   $185,452   $78,025   $5,863   $15,813 
                 
   Credit Risk Profile by Internally Assigned Grade Other Credit Exposure             
   Leases   Agriculture   Consumer           Total 
Grade:                            
   Pass  $205   $1,713   $713           $284,337 
   Watch           155            24,222 
   Special mention           70            2,940 
   Substandard           7            296 
   Doubtful or loss                       1,598 
          Total  $205   $1,713   $945           $313,393 
17
 

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

June 30, 2018                                        
(dollars in thousands)      Real Estate   Other         
         Multi-                           
   Commercial   Commercial   Family   Construction   Residential   Leases   Agriculture   Consumer   Unallocated   Total 
Allowance for Loan and Lease Losses                                                  
                                                   
Beginning balance, January 1, 2018  $447   $2,174   $1,047   $269   $205   $   $31   $14   $291   $4,478 
Provision for loan losses   213    (78)   (208)   29    34    (1)   18    (3)   (4)    
Loans charged-off                                        
Recoveries   9    4                1                14 
                                                   
Ending balance, June 30, 2018  $669   $2,100   $839   $298   $239   $   $49   $11   $287   $4,492 
                                                   
Ending balance:                                                  
Individually evaluated for impairment  $200   $171   $   $   $75   $   $   $   $   $446 
                                                   
Ending balance:                                                  
Collectively evaluated for impairment  $469   $1,929   $839   $298   $164   $   $49   $11   $287   $4,046 
                                                   
Loans                                                  
                                                   
Ending balance  $25,026   $177,544   $66,068   $6,408   $16,824   $117   $2,603   $749   $   $295,339 
                                                   
Ending balance:                                                  
Individually evaluated for impairment  $1,562   $8,761   $   $   $1,589   $   $   $69   $   $11,981 
                                                   
Ending balance:                                                  
Collectively evaluated for impairment  $23,464   $168,783   $66,068   $6,408   $15,235   $117   $2,603   $680   $   $283,358 
                                                   
Allowance for Loan and Lease Losses                                                  
                                                   
Beginning balance, March 31, 2018  $546   $2,143   $966   $288   $218   $   $31   $15   $281   $4,488 
Provision for loan losses   121    (45)   (127)   10    21        18    (4)   6     
Loans charged off                                        
Recoveries   2    2                                4 
                                                   
Ending balance, June 30, 2018  $669   $2,100   $839   $298   $239   $   $49   $11   $287   $4,492 
18
 
December 31, 2017                                        
(dollars in thousands)      Real Estate   Other         
  Commercial   Commercial   Multi-Family   Construction   Residential   Leases   Agriculture   Consumer   Unallocated   Total 
Ending balance:                                        
Individually evaluated for impairment  $   $261   $21   $   $73   $   $   $   $   $355 
                                                   
Ending balance:                                                  
Collectively evaluated for impairment  $447   $1,913   $1,026   $269   $132   $   $31   $14   $291   $4,123 
                                                   
Loans                                                  
                                                   
Ending balance  $25,377   $185,452   $78,025   $5,863   $15,813   $205   $1,713   $945   $   $313,393 
                                                   
Ending balance:                                                  
Individually evaluated for impairment  $1,598   $10,070   $474   $   $1,615   $   $   $   $   $13,757 
                                                   
Ending balance:                                                  
Collectively evaluated for impairment  $23,779   $175,382   $77,551   $5,863   $14,198   $205   $1,713   $945   $   $299,636 

  

June 30, 2017                                        
(dollars in thousands)      Real Estate   Other         
           Multi-                             
   Commercial   Commercial   Family   Construction   Residential   Leases   Agriculture   Consumer   Unallocated   Total 
Allowance for Loan and Lease Losses                                                  
                                                   
Beginning balance, January 1, 2017  $855   $2,050   $851   $446   $253   $1   $64   $24   $278   $4,822 
Provision for loan losses   58    (12)   (62)   11    15        (5)   (8)   3     
Loans charged-off                                        
Recoveries   3    53                        3        59 
                                                   
Ending balance, June 30, 2017  $916   $2,091   $789   $457   $268   $1   $59   $19   $281   $4,881 
                                                   
Allowance for Loan and Lease Losses                                                  
                                                   
Beginning balance, March 31, 2017  $836   $2,107   $836   $479   $232   $1   $62   $21   $259   $4,833 
Provision for loan losses   78    (60)   (47)   (22)   36        (3)   (4)   22     
Loans charged off                                        
Recoveries   2    44                        2        48 
                                                   
Ending balance, June 30, 2017  $916   $2,091   $789   $457   $268   $1   $59   $19   $281   $4,881 

19
 

The Company’s aging analysis of the loan and lease portfolio at June 30, 2018 and December 31, 2017 are summarized below:

 

June 30, 2018                          Past Due     
(dollars in thousands)          Past Due               Greater Than     
   30-59 Days   60-89 Days   Greater Than   Total Past           90 Days and     
   Past Due   Past Due   90 Days   Due   Current   Total Loans   Accruing   Nonaccrual 
Commercial:                                        
Commercial  $   $18   $1,562   $1,580   $23,446   $25,026       $1,593 
Real estate:                                        
Commercial           283    283    177,261    177,544        283 
Multi-family                   66,068    66,068         
Construction                   6,408    6,408         
Residential   99            99    16,725    16,824         
Other:                                        
Leases                   117    117         
Agriculture                   2,603    2,603         
Consumer           69    69    680    749        68 
Total  $99   $18   $1,914   $2,031   $293,308   $295,339   $   $1,944 

 

December 31, 2017                          Past Due     
(dollars in thousands)          Past Due               Greater Than     
   30-59 Days   60-89 Days   Greater Than   Total Past           90 Days and     
   Past Due   Past Due   90 Days   Due   Current   Total Loans   Accruing   Nonaccrual 
Commercial:                                        
Commercial  $   $   $   $   $25,377   $25,377   $   $1,597 
Real estate:                                        
Commercial           289    289    185,163    185,452        289 
Multi-family                   78,025    78,025         
Construction                   5,863    5,863         
Residential   146            146    15,667    15,813         
                                         
Other:                                        
Leases                   205    205         
Agriculture                   1,713    1,713         
Consumer   1            1    944    945        6 
                                         
Total  $147   $   $289   $436   $312,957   $313,393   $   $1,892 
20
 

9. BORROWING ARRANGEMENTS

 

At June 30, 2018, the Company had $17,000,000 of unsecured short-term borrowing arrangements with two of its correspondent banks. There were no advances under the borrowing arrangements as of June 30, 2018 or December 31, 2017.

 

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 $15,500,000 were outstanding from the FHLB at June 30, 2018, bearing interest rates ranging from 1.18% to 1.90% and maturing between July 20, 2018 and April 12, 2021. Advances totaling $15,500,000 were outstanding from the FHLB at December 31, 2017, bearing interest rates ranging from 1.18% to 1.90% and maturing between July 20, 2018 and April 12, 2021. Remaining amounts available under the borrowing arrangement with the FHLB at June 30, 2018 and December 31, 2017 totaled $108,277,000 and $117,546,000, respectively. In addition, the Company has a secured borrowing agreement with the Federal Reserve Bank of San Francisco. The borrowing can be secured by pledging selected loans and investment securities. Borrowings generally are short-term including overnight advances as well as loans with terms up to ninety days. Amounts available under this borrowing arrangement at June 30, 2018 and December 31, 2017 were $7,920,000 and $9,085,000, respectively. There were no advances outstanding under this borrowing arrangement as of June 30, 2018 and December 31, 2017.

 

10. INCOME TAXES

 

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

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

The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any.  Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above, if applicable, is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company recognizes accrued interest and penalties related to unrecognized tax benefits, if applicable, as a component of interest expense in the consolidated statement of income. There have been no unrecognized tax benefits or accrued interest and penalties for the three-month and six-month periods ended June 30, 2018 and 2017.

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11. FAIR VALUE MEASUREMENTS

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring and nonrecurring basis as of June 30, 2018 and December 31, 2017. 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 2018, the Company adopted the provisions of Accounting Standard Update 2016-01 “Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”). ASU 2016-01 requires the Company to use the exit price notion when measuring the fair value of financial instruments. The Company used the exit price notion for valuing financial instruments in 2018 and the entry price notion for valuing financial instruments in 2017. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

 

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

 

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

   Carrying   Fair Value Measurements Using:     
June 30, 2018  Amount   Level 1   Level 2   Level 3   Total 
Financial assets:                         
Cash and due from banks  $45,068   $45,068   $   $   $45,068 
Federal funds sold   8,000    8,000            8,000 
Interest-bearing deposits in banks   1,746        1,746        1,746 
Available-for-sale securities   281,660    2,985    278,675        281,660 
Held-to-maturity securities   330        349        349 
FHLB stock   3,932    N/A    N/A    N/A    N/A 
Net loans and leases:   290,552            298,480    298,480 
Accrued interest receivable   1,873        1,067    806    1,873 
Financial liabilities:                         
Deposits:                         
Noninterest-bearing  $221,402   $221,402   $   $   $221,402 
Savings   70,184    70,184            70,184 
Money market   145,801    145,901            145,901 
Interest checking   66,729    66,729            66,729 
Time Deposits   77,200        77,038        77,038 
Short-term borrowings   6,500    6,500            6,500 
Long-term borrowings   9,000        8,980        8,980 
Accrued interest payable   65    7    58        65 
22
 
   Carrying   Fair Value Measurements Using:     
December 31, 2017     Amount   Level 1   Level 2   Level 3   Total 
Financial assets:                         
Cash and due from banks  $38,467   $38,467   $   $   $38,467 
Interest-bearing deposits in banks   1,746        1,750        1,750 
Available-for-sale securities   262,322    66    262,256        262,322 
Held-to-maturity securities   378        404        404 
FHLB stock   3,932    N/A    N/A    N/A    N/A 
Net loans and leases:   308,713            317,900    317,900 
Accrued interest receivable   1,956        1,124    832    1,956 
Financial liabilities:                         
Deposits:                         
Noninterest-bearing  $215,528   $215,528   $   $   $215,528 
Savings   66,130    66,130            66,130 
Money market   130,032    130,032            130,032 
Interest checking   64,709    64,709            64,709 
Time Deposits   79,681        79,614        79,614 
Short-term borrowings   3,500    3,500            3,500 
Long-term borrowings   12.000        11,978        11,978 
Accrued interest payable   65    4    61        65 

  

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 December 31, 2017:

Cash and due from banks: The carrying amounts of cash and short-term instruments, including Federal funds sold, 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.

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.

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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 December 31, 2017.

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

Description      Fair Value Measurements Using   Total Gains 
(dollars in thousands)  Fair Value   Level 1   Level 2   Level 3   (Losses) 
June 30, 2018                         
Assets and liabilities measured on a recurring basis:                         
Available-for-sale securities:                         
US Government Agencies and Sponsored Entities  $256,459   $   $256,459   $   $ 
Obligations of states and political subdivisions   15,710        15,710         
Corporate bonds   6,506        6,506         
U.S. Treasury bonds   2,985    2,985             
Total recurring  $281,660   $2,985   $278,675   $   $ 
                          
Assets and liabilities measured on a nonrecurring basis:                         
Impaired loans:                         
Real estate:                          
Commercial  $1,362   $   $   $1,362   $ 
Total nonrecurring  $1,362   $   $   $1,362   $ 
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Description     Fair Value Measurements Using   Total Gains 
(dollars in thousands)  Fair Value   Level 1   Level 2   Level 3   (Losses) 
December 31, 2017                         
Assets and liabilities measured on a recurring basis:                         
Available-for-sale securities:                         
US Government Agencies and Sponsored Agencies  $232,869   $   $232,869   $   $ 
Corporate Debt securities   6,626        6,626           
Obligations of states and political subdivisions   22,715        22,715         
Corporate stock   112    66    46         
Total recurring  $262,322   $66   $262,256   $   $ 
                          
Assets and liabilities measured on a nonrecurring basis:                         
Impaired loans:                         
Commercial  $1,598   $   $   $1,598   $(1,073)
Real estate:                         
Commercial   178            178     
Residential   329            329     
                          
Other real estate owned                         
Land   961            961     
Total nonrecurring  $3,066   $   $   $3,066   $(1,073)

  

There were no significant transfers between Levels 1 and 2 during the three-month and six-month periods ended June 30, 2018 or the twelve months ended December 31, 2017.

 

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 dues 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%.

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12. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In May 2014, the Financial Accounting Standards Board (the “FASB”) and the International Accounting Standards Board (the “IASB”) jointly issued a comprehensive new revenue recognition standard that will supersede nearly all existing revenue recognition guidance under GAAP and International Financial Reporting Standards (“IFRS”). Previous revenue recognition guidance in GAAP consisted of broad revenue recognition concepts together with numerous revenue requirements for particular industries or transactions, which sometimes resulted in different accounting for economically similar transactions. In contrast, IFRS provided limited revenue recognition guidance and, consequently, could be difficult to apply to complex transactions. Accordingly, the FASB and the IASB initiated a joint project to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and IFRS that would: (1) remove inconsistencies and weaknesses in revenue requirements; (2) provide a more robust framework for addressing revenue issues; (3) improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets; (4) provide more useful information to users of financial statements through improved disclosure requirements; and (5) simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. To meet those objectives, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers.” The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies generally will be required to use more judgment and make more estimates than under current guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The standard was initially effective for public entities for interim and annual reporting periods beginning after December 15, 2016; early adoption was not permitted. However, in August 2015, the FASB issued ASU No. 2015-14, “Revenue from Contracts with Customers - Deferral of the Effective Date” which deferred the effective date by one year (i.e., interim and annual reporting periods beginning after December 15, 2017). For financial reporting purposes, the standard allows for either full retrospective adoption, meaning the standard is applied to all of the periods presented, or modified retrospective adoption, meaning the standard is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. In addition, the FASB has begun to issue targeted updates to clarify specific implementation issues of ASU 2014- 09. These updates include ASU No. 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net),” ASU No. 2016-10, Identifying Performance Obligations and Licensing,” ASU No. 2016-12, Narrow-Scope Improvements and Practical Expedients,” and ASU No. 2016-20 Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers.” The Company has assessed its revenue streams and reviewed its contracts that could potentially be affected by the ASU including deposit related fees, interchange fees, and merchant income, to determine the potential impact the new guidance is expected to have on the Company’s financial position, results of operations or cash flows. The Company adopted ASU No. 2014-09 on January 1, 2018. The effects of adopting ASU No. 2014-09 did not change the amounts of revenue recorded for the Company’s in-scope revenue streams.

 

In January 2016, the FASB issued 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 was 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 were not permitted. The Company adopted ASU No. 2016-01 on January 1, 2018. The effects of adopting ASU No. 2016-01 resulted in the Company using the exit price notion for valuing financial instruments in 2018, but did not have a material impact on the Company’s financial position, results of operations or cash flows.

26
 

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. Based on the initial evaluation of the Company’s current lease obligations, the Company has determined that the provisions of ASU No. 2016-02 may result in an increase in assets to recognize the present value of the lease obligations with a corresponding increase in liabilities, however, the Company does not expect this to have a material impact on the Company’s financial position, results of operations or cash flows.

 

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). While 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, it has taken steps to prepare for the implementation when it becomes effective, such as forming an internal task force, gathering pertinent data, consulting with outside professionals, evaluating its current IT systems, and purchasing a software solution.

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13. REVENUE FROM CONTRACTS WITH CUSTOMERS

 

On January 1, 2018 the Company adopted ASC Topic 606, as revised under ASU’s 2014-09, 2014-08 and 2016-20, using the modified retrospective method as of January 1, 2018.  Other income disclosures for periods beginning after January 1, 2018 are presented under revised ASC Topic 606, which have not materially changed from the prior year amounts.  Consistent with Topic 606, noninterest income covered by this guidance is recognized as services are transferred to our customers in an amount that reflects the consideration we expect to be entitled to in exchange for those services.

 

Deposit Service Charges — Deposit service charges primarily consist of fees earned from our treasury management services.  These services include bill pay, ACH, positive pay, lockbox, remote deposit capture, online banking and cash vault, among others.  Customers are given the option to pay for these services in cash or by offsetting the fees for these services against an earnings credit that is given for maintaining noninterest-bearing deposits.  The Company’s performance obligations on its treasury services are satisfied either at the time of the transaction or over the course of a month.  Most customers pay deposit charges on a monthly basis.  

 

Merchant and Bankcard Fees — The Company earns various types of network transaction fees from third party payment network providers which consist of (i) interchange fees earned from the payment network as a debit card issuer and (ii) ongoing merchant fees earned by the Company for referring our clients to the payment processing provider which allows our clients to accept credit cards as a form of payment. The Company is an issuer of debit cards only as it relates to Merchant and Bankcard fees.  Interchange income, which is settled on a daily basis, is recognized as settlement occurs. Chargebacks have not historically been, nor are they expected to be significant to the overall fee revenue and will be recognized upon occurrence.  Referral and merchant fees are recognized when the transaction occurs.

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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, 2017 and June 30, 2018 and its income and expense accounts for the three-month and six-month periods ended June 30, 2018 and 2017. 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 “this 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:

·legislation promulgated by the United States Congress and actions taken by governmental agencies that may impact 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 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, natural disasters (including earthquakes and wildfires), 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;
·our ability to comply with any regulatory orders or requirements we may become subject to;
·the effects and costs of litigation and other legal developments;
·the reputation of the financial services industry could experience 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.
  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, 2017, 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.
29
 

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 21% effective tax rate for 2018 and a 34% effective tax rate for 2017 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. The efficiency ratio is a measure of a banking company’s overhead as a percentage of its revenue. The Company derives this ratio by dividing total noninterest expense by the sum of the taxable equivalent net interest income and the total noninterest income.

 

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.

30
 

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

Stock-Based Compensation

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

 

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 100 full-time employees as of June 30, 2018.

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 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”). On November 9, 2010, the FDIC implemented a final rule to permanently increase the maximum insurance limit to $250,000 per depositor under the Dodd-Frank Act.

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 2018 and 2017, 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.”

31
 

Overview

The Company recorded net income of $1,269,000 for the quarter ended June 30, 2018, which was a decrease of $28,000 compared to $1,297,000 reported for the same period of 2017. Diluted earnings per share for the second quarter of 2018 were $0.22 compared to $0.20 recorded in the second quarter of 2017. The return on average equity (“ROAE”) and the return on average assets (“ROAA”) for the second quarter of 2018 were 7.09% and 0.75%, respectively, as compared to 6.35% and 0.80%, respectively, for the same period in 2017.

 

Net income for the six months ended June 30, 2018 and 2017 was $2,622,000 and $2,481,000, respectively, with diluted earnings per share of $0.44 in 2018 and $0.38 in 2017. For the first six months of 2018, ROAE was 7.24% and ROAA was 0.77% compared to 6.05% and 0.77%, respectively, for the same period in 2017.

 

Total assets of the Company increased by $19,634,000, or 3.0%, from $655,622,000 at December 31, 2017 to $675,256,000 at June 30, 2018. Net loans totaled $290,552,000 at June 30, 2018, a decrease of $18,161,000 or (5.9%) from $308,713,000 at December 31, 2017. Deposit balances at June 30, 2018 totaled $581,316,000, an increase of $25,236,000, or 4.5%, from the $556,080,000 at December 31, 2017.

 

The Company ended the second quarter of 2018 with a leverage capital ratio of 8.8%, a Tier 1 capital ratio of 17.6%, and a total risk-based capital ratio of 18.8% compared to 9.5%, 18.1%, and 19.3%, respectively, at December 31, 2017. Table One below provides a summary of the components of net income for the periods indicated (See the “Results of Operations” section that follows for an explanation of the fluctuations in the individual components).

 

Table One: Components of Net Income

 

(dollars in thousands)  For the three months ended
June 30,
   For the six months ended
June 30,
 
   2018   2017   2018   2017 
Interest income*  $5,553   $5,222   $10,678   $10,373 
Interest expense   (378)   (252)   (707)   (494)
Net interest income*   5,175    4,970    9,971    9,879 
Provision for loan and lease losses                
Noninterest income   380    439    752    858 
Noninterest expense   (3,828)   (3,368)   (7,178)   (6,798)
Provision for income taxes   (403)   (643)   (809)   (1,259)
Tax equivalent adjustment   (55)   (101)   (114)   (199)
Net income  $1,269   $1,297   $2,622   $2,481 
                     
Average total assets  $681,932   $647,381   $683,155   $650,058 
Net income (annualized) as a percentage of average total assets   0.75%   0.80%   0.77%   0.77%

* Fully taxable equivalent basis (FTE)

32
 

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 3.36% for the three months ended June 30, 2018, 3.41% for the three months ended June 30, 2017, 3.32% for the six months ended June 30, 2018 and 3.43% for the six months ended June 30, 2017.

The total fully taxable equivalent interest income component for the second quarter of 2018 increased $331,000, or 6.3%, to $5,553,000 compared to $5,222,000 for the three months ended June 30, 2017. The increase in the fully taxable equivalent interest income for the second quarter of 2018 compared to the same period in 2017 is broken down by rate (up $346,000) and volume (down $15,000). The yield on earning assets increased from 3.59% during the second quarter of 2017 to 3.60% during the second quarter of 2018. The primary driver in this rate increase was an increase in the yield on loans which increased from 4.61% in the second quarter of 2017 to 4.79% in the second quarter of 2018 and an increase in yields on the investment portfolio which increased from 2.38% in the second quarter of 2017 to 2.51% in the second quarter of 2018. The increased yield in 2018 compared to 2017 was due to the overall higher interest rate environment. Despite the increased yield earned on the loans and investments the yield on earning assets increased just 0.01% from 3.59% to 3.60%. The increase in yield from the loans and investments was partially offset by an increase in the balances of Federal funds sold. Federal funds sold balances increased from zero in the second quarter of 2017 to an average balance of $22,209,000 in the second quarter of 2018. However, the yield on these lower earning Federal fund balances was 1.77%, thus reducing the overall yield on earning assets.

The volume decrease of $15,000 was primarily from a decrease in loans ($134,000), partially offset by an increase in investment balances ($118,000). Average loans balances decreased $11,691,000, or (3.7%), from $316,423,000 during the second quarter of 2017 to $304,732,000 during the second quarter of 2018 and the average investment balances increased $23,395,000, or 8.8%, from $266,109,000 during the second quarter of 2017 to $289,504,000 during the second quarter of 2018.

The total fully taxable equivalent interest income for the six months ended June 30, 2018 increased $305,000, 2.9%, to $10,678,000 compared to $10,373,000 for the six months ended June 30, 2017. The breakdown of the fully taxable equivalent interest income for the six months ended June 30, 2018 over the same period in 2017 resulted from a increase in rate (up $408,000) and a decrease in volume (down $103,000). The primary driver in this rate increase was an increase in the yield on loans which increased from 4.59% in 2017 to 4.69% in 2018 and an increase in yields on the investment portfolio which increased from 2.40% in 2017 to 2.45% in 2018. The increased yield in 2018 compared to 2017 was due to the overall higher interest rate environment. Despite the increased yield earned on the loans and investments the yield on earning assets decreased from 3.60% in 2017 to 3.56% in 2018. The increase in yield from the loans and investments was partially offset by an increase in the balances of Federal funds sold. Federal funds sold balances increased from zero in the first six months of 2017 to an average balance of $17,994,000 in the first six months of 2018. The yield on these lower earning Federal fund balances was 1.66%, thus reducing the overall yield on earning assets.

Interest expense was $126,000, or 50.0%, higher in the second quarter of 2018 versus the prior year period, increasing from $252,000 to $378,000. The $126,000 increase in interest expense during the second quarter of 2018 compared to the second quarter of 2017 was due to higher rates (up $125,000) and higher volume (up $1,000). The increase in interest expense can be attributed to an increase in rates paid on deposit and borrowing balances during a higher interest rate environment. Rates paid on interest bearing liabilities increased 11 basis points from 0.28% to 0.39% for the second quarter of 2017 compared to the same period in 2018. The largest increase due to rates occurred in the time deposits. Some of these time deposits are indexed to the three- or six-month treasury rates which have increased over the past twelve months. Interest expense on time deposits increased by $79,000, or 48.8%, from $162,000 in the second quarter of 2017 to $241,000 in the second quarter of 2018 while the average time deposit balances decreased by $2,439,000, or (3.0%), from $81,643,000 in the second quarter of 2017 to $79,204,000 in the second quarter of 2018.

Interest expense was $213,000, or 43.1% higher, in the six-month period ended June 30, 2018 increasing from $494,000 in 2017 to $707,000 in 2018. The increase is related to rates (up $213,000). Rates paid on interest bearing liabilities increased 9 basis points from 0.28% to 0.37% for the first six months of 2017 compared to the first six months of 2018. Of the $213,000 increase in interest expense, $146,000 is related to higher rates paid on time deposit balances. Some of these time deposits are indexed to the three- or six-month treasury rates which have increased over the past twelve months. Net interest expense on time deposits increased by $136,000, or 42.9%, from $317,000 in 2017 to $453,000 in 2018 while the average time deposit balances decreased by $2,524,000, or 3.1%, from $81,971,000 in 2017 to $79,447,000 in 2018.

33
 

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.

Table Two: Analysis of Net Interest Margin on Earning Assets

 

Three Months Ended June 30,   2018     2017  
(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)   $ 290,933     $ 3,483       4.80 %   $ 302,062     $ 3,458       4.59 %
Tax-exempt loans and leases (2)     13,799       153       4.45 %     14,361       180       5.03 %
Taxable investment securities     268,731       1,637       2.44 %     243,199       1,363       2.25 %
Tax-exempt investment securities (2)     20,773       175       3.38 %     22,811       212       3.73 %
Corporate stock (2)                       99       6       24.31 %
Federal funds sold     22,209       98       1.77 %                  
Investments in time deposits     1,741       7       1.61 %     1,259       3       0.96 %
Total earning assets     618,186       5,553       3.60 %     583,791       5,222       3.59 %
Cash & due from banks     29,703                       29,263                  
Other assets     38,533                       39,191                  
Allowance for loan & lease losses     (4,490 )                     (4,864 )                
    $ 681,932                     $ 647,381                  
                                                 
Liabilities & Shareholders’ Equity                                                
Interest bearing liabilities:                                                
Interest checking and money market   $ 227,094       76       0.13 %   $ 201,166       36       0.07 %
Savings     70,129       7       0.04 %     63,467       5       0.03 %
Time deposits     79,204       241       1.22 %     81,643       162       0.80 %
Other borrowings     15,500       54       1.40 %     15,500       49       1.27 %
Total interest bearing liabilities     391,927       378       0.39 %     361,776       252       0.28 %
Noninterest bearing demand deposits     212,305                       196,549                  
Other liabilities     5,910                       7,195                  
Total liabilities     610,142                       565,520                  
Shareholders’ equity     71,790                       81,861                  
    $ 681,932                     $ 647,381                  
Net interest income & margin (3)           $ 5,175       3.36 %           $ 4,970       3.41 %

 

(1)Loan interest includes loan fees of $243,000 and $43,000, respectively, during the three months ended June 30, 2018 and June 30, 2017.  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 21% for 2018 and 34% for 2017.
(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 (91 days) and annualized to actual days in the year (365 days).
34
 
Six Months Ended June 30,   2018     2017  
(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)   $ 292,113     $ 6,811       4.70 %   $ 303,834     $ 6,888       4.57 %
Tax-exempt loans and leases (2)     13,879       306       4.45 %     14,424       356       4.98 %
Taxable investment securities     257,145       3,028       2.37 %     239,207       2,686       2.26 %
Tax-exempt investment securities (2)     22,166       372       3.38 %     22,768       422       3.74 %
Corporate stock (2)                       103       16       31.33 %
Federal funds sold     17,994       148       1.66 %                  
Interest-bearing deposits in banks     1,743       13       1.50 %     1,189       5       0.85 %
Total earning assets     605,040       10,678       3.56 %     581,525       10,373       3.60 %
Cash & due from banks     43,262                       34,261                  
Other assets     39,341                       39,118                  
Allowance for loan & lease losses     (4,488 )                     (4,846 )                
    $ 683,155                     $ 650,058                  
                                                 
Liabilities & Shareholders’ Equity                                                
Interest-bearing liabilities:                                                
Interest checking and money market   $ 223,317       133       0.12 %   $ 198,794       70       0.07 %
Savings     69,872       13       0.04 %     63,367       10       0.03 %
Time deposits     79,447       453       1.15 %     81,971       317       0.78 %
Other borrowings     15,500       108       1.41 %     15,500       97       1.26 %
Total interest-bearing liabilities     388,136       707       0.37 %     359,632       494       0.28 %
Noninterest-bearing demand deposits     214,930                       200,086                  
Other liabilities     7,078                       7,597                  
Total liabilities     610,144                       567,315                  
Shareholders’ equity     73,011                       82,743                  
    $ 683,155                     $ 650,058                  
Net interest income & margin (3)           $ 9,971       3.32 %           $ 9,879       3.43 %

 

(1)Loan interest includes loan fees of $374,000 and $110,000, respectively, during the six months ended June 30, 2018 and June 30, 2017.   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 21% for 2018 and 34% for 2017.
(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 (181 days) and annualized to actual days in the year (365 days).
35
 

Table Three: Analysis of Volume and Rate Changes on Net Interest Income and Expenses

 

Three Months Ended June 30, 2018 over 2017 (dollars in thousands)

Increase (decrease) due to change in:

 

Interest-earning assets:  Volume   Rate (4)   Net Change 
Taxable loans and leases (1)  $(127)  $152   $25 
Tax-exempt loans and leases (2)   (7)   (20)   (27)
Taxable investment securities   143    131    274 
Tax exempt investment securities (3)   (19)   (18)   (37)
Corporate stock   (6)       (6)
Federal funds sold       98    98 
Interest-bearing deposits in banks   1    3    4 
Total   (15)   346    331 
Interest-bearing liabilities:               
Interest checking and money market   5    35    40 
Savings deposits   1    1    2 
Time deposits   (5)   84    79 
Other borrowings       5    5 
Total   1    125    126 
Interest differential  $(16)  $221   $205 

 

Six Months Ended June 30, 2018 over 2017 (dollars in thousands)

Increase (decrease) due to change in:

 

Interest-earning assets:  Volume   Rate (4)   Net Change 
Taxable loans and leases (1)  $(266)  $189   $(77)
Tax-exempt loans and leases (2)   (13)   (37)   (50)
Taxable investment securities   201    141    342 
Tax exempt investment securities (3)   (11)   (39)   (50)
Corporate stock   (16)       (16)
Federal funds sold       148    148 
Interest-bearing deposits in banks   2    6    8 
Total   (103)   408    305 
Interest-bearing liabilities:               
Interest checking and money market   9    54    63