SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended June 30, 2002 ------------- [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No. 0-31525 AMERICAN RIVER HOLDINGS ------------------------------------------------------------------- (Exact name of registrant as specified in its charter) California 68-0352144 ---------------------------------- --------------------------------- (State or other jurisdiction of (IRS Employer ID Number) incorporation or organization) 1545 River Park Drive, Sacramento, California 95815 ---------------------------------------------- ---------- (Address of principal executive offices) (Zip code) (916) 565-6100 --------------- (Registrant's telephone number, including area code) Not Applicable -------------- (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate 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 - 2,503,180 shares outstanding at August 2, 2002. 1 PART 1-FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS: AMERICAN RIVER HOLDINGS UNAUDITED CONSOLIDATED BALANCE SHEETS (In thousands, except number of shares) June 30, December 31, 2002 2001 ---------- ----------- ASSETS Cash and due from banks $ 21,660 $ 20,342 Federal funds sold 4,280 7,814 Interest-bearing deposits in banks 6,334 5,740 Investment securities: Available-for-sale (amortized cost: 2002--$35,172; 2001--$35,007) 36,194 35,803 Held-to-maturity (market value: 2002--$10,824; 2001--$13,234) 10,605 13,109 Loans and leases, less allowance for loan and lease losses of $2,894 at June 30, 2002 and $2,614 at December 31, 2001 208,974 195,026 Bank premises and equipment, net 1,840 1,903 Accounts receivable servicing receivables, net 2,305 2,869 Accrued interest receivable and other assets 3,246 3,953 ---------- ----------- $ 295,438 $ 286,559 ========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest bearing $ 75,001 $ 67,740 Interest bearing 187,586 187,148 ---------- ----------- Total deposits 262,587 254,888 Short-term borrowed funds - - Long-term debt 2,016 2,039 Accrued interest payable and other liabilities 1,629 1,690 ---------- ----------- Total liabilities 266,232 258,617 ---------- ----------- Commitments and contingencies (Note 2) Shareholders' equity: Common stock - no par value; 20,000,000 shares authorized; issued and outstanding - 2,502,414 shares at June 30, 2002 and 2,519,717 at December 31, 2001 13,668 14,167 Retained earnings 14,916 13,290 Accumulated other comprehensive income (Note 4) 622 485 ---------- ----------- Total shareholders' equity 29,206 27,942 ---------- ----------- $ 295,438 $ 286,559 ========== =========== See notes to Unaudited Consolidated Financial Statements 2 AMERICAN RIVER HOLDINGS UNAUDITED CONSOLIDATED STATEMENT OF INCOME (In thousands, except per share data) For the periods ended June 30, Three months Six months 2002 2001 2002 2001 ---------------------------------------------------- Interest income: Interest and fees on loans $ 3,798 $ 4,590 $ 7,556 $ 9,592 Interest on Federal funds sold 25 42 38 63 Interest on deposits in banks 64 90 137 182 Interest and dividends on investment securities: Taxable 480 452 980 986 Exempt from Federal income taxes 115 117 229 235 Dividends 4 26 11 42 ---------------------------------------------------- Total interest income 4,486 5,317 8,951 11,100 ---------------------------------------------------- Interest expense: Interest on deposits 826 1,634 1,672 3,624 Interest on short-term borrowings 6 22 11 96 Interest on long-term debt 31 32 62 64 ---------------------------------------------------- Total interest expense 863 1,688 1,745 3,784 ---------------------------------------------------- Net interest income 3,623 3,629 7,206 7,316 Provision for loan and lease losses 186 187 334 381 ---------------------------------------------------- Net interest income after provision for loan and lease losses 3,437 3,442 6,872 6,935 ---------------------------------------------------- Noninterest income 552 556 1,044 1,135 ---------------------------------------------------- Noninterest expense: Salaries and employee benefits 1,359 1,421 2,720 2,831 Occupancy 205 202 409 401 Furniture and equipment 153 138 296 271 Other expense 571 739 1,207 1,377 ---------------------------------------------------- Total noninterest expense 2,288 2,500 4,632 4,880 ---------------------------------------------------- Income before income taxes 1,701 1,498 3,284 3,190 Income taxes 674 597 1,296 1,265 ---------------------------------------------------- Net income $ 1,027 $ 901 $ 1,988 $ 1,925 ==================================================== Basic earnings per share (Note 3) $ .41 $ .36 $ 0.79 $ 0.76 ==================================================== Diluted earnings per share (Note 3) $ .38 $ .34 $ 0.74 $ 0.72 ==================================================== Cash dividends per common share $ .15 $ .14 $ .15 $ .14 ==================================================== See notes to Unaudited Consolidated Financial Statements 3 AMERICAN RIVER HOLDINGS UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (In thousands, except number of shares) Accumulated Common Stock Other ----------------------- Retained Comprehensive Shareholders' Comprehensive Shares Amount Earnings Income Equity Income --------- --------- --------- ------------- ------------ ------------- Balance, January 1, 2001 2,395,158 $ 12,320 $ 11,876 $ 217 $ 24,413 Comprehensive income (Note 4): Net income 4,037 4,037 $ 4,037 Other comprehensive income, net of tax: Unrealized gain on available-for-sale investment securities 268 268 268 ------- Total comprehensive income $ 4,305 ======== Cash dividends (681) (681) 5% stock dividend 120,531 1,935 (1,935) Fractional shares redeemed (7) (7) Stock options exercised 25,428 247 247 Retirement of common stock (21,400) (335) (335) --------- --------- --------- -------- --------- Balance, December 31, 2001 2,519,717 14,167 13,290 485 27,942 Comprehensive income (Note 4): Net income 1,988 1,988 $ 1,988 Other comprehensive income, net of tax: Unrealized gain on available-for-sale investment securities 137 137 137 ------- Total comprehensive income $ 2,125 ======= Cash dividends (362) (362) Stock options exercised 15,097 114 114 Retirement of common stock (32,400) (613) (613) --------- --------- --------- -------- --------- Balance, June 30, 2002 2,502,414 $ 13,668 $ 14,916 $ 622 $ 29,206 ========= ========= ========= ======== ========= See notes to Unaudited Consolidated Financial Statements 4 AMERICAN RIVER HOLDINGS UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) For the six months ended June 30, 2002 2001 ---------- ---------- Cash flows from operating activities: Net income $ 1,988 $ 1,925 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan and lease losses 334 381 Increase (decrease) in deferred loan origination fees (costs), net 57 (200) Depreciation and amortization 222 221 Amortization (accretion) of investment security premiums (discounts), net 74 (38) Provision for accounts receivable servicing asset - 8 Gain on sale of securities - - Gain on sale of equipment - - Decrease (increase) in accrued interest receivable and other assets 661 (158) Decrease in accrued interest payable and other liabilities (70) (908) ---------- ---------- Net cash provided by operating activities 3,266 1,231 ---------- ---------- Cash flows from investing activities: Proceeds from the sale of available-for-sale investment securities 252 1,979 Proceeds from called available-for-sale investment securities 250 - Proceeds from called held-to-maturity investment securities - 1,250 Proceeds from matured available-for-sale investment securities 5,755 4,500 Proceeds from matured held-to-maturity investment securities - 1,000 Purchases of available-for-sale investment securities (6,505) (269) Purchases of held-to-maturity investment securities - - Proceeds from principal repayments for available- for-sale mortgage-related securities 51 45 Proceeds from principal repayments for held-to- maturity mortgage-related securities 2,462 1,395 Net (increase) decrease in interest-bearing deposits in banks (594) 195 Net (increase) decrease in loans (14,384) 3,342 Net decrease (increase) in accounts receivable servicing receivables 564 (607) Purchases of equipment (157) (486) ---------- ---------- Net cash (used in) provided by investing activities (12,306) 12,344 ---------- ---------- 5 2002 2001 ---------- ---------- Cash flows from financing activities: Net increase (decrease) in demand, interest-bearing and savings deposits $ 8,519 $ (9,013) Net (decrease) increase in time deposits (820) 12,877 Repayment of Federal Home Loan Bank advance (23) (22) Net decrease in short-term borrowings - (15,990) Payment of cash dividends (353) (312) Cash paid to repurchase common stock (613) - Cash paid for fractional shares - - Exercise of stock options 114 170 ---------- ---------- Net cash provided by (used in) financing activities 6,824 (12,290) ---------- ---------- (Decrease) increase in cash and cash equivalents (2,216) 1,285 Cash and cash equivalents at beginning of period 28,156 21,236 ---------- ---------- Cash and cash equivalents at end of period $ 25,940 $ 22,521 ========== ========== See notes to Unaudited Consolidated Financial Statements 6 AMERICAN RIVER HOLDINGS NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2002 1. UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS In the opinion of management, the unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the consolidated financial position of American River Holdings (the "Company") at June 30, 2002 and December 31, 2001, and the results of its operations for the three and six month periods ended June 30, 2002 and 2001 and cash flows for the six month periods ended June 30, 2002 and 2001. Certain disclosures normally presented in the notes to the financial statements prepared in accordance with generally accepted accounting principles have been omitted. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 2001 Annual Report to Shareholders. The results of operations for the three and six month periods ended June 30, 2002 may not necessarily be indicative of the operating results for the full year. In preparing such financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant changes in the near term relate to the determination of the allowance for loan and lesae losses. 2. 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 $61,863,000 and letters of credit of $3,368,000 at June 30, 2002. However, all such commitments will not necessarily culminate in actual extensions of credit by the Company during 2002. Approximately $13,267,000 of loan commitments outstanding at June 30, 2002 are for real estate construction loans and are expected to fund within the next twelve months. The remaining commitments primarily relate to revolving lines of credit or other commercial loans, and many of these are expected to expire without being drawn upon. Therefore, the total commitments do not necessarily represent future cash requirements. Each potential borrower and the necessary collateral are evaluated on an individual basis. Collateral varies, but may include real property, bank deposits, debt or equity securities or business assets. Stand-by letters of credit are commitments written to guarantee the performance of a customer to a third party. These guarantees are issued primarily relating to purchases of inventory by commercial customers and are typically short-term in nature. Credit risk is similar to that involved in extending loan commitments to customers and accordingly, evaluation and collateral requirements similar to those for loan commitments are used. Virtually all such commitments are collateralized. 3. EARNINGS PER SHARE COMPUTATION Basic earnings per share is computed by dividing net income by the weighted average common shares outstanding for the period (2,514,518 and 2,517,732 shares for the three and six month periods ended June 30, 2002, and 2,539,053 and 2,536,557 shares for the three and six month periods ended June 30, 2001). Diluted earnings per share reflect the potential dilution that could occur if outstanding stock options were exercised. Diluted earnings per share is computed by dividing net income by the weighted average common shares outstanding for the period plus the dilutive effect of options (192,338 and 186,432 shares for the three and six month periods ended June 30, 2002 and 155,341 and 153,561 shares for the three and six month periods ended June 30, 2001). Earnings per share is retroactively adjusted for stock dividends for all periods presented. 7 4. COMPREHENSIVE INCOME Comprehensive income is reported in addition to net income for all periods presented. Comprehensive income is made up of net income plus other comprehensive income (loss). Other comprehensive income (loss), net of taxes, was comprised of the unrealized gains (losses) on available-for-sale investment securities of $294,000 and $137,000, respectively, for the three and six month periods ended June 30, 2002 and $(11,000) and $161,000, respectively, for the six month periods ended June 30, 2001. Comprehensive income was $1,321,000 and $2,125,000, respectively, for the three and six month periods ended June 30, 2002 and $890,000 and $2,086,000, respectively, for the three and six month periods ended June 30, 2001. 5. ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Standards Accounting Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations covering elimination of pooling accounting treatment in business combinations and financial accounting and reporting for acquired goodwill and other intangible assets at acquisition. SFAS No. 141 supersedes APB Opinion No. 16, Business Combinations and SFAS No. 38, Accounting for Preacquisition Contingencies of Purchased Enterprises and is effective for transactions initiated after June 30, 2001. Under SFAS No. 141, all mergers and business combinations initiated after the effective date must be accounted for as "purchase" transactions. A merger or business combination was considered initiated if the major terms of the transaction, including the exchange or conversion ratio, were publicly announced or otherwise disclosed to shareholders of the combining companies prior to the effective date. Goodwill in any merger or business combination which was not initiated prior to the effective date will be recognized as an asset in the financial statements, measured as the excess of the cost of an acquired entity over the net of the amounts assigned to identifiable assets acquired and liabilities assumed, and then tested for impairment to assess losses and expensed against earnings only in the periods in which the recorded value of goodwill exceeded its implied fair value. The FASB concurrently adopted SFAS No. 142, Goodwill and Other Intangible Assets to address financial accounting and reporting for acquired goodwill and other intangible assets at acquisition in transactions other than business combinations covered by SFAS No. 141, and the accounting treatment of goodwill and other intangible assets after acquisition and initial recognition in the financial statements. SFAS No. 142 supersedes APB Opinion No. 17, Intangible Assets and is required to be applied at the beginning of an entity's fiscal year to all goodwill and other intangible assets recognized in its financial statements at that date, for fiscal years beginning after December 15, 2001. It is not certain what effect SFAS No. 141 and SFAS No. 142 may have upon the pace of business combinations in the banking industry in general or upon prospects of any merger or business combination opportunities involving the Company in the future. The Company adopted SFAS No. 142 on January 1, 2002. The adoption of SFAS No. 142 did not have a material effect on the Company's financial position, results of operations, or cash flows as the Company had only $63,000 in goodwill as of June 30, 2002 and all of the Company's intangible assets at June 30, 2002 will continue to be amortized. 8 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF AMERICAN RIVER HOLDINGS The following is management's discussion and analysis of the significant changes in American River Holdings (the "Company") balance sheet accounts for the periods ended June 30, 2002 and December 31, 2001 and its income and expense accounts for the three and six-month periods ended June 30, 2002 and 2001. 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. In addition to the historical information contained herein, this report on Form 10-Q contains certain forward-looking statements. The reader of this report should understand that all such forward-looking statements are subject to various uncertainties and risks that could affect their outcome. The Company's actual results could differ materially from those suggested by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, variances in the actual versus projected growth in assets, return on assets, loan and lesae losses, expenses, rates charged on loans and earned on securities investments, rates paid on deposits, competition effects, fee and other noninterest income earned, general economic conditions, nationally, regionally and in the operating market areas of the Company and its subsidiaries, changes in the regulatory environment, changes in business conditions and inflation, changes in securities markets, changes in accounting principals and procedures, data processing problems, a decline in real estate values in the Company's market area, the California energy shortage, the effects of terrorism, including the events of September 11, 2001 and thereafter, and the conduct of the war on terrorism by the United States and its allies, as well as other factors. This entire report should be read to put such forward-looking statements in context. To gain a more complete understanding of the uncertainties and risks involved in the Company's business, this report should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2001. Interest income and net interest income are presented on a fully taxable equivalent basis ("FTE") within management's discussion and analysis. 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 1545 River Park Drive, Suite 107, Sacramento, California 95815 and its telephone number is (916) 565-6100. The Company owns 100% of the issued and outstanding common shares of American River Bank. American River Bank was incorporated and commenced business in Fair Oaks, California, in 1983. American River Bank operates four full service offices within its primary service areas of Sacramento and Placer Counties. American River Bank's primary business is serving the commercial banking needs of small to mid-sized businesses within those counties. 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. The Company also owns 100% of First Source Capital formed in July 1999 to conduct lease financing for most types of business assets, from computer software to heavy earth-moving equipment. Specific leasing programs are tailored for vendors of equipment in order to increase their sales. First Source Capital acts as a lease broker and receives a fee for each lease recorded on the books of the party acting as the funding source. The Company also owns 100% of North Coast Bank, National Association ("North Coast Bank"). North Coast Bank was incorporated and commenced business in 1990 as Windsor Oaks National Bank in Windsor, California. In 1997, the 9 name was changed to North Coast Bank. North Coast Bank is headquartered in Santa Rosa, California and operates three full service banking offices within its primary service areas of Sonoma County, in the cities of Healdsburg, Santa Rosa and Windsor. North Coast Bank's primary business is serving the business or commercial banking needs of small to mid-sized businesses within Sonoma County. Overview The Company recorded net income of $1,027,000 for the quarter ended June 30, 2002, which was a 14.0% increase over the $901,000 reported for the same period of 2001. Diluted earnings per share for the second quarter of 2002 were $0.38 compared to the $0.34 recorded in the second quarter of 2001. The return on average equity ("ROAE") and the return on average assets ("ROA") for the second quarter of 2002 were 14.26% and 1.42%, respectively, as compared to 13.89% and 1.31%, respectively, for the same period in 2001. Net income for the six months ended June 30, 2002 and 2001 was $1,988,000 and $1,925,000, respectively, with diluted earnings per share of $.74 and $.72, respectively. For the first six months of 2002, ROAE was 14.03% and ROA was 1.39 as compared to 15.28% and 1.40% for the same period in 2001. Total assets of the Company increased by $8,879,000 (3.1%) from December 31, 2001 to $295,438,000 at June 30, 2002. Net loans totaled $208,974,000, up $13,948,000 (7.2%) from the ending balances on December 31, 2001. Deposit balances at June 30, 2002 totaled $262,587,000, up $7,699,000 (3.0%) from December 31, 2001. The Company ended the second quarter of 2002 with a Tier 1 capital ratio of 12.3% and a total risk-based capital ratio of 13.6% versus 12.4% and 13.6%, respectively, at December 31, 2001. Table One below provides a summary of the components of net income for the periods indicated: Table One: Components of Net Income - ------------------------------------------------------------------------------------------------------ For the three For the six months ended months ended June 30, June 30, ------------------- ------------------- (In thousands, except percentages) 2002 2001 2002 2001 ------- ------- ------- ------- Net interest income* $ 3,663 $ 3,663 $ 7,287 $ 7,394 Provision for loan and lease losses (186) (187) (334) (381) Noninterest income 552 556 1,044 1,135 Noninterest expense (2,288) (2,500) (4,632) (4,880) Provision for income taxes (674) (597) (1,296) (1,265) Tax equivalent adjustment (40) (34) (81) (78) ------- ------- ------- ------- Net income $ 1,027 $ 901 $ 1,988 $ 1,925 ======= ======= ======= ======= - ------------------------------------------------------------------------------------------------------ Average total assets $ 291.1 $ 275.5 $ 287.9 $ 276.5 Net income (annualized) as a percentage of average total assets 1.42% 1.31% 1.39% 1.40% - ------------------------------------------------------------------------------------------------------ * Fully taxable equivalent basis (FTE) 10 Results of Operations Net Interest Income and Net Interest Margin Net interest income represents the excess of interest and fees earned on interest earning assets (loans and leases, securities, Federal funds sold and investments in time deposits) over the interest paid on deposits and borrowed funds. Net interest margin is net interest income expressed as a percentage of average earning assets. The Company's net interest margin was 5.57% for the three months ended June 30, 2002, 5.84% for the three months ended June 30, 2001, 5.65% for the six months ended June 30, 2002 and 5.87% for the six months ended June 30, 2001. The fully taxable equivalent interest income component for the second quarter of 2002 decreased $825,000 (15.4%) to $4,526,000 compared to $5,351,000 for the three months ended June 30, 2001. Total fully taxable equivalent interest income for the six months ended June 30, 2002 decreased $2,146,000 (19.2%) to $9,032,000 compared to $11,178,000 for the six months ended June 30, 2001. The decrease in the fully taxable equivalent interest income for the second quarter of 2002 compared to the same period in 2001 is broken down by rate (down $1,011,000) and volume (up $186,000). The rate decrease can be attributed to decreases implemented by the Company during 2001 in response to the Federal Reserve Board (the "FRB") decreases in the Federal funds and Discount rates. Although there were no FRB rate decreases during the second quarter of 2002, the effects of five such rate decreases by the FRB for the period beginning on July 1, 2001 and ending on December 31, 2001 resulting in a 200 basis point drop in the prime rate contributed to the drop in the yield in average earning assets from 8.62% for the second quarter of 2001 to 6.96% for the second quarter of 2002. The volume increase was the result of a 4.8% increase in earning assets primarily the result of a concentrated focus on business lending and the effects of a strong local market and an increase in investment securities as a result of an increase in average deposits of $13,637,000. Average loan balances were up 1.1% for the three months ended June 30, 2002 as compared to the same quarter in 2001, while average investments were up 17.1% during the same period. The breakdown of the fully taxable equivalent interest income for the six months ended June 30, 2002 over the same period in 2001 resulted from increases in volume (up $140,000) and decreases in rate (down $2,286,000). Average earning assets increased 2.4% during the first six months of 2002 as compared to the same period in 2001. Average loan balances decreased $1,717,000 (0.8%) during that same period; however, average investments and Federal funds balances increased a combined $7,742,000 (15.6%). Interest expense was $825,000 (48.9%) lower in the second quarter of 2002 versus the prior year period. The average balances on interest bearing liabilities were $1,979,000 (1.1%) higher in the second quarter of 2002 versus the same quarter in 2001. Despite the higher average balances, there was actually a decrease in interest expense related to volume ($50,000). This occurred as there was an increase in lower cost transaction (checking) accounts (average increase of $10,115,000 or 11.6%) and a decrease in higher cost Time Deposits (average decrease of $7,238,000 or 8.9%). The majority of the decrease in interest expense for the three month period can be related to a drop in rates (down $775,000). Rates paid on interest bearing liabilities decreased 180 basis points on a quarter over quarter basis. Interest expense was $2,039,000 (53.9%) lower in the six month period ended June 30, 2002 versus the prior year period. The average balances on interest bearing liabilities were $1,405,000 (0.7%) lower in the six month period ended June 30, 2002 versus the same period in 2001. The lower balances accounted for $117,000 of the decrease in interest expense, while rates paid on interest bearing liabilities decreased 217 basis points on a year over year basis and accounted for $1,922,000 of the decrease. 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. 11 Table Two: Analysis of Net Interest Margin on Earning Assets - ------------------------------------------------------------------------------------------------------------------------------------ Three Months Ended June 30, 2002 2001 ------------------------------------------ --------------------------------------- Avg Avg Avg Avg (Taxable Equivalent Basis) Balance Interest Yield (4) Balance Interest Yield (4) (In thousands, except percentages) --------- -------- -------- ---------- -------- --------- Assets: Earning assets Loans (1) $ 205,689 $ 3,798 7.41% $ 203,387 $ 4,590 9.05% Taxable investment securities 36,042 480 5.34% 28,575 452 6.34% Tax-exempt investment securities (2) 9,704 154 6.37% 9,637 149 6.20% Corporate stock (2) 275 5 7.29% 798 28 14.07% Federal funds sold 6,063 25 1.65% 3,834 42 4.39% Investments in time deposits 5,950 64 4.31% 5,389 90 6.70% --------- -------- ---------- -------- Total earning assets 263,723 4,526 6.96% 251,620 5,351 8.62% -------- -------- Cash & due from banks 22,092 17,380 Other assets 8,076 9,116 Allowance for loan & lease losses (2,803) (2,604) --------- ---------- $ 291,088 $ 275,512 ========= ========== Liabilities & Shareholders' Equity Interest bearing liabilities: NOW & MMDA $ 97,504 233 0.96% $ 87,389 499 2.29% Savings 13,848 13 0.38% 13,919 50 1.44% Time deposits 74,300 580 3.13% 81,538 1,085 5.34% Other borrowings 2,987 37 4.97% 3,814 54 5.68% --------- -------- ---------- -------- Total interest bearing liabilities 188,639 863 1.83% 186,660 1,688 3.63% -------- -------- Demand deposits 71,734 60,903 Other liabilities 1,822 1,928 --------- ---------- Total liabilities 262,195 249,491 Shareholders' equity 28,893 26,021 --------- ---------- $ 291,088 $ 275,512 ========= ========== Net interest income & margin (3) $ 3,663 5.57% $ 3,663 5.84% ======== ==== ======== ===== (1) Loan interest includes loan fees of $154,000 and $148,000 during the three months ending June 30, 2002 and June 30, 2001, respectively. (2) Includes taxable-equivalent adjustments that primarily relate to income on certain securities that is exempt from federal income taxes. The effective federal statutory tax rate was 34% for the periods presented. (3) Net interest margin is computed by dividing net interest income by total average earning assets. (4) Average yield is calculated based on actual days in quarter (91) and annualized to actual days in year (365). 12 - ---------------------------------------------------------------------------------------------------------------- Six Months Ended June 30, 2002 2001 ------------------------------------ --------------------------------- (Taxable Equivalent Basis) Avg Avg Avg Avg (In thousands, except percentages) Balance Interest Yield (4) Balance Interest Yield (4) ---------- -------- --------- ---------- -------- -------- Assets: Earning assets Loans (1) $ 202,606 $ 7,556 7.52% $ 204,323 $ 9,592 9.47% Taxable investment securities 36,755 980 5.38% 30,908 986 6.43% Tax-exempt investment securities (2) 9,656 307 6.41% 9,722 306 6.35% Corporate stock (2) 360 14 7.84% 896 49 11.03% Federal funds sold 4,628 38 1.66% 2,659 63 4.78% Investments in time deposits 5,971 137 4.63% 5,443 182 6.74% --------- -------- ---------- -------- Total earning assets 259,976 9,032 7.01% 253,951 11,178 8.88% -------- -------- Cash & due from banks 22,413 16,465 Other assets 8,206 8,680 Allowance for loan & lease losses (2,733) (2,566) --------- ---------- $ 287,862 $ 276,530 ========= ========== Liabilities & Shareholders' Equity Interest bearing liabilities: NOW & MMDA $ 96,183 461 0.97% $ 91,314 1,315 2.90% Savings 13,491 26 0.39% 13,142 115 1.76% Time deposits 74,249 1,185 3.22% 78,428 2,194 5.64% Other borrowings 2,919 73 5.04% 5,363 160 6.02% --------- -------- -------- Total interest bearing liabilities 186,842 1,745 1.88% 188,247 3,784 4.05% -------- -------- Demand deposits 70,647 60,902 Other liabilities 1,792 1,982 --------- ---------- Total liabilities 259,281 251,131 Shareholders' equity 28,581 25,399 --------- ---------- $ 287,862 $ 276,530 ========= ========== Net interest income & margin (3) $ 7,287 5.65% $ 7,394 5.87% ======== ==== ======== ===== (1) Loan interest includes loan fees of $311,000 and $297,000 during the six months ending June 30, 2002 and June 30, 2001, respectively. (2) Includes taxable-equivalent adjustments that primarily relate to income on certain securities that is exempt from federal income taxes. The effective federal statutory tax rate was 34% for the periods presented. (3) Net interest margin is computed by dividing net interest income by total average earning assets. (4) Average yield is calculated based on actual days in period (181) and annualized to actual days in year (365). 13 Table Three: Analysis of Volume and Rate Changes on Net Interest Income and Expenses - -------------------------------------------------------------------------------------- (In thousands) Three Months Ended June 30, 2002 over 2001 Increase (decrease) due to change in: Interest-earning assets: Volume Rate (4) Net Change ---------- ---------- ---------- Net loans (1)(2) $ 52 $ (844) $ (792) Taxable investment securities 118 (90) 28 Tax exempt investment securities (3) 1 4 5 Corporate stock (18) (5) (23) Federal funds sold 24 (41) (17) Investment in time deposits 9 (35) (26) ---------- ---------- ---------- Total 186 (1,011) (825) ---------- ---------- ---------- Interest-bearing liabilities: Demand deposits 58 (324) (266) Savings deposits - (37) (37) Time deposits (96) (409) (505) Other borrowings (12) (5) (17) ---------- ---------- ---------- Total (50) (775) (825) ---------- ---------- ---------- Interest differential $ 236 $ (236) $ - ========== ========== ========== - -------------------------------------------------------------------------------------- (In thousands) Six Months Ended June 30, 2002 over 2001 Increase (decrease) due to change in: Interest-earning assets: Volume Rate (4) Net Change ---------- ---------- ---------- Net loans (1)(2) $ (81) $ (1,955) $ (2,036) Taxable investment securities 187 (193) (6) Tax exempt investment securities (3) (2) 3 1 Corporate stock (29) (6) (35) Federal funds sold 47 (72) (25) Investment in time deposits 18 (63) (45) ---------- ---------- ---------- Total 140 (2,286) (2,146) ---------- ---------- ---------- Interest-bearing liabilities: Demand deposits 70 (924) (854) Savings deposits 3 (92) (89) Time deposits (117) (892) (1,009) Other borrowings (73) (14) (87) ---------- ---------- ---------- Total (117) (1,922) (2,039) ---------- ---------- ---------- Interest differential $ 257 $ (364) $ (107) ========== ========== ========== - -------------------------------------------------------------------------------------- (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 $154,000 and $148,000 during the three months ending June 30, 2002 and June 30, 2001, respectively, and $311,000 and $297,000 during the six months ending June 30, 2002 and June 30, 2001, respectively, have been included in the interest income computation. (3) Includes taxable-equivalent adjustments that primarily relate to income on certain securities that is exempt from federal income taxes. The effective federal statutory tax rate was 34% for the periods presented. (4) The rate/volume variance has been included in the rate variance. 14 Provision for Loan and Lease Losses The Company provided $186,000 for loan and lease losses for the second quarter of 2002 as compared to $187,000 for the second quarter of 2001. Net loan and lease charge-offs for the three months ended June 30, 2002 were $44,000 or ..09% (on an annualized basis) of average loans and leases as compared to $203,000 or .40% (on an annualized basis) of average loans and leases for the three months ended June 30, 2001. For the first six months of 2002, the Company made provisions for loan and lease losses of $334,000 and net loan and lease charge-offs were $54,000 or .05% (on an annualized basis) of average loans and leases outstanding. This compares to provisions for loan and lease losses of $381,000 and net loan and lease charge-offs of $303,000 for the first six months of 2001 or .30% (on an annualized basis) of average loans and leases outstanding. Noninterest Income Table Four below provides a summary of the components of noninterest income for the periods indicated (dollars in thousands): Table Four: Components of Noninterest Income (Unaudited) - ------------------------------------------------------------------------------------- Three Months Six Months Ended Ended June 30, June 30, -------------------- -------------------- 2002 2001 2002 2001 - ------------------------------------------------------------------------------------- Service charges on deposit accounts $ 148 $ 151 $ 286 $ 293 Accounts receivable servicing fees 75 119 153 248 Fees from lease brokerage services 88 65 137 155 Merchant fee income 89 67 162 121 Income from residential lending 57 50 103 106 Financial services income 14 28 37 49 Other 81 76 166 163 - ------------------------------------------------------------------------------------- Total noninterest income $ 552 $ 556 $ 1,044 $ 1,135 - ------------------------------------------------------------------------------------- Noninterest income was down $4,000 (0.7%) to $552,000 for the three months ended June 30, 2002 as compared to $556,000 for the three months ended June 30, 2001. The decrease in noninterest income for the quarter can be attributed to a decrease in accounts receivable servicing (down $44,000 or 37.0%). The decrease in fees from accounts receivable servicing was offset by increases in fees from lease brokerage services (up $23,000 or 35.4%) and an increase in merchant fee income (up $22,000 or 32.8%). The decrease in accounts receivable servicing was a result of a decrease in average accounts receivable balances outstanding from $3,657,000 in the second quarter of 2001 to $2,248,000 (38.5%) in the second quarter of 2002. For the six months ended June 30, 2002, noninterest income was down $91,000 (8.0%) to $1,044,000. The decrease in noninterest income for the six-month period can be attributed to a decrease in accounts receivable servicing (down $95,000 or 38.3%). There was an increase in merchant fee income (up $41,000 or 33.9%) during the six-month period ending June 30, 2002. The decrease in accounts receivable servicing was a result of a decrease in average accounts receivable balances outstanding from $3,467,000 in the six-month period ended June 30, 2001 to $2,469,000 (28.8%) in the six-month period ended 2002. The increase in merchant fee income can be attributed to higher transaction volume from existing clients and more favorable pricing received by the Company from its processor. Noninterest Expense Noninterest expenses decreased $212,000 (8.5%) to a total of $2,288,000 in the second quarter of 2002 versus the second quarter of 2001. Salary and employee benefits, which include commissions, decreased $62,000 (4.4%) from $1,421,000 during the second quarter of 2001 to $1,359,000 during the second quarter of 2002. The decrease is primarily the result of lower commissions paid out in the Real Estate Division of North Coast Bank (down $48,000). On a quarter 15 over quarter basis, furniture and equipment increased $15,000 (10.9%). The increase relates to the depreciation of technology related equipment purchased by the Company over the past twelve months. Other expense decreased $168,000 (22.7%) to a total of $571,000 in the second quarter of 2002 versus the second quarter of 2001. Professional fees, which are classified in the other expense line item, decreased $94,000 (72.9%) from $129,000 during the second quarter of 2001 to $35,000 during the second quarter of 2002. The decrease in professional fees results from a recovery of legal fees ($59,000) related to the resolution of a problem loan credit; the remainder of the decrease relates to lower legal fees paid to resolve problem loan credits. The overhead efficiency ratios for the 2002 and 2001 second quarters were 54.3% and 59.3%, respectively. Noninterest expense for the six-month period ended June 30, 2002 was $4,632,000 versus $4,880,000 for the same period in 2001 for a decrease of $248,000 (5.1%). Salaries and benefits decreased $111,000 (3.9%) in 2002 as compared to 2001. The decrease is primarily the result of lower commissions paid out in the Real Estate Division of North Coast Bank (down $57,000) and efficiencies created throughout the Company as a result of consolidating back office departments. The departments were consolidated during the second quarter of 2001 as we further integrated North Coast Bank into the Company. Full time equivalent employees decreased to 100 at June 30, 2002 from 104 at June 30, 2001. Furniture and equipment increased $25,000 (9.2%). The increase relates to the depreciation of technology related equipment purchased by the Company over the past twelve months. Other expense decreased $170,000 (12.3%). Professional fees decreased $62,000 (31.0%) from $201,000 during the first six months of 2001 to $138,000 during the first six months of 2002. The decrease in professional fees results from a recovery of legal fees ($64,000) related to the resolution of a problem loan credit; the remainder of the decrease relates to lower legal fees paid to resolve problem loan credits. An additional other expense item that decreased during the period was data processing ($43,000) at North Coast Bank. The outsourced data processing at North Coast Bank was converted in 2001 and is now processed internally by the Company. The overhead efficiency ratio (fully tax equivalent) for the first six months of 2002 was 55.6% as compared to 57.2% in the same period of 2001. Provision for Income Taxes The effective tax rate for the second quarter and first six months of 2002 was 39.6% and 39.5%, respectively, versus 39.9% and 39.7%, respectively, for the same two periods of 2001. Balance Sheet Analysis The Company's total assets were $295,438,000 at June 30, 2002 as compared to $286,559,000 at December 31, 2001, representing an increase of 3.1%. The average balances of total assets for the six months ended June 30, 2002 was $287,862,000 which represents an increase of $11,332,000 or 4.1% over the $276,530,000 during the six month period ended June 30, 2001. Total average assets for the second quarter of 2002 were $291,088,000 compared to $275,512,000 during the second quarter of 2001 for an increase of 5.7%. Loans The Company concentrates its lending activities in the following principal areas: 1) commercial; 2) commercial real estate; 3) real estate construction (both commercial and residential); 4) residential real estate; 5) lease financing receivable; 6) agriculture; and 7) consumer loans. At June 30, 2002, these categories accounted for approximately 22%, 55%, 13%, 1%, 2%, 4% and 3%, respectively, of the Company's loan portfolio. This mix was relatively unchanged compared to 22%, 51%, 15%, 2%, 1%, 5% and 4% at December 31, 2001. Continuing strong economic activity in the Company's market area, new borrowers developed through the Company's marketing efforts and credit extensions expanded to existing borrowers, offset by normal loan paydowns and payoffs, resulted in net increases in balances for commercial ($3,605,000 or 8.3%), commercial real estate ($16,384,000 or 16.4%) and lease financing receivable ($975,000 or 39.0%). Despite the new borrowers, the Company experienced decreases in real estate construction ($3,242,000 or 10.5%), residential real estate ($1,560,000 or 50.0%), agriculture ($1,692,000 or 16.5%) and consumer ($185,000 or 2.4%) as a result of normal paydowns and higher than average payoffs. The higher payoffs can be partly attributed to refinances during the low rate environment. Table Five below summarizes the composition of the loan portfolio as of June 30, 2002 and December 31, 2001. 16 Table Five: Loan and Lease Portfolio Composition - --------------------------------------------------------------------- June 30, December 31, (In thousands) 2002 2001 - --------------------------------------------------------------------- Commercial $ 47,224 $ 43,619 Real estate: Commercial 116,542 100,158 Construction 27,579 30,821 Residential 1,559 3,119 Lease financing receivable 3,474 2,499 Agriculture 8,559 10,251 Consumer 7,413 7,598 - --------------------------------------------------------------------- Total loans 212,350 198,065 Allowance for loan and lease losses (2,894) (2,614) Deferred loan and lease fees (482) (425) - --------------------------------------------------------------------- Total net loans & leases $ 208,974 $ 195,026 ===================================================================== A significant portion of the Company's loans are direct loans made to individuals and local businesses. The Company relies substantially on local promotional activity and personal contacts by bank officers, directors and employees to compete with other financial institutions. The Company makes loans 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 loans to finance purchases of autos, boats, recreational vehicles, mobile homes and various other consumer items. Construction loans are generally composed of commitments to customers within the Company's service area for construction of both commercial properties and custom and tract-type single-family residences. Other real estate loans consist primarily of loans secured by first trust deeds on commercial and residential properties typically with maturities from 3 to 10 years and original loan to value ratios generally from 65% to 80%. Agriculture loans consist primarily of vineyard loans and development loans to plant vineyards. In general, except in the case of loans with SBA or Farm Services Agency guarantees, the Company does not make long-term mortgage loans; however, American River Bank has a residential lending division to assist customers in securing most forms of longer term single-family mortgage financing. American River Bank acts as a broker between American River Bank's customers and the loan wholesalers. American River Bank receives an origination fee for loans closed. Risk Elements The Company assesses and manages credit risk on an ongoing basis through a total credit culture that emphasizes excellent credit quality, extensive internal monitoring and established formal lending policies. Additionally, the Company contracts with an outside loan review consultant to periodically review the existing loan and lease portfolio. Management believes its ability to identify and assess risk and return characteristics of the Company's loan and lease portfolio is critical for profitability and growth. Management strives to continue its emphasis on credit quality in the loan and lease approval process, active credit administration and regular monitoring. With this in mind, management has designed and implemented a comprehensive loan and lease review and grading system that functions to continually assess the credit risk inherent in the loan and lease portfolio. Ultimately, underlying trends in economic and business cycles may influence credit quality. American River Bank's business is concentrated in the Sacramento Metropolitan Statistical Area, which is a diversified economy, but with a large State of California government presence and employment base. North Coast Bank's business is focused on Sonoma County. Special emphasis is placed within the three communities in which North Coast Bank has offices (Santa Rosa, Windsor, and Healdsburg). The economy of Sonoma County is diversified with 17 professional services, manufacturing, agriculture and 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, absorption and sale rates; real estate values and rates of return; operating expenses; inflation; and sufficiency of collateral independent of the real estate including, in some instances, personal guarantees. In extending credit and commitments to borrowers, the Company generally requires collateral and/or guarantees as security. The repayment of such loans is expected to come from cash flow or from proceeds from the sale of selected assets of the borrowers in the normal course of business. 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 68.6% of the Company's loan and lease portfolio at June 30, 2002. Although management believes the concentration to have no more than the normal risk of collectability, a substantial decline in the economy in general, or a decline in real estate values in the Company's primary market areas in particular, could have an adverse impact on the collectability of these loans and require an increase in the provision for loan and lease losses which could adversely affect the Company's future prospects, results of operations, profitability and stock price. Management believes that its lending policies and underwriting standards will tend to minimize losses in an economic downturn, however, there is no assurance that losses will not occur under such circumstances. The Company's loan policies and underwriting standards include, but are not limited to, the following: (1) maintaining a thorough understanding of the Company's service area and originating a significant majority of its loans and leases 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), (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, and (5) limiting and monitoring lending within specific property categories. Nonaccrual, Past Due and Restructured Loans & Leases Management generally places loans on nonaccrual status when they become 90 days past due, unless the loan is well secured and in the process of collection. Loans are charged off when, in the opinion of management, collection appears unlikely. Table Six below sets forth nonaccrual loans and loans past due 90 days or more as of June 30, 2002 and December 31, 2001. Table Six: Non-Performing Loans & Leases - ---------------------------------------------------------------------------- June 30, December 31, ---------- ------------ (In thousands) 2002 2001 - ---------------------------------------------------------------------------- Past Due 90 days or more and still accruing: Commercial $ - $ - Real estate 190 - Consumer and other - - - ---------------------------------------------------------------------------- Nonaccrual: Commercial 292 534 Real estate 291 314 Consumer and other - 8 - ---------------------------------------------------------------------------- Total non-performing loans & leases $ 773 $ 856 ============================================================================ 18 At June 30, 2002, non-performing loans and leases were 0.36% of total loans and leases. The recorded investments in loans that were considered to be impaired totaled $773,000 at June 30, 2002 and $856,000 at December 31, 2001. On July 2, 2002, two loans, to one borrower, that were classified as non-performing as of June 30, 2002 paid off in full. The book balance of these two loans as of June 30, 2002 was $497,000. The recorded investment in troubled debt restructurings as of June 30, 2002 was $240,000 of which $190,000 was past due 90 days or more and still accruing and classified as part of the $773,000 in non-performing totals mentioned above. Management believes the $190,000 is well collateralized. There were no loan concentrations in excess of 10% of total loans not otherwise disclosed as a category of loans as of June 30, 2002 or December 31, 2001. Management is not aware of any potential problem loans, which were accruing and current at June 30, 2002, where serious doubt exists as to the ability of the borrower to comply with the present repayment terms. Allowance for Loan and Lease Losses Activity The provision for loan and lease losses is based upon management's evaluation of the adequacy of the existing allowance for loans and leases outstanding and loan commitments. This allowance is increased by provisions charged to expense and recoveries, and is reduced by loan and lease charge-offs. Management determines an appropriate provision based upon the interaction of three primary factors: (1) loan and lease portfolio growth, (2) a comprehensive grading and review formula for total loans and leases outstanding, and (3) estimated inherent credit risk in the portfolio. Management reserves 2% of credit exposures graded "Special Mention", 15% of credits classified "Substandard" and 50% of credits classified "Doubtful". These reserve factors may be adjusted for significant loans that are individually evaluated by management for specific risk of loss. The amounts allocated for "Special Mention", "Substandard" and "Doubtful" represent $411,000 at June 30, 2002. In addition, reserve factors ranging from 0.375% to 3.000% are assigned to currently performing loans that are not otherwise graded as Special Mention, Substandard or Doubtful. These factors are assigned based on management's assessment of the following for each identified loan type: (1) inherent credit risk, (2) historical losses and, (3) where the Company has not experienced losses, historical losses experienced by peer banks. Finally, a residual component is maintained to cover uncertainties that could affect management's estimate of probable losses. This residual component of the allowance reflects a margin of imprecision inherent in the underlying assumptions used to estimate losses in specifically graded loans and expected losses in the performing portfolio. The Loan Committees of each of the Subsidiary Banks review the adequacy of the allowance for loan and lease losses at least quarterly to include consideration of the relative risks in the portfolio and current economic conditions. The Subsidiary Banks also engage outside firms to independently assess our methodology and reserve adequacy, and on a regular basis engage outside firms to perform independent reviews of the loan portfolios. The allowance is adjusted based on those reviews if, in the judgment of the loan committees and management, changes are warranted. The allowance for loan and lease losses totaled $2,894,000 or 1.37% of total loans and leases at June 30, 2002 and $2,614,000 or 1.32% at December 31, 2001. Net charge-offs to average loans and leases were 0.09% (on an annualized basis) for the second quarter of 2002 and 0.05% (on an annualized basis) for the six months ended June 30, 2002. Net charge-offs to average loans and leases were 0.40% (on an annualized basis) for the second quarter of 2001 and 0.30% (on an annualized basis) for the six months ended June 30, 2001. It is the policy of management to maintain the allowance for loan and lease losses at a level adequate for known and inherent risks in the portfolio. Based on information currently available to analyze inherent credit risk, including economic factors, overall credit quality, historical delinquencies and a history of actual charge-offs, management believes that the provision for loan and lease losses and the allowance are prudent and adequate. 19 Each of the Subsidiary Banks generally makes monthly allocations to the allowance for loan and lease losses based on estimates of loss risk and loan and lease growth. Adjustments may be made based on differences from estimated loan growth, the types of loans constituting this growth, changes in risk ratings within the portfolio, and general economic conditions. However, no prediction of the ultimate level of loans charged off in future periods can be made with any certainty. Table Seven below summarizes, for the periods indicated, the activity in the allowance for loan and lease losses. Table Seven: Allowance for Loan and Lease Losses - ---------------------------------------------------------------------------------------------------------- Three Months Six Months (In thousands, except for percentages) Ended Ended June 30, June 30, ------------------------- ------------------------- 2002 2001 2002 2001 - ---------------------------------------------------------------------------------------------------------- Average loans and leases outstanding $ 205,689 $ 203,387 $ 202,606 $ 204,323 - ---------------------------------------------------------------------------------------------------------- Allowance for possible loan and lease losses at beginning of period $ 2,752 $ 2,548 $ 2,614 $ 2,454 Loans charged off: Commercial - (200) (1) (300) Real estate - - (54) - Consumer (45) (5) - (5) - ---------------------------------------------------------------------------------------------------------- Total (45) (205) (55) (305) - ---------------------------------------------------------------------------------------------------------- Recoveries of loans previously Charged off: Commercial 1 2 1 2 Real estate - - - - Consumer - - - - - ---------------------------------------------------------------------------------------------------------- Total 1 2 1 2 - ---------------------------------------------------------------------------------------------------------- Net loans (charged off) (44) (203) (54) (303) Additions to allowance charged to operating expenses 186 187 334 381 - ---------------------------------------------------------------------------------------------------------- Allowance for possible loan and lease losses at end of period $ 2,894 $ 2,532 $ 2,894 $ 2,532 - ---------------------------------------------------------------------------------------------------------- Ratio of net charge-offs to average loans and leases outstanding .09% .40% .05% .30% Provision of allowance for possible loan and lease losses to average loans .36% .37% .33% .38% and leases outstanding Allowance for possible loan and lease losses to loans and leases net of deferred fees at end of period 1.37% 1.27% 1.37% 1.27% Other Real Estate At June 30, 2002 and December 31, 2001, the Company had $48,000 and zero, respectively, in other real estate ("ORE") properties. The entire $48,000 balance represented one property and on July 29, 2002, the Company sold the property for a slight gain over the June 30, 2002 book value. As of the date of filing this document, the Company did not have any ORE. 20 Deposits At June 30, 2002, total deposits were $262,587,000 representing an increase of $7,699,000 (3.0%) from the December 31, 2001 balance of $254,888,000. Noninterest-bearing deposits increased $7,261,000 (10.7%) while interest-bearing deposits increased $438,000 (0.2%). The Company has attempted to reduce higher rate time deposits while increasing the balances of more profitable, lower-cost transaction accounts. Capital Resources The current and projected capital position of the Company and the impact of capital plans and long-term strategies is reviewed regularly by management. The Company's capital position represents the level of capital available to support continued operations and expansion. In May of 1997, the board of directors of the Company authorized a stock repurchase plan. The Company acquired 77,000 shares of its common stock during 1999, 60,000 in 1998 and 25,000 in 1997. These repurchases were made periodically in the open market with the intention to lessen the dilutive impact of issuing new shares in connection with stock option plans and in conjunction with annual distributions of a five percent common stock dividend. As a result of the acquisition of North Coast Bank during 2000, which was accounted for as a pooling of interests, the Company was required to discontinue the repurchase of its common stock during the transition period. On September 20, 2001, the Company announced a new plan to repurchase, as conditions warrant, up to 5% annually of the Company's common stock in connection with the Company's annual distribution of a 5% stock dividend. During 2001, the Company repurchased 21,400 shares under the new plan and during the first six months of 2002, 32,400 shares were repurchased. The Company and the Subsidiary Banks are subject to certain regulations issued by the Board of Governors of the Federal Reserve System, the FDIC and the OCC, which require maintenance of certain levels of capital. At June 30, 2002, shareholders' equity was $29,206,000, representing an increase of $1,264,000 (4.5%) from $27,942,000 at December 31, 2001. The ratio of total risk-based capital to risk adjusted assets was 13.6% at June 30, 2002 compared to 13.6% at December 31, 2001. Tier 1 risk-based capital to risk-adjusted assets was 12.3% at June 30, 2002 and 12.4% at December 31, 2001. Table Eight below lists the Company's actual capital ratios at June 30, 2002 and December 31, 2001 as well as the minimum capital ratios for capital adequacy. Table Eight: Capital Ratios - ------------------------------------------------------------------------------------------------- At June 30, 2002 At December 31, Minimum Regulatory Capital to Risk-Adjusted Assets 2001 Capital Requirements - ------------------------------------------------------------------------------------------------- Leverage ratio 9.9% 9.8% 4.00% Tier 1 Risk-Based Capital 12.3% 12.4% 4.00% Total Risk-Based Capital 13.6% 13.6% 8.00% Capital ratios are reviewed on a regular basis to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet future needs. All Subsidiary Banks ratios are in excess of the regulatory definition of "well capitalized" at June 30, 2002 and December 31, 2001. Market Risk Management Overview. Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises primarily from interest rate risk inherent in its loan 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 21 exposing the Company to undue interest rate risk. The board of directors has overall responsibility for the interest rate risk management policies. Each Subsidiary Bank has an Asset and Liability Management Committee (ALCO) that establishes and monitors guidelines to control the sensitivity of earnings to changes in interest rates. Asset/Liability Management. Activities involved in asset/liability management include but are not limited to lending, accepting and placing deposits and investing in securities. Interest rate risk is the primary market risk associated with asset/liability management. Sensitivity of earnings to interest rate changes arises when yields on assets change in a different time period or in a different amount from that of interest costs on liabilities. To mitigate interest rate risk, the structure of the balance sheet is managed with the goal that movements of interest rates on assets and liabilities are correlated and contribute to earnings even in periods of volatile interest rates. The asset/liability management policy sets limits on the acceptable amount of variance in net interest margin and market value of equity under changing interest environments. The Company uses simulation models to forecast earnings, net interest margin and market value of equity. Simulation of earnings is the primary tool used to measure the sensitivity of earnings to interest rate changes. Using computer-modeling techniques, the Company is able to estimate the potential impact of changing interest rates on earnings. A balance sheet forecast is prepared quarterly using inputs of actual loans, securities and interest bearing liabilities (i.e. deposits/borrowings) positions as the beginning base. The forecast balance sheet is processed against three interest rate scenarios. The scenarios include a 200 basis point rising rate forecast, a flat rate forecast and a 200 basis point falling rate forecast which take place within a one year time frame. The net interest income is measured during the year assuming a gradual change in rates over the twelve-month horizon. The Company's net interest income, as forecast below, was modeled utilizing a forecast balance sheet projected from balances as of the date indicated. Table Nine below summarizes the effect on net interest income (NII) of a +/-200 basis point change in interest rates as measured against a constant rate (no change) scenario. Table Nine: Interest Rate Risk Simulation of Net Interest as of June 30, 2002 and December 31, 2001 - -------------------------------------------------------------------------------- (In thousands) $ Change in NII $ Change in NII from Current from Current 12 Month Horizon 12 Month Horizon June 30, 2002 December 31, 2001 ------------- ----------------- Variation from a constant rate scenario +200bp $ 531 $ 635 -200bp $ (523) $ (587) 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 conservative estimates of interest rate risk. Inflation The impact of inflation on a financial institution differs significantly from that exerted on manufacturing, or other commercial concerns, primarily because its assets and liabilities are largely monetary. In general, inflation primarily affects the Company and it subsidiaries through its effect on market rates of interest, which affects the Company's ability to attract loan customers. Inflation affects the growth of total assets by increasing the level of loan demand, and potentially adversely affects capital adequacy because loan growth in inflationary periods can increase at rates higher than the rate that capital grows through retention of earnings which may be generated in the future. In addition to its effects on interest rates, inflation increases overall operating expenses. Inflation has not had a material effect upon the results of operations of the Company and its subsidiaries during the periods ended June 30, 2002 and 2001. 22 Liquidity Liquidity management refers to the Company's ability to provide funds on an ongoing basis to meet fluctuations in deposit levels as well as the credit needs and requirements of its clients. Both assets and liabilities contribute to the Company's liquidity position. Federal funds lines, short-term investments and securities, and loan repayments contribute to liquidity, along with deposit increases, while loan funding and deposit withdrawals decrease liquidity. The Company assesses the likelihood of projected funding requirements by reviewing historical funding patterns, current and forecasted economic conditions and individual client funding needs. Commitments to fund loans and outstanding letters of credit at June 30, 2002 and December 31, 2001 were approximately $61,863,000 and $3,368,000 and $60,840,000 and $3,776,000, respectively. Such loans 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. On June 30, 2002, consolidated liquid assets totaled $49.9 million or 16.9% of total assets compared to $54.8 million or 19.1% of total assets on December 31, 2001. In addition to liquid assets, the Company maintains short-term lines of credit in the amount of $24,000,000 with correspondent banks. At June 30, 2002, the Company had $24,000,000 available under these credit lines. Additionally, the subsidiary banks are members of the Federal Home Loan Bank (the "FHLB"). At June 30, 2002, the subsidiary banks could have arranged for up to $4,762,000 in secured borrowings from the FHLB. American River Bank also has informal agreements with various other banks to sell participations in loans, if necessary. The Company serves primarily a business and professional customer base and, as such, its deposit base is susceptible to economic fluctuations. Accordingly, management strives to maintain a balanced position of liquid assets to volatile and cyclical deposits. Liquidity is also affected by portfolio maturities and the effect of interest rate fluctuations on the marketability of both assets and liabilities. The Company can sell any of its unpledged securities held in the available-for-sale category to meet liquidity needs. Due to the falling interest rate environment throughout the last half of 2000 and continuing through the end of the second quarter of 2002, much of the investment portfolio has experienced significant price appreciation, which has resulted in unrealized gains. These unrealized gains allow the Company the ability to sell these securities should the liquidity needs arise. These securities are also available to pledge as collateral for borrowings if the need should arise. American River Bank has established a master repurchase agreement with a correspondent bank to enable such transactions. American River Bank and North Coast Bank can also pledge securities to borrow from the Federal Reserve Bank and the FHLB. The principal cash requirements of the Company are for expenses incurred in the support of administration and operations. For nonbanking functions, the Company is dependent upon the payment of cash dividends from its subsidiaries to service its commitments. The Company expects that the cash dividends paid by the subsidiaries to the Company will be sufficient to meet this payment schedule. Off-Balance Sheet Items The Company has certain ongoing commitments under operating leases. These commitments do not significantly impact operating results. As of June 30, 2002 and December 31, 2001, commitments to extend credit and 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 letters of credit were $65,231,000 and $64,616,000 at June 30, 2002 and December 31, 2001, respectively. As a percentage of net loans these off-balance sheet items represent 31.2% and 33.1%, respectively. Certain financial institutions have elected to use special purpose vehicles ("SPV") to dispose of problem assets. A SPV is typically a subsidiary company with an asset and liability structure and legal status that makes its 23 obligations secure even if the parent corporation goes bankrupt. Under certain circumstances, these financial institutions may exclude the problem assets from their reported impaired and non-performing assets. We do not use those vehicles or any other structures to dispose of problem assets. Other Matters California Energy Shortage. The State of California recently experienced periodic electric power shortages. It is uncertain whether these shortages will arise in the future. Conservation efforts and unanticipated cooler weather conditions through the summer months of 2001 and 2002, has resulted in lower demand for electricity throughout California and an electricity surplus. California also initiated action to supplement conservation efforts including acceleration of the approval process for development of new energy production facilities and entering into long-term energy contracts for the supply of electricity. The Company and its subsidiaries could be materially and adversely affected either directly or indirectly by a severe electric power shortage if such a shortage caused any of its critical data processing or computer systems and related equipment to fail, or if the local infrastructure systems such as telephone systems should fail, or the Company's and its subsidiaries' significant vendors, suppliers, service providers, customers, borrowers, or depositors are adversely impacted by their internal systems or those of their respective customers or suppliers. Material increases in the expenses related to electric power consumption and the related increase in operating expense could also have an adverse effect on the Company's future results of operations. Effects of Terrorism. The terrorist actions on September 11, 2001 and thereafter have had significant adverse effects upon the United States economy. Whether the terrorist activities in the future and the actions of the United States and its allies in combating terrorism on a worldwide basis will adversely impact the Company and the extent of such impact is uncertain. However, such events have had and may continue to have an adverse effect on the economy in the Company's market areas. Such continued economic deterioration could adversely affect the Company's future results of operations by, among other matters, reducing the demand for loans and other products and services offered by the Company, increasing nonperforming loans and the amounts reserved for loan and lease losses, and causing a decline in the Company's stock price. Subsequent Events Corporate Reform Legislation. President George W. Bush signed the Sarbanes-Oxley Act of 2002 (the "Act") on July 30, 2002, which responds to recent issues in corporate governance and accountability. Among other matters, key provisions of the Act provide for: o Expanded oversight of the Accounting Profession by creating a new independent oversight board to be monitored by the SEC. o Revised rules on auditor independence to restrict the nature of non-audit services provided to audit clients and to require such services to be pre-approved by the audit committee. o Improved corporate responsibility through mandatory listing standards relating to audit committees, certifications of periodic reports by the CEO and CFO, and makes it a crime for an issuer to interfere with an audit. o Enhanced financial disclosures, including periodic reviews for largest issuers and real time disclosure of material company information. o Enhanced criminal penalties for a broad array of white collar crimes and increases in the statute of limitations for securities fraud lawsuits. The effect of the Act upon corporations is uncertain; however, it is likely that compliance costs may increase as corporations modify procedures if required to conform to the provisions of the Act. The Company does not currently anticipate that compliance with the Act will have a material effect upon its financial position or results of its operations or its cash flows. 24 PART II - OTHER INFORMATION Item 1. Legal Proceedings. None. Item 2. Changes in Securities and Use of Proceeds. None. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. The following are the voting results of the registrant's annual meeting of the shareholders held on May 23, 2002: PROPOSAL NO. 1: Election of directors On the proposal to elect Directors of American River Holdings, Management's nominees, James O. Burpo, Sam J. Gallina, Roger J. Taylor, D.D.S. and Larry L. Wasem were elected as directors of AMERICAN RIVER HOLDINGS for the period corresponding to the class designated and until their successors are duly elected and qualified. PROPOSAL NO. 2: To ratify the selection of Perry-Smith LLP as independent public accountants for the Company. Voted for: 1,913,324 Voted against: 4,487 Abstained: 3,759 Item 5. Other Information. None Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits Exhibit Number Document Description ------ -------------------- (2.1) Agreement and Plan of Reorganization and Merger by and among the Registrant, ARH Interim National Bank and North Coast Bank, N.A., dated as of March 1, 2000 (included as Annex A to the joint proxy statement/prospectus). ** 25 (3.1) Articles of Incorporation, as amended, incorporated by reference from Exhibit 3.1 to the Company's Annual Report on Form 10-K for the period ended December 31, 2000 filed with the Commission on April 2, 2001. (3.2) Bylaws, as amended, incorporated by reference from Exhibit 3.2 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2001, filed with the Commission on May 14, 2001. (4.1) Specimen of the Registrant's common stock certificate. ** (10.1) Lease agreement between American River Bank and Spieker Properties, L.P., a California limited partnership, dated April 1, 2000, related to 1545 River Park Drive, Suite 107, Sacramento, California. ** (10.2) Lease agreement and addendum between American River Bank and Bradshaw Plaza Group each dated January 31, 2000, related to 9750 Business Park Drive, Sacramento, California. ** (10.3) Lease agreement between American River Bank and Marjorie G. Taylor dated April 5, 1984, and addendum dated July 16, 1997, related to 10123 Fair Oaks Boulevard, Fair Oaks, California. ** (10.4) Lease agreement between American River Bank and Sandalwood Land Company dated August 28, 1996, related to 2240 Douglas Boulevard, Suite 100, Roseville, California. ** (10.5) Lease agreement between American River Holdings and Union Bank of California dated June 29, 1999, related to 1540 River Park Drive, Suite 108, Sacramento, California. ** *(10.6) American River Holdings 1995 Stock Option Plan. ** *(10.7) Form of Nonqualified Stock Option Agreement under the 1995 Stock Option Plan. ** *(10.8) Form of Incentive Stock Option Agreement under the 1995 Stock Option Plan. ** *(10.9) American River Bank 401(k) Plan and amendment no. 1 dated April 1, 1998. ** *(10.10) American River Holdings Stock Option Gross-Up Plan and Agreement, as amended, dated May 20, 1998. ** *(10.11) American River Bank Deferred Compensation Plan dated May 1, 1998. ** *(10.12) American River Bank Deferred Fee Plan dated April 1, 1998. ** *(10.16) American River Bank Employee Severance Policy dated March 18, 1998. ** *(10.18) Employment agreement with David T. Taber dated August 16, 2000, incorporated by reference from Exhibit 10.18 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2000, filed with the Commission on November 14, 2000. *(10.19) Employment agreement with William L. Young dated August 16, 2000, incorporated by reference from Exhibit 10.19 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2000, filed with the Commission on November 14, 2000. 26 *(10.20) American River Holdings Incentive Compensation Plan for the Year Ended December 31, 2000, incorporated by reference from Exhibit 10.20 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2000, filed with the Commission on November 14, 2000. (10.21) Amendment No. 1 dated March 1, 2001, to the lease agreement between American River Holdings and Union Bank of California dated June 29, 1999, related to 1540 River Park Drive, Suite 108 and Suite 106, Sacramento, California, incorporated by reference from Exhibit 10.21 to the Company's Annual Report on Form 10-K for the period ended December 31, 2000, filed with the Commission on April 2, 2001. *(10.22) First Amendment dated December 20, 2000, to the American River Bank Deferred Compensation Plan dated May 1, 1998, incorporated by reference from Exhibit 10.22 to the Company's Annual Report on Form 10-K for the period ended December 31, 2000, filed with the Commission on April 2, 2001. *(10.22) First Amendment dated December 20, 2000, to the American River Bank Deferred Compensation Plan dated May 1, 1998, incorporated by reference from Exhibit 10.22 to the Company's Annual Report on Form 10-K for the period ended December 31, 2000, filed with the Commission on April 2, 2001. *(10.23) Amendment No.1 to the American River Holdings Incentive Compensation Plan, incorporated by reference from Exhibit 10.23 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2001, filed with the Commission on August 14, 2001. *(10.24) American River Holdings Employee Stock Purchase Plan dated November 21, 2001, incorporated by reference from Exhibit 10.24 to the Company's Annual Report on Form 10-K for the period ended December 31, 2001, filed with the Commission on March 26, 2002. (10.25) Amendment No. 2 dated March 20, 2002, to the lease agreement between American River Holdings and Union Bank of California dated June 29, 1999, related to 1540 River Park Drive, Suite 108 and Suite 106, Sacramento, California, incorporated by reference from Exhibit 10.25 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2002, filed with the Commission on May 3, 2002. (21.1) The Registrant's only subsidiaries are American River Bank, North Coast Bank, N.A. and First Source Capital. *Denotes management contracts, compensatory plans or arrangements. **Incorporated by reference to registrant's Registration Statement on Form S-4 (No. 333-36326) filed with the Commission on May 5, 2000. (b) Reports on Form 8-K On April 18, 2002, the Company filed a Report on Form 8-K announcing its financial results for the quarter ended March 31, 2002. On June 20, 2002, the Company filed a Report on Form 8-K announcing a semi-annual cash dividend. 27 SIGNATURES Pursuant to the requirements of the Securities and 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 HOLDINGS August 2, 2002 - -------------- By: /s/ DAVID T. TABER -------------------------------------------- David T. Taber President Chief Executive Officer By: /s/ MITCHELL A. DERENZO -------------------------------------------- Mitchell A. Derenzo Chief Financial Officer (Principal Financial and Accounting Officer) 28