Quarterly Report (10-q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended

September 30, 2019

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

For the transition period from

Commission File Number: 0-31525

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

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

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

(916) 851-0123

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

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

Title of each class	Trading symbol(s)	Name of each exchange on which registered
Common Stock, no par value	AMRB	Nasdaq Global Select Market

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 such files).

Yes x No o

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

	Large accelerated filer o	Accelerated filer x
	Non-accelerated filer o	Smaller reporting company x
		Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

Yes o No x

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

No par value Common Stock – 5,900,239 shares outstanding at November 7, 2019

AMERICAN RIVER BANKSHARES

INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2019

Part I.		Page

Item 1.	Financial Statements	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	46
Item 4.	Controls and Procedures	47

Part II.

Item 1.	Legal Proceedings	48
Item 1A.	Risk Factors	48
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	48
Item 3.	Defaults Upon Senior Securities	48
Item 4.	Mine Safety Disclosures	48
Item 5.	Other Information	48
Item 6.	Exhibits	49

Signatures		50

Exhibits

31.1	Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	51
31.2	Certifications of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	52
32.1	Certification of American River Bankshares by its Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	53

101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema
101.CAL	XBRL Taxonomy Extension Calculation
101.DEF	XBRL Taxonomy Extension Definition
101.LAB	XBRL Taxonomy Extension Label
101.PRE	XBRL Taxonomy Extension Presentation

PART I-FINANCIAL INFORMATION

Item 1. Financial Statements.

AMERICAN RIVER BANKSHARES

CONSOLIDATED BALANCE SHEET

(Unaudited)

(dollars in thousands)	September 30, 2019		December 31, 2018
ASSETS

Cash and due from banks	$	14,512	$	20,987
Interest-bearing deposits in banks		14,870		1,746
Federal funds sold		—		7,000
Total cash and cash equivalents		29,382		29,733
Investment securities:
Available-for-sale, at fair value		276,055		294,933
Held-to-maturity, at amortized cost		256		292
Loans and leases, less allowance for loan and lease losses of $4,953 at September 30, 2019 and $4,392 at December 31, 2018		369,940		318,516
Premises and equipment, net		1,217		1,071
Federal Home Loan Bank stock		4,259		3,932
Goodwill and other intangible assets		16,321		16,321
Other real estate owned		957		957
Bank owned life insurance		15,676		15,429
Accrued interest receivable and other assets		7,218		6,908
Total assets	$	721,281	$	688,092

LIABILITIES AND SHAREHOLDERS’ EQUITY

Deposits:
Noninterest bearing	$	228,517	$	214,745
Interest-bearing		384,387		375,929
Total deposits		612,904		590,674

Short-term borrowings		5,000		5,000
Long-term borrowings		10,500		10,500
Accrued interest payable and other liabilities		10,028		7,197

Total liabilities		638,432		613,371

Shareholders’ equity:
Preferred stock, no par value; 10,000,000 shares authorized; none outstanding		—		—
Common stock, no par value; 20,000,000 shares authorized; issued and outstanding – 5,903,228 shares at September 30, 2019 and 5,858,428 shares at December 31, 2018		30,466		30,103
Retained earnings		49,487		46,494
Accumulated other comprehensive income (loss), net of taxes		2,896		(1,876	)

Total shareholders’ equity		82,849		74,721
Total liabilities and shareholders’ equity	$	721,281	$	688,092

See Notes to Unaudited Consolidated Financial Statements

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF INCOME

(Unaudited)

(dollars in thousands, except per share data)
For the periods ended September 30,	Three months					Nine months
	2019			2018		2019		2018
Interest income:
Interest and fees on loans:
Taxable	$	4,397		$	3,405	$	12,329	$	10,216
Exempt from Federal income taxes		186			127		501		383
Interest on Federal funds sold		—			120		5		268
Interest on deposits in banks		71			10		151		23
Interest and dividends on investment securities:
Taxable		1,846			1,902		5,756		4,930
Exempt from Federal income taxes		55			102		221		410
Total interest income		6,555			5,666		18,963		16,230
Interest expense:
Interest on deposits		545			346		1,558		945
Interest on borrowings		82			63		300		171
Total interest expense		627			409		1,858		1,116

Net interest income		5,928			5,257		17,105		15,114

Provision for loan and lease losses		120			50		480		50

Net interest income after provision for loan and lease losses		5,808			5,207		16,625		15,064

Noninterest income:
Service charges on deposit accounts		149			119		409		352
Gain on sale or call of securities		9			8		74		19
Other noninterest income		259			250		766		758
Total noninterest income		417			377		1,249		1,129

Noninterest expense:
Salaries and employee benefits		2,898			2,551		8,423		7,274
Occupancy		256			267		768		791
Furniture and equipment		120			141		400		415
Federal Deposit Insurance Corporation assessments		(47	)		52		48		158
Expenses related to other real estate owned		7			10		15		12
Other expense		859			982		2,847		2,531
Total noninterest expense		4,093			4,003		12,501		11,181

Income before provision for income taxes		2,132			1,581		5,373		5,012

Provision for income taxes		561			428		1,380		1,237

Net income	$	1,571		$	1,153	$	3,993	$	3,775

Basic earnings per share	$	0.27		$	0.20	$	0.68	$	0.64
Diluted earnings per share	$	0.27		$	0.20	$	0.68	$	0.64

See notes to Unaudited Consolidated Financial Statements

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(Unaudited)

(dollars in thousands)
For the periods ended September 30,	Three months						Nine months
	2019			2018			2019			2018
Net income	$	1,571		$	1,153		$	3,993		$	3,775
Other comprehensive income (loss):
Increase (decrease) in net unrealized gains (losses) on investment securities		972			(1,606	)		6,849			(5,516	)
Deferred tax (expense) benefit		(287	)		511			(2,025	)		1,760
Increase (decrease) in net unrealized gains (losses) on investment securities, net of tax		685			(1,095	)		4,824			(3,756	)

Reclassification adjustment for realized gains included in net income		(9	)		(8	)		(74	)		(19	)
Tax effect		3			3			22			6
Realized gains, net of tax		(6	)		(5	)		(52	)		(13	)

Total other comprehensive income (loss)		679			(1,100	)		4,772			(3,769	)

Comprehensive income	$	2,250		$	53		$	8,765		$	6

See Notes to Unaudited Consolidated Financial Statements

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

										Accumulated
(dollars in thousands, except per share data)										Other			Total
	Common Stock						Retained			Comprehensive			Shareholders'
	Shares			Amount			Earnings			Income (Loss)			Equity
Balance, January 1, 2018		6,132,362		$	34,463		$	42,779		$	(321	)	$	76,921

Net income								3,775						3,775
Other comprehensive loss, net of tax:											(3,769	)		(3,769	)
Cash dividends ($0.15 per share)								(895	)					(895	)
Net restricted stock award activity and related compensation expense		17,859			212			1						213
Stock options exercised		13,359			123									123
Stock option compensation expense					21									21
Retirement of common stock		(298,778	)		(4,654	)								(4,654	)

Balance, September 30, 2018		5,864,802		$	30,165		$	45,660		$	(4,090	)	$	71,735

Balance, January 1, 2019		5,858,428		$	30,103		$	46,494		$	(1,876	)	$	74,721

Net income								3,993						3,993
Other comprehensive income, net of tax:											4,772			4,772
Cash dividends ($0.17 per share)								(1,000	)					(1,000	)
Net restricted stock award activity and related compensation expense		33,660			257									257
Stock options exercised		11,140			95									95
Stock option compensation expense					11									11

Balance, September 30, 2019		5,903,228		$	30,466		$	49,487		$	2,896		$	82,849

See Notes to Unaudited Consolidated Financial Statements

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

								Accumulated
(dollars in thousands, except per share data)								Other			Total
	Common Stock				Retained			Comprehensive			Shareholders'
	Shares		Amount		Earnings			(Loss) Income			Equity
Balance, July 1, 2018		5,864,802	$	30,082	$	44,801		$	(2,990	)	$	71,893

Net income						1,153						1,153
Other comprehensive loss, net of tax									(1,100	)		(1,100	)
Cash dividends ($0.05 per share)						(294	)					(294	)
Net restricted stock award activity and related compensation expense				76								76
Stock option compensation expense				7								7

Balance, September 30, 2018		5,864,802	$	30,165	$	45,660		$	(4,090	)	$	71,735

Balance, July 1, 2019		5,903,228	$	30,373	$	48,329		$	2,217		$	80,919

Net income						1,571						1,571
Other comprehensive income, net of tax									679			679
Cash dividends ($0.07 per share)						(413	)					(413	)
Net restricted stock award activity and related compensation expense				90								90
Stock option compensation expense				3								3

Balance, September 30, 2019		5,903,228	$	30,466	$	49,487		$	2,896		$	82,849

See Notes to Unaudited Consolidated Financial Statements

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)

(dollars in thousands)
For the nine months ended September 30,	2019			2018
Cash flows from operating activities:
Net income	$	3,993		$	3,775
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan and lease losses		480			50
Decrease in deferred loan origination fees and costs, net		(454	)		(53	)
Depreciation and amortization		170			201
Gain on sale of investment securities, net		(74	)		(19	)
Amortization of investment security premiums and discounts, net		1,117			1,969
Increase in cash surrender values of life insurance policies		(247	)		(228	)
Stock based compensation expense		268			234
Decrease in accrued interest receivable and other assets		479			163
Increase (decrease) in accrued interest payable and other liabilities		39			(182	)

Net cash provided by operating activities		5,771			5,910

Cash flows from investing activities:
Proceeds from the sale of available-for-sale investment securities		43,213			24,753
Proceeds from matured available-for-sale investment securities		5,000			—
Proceeds from called available-for-sale investment securities		—			1,499
Purchases of available-for-sale investment securities		(56,978	)		(81,850	)
Proceeds from principal repayments for available-for-sale investment securities		33,375			33,196
Proceeds from principal repayments for held-to-maturity investment securities		36			67
Net increase in loans		(34,077	)		(2,956	)
Purchases of loans		(17,373	)		—
Proceed from sale of loans		—			1,349
Net increase in FHLB stock		(327	)		—
Purchases of equipment		(316	)		(115	)

Net cash used in investing activities		(27,447	)		(24,057	)

(Continued)

AMERICAN RIVER BANKSHARES

CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
(Unaudited)

(dollars in thousands)
For the nine months ended September 30,	2019			2018
Cash flows from financing activities:
Net increase in demand, interest-bearing and savings deposits	$	24,081		$	22,420
Net decrease in time deposits		(1,851	)		(2,680	)
Net increase in short-term borrowings		—			3,000
Net decrease to long-term borrowings		—			(3,000	)
Proceeds from stock options exercised		95			123
Cash dividends paid		(1,000	)		(895	)
Cash paid to repurchase common stock		—			(4,654	)

Net cash provided by financing activities	$	21,325		$	14,314

Decrease in cash and cash equivalents		(351	)		(3,833	)

Cash and cash equivalents at beginning of year		29,733			38,467

Cash and cash equivalents at end of period	$	29,382		$	34,634

Supplemental noncash disclosures:
Right of use asset and obligation recorded upon adoption of ASU 2016-02	$	3,570		$	—

Cash paid during the year for:
Interest expense	$	1,682		$	1,113
Income taxes	$	1,218		$	785

See Notes to Unaudited Consolidated Financial Statements

AMERICAN RIVER BANKSHARES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

1. CONSOLIDATED FINANCIAL STATEMENTS

In the opinion of management, the unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the consolidated financial position of American River Bankshares (the “Company”) at September 30, 2019 and December 31, 2018, the results of its operations and statement of comprehensive income for the three-month and nine-month periods ended September 30, 2019 and 2018, its cash flows for the nine-month periods ended September 30, 2019 and 2018 and its statement of changes in shareholders’ equity for the nine-month periods ended September 30, 2019 and 2018 in conformity with accounting principles generally accepted in the United States of America.

Certain disclosures normally presented in the notes to the annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. The Company believes that the disclosures are adequate to make the information not misleading. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2018. The results of operations for the three-month and nine-month periods ended September 30, 2019 may not necessarily be indicative of the operating results for the full year.

In preparing such financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates.

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

Adoption of New Accounting Standard: On January 1, 2019, the Company adopted ASU No. 2016-02, “Leases”, utilizing the effective date method under the modified retrospective approach. The Company currently leases nine of its office leases under operating leases. The Company’s present value of future lease payments as of January 1, 2019 was $3,570,000 which was recorded as a right-of-use asset included in accrued interest receivable and other assets with an offsetting liability included in accrued interest payable and other liabilities on the consolidated balance sheet. The effects of adopting ASU No. 2016-02 did not have a material impact on the Company’s financial position, results of operations or cash flows.

2. STOCK-BASED COMPENSATION

Equity Plans

On March 17, 2010, the Board of Directors adopted the 2010 Equity Incentive Plan (the “2010 Plan”). The 2010 Plan was approved by the Company’s shareholders on May 20, 2010. At September 30, 2019 there were 29,958 stock options and 50,765 restricted shares outstanding and the total number of authorized shares that remain available for issuance was 1,271,673. The 2010 Plan provides for the following types of stock-based awards: incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, restricted performance stock, unrestricted Company stock, and performance units. Under the 2010 Plan, the awards may be granted to employees and directors under incentive and nonqualified option agreements, restricted stock agreements, and other awards agreements. The unvested restricted stock under the 2010 Plan have dividend and voting rights. The 2010 Plan requires that the option price may not be less than the fair market value of the stock at the date the option is awarded. The option awards expire on dates determined by the Board of Directors, but not later than ten years from the date of award. The vesting period is generally five years; however, the vesting period can be modified at the discretion of the Company’s Board of Directors. Outstanding option awards are exercisable until their expiration. New shares are issued upon exercise of an option.

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

Equity Compensation

For the three-month periods ended September 30, 2019 and 2018, the compensation cost recognized for equity compensation was $93,000 and $83,000, respectively and the recognized tax benefit for equity compensation expense was $25,000 and $21,000, respectively, for the same three-month periods ended. For the nine-month periods ended September 30, 2019 and 2018, the compensation cost recognized for equity compensation was $268,000 and $233,000, respectively, and the recognized tax benefit for equity compensation expense was $69,000 and $57,000, respectively, for the nine-month periods ended September 30, 2019 and 2018, respectively.

At September 30, 2019, the total unrecognized pre-tax compensation cost related to nonvested stock option awards not yet recorded was $6,000. This amount will be recognized over the next 1.8 years and the weighted average period of recognizing these costs is expected to be 0.8 years. At September 30, 2019, the total compensation cost related to restricted stock awards not yet recorded was $521,000. This amount will be recognized over the next 4.7 years and the weighted average period of recognizing these costs is expected to be 1.0 years.

Equity Plans Activity

Stock Options

There were no stock options awarded during the three-month and nine-month periods ended September 30, 2019 or September 30, 2018. A summary of option activity under the Plans as of September 30, 2019 and changes during the period then ended is presented below:

Options	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value ($000)
Outstanding at January 1, 2019		41,098		$	8.71		2.3 years	$	215
Awarded		—			—		—		—
Exercised		(11,140	)		8.50		—		—
Expired, forfeited or cancelled		—			—		—		—
Outstanding at September 30, 2019		29,958		$	8.79		4.6 years	$	150

Vested at September 30, 2019		27,735		$	8.73		4.6 years	$	141

Non-vested at September 30, 2019		2,223		$	9.56		5.6 years	$	9

Restricted Stock

There were no shares of restricted stock awarded during the three-month periods ended September 30, 2019 and 2018. There were 33,968 and 22,514 shares of restricted stock awarded during the nine-month periods ended September 30, 2019 and 2018, respectively.

There were no restricted share awards that were fully vested during the three-month periods ended September 30, 2019 and 2018. There were 15,423 restricted share awards that were fully vested during the nine-month period ended September 30, 2019 and 25,455 restricted share awards that were fully vested during the nine-month period ended September 30, 2018. There were zero and 308 restricted share awards forfeited during the three-month and nine-month periods ended September 30, 2019, respectively. There were zero and 4,655 restricted share awards forfeited during the three-month and nine-month periods ended September 30, 2018, respectively. The intrinsic value of nonvested restricted shares at September 30, 2019 was $701,000.

Restricted Stock	Shares			Weighted Average Award Date Fair Value
Nonvested at January 1, 2019		32,528		$	14.60
Awarded		33,968			13.67
Less: Vested		(15,423	)		14.55
Less: Expired, forfeited or cancelled		(308	)		15.58
Nonvested at September 30, 2019		50,765		$	13.98

Other Equity Awards

There were no stock appreciation rights, restricted performance stock, unrestricted Company stock, or performance units awarded during the three-month or nine-month month periods ended September 30, 2019 or 2018 or outstanding at September 30, 2019 or December 31, 2018.

The intrinsic value used for stock options and restricted stock awards was derived from the market price of the Company’s common stock of $13.80 as of September 30, 2019.

3. COMMITMENTS AND CONTINGENCIES

In the normal course of business there are outstanding various commitments to extend credit which are not reflected in the financial statements, including loan commitments of approximately $37,117,000 and standby letters of credit of approximately $300,000 at September 30, 2019 and loan commitments of approximately $34,276,000 and standby letters of credit of approximately $361,000 at December 31, 2018. Such commitments relate primarily to real estate construction loans, revolving lines of credit and other commercial loans. However, all such commitments will not necessarily culminate in actual extensions of credit by the Company during 2019 as some of these are expected to expire without being fully drawn upon.

Standby letters of credit are commitments issued to guarantee the performance or financial obligation of a client to a third party. These guarantees are issued primarily relating to purchases of inventory, insurance programs, performance obligations to government agencies, or as security for real estate rents by commercial clients and are typically short-term in nature. Credit risk is similar to that involved in extending loan commitments to clients and accordingly, evaluation and collateral requirements similar to those for loan commitments are used. The majority of all such commitments are collateralized. The fair value of the liability related to these standby letters of credit, which represents the fees received for issuing the guarantees, was not significant at September 30, 2019 or December 31, 2018.

4. EARNINGS PER SHARE COMPUTATION

Basic earnings per share is computed by dividing net income by the weighted average common shares outstanding for the period (5,852,463 and 5,845,242 shares for the three-month and nine-month periods ended September 30, 2019, and 5,823,345 and 5,886,977 shares for the three-month and nine-month periods ended September 30, 2018). Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock, such as stock options or restricted stock, result in the issuance of common stock. Diluted earnings per share is computed by dividing net income by the weighted average common shares outstanding for the period plus the dilutive effect of stock based awards. There were 18,453 and 18,737, respectively, dilutive shares for the three-month and nine-month periods ended September 30, 2019 and 41,482 and 38,700, respectively, dilutive shares for the three-month and nine-month periods ended September 30, 2018. For the three-month periods ended September 30, 2019 and 2018, there were zero stock options that were excluded from the calculation as they were considered antidilutive.

For the nine-month periods ended September 30, 2019 and 2018, there were zero stock options that were excluded from the calculation as they were considered antidilutive. Earnings per share is retroactively adjusted for stock dividends and stock splits, if applicable, for all periods presented.

5. INVESTMENT SECURITIES

The amortized cost and estimated fair values of Available-for-Sale and Held-to-Maturity investment securities at September 30, 2019 and December 31, 2018 consisted of the following (dollars in thousands):

Available-for-Sale

	September 30, 2019
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Debt securities:
U.S. Government Agencies and Sponsored Entities	$	257,664	$	4,550	$	(898	)	$	261,316
Obligations of states and political subdivisions		7,785		328		—			8,113
Corporate bonds		6,495		131		—			6,626
	$	271,944	$	5,009	$	(898	)	$	276,055

	December 31, 2018
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Debt securities:
U.S. Government Agencies and Sponsored Entities	$	271,685	$	984	$	(3,620	)	$	269,049
Obligations of states and political subdivisions		14,440		165		(205	)		14,400
Corporate bonds		6,493		74		(59	)		6,508
U.S. Treasury securities		4,979		—		(3	)		4,976
	$	297,597	$	1,223	$	(3,887	)	$	294,933

Net unrealized gains on available-for-sale investment securities totaling $4,111,000 were recorded, net of $1,215,000 in tax liabilities, as accumulated other comprehensive income within shareholders’ equity at September 30, 2019. Proceeds and gross realized gains from the sale and call of available-for-sale investment securities totaled $13,538,000 and $9,000, respectively, for the three-month period ended September 30, 2019 and for the nine-month period ended September 30, 2019, proceeds and gross realized gains from the sale and call of available-for-sale investment securities totaled $43,213,000 and $74,000, respectively. There were no transfers of available-for-sale investment securities for the three-month and nine-month periods ended September 30, 2019.

Net unrealized losses on available-for-sale investment securities totaling $2,664,000 were recorded, net of $788,000 in tax liabilities, as accumulated other comprehensive loss within shareholders’ equity at December 31, 2018. Proceeds and gross realized gains from the sale and call of available-for-sale investment securities totaled $10,310,000 and $8,000, respectively, for the three-month period ended September 30, 2018 and for the nine-month period ended September 30, 2018, proceeds and gross realized gains from the sale and call of available-for-sale investment securities totaled $26,252,000 and $19,000, respectively. There were no transfers of available-for-sale investment securities for the three-month and nine-month periods ended September 30, 2018.

Held-to-Maturity

September 30, 2019
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Debt securities:
U.S. Government Agencies and Sponsored Entities	$	256	$	19	$	—	$	275

December 31, 2018	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Debt securities:
U.S. Government Agencies and Sponsored Entities	$	292	$	14	$	—	$	306

There were no sales or transfers of held-to-maturity investment securities for the periods ended September 30, 2019 and September 30, 2018. Investment securities with unrealized losses at September 30, 2019 and December 31, 2018 are summarized and classified according to the duration of the loss period as follows (dollars in thousands):

September 30, 2019	Less than 12 Months					12 Months or More					Total
Available-for-Sale	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses

Debt securities:
U.S. Government Agencies and Sponsored Entities	$	52,569	$	(242	)	$	53,438	$	(656	)	$	106,007	$	(898	)
	$	52,569	$	(242	)	$	53,438	$	(656	)	$	106,007	$	(898	)

December 31, 2018	Less than 12 Months					12 Months or More					Total
Available-for-Sale	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses

Debt securities:
U.S. Government Agencies and Sponsored Entities	$	39,267	$	(310	)	$	138,894	$	(3,310	)	$	178,161	$	(3,620	)
Obligations of states and political subdivisions		2,168		(28	)		5,583		(177	)		7,751		(205	)
Corporate bonds		497		(4	)		1,938		(55	)		2,435		(59	)
U.S. Treasury securities		4,976		(3	)		—		—			4,976		(3	)
	$	46,908	$	(345	)	$	146,415	$	(3,542	)	$	193,323	$	(3,887	)

There were no held-to-maturity investment securities with unrealized losses as of September 30, 2019 or December 31, 2018. At September 30, 2019, the Company held 210 securities of which 26 were in a loss position for less than twelve months and 39 were in a loss position for twelve months or more. Of the 26 securities in a loss position for less than twelve months, all 26 were U.S. Government Agencies and Sponsored Entities securities and of the 39 securities that were in a loss position for greater than twelve months, all 39 were U.S. Government Agencies and Sponsored Entities securities.

At December 31, 2018, the Company held 220 securities of which 26 were in a loss position for less than twelve months and 97 were in a loss position for twelve months or more. Of the 97 securities in a loss position for greater than twelve months at December 31, 2018, one was a corporate securities, five were municipal securities and 91 were U.S. Government Agencies and Sponsored Entities securities.

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

The amortized cost and estimated fair values of investment securities at September 30, 2019 by contractual maturity are shown below (dollars in thousands).

	Available-for-Sale				Held-to-Maturity
	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value

Within one year	$	755	$	758
After one year through five years		2,937		2,954
After five years through ten years		7,153		7,380
After ten years		3,435		3,647
		14,280		14,739
Investment securities not due at a single maturity date:
U.S. Government Agencies and Sponsored Entities		257,664		261,316	$	256	$	275
	$	271,944	$	276,055	$	256	$	275

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

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

At September 30, 2019 and December 31, 2018, the recorded investment in nonperforming loans and leases was zero and $27,000, respectively. Nonperforming loans and leases include all such loans and leases that are either placed on nonaccrual status or are 90 days past due as to principal or interest but still accrue interest because such loans are well-secured and in the process of collection. The Company considers a loan to be impaired when, based on current information and events, it is probable that it will be unable to collect all amounts due (principal and interest) according to the contractual terms of the original loan agreement. At September 30, 2019, the recorded investment in loans and leases that were considered to be impaired totaled $7,662,000, all of which were considered performing loans and leases. Of the total impaired loans of $7,662,000, loans totaling $5,879,000 were deemed to require no specific reserve and loans totaling $1,783,000 were deemed to require a related valuation allowance of $82,000. At December 31, 2018, the recorded investment in loans and leases that were considered to be impaired totaled $8,702,000. Of the total impaired loans of $8,702,000, loans totaling $5,968,000 were deemed to require no specific reserve and loans totaling $2,734,000 were deemed to require a related valuation allowance of $185,000.

At September 30, 2019 and December 31, 2018, the recorded investment in other real estate owned (“OREO”) was $957,000. At September 30, 2019 the Company did not own any residential OREO properties nor were there any residential properties in the process of foreclosure. During the first nine months of 2019, the Company did not add any new or sell any of the OREO properties, nor did we decrease the book value on any of the properties. The September 30, 2019 OREO balance of $957,000 consisted of one parcel of land zoned for commercial use.

Nonperforming assets at September 30, 2019 and December 31, 2018 are summarized as follows:

(dollars in thousands)	September 30, 2019			December 31, 2018
Nonaccrual loans and leases that are current to terms (less than 30 days past due)	$	—		$	27
Nonaccrual loans and leases that are past due		—			—
Loans and leases past due 90 days and accruing interest		—			—
Other real estate owned		957			957
Total nonperforming assets	$	957		$	984

Nonperforming loans and leases to total loans and leases		0.00	%		0.01	%
Total nonperforming assets to total assets		0.13	%		0.14	%

Impaired loans and leases as of and for the periods ended September 30, 2019 and December 31, 2018 are summarized as follows:

(dollars in thousands)	As of September 30, 2019						As of December 31, 2018
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:

Real estate-commercial	$	5,560	$	5,694	$	—	$	5,645	$	5,879	$	—
Real estate-residential		319		406		—		323		410		—
Subtotal	$	5,879	$	6,100	$	—	$	5,968	$	6,289	$	—

With an allowance recorded:

Real estate-commercial	$	1,645	$	1,718	$	72	$	2,138	$	2,217	$	132
Real estate-residential		138		138		10		596		596		53
Subtotal	$	1,783	$	1,856	$	82	$	2,734	$	2,813	$	185

Total:

Real estate-commercial	$	7,205	$	7,412	$	72	$	7,783	$	8,096	$	132
Real estate-residential		457		544		10		919		1,006		53
	$	7,662	$	7,956	$	82	$	8,702	$	9,102	$	185

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

	Average Recorded Investments for the three months ended				Average Recorded Investments for the nine months ended
	September 30,		September 30,		September 30,		September 30,
	2019		2018		2019		2018
Real estate-commercial	$	7,231	$	8,167	$	7,347	$	8,231
Real estate-residential		460		1,063		465		1,073
Consumer		—		68		—		69
Total	$	7,691	$	9,298	$	7,812	$	9,373

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

	Interest Income Recognized for the three months ended				Interest Income Recognized for the nine months ended
	September 30,		September 30,		September 30,		September 30,
	2019		2018		2019		2018
Real estate-commercial	$	110	$	120	$	329	$	341
Real estate-residential		7		13		19		41
Consumer		—		1		—		2
Total	$	117	$	134	$	348	$	384

7. TROUBLED DEBT RESTRUCTURINGS

During the three and nine-month periods ended September 30, 2019, there were no loans that were modified as troubled debt restructurings. During the three and nine-month periods ended September 30, 2018, there was one $18,000 commercial loan that was modified as a troubled debt restructuring. The loan was a term out of a line of credit to an amortizing loan with a rate reduction. There were no payment defaults on troubled debt restructurings within 12 months following the modification for the three-month and nine-month periods ended September 30, 2019 and September 30, 2018. At September 30, 2019 and December 31, 2018, there were no unfunded commitments on those loans considered troubled debt restructures. See also “Impaired Loans and Leases” in Item 2.

8. ALLOWANCE FOR LOAN AND LEASE LOSSES

The Company’s loan and lease portfolio allocated by management’s internal risk ratings as of September 30, 2019 and December 31, 2018 are summarized below:

September 30, 2019	Credit Risk Profile by Internally Assigned Grade
(dollars in thousands)			Real Estate
	Commercial		Commercial		Multi-family		Construction		Residential
Grade:
Pass	$	36,080	$	195,428	$	57,221	$	13,657	$	28,355
Watch		4,978		7,151		—		—		623
Special mention		21		—		—		—		—
Substandard		—		135		—		—		—
Total	$	41,079	$	202,714	$	57,221	$	13,657	$	28,978

	Credit Risk Profile by Internally Assigned Grade Other Credit Exposure
	Leases		Agriculture		Consumer		Total
Grade:
Pass	$	—	$	6,570	$	24,652	$	361,963
Watch		—		—		22		12,774
Special mention		—		—		—		21
Substandard		—		—		—		135
Total	$	—	$	6,570	$	24,674	$	374,893

December 31, 2018	Credit Risk Profile by Internally Assigned Grade
(dollars in thousands)			Real Estate
	Commercial		Commercial		Multi-family		Construction		Residential
Grade:
Pass	$	29,570	$	185,548	$	52,301	$	5,685	$	15,373
Watch		53		13,118		3,838		—		965
Special mention		—		1,087		—		—		—
Substandard		27		141		—		—		—
Doubtful		—		—		—		—		—
Total	$	29,650	$	199,894	$	56,139	$	5,685	$	16,338

	Credit Risk Profile by Internally Assigned Grade Other Credit Exposure
	Leases		Agriculture		Consumer		Total
Grade:
Pass	$	32	$	4,419	$	10,691	$	303,619
Watch		—		—		22		17,996
Special mention		—		—		1		1,088
Substandard		—		—		—		168
Doubtful		—		—		—		—
Total	$	32	$	4,419	$	10,714	$	322,871

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

September 30, 2019			Real Estate											Other
(dollars in thousands)	Commercial		Commercial			Multi-Family			Construction		Residential			Leases		Agriculture			Consumer			Unallocated			Total
Allowance for Loan and Lease Losses
Beginning balance, January 1, 2019	$	668	$	2,114		$	564		$	267	$	220		$	—	$	88		$	192		$	279		$	4,392
Provision for loan losses		257		(184	)		(149	)		339		105			—		29			92			(9	)		480
Loans charged-off		—		—			—			—		—			—		—			—			—			—
Recoveries		5		8			—			—		—			—		—			68			—			81

Ending balance, September 30, 2019	$	930	$	1,938		$	415		$	606	$	325		$	—	$	117		$	352		$	270		$	4,953

Ending balance:
Individually evaluated for impairment	$	—	$	72		$	—		$	—	$	10		$	—	$	—		$	—		$	—		$	82

Ending balance:
Collectively evaluated for impairment	$	930	$	1,866		$	415		$	606	$	315		$	—	$	117		$	352		$	270		$	4,871

Loans

Ending balance	$	41,079	$	202,714		$	57,221		$	13,657	$	28,978		$	—	$	6,570		$	24,674		$	—		$	374,893

Ending balance:
Individually evaluated for impairment	$	—	$	7,205		$	—		$	—	$	457		$	—	$	—		$	—		$	—		$	7,662

Ending balance:
Collectively evaluated for impairment	$	41,079	$	195,509		$	57,221		$	13,657	$	28,521		$	—	$	6,570		$	24,674		$	—		$	367,231

Allowance for Loan and Lease Losses

Beginning balance, June 30, 2019	$	794	$	2,085		$	390		$	454	$	358		$	—	$	131		$	318		$	231		$	4,761
Provision for loan losses		134		(149	)		25			152		(33	)		—		(14	)		(34	)		39			120
Loans charged off		—		—			—			—		—			—		—			—			—			—
Recoveries		2		2			—			—		—			—		—			68			—			72

Ending balance, September 30, 2019	$	930	$	1,938		$	415		$	606	$	325		$	—	$	117		$	352		$	270		$	4,953

December 31, 2018				Real Estate										Other
(dollars in thousands)	Commercial			Commercial			Multi-Family			Construction		Residential		Leases			Agriculture		Consumer		Unallocated			Total
Ending balance:
Individually evaluated for impairment	$	—		$	132		$	—		$	—	$	53	$	—		$	—	$	—	$	—		$	185

Ending balance:
Collectively evaluated for impairment	$	668		$	1,982		$	564		$	267	$	167	$	—		$	88	$	192	$	279		$	4,207

Loans

Ending balance	$	29,650		$	199,894		$	56,139		$	5,685	$	16,338	$	32		$	4,419	$	10,714	$	—		$	322,871

Ending balance:
Individually evaluated for impairment	$	—		$	7,783		$	—		$	—	$	919	$	—		$	—	$	—	$	—		$	8,702

Ending balance:
Collectively evaluated for impairment	$	29,650		$	192,111		$	56,139		$	5,685	$	15,419	$	32		$	4,419	$	10,714	$	—		$	314,169

September 30, 2018
(dollars in thousands)				Real Estate										Other
	Commercial			Commercial			Multi-Family			Construction		Residential		Leases			Agriculture		Consumer		Unallocated			Total
Allowance for Loan and Lease Losses

Beginning balance, January 1, 2018	$	447		$	2,174		$	1,047		$	269	$	205	$	—		$	31	$	14	$	291		$	4,478
Provision for loan losses		300			(208	)		(307	)		89		35		(1	)		64		80		(2	)		50
Loans charged-off		(213	)		—			—			—		—		—			—		—		—			(213	)
Recoveries		10			6			—			—		—		1			—		—		—			17

Ending balance, September 30, 2018	$	544		$	1,972		$	740		$	358	$	240	$	—		$	95	$	94	$	289		$	4,332


Allowance for Loan and Lease Losses

Beginning balance, June 30, 2018	$	669		$	2,100		$	839		$	298	$	239	$	—		$	49	$	11	$	287		$	4,492
Provision for loan losses		87			(130	)		(99	)		60		1		—			46		83		2			50
Loans charged off		(213	)		—			—			—		—		—			—		—		—			(213	)
Recoveries		1			2			—			—		—		—			—		—		—			3

Ending balance, September 30, 2018	$	544		$	1,972		$	740		$	358	$	240	$	—		$	95	$	94	$	289		$	4,332

The Company’s aging analysis of the loan and lease portfolio at September 30, 2019 and December 31, 2018 are summarized below:

September 30, 2019
(dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		Past Due Greater Than 90 Days		Total Past Due		Current		Total Loans		Past Due Greater Than 90 Days and Accruing		Nonaccrual
Commercial:
Commercial	$	—	$	—	$	—	$	—	$	41,079	$	41,079	$	—	$	—
Real estate:
Commercial		—		—		—		—		202,714		202,714		—		—
Multi-family		—		—		—		—		57,221		57,221		—		—
Construction		—		—		—		—		13,657		13,657		—		—
Residential		—		—		—		—		28,978		28,978		—		—

Other:
Leases		—		—		—		—		—		—		—		—
Agriculture		—		—		—		—		6,570		6,570		—		—
Consumer		—		—		—		—		24,674		24,674		—		—

Total	$	—	$	—	$	—	$	—	$	374,893	$	374,893	$	—	$	—

December 31, 2018
(dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		Past Due Greater Than 90 Days		Total Past Due		Current		Total Loans		Past Due Greater Than 90 Days and Accruing		Nonaccrual
Commercial:
Commercial	$	—	$	—	$	—	$	—	$	29,650	$	29,650	$	—	$	27

Real estate:
Commercial		—		—		—		—		199,894		199,894		—		—
Multi-family		—		—		—		—		56,139		56,139		—		—
Construction		—		—		—		—		5,685		5,685		—		—
Residential		—		—		—		—		16,338		16,338		—		—

Other:
Leases		—		—		—		—		32		32		—		—
Agriculture		—		—		—		—		4,419		4,419		—		—
Consumer		—		—		—		—		10,714		10,714		—		—

Total	$	—	$	—	$	—	$	—	$	322,871	$	322,871	$	—	$	27

9. LEASES

The Company adopted ASU 2016-02, Leases (Topic 842), on January 1, 2019, using the alternative transition method whereby comparative periods were not restated. No cumulative effect adjustment to the opening balance of retained earnings was required. The Company also elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things allowed the Company to carry forward the historical lease classifications. Additionally, the Company elected the hindsight practical expedient to determine the lease term for existing leases.

The Company leases nine locations for administrative offices and branch locations. All leases were classified as operating leases. Leases with an initial term of 12 months or less are not recorded on the balance sheet and the related lease expense is recognized on a straight-line basis over the lease term. The Company elected to use the practical expedient to not recognize short-term leases on the consolidated balance sheet and instead account for them as executory contracts.

Certain leases include options to renew, with renewal terms that can extend the lease term, typically for five years. Lease assets and liabilities include related options that are reasonably certain of being exercised, however, in the case of those leases that have renewal options, the Company is not including those additional lease terms as the rates are undeterminable and it has been the Company’s historical practice to renegotiate lease terms upon expiration of the original lease terms. The depreciable life of leased assets is limited by the expected lease term.

Adoption of this standard resulted in the Company recognizing a right of use asset and a corresponding lease liability of $3,570,000 on January 1, 2019.

Supplemental lease information at or for the nine months ended September 30, 2019 is as follows:

Balance Sheet
Operating lease asset classified as other assets	$	2,798,000
Operating lease liability classified as other liabilities		3,025,000
Income Statement
Operating lease cost classified as occupancy and equipment expense	$	567,000
Weighted average lease term, in years		6.01
Weighted average discount rate (1)		3.07	%
Operating cash flows	$	565,000

(1)	The discount rate was developed by using the fixed rate credit advance borrowing rate at the Federal Home Loan Bank of San Francisco for a term correlating to the remaining life of each lease.

A maturity analysis of the Company’s lease liabilities at September 30, 2019 was as follows:

	Balance
October 1, 2019 to December 31, 2019	$	182,000
January 1, 2020 to December 31, 2020		688,000
January 1, 2021 to December 31, 2021		633,000
January 1, 2022 to December 31, 2022		282,000
January 1, 2023 to December 31, 2023		273,000
Thereafter		657,000
Total lease payments		3,375,000
Less: Interest		(350,000	)
Present value of lease liabilities	$	3,025,000

10. BORROWING ARRANGEMENTS

At September 30, 2019, the Company had $17,000,000 of unsecured short-term borrowing arrangements with two of its correspondent banks. There were no advances under the borrowing arrangements as of September 30, 2019 or December 31, 2018.

The Company has a line of credit available with the Federal Home Loan Bank of San Francisco (the “FHLB”) which is secured by pledged mortgage loans and investment securities. Borrowings may include overnight advances as well as loans with terms of up to thirty years. Advances (both short-term and long-term) totaling $15,500,000 were outstanding from the FHLB at September 30, 2019, bearing interest rates ranging from 1.31% to 3.17% and maturing between July 13, 2020 and November 24, 2023. Advances totaling $15,500,000 were outstanding from the FHLB at December 31, 2018, bearing interest rates ranging from 1.18% to 3.17% and maturing between April 30, 2019 and November 24, 2023. Remaining amounts available under the borrowing arrangement with the FHLB at September 30, 2019 and December 31, 2018 totaled $131,626,000 and $107,262,000, respectively. In addition, the Company has a secured borrowing agreement with the Federal Reserve Bank of San Francisco. The borrowing can be secured by pledging selected loans and investment securities. Borrowings generally are short-term including overnight advances as well as loans with terms up to ninety days. Amounts available under this borrowing arrangement at September 30, 2019 and December 31, 2018 were $9,322,000 and $8,340,000, respectively. There were no advances outstanding under this borrowing arrangement as of September 30, 2019 and December 31, 2018.

11. INCOME TAXES

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

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

The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above, if applicable, is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company recognizes accrued interest and penalties related to unrecognized tax benefits, if applicable, as a component of interest expense in the consolidated statement of income. There have been no unrecognized tax benefits or accrued interest and penalties for the three-month and nine-month periods ended September 30, 2019 and 2018.

12. FAIR VALUE MEASUREMENTS

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring and nonrecurring basis as of September 30, 2019 and December 31, 2018. They indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In 2018, the Company adopted the provisions of Accounting Standard Update 2016-01 “Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”). ASU 2016-01 requires the Company to use the exit price notion when measuring the fair value of financial instruments. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

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

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

	Carrying		Fair Value Measurements Using:
September 30, 2019	Amount		Level 1		Level 2		Level 3		Total
Financial assets:
Cash and due from banks	$	14,512	$	14,512	$	—	$	—	$	14,512
Federal funds sold		—		—		—		—		—
Interest-bearing deposits in banks		14,870		13,124		1,746		—		14,870
Available-for-sale securities		276,055		—		276,055		—		276,055
Held-to-maturity securities		256		—		275		—		275
FHLB stock		4,259		N/A		N/A		N/A		N/A
Net loans and leases		369,940		—		—		375,167		375,167
Accrued interest receivable		2,019		—		762		1,157		1,919

Financial liabilities:
Deposits:
Noninterest-bearing	$	228,517	$	228,517	$	—	$	—	$	228,517
Savings		75,980		75,980		—		—		75,980
Money market		151,469		151,469		—		—		151,469
NOW accounts		70,712		70,712		—		—		70,712
Time Deposits		86,226		—		86,456		—		86,456
Short-term borrowings		5,000		5,000		—		—		5,000
Long-term borrowings		10,500		—		10,802		—		10,802
Accrued interest payable		239		4		235		—		235

	Carrying		Fair Value Measurements Using:
December 31, 2018	Amount		Level 1		Level 2		Level 3		Total
Financial assets:
Cash and due from banks	$	20,987	$	20,987	$	—	$	—	$	20,987
Federal funds sold		7,000		7,000						7,000
Interest-bearing deposits in banks		1,746		—		1,746		—		1,746
Available-for-sale securities		294,933		4,976		289,957		—		294,933
Held-to-maturity securities		292		—		306		—		306
FHLB stock		3,932		N/A		N/A		N/A		N/A
Net loans and leases:		318,516		—		—		315,235		315,235
Accrued interest receivable		1,959		—		1,044		915		1,959

Financial liabilities:
Deposits:
Noninterest-bearing	$	214,745	$	214,745	$	—	$	—	$	214,745
Savings		72,522		72,522		—		—		72,522
Money market		145,831		145,831		—		—		145,831
Interest checking		69,489		69,489		—		—		69,489
Time Deposits		88,087		—		88,078		—		88,078
Short-term borrowings		5,000		5,000		—		—		5,000
Long-term borrowings		10.500		—		10,733		—		10,733
Accrued interest payable		63		1		62		—		63

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

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

Description			Fair Value Measurements Using						Total Gains
(dollars in thousands)	Fair Value		Level 1		Level 2		Level 3		(Losses)
September 30, 2019
Assets and liabilities measured on a recurring basis:
Available-for-sale securities:
U.S. Government Agencies and Sponsored Entities	$	261,316	$	—	$	261,316	$	—	$	—
Obligations of states and political subdivisions		8,113		—		8,113		—		—
Corporate bonds		6,626		—		6,626		—		—
Total recurring	$	276,055	$	—	$	276,055	$	—	$	—

Assets and liabilities measured on a nonrecurring basis:

Other real estate owned
Land	$	957	$	—	$	—	$	957	$	—
Total nonrecurring	$	957	$	—	$	—	$	957	$	—

At September 30, 2019, there were no impaired loans carried at fair value as the appraised value exceeded carrying value.

Description			Fair Value Measurements Using						Total Gains
(dollars in thousands)	Fair Value		Level 1		Level 2		Level 3		(Losses)
December 31, 2018
Assets and liabilities measured on a recurring basis:
Available-for-sale securities:
U.S. Government Agencies and Sponsored Entities	$	269,049	$	—	$	269,049	$	—	$	—
Corporate bonds		6,508		—		6,508
Obligations of states and political subdivisions		14,400		—		14,400		—		—
U.S. Treasury securities		4,976		4,976		—		—		—
Total recurring	$	294,933	$	4,976	$	289,957	$	—	$	—

Assets and liabilities measured on a nonrecurring basis:
Impaired loans:
Real estate:
Commercial	$	5,274	$	—	$	—	$	5,274	$	—

Other real estate owned Land		957		—		—		957		(4	)
Total nonrecurring	$	6,231	$	—	$	—	$	6,231	$	(4	)

There were no significant transfers between Levels 1 and 2 during the three-month and nine-month periods ended September 30, 2019 or the twelve months ended December 31, 2018.

The following methods were used to estimate the fair value of each class of financial instrument above:

Available-for-sale securities – Fair values for investment securities are based on quoted market prices, if available, and are considered Level 1, or evaluated using pricing models that vary by asset class and incorporate available trade, bid and other market information and are considered Level 2. Pricing applications apply available information, as applicable, through processes such as benchmark curves, benchmarking to like securities, sector groupings and matrix pricing.

Impaired loans – The fair value of collateral dependent impaired loans adjusted for specific allocations of the allowance for loan losses is generally based on recent real estate appraisals and/or evaluations. These appraisals and/or evaluations may utilize a single valuation approach or a combination of approaches including comparable sales, cost and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income and other available data. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. The valuation technique used for all Level 3 nonrecurring impaired loans is the sales comparison approach less a reserve for past dues taxes and selling costs ranging from 8% to 10%.

Other real estate owned – Certain commercial and residential real estate properties classified as OREO are measured at fair value, less costs to sell. Fair values are based on recent real estate appraisals and/or evaluations. These appraisals and/or evaluations may use a single valuation approach or a combination of approaches including comparable sales, cost and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income and other available data. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. The valuation technique used for all Level 3 nonrecurring OREO is the sales comparison approach less selling costs ranging from 8% to 10%.

13. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In February 2016, the FASB issued ASU No. 2016-02, “Leases.” Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases): 1) a lease liability, which is the present value of a lessee’s obligation to make lease payments, and 2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Lessor accounting under the new guidance remains largely unchanged as it is substantially equivalent to existing guidance for sales-type leases, direct financing leases, and operating leases. Leveraged leases have been eliminated, although lessors can continue to account for existing leveraged leases using the current accounting guidance. Other limited changes were made to align lessor accounting with the lessee accounting model and the new revenue recognition standard. All entities will classify leases to determine how to recognize lease-related revenue and expense. Quantitative and qualitative disclosures will be required by lessees and lessors to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. The intention is to require enough information to supplement the amounts recorded in the financial statements so that users can understand more about the nature of an entity’s leasing activities. ASU No. 2016-02 was effective for interim and annual reporting periods beginning after December 15, 2018; early adoption was permitted. All entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. They have the option to use certain relief; full retrospective application is prohibited. Based on evaluation of the Company’s current lease obligations, the Company has determined that the provisions of ASU No. 2016-02 resulted in an increase in assets to recognize the present value of the lease obligations with a corresponding increase in liabilities. The Company currently leases nine of its office leases under operating leases. The Company adopted ASU No. 2016-02 on January 1, 2019. The Company’s present value of future lease payments as of January 1, 2019 is $3,570,000, to be recorded as a right-of-use asset with an offsetting liability. Other than the just noted increase in assets and liabilities, the effects of adopting ASU No. 2016-02 did not have a material impact on the Company’s financial position, results of operations or cash flows.

In June 2016, the FASB issued ASU No. 2016-13, “Measurement of Credit Losses on Financial Instruments.” This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that aren’t measured at fair value through net income. In issuing the standard, the FASB is responding to criticism that today’s guidance delays recognition of credit losses. The standard will replace today’s “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments, and financial guarantees. The CECL model does not apply to available-for-sale (“AFS”) debt securities. For AFS debt securities with unrealized losses, entities will measure credit losses in a manner similar to what they do today, except that the losses will be recognized as allowances rather than reductions in the amortized cost of the securities. As a result, entities will recognize improvements to estimated credit losses immediately in earnings rather than as interest income over time, as they do today. The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans. ASU 2016-13 also expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance for loan and lease losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. ASU No. 2016-13 was initially scheduled to become effective for interim and annual reporting periods beginning after December 15, 2019, however, on October 16, 2019, the FASB approved its former tentative decision with respect to the effective date of implementing ASU No. 2016-13. Subject to the final ASU, which is expected in mid-November, the FASB approved the tentative decision to defer the effective date of ASU No. 2016-13 for smaller reporting companies, such as the Company, to interim and annual reporting periods beginning after December 15, 2022; early adoption would still be permitted for interim and annual reporting periods beginning after December 15, 2018. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (i.e., modified retrospective approach). While the Company is currently evaluating the provisions of ASU No. 2016-13 to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements, including if it will early adopt the standard, it has taken steps to prepare for the implementation when it becomes effective, such as forming an internal task force, gathering pertinent data, consulting with outside professionals, evaluating its current IT systems, and purchasing a software solution. The Company has imported current and historical data into the new software and is currently validating the data and intends to begin processing information, on a test basis, with the new CECL specific software during 2019 and 2020 and to disclose any material potential impact of this modeling once it becomes available.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following is management’s discussion and analysis of the significant changes in American River Bankshares’ (the “Company”) balance sheet accounts between December 31, 2018 and September 30, 2019 and its income and expense accounts for the three-month and nine-month periods ended September 30, 2019 and 2018. The discussion is designed to provide a better understanding of significant trends related to the Company’s financial condition, results of operations, liquidity, capital resources and interest rate sensitivity. This discussion and supporting tables and the consolidated financial statements and related notes appearing elsewhere in this report are unaudited. Interest income and net interest income are presented on a fully taxable equivalent basis (FTE) within management’s discussion and analysis. Certain matters discussed or incorporated by reference in this Quarterly Report on Form 10-Q including, but not limited to, matters described in this “Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations,” are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, Section 27A of the Securities Act of 1933, as amended, and subject to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may contain words related to future projections including, but not limited to, words such as “believe,” “expect,” “anticipate,” “intend,” “may,” “will,” “should,” “could,” “would,” and variations of those words and similar words that are subject to risks, uncertainties and other factors that could cause actual results to differ significantly from those projected. Factors that could cause or contribute to such differences include, but are not limited to, the following:

Current and future legislation and regulation 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;

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;

inadequate internal controls over financial reporting or disclosure controls and procedures;

changes in accounting policies and practices and the effects of adopting ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments (“CECL”);

potential declines in fee and other noninterest income earned associated with economic factors;

general economic conditions nationally, regionally, and within our operating markets could be less favorable than expected or could have a more direct and pronounced effect on us than expected and adversely affect our ability to continue internal growth at historical rates and maintain the quality of our earning assets;

changes in the regulatory environment including increased capital and regulatory compliance requirements and government intervention in the U.S. financial system;

changes in business conditions and inflation;

changes in securities markets, public debt markets, and other capital markets;

potential data processing, cybersecurity and other operational systems failures, breach or fraud;

potential decline in real estate values in our operating markets;

the effects of uncontrollable events such as terrorism, the threat of terrorism or the impact of military conflicts in connection with the conduct of the war on terrorism by the United States and its allies, natural disasters (including earthquakes and wildfires), and disruption of power supplies and communications;

changes in accounting standards, tax laws or regulations and interpretations of such standards, laws or regulations;

projected business increases following any future strategic expansion could be lower than expected;

the goodwill we have recorded in connection with acquisitions could become impaired, which may have an adverse impact on our earnings;

our ability to comply with any regulatory orders or requirements we may become subject to;

the effects and costs of litigation and other legal developments;

the reputation of the financial services industry could experience deterioration, which could adversely affect our ability to access markets for funding and to acquire and retain customers; and

the efficiencies we may expect to receive from any investments in personnel and infrastructure may not be realized.

The factors set forth under “Item 1A - Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, and other cautionary statements and information set forth in this Quarterly Report on Form 10-Q should be carefully considered and understood as being applicable to all related forward-looking statements contained in this Quarterly Report on Form 10-Q, when evaluating the business prospects of the Company and its subsidiaries.

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

Use of Non-GAAP Financial Measures

This Quarterly Report on Form 10-Q (“Form 10Q”) contains certain non-GAAP (Generally Accepted Accounting Principles) financial measures in addition to results presented in accordance with GAAP. These measures include the taxable equivalent basis used in the computation of the net interest margin and efficiency ratio. Management has presented these non-GAAP financial measures in this Form 10Q because it believes that they provide useful and comparative information to assess trends in the Company’s financial position reflected in the current quarter and year-to-date results and facilitate comparison of our performance with the performance of our peers.

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

In accordance with industry standards, certain designated net interest income amounts are presented on a taxable equivalent basis, including the calculation of net interest margin and the efficiency ratio. The Company believes the presentation of net interest margin on a taxable equivalent basis using a 21% effective tax rate 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.

Reconciliation of Annualized Net Interest Margin, Fully Tax Equivalent (non-GAAP)

(dollars in thousands)	For the three months ended September 30,						For the nine months ended September 30,
	2019			2018			2019			2018
Net interest income (GAAP)	$	5,928		$	5,257		$	17,105		$	15,114
Tax equivalent adjustment		49			45			148			159
Net interest income - tax equivalent adjusted (non-GAAP)	$	5,977		$	5,302		$	17,253		$	15,273

Average earning assets	$	655,937		$	611,743		$	642,605		$	607,299
Net interest margin (GAAP)		3.59	%		3.41	%		3.56	%		3.33	%
Net interest margin (non-GAAP)		3.62	%		3.44	%		3.59	%		3.36	%

Reconciliation of Non-GAAP Measure – Efficiency Ratio

(dollars in thousands)	For the three months ended September 30,						For the nine months ended September 30,
	2019			2018			2019			2018
Net interest income (GAAP)	$	5,928		$	5,257		$	17,105		$	15,114
Tax equivalent adjustment		49			45			148			159
Net interest income – tax-equivalent adjusted (non-GAAP)	$	5,977		$	5,302		$	17,253		$	15,273
Noninterest income		417			377			1,249			1,129
Total income		6,394			5,555			18,502			16,402
Total noninterest expense		4,093			4,003			12,501			11,181
Efficiency ratio, fully tax-equivalent (non-GAAP)		64.01	%		70.49	%		67.57	%		68.17	%

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.

General Development of Business

The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Company was incorporated under the laws of the State of California in 1995. As a bank holding company, the Company is authorized to engage in the activities permitted under the Bank Holding Company Act of 1956, as amended, and regulations thereunder. Its principal office is located at 3100 Zinfandel Drive, Suite 450, Rancho Cordova, California 95670 and its telephone number is (916) 854-0123. The Company employed an equivalent of 104 full-time employees as of September 30, 2019.

The Company owns 100% of the issued and outstanding common shares of its banking subsidiary, American River Bank (the “Bank”), and American River Financial, a California corporation which has been inactive since its incorporation in 2003.

American River Bank was incorporated and commenced business in Fair Oaks, California, in 1983 and thereafter moved its headquarters to Sacramento, California in 1985. American River Bank operates five full service offices in Sacramento and Placer Counties including the main office located at 1545 River Park Drive, Suite 107, Sacramento and branch offices in Sacramento, Gold River, and Roseville; two full service offices in Sonoma County in Healdsburg and Santa Rosa; and three full service offices in Amador County in Jackson, Pioneer, and Ione.

The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to applicable legal limits. American River Bank does not offer trust services or international banking services and does not plan to do so in the near future. American River Bank’s primary business is serving the commercial banking needs of small to mid-sized businesses within those counties listed above. American River Bank accepts checking and savings deposits, offers money market deposit accounts and certificates of deposit, makes secured and unsecured commercial, secured real estate, and other installment and term loans and offers other customary banking services. American River Bank also conducts lease financing for certain types of business equipment. American River Bank owns 100% of two inactive companies, ARBCO and American River Mortgage. ARBCO was formed in 1984 to conduct real estate development and has been inactive since 1995. American River Mortgage has been inactive since its formation in 1994. During 2019 and 2018, the Company conducted no significant activities other than holding the shares of its subsidiaries. However, it is authorized, with the prior approval of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), the Company’s principal regulator, to engage in a variety of activities which are deemed closely related to the business of banking. The common stock of the Company is registered under the Securities Exchange Act of 1934, as amended, and is listed and traded on the Nasdaq Global Select Market under the symbol “AMRB.”

Overview

The Company recorded net income of $1,571,000 for the quarter ended September 30, 2019, which was an increase of $418,000 compared to $1,153,000 reported for the same period of 2018. Diluted earnings per share for the third quarter of 2019 were $0.27 compared to $0.20 recorded in the third quarter of 2018. The return on average equity (“ROAE”) and the return on average assets (“ROAA”) for the third quarter of 2019 were 7.65% and 0.88%, respectively, as compared to 6.37% and 0.68%, respectively, for the same period in 2018.

Net income for the nine months ended September 30, 2019 and 2018 was $3,993,000 and $3,775,000, respectively, with diluted earnings per share of $0.68 in 2019 and $0.64 in 2018. For the first nine months of 2019, ROAE was 6.81% and ROAA was 0.77% compared to 6.95% and 0.74%, respectively, for the same period in 2018.

Total assets of the Company increased by $33,189,000 (4.8%) from $688,092,000 at December 31, 2018 to $721,281,000 at September 30, 2019. Net loans totaled $369,940,000 at September 30, 2019, an increase of $51,424,000 (16.1%) from $318,516,000 at December 31, 2018. Deposit balances at September 30, 2019 totaled $612,904,000, an increase of $22,230,000 (3.8%) from $590,674,000 at December 31, 2018.

The Company ended the third quarter of 2019 with a leverage capital ratio of 9.2%, a Tier 1 capital ratio of 15.4%, and a total risk-based capital ratio of 16.6% compared to 8.9%, 16.1%, and 17.3%, respectively, at December 31, 2018. Table One below provides a summary of the components of net income for the periods indicated (See the “Results of Operations” section that follows for an explanation of the fluctuations in the individual components).

Table One: Components of Net Income

(dollars in thousands)	For the three months ended September 30,						For the nine months ended September 30,
	2019			2018			2019			2018
Interest income*	$	6,604		$	5,711		$	19,111		$	16,389
Interest expense		(627	)		(409	)		(1,858	)		(1,116	)
Net interest income*		5,977			5,302			17,253			15,273
Provision for loan and lease losses		(120	)		(50	)		(480	)		(50	)
Noninterest income		417			377			1,249			1,129
Noninterest expense		(4,093	)		(4,003	)		(12,501	)		(11,181	)
Provision for income taxes		(561	)		(428	)		(1,380	)		(1,237	)
Tax equivalent adjustment		(49	)		(45	)		(148	)		(159	)
Net income	$	1,571		$	1,153		$	3,993		$	3,775

Average total assets	$	708,698		$	673,959		$	695,364		$	680,056
Net income (annualized) as a percentage of average total assets		0.88	%		0.68	%		0.77	%		0.74	%

* Fully taxable equivalent basis (FTE)

Results of Operations

Net Interest Income and Net Interest Margin

Net interest income represents the excess of interest and fees earned on interest earning assets (loans and leases, securities, Federal funds sold and investments in time deposits) over the interest paid on interest-bearing deposits and borrowed funds. Net interest margin is net interest income expressed as a percentage of average earning assets. The Company’s net interest margin was 3.62% for the three months ended September 30, 2019, 3.44% for the three months ended September 30, 2018, 3.59% for the nine months ended September 30, 2019 and 3.36% for the nine months ended September 30, 2018.

The fully taxable equivalent interest income component for the third quarter of 2019 increased $893,000 (15.6%) to $6,604,000 compared to $5,711,000 for the three months ended September 30, 2018. The increase in the fully taxable equivalent interest income for the third quarter of 2019 compared to the same period in 2018 is broken down by rate (up $227,000) and volume (up $666,000). The primary driver in this rate increase was an increase in the yield on loans which saw an increase from 4.71% in the third quarter of 2018 to 4.98% in the third quarter of 2019. The increased yield in 2019 compared to 2018 was due to the overall higher interest rate environment. The yield on earning assets increased from 3.70% during the third quarter of 2018 to 3.99% during the third quarter of 2019.

The volume increase of $666,000 was primarily from an increase in loans ($806,000) and interest bearing balances in banks ($68,000), partially offset by a decrease in investment balances ($208,000). Average loans balances increased $68,970,000, (or 22.7%), from $299,934,000 during the third quarter of 2018 to $368,160,000 during the third quarter of 2019; average interest bearing balances in banks increased $11,916,000, (or 682.5%), from $1,746,000 during the third quarter of 2018 to $13,662,000 during the third quarter of 2019; and the average investment balances decreased $11,589,000, (or 4.1%), from $285,704,000 during the third quarter of 2018 to $274,115,000 during the third quarter of 2019.

Total fully taxable equivalent interest income for the nine months ended September 30, 2019 increased $2,722,000 (16.6%) to $19,111,000 compared to $16,389,000 for the nine months ended September 30, 2018. The breakdown of the decrease in fully taxable equivalent interest income for the nine months ended September 30, 2019 over the same period in 2018 resulted from an increase in rate (up $1,304,000) and in volume (up $1,418,000). The primary driver in this rate increase was an increase in the yield on loans which increased from 4.70% in 2018 to 4.94% in 2019 and an increase in yields on the investment portfolio which increased from 2.58% in 2018 to 2.84% in 2019. The increased yield in 2019 compared to 2018 was due to the overall higher interest rate environment. The yield on earning assets increased from 3.61% during 2018 to 3.98% during 2019. The volume increase of $1,418,000 was primarily from an increase in loans ($1,600,000), and average interest bearing balances in banks ($97,000), partially offset by a decrease in investment balances ($14,000) and in Fed fund balances ($265,000). Average loans balances increased $45,767,000, (or 15.1%), from $303,951,000 during the first nine months of 2018 to $349,718,000 during the first nine months of 2019; the average interest bearing balances in banks increased $7,352,000, (or 421.6%), from $1,744,000 during the first nine months of 2018 to $9,096,000 during the first nine months of 2019; and average Fed fund balances decreased $19,908,000, (or 98.9%), from $20,139,000 during the first nine months of 2018 to $231,000 during the first nine months of 2019.

Interest expense was $218,000 (or 53.3%) higher in the third quarter of 2019 versus the prior year period, increasing from $409,000 to $627,000. The $218,000 increase in interest expense during the third quarter of 2019 compared to the third quarter of 2018 was due to higher rates (up $184,000) and higher volume (up $34,000). The increase in interest expense can be attributed to an increase in rates paid on deposit and borrowing balances during a higher interest rate environment. Rates paid on interest bearing liabilities increased 21 basis points from 0.43% to 0.64% for the third quarter of 2018 compared to the same period in 2019. The largest increase due to rates occurred in interest checking and money market accounts and in the time deposits. The rate paid on interest checking and money market accounts increased from 0.12% during the third quarter of 2018 to 0.29% during the third quarter of 2019 and accounted for $92,000 of the $184,000 increase attributed to rates. The rate paid on time deposit accounts increased from 1.42% during the third quarter of 2018 to 1.75% during the third quarter of 2019 and accounted for $72,000 of the $184,000 increase attributed to rates. The volume increase of $34,000 was attributed to an increase in average time deposit balances which increased from $77,411,000 during the third quarter of 2018 to $86,938,000 during the third quarter of 2018.

Interest expense was $742,000 (or 66.5%) higher in the nine-month period ended September 30, 2019 increasing from $1,116,000 in 2018 to $1,858,000 in 2019. The increase is related to rates (up $627,000) and volume (up $115,000). The largest increase due to rates occurred in interest checking and money market accounts and in the time deposits. The rate paid on interest checking and money market accounts increased from 0.12% during the first nine months of 2018 to 0.24% during the first nine months of 2019 and accounted for $183,000 of the $627,000 increase attributed to rates. The rate paid on time deposit accounts increased from 1.24% during the first nine months of 2018 to 1.78% during the first nine months of 2019 and accounted for $356,000 of the $627,000 increase attributed to rates. The volume increase of $115,000 was attributed to an increase in average time deposit balances which increased from $78,761,000 during the first nine months of 2018 to $87,655,000 during the first nine months of 2019 and accounted for $82,000 of the $115,000 increase and an increase in average other borrowings which increased from $15,544,000 during the first nine months of 2018 to $19,341,000 during the first nine months of 2019 and accounted for $42,000 of the $115,000 increase.

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

Table Three sets forth a summary of the changes in interest income and interest expense from changes in average asset and liability balances (volume) and changes in average interest rates.

Table Two: Analysis of Net Interest Margin on Earning Assets

Three Months Ended September 30,	2019								2018
(Taxable Equivalent Basis) (dollars in thousands)	Avg Balance			Interest		Avg Yield (4)			Avg Balance			Interest		Avg Yield (4)
Assets
Earning assets:
Taxable loans and leases (1)	$	346,598		$	4,397		5.03	%	$	286,261		$	3,405		4.72	%
Tax-exempt loans and leases (2)		21,562			224		4.12	%		13,673			152		4.41	%
Taxable investment securities		267,012			1,846		2.74	%		270,014			1,902		2.79	%
Tax-exempt investment securities (2)		7,103			66		3.69	%		15,690			122		3.08	%
Federal funds sold		—			—		—	%		24,359			120		1.95	%
Interest-bearing deposits in banks		13,662			71		2.06	%		1,746			10		2.27	%
Total earning assets		655,937			6,604		3.99	%		611,743			5,711		3.70	%
Cash & due from banks		17,215								26,272
Other assets		40,406								40,343
Allowance for loan & lease losses		(4,860	)							(4,399	)
Total average assets	$	708,698							$	673,959

Liabilities & Shareholders’ Equity
Interest bearing liabilities:
Interest checking and money market	$	211,930			155		0.29	%	$	212,872			63		0.12	%
Savings		74,738			7		0.04	%		72,580			6		0.03	%
Time deposits		86,938			383		1.75	%		77,411			277		1.42	%
Other borrowings		15,614			82		2.08	%		15,630			63		1.60	%
Total interest bearing liabilities		389,220			627		0.64	%		378,493			409		0.43	%
Noninterest bearing demand deposits		227,644								216,732
Other liabilities		10,368								6,887
Total liabilities		627,232								602,112
Shareholders’ equity		81,466								71,847
Total average liabilities and shareholders’ equity	$	708,698							$	673,959
Net interest income & margin (3)				$	5,977		3.62	%				$	5,302		3.44	%

(1)

Loan interest includes loan fees of $18,000 and $100,000, respectively, during the three months ended September 30, 2019 and September 30, 2018. Average loan balances include nonperforming loans.

(2)

Includes taxable-equivalent adjustments that primarily relate to income on certain securities that is exempt from federal income taxes. The effective federal statutory tax rate was 21% for 2019 and 2018.

(3)

Net interest margin is computed by dividing net interest income by total average earning assets.

(4)

Average yield is calculated based on actual days in the period (92 days) and annualized to actual days in the year (365 days).

Nine Months Ended September 30,	2019								2018
(Taxable Equivalent Basis) (dollars in thousands)	Avg Balance			Interest		Avg Yield (4)			Avg Balance			Interest		Avg Yield (4)
Assets
Earning assets:
Taxable loans and leases (1)	$	330,312		$	12,329		4.99	%	$	290,142		$	10,216		4.71	%
Tax-exempt loans and leases (2)		19,406			604		4.16	%		13,809			458		4.43	%
Taxable investment securities		272,738			5,756		2.82	%		261,482			4,930		2.52	%
Tax-exempt investment securities (2)		10,822			266		3.29	%		19,983			494		3.31	%
Federal funds sold		231			5		2.89	%		20,139			268		1.78	%
Interest-bearing deposits in banks		9,096			151		2.22	%		1,744			23		1.76	%
Total earning assets		642,605			19,111		3.98	%		607,299			16,389		3.61	%
Cash & due from banks		16,356								37,537
Other assets		41,048								39,678
Allowance for loan & lease losses		(4,645	)							(4,458	)
Total average assets	$	695,364							$	680,056

Liabilities & Shareholders’ Equity
Interest-bearing liabilities:
Interest checking and money market	$	208,607			369		0.24	%	$	219,797			196		0.12	%
Savings		73,596			21		0.04	%		70,785			19		0.04	%
Time deposits		87,655			1,168		1.78	%		78,761			730		1.24	%
Other borrowings		19,341			300		2.07	%		15,544			171		1.47	%
Total interest-bearing liabilities		389,199			1,858		0.64	%		384,887			1,116		0.39	%
Noninterest-bearing demand deposits		217,760								215,537
Other liabilities		10,019								7,013
Total liabilities		616,978								607,437
Shareholders’ equity		78,386								72,619
Total average liabilities and shareholders’ equity	$	695,364							$	680,056
Net interest income & margin (3)				$	17,253		3.59	%				$	15,273		3.36	%

(1)

Loan interest includes loan fees of $194,000 and $474,000, respectively, during the nine months ended September 30, 2019 and September 30, 2018. Average loan balances include nonperforming loans.

(2)

(3)

Net interest margin is computed by dividing net interest income by total average earning assets.

(4)

Average yield is calculated based on actual days in the period (273 days) and annualized to actual days in the year (365 days).

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

Three Months Ended September 30, 2019 over 2018 (dollars in thousands)

Increase (decrease) due to change in:

Interest-earning assets:	Volume			Rate (4)			Net Change
Taxable loans and leases (1)	$	718		$	274		$	992
Tax-exempt loans and leases (2)		88			(16	)		72
Taxable investment securities		(21	)		(35	)		(56	)
Tax exempt investment securities (3)		(67	)		11			(56	)
Federal funds sold		(120	)		—			(120	)
Interest-bearing deposits in banks		68			(7	)		61
Total		666			227			893
Interest-bearing liabilities:
Interest checking and money market		—			92			92
Savings deposits		—			1			1
Time deposits		34			72			106
Other borrowings		—			19			19
Total		34			184			218
Interest differential	$	632		$	43		$	675

Nine Months Ended September 30, 2019 over 2018 (dollars in thousands)
Increase (decrease) due to change in:

Interest-earning assets:	Volume			Rate (4)			Net Change
Taxable loans and leases (1)	$	1,414		$	699		$	2,113
Tax-exempt loans and leases (2)		186			(40	)		146
Taxable investment securities		212			614			826
Tax exempt investment securities (3)		(226	)		(2	)		(228	)
Federal funds sold		(265	)		2			(263	)
Interest-bearing deposits in banks		97			31			128
Total		1,418			1,304			2,722
Interest-bearing liabilities:
Interest checking and money market		(10	)		183			173
Savings deposits		1			1			2
Time deposits		82			356			438
Other borrowings		42			87			129
Total		115			627			742
Interest differential	$	1,303		$	677		$	1,980

(1)

The average balance of non-accruing loans is immaterial as a percentage of total loans and, as such, has been included in net loans.

(2)

Loan fees of $18,000 and $100,000, respectively, during the three months ended September 30, 2019 and September 30, 2018, and loan fees of $194,000 and $474,000, respectively, during the nine months ended September 30, 2019 and September 30, 2018, have been included in the interest income computation.

(3)

(4)

The rate/volume variance has been included in the rate variance.

Provision for Loan and Lease Losses

The Company added $120,000 to the provision for loan and lease losses for the third quarter of 2019 compared to $50,000 in the third quarter of 2018. The Company experienced net loan and lease recoveries of $72,000 or 0.08% (on an annualized basis) of average loans and leases for the three months ended September 30, 2019 compared to net loan and lease losses of ($210,000) or 0.28% (on an annualized basis) of average loans and leases for the three months ended September 30, 2018. As a result of the loan growth in 2019, the Company added $480,000 to the allowance for loan and lease losses during the first nine months of 2019. This compares to additions of $50,000 to the allowance for loan and lease losses during the first nine months of 2018. Net loan and lease recoveries were $81,000 (0.03%) (on an annualized basis) of average loans and leases outstanding in 2019 and net loan and lease losses of ($196,000) or 0.09% (on an annualized basis) of average loans and leases outstanding in 2018. The Company continues to experience an overall improvement in the credit quality of the loan and lease portfolio and a reduction of credit losses. For additional information see the “Allowance for Loan and Lease Losses Activity.”

Noninterest Income

Table Four below provides a summary of the components of noninterest income for the periods indicated:

Table Four: Components of Noninterest Income

(dollars in thousands)	Three Months Ended September 30,				Nine Months Ended September 30,
	2019		2018		2019		2018
Service charges on deposit accounts	$	149	$	119	$	409	$	352
Gain on sale of securities		9		8		74		19
Merchant fee income		105		105		294		324
Bank owned life insurance		83		77		248		228
Other		71		68		224		206
Total noninterest income	$	417	$	377	$	1,249	$	1,129

Noninterest income increased $40,000 (10.6%) to $417,000 for the three months ended September 30, 2019 compared to $377,000 during the three months ended September 30, 2018. The increase from the third quarter of 2018 to the third quarter of 2019 was primarily related to an increase in service charges on deposit accounts which increased $30,000 from $119,000 in 2018 to $149,000 in 2019.

Noninterest income increased $120,000 (or 10.6%) from $1,129,000 during the first nine months of 2019 to $1,249,000 during the first nine months of 2018. The increase from the first nine months of 2018 compared to the same period in 2019 was primarily related to an increase in gain on sale of securities (up $55,000 or 289.5%) resulting in income of $19,000 in the first nine months of 2018 compared to $74,000 for the first nine months of 2019 and an increase in service charges on deposit accounts which increased $57,000 (16.2%) from $352,000 in 2018 to $409,000 in 2019.

Noninterest Expense

Noninterest expense increased $90,000 (2.2%) from $4,003,000 in the third quarter of 2018 to $4,093,000 in the third quarter of 2019. Salary and employee benefits expense increased $347,000 (13.6%) from $2,551,000 during the third quarter of 2018 to $2,898,000 during the third quarter of 2019. The increase in salaries and benefits expense resulted from filling some vacant positions, normal cost of living increases and promotions and higher incentive accruals as a result of the increased loan activity. Average full-time equivalent employees was 101 during the third quarter of 2019 compared to 100 during the third quarter of 2018. Occupancy expense decreased $11,000 (4.1%) and furniture and equipment expense decreased $21,000 (14.9%) from the third quarter of 2018 to the third quarter of 2019. FDIC assessments decreased $99,000 (190.4%) from the third quarter of 2018 to the third quarter of 2019. OREO related expenses decreased $3,000 (30.0%) during the third quarter of 2019 compared to the third quarter of 2018. Other expenses decreased $123,000 (12.5%) to $859,000 in the third quarter of 2019 compared to $982,000 in the third quarter of 2018. The decreased FDIC assessments result from the FDIC insurance fund reaching the target of 1.38% and the Company being able to use the Small Bank Assessment Credits, awarded to banks like American River Bank, which essentially gave banks a credit for the assessments paid for the second quarter of 2019 and allowed them to forgo the assessment expense for the third quarter of 2019. The most significant decrease in other expenses relates to lower advertising and business development expenses which decreased $62,000 (43.1%) from $144,000 in the third quarter of 2018 to $82,000 during the third quarter of 2019 and relates to the Company better analyzing its business development opportunities which allowed the Company to more precisely target its marketing expenses. Telephone expense also decreased $47,000 (42.0%) from $112,000 in the third quarter of 2018 to $65,000 during the third quarter of 2019 and relates to the Company converted to a more cost-effective telephone system. The fully taxable equivalent efficiency ratio for the third quarter of 2019 decreased to 64.0% from 70.5% for the third quarter of 2018.

Noninterest expense for the nine-month period ended September 30, 2019 was $12,501,000 compared to $11,181,000 for the same period in 2018 for an increase of $1,320,000 (11.8%). Salaries and employee benefits expense increased $1,149,000 (15.8%) from $7,274,000 for the nine months ended September 30, 2018 to $8,423,000 for the same period in 2019. The increase in salaries and benefits expense resulted from filling some vacant positions, hiring additional relationship managers, replacing the Chief Credit Officer in May 2018, higher incentive accruals for the loan production team, and normal cost of living increases and promotions. Average full-time equivalent employees was 102 during 2019 compared to 96 during 2018. Occupancy expense decreased $23,000 (2.9%) and furniture and equipment expense decreased $15,000 (3.6%). FDIC assessments decreased $110,000 (69.6%). OREO related expenses increased $3,000 (25.0%) during 2018 to $15,000, from $12,000 in 2018. Other expenses increased $316,000 (12.5%) from $2,531,000 for the nine months ended September 30, 2018 to $2,847,000 for the same period in 2019. The decreased FDIC assessments result from the FDIC insurance fund reaching the target of 1.38% and the Company being able to use the Small Bank Assessment Credits. There were numerous line items that make up the $316,000 increase in other expenses including advertising and business development (increased $96,000), correspondent bank charges (increased $201,000), and professional fees (increased $72,000).

The overhead efficiency ratio (fully taxable equivalent) for the first nine months of 2019 was 67.6% as compared to 68.2% in the same period of 2018.

Provision for Income Taxes

Federal and state income taxes for the quarter ended September 30, 2019 increased $133,000 (31.1%) from $428,000 in the third quarter of 2018 to $561,000 in the third quarter of 2019. The combined federal and state effective tax rate for the quarter ended September 30, 2019 was 26.3%, compared to 27.1% for the third quarter of 2018. The effective tax rate decreased during this period despite the higher level of taxable income as the Company benefitted from a higher level of tax exempt loans during the third quarter of 2019 as compared to the third quarter of 2018. Average tax exempt loans were $13,673,000 during the third quarter of 2018 compared to $20,486,000 during the third quarter of 2019. Federal and state income taxes increased $143,000 (11.6%) from $1,237,000 in the nine months ended September 30, 2018 to $1,380,000 for the nine months ended September 30, 2019. For the nine months ended September 30, 2018, the combined federal and state effective tax rate was 25.7% compared to 24.7% for the nine months ended September 30, 2018.

The higher effective tax rate in 2019 compared to 2018 is related to the tax treatment of equity based compensation under Accounting Standards Update 2016-09 (“ASU 2016-09”). Under ASU 2016-09, if the market value of the Company’s stock price on the date restricted stock vests is higher than the Company’s stock price on the date the restricted stock was awarded the Company receives a tax credit for the difference in values and if the market price on the vesting date is lower than the stock price on the award date the Company recognizes additional tax expense. In the first nine months of 2018, the Company recognized a $135,000 tax credit under ASU 2016-09 and in the first nine months of 2019 the Company recognized a $32,000 tax credit under ASU 2016-09. There were $3,000 and $2,000 in tax credits recognized under ASU 2016-09 and in the three months ended September 30, 2019 and September 30, 2018, respectively.

Balance Sheet Analysis

The Company’s total assets were $721,281,000 at September 30, 2019 compared to $688,092,000 at December 31, 2018, representing an increase of $33,189,000 (4.8%). The average assets for the three months ended September 30, 2019 were $708,698,000, which represents an increase of $34,739,000 (5.2%) from the average balance of $673,959,000 during the three-month period ended September 30, 2018. The average assets for the nine months ended September 30, 2019 were $695,364,000, which represents an increase of $15,308,000 (2.3%) from the average balance of $680,056,000 during the nine-month period ended September 30, 2018.

Federal Funds

The balance held in correspondent banks classified as Federal funds at September 30, 2019, was zero compared to $7,000,000 at December 31, 2018. The primary reason for the decrease in Federal funds since December 31, 2018 is directly related to the increase in loan balances during the same period.

Investment Securities

Table Five below summarizes the values of the Company’s investment securities held on September 30, 2019 and December 31, 2018.

Table Five: Investment Securities Composition

(dollars in thousands)
Available-for-sale (at fair value)	September 30, 2019		December 31, 2018
Debt securities:
U.S. Government Agencies and Sponsored Entities	$	261,316	$	269,049
Obligations of states and political subdivisions		8,113		14,400
Corporate bonds		6,626		6,508
U.S. Treasury bonds		—		4,976
Total available-for-sale investment securities	$	276,055	$	294,933

Held-to-maturity (at amortized cost)
Debt securities:
U.S. Government Agencies and Sponsored Entities	$	256	$	292
Total held-to-maturity investment securities	$	256	$	292

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

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

Loans and Leases

The Company’s historical lending activities have been in the following principal areas: (1) commercial; (2) commercial real estate; (3) multi-family real estate; (4) real estate construction (both commercial and residential); (5) residential real estate; (6) lease financing receivable; (7) agriculture; and (8) consumer loans. The Company’s continuing focus in our market area, new borrowers developed through the Company’s marketing efforts, and credit extensions expanded to existing borrowers resulted in the Company originating $106.2 million in new loans during the first nine months of 2019. This production was partially offset by pay downs and payoffs, but resulted in an overall increase in net loans and leases of $51,424,000 (16.1%) from December 31, 2018.

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 networking, local promotional activity, and personal contacts by American River Bank officers, directors and employees to compete with other financial institutions. The Company makes loans and leases to borrowers whose applications include a sound purpose and a viable primary repayment source, generally supported by a secondary source of repayment. Commercial loans consist of credit lines for operating needs, loans for equipment purchases, working capital, and various other business loan products. Consumer loans include a range of traditional consumer loan products such as personal lines of credit and homeowner equity lines of credit and loans to finance purchases of autos (including classic and collectors autos), boats, recreational vehicles, mobile homes and various other consumer items. Construction loans are generally comprised of commitments to customers within the Company’s service area for construction of commercial properties, multi-family properties and custom and semi-custom single-family residences. Other real estate loans consist primarily of loans secured by first trust deeds on commercial, multi-family, and residential properties typically with maturities from 3 to 10 years and original loan-to-value ratios generally from 65% to 75%. Agriculture loans consist primarily of first trust deed loans on properties that produce grapes, fruit, and nut loans. In general, except in the case of loans under SBA programs or Farm Services Agency guarantees, the Company does not make long-term residential mortgage loans.

Table Six below summarizes the composition of the loan portfolio as of September 30, 2019 and December 31, 2018.

Table Six: Loan and Lease Portfolio Composition

(dollars in thousands)	September 30, 2019						December 31, 2018						Change in			Percentage
	$			%			$			%			dollars			change
Commercial	$	41,079			11	%	$	29,650			9	%	$	11,429			38.6	%
Real estate
Commercial		202,714			54	%		199,894			62	%		2,820			1.4	%
Multi-family		57,221			15	%		56,139			18	%		1,082			1.9	%
Construction		13,657			4	%		5,685			2	%		7,972			140.2	%
Residential		28,978			8	%		16,338			5	%		12,640			77.4	%
Lease financing receivable		—			—	%		32			—	%		(32	)		(100.0	%)
Agriculture		6,570			2	%		4,419			1	%		2,151			48.7	%
Consumer		24,674			6	%		10,714			3	%		13,960			130.3	%
Total loans and leases		374,893			100	%		322,871			100	%		52,022			16.1	%
Deferred loan fees and costs, net		—						37						(37	)
Allowance for loan and lease losses		(4,953	)					(4,392	)					(461	)
Total net loans and leases	$	369,940					$	318,516					$	51,424			16.1	%

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 serviced markets in Santa Clara, Contra Costa, and Alameda Counties through a loan production office. In the fourth quarter of 2016, the Company discontinued operating the loan production office, however, the Company continues to service loans originated through these offices. The economies of Santa Clara, Contra Costa and Alameda Counties are diversified with professional services, manufacturing, technology related companies, real estate investment and construction.

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

In management’s judgment, a concentration exists in real estate loans, which represented approximately 81% of the Company’s loan and lease portfolio at September 30, 2019 and 86% as of December 31, 2018. Management believes that the residential land portion of the Company’s loan portfolio carries a reasonable level of credit risk. As of September 30, 2019, outstanding unimproved residential land commitments were $5,803,000 (or just 1.5% of the total real estate loans). Of the $5,803,000, $2,025,000, or 35%, was represented by one amortizing loan, which was considered well-secured, with a favorable loan-to-value ratio. 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 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 market area and originating a significant majority of its loans within that area, (2) maintaining a thorough understanding of borrowers’ knowledge, capacity, and market position in their field of expertise, (3) basing real estate loan approvals not only on market demand for the project, but also on the borrowers’ capacity to support the project financially in the event it does not perform to expectations (whether sale or income performance), and (4) maintaining conforming and prudent loan-to-value and loan-to-cost ratios based on independent outside appraisals and ongoing inspection and analysis by the Company’s lending officers or contracted third-party professionals.

Nonperforming, Past Due and Restructured Loans and Leases

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 zero and $27,000 at September 30, 2019 and December 31, 2018, respectively. The $27,000 in nonperforming loans and leases at December 31, 2018 was comprised of one commercial loan relationship with two loans totaling $27,000, both of which were current to terms. Because these loans were current and had shown a pattern of consistent, timely payments, the loans were upgraded to accrual status during the second quarter of 2019.

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 September 30, 2019. Management is not aware of any potential problem loans, which were accruing and current at September 30, 2019, 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.

Table Seven below sets forth nonaccrual loans and loans past due 90 days or more as of September 30, 2019 and December 31, 2018.

Table Seven: Nonperforming Loans and Leases
(dollars in thousands)
	September 30, 2019		December 31, 2018
Past due 90 days or more and still accruing:
Commercial	$	—	$	—
Real estate		—		—
Lease financing receivable		—		—
Agriculture		—		—
Consumer		—		—
Nonaccrual:
Commercial		—		27
Real estate		—		—
Lease financing receivable		—		—
Agriculture		—		—
Consumer		—		—
Total nonperforming loans	$	—	$	27

There were no loans that were considered past due between 30 and 89 days at September 30, 2019 or December 31, 2018.

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.

At September 30, 2019, the recorded investment in loans and leases that were considered to be impaired totaled $7,662,000, all of which were considered performing loans and leases. Of the total impaired loans of $7,662,000, loans totaling $5,879,000 were deemed to require no specific reserve and loans totaling $1,783,000 were deemed to require a related valuation allowance of $82,000. At December 31, 2018, the recorded investment in loans and leases that were considered to be impaired totaled $8,702,000. Of the total impaired loans of $8,702,000, loans totaling $5,968,000 were deemed to require no specific reserve and loans totaling $2,734,000 were deemed to require a related valuation allowance of $185,000.

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 is focused on monitoring collateral values for those loans considered collateral dependent. For collateral dependent loans the Company performs an internal evaluation or obtains an updated appraisal, as necessary. In the third quarter of 2019, the Company had net loan recoveries of $71,000 with $120,000 in provisions for loan and lease losses. Despite the Company’s continued improvement in the credit quality of the loan and lease portfolio, due to the net growth in the loans outstanding during 2019, management believes the $120,000 addition to the provision for loan and lease losses was warranted. In the third quarter of 2018, the Company had net loan losses of $210,000 and a provision of $50,000.

During the quarters ended September 30, 2019 and September 30, 2018, there were no loans that were modified as troubled debt restructurings. There were no payment defaults on troubled debt restructurings within 12 months following the modification for the three-month and nine-month periods ended September 30, 2019.

There were no payment defaults on troubled debt restructurings within 12 months following the modification for the three-month and nine-month periods ended September 30, 2018. At September 30, 2019 and December 31, 2018 there were no unfunded commitments on those loans considered troubled debt restructures.

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

Table Eight: Allowance for Loan and Lease Losses

(dollars in thousands)	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Average loans and leases outstanding	$	368,160		$	299,934		$	349,718		$	303,951

Allowance for loan and lease losses at beginning of period	$	4,761		$	4,492		$	4,392		$	4,478

Loans and leases charged off:
Commercial		—			(213	)		—			(213	)
Real estate		—			—			—			—
Lease financing receivable		—			—			—			—
Agriculture		—			—			—			—
Consumer		—			—			—			—
Total		—			(213	)		—			(213	)
Recoveries of loans and leases previously charged off:
Commercial		2			1			5			10
Real estate		2			2			8			6
Lease financing receivable		—			—			—			1
Agriculture		—			—			—			—
Consumer		68			—			68			—
Total		72			3			81			17
Net loans and leases recovered (charged off)		72			(210	)		81			(196	)
Additions to allowance charged to operating expenses		120			50			480			50
Allowance for loan and lease losses at end of period	$	4,953		$	4,332		$	4,953		$	4,332
Ratio of net (recoveries) charge-offs to average loans and leases outstanding (annualized)		-0.08	%		0.28	%		-0.03	%		0.09	%
Provision of allowance for loan and lease losses to average loans and leases outstanding (annualized)		0.13	%		0.07	%		0.18	%		0.02	%
Allowance for loan and lease losses to loans and leases net of deferred fees at end of period		1.32	%		1.38	%		1.32	%		1.38	%

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 borrower’s business, valuation of collateral, the determination of impaired loans or leases and exposure to potential losses.

The ALLL totaled $4,953,000 or 1.32% of total loans and leases at September 30, 2019 compared to $4,392,000 or 1.38% of total loans and leases at December 31, 2018. 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 ALLL as a percentage of impaired loans and leases was 64.6% at September 30, 2019 and 50.5% at December 31, 2018. Of the total nonperforming and impaired loans and leases outstanding as of September 30, 2019, there were $801,000 in loans or leases that had been reduced by partial charge-offs of $294,000.

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.

Other Real Estate Owned

At September 30, 2019 and December 31, 2018, the Company had one other real estate owned (“OREO”) property totaling $957,000. During 2019, the Company did not acquire or sell any OREO properties nor were there any impairment charges to this property. There was no valuation allowance at September 30, 2019 nor at year-end 2018. The Company believes that the OREO property owned at September 30, 2019 was carried approximately at fair value.

Deposits

At September 30, 2019, total deposits were $612,904,000 representing a $22,230,000 (3.8%) increase from the December 31, 2018 balance of $590,674,000. The Company’s deposit growth plan for 2019 is to concentrate its efforts on increasing noninterest-bearing demand, interest-bearing money market and NOW accounts, and savings accounts while continuing to focus on maintaining an overall lower cost of funds than our peer group while at the same time retaining our high-valued deposit relationships. The Company’s balances in interest-bearing checking, savings, and time, in total, remained relatively unchanged from December 31, 2018, however, noninterest-bearing checking increased $13,772,000 (6.4%) and money market accounts increased $5,638,000 (3.9%).

Other Borrowed Funds

Other borrowings outstanding as of September 30, 2019 and December 31, 2018, consist of advances (both long-term and short-term) from the FHLB. Table Nine below summarizes these borrowings.

Table Nine: Other Borrowed Funds

(dollars in thousands)

	September 30, 2019					December 31, 2018
	Amount		Rate			Amount		Rate
Short-term borrowings:
FHLB advances	$	5,000		1.31	%	$	5,000		1.32	%
Long-term borrowings:
FHLB advances	$	10,500		2.48	%	$	10,500		2.02	%

The maximum amount of short-term borrowings at any month-end during the first nine months of 2019 and 2018 was $16,000,000 and $6,500,000, 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	$	5,000		$	10,500
Maturity		2020			2021 to 2023
Weighted average rates		1.31	%		2.48	%

Capital Resources

The Company and American River Bank are subject to certain regulatory capital requirements administered by the Federal Reserve Board and the Federal Deposit Insurance Corporation (the “FDIC”). 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 current 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. Table Ten below lists the Company’s and American River Bank’s capital ratios at September 30, 2019 and December 31, 2018 as well as the minimum regulatory requirements.

Table Ten: Capital Ratios
							Minimum Regulatory Capital
	September 30,			December 31,			Requirements
	2019			2018			2019			2018
American River Bankshares
Leverage Ratio		9.2	%		8.9	%		N/A			N/A
Tier 1 Risk-Based Capital		15.4	%		16.1	%		N/A			N/A
Total Risk-Based Capital		16.6	%		17.3	%		N/A			N/A

American River Bank
Leverage Ratio		9.3	%		9.0	%		6.5	%		5.9	%
Common Equity Tier 1 Risk-Based Capital		15.6	%		16.2	%		7.0	%		6.4	%
Tier 1 Risk-Based Capital		15.6	%		16.2	%		8.5	%		7.9	%
Total Risk-Based Capital		16.7	%		17.4	%		10.5	%		9.9	%

At September 30, 2019, shareholders’ equity was $82,849,000, representing an increase of $8,128,000 (10.9%) from $74,721,000 at December 31, 2018. The increase results from net income for the period ($3,993,000), stock based compensation ($363,000), and the increase from other comprehensive income ($4,772,000), exceeding the payment of cash dividends ($1,000,000).

Capital ratios are reviewed on a regular basis to ensure that capital exceeds the prescribed regulatory requirements, are adequate to meet future needs, and whether to raise additional capital or return capital to shareholders. Management believes that both the Company and American River Bank met all of their capital adequacy requirements as of September 30, 2019 and December 31, 2018.

Effective January 1, 2015, bank holding companies with consolidated assets of $1 Billion or more ($3 Billion or more effective August 30, 2018) and banks like American River Bank must comply with new minimum capital ratio requirements, 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%; (iii) a total capital to total risk weighted assets ratio of 8%; and (iv) a Tier 1 capital to adjusted average total assets (“leverage”) ratio of 4%.

In addition, a “capital conservation buffer,” was established which is now fully phased-in and requires 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 increases 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 was phased-in between January 1, 2016 and January 1, 2019. The buffer requirement for 2018 was 1.875% and became fully phased in on January 1, 2019, increasing to 2.50%. 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.

On January 24, 2018, the Company approved and authorized a 5% stock repurchase program for 2018 (the “2018 Program”). See Part II, Item 2, for additional disclosure regarding the 2018 Program. In addition, on February 13, 2019 and May 15, 2019, the Company paid cash dividends of $0.05 per common share to shareholders of record on January 30, 2019 and May 1, 2019, respectively, and on August 14, 2019 the Company paid cash dividends of $0.07 per common share to shareholders of record on July 31, 2019. These 2019 quarterly cash dividends follow four quarterly cash dividends, totaling $0.20 per share, paid in 2018.

Inflation

The impact of inflation on a financial institution differs significantly from that exerted on manufacturing or other commercial concerns primarily because its assets and liabilities are largely monetary. In general, inflation primarily affects the Company and its subsidiaries through its effect on market rates of interest, which affects the Company’s ability to attract loan customers. Inflation affects the growth of total assets by increasing the level of loan demand and potentially adversely affects capital adequacy because loan growth in inflationary periods can increase at rates higher than the rate that capital grows through retention of earnings which may be generated in the future. In addition to its effects on interest rates, inflation increases overall operating expenses. Inflation has not had a significant effect upon the results of operations of the Company and its subsidiaries during the periods ended September 30, 2019 and 2018.

Liquidity

Liquidity management refers to the Company’s ability to provide funds on an ongoing basis to meet fluctuations in deposit levels as well as the credit needs and requirements of its clients. Both assets and liabilities contribute to the Company’s liquidity position. Federal funds lines, short-term investments and securities, and loan and lease repayments contribute to liquidity, along with deposit increases, while loan and lease funding and deposit withdrawals decrease liquidity. The Company assesses the likelihood of projected funding requirements by reviewing historical funding patterns, current and forecasted economic conditions and individual client funding needs. Commitments to fund loans and outstanding standby letters of credit at September 30, 2019 were approximately $37,117,000 and $300,000, respectively. Such loan commitments relate primarily to revolving lines of credit and other commercial loans and to real estate construction loans. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

The Company’s sources of liquidity consist of cash and due from correspondent banks, overnight funds sold to correspondent banks, unpledged marketable investments and loans held for sale and/or pledged for secured borrowings. At September 30, 2019, consolidated liquid assets totaled $152.0 million or 21.1% of total assets compared to $226.5 million or 32.9% of total assets on December 31, 2018. In addition to liquid assets, the Company maintains two short-term unsecured lines of credit in the amount of $17,000,000 with two of its correspondent banks. At September 30, 2019, the Company had $17,000,000 available under these credit lines. Additionally, the Bank is a member of the FHLB. At September 30, 2019, the Bank could have arranged for up to $147,126,000 in secured borrowings from the FHLB. These borrowings are secured by pledged mortgage loans and investment securities. At September 30, 2019, the Bank had advances, borrowings and commitments (including letters of credit) outstanding of $15,500,000, leaving $131,626,000 available under these FHLB secured borrowing arrangements. The Bank also has a secured borrowing arrangement with the Federal Reserve Bank of San Francisco. The borrowing can be secured by pledging selected loans and investment securities. At September 30, 2019, the Bank’s borrowing capacity at the Federal Reserve Bank was $9,322,000. The Company serves primarily a business and professional customer base and, as such, its deposit base is susceptible to economic fluctuations. Accordingly, management strives to maintain a balanced position of liquid assets and borrowing capacity to offset the potential runoff of these volatile and/or cyclical deposits.

Liquidity is also affected by portfolio maturities and the effect of interest rate fluctuations on the marketability of both assets and liabilities. The Company can sell any of its unpledged securities held in the available-for-sale category to meet liquidity needs. Furthermore, the Bank can pledge additional unencumbered securities to borrow from the Federal Reserve Bank of San Francisco and the FHLB.

Off-Balance Sheet Items

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business in order to meet the financing needs of its customers and to reduce its exposure to fluctuations in interest rates. These financial instruments consist of commitments to extend credit and letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized on the balance sheet.

The Company’s exposure to credit loss in the event of nonperformance by the other party for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company applies the same credit policies to commitments and letters of credit as it does for loans included on the consolidated balance sheet. As of September 30, 2019 and December 31, 2018, commitments to extend credit and standby letters of credit were the only financial instruments with off-balance sheet risk. The Company has not entered into any contracts for financial derivative instruments such as futures, swaps, options or similar instruments. Loan commitments and standby letters of credit were $37,417,000 and $34,637,000 at September 30, 2019 and December 31, 2018, respectively. As a percentage of net loans and leases these off-balance sheet items represent 10.1% and 10.9%, respectively. See also, Note 3 to the unaudited consolidated financial statements included herein for additional information about the Company’s off-balance sheet items. The Company has certain ongoing commitments under operating leases. These commitments do not significantly impact operating results.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Overview. Market risk is the risk of loss from adverse changes in market prices and rates. The Company’s market risk arises primarily from interest rate risk inherent in its loan, investment and deposit functions. The goal for managing the assets and liabilities of the Company is to maximize shareholder value and earnings while maintaining a high quality balance sheet without exposing the Company to undue interest rate risk. The Board of Directors has overall responsibility for the interest rate risk management policies. The Company has an Enterprise Risk Management Committee, made up of Company management that establishes and monitors guidelines to control the sensitivity of earnings to changes in interest rates.

Asset/Liability Management. Activities involved in asset/liability management include but are not limited to lending, accepting and placing deposits and investing in securities. Interest rate risk is the primary market risk associated with asset/liability management. Sensitivity of earnings to interest rate changes arises when yields on assets change in a different time period or in a different amount from that of interest costs on liabilities. To mitigate interest rate risk, the structure of the balance sheet is managed with the goal that movements of interest rates on assets and liabilities are correlated and contribute to earnings even in periods of volatile interest rates. The asset/liability management policy sets limits on the acceptable amount of variance in net interest margin and market value of equity under changing interest environments. The Company uses simulation models to forecast earnings, net interest margin and market value of equity.

Interest Rate Sensitivity Analysis Interest rate sensitivity is a function of the repricing characteristics of the portfolio of assets and liabilities. These repricing characteristics are the time frames within which the interest-bearing assets and liabilities are subject to change in interest rates either at replacement, repricing or maturity. Interest rate sensitivity management focuses on the maturity of assets and liabilities and their repricing during periods of changes in market interest rates. Interest rate sensitivity is measured as the difference between the volumes of assets and liabilities in the current portfolio that are subject to repricing at various time horizons. The differences are known as interest sensitivity gaps. A positive cumulative gap may be equated to an asset sensitive position. An asset sensitive position in a rising interest rate environment will cause a bank’s interest rate margin to expand. This results as floating or variable rate loans reprice more rapidly than fixed rate certificates of deposit that reprice as they mature over time. Conversely, a declining interest rate environment will cause the opposite effect. A negative cumulative gap may be equated to a liability sensitive position. A liability sensitive position in a rising interest rate environment will cause a bank’s interest rate margin to contract, while a declining interest rate environment will have the opposite effect.

Table Eleven below summarizes the effect on net interest income (NII) of a ±100 and ±200 basis point change in interest rates as measured against a constant rate (no change) scenario.

Table Eleven: Interest Rate Risk Simulation of Net Interest as of September 30, 2019
(dollars in thousands)	$ Change in NII from Current 12 Month Horizon			$ Change in NII from Current 24 Month Horizon
Variation from a constant rate scenario
+100bp	$	391		$	1,234
+200bp	$	742		$	2,256
-100bp	$	(342	)	$	(1,513	)
-200bp	$	(824	)	$	(3,900	)

Simulation of earnings is the primary tool used to measure the sensitivity of earnings to interest rate changes. Using computer-modeling techniques, with specialized software built for this specific purpose for financial institutions, the Company is able to estimate the potential impact of changing interest rates on earnings, net interest margin and market value of equity. A balance sheet is prepared using detailed inputs of actual loans, securities and interest-bearing liabilities (i.e. deposits/borrowings). The balance sheet is processed using multiple interest rate scenarios. The scenarios include a rising rate forecast, a flat rate forecast and a falling rate forecast which take place within a one-year time frame. The net interest income is measured over one-year and two-year periods assuming a gradual change in rates over the twelve-month horizon. The simulation modeling attempts to estimate changes in the Company’s net interest income utilizing a detailed current balance sheet. After a review of the model results as of September 30, 2019, the Company does not consider the fluctuations from the base case, to have a material impact on the Company’s projected results and are within the tolerance levels outlined in the Company’s interest rate risk polices. The simulations of earnings do not incorporate any management actions, which might moderate the negative consequences of interest rate deviations. Therefore, they do not reflect likely actual results, but serve as reasonable estimates of interest rate risk.

Item 4. Controls and Procedures.

The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s “disclosure controls and procedures” (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of September 30, 2019. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

During the quarter ended September 30, 2019, there have been no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, these controls.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

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

Item 1A. Risk Factors.

There have been no significant changes in the risk factors previously disclosed in the Company’s Form 10-K for the period ended December 31, 2018, filed with the Securities and Exchange Commission on February 21, 2019.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

The Company did not repurchase any shares during 2018 or the first nine months of 2019 and does not currently have a stock repurchase program in place.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.

Exhibit
Number		Document Description

(31.1)		Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

(31.2)		Certifications of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

(32.1)		Certification of American River Bankshares by its Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**

101.INS		XBRL Instance Document*
101.SCH		XBRL Taxonomy Extension Schema*
101.CAL		XBRL Taxonomy Extension Calculation*
101.DEF		XBRL Taxonomy Extension Definition*
101.LAB		XBRL Taxonomy Extension Label*
101.PRE		XBRL Taxonomy Extension Presentation*

		*Filed herewith
		** Furnished herewith

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	AMERICAN RIVER BANKSHARES

November 7, 2019	By:	/s/ DAVID E. RITCHIE, JR.
		David E. Ritchie, Jr.
		President and
		Chief Executive Officer

	AMERICAN RIVER BANKSHARES

November 7, 2019	By:	/s/ MITCHELL A. DERENZO
		Mitchell A. Derenzo
		Executive Vice President and
		Chief Financial Officer
		(Principal Financial and Accounting Officer)