UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
(Mark One)
For the quarterly period ended
For the transition period from to
Commission file number
Bank of Commerce Holdings
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| (State or jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
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| (Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: (
Securities registered pursuant to Section 12(b) of the Exchange Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
| | | |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer ☐ | | Non-accelerated filer ☐ | Smaller reporting company | Emerging growth company |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
Yes
Outstanding shares of Common Stock, no par value, as of October 20, 2020:
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Index to Form 10-Q
| Part I. FINANCIAL INFORMATION |
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| 3 |
||
| Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations |
41 |
|
| Item 3. Quantitative and Qualitative Disclosures About Market Risk |
75 |
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| 75 |
||
|
|
||
| Part II. OTHER INFORMATION |
||
| 76 |
||
| 76 |
||
| Item 2. Unregistered Sales of Equity Securities and Use of Proceeds |
76 |
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| 76 |
||
| 76 |
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| 76 |
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| 77 |
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| 78 |
||
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Consolidated Balance Sheets (Unaudited)
| September 30, | December 31, | |||||||
| (Amounts in thousands, except share information) | 2020 | 2019 | ||||||
| Assets: | ||||||||
| Cash and due from banks | $ | $ | ||||||
| Interest-bearing deposits in other banks | ||||||||
| Total cash and cash equivalents | ||||||||
| Securities available-for-sale, at fair value | ||||||||
| Loans, net of deferred fees and costs | ||||||||
| Allowance for loan and lease losses | ( | ) | ( | ) | ||||
| Net loans | ||||||||
| Premises and equipment, net | ||||||||
| Other real estate owned | ||||||||
| Life insurance | ||||||||
| Deferred tax asset, net | ||||||||
| Goodwill | ||||||||
| Other intangible assets, net | ||||||||
| Other assets | ||||||||
| Total assets | $ | $ | ||||||
| Liabilities and shareholders' equity: | ||||||||
| Liabilities: | ||||||||
| Demand - noninterest-bearing | $ | $ | ||||||
| Demand - interest-bearing | ||||||||
| Money market | ||||||||
| Savings | ||||||||
| Certificates of deposit | ||||||||
| Total deposits | ||||||||
| Term debt: | ||||||||
| Federal Home Loan Bank of San Francisco borrowings | ||||||||
| Other borrowings | ||||||||
| Less unamortized debt issuance costs | ( | ) | ( | ) | ||||
| Net term debts | ||||||||
| Junior subordinated debentures | ||||||||
| Other liabilities | ||||||||
| Total liabilities | ||||||||
| Commitments and contingencies (Note 7) | ||||||||
| Shareholders' equity: | ||||||||
| Common stock, par value, shares authorized: issued and outstanding - as of September 30, 2020 and as of December 31, 2019 | ||||||||
| Retained earnings | ||||||||
| Accumulated other comprehensive income, net of tax | ||||||||
| Total shareholders' equity | ||||||||
| Total liabilities and shareholders' equity | $ | $ | ||||||
See accompanying notes to consolidated financial statements.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Consolidated Statements of Income (Unaudited)
| For the Three Months Ended |
For the Nine Months Ended |
|||||||||||||||
| September 30, |
September 30, |
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| (Amounts in thousands, except per share information) |
2020 |
2019 |
2020 |
2019 |
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| Interest income: |
||||||||||||||||
| Interest and fees on loans |
$ | $ | $ | $ | ||||||||||||
| Interest on taxable securities |
||||||||||||||||
| Interest on tax-exempt securities |
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| Interest on interest-bearing deposits in other banks |
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| Total interest income |
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| Interest expense: |
||||||||||||||||
| Interest on demand - interest-bearing |
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| Interest on money market |
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| Interest on savings |
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| Interest on certificates of deposit |
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| Interest on Federal Home Loan Bank of San Francisco borrowings |
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| Interest on other borrowings |
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| Interest on junior subordinated debentures |
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| Total interest expense |
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| Net interest income |
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| Provision for loan and lease losses |
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| Net interest income after provision for loan and lease losses |
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| Noninterest income: |
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| Service charges on deposit accounts |
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| ATM and point of sale fees |
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| Payroll and benefit processing fees |
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| Life insurance |
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| Gain on sale of investment securities, net |
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| Federal Home Loan Bank of San Francisco dividends |
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| (Loss) gain on sale of OREO |
( |
) | ||||||||||||||
| Other income |
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| Total noninterest income |
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| Noninterest expense: |
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| Salaries and related benefits |
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| Premises and equipment |
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| FDIC insurance premium |
( |
) | ||||||||||||||
| Data processing |
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| Professional services |
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| Telecommunications |
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| Acquisition and merger |
( |
) | ||||||||||||||
| Other expenses |
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| Total noninterest expense |
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| Income before provision for income taxes |
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| Provision for income taxes |
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| Net income |
$ | $ | $ | $ | ||||||||||||
| Earnings per share - basic |
$ | $ | $ | $ | ||||||||||||
| Weighted average shares - basic |
||||||||||||||||
| Earnings per share - diluted |
$ | $ | $ | $ | ||||||||||||
| Weighted average shares - diluted |
||||||||||||||||
See accompanying notes to consolidated financial statements.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Unaudited)
| For the Three Months Ended |
For the Nine Months Ended |
|||||||||||||||
| September 30, |
September 30, |
|||||||||||||||
| (Amounts in thousands) |
2020 |
2019 |
2020 |
2019 |
||||||||||||
| Net income |
$ | $ | $ | $ | ||||||||||||
| Available-for-sale securities: |
||||||||||||||||
| Changes in unrealized gains arising during the period |
( |
) | ||||||||||||||
| Income taxes |
( |
) | ( |
) | ( |
) | ||||||||||
| Change in unrealized gain, net of tax |
( |
) | ||||||||||||||
| Reclassification adjustment for realized gains included in net income |
( |
) | ( |
) | ( |
) | ( |
) | ||||||||
| Income taxes |
||||||||||||||||
| Realized gains, net of tax |
( |
) | ( |
) | ( |
) | ( |
) | ||||||||
| Net change in unrealized gains (losses) on available-for-sale securities |
( |
) | ||||||||||||||
| Other comprehensive income (loss) |
( |
) | ||||||||||||||
| Comprehensive income – Bank of Commerce Holdings |
$ | $ | $ | $ | ||||||||||||
See accompanying notes to consolidated financial statements.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Consolidated Statements of Shareholders’ Equity (Unaudited)
| Accumulated Other | ||||||||||||||||||||
| Common | Comprehensive | |||||||||||||||||||
| Common | Stock | Retained | (Loss) Income | |||||||||||||||||
| (Amounts in thousands except per share information) | Shares | Amount | Earnings | Net of Tax | Total | |||||||||||||||
| Balance at December 31, 2018 | $ | $ | $ | ( | ) | $ | ||||||||||||||
| Net income | — | |||||||||||||||||||
| Other comprehensive income, net of tax | — | |||||||||||||||||||
| Comprehensive income | — | |||||||||||||||||||
| Dividend declared on common stock ($ per share) | — | ( | ) | ( | ) | |||||||||||||||
| Stock issued for Merchants acquisition | ||||||||||||||||||||
| Stock compensation grants | ||||||||||||||||||||
| Restricted stock granted, net | ||||||||||||||||||||
| Stock options exercised | ||||||||||||||||||||
| Compensation expense associated with restricted stock, net of cash paid for shares surrendered for tax-withholding purposes | — | ( | ) | ( | ) | |||||||||||||||
| Balance at March 31, 2019 | $ | $ | $ | ( | ) | $ | ||||||||||||||
| Net income | — | |||||||||||||||||||
| Other comprehensive income, net of tax | — | |||||||||||||||||||
| Comprehensive income | — | |||||||||||||||||||
| Dividend declared on common stock ($ per share) | — | ( | ) | ( | ) | |||||||||||||||
| Restricted stock granted, net | ||||||||||||||||||||
| Compensation expense associated with restricted stock, net of cash paid for shares surrendered for tax-withholding purposes | — | |||||||||||||||||||
| Balance at June 30, 2019 | $ | $ | $ | $ | ||||||||||||||||
| Net income | — | |||||||||||||||||||
| Other comprehensive loss, net of tax | — | ( | ) | ( | ) | |||||||||||||||
| Comprehensive income | — | |||||||||||||||||||
| Dividend declared on common stock ($ per share) | — | ( | ) | ( | ) | |||||||||||||||
| Restricted stock granted, net | ( | ) | ||||||||||||||||||
| Compensation expense associated with restricted stock, net of cash paid for shares surrendered for tax-withholding purposes | — | |||||||||||||||||||
| Balance at September 30, 2019 | $ | $ | $ | $ | ||||||||||||||||
| Net income | — | |||||||||||||||||||
| Other comprehensive income, net of tax | — | |||||||||||||||||||
| Comprehensive income | — | |||||||||||||||||||
| Dividend declared on common stock ($ per share) | — | ( | ) | ( | ) | |||||||||||||||
| Repurchase of common stock | ( | ) | ( | ) | ( | ) | ||||||||||||||
| Restricted stock granted, net | ||||||||||||||||||||
| Stock options exercised | ||||||||||||||||||||
| Compensation expense associated with restricted stock, net of cash paid for shares surrendered for tax-withholding purposes | — | |||||||||||||||||||
| Balance at December 31, 2019 | $ | $ | $ | $ | ||||||||||||||||
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Consolidated Statements of Shareholders’ Equity (Unaudited) (Continued)
| Accumulated Other | ||||||||||||||||||||
| Common | Comprehensive | |||||||||||||||||||
| Common | Stock | Retained | Income | |||||||||||||||||
| (Amounts in thousands except per share information) | Shares | Amount | Earnings | Net of Tax | Total | |||||||||||||||
| Balance at December 31, 2019 | $ | $ | $ | $ | ||||||||||||||||
| Net income | — | |||||||||||||||||||
| Other comprehensive income, net of tax | — | |||||||||||||||||||
| Comprehensive income | — | |||||||||||||||||||
| Dividend declared on common stock ($ per share) | — | ( | ) | ( | ) | |||||||||||||||
| Repurchase of common stock | ( | ) | ( | ) | ( | ) | ||||||||||||||
| Restricted stock granted, net | ||||||||||||||||||||
| Compensation expense associated with restricted stock, net of cash paid for shares surrendered for tax-withholding purposes | — | ( | ) | ( | ) | |||||||||||||||
| Balance at March 31, 2020 | $ | $ | $ | $ | ||||||||||||||||
| Net income | — | |||||||||||||||||||
| Other comprehensive income, net of tax | — | |||||||||||||||||||
| Comprehensive income | — | |||||||||||||||||||
| Dividend declared on common stock ($ per share) | — | ( | ) | ( | ) | |||||||||||||||
| Repurchase of common stock | ( | ) | ( | ) | ( | ) | ||||||||||||||
| Compensation expense associated with restricted stock, net of cash paid for shares surrendered for tax-withholding purposes | — | |||||||||||||||||||
| Balance at June 30, 2020 | $ | $ | $ | $ | ||||||||||||||||
| Net income | — | |||||||||||||||||||
| Other comprehensive income, net of tax | — | |||||||||||||||||||
| Comprehensive income | — | |||||||||||||||||||
| Dividend on common stock ($ per share) | — | ( | ) | ( | ) | |||||||||||||||
| Restricted stock granted, net | ||||||||||||||||||||
| Compensation expense associated with restricted stock, net of cash paid for shares surrendered for tax-withholding purposes | — | |||||||||||||||||||
| Balance at September 30, 2020 | $ | $ | $ | $ | ||||||||||||||||
See accompanying notes to consolidated financial statements.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
| For the Nine Months Ended |
||||||||
| September 30, |
||||||||
| (Amounts in thousands) |
2020 |
2019 |
||||||
| Cash flows from operating activities: |
||||||||
| Net income |
$ | $ | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
| Provision for loan and lease losses |
||||||||
| Provision for unfunded commitments |
||||||||
| Provision for depreciation and amortization |
||||||||
| Amortization of core deposit intangible |
||||||||
| Amortization of debt issuance costs |
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| Compensation expense associated with restricted stock |
||||||||
| Tax benefits from vesting of restricted stock |
( |
) | ( |
) | ||||
| Net gain on sale or call of securities |
( |
) | ( |
) | ||||
| Amortization of premiums and accretion of discounts on investments, net |
||||||||
| Amortization of premiums and accretion of discounts on acquired loans, net |
( |
) | ( |
) | ||||
| Loss on disposal of fixed assets |
||||||||
| Loss (gain) on sale of OREO |
( |
) | ||||||
| Increase in cash surrender value of life insurance |
( |
) | ( |
) | ||||
| Deferred compensation and salary continuation plan payments |
( |
) | ( |
) | ||||
| Increase in deferred compensation and salary continuation plans |
||||||||
| Increase (decrease) in deferred loan fees and costs |
( |
) | ||||||
| (Increase) decrease in other assets |
( |
) | ||||||
| Increase in other liabilities |
||||||||
| Net cash provided by operating activities |
||||||||
| Cash flows from investing activities: |
||||||||
| Proceeds from maturities of and payments on available-for-sale securities |
||||||||
| Proceeds from sale of available-for-sale securities |
||||||||
| Purchases of available-for-sale securities |
( |
) | ( |
) | ||||
| Investment in qualified affordable housing partnerships |
( |
) | ||||||
| Net purchase of Federal Home Loan Bank of San Francisco stock |
( |
) | ||||||
| Loan originations, net of principal repayments |
( |
) | ( |
) | ||||
| Net repayment on loan pools |
||||||||
| Purchase of premises and equipment |
( |
) | ( |
) | ||||
| Proceeds from the sale of OREO |
||||||||
| Acquisition of Merchants Holding Company, net of cash paid |
( |
) | ||||||
| Net cash (used) provided by investing activities |
( |
) | ||||||
See accompanying notes to consolidated financial statements.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited) (Continued)
| For the Nine Months Ended |
||||||||
| September 30, |
||||||||
| (Amounts in thousands) |
2020 |
2019 |
||||||
| Cash flows from financing activities: |
||||||||
| Net increase (decrease) in demand, money market and savings deposits |
$ | $ | ( |
) | ||||
| Net decrease in certificates of deposit |
( |
) | ( |
) | ||||
| Advances on term debt |
||||||||
| Repayment of term debt |
( |
) | ( |
) | ||||
| Proceeds from stock options exercised |
||||||||
| Repurchase of common stock |
( |
) | ||||||
| Cash paid for shares surrendered for tax-withholding purposes |
( |
) | ( |
) | ||||
| Cash dividends paid on common stock |
( |
) | ( |
) | ||||
| Net cash provided (used) by financing activities |
( |
) | ||||||
| Net increase in cash and cash equivalents |
||||||||
| Cash and cash equivalents at beginning of year |
||||||||
| Cash and cash equivalents at end of period |
$ | $ | ||||||
| For the Nine Months Ended |
||||||||
| September 30, |
||||||||
| (Amounts in thousands) |
2020 |
2019 |
||||||
| Supplemental disclosures of cash flow activity: |
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| Cash paid during the period for: |
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| Income taxes |
$ | $ | ||||||
| Interest |
$ | $ | ||||||
| Operating leases |
$ | $ | ||||||
| Supplemental disclosures of non-cash investing activities: |
||||||||
| Transfer of loans to other real estate owned |
$ | $ | ||||||
| Investment in qualified affordable housing partnership |
$ | $ | ||||||
| Unrealized gain on investment securities available-for-sale, net of gains included in net income |
$ | $ | ||||||
| Changes in net deferred tax asset related to changes in net unrealized gain on investment securities available-for-sale |
( |
) | ( |
) | ||||
| Changes in accumulated other comprehensive income due to net unrealized gain on investment securities available-for-sale |
$ | $ | ||||||
| Supplemental disclosures of non-cash financing activities: |
||||||||
| Stock compensation grants |
$ | $ | ||||||
| Cash dividend declared on common shares and payable after period-end |
$ | $ | ||||||
| Right-of-use lease asset recorded on new leases |
$ | $ | ||||||
| Right-of-use lease asset recorded on adoption of ASU No. 2016-02 |
$ | $ | ||||||
| Lease liability recorded on adoption of ASU No. 2016-02 |
$ | $ | ||||||
| Disclosures related to the acquisition of Merchants Holding Company: |
||||||||
| Consideration paid |
$ | $ | ||||||
| Assets acquired - fair value |
$ | $ | ||||||
| Goodwill |
$ | $ | ||||||
| Liabilities assumed - fair value |
$ | $ | ||||||
See accompanying notes to consolidated financial statements.
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Bank of Commerce Holdings (“Company,” “Holding Company,” “we,” or “us”), is a corporation organized under the laws of California and a bank holding company (“BHC”) registered under the Bank Holding Company Act of 1956, as amended (“BHC Act”) with its principal offices in Sacramento, California. The Holding Company’s principal business is to serve as a holding company for Merchants Bank of Commerce (the “Bank” and together with the Holding Company, the “Company”) and for Bank of Commerce Mortgage (inactive). The Bank, which previously operated under three separate names, changed its name for all operations to Merchants Bank of Commerce effective May 20, 2019. We have an unconsolidated subsidiary in Bank of Commerce Holdings Trust II. The Consolidated Balance Sheets as of September 30, 2020 and December 31, 2019 are derived from the unaudited interim consolidated financial statements or the audited consolidated financial statements, and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in annual consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations. The Company believes that all adjustments (all of which are normal and recurring in nature) considered necessary for a fair presentation have been included and the disclosures made are adequate to make the information not misleading.
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and with prevailing practices within the banking and securities industries. In preparing such consolidated financial statements, management is required to make certain estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the dates of the Consolidated Balance Sheets and the reported amounts of revenues and expenses for the reporting periods. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change relate to the valuation and impairment of investment securities, the determination of the allowance for loan and lease losses (“ALLL”), income taxes, the valuation of goodwill and Other Real Estate Owned (“OREO”), and fair value measurements. Certain amounts for prior periods have been reclassified to conform to the current financial statement presentation. The results of reclassifications are not considered material and have no effect on previously reported net income or shareholders' equity. The accompanying unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in Bank of Commerce Holdings 2019 Annual Report on Form 10-K. The consolidated results of operations and cash flows for the 2020 interim period shown in this report are not necessarily indicative of the results for any future interim period or the entire fiscal year.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Holding Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. As of September 30, 2020 and December 31, 2019, the Company had one wholly-owned trust formed in 2005 to issue trust preferred securities and related common securities. We have not consolidated the accounts of the Trust in our consolidated financial statements in accordance with Financial Accounting Standards Board Accounting Standards Codification (“FASB”), Consolidation (“ASC 810”). We are not considered the primary beneficiary of the Trust (variable interest entity). As a result, the junior subordinated debentures issued by the Holding Company to the Trust are reflected on the Company’s Consolidated Balance Sheets.
Leases
We determine if an arrangement is a lease at inception. Operating leases are included in Other Assets and Other Liabilities in our Consolidated Balance Sheets. Operating lease right-of-use assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most of our leases do not provide an incremental borrowing rate, we use borrowing rates available under our existing line of credit with the Federal Home Loan Bank of San Francisco for periods similar to the lease terms as our incremental borrowing rate to determine the present value of future lease payments. Our lease terms may include options to extend or terminate the lease which we recognize when it is reasonably certain that we will exercise that option. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.
Application of new accounting guidance
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this ASU remove, modify, and add disclosure requirements for the fair value reporting of assets and liabilities. The modifications and additions relate to Level 3 fair value measurements at the end of the reporting period. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. We adopted the requirements of this ASU on January 1, 2020 and added disclosure about significant observable inputs used to develop Level 3 fair value measurements prospectively. As the ASU’s requirements only relate to disclosures, the amendments will not impact our financial condition or results of operations.
NOTE 2. COMMON STOCK OUTSTANDING AND EARNINGS PER SHARE
Basic earnings per share excludes dilution and is computed by dividing income by the weighted-average number of common shares outstanding for the period, excluding unvested restricted stock awards which do not have voting rights or share in dividends. Diluted earnings per share reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Holding Company. The computation of diluted earnings per share does not assume conversion, exercise, or contingent issuance of securities that would have an anti-dilutive effect on earnings per share.
The following is a computation of basic and diluted earnings per share for the three and nine months ended September 30, 2020 and 2019.
| For the Three Months Ended |
For the Nine Months Ended |
|||||||||||||||
| September 30, |
September 30, |
|||||||||||||||
| (Amounts in thousands, except per share information) |
2020 |
2019 |
2020 |
2019 |
||||||||||||
| Earnings Per Share: |
||||||||||||||||
| Numerators: |
||||||||||||||||
| Net income |
$ | $ | $ | $ | ||||||||||||
| Denominators: |
||||||||||||||||
| Weighted average number of common shares outstanding - basic (1) |
||||||||||||||||
| Effect of potentially dilutive common shares (2) |
||||||||||||||||
| Weighted average number of common shares outstanding - diluted |
||||||||||||||||
| Earnings per common share: |
||||||||||||||||
| Basic |
$ | $ | $ | $ | ||||||||||||
| Diluted |
$ | $ | $ | $ | ||||||||||||
| Anti-dilutive restricted shares not included in diluted earnings per share calculation |
||||||||||||||||
| (1) | Excludes unvested restricted shares because they do not have dividend or voting rights |
| (2) | Represents the effects of the assumed exercise of stock options and vesting of non-participating restricted shares. |
In 2019, we announced a stock repurchase program for
NOTE 3. SECURITIES
The following tables present the amortized costs, unrealized gains, unrealized losses and estimated fair values of our investment securities as of September 30, 2020, and December 31, 2019.
| As of September 30, 2020 | ||||||||||||||||
| Gross | Gross | |||||||||||||||
| Amortized | Unrealized | Unrealized | Estimated | |||||||||||||
| (Amounts in thousands) | Costs | Gains | Losses | Fair Values | ||||||||||||
| Available-for-sale securities: | ||||||||||||||||
| U.S. government & agencies | $ | $ | $ | ( | ) | $ | ||||||||||
| Obligations of state and political subdivisions | ( | ) | ||||||||||||||
| Residential mortgage-backed securities and collateralized mortgage obligations | ( | ) | ||||||||||||||
| Commercial mortgage-backed securities | ( | ) | ||||||||||||||
| Other asset-backed securities | ( | ) | ||||||||||||||
| Total | $ | $ | $ | ( | ) | $ | ||||||||||
| As of December 31, 2019 | ||||||||||||||||
| Gross | Gross | |||||||||||||||
| Amortized | Unrealized | Unrealized | Estimated | |||||||||||||
| (Amounts in thousands) | Costs | Gains | Losses | Fair Values | ||||||||||||
| Available-for-sale securities: | ||||||||||||||||
| U.S. government & agencies | $ | $ | $ | ( | ) | $ | ||||||||||
| Obligations of state and political subdivisions | ( | ) | ||||||||||||||
| Residential mortgage-backed securities and collateralized mortgage obligations | ( | ) | ||||||||||||||
| Corporate securities | ( | ) | ||||||||||||||
| Commercial mortgage-backed securities | ( | ) | ||||||||||||||
| Other asset-backed securities | ( | ) | ||||||||||||||
| Total | $ | $ | $ | ( | ) | $ | ||||||||||
The following table presents the contractual maturities of investment securities at September 30, 2020.
| Available-For-Sale | ||||||||
| (Amounts in thousands) | Amortized Costs | Fair Values | ||||||
| Amounts maturing in: | ||||||||
| One year or less | $ | $ | ||||||
| After one year through five years | ||||||||
| After five years through ten years | ||||||||
| After ten years | ||||||||
| Total | $ | $ | ||||||
The amortized costs and fair values of residential mortgage-backed securities, collateralized mortgage obligations and commercial mortgage securities are presented by their expected average life, rather than contractual maturity, because the underlying loans may be repaid without prepayment penalties.
At September 30, 2020 and December 31, 2019, securities with a fair value of $
The following table presents the cash proceeds from sales of investment securities, and the associated gross realized gains and gross realized losses that have been included in earnings for the three and nine months ended September 30, 2020 and 2019.
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| (Amounts in thousands) | 2020 | 2019 | 2020 | 2019 | ||||||||||||
| Investment Securities: | ||||||||||||||||
| Proceeds from sales of investment securities | $ | $ | $ | $ | ||||||||||||
| Gross realized gains on sales of investment securities: | ||||||||||||||||
| U.S. government & agencies | $ | $ | $ | $ | ||||||||||||
| Obligations of state and political subdivisions | ||||||||||||||||
| Residential mortgage-backed securities and collateralized mortgage obligations | ||||||||||||||||
| Corporate securities | ||||||||||||||||
| Commercial mortgage-backed securities | ||||||||||||||||
| Total gross realized gains on sales of investment securities | ||||||||||||||||
| Gross realized losses on sales of investment securities: | ||||||||||||||||
| U.S. government & agencies | ( | ) | ( | ) | ( | ) | ||||||||||
| Obligations of state and political subdivisions | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Residential mortgage-backed securities and collateralized mortgage obligations | ( | ) | ( | ) | ( | ) | ||||||||||
| Commercial mortgage-backed securities | ( | ) | ( | ) | ||||||||||||
| Total gross realized losses on sales of investment securities | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Gain on sales of investment securities, net | $ | $ | $ | $ | ||||||||||||
Investment securities that were in an unrealized loss position as of September 30, 2020 and December 31, 2019 are presented in the following tables, based on the length of time individual securities have been in an unrealized loss position.
| As of September 30, 2020 | ||||||||||||||||||||||||
| Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| (Amounts in thousands) | Values | Losses | Values | Losses | Values | Losses | ||||||||||||||||||
| Available-for-sale securities: | ||||||||||||||||||||||||
| U.S. government & agencies | $ | $ | $ | $ | ( | ) | $ | $ | ( | ) | ||||||||||||||
| Obligations of state and political subdivisions | ( | ) | ( | ) | ||||||||||||||||||||
| Residential mortgage-backed securities and collateralized mortgage obligations | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Commercial mortgage-backed securities | ( | ) | ( | ) | ||||||||||||||||||||
| Other asset-backed securities | ( | ) | ( | ) | ||||||||||||||||||||
| Total temporarily impaired securities | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | ( | ) | ||||||||||||
| As of December 31, 2019 | ||||||||||||||||||||||||
| Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| (Amounts in thousands) | Values | Losses | Values | Losses | Values | Losses | ||||||||||||||||||
| Available-for-sale securities: | ||||||||||||||||||||||||
| U.S. government & agencies | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | ( | ) | ||||||||||||
| Obligations of state and political subdivisions | ( | ) | ( | ) | ||||||||||||||||||||
| Residential mortgage-backed securities and collateralized mortgage obligations | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Corporate securities | ( | ) | ( | ) | ||||||||||||||||||||
| Commercial mortgage-backed securities | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Other asset-backed securities | ( | ) | ( | ) | ||||||||||||||||||||
| Total temporarily impaired securities | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | ( | ) | ||||||||||||
At September 30, 2020 and December 31, 2019, the number of securities that were in an unrealized loss position was
The following table presents the characteristics of our securities that are in unrealized loss positions at September 30, 2020 and December 31, 2019.
| Characteristics of securities in unrealized loss positions at | ||
| Available-for-sale securities: | September 30, 2020 and December 31, 2019 | |
| U.S. government & agencies | Direct obligations of the U.S. Government or obligations guaranteed by U.S. Government agencies. | |
| Obligations of state and political subdivisions | General obligation issuances or revenue securities issued by municipalities and political subdivisions located within the U.S. secured by revenues from specific sources. | |
| Residential mortgage-backed securities and collateralized mortgage obligations | Obligations issued by U.S. government sponsored entities or non-governmental entities collateralized by high quality mortgages on residential properties. Issuances by non-governmental entities usually include good credit enhancements. Of the residential mortgage-backed securities and collateralized mortgage obligations that we owned at September 30, 2020 and December 31, 2019, | |
| Corporate securities | Debt obligations generally issued or guaranteed by large U.S. corporate institutions. | |
| Commercial mortgage-backed securities | Obligations issued by U.S. government sponsored entities or non-governmental entities collateralized by high quality mortgages on commercial properties. Issuances by non-governmental entities usually include good credit enhancements. Of the commercial mortgage-backed securities that we owned at September 30, 2020 and December 31, 2019, | |
| Other asset-backed securities | Obligations issued by non-governmental issuers secured by high quality loans with good credit enhancements. |
NOTE 4. LOANS
Outstanding loan balances consisted of the following at September 30, 2020, and December 31, 2019.
| September 30, | December 31, | |||||||
| (Amounts in thousands) | 2020 | 2019 | ||||||
| Loan Portfolio: | ||||||||
| Commercial | $ | $ | ||||||
| Paycheck protection program | ||||||||
| Commercial real estate: | ||||||||
| Construction and land development | ||||||||
| Non-owner occupied | ||||||||
| Owner occupied | ||||||||
| Residential real estate: | ||||||||
| Individual Tax Identification Number (“ITIN”) | ||||||||
| 1-4 family mortgage | ||||||||
| Equity lines | ||||||||
| Consumer and other | ||||||||
| Gross loans | ||||||||
| Deferred (fees) and costs | ( | ) | ||||||
| Loans, net of deferred fees and costs | ||||||||
| Allowance for loan and lease losses | ( | ) | ( | ) | ||||
| Net loans | $ | $ | ||||||
Certain loans are pledged as collateral for lines of credit with the Federal Home Loan Bank of San Francisco and the Federal Reserve Bank. Pledged loans totaled $
Gross loan balances in the table above include discounts on purchased loans and fair value discounts on loans acquired in conjunction with our acquisition of Merchants during the first quarter of 2019.
Discounts on purchased loans - Gross loan balances include net purchase discounts of $
Fair value discount - Gross loan balances include a fair value discount of $
Short-Term Loan Modifications
We have made short-term COVID-19 related loan payment deferrals on
Past Due Loans
Past due loans (gross), segregated by loan portfolio were as follows, as of September 30, 2020, and December 31, 2019.
| Recorded | ||||||||||||||||||||||||||||
| 30-59 | 60-89 | 90 or Greater | Investment > | |||||||||||||||||||||||||
| Days Past | Days Past | Days Past | Total Past | 90 Days and | ||||||||||||||||||||||||
| (Amounts in thousands) | Due | Due | Due | Due | Current | Total | Accruing | |||||||||||||||||||||
| Past Due Loans at September 30, 2020 | ||||||||||||||||||||||||||||
| Commercial | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Paycheck protection program | ||||||||||||||||||||||||||||
| Commercial real estate: | ||||||||||||||||||||||||||||
| Construction and land development | ||||||||||||||||||||||||||||
| Non-owner occupied | ||||||||||||||||||||||||||||
| Owner occupied | ||||||||||||||||||||||||||||
| Residential real estate: | ||||||||||||||||||||||||||||
| ITIN | ||||||||||||||||||||||||||||
| 1-4 family mortgage | ||||||||||||||||||||||||||||
| Equity lines | ||||||||||||||||||||||||||||
| Consumer and other | ||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Recorded | ||||||||||||||||||||||||||||
| 30-59 | 60-89 | 90 or Greater | Investment > | |||||||||||||||||||||||||
| Days Past | Days Past | Days Past | Total Past | 90 Days and | ||||||||||||||||||||||||
| (Amounts in thousands) | Due | Due | Due | Due | Current | Total | Accruing | |||||||||||||||||||||
| Past Due Loans at December 31, 2019 | ||||||||||||||||||||||||||||
| Commercial | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Commercial real estate: | ||||||||||||||||||||||||||||
| Construction and land development | ||||||||||||||||||||||||||||
| Non-owner occupied | ||||||||||||||||||||||||||||
| Owner occupied | ||||||||||||||||||||||||||||
| Residential real estate: | ||||||||||||||||||||||||||||
| ITIN | ||||||||||||||||||||||||||||
| 1-4 family mortgage | ||||||||||||||||||||||||||||
| Equity lines | ||||||||||||||||||||||||||||
| Consumer and other | ||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
Nonaccrual Loans
Nonaccrual loans, segregated by loan portfolio, were as follows as of September 30, 2020 and December 31, 2019.
| September 30, | December 31, | |||||||
| (Amounts in thousands) | 2020 | 2019 | ||||||
| Nonaccrual Loans: | ||||||||
| Commercial | $ | $ | ||||||
| Commercial real estate: | ||||||||
| Non-owner occupied | ||||||||
| Owner occupied | ||||||||
| Residential real estate: | ||||||||
| ITIN | ||||||||
| 1-4 family mortgage | ||||||||
| Consumer and other | ||||||||
| Total | $ | $ | ||||||
Had nonaccrual loans performed in accordance with their contractual terms, we would have recognized additional interest income, net of tax, as shown in the table below.
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| (Amounts in thousands) | 2020 | 2019 | 2020 | 2019 | ||||||||||||
| Nonaccrual Loans: | ||||||||||||||||
| Interest income, net of tax | $ | $ | $ | $ | ||||||||||||
Impaired Loans
A loan is considered impaired when, based on current information and events, we determine it is probable that we will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. The following tables summarize impaired loans by loan portfolio as of September 30, 2020 and December 31, 2019.
| As of September 30, 2020 | ||||||||||||
| Unpaid | ||||||||||||
| Recorded | Principal | Related | ||||||||||
| (Amounts in thousands) | Investment | Balance | Allowance | |||||||||
| Impaired Loans: | ||||||||||||
| With no related allowance recorded: | ||||||||||||
| Commercial | $ | $ | $ | — | ||||||||
| Commercial real estate: | ||||||||||||
| Non-owner occupied | — | |||||||||||
| Owner occupied | — | |||||||||||
| Residential real estate: | ||||||||||||
| ITIN | — | |||||||||||
| 1-4 family mortgage | — | |||||||||||
| Total with no related allowance recorded | $ | $ | $ | — | ||||||||
| With an allowance recorded: | ||||||||||||
| Commercial | $ | $ | $ | |||||||||
| Residential real estate: | ||||||||||||
| ITIN | ||||||||||||
| Equity lines | ||||||||||||
| Consumer and other | ||||||||||||
| Total with an allowance recorded | $ | $ | $ | |||||||||
| By loan portfolio: | ||||||||||||
| Commercial | $ | $ | $ | |||||||||
| Commercial real estate | ||||||||||||
| Residential real estate | ||||||||||||
| Consumer and other | ||||||||||||
| Total impaired loans | $ | $ | $ | |||||||||
| As of December 31, 2019 | ||||||||||||
| Unpaid | ||||||||||||
| Recorded | Principal | Related | ||||||||||
| (Amounts in thousands) | Investment | Balance | Allowance | |||||||||
| Impaired Loans: | ||||||||||||
| With no related allowance recorded: | ||||||||||||
| Commercial | $ | $ | $ | — | ||||||||
| Commercial real estate: | ||||||||||||
| Owner occupied | — | |||||||||||
| Residential real estate: | ||||||||||||
| ITIN | — | |||||||||||
| 1-4 family mortgage | — | |||||||||||
| Total with no related allowance recorded | $ | $ | $ | — | ||||||||
| With an allowance recorded: | ||||||||||||
| Commercial | $ | $ | $ | |||||||||
| Residential real estate: | ||||||||||||
| ITIN | ||||||||||||
| Equity lines | ||||||||||||
| Consumer and other | ||||||||||||
| Total with an allowance recorded | $ | $ | $ | |||||||||
| By loan portfolio: | ||||||||||||
| Commercial | $ | $ | $ | |||||||||
| Commercial real estate | ||||||||||||
| Residential real estate | ||||||||||||
| Consumer and other | ||||||||||||
| Total impaired loans | $ | $ | $ | |||||||||
The following tables summarize average recorded investment and interest income recognized on impaired loans by loan portfolio for the three and nine months ended September 30, 2020 and 2019.
| Three Months Ended | Three Months Ended | |||||||||||||||
| September 30, 2020 | September 30, 2019 | |||||||||||||||
| Average | Interest | Average | Interest | |||||||||||||
| Recorded | Income | Recorded | Income | |||||||||||||
| (Amounts in thousands) | Investment | Recognized | Investment | Recognized | ||||||||||||
| Average Recorded Investment and Interest Income: | ||||||||||||||||
| Commercial | $ | $ | $ | $ | ||||||||||||
| Commercial real estate: | ||||||||||||||||
| Non-owner occupied | ||||||||||||||||
| Owner occupied | ||||||||||||||||
| Residential real estate: | ||||||||||||||||
| ITIN | ||||||||||||||||
| 1-4 family mortgage | ||||||||||||||||
| Equity lines | ||||||||||||||||
| Consumer and other | ||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||
| Nine Months Ended | Nine Months Ended | |||||||||||||||
| September 30, 2020 | September 30, 2019 | |||||||||||||||
| Average | Interest | Average | Interest | |||||||||||||
| Recorded | Income | Recorded | Income | |||||||||||||
| (Amounts in thousands) | Investment | Recognized | Investment | Recognized | ||||||||||||
| Average Recorded Investment and Interest Income: | ||||||||||||||||
| Commercial | $ | $ | $ | $ | ||||||||||||
| Commercial real estate: | ||||||||||||||||
| Non-owner occupied | ||||||||||||||||
| Owner occupied | ||||||||||||||||
| Residential real estate: | ||||||||||||||||
| ITIN | ||||||||||||||||
| 1-4 family mortgage | ||||||||||||||||
| Equity lines | ||||||||||||||||
| Consumer and other | ||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||
The impaired loans on which these interest income amounts were recognized are primarily accruing troubled debt restructured loans. Loans are reported as troubled debt restructurings when we grant a concession(s) to a borrower experiencing financial difficulties that we would not otherwise consider. Examples of such concessions include a reduction in the loan rate, forgiveness of principal or accrued interest, extending the maturity date(s) significantly, or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, restructured loans are impaired as we will not collect all amounts due, either principal or interest, in accordance with the terms of the original loan agreement.
Troubled Debt Restructurings
As of September 30, 2020, we had $
At September 30, 2020 and December 31, 2019, impaired loans of $
For a troubled debt restructured loan to be on accrual status, the loan’s collateral coverage must generally be greater than or equal to
The types of modifications offered can generally be described in the following categories:
Maturity – A modification in which the maturity date is changed.
Payment Deferral – A modification in which a portion of the principal is deferred.
The following tables present the period ended balances of newly restructured loans and the types of modifications that occurred during the nine months ended September 30, 2020 and 2019. There were
| Modification Types For the Nine Months Ended September 30, 2020 | Modification Types For the Nine Months Ended September 30, 2019 | |||||||||||||||||||||||
| (Amounts in thousands) | Maturity | Payment Deferral | Total | Maturity | Payment Deferral | Total | ||||||||||||||||||
| Troubled Debt Restructurings: | ||||||||||||||||||||||||
| Commercial | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Commercial real estate: | ||||||||||||||||||||||||
| Owner occupied | ||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
For the nine month periods ended September 30, 2020 and 2019, the tables below provide information regarding the number of loans where the contractual terms have been restructured in a manner, which grants a concession to a borrower experiencing financial difficulties.
| For the Nine Months Ended September 30, 2020 | For the Nine Months Ended September 30, 2019 | |||||||||||||||||||||||
| Pre- | Post- | Pre- | Post- | |||||||||||||||||||||
| Modification | Modification | Modification | Modification | |||||||||||||||||||||
| Outstanding | Outstanding | Outstanding | Outstanding | |||||||||||||||||||||
| Number of | Recorded | Recorded | Number of | Recorded | Recorded | |||||||||||||||||||
| (Dollars in thousands) | Contracts | Investment | Investment | Contracts | Investment | Investment | ||||||||||||||||||
| Troubled Debt Restructurings: | ||||||||||||||||||||||||
| Commercial | $ | $ | $ | $ | ||||||||||||||||||||
| Commercial real estate: | ||||||||||||||||||||||||
| Owner occupied | ||||||||||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||||||||||
There were
Performing and Nonperforming Loans
We define a performing loan as a loan where any installment of principal or interest is not 90 days or more past due, and management believes the ultimate collection of original contractual principal and interest is likely. We define a nonperforming loan as an impaired loan, which may be on nonaccrual, or is 90 days past due and still accruing, or has been restructured and does not comply with its modified terms, and our ultimate collection of original contractual principal and interest is uncertain. Performing and nonperforming loans, segregated by loan portfolio, were as follows at September 30, 2020 and December 31, 2019.
| September 30, 2020 | ||||||||||||
| (Amounts in thousands) | Performing | Nonperforming | Total | |||||||||
| Performing and Nonperforming Loans: | ||||||||||||
| Commercial | $ | $ | $ | |||||||||
| Paycheck protection program | ||||||||||||
| Commercial real estate: | ||||||||||||
| Construction and land development | ||||||||||||
| Non-owner occupied | ||||||||||||
| Owner occupied | ||||||||||||
| Residential real estate: | ||||||||||||
| ITIN | ||||||||||||
| 1-4 family mortgage | ||||||||||||
| Equity lines | ||||||||||||
| Consumer and other | ||||||||||||
| Total | $ | $ | $ | |||||||||
| December 31, 2019 | ||||||||||||
| (Amounts in thousands) | Performing | Nonperforming | Total | |||||||||
| Performing and Nonperforming Loans: | ||||||||||||
| Commercial | $ | $ | $ | |||||||||
| Commercial real estate: | ||||||||||||
| Construction and land development | ||||||||||||
| Non-owner occupied | ||||||||||||
| Owner occupied | ||||||||||||
| Residential real estate: | ||||||||||||
| ITIN | ||||||||||||
| 1-4 family mortgage | ||||||||||||
| Equity lines | ||||||||||||
| Consumer and other | ||||||||||||
| Total | $ | $ | $ | |||||||||
Credit Quality Ratings
Management assigns a credit quality rating (risk grade) to each loan. The foundation or primary factor in determining the appropriate credit quality rating is the degree of a debtor’s willingness and ability to perform as agreed. In conjunction with evaluating the performing versus nonperforming nature of our loan portfolio, management evaluates the following credit risk and other relevant factors in determining the appropriate credit quality indicator (rating) for each loan portfolio:
Pass Grade: A Pass loan is a strong credit with no existing or known weaknesses that may require management’s close attention. Some pass loans require short-term enhanced monitoring to determine when the credit relationship would merit either an upgrade or a downgrade. Loans classified as Pass Grade specifically demonstrate:
| ● | Strong Cash Flows – borrower’s cash flows must meet or exceed our minimum debt service coverage ratio. |
| ● | Collateral Margin – generally, the borrower must have pledged an acceptable collateral class with an adequate collateral margin. |
| ● | Qualitative Factors – in addition to meeting our minimum cash flow and collateral requirements, a number of other qualitative factors are also factored into assigning a Pass Grade including the borrower’s level of leverage (debt to equity), prospects, history and experience in their industry, credit history, and any other relevant factors including a borrower’s character. |
Those borrowers who qualify for unsecured loans must fully demonstrate above average cash flows and strong secondary sources of repayment to mitigate the lack of unpledged collateral.
Watch Grade: The credit is acceptable but the borrower has experienced a temporary setback or adverse information has been received, and may exhibit one or more of the characteristics shown in the list below. This risk grade could apply to credits on a temporary basis pending a full review. Credits with this risk grade will require more handling time and increased management. The list below contains characteristics of this risk grade, but individually do not automatically cause the loan to be assigned a Watch Grade.
| ● | The primary source of repayment may be weakening causing greater reliance on the secondary source of repayment or |
| ● | The primary source of repayment is adequate, but the secondary source of repayment is insufficient |
| ● | In-depth financial analysis would compare to the lower quartile in two or more of the major components of the Risk Management Association Annual Statement Studies |
| ● | Volatile or deteriorating collateral |
| ● | Management decisions may be called into question |
| ● | Delinquencies in bank credits or other financial/trade creditors |
| ● | Frequent overdrafts |
| ● | Significant change in management/ownership |
Special Mention Grade: Credits in this grade are potentially weak and deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects of the credit. Special Mention credits are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. The list below exhibits the characteristics of this grade, but individually do not automatically cause the borrower to be assigned a grade of Special Mention:
| ● | Inadequate or incomplete loan documentation or perfection of collateral, or any other deviation from prudent lending practices |
| ● | Credit is structured in a manner in which the timing of the repayment source does not match the payment schedule or maturity, materially jeopardizing repayment |
| ● | Current economic or market conditions exist which may affect the borrower's ability to perform or affect the Bank's collateral position |
| ● | Adverse trends in the borrower's operations or continued deterioration in the borrower’s financial condition that has not yet reached a point where the retirement of debt is jeopardized. A credit in this grade should have favorable prospects of the deteriorating financial trends reversing within a reasonable timeframe. |
| ● | The borrower is less than cooperative or unable to produce current and adequate financial information |
Substandard Grade: A Substandard credit is inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard credits have a well-defined weakness or weaknesses that jeopardize the liquidation or timely collection of the debt. Substandard credits are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. However, a potential loss does not have to be recognizable in an individual credit for it to be considered a substandard credit. As such, substandard credits may or may not be graded as impaired.
The following represents, but is not limited to, the potential characteristics of a Substandard Grade and do not necessarily generate automatic reclassification into this loan grade:
| ● | Sustained or substantial deteriorating financial trends, |
| ● | Unresolved management problems, |
| ● | Collateral is insufficient to repay debt; collateral is not sufficiently supported by independent sources, such as asset-based financial audits, appraisals, or equipment evaluations, |
| ● | Improper perfection of lien position, which is not readily correctable, |
| ● | Unanticipated and severe decline in market values, |
| ● | High reliance on secondary source of repayment, |
| ● | Legal proceedings, such as bankruptcy or a divorce, which has substantially decreased the borrower’s capacity to repay the debt, |
| ● | Fraud committed by the borrower, |
| ● | IRS liens that take precedence, |
| ● | Forfeiture statutes for assets involved in criminal activities, |
| ● | Protracted repayment terms outside of policy that are for longer than the same type of credit in our portfolio, |
| ● | Any other relevant quantitative or qualitative factor that negatively affects the current net worth and paying capacity of the borrower or of the collateral pledged, if any. |
Doubtful Grade: A Doubtful loan has all the weaknesses inherent in one classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain pending factors that may work to the advantage and strengthening of the credit, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors may include, but are not limited to:
| ● | Proposed merger(s), |
| ● | Acquisition or liquidation procedures, |
| ● | Capital injection, |
| ● | Perfecting liens on additional collateral, |
| ● | Refinancing plans. |
Generally, a Doubtful Grade does not remain outstanding for a period greater than six months. Within six months, the pending events should have been resolved. Based on resolution of the pending events, the credit grade should have improved or the principal balance charged against the ALLL.
The following tables summarize loans by internal risk grades and by loan class as of September 30, 2020 and December 31, 2019.
| As of September 30, 2020 | ||||||||||||||||||||||||
| Special | ||||||||||||||||||||||||
| (Amounts in thousands) | Pass | Watch | Mention | Substandard | Doubtful | Total | ||||||||||||||||||
| Loan Portfolio: | ||||||||||||||||||||||||
| Commercial | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Paycheck protection program | ||||||||||||||||||||||||
| Commercial real estate: | ||||||||||||||||||||||||
| Construction and land development | ||||||||||||||||||||||||
| Non-owner occupied | ||||||||||||||||||||||||
| Owner occupied | ||||||||||||||||||||||||
| Residential real estate: | ||||||||||||||||||||||||
| ITIN | ||||||||||||||||||||||||
| 1-4 family mortgage | ||||||||||||||||||||||||
| Equity lines | ||||||||||||||||||||||||
| Consumer and other | ||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| As of December 31, 2019 | ||||||||||||||||||||||||
| Special | ||||||||||||||||||||||||
| (Amounts in thousands) | Pass | Watch | Mention | Substandard | Doubtful | Total | ||||||||||||||||||
| Loan Portfolio: | ||||||||||||||||||||||||
| Commercial | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Commercial real estate: | ||||||||||||||||||||||||
| Construction and land development | ||||||||||||||||||||||||
| Non-owner occupied | ||||||||||||||||||||||||
| Owner occupied | ||||||||||||||||||||||||
| Residential real estate: | ||||||||||||||||||||||||
| ITIN | ||||||||||||||||||||||||
| 1-4 family mortgage | ||||||||||||||||||||||||
| Equity lines | ||||||||||||||||||||||||
| Consumer and other | ||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
The recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure was $
Allowance for Loan and Lease Losses
Our ALLL is based on management’s estimate of future loan and lease losses and risks inherent in the loan portfolio in accordance with ASC Topics 450 and 310. In June of 2016, the FASB issued a new standard under ASC 326 the Current Expected Credit Losses methodology (“CECL”). We have the option to delay until January 2023 the implementation of the new methodology and have not determined when it will be implemented or the financial impact.
The following tables summarize activity within the ALLL by portfolio for the three and nine months ended September 30, 2020 and 2019.
| For the Three Months Ended September 30, 2020 | ||||||||||||||||||||||||||||
| Paycheck | ||||||||||||||||||||||||||||
| Protection | Commercial | Residential | ||||||||||||||||||||||||||
| (Amounts in thousands) | Commercial | Program | Real Estate | Real Estate | Consumer | Unallocated | Total | |||||||||||||||||||||
| ALLL by Loan Portfolio: | ||||||||||||||||||||||||||||
| Beginning balance | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Charge-offs | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||||||
| Provision | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||
| Ending balance | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| For the Three Months Ended September 30, 2019 | ||||||||||||||||||||||||||||
| Paycheck | ||||||||||||||||||||||||||||
| Protection | Commercial | Residential | ||||||||||||||||||||||||||
| (Amounts in thousands) | Commercial | Program | Real Estate | Real Estate | Consumer | Unallocated | Total | |||||||||||||||||||||
| ALLL by Loan Portfolio: | ||||||||||||||||||||||||||||
| Beginning balance | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Charge-offs | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||||||
| Provision | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||
| Ending balance | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| For the Nine Months Ended September 30, 2020 | ||||||||||||||||||||||||||||
| Paycheck | ||||||||||||||||||||||||||||
| Protection | Commercial | Residential | ||||||||||||||||||||||||||
| (Amounts in thousands) | Commercial | Program | Real Estate | Real Estate | Consumer | Unallocated | Total | |||||||||||||||||||||
| ALLL by Loan Portfolio: | ||||||||||||||||||||||||||||
| Beginning balance | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Charge-offs | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||||||
| Provision | ||||||||||||||||||||||||||||
| Ending balance | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| For the Nine Months Ended September 30, 2019 | ||||||||||||||||||||||||||||
| Paycheck | ||||||||||||||||||||||||||||
| Protection | Commercial | Residential | ||||||||||||||||||||||||||
| (Amounts in thousands) | Commercial | Program | Real Estate | Real Estate | Consumer | Unallocated | Total | |||||||||||||||||||||
| ALLL by Loan Portfolio: | ||||||||||||||||||||||||||||
| Beginning balance | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Charge-offs | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||||||
| Provision | ( | ) | ( | ) | ||||||||||||||||||||||||
| Ending balance | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
While the ALLL composition is an indication of specific amounts or loan categories in which future charge-offs may occur, actual amounts may differ. The unallocated portion of the ALLL provides for coverage of credit losses inherent in the loan portfolio but not captured in the credit loss factors that are utilized in the risk rating-based component, or in the specific impairment reserve component of the ALLL, and acknowledges the inherent imprecision of all loss prediction models. As of September 30, 2020 and December 31, 2019, the unallocated allowance amount represented
| As of September 30, 2020 | ||||||||||||||||||||||||||||
| Paycheck | ||||||||||||||||||||||||||||
| Protection | Commercial | Residential | ||||||||||||||||||||||||||
| (Amounts in thousands) | Commercial | Program | Real Estate | Real Estate | Consumer | Unallocated | Total | |||||||||||||||||||||
| ALLL: | ||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Collectively evaluated for impairment | ||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Gross loans: | ||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Collectively evaluated for impairment | ||||||||||||||||||||||||||||
| Total gross loans | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| As of December 31, 2019 | ||||||||||||||||||||||||||||
| Paycheck | ||||||||||||||||||||||||||||
| Protection | Commercial | Residential | ||||||||||||||||||||||||||
| (Amounts in thousands) | Commercial | Program | Real Estate | Real Estate | Consumer | Unallocated | Total | |||||||||||||||||||||
| ALLL: | ||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Collectively evaluated for impairment | ||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Gross loans: | ||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Collectively evaluated for impairment | ||||||||||||||||||||||||||||
| Total gross loans | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
The ALLL totaled $
We believe that the ALLL was adequate as of September 30, 2020. There is, however, no assurance that future loan and lease losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses. In addition, bank regulatory authorities, as part of their periodic examination of the Company, may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review.
COVID‐19
We anticipate that the COVID‐19 pandemic will result in continued economic recession and increased loan losses, particularly in certain hard hit industries such as airlines, travel and hospitality, retail and energy sectors. As a result, we have significantly increased our qualitative credit risk factors for “changes in international, national, regional and local conditions” and “changes in the volume and severity of past due loans and other similar conditions”.
ALLL Methodology
We have lending policies and procedures in place with the objective of optimizing loan income within an accepted risk tolerance level. We review and approve these policies and procedures annually. Monitoring and reporting systems supplement the review process with regular frequency as related to loan production, loan quality, concentrations of credit, potential problem loans, loan delinquencies, and nonperforming loans.
We formally assess the adequacy of the ALLL on a quarterly basis. The ALLL is based upon estimates of future loan and lease losses and is maintained at a level considered adequate to provide for probable losses inherent in the outstanding loan and lease portfolio. Our ALLL methodology incorporates management’s current judgments, and reflects management’s estimate of future loan and lease losses and risks inherent in the loan portfolio in accordance with ASC Topic 450 Contingencies (“ASC 450”) and ASC Topic 310 Receivables (“ASC 310”).
Management’s assessment of the ALLL is based on our continuing evaluation of all known relevant quantitative and qualitative internal and external risk factors provides the foundation for the three major components of the ALLL:
| (1) | Historical valuation allowances established in accordance with ASC 450, for groups of similarly situated loan pools. |
| (2) | General valuation allowances established in accordance with ASC 450, that are based on qualitative credit risk factors (e.g., portfolio trends, concentration of credit, growth, economic factors). Loss estimation factors are based on analysis of local economic factors. Allowances for changing environmental factors are management’s best estimate of the probable impact these changes have had on the loan portfolio as a whole. |
| (3) | Specific valuation allowances established in accordance with ASC 310, that are based on estimated probable losses on specific impaired loans. |
All three components are aggregated and constitute the ALLL; while portions of the allowance may be allocated to specific credits, the allowance net of specific reserves is available for the remaining credits that management deems as “loss.” It is our policy to classify a credit as loss with a concurrent charge-off when management considers the credit uncollectible and of such little value that its continuance as a bankable asset is not warranted. A loss classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer recognizing the likely credit loss of a valueless asset even though partial recovery may occur in the future.
The allowance is increased by provisions charged to expense and reduced by net charge-offs. In periodic evaluations of the adequacy of the allowance balance, management considers past loan and lease loss experience by type of credit, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay, the estimated value of any underlying collateral, current economic conditions and other factors.
Our assessment of the adequacy of the ALLL includes the periodic re-grading of classified loans based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the interest rate environment and other factors as warranted. Loans are initially rated when originated. They are reviewed as they are renewed, when there is a new loan to the same borrower and/or when identified facts demonstrate heightened risk of default.
Our loan portfolio is evaluated by general loan class including commercial, commercial real estate (which includes construction and other real estate), residential real estate (which includes 1-4 family and home equity loans), consumer and other loans. In accordance with ASC 450, historical valuation allowances are established for loan pools with similar risk characteristics common to each loan grouping. These loan pools are similarly risk-graded and each portfolio is evaluated by identifying all relevant risk characteristics that are common to these segmented groups of loans. These characteristics include a significant emphasis on historical losses within each loan group, inherent risks for each, and specific loan class characteristics such as trends related to nonaccrual loans, past due loans, criticized loans, net charge-offs or recoveries, among other relevant credit risk factors. We periodically review and update our historical loss ratios based on net charge-off experience for each loan and lease class. Other credit risk factors are also reviewed periodically and adjusted as necessary to account for any changes in potential loss exposure.
General valuation allowances, as prescribed by ASC 450, are based on qualitative factors such as changes in asset quality trends, concentrations of credit or changes in concentrations of credit, changes in underwriting standards, changes in experience or depth of lending staff or management, the effectiveness of loan grading and the internal loan review function, and any other relevant factors. Management evaluates each qualitative component quarterly to determine the associated risks to the quality of our loan portfolio.
Impaired loans
Management monitors delinquent loans continuously and identifies problem loans to be evaluated individually for impairment testing. For loans that are determined impaired, a formal impairment measurement is performed at least quarterly on a loan-by-loan basis. If the measurement of each impaired loans’ value is less than the recorded investment in the loan, we recognize this impairment and adjust the carrying value of the loan to fair value through the ALLL. For collateral dependent loans, this can be accomplished by charging off the impaired portion of the loan based on the underlying value of the collateral. For non-collateral dependent loans, we establish a specific component within the ALLL based on the present value of the future cash flows. If we determine the sources of repayment will not result in a reasonable probability that the carrying value of a loan can be recovered, the amount of a loan’s specific impairment is charged off against the ALLL. Impairment reserves on non-collateral dependent restructured loans are measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s carrying value. These impairment reserves are recognized as a specific component to be provided for in the ALLL.
Risk Characteristics and Underwriting
The following is a brief summary, by loan type, of management’s evaluation of the general risk characteristics and underwriting standards:
Commercial Loans – Commercial loans are underwritten after evaluating the borrower’s financial ability to maintain profitability including future expansion objectives. In addition, the borrower’s qualitative qualities are evaluated, such as management skills and experience, ethical traits, and overall business acumen. Commercial loans are primarily extended based on the cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The borrower’s cash flow may deviate from initial projections, and the value of collateral securing these loans may change.
Most commercial loans are generally secured by the assets being financed and other business assets such as accounts receivable or inventory. Management may also incorporate a personal guarantee; however, some short-term loans may be extended on an unsecured basis. Repayment of commercial loans secured by accounts receivable may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
PPP Loans - The Paycheck Protection Program (“PPP”) was launched in April of 2020 to provide small businesses assistance in the form of forgivable 100% guaranteed U.S. Small Business Administration (“SBA”) loans. We have actively participated in the PPP, funding $
Commercial Real Estate (“CRE”) Loans – CRE loans are subject to similar underwriting standards and processes as commercial loans. CRE loans are viewed predominantly as cash flow loans and secondarily as loans collateralized by real estate. Generally, CRE lending involves larger principal amounts with repayment largely dependent on the successful operation of the property securing the loan or the business conducted on the collateralized property. CRE loans tend to be more adversely affected by conditions in the real estate markets or by general economic conditions.
The properties securing the CRE portfolio are diverse in terms of type and primary source of repayment. This diversity helps reduce our exposure to adverse economic events that affect any single industry. We monitor and evaluate CRE loans based on occupancy status (investor versus owner occupied), collateral, geography, and risk grade criteria.
Generally, CRE loans are made to developers and builders that are secured by non-owner occupied properties require the borrower to have had an existing relationship with the Company and a proven record of success. Construction loans are underwritten utilizing feasibility studies, sensitivity analysis of absorption and lease rates, and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of cost and value associated with the complete project (as-is value). These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment largely dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property, or an interim loan commitment from the Company until permanent financing is secured. These loans are closely monitored by on-site inspections, and are considered to have higher inherent risks than other CRE loans due to their ultimate repayment sensitivity to interest rate changes, governmental regulation of real property, general economic conditions, and the availability of long-term financing.
Residential Real Estate Loans – We do not originate consumer real estate mortgage loans. The majority of our loans secured by non owner occupied residential real estate are made either as part of a commercial relationship and subject to similar underwriting standards and processes as the CRE portfolio, or loans that were purchased in a prior year as part of a pool of loans. Purchased loan pools are evaluated based on risk characteristics established for each segmented group of loans. These characteristics include a significant emphasis on historical losses within each loan group, inherent risks for each, and specific loan class characteristics such as trends related to nonaccrual loans, past due loans, criticized loans, net charge-offs or recoveries, among other relevant credit risk factors. Residential equity lines of credit are included in the discussion of consumer loans below.
We originate some single-family residence construction loans. The loan amounts are no greater than $1 million and are short-term real estate secured financing for the construction of a single-family residence to be occupied by the owner. The loans have a draw down feature with interest only payments, and a balloon payment at the 12-month maturity. All of these loans are refinanced and paid-off by the borrower’s permanent mortgage lender who provided the initial pre-approved mortgage financing. These loans are underwritten utilizing financial analysis of the borrower and are generally based upon estimates of cost and value associated with the complete project (as-is value). These estimates may be inaccurate. The loan disbursement and monitoring process is controlled utilizing similar processes as our CRE construction loans.
Consumer Loans – Our consumer loan originations are generally limited to home equity loans with nominal originations in unsecured personal loans. The portfolio also includes unsecured consumer home improvement loans and residential solar panel loans secured by UCC filings. We are highly dependent on third party credit scoring analysis to supplement the internal underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by management and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of
Concentrations of Credit Risk
As of September 30, 2020, approximately
Credit review
Confirmation of the quality of our loan grading process is obtained by independent reviews conducted by outside consultants specifically hired for this purpose and by periodic examination by various bank regulatory agencies. We maintain an independent loan review program that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to the Board of Directors, Loan Committee and Audit Committee. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as our policies and procedures.
Reserve For Unfunded Commitments
The reserve for unfunded commitments, which is included in Other Liabilities in the Consolidated Balance Sheets, was $
NOTE 5. QUALIFIED AFFORDABLE HOUSING PARTNERSHIP INVESTMENTS
We have invested in five separate LIHTC partnerships, which provide the Company with CRA credit. Additionally, the investments in LIHTC partnerships provide us with tax credits and with operating loss tax benefits over an approximately
Our investments in Qualified Affordable Housing Partnerships totaled $
The following tables present our original investment in LIHTC partnerships, the current recorded investment balance, and the unfunded liability balance of each investment at September 30, 2020 and December 31, 2019. In addition, the tables reflect the tax credits and tax benefits, amortization of the investment and the net impact to our income tax provision for the nine months ended September 30, 2020 and 2019.
| At September 30, 2020 |
For the Nine Months Ended September 30, 2020 |
|||||||||||||||||||||||
| Original |
Current |
Unfunded |
Tax Credits |
Amortization |
Net |
|||||||||||||||||||
| Investment |
Recorded |
Liability |
and |
of |
Income Tax |
|||||||||||||||||||
| (Amounts in thousands) |
Value |
Investment |
Obligation |
Benefits |
Investments |
Benefit (Expense) |
||||||||||||||||||
| Qualified Affordable Housing Partnerships: |
||||||||||||||||||||||||
| Raymond James California Housing Opportunities Fund II |
$ | $ | $ | $ | $ | $ | ||||||||||||||||||
| WNC Institutional Tax Credit Fund 38, L.P. |
||||||||||||||||||||||||
| Merritt Community Capital Corporation Fund XV, L.P. |
||||||||||||||||||||||||
| California Affordable Housing Fund |
( |
) | ||||||||||||||||||||||
| Boston Capital |
||||||||||||||||||||||||
| Total |
$ | $ | $ | $ | $ | $ | ||||||||||||||||||
| At December 31, 2019 |
For the Nine Months Ended September 30, 2019 |
|||||||||||||||||||||||
| Original |
Current |
Unfunded |
Tax Credits |
Amortization |
Net |
|||||||||||||||||||
| Investment |
Recorded |
Liability |
and |
of |
Income Tax |
|||||||||||||||||||
| (Amounts in thousands) |
Value |
Investment |
Obligation |
Benefits |
Investments |
Benefit (Expense) |
||||||||||||||||||
| Qualified Affordable Housing Partnerships: |
||||||||||||||||||||||||
| Raymond James California Housing Opportunities Fund II |
$ | $ | $ | $ | $ | $ | ||||||||||||||||||
| WNC Institutional Tax Credit Fund 38, L.P. |
||||||||||||||||||||||||
| Merritt Community Capital Corporation Fund XV, L.P. |
||||||||||||||||||||||||
| California Affordable Housing Fund |
( |
) | ||||||||||||||||||||||
| Total |
$ | $ | $ | $ | $ | $ | ||||||||||||||||||
The following tables present our generated tax credits and tax benefits from investments in qualified affordable housing partnerships for the three and nine months ended September 30, 2020 and 2019.
| For the Three Months Ended |
||||||||||||||||
| September 30, 2020 |
September 30, 2019 |
|||||||||||||||
| Generated |
Tax Benefits From |
Generated |
Tax Benefits from |
|||||||||||||
| (Amounts in thousands) |
Tax Credits |
Taxable Losses |
Tax Credits |
Taxable Losses |
||||||||||||
| Qualified Affordable Housing Partnerships: |
||||||||||||||||
| Raymond James California Housing Opportunities Fund II |
$ | $ | $ | $ | ||||||||||||
| WNC Institutional Tax Credit Fund 38, L.P. |
||||||||||||||||
| Merritt Community Capital Corporation Fund XV, L.P. |
||||||||||||||||
| California Affordable Housing Fund |
||||||||||||||||
| Boston Capital |
||||||||||||||||
| Total |
$ | $ | $ | $ | ||||||||||||
| For the Nine Months Ended |
||||||||||||||||
| September 30, 2020 |
September 30, 2019 |
|||||||||||||||
| Generated |
Tax Benefits From |
Generated |
Tax Benefits from |
|||||||||||||
| (Amounts in thousands) |
Tax Credits |
Taxable Losses |
Tax Credits |
Taxable Losses |
||||||||||||
| Qualified Affordable Housing Partnerships: |
||||||||||||||||
| Raymond James California Housing Opportunities Fund II |
$ | $ | $ | $ | ||||||||||||
| WNC Institutional Tax Credit Fund 38, L.P. |
||||||||||||||||
| Merritt Community Capital Corporation Fund XV, L.P. |
||||||||||||||||
| California Affordable Housing Fund |
||||||||||||||||
| Boston Capital |
||||||||||||||||
| Total |
$ | $ | $ | $ | ||||||||||||
The following table reflects the anticipated net income tax benefit and (expense) at September 30, 2020 that is expected to be recognized over the remaining lives of the investments.
| (Amounts in thousands) |
||||||||||||||||||||||||
| Qualified Affordable Housing Partnerships: |
2024 |
|||||||||||||||||||||||
| Anticipated income tax benefit, net less |
and |
|||||||||||||||||||||||
| amortization of investments |
2020 |
2021 |
2022 |
2023 |
thereafter |
Total |
||||||||||||||||||
| Raymond James California Housing Opportunities Fund II |
$ | $ | $ | $ | $ | $ | ||||||||||||||||||
| WNC Institutional Tax Credit Fund 38, L.P. |
||||||||||||||||||||||||
| Merritt Community Capital Corporation Fund XV, L.P. |
||||||||||||||||||||||||
| California Affordable Housing Fund |
( |
) | ( |
) | ( |
) | ( |
) | ( |
) | ||||||||||||||
| Boston Capital |
||||||||||||||||||||||||
| Total income tax benefit, net |
$ | $ | $ | $ | $ | $ | ||||||||||||||||||
NOTE 6. TERM DEBT
Term debt at September 30, 2020 and December 31, 2019 consisted of the following.
| (Amounts in thousands) | September 30, 2020 | December 31, 2019 | ||||||
| Term Debt: | ||||||||
| Federal Home Loan Bank of San Francisco borrowings | $ | $ | ||||||
| Subordinated Debt | ||||||||
| Unamortized debt issuance costs | ( | ) | ( | ) | ||||
| Net term debt | $ | $ | ||||||
Future contractual maturities of term debt at September 30, 2020 are as follows.
| (Amounts in thousands) | 2020 | 2021 | 2022 | 2023 | 2024 | Thereafter | Total | |||||||||||||||||||||
| Future Maturities: | ||||||||||||||||||||||||||||
| Federal Home Loan Bank of San Francisco borrowings | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Subordinated Debt | ||||||||||||||||||||||||||||
| Total future maturities | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
Federal Home Loan Bank of San Francisco Borrowings
We have an available line of credit with the Federal Home Loan Bank of San Francisco of $
The Bank had $
As of September 30, 2020, we have pledged $
Senior Debt
In December of 2015, the Holding Company entered into a senior debt loan agreement to borrow $
Subordinated Debt
In December of 2015, the Holding Company issued $
The Subordinated Debt is subordinate and junior in right of payment to the prior payment in full of all existing and future claims of creditors and depositors of the Holding Company and its subsidiaries, whether now outstanding or subsequently created. The Subordinated Debt ranks equally with all other unsecured subordinated debt, except any which by its terms is expressly stated to be subordinated to the Subordinated Debt. The Subordinated Debt ranks senior to all preferred stock and common stock of the Holding Company and all future junior subordinated debt obligations. The Subordinated Debt is recorded as term debt on the Holding Company’s balance sheet; however, for regulatory purposes, it is treated as Tier 2 capital by the Holding Company.
The Subordinated Debt will mature on December 10, 2025 but may be prepaid at the Holding Company’s option and with regulatory approval at any time on or after five years after the closing date or at any time upon certain events, such as a change in the regulatory capital treatment of the Subordinated Debt or the interest on the Subordinated Debt is no longer deductible by the Holding Company for United States federal income tax purposes.
Federal Funds
We have entered into nonbinding unsecured federal funds line of credit agreements with three financial institutions to support short-term liquidity needs. The lines totaled $
Federal Reserve Bank
We have an available line of credit with the Federal Reserve Bank totaling $
In April of 2020, we received approval from the Federal Reserve Bank to participate in the Paycheck Protection Program Liquidity Facility (“PPPLF”). The credit facility provides term funding for loans made under the PPP. Advances under the PPPLF will be collateralized with PPP loans, bear a fixed rate of interest at 0.35% and are to be repaid as the underlying loans are paid down, forgiven, or sold to the SBA. Participating institutions will receive preferential capital treatment for loans that are funded with this borrowing facility. To date, we have not utilized the liquidity available to us under the PPPLF and its associated beneficial capital treatment.
NOTE 7. COMMITMENTS AND CONTINGENCIES
Financial Instruments with Off-Balance Sheet Risk
Our consolidated financial statements do not reflect various commitments and contingent liabilities that arise in the normal course of our business and involve elements of credit, liquidity, and interest rate risk. In the normal course of business we are party to financial instruments with off-balance sheet credit risk to meet the financing needs of our customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. These instruments involve elements of credit and interest rate risk similar to the amounts recognized in the Consolidated Balance Sheets. The contract or notional amounts of these instruments reflect the extent of our involvement in particular classes of financial instruments.
The following table presents a summary of our commitments and contingent liabilities at September 30, 2020 and December 31, 2019.
| (Amounts in thousands) |
September 30, 2020 |
December 31, 2019 |
||||||
| Commitments: |
||||||||
| Commitments to extend credit |
$ | $ | ||||||
| Standby letters of credit |
||||||||
| Affordable housing grant sponsorships |
||||||||
| Access to housing and economic assistance for development grant sponsorships |
||||||||
| Total commitments and contingent liabilities |
$ | $ | ||||||
We were not required to perform on any financial guarantees during the nine months ended September 30, 2020, or during the year ended December 31, 2019. At September 30, 2020, approximately $
Affordable Housing Grants and Access to Housing and Economic Assistance for Development Grant Sponsorships
In fulfilling our CRA responsibilities, we are a sponsor for various nonprofit organizations that receive cash grants from the Federal Home Loan Bank of San Francisco. Those grants require the nonprofit organization to comply with stipulated conditions of the grant over specified periods of time which typically vary from 10 to 15 years. If the nonprofit organization fails to comply, Federal Home Loan Bank of San Francisco can require us to refund the amount of the grant to Federal Home Loan Bank of San Francisco. To mitigate this contingent credit risk, our Credit Administration underwrites the financial strength of the nonprofit organization and reviews their systems of internal control to determine, as best as possible, that they will comply with the conditions of the grant.
Death Benefit Agreement
The Company has entered into agreements with certain employees to pay a cash benefit to designated beneficiaries following the death of the employee. The payment will be made only if, at the time of death, the deceased employee was employed by the Bank and the Bank owned a life insurance policy on the employee’s life. Depending on specific facts and circumstances, the payment amount can vary up to a maximum of $
Legal Proceedings
We are involved in various pending and threatened legal actions arising in the ordinary course of business and if necessary, we maintain reserves for losses from legal actions, which are both probable and estimable. In our opinion, the disposition of claims currently pending will not have a material adverse effect on our financial position or results of operations.
Concentrations of Credit Risk
We grant many loans collateralized by real estate. In our judgment, a concentration exists in real estate related loans, which represented approximately
Although we believe such concentrations have no more than the normal risk of collectability, a substantial decline in the economy in general, material increases in interest rates, changes in tax policies, tightening credit or refinancing markets, or a decline in real estate values in our principal market areas in particular, could have an adverse impact on the repayment of these loans. Business and personal incomes, cash flows from rental operations, proceeds from the sale of real property, or proceeds from refinancing, represent the primary sources of repayment for a majority of these loans.
We recognize the credit risks inherent in dealing with other depository institutions. Accordingly, to prevent excessive exposure to other depository institutions in aggregate or individually, we have established general standards for selecting correspondent banks as well as internal limits for allowable exposure to other depository institutions in aggregate or individually. In addition, we have an investment policy that sets forth limitations that apply to all investments with respect to credit rating and concentrations with an issuer.
NOTE 8. LEASES
We lease eight locations under non-cancelable operating leases. The leases contain various provisions for increases in rental rates based on predetermined escalation schedules. Substantially all of the leases include the option to extend or terminate the lease term one or more times following expiration of the initial term at a rental rate established in the lease. For leases where we are reasonably certain that we will exercise the option to renew the lease, we have recognized those options in our right-of-use lease asset and liability. We had no other (financing, short-term or variable) lease arrangements during the current period or the prior year.
We have applied ASC Topic 842 as of January 1, 2019 and elected the practical expedients package for all of our leases. In accordance with the practical expedients package we were not required to reassess whether any expired or existing contracts are leases or contain leases. We were also not required to reassess the lease classification for existing or expired leases between operating and finance leases. We have recorded a liability in Other Liabilities in our Consolidated Balance Sheets representing the present value of the remaining minimum lease payments and we have recorded an offsetting right-of-use asset in Other Assets in our Consolidated Balance Sheets. The present value calculation uses a discount rate, which is based on our incremental borrowing rate. The right-of-use asset was also reduced for amounts recognized under the previous accounting requirements. The table below presents information regarding our leases as of September 30, 2020.
| (Dollars in thousands) |
September 30, 2020 |
|||
| Leases: |
||||
| Right-of-use lease asset |
$ | |||
| Lease liability |
$ | |||
| Weighted Average Remaining Lease Term |
||||
| Weighted Average Discount Rate |
% |
|||
Lease expenses are recorded on a straight-line basis over the life of each lease. Lease expense and cash paid on leases are presented in the table below for the periods indicated.
| Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
| (Amounts in thousands) |
2020 |
2019 |
2020 |
2019 |
||||||||||||
| Leases: |
||||||||||||||||
| Operating lease expense |
$ | $ | $ | $ | ||||||||||||
| Cash paid for operating leases |
$ | $ | $ | $ | ||||||||||||
The following table sets forth, as of September 30, 2020, the future minimum lease cash payments under non-cancelable operating leases and a reconciliation of the undiscounted cash flows to the operating lease liability.
| (Amounts in thousands) |
Amount |
|||
| Due in: |
||||
| 2020 |
$ | |||
| 2021 |
||||
| 2022 |
||||
| 2023 |
||||
| 2024 |
||||
| Thereafter |
||||
| Total undiscounted future minimum lease cash payments |
||||
| Present value adjustment |
( |
) | ||
| Lease liability |
$ | |||
Our election to utilize the practical expedients package did not result in the recognition of any additional leases, changes in lease terms, changes in classification or in the assessment of initial direct costs. ASC 842 was applied as a change in accounting principle and did not result in any adjustment to equity. The significant judgments made in applying the requirements in ASC Topic 842 are the determination of the incremental borrowing rate for the lease and determination of the length of the lease beyond non-cancellable periods. We used the borrowing rates available under our existing line of credit with the Federal Home Loan Bank of San Francisco for terms similar to the lease terms as our incremental borrowing rate. We recognize renewal periods beyond the non-cancellable term of the lease for periods when we are reasonably certain to exercise our option to extend the term of the lease.
NOTE 9. FAIR VALUES
The following tables present estimated fair values of our financial instruments as of September 30, 2020 and December 31, 2019, whether or not recognized or recorded at fair value in the Consolidated Balance Sheets. The tables indicate the fair value hierarchy of the valuation techniques we utilized to determine such fair value. Non-financial assets and non-financial liabilities defined by the FASB ASC 820, Fair Value Measurement, such as Bank premises and equipment, deferred taxes and other liabilities are excluded from the table. In addition, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements of FASB ASC 825, Financial Instruments, such as bank-owned life insurance policies.
| Carrying |
Fair Value Measurements Using |
|||||||||||||||
| (Amounts in thousands) |
Amounts |
Level 1 |
Level 2 |
Level 3 |
||||||||||||
| September 30, 2020 |
||||||||||||||||
| Financial assets |
||||||||||||||||
| Cash and cash equivalents |
$ | $ | $ | $ | ||||||||||||
| Securities available-for-sale |
$ | $ | $ | $ | ||||||||||||
| Net loans |
$ | $ | $ | $ | ||||||||||||
| Federal Home Loan Bank of San Francisco stock |
$ | $ | $ | $ | ||||||||||||
| Financial liabilities |
||||||||||||||||
| Deposits |
$ | $ | $ | $ | ||||||||||||
| Term debts |
$ | $ | $ | $ | ||||||||||||
| Junior subordinated debenture |
$ | $ | $ | $ | ||||||||||||
| Carrying |
Fair Value Measurements Using |
|||||||||||||||
| (Amounts in thousands) |
Amounts |
Level 1 |
Level 2 |
Level 3 |
||||||||||||
| December 31, 2019 |
||||||||||||||||
| Financial assets |
||||||||||||||||
| Cash and cash equivalents |
$ | $ | $ | $ | ||||||||||||
| Securities available-for-sale |
$ | $ | $ | $ | ||||||||||||
| Net loans |
$ | $ | $ | $ | ||||||||||||
| Federal Home Loan Bank of San Francisco stock |
$ | $ | $ | $ | ||||||||||||
| Financial liabilities |
||||||||||||||||
| Deposits |
$ | $ | $ | $ | ||||||||||||
| Term debt |
$ | $ | $ | $ | ||||||||||||
| Junior subordinated debenture |
$ | $ | $ | $ | ||||||||||||
Fair Value Hierarchy
Level 1 valuations utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access.
Level 2 valuations utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 valuations include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 valuations are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety.
We maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. The following table presents the quantitative information used to fair value our net loans at September 30, 2020.
| Quantitative Information about Level 3 Fair Value Measurements |
|||||||
| Unobservable Inputs |
Range (Weighted Average) |
||||||
| Probability of Default (PD) |
- | - | |||||
| Loss Given Default (LGD) |
- | - | |||||
| Prepayment Rate |
- | - | |||||
| Discount Rate |
- | - | |||||
Recurring Items
Debt Securities – The available-for-sale securities amount in the recurring fair value table above represents securities that have been adjusted to their fair values. For these securities, we obtain fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions among other things. We have determined that the source of these fair values falls within Level 2 of the fair value hierarchy.
The following tables present information about our assets and liabilities measured at fair value on a recurring basis, and indicate the fair value hierarchy of the valuation techniques we utilized to determine such fair value, as of September 30, 2020 and December 31, 2019.
| (Amounts in thousands) |
Fair Value at September 30, 2020 |
|||||||||||||||
| Recurring Basis |
Total |
Level 1 |
Level 2 |
Level 3 |
||||||||||||
| Available-for-sale securities: |
||||||||||||||||
| U.S. government and agencies |
$ | $ | $ | $ | ||||||||||||
| Obligations of state and political subdivisions |
||||||||||||||||
| Residential mortgage-backed securities and collateralized mortgage obligations |
||||||||||||||||
| Commercial mortgage-backed securities |
||||||||||||||||
| Other asset-backed securities |
||||||||||||||||
| Total assets measured at fair value |
$ | $ | $ | $ | ||||||||||||
| (Amounts in thousands) |
Fair Value at December 31, 2019 |
|||||||||||||||
| Recurring Basis |
Total |
Level 1 |
Level 2 |
Level 3 |
||||||||||||
| Available-for-sale securities: |
||||||||||||||||
| U.S. government and agencies |
$ | $ | $ | $ | ||||||||||||
| Obligations of state and political subdivisions |
||||||||||||||||
| Residential mortgage-backed securities and collateralized mortgage obligations |
||||||||||||||||
| Corporate securities |
||||||||||||||||
| Commercial mortgage-backed securities |
||||||||||||||||
| Other asset-backed securities |
||||||||||||||||
| Total assets measured at fair value |
$ | $ | $ | $ | ||||||||||||
Transfers Between Fair Value Hierarchy Levels
Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstance that caused the transfer. There were no transfers between levels of the fair value hierarchy during the three and nine months ended September 30, 2020 or the year ended December 31, 2019.
Nonrecurring items
We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis. These adjustments to fair value generally result from the application of lower of cost or fair value accounting or write-downs of individual assets due to impairment.
Collateral Dependent Loans - The loan amounts below represent impaired, collateral dependent loans that have been adjusted to fair value during the respective reporting period. When we identify a collateral dependent loan as impaired, we measure the impairment using the current fair value of the collateral, less selling costs. Depending on the characteristics of a loan, the fair value of collateral is generally estimated by obtaining external appraisals. If we determine that the value of the impaired loan is less than the recorded investment in the loan, we recognize this impairment and adjust the carrying value of the loan to fair value through the ALLL. When the fair value of the collateral is based on an appraisal or other estimate and there is no observable market price, we record the impaired loan as nonrecurring Level 3 fair value. Impaired loan valuations are adjusted for estimated selling costs ranging from
OREO - The OREO amounts below represent impaired real estate that has been adjusted to fair value during the respective reporting period. The loss represents impairments on OREO for fair value adjustments based on the fair value of the real estate. The determination of fair value is based on recent appraisals of the foreclosed properties, which take into account recent sales prices adjusted for unobservable inputs, such as opinions provided by local real estate brokers and other real estate experts. OREO fair values are adjusted for estimated selling costs of
The following tables present information about our assets at September 30, 2020 and December 31, 2019 measured at fair value on a nonrecurring basis for which a nonrecurring fair value adjustment has been recorded during the reporting period. The amounts disclosed below present the fair values at the time the nonrecurring fair value measurements were made, and not necessarily the fair values as of the date reported upon.
| Fair Value at September 30, 2020 |
||||||||||||||||
| (Amounts in thousands) |
Total |
Level 1 |
Level 2 |
Level 3 |
||||||||||||
| Nonrecurring basis: |
||||||||||||||||
| Collateral dependent impaired loans |
$ | $ | $ | $ | ||||||||||||
| Other real estate owned |
||||||||||||||||
| Total assets measured at fair value |
$ | $ | $ | $ | ||||||||||||
| Fair Value at December 31, 2019 |
||||||||||||||||
| (Amounts in thousands) |
Total |
Level 1 |
Level 2 |
Level 3 |
||||||||||||
| Nonrecurring basis: |
||||||||||||||||
| Collateral dependent impaired loans |
$ | $ | $ | $ | ||||||||||||
| Other real estate owned |
||||||||||||||||
| Total assets measured at fair value |
$ | $ | $ | $ | ||||||||||||
The following table presents the losses resulting from nonrecurring fair value adjustments for the three and nine months ended September 30, 2020 and 2019 related to assets outstanding at September 30, 2020 and 2019.
| Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
| (Amounts in thousands) |
2020 |
2019 |
2020 |
2019 |
||||||||||||
| Fair value adjustments: |
||||||||||||||||
| Collateral dependent impaired loans |
$ | $ | $ | $ | ||||||||||||
| Other real estate owned |
||||||||||||||||
| Total |
$ | $ | $ | $ | ||||||||||||
During the nine months ended September 30, 2020, collateral dependent impaired loans with a carrying value of $
During the nine months ended September 30, 2019, collateral dependent impaired loans with a carrying value of $
During the nine months ended September 30, 2020,
During the nine months ended September 30, 2019,
Limitations
Fair value estimates are made at a specific point in time, based on relevant market information and other information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time, our entire holdings of a particular financial instrument. Because no market exists for a significant portion of our financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature, involve uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based only on current on and off-balance sheet financial instruments. Our fair value estimates do not include any adjustment for anticipated future business. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.
NOTE 10. ACQUISITION
On January 31, 2019, we completed the acquisition of Merchants Holding Company (“Merchants”), to extend our presence in the Sacramento marketplace. Merchants, headquartered in Sacramento, California, was the parent company of Merchants National Bank of Sacramento (“Merchants Bank”), a 97-year-old bank with approximately $
We paid $
The acquisition of Merchants constituted a business combination and was accounted for using the acquisition method of accounting. The assets acquired and liabilities assumed, both tangible and intangible, were recorded at their fair values as of the acquisition date in accordance with ASC 805, Business Combinations. The Bank engaged third party specialists to assist in valuing certain assets, including investment securities, loans, real estate and the core deposit intangible that resulted from the acquisition. The acquisition was treated as a "reorganization" within the definition of section 368(a) of the Internal Revenue Code and is generally considered tax-free for U.S. federal income tax purposes.
The calculation of goodwill recorded during 2019 is detailed below.
| As Recorded by | Fair Value | |||||||||||
| Merchants | And Other Acquisition | As Recorded by | ||||||||||
| (Amounts in thousands) | Holding Company | Related Adjustments | the Company | |||||||||
| Consideration paid: | ||||||||||||
| Cash | $ | |||||||||||
| Stock 1,834,142 shares at $10.69 per share | ||||||||||||
| Total consideration | $ | |||||||||||
| Assets acquired: | ||||||||||||
| Cash and fed funds sold | $ | $ | — | $ | ||||||||
| Investment securities | ( | ) | ||||||||||
| Loans, gross | ( | ) | ||||||||||
| Allowance for loan and lease losses | ( | ) | ||||||||||
| Interest receivable | — | |||||||||||
| Premises and equipment, net | ||||||||||||
| Deferred tax assets, net | ( | ) | ||||||||||
| Federal Home Loan Bank of San Francisco stock | — | |||||||||||
| Life insurance | — | |||||||||||
| Other assets | ||||||||||||
| Core deposit intangible | ||||||||||||
| Total assets acquired | $ | $ | $ | |||||||||
| Liabilities assumed: | ||||||||||||
| Demand, money market and savings | $ | $ | — | $ | ||||||||
| Certificates of deposit | — | |||||||||||
| Total deposits | — | |||||||||||
| Other liabilities | ||||||||||||
| Total liabilities assumed | $ | $ | $ | |||||||||
| Net identifiable assets acquired over liabilities assumed | $ | $ | $ | |||||||||
| Goodwill | $ | |||||||||||
Goodwill
As a result of the Merchants acquisition, we recorded goodwill totaling $
The following is a description of the methods used to determine the fair values of significant assets and liabilities whose fair values are different from their carrying amounts on Merchants' books at acquisition date presented above.
Investment Securities
Fair values for securities were obtained from an independent pricing service and were based on quoted market prices, where available. If quoted market prices were not available, fair value estimates were based on observable inputs including quoted market prices for similar instruments, quoted market prices that were not in an active market, other inputs that were observable in the market or a discounted cash flow model.
Loans
We engaged a third party to assist us in determining the fair values for the loans acquired from Merchants based upon the present values of the expected cash flows and market-derived discount rates. There were no loans acquired with evidence of deterioration of credit quality since origination for which we believe it is probable that we will be unable to collect all contractually required payments receivable. A fair value discount of $
Premises and Equipment
We engaged an independent licensed appraiser to determine the fair value of the acquired branch located in Sacramento. The fair value of tangible personal property was not material.
Deferred Tax Assets
Deferred income tax assets were recorded to reflect the difference between the carrying values of the acquired assets and liabilities for financial reporting purposes and the basis for income tax purposes using the Company’s statutory federal and state income tax rates. During 2019, the final tax returns were completed for Merchants and the net deferred tax assets were adjusted to fair value.
Core Deposit Intangible
We engaged an independent third party to assist us in determining the core deposit intangible asset of $
| (Amounts in thousands) | 2020 | 2021 | 2022 | 2023 | 2024 | Thereafter | Total | |||||||||||||||||||||
| Core deposit intangible amortization | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
Pro Forma Results of Operations
The following table presents pro forma information of the combined entity as if the acquisition occurred on January 1, 2019. The pro forma information does not necessarily reflect the results of operations that would have resulted had the acquisition been completed at the beginning of the periods presented, nor is it indicative of the results of operations in future periods. Furthermore, cost savings and other business synergies related to the acquisition are not reflected in the pro forma amounts.
| For the Three Months Ended | For the Nine Months Ended | |||||||
| September 30, | September 30, | |||||||
| (Amounts in thousands) | 2019 | 2019 | ||||||
| Pro forma revenue and earnings: | ||||||||
| Net interest income | $ | $ | ||||||
| Net income (1) | $ | $ | ||||||
| (1) Net income includes acquisition-related costs of ($ | ||||||||
It is impracticable to separately provide information regarding the amount of revenue and earnings from Merchants included in our Consolidated Statement of Income because the operations of Merchants were substantially comingled with the operations of the Company as of the acquisition date.
NOTE 11. GOODWILL AND OTHER INTANGIBLES
Goodwill and Other Intangibles, net consisted of the following at September 30, 2020 and December 31, 2019.
| September 30, | December 31, | |||||||
| (Amounts in thousands) | 2020 | 2019 | ||||||
| Goodwill and Other Intangibles: | ||||||||
| Goodwill | $ | $ | ||||||
| Core deposit intangibles | ||||||||
| Domain name | ||||||||
| Accumulated amortization | ( | ) | ( | ) | ||||
| Goodwill and other intangibles, net | $ | $ | ||||||
Goodwill
Goodwill is a common byproduct of a business combination, and is calculated as the amount of consideration paid in excess of the fair value of the net assets acquired in a transaction. Goodwill is considered to have an indefinite life and is therefore not amortized. It is reviewed annually for impairment, or more frequently if required by circumstances known as triggering events. At September 30, 2020, goodwill totaled $
Events during 2020 have caused management to consider reviewing goodwill for impairment more frequently than on an annual basis. These events include deterioration in general economic conditions, decreased overall financial performance of the Company and a sustained decrease in the Company’s stock price.
The Company’s share price has traded below tangible book value for the entire second and third quarters of 2020 without interruption, a period we deemed to be sustained. We considered the sustained depressed price of our stock to be a triggering event that required us to evaluate if goodwill had been impaired on an interim basis.
After performing our qualitative assessment at September 30, 2020, we believe that it is more-likely-than- that the fair value of our Bank (our only reporting unit) was more than the carrying amount and that a quantitative impairment test was unnecessary.
Core Deposit Intangibles
Acquired core deposits provide value as a source of below market rate funds and the realization of interest cost savings is a fundamental rationale for assuming these deposit liabilities. The cost savings is defined as the difference between the cost of funds on our new deposits (i.e., interest and net maintenance costs) and the cost of an equal amount of funds from an alternative source having a similar term as the new deposit base. Our core deposit intangibles were recorded at fair value which was derived using the income approach and represent the present value of the cost savings over the projected term of our new deposit base. The core deposit intangible is being amortized on a straight-line basis over an estimated eight-year life, and is evaluated annually for impairment.
The following table sets forth, as of September 30, 2020, the total estimated future amortization of intangible assets:
| (Amounts in thousands) | Amount | |||
| Amortization: | ||||
| 2020 | $ | |||
| 2021 | ||||
| 2022 | ||||
| 2023 | ||||
| 2024 | ||||
| 2025 and thereafter | ||||
| Total | $ | |||
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward Looking Statements and Risk Factors
This report includes forward-looking statements within the meaning of the Securities Exchange Act of 1934 (“Exchange Act”) and the Private Securities Litigation Reform Act of 1995. These statements are based on management’s current beliefs and assumptions, and on information available to management as of the date of this document. Forward-looking statements include the information concerning possible or assumed future results of operations of the Company set forth under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Forward-looking statements may also include statements in which words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” “considers” or similar expressions or conditional verbs such as “will,” “should,” “would” and “could” and other comparable words or phrases of a future- or forward-looking nature, are intended to identify such forward-looking statements. Forward-looking statements are not guarantees of future performance. They involve risks, uncertainties and assumptions. The Company’s actual future results and shareholder values may differ materially from those anticipated and expressed in these forward-looking statements. Many of the factors that will determine these results and values are beyond the Company’s ability to control or predict. Except as specifically noted herein all references to the “Company” refer to Bank of Commerce Holdings, a California corporation, and its consolidated subsidiaries.
The following factors, among others, could cause our actual results to differ materially from those expressed in such forward-looking statements:
| ● |
The strength of the United States economy in general and the strength of the local economies in California in which we conduct operations; |
| ● |
The effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System, or the Federal Reserve Board; |
| ● |
Developments and changes in Federal and state laws and regulations, such as the recently enacted Coronavirus Aid Relief and Economic Security Act (“CARES Act”) addressing the economic effects of the COVID-19 pandemic and increased regulation of the banking industry through legislative action and revised rules and standards applied by the Federal Reserve Board, the Federal Deposit Insurance Corporation and the California Department of Financial Protection and Innovation; |
| ● |
The economic effects of COVID-19 or similar pandemic diseases could adversely affect our future results of operations or the market price of our stock; |
| ● |
The effects of the COVID-19 pandemic could adversely affect our customers’ future results of operations; |
| ● |
Our inability to successfully manage our growth or implement our growth strategy; |
| ● |
Volatility in the capital or credit markets; |
| ● |
Our inability to transition from LIBOR to a substitute index; |
| ● |
Changes in the financial performance and/or condition of our borrowers; |
| ● |
Our concentration in real estate lending; |
| ● |
Changes in the cost and scope of insurance from the Federal Deposit Insurance Corporation and other third parties; |
| ● |
Changes in consumer spending, borrowing and savings habits; |
| ● |
Deterioration in the reputation of banks and the financial services industry could adversely affect the Company's ability to obtain and retain customers; |
| ● |
Changes in the level of our nonperforming assets and loan charge-offs; |
| ● |
Deterioration in values of real estate in California and the United States generally, both residential and commercial; |
| ● |
Possible other-than-temporary impairment of securities held by us; |
| ● |
Possible impairment of goodwill or core deposit intangibles; |
| ● |
Our inability to timely develop competitive new products and services and/or resistance to the acceptance of these products and services by new and existing customers; |
| ● |
The willingness of customers to substitute competitors’ products and services for our products and services; |
| ● |
Technological changes could expose us to new risks, including potential systems failures or fraud; |
| ● |
The effect of changes in accounting policies and practices, as may be adopted from time-to-time by bank regulatory agencies, the Securities and Exchange Commission (“SEC”), the Public Company Accounting Oversight Board, the Financial Accounting Standards Board (“FASB”) or other accounting standards setters; |
| ● |
The risks presented by public stock market volatility, which could adversely affect the market price of the Company's common stock and the ability to raise additional capital; |
| ● |
Our inability to attract deposits and other sources of liquidity at acceptable costs; |
| ● |
Changes in the competitive environment among financial and bank holding companies and other financial service providers, including Fintech companies; |
| ● |
Consolidation in the financial services industry resulting in the creation of larger financial institutions that may have greater resources could change the competitive landscape; |
| ● |
The loss of critical personnel and the challenge of hiring qualified personnel at acceptable compensation levels; |
| ● |
Natural disasters, such as earthquakes, volcanic eruptions, tsunami, wildfires, droughts, floods, mudslides, hurricanes, tornados and other geologic processes; |
| ● |
Natural disasters outside California, could negatively impact our purchased loan portfolio or our third party loan servicers; |
| ● |
Unauthorized computer access, computer hacking, cyber-attacks, electronic fraudulent activity, attempted theft of financial assets, computer viruses, phishing schemes and other security problems; |
| ● |
Geopolitical conditions, including acts or threats of war or terrorism, actions taken by the United States or other governments in response to acts or threats of war or terrorism and/or military conflicts, which could impact business and economic conditions in the United States and abroad; |
| ● |
Our inability to manage the risks involved in the foregoing; and |
| ● |
The effects of any reputational damage to the Company resulting from any of the foregoing. |
If our assumptions regarding one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements contained in this document and in the information incorporated by reference in this document. Therefore, we caution you not to place undue reliance on our forward-looking information and statements. We do not undertake any obligation to publicly correct, revise, or update any forward-looking statement if we later become aware that actual results are likely to differ materially from those expressed in such forward-looking statement, except as required under federal securities laws. Forward-looking statements should not be viewed as predictions, and should not be the primary basis upon which investors evaluate us. Any investor in our common stock should consider all risks and uncertainties discussed in “RISK FACTORS” and in “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS”.
For additional information concerning risks and uncertainties related to the Company and its operations please refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 under the heading “Risk Factors”. The Company undertakes no obligation to revise or publicly release the results of any revision to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
The following sections discuss significant changes and trends in the financial condition, capital resources and liquidity of the Company from December 31, 2019 to September 30, 2020. Also discussed are significant trends and changes in the Company’s results of operations for the three and nine months ended September 30, 2020, compared to the same periods in 2019. The consolidated financial statements and related notes appearing elsewhere in this report are unaudited. The following discussion and analysis is intended to provide greater detail of the Company's financial condition and results.
GENERAL
Bank of Commerce Holdings (“Company,” “Holding Company,” “we,” or “us”) is a corporation organized under the laws of California and a bank holding company (“BHC”) registered under the Bank Holding Company Act of 1956, as amended (“BHC Act”) with its principal offices in Sacramento, California. The Holding Company’s principal business is to serve as a holding company for Merchants Bank of Commerce (the “Bank” and together with the Holding Company, the “Company”) and Bank of Commerce Mortgage (inactive). The Bank changed its name for all operations to Merchants Bank of Commerce effective May 20, 2019. We have an unconsolidated subsidiary in Bank of Commerce Holdings Trust II, which was organized in connection with our prior issuance of trust-preferred securities. Our common stock is traded on the NASDAQ Global Market under the symbol “BOCH.”
We commenced banking operations in 1982 and grew organically to four branches before purchasing five Bank of America branches in 2016. With our 2019 acquisition of Merchants Holding Company, we now operate ten full service facilities and one limited service facility in northern California. We also operate a “cyber office” as identified in our summary of deposits reporting filed with the FDIC. We provide a wide range of financial services and products for business and retail customers which are competitive with those traditionally offered by banks of similar size in California. As of September 30, 2020 and December 31, 2019, we operated under one primary business segment: Community Banking.
Our principal executive office is located at 555 Capitol Mall Suite 1255, Sacramento, California 95814 and the telephone number is (800) 421-2575.
EXECUTIVE OVERVIEW
Significant items for the first nine months of 2020:
| ● |
$5.3 million provision for loan and lease losses. |
| ● |
$1.1 million in non-recurring costs associated with the termination of a technology management services contract and a previously disclosed severance agreement. |
| ● |
$163.5 million in loans funded through September 30, 2020 under the SBA’s Paycheck Protection Program (“PPP”) (606 loans). |
| ● |
1,409,499 shares of common stock repurchased. |
| ● |
COVID-19 loan deferrals totaled $38.6 million at September 30, 2020. Loans totaling $82.5 million with COVID-19 related payment deferrals at June 30, 2020 have resumed making payments. |
Financial highlights for the third quarter of 2020 compared to the same quarter a year ago:
Performance
| ● |
Net income of $4.3 million was a decrease of $313 thousand (7%) from $4.6 million earned during the same period in the prior year. Earnings of $0.26 per share – diluted was unchanged from the same period in the prior year and reflects the impact of the following: |
| o |
1.5 million shares of common stock repurchased between October of 2019 and April of 2020. |
| o |
$1.1 million provision for loan and lease losses for the current quarter compared to no provision for the same period in the prior year. |
| ● |
Net interest income increased $408 thousand (3%) to $14.1 million compared to $13.7 million for the same period in the prior year. |
| ● |
Net interest margin declined to 3.51% compared to 4.00% for the same period in the prior year. |
| ● |
Return on average assets decreased to 1.01% compared to 1.26% for the same period in the prior year. |
| ● |
Return on average equity decreased to 10.05% compared to 10.86% for the same period in the prior year. |
| ● |
Average loans totaled $1.209 billion, an increase of $180 million (17%) compared to average loans for the same period in the prior year. |
| ● |
Average earning assets totaled $1.601 billion, an increase of $241 million (18%) compared to average earning assets for the same period in the prior year. |
| ● |
Average deposits totaled $1.485 billion, an increase of $231 million (18%) compared to average deposits for the same period in the prior year. |
| o |
Average non-maturing deposits totaled $1.345 billion, an increase of $248 million (23%) compared to the same period in the prior year. |
| o |
Average certificates of deposit totaled $139.8 million, a decrease of $17.9 million (11%) compared to same period in the prior year. |
| ● |
The Company’s efficiency ratio was 54.8% compared to 56.4% during the same period in the prior year. |
| ● |
Book value per common share was $10.32 at September 30, 2020 compared to $9.42 at September 30, 2019. |
| ● |
Tangible book value per common share was $9.38 at September 30, 2020 compared to $8.51 at September 30, 2019. |
Credit Quality
| ● |
Nonperforming assets at September 30, 2020 totaled $8.1 million or 0.47% of total assets, a decrease of $4.7 million (37%) since September 30, 2019. The decrease in nonperforming assets results from one $10.9 million commercial real estate loan which was placed in nonaccrual status in the first quarter of 2019 and sold in the fourth quarter of 2019. |
| ● |
Net loan charge-offs were $316 thousand in the third quarter of 2020 compared with net loan recoveries of $160 thousand for the same quarter a year ago. Net loan charge-offs during the current quarter were primarily related to the unguaranteed portion of two commercial loans that are partially guaranteed under the California Capital Access Program for Small Business. |
Financial highlights for the first nine months of 2020 compared to the same period a year ago:
Performance
| ● |
Net income of $9.1 million was a decrease of $1.5 million (14%) from $10.6 million earned during the same period in the prior year. Earnings of $0.53 per share – diluted was a decrease of $0.06 (10%) per share from $0.59 per share – diluted earned during the same period in the prior year and reflects the impact of the following: |
| o |
1.5 million shares of common stock repurchased between October of 2019 and April of 2020. |
| o |
$5.3 million provision for loan and lease losses for the nine months ended September 30, 2020 compared to no provision for the same period in the prior year. |
| o |
$1.1 million in non-recurring costs for the first quarter of 2020 associated with the termination of a technology management services contract and a previously announced severance agreement. |
| o |
$2.7 million in non-recurring costs recorded during the nine months ended September 30, 2019 associated with our January 31, 2019 acquisition of Merchants National Bank of Sacramento and the name change of our subsidiary bank. |
| ● |
Net interest income increased $678 thousand (2%) to $40.9 million compared to $40.2 million for the same period in the prior year. |
| ● |
Net interest margin declined to 3.66% compared to 3.98% for the same period in the prior year. |
| ● |
Return on average assets decreased to 0.76% compared to 0.98% for the same period in the prior year. |
| ● |
Return on average equity decreased to 7.14% compared to 8.74% for the same period in the prior year. |
| ● |
Average loans totaled $1.142 billion, an increase of $124 million (12%) compared to average loans for the same period in the prior year. |
| ● |
Average earning assets totaled $1.493 billion, an increase of $143 million (11%) compared to the same period in the prior year. |
| ● |
Average deposits totaled $1.379 billion, an increase of $147 million (12%) compared to the same period in the prior year. |
| o |
Average non-maturing deposits totaled $1.236 billion, an increase of $167 million (16%) compared to the same period in the prior year. |
| o |
Average certificates of deposit totaled $143.3 million, a decrease of $19.7 million (12%) compared to the same period in the prior year. |
| ● |
The Company’s efficiency ratio was 60.2% compared to 66.5% for the same period in the prior year. |
| o |
The Company’s efficiency ratio of 60.2% for the first nine months of 2020 included $1.1 million in non-recurring costs. The efficiency ratio excluding these costs was 57.7%. |
| o |
The Company’s efficiency ratio of 66.5% for the first nine months of 2019 includes $2.7 million in non-recurring costs. The efficiency ratio excluding these non-recurring costs was 60.3%. |
| ● |
Book value per common share was $10.32 at September 30, 2020 compared to $9.62 at December 31, 2019. |
| ● |
Tangible book value per common share was $9.38 at September 30, 2020 compared to $8.71 at December 31, 2019. |
Credit Quality
| ● |
Nonperforming assets at September 30, 2020 totaled $8.1 million or 0.47% of total assets, an increase of $2.5 million (36% annualized) since December 31, 2019. The increase in nonperforming assets results from four loans that were placed in nonaccrual status during the nine months ended September 30, 2020. |
| ● |
Net loan charge-offs were $608 thousand in the first nine months of 2020 compared with net loan charge-offs of $7 thousand for the same period in the prior year. |
Impacts of COVID-19:
In response to challenges created by the COVID-19 pandemic, we are addressing those things which are within our control including the following.
| ● |
All of our branch offices remain open, although they are operating under a reduced schedule. Our pandemic response team is continuing to modify and enhance our workforce and customer protection as additional information or requirements are promulgated by the state of California. |
| ● |
At September 30, 2020, our workforce totaled 211 employees of which 107 are working remotely. |
| ● |
Through September 30, 2020, we have funded 606 loans totaling $163.5 million for the PPP. |
| ● |
The growth in our assets resulting from the PPP has impacted our Tier 1 Leverage capital ratio as we have not utilized the liquidity available to us from the Federal Reserve’s PPP Liquidity Facility and its associated beneficial capital treatment. Substantially all of the loans were made to existing customers and were funded under the two-year PPP loan program. |
| ● |
We have experienced a significant increase in deposit balances as all PPP loan funds were deposited into customer accounts at our Bank and as a result of customer behavior which is focused on cash accumulation. |
| ● |
At September 30, 2020, we have approved short-term loan payment deferrals on 107 loans totaling $38.6 million. Most of these deferrals expire during the fourth quarter of 2020. |
| ● |
For the six-month period from April through September, the SBA has made principal and interest payments on all our SBA 7(a) loans. Borrowers will resume responsibility for their payments in October. |
| ● |
Organic loan growth has been slowed as we maintain credit underwriting discipline in light of the current economic environment. |
| ● |
After considering qualitative factors, management determined that the Company’s goodwill was not impaired at September 30, 2020. |
SUMMARY OF CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are described in Note 2 of the Notes to the Consolidated Financial Statements included in the Form 10-K for the year ended December 31, 2019 filed with the SEC on March 6, 2020. Some of these significant accounting policies are considered critical and require management to make difficult, subjective or complex judgments or estimates. Management believes that the following policies would be considered critical under the SEC’s definition.
Valuation and Impairment of Investment Securities
At the time of purchase, we designate a security as held-to-maturity or available-for-sale, based on our investment objectives, operational needs and intent to hold. We do not engage in trading activity. Securities designated as held-to-maturity are carried at amortized cost. We have the ability and intent to hold these securities to maturity. Securities designated as available-for-sale may be sold to implement our asset/liability management strategies and in response to changes in interest rates, prepayment rates and similar factors. Securities designated as available-for-sale are recorded at fair value and unrealized gains or losses, net of income taxes, are reported as part of accumulated other comprehensive income (loss), a separate component of shareholders’ equity. Gains or losses on sale of securities are based on the specific identification method. The market value and credit rating of each security is monitored to identify changes in asset quality.
Security values may be adjusted to reflect changes in valuation as a result of other-than-temporary declines in value. Investments with fair values that are less than amortized costs are considered impaired. Impairment may result from either a decline in the financial condition of the issuing entity or from changes in interest rates. At each financial statement date, management assesses each investment to determine if impaired investments are temporarily impaired or if the impairment is other-than-temporary based upon the positive and negative evidence available. Evidence evaluated includes, but is not limited to, industry analyst reports, credit market conditions, and interest rate trends.
When an investment is other-than-temporarily impaired, we assess whether we intend to sell the security, or it is more-likely-than-not that we will be required to sell the security before recovery of its amortized cost basis less any current-period credit losses. If we intend to sell the security or if it is more-likely-than-not that we will be required to sell security before recovery of the amortized cost basis, the entire amount of other-than-temporary impairment is recognized in earnings.
For debt securities that are considered other-than-temporarily impaired and that we do not intend to sell and will not be required to sell prior to recovery of our amortized cost basis, we separate the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is calculated as the difference between the investment’s amortized cost basis and the present value of its expected future cash flows.
The remaining differences between the investment’s fair value and the present value of future expected cash flows is deemed to be due to factors that are not credit related and is recognized in other comprehensive income. Significant judgment is required in the determination of whether other-than-temporary impairment has occurred for an investment. We follow a consistent and systematic process for determining other-than-temporary impairment loss. We have designated the ALCO responsible for the other-than-temporary evaluation process.
The ALCO’s assessment of whether an other-than-temporary impairment loss should be recognized incorporates both quantitative and qualitative information including, but not limited to: (1) the length of time and the extent of which the fair value has been less than amortized cost, (2) the financial condition and near term prospects of the issuer, (3) our intent and ability to retain the investment for a period of time sufficient to allow for an anticipated recovery in value, (4) whether the debtor is current on interest and principal payments, and (5) general market conditions and industry or sector specific outlook. See Note 3 Securities in the Notes to Consolidated Financial Statements in this document for further detail on other-than-temporary impairment and the securities portfolio.
Allowance for Loan and Lease Losses
The ALLL is based upon estimates of loan and lease losses and is maintained at a level considered adequate to provide for probable losses inherent in the outstanding loan and lease portfolio. The allowance is increased by provisions charged to expense and reduced by net charge-offs. In periodic evaluations of the adequacy of the allowance balance, management considers our past loan and lease loss experience by type of credit, known and inherent risks in the portfolio, adverse situations that may affect a borrower's ability to repay, the estimated value of any underlying collateral, current economic conditions and other factors.
Management reviews the ALLL on a monthly basis and conducts a formal assessment of the adequacy of the ALLL on a quarterly basis. These assessments include the periodic re-grading of classified loans based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the interest rate environment and other factors as warranted. Loans are initially graded when originated. Loans are reviewed as they are renewed, when there is a new loan to the same borrower and/or when identified facts demonstrate heightened risk of default. Confirmation of the quality of our grading process is obtained by independent reviews conducted by outside consultants specifically hired for this purpose and by periodic examination by various bank regulatory agencies. Management monitors delinquent loans continuously and identifies problem loans to be evaluated individually for impairment testing. For loans that are determined impaired, formal impairment measurement is performed at least quarterly on a loan-by-loan basis.
Our method for assessing the appropriateness of the allowance includes specific allowances for identified problem loans, an allowance factor for categories of credits and allowances for changing environmental factors (e.g., portfolio trends, concentration of credit, growth, economic factors). Allowances for identified problem loans are based on specific analysis of individual credits. Loss estimation factors for unimpaired loan categories are based on analysis of historical losses adjusted for changing environmental factors applicable to each loan category. Allowances for changing environmental factors are management's best estimate of the probable impact these changes would have on the loan portfolio as a whole. See Note 4 Loans in the Notes to Consolidated Financial Statements in this document for further detail on the ALLL and the loan portfolio.
Income Taxes
Income taxes reported in the consolidated financial statements are computed based on an asset and liability approach. We recognize the amount of taxes payable or refundable for the current year, and deferred tax assets and liabilities for the expected future tax consequences that have been recognized in the consolidated financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the consolidated financial statements and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We record net deferred tax assets to the extent it is more-likely-than-not that they will be realized. In evaluating our ability to recover the deferred tax assets, management considers all available positive and negative evidence, including projected future taxable income, tax planning strategies and recent financial operations.
In projecting future taxable income, management develops assumptions including the amount of future state and federal pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates being used to manage the underlying business. We file consolidated federal and state income tax returns.
ASC 740-10-55 Income Taxes requires a two-step process that separates recognition from measurement of tax positions. We recognize the financial statement effect of a tax position when it is more-likely-than-not, based on the technical merits, that the position will be sustained upon examination by a taxing authority. The measurement process is applied only after satisfying the recognition requirement and determines what amount of a tax position will be sustainable upon a potential examination or settlement. If upon measuring, the tax position produces a range of potential tax benefits, we may claim the highest tax benefit from that range as long as it is over 50% likely to be realized using a probability analysis.
We believe that all of the tax positions we have taken, meet the more-likely-than-not recognition threshold. To the extent tax authorities disagree with these tax positions, our effective tax rates could be materially affected in the period of settlement with the taxing authorities.
Fair Value Measurements
We use fair value measurements to record fair value adjustments to certain assets and liabilities, and to determine fair value disclosures. We base our fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Securities available-for-sale and derivatives are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record certain assets at fair value on a nonrecurring basis, such as certain impaired loans held for investment, (“OREO”), core deposit intangible and goodwill. These nonrecurring fair value adjustments typically involve write-downs of individual assets due to application of lower of cost or market accounting.
We have established and documented a process for determining fair value. We maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. Whenever there is no readily available market data, we use our best estimate and assumptions in determining fair value, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result, if other assumptions had been used, our recorded earnings or disclosures could have been materially different from those reflected in these consolidated financial statements. Additional information on our use of fair value measurements and our related valuation methodologies is provided in Note 9 Fair Values in the Notes to Consolidated Financial Statements incorporated in this document.
RECENT ACCOUNTING PRONOUNCEMENTS
ASU No. 2016-13
Description - In June of 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments are intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates.
Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. The ASU requires enhanced disclosures to help investors and other financial statement users to better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. In addition, the ASU amends the accounting guidance for credit losses on securities and purchased financial assets with credit deterioration.
Methods and timing of adoption – The FASB has voted to delay until January 2023 the implementation of the ASU No. 2016-13 for smaller reporting companies as defined by the SEC. We qualify as a smaller reporting company and in light of this delay, we have postponed the implementation of the ASU and have not determined when it will be implemented or the financial impact.
SOURCES OF INCOME
Net Interest Income
We derive our income primarily from net interest income, which is the difference between the interest income we receive on interest-earning assets and the interest expense we pay on interest-bearing liabilities. Net interest income is impacted by many factors that are beyond our control, including general economic conditions and the policies of various governmental and regulatory agencies, the Federal Reserve Board in particular. Aside from changes in market interest rates, the current net interest margin will be affected by the following:
| ● | The majority of our loans are fixed rate loans or variable rate loans that are already at their floor rate. This has mitigated the impact of declining interest rates on loan yields during 2020. The yield on loans, exclusive of PPP loans, has declined only four basis points from 4.80% during the first quarter of 2020 to 4.76% during the third quarter. | |
| ● |
We have funded PPP loans totaling $163.5 million which bear an interest rate of 1.00%. The yield on PPP loans is highly dependent on fees earned over the 24-month duration of the loans. For the three and nine months ended September 30, 2020, the average yield for PPP loans was 2.31% and 2.38%, respectively, including $538 thousand and $1.0 million, respectively, in fees earned on loans. At September 30, 2020, $3.3 million in unamortized fee income remains to be earned over the remaining contractual term of the loans. If the PPP loans are forgiven and repaid before the end of the 24-month loan term, we will accelerate the recognition the unamortized loan fee, which will increase the average yield on PPP loans for the quarter of forgiveness. | |
| ● | The impact of declining interest rates has been more immediate on our investment portfolio and out interest-bearing deposits in other banks. Much of our investment portfolio is collateralized by residential and commercial real estate mortgages. The rapid decline interest rates earlier in the year facilitated the refinance of many of these mortgages which accelerated bond repayments and accelerated amortization of bond premiums, lowering yields. Additionally, the cash flows from the investment portfolio were reinvested at substantially lower yields. Yield on taxable securities declined from 2.68% in the first quarter of 2020 to 2.24% in the third quarter of 2020. |
| ● |
During the first nine months of 2020, in response to the economic effects of the COVID-19 pandemic, the Federal Reserve cut its interest rates by 150 to 175 basis points. Our average yield on interest bearing deposits in other banks decreased 195 basis points for the current quarter compared to the same quarter a year ago. We have also experienced significant increased deposit balances due to PPP loan program disbursements and changes in customer behavior. If we can invest this excess liquidity into loans or our investment portfolio, we will enhance our net interest margin and net interest income. |
| ● |
Cash flows from our loan and investment portfolio are being reinvested in the current market at significantly lower rates. Recent bond purchases have centered on longer duration investments such as longer maturity municipal bonds and lower coupon mortgage backed securities. |
Net interest income reflects both the amount of earning assets we hold and our net interest margin, which is the difference between the yields we receive on our earning assets and the interest rates we pay to fund those assets. As a result, changes in either our net interest margin or the amount of earning assets we hold will affect our net interest income and earnings.
Increases or decreases in interest rates could adversely affect our net interest margin. Although our asset yields and funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, and cause our net interest margin to expand or contract. Many of our assets are tied to indexes, which adjust in response to changes in interest rates.
When market interest rates begin to increase in the future, we anticipate that our interest rate risk position will be neutral to moderately liability sensitive.
The low interest rate environment combined with excess liquidity from increased deposits that is being invested in lower yielding assets has contributed to reducing our net interest margin. Because many of our liabilities are already priced near historic lows with little room for further reductions, when interest rates decline, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets. This is particularly true given the large inflow of deposits we have experienced requiring funds to be invested at lower yields, providing further downward pressure on our net interest margin. We assess our interest rate risk by estimating the effect of interest rate changes on our earnings under various simulated scenarios. The scenarios differ based on assumptions including the direction, magnitude and speed of interest rate changes, and the slope of the yield curve.
There is always the risk that changes in interest rates could reduce our net interest income and earnings in material amounts, especially if actual conditions turn out to be materially different than simulated scenarios. For example, if interest rates rise or fall faster than we assumed or the slope of the yield curve changes, we may incur significant losses on debt securities we hold as investments. To reduce our interest rate risk, we may rebalance our investment and loan portfolios, refinance our debt and take other strategic actions which may result in losses or expenses.
The following table summarizes as of September 30, 2020, when loans are projected to reprice by year and by rate index.
| Years 6 |
||||||||||||||||||||||||||||||||
| Through |
Beyond |
|||||||||||||||||||||||||||||||
| (Amounts in thousands) |
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
Year 10 |
Year 10 |
Total |
||||||||||||||||||||||||
| Rate Index: |
||||||||||||||||||||||||||||||||
| Fixed |
$ | 151,140 | $ | 112,246 | $ | 80,366 | $ | 31,253 | $ | 28,809 | $ | 163,536 | $ | 22,862 | $ | 590,212 | ||||||||||||||||
| Variable: |
||||||||||||||||||||||||||||||||
| Prime |
84,620 | 4,712 | 7,187 | 6,788 | 7,724 | 1,412 | — | 112,443 | ||||||||||||||||||||||||
| 5 Year Treasury |
46,749 | 60,366 | 87,327 | 66,646 | 105,976 | 48,013 | — | 415,077 | ||||||||||||||||||||||||
| 7 Year Treasury |
3,252 | 609 | 4,764 | 5,631 | 368 | 13,560 | — | 28,184 | ||||||||||||||||||||||||
| 1 Year LIBOR |
21,748 | — | — | — | — | — | — | 21,748 | ||||||||||||||||||||||||
| Other Indexes |
5,627 | 1,668 | 2,030 | 1,443 | 7,314 | 10,278 | 906 | 29,266 | ||||||||||||||||||||||||
| Total variable |
161,996 | 67,355 | 101,308 | 80,508 | 121,382 | 73,263 | 906 | 606,718 | ||||||||||||||||||||||||
| Nonaccrual |
2,109 | 1,026 | 994 | 695 | 498 | 2,015 | 761 | 8,098 | ||||||||||||||||||||||||
| Total |
$ | 315,245 | $ | 180,627 | $ | 182,668 | $ | 112,456 | $ | 150,689 | $ | 238,814 | $ | 24,529 | $ | 1,205,028 | ||||||||||||||||
For variable rate loans, the following table summarizes those that are at or above their floor rate, and those that do not possess a contractual floor rate.
| At September 30, 2020 |
||||||||||||
| Loans At |
Loans Above |
|||||||||||
| (Amounts in thousands) |
Floor Rate |
Floor Rate |
Total |
|||||||||
| Variable rate loans with contractual floor rates: |
||||||||||||
| Prime |
$ | 58,674 | $ | 4,977 | $ | 63,651 | ||||||
| 5 year Treasury |
339,407 | 47,132 | 386,539 | |||||||||
| 7 Year Treasury |
28,184 | — | 28,184 | |||||||||
| 1 Year LIBOR |
— | 726 | 726 | |||||||||
| Other Indexes |
15,141 | 1,260 | 16,401 | |||||||||
| $ | 441,406 | $ | 54,095 | 495,501 | ||||||||
| Variable rate loans without contractual floor rates: |
||||||||||||
| Prime |
48,792 | |||||||||||
| 5 year Treasury |
28,538 | |||||||||||
| 1 Year LIBOR |
21,022 | |||||||||||
| Other Indexes |
12,865 | |||||||||||
| 111,217 | ||||||||||||
| Total accruing variable rate loans |
$ | 606,718 | ||||||||||
| Nonaccrual |
8,098 | |||||||||||
| Total variable rate loans |
$ | 614,816 | ||||||||||
Non Interest Income
We also earn noninterest income. Sources of noninterest income include fees earned on deposit related services, ATM and point of sale fees, payroll and benefit processing fees, earnings on bank-owned life insurance, gains on sale of available-for-sale securities, and dividends on Federal Home Loan Bank of San Francisco stock. Most of these sources of income do not vary significantly from quarter to quarter. Possible exceptions include gains on sale of available-for-sale securities and death proceeds from bank-owned life insurance.
RESULTS OF OPERATIONS
OVERVIEW
Third Quarter of 2020 Compared With Third Quarter of 2019
Net income for the third quarter of 2020 decreased $313 thousand compared to the third quarter of 2019. In the current quarter, net interest income was $408 thousand higher, noninterest income was $183 thousand higher and income taxes were $286 thousand lower. These changes were partially offset by a provision for loan and lease losses that was $1.1 million higher and noninterest expense that was $90 thousand higher.
First Nine Months of 2020 Compared With First Nine Months of 2019
Net income for the first nine months of 2020 decreased $1.5 million compared to the first nine months of 2019. In the current year, net interest income was $678 thousand higher, noninterest expense was $2.4 million lower and income taxes were $808 thousand lower. These changes were partially offset by a provision for loan and leases losses that was $5.3 million higher and noninterest income that was $127 thousand lower.
Return on Average Assets and Return on Average Equity
The following table presents the return on average assets and return on average equity for the three and nine months ended September 30, 2020 and 2019. For each of the periods presented, the table includes the calculated ratios based on reported net income as shown in the Consolidated Statements of Income incorporated in this document.
| For the Three Months Ended |
For the Nine Months Ended |
|||||||||||||||
| September 30, 2020 |
September 30, 2019 |
September 30, 2020 |
September 30, 2019 |
|||||||||||||
| Return on average assets |
1.01 | % |
1.26 | % |
0.76 | % |
0.98 | % |
||||||||
| Return on average equity |
10.05 | % |
10.86 | % |
7.14 | % |
8.74 | % |
||||||||
NET INTEREST INCOME AND NET INTEREST MARGIN
During the 2020, in response to the economic effects of the COVID-19 pandemic, the Federal Reserve cut interest rates by 150 to 175 basis points which contributed to a decrease in our net interest margin.
For the three months ended September 30, 2020 compared to the same period a year ago, net interest income increased $408 thousand.
Interest income for the third quarter of 2020 increased $17 thousand or less than 1% to $15.2 million.
| ● |
Interest and fees on loans increased $435 thousand due to a $179.7 million increase in average loan balances partially offset by a 59 basis point decrease in the average yield on the loan portfolio. Much of the 59 basis point decrease was caused by PPP loans which yielded only 2.31%. The yield on loans exclusive of PPP loans declined 26 basis points. |
| ● |
Interest on investment securities decreased $139 thousand due to a 41 basis point decrease in average yield partially offset by a $25.2 million increase in average securities balances. |
| ● |
Interest on interest-bearing deposits due from banks decreased $279 thousand due to a 195 basis point decrease in average yield that was partially offset by a $36.4 million increase in average interest-bearing deposit balances. |
Interest expense for the third quarter of 2020 decreased $391 thousand or 26% to $1.1 million.
| ● |
Interest expense on interest-bearing deposits decreased $336 thousand. Average interest-bearing demand and savings deposit balances increased $122.8 million, while average certificate of deposit balances decreased $17.9 million. The average rate paid on interest-bearing deposits decreased 20 basis points. |
| ● |
Average FHLB borrowings were $10.0 million in the current quarter. The borrowings bear no interest under a program offered by the FHLB during the second quarter of 2020 in response to COVID-19 liquidity concerns. There were no borrowings during the same period a year ago. |
| ● |
Interest expense on other term debt decreased $1 thousand. The average rate paid on other term debt increased three basis points. |
| ● |
Interest expense on junior subordinated debentures decreased $56 thousand. The average rate paid on junior subordinated debentures decreased 215 basis points. |
For the nine months ended September 30, 2020 compared to the same period a year ago, net interest income increased $678 thousand.
Interest income for the first nine months of 2020 decreased $195 thousand or less than 1% to $44.6 million.
| ● |
Interest and fees on loans increased $1.1 million due to a $124.4 million increase in average loan balances partially offset by a 42 basis point decrease in the average yield on the loan portfolio. Much of the 42 basis point decrease was caused by PPP loans which yielded only 2.38%. The yield on loans exclusive of PPP loans declined 21 basis points. |
| ● |
Interest on investment securities decreased $746 thousand due to an $8.4 million decrease in average securities balances and a 27 basis point decrease in average yield on the securities portfolio. |
| ● |
Interest on interest-bearing deposits due from banks decreased $568 thousand, a $26.8 million increase in average interest-bearing deposit balances was offset by a 191 basis point decrease in average yield. |
Interest expense for the first nine months of 2020 decreased $873 thousand or 19% to $3.7 million.
| ● |
Interest expense on interest-bearing deposits decreased $432 thousand. Average interest-bearing demand and savings deposit balances increased $74.4 million, while average certificate of deposit balances decreased $19.7 million. The average rate paid on interest-bearing deposits decreased ten basis points. |
| ● |
Interest expense on FHLB borrowings decreased $242 thousand. Average FHLB borrowings were $8.8 million for the first nine months of 2020 compared to $12.9 million for the same period a year ago. The average rate paid on FHLB borrowings decreased 248 basis points. The decrease in the average rate paid on FHLB borrowings is primarily due to borrowings in the current period that bear no interest under a program offered by the FHLB during the second quarter of 2020 in response to COVID-19 liquidity concerns. |
| ● |
Interest expense on other term debt decreased $71 thousand. During the second quarter of 2019, we completed the early repayment of our variable rate senior debt. |
| ● |
Interest expense on junior subordinated debentures decreased $128 thousand. The average rate paid on junior subordinated debentures decreased 166 basis points. |
Average Balances, Interest Income/Expense and Yields/Rates Earned/Paid
The following tables present condensed average balance sheet information, together with interest income and yields earned on average interest-earning assets, and interest expense and rates paid on average interest-bearing liabilities for the three and nine months ended September 30, 2020 and 2019.
| Three Months Ended September 30, 2020 |
Three Months Ended September 30, 2019 |
|||||||||||||||||||||||
| Average |
Average |
|||||||||||||||||||||||
| (Dollars in thousands) |
Balance |
Interest(1) |
Yield/ Rate(5) |
Balance |
Interest(1) |
Yield/ Rate(5) |
||||||||||||||||||
| Interest-earning assets: |
||||||||||||||||||||||||
| Loans, net of PPP (2) |
$ | 1,046,187 | $ | 12,499 | 4.75 | % |
$ | 1,029,534 | $ | 13,013 | 5.01 | % |
||||||||||||
| PPP loans |
163,090 | 949 | 2.31 | % |
— | — | — | % |
||||||||||||||||
| Taxable securities |
228,045 | 1,284 | 2.24 | % |
238,601 | 1,609 | 2.68 | % |
||||||||||||||||
| Tax-exempt securities (3) |
68,766 | 457 | 2.64 | % |
32,974 | 271 | 3.26 | % |
||||||||||||||||
| Interest-bearing deposits in other banks |
95,348 | 29 | 0.12 | % |
58,897 | 308 | 2.07 | % |
||||||||||||||||
| Average interest-earning assets |
1,601,436 | 15,218 | 3.78 | % |
1,360,006 | 15,201 | 4.43 | % |
||||||||||||||||
| Cash and due from banks |
23,381 | 23,822 | ||||||||||||||||||||||
| Premises and equipment, net |
15,365 | 15,922 | ||||||||||||||||||||||
| Goodwill |
11,671 | 11,686 | ||||||||||||||||||||||
| Other intangibles, net |
4,318 | 5,083 | ||||||||||||||||||||||
| Other assets |
47,945 | 45,925 | ||||||||||||||||||||||
| Average total assets |
$ | 1,704,116 | $ | 1,462,444 | ||||||||||||||||||||
| Interest-bearing liabilities: |
||||||||||||||||||||||||
| Demand - interest-bearing |
$ | 279,744 | 71 | 0.10 | % |
$ | 243,553 | 117 | 0.19 | % |
||||||||||||||
| Money market |
387,995 | 289 | 0.30 | % |
309,188 | 451 | 0.58 | % |
||||||||||||||||
| Savings |
146,074 | 74 | 0.20 | % |
138,296 | 131 | 0.38 | % |
||||||||||||||||
| Certificates of deposit |
139,757 | 420 | 1.20 | % |
157,620 | 491 | 1.24 | % |
||||||||||||||||
| Federal Home Loan Bank of San Francisco borrowings |
10,000 | — | — | % |
— | — | — | % |
||||||||||||||||
| Other borrowings |
9,988 | 184 | 7.33 | % |
9,942 | 183 | 7.30 | % |
||||||||||||||||
| Junior subordinated debentures |
10,310 | 50 | 1.93 | % |
10,310 | 106 | 4.08 | % |
||||||||||||||||
| Average interest-bearing liabilities |
983,868 | 1,088 | 0.44 | % |
868,909 | 1,479 | 0.68 | % |
||||||||||||||||
| Noninterest-bearing demand |
531,459 | 405,853 | ||||||||||||||||||||||
| Other liabilities |
17,356 | 18,074 | ||||||||||||||||||||||
| Shareholders’ equity |
171,433 | 169,608 | ||||||||||||||||||||||
| Average liabilities and shareholders’ equity |
$ | 1,704,116 | $ | 1,462,444 | ||||||||||||||||||||
| Net interest income and net interest margin (4) |
$ | 14,130 | 3.51 | % |
$ | 13,722 | 4.00 | % |
||||||||||||||||
| (1)Interest income on loans includes deferred fees and costs of approximately $240 thousand and $161 thousand for the three months ended September 30, 2020 and 2019, respectively. Interest income on PPP loans includes $538 thousand of fee income for the three months ended September 30, 2020. |
||||||||||||||||||
| (2) Loans, net of PPP includes average nonaccrual loans of $6.6 million and $13.2 million for the three months ended September 30, 2020 and 2019, respectively. |
||||||||||||||||||
| (3) Interest income and yields on tax-exempt securities are not presented on a taxable equivalent basis. |
||||||||||||||||||
| (4) Net interest margin is net interest income expressed as a percentage of average interest-earning assets. Net interest income for the three months ended September 30, 2020 and 2019 included $233 thousand and $193 thousand, respectively, in accretion of the discount on the loans acquired from Merchants Holding Company, which improved the net interest margin by 7 basis points. PPP loans decreased the net interest margin by 14 basis points. |
||||||||||||||||||
| (5) Yields and rates are calculated by dividing the income or expense by the average balance of the assets or liabilities, respectively, and annualizing the result. |
| Nine Months Ended September 30, 2020 |
Nine Months Ended September 30, 2019 |
|||||||||||||||||||||||
| Average |
Average |
|||||||||||||||||||||||
| (Dollars in thousands) |
Balance |
Interest(1) |
Yield/ Rate(5) |
Balance |
Interest(1) |
Yield/ Rate(5) |
||||||||||||||||||
| Interest-earning assets: |
||||||||||||||||||||||||
| Loans, net of PPP (2) |
$ | 1,042,685 | $ | 37,248 | 4.77 | % |
$ | 1,017,127 | $ | 37,891 | 4.98 | % |
||||||||||||
| PPP loans |
98,857 | 1,762 | 2.38 | % |
— | — | — | % |
||||||||||||||||
| Taxable securities |
225,558 | 4,195 | 2.48 | % |
247,139 | 5,106 | 2.76 | % |
||||||||||||||||
| Tax-exempt securities (3) |
54,112 | 1,151 | 2.84 | % |
40,912 | 986 | 3.22 | % |
||||||||||||||||
| Interest-bearing deposits in other banks |
71,749 | 204 | 0.38 | % |
44,995 | 772 | 2.29 | % |
||||||||||||||||
| Average interest-earning assets |
1,492,961 | 44,560 | 3.99 | % |
1,350,173 | 44,755 | 4.43 | % |
||||||||||||||||
| Cash and due from banks |
22,314 | 22,375 | ||||||||||||||||||||||
| Premises and equipment, net |
15,514 | 15,445 | ||||||||||||||||||||||
| Goodwill |
11,671 | 10,450 | ||||||||||||||||||||||
| Other intangibles, net |
4,508 | 4,780 | ||||||||||||||||||||||
| Other assets |
48,418 | 43,253 | ||||||||||||||||||||||
| Average total assets |
$ | 1,595,386 | $ | 1,446,476 | ||||||||||||||||||||
| Interest-bearing liabilities: |
||||||||||||||||||||||||
| Demand - interest-bearing |
$ | 258,420 | 256 | 0.13 | % |
$ | 241,924 | 372 | 0.21 | % |
||||||||||||||
| Money market |
353,775 | 1,009 | 0.38 | % |
299,694 | 1,120 | 0.50 | % |
||||||||||||||||
| Savings |
140,048 | 287 | 2.27 | % |
136,254 | 365 | 0.36 | % |
||||||||||||||||
| Certificates of deposit |
143,305 | 1,351 | 1.26 | % |
163,020 | 1,478 | 1.21 | % |
||||||||||||||||
| Federal Home Loan Bank of San Francisco borrowings |
8,759 | 5 | 0.08 | % |
12,894 | 247 | 2.56 | % |
||||||||||||||||
| Other borrowings |
9,976 | 552 | 7.39 | % |
11,213 | 623 | 7.43 | % |
||||||||||||||||
| Junior subordinated debentures |
10,310 | 201 | 2.60 | % |
10,310 | 329 | 4.27 | % |
||||||||||||||||
| Average interest-bearing liabilities |
924,593 | 3,661 | 0.53 | % |
875,309 | 4,534 | 0.69 | % |
||||||||||||||||
| Noninterest-bearing demand |
483,490 | 391,208 | ||||||||||||||||||||||
| Other liabilities |
17,102 | 17,927 | ||||||||||||||||||||||
| Shareholders’ equity |
170,201 | 162,032 | ||||||||||||||||||||||
| Average liabilities and shareholders’ equity |
$ | 1,595,386 | $ | 1,446,476 | ||||||||||||||||||||
| Net interest income and net interest margin (4) |
$ | 40,899 | 3.66 | % |
$ | 40,221 | 3.98 | % |
||||||||||||||||
| (1)Interest income on loans includes deferred fees and costs of approximately $636 thousand and $433 thousand for the nine months ended September 30, 2020 and 2019, respectively. Interest income on PPP loans included $1.0 million of fee income for the nine months ended September 30, 2020. |
||||||||||||||||||
| (2) Loans, net of PPP includes average nonaccrual loans of $5.8 million and $11.8 million for the nine months ended September 30, 2020 and 2019, respectively. |
||||||||||||||||||
| (3) Interest income and yields on tax-exempt securities are not presented on a taxable equivalent basis. |
||||||||||||||||||
| (4) Net interest margin is net interest income expressed as a percentage of average interest-earning assets. Net interest income for the nine months ended September 30, 2020 and 2019 included $612 thousand and $431 thousand in accretion of the discount on the loans acquired from Merchants Holding Company, which improved the net interest margin by 7 and 6 basis points, respectively. PPP loans decreased the net interest margin by 9 basis points. |
||||||||||||||||||
| (5) Yields and rates are calculated by dividing the income or expense by the average balance of the assets or liabilities, respectively, and annualizing the result. |
Analysis of Changes in Net Interest Income
The following tables set forth a summary of the changes in net interest income due to changes in average asset and liability balances (volume variance) and changes in average rates (rate variance) for the three and nine months ended September 30, 2020 and 2019. Changes in interest income and expense, which are not specifically attributable specifically to either volume or rate, are allocated proportionately between both variances. Interest income and yields on tax-exempt securities are presented on a nominal basis; and not on a tax equivalent basis.
| Three Months Ended September 30, 2020 Over |
||||||||||||
| (Amounts in thousands) |
Volume |
Rate |
Net Change |
|||||||||
| Increase (decrease) in interest income: |
||||||||||||
| Loans, net of PPP |
$ | 441 | $ | (955 | ) | $ | (514 | ) | ||||
| PPP loans |
949 | — | 949 | |||||||||
| Taxable securities |
(69 | ) | (256 | ) | (325 | ) | ||||||
| Tax-exempt securities (1) |
226 | (40 | ) | 186 | ||||||||
| Interest-bearing deposits in other banks |
532 | (811 | ) | (279 | ) | |||||||
| Total increase (decrease) |
2,079 | (2,062 | ) | 17 | ||||||||
| Increase (decrease) in interest expense: |
||||||||||||
| Demand - interest-bearing |
21 | (67 | ) | (46 | ) | |||||||
| Money market |
175 | (337 | ) | (162 | ) | |||||||
| Savings |
8 | (65 | ) | (57 | ) | |||||||
| Certificates of deposit |
(54 | ) | (17 | ) | (71 | ) | ||||||
| Other borrowings |
1 | — | 1 | |||||||||
| Junior subordinated debentures |
— | (56 | ) | (56 | ) | |||||||
| Total increase (decrease) |
151 | (542 | ) | (391 | ) | |||||||
| Net increase (decrease) |
$ | 1,928 | $ | (1,520 | ) | $ | 408 | |||||
| (1) Interest income on tax-exempt securities is not presented on a tax equivalent basis. |
| Nine Months Ended September 30, 2020 Over |
||||||||||||
| (Amounts in thousands) |
Volume |
Rate |
Net Change |
|||||||||
| Increase (decrease) in interest income: |
||||||||||||
| Loans, net of PPP |
$ | 1,693 | $ | (2,336 | ) | $ | (643 | ) | ||||
| PPP loans |
1,762 | — | 1,762 | |||||||||
| Taxable securities |
(426 | ) | (485 | ) | (911 | ) | ||||||
| Tax-exempt securities (1) |
259 | (94 | ) | 165 | ||||||||
| Interest-bearing deposits in other banks |
1,413 | (1,981 | ) | (568 | ) | |||||||
| Total increase (decrease) |
4,701 | (4,896 | ) | (195 | ) | |||||||
| Increase (decrease) in interest expense: |
||||||||||||
| Demand - interest-bearing |
28 | (144 | ) | (116 | ) | |||||||
| Money market |
356 | (467 | ) | (111 | ) | |||||||
| Savings |
10 | (88 | ) | (78 | ) | |||||||
| Certificates of deposit |
(190 | ) | 63 | (127 | ) | |||||||
| Federal Home Loan Bank of San Francisco borrowings |
(60 | ) | (182 | ) | (242 | ) | ||||||
| Other borrowings |
(68 | ) | (3 | ) | (71 | ) | ||||||
| Junior subordinated debentures |
— | (128 | ) | (128 | ) | |||||||
| Total increase (decrease) |
76 | (949 | ) | (873 | ) | |||||||
| Net increase (decrease) |
$ | 4,625 | $ | (3,947 | ) | $ | 678 | |||||
| (1) Interest income on tax-exempt securities is not presented on a tax equivalent basis. |
PROVISION FOR LOAN AND LEASE LOSSES
We recorded a provision for loan and lease losses of $5.3 million for the first nine months of 2020. There was no provision for loan and lease losses in the first nine months of 2019. A detailed discussion of our provision is provided later in this filing under the heading “Allowance for Loan and Lease Losses”. Also, see Note 4 Loans in the Notes to Consolidated Financial Statements for further information.
NONINTEREST INCOME
The following table presents the key components of noninterest income for the three and nine months ended September 30, 2020 and 2019.
| Three Months Ended September 30, |
Change |
Nine Months Ended September 30, |
Change |
|||||||||||||||||||||||||||||
| (Dollars in thousands) |
2020 |
2019 |
Amount |
Percent |
2020 |
2019 |
Amount |
Percent |
||||||||||||||||||||||||
| Noninterest income: |
||||||||||||||||||||||||||||||||
| Service charges on deposit accounts |
$ | 142 | $ | 177 | $ | (35 | ) | (20 | )% |
$ | 463 | $ | 532 | $ | (69 | ) | (13 | )% |
||||||||||||||
| ATM and point of sale fees |
297 | 293 | 4 | 1 | % |
828 | 876 | (48 | ) | (5 | )% |
|||||||||||||||||||||
| Payroll and benefit processing fees |
152 | 158 | (6 | ) | (4 | )% |
465 | 486 | (21 | ) | (4 | )% |
||||||||||||||||||||
| Life insurance |
125 | 126 | (1 | ) | (1 | )% |
396 | 410 | (14 | ) | (3 | )% |
||||||||||||||||||||
| Gain on sales of investment securities, net |
258 | 12 | 246 | 2,050 | % |
482 | 137 | 345 | 252 | % |
||||||||||||||||||||||
| Federal Home Loan Bank of San Francisco dividends |
109 | 131 | (22 | ) | (17 | )% |
275 | 376 | (101 | ) | (27 | )% |
||||||||||||||||||||
| (Loss) gain on sale of OREO |
— | — | — | — | % |
(23 | ) | 41 | (64 | ) | (156 | )% |
||||||||||||||||||||
| Loss on disposal of equipment |
— | — | — | — | % |
(132 | ) | — | (132 | ) | (100 | )% |
||||||||||||||||||||
| Other |
106 | 109 | (3 | ) | (3 | )% |
282 | 305 | (23 | ) | (8 | )% |
||||||||||||||||||||
| Total noninterest income |
$ | 1,189 | $ | 1,006 | $ | 183 | 18 | % |
$ | 3,036 | $ | 3,163 | $ | (127 | ) | (4 | )% |
|||||||||||||||
Service charges and fee income have decreased for the three and nine months ended September 30, 2020 when compared to the same periods a year ago due to changes in customer behavior in response to the COVID-19 pandemic. Customers are maintaining higher deposit balances, avoiding service and overdraft charges, and are conducting fewer ATM and point of sale transactions.
The decrease in Federal Home Loan Bank of San Francisco dividends for the three and nine months ended September 30, 2020 is due to a reduction in the dividend rate paid compared to the same periods a year ago.
During the first quarter of 2020, we recorded a loss on disposal of ATM equipment from closure of two offsite locations.
NONINTEREST EXPENSE
The following table presents the key components of noninterest expense for the three and nine months ended September 30, 2020 and 2019.
| Three Months Ended September 30, |
Change |
Nine Months Ended September 30, |
Change |
|||||||||||||||||||||||||||||
| (Dollars in thousands) |
2020 |
2019 |
Amount |
Percent |
2020 |
2019 |
Amount |
Percent |
||||||||||||||||||||||||
| Noninterest expense: |
||||||||||||||||||||||||||||||||
| Salaries & related benefits |
$ | 5,587 | $ | 5,407 | $ | 180 | 3 | % |
$ | 18,088 | $ | 17,141 | $ | 947 | 6 | % |
||||||||||||||||
| Loan origination costs |
(461 | ) | (402 | ) | (59 | ) | (15 | )% |
(2,110 | ) | (1,261 | ) | (849 | ) | (67 | )% |
||||||||||||||||
| Premises & equipment |
951 | 933 | 18 | 2 | % |
2,631 | 2,836 | (205 | ) | (7 | )% |
|||||||||||||||||||||
| FDIC insurance premium |
101 | (104 | ) | 205 | 197 | % |
227 | 91 | 136 | 149 | % |
|||||||||||||||||||||
| Data processing fees |
581 | 582 | (1 | ) | (0 | )% |
1,697 | 1,796 | (99 | ) | (6 | )% |
||||||||||||||||||||
| Professional services |
342 | 392 | (50 | ) | (13 | )% |
1,145 | 1,230 | (85 | ) | (7 | )% |
||||||||||||||||||||
| Telecommunications |
157 | 194 | (37 | ) | (19 | )% |
484 | 547 | (63 | ) | (12 | )% |
||||||||||||||||||||
| Acquisition and merger |
— | (113 | ) | 113 | 100 | % |
— | 2,193 | (2,193 | ) | (100 | )% |
||||||||||||||||||||
| Other |
1,132 | 1,411 | (279 | ) | (20 | )% |
4,281 | 4,261 | 20 | 0 | % |
|||||||||||||||||||||
| Total noninterest expense |
$ | 8,390 | $ | 8,300 | $ | 90 | 1 | % |
$ | 26,443 | $ | 28,834 | $ | (2,391 | ) | (8 | )% |
|||||||||||||||
Third Quarter of 2020 Compared With The Third Quarter of 2019
Noninterest expense for the three months ended September 30, 2020 increased $90 thousand compared to the same period in the previous year. The increase in FDIC premiums was due to a $193 thousand Small Bank Assessments Credit from the FDIC recorded during the three months ended September 30, 2019 that did not recur in the current year. The decrease in other noninterest expense includes a $100 thousand provision for unfunded commitments during the third quarter of the prior year that did not recur in the current year.
The Company’s efficiency ratio was 54.8% for the third quarter of 2020. The ratio during the same period in 2019 was 56.4%.
First Nine Months of 2020 Compared With The First Nine Months of 2019
Noninterest expense for the nine months ended September 30, 2020 decreased $2.4 million compared to the same period in the previous year. Decreases in noninterest expense included the following items:
| ● |
$849 thousand increase in deferred loan origination cost benefit for the nine months ended September 30, 2020 compared to the same period in the previous year, primarily from PPP loan originations. |
| ● |
$2.2 million in non-recurring costs recorded during the nine months ended September 30, 2019 associated with the acquisition of Merchants. |
| ● |
$501 thousand in non-recurring costs recorded during the nine months ended September 30, 2019 associated with the name change of our subsidiary bank. |
The decreases in noninterest expense were partially offset by the following increases:
| ● |
$414 thousand in non-recurring costs from a previously disclosed severance agreement during the nine months ended September 30, 2020. |
| ● |
$700 thousand in non-recurring costs related to the termination of a technology management services contract during the nine months ended September 30, 2020. |
| ● |
$175 thousand increase in vacation accrual costs for the nine months ended September 30, 2020 compared to the same period in the previous year. Our employees have used less of their vacation benefits in the current year due to travel restrictions imposed in response to the COVID-19 pandemic. |
| ● |
$143 thousand increase in health insurance premiums for the nine months ended September 30, 2020 compared to the same period in the previous year resulting from rate increases. |
The Company’s efficiency ratio was 60.2% for the first nine months of 2020 (57.7% excluding $1.1 million of non-recurring costs). The ratio during the same period in 2019 was 66.5% (60.3% excluding $2.7 million of non-recurring costs).
INCOME TAXES
Our provision for income taxes includes both federal and state income taxes and reflects the application of federal and state statutory rates to our income before taxes. The following table reflects our tax provision and the related effective tax rate for the periods indicated. The higher effective tax rates in 2019 reflect the non-deductibility of certain acquisition-related expenses.
| For the Three Months Ended September 30, |
For the Nine Months Ended September 30, |
|||||||||||||||
| (Dollars in thousands) |
2020 |
2019 |
2020 |
2019 |
||||||||||||
| Income Taxes: |
||||||||||||||||
| Income before provision for income taxes |
$ | 5,829 | $ | 6,428 | $ | 12,242 | $ | 14,550 | ||||||||
| Provision for income taxes |
$ | 1,500 | $ | 1,786 | $ | 3,150 | $ | 3,958 | ||||||||
| Effective tax rate |
25.7 | % |
27.8 | % |
25.7 | % |
27.2 | % |
||||||||
FINANCIAL CONDITION
CONSOLIDATED BALANCE SHEETS
As of September 30, 2020, we had total consolidated assets of $1.740 billion, gross loans of $1.206 billion, allowance for loan and lease losses (“ALLL”) of $17 million, total deposits of $1.518 billion, and shareholders’ equity of $173 million.
We maintained noninterest-bearing cash positions at the Federal Reserve Bank and correspondent banks in the amount of $22.9 million and we also held interest-bearing deposits in the amount of $105.0 million.
Available-for-sale investment securities totaled $337.0 million at September 30, 2020, compared to $287.0 million at December 31, 2019. During the first nine months of 2020, we purchased securities with a par value of $154.3 million. During the first nine months of 2020, we sold securities with a par value of $54.2 million resulting in $482 thousand in net realized gains. During the nine months ended September 30, 2020, we also received $61.1 million in proceeds from principal payments, calls and maturities within the available-for-sale securities portfolio.
At September 30, 2020, our net unrealized gains on available-for-sale investment securities were $10.4 million compared to net unrealized gains of $3.7 million at December 31, 2019. The change in net unrealized gains during the nine months ended September 30, 2020 was driven by significant declines in market interest rates.
We recorded gross loan balances of $1.206 billion at September 30, 2020, compared to $1.033 billion at December 31, 2019, an increase of $173 million. The increase in gross loans occurred primarily from loans originated from the PPP.
Nonperforming loans, which include nonaccrual loans and accruing loans past due over 90 days, increased by $2.5 million to $8.1 million, or 0.67% of gross loans (0.78% of gross loans excluding PPP loans), as of September 30, 2020, compared to $5.6 million, or 0.54% of gross loans as of December 31, 2019. The increase was due to two commercial loans totaling $1.4 million and two commercial real estate loans totaling $1.7 million that were placed in nonaccrual status during the nine months ended September 30, 2020.
Past due loans as of September 30, 2020 decreased $542 thousand to $4.4 million, compared to $4.9 million as of December 31, 2019. We believe that credit grading for past due loans appropriately reflects the risk associated with those loans.
The ALLL at September 30, 2020 increased $4.7 million to $16.9 million compared to $12.2 million at December 31, 2019. At September 30, 2020, relying on our ALLL methodology, which uses criteria such as credit grading and historical loss rates, and qualitative factors we believe the ALLL is adequate. There is, however, no assurance that future loan and lease losses will not exceed the levels provided for in the ALLL and could result in additional charges to the provision for loan and lease losses. A detailed discussion of the ALLL is provided later in this document under the heading “Allowance for Loan and Lease Losses”. Also, see Note 4 Loans in the Notes to Consolidated Financial Statements for further information on the ALLL and the loan portfolio.
Premises and equipment totaled $15.2 million at September 30, 2020, a decrease of $696 thousand compared to $15.9 million at December 31, 2019.
Our OREO balance at September 30, 2020 was $8 thousand compared to $35 thousand in OREO properties at December 31, 2019. For the nine months ended September 30, 2020, we transferred into OREO one foreclosed property in the amount of $8 thousand and sold one property out of OREO with a balance of $35 thousand for a net loss of $23 thousand.
Bank-owned life insurance increased $385 thousand during the nine months ended September 30, 2020 to $24.1 million compared to $23.7 million at December 31, 2019.
Goodwill and other intangible assets, net totaled $15.9 million at September 30, 2020, a decrease of $574 thousand compared to $16.5 million at December 31, 2019 due to amortization of core deposit intangibles. After considering qualitative factors, management determined that the Company’s goodwill was not impaired at September 30, 2020. A detailed discussion of our impairment analysis is presented below under the heading “Goodwill and Other Intangible Assets”.
Other assets, which include the Bank’s investment qualified zone academy bonds, Federal Home Loan Bank of San Francisco stock, right-of-use lease asset and low-income housing tax credit partnerships totaled $29.0 million at September 30, 2020 compared to $28.6 million at December 31, 2019. The increase included one new $1.0 million low income housing tax credit investment.
Total deposits at September 30, 2020, increased $251 million or 26% annualized to $1.518 billion compared to $1.267 billion at December 31, 2019.
| ● |
Total non-maturing deposits increased $261.8 million or 31% annualized compared to December 31, 2019. The increase in non-maturing deposits was due to PPP loan program disbursements and changes in customer behavior, which is focused on cash accumulation. |
| ● |
Certificates of deposit decreased $10.9 million or 10% annualized compared to December 31, 2019. The decrease in certificates of deposits reflects our decision to reduce our reliance on public deposits and depositor’s reaction to the recent substantial decline in interest rates. |
Other liabilities, which include the Bank’s supplemental executive retirement plan, deferred director compensation, operating leases and the funding obligation for investments in qualified affordable housing partnerships, increased $404 thousand to $18.1 million as of September 30, 2020 compared to $17.7 million at December 31, 2019.
Investment Securities
The composition of our investment securities portfolio reflects management’s investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of interest income.
The investment securities portfolio also:
| ● |
Partially mitigates interest rate risk; |
| ● |
Diversifies the credit risk inherent in the loan portfolio; |
| ● |
Provides a vehicle for the investment of excess liquidity; |
| ● |
Provides a source of liquidity when pledged as collateral for lines of credit; |
| ● |
Is used as collateral for certain public funds. |
The carrying value of our available-for-sale investment securities totaled $337.0 million at September 30, 2020, compared to $287.0 million at December 31, 2019. During the third quarter of 2020, we continued the deployment of excess cash into investment securities as deposits continued to grow. Investment purchases were comprised primarily of longer duration municipal bonds and lower coupon mortgage backed securities. During the nine months ended September 30, 2020, we purchased securities with a par value of $154.3 million and weighted average yield of 2.01% (2.47% tax equivalent) and sold securities with a par value of $54.2 million and weighted average yield of 2.21% (2.32% tax equivalent).
The following table presents the available-for-sale investment securities portfolio at fair value by classification and major type as of September 30, 2020 and December 31, 2019.
| September 30, |
December 31, |
|||||||
| (Amounts in thousands) |
2020 |
2019 |
||||||
| Available-for-sale securities: |
||||||||
| U.S. government & agencies |
$ | 31,811 | $ | 38,733 | ||||
| Obligations of state and political subdivisions |
91,863 | 42,098 | ||||||
| Residential mortgage-backed securities and collateralized mortgage obligations |
165,692 | 180,835 | ||||||
| Corporate securities |
— | 2,966 | ||||||
| Commercial mortgage-backed securities |
19,577 | 19,307 | ||||||
| Other asset-backed securities |
28,089 | 3,011 | ||||||
| Total |
$ | 337,032 | $ | 286,950 | ||||
The following table presents information regarding the amortized cost, and maturity structure of the investment portfolio at September 30, 2020.
| Maturities |
Maturities |
|||||||||||||||||||||||||||||||||||||||
| Maturities |
Over One Through |
Over Five Through |
Maturities |
|||||||||||||||||||||||||||||||||||||
| Within One Year |
Five Years |
Ten Years |
Over Ten Years |
Total |
||||||||||||||||||||||||||||||||||||
| (Dollars in thousands) |
Amount |
Yield |
Amount |
Yield |
Amount |
Yield |
Amount |
Yield |
Amount |
Yield |
||||||||||||||||||||||||||||||
| Available-for-sale securities: (1) |
||||||||||||||||||||||||||||||||||||||||
| U.S. government & agencies |
$ | 40 | 2.88 | % |
$ | 331 | 2.43 | % |
$ | 18,076 | 2.31 | % |
$ | 12,495 | 2.33 | % |
$ | 30,942 | 2.32 | % |
||||||||||||||||||||
| Obligations of state and political subdivisions |
453 | 3.29 | % |
8,991 | 3.78 | % |
12,183 | 2.73 | % |
66,001 | 2.49 | % |
87,628 | 2.66 | % |
|||||||||||||||||||||||||
| Residential mortgage-backed securities and collateralized mortgage obligations |
21,764 | 1.65 | % |
99,594 | 2.53 | % |
15,821 | 1.87 | % |
24,166 | 1.73 | % |
161,345 | 2.23 | % |
|||||||||||||||||||||||||
| Commercial mortgage-backed securities |
— | — | % |
1,746 | 2.48 | % |
4,007 | 2.57 | % |
13,167 | 2.22 | % |
18,920 | 2.32 | % |
|||||||||||||||||||||||||
| Other asset-backed securities |
— | — | % |
— | — | % |
— | — | % |
27,799 | 1.74 | % |
27,799 | 1.74 | % |
|||||||||||||||||||||||||
| Total |
$ | 22,257 | 1.68 | % |
$ | 110,662 | 2.63 | % |
$ | 50,087 | 2.29 | % |
$ | 143,628 | 2.18 | % |
$ | 326,634 | 2.31 | % |
||||||||||||||||||||
| (1) The maturities for the collateralized mortgage obligations and mortgage-backed securities are presented by expected average life, rather than contractual maturity. The yield on tax-exempt securities has not been adjusted to a tax-equivalent yield basis. |
Loan Portfolio
Historically, we have concentrated our loan origination activities primarily within El Dorado, Placer, Sacramento, and Shasta counties in California. In recent years, our loan origination activity has expanded to include other portions of California and northern Nevada. We manage our credit risk through various diversifications of our loan portfolio, the application of sound underwriting policies and procedures, and ongoing credit monitoring practices. Generally, the loans are secured by real estate or other assets located in California. Repayment is expected from the borrower’s cash flows or cash flows from real estate investments.
The following table presents the composition of the loan portfolio as of September 30, 2020 and December 31, 2019.
| September 30, 2020 |
December 31, 2019 |
|||||||||||||||
| (Dollars in thousands) |
Amount |
% |
Amount |
% |
||||||||||||
| Loan Portfolio: |
||||||||||||||||
| Commercial |
$ | 121,025 | 10 | % |
$ | 141,197 | 14 | % |
||||||||
| Paycheck protection program |
163,493 | 14 | — | — | ||||||||||||
| Commercial real estate: |
||||||||||||||||
| Construction and land development |
40,289 | 3 | 26,830 | 3 | ||||||||||||
| Non-owner occupied |
538,079 | 45 | 493,920 | 48 | ||||||||||||
| Owner occupied |
210,455 | 17 | 218,833 | 21 | ||||||||||||
| Residential real estate: |
||||||||||||||||
| ITIN |
30,071 | 2 | 33,039 | 3 | ||||||||||||
| 1-4 family mortgage |
57,867 | 5 | 63,661 | 6 | ||||||||||||
| Equity lines |
20,296 | 2 | 22,099 | 2 | ||||||||||||
| Consumer and other |
24,490 | 2 | 33,324 | 3 | ||||||||||||
| Gross loans |
1,206,065 | 100 | % |
1,032,903 | 100 | % |
||||||||||
| Deferred loan (fees) and costs |
(1,037 | ) | 2,162 | |||||||||||||
| Loans, net of deferred fees and costs |
1,205,028 | 1,035,065 | ||||||||||||||
| Allowance for loan and lease losses |
(16,873 | ) | (12,231 | ) | ||||||||||||
| Net loans |
$ | 1,188,155 | $ | 1,022,834 | ||||||||||||
The following table sets forth the maturity and distribution of our loan portfolio as of September 30, 2020.
| After One |
||||||||||||||||
| Within One |
Through |
After Five |
||||||||||||||
| (Amounts in thousands) |
Year |
Five Years |
Years |
Total |
||||||||||||
| Loan Portfolio: |
||||||||||||||||
| Commercial |
$ | 41,697 | $ | 72,948 | $ | 7,261 | $ | 121,906 | ||||||||
| Paycheck protection program |
100,211 | 59,951 | — | 160,162 | ||||||||||||
| Commercial real estate: |
||||||||||||||||
| Construction and land development |
6,275 | 15,402 | 18,569 | 40,246 | ||||||||||||
| Non-owner occupied |
42,661 | 213,694 | 281,236 | 537,591 | ||||||||||||
| Owner occupied |
21,808 | 86,915 | 103,268 | 211,991 | ||||||||||||
| Residential real estate: |
||||||||||||||||
| ITIN |
3,337 | 13,188 | 13,546 | 30,071 | ||||||||||||
| 1-4 family mortgage |
4,470 | 19,089 | 34,395 | 57,954 | ||||||||||||
| Equity lines |
1,180 | 809 | 18,604 | 20,593 | ||||||||||||
| Consumer and other |
1,129 | 2,087 | 21,298 | 24,514 | ||||||||||||
| Loans, net of deferred fees and costs |
$ | 222,768 | $ | 484,083 | $ | 498,177 | $ | 1,205,028 | ||||||||
| Loans with: |
||||||||||||||||
| Fixed rates |
$ | 151,140 | $ | 252,674 | $ | 186,398 | $ | 590,212 | ||||||||
| Variable rates |
71,628 | 231,409 | 311,779 | 614,816 | ||||||||||||
| Total |
$ | 222,768 | $ | 484,083 | $ | 498,177 | $ | 1,205,028 | ||||||||
Loans with Unique Credit Characteristics
ITIN Loans
We own a pool of Individual Tax Identification Number (“ITIN”) residential mortgage loans. The ITIN loans are geographically disbursed throughout the United States and are made to legal United States residents who do not possess a social security number. The ITIN loan portfolio is serviced by a third party. The majority of the ITIN loans are variable rate loans and may have an increased default risk in a rising rate environment. Worsening economic conditions in the United States may cause us to suffer higher default rates on our ITIN loans and reduce the value of the assets that we hold as collateral. In addition, if we become responsible for servicing these loans, we may realize additional monitoring, servicing and appraisal costs due to the geographic disbursement of the portfolio which would adversely affect our noninterest expense. As of September 30, 2020, we have granted 57 COVID-19 related deferrals for ITIN loans totaling $3.6 million.
SFC Loans
Between May of 2014 and December of 2018, we purchased unsecured retail installment home improvement loans that were originated by Service Finance Company, LLC (SFC). The loans were made through a network of over 8,000 approved home improvement dealers throughout the United States and Puerto Rico. Loans within the portfolio have a wide range of terms, interest rates and purchase discounts or premiums. The loans are serviced by a third party and have an average FICO credit score over 750 at origination. Principal repayments on these loans totaled $7.9 million for the nine months ended September 30, 2020. In addition, if we become responsible for servicing these loans, we may realize additional monitoring and servicing costs due to the geographic disbursement of the portfolio which would adversely affect our noninterest expense. As of September 30, 2020, we have granted 16 COVID-19 related deferrals for SFC loans totaling $135 thousand.
PPP Loans
Through September 30, 2020, we have funded 606 PPP loans totaling $163.5 million. Substantially all of the loans were made to existing customers and all loan proceeds were initially deposited with our institution. At origination, loan fee income net of loan origination costs totaled $4.3 million and is being earned over the 24-month life of the loans as a part of the loan yield. At September 30, 2020, $3.3 million remains to be earned in future quarters. The following tables provide additional information on the PPP loans by industry and by loan size at September 30, 2020.
| At September 30, 2020 |
||||||||
| (Dollars in thousands) |
Number |
Balance |
||||||
| Industry: |
||||||||
| Construction |
98 | $ | 64,750 | |||||
| Healthcare and Social Assistance |
96 | 17,701 | ||||||
| Professional, Scientific and Tech Services |
78 | 12,155 | ||||||
| Accommodation and Food Services |
51 | 10,328 | ||||||
| Admin, Support, Waste Management and Remediation Services |
20 | 7,383 | ||||||
| Primary Metal Manufacturing |
16 | 6,641 | ||||||
| Retail Trade |
59 | 8,050 | ||||||
| Other |
188 | 36,485 | ||||||
| Total |
606 | $ | 163,493 | |||||
| At September 30, 2020 |
||||||||||||
| (Dollars in thousands) |
Balance |
Number |
Average Loan Size |
|||||||||
| Loan Size: |
||||||||||||
| $50,000 or less |
$ | 5,142 | 205 | $ | 25 | |||||||
| $50,001 to $150,000 |
15,462 | 185 | 84 | |||||||||
| $150,001 to $350,000 |
25,406 | 110 | 231 | |||||||||
| $350,001 to $1,999,999 |
73,927 | 94 | 786 | |||||||||
| $2,000,000 or greater |
43,556 | 12 | 3,630 | |||||||||
| Total |
$ | 163,493 | 606 | $ | 270 | |||||||
During the third quarter of 2020, the SBA began accepting applications for PPP loan forgiveness. The Bank has 60 days to review and approve an application before submitting it to SBA, and the SBA then has 90 days to process it for forgiveness. The following table presents the progress of our loans in the forgiveness process.
| At September 30, 2020 |
||||||||||||
| (Dollars in thousands) |
Balance |
Number |
Average Loan Size |
|||||||||
| Borrower has not started application |
$ | 78,930 | 390 | $ | 202 | |||||||
| Borrower is working on application |
38,624 | 123 | 314 | |||||||||
| Borrower has completed application and submitted it to the bank |
32,400 | 73 | 444 | |||||||||
| Bank has approved application and submitted it to the SBA |
13,539 | 20 | 677 | |||||||||
| SBA has approved the application and the loan has been repaid |
— | — | — | |||||||||
| Total |
$ | 163,493 | 606 | $ | 270 | |||||||
As of November 3, 2020, PPP loans totaling $11.5 million that were outstanding on September 30, 2020 have been forgiven and repaid by the SBA.
Purchased Loans
In addition to loans we have originated or loans we acquired in conjunction with our acquisition of Merchants, the loan portfolio includes purchased loan pools and purchased participations. Purchased loan pools and participations are recorded at their fair value at the acquisition date.
The following table presents the recorded investment in purchased loan pools and purchased participations at September 30, 2020 and December 31, 2019. The purchased loans presented in the table include the ITIN and SFC loans discussed under the heading “Loans with Unique Credit Characteristics”.
| September 30, 2020 |
December 31, 2019 |
|||||||||||||||
| (Dollars in thousands) |
Balance |
% of Gross Loan Portfolio |
Balance |
% of Gross Loan Portfolio |
||||||||||||
| Loan Type: |
||||||||||||||||
| Commercial real estate |
$ | 17,707 | 1 | % |
$ | 19,506 | 2 | % |
||||||||
| Residential real estate |
41,662 | 3 | % |
45,494 | 4 | % |
||||||||||
| Consumer and other |
20,579 | 2 | % |
28,579 | 3 | % |
||||||||||
| Total purchased loans |
$ | 79,948 | 6 | % |
$ | 93,579 | 9 | % |
||||||||
Asset Quality
Nonperforming Assets
Our loan portfolio is heavily concentrated in real estate and a significant portion of our borrowers’ ability to repay their loans is dependent upon the professional services, commercial real estate market and the residential real estate development industry sectors. Loans secured by real estate or other assets primarily located in California are expected to be repaid from cash flows of the borrower or proceeds from the sale of collateral. As such, our dependence on real estate secured loans increases the risk of loss in our loan portfolio in a market of declining real estate values. Furthermore, declining real estate values would negatively impact holdings of OREO.
We manage asset quality and mitigate credit risk through the application of policies designed to promote sound underwriting and loan monitoring practices. Our Loan Committee is charged with monitoring asset quality, establishing credit policies and procedures and enforcing the consistent application of these policies and procedures across the Bank. The provision for loan and lease losses charged to earnings is based upon management’s judgment of the amount necessary to maintain the allowance at a level adequate to provide for probable losses inherent in the outstanding loan and lease portfolio. The amount of provision charge is dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management’s assessment of loan portfolio quality, general economic conditions that can impact the value of collateral, and other trends. The evaluation of these factors is performed through an analysis of the adequacy of the ALLL. Reviews of nonperforming, past due loans and larger credits, designed to identify potential charges to the ALLL, and to determine the adequacy of the allowance, are conducted on a quarterly basis. These reviews consider such factors as the financial strength of borrowers, the value of the applicable collateral, loan and lease loss experience, estimated loan and lease losses, growth in the loan portfolio, prevailing economic conditions and other factors.
A loan is considered impaired when, based on current information and events, we determine it is probable that we will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. Generally, when we identify a loan as impaired, we measure the loan for potential impairment using discount cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of collateral, less selling costs. The starting point for determining the fair value of collateral is through obtaining external appraisals. Generally, external appraisals are updated every twelve months. We obtain appraisals from a pre-approved list of independent, third party, local appraisal firms. Approval and addition to the list is based on experience, reputation, character, consistency and knowledge of the respective real estate market. At a minimum, it is ascertained that the appraiser is: (1) currently licensed in the state in which the property is located, (2) is experienced in the appraisal of properties similar to the property being appraised, (3) is actively engaged in the appraisal work, (4) has knowledge of current real estate market conditions and financing trends, (5) is reputable, and (6) is not on Freddie Mac’s nor our Exclusionary List of appraisers and brokers. In most cases, appraisals will be reviewed by another independent third party to ensure the quality of the appraisal and the expertise and independence of the appraiser. Upon receipt and review, an external appraisal is utilized to measure a loan for potential impairment.
Our impairment analysis documents the date of the appraisal used in the analysis, whether the officer preparing the report deems it current, and, if not, allows for internal valuation adjustments with justification. Typical justified adjustments might include discounts for continued market deterioration subsequent to appraisal date, adjustments for the release of collateral contemplated in the appraisal, or the value of other collateral or consideration not contemplated in the appraisal. An appraisal over one year old in most cases will be considered stale dated and an updated or new appraisal will be required. Any adjustments from appraised value to net realizable value are detailed and justified in the impairment analysis, which is reviewed and approved by our Chief Credit Officer. Although an external appraisal is the primary source to value collateral dependent loans, we may also utilize values obtained through purchase and sale agreements, negotiated short sales, broker price opinions, or the sales price of the note. These alternative sources of value are used only if deemed to be more representative of value based on updated information regarding collateral resolution. Impairment analyses are updated, reviewed and approved on a quarterly basis at or near the end of each reporting period. Based on these processes, we do not believe there are significant time lapses for the recognition of additional provision for loan and lease losses or charge-offs from the date they become known.
Loans are classified as nonaccrual when collection of principal or interest is doubtful; generally these are loans that are past due as to maturity or payment of principal or interest by 90 days or more, unless such loans are well-secured and in the process of collection. Additionally, all loans that are impaired are considered for nonaccrual status. Loans placed on nonaccrual will typically remain in nonaccrual status until all principal and interest payments are brought current and the prospects for future payments in accordance with the loan agreement appear certain.
Upon acquisition of real estate collateral, typically through the foreclosure process, we promptly begin to market the property for sale. If we do not receive offers or indications of interest within a reasonable timeframe, we will review market conditions to assess the pricing level that would enable us to sell the property. At the time of foreclosure, OREO is recorded at fair value less costs to sell (“cost”), which becomes the property’s new basis. Unless a current appraisal is available, an appraisal will be ordered prior to a loan migrating to OREO. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the ALLL. After foreclosure, management periodically performs valuations and the property is carried at the lower of the cost or fair value less expected selling costs. We obtain updated appraisals on OREO property every six to twelve months. Valuation adjustments recorded in a period are primarily based on (1) updated appraisals received during the period, or (2) management’s authorization to reduce the selling price of the property during the period.
The following table summarizes our nonperforming assets as of September 30, 2020 and December 31, 2019.
| September 30, |
December 31, |
|||||||
| (Dollars in thousands) |
2020 |
2019 |
||||||
| Nonperforming Assets: |
||||||||
| Commercial |
$ | 1,549 | $ | 61 | ||||
| Commercial real estate: |
||||||||
| Non-owner occupied |
1,062 | — | ||||||
| Owner occupied |
3,750 | 3,103 | ||||||
| Total commercial real estate |
4,812 | 3,103 | ||||||
| Residential real estate: |
||||||||
| ITIN |
1,574 | 2,221 | ||||||
| 1-4 family mortgage |
145 | 191 | ||||||
| Total residential real estate |
1,719 | 2,412 | ||||||
| Consumer and other |
18 | 40 | ||||||
| Total nonaccrual loans |
8,098 | 5,616 | ||||||
| 90 days past due and still accruing |
— | — | ||||||
| Total nonperforming loans |
8,098 | 5,616 | ||||||
| Other real estate owned |
8 | 35 | ||||||
| Total nonperforming assets |
$ | 8,106 | $ | 5,651 | ||||
| Nonperforming loans to gross loans |
0.67 | % |
0.54 | % |
||||
| Nonperforming loans to gross loans (excluding PPP) |
0.78 | % |
0.54 | % |
||||
| Nonperforming assets to total assets |
0.47 | % |
0.38 | % |
||||
We regularly perform thorough reviews of the commercial real estate portfolio, including semi-annual stress testing. These reviews are performed on both our non-owner and owner occupied credits. These reviews are completed to verify leasing status, to ensure the accuracy of risk ratings, and to develop proactive action plans with borrowers on projects. Stress testing is performed to determine the effect of rising cap rates, interest rates, and vacancy rates on the portfolio. Based on our analysis, we believe we are effectively managing the risks in this portfolio. There can be no assurance that declines in economic conditions, such as potential increases in retail or office vacancy rates, will not exceed the projected assumptions utilized in stress testing resulting in additional nonperforming loans in the future.
Loans are reported as troubled debt restructurings when we grant a concession(s) to a borrower experiencing financial difficulties that we would not otherwise consider. Examples of such concessions include a reduction in the loan rate, forgiveness of principal or accrued interest, extending the maturity date(s) significantly, or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, troubled debt restructured loans are impaired as we will not collect all amounts due, either principal or interest, in accordance with the terms of the original loan agreement. Impairment reserves on non-collateral dependent troubled debt restructured loans are measured by comparing the present value of expected future cash flows of the restructured loans, discounted at the effective interest rate of the original loan agreement to the loans carrying value. These impairment reserves are recognized as a specific component to be provided for in the ALLL.
As of September 30, 2020, we had $6.3 million in troubled debt restructurings compared to $6.5 million as of December 31, 2019. As of September 30, 2020, we had 92 restructured loans that qualified as troubled debt restructurings, of which 91 loans were performing according to their restructured terms. Troubled debt restructurings represented 0.52% of gross loans (0.61% of gross loans excluding PPP loans) as of September 30, 2020, compared to 0.63% at December 31, 2019. There was one new troubled debt restructuring on a $650 thousand commercial real estate loan during the nine months ended September 30, 2020.
Impaired loans of $4.3 million and $4.8 million were classified as accruing troubled debt restructurings at September 30, 2020 and December 31, 2019, respectively. For a troubled debt restructured loan to be on accrual status, the loan’s collateral coverage must generally be greater than or equal to 100% of the loan balance, the loan payments must be current, and the borrower must demonstrate the ability to make payments from a verified source of cash flow. As of September 30, 2020 and December 31, 2019, we had no obligations to lend additional funds on any troubled debt restructured loans.
The following table sets forth a summary of our restructured loans that qualify as troubled debt restructurings as of September 30, 2020 and December 31, 2019.
| September 30, |
December 31, |
|||||||
| (Dollars in thousands) |
2020 |
2019 |
||||||
| Troubled Debt Restructurings: |
||||||||
| Accruing troubled debt restructurings |
||||||||
| Commercial |
$ | 531 | $ | 595 | ||||
| Residential real estate: |
||||||||
| ITIN |
3,597 | 3,957 | ||||||
| Equity lines |
131 | 231 | ||||||
| Total accruing troubled debt restructurings |
$ | 4,259 | $ | 4,783 | ||||
| Nonaccruing troubled debt restructurings |
||||||||
| Commercial |
$ | — | $ | 47 | ||||
| Commercial real estate: |
||||||||
| Owner occupied |
650 | — | ||||||
| Residential real estate: |
||||||||
| ITIN |
1,395 | 1,593 | ||||||
| Consumer and other |
18 | 40 | ||||||
| Total nonaccruing troubled debt restructurings |
$ | 2,063 | $ | 1,680 | ||||
| Total troubled debt restructurings |
||||||||
| Commercial |
$ | 531 | $ | 642 | ||||
| Commercial real estate: |
||||||||
| Owner occupied |
650 | — | ||||||
| Residential real estate: |
||||||||
| ITIN |
4,992 | 5,550 | ||||||
| Equity lines |
131 | 231 | ||||||
| Consumer and other |
18 | 40 | ||||||
| Total troubled debt restructurings |
$ | 6,322 | $ | 6,463 | ||||
| Total troubled debt restructurings to gross loans outstanding at period end |
0.52 | % |
0.63 | % |
||||
| Total troubled debt restructurings to gross loans outstanding at period end (excluding PPP) |
0.61 | % |
0.63 | % |
||||
Troubled Debt Restructuring Guidance
Financial institution regulators and the CARES Act have clarified the treatment of short-term loan modifications for borrowers impacted by COVID-19. The change provides that modifications made in response to COVID-19, to borrowers under certain circumstances, should not be considered a troubled debt restructuring.
We have responded to the needs of our borrowers in accordance with the CARES Act and regulatory guidance to grant short-term COVID-19 related loan modifications. These modified loans are not troubled debt restructurings and are not considered to be past due or non-performing. We have granted deferrals ranging from one to six months determined on a case-by-case basis considering the nature of the business and the impact of COVID-19. For some borrowers who where initially granted a deferral of less than 6 months, we have granted an additional deferral period on a case-by-case basis. Since March of 2020, we have granted 261 payment deferrals totaling $125.3 million. As of September 30, 2020, loans totaling $82.5 million have resumed making payments.
The following table presents approved loan deferrals that are still in effect at September 30, 2020, none of which meet the definition of a troubled debt restructuring. For the remaining loans that were modified, nine borrowers also received a PPP loan through our U.S. Small Business Administration (“SBA”) department.
| At September 30, 2020 |
||||||||||||||||||||||||
| Payments Scheduled to Resume in the Three Month Period Ended |
||||||||||||||||||||||||
| December 31, 2020 |
March 31, 2021 |
|||||||||||||||||||||||
| (Dollars in thousands) |
# |
Amount |
# |
Amount |
# |
Total |
||||||||||||||||||
| Length of 1st deferral granted: |
||||||||||||||||||||||||
| 3 months |
2 | $ | 1,748 | — | $ | — | 2 | $ | 1,748 | |||||||||||||||
| 5 months |
2 | 935 | — | — | 2 | 935 | ||||||||||||||||||
| 6 months |
18 | 19,986 | 3 | 484 | 21 | 20,470 | ||||||||||||||||||
| Length of 2nd deferral granted: |
||||||||||||||||||||||||
| 2 months |
1 | 2,873 | — | — | 1 | 2,873 | ||||||||||||||||||
| 3 months |
7 | 6,865 | 1 | 2,033 | 8 | 8,898 | ||||||||||||||||||
| Total loan deferrals |
30 | 32,407 | 4 | 2,517 | 34 | 34,924 | ||||||||||||||||||
| Loans serviced by others (1) |
— | — | — | — | 73 | 3,694 | ||||||||||||||||||
| Total |
30 | $ | 32,407 | 4 | $ | 2,517 | 107 | $ | 38,618 | |||||||||||||||
| (1) These loans are small residential mortgages and consumer home improvement loans, which are mostly deferred on a rolling one-month basis not to exceed six months. These loans are geographically disbursed throughout the United States and are serviced by a third party. |
| At September 30, 2020 |
||||||||||||||||||||||||
| Payments Scheduled to Resume in the Three Month Period Ended |
||||||||||||||||||||||||
| December 31, 2020 |
March 31, 2021 |
|||||||||||||||||||||||
| (Dollars in thousands) |
# |
Amount |
# |
Amount |
# |
Total |
||||||||||||||||||
| Industry: |
||||||||||||||||||||||||
| Health care and social assistance |
6 | $ | 4,550 | 1 | $ | 12 | 7 | $ | 4,562 | |||||||||||||||
| Hotels, motels and bed-and-breakfast inns |
3 | 9,986 | — | — | 3 | 9,986 | ||||||||||||||||||
| Other services |
1 | 231 | 1 | 2,033 | 2 | 2,264 | ||||||||||||||||||
| Restaurants, bars and caterers |
2 | 1,605 | — | — | 2 | 1,605 | ||||||||||||||||||
| Arts, entertainment and recreation |
5 | 1,698 | — | — | 5 | 1,698 | ||||||||||||||||||
| Other industries |
13 | 14,337 | 2 | 472 | 15 | 14,809 | ||||||||||||||||||
| Total loan deferrals by industry |
30 | 32,407 | 4 | 2,517 | 34 | 34,924 | ||||||||||||||||||
| Loans serviced by others (1) |
— | — | — | — | 73 | 3,694 | ||||||||||||||||||
| Total |
30 | $ | 32,407 | 4 | $ | 2,517 | 107 | $ | 38,618 | |||||||||||||||
| (1) These loans are small residential mortgages and consumer home improvement loans, which are mostly deferred on a rolling one-month basis not to exceed six months. These loans are geographically disbursed throughout the United States and are serviced by a third party. |
SBA Loan Payments
As part of the SBA coronavirus debt relief efforts, the SBA made six months of principal and interest payments on all SBA 7(a) loans that were in regular servicing status at March 27, 2020 and for new SBA 7(a) loans originated between March 27, 2020 and September 27, 2020. At September 30, 2020, our loan portfolio included $32.3 million of SBA 7(a) loans (generally 75% guaranteed). Borrowers will resume responsibility for making their payments on these 7(a) loans in October 2020.
Allowance for Loan and Lease Losses
We monitor credit quality and the general economic environment to ensure that the ALLL is maintained at a level that is adequate to cover estimated credit losses in the loan and lease portfolio. Our review of ALLL adequacy utilizes both quantitative and qualitative factors. The quantitative analysis relies on historical loss rates which, unfortunately, may not be indicative of potential losses related to a pandemic such as we are currently experiencing with COVID-19. As a result, we have placed a high reliance on qualitative factors (Q-Factors).
During the nine months ended September 30, 2020, our review of the adequacy of our allowance for loan and lease losses (ALLL) focused on our Q-Factors for:
| ● |
“Changes in international, national, regional and local conditions” and |
| ● |
“Changes in the volume and severity of past due loans and other similar conditions”. |
We considered concentrations of credit in industries that are more likely to be significantly impacted by the effects of COVID-19. We evaluated our C&I portfolio by NAICS code and our CRE portfolio for concentrations of tenants and businesses in higher risk industries or for loans with higher LTVs. We also completed analyses on individual borrowers who may be higher risk. After completing this work, we significantly increased our Q-Factors for “changes in the volume and severity of past due loans and other similar conditions” and “changes in international, national, regional and local conditions”.
Our ALLL methodology, adjusted for the revised Q-Factors discussed above necessitated an ALLL of $16.9 million at September 30, 2020, an increase of 38% compared to our ALLL of $12.2 million at December 31, 2019. A provision for loan and lease losses of $5.3 million was recorded for the nine months ended September 30, 2020. There was no provision for loan and lease loss during the same period a year ago. Our ALLL as a percentage of gross loans was 1.40% as of September 30, 2020 compared to 1.18% as of December 31, 2019. Excluding PPP loans (on all of which we have no expectation of loss) our ALLL as a percentage of gross loans was 1.62% as of September 30, 2020.
Management believes the Company’s ALLL is adequate at September 30, 2020. There is, however, no assurance that future loan and lease losses will not exceed the levels provided for in the ALLL and could possibly result in future charges to the provision for loan and lease losses.
The following table summarizes the ALLL roll forward for the nine months ended September 30, 2020, twelve months ended December 31, 2019 and the nine months ended September 30, 2019. This table also includes impaired loan information at September 30, 2020, December 31, 2019 and September 30, 2019.
| For The Nine Months Ended |
For The Twelve Months Ended |
For The Nine Months Ended |
||||||||||
| (Dollars in thousands) |
September 30, 2020 |
December 31, 2019 |
September 30, 2019 |
|||||||||
| ALLL: |
||||||||||||
| Beginning balance ALLL |
$ | 12,231 | $ | 12,292 | $ | 12,292 | ||||||
| Provision for loan and lease loss charged to expense |
5,250 | — | — | |||||||||
| Loans charged off |
(1,027 | ) | (1,500 | ) | (1,326 | ) | ||||||
| Loan and lease loss recoveries |
419 | 1,439 | 1,319 | |||||||||
| Ending balance ALLL |
$ | 16,873 | $ | 12,231 | $ | 12,285 | ||||||
| At September 30, 2020 |
At December 31, 2019 |
At September 30, 2019 |
||||||||||
| Nonaccrual loans: |
||||||||||||
| Commercial |
$ | 1,549 | $ | 61 | $ | 139 | ||||||
| Commercial real estate: |
||||||||||||
| Non-owner occupied |
1,062 | — | 10,099 | |||||||||
| Owner occupied |
3,750 | 3,103 | — | |||||||||
| Residential real estate: |
||||||||||||
| ITIN |
1,574 | 2,221 | 2,339 | |||||||||
| 1-4 family mortgage |
145 | 191 | 198 | |||||||||
| Consumer and other |
18 | 40 | 21 | |||||||||
| Total nonaccrual loans |
8,098 | 5,616 | 12,796 | |||||||||
| Accruing troubled debt restructured loans: |
||||||||||||
| Commercial |
531 | 595 | 629 | |||||||||
| Residential real estate: |
||||||||||||
| ITIN |
3,597 | 3,957 | 4,072 | |||||||||
| Equity lines |
131 | 231 | 236 | |||||||||
| Total accruing troubled debt restructured loans |
4,259 | 4,783 | 4,937 | |||||||||
| All other accruing impaired loans |
— | — | — | |||||||||
| Total impaired loans |
$ | 12,357 | $ | 10,399 | $ | 17,733 | ||||||
| Gross loans outstanding |
$ | 1,206,065 | $ | 1,032,903 | $ | 1,033,082 | ||||||
| Ratio of ALLL to gross loans outstanding |
1.40 | % |
1.18 | % |
1.19 | % |
||||||
| Ratio of ALLL to gross loans outstanding (excluding PPP) |
1.62 | % |
1.18 | % |
1.19 | % |
||||||
| Nonaccrual loans to gross loans outstanding |
0.67 | % |
0.54 | % |
1.24 | % |
||||||
| Nonaccrual loans to gross loans outstanding (excluding PPP) |
0.78 | % |
0.54 | % | 1.24 | % | ||||||
The following tables summarizes the allowance, reserve and discount on loans for the nine months ended September 30, 2020, twelve months ended December 31, 2019 and the nine months ended September 30, 2019.
| (Dollars in thousands) |
At September 30, 2020 |
At December 31, 2019 |
At September 30, 2019 |
|||||||||
| ALLL |
$ | 16,873 | $ | 12,231 | $ | 12,285 | ||||||
| Reserve for unfunded commitments |
800 | 695 | 695 | |||||||||
| Discount on acquired loans (1) |
1,060 | 1,672 | 1,860 | |||||||||
| Total allowances, reserve and discount |
$ | 18,733 | $ | 14,598 | $ | 14,840 | ||||||
| Gross loans |
$ | 1,206,065 | $ | 1,032,903 | $ | 1,033,082 | ||||||
| PPP loans |
163,493 | — | — | |||||||||
| Total gross loans, net of PPP loans |
$ | 1,042,572 | $ | 1,032,903 | $ | 1,033,082 | ||||||
| Total allowance, reserves and discount as a percentage of total gross loans, net of PPP loans |
1.80 | % |
1.41 | % |
1.44 | % |
||||||
| (1) Discount on acquired loans includes fair value discount for loans acquired from Merchants in January 2019. |
At September 30, 2020, impaired loans had a corresponding specific allowance of $204 thousand. The specific allowance on impaired loans represents the impairment reserves on performing restructured loans, other accruing loans, and nonaccrual loans.
The following table sets forth the allocation of the ALLL as of September 30, 2020 and December 31, 2019.
| September 30, 2020 |
December 31, 2019 |
|||||||||||||||
| (Dollars in thousands) |
Amount |
% Loan Category |
Amount |
% Loan Category |
||||||||||||
| ALLL: |
||||||||||||||||
| Commercial |
$ | 2,440 | 14 | % |
$ | 1,822 | 15 | % |
||||||||
| Commercial real estate: |
||||||||||||||||
| Construction and land development |
373 | 2 | 131 | 1 | ||||||||||||
| Non-owner occupied |
8,606 | 52 | 5,907 | 47 | ||||||||||||
| Owner occupied |
2,770 | 16 | 2,058 | 17 | ||||||||||||
| Residential real estate: |
||||||||||||||||
| ITIN |
620 | 4 | 569 | 5 | ||||||||||||
| 1-4 family mortgage |
376 | 2 | 185 | 2 | ||||||||||||
| Equity lines |
326 | 2 | 278 | 2 | ||||||||||||
| Consumer and other |
828 | 5 | 933 | 8 | ||||||||||||
| Unallocated |
534 | 3 | 348 | 3 | ||||||||||||
| Total ALLL |
$ | 16,873 | 100 | % |
$ | 12,231 | 100 | % |
||||||||
The unallocated portion of ALLL provides for coverage of credit losses inherent in the loan portfolio but not captured in the credit loss factors that are utilized in the credit grading-based component, or in the specific reserve component of the ALLL, and acknowledges the inherent imprecision of all loss prediction models. As of September 30, 2020 and December 31, 2019, the unallocated allowance amount represented 3% of the ALLL. While the ALLL composition is an indication of specific amounts or loan categories in which future charge-offs may occur, actual amounts may differ.
Reserve for Unfunded Commitments
The reserve for unfunded commitments, which is included in Other Liabilities in the Consolidated Balance Sheets, was $800 thousand and $695 thousand at September 30, 2020 and December 31, 2019, respectively. The adequacy of the reserve for unfunded commitments is reviewed on a quarterly basis. Based upon changes in the amount of commitments, loss experience, and economic conditions we recorded $105 thousand of provision expense during the nine months ended September 30, 2020. When necessary, provision adjustments are recorded in Other Expenses in the Consolidated Statements of Income.
COVID‐19 Loan Analysis
During the third quarter of 2020, we continued to proactively monitor our loan portfolio by maintaining close contact with our borrowers to update our understanding of the impact of the pandemic on them, their businesses and the underlying collateral for our loans. For borrowers who continue to have been granted a loan payment deferral, we have evaluated their credit quality position and the potential for loss of principal.
We have segmented our commercial loan and commercial real estate loan portfolios (86% of gross loans excluding PPP loans) to identify those loans in industries that are most at risk of loss or where other information indicates the borrower may be significantly impacted by the effects of COVID-19. The following table presents loans by industry that are most at risk of loss or where other information indicates the loan or borrower may be highly impacted by COVID-19 and the related loan modifications. The table below includes $10.0 million and $21.3 million of SBA 7(a) (generally 75% guaranteed) loans in the high risk and low to moderate risk categories, respectively.
| At September 30, 2020 |
||||||||||||||||||||||||||||||||||||
| Individually Analyzed Loans With a COVID-19 Risk Of |
Loan Modifications |
|||||||||||||||||||||||||||||||||||
| Low and |
Low and |
|||||||||||||||||||||||||||||||||||
| High |
Moderate |
PPP |
Total |
High |
Moderate |
|||||||||||||||||||||||||||||||
| (Dollars in thousands) |
# |
Amount |
Amount |
Amount |
Amount |
# |
Amount |
# |
Amount |
|||||||||||||||||||||||||||
| Loan Portfolio: |
||||||||||||||||||||||||||||||||||||
| CRE and C&I |
||||||||||||||||||||||||||||||||||||
| Industries highly impacted by COVID-19: |
||||||||||||||||||||||||||||||||||||
| Retail trade |
12 | $ | 15,896 | $ | 24,641 | $ | 8,050 | $ | 48,587 | — | $ | — | — | $ | — | |||||||||||||||||||||
| Health care and social assistance |
46 | 14,148 | 12,847 | 17,701 | 44,696 | 6 | 3,608 | 1 | 954 | |||||||||||||||||||||||||||
| Hotels, motels and bed-and-breakfast inns |
17 | 34,635 | — | 1,402 | 36,037 | 3 | 9,986 | — | — | |||||||||||||||||||||||||||
| Other services |
7 | 6,014 | 18,318 | 2,967 | 27,299 | 1 | 2,032 | 1 | 231 | |||||||||||||||||||||||||||
| Restaurants, bars and caterers |
20 | 11,103 | — | 6,370 | 17,473 | 2 | 1,606 | — | — | |||||||||||||||||||||||||||
| Educational services |
3 | 7,348 | 303 | 2,693 | 10,344 | — | — | — | — | |||||||||||||||||||||||||||
| Arts, entertainment and recreation |
20 | 4,200 | 60 | 4,579 | 8,839 | 5 | 1,698 | — | — | |||||||||||||||||||||||||||
| Other industries |
22 | 17,255 | 739,069 | 119,731 | 876,055 | 3 | 4,032 | 10 | 10,757 | |||||||||||||||||||||||||||
| Residential, Consumer and All Other not individually analyzed |
— | — | 136,735 | — | 136,735 | — | — | 75 | 3,714 | |||||||||||||||||||||||||||
| Total |
147 | $ | 110,599 | $ | 931,973 | $ | 163,493 | $ | 1,206,065 | 20 | $ | 22,962 | 87 | $ | 15,656 | |||||||||||||||||||||
| % of gross loans |
9.17 | % |
77.27 | % |
13.56 | % |
1.90 | % |
1.30 | % |
||||||||||||||||||||||||||
Goodwill and Other Intangible Assets
Goodwill and other intangible assets, net totaled $15.9 million at September 30, 2020 and primarily consisted of goodwill and core deposit intangibles recorded as part of previous acquisitions. Goodwill is evaluated for impairment annually and any such impairment is recognized in the period identified. A more frequent assessment of possible goodwill impairment is performed whenever we identify certain triggering events or circumstances that would more likely than not indicate that the fair value of the Bank is less than the carrying amount of the Bank’s equity. The triggering events to be considered include a deterioration in general economic conditions, decreased overall financial performance of the Company, and a sustained decrease in the Company’s stock price.
The Company’s share price has traded below tangible book value for the entire second and third quarters of 2020 without interruption, a period we deemed to be sustained. We considered the sustained depressed price of our stock to be a triggering event that required us to evaluate if goodwill had been impaired on an interim basis.
We engaged a third party consultant to assist us in performing impairment testing at June 30, 2020 and determined that the indicated fair value of the Bank (our only reporting unit) exceeded the carrying amount of the Bank’s equity by approximately 3%. We believe that there have not been any significant changes in the Company’s financial performance or in the markets for which the Company’s stock is traded, that would change the results of the prior quantitative analysis. After performing our qualitative assessment at September 30, 2020, we believe that it is more-likely-than-not that the fair value of our Bank (our only reporting unit) was more than the carrying amount and that a quantitative impairment test was unnecessary.
Our conclusion at September 30, 2020 is heavily dependent on the relatively short time-period since the onset of COVID-19 and its impact on corporate valuations and the economy as a whole. Uncertainties remain about how the economy will respond to government stimulus and updated news about medical advances. At December 31, 2020, we will again evaluate the possibility of goodwill impairment. There is no certainty that we will arrive at the same conclusion as we did at September 30, 2020.
Deposits
Total deposits as of September 30, 2020 were $1.518 billion compared to $1.267 billion at December 31, 2019, an increase of $251 million. The following table presents the deposit balances by major category as of September 30, 2020, and December 31, 2019. The increase in non-maturing deposits from December 31, 2019 to September 30, 2020 was due to PPP loan program disbursements and changes in customer behavior, which is focused on cash accumulation. The decrease in certificates of deposit from December 31, 2019 to September 30, 2020 reflects our decision to reduce reliance our on public deposits and depositor reaction to the recent substantial declines in interest rates.
| September 30, 2020 |
December 31, 2019 |
|||||||||||||||
| (Dollars in thousands) |
Amount |
% |
Amount |
% |
||||||||||||
| Deposits: |
||||||||||||||||
| Noninterest-bearing demand |
$ | 542,060 | 36 | % |
$ | 432,680 | 34 | % |
||||||||
| Interest-bearing demand |
280,370 | 18 | 239,258 | 19 | ||||||||||||
| Money market |
403,785 | 27 | 307,559 | 24 | ||||||||||||
| Savings |
151,016 | 10 | 135,888 | 11 | ||||||||||||
| Certificates of deposit, $100,000 or greater |
109,801 | 7 | 120,282 | 10 | ||||||||||||
| Certificates of deposit, less than $100,000 |
31,099 | 2 | 31,504 | 2 | ||||||||||||
| Total |
$ | 1,518,131 | 100 | % |
$ | 1,267,171 | 100 | % |
||||||||
The following table sets forth the distribution of average deposits and their respective average rates for the periods indicated.
| For the Nine Months Ended September 30, 2020 |
For the Year Ended December 31, 2019 |
|||||||||||||||
| (Dollars in thousands) |
Average Balance |
Average Rate |
Average Balance |
Average Rate |
||||||||||||
| Deposits: |
||||||||||||||||
| Interest-bearing demand |
$ | 258,420 | 0.13 | % |
$ | 242,516 | 0.20 | % |
||||||||
| Money market |
353,775 | 0.38 | % |
304,340 | 0.53 | % |
||||||||||
| Savings |
140,048 | 2.27 | % |
136,733 | 0.36 | % |
||||||||||
| Certificates of deposit |
143,305 | 1.26 | % |
160,550 | 1.23 | % |
||||||||||
| Interest-bearing deposits |
895,548 | 0.43 | % |
844,139 | 0.54 | % |
||||||||||
| Noninterest-bearing demand |
483,490 | 400,588 | ||||||||||||||
| Total deposits |
$ | 1,379,038 | 0.28 | % |
$ | 1,244,727 | 0.37 | % |
||||||||
We have an agreement with IntraFi Network (“IntraFi”), formally known as Promontory Interfinancial Network LLC (“Promontory”) which facilitates provision of FDIC deposit insurance to balances in excess of current FDIC deposit insurance limits. IntraFi’s Certificate of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep (“ICS”) products use a deposit-matching program to exchange Bank deposits in excess of the current deposit insurance limits for excess balances at other participating banks, on a dollar-for-dollar basis (reciprocal arrangement). These products are designed to enhance our ability to attract and retain customers and increase deposits, by providing additional FDIC coverage to customers. CDARS and ICS deposits can also be arranged on a non-reciprocal basis.
Deposit Maturity Schedule
The following table sets forth the maturities of certificates of deposit in amounts of $100,000 or more as of September 30, 2020.
| September 30, |
||||
| (Amounts in thousands) |
2020 |
|||
| Maturing in: |
||||
| Three months or less |
$ | 15,515 | ||
| Three through six months |
18,946 | |||
| Six through twelve months |
36,616 | |||
| Over twelve months |
38,724 | |||
| Total |
$ | 109,801 | ||
Borrowings
The following table sets forth year-to-date average balances for our borrowings and their respective average rates for the periods indicated.
| For the Nine Months Ended September 30, 2020 |
For the Year Ended December 31, 2019 |
|||||||||||||||
| (Dollars in thousands) |
Average Balance |
Average Rate |
Average Balance |
Average Rate |
||||||||||||
| Borrowings: |
||||||||||||||||
| Federal Home Loan Bank of San Francisco borrowings |
$ | 8,759 | 0.08 | % |
$ | 9,644 | 2.56 | % |
||||||||
| Senior debt, net |
— | — | % |
960 | 7.60 | % |
||||||||||
| Subordinated debt, net |
9,976 | 7.39 | % |
9,935 | 7.38 | % |
||||||||||
| Junior subordinated debentures |
10,310 | 2.60 | % |
10,310 | 4.13 | % |
||||||||||
| Total borrowings |
$ | 29,045 | 3.49 | % |
$ | 30,849 | 4.80 | % |
||||||||
Term Debt
At September 30, 2020, we had term debt outstanding with a carrying value of $20.0 million compared to $10.0 million at December 31, 2019. Term debt consisted of the following:
Federal Home Loan Bank of San Francisco Borrowings
As of September 30, 2020, the Bank had $10.0 million in Federal Home Loan Bank of San Francisco advances outstanding. There were no Federal Home Loan Bank of San Francisco advances outstanding at December 31, 2019. The advance under our FHLB line of credit for $10.0 million is interest free with $5.0 million due in November of 2020 and $5.0 million due in May of 2021. See Note 6 Term Debt in the Notes to Consolidated Financial Statements for information on our Federal Home Loan Bank of San Francisco borrowings.
Senior Debt
In December of 2015, we entered into a senior debt loan agreement to borrow $10.0 million. During the second quarter of 2019, we completed the early repayment and termination of this variable-rate debt agreement.
Subordinated Debt
In December of 2015, we issued $10.0 million of fixed to floating rate Subordinated Notes. The Subordinated Debt initially bears interest at 6.88% per annum through December 19, 2020. Thereafter, interest on the Subordinated Debt will be paid at a variable rate equal to three month LIBOR plus 526 basis points resetting quarterly. At September 30, 2020, the Subordinated Debt had a balance of $10.0 million net of unamortized debt issuance costs. The notes are due in 2025.
Junior Subordinated Debentures
Bank of Commerce Holdings Trust II
During July of 2005, we participated in a $10.0 million private placement of fixed rate trust-preferred securities (the "Trust-Preferred Securities") through a wholly owned Delaware trust affiliate, Bank of Commerce Holdings Trust II (the "Trust II"). Trust II simultaneously issued $310 thousand common securities to the Holding Company. Rates paid on the Trust-Preferred Securities have transitioned from fixed to floating and are now paid on a quarterly basis at a rate equal to three month LIBOR plus 158 basis points (1.8% at September 30, 2020). The Trust-Preferred Securities mature on September 15, 2035, and the covenants allow for redemption of the securities at our option during any quarter prior to maturity.
The proceeds from the sale of the Trust-Preferred Securities were used by Trust II to purchase from the Holding Company the aggregate principal amount of $10.3 million of the Holding Company’s junior subordinate debentures (the "Notes"). The net proceeds to the Holding Company from the sale of the Notes to Trust II were partially distributed to the Bank. The proceeds from the Notes qualify as Tier 1 capital under Federal Reserve Board guidelines.
LIQUIDITY AND CASH FLOW
Merchants Bank of Commerce
We have experienced significant increased deposit balances as all of the PPP loan funds were deposited into customer accounts at our bank and as a result of customer behavior which is focused on cash accumulation. Through September 30, 2020, we have not experienced any unusual pressure on our deposit balances or on our liquidity position as a result of the COVID-19 pandemic. Should this change, in addition to our primary sources of liquidity, the Bank has credit arrangements as discussed below.
The principal objective of our liquidity management program is to maintain our ability to meet the day-to-day cash flow requirements of our customers who wish either to withdraw funds on deposit or to draw upon their credit facilities.
We monitor the sources and uses of funds on a daily basis to maintain an acceptable liquidity position. One source of funds is public deposits. We are required to collateralize the portion of public deposits that exceed FDIC insurance limitations. Public deposits represent 2% of our total deposits at September 30, 2020 and December 31, 2019.
In addition to liquidity provided by core deposits, loan repayments and cash flows from securities, the Bank can borrow on established conditional federal funds lines of credit, sell securities, borrow on a secured basis from the Federal Home Loan Bank of San Francisco, borrow on a secured basis from the Federal Reserve Bank, or issue subscription / brokered certificates of deposit.
At September 30, 2020, the Bank has the following credit arrangements:
| ● |
We have an available line of credit with the Federal Home Loan Bank of San Francisco of $390.6 million; credit availability is subject to certain collateral requirements, namely the amount of pledged loans and investment securities. |
| ● |
We have an available line of credit with the Federal Reserve Bank of $8.4 million subject to collateral requirements, namely the amount of pledged loans. |
| ● |
We have entered into nonbinding federal funds line of credit agreements with three financial institutions. The available credit on these lines totaled $75.0 million at September 30, 2020 and had interest rates ranging from 0.12% to 0.30%. Advances under the lines are subject to funds availability, continued borrower eligibility, and may have consecutive day usage restrictions. |
| ● |
We have available credit from the Federal Reserve Bank Paycheck Protection Program Liquidity Facility (“PPPLF”). The credit facility provides term funding for loans made under the SBA’s PPP. Advances under the program will be collateralized with PPP loans, bear a fixed rate of interest at 0.35% and are to be repaid as the underlying loans are paid down, forgiven, or sold to SBA. We have not utilized any of the liquidity provided by the PPPLF. |
Bank of Commerce Holdings
The Holding Company is a separate entity from the Bank and must provide for its own liquidity. At September 30, 2020, the Holding Company had cash balances of $4.3 million. Our principal source of cash is dividends received from the Bank. During the first nine months of 2020, the Bank paid dividends totaling $14.0 million to the Holding Company, most of which was used to repurchase common stock. There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to the Holding Company in the future.
Consolidated Statements of Cash Flows
Net cash of $18.3 million was provided by operating activities during the nine months ended September 30, 2020. As disclosed in the Consolidated Statements of Cash Flows, the primary difference between net income and cash provided by operating activities was non-cash items including:
| ● |
$5.3 million provision for loan and lease losses. |
| ● |
$3.2 million in deferred loan fees and costs. |
| ● |
$1.5 million in depreciation and amortization. |
Net cash of $216.7 million was used by investing activities during the nine months ended September 30, 2020 consisted principally of:
| ● |
$160.8 million in purchases of investment securities. |
| ● |
$186.3 million in net loan originations. |
These uses of cash were partially offset by:
| ● |
$56.0 million in proceeds from sale of investment securities. |
| ● |
$61.1 million in proceeds from maturities and payments of investment securities. |
| ● |
$13.6 million in repayments on purchased loan pools. |
Net cash of $245.6 million was provided by financing activities during the nine months ended September 30, 2020 principally consisted of:
| ● |
$261.8 million increase in non-maturing deposits. |
| ● |
$10.0 million in advances net of repayments from our line of credit with the Federal Home Loan Bank of San Francisco. |
These sources were partially offset by:
| ● |
$10.9 million decrease in certificates of deposit. |
| ● |
$12.7 million repurchase of common stock. |
CAPITAL RESOURCES
Equity capital is available to support organic and strategic growth, pay dividends and repurchase shares. The objective of effective capital management is to produce above market long-term returns for our shareholders. Our sources of capital include retained earnings, common and preferred stock issuance, and issuance of subordinated debt or trust notes.
REGULATORY CAPITAL GUIDELINES
Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank holding companies and banks. The guidelines are “risk-based,” meaning that they are designed to make capital requirements more sensitive to differences in risk profiles among banks and bank holding companies. The current rules (commonly known as Basel III) require the Bank and the Company to meet a capital conservation buffer requirement in order to avoid constraints on capital distributions, such as dividends and equity repurchases, and certain bonus compensation for executive officers. The capital conservation buffer of 2.50% is added to the minimum capital ratios.
The Basel III minimum capital requirements plus the conservation buffer exceed the prior regulatory “well-capitalized” capital thresholds by 0.5 percentage points. This 0.5 percentage-point cushion allows institutions to dip into a portion of their capital conservation buffer before reaching a status that is considered less than well capitalized for prompt corrective action purposes.
As of January 1, 2020 for certain qualifying institutions, the FDIC accepts compliance with a Community Bank Leverage Ratio in lieu of the Basel III capital requirements. We are a qualifying institution however, we have opted to continue reporting under the Basel III requirements. We can opt-in to use the Community Bank Leverage Ratio at any time in the future.
CAPITAL ADEQUACY
Overall capital adequacy is monitored on a day-to-day basis by management and reported to our Board of Directors on a monthly basis.
As of September 30, 2020, the most recent notification from the FDIC categorized the Bank as “well capitalized” under the regulatory framework for Prompt Corrective Action (“FDIC PCA”). There are no conditions or events since the notification that management believes have changed the Bank’s risk category. The Holding Company and the Bank’s capital amounts and ratios as of September 30, 2020, are presented in the following table.
| September 30, 2020 |
||||||||||||||||||||||||
| FDIC PCA |
BASEL III |
|||||||||||||||||||||||
| Well |
Minimum |
Capital |
Minimum Capital |
|||||||||||||||||||||
| Actual |
Capitalized |
Capital |
Conservation |
Ratio plus Capital |
||||||||||||||||||||
| (Dollars in thousands) |
Capital |
Ratio |
Requirement |
Requirement |
Buffer |
Conservation Buffer |
||||||||||||||||||
| Holding Company: |
||||||||||||||||||||||||
| Common equity tier 1 capital ratio |
$ | 151,147 | 12.61 | % |
n/a | 4.50 | % |
2.50 | % |
7.00 | % |
|||||||||||||
| Tier 1 capital ratio |
$ | 161,147 | 13.44 | % |
n/a | 6.00 | % |
2.50 | % |
8.50 | % |
|||||||||||||
| Total capital ratio |
$ | 186,169 | 15.53 | % |
n/a | 8.00 | % |
2.50 | % |
10.50 | % |
|||||||||||||
| Tier 1 leverage ratio |
$ | 161,147 | 9.60 | % |
n/a | 4.00 | % |
n/a | 4.00 | % |
||||||||||||||
| Bank: |
||||||||||||||||||||||||
| Common equity tier 1 capital ratio |
$ | 167,804 | 14.01 | % |
6.50 | % |
4.50 | % |
2.50 | % |
7.00 | % |
||||||||||||
| Tier 1 capital ratio |
$ | 167,804 | 14.01 | % |
8.00 | % |
6.00 | % |
2.50 | % |
8.50 | % |
||||||||||||
| Total capital ratio |
$ | 182,813 | 15.26 | % |
10.00 | % |
8.00 | % |
2.50 | % |
10.50 | % |
||||||||||||
| Tier 1 leverage ratio |
$ | 167,804 | 9.99 | % |
5.00 | % |
4.00 | % |
n/a | 4.00 | % |
|||||||||||||
On December 10, 2015, the Holding Company issued $10.0 million in aggregate principal amount of Subordinated Notes to certain institutional investors. The Subordinated Notes qualify as Tier 2 Capital under the Final Rules. See Item 1A - Risk Factors, in our Annual Report on Form 10-K for the year ended December 31, 2019 for further detail on potential risks relating to the Subordinated Notes.
Goodwill and other intangible assets, net totaled $15.9 million at September 30, 2020 and primarily consisted of goodwill and core deposit intangibles recorded as part of previous acquisitions. When calculating capital ratios, goodwill and other intangible assets, net are deducted from Tier 1 capital.
In 2019, we announced a stock repurchase program for 1.0 million shares of common stock that was increased to 1.5 million shares of common stock in February of 2020. Between October of 2019 and April 2020, all 1.5 million shares were repurchased at a total cost of $13.6 million including commissions, or an average of $9.11 per share.
We are participating in the PPP administered through the SBA. The growth in our assets resulting from the PPP has impacted our Tier 1 Leverage capital ratio as we have not utilized the liquidity available to us from the PPPLF and its associated beneficial capital treatment. We have not utilized the PPPLF because we have sufficient liquidity provided by significant growth in deposit balances.
Cash Dividends and Payout Ratios per Common Share
The following table presents cash dividends declared and dividend payout ratios (dividends declared per common share divided by basic earnings per common share) for the three and nine months ended September 30, 2020 and 2019. These dividends were made pursuant to our existing dividend policy and in consideration of, among other things, earnings, regulatory capital levels, capital preservation and expected growth. The dividend rate is reassessed periodically by the Board of Directors in accordance with the dividend policy. There is no assurance that future cash dividends on common shares will be declared or increased.
| Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
| 2020 |
2019 |
2020 |
2019 |
|||||||||||||
| Dividends declared per common share |
$ | 0.05 | $ | 0.05 | $ | 0.15 | $ | 0.14 | ||||||||
| Dividend payout ratio |
19 | % |
19 | % |
28 | % |
24 | % |
||||||||
Tangible Book Value Per Share and Tangible Common Equity Ratio
We believe the tangible common equity ratio and tangible book value per share are meaningful measures that the Company and investors commonly use to assess the value and capital levels of the Company.
The following table provides a reconciliation of shareholders' equity (GAAP) to tangible common equity (non-GAAP), and total assets (GAAP) to tangible assets (non-GAAP) as of September 30, 2020 and December 31, 2019.
| September 30, |
December 31, |
|||||||
| (Dollars in thousands except ratio and per share data) |
2020 |
2019 |
||||||
| Tangible common shareholders' equity: |
||||||||
| Total shareholders' equity (GAAP) |
$ | 173,350 | $ | 174,478 | ||||
| Subtract: |
||||||||
| Goodwill (GAAP) |
11,671 | 11,671 | ||||||
| Other intangible assets, net (GAAP) |
4,235 | 4,809 | ||||||
| Tangible common shareholders' equity (non-GAAP) |
$ | 157,444 | $ | 157,998 | ||||
| Total assets (GAAP) |
$ | 1,739,888 | $ | 1,479,616 | ||||
| Subtract: |
||||||||
| Goodwill (GAAP) |
11,671 | 11,671 | ||||||
| Other intangible assets, net (GAAP) |
4,235 | 4,809 | ||||||
| Tangible assets (non-GAAP) |
$ | 1,723,982 | $ | 1,463,136 | ||||
| Common equity ratio (GAAP) |
9.96 | % |
11.79 | % |
||||
| Tangible common equity ratio (non-GAAP) |
9.13 | % |
10.80 | % |
||||
| Book value per share (GAAP) |
$ | 10.32 | $ | 9.62 | ||||
| Tangible book value per share (non-GAAP) |
$ | 9.38 | $ | 8.71 | ||||
Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although we believe these non-GAAP financial measures are frequently used by stakeholders in the evaluation of a company, they have limitations as analytical tools, and should not be considered in isolation or as a substitute for analyses of results as reported under GAAP.
Tangible common shareholders’ equity is calculated as total shareholders' equity less goodwill and other intangible assets, net. Tangible assets are total assets less goodwill and other intangible assets, net. The tangible common equity ratio is calculated as tangible common shareholders' equity divided by tangible assets. Tangible book value is calculated as tangible common shareholders’ equity divided by the number of shares outstanding. The tangible common equity, tangible common equity ratio and tangible book value are considered a non-GAAP financial measures and should be viewed in conjunction with the total shareholders' equity, total shareholders' equity ratio and book value per share.
OFF-BALANCE SHEET ARRANGEMENTS
Information regarding Off-Balance Sheet Arrangements is included in Note 7, Commitments and Contingencies, in the Notes to Consolidated Financial Statements incorporated in this document.
CONCENTRATION OF CREDIT RISK
Information regarding Concentration of Credit Risk is included in Note 7, Commitments and Contingencies, in the Notes to Consolidated Financial Statements incorporated in this document.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our assessment of market risk as of September 30, 2020 indicates there are no material changes in the quantitative and qualitative disclosures from those in our Annual Report on Form 10-K for the year ended December 31, 2019.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including its President and Chief Executive Officer and its Chief Financial Officer, of the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based on that evaluation, the President and Chief Executive Officer and the Chief Financial Officer concluded that these disclosure controls and procedures were effective.
Disclosure controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving an entity’s disclosure objectives. The likelihood of achieving such objectives is affected by limitations inherent in disclosure controls and procedures. These include the fact that human judgment in decision-making can be faulty and that breakdowns in internal controls can occur because of human failures such as simple errors, mistakes or intentional circumvention of the established processes.
Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the Company’s Chief Executive Officer and the Chief Financial Officer and implemented by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America.
The Company’s internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
On a quarterly basis, we carry out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Principal Financial Officer (whom is also our Principal Accounting Officer) of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934. As of September 30, 2020, our management, including our Chief Executive Officer, and Principal Financial Officer, concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us that is required to be included in our periodic SEC filings.
Although we change and improve our internal controls over financial reporting on an ongoing basis, we do not believe that any such changes occurred in the first nine months of 2020 that materially affected or are reasonably likely to materially affect our internal control over financial reporting.
We are subject to various pending and threatened legal actions arising in the ordinary course of business and maintains reserves for losses from legal actions that are both probable and estimable. There are no legal proceedings adverse to the Company that will have a material effect on our consolidated financial position or results of operations.
The risks described below, as well as the risk factors previously disclosed in our Form 10-K for the period ended December 31, 2019, filed with the SEC on March 6, 2020 should be carefully considered. The risks described may not be the only risks facing us. Additional risks and uncertainties not currently known to us or that are currently considered to not be material also may materially adversely affect our business, financial condition and/or operating results. Our risk factors regarding the COVID-19 pandemic have been updated to address the evolution of the pandemic.
The effects of the COVID-19 pandemic could adversely affect our customers’ future results of operations and/or the market price of our stock.
The COVID-19 pandemic continues to rapidly evolve, as do federal, state and local efforts to address it. Both the direct effects of the pandemic and the resulting United States governmental responses are of an unprecedented scope as it impacts both the health and the economy of our country and the world at large. No one can predict the extent or duration of the pandemic, or its effect on the markets that we serve. Further, the ongoing efforts and impact of the government in mitigating the health and the economic effects of the pandemic cannot currently be predicted, whether on our business or as to the economy as a whole. The pandemic has thus far resulted in significant volatility in international and United States markets, which could adversely affect the market price of our stock. To date, the pandemic has resulted in significant business disruption and volatility in the international and domestic markets, which has adversely affected the market price of our stock.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
| a) |
Not Applicable |
| b) |
Not Applicable |
| c) |
Not Applicable |
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Mine Safety Disclosures
Not Applicable
COVID-19 Legislation and Regulation.
Coronavirus Aid, Relief, and Economic Security Act
Governments at the federal, state, and local levels continue to take steps to address the impact of the COVID-19 emergency. On March 27, 2020 the President signed into law the historic $2 trillion federal stimulus package known as the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which included $350 billion in stimulus for small businesses under the so-called “Paycheck Protection Program,” along with direct stimulus payments (i.e., “economic impact payments” or “stimulus checks”) for many eligible Americans. The initial amounts available under the Paycheck Protection Program were quickly exhausted in less than two weeks, which prompted Congress to negotiate additional funding. On April 24, 2020, the Paycheck Protection Program and Health Care Enforcement Act was signed into law to replenish funding to the Paycheck Protection Program and to provide other spending for hospitals and virus testing. Further, on July 3, 2020 the President extended the deadline for potential borrowers to apply for Paycheck Protection Program funds until August 8, 2020. The legislative and regulatory landscape surrounding COVID-19 is rapidly changing, and neither the Company nor the Bank can predict with certainty the impact it will have on our operations or business.
Paycheck Protection Program
The initial amounts available under the Paycheck Protection Program were quickly exhausted in less than two weeks, leaving many pending loan applications in limbo as Congress negotiated additional funding. On April 24, 2020, the Paycheck Protection Program and Health Care Enhancement Act was signed into law to replenish funding to the Paycheck Protection Program and to provide other spending for hospitals and virus testing. In part, the bill includes an additional $320 billion to make new loans under the Paycheck Protection Program, and set aside $30 billion of the loans for banks and credit unions with $10 billion to $50 billion in assets, and another $30 billion for even smaller institutions. The bill also includes $60 billion in loans and grants under the Economic Industry Disaster Loan program, and makes farms and ranches eligible for loans. The SBA resumed accepting applications under the Paycheck Protection Program on April 27, 2020.
| 10.1 |
|
| 31.1 |
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 31.2 |
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 32.0 |
|
| 101.INS |
Inline XBRL Instance Document |
| 101.SCH |
Inline XBRL Taxonomy Extension Schema Document |
| 101.CAL |
Inline XBRL Taxonomy Calculation Linkbase Document |
| 101.DEF |
Inline XBRL Taxonomy Definition Linkbase Document |
| 101.LAB |
Inline XBRL Taxonomy Label Linkbase Document |
| 101.PRE |
Inline XBRL Taxonomy Extension Presentation Linkbase Document |
| 104 |
XBRL Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101) |
Following 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.
BANK OF COMMERCE HOLDINGS
(Registrant)
| Date: November 6, 2020 |
/s/ James A. Sundquist |
||
| James A. Sundquist |
|||
| Executive Vice President and Chief Financial Officer |
|||
| (Principal Financial and Accounting Officer) |