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 March 31, 2004 ------------------ [ ] 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 by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: No par value Common Stock - 4,213,081 shares outstanding at May 10, 2004. Page 1 of 67 The Index to the Exhibits is located at Page 31 PART 1-FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS AMERICAN RIVER HOLDINGS CONSOLIDATED BALANCE SHEETS (Unaudited) (In thousands, except number of shares) March 31, December 31, 2004 2003 ----------- ------------ ASSETS Cash and due from banks $ 27,783 $ 29,797 Federal funds sold -- -- Interest-bearing deposits in banks 4,848 4,650 Investment securities: Available-for-sale, (amortized cost: 2004--$59,964; 2003--$61,256) 61,770 62,686 Held-to-maturity (market value: 2004--$28,211; 2003--$27,216) 27,940 27,160 Loans and leases, less allowance for loan and lease losses of $4,098 at March 31, 2004 and $3,949 at December 31, 2003 272,025 262,464 Premises and equipment, net 1,602 1,505 FHLB and FRB stock 1,440 1,546 Accounts receivable servicing receivables, net 1,714 1,778 Accrued interest receivable and other assets 5,775 5,807 ----------- ----------- $ 404,897 $ 397,393 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest bearing $ 102,047 $ 102,308 Interest bearing 230,230 220,199 ----------- ----------- Total deposits 332,277 322,507 Short-term borrowed funds 30,800 34,600 Long-term debt 1,929 1,942 Accrued interest payable and other liabilities 2,357 2,887 ----------- ----------- Total liabilities 367,363 361,936 ----------- ----------- Commitments and contingencies (Note 3) Shareholders' equity: Common stock - no par value; 20,000,000 shares authorized; issued and outstanding - 4,212,961 shares at March 31, 2004 and 4,055,260 at December 31, 2003 17,863 16,693 Retained earnings 18,571 17,900 Accumulated other comprehensive income (Note 5) 1,100 864 ----------- ----------- Total shareholders' equity 37,534 35,457 ----------- ----------- $ 404,897 $ 397,393 =========== =========== See Notes to Unaudited Consolidated Financial Statements 2 AMERICAN RIVER HOLDINGS CONSOLIDATED STATEMENT OF INCOME (Unaudited) (In thousands, except per share data) For the three month periods ended March 31, 2004 2003 ----------- ----------- Interest income: Interest and fees on loans $ 4,280 $ 3,981 Interest on Federal funds sold -- 1 Interest on deposits in banks 29 56 Interest and dividends on investment securities: Taxable 673 652 Exempt from Federal income taxes 123 116 Dividends 8 4 ----------- ----------- Total interest income 5,113 4,810 ----------- ----------- Interest expense: Interest on deposits 556 594 Interest on short-term borrowings 105 129 Interest on long-term debt 30 30 ----------- ----------- Total interest expense 691 753 ----------- ----------- Net interest income 4,422 4,057 Provision for loan and lease losses 198 189 ----------- ----------- Net interest income after provision for loan and lease losses 4,224 3,868 ----------- ----------- Noninterest income 429 526 ----------- ----------- Noninterest expense: Salaries and employee benefits 1,575 1,667 Occupancy 205 205 Furniture and equipment 180 156 Other expense 789 631 ----------- ----------- Total noninterest expense 2,749 2,659 ----------- ----------- Income before income taxes 1,904 1,735 Income taxes 744 686 ----------- ----------- Net income $ 1,160 $ 1,049 =========== =========== Basic earnings per share (Note 4) $.28 $.27 ==== ==== Diluted earnings per share (Note 4) $.27 $.25 ==== ==== See Notes to Unaudited Consolidated Financial Statements 3 AMERICAN RIVER HOLDINGS CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (In thousands, except number of shares) (Unaudited) Common Stock Accumulated ---------------------- Other Retained Comprehensive Shareholders' Comprehensive Shares Amount Earnings Income(Loss) Equity Income --------- -------- --------- ------------- ------------- ------------- Balance, January 1, 2003 3,938,883 16,064 14,358 1,304 31,726 Comprehensive income (Note 5): Net income 4,741 4,741 $ 4,741 Other comprehensive income, net of tax: Unrealized loss on available-for-sale investment securities (440) (440) (440) -------- Total comprehensive income $ 4,301 ======== Cash dividends ($0.30 per share) (1,192) (1,192) Fractional shares redeemed (225) (7) (7) Stock options exercised 135,704 653 653 Retirement of common stock (19,102) (24) (24) --------- -------- --------- -------- --------- Balance, December 31, 2003 4,055,260 16,693 17,900 864 35,457 Comprehensive income (Note 5): Net income 1,160 1,160 $ 1,160 Other comprehensive loss, net of tax: Unrealized gain on available-for-sale investment securities 236 236 236 -------- Total comprehensive income $ 1,396 ======== Cash dividends ($0.115 per share) (489) (489) Stock options exercised 184,237 1,288 1,288 Retirement of common stock (26,536) (118) (118) --------- -------- --------- -------- --------- Balance, March 31, 2004 4,212,961 $ 17,863 $ 18,571 $ 1,100 $ 37,534 ========= ======== ========= ======== ========= See Notes to Unaudited Consolidated Financial Statements 4 AMERICAN RIVER HOLDINGS CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited) (In thousands) For the three months ended March 31, 2004 2003 ----------- ----------- Cash flows from operating activities: Net income $ 1,160 $ 1,049 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan and lease losses 198 189 (Decrease) increase in deferred loan origination fees, net (34) 25 Depreciation and amortization 129 117 Net amortization of investment security premiums 300 196 Provision for accounts receivable servicing asset losses -- 1 Gain on sale of securities -- -- Gain on sale of equipment -- -- Decrease in accrued interest receivable and other assets (108) (535) Decrease in accrued interest payable and other liabilities (406) (61) ----------- ----------- Net cash provided by operating activities 1,239 981 ----------- ----------- Cash flows from investing activities: Proceeds from the sale of available-for-sale investment securities -- -- Proceeds from called available-for-sale investment securities -- -- Proceeds from matured available-for-sale investment securities 1,000 2,000 Purchases of held-to-maturity investment securities (2,080) (3,088) Purchases of available-for-sale investment securities (305) (368) Proceeds from principal repayments for available- for-sale mortgage-related securities 470 2,071 Proceeds from principal repayments for held-to- maturity mortgage-related securities 1,127 1,559 Net (increase) decrease in interest-bearing deposits in banks (198) 595 Net increase in loans (9,723) (21,315) Net decrease in accounts receivable servicing receivables 64 49 Proceeds from the sale of equipment -- -- Purchases of equipment (228) (35) Net decrease (increase) in FHLB and FRB stock 106 (19) ----------- ----------- Net cash used in investing activities (9,767) (18,551) ----------- ----------- 5 AMERICAN RIVER HOLDINGS CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited) (Continued) (In thousands) For the three months ended March 31, 2004 2003 ----------- ----------- Cash flows from financing activities: Net increase in demand, interest-bearing and savings deposits $ 9,824 $ 6,976 Net decrease in time deposits (54) (101) Repayment of long-term debt (13) (12) Net (decrease) increase in short-term borrowings (3,800) 7,550 Payment of cash dividends (613) (551) Cash paid to repurchase common stock (118) -- Exercise of stock options 1,288 219 ----------- ----------- Net cash provided by financing activities 6,514 14,081 ----------- ----------- Decrease in cash and cash equivalents (2,014) (3,489) Cash and cash equivalents at beginning of year 29,797 25,899 ----------- ----------- Cash and cash equivalents at end of period $ 27,783 $ 22,410 =========== =========== See Notes to Unaudited Consolidated Financial Statements 6 AMERICAN RIVER HOLDINGS NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS March 31, 2004 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 Holdings (the "Company") at March 31, 2004 and December 31, 2003, and the results of its operations and its cash flows for the three-month periods ended March 31, 2004 and 2003. 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 2003 Annual Report to Shareholders. The results of operations for the three-month period ended March 31, 2004 may not necessarily be indicative of the operating results for the full year. In preparing such financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant changes in the near term relate to the determination of the allowance for loan and lease losses, the provision for taxes and the estimated fair value of investment securities. 2. STOCK-BASED COMPENSATION At March 31, 2004, the Company had two stock-based compensation plans. The Company accounts for these plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Under APB Opinion No. 25, stock-based compensation cost is only reflected in net income when options granted under these plans have an exercise price less than the market value of the underlying common stock on the date of grant. Pro forma adjustments to the Company's consolidated net earnings and earnings per share are disclosed during the years in which the options become vested. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based compensation. Three Months Ended March 31, -------------------------------- 2004 2003 ----------- ----------- (Dollars in thousands, except per share data) Net income, as reported $ 1,160 $ 1,049 Add: Stock-based compensation expense included in reported net income, net of tax effect -- 20 Deduct: Total stock-based compensation expense determined under the fair value based method for all awards, net of related tax effects (13) (31) ----------- ----------- Pro forma net income $ 1,147 $ 1,038 =========== =========== Basic earnings per share - as reported $0.28 $0.27 Basic earnings per share - pro forma $0.28 $0.26 Diluted earnings per share - as reported $0.27 $0.25 Diluted earnings per share - pro forma $0.26 $0.24 7 There were no options granted during the three-month period ended March 31, 2004. The fair value of each option granted during the three-month period ended March 31, 2003 is estimated on the date of grant using an option-pricing model with the following weighted-average assumptions: Dividend yield 1.88% Expected life 7 years Expected volatility 56.41% Risk-free rate 3.52% Weighted average fair value of options granted during the period $3.50 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 $67,184,000 and letters of credit of $741,000 at March 31, 2004. However, all such commitments will not necessarily culminate in actual extensions of credit by the Company during 2004. Approximately $14,859,000 of the loan commitments outstanding at March 31, 2004 are for real estate construction loans and are expected to fund within the next twelve months. The remaining commitments primarily relate to revolving lines of credit or other commercial loans, and many of these are expected to expire without being fully drawn upon. 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. 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. 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 (4,140,743 shares for the three-month period ended March 31, 2004, and 3,953,025 shares for the three-month period ended March 31, 2003). 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 (235,856 shares for the three-month period ended March 31, 2004 and 325,727 for the three-month period ended March 31, 2003). Earnings per share is retroactively adjusted for stock splits and stock dividends for all periods presented. 5. 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 $236,000 for the three-month period ended March 31, 2004 and $(105,000) for the three-month period ended March 31, 2003. Comprehensive income was $1,396,000 for the three-month period ended March 31, 2004 and $944,000 for the three-month period ended March 31, 2003. 8 6. SHORT-TERM BORROWING ARRANGEMENTS The Company has a total of $38,000,000 in unsecured short-term borrowing arrangements with four of its correspondent banks. An advance totaling $5,300,000 was outstanding from one of its correspondent banks at March 31, 2004, bearing an interest rate of 1.50% and maturing on April 1, 2004. An advance totaling $9,600,000 was outstanding from one of its correspondent banks at December 31, 2003, bearing an interest rate of 1.44% and maturing on January 1, 2004. In addition, the Company has a line of credit available with the Federal Home Loan Bank (the "FHLB") which is secured by pledged mortgage loans and investment securities. Borrowings may include overnight advances as well as loans with terms of up to thirty years. Advances totaling $25,500,000 were outstanding from the FHLB at March 31, 2004, bearing interest rates ranging from 1.17% to 1.45% and maturing between April 4, 2004 and January 28, 2005. Advances totaling $25,000,000 were outstanding from the FHLB at December 31, 2003, bearing interest rates ranging from 1.03% to 1.45% and maturing between January 2, 2004 and November 1, 2004. 9 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 at March 31, 2004 and December 31, 2003 and its results of operations for the three-month periods ended March 31, 2004 and 2003. 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 lease losses, expenses, changes in the interest rate environment including interest rates charged on loans, earned on securities investments and 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, data processing problems, a decline in real estate values in the Company's market area, the effects of terrorism, the threat of terrorism or the impact of the current military conflict in Iraq and the conduct of the war on terrorism by the United States and its allies, as well as other factors. This entire report should be read to put such forward-looking statements in context. To gain a more complete understanding of the uncertainties and risks involved in the Company's business, this report should be read in conjunction with the Company's annual report on Form 10-K for the year ended December 31, 2003 and its 2004 reports filed on Form 8-K. Interest income and net interest income are presented on a fully taxable equivalent basis (FTE) within management's discussion and analysis. Critical Accounting Policies General The Company's financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. We use historical loss data, peer group experience 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 historical factors that we use. Other estimates that we use are related to the expected useful lives of our depreciable assets. In addition GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change. Allowance for Loan Losses The allowance for loan and lease losses is an estimate of the credit loss risk in our loan and lease portfolio. The allowance is based on two basic principles of accounting. (1) Statement of Financial Accountings Standards ("SFAS") No. 5 "Accounting for Contingencies," which requires that losses be accrued when they are probable of occurring and estimable and (2) SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. 10 The allowance for loan and lease losses is determined based upon estimates that can and do change when the actual risk or loss events occur. The analysis of the allowance uses an historical loss view as an indicator of future losses and as a result could differ from the loss incurred in the future. However, since our analysis of risk and loss potential is updated regularly, the errors that might otherwise occur are mitigated. The use of factors and ranges is inherently subjective and our actual losses could be greater or less than the estimates. The Company's goal is to maintain an allowance for loan and lease losses that is between the lower and upper ranges as described above. If the allowance for loan and lease losses falls below the lower range of adequate reserves (by reason of loan and lease growth, actual losses, the effect of changes in risk ratings, or some combination of these factors), the Company has a strategy for supplementing the allowance for loan and lease losses, over the short term, so that it would again fall within the lower and upper acceptable ranges. For further information regarding our allowance for loan and lease losses, see "Allowance for Loan and Lease Losses Activity" discussion later in this Item. Stock Based Awards The Company accounts for its stock based awards using the intrinsic value method in accordance with Accounting Principles Board ("APB") Opinion No. 25 and related interpretations. Since the Company's stock option plan provides for the issuance of options at a price of no less than the fair market value at the date of the grant, no compensation expense is recognized in the financial statements unless the options are modified after the grant date. 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 and American River Financial. American River Bank was incorporated and commenced business in Fair Oaks, California, in 1983. American River Bank operates five full service offices in Sacramento and Placer Counties, and three full service offices in Sonoma County through North Coast Bank, a division of American River Bank. 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. American River Bank also conducts lease financing for most types of business equipment, from computer software to heavy earth-moving equipment, through First Source Capital, a division of American River Bank. The Company also owns 100% of an inactive subsidiary, American River Financial. American River Financial was incorporated on August 26, 2003 and has been inactive since its formation. Overview The Company recorded net income of $1,160,000 for the quarter ended March 31, 2004, which was $111,000 above the $1,049,000 reported for the same period of 2003. Diluted earnings per share for the first quarter of 2004 were $0.27 versus $0.25 for the first quarter of 2003. The return on average equity (ROAE) and the return on average assets (ROAA) for the first quarter of 2004 were 12.96% and 1.17%, respectively, as compared to 13.29% and 1.24%, respectively, for the same period in 2003. Total assets of the Company increased by $7,504,000 (1.9%) from December 31, 2003 to $404,897,000 at March 31, 2004. Net loans totaled $272,025,000, up $9,561,000 (3.6%) from the ending balances on December 31, 2003. Deposit balances at March 31, 2004 totaled $332,277,000, up $9,770,000 (3.0%) from December 31, 2003. 11 The Company ended the first quarter of 2004 with a Tier 1 capital ratio of 11.9% and a total risk-based capital ratio of 13.2% versus 11.6% and 12.9%, respectively, at December 31, 2003. 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 months ended March 31 ------------------------------ (In thousands, except percentages) 2004 2003 ---------- ---------- Net interest income* $ 4,467 $ 4,097 Provision for loan losses (198) (189) Noninterest income 429 526 Noninterest expense (2,749) (2,659) Provision for income taxes (744) (686) Tax equivalent adjustment (45) (40) ---------- ---------- Net income $ 1,160 $ 1,049 ========== ========== - ------------------------------------------------------------------------------- Average total assets $ 397,332 $ 343,429 Net income (annualized) as a percentage of average total assets 1.17% 1.24% - ------------------------------------------------------------------------------- * Fully taxable equivalent basis (FTE) 12 Results of Operations Net Interest Income and Net Interest Margin Net interest income represents the excess of interest and fees earned on interest earning assets (loans and leases, securities, Federal funds sold and investments in time deposits) over the interest paid on deposits and borrowed funds. Net interest margin is net interest income expressed as a percentage of average earning assets. The Company's net interest margin was 4.94% for the three months ended March 31, 2004 and 5.25% for the three months ended March 31, 2003. The fully taxable equivalent interest income component increased from $4,850,000 for the three months ended March 31, 2003 to $5,158,000 for the three months ended March 31, 2004, representing a 6.4% increase. The increase in the fully taxable equivalent interest income for the first three months of 2004 compared to the same period in 2003 is broken down by rate (down $411,000) and volume (up $719,000). The rate decrease can be attributed to decreases implemented by the Company during 2001 and 2002 in response to Federal Reserve Board (the "FRB") decreases in the Federal funds and Discount rates. Although there was only one FRB rate decrease in 2003 and none so far in 2004, the effects of thirteen such rate decreases by the FRB since January 1, 2001, resulted in a 52 basis point drop in the yield on average earning assets from 6.22% for the first quarter of 2003 to 5.70% during the first quarter of 2004. The volume increase was the result of a 15.1% increase in average earning assets. Average loan balances were up $33,003,000 (14.0%) in 2004 over the balances in 2003, while average investment securities balances were up $15,836,000 (21.2%). The increase in average loans is the result of a concentrated focus on business lending, the demand for commercial real estate and the effects of a favorable local market. The increase in investment securities is primarily due to the Company investing its excess funds in investment securities. The excess funds were created by an increase in deposit balances. Interest expense decreased $62,000 (8.2%) during the first quarter of 2004 compared to the first quarter of 2003. The average balances of interest bearing liabilities were $27,805,000 (12.2%) higher in 2004 versus 2003. The higher balances accounted for a $47,000 increase in interest expense, however, the overall decrease in interest expense for the three-month period can be related to a drop in rates (down $109,000). The decrease in rates paid on interest bearing liabilities was a result of the lower interest rate environment over the past three years. Rates paid on interest bearing liabilities decreased 25 basis points on a quarter-over-quarter basis from 1.34% to 1.09%. 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. 13 Table Two: Analysis of Net Interest Margin on Earning Assets - ------------------------------------------------------------------------------------------------------------------------------------ Three Months Ended March 31, 2004 2003 ---------------------------------------- ---------------------------------------- (Taxable Equivalent Basis) Avg Avg Avg Avg (In thousands, except percentages) Balance Interest Yield (4) Balance Interest Yield (4) --------- -------- --------- --------- -------- --------- Assets: Earning assets: Loans and leases (1) $ 268,732 $ 4,280 6.41% $ 235,729 $ 3,981 6.85% Taxable investment securities 78,349 673 3.45% 64,277 652 4.11% Tax-exempt investment securities (2) 11,323 165 5.86% 10,060 155 6.25% Corporate stock 795 11 5.57% 294 5 6.90% Federal funds sold - - 0.00% 342 1 1.19% Investments in time deposits 4,779 29 2.44% 5,607 56 4.05% --------- ------- --------- ------- Total earning assets 363,978 5,158 5.70% 316,309 4,850 6.22% ------- ------- Cash & due from banks 27,348 23,546 Other assets 10,073 6,863 Allowance for loan & lease losses (4,067) (3,289) --------- --------- $ 397,332 $ 343,429 ========= ========= Liabilities & Shareholders' Equity Interest bearing liabilities: NOW & MMDA $ 132,961 232 0.70% $ 108,497 181 0.68% Savings 18,345 9 0.20% 16,227 8 0.20% Time deposits 70,365 315 1.80% 71,193 404 2.30% Other borrowings 34,012 135 1.60% 34,012 160 2.03% --------- ------- --------- ------- Total interest bearing liabilities 255,683 691 1.09% 227,878 753 1.34% ------- ------- Demand deposits 101,561 80,874 Other liabilities 4,076 2,657 --------- --------- Total liabilities 361,320 311,409 Shareholders' equity 36,012 32,020 --------- --------- $ 397,332 $ 343,429 ========= ========= Net interest income & margin (3) $ 4,467 4.94% $ 4,097 5.25% ======= ===== ======= ===== (1) Loan and lease interest includes loan fees of $167,000 and $121,000 during the three months ended March 31, 2004 and March 31, 2003, 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 for 2004 and 90 for 2003) and annualized to actual days in year (366 for 2004 and 365 for 2003). 14 Table Three: Analysis of Volume and Rate Changes on Net Interest Income and Expenses - -------------------------------------------------------------------------------------------- (In thousands) Three Months Ended March 31, 2004 over 2003 Increase (decrease) due to change in: Interest-earning assets: Volume Rate (4) Net Change ----------- ----------- ----------- Net loans and leases (1)(2) $ 557 $ (258) $ 299 Taxable investment securities 143 (122) 21 Tax exempt investment securities (3) 19 (9) 10 Corporate stock 9 (3) 6 Federal funds sold (1) -- (1) Investment in time deposits (8) (19) (27) ----------- ----------- ----------- Total 719 (411) 308 ----------- ----------- ----------- Interest-bearing liabilities: Demand deposits 41 10 51 Savings deposits 1 -- 1 Time deposits (5) (84) (89) Other borrowings 10 (35) (25) ----------- ----------- ----------- Total 47 (109) (62) ----------- ----------- ----------- Interest differential $ 672 $ (302) $ 370 =========== =========== =========== - -------------------------------------------------------------------------------- (1) The average balance of non-accruing loans and leases is immaterial as a percentage of total loans and leases and, as such, has been included in net loans. (2) Loan fees of $167,000 and $121,000 during the three months ending March 31, 2004 and March 31, 2003, 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. Provision for Loan and Lease Losses The Company provided $198,000 for loan and lease losses for the first quarter of 2004 as compared to $189,000 for the first quarter of 2003. Net loan and lease charge-offs for the three months ended March 31, 2004 were $49,000 or ..07% (on an annualized basis) of average loans and leases as compared to charge-offs (recoveries) of ($45,000) or (.08%) (on an annualized basis) for the three months ended March 31, 2003. A negative number and percentage occur in 2003 as recoveries exceeded charge-offs during the period. Noninterest Income Table Four below provides a summary of the components of noninterest income for the periods indicated (dollars in thousands): Table Four: Components of Noninterest Income - ------------------------------------------------------------------------------- Three Months Ended March 31, ----------------------- 2004 2003 - ------------------------------------------------------------------------------- Service charges on deposit accounts $ 141 $ 135 Accounts receivable servicing fees 66 49 Fees from lease brokerage services - 93 Merchant fee income 84 80 Income from residential lending 37 86 Financial services income 16 21 Other 85 62 - ------------------------------------------------------------------------------- Total noninterest income $ 429 $ 526 - ------------------------------------------------------------------------------- 15 Noninterest income was down $97,000 (18.4%) to $429,000 for the three months ended March 31, 2004 as compared to $526,000 for the three months ended March 31, 2003. The decrease in noninterest income for the quarter can be attributed to decreases in fees from lease brokerage services (down $93,000 or 100.0%) and a decrease in residential lending fee income (down $49,000 or 57.0%). The decrease in lease brokerage services results from a decision by the Company, which became effective on January 7, 2004, to discontinue the Company's leasing subsidiary operations as a subsidiary of the Company and commence similar leasing operations at American River Bank through a division identified as "First Source Capital, a division of American River Bank" ("First Source Capital"). The majority of the leases originated by First Source Capital are now recorded on the books of the Company as opposed to receiving fee income for brokering to outside funding sources. The residential lending division experienced a decrease in loan volume as a result of a slight increase in mortgage rates, which caused the number of refinances to decrease. Noninterest Expense Noninterest expense increased $90,000 (3.4%) to a total of $2,749,000 in the first quarter of 2004 versus the $2,659,000 recorded in the first quarter of 2003. Salary and employee benefits decreased $92,000 (5.5%). Base salaries, which include commissions, decreased $118,000 mainly as a result of expenses related to employee departures in the first quarter of 2003 and lower commissions paid out in 2004 in the Residential Lending Division of American River Bank. The remaining difference relates to higher employer taxes and an increase in benefits, mainly due to higher health related and workers compensation insurance premiums. At March 31, 2004, the Company and its subsidiaries employed 105 persons on a full-time equivalent basis as compared to 97 at March 31, 2003. The majority of the increase can be attributed to staff at the Company's newest full service branch located in downtown Sacramento. On a quarter-over-quarter basis, occupancy expenses were identical and furniture and equipment expenses were higher by $24,000 (15.4%). The increase in furniture and equipment relates to purchases made for the new branch in downtown Sacramento, which opened during the first quarter on 2004, and depreciation of technology related equipment purchased by the Company over the past twelve months. Other expenses for the first quarter of 2004 were $789,000, an increase of $158,000 (25.0%) over the prior year quarter. Included in other expenses are professional fees (up $26,000 or 37.7%), stationery and supplies (up $24,000 or 57.1%) and directors expenses (up $42,000 or 56.0%). Professional fees, which includes accounting, legal and other professional services, was up primarily due to higher legal fees for compliance with SEC and NASD rules as well as general corporate matters. The increase in stationery and supplies is due mainly to the new location in downtown Sacramento. The increase in director fees relates to higher amounts accrued under the Gross-Up Plan (the "Plan"). The Plan compensates for the tax effects of the exercise of nonstatutory stock options. The Plan named certain non-employee Directors as participants and applies only to those options granted on August 25, 1995. The Plan encourages participating optionees to retain shares acquired through the exercise of nonstatutory stock options by the Company paying to the participating optionee an amount equal to the taxable income resulting from an exercise of a nonstatutory stock option multiplied by the Company's effective tax rate, subject to the optionee's agreement to hold the shares acquired for a minimum of one (1) year. The efficiency ratios (fully taxable equivalent) for the 2004 and 2003 first quarters were 56.2% and 57.5%, respectively. Provision for Income Taxes The effective tax rate for the first quarter of 2004 was 39.1% versus 39.5% for the first quarter of 2003. Balance Sheet Analysis The Company's total assets were $404,897,000 at March 31, 2004 as compared to $397,393,000 at December 31, 2003, representing an increase of 1.9%. The average balance of total assets for the three months ended March 31, 2004 was $397,332,000, which represents an increase of $53,903,000 or 15.7% over the average balance of $343,429,000 for the three-month period ended March 31, 2003. 16 Loans and Leases The Company concentrates its lending activities in the following principal areas: 1) commercial; 2) commercial real estate; 3) multi-family real estate; 4) real estate construction (both commercial and residential); 5) residential real estate; 6) lease financing receivable; 7) agriculture; and 8) consumer loans. At March 31, 2004, these categories accounted for approximately 21%, 50%, 1%, 18%, 1%, 4%, 3% and 2%, respectively, of the Company's loan portfolio. This mix was relatively unchanged compared to 22%, 53%, 2%, 14%, 1%, 3%, 3% and 2% at December 31, 2003. Continuing economic activity in the Company's market area, new borrowers developed through the Company's marketing efforts and credit extensions expanded to existing borrowers, offset by normal loan paydowns and payoffs, resulted in net increases in balances for real estate construction ($11,988,000 or 32.0%), residential real estate ($806,000 or 53.5%), lease financing receivable ($1,536,000 or 16.6%), agriculture ($545,000 or 6.8%) and consumer ($259,000 or 4.4%). Despite the new borrowers the Company experienced a slight decrease in commercial ($97,000 or 0.2%), commercial real estate ($3,060,000 or 2.2%) and multi-family real estate ($2,301,000 or 43.4%) as a result of normal paydowns. Table Five below summarizes the composition of the loan portfolio as of March 31, 2004 and December 31, 2003. Table Five: Loan and Lease Portfolio Composition - ------------------------------------------------------------------------------- March 31, December 31, (In thousands) 2004 2003 - ------------------------------------------------------------------------------- Commercial $ 57,249 $ 57,346 Real estate: Commercial 139,189 142,249 Multi-family 3,000 5,301 Construction 49,422 37,434 Residential 2,314 1,508 Lease financing receivable 10,812 9,276 Agriculture 8,572 8,027 Consumer 6,209 5,950 - ------------------------------------------------------------------------------- Total loans and leases 276,767 267,091 Deferred loan and lease fees, net (644) (678) Allowance for loan and lease losses (4,098) (3,949) - ------------------------------------------------------------------------------- Total net loans and leases $ 272,025 $ 262,464 =============================================================================== A significant portion of the Company's loans and leases are direct loans and leases made to individuals and local businesses. The Company relies substantially on local promotional activity and personal contacts by bank officers, directors and employees to compete with other financial institutions. The Company makes loans and leases to borrowers whose applications include a sound purpose and a viable primary repayment source, generally supported by a secondary source of repayment. Commercial loans consist of credit lines for operating needs, loans for equipment purchases, working capital, and various other business loan products. Consumer loans include a range of traditional consumer loan products such as personal lines of credit and loans to finance purchases of autos, boats, recreational vehicles, mobile homes and various other consumer items. Construction loans are generally comprised of commitments to customers within the Company's service area for construction of commercial properties, multi-family properties and custom and production-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 75%. Agriculture loans consist primarily of vineyard loans and development loans to plant vineyards. In general, except in the case of loans under SBA programs or Farm Services Agency guarantees, the Company does not make long-term mortgage loans; however, American River Bank has a residential lending division to assist customers in securing most forms of longer term single-family mortgage financing. American River Bank acts as a broker between American River Bank's customers and the loan wholesalers. American River Bank receives an origination fee for loans closed. 17 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, and in Sonoma County through North Coast Bank, a division of American River Bank. The Company's business in Sonoma County is focused mainly on commercial and real estate enterprises within the three communities in which it has offices (Santa Rosa, Windsor, and Healdsburg). The economy of Sonoma County is diversified with 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 rate and terms, absorption and sale rates; real estate values and rates of return; operating expenses; inflation; and sufficiency of repayment sources independent of the real estate including, in some instances, personal guarantees. In extending credit and commitments to borrowers, the Company generally requires collateral and/or guarantees as security. The repayment of such loans is expected to come from cash flow or from proceeds from the sale of selected assets of the borrowers. The Company's requirement for collateral and/or guarantees is determined on a case-by-case basis in connection with management's evaluation of the creditworthiness of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, income-producing properties, residences and other real property. The Company secures its collateral by perfecting its security interest in business assets, obtaining deeds of trust, or outright possession among other means. In management's judgment, a concentration exists in real estate loans which represented approximately 70.1% of the Company's loan and lease portfolio at March 31, 2004. Although management believes this 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 within that area, (2) maintaining a thorough understanding of borrowers' knowledge, capacity, and market position in their field of expertise, (3) basing real estate loan approvals not only on market demand for the project, but also on the borrowers' capacity to support the project financially in the event it does not perform to expectations (whether sale or income performance), and (4) maintaining conforming and prudent loan to value and loan to cost ratios based on independent outside appraisals and ongoing inspection and analysis by the Company's lending officers. Nonaccrual, Past Due and Restructured Loans and Leases Management generally places loans and leases on nonaccrual status when they become 90 days past due, unless the loan is well secured and in the process of collection. Loans are charged off when, in the opinion of management, collection appears unlikely. 18 At March 31, 2004, non-performing loans and leases were 0.10% of total loans and leases. The recorded investments in loans that were considered to be impaired totaled $286,000 at March 31, 2004 and $181,000 at December 31, 2003. There were no loan concentrations in excess of 10% of total loans not otherwise disclosed as a category of loans as of March 31, 2004 or December 31, 2003. Management is not aware of any potential problem loans, which were accruing and current at March 31, 2004, where serious doubt exists as to the ability of the borrower to comply with the present repayment terms or that would result in a material loss to the Company. Table Six below sets forth nonaccrual loans and loans past due 90 days or more as of March 31, 2004 and December 31, 2003. Table Six: Non-Performing Loans - -------------------------------------------------------------------------------- March 31, December 31, (In thousands) 2004 2003 - -------------------------------------------------------------------------------- Past Due 90 days or more and still accruing: Commercial $ 2 $ 2 Real estate -- -- Lease financing receivable 182 -- Consumer and other -- -- - -------------------------------------------------------------------------------- Nonaccrual: Commercial -- -- Real estate -- -- Lease financing receivable 102 179 Consumer and other -- -- - -------------------------------------------------------------------------------- Total non-performing loans $ 286 $ 181 ================================================================================ Allowance for Loan and Lease Losses Activity The Company maintains an allowance for loan and lease losses ("ALLL") to cover probable losses inherent in the loan and lease portfolio, which is based upon management's estimated range of those losses. The ALLL is established through a provision for loan and lease losses and is increased by provisions charged against current earnings and recoveries and reduced by charge-offs. Actual losses for loans and leases can vary significantly from this estimate. The methodology and assumptions used to calculate the allowance are continually reviewed as to their appropriateness given the most recent losses realized and other factors that influence the estimation process. The model assumptions and resulting allowance level are adjusted accordingly as these factors change. The ALLL totaled $4,098,000 or 1.48% of total loans and leases at March 31, 2004 and $3,949,000 or 1.48% at December 31, 2003. Net charge-offs to average loans and leases were 0.07% (on an annualized basis) for the first quarter of 2004. Net charge-offs (recoveries) to average loans and leases were (0.08%) (on an annualized basis) for the first quarter of 2003. The adequacy of the ALLL and the level of the related provision for loan and lease losses is determined based on management's judgment after consideration of numerous factors including but not limited to: (i) local and regional economic conditions, (ii) borrowers' financial condition, (iii) loan impairment and the related level of expected charge-offs, (iv) evaluation of industry trends, (v) industry and other concentrations, (vi) loans 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 desired level considering objective and subjective measures, such as knowledge of the borrowers' business, valuation of collateral, the determination of impaired loans or leases and exposure to potential losses. The Company establishes general reserves in accordance with Statement of Accounting Standards ("SFAS") No. 5., Accounting for Contingencies, and specific reserves in accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan. The ALLL is maintained by categories of the loan 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 19 to the allowance may be necessary, based on changes in economic conditions and other matters. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's ALLL. Such agencies may require the Company to provide additions to the allowance based on their judgment of information available to them at the time of their examination. The adequacy of the ALLL is determined based on three components. First is the dollar weighted risk rating of the loan portfolio, including all outstanding loans and leases. Every extension of credit has been assigned a risk rating based upon a comprehensive definition intended to measure the inherent risk of lending money. Each rating has an assigned risk factor expressed as a reserve percentage. Second, established specific reserves consistent with SFAS No. 114 "Accounting by Creditors for Impairment of a Loan" are assigned to individually impaired loans. These are estimated potential losses associated with specific borrowers based upon estimated cash flows or collateral value and events affecting the risk rating. Third, the Company maintains a reserve for qualitative factors that may affect the portfolio as a whole, such as those factors described above, including a reserve for model imprecision consistent with SFAS No. 5 "Accounting for Contingencies". 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 - --------------------------------------------------------------------------------------------------- (In thousands, except for percentages) Three Months Ended March 31, --------------------------------- 2004 2003 - --------------------------------------------------------------------------------------------------- Average loans and leases outstanding $ 268,732 $ 235,729 - --------------------------------------------------------------------------------------------------- Allowance for possible loan and lease losses at beginning of period $ 3,949 $ 3,197 Loans and leases charged off: Commercial -- -- Real estate -- -- Consumer -- (2) Lease financing receivable (103) -- - --------------------------------------------------------------------------------------------------- Total (103) (2) - --------------------------------------------------------------------------------------------------- Recoveries of loans and leases previously charged off: Commercial 54 -- Real estate -- 47 Consumer -- -- Lease financing receivable -- -- - --------------------------------------------------------------------------------------------------- Total 54 47 - --------------------------------------------------------------------------------------------------- Net loans and leases recovered (charged off) (49) 45 Additions to allowance charged to operating expenses 198 189 - --------------------------------------------------------------------------------------------------- Allowance for possible loan and lease losses at end of period $ 4,098 $ 3,431 - --------------------------------------------------------------------------------------------------- Ratio of net (recoveries) charge-offs to average loans and leases outstanding (annualized) .07% (.08%) Provision for possible loan and lease losses to average loans and leases outstanding (annualized) .30% .33% Allowance for possible loan and lease losses to loans and leases, net of deferred fees, at end of period 1.48% 1.35% 20 Other Real Estate At March 31, 2004 and December 31, 2003, the Company did not have any other real estate ("ORE") properties. Deposits At March 31, 2004, total deposits were $332,277,000 representing an increase of $9,770,000 (3.0%) from the December 31, 2003 balance of $322,507,000. Noninterest-bearing deposits decreased $261,000 (0.3%) while interest-bearing deposits increased $10,031,000 (4.6%). Interest checking, money market and savings accounts increased $10,085,000 (6.8%) while time deposits decreased $54,000 (0.1%). Other Borrowed Funds Other borrowings outstanding as of March 31, 2003 consist of advances (both long-term and short-term) from the FHLB and overnight borrowings from correspondent banks. The following table summarizes these borrowings (in thousands): March 31, 2004 December 31, 2003 ---------------------- ----------------------- Amount Rate Amount Rate --------- ---- --------- ---- Short-Term borrowings: FHLB advances $ 25,500 1.25% $ 25,000 1.40% Advances from correspondent banks 5,300 1.50% 9,600 1.44% --------- ---- --------- ---- Total Short-Term borrowings $ 30,800 1.29% $ 34,600 1.41% --------- ---- --------- ---- Long-Term Borrowings: FHLB advances $ 1,929 6.13% $ 1,942 6.13% --------- ---- --------- ---- The maximum amount of short-term borrowings at any month-end during 2004 and 2003 was $38,800,000 and $38,100,000, respectively. The advances from correspondent banks at March 31, 2004, bear an average interest rate of 1.50% and mature on April 1, 2004. 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 $ 25,500 $ 1,929 Maturity 2004 to 2005 2007 Average rates 1.25% 6.13% The Company has also been issued a total of $667,000 in letters of credit by the FHLB which have been pledged to secure Local Agency Deposits. The letters of credit act as a guarantee of payment to certain third parties in accordance with specified terms and conditions. The letters of credit were not drawn upon in 2004 or 2003 and management does not expect to draw upon these lines in the future. Capital Resources The current and projected capital position of the Company and the impact of capital plans and long-term strategies is reviewed regularly by management. The Company's capital position represents the level of capital available to support continuing operations and expansion. The Company and American River Bank are subject to certain regulations issued by the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, which require maintenance of certain levels of 21 capital. At March 31, 2004, shareholders' equity was $37,534,000, representing an increase of $2,077,000 (5.9%) from $35,457,000 at December 31, 2003. The ratio of total risk-based capital to risk adjusted assets was 13.2% at March 31, 2004 compared to 12.9% at December 31, 2003. Tier 1 risk-based capital to risk-adjusted assets was 11.9% at March 31, 2004 and 11.6% at December 31, 2003. Table Eight below lists the Company's actual capital ratios at March 31, 2004 and December 31, 2003 as well as the minimum capital ratios for capital adequacy. Table Eight: Capital Ratios - ----------------------------------------------------------------------------------------------------------------------- Capital to Risk-Adjusted Assets At March 31, At December 31, Minimum Regulatory Capital 2004 2003 Requirements - ----------------------------------------------------------------------------------------------------------------------- Leverage ratio 9.2% 9.0% 4.00% Tier 1 Risk-Based Capital 11.9% 11.6% 4.00% Total Risk-Based Capital 13.2% 12.9% 8.00% On September 20, 2001, the Company announced a plan to repurchase, as conditions warrant, up to 5% annually of the Company's common stock. During the first quarter of 2004, Company repurchased 6,100 shares; during 2003, the Company repurchased 1,500 shares; during 2002, the Company repurchased 65,627 shares and in 2001, the Company repurchased 33,705 shares under the repurchase plan. (See Part II, Item 2, for additional disclosure). Capital ratios are reviewed on a regular basis to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet future needs. Management believes that both the Company and American River Bank met all their capital adequacy requirements as of March 31, 2004 and December 31, 2003. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market Risk Management Overview. Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises primarily from interest rate risk inherent in its loan, investment and deposit functions. The goal for managing the assets and liabilities of the Company is to maximize shareholder value and earnings while maintaining a high quality balance sheet without exposing the Company to undue interest rate risk. The Board of Directors has overall responsibility for the interest rate risk management policies. The Company has a Risk Management Committee, made up of Company management that establishes and monitors guidelines to control the sensitivity of earnings to changes in interest rates. Asset/Liability Management. Activities involved in asset/liability management include but are not limited to lending, accepting and placing deposits and investing in securities. Interest rate risk is the primary market risk associated with asset/liability management. Sensitivity of earnings to interest rate changes arises when yields on assets change in a different time period or in a different amount from that of interest costs on liabilities. To mitigate interest rate risk, the structure of the balance sheet is managed with the goal that movements of interest rates on assets and liabilities are correlated and contribute to earnings even in periods of volatile interest rates. The asset/liability management policy sets limits on the acceptable amount of variance in net interest margin and market value of equity under changing interest environments. The Company uses simulation models to forecast earnings, net interest margin and market value of equity. Simulation of earnings is the primary tool used to measure the sensitivity of earnings to interest rate changes. Using computer-modeling techniques, the Company is able to estimate the potential impact of changing interest rates on earnings. A balance sheet forecast is prepared quarterly using inputs of actual loans, securities and interest bearing liabilities (i.e. deposits/borrowings) positions as the beginning base. The forecast balance sheet is processed against three interest rate scenarios. The scenarios include a 200 basis point rising rate forecast, a flat rate forecast and a 200 basis point 22 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 March 31, 2004 and December 31, 2003 - ----------------------------------------------------------------------------------------------------------------- (In thousands) $ Change in NII $ Change in NII from Current from Current 12 Month Horizon 12 Month Horizon March 31, 2004 December 31, 2003 ---------------- ----------------- Variation from a constant rate scenario +200bp $ 526 $ 427 -200bp $ (462) $ (592) 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 March 31, 2004 and 2003. 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 March 31, 2004 and December 31, 2003 were approximately $67,184,000 and $741,000 and $71,858,000 and $741,000, 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 March 31, 2004, consolidated liquid assets totaled $56.4 million or 13.9% of total assets compared to $56.8 million or 14.3% of total assets on December 31, 2003. In addition to liquid assets, the Company maintains short-term lines of credit in the amount of $38,000,000 with correspondent banks. At March 31, 2004, the Company had $32,700,000 available under these credit lines. Additionally, American River Bank is member of the Federal Home Loan Bank (the "FHLB"). At March 31, 2004, American River Bank could have arranged for up to $36,775,000 in secured borrowings from the FHLB. These borrowings are secured by pledged mortgage loans and investment securities. At 23 March 31, 2004, the Company had $8,674,000 available under these secured borrowing arrangements. American River Bank also has informal agreements with various other banks to sell participations in loans, if necessary. The Company serves primarily a business and professional customer base and, as such, its deposit base is susceptible to economic fluctuations. Accordingly, management strives to maintain a balanced position of liquid assets to volatile and cyclical deposits. Liquidity is also affected by portfolio maturities and the effect of interest rate fluctuations on the marketability of both assets and liabilities. The Company can sell any of its unpledged securities held in the available-for-sale category to meet liquidity needs. Due to the falling interest rate environment throughout the last half of 2000 and continuing through the end of 2003, 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 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 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 uses the same credit policies in making commitments and letters of credit as it does for loans included on the consolidated balance sheet. As of March 31, 2004 and December 31, 2003, 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 $67,925,000 and $72,599,000 at March 31, 2004 and December 31, 2003, respectively. As a percentage of net loans and leases these off-balance sheet items represent 25.0% and 27.7%, respectively. The Company has certain ongoing commitments under operating leases. These commitments do not significantly impact operating results. Certain financial institutions have elected to use special purpose vehicles ("SPV") to dispose of problem assets. The SPV is typically a subsidiary company with an asset and liability structure and legal status that makes its obligations secure even if the parent corporation goes bankrupt. Under certain circumstances, these financial institutions may exclude the problem assets from their reported impaired and non-performing assets. The Company does not use these vehicles or any other structures to dispose of problem assets. Item 4. CONTROLS AND PROCEDURES (a) Disclosure Controls and Procedures: An evaluation of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and other members of the Company's senior management as of the end of the period covered by this quarterly report on Form 10-Q. The Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under 24 the Exchange Act is (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) to allow timely decisions regarding required disclosure, and (ii) recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms. (b) Internal Control Over Financial Reporting: An evaluation of any changes in the Company's internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)), that occurred during the Company's fiscal quarter ended March 31, 2004, was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and other members of the Company's senior management. The Company's Chief Executive Officer and Chief Financial Officer concluded that no change identified in connection with such evaluation has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. Other Matters Effects of Terrorism. The terrorist actions on September 11, 2001 and thereafter and the current military conflict in Iraq have had significant adverse effects upon the United States economy. Whether the terrorist activities in the future and the actions of the United States and its allies in combating terrorism on a worldwide basis will adversely impact the Company and the extent of such impact is uncertain. 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. Website Access. American River Holdings maintains a website where certain information about the Company is posted. Through the website, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments thereto are available as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. These reports are free of charge and can be accessed through the address www.amrb.com/financial.html by clicking on the SEC Filings link located at that address. 25 PART II - OTHER INFORMATION Item 1. Legal Proceedings. None. Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities. - ---------------------------------------------------------------------------------------------------------------------------- Period (a) (b) (c) (d) Total Number of Average Price Total Number of Shares Maximum Number (or Approximate Shares (or Paid Per Share (or Units) Purchased as Dollar Value) of Shares (or Units) Purchased (or Unit) Part of Publicly Units) That May Yet Be Announced Plans or Purchased Under the Plans or Programs Programs - ---------------------------------------------------------------------------------------------------------------------------- Month #1 January 1 through 6,100 $19.30 6,100 196,663 January 31, 2004 Month #2 February 1 through None N/A None 196,663 February 29, 2004 Month #3 March 1 through March None N/A None 196,663 31, 2004 - ---------------------------------------------------------------------------------------------------------------------------- Total 6,100 6,100 - ---------------------------------------------------------------------------------------------------------------------------- On September 20, 2001 the Board of Directors of the Company authorized a stock repurchase program which calls for the repurchase of up to five percent (5%) annually of the Company's outstanding shares of common stock shares. Each year the Company may repurchase up to 5% of the shares outstanding (adjusted for stock splits or stock dividends). The 196,663 shares reported in the table as shares that may be repurchased under the plan represent shares eligible for the calendar year 2004. The repurchases are to be made from time to time in the open market as conditions allow and will be structured to comply with Commission Rule 10b-18. All repurchased shares reflected in the table above were made in open market transactions and then retired. The Board of Directors has reserved the right to suspend, terminate, modify or cancel this repurchase program at any time for any reason. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. None. Item 5. Other Information. None. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits 26 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). ** (3.1) Articles of Incorporation, 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. (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 Holdings 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 Holdings Deferred Compensation Plan dated May 1, 1998. ** *(10.12) American River Holdings Deferred Fee Plan dated April 1, 1998. ** *(10.16) American River Bank Employee Severance Policy dated March 18, 1998. ** *(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. 27 (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 Holdings 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 10.24 to the Company's Form 10-Q for the period ended March 31, 2002, filed with the Commission on May 3, 2002. (10.27) Lease agreement and addendum between North Coast Bank, N.A. and Rosario LLC, each dated September 1, 1998, related to 50 Santa Rosa Avenue, Santa Rosa, California. ** (10.28) Amendment No. 3 dated March 18, 2003, 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 10.28 to the Company's Form 10-Q for the period ended March 31, 2003, filed with the Commission on May 12, 2003. (10.29) Lease agreement between American River Bank and 520 Capitol Mall, Inc., dated August 19, 2003, related to 520 Capitol Mall, Suite 100, Sacramento, California, incorporated by reference from Exhibit 10.29 to the Company's Form 10-Q for the period ended September 30, 2003, filed with the Commission on November 7, 2003. *(10.30) Employment Agreement between American River Holdings and David T. Taber dated August 22, 2003, incorporated by reference from Exhibit 10.30 to the Company's Form 10-Q for the period ended September 30, 2003, filed with the Commission on November 7, 2003. (10.32) Lease agreement between R & R Partners, A California General Partnership and North Coast Bank, N.A., dated July 1, 2003, related to 8733 Lakewood Drive, Suite A, Windsor, California, incorporated by reference from Exhibit 10.32 to the Company's Form 10-Q for the period ended September 30, 2003, filed with the Commission on November 7, 2003. *(10.33) Salary Continuation Agreement between American River Bank and Mitchell A. Derenzo dated August 22, 2003, incorporated by reference from Exhibit 10.33 to the Company's Form 10-Q for the period ended September 30, 2003, filed with the Commission on November 7, 2003. 28 *(10.34) Salary Continuation Agreement between American River Holdings and David T. Taber dated August 22, 2003, incorporated by reference from Exhibit 10.34 to the Company's Form 10-Q for the period ended September 30, 2003, filed with the Commission on November 7, 2003. *(10.35) Salary Continuation Agreement between American River Bank and Douglas E. Tow dated August 22, 2003, incorporated by reference from Exhibit 10.35 to the Company's Form 10-Q for the period ended September 30, 2003, filed with the Commission on November 7, 2003. (14.1) American River Holdings Code of Ethics, incorporated by reference from Exhibit 14.1 to the Company's Annual Report on Form 10-K for the period ended December 31, 2003, filed with the Commission on March 19, 2004. (21.1) As of the date of this report, the Registrant's only subsidiaries are American River Bank and American River Financial. (31.1) Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (31.2) Certifications of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (32.1) Certification of American River Holdings by its Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *Denotes management contracts, compensatory plans or arrangements. **Incorporated by reference to registrant's Registration Statement on Form S-4 (No. 333-36326) filed with the Commission on May 5, 2000. (b) Reports on Form 8-K On January 7, 2004, the Company filed a Report on Form 8-K announcing William Robotham as a new American River Holdings Director. On January 8, 2004, the Company filed a Report on Form 8-K disclosing consummation of the merger of North Coast Bank, National Association with and into American River Holdings subsidiary, American River Bank, effective December 31, 2003. North Coast Bank operates as a division of American River Bank under the name North Coast Bank, a division of American River Bank. Effective January 7, 2004, American River Holdings also announced that first source capital discontinued operations as a subsidiary of American River Holdings. Similar leasing operations have commenced at American River Bank, under First Source Capital, a division of American River Bank. On January 20, 2004, the Company filed a Report on Form 8-K announcing its financial results for the year 2003, and the fourth quarter ended December 31, 2003. On February 20, 2004, the Company filed a Report on Form 8-K announcing adoption of an amended Code of Ethics. 29 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 HOLDINGS May 10, 2004 By: /s/ DAVID T. TABER --------------------------------------- David T. Taber President Chief Executive Officer AMERICAN RIVER HOLDINGS May 10, 2004 By: /s/ MITCHELL A. DERENZO --------------------------------------- Mitchell A. Derenzo Chief Financial Officer (Principal Financial and Accounting Officer) 30 EXHIBIT INDEX Exhibit Number Description Page - -------------------------------------------------------------------------------- 3.2 Bylaws, as amended. 32-64 31.1 Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 65 31.2 Certifications of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 66 32.1 Certification of American River Holdings by its Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 67 31