XNAS:AMRB American River Bankshares Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

(Mark One)

 

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

 

For the quarterly period endedJune 30, 2012  

or

 

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

 

For the transition period from _______________ to _______________

 

Commission File Number: 0-31525

 

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

 

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

 

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

 

(916) 851-0123
(Registrant’s telephone number, including area code)

 

Not Applicable
(Former name, former address and former fiscal year, if changed since last report.)

 

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

Yes S  No £  

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes S  No £  

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

 

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

 

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

Yes £  No S  

 

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 – 9,328,481 shares outstanding at August 6, 2012.

 
 

 

AMERICAN RIVER BANKSHARES

 

INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2012

 

Part I.       Page
         
  Item 1.   Financial Statements    3  
  Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations   26  
  Item 3.   Quantitative and Qualitative Disclosures About Market Risk   46  
  Item 4.   Controls and Procedures   47  
             
Part II.          
             
  Item 1.   Legal Proceedings   48  
  Item 1A.   Risk Factors   48  
  Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds   48  
  Item 3.   Defaults Upon Senior Securities   48  
  Item 4.   Mine Safety Disclosures   48  
  Item 5.   Other Information   48  
  Item 6.   Exhibits   48  
             
Signatures   53  

 

Exhibit Index

54
     
31.1

Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

55

 
31.2

Certifications of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

56

 
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

57

 

 

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,
2012
  December 31,
2011
       
ASSETS      
       
Cash and due from banks  $35,257   $23,768 
Interest-bearing deposits in banks   1,000    1,250 
Investment securities:          
Available-for-sale, at fair value   221,846    208,711 
Held-to-maturity, at amortized cost   3,049    4,010 
Loans and leases, less allowance for loan and lease losses of $6,201 at June 30, 2012 and $7,041 at December 31, 2011   277,605    293,731 
Premises and equipment, net   2,204    2,355 
Federal Home Loan Bank stock   3,254    3,093 
Goodwill and other intangible assets   16,404    16,504 
Other real estate owned   10,366    8,190 
Accrued interest receivable and other assets   18,687    19,906 
   $589,672   $581,518 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
           
Deposits:          
Noninterest bearing  $137,572   $133,440 
Interest-bearing   337,982    328,845 
Total deposits   475,554    462,285 
           
Short-term borrowings   2,000    5,000 
Long-term borrowings   12,000    14,000 
Accrued interest payable and other liabilities   7,776    6,134 
           
Total liabilities   497,330    487,419 
           
Commitments and contingencies          
           
Shareholders’ equity:          
Preferred stock, no par value; 20,000,000 shares authorized; none outstanding          
Common stock, no par value; 20,000,000 shares authorized; issued and outstanding – 9,328,481 shares at June 30, 2012 and 9,890,909 shares at December 31, 2011   67,901    72,016 
Retained earnings   20,082    18,525 
Accumulated other comprehensive income, net of taxes   4,359    3,558 
           
Total shareholders’ equity   92,342    94,099 
   $589,672   $581,518 

 

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
   2012  2011  2012  2011
             
Interest income:                    
Interest and fees on loans  $4,238   $4,845   $8,554   $9,842 
Interest on deposits in banks   3    5    6    11 
Interest and dividends on investment securities:                    
Taxable   931     1,351    1,970    2,152 
Exempt from Federal income taxes   148    166    300     316 
Dividends   4        4     
Total interest income   5,324    6,367    10,834    12,321 
Interest expense:                    
Interest on deposits   418    592    853    1,223 
Interest on borrowings   64    86    131    180 
Total interest expense   482    678    984    1,403 
                     
Net interest income   4,842    5,689    9,850    10,918 
                     
Provision for loan and lease losses   375    1,700    955    3,075 
                     
Net interest income after provision for
loan and lease losses
   4,467    3,989    8,895    7,843 
                     
Noninterest income:                    
Service charges on deposit accounts   194    187    390    383 
Gain on sale of securities   11    25    75    27 
Other noninterest income   489    242    922    477 
Total noninterest income   694    454    1,387    887 
                     
Noninterest expense:                    
Salaries and employee benefits   2,033    2,043    4,235    4,123 
Occupancy   299    290    595    568 
Furniture and equipment   202    174    392    361 
Federal Deposit Insurance Corporation assessments   141    242    283    540 
Expenses related to other real estate owned   468    507    842    709 
Other expense   908    941    1,816    1,947 
Total noninterest expense   4,051    4,197    8,163    8,248 
                     
Income before provision for income taxes   1,110    246    2,119    482 
                     
Provision for income taxes   265    25    562    55 
                     
Net income  $845   $221   $1,557   $427 
                     
Basic earnings per share  $0.09   $0.02   $0.16   $0.04 
Diluted earnings per share  $0.09   $0.02   $0.16   $0.04 
                     
Cash dividends per share  $0.00   $0.00   $0.00   $0.00 

 

See notes to Unaudited Consolidated Financial Statements

 

4
 

 

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF COMPRENENSIVE INCOME

(Unaudited)

 

(dollars in thousands, except per share data)            
For the periods ended June 30,  Three months  Six months
   2012  2011    2012  2011  
             
Net income  $845   $221   $1,557   $427 
Other comprehensive income:                    
Increase in net unrealized gains on investment securities   761    1,649    1,380    1,863 
Deferred tax expense   (302)   (654)   (534)   (739)
Increase in net unrealized gains on investment securities, net of tax   459    995    846    1,124 
                     
Reclassification adjustment for realized gains included in net income   (11)   (25)   (75)   (27)
Tax effect   5    10    30    11 
Realized gains, net of tax   (6)   (15)   (45)   (16)
                     
Total other comprehensive income   453    980    801    1,108 
Comprehensive income  $1,298   $1,201   $2,358   $1,535 

 

See notes to Unaudited Consolidated Financial Statements

 

5
 

 

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

 

            Accumulated      
(dollars in thousands)   Common Stock         Other    Total 
    Shares    Amount    Retained Earnings    Comprehensive Income    Shareholders’
Equity
 
                          
Balance, January 1, 2011   9,874,867    71,814    16,021    1,709    89,544 
                          
Net income             2,504         2,504 
Other comprehensive income, net of tax:                         
Net change in unrealized gains on available-for-sale investment securities                  1,849    1,849 
                          
Net restricted stock awarded and related compensation expense   16,042    86              86 
Stock option compensation expense        116              116 
                          
Balance, December 31, 2011   9,890,909    72,016    18,525    3,558    94,099 
Net income             1,557         1,557 
Other comprehensive income, net of tax:                         
Net change in unrealized gains on available-for-sale investment securities                  801    801 
                          
Net restricted stock award activity and related compensation expense   12,961    52              52 
Stock option compensation expense        27              27 
Retirement of common stock   (575,389)   (4,194)             (4,194)
                          
Balance, June 30, 2012   9,328,481   $67,901   $20,082   $4,359   $92,342 

 

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,          
   2012    2011 
           
Cash flows from operating activities:          
Net income  $1,557   $427 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan and lease losses   955    3,075 
Decrease in deferred loan origination fees, net   (70)   (67)
Depreciation and amortization   816    373 
Gain on sale and call of investment securities   (75)   (27)
Amortization of investment security premiums and discounts, net   2,060    1,122 
Increase in cash surrender values of life insurance policies   (132)   (137)
Stock based compensation expense   79    108 
Loss on sale and write-down of other real estate owned   373    260 
Decrease in accrued interest receivable and other assets   403    371 
Increase (decrease) in accrued interest payable and other liabilities   1,642    (999)
           
Net cash provided by operating activities   7,608    4,506 
           
Cash flows from investing activities:          
Proceeds from the sale of available-for-sale investment securities   5,543    632 
Proceeds from matured available-for-sale investment securities   665    130 
Proceeds from called available-for-sale investment securities   195    1,145 
Purchases of available-for-sale investment securities   (43,475)   (24,557)
Proceeds from principal repayments for available- for-sale investment securities   23,284    12,156 
Proceeds from principal repayments for held-to- maturity investment securities   964    1,179 
Net decrease (increase) in interest-bearing deposits in banks   250    (1)
Net decrease in loans   11,886    17,197 
Proceeds from sale of other real estate   807    678 
Net (increase) decrease in FHLB stock   (161)   282 
Purchases of equipment   (152)   (311)
           
Net cash (used in) provided by investing activities   (194)   8,530 
           
Cash flows from financing activities:          
Net increase (decrease) in demand, interest-bearing and savings deposits  $9,032   $(1,868)
Net increase (decrease) in time deposits   4,237    (7,991)
Net decrease in short-term borrowings   (3,000)    
Net decrease in long-term borrowings   (2,000)    
Cash paid to repurchase common stock   (4,194)    
           
Net cash provided by (used in) financing activities  $4,075   $(9,859)
           
Increase in cash and cash equivalents   11,489    3,177 
           
Cash and cash equivalents at beginning of year   23,768    31,871 
           
Cash and cash equivalents at end of period  $35,257   $35,048 

 

See Notes to Unaudited Consolidated Financial Statements

 

7
 

 

AMERICAN RIVER BANKSHARES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2012

 

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, 2012 and December 31, 2011, the results of its operations for the three and six month periods ended June 30,2012 and 2011, its cash flows for the six-month periods ended June 30, 2012 and 2011 and its statement of changes in shareholders’ equity for the year ended December 31, 2011 and the six months ended June 30, 2012 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 2011 annual report on Form 10-K. The results of operations for the three-month and six-month periods ended June 30, 2012 may not necessarily be indicative of the operating results for the full year.

 

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

 

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

 

2. STOCK-BASED COMPENSATION

 

Equity Plans

 

On March 17, 2010, the Board of Directors adopted the 2010 Equity Incentive Plan (the “2010 Plan”). The 2010 Plan was approved by the Company’s shareholders on May 20, 2010. In 2000, the Board of Directors adopted and the Company’s shareholders approved a stock option plan (the “2000 Plan”), under which 329,195 options remain outstanding at June 30, 2012. The total number of authorized shares that remain available for issuance under the 2010 Plan is 1,463,531. 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 granted 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 nonstatutory agreements and other awards agreements. The 2010 Plan and the 2000 Plan (collectively the “Plans”) require that the option price may not be less than the fair market value of the stock at the date the option is granted. The option awards under the Plans expire on dates determined by the Board of Directors, but not later than ten years from the date of award. The vesting period is generally five years; however, the vesting period can be modified at the discretion of the Company’s Board of Directors. Outstanding option awards under the Plans are exercisable until their expiration, however, no new options will be awarded under the 2000 Plan. New shares are issued upon exercise of an option.

 

8
 

 

The grant date fair value of awards is determined by the market price of the Company’s common stock on the date of grant and is recognized ratably as compensation expense or director expense over the vesting periods. The shares of common stock granted pursuant to such agreements vest in increments over one to five years from the date of grant. 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, 2012 and 2011, the compensation cost recognized for equity compensation was $46,000 and $36,000, respectively. The recognized tax benefit for equity compensation expense was $14,000 and $9,000, for the three-month periods ended June 30, 2012 and 2011, respectively. For the six-month periods ended June 30, 2012 and 2011, the compensation cost recognized for equity compensation was $79,000 and $108,000, respectively. The recognized tax benefit for equity compensation expense was $22,000 and $29,000, for the six-month periods ended June 30, 2012 and 2011, respectively.

At June 30, 2012, the total compensation cost related to nonvested stock option awards not yet recorded is $72,000. This amount will be recognized over the next 5.0 years and the weighted average period of recognizing these costs is expected to be 1.6 years. At June 30, 2012, the total compensation cost related to restricted stock awards not yet recorded is $193,000. This amount will be recognized over the next 5.0 years and the weighted average period of recognizing these costs is expected to be 1.3 years.

Equity Plans Activity

Stock Options

 

There were 17,329 stock options awarded during the three and six-month periods ended June 30, 2012 at an average exercise price of $7.07. The weighted average grant date fair value of options granted for the three and six- month periods ended June 30, 2012 was $2.31. There were no stock options awarded during the three- and six-month periods ended June 30, 2011. A summary of option activity under the Plans as of June 30, 2012 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, 2012  358,198   $17.25    4.0 years   $ 
Granted  17,329    7.07    9.9 years    4 
Exercised               
Cancelled  29,003    16.92         
Outstanding at June 30, 2012  346,524   $16.77    4.2 years   $4 
Vested at June 30, 2012  298,803   $17.91    3.7 years   $ 
Non-vested at June 30, 2012  47,721   $9.61    7.6 years   $4 

 

Restricted Stock

 

There were 16,207 shares of restricted stock awarded during the three- and six-month periods ended June 30, 2012. Of the 16,207 restricted common shares, 9,898 will vest one year from the date of the award and 6,309 will vest over five years at 20% per year from the date of the award. There was no restricted stock awarded during the three and six-month periods ended June 30, 2011. Grant date fair value is determined by the market price of the Company’s common stock on the date of grant ($7.07 on May 16, 2012).

 

9
 

 

There were no restricted awards that were fully vested during the three and six-month periods ended June 30, 2012 and 2011. There were zero and 3,246 awards that had been forfeited during the three and six-month periods ended June 30, 2012 and 2,860 awards that had been forfeited during the three and six-month periods ended June 30, 2011. The intrinsic value of nonvested restricted stock at June 30, 2012 was $328,000.

 

Restricted Stock

  Shares  Weighted Average Grant Date Fair Value
Nonvested at January 1, 2012   32,078   $5.96 
Awarded   16,207    7.07 
Vested        
Cancelled   (3,246)   6.54 
Nonvested at June 30, 2012   45,039   $6.32 

 

Other Equity Awards

 

There were no stock appreciation rights; restricted performance stock; unrestricted Company stock; or performance units awarded during the three or six month periods ended June 30, 2012 or 2011.

 

The intrinsic value used for stock options and restricted stock was derived from the market price of the Company’s common stock of $7.28 as of June 30, 2012.

 

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 $32,592,000 and standby letters of credit of approximately $8,355,000 at June 30, 2012 and loan commitments of approximately $36,479,000 and standby letters of credit of approximately $10,086,000 at December 31, 2011. 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 2012 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 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, 2012 or December 31, 2011.

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 (9,518,897 and 9,671,083 shares for the three-month and six-month periods ended June 30, 2012, and 9,845,533 for the three-month and six-month periods ended June 30, 2011). 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 13,306 and 11,794, respectively, dilutive shares for the three-month and six-month periods ended June 30, 2012 and 11,960 and 10,541, respectively, dilutive shares for the three-month and six-month periods ended June 30, 2011. Earnings per share is retroactively adjusted for stock dividends and stock splits, if applicable, for all periods presented.

 

10
 

 

5. INVESTMENT SECURITIES

 

The amortized cost and estimated fair values of investment securities at June 30, 2012 and December 31, 2011 consisted of the following (dollars in thousands):

 

Available-for-Sale

   June 30, 2012 
    Amortized Cost    Gross Unrealized Gains    Gross Unrealized Losses    Estimated Fair
Value
 
Debt securities:                    
Mortgage-backed securities  $185,047   $5,677   $(62)  $190,662 
Obligations of states and political subdivisions   27,963    1,665    (16)   29,612 
Corporate bonds   1,507        (7)   1,500 
Equity securities:                    
Corporate stock   64    8        72 
   $214,581   $7,350   $(85)  $221,846 

 

   December 31, 2011 
    Amortized Cost    Gross Unrealized Gains    Gross Unrealized Losses    Estimated Fair
Value
 
Debt securities:                    
Mortgage-backed securities  $175,038   $4,570   $(154)  $179,454 
Obligations of states and political subdivisions   27,678    1,510        29,188 
Equity securities:                    
Corporate stock   65    4        69 
   $202,781   $6,084   $(154)  $208,711 

 

Net unrealized gains on available-for-sale investment securities totaling $7,265,000 were recorded, net of $2,906,000 in tax liabilities, as accumulated other comprehensive income within shareholders’ equity at June 30, 2012. Proceeds and gross realized gains from the sale and call of available-for-sale investment securities for the three-month period ended June 30, 2012 totaled $830,000 and $11,000, respectively, and for the six-month period ended June 30, 2012 totaled $5,738,000 and $75,000, respectively. There were no transfers of available-for-sale investment securities for the three- and six-month periods ended June 30, 2012.

 

Net unrealized gains on available-for-sale investment securities totaling $5,930,000 were recorded, net of $2,372,000 in tax liabilities, as accumulated other comprehensive income within shareholders’ equity at December 31, 2011. Proceeds and gross realized gains from the sale and call of available-for-sale investment securities for the three-month period ended June 30, 2011 totaled $1,306,000 and $25,000, respectively, and the six-month period ended June 30, 2011 totaled $1,777,000 and $27,000, respectively. There were no transfers of available-for-sale investment securities for the three- and six-month periods ended June 30, 2011.

 

Held-to-Maturity                    
   June 30, 2012 
    Amortized Cost    Gross Unrealized Gains    Gross Unrealized Losses    Estimated Fair Value 
Debt securities:                    
Mortgage-backed securities  $3,049   $187   $   $3,236 

 

   December 31, 2011 
    Amortized Cost    Gross Unrealized Gains    Gross Unrealized Losses    Estimated air Value 
Debt securities:                    
Mortgage-backed securities  $4,010   $221   $   $4,231 

 

11
 

 

There were no sales or transfers of held-to-maturity investment securities for the periods ended June 30, 2012 and June 30, 2011. Investment securities with unrealized losses at June 30, 2012 and December 31, 2011 are summarized and classified according to the duration of the loss period as follows (dollars in thousands):

 

   2012  
      
   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:                              
Mortgage-backed securities  $17,068   $(62)          $17,068   $(62)
Obligations of states and political subdivisions   1,431   (16)           1,431   (16)
Corporate bonds   1,500   (7)           1,500   (7)
Equity Securities:                              
Corporate stock                        
   $19,999   $(85)  $   $   $19,999   $(85)

 

   2011 
                               
   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:                              
Mortgage-backed securities  $23,749   $(154)          $23,749   $(154)
   $23,749   $(154)  $   $   $23,749   $(154)

 

There were no held-to-maturity investment securities with unrealized losses as of June 30, 2012 or December 31, 2011.

 

At June 30, 2012, the Company held 191 securities of which ten were in a loss position for less than twelve months and none were in a loss position for twelve months or more. Of the ten securities in a loss position, seven are mortgage-backed securities, two are obligations of states and political subdivisions, and one is a corporate bond. At December 31, 2011, the Company held 189 securities of which eleven were in a loss position for less than twelve months and none were in a loss position for twelve months or more. All eleven securities in a loss position were mortgage-backed securities.

 

The unrealized loss on the Company’s investments in mortgage-backed securities, obligations of states and political subdivisions, and corporate bonds, 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.

 

12
 

The amortized cost and estimated fair values of investment securities at June 30, 2012 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  $345   $348           
After one year through five years   3,651    3,723           
After five years through ten years   10,985    11,646           
After ten years   14,489    15,395           
    29,470    31,112           
Investment securities not due at a single maturity date:                    
Mortgage-backed securities   185,047    190,662   $3,049   $3,236 
Corporate stock   64    72         
   $214,581   $221,846   $3,049   $3,236 

 

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, 2012 and December 31, 2011, the recorded investment in nonperforming loans and leases was approximately $10,673,000 and $13,423,000, 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, 2012, the recorded investment in loans and leases that were considered to be impaired totaled $29,565,000, which includes $10,673,000 in nonaccrual loans and leases and $18,892,000 in performing loans and leases. Of the total impaired loans of $29,565,000, loans totaling $14,241,000 were deemed to require no specific reserve and loans totaling $15,324,000 were deemed to require a related valuation allowance of $1,238,000. At December 31, 2011, the recorded investment in loans and leases that were considered to be impaired totaled $30,085,000 and had a related valuation allowance of $1,680,000. If interest had been accruing on the nonperforming loans, such income would have approximated $200,000 and $465,000 for the three months ended June 30, 2012 and 2011, respectively, and approximated $472,000 and $890,000 for the six months ended June 30, 2012 and 2011, respectively.

 

At June 30, 2012 and December 31, 2011, the recorded investment in other real estate owned (“OREO”) was $10,366,000 and $8,190,000, respectively. In addition, at December 31, 2011, the Company owned one repossessed mobile home classified on the balance sheet in accrued interest receivable and other assets with a book value of $55,000. For the three months ended March 31, 2012, the Company transferred four properties with loan balances in the amount of $3,439,000 to OREO and wrote these balances down by $194,000 to $3,245,000, and sold four properties with balances of $497,000 for a net loss of $30,000. In addition to the $194,000 in write downs, the Company also adjusted balances through charges to the allowance for loan and lease losses of $74,000 and OREO expense of $60,000 for properties obtained in the prior quarter. For the three months ended June 30, 2012, the Company transferred one property into OREO with a loan balance of $244,000 and the Company sold two properties and a mobile home with balances of $406,000 for a loss of $39,000. The property added during the quarter was adjusted to its current carrying value of $212,000, which is equal to fair value less selling costs. The single property added consisted of three contiguous undeveloped parcels in Amador County, which are zoned residential. One parcel is approximately eleven acres and the other two parcels are approximately five acres each.

 

The Company periodically obtains property valuations to determine whether the recorded book value is considered fair value. During the second quarter of 2012, this valuation process resulted in the Company reducing the book value of seven properties by $285,000. Of this adjustment, $216,000 was charged to OREO expense, $45,000 was an adjustment to receivables, and $24,000 was charged to the allowance for loan and lease loss.

 

13
 

 

The June 30, 2012 OREO balance of $10,366,000 consists of twenty properties including eight commercial real estate properties in the amount of $7,831,000, six residential land properties in the amount of $1,713,000, one commercial land property totaling $258,000 and five residential real estate properties in the amount of $564,000.

 

Nonperforming loans and leases and OREO at June 30, 2012 and December 31, 2011 are summarized as follows:

 

(in thousands)   June 30, 2012    December 31, 2011 
           
Nonaccrual loans and leases that are current to terms (less than 30 days past due)  $654   $396 
Nonaccrual loans and leases that are past due   10,019    13,027 
Loans and leases past due 90 days and accruing interest        
Other real estate owned   10,366    8,190 
Total nonperforming assets  $21,039   $21,613 
           
Nonperforming loans and leases to total loans and leases   3.76%   4.46%
Total nonperforming assets to total assets   3.57%   3.73%

 

Impaired loans and leases as of and for the periods ended June 30, 2012 and December 31, 2011 are summarized as follows:

 

(in thousands)  As of June 30, 2012    As of December 31, 2011  
    

 

Recorded

Investment

    

Unpaid Principal

Balance

    

 

Related

Allowance

    

 

Recorded

Investment

    

Unpaid Principal

Balance

    

 

Related

Allowance

 
With no related allowance recorded:                              
                               
Commercial  $2,534   $4,147   $   $3,069   $3,089   $ 
Real estate-commercial   9,951    10,731        4,723    6,428     
Real estate-multi-family               17    17     
Real estate-construction   1,719    1,790                 
Real estate-residential               180    180     
Leases               17    17     
Consumer   37    37        133    133     
Subtotal  $14,241   $16,705   $   $8,139   $9,864   $ 
                               
With an allowance recorded:                              
                               
Commercial  $2,810   $2,810   $393   $2,054   $3,705   $538 
Real estate-commercial   8,717    8,780    447    13,504    13,853    707 
Real estate-multi-family   1,176    1,176    78    1,187    1,280    5 
Real estate-construction   74    260    14    2,083    2,402    147 
Real estate-residential   1,994    1,994    107    1,936    1,936    118 
Agriculture   393    594    150    597    597    89 
Consumer   160    160    49    585    585    76 
Subtotal  $15,324   $15,774   $1,238   $21,946   $24,358   $1,680 
                               
Total:                              
                               
Commercial  $5,344   $6,957   $393   $5,123   $6,794   $538 
Real estate-commercial   18,668    19,511    447    18,227    20,281    707 
Real estate-multi-family   1,176    1,176    78    1,204    1,297    5 
Real estate-construction   1,793    2,050    14    2,083    2,402    147 
Real estate-residential   1,994    1,994    107    2,116    2,116    118 
Leases               17    17     
Agriculture   393    594    150    597    597    89 
Consumer   197    197    49    718    718    76 
   $29,565   $32,479   $1,238   $30,085   $34,222   $1,680 
                               

 

14
 

 

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

 

    Average Recorded Investments
for the three months ended
  Average Recorded Investments
for the six months ended
    June 30, 2012  June 30, 2011  June 30, 2012  June 30, 2011
              
Commercial  $5,256   $4,490   $5,123   $6,285 
Real estate-commercial   17,743    20,801    15,899    21,304 
Real estate-multi-family   1,187    1,894    1,228    1,897 
Real estate-construction   1,937    4,905    1,852    4,740 
Real estate-residential   2,253    4,314    1,543    3,998 
Leases   4             
Agriculture   395    489    495    490 
Consumer   457    452    212    479 
Total  $29,232   $38,345   $26,352   $39,193 

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

    Interest Income Recognized
for the three months ended
  Interest Income Recognized
for the six months ended
    June 30, 2012  June 30, 2011  June 30, 2012  June 30, 2011
              
Commercial  $23   $32   $74   $92 
Real estate-commercial   210    187    330    323 
Real estate-multi-family   15    8    30    17 
Real estate-construction       6        12 
Real estate-residential   25    38    45    67 
Leases                
Agriculture       3        3 
Consumer   3    3    8    13 
Total  $276   $277   $487   $527 

 

7. TROUBLED DEBT RESTRUCTURINGS

 

At June 30, 2012, there were 28 loans and leases that were considered to be troubled debt restructurings. Of these loans and leases, 19 were modified and are currently performing (less than ninety days past due) totaling $7,753,000 and 9 are considered nonperforming (and included in the $10,673,000 noted above in Note 6), totaling $2,746,000. At June 30, 2012 and December 31, 2011, there were no unfunded commitments on those loans considered troubled debt restructures. See also “Impaired Loans and Leases” in Item 2.

The Company has allocated $500,000 and $535,000 of specific reserves to loans whose terms have been modified as troubled debt restructurings as of June 30, 2012 and December 31, 2011.

 

During the six-month period ended June 30, 2012, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan.

 

15
 

 

The following table presents loans by class modified as troubled debt restructurings during the three months ended June 30, 2012 (dollars in thousands):

 

      Pre-  Post-
      Modification  Modification
      Outstanding  Outstanding
   Number  Recorded  Recorded
   of Loans  Investment  Investment
          
Troubled debt restructurings:               
Commercial   4   $646   $646 
Real estate – commercial   4    1,299    1,299 
Real estate – multi-family   1    274    274 
Total   9   $2,219   $2,219 

 

The following table presents loans by class modified as troubled debt restructurings during the six months ended June 30, 2012 (dollars in thousands):

 

      Pre-  Post-
      Modification  Modification
      Outstanding  Outstanding
   Number  Recorded  Recorded
   of Loans  Investment  Investment
          
Troubled debt restructurings:               
Commercial   5   $693   $693 
Real estate – commercial   6    3,509    3,509 
Real estate – multi-family   2    539    539 
Real estate – residential   3    921    808 
Other – agriculture   1    410    410 
Other – consumer   2    31    31 
Total   19   $6,103   $5,990 

 

The troubled debt restructurings described above increased the allowance for loan and lease losses by $96,000 and resulted in charge offs of $113,000 during the six months ended June 30, 2012.

 

The following table presents loans by class modified as troubled debt restructurings for which there was a payment default within twelve months following the modification during the period indicated (dollars in thousands):

 

Three months ended June 30, 2012  Number  Recorded
   of Loans  Investment
       
Troubled debt restructurings that subsequently defaulted:          
Commercial   2   $1,097 
Consumer   1    5 
           
Total   3   $1,102 

 

Six months ended June 30, 2012  Number  Recorded
   of Loans  Investment
Troubled debt restructurings that subsequently defaulted:          
Commercial   1   $863 
Real estate – commercial   6    2,357 
Consumer   1    5 
           
Total   8   $3,225 

 

16
 

 

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, 2012 and December 31, 2011 are summarized below:

 

June 30, 2012  Credit Risk Profile by Internally Assigned Grade
(dollars in thousands)     Real Estate
   Commercial  Commercial  Multi-family  Construction  Residential
Grade:                         
Pass  $30,067   $147,935   $6,921   $6,827   $16,636 
Watch   1,638    19,423    1,193    327    1,588 
Special mention   1,178    14,302    445    1,225    830 
Substandard   3,640    11,157    518    1,757    902 
Doubtful   714                 
Total  $37,237   $192,817   $9,077   $10,136   $19,956 

 

   Credit Risk Profile by Internally Assigned Grade Other Credit Exposure   
   Leases  Agriculture  Consumer  Total
Grade:                    
Pass  $1,307   $2,917   $8,594   $221,204 
Watch           694    24,863 
Special mention       408    77    18,465 
Substandard   5    392    420    18,791 
Doubtful               714 
Total  $1,312   $3,717   $9,785   $284,037 

 

 

December 31, 2011  Credit Risk Profile by Internally Assigned Grade
(dollars in thousands)     Real Estate
   Commercial  Commercial  Multi-family  Construction  Residential
Grade:                         
Pass  $33,856   $164,117   $5,669   $6,462   $16,215 
Watch   1,540    20,673    1,204    984    1,163 
Special mention   2,173    7,187    449    827    1,372 
Substandard   3,794    11,938    258    2,083    945 
Doubtful   745    128             
Total  $42,108   $204,043   $7,580   $10,356   $19,695 

 

   Credit Risk Profile by Internally Assigned Grade Other Credit Exposure   
   Leases  Agriculture  Consumer  Total
Grade:                    
Pass  $1,708   $3,416   $9,684   $241,127 
Watch       570    237    26,371 
Special mention           264    12,272 
Substandard   17    597    799    20,431 
Doubtful               873 
Total  $1,725   $4,583   $10,984   $301,074 

 

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, 2012

(dollars in thousands)

 

     Real Estate  Other      
   Com-  Com-  Multi-  Construc-       Agri-         
   mercial  mercial  Family  tion  Residential  Leases  culture  Consumer  Unallocated  Total
                               
Allowance for Loan and Lease Losses                                                  
                                                   
Beginning balance  $1,536   $3,156   $198   $582   $609   $79   $167   $348   $366   $7,041 
Provision for loan losses   (320)   703    70    (151)   6    (76)   241    510    (28)   955 
Loans charged-off   (151)   (845)   (8)   (82)   (113)   (8)   (202)   (492)      (1,901)
Recoveries       65    3    22        6        10        106 
                                                   
Ending balance allocated to portfolio segments  $1,065   $3,079   $263   $371   $502   $1   $206   $376   $338   $6,201 
                                                   
Ending balance:                                                  
Individually evaluated for impairment  $393   $447   $78   $14   $107   $   $150   $49   $   $1,238 
                                                   
Ending balance:                                                  
Collectively evaluated for impairment  $672   $2,631   $185   $357   $395   $1   $56   $327   $338   $4,962 
                                                   
Loans                                                  
                                                   
Ending balance  $37,237   $192,817   $9,077   $10,136   $19,956   $1,312   $3,717   $9,785   $   $284,037 
                                                   
Ending balance:                                                  
Individually evaluated for impairment  $5,344   $18,668   $1,176   $1,793   $1,994   $   $393   $197   $   $29,565 
                                                   
Ending balance:                                                  
Collectively evaluated for impairment  $31,893   $174,149   $7,901   $8,343   $17,962   $1,312   $3,324   $9,588   $   $254,472 

 

18
 

 

 

December 31, 2011                              
(dollars in thousands)     Real Estate  Other      
   Com-  Com-  Multi-  Construc-        Agri-     Un-   
   mercial  mercial  Family  tion  Residential  Leases  culture  Consumer  allocated  Total
Ending balance:                              
Individually evaluated for impairment  $538   $707   $5   $147   $118    $   $89   $76    $   $1,680 
                                                   
Ending balance:                                                  
Collectively evaluated for impairment  $998   $2,449   $193   $435   $491   $79   $78   $272   $366   $5,361 
                                                   
Loans                                                  
                                                   
Ending balance  $42,108   $204,043   $7,580   $10,356   $19,695   $1,725   $4,583   $10,984    $   $301,074 
                                                   
Ending balance:                                                  
Individually evaluated for impairment  $5,123   $18,227   $1,204   $2,083   $2,116   $17   $597   $718    $   $30,085 
                                                   
Ending balance:                                                  
Collectively evaluated for impairment  $36,985   $185,816   $6,376   $8,273   $17,579   $1,708   $3,986   $10,266    $   $270,989 

 

June 30, 2011                              
(dollars in thousands)     Real Estate  Other      
   Com-  Com-  Multi-  Construc-        Agri-         
   mercial  mercial  Family  tion  Residential  Leases  culture  Consumer  Unallocated  Total
Allowance for Loan and Lease Losses                              
                               
Beginning balance  $2,574   $2,715   $115   $1,090   $581   $7   $131   $221   $151   $7,585 
Charge-offs   (509)   (1,491)   (83)   (217)   (602)       (241)   (27)       (3,170)
Recoveries   141                1        241    14        397 
Provision   235    1,390    158    (378)   546    94    12    97    921    3,075 
Ending balance  $2,441   $2,614   $190   $495   $526   $101   $143   $305   $1,072   $7,887 

 

19
 

 

The Company’s aging analysis of the loan and lease portfolio at June 30, 2012 and December 31, 2011 are summarized below:

 

June 30, 2012                       
(dollars in thousands)                      
   30-59 Days Past Due  60-89 Days Past Due  Past Due Greater
Than 90 Days
  Total Past Due  Current  Total Loans  Past Due Greater Than 90 Days and Accruing  Nonaccrual
Commercial:                        
Commercial  $461   $74   $3,362   $3,897   $33,340   $37,237       $3,713 
Real estate:                                       
Commercial   1,727    994    3,991    6,712    186,105    192,817        4,607 
Multi-family                   9,077    9,077         
Construction           1,793    1,793    8,343    10,136        1,793 
Residential   51            51    19,905    19,956         
Other:                                        
Leases           5    5    1,307    1,312        5 
Agriculture           393    393    3,324    3,717        393 
Consumer   106        100    206    9,579    9,785    4    162 
Total  $2,345   $1,068   $9,644   $13,057   $270,980   $284,037   $4   $10,673 

 

December 31, 2011                       
(dollars in thousands)                      
   30-59 Days Past Due  60-89 Days Past Due  Past Due Greater Than 90 Days  Total Past Due  Current  Total Loans  Past Due Greater Than 90 Days and Accruing  Nonaccrual
Commercial:                        
Commercial  $60   $277   $2,472   $2,809   $39,299   $42,108       $2,775 
Real estate:                                        
Commercial   2,318    1,527    5,271    9,116    194,927    204,043        7,469 
Multi-family           257    257    7,323    7,580        257 
Construction       244    1,967    2,211    8,145    10,356        2,083 
Residential                   19,695    19,695         
Other:                                        
Leases           17    17    1,708    1,725        17 
Agriculture           597    597    3,986    4,583        597 
Consumer   188    411    139    738    10,246    10,984        225 
                                         
Total  $2,566   $2,459   $10,720   $15,745   $285,329   $301,074   $   $13,423 

 

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9. BORROWING ARRANGEMENTS

 

At June 30, 2012, 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, 2012 or December 31, 2011.

 

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 and long-term) totaling $14,000,000 were outstanding from the FHLB at June 30, 2012, bearing interest rates ranging from 0.67% to 2.73% and maturing between May 20, 2013 and July 10, 2016. Advances totaling $19,000,000 were outstanding from the FHLB at December 31, 2011, bearing interest rates ranging from 0.67% to 2.73% and maturing between January 9, 2012 and July 20, 2016. Remaining amounts available under the borrowing arrangement with the FHLB at June 30, 2012 and December 31, 2011 totaled $65,801,000 and $62,242,000, respectively. The increased borrowing capacity during 2012 resulted from the reduction in outstanding borrowings. 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, 2012 and December 31, 2011 were $26,226,000 and $30,396,000, respectively. The decreased borrowing capacity during 2012 resulted from the decrease in the pledged loan collateral. There were no advances outstanding under this borrowing arrangement as of June 30, 2012 and December 31, 2011.

 

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 tax bases. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. On the consolidated balance sheet, net deferred tax assets are included in accrued interest receivable and other assets.

The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above, 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- and six-month periods ended June 30, 2012 and 2011.

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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, 2012 and December 31, 2011. They indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

 

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

 

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

 

   Carrying  Fair Value Measurements Using:   
June 30, 2012  Amount  Level 1  Level 2  Level 3  Total
                
Financial assets:               
Cash and due from banks  $35,257   $35,257             $35,257 
Interest-bearing deposits in banks   1,000        $1,000         1,000 
Available-for-sale securities   221,846    13    221,833         221,846 
Held-to-maturity securities   3,049         3,236         3,236 
FHLB stock   3,254    N/A    N/A    N/A    N/A 
Net loans and leases:   277,605              275,070    275,070 
Accrued interest receivable   1,908              1,908    1,908 
                          
Financial liabilities:                         
Deposits:                         
Noninterest-bearing  $137,572   $137,572             $137,572 
Savings   51,491    51,491              51,491 
Money market   134,528    134,528              134,528 
NOW accounts   50,003    50,003              50,003 
Time, $100,000 or more   74,814         75,725         75,725 
Other time   27,146         27,390         27,390 
Short-term borrowings   2,000    2,000              2,000 
Long-term borrowings   12,000         12,121         12,121 
Accrued interest payable   168         168         168 

 

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  Carrying  Fair Value Measurements Using:   
December 31, 2011  Amount  Level 1  Level 2  Level 3  Total
                          
Financial assets:                          
Cash and due from banks  $23,768   $23,768             $23,768 
Interest-bearing deposits in banks   1,250        $1,254         1,254 
Available-for-sale securities   208,711    9    208,702         208,711 
Held-to-maturity securities   4,010         4,231         4,231 
FHLB stock   3,093    N/A    N/A    N/A    N/A 
Net loans and leases:   293,731             $290,505    290,505 
Accrued interest receivable   1,952              1,952    1,952 
                          
Financial liabilities:                         
Deposits:                         
Noninterest-bearing  $133,440   $133,440             $133,440 
Savings   47,919    47,919              47,919 
Money market   139,244    139,244              139,244 
NOW accounts   43,959    43,959              43,959 
Time, $100,000 or more   69,464         70,143         70,143 
Other time   28,259         28,513         28,513 
Short-term borrowings   5,000    5,000              5,000 
Long-term borrowings   14,000         14,326         14,326 
Accrued interest payable   226         226         226 

 

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

 

The following methods and assumptions were used by the Company to estimate the fair values of its financial instruments at June 30, 2012 and December 31, 2011:

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

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

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

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

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

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

Short-term and long-term borrowings: The fair value of short-term borrowings is estimated to be the carrying amount and are 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.

Off-balance sheet instruments: Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments was not material at June 30, 2012 and December 31, 2011.

Assets and liabilities measured at fair value on a recurring and non-recurring basis 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, 2012                    
Assets and liabilities measured on a recurring basis:                    
Available-for-sale securities:                    
Mortgage-backed securities  $190,662        $190,662           
Obligations of states and political subdivisions   29,612         29,612           
Corporate bonds   1,500         1,500           
Corporate stock   72   $13    59           
Total recurring  $221,846   $13   $221,833   $   $ 
                          
Assets and liabilities measured on a nonrecurring basis:                         
Impaired loans:                         
Commercial  $998   $   $   $998   $103 
Real estate:                         
Commercial   3,139            3,139    (273)
Multi-family                    
Construction   862            862    43 
Residential                    
Other:                         
Agriculture   393            393    (262)
Consumer   46            46    (56)
Other real estate owned   10,366            10,366    (373)
Total nonrecurring  $15,804   $   $   $15,804   $(818)

 

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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, 2011                    
Assets and liabilities measured on a recurring basis:                    
Available-for-sale securities:                    
Mortgage-backed securities  $179,454       $179,454         
Obligations of states and political subdivisions   29,188        29,188         
Corporate stock   69   $9    60           
Total recurring  $208,711   $9   $208,702   $   $ 
                          
Assets and liabilities measured on a nonrecurring basis:                         
Impaired loans:                         
Commercial  $1,828   $   $   $1,828   $(181)
Real estate:                         
Commercial   7,982            7,982    (489)
Construction   2,083            2,083    (422)
Other:                         
Agriculture   597            597    (330)
Consumer   565            565    (66)
Other real estate owned   8,190            8,190    (1,002)
Total nonrecurring  $21,245   $   $   $21,245   $(2,490)

 

There were no significant transfers between Levels 1 and 2 during the three-month and six-month periods ended June 30, 2012 or the twelve months ended December 31, 2011.

 

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 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 other real estate owned (“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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Item2.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, 2011 and June 30, 2012 and its income and expense accounts for the three-month and six-month periods ended June 30, 2012 and 2011. The discussion is designed to provide a better understanding of significant trends related to the Company’s financial condition, results of operations, liquidity, capital resources and interest rate sensitivity. This discussion and supporting tables and the consolidated financial statements and related notes appearing elsewhere in this report are unaudited. Interest income and net interest income are presented on a fully taxable equivalent basis (FTE) within management’s discussion and analysis. Certain matters discussed or incorporated by reference in this Quarterly Report on Form 10-Q including, but not limited to, matters described in “Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations,” are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, Section 27A of the Securities Act of 1933, as amended, and subject to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may contain words related to future projections including, but not limited to, words such as “believe,” “expect,” “anticipate,” “intend,” “may,” “will,” “should,” “could,” “would,” and variations of those words and similar words that are subject to risks, uncertainties and other factors that could cause actual results to differ significantly from those projected. Factors that could cause or contribute to such differences include, but are not limited to, the following:

·the duration of financial and economic volatility and decline and actions taken by the United States Congress and governmental agencies, including the United States Department of the Treasury, to deal with challenges to the U.S. financial system;
·the risks presented by a continued economic 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 continued or increasing loan and lease losses;
·potential increasing levels of 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 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 and other operational systems failures or fraud;
·the effects of uncontrollable events such as terrorism, the threat of terrorism or the impact of the current military conflicts in Afghanistan and Iraq and the conduct of the war on terrorism by the United States and its allies, worsening financial and economic conditions, natural disasters, and disruption of power supplies and communications;
·changes in accounting standards, tax laws or regulations and interpretations of such standards, laws or regulations;
·projected business increases following any future strategic expansion could be lower than expected;
·the goodwill we have recorded in connection with acquisitions could become impaired, which may have an adverse impact on our earnings;
·the reputation of the financial services industry could experience further deterioration, which could adversely affect our ability to access markets for funding and to acquire and retain customers;
·the efficiencies we may expect to receive from any investments in personnel and infrastructure may not be realized; and
·downgrades in the credit rating of the United States by credit rating agencies.

 

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The factors set forth under “Item 1A - Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, and other cautionary statements and information set forth in this Quarterly Report on Form 10-Q should be carefully considered and understood as being applicable to all related forward-looking statements contained in this Quarterly Report on Form 10-Q, when evaluating the business prospects of the Company and its subsidiaries.

 

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

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 credit loss risk in our loan and lease portfolio. 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.

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 grant 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.

 

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Goodwill

 

Business combinations involving the Company’s acquisition of the equity interests or net assets of another enterprise or the assumption of net liabilities in an acquisition of branch offices constituting a business may give rise to goodwill. Goodwill represents the excess of the cost of an acquired entity over the net fair value of the amounts assigned to assets acquired and liabilities assumed in transactions accounted for under the purchase method of accounting. The value of goodwill is ultimately derived from the Company’s ability to generate net earnings after the acquisition. A decline in net earnings could be indicative of a decline in the fair value of goodwill and result in impairment. For that reason, goodwill is assessed for impairment at a reporting unit level at least annually following the year of acquisition. The Company performed an evaluation of goodwill, recorded as a result of the Bank of Amador acquisition, during the fourth quarter of 2011 and determined that there was no impairment. No events have occurred since the last evaluation that would result in the Company recording an impairment of the goodwill. While the Company believes all assumptions utilized in its assessment of goodwill for impairment are reasonable and appropriate, changes in earnings, the effective tax rate, historical earnings multiples and the cost of capital could all cause different results for the calculation of the present value of future cash flows upon which the assessment is based.

 

Income Taxes

 

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

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

The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is, if applicable, reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company recognizes accrued interest and penalties related to unrecognized tax benefits, if applicable, as a component of interest expense in the consolidated statement of income. There were no unrecognized tax benefits or accrued interest and penalties at June 30, 2012 or 2011 or for the three-month and six-month periods then ended.

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 114 full-time employees as of June 30, 2012.

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. 

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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, Fair Oaks, and Roseville. American River Bank also operates two full service offices in Sonoma County in Healdsburg and Santa Rosa, operated under the name “North Coast Bank, a division of American River Bank.” 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. In 2000, North Coast Bank was acquired by the Company as a separate bank subsidiary. 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 and now operates three full service banking offices in Amador County in Jackson, Pioneer, and Ione, operating as “Bank of Amador, a division of American River Bank.”

The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to applicable legal limits. On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act includes a permanent increase to $250,000 as the maximum FDIC insurance limit per depositor retroactive to January 1, 2008 and the extension of unlimited FDIC insurance for noninterest-bearing transaction accounts effective December 31, 2010 through December 31, 2012. On November 9, 2010, the FDIC implemented a final rule to increase the coverage and extension of FDIC insurance under the Dodd-Frank Act. FDIC insurance coverage and assessments are discussed under “Item 1A--Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

 

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 2012, the Company conducted no significant activities other than holding the shares of its subsidiaries. However, it is authorized, with the prior approval of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), the Company’s principal regulator, to engage in a variety of activities which are deemed closely related to the business of banking. The common stock of the Company is registered under the Securities Exchange Act of 1934, as amended, and is listed and traded on the Nasdaq Global Select Market under the symbol “AMRB.”

Overview

The Company recorded net income of $845,000 for the quarter ended June 30, 2012, which was an increase of $624,000 compared to $221,000 reported for the same period of 2011. Diluted earnings per share for the second quarter of 2012 were $0.09 compared to $0.02 recorded in the second quarter of 2011. The return on average equity (“ROAE”) and the return on average assets (“ROAA”) for the second quarter of 2012 were 3.64% and 0.58%, respectively, as compared to 0.97% and 0.16%, respectively, for the same period in 2011.

 

Net income for the six months ended June 30, 2012 and 2011 was $1,557,000 and $427,000, respectively, with diluted earnings per share of $0.16 in 2012 and $0.04 in 2011. For the first six months of 2012, ROAE was 3.33% and ROAA was 0.54% compared to 0.95% and 0.15%, respectively, for the same period in 2011.

 

Total assets of the Company increased by $8,154,000 (1.4%) from $581,518,000 at December 31, 2011 to $589,672,000 at June 30, 2012. Net loans totaled $277,605,000 at June 30, 2012, down $16,126,000 (5.5%) from $293,731,000 at December 31, 2011. Deposit balances at June 30, 2012 totaled $475,554,000, up $13,269,000 (2.9%) from the $462,285,000 at December 31, 2011.

 

The Company ended the second quarter of 2012 with a leverage capital ratio of 12.8%, a Tier 1 capital ratio of 21.7%, and a total risk-based capital ratio of 23.0% compared to 13.1%, 21.5%, and 22.8%, respectively, at December 31, 2011. 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).

 

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Table One: Components of Net Income        
(dollars in thousands)  For the three months ended
June 30,
   For the six months ended
June 30,
 
   2012   2011   2012   2011 
Interest income*  $5,399   $6,422   $10,983   $12,426 
Interest expense   (482)   (678)   (984)   (1,403)
Net interest income*   4,917    5,744    9,999    11,023 
Provision for loan and lease losses   (375)   (1,700)   (955)   (3,075)
Noninterest income   694    454    1,387    887 
Noninterest expense   (4,051)   (4,197)   (8,163)   (8,248)
Provision for income taxes   (265)   (25)   (562)   (55)
Tax equivalent adjustment   (75)   (55)   (149)   (105)
Net income  $845   $221   $1,557   $427 
                     
Average total assets  $570,683   $570,683   $573,636   $573,636 
Net income (annualized) as a percentage of average total assets   0.58%   0.16%   0.54%   0.15%

 

* Fully taxable equivalent basis (FTE)

 

Results of Operations

Net Interest Income and Net Interest Margin

Net interest income represents the excess of interest and fees earned on interest earning assets (loans and leases, securities, Federal funds sold and investments in time deposits) over the interest paid on interest-bearing deposits and borrowed funds. Net interest margin is net interest income expressed as a percentage of average earning assets. The Company’s net interest margin was 3.93% for the three months ended June 30, 2012, 4.58% for the three months ended June 30, 2011, 3.97% for the six months ended June 30, 2012 and 4.41% for the six months ended June 30, 2011.

The fully taxable equivalent interest income component for the second quarter of 2012 decreased $1,023,000 (15.9%) to $5,399,000 compared to $6,422,000 for the three months ended June 30, 2011. The decrease in the fully taxable equivalent interest income for the second quarter of 2012 compared to the same period in 2011 is broken down by rate (down $848,000) and volume (down $175,000). The rate decrease can be attributed to the overall lower interest rate environment and lower average loan balances replaced with higher average investment securities. While forgone interest on nonaccrual loans has decreased, it continues to negatively impact the yield on earning assets. During the second quarter of 2012, foregone interest income on nonaccrual loans was approximately $200,000, compared to foregone interest of $465,000 during the second quarter of 2011. The foregone interest of $200,000 had a 19 basis point negative impact on the yield on earning assets. The average balance of earning assets increased $1,124,000 (0.2%) from $502,505,000 in the second quarter of 2011 to $503,629,000 in the second quarter of 2012; however, there was a significant change in the average earning asset mix during these periods, due to an increase in investment securities, offset by a decrease in loan balances. Principal reductions from loan balances were invested into investment securities. When compared to the second quarter of 2011, average loan balances were down $39,300,000 (12.0%) to $287,869,000 for the second quarter of 2012 and average investment securities were up $41,390,000 (23.9%) to $214,856,000 for the second quarter of 2012. The overall low interest rate environment and the change in the asset mix (lower loan totals and higher investment security totals) resulted in a 82 basis point decrease in the yield on average earning assets from 5.13% for the second quarter of 2011 to 4.31% for the second quarter of 2012. The volume decrease of $175,000 occurred mainly as a result of the decrease in average loans. The market in which the Company operates continues to see a slowdown in new loan volume as existing and potential new borrowers continue to pay down debt and delay expansion plans.

Total fully taxable equivalent interest income for the six months ended June 30, 2012 decreased $1,443,000 (11.6%) to $10,983,000 compared to $12,426,000 for the six months ended June 30, 2011. The breakdown of the fully taxable equivalent interest income for the six months ended June 30, 2012 over the same period in 2011 resulted from decreases in rate (down $1,032,000) and a decrease in volume (down $411,000). Average earning assets increased $3,123,000 (0.6%) during the first six months of 2012 as compared to the same period in 2011. Average loan balances decreased $39,905,000 (12.0%) during that same period and average investment securities balances increased $44,009,000 (26.0%).

 

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Interest expense was $482,000 or $196,000 (28.9%) lower in the second quarter of 2012 versus the prior year period. The average balances on interest bearing liabilities were $304,000 (0.1%) higher in the second quarter of 2012 compared to the same quarter in 2011. The slightly higher balances did not impact the overall interest expense, as the lower rate was the main cause for the decrease in interest expense. The net $196,000 decrease in interest expense during the second quarter of 2012 compared to the second quarter of 2011 was due to lower rates (down $190,000) and lower volume (down $6,000). The Company focused its marketing efforts on replacing higher cost time deposits with lower cost checking, savings, and money market accounts. Average time deposit balances were down $2,177,000 (2.1%) during the second quarter of 2012 compared to the second quarter of 2011, while average interest checking, savings, and money market accounts were up $3,008,000 (1.3%) during that same time period. The Company continues to have success attracting new deposit relationships as a direct result of its business development efforts. The decrease of $190,000 in rates is a result of the lower overall interest rate environment. Rates paid on interest bearing liabilities decreased 22 basis points from 0.78% to 0.56% for the second quarter of 2011 compared to the second quarter of 2012.

 

Interest expense was $419,000 (29.9%) lower in the six-month period ended June 30, 2012 versus the prior year period. The average balances on interest-bearing liabilities were $2,285,000 (0.7%) lower in the six-month period ended June 30, 2012 compared to the same period in 2011. The lower balances, especially in the level of average time deposits accounted for a $21,000 decrease in interest expense. Average time deposit balances were down $5,119,000 (4.9%) during the first six months of 2012 compared to the same period in 2011. The decrease in interest expense was also aided by lower rates, which accounted for a $398,000 decrease in interest expense for the six-month period. Rates paid on interest-bearing liabilities decreased 24 basis points from the first six months of 2011 to the first six months of 2012 from 0.81% to 0.57%.

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

 

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Table Two: Analysis of Net Interest Margin on Earning Assets

Three Months Ended June 30,  2012  2011
(Taxable Equivalent Basis)
(dollars in thousands)
 

Avg

Balance

 

 

Interest

 

Avg

Yield (4)

 

Avg

Balance

 

 

Interest

 

Avg

Yield (4)

Assets                  
Earning assets:                  
Loans and leases (1)  $287,869   $4,238    5.92%  $327,169   $4,845    5.94%
Taxable investment Securities   185,300    931    2.02%   156,264    1,351    3.47%
Tax-exempt investment securities (2)   29,547    223    3.04%   17,187    221    5.16%
Corporate stock (2)   9    4    178.75%   15         
Federal funds sold                        
Investments in time deposits   904    3    1.33%   1,870    5    1.07%
Total earning assets   503,629    5,399    4.31%   502,505    6,422    5.13%
Cash & due from banks   38,085              34,014           
Other assets   46,801              41,981           
Allowance for loan & lease losses   (6,333)             (7,817)          
   $582,182             $570,683           
                               
Liabilities & Shareholders’ Equity                              
Interest bearing liabilities:                              
Interest checking and money market  $181,611    170    0.38%  $184,056    281    0.61%
Savings   51,223    31    0.24%   45,770    50    0.44%
Time deposits   100,941    217    0.86%   103,118    261    1.02%
Other borrowings   14,000    64    1.84%   14,527    86    2.37%
Total interest bearing liabilities   347,775    482    0.56%   347,471    678    0.78%
Noninterest bearing demand deposits   134,611              126,163           
Other liabilities   6,364              5,878           
Total liabilities   488,750              479,512           
Shareholders’ equity   93,432              91,171           
   $582,182             $570,683           
Net interest income & margin (3)       $4,917    3.93%       $5,744    4.58%

 

(1)Loan interest includes loan fees of $7,000 and $26,000, respectively, during the three months ended June 30, 2012 and June 30, 2011. Average loan balances include non-performing loans.
(2)Includes taxable-equivalent adjustments that primarily relate to income on certain securities that is exempt from federal income taxes. The effective federal statutory tax rate was 34% for 2012 and 2011.
(3)Net interest margin is computed by dividing net interest income by total average earning assets.
(4)Average yield is calculated based on actual days in the period (92 days in 2012 and 91 in 2011) and annualized to actual days in the year (366 days for 2012 and 365 days for 2011).
   
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Six Months Ended June 30,  2012  2011
(Taxable Equivalent Basis)
(dollars in thousands)
 

Avg

Balance

 

 

Interest

 

Avg

Yield (4)

 

Avg

Balance

 

 

Interest

 

Avg

Yield (4)

Assets                              
Earning assets:                              
Loans and leases (1)  $292,485   $8,554    5.88%  $332,390   $9,842    5.97%
Taxable investment securities   184,138    1,970    2.15%   153,205    2,152    2.83%
Tax-exempt investment securities (2)   29,179    449    3.09%   16,091    421    5.28%
Corporate stock (2)   9    4    89.38%   21         
Federal funds sold                        
Interest-bearing deposits in banks   1,077    6    1.12%   2,058    11    1.08%
Total earning assets   506,888    10,983    4.36%   503,765    12,426    4.97%
Cash & due from banks   35,493              35,451           
Other assets   46,439              42,207           
Allowance for loan & lease losses   (6,657)             (7,787)          
   $582,163             $573,636           
                               
Liabilities & Shareholders’ Equity                              
Interest-bearing liabilities:                              
Interest checking and money market  $182,653    362    0.40%  $183,738    576    0.63%
Savings   49,850    60    0.24%   45,800    104    0.46%
Time deposits   99,914    431    0.87%   105,033    543    1.04%
Other borrowings   14,797    131    1.78%   14,928    180    2.43%
Total interest-bearing liabilities   347,214    984    0.57%   349,499    1,403    0.81%
Noninterest-bearing demand deposits   134,690              127,980           
Other liabilities   6,301              5,836           
Total liabilities   488,205              483,315           
Shareholders’ equity   93,958              90,321           
   $582,163             $573,636           
Net interest income & margin (3)       $9,999    3.97%       $11,023    4.41%

 

(1) Loan interest includes loan fees of $11,000 and $28,000, respectively, during the six months ended June 30, 2012 and June 30, 2011. Average loan balances include non-performing loans.
(2)Includes taxable-equivalent adjustments that primarily relate to income on certain securities that is exempt from federal income taxes. The effective federal statutory tax rate was 34% for 2012 and 2011.
(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 (183 days in 2012 and 181 in 2011) and annualized to actual days in the year (366 days for 2012 and 365 days for 2011).

 

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Table Three: Analysis of Volume and Rate Changes on Net Interest Income and Expenses
Three Months Ended June 30, 2012 over 2011 (dollars in thousands)
Increase (decrease) due to change in:               
                
Interest-earning assets:   Volume    Rate (4)    Net Change 
Net loans (1)(2)  $(580)  $(27)  $(607)
Taxable investment securities   250    (670)   (420)
Tax exempt investment securities (3)   158    (156)   2 
Corporate stock       4    4 
Federal funds sold            
Interest-bearing deposits in banks   (3)   1    (2)
Total   (175)   (848)   (1,023)
Interest-bearing liabilities:               
Interest checking and money market   (4)   (107)   (111)
Savings deposits   6    (25)   (19)
Time deposits   (5)   (39)   (44)
Other borrowings   (3)   (19)   (22)
Total   (6)   (190)   (196)
Interest differential  $(169)  $(658)  $(827)

 

Six Months Ended June 30, 2012 over 2011 (dollars in thousands)        
Increase (decrease) due to change in:        

 

Interest-earning assets:   Volume    Rate (4)     Net Change 
Net loans (1)(2)   $(1,185)  $(103)   $(1,288)
Taxable investment securities   436    (618)    (182)
Tax exempt investment securities (3)   343    (315)    28 
Corporate stock       4     4 
Federal funds sold             
Interest-bearing deposits in banks   (5)        (5)
Total   (411)   (1,032)    (1,443)
Interest-bearing liabilities:                
Interest checking and money market   (3)   (211)    (214)
Savings deposits   9    (53)    (44)
Time deposits   (26)   (86)    (112)
Other borrowings   (1)   (48)    (49)
Total   (21)   (398)    (419)
Interest differential  $(390)  $(634)   $(1,024)

  

(1)The average balance of non-accruing loans is immaterial as a percentage of total loans and, as such, has been included in net loans.
(2)Loan fees of $7,000 and $26,000, respectively, during the three months ended June 30, 2012 and June 30, 2011, and loan fees of $11,000 and $28,000, respectively, during the six months ended June 30, 2012 and June 30, 2011, have been included in the interest income computation.
(3) Includes taxable-equivalent adjustments that primarily relate to income on certain securities that is exempt from federal income taxes. The effective federal statutory tax rate was 34% for 2012 and 2011.
(4)The rate/volume variance has been included in the rate variance.

 

Provision for Loan and Lease Losses 

 

The Company provided $375,000 for loan and lease losses for the second quarter of 2012 as compared to $1,700,000 for the second quarter of 2011. Net loan and lease losses for the three months ended June 30, 2012 were $439,000 or 0.61% (on an annualized basis) of average loans and leases as compared to $1,175,000 or 1.44% (on an annualized basis) of average loans and leases for the three months ended June 30, 2011. For the first six months of 2012, the Company made provisions for loan and lease losses of $955,000 and net loan and lease losses were $1,795,000 or 1.23% (on an annualized basis) of average loans and leases outstanding. This compares to provisions for loan and lease losses of $3,075,000 and net loan and lease losses of $2,773,000 for the first six months of 2011 or 1.68% (on an annualized basis) of average loans and leases outstanding. The Company has continued to add to the allowance for loan and lease losses for 2012 as we continue to have a higher than historical average level of nonperforming loans and leases. The high level of nonperforming loans and leases is due to the impact that the overall challenging economy in the Company’s market areas and in the United States, has had on the Company’s borrowers. For additional information see the “Allowance for Loan and Lease Losses Activity.”

 

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Noninterest Income

 

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

Table Four: Components of Noninterest Income

  

Three Months
Ended

June 30,

 

Six Months
Ended

June 30,

   2012  2011  2012  2011
Service charges on deposit accounts  $194   $187   $390   $383 
Gain on sale/call of securities   11    25    75    27 
Merchant fee income   135    120    263    222 
Bank owned life insurance   66    69    132    137 
Income from OREO properties   229        392     
Other   59    53    135    118 
Total noninterest income  $694   $454   $1,387   $887 

Noninterest income increased $240,000 (52.9%) to $694,000 for the three months ended June 30, 2012 as compared to $454,000 for the three months ended June 30, 2011. The increase from the second quarter of 2011 to the second quarter of 2012 was primarily related to rents received on properties obtained through foreclosure. For the second quarter of 2012, rental income was $229,000 compared to zero in the second quarter of 2011. The income from the rental properties results primarily from leased office properties the Company foreclosed upon in the fourth quarter of 2011 and the first quarter of 2012. For the six months ended June 30, 2012, noninterest income increased $500,000 (56.4%) to $1,387,000. The increase from the first six months of 2011 compared to the same period in 2012 was also related to higher rents received on properties obtained through foreclosure.

Noninterest Expense

Noninterest expense decreased $146,000 (3.5%) to a total of $4,051,000 in the second quarter of 2012 compared to $4,197,000 in the second quarter of 2012. Salary and employee benefits expense decreased $10,000 (0.6%) from $2,043,000 during the second quarter of 2011 to $2,033,000 during the second quarter of 2012. On a quarter-over-quarter basis, occupancy expense increased $9,000 (3.0%) and furniture and equipment expense increased $28,000 (16.1%). FDIC assessments decreased $101,000 (41.7%) during the second quarter of 2012 to $141,000, from $242,000 in the second quarter of 2011. OREO related expenses decreased $39,000 (6.8%) during the second quarter of 2012 to $468,000, from $507,000 in the second quarter of 2011. Other expense decreased $33,000 (3.5%) to a total of $908,000 in the second quarter of 2012 versus the second quarter of 2011. The increase in the furniture and equipment expense resulted from depreciation related to purchases of furniture and equipment, including software and three new ATM machines. The decrease in the FDIC assessments resulted from the change in the FDIC assessment methodology from a deposit based system to an asset risk-based system. The fully taxable equivalent efficiency ratio for the second quarter of 2012 increased to 71.3% from 66.8% for the second quarter of 2012. Since the Company experienced a decrease in noninterest expense during this time period the increase in the efficiency is related to a decrease in the net interest margin.

Noninterest expense for the six-month period ended June 30, 2012 was $8,163,000 versus $8,248,000 for the same period in 2011 for a decrease of $85,000 (1.0%). Salaries and benefits expense increased $112,000 (2.7%) from $4,123,000 for the six months ended June 30, 2011 to $4,235,000 for the same period in 2012. The increase in salary and benefits was due in part to an increase in taxes (up $27,000 or 9.7%) and benefits (up $61,000 or 9.2%). The increase in taxes is related to taxes paid on incentive payments and the increase in benefits relates primarily to higher medical related insurance and 401(k) contributions. Occupancy expense increased $27,000 (4.8%) and furniture and equipment expense increased $31,000 (8.6%). FDIC assessments decreased $257,000 (47.6%) during 2012 to $283,000, from $540,000 in 2011. OREO related expenses increased $133,000 (18.8%) during 2012 to $842,000, from $709,000 in 2011. The primary reason for this increase in OREO expenses is due to higher costs to maintain the larger number of foreclosed properties now owned by the Company. Other expense decreased $131,000 (6.7%) from $1,947,000 for the six months ended June 30, 2011 to $1,816,000 for the same period in 2012. The decrease in other expenses results from the Company’s focus on reducing controllable expenses and a reduction in legal fees. Legal expenses are down $60,000 (26.1%), from $230,000 in 2012 to $170,000 in 2011, mainly as a result of lower number of loans that require legal assistance in the collection process. The overhead efficiency ratio (fully taxable equivalent), excluding the amortization of intangible assets, for the first six months of 2012 was 70.1% as compared to 68.3% in the same period of 2011.

 

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Provision for Income Taxes

 

Federal and state income taxes for the quarter ended June 30, 2012 increased $240,000 from $25,000 in the second quarter of 2011 to $265,000 in the second quarter of 2012. The effective tax rate for the quarter ended June 30, 2012 was 23.9%, an increase from 10.2% for the second quarter of 2011. For the six months ended June 30, 2012, the provision for income taxes was $562,000 with an effective tax rate of 26.5%, compared to a provision of $55,000 and an effective tax rate of 11.4% for the six months ended June 30, 2011. The higher level of income taxes and effective tax rate resulted from higher pretax income which contributed to a more normalized tax expense and effective tax rate when compared to the tax expense recorded in 2011. The Company realizes less of the benefits of tax-free income related to such items as municipal bonds and bank owned life insurance when it records an overall higher amount of taxable income as these benefits are spread over a larger base of taxable income.

 

Balance Sheet Analysis

The Company’s total assets were $589,672,000 at June 30, 2012 as compared to $581,518,000 at December 31, 2011, representing an increase of $8,154,000 (1.4%). The average assets for the three months ended June 30, 2012 were $582,182,000, which represents an increase of $11,499,000 or 2.0% over the balance of $570,683,000 during the three-month period ended June 30, 2011. The average assets for the six months ended June 30, 2012 were $582,163,000, which represents an increase of $8,527,000 or 1.5% from the average balance of $573,636,000 during the six-month period ended June 30, 2011.

Investment Securities

The Company classifies its investment securities as available-for-sale or held-to-maturity. The Company’s intent is to hold all securities classified as held-to-maturity until maturity and management believes that it has the ability to do so. Securities available-for-sale may be sold to implement asset/liability management strategies and in response to changes in interest rates, prepayment rates and similar factors. Table Five below summarizes the values of the Company’s investment securities held on June 30, 2012 and December 31, 2011.

Table Five: Investment Securities Composition

Available-for-sale (at fair value)
(dollars in thousands)
  June 30, 2012   December 31, 2011 
Debt securities:        
           
Mortgage-backed securities  $190,662   $179,454 
Obligations of states and political subdivisions   29,612    29,188 
Corporate bonds   1,500     
Corporate stock   72    69 
Total available-for-sale investment securities  $221,846   $208,711 

Held-to-maturity (at amortized cost)

Debt securities:        
Mortgage-backed securities  $3,049   $4,010 
Total held-to-maturity investment securities  $3,049   $4,010 

 

Net unrealized gains on available-for-sale investment securities totaling $7,265,000 were recorded, net of $2,906,000 in tax liabilities, as accumulated other comprehensive income within shareholders’ equity at June 30, 2012 and net unrealized gains on available-for-sale investment securities totaling $5,930,000 were recorded, net of $2,372,000 in tax liabilities, as accumulated other comprehensive income within shareholders’ equity at December 31, 2011.

 

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

Loans and Leases

The Company concentrates its lending activities in the following principal areas: (1) commercial; (2) commercial real estate; (3) multi-family real estate; (4) real estate construction (both commercial and residential); (5) residential real estate; (6) lease financing receivable; (7) agriculture; and (8) consumer loans. The Company’s continuing focus in our market area, new borrowers developed through the Company’s marketing efforts, and credit extensions expanded to existing borrowers resulted in the Company originating $13 million in new loans during the first half of 2012. Normal pay downs, loan charge-offs, and loans transferred to OREO resulted in a net decrease in total loans and leases of $17 million (5.7%) from December 31, 2011. The market in which the Company operates continues to see a slowdown in new loan volume as existing borrowers continue to pay down debt and delay expansion plans. Table Six below summarizes the composition of the loan portfolio as of June 30, 2012 and December 31, 2011. 

Table Six: Loan and Lease Portfolio Composition

(dollars in thousands)   June 30, 2012    December 31, 2011    Change in    Percentage 
    $    %    $    %    dollars    change 
Commercial  $37,237    13%  $42,108    14%  $(4,871)   (11.6%)
Real estate                              
Commercial   192,817    68%   204,043    68%   (11,226)   (5.5%)
Multi-family   9,077    3%   7,580    2%   1,497    19.7%
Construction   10,136    4%   10,356    3%   (220)   (2.1%)
Residential   19,956    7%   19,695    7%   261    1.3%
Lease financing receivable   1,312    1%   1,725    1%   (413)   (23.9%)
Agriculture   3,717    1%   4,583    1%   (866)   (18.9%)
Consumer   9,785    3%   10,984    4%   (1,199)   (10.9%)
Total loans and leases   284,037    100%   301,074    100%   (17,037)   (5.7%)
Deferred loan and lease fees, net   (231)        (302)        71      
Allowance for loan and lease losses   (6,201)        (7,041)        840      
Total net loans and leases  $277,605        $293,731        $(16,126)   (5.5%)

 

A significant portion of the Company’s loans and leases are direct loans and leases made to individuals and local businesses. The Company relies substantially on local promotional activity and personal contacts by American River Bank officers, directors and employees to compete with other financial institutions. The Company makes loans and leases to borrowers whose applications include a sound purpose and a viable primary repayment source, generally supported by a secondary source of repayment.

 

Commercial loans consist of credit lines for operating needs, loans for equipment purchases, working capital, and various other business loan products. Consumer loans include a range of traditional consumer loan products such as personal lines of credit and homeowner equity lines of credit and loans to finance purchases of autos, boats, recreational vehicles, mobile homes and various other consumer items. Construction loans are generally comprised of commitments to customers within the Company’s service area for construction of commercial properties, multi-family properties and custom and semi-custom single-family residences. Other real estate loans consist primarily of loans secured by first trust deeds on commercial, multi-family, and residential properties typically with maturities from 3 to 10 years and original loan-to-value ratios generally from 65% to 75%. Agriculture loans consist primarily of vineyard loans and development loans to plant vineyards. In general, except in the case of loans under SBA programs or Farm Services Agency guarantees, the Company does not make long-term mortgage loans.

 

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“Subprime” real estate loans generally refer to residential mortgages made to higher-risk borrowers with lower credit and/or income histories. Within the industry, many of these loans were originated with adjustable interest rates that reset upward after an introductory period. These “subprime” loans coupled with declines in housing prices have led to an increase in the banking industry’s default rates resulting in many instances of increased foreclosure rates as the adjustable interest rates reset to higher levels. The Company did not have any such “subprime” loans at June 30, 2012 and December 31, 2011.

Risk Elements

The Company assesses and manages credit risk on an ongoing basis through a total credit culture that emphasizes excellent credit quality, extensive internal monitoring and established formal lending policies. Additionally, the Company contracts with an outside loan review consultant to periodically review the existing loan and lease portfolio. Management believes its ability to identify and assess risk and return characteristics of the Company’s loan and lease portfolio is critical for profitability and growth. Management strives to continue its emphasis on credit quality in the loan and lease approval process, through active credit administration and regular monitoring. With this in mind, management has designed and implemented a comprehensive loan and lease review and grading system that functions to continually assess the credit risk inherent in the loan and lease portfolio.

 

Ultimately, underlying trends in economic and business cycles influence credit quality. American River Bank’s business is concentrated in the Sacramento Metropolitan Statistical Area, which is a diversified economy, but with a large State of California government presence and employment base, in Sonoma County, through North Coast Bank, a division of American River Bank, whose business is focused on businesses within the two communities in which it has offices (Santa Rosa and Healdsburg) and in other areas of Sonoma County and in Amador County, through Bank of Amador, a division of American River Bank, whose business is focused on businesses and consumers within the three communities in which it has offices (Jackson, Pioneer, and Ione). The economy of Sonoma County is diversified with professional services, manufacturing, agriculture and real estate investment and construction, while the economy of Amador County is reliant upon government, services, retail trade, manufacturing industries and Indian gaming.

 

The Company has significant extensions of credit and commitments to extend credit that are secured by real estate. The ultimate repayment of these loans is generally dependent on personal or business cash flows or the sale or refinancing of the real estate. The Company monitors the effects of current and expected market conditions and other factors on the collectability of real estate loans. The more significant factors management considers involve the following: lease rates and terms, vacancy rates, absorption and sale rates and capitalization rates; real estate values, supply and demand factors, and rates of return; operating expenses; inflation and deflation; and sufficiency of repayment sources independent of the real estate including, in some instances, personal guarantees. In extending credit and commitments to borrowers, the Company generally requires collateral and/or guarantees as security. The repayment of such loans is expected to come from cash flow or from proceeds from the sale of selected assets of the borrowers. The Company’s requirement for collateral and/or guarantees is determined on a case-by-case basis in connection with management’s evaluation of the creditworthiness of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, income-producing properties, residences and other real property. The Company secures its collateral by perfecting its security interest in business assets, obtaining deeds of trust, or outright possession among other means.

 

In management’s judgment, a concentration exists in real estate loans, which represented approximately 81.7% of the Company’s loan and lease portfolio at June 30, 2012, an increase from 79.8% at December 31, 2011. Management believes that the residential land and residential construction portion of the Company’s loan portfolio carries more than the normal credit risk it has seen in the past several years, due primarily to severely curtailed demand for new and resale residential property, a large supply of unsold residential land and new and resale homes, and observed reductions in values throughout the Company’s market area. Management has responded by evaluating loans that it considers to carry any significant risk above the normal risk of collectability by taking actions where possible to reduce credit risk exposure by methods that include, but are not limited to, seeking liquidation of the loan by the borrower, seeking additional tangible collateral or other repayment support, converting the property through judicial or non-judicial foreclosure proceedings, and other collection techniques. Management currently believes that it maintains its allowance for loan and lease losses at levels adequate to reflect the loss risk inherent in its total loan portfolio.

 

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A continued substantial further decline in the economy in general, or a continued additional decline in real estate values in the Company’s primary market areas, in particular, could continue to have an adverse impact on the collectability of real estate loans and require an increase in the provision for loan and lease losses. This could adversely affect the Company’s future prospects, results of operations, profitability and stock price. Management believes that its lending practices and underwriting standards are structured with the intent to minimize losses; however, there is no assurance that losses will not occur. The Company’s loan practices and underwriting standards include, but are not limited to, the following: (1) maintaining a thorough understanding of the Company’s service area and originating a significant majority of its loans within that area, (2) maintaining a thorough understanding of borrowers’ knowledge, capacity, and market position in their field of expertise, (3) basing real estate loan approvals not only on market demand for the project, but also on the borrowers’ capacity to support the project financially in the event it does not perform to expectations (whether sale or income performance), and (4) maintaining conforming and prudent loan-to-value and loan-to-cost ratios based on independent outside appraisals and ongoing inspection and analysis by the Company’s lending officers or contracted third-party professionals.

 

Nonperforming, Past Due and Restructured Loans and Leases

At June 30, 2012, nonperforming loans and leases (those loans and leases on nonaccrual status and those loans and leases still accruing and past due 90 days or more) were $10,673,000 or 3.76% of total loans and leases. The $10,673,000 in nonperforming loans and leases was made up of thirty-one loans and one lease. Four of those loans totaling $654,000 were current (less than 30 days past due pursuant to their original or modified terms). Nonperforming loans and leases were $13,423,000 or 4.46% of total loans and leases at December 31, 2011. Specific reserves of $583,000 were held on the nonperforming loans at June 30, 2012 and specific reserves of $1,680,000 were held on the nonperforming loans at December 31, 2011.

The overall level of nonperforming loans decreased $16,000 (.1%) to $10,673,000 at June 30, 2012 compared to $10,689,000 at March 31, 2012. At March 31, 2012, the Company had nonperforming loans and leases consisting of twelve real estate loans totaling $6,087,000; thirteen commercial loans totaling $3,995,000; four consumer loans totaling $204,000; one agriculture loan totaling $396,000 and one lease totaling $7,000. During the second quarter of 2012, five loans incurred charge-offs in the amount of $300,000, two loans in the amount of $248,000 were adjusted to market value and moved to OREO, one loan in the amount of $17,000 was paid off, and five loans in the total amount of $834,000 were placed on nonperforming status. The Company also collected approximately $285,000 in principal paydowns. Of the five loans added in the second quarter of 2012, three loans in the total amount of $779,000 were real estate secured and two loans in the amount of $55,000 were consumer loans.

There were no loan or lease concentrations in excess of 10% of total loans and leases not otherwise disclosed as a category of loans and leases as of June 30, 2012. Management is not aware of any potential problem loans, which were accruing and current at June 30, 2012, where serious doubt exists as to the ability of the borrower to comply with the present repayment terms and that would result in a significant loss to the Company. Table Seven below sets forth nonaccrual loans and loans past due 90 days or more and still accruing as of June 30, 2012 and December 31, 2011.

Table Seven: Nonperforming Loans and Leases    
(dollars in thousands)  June 30,   December 31, 
   2012   2011 
Past due 90 days or more and still accruing:        
Commercial  $   $ 
Real estate        
Lease financing receivable        
Agriculture        
Consumer        
Nonaccrual:          
Commercial   3,713    2,775 
Real estate   6,400    9,809 
Lease financing receivable   5    17 
Agriculture   393    597 
Consumer   162    225 
Total nonperforming loans  $10,673   $13,423 

 

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The net interest due on nonaccrual loans and leases but excluded from interest income was $200,000 for the three months ended June 30, 2012, compared to foregone interest of $465,000 during three months ended June 30, 2011.

Impaired Loans and Leases

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 original contractual terms of the loan or lease agreement. The measurement of impairment may be based on (i) the present value of the expected cash flows of the impaired loan or lease discounted at the loan or lease’s original effective interest rate, (ii) the observable market price of the impaired loan or lease, or (iii) the fair value of the collateral of a collateral-dependent loan. The Company does not apply this definition to smaller-balance loans or leases that are collectively evaluated for credit risk. In assessing whether a loan or lease is impaired, the Company typically reviews loans or leases graded substandard or lower with outstanding principal balances in excess of $100,000, as well as, loans considered troubled debt restructures with outstanding principal balances in excess of $25,000. The Company identifies troubled debt restructures by reviewing each renewal, modification, or extension of a loan with a screening document. This document is designed to identify any characteristic of such a loan that would qualify it as a troubled debt restructure. If the characteristics are not present that would qualify a loan as a troubled debt restructure, it is deemed to be a modification.

At June 30, 2012, the recorded investment in loans and leases that were considered to be impaired totaled $29,565,000, which includes $18,924,000 in performing loans and leases. Of the total impaired loans of $29,565,000, loans totaling $14,241,000 were deemed to require no specific reserve and loans totaling $15,324,000 were deemed to require a related valuation allowance of $1,238,000. Of the $14,241,000 impaired loans that did not carry a specific reserve there were $3,369,000 in loans or leases that had previous partial charge-offs and $10,888,000 in loans or leases that were analyzed and determined not to require a specific reserve or charge-off because the collateral value or discounted cash flow value exceeded the loan or lease balance. The recorded investment in loans and leases that were considered to be impaired totaled $30,085,000 at December 31, 2011. Of the total impaired loans of $30,085,000, loans totaling $8,139,000 were deemed to require no specific reserve and loans totaling $21,946,000 were deemed to require a related valuation allowance of $1,680,000.

The Company has been operating in a market that has experienced significant decreases in real estate values of commercial, residential, land, and construction properties. As such, the Company is focused on monitoring collateral values for those loans considered collateral dependent. The collateral evaluations performed by the Company are updated as necessary, which is generally once every six months, and are reviewed by a qualified credit officer. In the second quarter of 2012, the Company had net charge-offs of $439,000 with a provision of $375,000. In the second quarter of 2011, the Company had net charge-offs of $1,175,000 with a provision of $1,700,000.

At June 30, 2012, there were eighteen loans and leases that were modified and are currently performing (less than ninety days past due) totaling $7,689,000 and ten loans and leases that are considered nonperforming (and included in Table Seven above), totaling $2,810,000, that are considered troubled debt restructures (“TDR”). These TDRs have a specific reserve of $500,000. As of June 30, 2012, of the twenty-eight TDRs, there were seventeen extensions, four changes in terms, four rate reductions, one forbearance, one term out, and one interest only structure change. All were performing as agreed except for five extensions, three changes to amortizing loans, one interest rate decrease and one interest only structure change. The Company generally requires TDRs that are on non-accrual status to make six consecutive payments on the restructured loan or lease prior to returning the loan or lease to accrual status.

Allowance for Loan and Lease Losses Activity

The Company maintains an allowance for loan and lease losses (“ALLL”) to cover probable losses inherent in the loan and lease portfolio, which is based upon management’s estimated range of those losses. The ALLL is established through a provision for loan and lease losses and is increased by provisions charged against current earnings and recoveries and reduced by charge-offs. Actual losses for loans and leases can vary significantly from this estimate. The methodology and assumptions used to calculate the allowance are continually reviewed as to their appropriateness given the most recent losses realized and other factors that influence the estimation process. The model assumptions and resulting allowance level are adjusted accordingly as these factors change.

 

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The adequacy of the ALLL and the level of the related provision for loan and lease losses is determined based on management’s judgment after consideration of numerous factors including but not limited to: (i) local and regional economic conditions, (ii) the financial condition of the borrowers, (iii) loan impairment and the related level of expected charge-offs, (iv) evaluation of industry trends, (v) industry and other concentrations, (vi) loans and leases which are contractually current as to payment terms but demonstrate a higher degree of risk as identified by management, (vii) continuing evaluations of the performing loan portfolio, (viii) ongoing review and evaluation of problem loans identified as having loss potential, (ix) quarterly review by the Board of Directors, and (x)  assessments by banking regulators and other third parties. Management and the Board of Directors evaluate the ALLL and determine its appropriate level considering objective and subjective measures, such as knowledge of the borrowers’ business, valuation of collateral, the determination of impaired loans or leases and exposure to potential losses.

 

The allowance for loan and lease losses totaled $6,201,000 or 2.18% of total loans and leases at June 30, 2012 compared to $7,041,000 or 2.34% of total loans and leases at December 31, 2011. The Company establishes general and specific reserves in accordance with the generally accepted accounting principles. The ALLL is maintained by categories of the loan and lease portfolio based on loan type and loan rating; however, the entire allowance is available to cover actual loan and lease losses. While management uses available information to recognize possible losses on loans and leases, future additions to the allowance may be necessary, based on changes in economic conditions and other matters. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s ALLL. Such agencies may require the Company to provide additions to the allowance based on their judgment of information available to them at the time of their examination.

 

The allowance for loans and leases as a percentage of non-performing loans and leases was 58.1% at June 30, 2012 and 52.5% at December 31, 2011. The allowance for loans and leases as a percentage of impaired loans and leases was 21.0% at June 30, 2012 and 23.4% at December 31, 2011. Of the total non-performing and impaired loans and leases outstanding as of June 30, 2012, there were $4,261,000 in loans or leases that had been reduced by partial charge-offs of $2,935,000. As these loan or lease balances are charged off, the remaining balances, following analysis, normally do not initially require specific reserves and are not eligible for general reserves. The impact of this on credit ratios is such that the Company’s allowance for loan and lease losses as a percentage may be lower, because the partial charge-offs have reduced the potential future losses related to those credits.

 

The Company’s policy with regard to loan or lease charge-offs continues to be that a loan or lease is charged off against the allowance for loan and lease losses when management believes that the collectability of the principal is unlikely. Generally, a loan or lease is charged off, or partially charged down, when estimated losses related to impaired loans and leases are identified. If the loan is collateralized by real estate the impaired portion will be charged off to the allowance for loan and lease losses unless the loan or lease is in the process of collection, in which case a specific reserve may be warranted. If the collateral is other than real estate the Company will typically charge-off the impaired portion of a loan or lease, unless the loan or lease is in the process of collection, in which case a specific reserve may be warranted.

 

It is the policy of management to maintain the allowance for loan and lease losses at a level believed to be adequate for known and inherent risks in the portfolio. Our methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan and lease losses that management believes is appropriate at each reporting date. Based on information currently available to analyze inherent credit risk, including economic factors, overall credit quality, historical delinquencies and a history of actual charge-offs, management believes that the provision for loan and lease losses and the allowance for loan and lease losses are prudent and adequate. Adjustments may be made based on differences from estimated loan and lease growth, the types of loans constituting this growth, changes in risk ratings within the portfolio, and general economic conditions. However, no prediction of the ultimate level of loans and leases charged off in future periods can be made with any certainty. Table Eight below summarizes, for the periods indicated, the activity in the ALLL.

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Table Eight: Allowance for Loan and Lease Losses 
(dollars in thousands)  Three Months
Ended June 30,
   Six Months
Ended June 30,
 
   2012   2011   2012   2011 
Average loans and leases outstanding  $287,869   $327,169   $292,485   $332,390 
                     
Allowance for loan and lease losses at beginning of period  $6,265   $7,362   $7,041   $7,585 
                     
Loans and leases charged off:                    
Commercial   (103)   (459)   (151)   (509)
Real estate   (312)   (802)   (1,048)   (2,250)
Lease financing receivable           (8)    
Agriculture           (202)   (241)
Consumer   (82)   (164)   (492)   (170)
Total   (497)   (1,425)   (1,901)   (3,170)
Recoveries of loans and leases previously charged off:                    
Commercial       250        142 
Real estate   42        90     
Lease financing receivable   6        9    14 
Agriculture               241 
Consumer   10        10     
Total   58    250    106    397 
Net loans and leases charged off   (439)   (1,175)   (1,795)   (2,773)
Additions to allowance charged to operating expenses   375    1,700    955    3,075 
Allowance for loan and lease losses at end of period  $6,201   $7,887   $6,201   $7,887 
Ratio of net charge-offs to average loans and leases outstanding (annualized)   0.61%   1.44%   1.23%   1.68%
Provision of allowance for loan and lease  losses to average loans and leases  outstanding (annualized)   0.52%   2.08%   0.66%   1.87%
Allowance for loan and lease losses to loans and leases net of deferred fees at end of period   2.18%   2.43%   2.18%   2.43%

 

 

 

Other Real Estate Owned

 

At June 30, 2012, the Company had 20 other real estate owned (“OREO”) properties totaling $10,366,000. This compares to 21 properties totaling $8,190,000 at December 31, 2011 and 16 properties totaling $3,224,000 at June 30, 2011. In addition, at December 31, 2011, the Company owned one repossessed mobile home classified on the balance sheet in accrued interest receivable and other assets with a book value of $55,000. During the second quarter of 2012, the Company sold two properties and the one mobile home with balances of $396,000 for a loss of $39,000 and added one property to OREO. The property added during the quarter was adjusted to its current carrying value of $212,000, which is equal to fair value less costs to sell. The single property added consisted of three contiguous undeveloped parcels in Amador County, zoned residential. One parcel is approximately eleven acres and the other two parcels are approximately five acres each.

 

The Company periodically obtains property valuations as part of the process of determining whether the recorded book value represents fair value. During the second quarter of 2012, this valuation process resulted in the Company reducing the book value of the OREO properties by $261,000. In addition, the Company received an updated appraisal on a property that was obtained in in the first quarter of 2012 resulting in a write down to the allowance for loan and lease losses of $24,000. At June 30, 2012, OREO included a valuation reserve of $70,000. This compares to a reserve balance of $68,000 at June 30, 2011 and $56,000 at December 31, 2011. The Company believes that all 20 OREO properties owned at June 30, 2012 are carried approximately at fair value.

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Deposits

 

At June 30, 2012, total deposits were $475,554,000 representing a $13,269,000 (2.9%) increase from the December 31, 2011 balance of $462,285,000. The Company’s deposit growth plan for 2012 is to concentrate its efforts on increasing noninterest-bearing demand, interest-bearing money market and NOW accounts, and savings accounts while allowing higher cost time deposits to mature and close or renew at lower rates. The Company experienced increases in noninterest-bearing ($4,132,000 or 3.1%), interest-bearing checking ($6,044,000 or 13.7%), savings ($3,572,000 or 7.5%), and time deposits ($4,237,000 or 4.3%) accounts during 2012.

 

Other Borrowed Funds

 

Other borrowings outstanding as of June 30, 2012 and December 31, 2011, consist of advances (both long-term and short-term) from the Federal Home Loan Bank of San Francisco (“FHLB”). Table Nine below summarizes these borrowings.

 

Table Nine: Other Borrowed Funds

(dollars in thousands)  

 

   June 30, 2012   December 31, 2011 
   Amount   Rate   Amount   Rate 
Short-term borrowings:                    
FHLB advances  $2,000    0.67