10-K 1 arb_10k16.htm FORM 10-K
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

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

 

For the fiscal year ended December 31, 2016

or

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

For the transition period from     to   

Commission File 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 Identification No.)
incorporation or organization    

 

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

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

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class   Name of Each Exchange On Which Registered
Common Stock, no par value   NASDAQ Global Select Market

 

Securities registered pursuant to Section 12(g) of the Act:

None

 Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o No x

 Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes o No x

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

Yes x No o

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

Yes x No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $60,446,000.

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

As of February 22, 2017, the registrant’s no par value Common Stock totaled 6,679,909 shares outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The following documents are incorporated by reference into this Form 10-K: Part III, Items 10 through 14 from Registrant’s definitive proxy statement for the 2017 annual meeting of shareholders.

 
 

AMERICAN RIVER BANKSHARES

INDEX TO
ANNUAL REPORT ON FORM 10-K

FOR YEAR ENDED DECEMBER 31, 2016

Part I.   Page 
Item 1. Business   3
Item 1A. Risk Factors   16
Item 1B. Unresolved Staff Comments   24
Item 2. Properties   25
Item 3. Legal Proceedings   26
Item 4. Mine Safety Disclosures   26
       
Part II.     26
       
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   26
Item 6. Selected Financial Data   29
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations   30
Item 7A. Quantitative and Qualitative Disclosures About Market Risk   55
Item 8. Financial Statements and Supplementary Data   55
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   110
Item 9A. Controls and Procedures   110
Item 9B. Other Information   111
       
Part III.      112
       
Item 10. Directors, Executive Officers and Corporate Governance   112
Item 11. Executive Compensation   112
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   112
Item 13. Certain Relationships and Related Transactions, and Director Independence   112
Item 14. Principal Accounting Fees and Services   112
       
Part IV.     112
       
Item 15. Exhibits and Financial Statement Schedules   112
Item 16. Form 10-K Summary   117
       
Signatures     118
       
Exhibit Index     119
       
23.1 Consent of Independent Registered Public Accounting Firm   120
31.1 Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002   121
31.2 Certifications of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002   122
32.1 Certifications of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002   123
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PART I

Item 1. Business.

Cautionary Statements Regarding Forward-Looking Statements

Certain matters discussed or incorporated by reference in this Annual Report on Form 10-K including, but not limited to, matters described in “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations,” are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, Section 27A of the Securities Act of 1933, as amended, and subject to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may contain words related to future projections including, but not limited to, words such as “believe,” “expect,” “anticipate,” “intend,” “may,” “will,” “should,” “could,” “would,” and variations of those words and similar words that are subject to risks, uncertainties and other factors that could cause actual results to differ significantly from those projected. Factors that could cause or contribute to such differences include, but are not limited to, the following:

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

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

Introduction

American River Bankshares (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) 851-0123.

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 to Sacramento, California in 1985. American River Bank operates four full service offices in Sacramento County including the main office located at 1545 River Park Drive, Suite 107, Sacramento and branch offices in Sacramento and Gold River; one full service office in Placer County, located in Roseville; two full service offices in Sonoma County in Healdsburg and Santa Rosa; and three full service offices in Amador County in Jackson, Pioneer, and Ione. In 2000, 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.

American River Bank’s deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to applicable legal limits. On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act includes a permanent increase to $250,000 as the maximum FDIC insurance limit per depositor retroactive to January 1, 2008. On November 9, 2010, the FDIC implemented a final rule to permanently increase the maximum insurance limit to $250,000 under the Dodd-Frank Act.

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.

During 2016, the Company conducted no significant activities other than holding the shares of its subsidiaries. However, it is authorized, with the prior approval of the Board of Governors of the Federal Reserve System (the “Board of Governors”), the Company’s principal regulator, to engage in a variety of activities which are deemed closely related to the business of banking.

The common stock of the Company is registered under the Securities Exchange Act of 1934, as amended, and is listed and traded on the Nasdaq Global Select Market under the symbol “AMRB.”

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At December 31, 2016, the Company had consolidated assets of $651 million, net loans of $324 million, deposits of $545 million and shareholders’ equity of $84 million.

General

 

The Company is a regional bank holding company headquartered in Sacramento County, California. The principal communities served are located in Sacramento, Placer, Yolo, El Dorado, Sonoma, and Amador counties. The Company generates most of its revenue by providing a wide range of products and services to small and middle-market businesses and individuals. The Company’s principal source of revenue comes from interest income. Interest income is derived from interest and fees on loans and leases, interest on investments (principally government securities), and Federal funds sold (funds loaned on a short-term basis to other banks). For the year ended December 31, 2016, these sources comprised 69.6%, 30.4%, and 0.0%, respectively, of the Company’s interest income.

American River Bank’s deposits are not received from a single depositor or group of affiliated depositors, the loss of any one of which would have a materially adverse effect on the business of the Company. A material portion of American River Bank’s deposits are not concentrated within a single industry or group of related industries.

As of December 31, 2016 and December 31, 2015, American River Bank held $29,000,000 in certificates of deposit for the State of California. In connection with these deposits, American River Bank is generally required to pledge securities to secure such deposits, except for the first $250,000 insured by the FDIC.

Based on the most recent information made available by the FDIC through June 30, 2016, American River Bank competes with approximately 35 other banking or savings institutions in Sacramento County, 26 in Placer County, 19 in Sonoma County and 6 in Amador County. American River Bank’s market share of FDIC insured deposits was approximately 1.0% in the service areas of Sacramento County, in Placer County approximately 0.5%, in Sonoma County approximately 0.5%, and in Amador County approximately 14.8% (based upon the most recent information made available by the FDIC through June 30, 2016).

Employees

At December 31, 2016, the Company and its subsidiaries employed 97 persons on a full-time equivalent basis. The Company believes its employee relations are good.

Website Access

The Company 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 SEC. These reports are free of charge and can be accessed through the address www.americanriverbank.com by accessing the Investor Relations link, then the Company News link, then 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 on Forms 10-K, 10-Q and 8-K by the Company by selecting the appropriate link.

Competition

General Competitive Factors

In order to compete with the major financial institutions in its primary service areas, American River Bank uses to the fullest extent possible the flexibility which is accorded by their community bank status. This includes an emphasis on specialized services, local promotional activity, and personal contacts by their respective officers, directors and employees. American River Bank also seeks to provide special services and programs for individuals in their primary service area who are employed in the agricultural, professional and business fields, such as loans for equipment, furniture, tools of the trade or expansion of practices or businesses. In the event there are customers whose loan demands exceed their respective lending limits, they seek to arrange for such loans on a participation basis with other financial institutions. Furthermore, American River Bank also assists those customers requiring services not offered by either bank to obtain such services from correspondent banks.

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Commercial banks compete with savings and loan associations, credit unions, other financial institutions and other entities for funds. For instance, yields on corporate and government debt securities and other commercial paper affect the ability of commercial banks to attract and hold deposits. Commercial banks also compete for loans with savings and loan associations, credit unions, consumer finance companies, mortgage companies and other lending institutions.

Banking is a business that depends on interest rate differentials. In general, the difference between the interest rate paid by a bank to obtain their deposits and other borrowings and the interest rate received by a bank on loans extended to customers and on securities held in a bank’s portfolio comprise the major portion of a bank’s revenues.

The interest rate differentials of a bank, and therefore their revenues, are affected not only by general economic conditions, both domestic and foreign, but also by the monetary and fiscal policies of the United States as set by statutes and as implemented by federal agencies, particularly the Federal Reserve Board. The Federal Reserve Board can and does implement national monetary policy, such as seeking to curb inflation and combat recession, by its open market operations in United States government securities, adjustments in the amount of interest free reserves that banks and other financial institutions are required to maintain, and adjustments to the discount rates applicable to borrowing by banks from the Federal Reserve Board. These activities influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits. The nature and timing of any future changes in monetary policies and their impact on American River Bank is not predictable.

Competitive Data

At June 30, 2016, based on the most recent “Data Book Summary of Deposits in FDIC Insured Commercial and Savings Banks” report at that date, the competing commercial and savings banks had 180 offices in the cities of Gold River, Rancho Cordova, Roseville and Sacramento, California, where American River Bank has its five Sacramento area offices, 60 offices in the cities of Healdsburg and Santa Rosa, California, where American River Bank has its two Sonoma County offices, and three offices in the cities of Jackson, Pioneer and Ione, California, where American River Bank has its three Amador County offices. Additionally, American River Bank competes with thrifts and, to a lesser extent, credit unions, finance companies and other financial service providers for deposit and loan customers.

Larger banks may have a competitive advantage because of higher lending limits and major advertising and marketing campaigns. They also perform services, such as trust services, international banking, discount brokerage and insurance services, which American River Bank is neither authorized nor prepared to offer currently. American River Bank has made arrangements with its correspondent banks and with others to provide some of these services for its customers. For borrowers requiring loans in excess of American River Bank’s legal lending limits, American River Bank has offered, and intends to offer in the future, such loans on a participating basis with its correspondent banks and with other community banks, retaining the portion of such loans which is within its lending limits. As of December 31, 2016, American River Bank’s aggregate legal lending limits to a single borrower and such borrower’s related parties were $13,373,000 on an unsecured basis and $22,289,000 on a fully secured basis based on capital and allowable reserves of $89,156,000.

American River Bank’s business is concentrated in its service area, which primarily encompasses Sacramento County, South Western Placer County, Sonoma County, and Amador County. The economy of American River Bank’s service area is dependent upon government, manufacturing, tourism, retail sales, agriculture, population growth and smaller service oriented businesses.

Based upon the most recent “Data Book Summary of Deposits in FDIC Insured Commercial and Savings Banks” report dated June 30, 2016, there were 226 operating commercial and savings bank offices in Sacramento County with total deposits of $30,295,764,000. This was an increase of $2,022,739,000 compared to the June 30, 2015 balances. American River Bank held a total of $295,068,000 in deposits, representing approximately 1.0% of total commercial and savings banks deposits in Sacramento County as of June 30, 2016.

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Based upon the most recent “Data Book Summary of Deposits in FDIC Insured Commercial and Savings Banks” report dated June 30, 2016, there were 104 operating commercial and savings bank offices in Placer County with total deposits of $12,762,416,000. This was an increase of $918,061,000 over the June 30, 2015 balances. American River Bank held a total of $61,529,000 in deposits, representing approximately 0.5% of total commercial and savings banks deposits in Placer County as of June 30, 2016.

Based upon the most recent “Data Book Summary of Deposits in FDIC Insured Commercial and Savings Banks” report dated June 30, 2016, there were 122 operating commercial and savings bank offices in Sonoma County with total deposits of $12,284,732,000. This was an increase of $601,845,000 compared to the June 30, 2015 balances. American River Bank held a total of $66,759,000 in deposits, representing approximately 0.5% of total commercial and savings banks deposits in Sonoma County as of June 30, 2016.

Based upon the most recent “Data Book Summary of Deposits in FDIC Insured Commercial and Savings Banks” report dated June 30, 2016, there were 13 operating commercial and savings bank offices in Amador County with total deposits of $696,299,000. This was an increase of $31,783,000 compared to the June 30, 2015 balances. American River Bank held a total of $102,868,000 in deposits, representing approximately 14.8% of total commercial and savings bank deposits in Amador County as of June 30, 2016.

Supervision and Regulation

General

American River Bankshares is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”), and is registered as such with, and subject to the supervision of, the Board of Governors. The Company is required to obtain the approval of the Board of Governors before it may acquire all or substantially all of the assets of any bank, or ownership or control of the voting shares of any bank if, after giving effect to such acquisition of shares, the Company would own or control more than 5% of the voting shares of such bank. The Bank Holding Company Act prohibits the Company from acquiring any voting shares of, or interest in, all or substantially all of the assets of, a bank located outside the State of California unless such an acquisition is specifically authorized by the laws of the state in which such bank is located. Any such interstate acquisition is also subject to applicable California and federal law.

The common stock of the Company is subject to the registration requirements of the Securities Act of 1933, as amended, and the qualification requirements of the California Corporate Securities Law of 1968, as amended. The Company is also subject to the periodic reporting requirements of Section 13 of the Securities Exchange Act of 1934, as amended, which include, but are not limited to, annual, quarterly and other current reports with the SEC.

The Company, and any subsidiaries which it may acquire or organize, are deemed to be “affiliates” within the meaning of that term as defined in the Federal Reserve Act. This means, for example, that there are limitations (a) on loans by American River Bank to affiliates, (b) on investments by American River Bank in affiliates’ stock as collateral for loans to any borrower, and (c) other transactions between any bank subsidiary and the Company. The Company and its subsidiaries are also subject to certain restrictions with respect to engaging in the underwriting, public sale and distribution of securities.

 

American River Bank is licensed by the California Commissioner of the Department of Business Oversight (the “Commissioner”), and its deposits are insured by the FDIC up to the applicable legal limits.  On November 9, 2010, the FDIC implemented a final rule under the Dodd-Frank Act to permanently increase the maximum insurance limit to $250,000 per depositor.  American River Bank has chosen not to become a member of the Federal Reserve System.  Consequently, American River Bank is subject to the supervision of, and is regularly examined by, the Commissioner and the FDIC.  The supervision and regulation includes comprehensive reviews of all major aspects of American River Bank’s business and condition, including its capital ratios, allowance for possible loan and lease losses and other factors.  However, no inference should be drawn that such authorities have approved any such factors.  American River Bankshares and American River Bank are required to file reports with the Board of Governors, the Commissioner, and the FDIC and provide any additional information that the Board of Governors, the Commissioner, and the FDIC may require.

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Capital Standards

Risk-Based Capital. The Board of Governors and the FDIC adopted risk-based capital guidelines for evaluating the capital adequacy of bank holding companies and banks. The guidelines were designed to make capital requirements sensitive to differences in risk profiles among banking organizations, to take into account off-balance sheet exposures and to aid in making the definition of bank capital uniform internationally. Under the risk-based guidelines and prior to amendments to the capital rules effective January 1, 2015 as described below in “Basel III - New Capital and Prompt Corrective Action Regulations,” American River Bankshares and American River Bank were required to maintain capital equal to at least 8.0% of its assets and commitments to extend credit, weighted by risk, of which at least 4.0% was required to consist primarily of common equity (including retained earnings) and the remainder was to consist of subordinated debt, cumulative preferred stock, or a limited amount of loan and lease loss reserves.

Assets, commitments to extend credit, and off-balance sheet items were categorized according to risk and certain assets considered to present less risk than others permitted maintenance of capital at less than the 8% ratio. For example, most home mortgage loans were placed in a 50% risk category and therefore required maintenance of capital equal to 4% of those loans, while commercial loans were placed in a 100% risk category and therefore required maintenance of capital equal to 8% of those loans.

Under the risk-based capital guidelines, assets reported on an institution’s balance sheet and certain off-balance sheet items are assigned to risk categories, each of which has an assigned risk weight. Capital ratios are calculated by dividing the institution’s qualifying capital by its period-end risk-weighted assets. The guidelines established two categories of qualifying capital: Tier 1 capital (core capital including common shareholders’ equity and noncumulative perpetual preferred stock) and Tier 2 capital (supplementary capital which includes, among other items, limited life (and in the case of banks, cumulative) preferred stock, mandatory convertible securities, subordinated debt and a limited amount of reserve for credit losses. Each institution is required to maintain a minimum risk-based capital ratio (including Tier 1 and Tier 2 capital) of 8%, of which at least half must be Tier 1 capital.

A leverage capital standard was adopted as a supplement to the risk-weighted capital guidelines. Under the leverage capital standard, an institution was required to maintain a minimum ratio of Tier 1 capital to the sum of its quarterly average total assets and quarterly average reserve for loan losses, less intangible assets not included in Tier 1 capital. Period-end assets may be used in place of quarterly average total assets on a case-by-case basis. The Board of Governors and the FDIC also adopted a minimum leverage ratio for bank holding companies as a supplement to the risk-weighted capital guidelines. The leverage ratio establishes a minimum Tier 1 ratio of 3% (Tier 1 capital to total assets) for the highest rated bank holding companies or those that have implemented the risk-based capital market risk measure. All other bank holding companies must maintain a minimum Tier 1 leverage ratio of 4% with higher leverage capital ratios required for bank holding companies that have significant financial and/or operational weakness, a high-risk profile, or are undergoing or anticipating rapid growth.

Effective January 1, 2015, the risk-based capital regulations described above were amended to the extent described below in “Basel III - New Capital and Prompt Corrective Action Regulations.”

Basel III – New Capital and Prompt Corrective Action Regulations. In July 2013, the federal bank regulatory agencies issued interim final rules that revised and replaced the risk-based capital requirements in order to implement the “Basel III” regulatory capital reforms released by the Basel Committee on Banking Supervision and changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The Basel III reforms reflected in the final rules include an increase in the risk-based capital requirements and certain changes to capital components, as well as changes to the calculation and categories of risk-weighted assets. For example, changes to risk weighted assets include increasing the original risk weight to 150% on assets past due 90 days or more or on nonaccrual, utilizing loan to value ratios in the risk weighting of mortgage loans and assigning a 150% risk weight to certain higher risk commercial real estate loans.

 

Effective January 1, 2015, bank holding companies with consolidated assets of $1 Billion or more and banks like American River Bank must comply with new minimum capital ratio requirements to be phased-in between January 1, 2015 and January 1, 2019, which consist of the following: (i) a new common equity Tier 1 capital to total risk weighted assets ratio of 4.5%; (ii) a Tier 1 capital to total risk weighted assets ratio of 6% (increased from 4%); (iii) a total capital to total risk weighted assets ratio of 8% (unchanged); and (iv) a Tier 1 capital to adjusted average total assets (“leverage”) ratio of 4%.

8
 

In addition, a “capital conservation buffer,” is established which when fully phased-in will require maintenance of a minimum of 2.5% of common equity Tier 1 capital to total risk weighted assets in excess of the regulatory minimum capital ratio requirements described above. The 2.5% buffer will increase the minimum capital ratios to (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new buffer requirement will be phased-in between January 1, 2016 and January 1, 2019. If the capital ratio levels of a banking organization fall below the capital conservation buffer amount, the organization will be subject to limitations on (i) the payment of dividends; (ii) discretionary bonus payments; (iii) discretionary payments under Tier 1 instruments; and (iv) engaging in share repurchases.

 

The federal bank regulatory agencies also implemented changes to the prompt corrective action framework described below under “Prompt Corrective Action,” which is designed to place restrictions on insured depository institutions if their capital ratios begin to show signs of weakness. These changes took effect beginning January 1, 2015 and require insured depository institutions to meet the following increased capital ratio requirements in order to qualify as “well capitalized:” (i) a new common equity Tier 1 capital ratio of 6.5%; (ii) a Tier 1 capital ratio of 8%; (iii) a total capital ratio of 10%; and (iv) a Tier 1 leverage ratio of 5%. In order to qualify as “adequately capitalized,” institutions must have (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. See also the additional requirements of the prompt corrective action framework discussed below under “Prompt Corrective Action.”

 

Management believes that American River Bank is in compliance with the minimum capital requirements, including the fully phased-in capital conservation buffer requirement based upon its capital position at December 31, 2016.

 

Prompt Corrective Action

The Board of Governors and the FDIC adopted regulations implementing a system of prompt corrective action pursuant to Section 38 of the Federal Deposit Insurance Act and Section 131 of the FDIC Improvement Act of 1991 (“FDICIA”). Prior to amendments to the capital rules effective January 1, 2015 as described above in “Basel III - New Capital and Prompt Corrective Action Regulations,” the regulations established five capital categories with the following characteristics: (1) “Well capitalized” - consisting of institutions with a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater and a leverage ratio of 5% or greater, and the institution is not subject to an order, written agreement, capital directive or prompt corrective action directive; (2) “Adequately capitalized” - consisting of institutions with a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater and a leverage ratio of 4% or greater, and the institution does not meet the definition of a “well capitalized” institution; (3) “Undercapitalized” - consisting of institutions with a total risk-based capital ratio less than 8%, a Tier 1 risk-based capital ratio of less than 4%, or a leverage ratio of less than 4%; (4) “Significantly undercapitalized” - consisting of institutions with a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3%, or a leverage ratio of less than 3%; (5) “Critically undercapitalized” - consisting of an institution with a ratio of tangible equity to total assets that is equal to or less than 2%.

The regulations established procedures for classification of financial institutions within the capital categories, filing and reviewing capital restoration plans required under the regulations and procedures for issuance of directives by the appropriate regulatory agency, among other matters. The regulations impose restrictions upon all institutions to refrain from certain actions which would cause an institution to be classified within any one of the three “undercapitalized” categories, such as declaration of dividends or other capital distributions or payment of management fees, if following the distribution or payment the institution would be classified within one of the “undercapitalized” categories. In addition, institutions which are classified in one of the three “undercapitalized” categories are subject to certain mandatory and discretionary supervisory actions. Mandatory supervisory actions include (1) increased monitoring and review by the appropriate federal banking agency; (2) implementation of a capital restoration plan; (3) total asset growth restrictions; and (4) limitations upon acquisitions, branch expansion, and new business activities without prior approval of the appropriate federal banking agency. Discretionary supervisory actions may include (1) requirements to augment capital; (2) restrictions upon affiliate transactions; (3) restrictions upon deposit gathering activities and interest rates paid; (4) replacement of senior executive officers and directors; (5) restrictions upon activities of the institution and its affiliates; (6) requiring divestiture or sale of the institution; and (7) any other supervisory action that the appropriate federal banking agency determines is necessary to further the purposes of the regulations. Further, the federal banking agencies may not accept a capital restoration plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. In addition, for a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company under the guaranty is limited to the lesser of (i) an amount equal to 5 percent of the depository institution’s total assets at the time it became undercapitalized, and (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is treated as if it were “significantly undercapitalized.” FDICIA also restricts the solicitation and acceptance of and interest rates payable on brokered deposits by insured depository institutions that are not “well capitalized.” An “undercapitalized” institution is not allowed to solicit deposits by offering rates of interest that are significantly higher than the prevailing rates of interest on insured deposits in the particular institution’s normal market areas or in the market areas in which such deposits would otherwise be accepted.

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Any financial institution which is classified as “critically undercapitalized” must be placed in conservatorship or receivership within 90 days of such determination unless it is also determined that some other course of action would better serve the purposes of the regulations. Critically undercapitalized institutions are also prohibited from making (but not accruing) any payment of principal or interest on subordinated debt without prior regulatory approval and regulators must prohibit a critically undercapitalized institution from taking certain other actions without prior approval, including (1) entering into any material transaction other than in the usual course of business, including investment expansion, acquisition, sale of assets or other similar actions; (2) extending credit for any highly leveraged transaction; (3) amending articles or bylaws unless required to do so to comply with any law, regulation or order; (4) making any material change in accounting methods; (5) engaging in certain affiliate transactions; (6) paying excessive compensation or bonuses; and (7) paying interest on new or renewed liabilities at rates which would increase the weighted average costs of funds beyond prevailing rates in the institution’s normal market areas.

On November 18, 2014, the FDIC adopted the Assessments Final Rule which revises the FDIC’s risk-based deposit insurance assessment system to reflect changes in the regulatory capital rules effective commencing January 1, 2015. For smaller financial institutions (with total assets less than $1 Billion and which are not custodial banks), the Final Rule revised and conformed capital ratios and ratio thresholds to the new prompt corrective action capital ratios and ratio thresholds for “well capitalized” and “adequately capitalized” evaluations which were adopted by the federal banking agencies as part of the Basel III capital regulations. Consequently, effective January 1, 2015, the prompt corrective action regulations were amended to the extent described above in “Basel III – New Capital and Prompt Corrective Action Regulations.”

Additional Regulations

Under the FDICIA, the federal financial institution agencies have adopted regulations which require institutions to establish and maintain comprehensive written real estate policies which address certain lending considerations, including loan-to-value limits, loan administrative policies, portfolio diversification standards, and documentation, approval and reporting requirements. The FDICIA further generally prohibits an insured state bank from engaging as a principal in any activity that is impermissible for a national bank, absent FDIC determination that the activity would not pose a significant risk to the Bank Insurance Fund, and that the bank is, and will continue to be, within applicable capital standards.

The Federal Financial Institution Examination Counsel (“FFIEC”) utilizes the Uniform Financial Institutions Rating System (“UFIRS”) commonly referred to as “CAMELS” to classify and evaluate the soundness of financial institutions. Bank examiners use the CAMELS measurements to evaluate capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk. Effective January 1, 2005, bank holding companies such as the Company, were subject to evaluation and examination under a revised bank holding company rating system. The so-called BOPEC rating system implemented in 1979 was primarily focused on financial condition, consolidated capital and consolidated earnings. The rating system reflects the change toward analysis of risk management (as reflected in bank examination under the CAMELS measurements), in addition to financial factors and the potential impact of nondepository subsidiaries upon depository institution subsidiaries.

The federal financial institution agencies have established bases for analysis and standards for assessing a financial institution’s capital adequacy in conjunction with the risk-based and Basel III capital guidelines including analysis of interest rate risk, concentrations of credit risk, risk posed by non-traditional activities, and factors affecting overall safety and soundness. The safety and soundness standards for insured financial institutions include analysis of (1) internal controls, information systems and internal audit systems; (2) loan documentation; (3) credit underwriting; (4) interest rate exposure; (5) asset growth; (6) compensation, fees and benefits; and (7) excessive compensation for executive officers, directors or principal shareholders which could lead to material financial loss. If an agency determines that an institution fails to meet any standard, the agency may require the financial institution to submit to the agency an acceptable plan to achieve compliance with the standard. If the agency requires submission of a compliance plan and the institution fails to timely submit an acceptable plan or to implement an accepted plan, the agency must require the institution to correct the deficiency. The agencies may elect to initiate enforcement action in certain cases rather than rely on an existing plan particularly where failure to meet one or more of the standards could threaten the safe and sound operation of the institution.

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Community Reinvestment Act (“CRA”) regulations evaluate banks’ lending to low and moderate income individuals and businesses across a four-point scale from “outstanding” to “substantial noncompliance,” and are a factor in regulatory review of applications to merge, establish new branches or form bank holding companies. In addition, any bank rated in “substantial noncompliance” with the CRA regulations may be subject to enforcement proceedings. In its most recent exam for CRA compliance, American River Bank has a rating of “satisfactory.”

Limitations on Dividends

The Company’s ability to pay cash dividends is subject to restrictions set forth in the California General Corporation Law. Funds for payment of any cash dividends by the Company would be obtained from its investments as well as dividends and/or management fees from its subsidiaries. The payment of cash dividends and/or management fees by American River Bank is subject to restrictions set forth in the California Financial Code, as well as restrictions established by the FDIC. On January 25, 2017, the Board of Directors resumed the payment of cash dividends. The Company relies on distributions from American River Bank in the form of cash dividends in order to pay cash dividends to our shareholders. See Item 5. “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” for more information regarding cash dividends.

FDIC Insurance

On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law. The EESA temporarily raised the limit on federal deposit insurance coverage provided by the FDIC from $100,000 to $250,000 per depositor.  On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) into law. On November 9, 2010, the FDIC issued a final rule implementing section 343 of the Dodd-Frank Act that permanently raised the current standard maximum deposit insurance amount per depositor to $250,000. In addition, the Dodd-Frank Act also made other deposit insurance changes which may affect our insurance premium assessments to include (i) amendment of the assessment base used to calculate an insured depository institution’s deposit insurance premiums paid to the DIF by elimination of deposits and substitution of average consolidated total assets less average tangible equity during the assessment period as the revised assessment base; (ii) increasing the minimum designated reserve ratio of the DIF from 1.15 percent to 1.35 percent of the estimated amount of total insured deposits; (iii) eliminating the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds; and (iv) repeal of the prohibition upon the payment of interest on demand deposits to be effective one year after the date of enactment of the Dodd-Frank Act.

On November 18, 2014, the FDIC adopted the Assessments Final Rule which revises the FDIC’s risk-based deposit insurance assessment system to reflect changes in the regulatory capital rules adopted by the federal banking agencies as part of the so-called Basel III capital regulations to conform the prompt corrective action capital ratios and ratio thresholds for “well capitalized” and “adequately capitalized” evaluations.

On June 16, 2015, the FDIC proposed changes to the deposit insurance assessments for small insured banks having total assets less than $10 Billion which have been insured for at least five years, based upon experience with bank failures. The changes, among other matters, revise the financial ratios method of determining assessments to reflect a statistical model estimating the probability of failure over three years and updating the financial measures used in the financial ratios method consistent with the statistical model. The FDIC proposed additional changes on October 22, 2015 to require banks with over $10 Billion in assets to be responsible for the recapitalization of the DIF to 1.35 percent of insured deposits after achieving a 1.15 percent reserve ratio. On January 21, 2016, the FDIC proposed further revisions to the small insured bank assessments as the result of comments and recommendations received in response to its earlier proposal. The FDIC proposed that a final rule would go into effect the quarter after adoption, but the amendments would not become operative until the quarter after the DIF reserve ratio reached 1.15 percent. The DIF achieved a reserve ratio of 1.17 as of June 30, 2016. Among the effects of the amendments was a reduction in the initial assessment rates for all banks.

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Although American River Bank’s recent assessments have declined as a result of the change to the deposit assessment system, it is uncertain what effect the implementation of the changes to the insurance assessments will have upon the Company’s cost of operations in the future, but a deterioration in the economic conditions impacting financial institutions or a significant number of failed institutions might necessitate increases in premium assessments to maintain the DIF which could adversely impact the Company’s earnings.

Impact of Certain Legislation and Regulation

Interstate Banking. The Dodd-Frank Act signed into law by President Obama on July 21, 2010, includes provisions authorizing national and state banks to establish branch offices in other states to the same extent as a bank chartered by that state would be permitted to branch.  Previously, banks could only establish branch offices in other states if the host state expressly permitted out-of-state banks to establish branch offices in that state.  Accordingly, banks may be able to enter new markets more freely.

Gramm-Leach-Bliley Act. In 1999, the Gramm-Leach-Bliley Act (the “GLB Act”) was signed into law. The GLB Act eliminated most of the remaining depression-era “firewalls” between banks, securities firms and insurance companies which were established by The Banking Act of 1933, also known as the Glass-Steagall Act (“Glass-Steagall”). Glass-Steagall sought to insulate banks as depository institutions from the perceived risks of securities dealing and underwriting, and related activities. The GLB Act permitted bank holding companies that could qualify as “financial holding companies” to acquire securities firms or create them as subsidiaries, and securities firms could acquire banks or start banking activities through a financial holding company. Prior to the GLB Act, banks were also (with minor exceptions) prohibited from engaging in insurance activities or affiliating with insurers. The GLB Act removed these restrictions and substantially eliminated the prohibitions under the Bank Holding Company Act on affiliations between banks and insurance companies. Consequently, the common ownership of banks, securities firms and insurance firms was possible, in addition to the conduct of commercial banking, merchant banking, investment management, securities underwriting and insurance within a single financial institution using a “financial holding company” structure authorized by the GLB Act.

A bank holding company could qualify as a financial holding company if (i) its banking subsidiaries are “well capitalized” and “well managed” and (ii) it files with the Board of Governors a certification to such effect and a declaration that it elects to become a financial holding company. The Bank Holding Company Act was amended to permit financial holding companies to engage in activities, and acquire companies engaged in activities, that are financial in nature or incidental to such financial activities. Financial holding companies were also permitted to engage in activities that were complementary to financial activities if the Board of Governors determined that the activity did not pose a substantial risk to the safety or soundness of depository institutions or the financial system in general. These standards expanded upon the list of activities “closely related to banking” which have defined the permissible activities of bank holding companies under the Bank Holding Company Act. Neither the Company nor American River Bank has determined whether or when to seek to acquire and exercise powers or activities under the GLB Act.

Volcker Rule. On December 10, 2013, the federal banking agencies jointly issued a final rule implementing the so-called “Volcker Rule” (set forth in Section 619 of the Dodd-Frank Act). The Volcker Rule prohibits depository institutions, companies that control such institutions, bank holding companies, and the affiliates and subsidiaries of such banking entities, from engaging as principal for the trading account of the banking entity in any purchase or sale of one or more covered financial instruments (so-called “proprietary trading”) and imposes limitations upon retaining ownership interests in, sponsoring, investing in and transacting with certain investment funds, including hedge funds and private equity funds. The effective date of the final rule restricting proprietary trading was extended to July 21, 2015 and certain other matters were extended to July 21, 2016 with a final one-year extension anticipated to July 21, 2017. Neither the Company nor American River Bank engages in activities prohibited by the Volcker Rule nor do we expect the Volcker Rule to have a material impact upon the Company or American River Bank.

Patriot Act. On October 26, 2001, President Bush signed the USA Patriot Act (the “Patriot Act”), which includes provisions pertaining to domestic security, surveillance procedures, border protection, and terrorism laws to be administered by the Secretary of the Treasury. Title III of the Patriot Act entitled, “International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001” includes amendments to the Bank Secrecy Act which expand the responsibilities of financial institutions in regard to anti-money laundering activities with particular emphasis upon international money laundering and terrorism financing activities through designated correspondent and private banking accounts.

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The Patriot Act contains various provisions that affect the operations of financial institutions by encouraging cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities. The Company and American River Bank are not currently aware of any account relationships between American River Bank and any foreign bank or other person or entity which would not be in compliance with the Patriot Act.

Certain surveillance provisions of the Patriot Act expired on June 1, 2015, but were renewed the next day by the passage of the USA Freedom Act on June 2, 2015 and extended through 2019. However, the provision under which the National Security Agency (“NSA”) conducted mass phone data collection on individuals was changed to require the NSA to seek permission from a federal court in order to obtain such data from phone companies.

The effects which the Patriot Act and any amendments to the Patriot Act or additional legislation enacted by Congress may have upon financial institutions is uncertain; however, such legislation could increase compliance costs and thereby potentially may have an adverse effect upon the Company’s results of operations.

Sarbanes-Oxley Act. On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the “Act”) which responded to issues in corporate governance and accountability. Among other matters, key provisions of the Act and rules promulgated by the SEC pursuant to the Act include enhancement of financial disclosures and related certification requirements, rules related to audit committees, auditor independence, ethics requirements, securities trading prohibitions, securities reporting requirements, and securities listing requirements.

The Company’s securities are listed on the Nasdaq Global Select Market. Consequently, in addition to the rules promulgated by the SEC pursuant to the Act, the Company must also comply with the listing standards applicable to Nasdaq listed companies. The Nasdaq listing standards applicable to the Company include standards related to (i) director independence, (ii) executive session meetings of the board, (iii) requirements for audit, nominating and compensation committee charters, membership qualifications and procedures, (iv) shareholder approval of equity compensation arrangements, and (v) code of conduct requirements that comply with the code of ethics under the Act.

The effect of the Act upon the Company is uncertain; however, the Company has incurred and it is anticipated that it will continue to incur increased costs to comply with the Act and the rules and regulations promulgated pursuant to the Act by the SEC, Nasdaq and other regulatory agencies having jurisdiction over the Company or the issuance and listing of its securities. The Company does not currently anticipate, however, that compliance with the Act and such rules and regulations will have a material adverse effect upon its financial position or results of its operations or its cash flows.

Fair and Accurate Credit Transactions Act. The Board of Governors, the FDIC, the other federal financial institution regulatory agencies, and the Federal Trade Commission issued final rules and guidelines effective January 1, 2008, subject to mandatory compliance as of November 1, 2008, implementing sections 114 and 315 of the Fair and Accurate Credit Transactions Act of 2003 to require financial institutions and other creditors to develop and implement a written identity theft prevention program. The program must include reasonable policies and procedures for detecting, preventing, and mitigating identity theft in connection with certain new and existing covered accounts. Covered accounts are defined as (i) an account primarily for personal, family, or household purposes (i.e., consumer accounts), or (ii) any other account for which there is a reasonably foreseeable risk to customers or the safety and soundness of the financial institution or creditor from identity theft. The program must be appropriate to the size and complexity of the financial institution or creditor and the nature and scope of its activities and should be designed to:

·identify relevant patterns, practices, and specific forms of activity that are “red flags” of possible identity theft and incorporate those red flags into the program;
·detect the occurrence of red flags incorporated into the program;
·respond appropriately to any red flags that are detected to prevent and mitigate identity theft; and
·ensure that the program is updated periodically to reflect changes in risks to customers or to the safety and soundness of the financial institution or creditor from identity theft.
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The regulations include guidelines that each financial institution must consider and, to the extent appropriate, include in its program and steps that must be taken to administer the program including (i) obtaining approval of the program by the board of directors or a committee of the board, (ii) ensuring oversight of the development, implementation and administration of the program, (iii) training staff, and (iv) overseeing service provider arrangements. The guidelines contemplate that existing fraud prevention procedures may be incorporated into the program.

 The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”). The Dodd-Frank Act is intended to restructure the regulation of the financial services sector by, among other things, (i) establishing a framework to identify systemic risks in the financial system implemented by a newly created Financial Stability Oversight Council and other federal banking agencies; (ii) expanding the resolution authority of the federal banking agencies over troubled financial institutions; (iii) authorizing changes to capital and liquidity requirements; (iv) changing deposit insurance assessments; and (v) enhancing regulatory supervision to improve the safety and soundness of the financial services sector. The Dodd-Frank Act has had and is expected to continue to have a significant impact upon our business as its provisions are implemented over time. Below is a summary of certain provisions of the Dodd-Frank Act which, directly or indirectly, may affect us.

·Changes to Capital Requirements. The federal banking agencies are required to establish revised minimum leverage and risk-based capital requirements for banks and bank holding companies. Under these requirements, trust preferred securities are excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by a bank holding company with less than $15 Billion in assets. The Dodd-Frank Act requires capital requirements to be counter cyclical so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction consistent with safety and soundness.
·Enhanced Regulatory Supervision. The Dodd-Frank Act increases regulatory oversight, supervision and examination of banks, bank holding companies and their respective subsidiaries by the appropriate regulatory agency.
·Consumer Protection. The Dodd-Frank Act created the Consumer Financial Protection Bureau (“CFPB”) within the Federal Reserve System. The CFPB is responsible for establishing and implementing rules and regulations under various federal consumer protection laws governing certain consumer products and services. The CFPB has primary enforcement authority over large financial institutions with assets of $10 Billion or more, while smaller institutions will be subject to the CFPB’s rules and regulations through the enforcement authority of the federal banking agencies. States are permitted to adopt consumer protection laws and regulations that are more stringent than those laws and regulations adopted by the CFPB and state attorneys general are permitted to enforce consumer protection laws and regulations adopted by the CFPB.
·Deposit Insurance. The Dodd-Frank Act permanently increased the deposit insurance limit for insured deposits to $250,000 per depositor. Other deposit insurance changes under the Dodd-Frank Act include (i) amendment of the assessment base used to calculate an insured depository institution’s deposit insurance premiums paid to the Deposit Insurance Fund (“DIF”) by elimination of deposits and substitution of average consolidated total assets less average tangible equity during the assessment period as the revised assessment base; (ii) increasing the minimum designated reserve ratio of the DIF from 1.15 percent to 1.35 percent of the estimated amount of total insured deposits; (iii) eliminating the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds; and (iv) repeal of the prohibition upon the payment of interest on demand deposits to be effective one year after the date of enactment of the Dodd-Frank Act. The FDIC has proposed further changes to the deposit insurance assessments applicable to small insured depository institutions with assets less than $10 Billion and additional DIF recapitalization obligations for insured depository institutions with more than $10 Billion in assets. See the discussion of these changes in “Supervision and Regulation - FDIC Insurance.”
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·Transactions with Affiliates. The Dodd-Frank Act enhances the requirements for certain transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions” and increasing the amount of time for which collateral requirements regarding covered transactions must be maintained.
·Transactions with Insiders. Insider transaction limitations are expanded through the strengthening of loan restrictions to insiders and the expansion of the types of transactions subject to the various limits, including derivative transactions, repurchase agreements, reverse repurchase agreements and securities lending or borrowing transactions. Restrictions are also placed on certain asset sales to and from an insider to an institution, including requirements that such sales be on market terms and, in certain circumstances, approved by the institution’s board of directors.
·Enhanced Lending Limitations. The Dodd-Frank Act strengthens the existing limits on a depository institution’s credit exposure to include credit exposure arising from derivative transactions, repurchase agreements, and securities lending and borrowing transactions.
·Debit Card Interchange Fees.  The Dodd-Frank Act requires that the amount of any interchange fee charged by a debit card issuer with respect to a debit card transaction must be reasonable and proportional to the cost incurred by the issuer.  The Federal Reserve Board was required to establish standards for reasonable and proportional fees which may take into account the costs of preventing fraud.  The restrictions on interchange fees, however, do not apply to banks that, together with their affiliates, have assets of less than $10 Billion.
·Interstate Branching.  The Dodd-Frank Act authorizes national and state banks to establish branch offices in other states to the same extent as a bank chartered by that state would be permitted to branch.  Previously, banks could only establish branch offices in other states if the host state expressly permitted out-of-state banks to establish branch offices in that state.  Accordingly, banks may be able to enter new markets more freely.
·Charter Conversions. Effective one year after enactment of the Dodd-Frank Act, depository institutions that are subject to a cease and desist order or certain other enforcement actions issued with respect to a significant supervisory matter are prohibited from changing their federal or state charters, except in accordance with certain notice, application and other procedures involving the applicable regulatory agencies.
·Compensation Practices. The Dodd-Frank Act provides that the appropriate federal banking regulators must establish standards prohibiting as an unsafe and unsound practice any compensation plan of a bank holding company or other “covered financial institution” that provides an insider or other employee with “excessive compensation” or could lead to a material financial loss to such firm. In June 2010, prior to the enactment of the Dodd-Frank Act, the federal bank regulatory agencies jointly issued the Interagency Guidance on Sound Incentive Compensation Policies (“Guidance”), which requires that financial institutions establish metrics for measuring the risk to the financial institution of such loss from incentive compensation arrangements and implement policies to prohibit inappropriate risk taking that may lead to material financial loss to the institution. Together, the Dodd-Frank Act and the Guidance may impact our compensation policies and arrangements.
·Corporate Governance. The Dodd-Frank Act will enhance corporate governance requirements to include (i) requiring publicly traded companies to give shareholders a non-binding vote on executive compensation at their first annual meeting taking place six months after the date of enactment and at least every three years thereafter and on so-called “golden parachute” payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders; (ii) authorizing the SEC to promulgate rules that would allow shareholders to nominate their own candidates for election as directors using a company’s proxy materials; (iii) directing the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1 Billion, regardless of whether or not the company is publicly traded; and (iv) authorizing the SEC to prohibit broker discretionary voting on the election of directors and on executive compensation matters.

 

Requirements under the Dodd-Frank Act are anticipated to be implemented over an extended period of time, unless the implementation is changed as the result of additional legislation promulgated by Congress or as a result of actions taken by the administration of President Trump. Therefore, the nature and extent of regulations that will be issued by various regulatory agencies and the impact such regulations will have on the operations of financial institutions such as ours is unclear. Such regulations resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.

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Future Legislation and Regulation

In addition to legislative changes, the various federal and state financial institution regulatory agencies frequently propose rules and regulations to implement and enforce already existing legislation. It cannot be predicted whether or in what form any such rules or regulations will be enacted or the effect that such regulations may have on American River Bankshares or American River Bank. However, despite reported comments made by the administration of President Trump regarding the effect of regulations upon the current conditions in the U.S. financial markets and economy, it remains uncertain whether Congress will enact legislation which provides regulatory relief to financial institutions or alter the focus on the regulation of the financial services industry. The Company anticipates that additional regulations would likely increase the Company’s expenses, which may adversely impact the Company’s results of operations, financial condition, future prospects, profitability, and stock price.

Item 1A. Risk Factors.

The Company and its subsidiary, American River Bank, conduct business in an environment that includes certain risks described below which could have a material adverse effect on the Company’s business, results of operations, financial condition, future prospects and stock price. You are also referred to the matters described under the heading “Cautionary Statements Regarding Forward-Looking Statements,” in Part I, Item 1 and Part II, Item 7 of this report on Form 10-K for additional information regarding factors that may affect the Company’s business.

We are subject to extensive regulation, which could adversely affect our business.

Our operations are subject to extensive regulation by federal, state and local governmental authorities and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of our operations. We believe that we are in substantial compliance in all material respects with laws, rules and regulations applicable to the conduct of our business; however, because our business is highly regulated, the laws, rules and regulations applicable to us are subject to regular modification and change. These laws, rules and regulations may be modified, or other new laws, rules or regulations, may be adopted in the future, which could make compliance much more difficult or expensive, or restrict our ability to originate, broker or sell loans, reduce service charge income on deposits, or further limit or restrict the amount of commissions, or interest or other charges earned on loans originated or sold by us or otherwise adversely affect our business, results of operations, financial condition, or future prospects. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), signed into law on July 21, 2010, has had and is expected to continue to have a broad impact on the financial services sector, including significant regulatory and compliance changes. Many of the Dodd-Frank Act requirements are anticipated to be implemented over an extended period of time, unless the implementation is changed as the result of additional legislation promulgated by Congress or as the result of actions taken by the administration of President Trump. However, as a result of the uncertainty associated with the manner in which such regulations will be implemented by the various regulatory agencies, the full extent of the impact such requirements will have on our operations is not clear. Changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business, results of operations, financial condition or future prospects.

Difficult market conditions have adversely affected our business.

Dramatic declines occurred in the housing market during the economic downturn of 2007 through 2010 resulting in falling home prices and a significant number of foreclosures. These circumstances along with unemployment and under-employment negatively impacted the credit performance of our loan portfolio and resulted in significant write-downs of asset values. These asset write-downs had a significant impact on the Company’s financial results and ratios, including our net income, earnings per share, return on average equity and return on average assets. Our net income decreased from $7,751,000 in 2008 to $1,586,000 in 2009 and $476,000 in 2010. Net income increased in succeeding years compared to 2010 and recoveries of previously charged off loans helped increase net income to $6,404,000 in 2016. Our earnings per share decreased from $1.30 per share in 2008 to $0.26 per share in 2009 and $0.05 per share in 2010. Earnings per share also increased in succeeding years compared to 2010 and was $0.94 per share in 2016. Our return on average equity decreased from 12.39% in 2008 to 2.44% in 2009 and 0.53% in 2010, then increased in succeeding years compared to 2010 and was 7.60% in 2016. Our return on average assets decreased from 1.32% in 2008 to 0.28% in 2009 and 0.08% in 2010, then increased in succeeding years compared to 2010 and was 1.00% in 2016. While there has been an improvement in our financial results and ratios in recent years compared to the decreases experienced in the period 2008 through 2010, the increases are still below our historical averages and there is no guarantee that these increases will continue into the future, which could adversely affect our stock price. A significant decline in our stock price could result in substantial losses for individual shareholders.

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·Deterioration of economic conditions could adversely affect our business.

The economic conditions in the United States in general and within California and in our operating markets suffered from the economic downturn of 2007 through 2010. The availability of credit and consumer spending, real estate values, and consumer confidence have all been adversely affected by the economic downturn. Unemployment nationwide, in California and in our operating markets increased significantly through this economic downturn. Although unemployment statistics have returned to more normal historical levels, there is no certainty that these levels will continue in the future. As of December 31, 2016, the unemployment rate was 4.7% nationwide, 5.2% in California and 4.9%, 3.7% and 5.7%, respectively, in the Company’s primary markets of Sacramento, Sonoma and Amador Counties, which rates are significantly lower than the rates during the economic downturn. However, these unemployment statistics may not reflect the full extent of unemployment conditions nationwide, in California and in the Company’s primary operating markets due to the exclusion of statistics regarding the number of persons who are no longer seeking employment, among other statistical data. While economic conditions have improved, the sustainability of the economic recovery remains uncertain.

The Bank conducts banking operations principally in Northern California. As a result, our financial condition, results of operations and cash flows are subject to changes in the economic conditions in Northern California. Our business results are dependent in large part upon the business activity, population, income levels, deposits and real estate activity in Northern California, and adverse economic conditions could have a material adverse effect upon us. In addition, California’s budgetary and fiscal difficulties during the economic downturn of 2007 through 2010 resulted in a reduction of the number of California government employees. The businesses operating in California and, in particular in the City of Sacramento, depend on the relationships with these government employees, and reduced spending activity by these government employees could have a material impact on the success or failure of these businesses, some of which are current customers or could become future customers of the Bank.

The market in which the Company operates experienced a slowdown in new loan volume during the economic downturn as existing and potential new borrowers paid down debt and delayed expansion plans. This reduction in loan volume had an adverse effect upon our net interest margin and profitability. The Company’s operating market has begun to show demand for credit products as the continued low rate environment and expectations for economic expansion have increased refinancing as well as new loan activity. However, deterioration in economic conditions locally, regionally or nationally could result in an economic downturn in Northern California with the following consequences, any of which could further adversely affect our business:

§loan delinquencies and defaults may increase;
§problem assets and foreclosures may increase;
§demand for loans and other products and services may decline;
§low cost or noninterest bearing deposits may decrease;
§collateral for loans may decline in value, in turn reducing clients’ borrowing power, and reducing the value of assets and collateral as sources of repayment of existing loans;
§foreclosed assets may not be able to be sold;
§volatile securities market conditions could adversely affect valuations of investment portfolio assets; and
§reputational risk may increase due to public sentiment regarding the banking industry.

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·Nonperforming assets take significant time to resolve and adversely affect our results of operations and financial condition.

At December 31, 2016, our nonperforming loans and leases had decreased to 0.01% of total loans and leases compared to the highest level recorded during the economic downturn of 6.52% at December 31, 2010. At December 31, 2016, our nonperforming assets (which include foreclosed real estate and repossessed assets) to total assets had decreased to 0.21%, compared to the highest level recorded during the economic downturn of 4.36% at December 31, 2010. While these nonperforming loans and leases and nonperforming assets have decreased, there is no guarantee that these levels will continue into the future, which could adversely affect our stock price. A significant decline in our stock price could result in substantial losses for individual shareholders.

Nonperforming assets adversely affect our net income in various ways. We generally do not record interest income on nonperforming loans or other real estate owned, thereby adversely affecting our income and increasing our loan administration costs. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, which may ultimately result in a loss. An increase in the level of nonperforming assets increases our risk profile and may impact the capital levels our regulators believe are appropriate in light of the ensuing risk profile, which could result in a request to reduce our level of nonperforming assets and/or raise additional capital. When we reduce problem assets through loan sales, workouts, restructurings and otherwise, decreases in the value of the underlying collateral, or in these borrowers’ performance or financial condition, whether or not due to economic and market conditions beyond our control, could adversely affect our business, results of operations and financial condition. In addition, the resolution of nonperforming assets requires significant commitments of time from management and our directors, which can be detrimental to the performance of their other responsibilities. We may experience increases in nonperforming assets and the disposition of such nonperforming assets may adversely affect our profitability.

 

·Tightening of credit markets and liquidity risk could adversely affect our business, financial condition and results of operations.

A tightening of the credit markets or any inability to obtain adequate funds for asset growth at an acceptable cost could adversely affect our asset growth and liquidity position and, therefore, our earnings capability. In addition to core deposit growth, maturity of investment securities and loan and lease payments, we also rely on alternative funding sources including unsecured borrowing lines with correspondent banks, secured borrowing lines with the Federal Home Loan Bank of San Francisco and the Federal Reserve Bank of San Francisco, and public time certificates of deposits. Our ability to access these sources could be impaired by deterioration in our financial condition as well as factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations for the financial services industry or serious dislocation in the general credit markets. In the event such a disruption should occur, our ability to access these sources could be adversely affected, both as to price and availability, which would limit or potentially raise the cost of the funds available to us.

·We have a concentration risk in real estate related loans.

At December 31, 2016, $289.4 million, or 87.9% of our total loan and lease portfolio, consisted of real estate related loans. Of that amount, $191.1 million, or 66.0%, consisted of commercial real estate, $9.2 million, or 3.2% consisted of commercial and residential construction loans (including land acquisition and development loans) and $89.1 million, or 30.8%, consisted of residential mortgages and residential multi-family real estate. The majority of our real property collateral is located in our operating markets in Northern California. The deteriorating economic conditions in California and in our operating markets during the economic downturn of 2007 through 2010, contributed to an overall decline in commercial and residential real estate values. While property values have recovered somewhat, a substantial decline in commercial and residential real estate values in our primary market areas could occur in the future as a result of any deterioration in economic conditions or other events including natural disasters such as earthquakes, droughts, floods, fires, and similar adverse weather occurrences. Such a decline in values could have an adverse impact on us by limiting repayment of defaulted loans through sale of commercial and residential real estate collateral and by a likely increase in the number of defaulted loans to the extent that the financial condition of our borrowers is adversely affected by such a decline in values.

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·Our allowance for loan and lease losses may not be adequate to cover actual losses.

Like all financial institutions, the Bank maintains an allowance for loan and lease losses to provide for loan defaults and non-performance, but its allowance for loan and lease losses may not be adequate to cover actual loan and lease losses. In addition, future provisions for loan and lease losses could materially and adversely affect the Bank’s and therefore our Company’s operating results. The adequacy of the Bank’s allowance for loan and lease losses is based on prior experience, as well as an evaluation of the risks in the current portfolio. The amount of realizable future losses is susceptible to changes in economic, operating and other conditions, including changes in the local and general California real estate market and operating environment, as well as interest rates, employment levels and other economic factors that may be beyond our control, and these losses may exceed current estimates.

 

Federal regulatory agencies, as an integral part of the examination process, review the Bank’s loans and leases and allowance for loan and lease losses, as well as management’s policies and procedures for determining the adequacy of the allowance for loan and lease losses. We believe that our allowance for loan and lease losses policies are effective and that our allowance for loan and lease losses is adequate to cover current probable incurred losses. However, the Bank may have to further increase the allowance for loan and lease losses as a result of the effects of deterioration of economic conditions nationally and in the operating markets in which the Bank conducts business and/or as a result of changes in regulation or accounting methodologies.

·Our focus on lending to small to mid-sized community-based businesses may increase our credit risk.

As of December 31, 2016, our largest outstanding commercial business loan and largest outstanding commercial real estate loan amounted to $5.5 million and $6.0 million, respectively. At such date, our commercial real estate loans amounted to $191.1 million, or 58.1% of our total loan and lease portfolio, and our commercial business loans amounted to $35.4 million, or 10.7% of our total loan and lease portfolio. Commercial real estate and commercial business loans generally are considered riskier than single-family residential loans because they have larger balances to a single borrower or group of related borrowers. Commercial real estate and commercial business loans involve risks because the borrowers’ ability to repay the loans typically depends primarily on the successful operation of the businesses or the properties securing the loans. Most of the Bank’s commercial real estate and commercial business loans are made to small business or middle market customers who may have a heightened vulnerability to economic conditions. Moreover, a portion of these loans have been made by us in recent years and the borrowers may not have experienced a complete business or economic cycle. Furthermore, the deterioration of our borrowers’ businesses may hinder their ability to repay their loans with us, which could adversely affect our results of operations.

·Our business is subject to interest rate risk, and variations in interest rates may negatively affect our financial performance.

Changes in the interest rate environment may reduce our net interest income. It is expected that we will continue to realize income from the differential or “margin” between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. Net interest margins are affected by the difference between the maturities and repricing characteristics of interest-earning assets and interest-bearing liabilities. In addition, loan volume and yields are affected by market interest rates on loans, and rising interest rates generally are associated with a lower volume of loan originations. We may be unable to minimize our interest rate risk. In addition, an increase in the general level of interest rates may adversely affect the ability of certain borrowers to pay the interest on and principal of their obligations. Accordingly, changes in levels of market interest rates could materially and adversely affect our net interest margin, asset quality, and loan origination volume.

·Governmental fiscal and monetary policies may affect our business and are beyond our control.

The business of banking is affected significantly by the fiscal and monetary policies of the federal government and its agencies. Such policies are beyond our control. We are particularly affected by the policies established by the Federal Reserve Board in relation to the supply of money and credit in the United States. The instruments of monetary policy available to the Federal Reserve Board can be used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits, and this can and does have a material effect on our business. The deterioration in economic conditions during the period of 2007 through 2010 resulted in government intervention and legislation intended to stabilize the U.S. financial system. Despite some improvement in economic conditions, the sustainability of the economic recovery is uncertain and a deterioration of economic conditions could result in further intervention and legislation beyond our control. Such deterioration could also limit our access to capital or sources of liquidity in amounts and at times necessary to conduct operations in compliance with applicable regulatory requirements.

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·The Bank faces strong competition from banks, financial service companies and other companies that offer banking services, which could adversely affect our business.

Increased competition in our market may result in reduced loans and deposits or the rates charged or paid on these instruments and adversely affect our net interest margin. Ultimately, we may not be able to compete successfully against current and future competitors. Many competitors offer similar banking services compared to those that are offered by the Bank in its service area. These competitors include national and super-regional banks, finance companies, investment banking and brokerage firms, credit unions, government-assisted farm credit programs, other community banks and technology-oriented financial institutions offering online services. In particular, the Bank’s competitors include several major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns. Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits than we do and are thereby better able to serve the credit needs of larger customers. Areas of competition include interest rates for loans and deposits, efforts to obtain loans and deposits, as well as the range and quality of products and services provided, including new technology-driven products and services. Technological innovation continues to contribute to greater competition in domestic and international financial services markets as technological advances, such as Internet-based banking services that cross traditional geographic bounds, enable more companies to provide financial services. If the Bank is unable to attract and retain banking customers, we may be unable to maintain our historical levels of loans and leases and deposits or our net interest margin.

 

·Our operations are dependent upon key personnel.

Our future prospects are and will remain highly dependent on our directors, executive officers and other key personnel. Our success will, to some extent, depend on the continued service of our directors and continued employment of the executive officers, in addition to our ability to attract and retain experienced banking professionals to serve us and the Bank in other key positions. The unexpected loss of the services of any of these individuals could have a detrimental effect on our business.

 

·Technology implementation problems or computer system failures could adversely affect us.

Our future growth prospects will be highly dependent on the ability of the Bank to implement changes in technology that affect the delivery of banking services such as the increased demand for computer access to bank accounts and the availability to perform banking transactions electronically. The Bank’s ability to compete will depend upon its ability to continue to adapt technology on a timely and cost-effective basis to meet such demands. In addition, our business and operations and those of the Bank could be susceptible to adverse effects from computer failures, communication and energy disruption, and activities such as fraud of unethical individuals with the technological ability to cause disruptions or failures of the Bank’s data processing system.

 

·Cybersecurity breaches or other technological difficulties could adversely affect us.

We cannot be certain that the continued implementation of safeguards will eliminate the risk of vulnerability to technological difficulties or failures or ensure the absence of a breach of information security, including as a result of cybersecurity breach.  The FDIC highlighted in its Supervisory Insights publication that cybersecurity is a critical challenge facing the financial services industry and that the frequency and sophistication of cyber-attacks are increasing. The Bank will continue to enhance its information security programs consistent with regulatory requirements including reliance on the services of various vendors who provide data processing and communication services to the financial services industry.  Nonetheless, if information security is compromised or other technology difficulties or failures occur at the Bank or with one of our vendors, information may be lost or misappropriated, services and operations may be interrupted and the Bank could be exposed to claims from its customers as a result.

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·Our controls over financial reporting and related governance procedures may fail or be circumvented.

Management regularly reviews and updates our internal control over financial reporting, disclosure controls and procedures, and corporate governance policies and procedures. We maintain controls and procedures to mitigate risks such as processing system failures or errors and customer or employee fraud, and we maintain insurance coverage for certain of these risks. Any system of controls and procedures, however well designed and operated, is based in part on certain assumptions and provides only reasonable, not absolute, certainty that the objectives of the system will be met. Events could occur which are not prevented or detected by our internal controls, are not insured against, or are in excess of our insurance limits. Any failure or circumvention of our controls and procedures, or failure to comply with regulations related to controls and procedures, could have an adverse effect on our business.

·We may not be successful in raising additional capital needed in the future.

If additional capital is needed in the future as a result of losses, our business strategy or regulatory requirements, our efforts to raise such additional capital may be unsuccessful or shares sold in the future may be sold at prices or on terms that are not equal to or better than the current market price.  The inability to raise additional capital when needed or at prices and terms acceptable to us could adversely affect our ability to implement our business strategies.

 

·The effects of legislation in response to credit conditions may adversely affect us.

Legislation that has or may be passed at the federal level and/or by the State of California in response to conditions affecting credit markets could cause us to experience higher credit losses if such legislation reduces the amount that the Bank’s borrowers are otherwise contractually required to pay under existing loan contracts. Such legislation could also result in the imposition of limitations upon the Bank’s ability to foreclose on property or other collateral or make foreclosure less economically feasible. Such events could result in increased loan and lease losses and require a material increase in the allowance for loan and lease losses.

·The effects of changes to FDIC insurance coverage limits and assessments are uncertain and increased premiums may adversely affect us.

FDIC insurance premium assessments are uncertain and increased premium assessments may adversely affect our earnings. The FDIC charges insured financial institutions premiums to maintain the Deposit Insurance Fund (“DIF”). Bank failures increased significantly during the economic downturn causing the FDIC to take control of failed institutions and guarantee payment from the DIF up to the insured limit for deposits held at such failed institutions. The sustainability of the economic recovery is uncertain and a deterioration of economic conditions may cause losses which require premium increases to replenish the DIF.

On November 9, 2010, the FDIC issued a final rule implementing section 343 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) that made permanent a $250,000 deposit insurance limit per depositor. In addition, the Dodd-Frank Act also made other deposit insurance changes which may affect our insurance premium assessments to include (i) amendment of the assessment base used to calculate an insured depository institution’s deposit insurance premiums paid to the DIF by elimination of deposits and substitution of average consolidated total assets less average tangible equity during the assessment period as the revised assessment base; (ii) increasing the minimum designated reserve ratio of the DIF; (iii) eliminating the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds; and (iv) repeal of the prohibition upon the payment of interest on demand deposits to be effective one year after the date of enactment of the Dodd-Frank Act.

On November 18, 2014, the FDIC adopted the Assessments Final Rule which revises the FDIC’s risk-based deposit insurance assessment system to reflect changes in the regulatory capital rules that were effective commencing January 1, 2015. For smaller financial institutions such as the Bank (with total assets less than $1 billion and which are not custodial banks), the Final Rule revises and conforms capital ratios and ratio thresholds to the new prompt corrective action capital ratios and ratio thresholds for “well capitalized” and “adequately capitalized” evaluations which were adopted by the federal banking agencies as part of the so-called Basel III capital regulations.

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Although American River Bank’s recent assessments have declined as a result of the change to the deposit assessment system, it is uncertain what effect the implementation of the changes to the insurance assessments will have upon the Company’s costs of operations in the future, but a deterioration in the economic conditions impacting financial institutions or a significant number of failed institutions might necessitate increases in premium assessments to maintain the DIF which could adversely impact the Company’s earnings.

·In the future we may be required to recognize impairment with respect to investment securities, including the FHLB stock we hold.

Our securities portfolio currently includes securities with unrecognized losses.  We may continue to observe declines in the fair market value of these securities.  We evaluate the securities portfolio for any other than temporary impairment each reporting period, as required by generally accepted accounting principles, and as of December 31, 2016, we did not recognize any securities as other than temporarily impaired.  Future evaluations of the securities portfolio may require us to recognize an impairment charge with respect to these and other holdings. In addition, as a condition to membership in the Federal Home Loan Bank of San Francisco (the “FHLB”), we are required to purchase and hold a certain amount of FHLB stock. Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB. At December 31, 2016, we held stock in the FHLB totaling $3.8 million. The FHLB stock held by us is carried at cost and is subject to recoverability testing under applicable accounting standards. The FHLB currently distributes cash dividends on its shares, however, past dividend paying practices are not a guarantee of future dividends. To date, we have not recognized any impairment charges related to our FHLB stock holdings. Any future negative changes to the financial condition of the FHLB may require us to recognize an impairment charge with respect to such holdings.

·If the goodwill we have recorded in connection with our acquisition of Bank of Amador becomes impaired, it could have an adverse impact on our earnings and capital.

At December 31, 2016, we had approximately $16.3 million of goodwill on our balance sheet attributable to our merger with Bank of Amador in December 2004. In accordance with accounting principles generally accepted in the United States of America, our goodwill is not amortized but rather evaluated for impairment on an annual basis or more frequently if events or circumstances indicate that a potential impairment exists. Such evaluation is based on a variety of factors, including the quoted price of our common stock, market prices of the common stock of other banking organizations, common stock trading multiples, discounted cash flows, and data from comparable acquisitions. Future evaluations of goodwill may result in findings of impairment and write-downs, which could be material.

·The effects of terrorism and other events beyond our control may adversely affect our results of operations.

 

The terrorist actions on September 11, 2001 and thereafter, as well as the military conflicts in the Middle East, have had significant adverse effects upon the United States economy. Whether 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 us and the extent of such impact is uncertain. Similar events beyond our control including, but not limited to, financial and economic instability and governmental actions in response, natural disasters such as earthquakes, droughts, floods, fires, and similar adverse weather occurrences, disruption of power and energy supplies and communications equipment such as telephones, cellular phones, computers, and other forms of electronic equipment or media, and widespread, adverse public health occurrences, may adversely affect our future results of operations by, among other things, disrupting the conduct of our operations and those of our customers, which could result in a reduction in the demand for loans and other products and services offered by the Bank, increase nonperforming loans and the amounts reserved for loan and lease losses, or cause significant declines in our level of deposits.

 

·Future acquisitions and expansion activities may disrupt our business and adversely affect our operating results.

We regularly evaluate potential acquisitions and expansion opportunities. To the extent that we grow through acquisitions, we cannot ensure that we will be able to adequately or profitably manage this growth. Acquiring other banks, branches or other assets, as well as other expansion activities, involves various risks including the risks of incorrectly assessing the credit quality of acquired assets, encountering greater than expected costs of incorporating acquired banks or branches into the Bank, executing cost savings measures, and being unable to profitably deploy funds in an acquisition.

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·We may raise additional capital, which could have a dilutive effect on the existing holders of our common stock and adversely affect the market price of our common stock.

In December 2009, the Company raised $25.3 million (in gross proceeds) in a public offering of 4,048,000 shares of its common stock at $6.25 per share. Our articles of incorporation, as amended, provide the authority to issue without further shareholder approval, 20,000,000 shares of common stock, no par value per share, of which 6,661,726 shares were issued and outstanding at December 31, 2016. Pursuant to the Company’s 2010 Equity Incentive Plan and its 2000 Stock Option Plan, at December 31, 2016, employees and directors of the Company had outstanding options to purchase 186,023 shares of common stock. As of December 31, 2016, 1,376,819 shares of common stock remained available for awards under the 2010 Equity Incentive Plan.

We are not restricted from issuing additional shares of common stock or securities that are convertible into or exchangeable for, or that represent the right to receive, common stock. We frequently evaluate opportunities to access the capital markets taking into account our regulatory capital ratios, financial condition and other relevant considerations, and subject to market conditions, we may take further capital actions. Such actions could include, among other things, the issuance of additional shares of common stock in public or private transactions in order to further increase our capital levels above the requirements for a well capitalized institution established by the federal bank regulatory agencies as well as other regulatory targets.

The issuance of any additional shares of common stock or securities convertible into or exchangeable for common stock or that represent the right to receive common stock, or the exercise of such securities including, without limitation, securities issued upon exercise of outstanding equity awards under our 2010 Equity Incentive Plan or outstanding options under our 2000 Stock Option Plan, could be substantially dilutive to shareholders of our common stock.  Holders of our shares of common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series and, therefore, such sales or offerings could result in increased dilution to our shareholders.  The market price of our common stock could decline as a result of sales of shares of our common stock or the perception that such sales could occur.

·The price of our common stock may fluctuate significantly, and this may make it difficult for shareholders to resell shares of common stock they own at times or at prices they find attractive.

The stock market and, in particular, the market for financial institution stocks, has experienced significant volatility, which reached unprecedented levels during the economic downturn of 2007 through 2010. In some cases, the markets have produced downward pressure on stock prices for certain issuers without regard to those issuers’ underlying financial strength. Despite the fact that our current stock price may have increased since the economic downturn, there is no certainty that such increase will continue in the future. As a result, the trading volume in our common stock may fluctuate more than usual and cause significant price variations to occur. This may make it difficult for shareholders to resell shares of common stock they own at times or at prices they find attractive. The low trading volume in our common shares on the NASDAQ Global Select Market means that our shares may have less liquidity than other publicly traded companies. We cannot ensure that the volume of trading in our common shares will be maintained or will increase in the future.

The trading price of the shares of our common stock will depend on many factors, which may change from time to time and which may be beyond our control, including, without limitation, our financial condition, performance, creditworthiness and prospects, future sales or offerings of our equity or equity related securities, and other factors identified above in the forward-looking statement discussion in Part I, Item 1 of this Annual Report on Form 10-K under the heading “Cautionary Statements Regarding Forward-Looking Statements” and below. These broad market fluctuations have adversely affected and may continue to adversely affect the market price of our common stock. Among the factors that could affect our stock price are:

 

actual or anticipated quarterly fluctuations in our operating results and financial condition;
changes in financial estimates or publication of research reports and recommendations by financial analysts or actions taken by rating agencies with respect to our common stock or those of other financial institutions;
failure to meet analysts’ revenue or earnings estimates;
23
 
speculation in the press or investment community generally or relating to our reputation, our market area, our competitors or the financial services industry in general;
strategic actions by us or our competitors, such as acquisitions, restructurings, dispositions or financings;
actions by our current shareholders, including sales of common stock by existing shareholders and/or directors and executive officers;
fluctuations in the stock price and operating results of our competitors;
future sales of our equity, equity-related or debt securities;
changes in the frequency or amount of dividends or share repurchases;
proposed or adopted regulatory changes or developments;
anticipated or pending investigations, proceedings, or litigation that involves or affects us;
trading activities in our common stock, including short-selling;
domestic and international economic factors unrelated to our performance; and
general U.S. and international market conditions and, in particular, developments related to market conditions for the financial services industry.

 

A significant decline in our stock price could result in substantial losses for individual shareholders.

·We may be unable or choose not to pay cash dividends in the foreseeable future.

Our ability to pay dividends on our common stock depends on a variety of factors. On July 27, 2009 we announced suspension of our quarterly dividends and on January 25, 2017, the Company resumed its quarterly cash dividends. The Company relies on distributions from the Bank in the form of cash dividends in order to pay cash dividends to our shareholders. Cash dividends may or may not be paid in the future since they are subject to regulatory restrictions and to evaluation by our Board of Directors of financial factors including, but not limited to, our earnings, financial condition and capital requirements.

·Anti-takeover provisions in our articles of incorporation and bylaws and California law could make a third party acquisition of us difficult.

Our articles of incorporation and bylaws contain provisions that could make it more difficult for a third party to acquire us (even if doing so would be beneficial to our shareholders) and for holders of our common stock to receive any related takeover premium for their common stock. We are also subject to certain provisions of California law that would delay, deter or prevent a change in control of the Company. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock.

·The tax treatment of corporations could be subject to potential legislative, administrative or judicial changes or interpretations, which could adversely affect us.

The present federal income tax treatment of corporations may be modified by legislative, administrative or judicial changes or interpretations at any time. For example, President Trump's administration has indicated it will propose reductions to the corporate statutory tax rate. A decline in the federal corporate tax rate may lower the Company's tax provision expense, however, it may also significantly decrease the value of the Company's deferred tax assets ("DTAs"), which would result in a reduction of net income in the period in which the tax change is enacted. At December 31, 2016, the Company's net DTAs were approximately $4.1 million. As well, if President Trump and Congress approve comprehensive tax reform, the beneficial tax treatment of bank-owned life insurance and interest on municipal bonds and loans, or other current tax positions taken by the Company, could be at risk. We are unable to predict whether any of these changes, or other proposals, will ultimately be enacted, but if enacted, they could adversely impact the Company's earnings.

Item 1B. Unresolved Staff Comments.

None.

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Item 2. Properties.

The Company and American River Bank lease nine and own two of their respective premises. The Company’s headquarters is located at 3100 Zinfandel Drive, Suite 450, Rancho Cordova, California. The office space is located in a six-story office building. The seven (7) year lease term was set to expire on July 31, 2017 but was renewed in 2016 for an additional seventy-nine (79) months to expire on December 31, 2022. The premises consist of approximately 12,218 square feet on the fourth floor of the building. The space is leased from Ethan Conrad Properties, Inc., successor to MSCP Capital Center Investors, LLC PGOCC, LLC, and One Capital Center.

American River Bank’s main office is located at 1545 River Park Drive, Suite 107, Sacramento, California, in a modern, five-story building which has off-street parking for its clients. American River Bank leases premises in the building from Hines VAF II Sacramento Properties, L.P., the successor to Spieker Properties. The lease term is for one-hundred and twenty-seven (127) months and expires on February 28, 2021. The premises consist of 1,643 square feet on the ground floor.

 

American River Bank leases premises at 9750 Business Park Drive, Sacramento, California. The premises are leased from Bradshaw Plaza, Associates, Inc., which is owned in part by Charles D. Fite, a director of the Company. The lease term is three (3) years and expires on November 30, 2017. The premises consist of 3,711 square feet on the ground floor.

American River Bank leases premises at 11220 Gold River Express Drive, Gold River, California. The premises are leased from Gold River Village Associates, a California Limited Partnership. The lease term is one-hundred and twenty-six (126) months and expires on November 30, 2024. The premises consist of 1,650 square feet on the ground floor.

American River Bank leases premises at 2150 Douglas Boulevard, Roseville, California. The premises are leased from DDS Properties, a California General Partnership. The lease term is one hundred and twenty-six (126) months and expires on May 31, 2027. The premises consist of 2,269 square feet on the ground floor.

American River Bank leases premises at 520 Capitol Mall, Sacramento, California. The premises are leased from 520 Capitol Mall, Inc. The lease term is one-hundred and twenty-five (125) months and expires on October 31, 2024. The premises consist of 2,143 square feet on the second floor.

American River Bank (formerly North Coast Bank, a division of American River Bank), owns premises at 412 Center Street, Healdsburg, California. The premises were purchased June 1, 1993. The purchase price for the land and building was $343,849. The building consists of 2,620 square feet. The land consists of 10,835 square feet.

American River Bank (formerly North Coast Bank, a division of American River Bank), leases premises at 90 South E Street, Santa Rosa, California. The premises were subleased from Chicago Title Company through November 11, 2011 and now are leased from 90 E Street, LLC until January 31, 2019. The combined sublease and lease term is ten (10) years and expires on January 31, 2019. The premises consist of 3,600 square feet on the ground floor.

American River Bank leases premises at 422 Sutter Street, Jackson, California. The premises are leased from the United States Postal Service. The lease term is one (1) year and expires on May 31, 2017 and the premises consisted of 3,600 square feet on the ground floor.

American River Bank (formerly Bank of Amador, a division of American River Bank), leases premises at 26395 Buckhorn Ridge Road, Pioneer, California. The premises are leased from Joseph T. Bellamy, Trustee of the Joseph T. Bellamy 2005 Trust. The lease term is ten (10) years and expires on October 31, 2017. The premises consist of 1,757 square feet of office space on the ground floor, an attached garage consisting of approximately 400 square feet and 1,223 feet of office space on the second floor.

American River Bank, owns premises at 66 Main Street, Ione, California. The premises were purchased April 1, 1995. The purchase price for the land and building was $167,500. The building consists of 2,576 square feet. The land consists of 9,700 square feet.

The leases on the premises located at 1545 River Park Drive, 2150 Douglas Boulevard, 90 South E Street, 26395 Buckhorn Ridge Road, 11220 Gold River Express Drive, 520 Capitol Mall, 422 Sutter Street, and 3100 Zinfandel Drive, contain options to extend for five years. Included in the above premises is a facility leased from a current director of the Company at terms and conditions which management believes are consistent with the commercial lease market. The foregoing summary descriptions of leased premises are qualified in their entirety by reference to the lease agreements listed as exhibits in Part IV, Item 15 of this Annual Report on Form 10-K.

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Item 3. Legal Proceedings.

There are no material legal proceedings adverse to the Company and its subsidiaries to which any director, officer, affiliate of the Company, or 5% shareholder of the Company or its subsidiaries, or any associate of any such director, officer, affiliate or 5% shareholder of the Company or its subsidiaries are a party, and none of the above persons has a material interest adverse to the Company or its subsidiaries.

From time to time, the Company and/or its subsidiaries may be a party to claims and legal proceedings arising in the ordinary course of business. The Company’s management is not aware of any pending legal proceedings to which either it or its subsidiaries may be a party or has recently been a party, which will have a material adverse effect on the financial condition or results of operations of the Company or its subsidiaries.

 

Item 4. Mine Safety Disclosures.

Not applicable.

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Market Information

The Company’s common stock began trading on the NASDAQ National Stock Market (“Nasdaq”) under the symbol “AMRB” on October 26, 2000. Effective July 3, 2006, the Company’s common stock became listed and traded on the Nasdaq Global Select Market. The following table shows the high and the low prices for the common stock, for each quarter during 2016 and 2015, as reported by Nasdaq.

2016 High Low
First quarter                       10.98 9.71
Second quarter                   10.97 9.69
Third quarter                     10.91 10.15
Fourth quarter                   15.99 10.59
     
2015    
First quarter                       9.98 9.23
Second quarter                   9.95 9.10
Third quarter                     10.35 9.15
Fourth quarter                   11.19 9.40

The closing price for the Company’s common stock on February 22, 2017 was $15.35.

 

Holders

As of February 16, 2017, there were approximately 2,250 shareholders of record of the Company’s common stock.

Dividends

The Company paid quarterly cash dividends on its common stock from the first quarter of 2004 through the second quarter of 2009. Prior to that, the Company paid cash dividends twice a year since 1992. On July 27, 2009, the Company announced that the Board of Directors had suspended the payment of cash dividends, until such time that it was prudent to reestablish the payment of cash dividends. On January 25, 2017, the Board reinstated the quarterly cash dividend. The Company relies on distributions from the Bank in the form of cash dividends in order to pay cash dividends to our shareholders. In 2016 and 2015, there were no cash dividends paid to our shareholders. It is uncertain whether any dividends will continue to be paid in the future since they are subject to regulatory and statutory restrictions and the evaluation by the Company’s Board of Directors of financial factors including, but not limited to earnings, financial condition and capital requirements of the Company and its subsidiaries.

As a California corporation, the Company’s ability to pay cash dividends is subject to restrictions set forth in the California General Corporation Law (the “Corporation Law”). The Corporation Law provides that neither a corporation nor any of its subsidiaries shall make a distribution to the corporation’s shareholders unless the board of directors has determined in good faith either of the following: (1) the amount of retained earnings of the corporation immediately prior to the distribution equals or exceeds the sum of (A) the amount of the proposed distribution plus (B) the preferential dividends arrears amount; or (2) immediately after the distribution, the value of the corporation’s assets would equal or exceed the sum of its total liabilities plus the preferential rights amount. The good faith determination of the board of directors may be based upon (1) financial statements prepared on the basis of reasonable accounting practices and principles, (2) a fair valuation, or (3) any other method reasonable under the circumstances; provided, that a distribution may not be made if the corporation or subsidiary making the distribution is, or is likely to be, unable to meet its liabilities (except those whose payment is otherwise adequately provided for) as they mature.

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The term “preferential dividends arrears amount” means the amount, if any, of cumulative dividends in arrears on all shares having a preference with respect to payment of dividends over the class or series to which the applicable distribution is being made, provided that if the articles of incorporation provide that a distribution can be made without regard to preferential dividends arrears amount, then the preferential dividends arrears amount shall be zero.

 

The term “preferential rights amount” means the amount that would be needed if the corporation were to be dissolved at the time of the distribution to satisfy the preferential rights, including accrued but unpaid dividends, of other shareholders upon dissolution that are superior to the rights of the shareholders receiving the distribution, provided that if the articles of incorporation provide that a distribution can be made without regard to any preferential rights, then the preferential rights amount shall be zero.

The Board of Governors generally prohibits a bank holding company from declaring or paying a cash dividend which would impose undue pressure on the capital of subsidiary banks or would be funded only through borrowing or other arrangements that might adversely affect a bank holding company’s financial position. The Board of Governors’ policy is that a bank holding company should not continue its existing rate of cash dividends on its common stock unless its net income is sufficient to fully fund each dividend and its prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition.

The payment of cash dividends by American River Bank is subject to restrictions set forth in the California Financial Code (the “Financial Code”). The Financial Code provides that a bank may not make a cash distribution to its shareholders in excess of the lesser of (a) the bank’s retained earnings; or (b) the bank’s net income for its last three fiscal years, less the amount of any distributions made by the bank or by any majority-owned subsidiary of the bank to the shareholders of the bank during such period. However, a bank may, with the approval of the Commissioner, make a distribution to its shareholders in an amount not exceeding the greater of (a) its retained earnings; (b) its net income for its last fiscal year; or (c) its net income for its current fiscal year. In the event that the Commissioner determines that the shareholders’ equity of a bank is inadequate or that the making of a distribution by the bank would be unsafe or unsound, the Commissioner may order the bank to refrain from making a proposed distribution.

The FDIC may also restrict the payment of dividends by a subsidiary bank if such payment would be deemed unsafe or unsound or if after the payment of such dividends, the bank would be included in one of the “undercapitalized” categories for capital adequacy purposes pursuant to the FDIC Improvement Act of 1991.

Stock Repurchases

On January 20, 2016, the Company approved and authorized a stock repurchase program for 2016 (the “2016 Program”). The 2016 Program authorized the repurchase during 2016 of up to 5% of the outstanding shares of the Company’s common stock. In addition, on April 20, 2016, the Company approved and authorized an additional amount of 5% to be purchased under the 2016 Program. During 2016, the Company repurchased 716,897 shares of its common stock at an average price of $10.34 per share. Repurchases under the 2016 Program were made from time to time by the Company in the open market. All such transactions were structured to comply with Securities and Exchange Commission Rule 10b-18 and all shares repurchased under the 2016 Program were retired.

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The following table lists shares repurchased during the quarter ended December 31, 2016 and the maximum amount available to repurchase under the repurchase plan. As a result of the completion of the 2016 Program, there is no data to report in the table below.

Period (a)
Total Number of Shares (or Units) Purchased

(b)

Average Price Paid Per Share

(or Unit)

(c)
Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs
(d)
Maximum Number (or Approximate Dollar Value) of Shares (or Units) That May Yet Be Purchased Under the Plans or Programs
Month #1
October 1 through
October 31, 2016
Month #2
November 1 through
November 30, 2016
Month #3
December 1 through
December 31, 2016
Total N/A

 

The Company repurchased 790,989 shares in 2015, 424,462 shares in 2014, 849,404 shares in 2013, and 575,389 shares in 2012 and did not repurchase any of its shares in 2011 or 2010. Share amounts have been adjusted for stock dividends and/or splits.

On January 25, 2017, the Company approved and authorized a stock repurchase program for 2017 (the “2017 Program”). The 2017 Program authorized the repurchase during 2017 of up to 5% of the outstanding shares of the Company’s common stock, or approximately 333,086 shares based on the 6,661,726 shares outstanding as of December 31, 2016. Any repurchases under the 2017 Program will be made from time to time by the Company in the open market as conditions allow. All such transactions will be structured to comply with Commission Rule 10b-18 and all shares repurchased under the 2017 Program will be retired. The number, price and timing of the repurchases will be at the Company’s sole discretion and the 2017 Program may be re-evaluated depending on market conditions, capital and liquidity needs or other factors. Based on such re-evaluation, the Board of Directors may suspend, terminate, modify or cancel the 2017 Program at any time without notice.

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Item 6. Selected Financial Data.

 

FINANCIAL SUMMARY-The following table presents certain consolidated financial information concerning the business of the Company and its subsidiaries. This information should be read in conjunction with the Consolidated Financial Statements, the notes thereto, and Management’s Discussion and Analysis included in this report. All per share data has been retroactively restated to reflect stock dividends and stock splits.

As of and for the Years Ended December 31,

(In thousands, except per share amounts and ratios)

   2016   2015   2014   2013   2012 
Operations Data:                         
Net interest income  $20,243   $20,007   $18,797   $17,391   $19,405 
Provision for loan and lease losses   (1,344)       (541)   200    1,365 
Noninterest income   2,045    2,015    2,177    2,015    2,774 
Noninterest expenses   13,836    14,080    14,862    14,891    16,747 
Income before income taxes   9,796    7,942    6,653    4,315    4,067 
Income tax expense   3,392    2,674    2,292    1,258    860 
Net income  $6,404   $5,268   $4,361   $3,057   $3,207 
                          
Share Data:                         
Earnings per share – basic  $0.95   $0.70   $0.54   $0.34   $0.34 
Earnings per share – diluted  $0.94   $0.70   $0.54   $0.34   $0.34 
Cash dividends per share (1)  $0.00   $0.00   $0.00   $0.00   $0.00 
Book value per share  $12.59   $11.72   $11.08   $10.25   $10.08 
Tangible book value per share  $10.14   $9.50   $9.06   $8.33   $8.33 
                          
Balance Sheet Data:                         
Assets  $651,450   $634,640   $617,754   $592,753   $596,389 
Loans and leases, net   324,086    289,102    258,057    251,747    252,118 
Deposits   544,806    530,690    510,693    483,690    478,256 
Shareholders’ equity   83,850    86,075    89,647    87,020    93,994 
                          
Financial Ratios:                         
Return on average equity   7.60%   6.03%   4.98%   3.38%   3.42%
Return on average tangible equity   9.43%   7.42%   6.12%   4.13%   4.15%
Return on average assets   1.00%   0.85%   0.72%   0.52%   0.55%
Efficiency ratio (2)   60.81%   62.87%   69.96%   75.61%   73.69%
Net interest margin (2) (3)   3.62%   3.63%   3.54%   3.45%   3.91%
Net loans and leases to deposits   59.49%   54.48%   50.53%   52.05%   52.72%
Net (recoveries) charge-offs to average loans & leases   (0.39%)   0.12%   (0.20%)   0.25%   0.93%
Nonperforming loans and leases to total loans and leases (4)   0.01%   0.56%   0.63%   0.77%   2.12%
Allowance for loan and lease losses to total loans and leases   1.47%   1.69%   2.01%   2.08%   2.24%
Average equity to average assets   13.20%   14.02%   14.47%   15.31%   15.97%
Dividend payout ratio (1)   0%   0%   0%   0%   0%
                          
Capital Ratios:                         
Leverage capital ratio   10.50%   10.97%   11.60%   11.88%   12.82%
Tier 1 risk-based capital ratio   19.02%   19.34%   21.60%   21.95%   23.87%
Total risk-based capital ratio   20.27%   20.59%   22.85%   23.20%   25.13%
                          
(1)On January 25, 2017, the Company reinstated the payment of quarterly cash dividends.
(2)Fully taxable equivalent.
(3)Excludes the amortization of intangible assets.
(4)Nonperforming loans and leases consist of loans and leases past due 90 days or more and still accruing and nonaccrual loans and leases.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Cautionary Statements Regarding Forward-Looking Statements

Certain matters discussed or incorporated by reference in this Annual Report on Form 10-K including, but not limited to, matters described in “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations,” are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, Section 27A of the Securities Act of 1933, as amended, and subject to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may contain words related to future projections including, but not limited to, words such as “believe,” “expect,” “anticipate,” “intend,” “may,” “will,” “should,” “could,” “would,” and variations of those words and similar words that are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those projected. Factors that could cause or contribute to such differences include, but are not limited to, the following: (1) legislation promulgated by the United States Congress and actions taken by governmental agencies that may impact the U.S. financial system; (2) the risks presented by economic volatility and recession, which could adversely affect credit quality, collateral values, including real estate collateral, investment values, liquidity and loan originations and loan portfolio delinquency rates; (3) variances in the actual versus projected growth in assets and return on assets; (4) potential loan and lease losses; (5) potential expenses associated with resolving nonperforming assets as well as regulatory changes; (6) changes in the interest rate environment including interest rates charged on loans, earned on securities investments and paid on deposits and other borrowed funds; (7) competitive effects; (8) potential declines in fee and other noninterest income earned associated with economic factors, as well as regulatory changes; (9) general economic conditions nationally, regionally, and within our operating markets could be less favorable than expected or could have a more direct and pronounced effect on us than expected and adversely affect our ability to continue internal growth at historical rates and maintain the quality of our earning assets; (10) changes in the regulatory environment including increased capital and regulatory compliance requirements and government intervention in the U.S. financial system; (11) changes in business conditions and inflation; (12) changes in securities markets, public debt markets, and other capital markets; (13) potential data processing, cybersecurity and other operational systems failures, breach or fraud; (14) potential decline in real estate values in our operating markets; (15) the effects of uncontrollable events such as terrorism, the threat of terrorism or the impact of military conflicts in connection with the conduct of the war on terrorism by the United States and its allies, negative financial and economic conditions, natural disasters, and disruption of power supplies and communications; (16) changes in accounting standards, tax laws or regulations and interpretations of such standards, laws or regulations; (17) projected business increases following any future strategic expansion could be lower than expected; (18) the goodwill we have recorded in connection with acquisitions could become impaired, which may have an adverse impact on our earnings; (19) the reputation of the financial services industry could experience deterioration, which could adversely affect our ability to access markets for funding and to acquire and retain customers; and (20) the efficiencies we may expect to receive from any investments in personnel and infrastructure may not be realized.

 

The factors set forth under “Item 1A - Risk Factors” in this report and other cautionary statements and information set forth in this report should be carefully considered and understood as being applicable to all related forward-looking statements contained in this report, when evaluating the business prospects of the Company and its subsidiaries.

 

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

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Use of Non-GAAP Financial Measures

 

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

 

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

 

In accordance with industry standards, certain designated net interest income amounts are presented on a taxable equivalent basis, including the calculation of net interest margin and the efficiency ratio.  The Company believes the presentation of net interest margin on a taxable equivalent basis using a 34% effective tax rate allows comparability of net interest margin with industry peers by eliminating the effect of the differences in portfolios attributable to the proportion represented by both taxable and tax-exempt loans and investments. The efficiency ratio is a measure of a banking company’s overhead as a percentage of its revenue. The Company derives this ratio by dividing total noninterest expense by the sum of the taxable equivalent net interest income and the total noninterest income.

 

Tangible Equity (non-GAAP financial measures)

 

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

Critical Accounting Policies

General

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. We use historical loss data 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 factors that we use. 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 probable credit losses inherent in the Company’s credit portfolio that have been incurred as of the balance-sheet date. The allowance is based on two basic principles of accounting: (1) “Accounting for Contingencies,” which requires that losses be accrued when it is probable that a loss has occurred at the balance sheet date and such loss can be reasonably estimated; and (2) the “Receivables” topic, which requires that losses be accrued on impaired loans based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

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

Stock-Based Compensation

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

31
 

Goodwill  

 

Business combinations involving the Company’s acquisition of equity interests or net assets of another enterprise or the assumption of net liabilities in an acquisition of branches constituting a business may give rise to goodwill. Goodwill represents the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed. The value of goodwill is ultimately derived from the Company’s ability to generate net earnings after the acquisition and is not deductible for tax purposes. A decline in net earnings could be indicative of a decline in the fair value of goodwill and result in impairment. For that reason, goodwill is assessed for impairment at least annually. Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value. At December 31, 2016, the Company’s reporting unit had positive equity and the Company elected to perform a qualitative assessment to determine if it was more likely than not that the fair value of the reporting unit exceeded its carrying value, including goodwill. The qualitative assessment indicated that it was more likely than not that the fair value of the reporting unit exceeded its carrying value, resulting in no impairment.

 

Income Taxes

 

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

The Company accounts for income taxes using the balance sheet method, under which deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. On the consolidated balance sheet, net deferred tax assets are included in accrued interest receivable and other assets. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets will not be realized.  The Company conducted an analysis to assess the need for a valuation allowance at December 31, 2016, and determined that no valuation allowance was required. As part of this assessment, all available evidence, including both positive and negative, was considered to determine whether based on the weight of such evidence, a valuation allowance on the Company’s deferred tax assets was needed. A valuation allowance is deemed to be needed when, based on the weight of the available evidence, it is more likely than not (a likelihood of more than 50 percent) that some portion or all of a deferred tax asset will not be realized. The future realization of the deferred tax asset depends on the existence of sufficient taxable income within the carryback and carry forward periods.

The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any.  Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Only tax positions that meet the more-likely-than-not recognition threshold are recognized. The election has been made to record interest expense related to tax exposures in tax expense, if applicable, and the exposure for penalties related to tax exposures in tax expense, if applicable.

Overview

 

The Company recorded net income in 2016 of $6,404,000, an increase of $1,136,000 (21.6%) from $5,268,000 in 2015. Diluted earnings per share were $0.94 for 2016 and $0.70 for 2015. For 2016, the Company realized a return on average equity of 7.60% and a return on average assets of 1.00%, as compared to 6.03% and 0.85%, respectively, in 2015.

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Net income for 2015 increased $907,000 (20.8%) from $4,361,000 in 2014. Diluted earnings per share for 2014 were $0.54. For 2014, the Company realized a return on average equity of 4.98% and return on average assets of 0.72%. Table One below provides a summary of the components of net income for the years indicated (dollars in thousands):

 

Table One: Components of Net Income

 

             
   2016   2015   2014 
Interest income*  $21,618   $21,340   $20,242 
Interest expense   (910)   (961)   (1,168)
Net interest income*   20,708    20,379    19,074 
Provision for loan and lease losses   1,344        541 
Noninterest income   2,045    2,015    2,177 
Noninterest expense   (13,836)   (14,080)   (14,862)
Provision for income taxes   (3,392)   (2,674)   (2,292)
Tax equivalent adjustment   (465)   (372)   (277)
Net income  $6,404   $5,268   $4,361 
                
Average total assets  $638,276   $623,049   $605,247 
Net income as a percentage of average total assets   1.00%   0.85%   0.72%

* Fully taxable equivalent basis (FTE)

 

Under accounting principles generally accepted in the United States of America all share and per share data is adjusted for stock dividends and stock splits. There were no stock dividends or stock splits in 2016, 2015 or 2014.

During 2016, total assets of the Company increased $16,810,000 (2.6%) from $634,640,000 at December 31, 2015 to $651,450,000 at December 31, 2016. At December 31, 2016, net loans totaled $324,086,000, up $34,984,000 (12.1%) from the ending balance of $289,102,000 at December 31, 2015. Deposits increased $14,116,000 or 2.7% from $530,690,000 at December 31, 2015 to $544,806,000 at December 31, 2016. Shareholders’ equity decreased $2,225,000 or 2.6% from $86,075,000 at December 31, 2015 to $83,850,000 at December 31, 2016. The Company ended 2016 with a leverage capital ratio of 10.5% and a total risk-based capital ratio of 20.3% compared to a leverage capital ratio of 11.0% and a total risk-based capital ratio of 20.6% at the end of 2015.

 

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, securities, Federal funds sold and interest-bearing deposits in other banks) 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 fully taxable equivalent net interest margin was 3.62% in 2016, 3.63% in 2015, and 3.54% in 2014. The fully taxable equivalent net interest income was up $329,000 (1.6%), from $20,379,000 in 2015 to $20,708,000 in 2016. The fully taxable equivalent net interest income was up $1,312,000 (6.9%), from $19,067,000 in 2014 to $20,379,000 in 2015.

 

The fully taxable equivalent interest income component increased $278,000 (1.3%) from $21,340,000 in 2015 to $21,618,000 in 2016. The increase in the fully taxable equivalent interest income for 2016 compared to the same period in 2015 is comprised of two components - rate (down $613,000) and volume (up $891,000). The rate decrease primarily occurred in the loan portfolio. While average loans increased by $27,009,000 (9.7%) from $279,728,000 during 2015 to $306,737,000 during 2016, due to the overall lower interest rate environment, the new loans added were at lower yields than the existing loans. Yield on loans decreased from 5.01% in 2015 to 4.88% in 2016 and contributed to a decrease of $399,000 in loan interest income. The investment portfolio also contributed to the decrease in interest income. The yield on the investments decreased from 2.60% in 2015 to 2.51% in 2016 and contributed to a decrease of $217,000 in interest income. This decrease in investment income due to rates can also be attributed to the lower overall rate environment as proceeds from paid down securities were invested at lower rates. The volume increase of $891,000 was primarily from the increase of $1,346,000 in average loans mentioned above and partially offset by a decrease of $454,000 in investments. When compared to 2015, average investment securities decreased $17,168,000 (6.1%) from $281,344,000 in 2015 compared to $264,176,000 in 2016, as a portion of these funds helped fund the increase in loans.

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The fully taxable equivalent interest income component increased $1,098,000 (5.4%) from $20,242,000 in 2014 to $21,340,000 in 2015. The increase in the fully taxable equivalent interest income for 2015 compared to the same period in 2014 is comprised of two components - rate (down $285,000) and volume (up $1,383,000). The rate decrease primarily occurred in the loan portfolio. While average loans increased by $25,830,000 (10.2%) from $253,898,000 during 2014 to $279,728,000 during 2015, due to the overall lower interest rate environment, the new loans added were at lower yields than the existing loans. Yield on loans decreased from 5.37% in 2014 to 5.01% in 2015 and contributed to a decrease of $1,076,000 in loan interest income. The decrease of $1,076,000 in interest income created from the decrease in rates on the loan balances was partially offset by an increase in rates on the investment portfolio resulting in an increase of $790,000 related to the investments. This increase in investment income due to rates can be attributed to a slowdown in the mortgage refinance market. As mortgage refinancing slows it also reduces the principal prepayments that the Company receives on the mortgage backed securities, which reduces the premium amounts amortized on the bonds. A lower amount of amortized premium results in higher interest income. The volume increase of $1,383,000 was primarily from the increase of $1,466,000 in average loans mentioned above and partially offset by a decrease of $83,000 in investments. When compared to 2014, average investment securities decreased $3,092,000 (1.1%) from $284,436,000 in 2014 compared to $281,344,000 in 2015.

Interest expense was $51,000 (5.3%) lower in 2016 compared to 2015, decreasing from $961,000 to $910,000. The primary decrease in interest expense relates to lower rates (down $53,000). Rates paid on interest bearing liabilities decreased one basis point from 0.27% to 0.26% in 2015 compared to 2014. The average balances on interest bearing liabilities were $351,095,000 (or $4,957,000 and 1.4% lower) in 2016 compared to $356,052,000 in 2015. Despite the slightly lower average balances, the Company experienced a slight increase in interest expense of $2,000 due to volume as a result of an increase in the higher cost other borrowings which increased from $14,092,000 in 2015 to $17,201,000 in 2016 and had a $32,000 impact on the increase in interest expense due to volume. This increase was offset by a decrease in interest expense of $30,000 related to deposit balances.

Interest expense was $207,000 (17.7%) lower in 2015 compared to 2014, decreasing from $1,168,000 to $961,000. The primary decrease in interest expense relates to lower rates (down $222,000). Rates paid on interest bearing liabilities decreased six basis points from 0.33% to 0.27% in 2014 compared to 2015. The average balances on interest bearing liabilities were $356,052,000 (or $180,000 and 0.1% higher) in 2015 compared to $355,872,000 in 2014. The higher balances had only a slight impact on the overall interest expense.

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 past 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), computed on a daily average basis, and changes in average interest rates.

34
 

Table Two: Analysis of Net Interest Margin on Earning Assets

 

 

Year Ended December 31,   2016     2015     2014  
(Taxable Equivalent Basis)
(dollars in thousands)
  Avg
Balance
     Interest     Avg
Yield
    Avg
Balance
     Interest     Avg
Yield
    Avg
Balance
     Interest     Avg
Yield
 
Assets:                                                                        
Earning assets:                                                                        
Taxable loans and leases (1)   $ 289,699     $ 14,008       4.84 %   $ 270,267     $ 13,547       5.01 %   $ 253,434     $ 13,609       5.37 %
Tax-exempt loans and leases (2)     17,038       967       5.68 %     9,461       481       5.08 %     464       29       6.25 %
Taxable investment Securities     240,149       5,755       2.40 %     255,137       6,280       2.46 %     257,308       5,528       2.15 %
Tax-exempt investment securities (2)     23,952       867       3.62 %     26,128       1,015       3.88 %     27,051       1,057       3.91 %
Corporate stock     75       14       18.67 %     79       12       15.19 %     77       15       19.48 %
Federal funds sold                                                      
Interest bearing deposits in other banks     996       7       0.70 %     994       5       0.50 %     1,000       4       0.40 %
Total earning assets     571,909       21,618       3.78 %     562,066       21,340       3.80 %     539,334       20,242       3.75 %
Cash & due from banks     33,806                       26,313                       28,533                  
Other assets     37,753                       39,941                       42,924                  
Allowance for loan & lease losses     (5,192 )                     (5,271 )                     (5,544 )                
                                                                         
    $ 638,276                     $ 623,049                     $ 605,247                  
                                                                         
Liabilities & Shareholders’ Equity:                                                                        
Interest bearing liabilities:                                                                        
NOW & MMDA   $ 190,237       146       0.08 %   $ 196,120       244       0.12 %   $ 201,412       420       0.21 %
Savings     60,543       19       0.03 %     58,910       29       0.05 %     53,806       40       0.07 %
Time deposits     83,114       565       0.68 %     86,930       544       0.63 %     89,392       561       0.63 %
Other borrowings     17,201       180       1.05 %     14,092       144       1.02 %     11,262       147       1.31 %
Total interest bearing liabilities     351,095       910       0.26 %     356,052       961       0.27 %     355,872       1,168       0.33 %
Demand deposits     196,434                       173,130                       155,537                  
Other liabilities     6,494                       6,537                       6,275                  
Total liabilities     554,023                       535,719                       517,684                  
Shareholders’ equity     84,253                       87,330                       87,563                  
    $ 638,276                     $ 623,049                     $ 605,247                  
Net interest income &
margin (3)
          $ 20,708       3.62 %           $ 20,379       3.63 %           $ 19,074       3.54 %

 

(1)Loan and lease interest includes loan and lease fees of $253,000, $322,000 and $307,000 in 2016, 2015 and 2014, respectively.

(2)Includes taxable-equivalent adjustments that primarily relate to income on certain loans and securities that is exempt from federal income taxes.  The effective federal statutory tax rate was 34% in 2016, 2015 and 2014.
(3)Net interest margin is computed by dividing net interest income by total average earning assets.
35
 
Table Three:  Analysis of Volume and Rate Changes on Net Interest Income and Expenses
Year ended December 31, 2016 over 2015 (dollars in thousands) 
Increase (decrease) in interest income and expense due to change in: 
  
Interest-earning assets:  Volume   Rate (4)   Net Change 
   Taxable net loans and leases (1)(2)  $974   $(532)  $442 
Tax-exempt net loans and leases (3)   372    133    505 
   Taxable investment securities   (369)   (156)   (525)
   Tax-exempt investment securities (3)   (85)   (63)   (148)
   Corporate stock   (1)   3    2 
   Federal funds sold & other            
    Interest bearing deposits in other banks       2    2 
     Total   891    (613)   278 
                
Interest-bearing liabilities:               
   Demand deposits   (7)   (91)   (98)
   Savings deposits   1    (11)   (10)
   Time deposits   (24)   45    21 
   Other borrowings   32    4    36 
     Total   2    (53)   (51)
Interest differential  $889   $(560)  $329 
                
Year Ended December 31, 2015 over 2014 (dollars in thousands)
Increase (decrease) in interest income and expense due to change in:
 
  
Interest-earning assets:  Volume   Rate (4)    Net Change 
   Taxable net loans and leases (1)(2)  $904   $(966)  $(62)
Tax-exempt net loans and leases (3)   562    (110)   452 
   Taxable investment securities   (47)   799    752 
   Tax-exempt investment securities (3)   (36)   (6)   (42)
   Corporate stock       (3)   (3)
   Federal funds sold & other            
    Interest bearing deposits in other banks       1    1 
     Total   1,383    (285)   1,098 
                
Interest-bearing liabilities:               
   Demand deposits   (11)   (165)   (176)
   Savings deposits   4    (15)   (11)
   Time deposits   (15)   (2)   (17)
   Other borrowings   37    (40)   (3)
     Total   15    (222)   (207)
Interest differential  $1,368   $(63)  $1,305 

 

(1)The average balance of non-accruing loans and leases is immaterial as a percentage of total loans and leases and has been included in net loans and leases.
(2)Loan and lease fees of $253,000, $322,000 and $307,000 for the years ended December 31, 2016, 2015 and 2014, respectively, have been included in the interest income computation.
(3)Includes taxable-equivalent adjustments that primarily relate to income on certain loans and securities that is exempt from federal income taxes.  The effective federal statutory tax rate was 34% in 2016, 2015 and 2014.
(4)The rate/volume variance has been included in the rate variance.
36
 

Provision for Loan and Lease Losses

The Company experienced net loan and lease recoveries of $1,191,000 or 0.39% of average loans and leases during 2016 compared to net loan and lease losses of $326,000 or 0.12% of average loans and leases during 2015. As a result of the net recoveries in 2016, the Company reduced the allowance for loan and lease losses by recording a negative provision for loan and lease losses of $1,344,000. As a result of the improving credit quality over the past several years and a reduction in historical loan loss rates the Company did not require any loan or lease loss provision in 2015. The level of nonperforming loans and leases, which began to increase during the economic cycle of 2007 through 2010, reached a high of $22,571,000 at December 31, 2010, but has decreased to $19,000 at December 31, 2016. For additional information see the “Nonaccrual, Past Due and Restructured Loans and Leases” the “Allowance for Loan and Lease Losses Activity.”

Service Charges and Fees and Other 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         
     Year Ended December 31, 
     2016   2015   2014 
  Service charges on deposit accounts  $502   $498   $562 
  Income from OREO properties   279    335    365 
  Merchant fee income   377    378    413 
  Earnings on bank-owned life insurance   322    316    284 
  Life insurance death benefit           99 
  Gain on sale, impairment and call of securities   314    251    208 
  Other   251    237    246 
     $2,045   $2,015   $2,177 

Noninterest income increased $30,000 (1.5%) to $2,045,000 in 2016 from the 2015 level. The increase from 2015 to 2016 was primarily related to higher gains on sale of securities offset by lower earnings on OREO properties. Gain on sales of securities increased $63,000 (25.1%) from 2015 to 2016 while income from OREO properties decreased $56,000 (16.7%) during that same time period. The decrease in OREO income resulted from the sale of the Bank’s only remaining income producing OREO property in the first quarter of 2016.

 

Noninterest income decreased $162,000 (7.4%) to $2,015,000 in 2015 from the 2014 level. The decrease from 2014 to 2015 was primarily related to lower fees from service charges on deposit accounts (down $64,000 or 11.4%) and no life insurance death benefits in 2015 as compared to $99,000 in 2014. The decrease in service charges is related to a decrease in insufficient funds income.

 

Salaries and Benefits

Salaries and benefits were $8,435,000 (down $93,000 or 1.1%) for 2016 as compared to $8,528,000 in 2015. The decrease in salary and benefits was due in part to lower employee benefits which decreased $102,000 (7.2%) from $1,422,000 in 2015 to $1,320,000 in 2016. The decrease in other employee benefits, which includes health care related benefits, 401(k) matching, and employee placement fees, was primarily related to lower employer paid health care insurance and lower employee placement fees paid in 2016.

Salaries and benefits were decreased $248,000 (2.8%) to $8,528,000 for 2015 as compared to $8,776,000 in 2014. The decrease in salary and benefits was due in part to lower incentive compensation expense and lower employee benefits. Incentive accruals decreased $182,000, from $672,000 in 2014 to $490,000 in 2015 and other employee benefits decreased $107,000 (7.0%) from $1,529,000 in 2014 to $1,422,000 in 2015. The decrease in incentive compensation was primarily due to the Company not achieving all of the incentive targets under Company incentive plans in 2015. The decrease in other employee benefits, which includes health care related benefits, 401(k) matching, and employee placement fees, was primarily related to lower employee placement fees paid in 2015.

Other Real Estate Owned

The total other real estate owned (“OREO”) expense in 2016 was $246,000 (down $76,000 or 23.6%) compared to $322,000 in 2015. The primary reason for the decrease in OREO related expenses is due to the sale of a number of properties, including office buildings which have high operating expenses, and lower property write-downs. Operating expenses on the properties held in 2016 totaled $128,000 compared to $245,000 in 2015. In 2016, the gains on sale, which offset the overall OREO expense, were higher than in 2015. Gains from properties sold in 2016 totaled $257,000 compared to a loss of $1,000 in 2015. These reductions were offset by higher write-downs in 2016. In 2016, write-downs were $376,000 compared to $76,000 in 2015. This increase in the write-downs in 2016 was related to a single property that was evaluated during the first quarter of 2016. This property was eventually sold in 2016 for a gain of $89,000.

37
 

In 2015, the OREO expense decreased by $42,000 (11.5%) to $322,000 compared to $364,000 in 2014. The primary reason for the decrease in OREO related expenses is due to the sale of a number of properties and lower property write-downs. In 2015, write-downs were $76,000 compared to $165,000 in 2014. This decrease is related to a fewer number of owned properties and some stability in the real estate market. Operating expenses on the properties held in 2015 totaled $245,000 compared to $430,000 in 2014. In 2014, the gains on sale, which offset the overall OREO expense, were higher than in 2015. Gains from properties sold in 2014 totaled $231,000 compared to a loss of $1,000 in 2015.

 

Occupancy, Furniture and Equipment

Occupancy expense decreased $8,000 (0.1%) during 2016 to $1,175,000, compared to $1,183,000 in 2015. Furniture and equipment expense decreased $38,000 (5.5%) during 2016 to $652,000 compared to $690,000 in 2015. The decrease in the furniture and equipment expense resulted from lower maintenance expense on the Company’s equipment.

 

Occupancy expense decreased $5,000 (0.4%) during 2015 to $1,183,000, compared to $1,188,000 in 2014. Furniture and equipment expense decreased $34,000 (4.7%) during 2015 to $690,000 compared to $724,000 in 2014. The decrease in the furniture and equipment expense resulted from lower depreciation on the Company’s furniture and equipment.

 

Regulatory Assessments

 

Regulatory assessments include fees paid to the California Department of Business Oversight (the “DBO”) and the Federal Deposit Insurance Corporation (the “FDIC”). FDIC assessments decreased $68,000 (21.0%) during 2016 to $256,000, compared to $324,000 in 2015. The majority of this decrease relates to a lower assessment rate as a result of lower nonperforming assets and that the Deposit Insurance Fund reached the FDIC’s target level of 1.15% during 2016, which resulted in lower assessments for community banks such as American River Bank. The assessments paid to the DBO in 2016 were $72,000 compared to $71,000 in 2015.

 

FDIC assessments decreased $39,000 (10.7%) during 2015 to $324,000, compared to $363,000 in 2014. The majority of this decrease relates to a lower assessment rate as a result of lower nonperforming assets. The assessments paid to the DBO in 2015 were $71,000 compared to $70,000 in 2014.

Other Expenses

Table Five below provides a summary of the components of the other noninterest expenses for the periods indicated (dollars in thousands):

   Year Ended December 31, 
   2016   2015   2014 
Professional fees  $995   $863   $1,182 
Outsourced item processing   366    360    355 
Directors’ expense   417    402    394 
Telephone and postage   357    368    357 
Stationery and supplies   141    143    193 
Advertising and promotion   129    164    160 
Other operating expenses   595    662    736 
   $3,000   $2,962   $3,377 

  

Other expenses were $3,000,000 (up $38,000 or 1.3%) for 2016 as compared to $2,962,000 for 2015. The increase in other expenses occurred primarily in the professional expense category. Professional expenses, which primarily include legal, accounting and other professional services, increased $132,000 (15.3%), from $863,000 in 2015 to $995,000 in 2016. Much of this increase is related to network administration fees. Network administration fees increased from $278,000 to $441,000 related to additional work performed by the network vendor, including full hosting of the Company’s computer network. The overhead efficiency ratio on a taxable equivalent basis for 2016 was 60.8% as compared to 62.9% in 2015.

38
 

Other expenses were down $415,000 (12.3%) to $2,962,000 for 2015 as compared to $3,377,000 for 2014. The decrease in other expenses occurred primarily in the professional expense category. Professional expenses, which primarily include legal, accounting and other professional services, decreased $319,000 (27.0%), from $1,182,000 in 2014 to $863,000 in 2015. Legal expenses decreased $255,000 (61.6%) from $414,000 in 2014 to $255,000 during 2015. This decrease is primarily related to a lower number of problem loan credits and OREO properties. The overhead efficiency ratio on a taxable equivalent basis for 2014 was 70.0%.

 

Provision for Income Taxes

 

The effective tax rate on income was 34.6%, 33.7%, and 34.5% in 2016, 2015 and 2014, respectively. The effective tax rate differs from the federal statutory tax rate due to state tax expense (net of federal tax effect) of $697,000, $516,000, and $419,000 in these years. Tax-exempt income of $1,681,000, $1,412,000, and $1,194,000 from investment securities, loans, and bank-owned life insurance in these years helped to reduce the effective tax rate. The higher level of income taxes and effective tax rate in 2016 compared to 2015 resulted from the Company’s higher level of taxable income. Taxable income increased $1,854,000 (23.3%) from $7,942,000 in 2015 to $9,796,000 in 2016.

Balance Sheet Analysis

 

The Company’s total assets were $651,450,000 at December 31, 2016 as compared to $634,640,000 at December 31, 2015, representing an increase of $16,810,000 (2.6%). The average balances of total assets during 2016 were $638,276,000, up $15,227,000 or 2.4% from the 2015 average of $623,049,000.

Investment Securities

The Company classifies its investment securities as trading, held-to-maturity or available-for-sale. The Company’s intent is to hold all securities classified as held-to-maturity until maturity and management believes that it has the ability to do so. Securities classified as available-for-sale may be sold to implement asset/liability management strategies as part of our contingency funding plan and in response to changes in interest rates, prepayment rates and similar factors. Table Six below summarizes the values of the Company’s investment securities held on December 31 of the years indicated. The Company did not have any investment securities classified as trading in any of the years indicated below.

Table Six: Investment Securities Composition

 

(dollars in thousands)

 

Available-for-sale (at fair value)  2016   2015   2014 
Debt securities:               
US Government Agencies and US Government-Sponsored Agencies  $229,785   $246,185   $261,115 
Obligations of states and political subdivisions   22,612    26,013    26,289 
Corporate debt securities   1,519    1,551    1,583 
Equity securities:               
Corporate stock   104    70    77 
Total available-for-sale investment securities  $254,020   $273,819   $289,064 
                
Held-to-maturity (at amortized cost)                
Debt securities:               
US Government Agencies and US Government-Sponsored Agencies  $483   $623   $862 
Total held-to-maturity investment securities  $483   $623   $862 
39
 

Net unrealized gains on available-for-sale investment securities totaling $916,000 were recorded, net of $372,000 in tax liabilities, as accumulated other comprehensive income within shareholders’ equity at December 31, 2016 and net unrealized gains on available-for-sale investment securities totaling $3,504,000 were recorded, net of $1,401,000 in tax liabilities, as accumulated other comprehensive income within shareholders’ equity at December 31, 2015.

 

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

 

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 December 31, 2016, these categories accounted for approximately 11%, 58%, 22%, 3%, 5%, 0%, 1% and 0%, respectively, of the Company’s loan portfolio. This mix was relatively unchanged compared to 12%, 68%, 8%, 5%, 5%, 0%, 1% and 1%, respectively, at December 31, 2015, with the exception of an increase in multi-family loans which increased from 8% of the portfolio in 2015 to 22% of the portfolio in 2016. While the portfolio contains both commercial and residential construction, the Company’s focus has been on commercial construction, as such, the balance of single-family residential loans has decreased from $5,155,000 or 35.5% of the construction balance at December 31, 2015 to $2,467,000 or 26.9% of the construction balance at December 31, 2016. Also, as noted in Table 7 below, lease financing receivable, agriculture, and consumer loan balances have decreased as the Company’s primary focus is commercial and real estate loans.

Continuing focus in the Company’s market area, new borrowers developed through the Company’s marketing efforts, and credit extensions expanded to existing borrowers resulted in the Company originating approximately $89 million in new loans in 2016. This production was partially offset by normal pay downs and payoffs, but still resulted in an overall net increase in net loans and leases of $35.0 million (12.1%) from December 31, 2015. Included in the $89 million in new loans in 2016 was a $24.4 million pool of performing multi-family loans purchased from another financial institution. These purchased loans consisted of nineteen (19) loans primarily in the Company’s market areas and two loans in San Diego County. The market in which the Company operates has begun to show demand for credit products as the continued low rate environment and expectations for economic expansion have increased refinancing as well as new loan activity. Table Seven below summarizes the composition of the loan and lease portfolio for the past five years as of December 31.

Table Seven: Loan and Lease Portfolio Composition

 

   December 31, 
(dollars in thousands)  2016   2015   2014   2013   2012 
Commercial  $35,374   $36,195   $25,186   $24,545   $30,811 
Real estate:                         
Commercial   191,129    199,591    193,871    184,204    180,126 
Multi-family   73,373    23,494    14,167    11,085    9,155 
Construction   9,180    14,533    8,028    9,633    6,918 
Residential   15,718    14,200    13,309    17,703    17,701 
Lease financing receivable   404    732    1,286    1,344    1,509 
Agriculture   2,302    2,431    2,882    3,120    3,340 
Consumer   1,650    3,122    4,916    5,772    8,569 
    329,130    294,298    263,645    257,406    258,129 
Deferred loan fees, net   (222)   (221)   (287)   (313)   (230)
Allowance for loan and lease losses   (4,822)   (4,975)   (5,301)   (5,346)   (5,781)
Total net loans and leases  $324,086   $289,102   $258,057   $251,747   $252,118 

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

 

Commercial loans consist of credit lines for operating needs and working capital and loans for equipment or vehicle purchases. Consumer loans include traditional consumer products such as secured and unsecured personal loans and loans to finance the purchase of autos, boats and recreational vehicles. Construction loans are generally comprised of commitments to customers within the Company’s service area for construction of owner-occupied commercial properties. Other real estate loans consist primarily of loans secured by first trust deeds on commercial or multi-family properties, typically with maturities from 3 to 10 years and original loan-to-value ratios generally from 65% to 75%. In general, except in the case of loans under SBA programs, the Company does not make long-term mortgage loans.

 

“Subprime” real estate loans generally refer to residential mortgages made to higher-risk borrowers with lower credit and/or income histories. Within the banking industry, many of these loans were originated with adjustable interest rates that reset upward after an introductory period. These “subprime” loans coupled with declines in housing prices led to an increase in default rates resulting in many instances of increased foreclosure rates as the adjustable interest rates reset to higher levels. The Company did not have any such “subprime” loans at December 31, 2016 and December 31, 2015.

Average loans and leases in 2016 were $306,737,000 which represents an increase of $27,009,000 (9.7%) compared to the average in 2015. Average loans and leases in 2015 were $279,728,000 which represents an increase of $25,830,000 (10.2%) compared to the average in 2014.

 

Risk Elements

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

 

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

The Company has significant extensions of credit and commitments to extend credit that are secured by real estate. The ultimate repayment of these loans is generally dependent on personal or business cash flows or the sale or refinancing of the real estate. The Company monitors the effects of current and expected market conditions and other factors on the collectability of real estate loans. The more significant factors management considers involve the following: lease rates and terms, vacancy rates, absorption and sale rates and capitalization rates; real estate values, supply and demand factors, and rates of return; operating expenses; inflation and deflation; and sufficiency of repayment sources independent of the real estate including, in some instances, personal guarantees.

 

In extending credit and commitments to borrowers, the Company generally requires collateral and/or guarantees as security. The repayment of such loans is expected to come from cash flow or from proceeds from the sale of selected assets of the borrowers. The Company’s requirement for collateral and/or guarantees is determined on a case-by-case basis in connection with management’s evaluation of the creditworthiness of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, income-producing properties, residences and other real property. The Company secures its collateral by perfecting its security interest in business assets, obtaining deeds of trust, or outright possession among other means.

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In management’s judgment, a concentration exists in real estate loans which represented approximately 88% of the Company’s loan and lease portfolio at December 31, 2016 and 86% at December 31, 2015. Management believes that the residential land portion of the Company’s loan portfolio carries more than the normal credit risk, due primarily to curtailed demand for new and resale residential property, relative to pre-recession levels, a resulting oversupply of unsold residential land, and observed reductions in values throughout the Company’s market area. Management has responded by evaluating loans that it considers to carry any significant risk above the normal risk of collectability by taking actions where possible to reduce credit risk exposure by methods that include, but are not limited to, seeking liquidation of the loan by the borrower, seeking additional tangible collateral or other repayment support, converting the property through judicial or non-judicial foreclosure proceedings, and other collection techniques. Management currently believes that it maintains its allowance for loan and lease losses at levels adequate to reflect the loss risk inherent in its total loan portfolio.

 

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

 

Nonaccrual, Past Due and Restructured Loans and Leases

Management places loans and leases on nonaccrual status when they become 90 days past due or if a loss is expected, unless the loan or lease is well secured and in the process of collection. Loans and leases are partially or fully charged off when, in the opinion of management, collection of such amount appears unlikely.

 

The recorded investments in nonperforming loans and leases, which includes nonaccrual loans and leases and loans and leases that were 90 days or more past due and on accrual, totaled $19,000 and $1,643,000 at December 31, 2016 and 2015, respectively. The $19,000 in nonperforming loans and leases at December 31, 2016 were comprised of two consumer loans.  At December 31, 2015, the $1,643,000 in nonperforming loans consisted of four real estate loans totaling $1,493,000, four consumer loans totaling $120,000 and a single commercial loan totaling $30,000.

 

Table Eight:  Nonperforming Loans and Leases
   December 31, 
(dollars in thousands)  2016   2015     2014   2013   2012 
Past due 90 days or more and still accruing:                         
   Commercial  $   $   $   $80   $ 
   Real estate                    
   Lease financing receivable                    
   Consumer and other                    
Nonaccrual:                         
   Commercial       30    666    766    2,352 
   Real estate       1,493    845    977    2,897 
   Lease financing receivable                   3 
   Consumer and other   19    120    142    156    222 
Total nonperforming loans and leases  $19   $1,643   $1,653   $1,979   $5,474 

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Interest income recognized from payments received on nonaccrual loans and leases was approximately $115,000 in 2016, $59,000 in 2015 and $84,000 in 2014. Table Eight below sets forth nonaccrual loans and leases and loans and leases past due 90 days or more and on accrual as of year-end for the past five years. There were no loan or lease concentrations in excess of 10% of total loans and leases not otherwise disclosed as a category of loans and leases as of December 31, 2016. Management is not aware of any potential problem loans, which were accruing and current at December 31, 2016, where serious doubt exists as to the ability of the borrower to comply with the present repayment terms and that would result in a significant loss to the Company apart from those loans identified in the Bank’s impairment analysis.

 

Management monitors the Company’s performance metrics including the ratios related to nonperforming loans and leases. From 2008 to 2010, the Company experienced an increase in nonperforming loans and leases. In 2011, the focused efforts of the previous years resulted in a decrease in these levels. From 2012 to 2016, the level of nonperforming loans and leases continued to decrease to a level below the amount reported at December 31, 2008. However, the variations in the amount of nonperforming loans and leases does not directly impact the level of the Company’s allowance for loan and lease losses as management monitors each of the loans and leases for loss potential or probability of loss on an individual basis using accounting principles generally accepted in the United States of America.

Impaired Loans and Leases

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

The recorded investment in loans and leases that were considered to be impaired totaled $17,297,000 at December 31, 2016 and had a related valuation allowance of $421,000. The average recorded investment in impaired loans and leases during 2016 was approximately $17,503,000. As of December 31, 2015, the recorded investment in loans and leases that were considered to be impaired totaled $21,365,000 and had a related valuation allowance of $899,000. The average recorded investment in impaired loans and leases during 2015 was approximately $20,818,000. As of December 31, 2014, the recorded investment in loans and leases that were considered to be impaired totaled $25,120,000 and had a related valuation allowance of $1.603,000. The average recorded investment in impaired loans and leases during 2014 was approximately $24,127,000.

 

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 estimate of those losses. The ALLL is established through a provision for loan and lease losses and is increased by provisions charged against current earnings and recoveries and reduced by charge-offs. Actual losses for loans and leases can vary significantly from this estimate. The methodology and assumptions used to calculate the allowance are continually reviewed as to their appropriateness given the most recent losses realized and other factors that influence the estimation process. The model assumptions and resulting allowance level are adjusted accordingly as these factors change.

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

The ALLL totaled $4,822,000 or 1.47% of total loans and leases at December 31, 2016, $4,975,000 or 1.69% of total loans and leases at December 31, 2015, and $5,301,000 or 2.01% at December 31, 2014. The decrease in the allowance for loan and lease losses from $4,975,000 at December 31, 2015 to $4,822,000 at December 31, 2016, was mainly due to a decrease in historical losses impacting the loss factor used in calculating the reserve on loans collectively valued for impairment and a reduction in the valuation allowances held for impaired loans. The Company establishes general and specific reserves in accordance with accounting principles generally accepted in the United States of America. The ALLL is composed of categories of the loan and lease portfolio based on loan type and loan rating; however, the entire allowance is available to cover actual loan and lease losses. While management uses available information to recognize possible losses on loans and leases, future additions to the allowance may be necessary, based on changes in economic conditions and other matters. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s ALLL. Such agencies may require the Company to provide additions to the allowance based on their judgment of information available to them at the time of their examination.

The allowance for loans and leases as a percentage of nonperforming loans and leases was 25,379.0% at December 31, 2016 and 302.8% at December 31, 2015. The allowance for loans and leases as a percentage of impaired loans and leases was 27.9% at December 31, 2016 and 23.3% at December 31, 2015. Of the total nonperforming and impaired loans and leases outstanding as of December 31, 2016, there were $4,244,000 in loans or leases that had been reduced by partial charge-offs of $809,000.

At December 31, 2016, there was $11,244,000 in impaired loans or leases that did not carry a specific reserve. Of this amount, $3,869,000 were loans or leases that had previous partial charge-offs and $7,375,000 in loans or leases that were analyzed and determined not to require a specific reserve or charge-off because the collateral value or discounted cash flow value exceeded the loan or lease balance. Prior to 2013, the Company had been operating in a market that had experienced significant decreases in real estate values of commercial, residential, land, and construction properties. As such, the Company continues to focus on monitoring collateral values for those loans considered collateral dependent. The collateral evaluations performed by the Company are updated as necessary, which is generally once every twelve months, and are reviewed by a qualified credit officer.

The Company’s policy with regard to loan or lease charge-offs continues to be that a loan or lease is charged off against the ALLL when management believes that the collectability of the principal is unlikely. As previously discussed in the “Impaired Loans and Leases” section, certain loans are evaluated for impairment. Generally, if a loan is collateralized by real estate, and considered collateral dependent, the impaired portion will be charged off to the allowance for loan and lease losses unless it is in the process of collection, in which case a specific reserve may be warranted. If the collateral is other than real estate and considered impaired, a specific reserve may be warranted.

It is the policy of management to maintain the allowance for loan and lease losses at a level believed to be adequate for known and inherent risks in the portfolio. Our methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan and lease losses that management believes is appropriate at each reporting date. Formula allocations are calculated by applying historical loss factors to outstanding loans with similar characteristics.  Historical loss factors are based upon the Company’s loss experience. These historical loss factors are adjusted for changes in the business cycle and for significant factors that, in management’s judgment, affect the collectability of the loan portfolio as of the evaluation date.  The discretionary allocation is based upon management’s evaluation of various loan segment conditions that are not directly measured in the determination of the formula and specific allowances.  The conditions may include, but are not limited to, general economic and business conditions affecting the key lending areas of the Company, credit quality trends, collateral values, loan volumes and concentrations, and other business conditions. Based on information currently available, management believes that the allowance for loan and lease losses is prudent and adequate. However, no prediction of the ultimate level of loans and leases charged off in future periods can be made with any certainty.

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Table Nine below summarizes, for the periods indicated, the activity in the ALLL.

Table Nine: Allowance for Loan and Lease Losses

 

                     
(dollars in thousands)                    
   Year Ended December 31, 
   2016   2015   2014   2013   2012 
Average loans and leases outstanding  $306,737   $279,728   $253,898   $252,807   $282,136 
                          
Allowance for loan & lease losses at beginning
of period
  $4,975   $5,301   $5,346   $5,781   $7,041 
Loans and leases charged off:                         
Commercial       609        377    302 
Real estate   93            534    2,038 
Consumer   34    6    76    1    505 
Lease financing receivable       1        26    9 
Total   127    616    76    938    2,854 
Recoveries of loans and leases previously charged off:                         
Commercial   660    123    256    215    21 
Real estate   534    165    163    88    172 
Consumer   124    2    150        30 
Lease financing receivable           3        6 
Total   1,318    290    572    303    229 
Net loans and leases (recovered) charged off   (1,191)   326    (496)   635    2,625 
(Reductions) additions to allowance (credited) charged to operating expenses   (1,344)       (541)   200    1,365 
Allowance for loan and lease losses at end of period
  $4,822   $4,975   $5,301   $5,346   $5,781 
                          
Ratio of net (recoveries) charge-offs to average loans and leases outstanding
   (0.39%)   0.12%   (0.20%)   0.25%   0.93%
                          
Provision for loan and lease losses to average loans and leases outstanding   (0.44%)       (0.21%)   0.08%   0.48%
                          
Allowance for loan and lease losses to total loans and leases, at end of period   1.47%   1.69%   2.01%   2.08%   2.24%
                          
Allowance for loan and lease losses to nonperforming loans and leases, at end of period   25,378.95%   302.80%   320.69%   270.14%   105.61%

 

As part of its loan review process, management has allocated the overall allowance based on specific identified problem loans and leases, qualitative factors, uncertainty inherent in the estimation process and historical loss data. A risk exists that future losses cannot be precisely quantified or attributed to particular loans or leases or classes of loans and leases. Management continues to evaluate the loan and lease portfolio and assesses current economic conditions that will affect management’s conclusion as to future allowance levels. Table Ten below summarizes the allocation of the allowance for loan and lease losses for the five years ended December 31, 2016.

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Table Ten:  Allowance for Loan and Lease Losses by Loan Category
(dollars in thousands)  December 31, 2016   December 31, 2015   December 31, 2014 
   Amount   Percent of loans
in each category
to total loans
   Amount   Percent of loans
in each category
to total loans
   Amount   Percent of loans
in each category
to total loans
 
Commercial  $855    12%  $860    12%  $1,430    10%
Real estate   3,600    86%   3,729    86%   3,429    86%
Agriculture   64    1%   77    1%   62    1%
Consumer   24    1%   78    1%   124    2%
Lease financing receivable   1        1        2    1%
Unallocated   278        230        254     
Total  $4,822    100%  $4,975    100%  $5,301    100%
                         
   December 31, 2013   December 31, 2012                 
   Amount   Percent of loans
in each category
to total loans
   Amount   Percent of loans
in each category
to total loans
                 
Commercial  $885    10%  $1,351    12%                
Real estate   4,010    86%   3,835    83%                
Agriculture   80    1%   87    1%                
Consumer   161    2%   262    3%                
Lease financing receivable   4    1%   3    1%                
Unallocated   206        243                     
Total  $5,346    100%  $5,781    100%                

The allocation presented should not be interpreted as an indication that charges to the allowance for loan and lease losses will be incurred in these amounts or proportions, or that the portion of the allowance allocated to each loan and lease category represents the total amounts available for charge-offs that may occur within these categories.

Other Real Estate Owned

The balance in OREO at December 31, 2016 consisted of two properties acquired through deeds in lieu of foreclosure. The balance in OREO at December 31, 2015 consisted of three properties, all of which were sold in 2016. During 2016, the Company received $3,432,000 from the net proceeds of the sale of the three OREO properties with net gains of $257,000. The $3,432,000 proceeds included $1,746,000 in cash proceeds and $1,686,000 was financed by the Bank. Prior to the sale, the Company recognized a write-down of $376,000 to the OREO expense on one of the three properties. During 2016, the Company also added two properties, one of which had a market value greater than the recorded book value. The OREO balance was increased for the market value adjustment by $239,000 with a corresponding charge to loan recoveries of $66,000 (to recapture a previous write-down) and a charge to OREO income of $173,000. There was $1,348,000 in other real estate owned at December 31, 2016 with no valuation allowance and $3,551,000 in other real estate owned at December 31, 2015 with no valuation allowance.

Deposits

At December 31, 2016, total deposits were $544,806,000 representing an increase of $14,116,000 (2.7%) from the December 31, 2015 balance of $530,690,000. The Company’s deposit growth plan for 2016 was to concentrate its efforts on increasing noninterest-bearing demand, interest-bearing money market and interest-bearing checking, and savings accounts, while continuing to focus on reducing overall interest expense. Due to these efforts, the Company experienced increases during 2016 in noninterest-bearing demand ($10,565,000 or 5.5%), interest-bearing checking ($3,328,000 or 5.4%), and savings ($5,679,000 or 9.6%) and decreases in money market ($3,844,000 or 2.8%) and time deposit ($1,612,000 or 1.9%) accounts. The decrease in money market accounts is related to the plan to reduce interest expense as the Company evaluated the rate structure on some of the higher cost money market accounts and reduced the interest rates on some relationships.

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Other Borrowed Funds

Other borrowings outstanding as of December 31, 2016 consist of advances from the Federal Home Loan Bank (the “FHLB”). The following table summarizes these borrowings (dollars in thousands):

   2016   2015   2014 
   Amount   Rate   Amount   Rate   Amount   Rate 
Short-term borrowings:
FHLB advances
  $3,500    1.01%  $3,500    1.28%  $3,500    0.92%
                               
Long-term borrowings:
FHLB advances
  $12,000    1.32%  $7,500    1.24%  $7,500    1.39%
                               

The maximum amount of short-term borrowings at any month-end during 2016, 2015 and 2014, was $25,500,000, $11.500,000, and $3,500,000, 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  $3,500   $12,000 
Maturity   2017    2018 to 2020 
Average rates   1.01%   1.32%

 

The Company has the ability to enter into letters of credit with the FHLB. There were no letters of credit outstanding as of December 31, 2016 or 2015. There were no draws upon any letter of credit in 2016 or 2015 and management does not expect to draw upon these sources of liquidity in the foreseeable future.

Capital Resources

The current and projected capital position of the Company and the impact of capital plans and long-term strategies are reviewed regularly by management. The Company’s capital position represents the level of capital available to support continuing operations and expansion.

On January 21, 2015, the Company approved and authorized a stock repurchase program for 2015 (the “2015 Program”). The 2015 Program authorized the repurchase during 2015 of up to 5% of the outstanding shares of the Company’s common stock. In addition, on July 15, 2015, the Company approved and authorized an additional amount of 5% to be purchased under the 2015 Program. During 2015, the Company repurchased 790,989 shares of its common stock at an average price of $9.92 per share. On January 20, 2016, the Company approved and authorized a stock repurchase program for 2016 (the “2016 Program”). The 2016 Program authorized the repurchase during 2016 of up to 5% of the outstanding shares of the Company’s common stock. In addition, on April 20, 2016, the Company approved and authorized an additional amount of 5% to be purchased under the 2016 Program. During 2016, the Company repurchased 716,897 shares of its common stock at an average price of $10.34 per share

 

On January 25, 2017, the Company approved and authorized a stock repurchase program for 2017 (the “2017 Program”). The 2017 Program authorized the repurchase during 2017 of up to 5% of the outstanding shares of the Company’s common stock, or approximately 333,086 shares based on the 6,661,726 shares outstanding as of December 31, 2016. Any repurchases under the 2017 Program will be made from time to time by the Company in the open market as conditions allow. All such transactions will be structured to comply with Commission Rule 10b-18 and all shares repurchased under the 2017 Program will be retired. The number, price and timing of the repurchases will be at the Company’s sole discretion and the 2017 Program may be re-evaluated depending on market conditions, capital and liquidity needs or other factors. Based on such re-evaluation, the Board of Directors may suspend, terminate, modify or cancel the 2017 Program at any time without notice.

 

The Company did not repurchase any shares in 2011 or 2010 and repurchased 575,389 shares in 2012, 849,404 shares in 2013, and 424,462 in 2014. Share amounts have been adjusted for stock dividends and/or splits. See Part II, Item 5, “Stock Repurchases” for more information regarding stock repurchases.

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The Company and American River Bank are subject to certain regulatory capital requirements administered by the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation. 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, banks 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. As of December 31, 2016 and 2015, the most recent regulatory notification categorized American River Bank as well capitalized under the regulatory framework for prompt corrective action plan. There are no conditions or events since that notification that management believes have changed the Bank’s categories.

At December 31, 2016, shareholders’ equity was $83,850,000, representing a decrease of $2,225,000 (2.6%) from $86,075,000 at December 31, 2015. The decrease resulted from repurchases of common stock of $7,414,000 and a decrease in other comprehensive income of $1,559,000, as a result of the decrease in the unrealized gain on securities due to an increase in interest rates, exceeding the additions from net income of $6,404,000 for the period and the stock based compensation of $344,000. In 2015, shareholders’ equity decreased $3,572,000 (5.1%) from $89,647,000 at December 31, 2014. The decrease resulted from the reductions in other comprehensive income and repurchases of common stock exceeding the additions from net income for the period and the increase in stock based compensation.

Table Eleven below lists the Company’s and American River Bank’s actual capital ratios at December 31, 2016 and 2015, as well as the minimum capital ratios for capital adequacy.

Table Eleven: Capital Ratios

 

   At December 31,   Minimum Regulatory 
   2016   2015   Capital Requirements 
American River Bankshares:            
Leverage ratio   10.5%   11.0%   4.60%
Tier 1 Risk-Based Capital   19.0%   19.3%   6.60%
Total Risk-Based Capital   20.3%   20.6%   8.60%
                
American River Bank:               
Leverage ratio   10.6%   11.0%   4.60%
Common Equity Tier 1 Capital   18.9%   19.1%   5.10%
Tier 1 Risk-Based Capital   18.9%   19.1%   6.60%
Total Risk-Based Capital   20.2%   20.3%   8.60%

Capital ratios are reviewed on a regular basis to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet future needs. At December 31, 2016, American River Bank’s ratios were in excess of the regulatory definition of “well capitalized.” Management believes that the Company’s capital is adequate to support current operations and anticipated growth and currently foreseeable future capital requirements of the Company and its subsidiaries.

In July 2013, the federal bank regulatory agencies issued interim final rules that revised and replaced the then current risk-based capital requirements in order to implement the “Basel III” regulatory capital reforms released by the Basel Committee on Banking Supervision and changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The Basel III reforms reflected in the final rules included an increase in the risk-based capital requirements and certain changes to capital components and the calculation of risk-weighted assets.

 

Effective January 1, 2015, bank holding companies with consolidated assets of $1 Billion or more and banks like American River Bank were required to comply with new minimum capital ratio requirements to be phased-in between January 1, 2015 and January 1, 2019, which would consist of the following: (i) a new common equity Tier 1 capital to total risk weighted assets ratio of 4.5%; (ii) a Tier 1 capital to total risk weighted assets ratio of 6% (increased from 4%); (iii) a total capital to total risk weighted assets ratio of 8% (unchanged from current rules); and (iv) a Tier 1 capital to adjusted average total assets (“leverage”) ratio of 4%.

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In addition, a “capital conservation buffer,” is established which when fully phased-in will require maintenance of a minimum of 2.5% of common equity Tier 1 capital to total risk weighted assets in excess of the regulatory minimum capital ratio requirements described above. The 2.5% buffer will increase the minimum capital ratios to (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new