HERITAGE COMMERCE CORP The following discussion provides information about the results of operations, financial condition, liquidity, and capital resources ofHeritage Commerce Corp (the "Company" or "HCC"), its wholly-owned subsidiary,Heritage Bank of Commerce (the "Bank" or "HBC"), and HBC's wholly-owned subsidiary,CSNK Working Capital Finance Corp , aCalifornia Corporation , dba Bay View Funding. This information is intended to facilitate the understanding and assessment of significant changes and trends related to our financial condition and the results of operations. This discussion and analysis should be read in conjunction with our consolidated financial statements and the accompanying notes presented elsewhere in this report. Unless we state otherwise or the context indicates otherwise, references to the "Company," "Heritage," "we," "us," and "our," in this Report on Form 10-K refer toHeritage Commerce Corp and its subsidiaries. The Company completed its acquisition of Bay View Funding onNovember 1, 2014 . The Company completed its merger withFocus Business Bank ("Focus") onAugust 20, 2015 . The Company completed its merger withTri-Valley Bank ("Tri-Valley ") onApril 6, 2018 , and the Company completed its merger withUnited American Bank ("United American") onMay 4, 2018 . The Company completed its merger withPresidio Bank ("Presidio") onOctober 11, 2019 (the "Presidio merger date"). These mergers are discussed in more detail below, and in Notes 1, 8, and 9 to the consolidated financial statements.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with the accounting principles generally accepted inthe United States ("U.S. GAAP") requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expense in the financial statements. Various elements of our accounting policies, by their nature, involve the application of highly sensitive and judgmental estimates and assumptions. Some of these policies and estimates relate to matters that are highly complex and contain inherent uncertainties. It is possible that, in some instances, different estimates and assumptions could reasonably have been made and used by management, instead of those we applied, which might have produced different results that could have had a material effect on the financial statements. We have identified the following accounting policies and estimates that, due to the inherent judgments and assumptions and the potential sensitivity of the financial statements to those judgments and assumptions, are critical to an understanding of our financial statements. We believe that the judgments, estimates and assumptions used in the preparation of the Company's financial statements are appropriate. For a further description of our accounting policies, see Note 1 - Summary of Significant Accounting Policies in the financial statements included in this Form 10-K.
Allowance for Credit Losses on Loans ("ACLL")
As a result of ourJanuary 1, 2020 , adoption of Accounting Standards Update ("ASU") No. 2016-13, Measurement of Credit Losses on Financial Instruments, and its related amendments, our methodology for estimating the allowance for credit losses changed significantly fromDecember 31, 2019 . The standard replaced the "incurred loss" method with an "expected loss" method known as current expected credit loss ("CECL"). The CECL approach requires an estimate of the credit losses expected over the life of a loan (or pool of loans). It removes the incurred loss approach's threshold that delayed the recognition of a credit loss until it was "probable" a loss event was "incurred." The estimate of expected credit losses under the CECL approach is based on relevant information about past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amounts. Historical loss experience is generally the starting point for estimating expected credit losses. We then consider whether the historical loss experience should be adjusted for asset-specific risk characteristics or current conditions at the reporting date that did not exist over the period from which historical experience was used. Finally, we consider forecasts about future economic conditions that are reasonable and supportable. Management's evaluation of the appropriateness of the allowance for credit losses is often the most critical of accounting estimates for a financial institution. Our determination of the amount of the ACLL is a critical accounting estimate as it requires significant reliance on the use of estimates and significant judgment as to the amount and timing of expected future cash flows on criticized loans, significant reliance on historical loss rates, consideration of our quantitative and qualitative evaluation of economic factors, and the reliance on reasonable and supportable forecasts. 65
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The allowance for credit losses attributable to each portfolio segment considers relevant available information from internal and external sources, relating to past events and current conditions. Adjustments to historical loss information are made for differences in current loan-specific risk characteristics and environmental conditions such as concentrations of credit risk (geographic, large borrower, and industry), economic conditions, changes in underwriting standards, experience and depth of lending staff, trends in delinquencies, and the level of criticized loans. Going forward, the impact of utilizing the CECL approach to calculate the reserve for credit losses will be significantly influenced by the composition, characteristics and quality of our loan portfolio, and the prevailing economic conditions and forecasts utilized. Material changes to these and other relevant factors may result in greater volatility to the reserve for credit losses, and therefore, greater volatility to our reported earnings. See Note 4 to the Consolidated Financial Statements and the "Credit Quality and Performance" and "Allowance for Credit Losses on Loans" sections for more information on the Allowance.
Executive Summary
This summary is intended to identify the most important matters on which management focuses when it evaluates the financial condition and performance of the Company. When evaluating financial condition and performance management looks at certain key metrics and measures. The Company's evaluation includes comparisons with peer group financial institutions and its own performance objectives established in the internal planning process. The primary activity of the Company is commercial banking. The Company's operations are located in the generalSan Francisco Bay Area ofCalifornia in the counties ofAlameda ,Contra Costa ,Marin ,San Benito ,San Francisco ,San Mateo , andSanta Clara . The Company's market includes the cities ofOakland ,San Francisco andSan Jose and the headquarters of a number of technology based companies in the region known commonly asSilicon Valley . The Company's customers are primarily closely held businesses and professionals.
Performance Overview
For the year endedDecember 31, 2020 , net income was$35.3 million , or$0.59 per average diluted common share, compared to$40.5 million , or$0.84 per average diluted common share, for the year endedDecember 31, 2019 , and$35.3 million , or$0.84 per average diluted common share for the year endedDecember 31, 2018 . The Company's annualized return on average tangible assets was 0.83% and annualized return on average tangible equity was 9.04% for the year endedDecember 31, 2020 , compared to 1.25% and 13.09%, respectively, for the year endedDecember 31, 2019 , and 1.19% and 14.41%, respectively, for the year endedDecember 31, 2018 . Earnings for the year endedDecember 31, 2020 were impacted by the effect of our$13.3 million pre-tax CECL related provision for credit losses on loans for the first quarter of 2020, driven by forecasted effects on economic activity from the COVID-19 pandemic, and$2.6 million of pre-tax merger-related costs resulting from the merger with Presidio. Earnings for the year endedDecember 31, 2019 were reduced by pre-tax merger-related costs of$11.1 million , related to the merger with Presidio. Pre-tax earnings for the year endedDecember 31, 2019 were further reduced by an additional$2.0 million of provision for loan losses for certain non-impaired loans acquired at a premium from Presidio.
Earnings for the years ended
Coronavirus (COVID-19) In response to two economic stimulus laws passed byCongress in the first half of the 2020, the Bank funded 1,105U.S. Small Business Administration ("SBA") Paycheck Protection Program ("PPP") loans, with total principal balances of$333.4 million . Through 2020, PPP loan payoffs totaled$9.1 million while SBA loan forgiveness totaled$33.7 million and the Bank ended the fourth quarter of 2020 with$290.7 million in outstanding PPP loan balances. These loans generated$2.2 million in interest income and$3.9 million in net deferred fee revenue during 2020. AtDecember 31, 2020 , total loans included remaining deferred fees on PPP loans of($6.8) million and deferred costs of$783,000 . OnApril 7, 2020 , theU.S. banking agencies issued an Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus. The statement describes accounting for COVID-19-related loan modifications, including clarifying the interaction between current accounting rules and the temporary relief provided by the Coronavirus Aid, Relief, and Economic Security ("CARES Act"). The Bank made accommodations for initial payment deferrals for a number of customers of up to 90 days, generally, with the 66 Table of Contents potential, upon application, of an additional 90 days of payment deferral (180 days maximum). The Bank also waived all normal applicable fees. Most of the deferrals we originally granted have returned to regular payments. The following table shows the deferments atDecember 31, 2020 by category: Underlying Collateral Business Real Assets Estate Total (Dollar in thousands) Initial Deferments(1) $ -$ 1,573 $ 1,573 2nd Deferments(2) 295 684 979 Total $ 295$ 2,257 $ 2,552
(1) Initial deferments were generally for 3 months (2) 2nd deferments were for an additional 3 months
In addition to its portfolio of SBA PPP loans, the Bank also has a portfolio of SBA 7(a) loans totaling$50.3 million as ofFebruary 28, 2021 (the most recent available data). As part of the SBA's Coronavirus debt relief efforts, beginning in April of 2020, the SBA commenced a program to cover payments of principal, interest and any associated fees for these borrowers. The following table reflects the status of these SBA 7(a) loans as ofFebruary 28, 2021 :
Number
Dollars of Loans
(Dollars in thousands)
SBA 7(a) loans (monthly payments are made
through the Economic Aid Act) $ 46,245 239
Payments Not Made / NSF / Returned 604 7
New loans / No payment due 752 6
CARES 2,483 10
Request for Deferral or on Deferment 234 2
Total Portfolio $ 50,318 264
The CARES Act was recently amended to include
Credit Quality and Performance
At
There was a$13.2 million provision for credit losses on loans for the year endedDecember 31, 2020 , compared to an$846,000 provision for loan losses for the year endedDecember 31, 2019 . The increase in the provision for credit losses on loans for the year endedDecember 31, 2020 , compared to the year endedDecember 31, 2019 , was driven primarily by a deteriorated economic outlook resulting from the COVID-19 pandemic. The three loan classes where the largest increases in reserves were recorded under the CECL loss rate methodology were investor-owned CRE, land and construction, and commercial and industrial ("C&I"). Ongoing impacts of the CECL methodology will be dependent upon changes in economic conditions and forecasts, originated and acquired loan portfolio composition, portfolio duration, and other factors. 67 Table of Contents The Company continues to monitor portfolio loans made to commercial customers with businesses in higher risk sectors due to the COVID-19 pandemic. The following table provides a breakdown of such loans as a percentage of total loans atDecember 31, 2020 ,September 30, 2020 ,June 30, 2020 , andMarch 31, 2020 : % of Total % of Total % of Total % of Total Loans at Loans at Loans at Loans at HIGHER RISK SECTORS December 31,
2020
2.01 % 1.86 % 1.79 % 1.63 %
Offices of physicians (except mental health specialists) 0.81 % 0.74 % 0.76 % 0.70 %
Other community housing services 0.28 % 0.27 % 0.27 % 0.11 %
All others 2.15 % 2.15 % 2.21 % 1.84 %
Total health care and social assistance 5.25 % 5.02 % 5.03 % 4.28 %
Retail trade:
Gasoline stations with convenience stores 2.16 % 1.97 % 1.90 % 1.98 %
All others 2.34 % 2.44 % 2.44 % 2.18 %
Total retail trade 4.50 % 4.41 % 4.34 % 4.16 %
Accommodation and food services:
Full-service restaurants 1.30 % 1.40 % 1.38 % 0.86 %
Limited-service restaurants 0.57 % 0.74 % 0.79 % 0.63 %
Hotels (except casino hotels) and motels 0.95 % 0.92 % 0.89 % 0.94 %
All others 0.68 % 0.68 % 0.70 % 0.52 %
Total accommodation and food services 3.50 % 3.74 % 3.76 % 2.95 %
Educational services:
Elementary and secondary schools 0.58 % 0.57 % 0.65 % 0.15 %
Education support services 0.45 % 0.43 % 0.40 % 0.15 %
All others 0.19 % 0.17 % 0.24 % 0.17 %
Total educational services 1.22 % 1.17 % 1.29 % 0.47 %
Arts, entertainment, and recreation 1.34 % 1.27 % 1.26 % 1.09 %
Purchased participations in micro loan portfolio 0.60 % 0.68 % 0.80 % 0.95 %
Total higher risk sectors 16.41 % 16.29 % 16.48 % 13.90 %
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Presidio Merger
The Company completed its merger of its wholly-owned bank subsidiary Heritage
Bank of Commerce with Presidio effective October 11, 2019 (the "merger date").
Presidio's results of operations were included in the Company's results of
operations beginning October 12, 2019 . The Presidio systems and integration
conversion was successfully completed in the first quarter of 2020.
Merger-related costs reduced pre-tax earnings by
Presidio was a full-service
The Company completed the merger of its wholly-owned bank subsidiaryHeritage Bank of Commerce withTri-Valley effective as ofApril 6, 2018 .Tri-Valley's results of operations have been included in the Company's results of operations beginningApril 7, 2018 .Tri-Valley was a full-serviceCalifornia state-chartered commercial bank with branches inSan Ramon andLivermore, California and served businesses and individuals primarily inContra Costa andAlameda counties inNorthern California . The Company closed theSan Ramon office onJuly 13, 2018 . The Company completed the merger of its wholly-owned bank subsidiaryHeritage Bank of Commerce with United American effective as ofMay 4, 2018 . United American's results of operations have been included in the Company's results of operations beginningMay 5, 2018 . United American was a full-service commercial bank located inSan Mateo County with full-service branches located inSan Mateo ,Redwood City andHalf Moon Bay, California and serviced businesses, professionals and individuals. The Company closed theHalf Moon Bay office
onAugust 10, 2018 . 69 Table of Contents
Factoring Activities - Bay View Funding
December 31, December 31,
2020 2019
(Dollars in thousands)
Total factored receivables $ 47,201 $ 45,980
Average factored receivables
For the year ended $ 45,765 $ 46,710 Total full time equivalent employees 31 34
2020 Highlights
The following are major factors that impacted the Company's results of operations:
Net interest income increased 8% to
31, 2020, compared to
primarily due to an increase in the average balance of loans resulting from the
? Presidio merger, additional interest and fee income from PPP loans, and an
increase in the accretion of the loan discount into loan interest income from
our merger with Presidio, partially offset by decreases in the prime rate, and
decreases in the yield on investment securities and overnight funds.
The fully tax equivalent ("FTE") net interest margin contracted 78 basis points
to 3.50% for the year ended
? ended
loans, investment securities, and overnight funds, partially offset by a decline in the cost of interest-bearing liabilities.
The average yield on the total loan portfolio decreased to 5.06% for the year
ended
? primarily due to decreases in the prime rate on loans and new average balances
of lower yielding PPP loans, partially offset by higher PPP loan fees and an
increase in the accretion of the loan purchase discount into loan interest
income from the acquisitions.
In aggregate, the original total net purchase discount on loans from the Focus,
?
aggregate, the remaining net purchase discount on total loans acquired was
? The average cost of deposits was 0.17% for the year ended
compared to 0.29% for the year ended
There was a
ended
? the year ended
losses on loans for the year ended
ended
economic outlook resulting from the Coronavirus pandemic.
Noninterest income was
compared to
? to lower service charges and fees on deposit accounts, partially offset by an
increase in the cash surrender value of life insurance, a gain realized on a
warrant exercised, and a gain on the disposition of foreclosed assets during
the first quarter of 2020.
Noninterest expense for the year ended
million, compared to
? primarily due to higher salaries and employee benefits as a result of annual
salary increases, and additional employees and operating costs added as a
result of the Presidio merger, partially offset by lower merger-related costs.
? The following table reflects pre-tax merger-related costs resulting from the
mergers for the periods indicated:
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For the Year Ended
December 31, December 31, December 31,
2020 2019 2018
(Dollars in thousands)
Salaries and employee benefits $ 356
3,569
Other 2,245 4,500 5,598
Total merger-related costs $ 2,601 $ 11,080 $ 9,167 ? The efficiency ratio for the year ended
compared to 59.76% for the year ended
Income tax expense for the year ended
? compared to
tax rate was 28.1% for the years ended
The following are important factors in understanding our current financial condition and liquidity position:
Cash, interest bearing deposits in other financial institutions and securities
? available-for-sale increased 59% to
? Securities held-to-maturity, at amortized cost, totaled
Loans, excluding loans held-for-sale, increased
? billion at
Total loans at
? NPAs were
to
Classified assets were
? million at
2020 and
Net charge-offs totaled
to
million for the year ended
? lending relationships totaling
fourth quarter of 2019, including one large relationship which was previously
disclosed and specifically reserved for during the second and third quarters of
2018. The three lending relationships totaling
had a total of
The ACLL at
? representing 564.24% of nonperforming loans. The allowance for loan losses
("ALLL") at
representing 236.93% of nonperforming loans.
? Total deposits increased
31, 2020, compared to
Deposits, excluding all time deposits and CDARS deposits, increased
? million, or 16%, to
billion at
The ratio of noncore funding (which consists of time deposits of
? over, CDARS deposits, brokered deposits, securities under agreement to
repurchase, subordinated debt and short-term borrowings) to total assets was
3.61% at
? The loan to deposit ratio was 66.91% atDecember 31, 2020 , compared to 74.20% atDecember 31, 2019 . 71 Table of Contents
The Company's consolidated capital ratios exceeded regulatory guidelines and
? the Bank's capital ratios exceeded the regulatory guidelines for a
well-capitalized financial institution under the Basel III regulatory
requirements at
Well-capitalized
Heritage Heritage Financial Institution Basel III Minimum
Commerce Bank of Basel III PCA Regulatory Regulatory
Capital Ratios Corp Commerce Guidelines Requirement(1)
Total Risk-Based 16.5 % 15.8 % 10.0 % 10.5 %
Tier 1 Risk-Based 14.0 % 14.6 % 8.0 % 8.5 %
Common Equity Tier 1
Risk-based 14.0 % 14.6 % 6.5 % 7.0 %
Leverage 9.1 % 9.5 % 5.0 % 4.0 %
(1) Basel III minimum regulatory requirements for both HCC and HBC include a 2.5%
capital conservation buffer, except the leverage ratio.
RESULTS OF OPERATIONS
The Company earns income from two primary sources. The first is interest income, which is interest income generated by earning assets less interest expense on interest-bearing liabilities. The second is noninterest income, which primarily consists of gains on the sale of loans, loan servicing fees, customer service charges and fees, the increase in cash surrender value of life insurance, and gains on the sale of securities. The majority of the Company's noninterest expenses are operating costs that relate to providing a full range of banking services to our customers.
Net Interest Income and Net Interest Margin
The level of net interest income depends on several factors in combination,
including growth in earning assets, yields on earning assets, the cost of
interest-bearing liabilities, the relative volumes of earning assets and
interest-bearing liabilities, and the mix of products that comprise the
Company's earning assets, deposits, and other interest-bearing liabilities. Net
interest income can also be impacted by the reversal of interest on loans placed
on nonaccrual status, and recovery of interest on loans that have been on
nonaccrual and are either sold or returned to accrual status. To maintain its
net interest margin, the Company must manage the relationship between interest
earned and paid.
The following Distribution, Rate and Yield table presents for each of the past
three years, the average amounts outstanding for the major categories of the
Company's balance sheet, the average interest rates earned or paid thereon, and
the resulting net interest margin on average interest earning assets for the
periods indicated. Average balances are based on daily averages.
72
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Year Ended December 31,
2020 2019 2018
Interest Average Interest Average Interest Average
Average Income / Yield / Average Income / Yield / Average Income / Yield /
Balance Expense Rate Balance Expense Rate Balance Expense Rate
(Dollars in thousands)
Assets:
Loans, gross (1)(2) $ 2,631,495 $
133,169 5.06 %
578,506 11,637 2.01 % 682,602 15,836 2.32 % 669,994 15,211 2.27 % Securities - exempt from Federal tax (3)
74,849 2,415 3.23 % 84,165 2,720 3.23 % 87,639 2,817 3.21 %
Other investments, interest-bearing deposits
in other financial institutions and Federal funds sold 786,955 3,757 0.48 % 332,905 7,867 2.36 % 285,702 6,774 2.37 %
Total interest earning assets (3) 4,071,805 150,978 3.71 % 3,094,589 143,231 4.63 % 2,844,350 130,437 4.59 % Cash and due from banks
40,401 40,070 38,665
Premises and equipment, net 9,497 7,395 7,298
Goodwill and other intangible assets 186,239
116,481 82,398
Other assets 126,387 95,235 82,925
Total assets $ 4,434,329 $ 3,353,770 $ 3,055,636
Liabilities and shareholders' equity:
Deposits:
Demand, noninterest-bearing $ 1,638,055 $ 1,131,098 $ 1,029,860
Demand, interest-bearing 891,513 2,035 0.23 % 712,186 2,401 0.34 % 658,386 1,885 0.29 % Savings and money market
1,026,319
3,144 0.31 % 811,266 4,298 0.53 % 777,749 2,701 0.35 %
Time deposits - under
17,659
67 0.38 % 19,448 94 0.48 % 21,375 80 0.37 %
Time deposits -
128,461 1,009 0.79 % 130,856 1,359 1.04 % 130,548 830 0.64 %
CDARS - interest-bearing demand, money
market and time deposits 17,889 5 0.03 % 15,078 7 0.05 % 15,369 10 0.07 %
Total interest-bearing deposits 2,081,841 6,260 0.30 % 1,688,834 8,159 0.48 % 1,603,427 5,506 0.34 % Total deposits 3,719,896 6,260 0.17 % 2,819,932 8,159 0.29 % 2,633,287 5,506 0.21 %
Subordinated debt, net of issuance costs 39,641
2,320 5.85 % 41,278 2,686 6.51 % 39,270 2,314 5.89 % Short-term borrowings
139 1 0.72 % 208 2 0.96 % 106 2 1.89 %
Total interest-bearing liabilities 2,121,621 8,581 0.40 % 1,730,320 10,847 0.63 % 1,642,803 7,822 0.48 %
Total interest-bearing liabilities and demand,
noninterest-bearing / cost of funds 3,759,676 8,581 0.23 % 2,861,418 10,847 0.38 % 2,672,663 7,822 0.29 % Other liabilities 97,978 66,678 55,416 Total liabilities 3,857,654 2,928,096 2,728,079
Shareholders' equity 576,675 425,674 327,557 Total liabilities and shareholders' equity$ 4,434,329 $ 3,353,770 $ 3,055,636 Net interest income (3) / margin 142,397 3.50 % 132,384 4.28 % 122,615 4.31 % Less tax equivalent adjustment (3)
(507) (572) (592) Net interest income$ 141,890 $ 131,812 $ 122,023
(1) Includes loans held-for-sale. Nonaccrual loans are included in average
balance.
Yield amounts earned on loans include fees and costs. The accretion
(amortization) of deferred loan fees (costs) into loan interest income was
(2)
from PPP loans), compared to
and
(3) Reflects tax equivalent adjustment for Federal tax exempt income based on a
21% tax rate for the years ended
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The Volume and Rate Variances table below sets forth the dollar difference in
interest earned and paid for each major category of interest-earning assets and
interest-bearing liabilities for the noted periods, and the amount of such
change attributable to changes in average balances (volume) or changes in
average interest rates. Volume variances are equal to the increase or decrease
in the average balance multiplied by prior period rates and rate variances are
equal to the increase or decrease in the average rate multiplied by the prior
period average balance. Variances attributable to both rate and volume changes
are equal to the change in rate multiplied by the change in average balance and
are included below in the average volume column.
Year Ended December 31, Year Ended December 31,
2020 vs. 2019 2019 vs. 2018
Increase (Decrease) Increase (Decrease)
Due to Change in: Due to Change in:
Average Average Net Average Average Net
Volume Rate Change Volume Rate Change
(Dollars in thousands)
Income from the interest earning assets:
Loans, gross $ 32,226 $
(15,865)
(2,083) (2,116) (4,199) 292 333 625 Securities - exempt from Federal tax (1)
(304) (1) (305) (111) 14 (97)
Other investments, interest-bearing deposits in other financial institutions and Federal funds sold 2,159 (6,269) (4,110) 1,124 (31) 1,093 Total interest income on interest-earning assets
31,998 (24,251) 7,747 12,574 220 12,794
Expense from the interest-bearing liabilities: Demand, interest-bearing 397
(763) (366) 162 354 516 Savings and money market
629
(1,783) (1,154) 176 1,421 1,597
Time deposits - under
(7) (20) (27) (9) 23 14
Time deposits - $100 and over (25) (325) (350) 1 528 529
CDARS - interest-bearing demand, money market
and time deposits - (2) (2) (1) (2) (3) Subordinated debt, net of issuance costs
(95) (271) (366) 130 242 372 Short-term borrowings
- (1) (1) 1 (1) -
Total interest expense on interest-bearing liabilities 899 (3,165) (2,266) 460 2,565 3,025 Net interest income
$ 31,099 $
(21,086) 10,013
65 20
Net interest income $ 10,078 $ 9,789 (1) Reflects tax equivalent adjustment for Federal tax exempt income based on a
21% tax rate for the years ended December 31, 2020 , 2019 and 2018.
The Company's net interest margin (FTE), expressed as a percentage of average
earning assets, contracted 78 basis points to 3.50% for the year ended December
31, 2020 , compared to 4.28% for the year ended December 31, 2019 , primarily due
to a decline in the average yield on loans, investment securities, and overnight
funds, and an increase in the average balance of lower yielding overnight funds,
partially offset by a decline in the cost of interest-bearing liabilities.
The Company's net interest margin (FTE), expressed as a percentage of average
earning assets, contracted three basis points to 4.28% for the year ended
primarily due to a higher cost of deposits, and a decrease in the average balance of Bay View Funding's factored receivables, partially offset by an increase in the average balance of loans and securities and an increase in the accretion of the loan purchase discount into loan interest income from a merger during the year endedDecember 31, 2019 . 74
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The following tables present the average balance of loans outstanding, interest income, and the average yield for the periods indicated:
Year Ended December 31,
2020 2019 2018
Average Interest Average Average Interest Average Average Interest Average
Balance Income Yield Balance Income Yield Balance Income Yield
(Dollars in thousands)Loans, core bank and asset- based lending$ 2,327,624 $ 110,652 4.75 %$ 1,890,079 $ 100,380 5.31 %$ 1,670,065 $ 86,610 5.19 % SBA PPP loans 218,391 2,185 1.00 % - - N/A - - N/A PPP fees, net - 3,877 1.78 % - - N/A - - N/A
Bay View Funding factored receivables 45,765 10,727 23.44 %
46,710 11,688 25.02 % 59,220 14,698 24.82 % Purchased residential mortgages
29,648 725 2.45 % 35,343 951 2.69 % 40,998 1,118 2.73 %
Purchased CRE loans 24,072 831 3.45 % 30,936 1,107 3.58 % 36,080 1,257 3.48 %
Loan credit mark / accretion (14,005) 4,172 0.18 % (8,151) 2,682 0.14 % (5,348) 1,952 0.12 %
Total loans (includes loans
held-for-sale) $ 2,631,495 $ 133,169 5.06 % $ 1,994,917 $ 116,808 5.86 % $ 1,801,015 $ 105,635 5.87 %
The average yield on the total loan portfolio decreased to 5.06% for the year
ended December 31, 2020 , compared to 5.86% for the year ended December 31, 2019 ,
primarily due to decreases in the prime rate on loans and new average balances
of lower yielding PPP loans, partially offset by higher PPP loan fees and an
increase in the accretion of the loan purchase discount into loan interest
income from the acquisitions. The average yield on the total loan portfolio
decreased to 5.86% for the year ended December 31, 2019 , compared to 5.87% for
the year ended December 31, 2018 , primarily due to a decrease in the average
balance of Bay View Funding's factored receivables, partially offset by the
impact of the increasing prime rate on loans over the course of 2018 (prior to
the prime rate decreasing in the latter part of 2019), and an increase in the
accretion of the loan purchase discount into loan interest income from the
acquisitions.
In aggregate, the original total net purchase discount on loans from the Focus,
In
aggregate, the remaining net purchase discount on total loans acquired was
The average cost of deposits was 0.17% for the year endedDecember 31, 2020 , compared to 0.29% for the year endedDecember 31, 2019 , and 0.21% for the year endedDecember 31, 2018 . Net interest income, before provision for credit losses on loans, for the year endedDecember 31, 2020 increased 8% to$141.9 million , compared to$131.8 million for the year endedDecember 31, 2019 , primarily due to an increase in the average balance of loans resulting from the Presidio merger, additional interest and fee income from PPP loans, and an increase in the accretion of the loan discount into loan interest income from our merger with Presidio, partially offset by decreases in the prime rate, and decreases in the yield on investment securities and overnight funds. Net interest income, before provision for loan losses, for the year endedDecember 31, 2019 increased 8% to$131.8 million , compared to$122.0 million for the year endedDecember 31, 2018 , primarily due to the impact of the increase in loans and deposits from the Presidio merger, in addition to the full year impact of theTri-Valley and United American mergers.
Provision for Credit Losses on Loans
Credit risk is inherent in the business of making loans. The Company establishes an allowance for credit losses on loans through charges to earnings, which are presented in the statements of income as the provision for credit losses on loans. Specifically identifiable and quantifiable known losses are promptly charged off against the allowance. The provision for credit losses on loans is determined by conducting a quarterly evaluation of the adequacy of the Company's allowance for credit losses on loans and charging the shortfall or excess, if any, to the current quarter's expense. This has the effect of creating variability in the amount and frequency of charges to the Company's earnings. The provision for credit losses on loans and level of allowance for each period are dependent upon many factors, including loan growth, net charge offs, changes in the composition of the loan portfolio, delinquencies, management's assessment of the quality of the loan portfolio, the valuation of problem loans and the general economic conditions in the Company's market area. The provision for credit losses on loans and level of allowance for each period are also dependent on forecast data for the state ofCalifornia including GDP and unemployment projections provided by the CEF, (www.CaliforniaForecast.com). There was a$13.2 million provision for credit losses on loans for the year endedDecember 31, 2020 , compared to an$846,000 provision for loan losses for the year endedDecember 31, 2019 , and a$7.4 million provision for loan losses for the year endedDecember 31, 2018 . The increase in the provision for credit losses on loans for the year endedDecember 31, 2020 , compared to the year endedDecember 31, 2019 , was driven primarily by a significantly deteriorated 75
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economic outlook resulting from the Coronavirus pandemic. The three loan classes where the largest increases in reserves were recorded under the CECL loss rate methodology were investor-owned CRE, land and construction, and C&I. Ongoing impacts of the CECL methodology will be dependent upon changes in economic conditions and forecasts, originated and acquired loan portfolio composition, portfolio duration, and other factors. Provisions for credit losses on loans are charged to operations to bring the allowance for credit losses on loans to a level deemed appropriate by the Company based on the factors discussed under "Credit Quality and Performance" and "Allowance for Credit Losses on Loans."
The ACLL totaled
Total loans atDecember 31, 2020 , included$290.7 million of PPP loans which are guaranteed by the SBA, for which no ACLL was allocated. The ALLL was$23.3 million , or 0.92% of total loans atDecember 31, 2019 , and$27.8 million , or 1.48% of total loans atDecember 31, 2018 . The ACLL to total nonperforming loans was 564.24% atDecember 31, 2020 . The ALLL to total nonperforming loans was 236.93% atDecember 31, 2019 , and 187.06% atDecember 31, 2018 . The loans acquired from Presidio are included in total loans. Due to the addition of the Presidio loans at fair value with no allowance, the ALLL to total loans decreased atDecember 31, 2019 , compared toDecember 31, 2018 . However, the Company provided an additional$2.0 million in provision for loan losses to increase the ALLL atDecember 31, 2019 for certain non-impaired loans acquired at a premium from Presidio. This premium was due to higher interest rates on the loans versus market interest rates at the time of the merger. Due to the net premium on these loans, a provision for loan losses was required and it was not due to credit deterioration since the merger date. Net charge-offs totaled$688,000 for the year endedDecember 31, 2020 , compared to net charge-offs of$5.4 million for the year endedDecember 31, 2019 , and net recoveries of$769,000 for the year endedDecember 31, 2018 . Net charge-offs of$5.4 million for the year endedDecember 31, 2019 primarily consisted of three lending relationships totaling$5.5 million in net charge-offs during the fourth quarter of 2019, including one large relationship which was previously disclosed and specifically reserved for during the second and third quarters of 2018. The three lending relationships totaling$5.5 million in net charge-offs had a total of$4.7 million in specific reserves.
Noninterest Income
The following table sets forth the various components of the Company's
noninterest income:
Increase Increase
Year Ended (decrease) (Decrease)
December 31, 2020 versus 2019 2019 versus 2018
2020 2019 2018 Amount Percent Amount Percent
(Dollars in thousands)
Service charges and fees on deposit accounts $ 2,859 $ 4,510 1,045 441 31 % 359 34 % Gain on sales of SBA loans
839 689 698 150 22 % (9) (1) % Gain on the disposition of foreclosed assets
791 - - 791 N/A % (73) (10) % Servicing income
673 636 709 37 6 % 395 148 %
Gain on sales of securities 277 661
266 (384) (58) % - N/A
Other 2,638 2,344 2,743 294 13 % (399) (15) %
Total $ 9,922 $ 10,244 $ 9,574 $ (322) (3) % $ 670 7 %
For the year endedDecember 31, 2020 , noninterest income was$9.9 million , compared to$10.2 million for the year endedDecember 31, 2019 , primarily due to lower service charges and fees on deposit accounts, and a decrease in the gain on sale of securities, partially offset by an increase in the cash surrender value of life insurance, a gain realized on a warrant exercised, and a gain on the disposition of foreclosed assets during the first quarter of 2020. For the year endedDecember 31, 2019 , noninterest income was$10.2 million , compared to$9.6 million for the year endedDecember 31, 2018 . The increase in noninterest income for the year endedDecember 31, 2019 , was primarily due to higher service charges and fees on deposit accounts, an increase in the cash surrender value of life insurance, and an increase in the gain on sale of securities, partially offset by proceeds from a legal settlement in the year endedDecember 31, 2018 .
Historically, a portion of the Company's noninterest income is associated with its SBA lending activity, as gain
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on sales of loans sold in the secondary market and servicing income from loans sold with servicing rights retained. During 2020, SBA loan sales resulted in an$839,000 gain, compared to a$689,000 gain on sales of SBA loans in 2019, and a$698,000 gain on sales of SBA loans in 2018.
The servicing assets that result from the sales of SBA loans with servicing retained are amortized over the expected term of the loans using a method approximating the interest method. Servicing income generally declines as the respective loans are repaid.
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Noninterest Expense
The following table sets forth the various components of the Company's
noninterest expense:
Increase Increase
Year Ended (Decrease) (Decrease)
December 31, 2020 versus 2019 2019 versus 2018
2020 2019 2018 Amount Percent Amount Percent
(Dollars in thousands)
Salaries and employee benefits $ 50,571 $44,174$ 40,193 $ 6,397 14 %$ 3,981 10 % Occupancy and equipment 8,018 6,647 5,411 1,371 21 % 1,236 23 % Professional fees 5,338
3,259 2,891 2,079 64 % 368 13 % Amortization of intangible assets
3,751 2,739 1,943 1,012 37 % 796 41 % Software subscriptions
3,102 2,397 2,343 705 29 % 54 2 %
Data processing 2,770 2,890 1,978 (120) (4) % 912 46 %
Insurance expense 2,286 1,864 1,685 422 23 % 179 11 % Supplemental retirement plan cost
1,724 1,240 202 484 39 % 1,038 514 % Recovery of legal fees (1)
- - (922) - N/A 922 (100) %
Other, excluding merger-related costs 9,350 8,608 10,630 742 9 % (2,022) (19) % Total noninterest expense, excluding merger-related costs 86,910 73,818 66,354 13,092 18 % 7,464 11 % Salaries and employee benefits merger-related costs (2)
356 6,580 3,569 (6,224) (95) % 3,011 84 % Other merger-related costs (3)
2,245
4,500 5,598 (2,255) (50) % (1,098) (20) %
Total noninterest expense, including merger-related costs
The following table indicates the percentage of noninterest expense in each category:
Year Ended
Percent Percent Percent
2020 of Total 2019 of Total 2018 of Total
(Dollars in thousands)
Salaries and employee benefits $ 50,571 57 %$ 44,174 52 %$ 40,193 53 % Occupancy and equipment 8,018 9 % 6,647 8 % 5,411 7 % Professional fees 5,338 6 % 3,259 4 % 2,891 4 %
Amortization of intangible assets 3,751
4 % 2,739 3 % 1,943 3 %
Software subscriptions 3,102 3 % 2,397 3 % 2,343 3 %
Data processing 2,770 3 % 2,890 3 % 1,978 3 %
Insurance expense 2,286 3 % 1,864 2 % 1,685 2 %Supplemental retirement plan cost 1,724 2 % 1,240 2 % 202 0 % Recovery of legal fees (1) - - % - - % (922) (1) % Other, excluding merger-related costs 9,350 10 % 8,608 10 % 10,630 14 % Total noninterest expense, excluding merger-related costs 86,910 97 % 73,818 87 % 66,354 88 % Salaries and employee benefits merger-related costs (2) 356 0 % 6,580 8 % 3,569 5 % Other merger-related costs (3) 2,245 3 % 4,500 5 % 5,598 7 %
Total noninterest expense, including merger-related costs
100 %
(3)Included in the "Professional fees" category in the Consolidated Statements of Income.
(4)Included in "Salaries and employee benefits" category in the Consolidated Statements of Income.
(5)Included in the "Other noninterest expense" category in the Consolidated Statements of Income.
Noninterest expense for the year ended
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salary increases, and additional employees and operating costs added as a result
of the Presidio merger, partially offset by lower merger-related costs.
Full-time equivalent employees were 331 at December 31, 2020 , and 357 at
December 31, 2019 , and 302 at December 31, 2018 . Average full-time equivalent
employees were 341 during 2020, and 320 during 2019, and 292 during 2018.
Noninterest expense for the year ended December 31, 2019 increased 12% to $84.9
million , compared to $75.5 million for the year ended December 31, 2018 ,
primarily due to higher merger-related costs, a full year of additional
operating costs of Tri-Valley and United American, and the operating costs of
Presidio for most of the fourth quarter of 2019. Total noninterest expense for
the year ended December 31, 2019 included total merger-related costs of $11.1
million for the Presidio acquisition of which $6.6 million was included in
salaries and employee benefits, and $4.5 million was included in other
noninterest expense. Total merger-related costs were $9.2 million for the year
ended December 31, 2018 for the Tri-Valley and United American acquisitions, of
which $3.6 million was included in salaries and employee benefits and $5.6
million was included in other noninterest expense. Professional fees for the
year ended December 31, 2018 included a recovery of $922,000 from a legal
settlement.
Income Tax Expense
The Company computes its provision for income taxes on a monthly basis. The
effective tax rate is determined by applying the Company's statutory income tax
rates to pre-tax book income as adjusted for permanent differences between
pre-tax book income and actual taxable income. These permanent differences
include, but are not limited to increases in the cash surrender value of life
insurance policies, interest on tax-exempt securities, certain expenses that are
not allowed as tax deductions, and tax credits.
The following table shows the effective income tax rates for the dates
indicated:
Year Ended December 31,
2020 2019 2018
Effective income tax rate 28.1% 28.1% 27.4%
The Company's Federal and state income tax expense in 2020 was
The difference in the effective tax rate for the periods reported compared to the combined Federal and state statutory tax rate of 29.6% is primarily the result of the Company's investment in life insurance policies whose earnings are not subject to taxes, tax credits related to investments in low income housing limited partnerships (net of low income housing investment losses), and tax-exempt interest income earned on municipal bonds. Some items of income and expense are recognized in different years for tax purposes than when applying generally accepted accounting principles leading to timing differences between the Company's actual tax liability, and the amount accrued for this liability based on book income. These temporary differences comprise the "deferred" portion of the Company's tax expense or benefit, which is accumulated on the Company's books as a deferred tax asset or deferred tax liability until such time as they reverse. Realization of the Company's deferred tax assets is primarily dependent upon the Company generating sufficient future taxable income to obtain benefit from the reversal of net deductible temporary differences and the utilization of tax credit carryforwards and the net operating loss carryforwards for Federal and state income tax purposes. The amount of deferred tax assets considered realizable is subject to adjustment in future periods based on estimates of future taxable income. Under generally accepted accounting principles a valuation allowance is required to be recognized if it is "more likely than not" that the deferred tax assets will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning management's evaluation of both positive and negative evidence, including forecasts of future income, cumulative losses, applicable tax planning strategies, and assessments of current and future economic and business conditions. The Company had the net deferred tax assets of$28.2 million and$24.3 million atDecember 31, 2020 , andDecember 31, 2019 , respectively. After consideration of the matters in the preceding paragraph, the Company determined that it is more likely than not that the net deferred tax assets atDecember 31, 2020 andDecember 31, 2019 will be fully realized in future years. 79 Table of Contents FINANCIAL CONDITION As ofDecember 31, 2020 , total assets increased 13% to$4.63 billion , compared to$4.11 billion atDecember 31, 2019 . Securities available-for-sale, at fair value, were$235.8 million atDecember 31, 2020 , a decrease of (42%) from$404.8 million atDecember 31, 2019 . Securities held-to-maturity, at amortized cost, were$297.4 million atDecember 31, 2020 , a decrease of (19%) from$366.6 million atDecember 31, 2019 . Total loans, excluding loans held-for-sale, increased$85.4 million , or 3%, to$2.62 billion atDecember 31, 2020 , compared to$2.53 billion atDecember 31, 2019 . Total deposits increased$499.7 million , or 15%, to$3.91 billion atDecember 31, 2020 , compared to$3.41 billion atDecember 31, 2019 . Deposits, excluding all time deposits and CDARS deposits, increased$510.1 million , or 16%, to$3.74 billion atDecember 31, 2020 , from$3.23 billion atDecember 31, 2019 .
Securities Portfolio
The following table reflects the balances for each category of securities at
year-end:
December 31,
2020 2019 2018
(Dollars in thousands)
Securities available-for-sale (at fair value):
Agency mortgage-backed securities $ 175,326 $ 284,361 $ 302,854
U.S. Treasury 60,448 120,464 148,753
U.S. Government sponsored entities - -
7,436
Total$ 235,774 $ 404,825 $ 459,043 Securities held-to-maturity (at amortized cost): Agency mortgage-backed securities$ 228,652 $ 285,344 $ 291,241 Municipals - exempt from Federal tax 68,791 81,216
85,957
Total $ 297,443 $ 366,560 $ 377,198 The table below summarizes the weighted average life and weighted average yields
of securities as of
Weighted Average Life
After One and After Five and
Within One Within Five Within Ten After Ten
Year or Less Years Years Years Total
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
(Dollars in thousands)
Securities available-for-sale (at fair value):
Agency mortgage-backed securities $ 5,540 0.62 % $ 169,786 1.66 % $ - N/A $ - N/A $ 175,326 1.62 %
U.S. Treasury 60,448 2.83 % - N/A - N/A - N/A 60,448 2.83 %
Total $ 65,988 2.65 % $ 169,786 1.66 % $ - N/A $ - N/A $ 235,774 1.93 %
Securities held-to-maturity (at amortized cost):
Agency mortgage-backed securities $ 8,674 0.84 % $
175,898 1.79 %
28,201 3.18 % 40,590 3.31 % - N/A - N/A 68,791 3.26 %
Total $ 36,875 2.63 % $ 216,488 2.08 % $ 2,173 2.87 % $ 41,907 1.82 % $ 297,443 2.11 %
(1) Reflects tax equivalent adjustment for Federal tax exempt income based on a
21% tax rate.
The portfolio serves the following purposes: (i) it provides a source of pledged
assets for securing certain deposits and borrowed funds, as may be required by
law or by specific agreement with a depositor or lender; (ii) it provides
liquidity to even out cash flows from the loan and deposit activities of
customers; (iii) it can be used as an interest rate risk management tool, since
it provides a large base of assets, the maturity and interest rate
characteristics of which can be changed more readily than the loan portfolio to
better match changes in the deposit base and other funding sources of the
Company; and (iv) it is an alternative interest-earning use of funds when loan
demand is weak or when deposits grow more rapidly than loans.
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The Company's portfolio may include: (i)U.S. Treasury securities andU.S. Government sponsored entities' debt securities for liquidity and pledging; (ii) mortgage-backed securities, which in many instances can also be used for pledging, and which generally enhance the yield of the portfolio; (iii) municipal obligations, which provide tax free income and limited pledging potential; (iv) single entity issue trust preferred securities, which generally enhance the yield on the portfolio; (v) corporate bonds, which also enhance the yield on the portfolio; (vi) money market mutual funds; (vii) certificates of deposit; (viii) commercial paper; (ix) bankers acceptances; (x) repurchase agreements; (xi) collateralized mortgage obligations; and (xii) asset-backed securities.
The Company classifies its securities as either available-for-sale or held-to-maturity at the time of purchase. Accounting guidance requires available-for-sale securities to be marked to fair value with an offset to accumulated other comprehensive income (loss), a component of shareholders' equity. Monthly adjustments are made to reflect changes in the fair value of the Company's available-for-sale securities.
During the year ended
During the year endedDecember 31, 2020 , the Company purchased$30.9 million of investment securities held-to-maturity, which were all agency mortgage-backed securities, with an average book yield of 1.15%.
The Company has not used interest rate swaps or other derivative instruments to hedge fixed rate loans or securities to otherwise mitigate interest rate risk.
Loans
The Company's loans represent the largest portion of earning assets, substantially greater than the securities portfolio or any other asset category, and the quality and diversification of the loan portfolio is an important consideration when reviewing the Company's financial condition. Gross loans, excluding loans held-for-sale, represented 57% of total assets atDecember 31, 2020 and 62% atDecember 31, 2019 . The ratio of loans to deposits decreased to 66.91% atDecember 31, 2020 from 74.20% atDecember 31, 2019 .
Loan Distribution
The Loan Distribution table that follows sets forth the Company's gross loans
outstanding, excluding loans held-for-sale, and the percentage distribution in
each category at the dates indicated.
December 31,
2020 % to Total 2019 % to Total 2018 % to Total 2017 % to Total 2016 % to Total
(Dollars in thousands)
Commercial $ 555,707 21 % $ 603,345 24 % $ 549,998 29 % $ 516,952 33 % $ 542,638 36 %
SBA PPP loans 290,679 11 % - 0 % - - % - 0 % - - %
Real estate:
CRE - owner occupied 560,362 21 % 548,907 22 % 430,813 23 % 389,289 25 % 401,362 27 %
CRE - non-owner occupied 693,103 27 % 767,821 30 % 477,928 25 % 357,141 23 % 263,079 17 %
Land and construction 144,594 6 % 147,189 6 % 122,403 7 % 103,619 6 % 83,480 6 %
Home equity 111,885 4 % 151,775 6 % 95,478 5 % 77,175 5 % 82,410 5 %
Multifamily 166,425 6 % 180,623 7 % 88,614 5 % 56,058 3 % 37,812 3 %
Residential mortgages 85,116 3 % 100,759 4 % 100,586 5 % 62,579 4 % 67,162 4 %
Consumer and other 18,116 1 % 33,744 1 % 20,912 1 % 20,364 1 % 25,424 2 %
Total Loans 2,625,987 100 % 2,534,163 100 % 1,886,732 100 % 1,583,177 100 % 1,503,367 100 %
Deferred loan fees, net (6,726) - (319) - (327) - (510) - (760) -
Loans, net of deferred % % %
fees 2,619,261 100 2,533,844 100 1,886,405 100 1,582,667 100 % 1,502,607 100 %
Allowance for credit losses
on loans (44,400) (23,285) (27,848) (19,658) (19,089)
Loans, net $ 2,574,861 $ 2,510,559 $ 1,858,557 $ 1,563,009 $ 1,483,518
The Company's loan portfolio is concentrated in commercial (primarily
manufacturing, wholesale, and services oriented entities) and commercial real
estate, with the remaining balance in land development and construction and home
equity, purchased residential mortgages, and consumer loans. The Company does
not have any concentrations by industry or group of industries in its loan
portfolio, however, 67% of its gross loans were secured by real property as of
December 31, 2020 , compared to 75% as of December 31, 2019 . While no specific
industry concentration is considered significant, the Company's lending
operations are located in areas that are dependent on the technology and real
estate industries and their supporting companies.
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The Company has established concentration limits in its loan portfolio for commercial real estate loans, commercial loans, construction loans and unsecured lending, among others. All loan types are within established limits. The Company uses underwriting guidelines to assess the borrowers' historical cash flow to determine debt service, and we further stress test the debt service under higher interest rate scenarios. Financial and performance covenants are used in commercial lending to allow the Company to react to a borrower's deteriorating financial condition, should that occur. The Company's commercial loans are made for working capital, financing the purchase of equipment or for other business purposes. Commercial loans include loans with maturities ranging from thirty days to one year and "term loans" with maturities normally ranging from one to five years. Short-term business loans are generally intended to finance current transactions and typically provide for periodic principal payments, with interest payable monthly. Term loans normally provide for floating interest rates, with monthly payments of both principal and interest. The Company is an active participant in theSBA andU.S. Department of Agriculture guaranteed lending programs, and has been approved by the SBA as a lender under the Preferred Lender Program. The Company regularly makes such loans conditionally guaranteed by the SBA (collectively referred to as "SBA loans"). The guaranteed portion of these loans is typically sold in the secondary market depending on market conditions. When the guaranteed portion of an SBA loan is sold the Company retains the servicing rights for the sold portion. During 2020, loans were sold resulting in a gain on sales of SBA loans of$839,000 , compared to a gain on sales of SBA loans of$689,000 for 2019, and$698,000 for 2018. The Company's factoring receivables are from the operations of Bay View Funding whose primary business is purchasing and collecting factored receivables. Factored receivables are receivables that have been transferred by the originating organization and typically have not been subject to previous collection efforts. These receivables are acquired from a variety of companies, including, but not limited to, service providers, transportation companies, manufacturers, distributors, wholesalers, apparel companies, advertisers, and temporary staffing companies. The portfolio of factored receivables is included in the Company's commercial loan portfolio. The average life of the factored receivables was 37 days for the years endedDecember 31, 2020 andDecember 31, 2019 and 36 days forDecember 31, 2018 . The balance of the purchased receivables as ofDecember 31, 2020 andDecember 31, 2019 was$47.2 million and$46.0 million , respectively.
The commercial loan portfolio decreased
The Company's CRE loans consist primarily of loans based on the borrower's cash flow and are secured by deeds of trust on commercial property to provide a secondary source of repayment. The Company generally restricts real estate term loans to no more than 75% of the property's appraised value or the purchase price of the property depending on the type of property and its utilization. The Company offers both fixed and floating rate loans. Maturities on CRE loans are generally between five and ten years (with amortization ranging from fifteen to twenty-five years and a balloon payment due at maturity), however, SBA, and certain other real estate loans that can be sold in the secondary market, may be granted for longer maturities. The CRE owner-occupied loan portfolio increased$11.5 million , or 2% to$560.4 million atDecember 31, 2020 , from$548.9 million atDecember 31, 2019 . CRE non-owner occupied loans decreased$74.7 million , or (10%) to$693.1 million atDecember 31, 2020 . AtDecember 31, 2020 , 45% of the CRE loan portfolio was secured by owner-occupied real estate. The Company's land and construction loans are primarily to finance the development/construction of commercial and single family residential properties. The Company utilizes underwriting guidelines to assess the likelihood of repayment from sources such as sale of the property or availability of permanent mortgage financing prior to making the construction loan. Construction loans are provided primarily in our market area, and we have extensive controls for the disbursement process. Land and construction loans decreased$2.6 million , or (2%), to$144.6 million atDecember 31, 2020 , from$147.2 million atDecember 31, 2019 . The Company makes home equity lines of credit available to its existing customers. Home equity lines of credit are underwritten initially with a maximum 75% loan to value ratio. Home equity lines of credit decreased$39.9 million , or (26%), to$111.9 million atDecember 31, 2020 , from$151.8 million atDecember 31, 2019 . 82 Table of Contents
Multifamily loans decreased
Residential mortgage loans decreased
Additionally, the Company makes consumer loans for the purpose of financing automobiles, various types of consumer goods, and other personal purposes. Consumer loans generally provide for the monthly payment of principal and interest. Most of the Company's consumer loans are secured by the personal property being purchased or, real property in the instances of home equity loans or lines of credit.
With certain exceptions, state chartered banks are permitted to make extensions of credit to any one borrowing entity up to 15% of the bank's capital and reserves for unsecured loans and up to 25% of the bank's capital and reserves for secured loans. For HBC, these lending limits were$96.0 million and$160.0 million atDecember 31, 2020 , respectively.
Loan Maturities
The following table presents the maturity distribution of the Company's loans (excluding loans held-for-sale), as ofDecember 31, 2020 . The table shows the distribution of such loans between those loans with predetermined (fixed) interest rates and those with variable (floating) interest rates. Floating rates generally fluctuate with changes in the prime rate as reflected in the Western Edition ofThe Wall Street Journal . As ofDecember 31, 2020 , approximately 42% of the Company's loan portfolio consisted of floating interest rate loans.
Over One
Due in Year But
One Year Less than Over
or Less Five Years Five Years Total
(Dollars in thousands)
Commercial $ 421,369 $ 369,877 $ 55,140 $ 846,386
Real estate:
CRE - owner occupied 122,418 149,738 288,206 560,362
CRE - non-owner occupied 238,373 165,141 289,589 693,103
Land and construction 124,587 10,218 9,789 144,594
Home equity 111,768 - 117 111,885
Multifamily 1,779 50,008 114,638 166,425
Residential mortgages 1,545 23,075 60,496 85,116
Consumer and other 12,723 3,668 1,725 18,116
Loans $ 1,034,562 $ 771,725 $ 819,700 $ 2,625,987 Loans with variable interest rates
44,807 744,142 730,256 1,519,205
Loans $ 1,034,562 $ 771,725 $ 819,700 $ 2,625,987
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Loan Servicing
As of December 31, 2020 , 2019, and 2018 there were $78.0 million , $87.8 million ,
and $104.0 million , respectively, of SBA loans that were serviced by the Company
for others. Activity for loan servicing rights was as follows:
2020 2019 2018
(Dollars in thousands)
Beginning of period balance $ 583 $ 871 $ 1,373
Additions 213 157 200
Amortization (265) (445) (702)
End of period balance $ 531 $ 583 $ 871 Loan servicing rights are included in accrued interest receivable and other
assets on the consolidated balance sheets and reported net of amortization.
There was no valuation allowance as of
Activity for the I/O strip receivable was as follows:
2020 2019 2018
(Dollars in thousands)
Beginning of period balance
$ 305 $ 503 $ 568 Management reviews the key economic assumptions used to estimate the fair value of I/O strip receivables on a quarterly basis. The fair value of the I/O strip can be adversely impacted by a significant increase in either the prepayment speed of the portfolio or the discount rate. AtDecember 31, 2020 , key economic assumptions and the sensitivity of the fair value of the I/O strip receivables to immediate changes to the CPR assumption of 10% and 20%, and changes to the discount rate assumption of 1% and 2%, are as follows: (Dollars in thousands) Carrying amount/fair value of Interest-Only (I/O) strip $
305
Prepayment speed assumption (annual rate)
14.6%
Impact on fair value of 10% adverse change in prepayment speed (CPR 16.1%) $
(3)
Impact on fair value of 20% adverse change in prepayment speed (CPR 17.6%) $
(6)
Residual cash flow discount rate assumption (annual)
12.9%
Impact on fair value of 1% adverse change in discount rate (14.2% discount rate)
$ (8)
Impact on fair value of 2% adverse change in discount rate (15.5% discount rate) $ (15)
Credit Quality and Allowance for Credit Losses on Loans
Financial institutions generally have a certain level of exposure to credit
quality risk, and could potentially receive less than a full return of principal
and interest if a debtor becomes unable or unwilling to repay. Since loans are
the most significant assets of the Company and generate the largest portion of
its revenues, the Company's management of credit quality risk is focused
primarily on loan quality. Banks have generally suffered their most severe
earnings declines as a result of customers' inability to generate sufficient
cash flow to service their debts and/or downturns in national and regional
economies and declines in overall asset values including real estate. In
addition, certain debt securities that the Company may purchase have the
potential of declining in value if the obligor's financial capacity to repay
deteriorates.
The Company's policies and procedures identify market segments, set goals for
portfolio growth or contraction, and establish limits on industry and geographic
credit concentrations. In addition, these policies establish the Company's
underwriting standards and the methods of monitoring ongoing credit quality. The
Company's internal credit risk controls are centered in underwriting practices,
credit granting procedures, training, risk management techniques, and
familiarity
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with loan customers as well as the relative diversity and geographic concentration of our loan portfolio.
The Company's credit risk may also be affected by external factors such as the level of interest rates, employment, general economic conditions, real estate values, and trends in particular industries or geographic markets. As an independent community bank serving a specific geographic area, the Company must contend with the unpredictable changes in the generalCalifornia market and, particularly, primary local markets. The Company's asset quality has suffered in the past from the impact of national and regional economic recessions, consumer bankruptcies, and depressed real estate values. Nonperforming assets are comprised of the following: loans for which the Company is no longer accruing interest; restructured loans which have been current under six months; loans 90 days or more past due and still accruing interest (although they are generally placed on nonaccrual when they become 90 days past due, unless they are both well-secured and in the process of collection); and foreclosed assets. Past due loans 30 days or greater totaled$6.2 million and$15.3 million atDecember 31, 2020 andDecember 31, 2019 , respectively, of which$1.9 million and$7.4 million were on nonaccrual. There were also$5.9 million and$1.3 million loans less than 30 days past due included in nonaccrual loans held-for-investment, atDecember 31, 2020 andDecember 31, 2019 , respectively. Management's classification of a loan as "nonaccrual" is an indication that there is reasonable doubt as to the full recovery of principal or interest on the loan. At that point, the Company stops accruing interest income, and reverses any uncollected interest that had been accrued as income. The Company begins recognizing interest income only as cash interest payments are received and it has been determined the collection of all outstanding principal is not in doubt. The loans may or may not be collateralized, and collection efforts are pursued. Loans may be restructured by management when a borrower has experienced some change in financial status causing an inability to meet the original repayment terms and where the Company believes the borrower will eventually overcome those circumstances and make full restitution. Foreclosed assets consist of properties and other assets acquired by foreclosure or similar means that management is offering or will offer for sale. The following table summarizes the Company's nonperforming assets at the dates indicated: December 31, 2020 2019 2018 2017 2016 (Dollars in thousands)
Nonaccrual loans - held-for-investment$ 7,788 $ 8,675 $ 13,699 $ 2,250 $ 3,059 Restructured and loans 90 days past due and still accruing 81 1,153 1,188 235 - Total nonperforming loans 7,869 9,828 14,887 2,485 3,059 Foreclosed assets - - - - 229 Total nonperforming assets$ 7,869 $ 9,828
Nonperforming assets as a percentage of loans plus foreclosed assets 0.30 % 0.39 % 0.79 % 0.16 % 0.22 % Nonperforming assets as a percentage of total assets 0.17 % 0.24 %
0.48 % 0.09 % 0.13 %
Nonperforming assets were $7.9 million , or 0.17% of total assets, at December
31, 2020 , compared to $9.8 million , or 0.24% of total assets, at December 31,
2019 . The following table presents the amortized cost basis of nonperforming
loans and loans past due over 90 days and still accruing at December 31, 2020 :
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Restructured
Nonaccrual Nonaccrual and Loans
with no Special with Special over 90 Days
Allowance for Allowance for Past Due
Credit Credit and Still
Losses Losses Accruing Total
(Dollars in thousands)
Commercial $ 752 $ 1,974 $ 81 $ 2,807
Real estate: - - - -
CRE - Owner Occupied 3,706 - - 3,706
CRE - Non-Owner Occupied - - - -
Land and construction - - - -
Home equity 949 - - 949
Multifamily - - - -
Residential mortgages - - - -
Consumer and other 407 - - 407
Total $ 5,814 $ 1,974 $ 81 $ 7,869
The following table presents nonperforming loans by class at December 31, 2019 :
Restructured
and Loans
over 90 Days
Past Due
and Still
Nonaccrual Accruing Total
(Dollars in thousands)Commercial$ 3,444 $ 1,153 $ 4,597 Real estate: CRE 5,094 - 5,094 Home equity 137 - 137 Total$ 8,675 $ 1,153 $ 9,828
When management determines that foreclosures are probable, expected credit losses for collateral-dependent loans are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate. For loans which foreclosure is not probable, but for which repayment is expected to be provided substantially through the operation or sale of the collateral and the borrower is experiencing financial difficulty, management has elected the practical expedient under ASC 326 to estimate expected credit losses based on the fair value of collateral, adjusted for selling costs as appropriate. The class of loan represents the primary collateral type associated with the loan. Significant quarter over quarter changes are reflective of changes in nonaccrual status and not necessarily associated with credit quality indicators like appraisal value.
The following table presents the amortized cost basis of collateral-dependent
loans by loan classification
Collateral Type
Real
Estate Business
Property Assets Unsecured Total
(Dollars in thousands)
Commercial $ 29 $ 1,815 $ 130 $ 1,974
Total $ 29 $ 1,815 $ 130 $ 1,974 Loans with a well defined weakness, which are characterized by the distinct possibility that the Company will sustain a loss if the deficiencies are not corrected, are categorized as "classified." Classified loans include all loans considered as substandard, substandard nonaccrual, and doubtful and may result from problems specific to a borrower's business or from economic downturns that affect the borrower's ability to repay or that cause a decline in the value
of
the
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underlying collateral (particularly real estate). Loans held for sale are carried at the lower of cost or estimated fair value, and are not allocated an allowance for loan losses.
Classified loans increased to
In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed in accordance with the Company's underwriting policy.
Beginning
The allowance for credit loss estimation process involves procedures to appropriately consider the unique characteristics of its loan portfolio segments. These segments are further disaggregated into loan classes, the level at which credit risk is monitored. When computing the level of expected credit losses, credit loss assumptions are estimated using a model that categorizes loan pools based on loss history, delinquency status, and other credit trends and risk characteristics, including current conditions and reasonable and supportable forecasts about the future. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. In future periods evaluations of the overall loan portfolio, in light of the factors and forecasts then prevailing, may result in significant changes in the allowance and credit loss expense
in those future periods. The allowance level is influenced by loan volumes, loan risk rating migration or delinquency status, changes in historical loss experience, and other conditions influencing loss expectations, such as reasonable and supportable forecasts of economic conditions. The methodology for estimating the amount of expected credit losses reported in the allowance for credit losses has two basic components: first, an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans; and second, a pooled component for estimated expected credit losses for pools of loans that share similar
risk characteristics.
Prior to
Loans are charged-off against the allowance when management determines that a loan balance has been uncollectible. Subsequent recoveries, if any, are credited to the allowance for credit losses on loans.
The following provides a summary of the risks associated with various segments of the Company's loan portfolio, which are factors management regularly considers when evaluating the adequacy of the allowance:
Commercial Commercial loans primarily rely on the identified cash flows of the borrower for repayment and secondarily on the underlying collateral provided by the borrower. However, the cash flows of the borrowers may not be as expected and the collateral securing these loans may vary in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable, inventory or equipment and may incorporate a personal guarantee; however, some loans may be unsecured. Included in commercial loans are$290.7 million of PPP loans atDecember 31, 2020 .Commercial Real Estate Commercial real estate loans rely primarily on the cash flows of the properties securing the loan and secondarily on the value of the property that is securing the loan. Commercial real estate loans comprise two segments differentiated by owner occupied commercial real estate and non-owner commercial real estate. Owner occupied commercial real estate loans are secured by commercial properties that are at least 50% occupied by the borrower or borrower affiliate. Non-owner occupied commercial real estate loans are secured by commercial properties that are less than 50% occupied by the borrower or borrower affiliate. Commercial real estate loans may be adversely affected by conditions in the real estate markets or in the general economy. 87 Table of Contents Land and Construction Land and construction loans are generally based on estimates of costs and value associated with the complete project. Construction loans usually involve the disbursement of funds with repayment substantially dependent on the success of the completion of the project. Sources of repayment for these loans may be permanent loans from HBC or other lenders, or proceeds from the sales of the completed project. These loans are monitored by on-site inspections and are considered to have higher risk than other real estate loans due to the final repayment dependent on numerous factors including general economic conditions. Home Equity Home equity loans are secured by 1-4 family residences that are generally owner occupied. Repayment of these loans depends primarily on the personal income of the borrower and secondarily by the value of the property securing the loan which can be impacted by changes in economic conditions such as the unemployment rate and property values. Multifamily Multifamily loans are loans on residential properties with five or more units. These loans rely primarily on the cash flows of the properties securing the loan for repayment and secondarily on the value of the properties securing the loan.
The cash flows of these borrowers can fluctuate along with the values of the underlying property depending on general economic conditions.
Residential Mortgages Residential mortgage loans are secured by 1-4 family residences which are generally owner-occupied. Repayment of these loans depends primarily on the personal income of the borrower and secondarily by the value of the property securing the loan which can be impacted by changes in economic conditions such as the unemployment rate and property values. Consumer and Other
Consumer and other loans are secured by personal property or are unsecured and rely primarily on the income of the borrower for repayment and secondarily on the collateral value for secured loans. Borrower income and collateral value can vary dependent on economic conditions. As a result of the matters mentioned above, changes in the financial condition of individual borrowers, economic conditions, historical loss experience and the condition of the various markets in which collateral may be sold may all affect the required level of the allowance for credit losses on loans and the associated provision for credit losses on loans. On an ongoing basis, we have engaged an outside firm to perform independent credit reviews of our loan portfolio. TheFederal Reserve Board and theCalifornia Department of Financial Protection and Innovation ("DFPI") also review the allowance for credit losses as an integral part of the examination process. Based on information currently available, management believes that the allowance for credit losses on loans is adequate. However, the loan portfolio could be adversely affected ifCalifornia economic conditions and the real estate market in the Company's market area were to weaken. Also, any weakness of a prolonged nature in the technology industry would have a negative impact on the local market. The effect of such events, although uncertain at this time, could result in an increase in the level of nonperforming loans and increased loan losses, which could adversely affect the Company's future growth and profitability. No assurance of the ultimate level of credit losses can be given with any certainty. 88 Table of Contents
Changes in the allowance for credit losses on loans were as follows:
Year Ended December 31, 2020
CRE CRE
Owner Non-owner Land & Home Multi- Residential Consumer
Commercial Occupied Occupied Construction Equity Family Mortgages and Other Total
(Dollars in thousands)
Beginning of period balance $ 10,453 $ 3,825 $ 3,760 $ 2,621 $ 2,244 $ 57 $ 243$ 82 $ 23,285 Adoption of Topic 326 (3,663) 3,169 7,912 (1,163) (923) 1,196 435 1,607 8,570 Balance at adoption on January 1, 2020 6,790 6,994 11,672 1,458 1,321 1,253 678 1,689 31,855 Charge-offs (1,776) - - - - - - (104) (1,880) Recoveries 998 1 - 70 93 - - 30 1,192 Net (charge-offs) recoveries (778) 1 - 70 93 - - (74) (688) Provision for credit losses on loans 5,575 1,565 4,744 981 (117) 1,551 265 (1,331) 13,233 End of period balance$ 11,587 $ 8,560 $ 16,416 $ 2,509 $ 1,297 $ 2,804 $ 943$ 284 $ 44,400 Year Ended December 31, 2019 Commercial Real Estate Consumer Total (Dollars in thousands) Beginning of period balance$ 17,061 $ 10,671 $ 116 $ 27,848 Charge-offs (6,609) - (14) (6,623) Recoveries 1,045 169 - 1,214 Net (charge-offs) recoveries (5,564) 169 (14) (5,409)
Provision (credit) for loan losses (1,044) 1,910
(20) 846 End of period balance$ 10,453 $ 12,750 $ 82 $ 23,285 Year Ended December 31, 2018 Commercial Real Estate Consumer Total (Dollars in thousands) Beginning of period balance$ 10,608 $ 8,950 $ 100 $ 19,658 Charge-offs (2,002) - (24) (2,026) Recoveries 2,645 150 - 2,795 Net (charge-offs) recoveries 643 150 (24) 769 Provision for loan losses 5,810 1,571 40 7,421 End of period balance$ 17,061 $ 10,671 $ 116 $ 27,848 89 Table of Contents
Allocation of Allowance for Credit Losses on Loans
The following table summarizes the Company's loan loss experience, as well as
provisions and charges to the allowance for credit losses on loans and certain
pertinent ratios for the periods indicated:
2020 2019 2018 2017 2016
(Dollars in thousands)
Beginning of year balance $ 23,285 $ 27,848 $ 19,658$ 19,089 $ 18,926 Charge-offs: Commercial (1,776) (6,609) (2,002) (2,239) (1,961) Real estate:
CRE - non-owner occupied - -
- - (5) Consumer and other (104) (14) (24) - (41) Total charge-offs (1,880) (6,623) (2,026) (2,239) (2,007) Recoveries: Commercial 998 1,045 2,645 1,585 365 Real estate: CRE - owner occupied 1 - - 859 - Land and construction 70 76 114 244 568 Home equity 93 93 36 21 - Consumer and other 30 - - - - Total recoveries 1,192 1,214 2,795 2,709 933
Net (charge-offs) recoveries (688) (5,409) 769 470 (1,074) Impact of adopting Topic 326 8,570 - - - - Provision for credit losses on loans(1) 13,233 846 7,421 99 1,237 End of year balance$ 44,400 $ 23,285 $ 27,848 $ 19,658 $ 19,089
(1) Provision for credit losses on loans for the year ended
Provision for loan losses for the previous years
The following table provides a summary of the allocation of the allowance for
credit losses on loans by class at the dates indicated. The allocation presented
should not be interpreted as an indication that charges to the allowance for
credit losses on loans will be incurred in these amounts or proportions, or that
the portion of the allowance allocated to each category represents the total
amount available for charge-offs that may occur within these classes.
December 31,
2020 2019 2018 2017 2016
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in each in each in each in each in each
category category category category category
to total to total to total to total to total
Allowance loans Allowance loans Allowance loans Allowance loans Allowance loans
(Dollars in thousands)Commercial$ 11,587 32 %$ 10,453 24 %$ 17,061 29 %$ 10,608 33 %$ 10,656 36 % Real estate: - CRE - owner occupied 8,560 21 % 3,825 22 % 2,907 23 % 2,873 25 % 2,968 27 %
CRE - non-owner occupied 16,416 27 % 3,760 30 % 3,456 25 % 2,724 23 % 1,935 17 % Land and construction 2,509 6 % 2,621 6
% 2,008 7 % 1,441 6 % 1,221 6 % Home equity 1,297 4 % 2,244 6 % 1,609 5 % 1,390 5 % 1,639 5 % Multifamily 2,804 6 % 57 7
% 374 5 % 312 3 % 278 3 % Residential mortgages
943 3 % 243 4 % 317 5 % 210 4 % 286 4 %
Consumer and other 284 1 % 82 1 % 116 1 % 100 1 % 106 2 %
Total $ 44,400 100 % $ 23,285 100 % $ 27,848 100 % $ 19,658 99 % $ 19,089 100 %
The allowance for credit losses on loan totaled$44.4 million , or 1.70% of total loans atDecember 31, 2020 . The allowance for loan losses totaled$23.3 million , or 0.92% of total loans atDecember 31, 2019 . The allowance for credit losses on loan to total nonperforming loans increased to 564.24% atDecember 31, 2020 , compared to 236.93% atDecember 31, 2019 . The Company had net charge-offs of$688,000 or 0.03% of average loans, for the year ended 90
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December 31, 2020 , compared to net charge-offs of$5.4 million , or 0.27% of average loans, for the year endedDecember 31, 2019 . Net charge-offs of$5.4 million for the year endedDecember 31, 2019 primarily consisted of three lending relationships totaling$5.5 million in net charge-offs during the fourth quarter of 2019, including one large relationship which was previously disclosed and specifically reserved for during the second and third quarters of 2018.
The
three lending relationships totaling
The following table shows the results of adopting CECL for the year ended
DRIVERS OF CHANGE IN ACLL UNDER CECL (in$000 's, unaudited) ALLL atDecember 31, 2019 $ 23,285 Day 1 adjustment impact of adopting Topic 326 8,570 ACLL atJanuary 1, 2020 31,855 Net (charge-offs) during the first quarter of 2020 (422) Portfolio changes during the first quarter of 2020 1,216 Economic factors during the first quarter of 2020 12,054 ACLL atMarch 31, 2020 44,703 Net (charge-offs) during the second quarter of 2020 (373)
Portfolio changes during the second quarter of 2020 (4,282)
Qualitative and quantitative changes during the second
quarter of 2020 including changes in economic forecasts 5,396
ACLL at
45,444
Net (charge-offs) during the third quarter of 2020 (219)
Portfolio changes during the third quarter of 2020 488
Qualitative and quantitative changes during the third
quarter of 2020 including changes in economic forecasts (291)
ACLL at
$ 45,422 Net (charge-offs) during the fourth quarter of 2020 326
Portfolio changes during the fourth quarter of 2020 (1,622)
Qualitative and quantitative changes during the fourth
quarter of 2020 including changes in economic forecasts 274
ACLL at
$ 44,400 Leases OnJanuary 1, 2019 , the Company adopted Accounting Standards Update ("ASU") No. 2016-02, Leases (Topic 842). Under the new guidance, the Company recognizes the following for all leases, at the commencement date: (1) a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use ("ROU") asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. While the new standard impacts lessors and lessees, the Company is impacted as a lessee of the offices and real estate used for operations. Some of the Company's lease agreements include options to renew at the Company's discretion. The extensions are not reasonably certain to be exercised, therefore it was not considered in the calculation of the ROU asset and lease liability. Total assets and liabilities included$35.9 million of right-of-use assets, included in other assets, and lease liabilities, included in other liabilities, related to non-cancelable operating lease agreements for office space. See Note 7 to the consolidated financial statements. In June of 2019, the Company entered in to a lease agreement for 54,910 square feet of office space inSan Jose, California , which commenced onFebruary 1, 2020 . The Company moved its Bay View Funding office during the first quarter of 2020, and moved the main office of HBC during the second and third quarters of 2020, to this new location. The merger with Presidio resulted in the Company operating overlapping branch locations in the cities ofWalnut Creek andSan Mateo, California . These branches were consolidated in 2020 by vacating the HBC leased locations prior to the lease termination date, and moving the operations to the Presidio branch locations. The consolidation of these two branches into the Presidio locations resulted in the impairment of both leases atDecember 31, 2019 . The lease impairment and write-off of fixed assets and tenant improvements totaled$434,000 for theWalnut Creek location, and$625,000 for theSan Mateo location during the fourth quarter of 2019.
Deposits
The composition and cost of the Company's deposit base are important components
in analyzing the Company's net interest margin and balance sheet liquidity
characteristics, both of which are discussed in greater detail in other sections
in this report. The Company's liquidity is impacted by the volatility of
deposits from the propensity of that money to leave the institution for
rate-related or other reasons. Deposits can be adversely affected if economic
conditions weaken in
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California , and the Company's market area in particular. Potentially, the most
volatile deposits in a financial institution are jumbo certificates of deposit,
meaning time deposits with balances that equal or exceed $250,000 , as customers
with balances of that magnitude are typically more rate-sensitive than customers
with smaller balances.
The following table summarizes the distribution of deposits and the percentage of distribution in each category of deposits for the periods indicated:
December 31, 2020 December 31, 2019 December 31, 2018
Balance % to Total Balance % to Total Balance % to Total
(Dollars in thousands)
Demand, noninterest-bearing $ 1,661,655 42 % $ 1,450,873 42 % $ 1,021,582 39 %
Demand, interest-bearing 960,179 25 % 798,375 23 % 702,000 27 %
Savings and money market 1,119,968 29 % 982,430 29 % 754,277 28 %
Time deposits - under $250 45,027 1 % 54,361 2 % 58,661 2 %
Time deposits - $250 and over 103,746 3 % 99,882 3 % 86,114 3 %
CDARS - interest-bearing demand,
money market and time deposits 23,911 1 % 28,847 1 % 14,898 1 %
Total deposits $ 3,914,486 100 % $ 3,414,768 100 % $ 2,637,532 100 %
The Company obtains deposits from a cross-section of the communities it serves.
The Company's business is not generally seasonal in nature. Public funds were
less than 1% of deposits at December 31, 2020 and December 31, 2019 .
Total deposits increased $499.7 million , or 15%, to $3.91 billion at December
31, 2020 , compared to $3.41 billion at December 31, 2019 . Deposits, excluding
all time deposits and CDARS deposits, increased $510.1 million , or 16%, to $3.74
billion at December 31, 2020 , compared to $3.23 billion at December 31, 2019 .
At December 31, 2020 , the $23.9 million CDARS deposits were comprised of $18.6
million of interest-bearing demand deposits, $663,000 of money market accounts
and $4.6 million of time deposits. At December 31, 2019 , the $28.8 million CDARS
deposits were comprised of $12.9 million of interest-bearing demand deposits,
$2.1 million of money market accounts and $13.8 million of time deposits.
The following table indicates the contractual maturity schedule of the Company's
time deposits of $250,000 and over, and all CDARS time deposits as of December
31, 2020 :
Balance % of Total
(Dollars in thousands)
Three months or less $ 34,194 32 %
Over three months through six months 22,913 21 %
Over six months through twelve months 39,004 36 %
Over twelve months 12,270 11 %
Total $ 108,381 100 %
The Company focuses primarily on providing and servicing business deposit
accounts that are frequently over $250,000 in average balance per account. As a
result, certain types of business clients that the Company serves typically
carry average deposits in excess of $250,000 . The account activity for some
account types and client types necessitates appropriate liquidity management
practices by the Company to ensure its ability to fund deposit withdrawals.
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Return on Equity and Assets
The following table indicates the ratios for return on average assets and average equity, and average equity to average assets for the periods indicated:
2020 2019 2018
Return on average assets 0.80 % 1.21 % 1.16 %
Return on average tangible assets 0.83 % 1.25 % 1.19 % Return on average equity
6.12 % 9.51 % 10.79 %
Return on average tangible equity 9.04 % 13.09 % 14.41 % Average equity to average assets ratio 13.00 % 12.69 % 10.72 %
Off-Balance Sheet Arrangements
In the normal course of business, the Company makes commitments to extend credit to its customers as long as there are no violations of any conditions established in contractual arrangements. These commitments are obligations that represent a potential credit risk to the Company, yet are not reflected in any form within the Company's consolidated balance sheets. Total unused commitments to extend credit were$1.1 billion atDecember 31, 2020 andDecember 31, 2019 . Unused commitments represented 42% and 44% of outstanding gross loans atDecember 31, 2020 andDecember 31, 2019 , respectively. The effect on the Company's revenues, expenses, cash flows and liquidity from the unused portion of the commitments to provide credit cannot be reasonably predicted, because there is no certainty that the lines of credit will ever be fully utilized. For more information regarding the Company's off-balance sheet arrangements, see Note 16 to the consolidated financial statements located elsewhere herein. The following table presents the Company's commitments to extend credit for the periods indicated: December 31, 2020 2019 Fixed Variable Fixed Variable Rate Rate Total Rate Rate Total (Dollars in thousands) Unused lines of credit and commitments to make loans$ 121,560 $ 970,614 $ 1,092,174 $ 147,372 $ 951,206 $ 1,098,578 Standby letters of credit 3,049 18,970 22,019 11,445 10,615 22,060$ 124,609 $ 989,584 $ 1,114,193 $ 158,817 $ 961,821 $ 1,120,638 Contractual Obligations
The contractual obligations of the Company, summarized by type of obligation and
contractual maturity, at
Less Than One to Three to After
One Year Three Years Five Years Five Years Total
(Dollars in thousands)
Deposits(1) $ 3,899,179 $ 14,381 $ 926 $ - $ 3,914,486
Subordinated debt - - - 40,000 40,000
Operating leases 5,242 10,707 8,954 18,798 43,700
Other long-term liabilities(2) 2,123 3,732
3,980 48,615 58,450
Total contractual obligations
(1) Deposits with indeterminate maturities, such as demand, savings and money market accounts, are reflected as obligations due in less than one year.
Includes maximum payments related to employee benefit plans, assuming all (2) future vesting conditions are met. Additional information is provided in
Note 14 to the consolidated financial statements.
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In addition to those obligations listed above, in the normal course of business,
the Company will make cash distributions for the payment of interest on
interest-bearing deposit accounts and debt obligations, payments for quarterly
income tax estimates and contributions to certain employee benefit plans.
Liquidity and Asset/Liability Management
Liquidity refers to the Company's ability to maintain cash flows sufficient to fund operations and to meet obligations and other commitments in a timely and cost effective fashion. At various times the Company requires funds to meet short-term cash requirements brought about by loan growth or deposit outflows, the purchase of assets, or liability repayments. An integral part of the Company's ability to manage its liquidity position appropriately is the Company's large base of core deposits, which are generated by offering traditional banking services in its service area and which have historically been a stable source of funds. To manage liquidity needs properly, cash inflows must be timed to coincide with anticipated outflows or sufficient liquidity resources must be available to meet varying demands. The Company manages liquidity to be able to meet unexpected sudden changes in levels of its assets or deposit liabilities without maintaining excessive amounts of balance sheet liquidity. Excess balance sheet liquidity can negatively impact the Company's interest margin. In order to meet short-term liquidity needs the Company may utilize overnight Federal funds purchase arrangements and other borrowing arrangements with correspondent banks, solicit brokered deposits if cost effective deposits are not available from local sources, and maintain collateralized lines of credit with the FHLB and FRB. In addition, the Company can raise cash for temporary needs by selling securities under agreements to repurchase and selling securities available-for-sale.
One of the measures of liquidity is our loan to deposit ratio. Our loan to
deposit ratio was 66.91% at
FHLB and FRB Borrowings and Available Lines of Credit
The Company has off-balance sheet liquidity in the form of Federal funds purchase arrangements with correspondent banks, and lines of credit from the FHLB and FRB. The Company can borrow from the FHLB on a short-term (typically overnight) or long-term (over one year) basis. As ofDecember 31, 2020 , andDecember 31, 2019 , the Company had no overnight borrowings from the FHLB. The Company had$232.6 million of loans and pledged to the FHLB as collateral on a line of credit of$160.5 million atDecember 31, 2020 . The Company also had$3.2 million of securities pledged to the FHLB as collateral on an available line of credit of$3.0 million atDecember 31, 2020 , none of which was outstanding. The Company can also borrow from the FRB's discount window. The Company had approximately$921.4 million of loans pledged to the FRB as collateral on an available line of credit of approximately$528.1 million atDecember 31, 2020 , none of which was outstanding.
At
The Company has a$10.0 million line of credit with a correspondent bank, of which none was outstanding atDecember 31, 2020 . The Company had a$5,000,000 line of credit with a correspondent bank, of which none was outstanding atDecember 31, 2019 .
The Company may also utilize securities sold under repurchase agreements to
manage our liquidity position. There were no securities sold under agreements to
repurchase at
Capital Resources
The Company uses a variety of measures to evaluate capital adequacy. Management reviews various capital measurements on a regular basis and takes appropriate action to ensure that such measurements are within established internal and external guidelines. The external guidelines, which are issued by theFederal Reserve and theFDIC , establish a risk-adjusted ratio relating capital to different categories of assets and off-balance sheet exposures. OnMay 26, 2017 , the Company completed an underwritten public offering of$40.0 million aggregate principal amount of its fixed-to-floating rate subordinated notes ("Subordinated Debt") dueJune 1, 2027 . The Subordinated Debt 94
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initially bears a fixed interest rate of 5.25% per year. Commencing onJune 1, 2022 , the interest rate on the Subordinated Debt resets quarterly to the three-month LIBOR rate plus a spread of 336.5 basis points, payable quarterly in arrears. Interest on the Subordinated Debt is payable semi-annually onJune 1st andDecember 1st of each year throughJune 1, 2022 and quarterly thereafter onMarch 1st ,June 1st ,September 1st andDecember 1st of each year through the maturity date or early redemption date. The Company, at its option, may redeem the Subordinated Debt, in whole or in part, on any interest payment date on or afterJune 1, 2022 without a premium. It is anticipated that the LIBOR index will be phased-out by the end of 2021 and theFederal Reserve Bank of New York has established the Secured Overnight Financing Rate ("SOFR") as its recommended alternative to LIBOR. We have created a sub-committee of our Asset Liability Management Committee to address LIBOR transition and phase-out issues. We are currently reviewing loan documentation, technology systems and procedures we will need to implement for the transition.
The Company acquired
The following table summarizes risk based capital, risk weighted assets, and risk based capital ratios of the consolidated Company under the Basel III requirements for the periods indicated:
December 31,
2020 2019 2018
(Dollars in thousands)
Capital components:
Common equity Tier 1 capital $ 410,307 $ 393,432 $ 276,675
Additional Tier 1 capital - - -
Tier 1 Capital 410,307 393,432 276,675
Tier 2 Capital 73,563 63,726 67,922
Total risk-based capital $ 483,870 $ 457,158 $ 344,597
Risk-weighted assets $ 2,924,448 $ 3,136,252 $ 2,303,941
Average assets for capital purposes $ 4,507,032 $ 4,041,927 $ 3,118,150
Capital ratios:
Total risk-based capital 16.5 % 14.6 % 15.0 %
Tier 1 risk-based capital 14.0 % 12.5 % 12.0 %Common equity Tier 1 risk-based capital 14.0 % 12.5 %
12.0 %
Leverage(1) 9.1 % 9.7 % 8.9 %
(1) Tier 1 capital divided by quarterly average assets (excluding intangible
assets and disallowed deferred tax assets).
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The following table summarizes risk-based capital, risk-weighted assets, and
risk-based capital ratios of HBC under the Basel III requirements for the
periods indicated:
December 31,
2020 2019 2018
(Dollars in thousands)
Capital components:
Common equity Tier 1 capital $ 428,109 $ 411,585 $ 293,730
Additional Tier 1 capital - - -
Tier 1 Capital 428,109 411,585 293,730
Tier 2 Capital 33,824 24,172 28,553
Total risk-based capital $ 461,933 $ 435,757 $ 322,283
Risk-weighted assets $ 2,922,577 $ 3,134,848 $ 2,302,751
Average assets for capital purposes $ 4,505,265 $ 4,040,265 $ 3,116,645
Capital ratios:
Total risk-based capital 15.8 % 13.9 % 14.0 %
Tier 1 risk-based capital 14.6 % 13.1 % 12.8 %Common equity Tier 1 risk-based capital 14.6 % 13.1 %
12.8 %
Leverage(1) 9.5 % 10.2 % 9.4 %
(1) Tier 1 capital divided by quarterly average assets (excluding intangible
assets and disallowed deferred tax assets).
The following table presents the applicable well-capitalized regulatory
guidelines and the standards for minimum capital adequacy requirements under
Basel III:
Well-capitalized
Financial
Minimum Institution PCA
Regulatory Regulatory
Requirement(1) Guidelines
Capital ratios:
Total risk-based capital 10.5 % 10.0 %
Tier 1 risk-based capital 8.5 % 8.0 %
Common equity Tier 1 risk-based capital 7.0 % 6.5 %
Leverage 4.0 % 5.0 %
(1) Includes 2.5% capital conservation buffer, except the leverage ratio.
The Basel III capital rules introduce a new "capital conservation buffer," for banking organizations to maintain a common equity Tier 1 ratio more than 2.5% above these minimum risk-weighted asset ratios. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the capital conservation buffer will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall. AtDecember 31, 2020 , the Company's consolidated capital ratio exceeded regulatory guidelines and HBC's capital ratios exceed the highest regulatory capital requirement of "well-capitalized" under Basel III prompt corrective action provisions. Quantitative measures established by regulation to help ensure capital adequacy require the Company and HBC to maintain minimum amounts and ratios of total risk-based capital, Tier 1 capital, and common equity Tier 1 (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average assets (as defined). Management believes that, as ofDecember 31, 2020 ,December 31, 2019 , andDecember 31, 2018 , the Company and HBC met all capital adequacy guidelines to which they were subject. There are no conditions or events since ofDecember 31, 2020 , that management believes have changed the categorization of the Company or HBC as well-capitalized. 96 Table of Contents
AtDecember 31, 2020 , the Company had total shareholders' equity of$577.9 million , compared to$576.7 million atDecember 31, 2019 . AtDecember 31, 2020 , total shareholders' equity included$493.7 million in common stock,$94.9 million in retained earnings, and($10.7) million of accumulated other comprehensive loss. The book value per common share was$9.64 atDecember 31, 2020 , compared to$9.71 atDecember 31, 2019 . The tangible book value per common share was$6.57 atDecember 31, 2020 , compared to$6.55 atDecember 31, 2019 .
The following table reflects the components of accumulated other comprehensive loss, net of taxes, for the periods indicated:
ACCUMULATED OTHER COMPREHENSIVE LOSS December 31, December 31, (in$000 's, unaudited) 2020 2019 Unrealized gain on securities available-for-sale $ 3,709 $ 1,242 Remaining unamortized unrealized gain on securities available-for-sale transferred to held-to-maturity 261
298
Split dollar insurance contracts liability (6,140)
(4,835)
Supplemental executive retirement plan liability (8,767)
(6,843)
Unrealized gain on interest-only strip from SBA loans 220
360
Total accumulated other comprehensive loss
(9,778) Market Risk
Market risk is the risk of loss of future earnings, fair values, or future cash flows that may result from changes in the price of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market risk sensitive instruments. Market risk is attributed to all market risk sensitive financial instruments, including securities, loans, deposits and borrowings, as well as the Company's role as a financial intermediary in customer-related transactions. The objective of market risk management is to avoid excessive exposure of the Company's earnings and equity to loss and to reduce the volatility inherent in certain financial instruments.
Interest Rate Management
Market risk arises from changes in interest rates, exchange rates, commodity
prices and equity prices. The Company's market risk exposure is primarily that
of interest rate risk, and it has established policies and procedures to monitor
and limit earnings and balance sheet exposure to changes in interest rates. The
Company does not engage in the trading of financial instruments, nor does the
Company have exposure to currency exchange rates.
The principal objective of interest rate risk management (often referred to as
"asset/liability management") is to manage the financial components of the
Company in a manner that will optimize the risk/reward equation for earnings and
capital in relation to changing interest rates. The Company's exposure to market
risk is reviewed on a regular basis by the Asset/Liability Committee. Interest
rate risk is the potential of economic losses due to future interest rate
changes. These economic losses can be reflected as a loss of future net interest
income and/or a loss of current fair market values. The objective is to measure
the effect on net interest income and to adjust the balance sheet to minimize
the inherent risk while at the same time maximizing income. Management realizes
certain risks are inherent, and that the goal is to identify and manage the
risks. Management uses two methodologies to manage interest rate risk: (i) a
standard GAP analysis; and (ii) an interest rate shock simulation model.
The planning of asset and liability maturities is an integral part of the
management of an institution's net interest margin. To the extent maturities of
assets and liabilities do not match in a changing interest rate environment, the
net interest margin may change over time. Even with perfectly matched repricing
of assets and liabilities, risks remain in the form of prepayment of loans or
securities or in the form of delays in the adjustment of rates of interest
applying to either earning assets with floating rates or to interest bearing
liabilities. The Company has generally been able to control its exposure to
changing interest rates by maintaining primarily floating interest rate loans
and a majority of its time certificates with relatively short maturities.
Interest rate changes do not affect all categories of assets and liabilities
equally or at the same time. Varying interest rate environments can create
unexpected changes in prepayment levels of assets and liabilities, which may
have a
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significant effect on the net interest margin and are not reflected in the interest sensitivity analysis table. Because of these factors, an interest sensitivity GAP report may not provide a complete assessment of the exposure to changes in interest rates.
The Company uses modeling software for asset/liability management in order to simulate the effects of potential interest rate changes on the Company's net interest margin, and to calculate the estimated fair values of the Company's financial instruments under different interest rate scenarios. The program imports current balances, interest rates, maturity dates and repricing information for individual financial instruments, and incorporates assumptions on the characteristics of embedded options along with pricing and duration for new volumes to project the effects of a given interest rate change on the Company's interest income and interest expense. Rate scenarios consisting of key rate and yield curve projections are run against the Company's investment, loan, deposit and borrowed funds portfolios. These rate projections can be shocked (an immediate and parallel change in all base rates, up or down) and ramped (an incremental increase or decrease in rates over a specified time period), based on current trends and econometric models or stable economic conditions (unchanged from current actual levels). The following table sets forth the estimated changes in the Company's annual net interest income that would result from the designated instantaneous parallel shift in interest rates noted, as ofDecember 31, 2020 . Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results. Increase/(Decrease) in Estimated Net Interest Income Amount Percent (Dollars in thousands) Change in Interest Rates (basis points) +400$ 59,450 50.0 % +300$ 44,796 37.7 % +200$ 30,037 25.3 % +100$ 15,231 12.8 % 0 - - -100$ (11,927) (10.0) % -200$ (22,135) (18.6) %
This data does not reflect any actions that we may undertake in response to changes in interest rates such as changes in rates paid on certain deposit accounts based on local competitive factors, which could reduce the actual impact on net interest income, if any.
As with any method of gauging interest rate risk, there are certain shortcomings inherent to the methodology noted above. The model assumes interest rate changes are instantaneous parallel shifts in the yield curve. In reality, rate changes are rarely instantaneous. The use of the simplifying assumption that short-term and long-term rates change by the same degree may also misstate historic rate patterns, which rarely show parallel yield curve shifts. Further, the model assumes that certain assets and liabilities of similar maturity or period to repricing will react in the same way to changes in rates. In reality, certain types of financial instruments may react in advance of changes in market rates, while the reaction of other types of financial instruments may lag behind the change in general market rates. Additionally, the methodology noted above does not reflect the full impact of annual and lifetime restrictions on changes in rates for certain assets, such as adjustable rate loans. When interest rates change, actual loan prepayments and actual early withdrawals from certificates may deviate significantly from the assumptions used in the model. Finally, this methodology does not measure or reflect the impact that higher rates may have on adjustable-rate loan borrowers' ability to service their debt. All of these factors are considered in monitoring the Company's exposure to interest rate risk.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a financial institution, the Company's primary component of market risk is
interest rate volatility. Fluctuations in interest rates will ultimately impact
both the level of income and expense recorded on most of the Company's assets
and liabilities and the market value of all interest-earning assets, other than
those which have a short term to maturity. Based upon the nature of the
Company's operations, the Company is not subject to foreign exchange or
commodity price
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risk. The Company has no market risk sensitive instruments held for trading
purposes. As of
The information concerning quantitative and qualitative disclosure or market risk called for by Item 305 of Regulation S-K is included as part of Item 7 of this report.
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