10-Q 1 arh_3q05.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 2005 ------------------------ [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No. 0-31525 AMERICAN RIVER BANKSHARES ------------------------------------------------------ (Exact name of registrant as specified in its charter) California 68-0352144 ------------------------------- ------------------------ (State or other jurisdiction of (IRS Employer ID Number) incorporation or organization) 3100 Zinfandel Drive, Rancho Cordova, California 95670 ------------------------------------------------ ---------- (Address of principal executive offices) (Zip code) (916) 231-6723 ------------------------------- (Registrant's telephone number, including area code) 1545 River Park Drive, Sacramento, California 95815 --------------------------------------------- ---------- (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 such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: No par value Common Stock - 5,357,672 shares outstanding at November 10, 2005. Page 1 of 39 The Index to the Exhibits is located at Page 36
PART 1-FINANCIAL INFORMATION Item 1. Financial Statements. AMERICAN RIVER BANKSHARES UNAUDITED CONSOLIDATED BALANCE SHEETS (In thousands, except number of shares) September 30, December 31, 2005 2004 ------------ ------------ ASSETS Cash and due from banks $ 38,215 $ 28,115 Federal funds sold 1,100 7,000 Interest-bearing deposits in banks 5,339 5,939 Investment securities: Available-for-sale (amortized cost: 2005--$126,692; 2004--$115,161) 125,934 116,041 Held-to-maturity (market value: 2005--$46,800; 2004--$41,328) 47,026 41,203 Loans and leases, less allowance for loan and lease losses of $5,691 at September 30, 2005 and $5,496 at December 31, 2004 358,256 352,467 Premises and equipment, net 1,983 1,876 Federal Home Loan Bank Stock 2,579 2,158 Accounts receivable servicing receivables, net 2,486 2,409 Goodwill and other intangible assets 18,119 18,329 Accrued interest receivable and other assets 12,937 11,129 ------------ ------------ $ 613,974 $ 586,666 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest bearing $ 175,516 $ 143,710 Interest bearing 343,139 331,677 ------------ ------------ Total deposits 518,655 475,387 Short-term borrowed funds 18,860 24,457 Long-term debt 8,286 9,832 Accrued interest payable and other liabilities 5,961 18,000 ------------ ------------ Total liabilities 551,762 527,676 ------------ ------------ Commitments and contingencies (Note 3) Shareholders' equity: Common stock - no par value; 20,000,000 shares authorized; issued and outstanding - 5,375,872 shares at September 30, 2005 and 5,314,732 at December 31, 2004 42,336 42,557 Retained earnings 20,324 15,878 Accumulated other comprehensive (loss) income (Note 5) (448) 555 ------------ ------------ Total shareholders' equity 62,212 58,990 ------------ ------------ $ 613,974 $ 586,666 ============ ============
See notes to Unaudited Consolidated Financial Statements 2
AMERICAN RIVER BANKSHARES UNAUDITED CONSOLIDATED STATEMENT OF INCOME (In thousands, except per share data) For the periods ended September 30, Three months Nine months --------------------------- --------------------------- 2005 2004 2005 2004 ------------ ------------ ------------ ------------ Interest income: Interest and fees on loans $ 6,719 $ 4,410 $ 19,371 $ 12,999 Interest on Federal funds sold 42 17 77 23 Interest on deposits in banks 55 35 140 95 Interest and dividends on investment securities: Taxable 1,493 1,076 3,956 2,624 Exempt from Federal income taxes 245 127 678 376 Dividends 8 7 25 24 ------------ ------------ ------------ ------------ Total interest income 8,562 5,672 24,247 16,141 ------------ ------------ ------------ ------------ Interest expense: Interest on deposits 1,553 612 3,975 1,698 Interest on short-term borrowings 171 162 500 426 Interest on long-term debt 85 29 265 88 ------------ ------------ ------------ ------------ Total interest expense 1,809 803 4,740 2,212 ------------ ------------ ------------ ------------ Net interest income 6,753 4,869 19,507 13,929 Provision for loan and lease losses -- 266 272 695 ------------ ------------ ------------ ------------ Net interest income after provision for loan and lease losses 6,753 4,603 19,235 13,234 ------------ ------------ ------------ ------------ Noninterest income 594 441 1,759 1,892 ------------ ------------ ------------ ------------ Noninterest expense: Salaries and employee benefits 1,789 1,526 5,268 4,681 Occupancy 300 246 894 698 Furniture and equipment 228 189 688 556 Other expense 1,147 853 3,345 3,091 ------------ ------------ ------------ ------------ Total noninterest expense 3,464 2,814 10,195 9,026 ------------ ------------ ------------ ------------ Income before income taxes 3,883 2,230 10,799 6,100 Income taxes 1,507 891 4,182 2,174 ------------ ------------ ------------ ------------ Net income $ 2,376 $ 1,339 $ 6,617 $ 3,926 ============ ============ ============ ============ Basic earnings per share (Note 4) $ .44 $ .30 $ 1.24 $ 0.89 ============ ============ ============ ============ Diluted earnings per share (Note 4) $ .43 $ .29 $ 1.21 $ 0.85 ============ ============ ============ ============ Cash dividends per share $ .15 $ .11 $ .41 $ .33 ============ ============ ============ ============
See notes to Unaudited Consolidated Financial Statements 3
AMERICAN RIVER BANKSHARES CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (In thousands, except number of shares) (Unaudited) Accumulated Common Stock Other ----------------------- Retained Comprehensive Shareholders' Comprehensive Shares Amount Earnings Income (Loss) Equity Income --------- ---------- ---------- ---------- ---------- ---------- Balance, January 1, 2004 4,055,260 16,693 17,900 864 35,457 Comprehensive income (Note 5): Net income 5,827 5,827 $ 5,827 Other comprehensive loss, net of tax: Change in unrealized gains on available- for-sale investment securities (309) (309) (309) ---------- Total comprehensive income $ 5,518 ========== Shares issued in acquisition 775,548 18,284 18,284 Cash dividends ($0.44 per share) (2,044) (2,044) 5% stock dividend 252,392 5,805 (5,805) Stock options exercised 263,446 1,959 1,959 Retirement of common stock (31,914) (184) (184) --------- ---------- ---------- ---------- ---------- Balance, December 31, 2004 5,314,732 42,557 15,878 555 58,990 Comprehensive income (Note 5): Net income 6,617 6,617 $ 6,617 Other comprehensive loss, net of tax: Change in unrealized gains on available- for-sale investment securities (1,003) (1,003) (1,003) ---------- Total comprehensive income $ 5,614 ========== Cash dividends ($0.405 per share) (2,171) (2,171) Fractional shares redeemed (1) (16) (16) Stock options exercised 113,183 943 943 Retirement of common stock (52,042) (1,148) (1,148) --------- ---------- ---------- ---------- ---------- Balance, September 30, 2005 5,375,872 $ 42,336 $ 20,324 $ (448) $ 62,212 ========= ========== ========== ========== ==========
See Notes to Unaudited Consolidated Financial Statements 4
AMERICAN RIVER BANKSHARES UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) For the nine months ended September 30, 2005 2004 ------------ ------------ Cash flows from operating activities: Net income $ 6,617 $ 3,926 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Provision for loan and lease losses 272 695 Decrease in deferred loan origination fees, net (99) (47) Depreciation and amortization 751 408 Amortization of investment security premiums, net 868 933 Provision for accounts receivable servicing receivable losses 45 Gain on sale of securities (48) -- Gain on life insurance death benefit -- (553) Increase in cash surrender value of life insurance polices (133) (47) Increase in accrued interest receivable and other assets (1,095) (580) (Decrease) increase in accrued interest payable and other liabilities (12,263) 1,368 ------------ ------------ Net cash (used in) provided by operating activities (5,085) 6,103 ------------ ------------ Cash flows from investing activities: Proceeds from the sale of available-for-sale investment securities 6,964 -- Proceeds from matured and called available-for-sale investment investment securities 15,760 3,685 Proceeds from matured held-to-maturity investment securities -- 200 Purchases of available-for-sale investment securities (37,231) (32,230) Purchases of held-to-maturity investment securities (14,944) (21,661) Proceeds from principal repayments for available- for-sale mortgage-related securities 2,660 5,823 Proceeds from principal repayments for held-to- maturity mortgage-related securities 8,617 5,850 Net decrease (increase) in interest-bearing deposits in banks 600 (991) Net increase in loans (5,952) (6,181) Net increase in accounts receivable servicing receivables (122) (374) Death benefit from life insurance policy -- 1,236 Purchases of equipment (602) (641) Net increase in FHLB and FRB stock (421) (593) ------------ ------------ Net cash used in investing activities (24,671) (45,877) ------------ ------------
5
Cash flows from financing activities: Net increase in demand, interest-bearing and savings deposits $ 31,735 $ 58,405 Net increase (decrease) in time deposits 11,533 (5,675) Net decrease in of long-term debt (1,546) (40) Net (decrease) increase in short-term borrowings (5,597) 1,700 Payment of cash dividends (1,948) (1,581) Cash paid to repurchase common stock (1,148) (184) Cash paid for fractional shares (16) -- Exercise of stock options 943 1,591 ------------ ------------ Net cash provided by financing activities 33,956 54,216 ------------ ------------ Increase in cash and cash equivalents 4,200 14,442 Cash and cash equivalents at beginning of period 35,115 29,797 ------------ ------------ Cash and cash equivalents at end of period $ 39,315 $ 44,239 ============ ============
See notes to Unaudited Consolidated Financial Statements 6 AMERICAN RIVER BANKSHARES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS September 30, 2005 1. UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS In the opinion of management, the unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the consolidated financial position of American River Bankshares (the "Company") at September 30, 2005 and December 31, 2004, and the results of its operations for the three and nine month periods ended September 30, 2005 and 2004 and cash flows for the nine month periods ended September 30, 2005 and 2004 in conformity with accounting principles generally accepted in the United States of America. Certain disclosures normally presented in the notes to the financial statements prepared in accordance with generally accepted accounting principles have been omitted. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 2004 Annual Report to Shareholders. The results of operations for the three and nine month periods ended September 30, 2005 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 and the estimated fair value of investment securities. 2. STOCK-BASED COMPENSATION At September 30, 2005, the Company had two stock-based compensation plans. The Company accounts for these plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Under APB Opinion No. 25, stock-based compensation cost is only reflected in net income when options granted under these plans have an exercise price less than the market value of the underlying common stock on the date of grant or if the original terms are later modified. Pro forma adjustments to the Company's consolidated net earnings and earnings per share are disclosed during the years in which the options become vested. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based compensation.
Three Months Ended Nine Months Ended September 30, September 30, --------------------------- --------------------------- 2005 2004 2005 2004 ------------ ------------ ------------ ------------ (Dollars in thousands, except per share data) Net income, as reported $ 2,376 $ 1,339 $ 6,617 $ 3,926 Deduct: Total stock-based compensation expense determined under the fair value based method for all awards, net of related tax effects (21) (21) (58) (48) ------------ ------------ ------------ ------------ Pro forma net income $ 2,355 $ 1,318 $ 6,559 $ 3,878 ============ ============ ============ ============ Basic earnings per share - as reported $ 0.44 $ 0.30 $ 1.24 $ 0.89 Basic earnings per share - pro forma $ 0.44 $ 0.30 $ 1.23 $ 0.88 Diluted earnings per share - as reported $ 0.43 $ 0.29 $ 1.21 $ 0.85 Diluted earnings per share - pro forma $ 0.43 $ 0.29 $ 1.21 $ 0.85
7 The fair value of each option granted is estimated on the date of grant using an option-pricing model with the following weighted-average assumptions:
Options granted during the periods ended September 30, 2005: Three Months Nine Months ------------ ----------- Dividend yield 2.71% 2.27%-2.71% Expected life 7 years 7 years Expected volatility 80.06% 80.06%-83.15% Risk-free rate 4.08% 3.96%-4.08% Weighted average fair value of options granted during the period $6.51 $6.51-$6.80 Options granted during the periods ended September 30, 2004: Nine Months ----------- Dividend yield 2.15% Expected life 7 years Expected volatility 58.16% Risk-free rate 4.01% Weighted average fair value of options granted during the period $4.92
There were no options granted during the third quarter of 2004. 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 $130,675,000 and letters of credit of $3,203,000 at September 30, 2005. Such loans relate primarily to real estate construction loans and 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 2005 as some of these are expected to expire without being fully drawn upon. Standby letters of credit are conditional 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 material at September 30, 2005 or September 30, 2004. 4. EARNINGS PER SHARE COMPUTATION Basic earnings per share is computed by dividing net income by the weighted average common shares outstanding for the period (5,366,599 and 5,351,855 shares for the three- and nine-month periods ended September 30, 2005, and 4,456,106 and 4,408,863 shares for the three- and nine-month periods ended September 30, 2004). Diluted earnings per share reflect the potential dilution that could occur if outstanding stock options were exercised. 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 options (100,896 and 116,098 shares for the three- and nine-month periods ended September 30, 2005 and 183,827 and 212,483 shares for the three- and nine-month periods ended September 30, 2004). Earnings per share is retroactively adjusted for stock dividends and stock splits for all periods presented. 8 5. COMPREHENSIVE INCOME Comprehensive income is reported in addition to net income for all periods presented. Comprehensive income is comprised of net income plus other comprehensive income (loss). Other comprehensive income (loss), net of taxes, was comprised of the unrealized (losses) gains on available-for-sale investment securities of $(667,000) and $(1,003,000), respectively, for the three- and nine-month periods ended September 30, 2005 and $446,000 and $(226,000), respectively, for the three- and nine-month periods ended September 30, 2004. Comprehensive income was $1,709,000 and $5,614,000, respectively, for the three- and nine-month periods ended September 30, 2005 and $1,785,000 and $3,700,000, respectively, for the three- and nine-month periods ended September 30, 2004. Reclassification adjustments resulting from gain or loss on sale of investment securities were not material for all periods presented. 6. BORROWING ARRANGEMENTS The Company has a total of $48,000,000 in unsecured short-term borrowing arrangements with four of its correspondent banks. There were no advances outstanding with these correspondent banks at September 30, 2005 or December 31, 2004. In addition, the Company has a line of credit available with the Federal Home Loan Bank (the "FHLB") which is secured by pledged mortgage loans and investment securities. Borrowings may include overnight advances as well as terms of up to thirty years. Advances totaling $27,146,000 were outstanding from the FHLB at September 30, 2005, bearing interest rates ranging from 2.10% to 6.13% and maturing between October 4, 2005 and December 21, 2007. Advances totaling $34,289,000 were outstanding from the FHLB at December 31, 2004, bearing interest rates ranging from 1.29% to 6.13% and maturing between January 24, 2005 and December 21, 2007. Remaining amounts available under the borrowing arrangement with the FHLB at September 30, 2005 and December 31, 2004 totaled $16,750,000 and $16,071,000, respectively. 7. INVESTMENT SECURITIES Investment securities with unrealized losses at September 30, 2005 are summarized and classified according to the duration of the loss period as follows (dollars in thousands):
Less than 12 Months Greater than 12 Months Total ---------------------- ---------------------- ---------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Loss Value Loss Value Loss --------- --------- --------- --------- --------- --------- Available-for-Sale: U.S. Treasury securities and agencies $ 46,146 $ (471) $ 3,939 $ (92) $ 50,085 $ (563) Mortgage-backed securities 23,156 (361) 10,859 (238) 34,015 (599) Obligations of states and political subdivisions 19,421 (190) 2,177 (44) 21,598 (234) Corporate stock -- -- 233 (18) 233 (18) $ 88,723 $ (1,022) $ 17,208 $ (392) $ 105,931 $ (1,414) ========= ========= ========= ========= ========= ========= Held-to-Maturity: Mortgage-backed securities $ 32,312 $ (243) $ 4,466 $ (72) $ 36,778 $ (315) ========= ========= ========= ========= ========= =========
Management periodically evaluates each investment security relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations. Management believes it will be able to collect all amounts due according to the contractual terms of the underlying investment securities. Management believes that the noted decline in fair value is due only to interest rate fluctuations. 9 8. ACCOUNTING PRONOUNCEMENTS In December 2004, the Financial Accounting Standards Board (the "FASB") issued Statement Number 123 (revised 2004) ("SFAS 123 (R)"), Share-Based Payments. SFAS 123 (R) requires all entities to recognize compensation expense in an amount equal to the fair value of share-based payments such as stock options granted to employees. In April 2005, the Securities and Exchange Commission adopted a rule amending the effective date of SFAS 123(R) from the first reporting period after June 15, 2005 to the first fiscal year beginning after June 15, 2005, effectively January 1, 2006, for the Company. Management believes that the effect of SFAS 123 (R) will be consistent with its pro forma disclosures included in Note 2 to the Unaudited Consolidated Financial Statements in Item 1 - Financial Statements. FASB's Emerging Issues Task Force ("EITF"), reached consensus on " The Meaning of Other-Than-Temporary and Its Application to Certain Investments " in EITF Issue No. 03-1. The guidance included in the EITF consensus largely consisted of expanded disclosures and the guidance was intended to be fully effective in 2003, except for loss-recognition guidance which had a delayed effective date into 2004. In 2004, the FASB has further delayed the loss recognition provisions of Issue No. 03-1. In June 2005, the FASB announced plans to supersede the EITF guidance with a revised standard in late 2005. Because of the inconclusive status of the guidance on the loss recognition aspects of Issue No. 03-1, the Company's management is unable to speculate on the potential impact of this matter on the Company's consolidated financial statements. 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations of American River Bankshares. The following is management's discussion and analysis of the significant changes in American River Bankshares' (the "Company") balance sheet accounts for the periods ended September 30, 2005 and December 31, 2004 and its income and expense accounts for the three- and nine-month periods ended September 30, 2005 and 2004. 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 the consolidated financial statements and related notes appearing elsewhere in this report are condensed and unaudited. In addition to the historical information contained herein, this report on Form 10-Q contains certain forward-looking statements. The reader of this report should understand that all such forward-looking statements are subject to various uncertainties and risks that could affect their outcome. The Company's actual results could differ materially from those suggested by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to: 1) variances in the actual versus projected growth in assets; 2) return on assets; 3) loan and lease losses; 4) expenses; 5) changes in the interest rate environment including interest rates charged on loans, earned on securities investments and paid on deposits; 6) competition effects; 7) fee and other noninterest income earned; 8) general economic conditions nationally, regionally, and in the operating market areas of the Company and its subsidiaries; 9) changes in the regulatory environment; 10) changes in business conditions and inflation; 11) changes in securities markets; 12) data processing problems; 13) a decline in real estate values in the Company's market area; 14) the effects of terrorism, the threat of terrorism or the impact of the current military conflict in Iraq and the conduct of the war on terrorism by the United States and its allies, as well as other factors. This entire report should be read to put such forward-looking statements in context. To gain a more complete understanding of the uncertainties and risks involved in the Company's business, this report should be read in conjunction with the Company's annual report on Form 10-K for the year ended December 31, 2004 and its 2005 reports filed on Forms 10-Q and 8-K. Interest income and net interest income are presented on a fully taxable equivalent basis (FTE) within management's discussion and analysis. 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. We use historical loss data, portfolio characteristics by loan and lease type and risk rating, loan impairment, and the economic environment as factors, among others, in determining the inherent loss that may be present in our loan and lease portfolio. Actual losses could differ significantly from the estimates that we use. Other estimates that we use are related to the expected useful lives of our depreciable assets. 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) Statement of Financial Accounting Standards ("SFAS") No. 5 "Accounting for Contingencies," which requires that losses be accrued when they are probable of occurring and estimable; and (2) SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," which requires that losses be accrued based on the differences between the value of collateral, present 11 value of future cash flows or values that are observable in the secondary market and the loan balance. The allowance for loan and lease losses is determined based upon estimates that can and do change when the actual risk or loss events occur. The analysis of the allowance uses an historical loss view as one indicator of future losses and as a result could differ from the loss incurred in the future. However, since our analysis of risk and loss potential is updated regularly, the errors that might otherwise occur are mitigated. The use of estimates is inherently subjective and our actual losses could be greater or less than the estimates. The Company's goal is to maintain an allowance for loan and lease losses that is an estimate of credit losses inherent in the Company's loan portfolio and derived from the application of SFAS 5 and SFAS 114. 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 accounts for its stock-based compensation under the recognition and measurement principles of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Since the Company's stock option plan provides for the issuance of options at a price of no less than the fair market value at the date of the grant, no compensation expense is recognized in the financial statements unless the options are modified after the grant date. In January 1, 2006, the Company will be required to apply SFAS 123 (R) on a modified prospective method. Under this method, the Company is required to record compensation expense (as previous awards continue to vest) for the unvested portion of previously granted awards that remain outstanding at the date of adoption. The fair value of each option is estimated on the date of grant and amortized over the service period using an option pricing model. Critical assumptions that affect the estimated fair value of each option include expected stock price volatility, dividend yields, option life and forfeiture rates and the risk-free interest rate. 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 branches constituting a business may give rise to goodwill. Goodwill represents the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed 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. In addition, goodwill should be tested for impairment more frequently than annually if events occur that could reduce the fair value of the assets such as: a significant adverse change in legal factors or in the business climate; an adverse action or assessment by a regulator; unanticipated competition; a loss of key personnel; a more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of; the testing for recoverability under Statement 121 of a significant asset group within a reporting unit; and recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit. The Company will perform an impairment evaluation of the goodwill, recorded as a result of the Bank of Amador acquisition, in the fourth quarter of 2005. 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. 12 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) 231-6723. The Company employed an equivalent of 115 full-time employees as of September 30, 2005. The Company owns 100% of the issued and outstanding common shares of its banking subsidiary, American River Bank, and American River Financial, a California corporation which has been inactive since its incorporation in 2003. American River Bank was incorporated and commenced business in Fair Oaks, California, in 1983 and thereafter moved its headquarters office to Sacramento, California in 1985. American River Bank operates five full service offices in Sacramento and Placer Counties including the head office located at 1545 River Park Drive, Suite 107, Sacramento, and branch offices located at 520 Capitol Mall, Suite 100, Sacramento, 9750 Business Park Drive, Sacramento, 10123 Fair Oaks Boulevard, Fair Oaks and 2240 Douglas Boulevard, Roseville, and three full service offices in Sonoma County located at 412 Center Street, Healdsburg, 8733 Lakewood Drive, Windsor, and 50 Santa Rosa Avenue, Suite 100, 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 as "Bank of Amador, a division of American River Bank" within its primary service area of Amador County, in the communities of Jackson, Pioneer and Ione, located at 422 Sutter Street, Jackson, 26675 Tiger Creek Road, Pioneer, and 66 Main Street, Ione. The business combination was accounted for under the purchase method of accounting and accordingly the results of their operations have been included in the consolidated financial statements of the Company since the date of acquisition. American River Bank's deposits are insured by the Federal Deposit Insurance Corporation up to applicable legal limits. 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 most types of business equipment, from computer software to heavy earth-moving 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. 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 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 National Market under the symbol "AMRB." 13 Overview The Company recorded net income of $2,376,000 for the quarter ended September 30, 2005, which was a 77.4% increase over the $1,339,000 reported for the same period of 2004. Diluted earnings per share for the third quarter of 2005 were $0.43 compared to the $0.29 recorded in the third quarter of 2004. The return on average equity ("ROE") and the return on average assets ("ROA") for the third quarter of 2005 were 15.32% and 1.54%, respectively, as compared to 13.96% and 1.19%, respectively, for the same period in 2004. Net income for the nine months ended September 30, 2005 and 2004 was $6,617,000 and $3,926,000, respectively, with diluted earnings per share of $1.21 and $0.85, respectively. For the first nine months of 2005, ROE was 14.71% and ROA was 1.49% as compared to 14.13% and 1.24% for the same period in 2004. Total assets of the Company increased by $27,308,000 (4.7%) from December 31, 2004 to $606,052,000 at September 30, 2005. Net loans totaled $358,256,000, up $5,789,000 (1.6%) from the ending balances on December 31, 2004. Deposit balances at September 30, 2005 totaled $518,655,000, up $43,268,000 (9.1%) from December 31, 2004. The Company ended the third quarter of 2005 with a Tier 1 capital ratio of 10.5% and a total risk-based capital ratio of 11.8% versus 9.6% and 10.9%, respectively, at December 31, 2004. Table One below provides a summary of the components of net income for the periods indicated:
Table One: Components of Net Income ----------------------------------------------------------------------------------------------------- For the three For the nine months ended months ended September 30, September 30, --------------------------- --------------------------- (In thousands, except percentages) 2005 2004 2005 2004 ------------ ------------ ------------ ------------ Net interest income* $ 6,833 $ 4,913 $ 19,730 $ 14,059 Provision for loan and lease losses -- (266) (272) (695) Noninterest income 594 441 1,759 1,892 Noninterest expense (3,464) (2,814) (10,195) (9,026) Provision for income taxes (1,507) (891) (4,182) (2,174) Tax equivalent adjustment (80) (44) (223) (130) ------------ ------------ ------------ ------------ Net income $ 2,376 $ 1,339 $ 6,617 $ 3,926 ============ ============ ============ ============ ----------------------------------------------------------------------------------------------------- Average total assets $ 611,175 $ 446,772 $ 591,869 $ 421,836 Net income (annualized) as a percentage of average total assets 1.54% 1.19% 1.49% 1.24% -----------------------------------------------------------------------------------------------------
* 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 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 4.92% for the three months ended September 30, 2005, 4.78% for the three months ended September 30, 2004, 4.95% for the nine months ended September 30, 2005 and 4.85% for the nine months ended September 30, 2004. 14 The fully taxable equivalent interest income component for the third quarter of 2005 increased $2,926,000 (51.2%) to $8,642,000 compared to $5,716,000 for the three months ended September 30, 2004. Total fully taxable equivalent interest income for the nine months ended September 30, 2005 increased $8,199,000 (50.4%) to $24,470,000 compared to $16,271,000 for the nine months ended September 30, 2004. The increase in the fully taxable equivalent interest income for the third quarter of 2005 compared to the same period in 2004 is broken down by rate (up $895,000) and volume (up $2,031,000). The rate increase can be attributed to increases implemented by the Company during the latter half of 2004 and continuing through 2005 in response to Federal Reserve Board (the "FRB") increases in the Federal funds and Discount rates. The effects of eleven such rate increases by the FRB since June 2004, resulted in a 66 basis point increase in the yield on average earning assets from 5.56% for the third quarter of 2004 to 6.22% during the third quarter of 2005. The volume increase was the result of a 34.8% increase in average earning assets. Average loan balances were up $88,213,000 (32.7%) in 2005 over the balances in 2004, while average investment securities balances were up $55,002,000 (41.1%). The increase in average loans is the result of the December 2004, Bank of Amador acquisition, concentrated focus on business lending, the demand for commercial real estate and the effects of a favorable local market. The increase in investment securities is primarily due to the December 2004, Bank of Amador acquisition and the Company investing its excess funds in investment securities. The excess funds were created by an increase in deposit balances. The breakdown of the fully taxable equivalent interest income for the nine months ended September 30, 2005 over the same period in 2004 resulted from increases in volume (up $5,997,000) and increases in rate (up $2,202,000). Average earning assets increased $145,803,000 (37.7%) during the first nine months of 2005 as compared to the same period in 2004. Average loan balances increased $87,733,000 (32.5%) during that same period and average investments securities balances increased $57,619,000 (50.4%). Interest expense was $1,006,000 (125.3%) higher in the third quarter of 2005 versus the prior year period. The average balances on interest bearing liabilities were $96,823,000 (33.8%) higher in the third quarter of 2005 versus the same quarter in 2004. The higher balances accounted for a $267,000 increase in interest expense. The higher average balances in interest bearing liabilities was created by internal growth in the Company's deposits and deposits acquired from the Bank of Amador acquisition. Increased rates accounted for an additional $739,000 in interest expense for the three-month period. The increase in rates paid on interest bearing liabilities was a result of the higher interest rate environment over the past twelve months. Rates paid on interest bearing liabilities increased 75 basis points on a quarter-over-quarter basis from 1.12% to 1.87%. Interest expense was $2,528,000 (114.3%) higher in the nine-month period ended September 30, 2005 versus the prior year period. The average balances on interest bearing liabilities were $99,592,000 (36.5%) higher in the nine-month period ended September 30, 2005 versus the same period in 2004. The higher balances accounted for a $766,000 increase in interest expense. Increased rates accounted for an additional $1,762,000 in interest expense for the nine-month period. Rates paid on interest bearing liabilities increased 62 basis points on a year-over-year basis from 1.08% to 1.70%. 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. 15
Table Two: Analysis of Net Interest Margin on Earning Assets ---------------------------------------------------------------------------------------------------------------------------------- Three Months Ended September 30, 2005 2004 ---------------------------------------- ---------------------------------------- (Taxable Equivalent Basis) Avg Avg Avg Avg (In thousands, except percentages) Balance Interest Yield (4) Balance Interest Yield (4) ---------- ---------- ---------- ---------- ---------- ---------- Assets: Earning assets Loans (1) $ 357,728 $ 6,719 7.45% $ 269,515 $ 4,410 6.51% Taxable investment securities 154,876 1,493 3.82% 115,599 1,076 3.70% Tax-exempt investment securities (2) 27,078 323 4.73% 11,894 169 5.65% Corporate stock (2) 565 10 7.02% 554 9 6.46% Federal funds sold 5,070 42 3.29% 5,913 17 1.14% Investments in time deposits 6,184 55 3.53% 5,654 35 2.46% ---------- ---------- ---------- ---------- Total earning assets 551,501 8,642 6.22% 409,129 5,716 5.56% ---------- ---------- Cash & due from banks 30,075 30,219 Other assets 35,342 11,743 Allowance for loan & lease losses (5,743) (4,319) ---------- ---------- $ 611,175 $ 446,772 ========== ========== Liabilities & Shareholders' Equity Interest bearing liabilities: NOW & MMDA $ 196,324 634 1.28% $ 153,037 281 0.73% Savings 39,593 38 0.38% 25,438 14 0.22% Time deposits 116,943 881 2.99% 68,781 317 1.83% Other borrowings 30,402 256 3.34% 39,183 191 1.94% ---------- ---------- ---------- ---------- Total interest bearing liabilities 383,262 1,809 1.87% 286,439 803 1.12% ---------- ---------- Noninterest demand deposits 161,172 118,826 Other liabilities 5,200 3,352 ---------- ---------- Total liabilities 549,634 408,617 Shareholders' equity 61,541 38,155 ---------- ---------- $ 611,175 $ 446,772 ========== ========== Net interest income & margin (3) $ 6,833 4.92% $ 4,913 4.78% ========== ========== ========== ==========
(1) Loan interest includes loan fees of $240,000 and $168,000 during the three months ending September 30, 2005 and September 30, 2004, respectively. (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 the periods presented. (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 quarter (92) and annualized to actual days in year (365) for 2005 and (92) and (366) for 2004. 16
---------------------------------------------------------------------------------------------------------------------------------- Nine Months Ended September 30, 2005 2004 -------------------------------------- ---------------------------------------- (Taxable Equivalent Basis) Avg Avg Avg Avg (In thousands, except percentages) Balance Interest Yield (4) Balance Interest Yield (4) ---------- ------------ ---------- ------------ ------------ -------- Assets: Earning assets Loans (1) $ 357,642 $ 19,371 7.24% $ 269,909 $ 12,999 6.43% Taxable investment securities 140,336 3,956 3.77% 97,066 2,624 3.61% Tax-exempt investment securities (2) 25,053 895 4.78% 11,498 500 5.81% Corporate stock (2) 564 31 7.35% 568 30 7.06% Federal funds sold 3,368 77 3.06% 2,917 23 1.05% Investments in time deposits 6,022 140 3.11% 5,224 95 2.43% ---------- ------------ ------------ ------------ Total earning assets 532,985 24,470 6.14% 387,182 16,271 5.61% ------------ ------------ Cash & due from banks 29,084 27,873 Other assets 35,487 10,966 Allowance for loan & lease losses (5,687) (4,185) ---------- ------------ $ 591,869 $ 421,836 ========== ============ Liabilities & Shareholders' Equity Interest bearing liabilities: NOW & MMDA $ 186,116 1,584 1.14% $ 141,155 727 0.69% Savings 39,491 113 0.38% 22,778 34 0.20% Time deposits 111,943 2,278 2.72% 69,708 937 1.80% Other borrowings 34,553 765 2.96% 38,870 514 1.77% ---------- ------------ ------------ ------------ Total interest bearing liabilities 372,103 4,740 1.70% 272,511 2,212 1.08% ------------ ------------ Noninterest demand deposits 153,625 109,146 Other liabilities 5,984 3,070 ---------- ------------ Total liabilities 531,712 384,727 Shareholders' equity 60,157 37,109 ---------- ------------ $ 591,869 $ 421,836 ========== ============ Net interest income & margin (3) $ 19,730 4.95% $ 14,059 4.85% ============ ========== ============ ========
(1) Loan interest includes loan fees of $794,000 and $473,000 during the nine months ending September 30, 2005 and September 30, 2004, respectively. (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 the periods presented. (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 period (273) and annualized to actual days in year (365) for 2005 and (274) and (366) in 2004. 17
Table Three: Analysis of Volume and Rate Changes on Net Interest Income and Expenses ---------------------------------------------------------------------------------------------------------- Three Months Ended September 30, 2005 over 2004 (in thousands) Increase (decrease) due to change in: Interest-earning assets: Volume Rate (4) Net Change ------------ ------------ ------------ Net loans (1)(2) $ 1,447 $ 862 $ 2,309 Taxable investment securities 367 50 417 Tax exempt investment securities (3) 216 (62) 154 Corporate stock -- 1 1 Federal funds sold (2) 27 25 Investment in time deposits 3 17 20 ------------ ------------ ------------ Total 2,031 895 2,926 ------------ ------------ ------------ Interest-bearing liabilities: NOW & MMDA deposits 80 273 353 Savings deposits 8 16 24 Time deposits 222 342 564 Other borrowings (43) 108 65 ------------ ------------ ------------ Total 267 739 1,006 ------------ ------------ ------------ Interest differential $ 1,764 $ 156 $ 1,920 ============ ============ ============
---------------------------------------------------------------------------------------------------------- Nine Months Ended September 30, 2005 over 2004 (in thousands) Increase (decrease) due to change in: Interest-earning assets: Volume Rate (4) Net Change ------------ ------------ ------------ Net loans (1)(2) $ 4,221 $ 2,151 $ 6,372 Taxable investment securities 1,169 163 1,332 Tax exempt investment securities (3) 589 (194) 395 Corporate stock -- 1 1 Federal funds sold 4 50 54 Investment in time deposits 14 31 45 ------------ ------------ ------------ Total 5,997 2,202 8,199 ------------ ------------ ------------ Interest-bearing liabilities: NOW & MMDA deposits 231 626 857 Savings deposits 25 54 79 Time deposits 567 774 1,341 Other borrowings (57) 308 251 ------------ ------------ ------------ Total 766 1,762 2,528 ------------ ------------ ------------ Interest differential $ 5,231 $ 440 $ 5,671 ============ ============ ============ ----------------------------------------------------------------------------------------------------------
(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 $240,000 and $168,000 during the three months ending September 30, 2005 and June 30, 2004, respectively, and $794,000 and $473,000 during the nine months ending September 30, 2005 and September 30, 2004, respectively, 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 the periods presented. (4) The rate/volume variance has been included in the rate variance. 18 Provision for Loan and Lease Losses As a result of the Company's excellent credit quality and moderate low growth in 2005, the Company did not provide for loan and lease losses for the third quarter of 2005 as compared to $266,000 for the third quarter of 2004. Net loan and lease charge-offs for the three months ended September 30, 2005 were $46,000 or .05% (on an annualized basis) of average loans and leases as compared to $3,000 or .00% (on an annualized basis) of average loans and leases for the three months ended September 30, 2004. For the first nine months of 2005, the Company made provisions for loan and lease losses of $272,000 and net loan and lease charge-offs were $77,000 or .04% (on an annualized basis) of average loans and leases outstanding. This compares to provisions for loan and lease losses of $695,000 and net loan and lease charge-offs of $148,000 for the first nine months of 2004 or .07% (on an annualized basis) of average loans and leases outstanding. For additional information see the Allowance for Loan and Lease Losses Activity later in this section. 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 Nine Months Ended Ended September 30, September 30, --------------------------- --------------------------- 2005 2004 2005 2004 ----------------------------------------------------------------------------------------------------- Service charges on deposit accounts $ 168 $ 129 $ 509 $ 408 Accounts receivable servicing fees 82 87 262 228 Gain on sale of securities 5 -- 48 -- Merchant fee income 140 109 377 286 Income from residential lending 86 28 214 109 Bank owned life insurance 45 11 134 47 Gain on life insurance death benefit -- -- -- 553 Other 68 77 215 261 ----------------------------------------------------------------------------------------------------- Total noninterest income $ 594 $ 441 $ 1,759 $ 1,892 -----------------------------------------------------------------------------------------------------
Noninterest income was up $153,000 (34.7%) to $594,000 for the three months ended September 30, 2005 as compared to $441,000 for the three months ended September 30, 2004. The primary traditional sources of noninterest income for the Company are service charges on deposit accounts, accounts receivable servicing fees, merchant credit card fees and income from residential lending. The increase in noninterest income for the quarter can be attributed to increases in fees from services charges (up $39,000 or 30.2%), an increase in merchant fee income (up $31,000 or 28.4%), and an increase in income from residential lending (up $28,000 or 207.1%). The increase in service charges results from a larger number of accounts, due in part to the acquisition of Bank of Amador in December 2004. The increase in income from residential lending results from additional business in the residential lending area, due in part to the acquisition of Bank of Amador in December 2004. For the nine months ended September 30, 2005, noninterest income was down $133,000 (7.0%) to $1,759,000. The September 30, 2004 period included the tax-free net proceeds from a life insurance policy ($553,000) that the Company received, in June of 2004, as a result of the death of a former executive officer. Without the life insurance proceeds, noninterest income would have shown an increase of $420,000. This increase in noninterest income for the first nine months of 2005 can be attributed to increases in fees from services charges (up $101,000 or 24.8%), an increase in merchant fee income (up $91,000 or 31.8%), and an increase in income from residential lending (up $105,000 or 96.3%). 19 Noninterest Expense Noninterest expenses increased $650,000 (23.1%) to a total of $3,464,000 in the third quarter of 2005 versus the third quarter of 2004. Salary and employee benefits, which include commissions, increased $263,000 (17.2%) from $1,526,000 during the third quarter of 2004 to $1,789,000 during the third quarter of 2005 mainly as a result of expenses related to the new employees retained in the December 2004 Bank of Amador acquisition. At September 30, 2005, the Company and its subsidiaries employed 115 persons on a full-time equivalent basis as compared to 96 at September 30, 2004. The salaries, employee benefits, and taxes component increased $424,000, primarily as a result of the increase in number of employees. These increases were offset by higher loan origination costs of $211,000. The loan origination costs are derived from recording new loans and are recorded as a reduction to compensation expense. The increase in the third quarter of 2005 is attributed to originating a higher number of loans in 2005 as compared to 2004. On a quarter-over-quarter basis, occupancy increased $54,000 (22.0%) and furniture and equipment increased $39,000 (20.6%). The increase in occupancy and furniture and equipment is related to the three new facilities acquired in the Bank of Amador acquisition. Other expense increased $294,000 (34.5%) to a total of $1,147,000 in the third quarter of 2005 versus $853,000 in the third quarter of 2004. Included in other expenses are professional fees (up $88,000 or 62.4%), item processing (up $22,000 or 23.2%), and the amortization of the core deposit premium related to the Bank of Amador acquisition (up $89,000 from zero). Professional fees, which includes accounting, legal and other professional services, was up primarily due to retainer fees paid to a deposit gathering relationship established in 2004 and higher fees for compliance with SEC rules as well as general corporate matters. The increase in item processing is due mainly to the new relationships acquired in the Bank of Amador acquisition. The efficiency ratios (fully taxable equivalent), excluding the amortization of intangible assets, for the 2005 and 2004 third quarters were 45.4% and 52.6%, respectively. Noninterest expense for the nine-month period ended September 30, 2005 was $10,195,000 versus $9,026,000 for the same period in 2004 for an increase of $1,169,000 (13.0%). Salaries and benefits increased $587,000 (12.5%) in 2005 as compared to 2004. The increase relates to new employees retained in the December 2004, Bank of Amador acquisition. Occupancy increased $196,000 (28.1%) and furniture and equipment increased $132,000 (23.7%). The increase in occupancy and furniture and equipment is related to the three new facilities acquired in the Bank of Amador acquisition and three full quarters of expense related to the branch office in downtown Sacramento, which opened during the last part of the first quarter in 2004. The new locations contributed $157,000 to the increased occupancy expense and $131,000 to the increased furniture and equipment expense. Other expense increased $254,000 (8.2%). Included in other expenses are professional fees (up $193,000 or 52.3%), item processing (up $75,000 or 25.9%), and the amortization of the core deposit premium related to the Bank of Amador acquisition (up $266,000 from zero). The overhead efficiency ratio (fully taxable equivalent), excluding the amortization of intangible assets, for the first nine months of 2005 was 47.4% as compared to 56.6% in the same period of 2004. Provision for Income Taxes The effective tax rate for the third quarter and first nine months of 2005 was 38.8% and 38.7%, respectively, versus 40.0% and 35.6%, respectively, for the same two periods of 2004. The increase in the year-to-date effective tax rate for 2005 is related to the 2004 receipt of the tax-free life insurance proceeds referenced above. 20 Balance Sheet Analysis The Company's total assets were $613,974,000 at September 30, 2005 as compared to $586,666,000 at December 31, 2004, representing an increase of 4.7%. The average balances of total assets for the nine months ended September 30, 2005 was $591,869,000 which represents an increase of $170,033,000 or 40.3% over the $421,836,000 during the nine-month period ended September 30, 2004. Total average assets for the third quarter of 2005 were $611,175,000 compared to $446,772,000 during the third quarter of 2004 for an increase of 36.8%. 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. At September 30, 2005, these categories accounted for approximately 19%, 44%, 1%, 26%, 2%, 2%, 3% and 3%, respectively, of the Company's loan portfolio. This mix was relatively unchanged compared to 19%, 46%, 1%, 25%, 1%, 3%, 2% and 3% at December 31, 2004. Continuing economic activity in the Company's market area, new borrowers developed through the Company's marketing efforts and credit extensions expanded to existing borrowers, were offset by higher than normal loan paydowns and payoffs. The loan activity during the period resulted in net increases in balances for commercial loans ($3,543,000 or 5.3%), multi-family real estate ($1,142,000 or 42.9%), real estate construction ($5,408,000 or 6.0%), agriculture ($415,000 or 5.0%), and consumer ($2,459,000 or 26.1%). Despite the increased loan activity and the new borrowers, the Company experienced decreases in commercial real estate ($4,827,000 or 2.9%), residential real estate ($70,000 or 1.3%), and lease financing receivable ($2,185,000 or 21.9%) as a result of normal paydowns and higher than normal loan payoffs. Table Five below summarizes the composition of the loan portfolio as of September 30, 2005 and December 31, 2004. Table Five: Loan and Lease Portfolio Composition ----------------------------------------------------------------------- September 30, December 31, (In thousands) 2005 2004 ----------------------------------------------------------------------- Commercial $ 70,407 $ 66,864 Real estate: Commercial 161,436 166,263 Multi-family 3,802 2,660 Construction 95,570 90,162 Residential 5,166 5,236 Lease financing receivable 7,809 9,994 Agriculture 8,667 8,252 Consumer 11,876 9,417 ----------------------------------------------------------------------- Total loans and leases 364,733 358,848 Deferred loan and lease fees, net (786) (885) Allowance for loan and lease losses (5,691) (5,496) ----------------------------------------------------------------------- Total net loans and leases $ 358,256 $ 352,467 ======================================================================= 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 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 home equity lines of credit, personal 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 21 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 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; however, American River Bank has a residential lending division to assist customers in securing most forms of longer term single-family mortgage financing. American River Bank acts as a broker between American River Bank's customers and the loan wholesalers. American River Bank receives an origination fee for loans closed. 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, 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 may influence credit quality. American River Bank's business is focused in the Sacramento Metropolitan Statistical Area, which is a diversified economy, but with a large State of California government presence and employment base. American River Bank operates in Sonoma County, through North Coast Bank, a division of American River Bank, whose business is focused on businesses within the three communities in which it has offices (Santa Rosa, Windsor, and Healdsburg) 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) as well as a diversified residential construction loan business in numerous Northern California counties. 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 rate and terms, absorption and sale rates; real estate values and rates of return; operating expenses; inflation; 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 75.1% of the Company's loan and lease portfolio at September 30, 2005. Although management believes this concentration to have no more than the normal risk of collectability, a substantial decline in 22 the economy in general, or a decline in real estate values in the Company's primary market areas in particular, could have an adverse impact on the collectability of these loans and require an increase in the provision for loan and lease losses which could adversely affect the Company's future prospects, results of operations, profitability and stock price. Management believes that its lending policies and underwriting standards will tend to minimize losses in an economic downturn, however, there is no assurance that losses will not occur under such circumstances. The Company's loan policies 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. Nonaccrual, Past Due and Restructured Loans and Leases Management generally places loans and leases on nonaccrual status when they become 90 days past due, unless the loan or lease is well secured and in the process of collection. Loans and leases are charged off when, in the opinion of management, collection appears unlikely. At September 30, 2005, non-performing loans and leases were 0.05% of total loans and leases, compared to 0.07% as of December 31, 2004. The recorded investments in loans that were considered to be impaired totaled $183,000 at September 30, 2005 and $247,000 at December 31, 2004. There were no loan concentrations in excess of 10% of total loans not otherwise disclosed as a category of loans as of September 30, 2005 or December 31, 2004. Management is not aware of any potential problem loans which were accruing and current at September 30, 2005, where serious doubt exists as to the ability of the borrower to comply with the present repayment terms or that would result in a material loss to the Company. Table Six below sets forth nonaccrual loans and loans past due 90 days or more as of September 30, 2005 and December 31, 2004. Table Six: Non-Performing Loans --------------------------------------------------------------------------- September 30, December 31, (In thousands) 2005 2004 ----------------------------------------------------------------------- Past Due 90 days or more and still accruing: Commercial $ -- $ -- Real estate -- -- Lease financing receivable -- 11 Consumer and other 57 -- ----------------------------------------------------------------------- Nonaccrual: Commercial -- 52 Real estate 15 113 Lease financing receivable 111 71 Consumer and other -- -- ----------------------------------------------------------------------- Total non-performing loans $ 183 $ 247 ======================================================================= 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 magnitude 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. 23 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) borrowers' financial condition, (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 $5,691,000 or 1.56% of total loans and leases at September 30, 2005 and $5,496,000 or 1.54% of total loans and leases at December 31, 2004. Table Seven below summarizes, for the periods indicated, the activity in the allowance for loan and lease losses.
Table Seven: Allowance for Loan and Lease Losses --------------------------------------------------------------------------------------------------------------- Three Months Nine Months (In thousands, except for percentages) Ended Ended September 30, September 30, --------------------------- --------------------------- 2005 2004 2005 2004 --------------------------------------------------------------------------------------------------------------- Average loans and leases outstanding $ 357,728 $ 269,515 $ 357,642 $ 269,909 --------------------------------------------------------------------------------------------------------------- Allowance for possible loan and lease losses at beginning of period $ 5,737 $ 4,233 $ 5,496 $ 3,949 Loans and leases charged off: Commercial (3) -- (55) -- Real estate -- -- -- -- Lease financing receivable (48) (6) (87) (207) Consumer -- -- -- (1) --------------------------------------------------------------------------------------------------------------- Total (51) (6) (142) (208) --------------------------------------------------------------------------------------------------------------- Recoveries of loans and leases previously Charged off: Commercial -- -- 8 57 Real estate -- -- -- -- Lease financing receivable 5 3 55 3 Consumer -- -- 2 -- --------------------------------------------------------------------------------------------------------------- Total 5 3 65 60 --------------------------------------------------------------------------------------------------------------- Net loans recovered (charged off) (46) (3) (77) (148) Additions to allowance charged to operating expenses -- 266 272 695 --------------------------------------------------------------------------------------------------------------- Allowance for possible loan and lease losses at end of period $ 5,691 $ 4,496 $ 5,691 $ 4,496 --------------------------------------------------------------------------------------------------------------- Ratio of net (recoveries) charge-offs to average loans and leases outstanding (annualized) .05% .00% .04% .07% Provision of allowance for possible loan and lease losses to average loans and leases outstanding (annualized) .00% .39% .15% .34% Allowance for possible loan and lease losses to loans and leases net of deferred fees at end of period 1.56% 1.65% 1.56% 1.65%
24 It is the policy of management to maintain the allowance for loan and lease losses at a level 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. The Company establishes general reserves in accordance with Statement of Financial Accounting Standards ("SFAS") No. 5., Accounting for Contingencies, and specific reserves in accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan. 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 probable 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 adequacy of the ALLL is determined based on three components. First is the dollar weighted risk rating of the loan portfolio, including all outstanding loans and leases. Every extension of credit has been assigned a risk rating based upon a comprehensive definition intended to measure the inherent risk of lending money. Each rating has an assigned risk factor expressed as a reserve percentage. Second, established specific reserves consistent with SFAS No. 114 "Accounting by Creditors for Impairment of a Loan" are assigned to individually impaired loans. These are estimated potential losses associated with specific borrowers based upon estimated cash flows or collateral value and events affecting the risk rating. Third, the Company maintains a reserve for qualitative factors that may affect the portfolio as a whole, such as those factors described above, including management's adjustments, up or down, based on internal and external risk factors at the financial statement date consistent with SFAS No. 5 "Accounting for Contingencies". Other Real Estate At September 30, 2005 and December 31, 2004, the Company did not have any other real estate ("ORE") properties. Deposits At September 30, 2005, total deposits were $518,655,000 representing an increase of $43,268,000 (9.1%) from the December 31, 2004 balance of $475,387,000. Noninterest-bearing deposits increased $31,806,000 (22.1%) while interest-bearing deposits increased $11,462,000 (3.5%). Interest checking, money market and savings accounts decreased $41,000 while time deposits increased $11,533,000 (10.8%). 25
Other Borrowed Funds Other borrowings outstanding as of September 30, 2005 and December 31, 2004, consist of advances (both long-term and short-term) from the FHLB. The following table summarizes these borrowings (in thousands): September 30, 2005 December 31, 2004 ---------------------------- --------------------------- Amount Rate Amount Rate ------------------------------------------------------------------------------------------- Short-Term borrowings: FHLB advances $ 18,860 3.63% $ 24,457 1.85% Advances from correspondent banks -- -- -- -- ---------------------------------------------------------- Total Short-Term borrowings $ 18,860 3.63% $ 24,457 1.85% ---------------------------------------------------------- Long-Term Borrowings: FHLB advances $ 8,286 3.93% $ 9,832 3.15% ----------------------------------------------------------
The maximum amount of short-term borrowings at any month-end during the first nine months of 2005 and 2004 was $32,857,000 and $40,855,000, respectively. The FHLB advances are collateralized by loans and securities pledged to the FHLB. The following is a breakdown of rates and maturities on FHLB advances (dollars in thousands): Short Term Long Term Amount $ 18,860 $ 8,286 Maturity 2005 to 2006 2006 to 2007 Average rates 3.63% 3.93% The Company has also been issued a total of $1,500,000 in letters of credit by the FHLB which have been pledged to secure Local Agency Deposits. The letters of credit act as a guarantee of payment to certain third parties in accordance with specified terms and conditions. The letters of credit were not drawn upon in 2005 or 2004 and management does not expect to draw upon these lines in the future. Capital Resources The current and projected capital position of the Company and the impact of capital plans and long-term strategies is reviewed regularly by management. The Company's capital position represents the level of capital available to support continuing operations and expansion. The Company and American River Bank are subject to certain regulations issued by the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, which require maintenance of certain levels of capital. Failure to meet these minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, American River Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's and American River Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. At September 30, 2005, shareholders' equity was $62,212,000, representing an increase of $3,222,000 (5.5%) from $58,990,000 at December 31, 2004. The ratio of total risk-based capital to risk adjusted assets was 11.8% at September 30, 2005 compared to 10.9% at December 31, 2004. Tier 1 risk-based capital to risk-adjusted assets was 10.5% at September 30, 2005 and 9.6% at December 31, 2004. 26 Table Eight below lists the Company's actual capital ratios at September 30, 2005 and December 31, 2004 as well as the minimum capital ratios for capital adequacy. Table Eight: Capital Ratios -------------------------------------------------------------------------------- Capital to Risk-Adjusted At At Minimum Regulatory Assets September 30, December 31, Capital 2005 2004 Requirements -------------------------------------------------------------------------------- Leverage ratio 7.5% 8.4% 4.00% Tier 1 Risk-Based Capital 10.5% 9.6% 4.00% Total Risk-Based Capital 11.8% 10.9% 8.00% The Company, through a Board of Director's authorized plan, may repurchase, as conditions warrant, up to 5% annually of the Company's common stock. Repurchases are generally made in the open market at market prices. (See Part II, Item 2, for additional disclosure). Capital ratios are reviewed on a regular basis to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet future needs. Management believes that both the Company and American River Bank met all their capital adequacy requirements as of September 30, 2005 and December 31, 2004. Off-Balance Sheet Items The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business in order to meet the financing needs of its customers and to reduce its exposure to fluctuations in interest rates. These financial instruments consist of commitments to extend credit and letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized on the balance sheet. The Company's exposure to credit loss in the event of nonperformance by the other party for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company applies the same credit policies to commitments and letters of credit as it does for loans included on the consolidated balance sheet. As of September 30, 2005 and December 31, 2004, commitments to extend credit and standby letters of credit were the only financial instruments with off-balance sheet risk. The Company has not entered into any contracts for financial derivative instruments such as futures, swaps, options or similar instruments. Loan commitments and standby letters of credit were $133,878,000 and $128,201,000 at September 30, 2005 and December 31, 2004, respectively. As a percentage of net loans and leases these off-balance sheet items represent 38.7% and 36.4%, respectively. The Company has certain ongoing commitments under operating leases. These commitments do not significantly impact operating results. Certain financial institutions have elected to use special purpose vehicles ("SPV") to dispose of problem assets. The SPV is typically a subsidiary company with an asset and liability structure and legal status that makes its obligations secure even if the parent corporation goes bankrupt. Under certain circumstances, these financial institutions may exclude the problem assets from their reported impaired and non-performing assets. The Company does not use these vehicles or any other structures to dispose of problem assets. Other Matters Effects of Terrorism. The terrorist actions on September 11, 2001 and thereafter and the current military conflict in Iraq have had significant adverse effects upon the United States economy. Whether the terrorist activities in the future and the actions of the United States and its allies in combating terrorism on a worldwide basis will adversely impact the Company and the extent of such impact is uncertain. Such economic deterioration could adversely affect 27 the Company's future results of operations by, among other matters, reducing the demand for loans and other products and services offered by the Company, increasing nonperforming loans and the amounts reserved for loan and lease losses, and causing a decline in the Company's stock price. Website Access. American River Bankshares maintains a website where certain information about the Company is posted. Through the website, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments thereto, as well as Section 16 Reports and amendments thereto, are available as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (the "SEC"). These reports are free of charge and can be accessed through the address www.amrb.com by clicking on the SEC Filings link located at that address. Once you have selected the SEC Filings link you will have the option to access the Section 16 Reports or the Reports filed by the Company by selecting the appropriate link. Item 3. Quantitative and Qualitative Disclosures About Market Risk. Market Risk Management Overview. Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises primarily from interest rate risk inherent in its loan, investment and deposit functions. The goal for managing the assets and liabilities of the Company is to maximize shareholder value and earnings while maintaining a high quality balance sheet without exposing the Company to undue interest rate risk. The Board of Directors has overall responsibility for the interest rate risk management policies. The Company has a Risk Management Committee, made up of Company management that establishes and monitors guidelines to control the sensitivity of earnings to changes in interest rates. Asset/Liability Management. Activities involved in asset/liability management include but are not limited to lending, accepting and placing deposits and investing in securities. Interest rate risk is the primary market risk associated with asset/liability management. Sensitivity of earnings to interest rate changes arises when yields on assets change in a different time period or in a different amount from that of interest costs on liabilities. To mitigate interest rate risk, the structure of the balance sheet is managed with the goal that movements of interest rates on assets and liabilities are correlated and contribute to earnings even in periods of volatile interest rates. The asset/liability management policy sets limits on the acceptable amount of variance in net interest margin and market value of equity under changing interest environments. The Company uses simulation models to forecast earnings, net interest margin and market value of equity. Simulation of earnings is the primary tool used to measure the sensitivity of earnings to interest rate changes. Using computer-modeling techniques, the Company is able to estimate the potential impact of changing interest rates on earnings. A balance sheet forecast is prepared quarterly using inputs of actual loans, securities and interest bearing liabilities (i.e. deposits/borrowings) positions as the beginning base. The forecast balance sheet is processed against three interest rate scenarios. The scenarios include a 200 basis point rising rate forecast, a flat rate forecast and a 200 basis point falling rate forecast which take place within a one year time frame. The net interest income is measured during the year assuming a gradual change in rates over the twelve-month horizon. The simulation modeling indicated below attempts to estimate changes in the Company's net interest income utilizing a forecast balance sheet projected from the end of period balances. Table Nine below summarizes the effect on net interest income (NII) of a +/-200 basis point change in interest rates as measured against a constant rate (no change) scenario. 28
Table Nine: Interest Rate Risk Simulation of Net Interest as of September 30, 2005 and December 31, 2004 ----------------------------------------------------------------------------------------- (In thousands) $ Change in NII $ Change in NII from Current from Current 12 Month Horizon 12 Month Horizon September 30, 2005 December 31, 2004 -------------------- -------------------- Variation from a constant rate scenario +200bp $ 939 $ 673 - 200bp $ (1,459) $ (466)
The simulations of earnings do not incorporate any management actions, which might moderate the negative consequences of interest rate deviations. Therefore, they do not reflect likely actual results, but serve as reasonable estimates of interest rate risk. Inflation The impact of inflation on a financial institution differs significantly from that exerted on manufacturing, or other commercial concerns, primarily because its assets and liabilities are largely monetary. In general, inflation primarily affects the Company and it subsidiaries through its effect on market rates of interest, which affects the Company's ability to attract loan customers. Inflation affects the growth of total assets by increasing the level of loan demand, and potentially adversely affects capital adequacy because loan growth in inflationary periods can increase at rates higher than the rate that capital grows through retention of earnings which may be generated in the future. In addition to its effects on interest rates, inflation increases overall operating expenses. Inflation has not had a material effect upon the results of operations of the Company and its subsidiaries during the periods ended September 30, 2005 and 2004. Liquidity Liquidity management refers to the Company's ability to provide funds on an ongoing basis to meet fluctuations in deposit levels as well as the credit needs and requirements of its clients. Both assets and liabilities contribute to the Company's liquidity position. Federal funds lines, short-term investments and securities, and loan repayments contribute to liquidity, along with deposit increases, while loan funding and deposit withdrawals decrease liquidity. The Company assesses the likelihood of projected funding requirements by reviewing historical funding patterns, current and forecasted economic conditions and individual client funding needs. Commitments to fund loans and outstanding letters of credit at September 30, 2005 and December 31, 2004 were approximately $130,675,000 and $3,203,000 and $125,413,000 and $2,788,000, respectively. Approximately $56,847,000 of the loan commitments outstanding at September 30, 2005 are for real estate construction loans and are expected to fund within the next twelve months. The remaining commitments primarily relate to revolving lines of credit or other commercial loans, and many of these are expected to expire without being fully drawn upon. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company's sources of liquidity consist of cash and due from correspondent banks, overnight funds sold to correspondent banks, unpledged marketable investments and loans held for sale and/or pledged for secured borrowings. On September 30, 2005, consolidated liquid assets totaled $110.5 million or 18.0% of total assets compared to $96.4 million or 16.4% of total assets on December 31, 2004. In addition to liquid assets, the Company maintains short-term lines of credit in the amount of $48,000,000 with correspondent banks. At September 30, 2005, the Company had $48,000,000 available under these credit lines. Additionally, American River Bank is member of the Federal Home Loan Bank (the "FHLB"). At September 30, 2005, American River Bank could have arranged for up to $45,395,000 in secured borrowings from the FHLB. These borrowings are secured by pledged mortgage loans and investment securities. At September 30, 2005, the Company had advances, borrowings and commitments outstanding of $28,645,000, leaving $16,750,000 available under these secured 29 borrowing arrangements. American River Bank also has informal agreements with various other banks to sell participations in loans, if necessary. The Company serves primarily a business and professional customer base and, as such, its deposit base is susceptible to economic fluctuations. Accordingly, management strives to maintain a balanced position of liquid assets to volatile and cyclical deposits. Liquidity is also affected by portfolio maturities and the effect of interest rate fluctuations on the marketability of both assets and liabilities. The Company can sell any of its unpledged securities held in the available-for-sale category to meet liquidity needs. These securities are also available to pledge as collateral for borrowings if the need should arise. American River Bank has established a master repurchase agreement with a correspondent bank to enable such transactions. American River Bank can also pledge securities to borrow from the FRB and the FHLB. The principal cash requirements of the Company are for expenses incurred in the support of administration and operations. For nonbanking functions, the Company is dependent upon the payment of cash dividends from American River Bank to service its commitments. The Company expects that the cash dividends paid by American River Bank to the Company will be sufficient to meet this payment schedule. Item 4. Controls and Procedures. (a) Disclosure Controls and Procedures: An evaluation of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and other members of the Company's senior management as of the end of the period covered by this quarterly report on Form 10-Q. The Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) to allow timely decisions regarding required disclosure, and (ii) recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms. (b) Internal Control Over Financial Reporting: An evaluation of any changes in the Company's internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)), that occurred during the Company's fiscal quarter ended September 30, 2005, was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and other members of the Company's senior management. The Company's Chief Executive Officer and Chief Financial Officer concluded that no change identified in connection with such evaluation has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 30 PART II - OTHER INFORMATION Item 1. Legal Proceedings. None. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
------------------------------------------------------------------------------------ Period (a) (b) (c) (d) Total Average Total Number of Maximum Number (or Number of Price Paid Shares (or Approximate Dollar Shares (or Per Share Units) Purchased Value) of Shares (or Units) (or Unit) as Part of Units) That May Yet Purchased Publicly Be Purchased Under Announced Plans the Plans or Programs or Programs ------------------------------------------------------------------------------------ Month #1 July 1 through None N/A None 228,123 shares July 31, 2005 Month #2 August 1 None N/A None 228,123 shares through August 31, 2005 Month #3 September 1 None N/A None 228,123 shares through September 30, 2005 ------------------------------------------------------------------------------------ Total - - ------------------------------------------------------------------------------------
On September 20, 2001, the Board of Directors of the Company authorized a stock repurchase program which calls for the repurchase of up to five percent (5%) annually of the Company's outstanding shares of common stock. Each year the Company may repurchase up to 5% of the shares outstanding (adjusted for stock splits or stock dividends). The repurchases are to be made from time to time in the open market as conditions allow and will be structured to comply with Commission Rule 10b-18. Management reports monthly to the Board of Directors on the status of the repurchase program. The Board of Directors has reserved the right to suspend, terminate, modify or cancel this repurchase program at any time for any reason. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. None. Item 5. Other Information. None Item 6. Exhibits. Exhibit Number Document Description ------ -------------------- (2.1) Agreement and Plan of Reorganization and Merger by and among the Registrant, ARH Interim National Bank and North Coast Bank, N.A., dated as of March 1, 2000 (included as Annex A). ** 31 (2.2) Agreement and Plan of Reorganization and Merger by and among the Registrant, American River Bank and Bank of Amador, dated as of July 8, 2004 (included as Annex A). *** (3.1) Articles of Incorporation, as amended, incorporated by reference from Exhibit 3.1 to the Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 2004, filed with the Commission on August 11, 2004. (3.2) Bylaws, as amended, incorporated by reference from Exhibit 3.2 to the Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 2004, filed with the Commission on August 11, 2004. (4.1) Specimen of the Registrant's common stock certificate, incorporated by reference from Exhibit 4.1 to the Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 2004, filed with the Commission on August 11, 2004. (10.1) Lease agreement between American River Bank and Spieker Properties, L.P., a California limited partnership, dated April 1, 2000, related to 1545 River Park Drive, Suite 107, Sacramento, California. ** (10.2) Lease agreement and addendum between American River Bank and Bradshaw Plaza Group each dated January 31, 2000, related to 9750 Business Park Drive, Sacramento, California. ** (10.3) Lease agreement between American River Bank and Marjorie G. Taylor dated April 5, 1984, and addendum dated July 16, 1997, related to 10123 Fair Oaks Boulevard, Fair Oaks, California. ** (10.4) Lease agreement between American River Bank and Sandalwood Land Company dated August 28, 1996, related to 2240 Douglas Boulevard, Suite 100, Roseville, California. ** *(10.5) Registrant's 1995 Stock Option Plan. ** *(10.6) Form of Nonqualified Stock Option Agreement under the 1995 Stock Option Plan. ** *(10.7) Form of Incentive Stock Option Agreement under the 1995 Stock Option Plan. ** *(10.8) Registrant's Stock Option Gross-Up Plan and Agreement, as amended, dated May 20, 1998. ** *(10.9) Registrant's Deferred Compensation Plan dated May 1, 1998. ** *(10.10) Registrant's Deferred Fee Plan dated April 1, 1998. ** *(10.11) American River Bank Employee Severance Policy dated March 18, 1998. ** *(10.12) Registrant's Incentive Compensation Plan for the Year Ended December 31, 2000, incorporated by reference from Exhibit 10.20 to the Registrant's Quarterly Report on Form 10-Q for the period ended September 30, 2000, filed with the Commission on November 14, 2000. *(10.13) First Amendment dated December 20, 2000, to the Registrant's Deferred Compensation Plan dated May 1, 1998, incorporated by reference from Exhibit 10.22 to the Registrant's Annual Report on Form 10-K for the period ended December 31, 2000, filed with the Commission on April 2, 2001. 32 *(10.14) Amendment No. 1 to the Registrant's Incentive Compensation Plan, incorporated by reference from Exhibit 10.23 to the Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 2001, filed with the Commission on August 14, 2001. (10.15) Lease agreement and addendum between North Coast Bank, N.A. and Rosario LLC, each dated September 1, 1998, related to 50 Santa Rosa Avenue, Santa Rosa, California. ** (10.16) Lease agreement between American River Bank and 520 Capitol Mall, Inc., dated August 19, 2003, related to 520 Capitol Mall, Suite 100, Sacramento, California, incorporated by reference from Exhibit 10.29 to the Registrant's Form 10-Q for the period ended September 30, 2003, filed with the Commission on November 7, 2003. *(10.17) Employment Agreement between Registrant and David T. Taber dated August 22, 2003, incorporated by reference from Exhibit 10.30 to the Registrant's Form 10-Q for the period ended September 30, 2003, filed with the Commission on November 7, 2003. (10.18) Lease agreement between R & R Partners, a California General Partnership and North Coast Bank, N.A., dated July 1, 2003, related to 8733 Lakewood Drive, Suite A, Windsor, California, incorporated by reference from Exhibit 10.32 to the Company's Form 10-Q for the period ended September 30, 2003, filed with the Commission on November 7, 2003. *(10.19) Salary Continuation Agreement between American River Bank and Mitchell A. Derenzo dated August 22, 2003, incorporated by reference from Exhibit 10.33 to the Company's Form 10-Q for the period ended September 30, 2003, filed with the Commission on November 7, 2003. *(10.20) Salary Continuation Agreement between the Registrant and David T. Taber dated August 22, 2003, incorporated by reference from Exhibit 10.34 to the Company's Form 10-Q for the period ended September 30, 2003, filed with the Commission on November 7, 2003. *(10.21) Salary Continuation Agreement between American River Bank and Douglas E. Tow dated August 22, 2003, incorporated by reference from Exhibit 10.35 to the Company's Form 10-Q for the period ended September 30, 2003, filed with the Commission on November 7, 2003. *(10.22) Registrant's 2000 Stock Option Plan with forms of Nonqualified Stock Option Agreement and Incentive Stock Option Agreement. ** (10.23) First Amendment dated April 21, 2004, to the lease agreement between American River Bank and 520 Capitol Mall, Inc. dated August 19, 2003, related to 520 Capitol Mall, Suite 100 Sacramento, California, incorporated by reference from Exhibit 10.37 to the Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 2004, filed with the Commission on August 11, 2004. *(10.24) Registrant's 401(k) Plan dated September 20, 2004, incorporated by reference from Exhibit 10.38 to the Registrant's Quarterly Report on Form 10-Q for the period ended September 30, 2004, filed with the Commission on November 12, 2004. (10.25) Agreement between Bank of Amador and the United States Postal Service, dated April 24, 2001, related to 424 Sutter Street, Jackson, California. *** 33 (10.26) Ground lease agreement between Bank of Amador and the James B. Newman and Helen M. Newman, dated June 1, 1992, related to 26675 Tiger Creek Road, Pioneer, California. *** *(10.27) Salary Continuation Agreement between Bank of Amador and Larry D. Standing dated April 1, 2004, and related Endorsement Split Dollar Agreement dated April 1, 2004. *** *(10.28) Amended and Restated Director Retirement Agreement dated as of August 1, 2003, between Bank of Amador and Larry D. Standing. *** *(10.29) Employment Agreement between Registrant and Larry D. Standing dated December 3, 2004. *** (10.30) Item Processing Agreement between American River Bank and Fidelity Information Services, Inc., dated April 22, 2005, incorporated by reference from Exhibit 99.1 to the Registrant's Report on Form 8-K, filed with the Commission on April 27, 2005. (10.31) Lease agreement between Registrant and One Capital Center, a California limited partnership, dated May 17, 2005, related to 3100 Zinfandel Drive, Rancho Cordova, California, incorporated by reference from Exhibit 99.1 to the Registrant's Report on Form 8-K, filed with the Commission on May 18, 2005. (10.32) Managed Services Agreement between American River Bankshares and ProNet Solutions, Inc., dated September 8, 2005, incorporated by reference from Exhibit 99.1 to the Registrant's Report on Form 8-K, filed with the Commission on September 9, 2005. (14.1) Registrant's Code of Ethics, incorporated by reference from Exhibit 14.1 to the Registrant's Annual Report on Form 10-K for the period ended December 31, 2003, filed with the Commission on March 19, 2004. (21.1) The Registrant's only subsidiaries are American River Bank and American River Financial. (31.1) Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (31.2) Certifications of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (32.1) Certification of Registrant by its Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * Denotes management contracts, compensatory plans or arrangements. ** Incorporated by reference to Registrant's Registration Statement on Form S-4 (No. 333-36326) filed with the Commission on May 5, 2000. *** Incorporated by reference to Registrant's Registration Statement on Form S-4 (No. 333-119085) filed with the Commission on September 17, 2004. 34 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. AMERICAN RIVER BANKSHARES November 10, 2005 By: /s/ DAVID T. TABER ------------------------------------- David T. Taber President and Chief Executive Officer November 10, 2005 By: /s/ MITCHELL A. DERENZO ------------------------------------- Mitchell A. Derenzo Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) 35 EXHIBIT INDEX Exhibit Number Description Page -------------------------------------------------------------------------------- 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 37 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 38 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. 39 36