PACIFIC MERCANTILE BANCORP 38
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Forward Looking Statements
Statements contained in this Quarterly Report on Form 10-Q (this "Report") that
are not historical facts or that discuss our expectations, beliefs or views,
including those regarding our proposed merger with Banc of California, Inc.
("Banc of California "), our future financial performance and our business,
trends and expectations regarding the markets in which we operate, and our
future plans, including the credit exposure of certain loan products and other
components of our business that could be impacted by the COVID-19 pandemic,
constitute "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of
the Securities Exchange Act of 1934, as amended (the "Exchange Act").
Forward-looking statements can be identified by the fact that they do not relate
strictly to historical or current facts. Often, they include words such as
"believe," "expect," "anticipate," "intend," "plan," "estimate," "project,"
"forecast," or words of similar meaning, or future or conditional verbs such as
"will," "would," "should," "could," or "may." The information contained in such
forward-looking statements is based on current information available to us and
on assumptions that we make about future economic and market conditions and
other events over which we do not have control. In addition, our business and
the markets in which we operate are subject to a number of risks and
uncertainties. Such risks and uncertainties, and the occurrence of events in the
future or changes in circumstances that had not been anticipated, could cause
our financial condition or actual operating results in the future to differ
materially from our expected financial condition or operating results that are
set forth in the forward-looking statements contained in this Report and could,
therefore, also affect the price performance of our shares.
In addition to the risk of incurring loan losses and provision for loan losses,
which is an inherent risk of the banking business, these risks and uncertainties
include, but are not limited to, the following: the possibility that the merger
with Banc of California does not close when expected or at all because required
regulatory, or other approvals, financial tests or other conditions to closing
are not received or satisfied on a timely basis or at all; changes in Banc of
California's or our stock price before closing, including as a result of the
companies' financial performance prior to closing, general stock market
movements, and the performance of other financial companies and peer group
companies; the risk that the anticipated benefits of the merger may not be fully
realized or may take longer to realize than expected, including as a result of
changes in general economic and market conditions, interest and exchange rates,
monetary policy, laws and regulations and their enforcement, and the degree of
competition in the geographic and business areas in which Banc of California and
we operate; Banc of California's ability to promptly and effectively integrate
our businesses following the merger; the reaction to the transaction of the
companies' customers, employees and counterparties; diversion of management time
on merger-related issues; deteriorating economic conditions and macroeconomic
factors such as unemployment rates and the volume of bankruptcies, as well as
changes in monetary, fiscal or tax policy to address the impact of COVID-19, any
of which could cause us to incur additional loan losses and adversely affect our
results of operations in the future; the risk that the credit quality of our
borrowers declines; potential declines in the value of the collateral for
secured loans; the risk that steps we have taken to strengthen our overall
credit administration are not effective; the risk of a recession in the United
States economy, and domestic or international economic conditions, which could
cause us to incur additional loan losses and adversely affect our results of
operations in the future; the risk that our interest margins and, therefore, our
net interest income will be adversely affected by changes in prevailing interest
rates; the risk that we will not succeed in further reducing our remaining
nonperforming assets, in which event we would face the prospect of further loan
charge-offs and write-downs of other real estate owned and would continue to
incur expenses associated with the management and disposition of those assets;
the risk that we will not be able to manage our interest rate risks effectively,
in which event our operating results could be harmed; the prospect of changes in
government regulation of banking and other financial services organizations,
which could impact our costs of doing business and restrict our ability to take
advantage of business and growth opportunities; the risk that our efforts to
develop a robust commercial banking platform may not succeed; and the risk that
we may be unable to realize our expected level of increasing deposit inflows.
Many of the foregoing risks and uncertainties are, and will be, exacerbated by
the COVID-19 pandemic and any worsening of the global business and economic
environment as a result. Readers of this Report are encouraged to review the
additional information regarding these and other risks and uncertainties to
which our business is subject that is contained in Part I, Item 1A of our Annual
Report on Form 10-K for the year ended December 31, 2020 (as amended, the "2020
Form 10-K") that we filed with the Securities and Exchange Commission ("SEC") on
March 15, 2021 , as such information may be updated from time to time in
subsequent Quarterly Reports on Form 10-Q that we file with the SEC . We urge you
to read those risk factors in conjunction with your review of the following
discussion and analysis of our results of operations for the three and six
months ended, and our financial condition at, June 30, 2021 .
Due to the risks and uncertainties we face, readers are cautioned not to place
undue reliance on the forward-looking statements contained in this Report, which
speak only as of the date of this Report, or to make predictions about future
performance based solely on historical financial performance. We also disclaim
any obligation to update forward-looking statements contained in this Report as
a result of new information, future events or otherwise, except as may otherwise
be required by law.
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Recent Developments
On March 22, 2021 , Pacific Mercantile Bancorp entered into an Agreement and Plan
of Merger (the "Merger Agreement") with Banc of California. The Merger Agreement
provides that, upon the terms and subject to the conditions set forth therein,
Pacific Mercantile Bancorp will merge with and into Banc of California (the
"Merger"), with Banc of California surviving the Merger. Promptly following the
Merger, the Bank will merge with and into Banc of California's wholly-owned bank
subsidiary, Banc of California, National Association , a national banking
association (the "Bank Merger"). Banc of California, National Association will
be the surviving bank in the Bank Merger. The Merger Agreement was adopted and
approved by the Board of Directors of each of Pacific Mercantile Bancorp and
Banc of California. The closing of the Merger, which is expected to occur in the
third quarter of 2021, is contingent upon receipt of necessary regulatory
approvals, along with the satisfaction of other customary closing conditions.
Overview
The following discussion presents information about our consolidated results of operations, financial condition, liquidity and capital resources and should be read in conjunction with our consolidated financial statements and the notes thereto included in Item 1 above of this Report. Our principal operating subsidiary isPacific Mercantile Bank (the "Bank"), which is aCalifornia state chartered bank. The Bank accounts for substantially all of our consolidated revenues, expenses and income and our consolidated assets and liabilities. Accordingly, the following discussion focuses primarily on the Bank's results of operations and financial condition. As ofJune 30, 2021 , our total assets, net loans and total deposits were$1.5 billion ,$1.1 billion and$1.3 billion , respectively. The Bank, which is headquartered inOrange County, California , approximately 40 miles south ofLos Angeles , conducts a commercial banking business inOrange ,Los Angeles ,San Bernardino andSan Diego counties inSouthern California . The Bank is also a member of theFederal Reserve System and its deposits are insured, to the maximum extent permitted by law, by theFederal Deposit Insurance Corporation (the "FDIC"). For the six months endedJune 30, 2021 and 2020, we operated as one reportable segment, Commercial Banking. Unless the context otherwise requires, the "Company," "we," "our," "ours," and "us" refer toPacific Mercantile Bancorp and its consolidated subsidiaries. 40 -------------------------------------------------------------------------------- Table of Contents COVID-19 Impact The outbreak of the novel coronavirus ("COVID-19") and theFederal Reserve's response to the economic challenges have resulted in an uncertain and rapidly evolving economy. Governmental response to combat this pandemic has resulted in approximately 25% of our staff to shift to work remotely. Our business continuity plans have been activated by COVID-19 and we have been able to fully support our remote workforce and have the ability to support all employees in a remote work environment. These remote work arrangements have not adversely impacted our ability to serve our clients, and have not had an impact on our financial reporting systems or the internal controls we have over financial reporting, disclosures and related procedures. The most significant impact of COVID-19 on our business has been to the quality of our loan portfolio and to net interest income as short-term interest rates sharply declined. We have no certainty that the provisions we made during 2020 will be sufficient to absorb the losses that stem from the impact of COVID-19 on our clients. As the longer term effects on our clients from the COVID-19 pandemic become more apparent, we may need to charge-off some or all of the balance on certain loans and make further provisions to increase our allowance for loan and lease losses. These potential additional provisions for loan and lease losses will have a direct impact upon our capital, including the potential need to reevaluate the need for a valuation allowance on our deferred tax asset. At this time, we don't expect that there would be any material impairment to the valuation of other long-lived assets, right of use assets, or our investment securities. The Bank is currently Well Capitalized under federal banking regulations that apply to allUnited States -based banks, with approximately$85 million of capital in excess of what is required for the Bank to be Well Capitalized using the ratio of Total Capital to Risk Weighted Assets. The Company has approximately$10 million of capital that it could contribute to the Bank should it be needed. In the event that future loan and leases loss and/or tax provisions reduce our capital surplus, we would be required to undertake measures to return the Bank's capital ratios to Well Capitalized levels, which could include but not be limited to raising additional capital or reducing the Bank's asset size. We believe that we would have access to equity and debt markets to secure additional capital for the Bank should the need arise, but we have no certainty regarding the extent of the availability of these markets at the time such need would arise. Increased demand for liquidity by our clients is another impact that we anticipate could occur should the COVID-19 effects be prolonged. As ofJune 30, 2021 the Company and the Bank's on-balance sheet liquidity was very strong and combined with our contingent liquidity resources, we believe that the Bank has sufficient resources to meet the liquidity needs of our clients. In response to COVID-19, theFederal Reserve has made other provisions that could assist the Bank in satisfying its liquidity needs, such as reducing our reserve requirement to zero, expanding access to the discount window through collateral pledging and extension of term borrowings. 41 -------------------------------------------------------------------------------- Table of Contents Results of Operations Operating Results for the Three and Six Months EndedJune 30, 2021 and 2020
Our operating results for the three and six months ended
Three Months Ended June 30, 2021 vs. 2020 Six Months Ended June 30, 2021 vs. 2020
2021 2020 % Change 2021 2020 % Change
(Dollars in thousands)
Interest income $ 12,539 $ 15,580 (19.5) % $ 26,237 $ 30,349 (13.5) %
Interest expense 838 2,262 (63.0) % 1,798 5,558 (67.7) %
Provision for loan and
lease losses - 2,850 (100.0) - 9,050 (100.0) %
Noninterest income 2,865 1,171 144.7 % 4,603 2,265 103.2 %
Noninterest expense 9,193 8,934 2.9 % 18,857 18,651 1.1 %
Income tax expense
(benefit) 1,479 800 84.9 % 2,903 (190) (1,627.9) %
Net income (loss) $ 3,894 $ 1,905 104.4 % $ 7,282 $ (455) (1,700.4) %
Interest Income
Three Months Ended June 30, 2021 and 2020
Total interest income decreased 19.5% to $12.5 million for the three months
ended June 30, 2021 from $15.6 million for the three months ended June 30, 2020 .
This was primarily due to a decrease in interest earned on loans as a result of
a lower average yield and lower average balance during the three months ended
June 30, 2021 as compared to the same period prior year, and a decrease in PPP
fee income compared to the same quarter prior year. During the three months
ended June 30, 2021 and 2020, interest income on loans was $12.2 million and
$15.3 million , respectively, yielding 3.99% and 4.62% on average loan balances
of $1.22 billion and $1.33 billion , respectively.
During the three months ended June 30, 2021 and 2020, interest income from our
securities available-for-sale and stock was $317 thousand and $210 thousand ,
respectively, yielding 2.55% and 2.41% on average balances of $49.8 million and
$35.0 million , respectively. Interest income from our short-term investments,
including our Federal Funds sold and interest-bearing deposits, was $66 thousand
and $79 thousand for the three months ended June 30, 2021 and 2020,
respectively, yielding 0.10% and 0.10% on average balances of $257.1 million and
$322.0 million , respectively. The increase in interest income from our
securities available-for-sale and stock was primarily attributable to a higher
average balance and higher average yield. As a result, total interest income on
investments increased for the three months ended June 30, 2021 as compared to
the three months ended June 30, 2020 .
Six Months Ended June 30, 2021 and 2020
Total interest income decreased 13.5% to $26.2 million for the six months ended
June 30, 2021 from $30.3 million for the six months ended June 30, 2020 . This
was primarily due to a decrease in interest income on loans and short-term
investments during the six months ended June 30, 2021 as compared to the same
prior year period. During the six months ended June 30, 2021 and 2020, interest
income on loans was $25.5 million and $29.1 million , respectively, yielding
4.16% and 4.78% on average loan balances of $1.24 billion and $1.22 billion ,
respectively. The increase in the average loan balances is attributable to our
participation in the Paycheck Protection Program. The decrease in average loan
yield is primarily attributable to the Federal Reserve Board decreasing
short-term interest rates in the first quarter of 2020 in response to the
economic conditions cause by the outbreak of COVID-19.
During the six months ended June 30, 2021 and 2020, interest income from our
securities available-for-sale and stock was $633 thousand and $471 thousand ,
respectively, yielding 2.47% and 2.67% on average balances of $51.7 million and
$35.4 million , respectively. The average securities balances increased as a
result of purchases of $10.0 million in available for sale securities during the
six months ended June 30, 2021 . Interest income from our short-term investments,
including our Federal Funds sold and interest-bearing deposits, was $118
thousand and $800 thousand for the six months ended June 30, 2021 and 2020,
respectively, yielding 0.10% and 0.59% on average balances of $229.5 million and
$271.3 million , respectively. The decrease in interest income from our
short-term investments was primarily attributable to a decrease in the average
yield for the six months ended June 30, 2021 as a result of the Federal Reserve
Board cutting short-term interest rates in the first quarter of 2020 in response
to the economic conditions caused by the outbreak of COVID-19. As a result,
total interest income on investments decreased for the six months ended June 30,
2021 as compared to the six months ended June 30, 2020 .
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Interest Expense Three Months EndedJune 30, 2021 and 2020 Total interest expense decreased 63.0% to$838 thousand for the three months endedJune 30, 2021 from$2.3 million for the three months endedJune 30, 2020 . The decrease was primarily due to a decrease in our cost of funds from 0.95% atJune 30, 2020 to 0.44% atJune 30, 2021 , in addition to a decrease in the average balance of interest-bearing liabilities from$957.9 million atJune 30, 2020 to$771.4 million atJune 30, 2021 , which consisted of deposits, borrowings and junior subordinated debentures. The decrease to our cost of funds is primarily attributable to our ongoing focus on reducing costs of deposits by monitoring and lowering interest rates in response to the current interest rate environment and actively managing our deposit portfolio away from higher costing money market deposits and certificates of deposit and into noninterest bearing deposits. Interest expense on our certificates of deposit for the three months endedJune 30, 2021 and 2020 was$461 thousand and$1.4 million , respectively, with a cost of funds of 0.96% and 2.12% on average balances of$192.3 million and$260.4 million , respectively. Six Months EndedJune 30, 2021 and 2020 Total interest expense decreased 67.7% to$1.8 million for the six months endedJune 30, 2021 from$5.6 million for the six months endedJune 30, 2020 . The decrease was primarily due to a decrease in our cost of funds from 1.24% atJune 30, 2020 to 0.47% atJune 30, 2021 and a decrease in the average balance of interest-bearing liabilities of$902.0 million atJune 30, 2020 to$764.5 million atJune 30, 2021 , which consisted of deposits, borrowings and junior subordinated debentures. Our cost of funds decreased as a result of our ongoing focus on reducing costs of deposits by monitoring and lowering interest rates in response to the current interest rate environment and actively managing our deposit portfolio away from higher costing money market deposits and certificates of deposit and into noninterest bearing deposits. Interest expense on our certificates of deposit for the six months endedJune 30, 2021 and 2020 was$1.0 million and$3.0 million , respectively, with a cost of funds of 1.06% and 2.21% on average balances of$198.4 million and$268.2 million , respectively. Net Interest Margin One of the principal determinants of a bank's income is its net interest income, which is the difference between (i) the interest that a bank earns on loans, investment securities and other interest earning assets, on the one hand, and (ii) its interest expense, which consists primarily of the interest it must pay to attract and retain deposits and the interest that it pays on borrowings and other interest-bearing liabilities, on the other hand. As a general rule, all other things being equal, the greater the difference or "spread" between the amount of our interest income and the amount of our interest expense, the greater will be our net income; whereas, a decline in that difference or "spread" will generally result in a decline in our net income. A bank's interest income and interest expense are affected by a number of factors, some of which are outside of its control, including national and local economic conditions and the monetary policies of theFederal Reserve Board which affect interest rates, competition in the market place for loans and deposits, the demand for loans and the ability of borrowers to meet their loan payment obligations. Net interest income, when expressed as a percentage of total average interest earning assets, is a banking organization's "net interest margin." The following tables set forth information regarding our average balances, yields on interest earning assets, interest expense on interest-bearing liabilities, the interest rate spread and the interest rate margin for the three and six months endedJune 30, 2021 and 2020. Average balances are calculated based on average daily balances. 43
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Three Months Ended June 30,
2021 2020
Interest Average Interest Average
Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate
(Dollars in thousands)
Interest-earning assets
Short-term investments(1) $ 257,133 $ 66 0.10 % $ 322,023 $ 79 0.10 %
Securities available for sale and stock(2) 49,765 317 2.55 % 35,000 210 2.41 %
Loans(3) 1,222,889 12,156 3.99 % 1,331,270 15,291 4.62 %
Total interest-earning assets 1,529,787 12,539 3.29 % 1,688,293 15,580 3.71 %
Noninterest-earning assets
Cash and due from banks 17,997 16,622
All other assets 23,438 28,048
Total assets $ 1,571,222 $ 1,732,963
Interest-bearing liabilities:
Interest-bearing checking accounts $ 193,113 $ 42 0.09 % $ 103,164 $ 25 0.10 %
Money market and savings accounts 368,367 189 0.21 % 454,877 567 0.50 %
Certificates of deposit 192,307 461 0.96 % 260,354 1,371 2.12 %
Other borrowings 55 - - % 122,015 130 0.43 %
Junior subordinated debentures 17,527 146 3.34 % 17,527 169 3.88 %
Total interest bearing liabilities 771,369 838 0.44 % 957,937 2,262 0.95 %
Noninterest bearing liabilities
Demand deposits 618,404 606,481
Accrued expenses and other liabilities 17,574 18,649
Shareholders' equity 163,875 149,896
Total liabilities and shareholders' equity $ 1,571,222 $ 1,732,963
Net interest income $ 11,701 $ 13,318
Net interest income/spread 2.85 % 2.76 %
Net interest margin 3.07 % 3.17 %
(1)Short-term investments consist of Federal Funds sold and interest bearing
deposits that we maintain at other financial institutions.
(2)Stock consists of FHLB stock and FRBSF stock.
(3)Loans include the average balance of nonaccrual loans.
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Six Months Ended June 30,
2021 2020
Interest Average Interest Average
Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate
(Dollars in thousands)
Interest-earning assets
Short-term investments(1) $ 229,469 $ 118 0.10 % $ 271,310 $ 800 0.59 %
Securities available for sale and stock(2) 51,742 633 2.47 % 35,422 471 2.67 %
Loans(3) 1,236,790 25,486 4.16 % 1,224,134 29,078 4.78 %
Total interest-earning assets 1,518,001 26,237 3.49 % 1,530,866 30,349 3.99 %
Noninterest-earning assets
Cash and due from banks 17,899 16,698
All other assets 23,114 26,601
Total assets $ 1,559,014 $ 1,574,165
Interest-bearing liabilities:
Interest-bearing checking accounts $ 166,805 $ 69 0.08 % $ 103,260 $ 113 0.22 %
Money market and savings accounts 380,388 401 0.21 % 435,205 1,864 0.86 %
Certificates of deposit 198,419 1,047 1.06 % 268,200 2,951 2.21 %
Other borrowings 1,354 11 1.64 % 77,821 263 0.68 %
Junior subordinated debentures 17,527 269 3.09 % 17,527 367 4.21 %
Total interest bearing liabilities 764,493 1,797 0.47 % 902,013 5,558 1.24 %
Noninterest bearing liabilities
Demand deposits 614,675 502,514
Accrued expenses and other liabilities 17,412 19,175
Shareholders' equity 162,434 150,463
Total liabilities and shareholders' equity $ 1,559,014 $ 1,574,165
Net interest income $ 24,440 $ 24,791
Net interest income/spread 3.02 % 2.75 %
Net interest margin 3.25 % 3.26 %
(1)Short-term investments consist of Federal Funds sold and interest bearing
deposits that we maintain at other financial institutions.
(2)Stock consists of FHLB stock and FRBSF stock.
(3)Loans include the average balance of nonaccrual loans.
45-------------------------------------------------------------------------------- Table of Contents The following table sets forth changes in interest income, including loan fees, and interest paid in the three months endedJune 30, 2021 and 2020 and the extent to which those changes were attributable to changes in (i) the volumes of or the rates of interest earned on interest-earning assets and (ii) the volumes of or the rates of interest paid on our interest-bearing liabilities. Three Months EndedJune 30, 2021 Compared to Three Months EndedJune 30, 2020 Six Months EndedJune 30, 2021 Compared to Increase (Decrease) due to Changes in Six Months EndedJune 30, 2020
Increase (Decrease) due to Changes in
Total
Total Increase Increase
Volume Rates (Decrease) Volume Rates (Decrease)
(Dollars in thousands)
Interest income
Short-term investments(1) $ (16) $ 3 $ (13) $ (107) $ (575) $ (682)
Securities available for sale and stock(2) 94 13 107 201 (39) 162
Loans (1,169) (1,966) (3,135) 291 (3,883) (3,592)
Total earning assets (1,091) (1,950) (3,041) 385 (4,497) (4,112)
Interest expense
Interest-bearing checking accounts 20 (3) 17 48 (92) (44)
Money market and savings accounts (92) (286) (378) (210) (1,253) (1,463)
Certificates of deposit (295) (615) (910) (636) (1,268) (1,904)
Borrowings (65) (65) (130) (407) 155 (252)
Junior subordinated debentures - (23) (23) - (98) (98)
Total interest-bearing liabilities (432) (992) (1,424) (1,205) (2,556) (3,761)
Net interest income $ (659) $ (958) $ (1,617) $ 1,590 $ (1,941) $ (351) (1)Short-term investments consist of Federal Funds sold and interest bearing deposits that we maintain at other financial institutions. (2)Stock consists of FHLB stock and FRBSF stock.
Provision for Loan and Lease Losses
We maintain reserves to provide for loan losses that occur in the ordinary
course of the banking business. When it is determined that the payment in full
of a loan has become unlikely, the carrying value of the loan is reduced
("written down") to what management believes is its realizable value or, if it
is determined that a loan no longer has any realizable value, the carrying value
of the loan is written off in its entirety (a loan "charge-off"). Loan
charge-offs and write-downs are charged against our allowance for loan and lease
losses ("ALLL"). The amount of the ALLL is increased periodically to replenish
the ALLL after it has been reduced due to loan write-downs or charge-offs. The
ALLL also is increased or decreased periodically to reflect increases or
decreases in the volume of outstanding loans and to take account of changes in
the risk of probable loan losses due to financial performance of borrowers, the
value of collateral securing nonperforming loans or changing economic
conditions. Increases in the ALLL are made through a "provision for loan and
lease losses" that is recorded as an expense in the statement of operations.
Increases in the ALLL are also recognized through the recovery of charged-off
loans which are added back to the ALLL. As such, recoveries are a direct offset
for a provision for loan and lease losses that would otherwise be needed to
replenish or increase the ALLL.
We employ economic models and data that conform to bank regulatory guidelines
and reflect sound industry practices as well as our own historical loan loss
experience to determine the sufficiency of the ALLL and any provisions needed to
increase or replenish the ALLL. Those determinations involve judgments and
assumptions about current economic conditions and external events that can
impact the ability of borrowers to meet their loan obligations. However, the
duration and impact of these factors cannot be determined with any certainty. As
such, unanticipated changes in economic or market conditions, bank regulatory
guidelines or the sound practices that are used to determine the sufficiency of
the ALLL, could require us to record additional, and possibly significant,
provisions to increase the ALLL. This would have the effect of reducing
reportable income or, in the most extreme circumstance, creating a reportable
loss. In addition, the Federal Reserve Bank and the California Department of
Financial Protection and Innovation ("CDFPI"), as an integral part of their
regulatory oversight, periodically review the adequacy of our ALLL. These
agencies may require us to make additional provisions for perceived potential
loan losses, over and above the provisions that we have already made, the effect
of which would be to reduce our income or increase any losses we might incur.
We recorded no provision for loan and lease losses during the three and six
months ended June 30, 2021 as the level of allowance built earlier in the prior
year in anticipation of credits impacted by COVID-19 eventually migrating to
nonperforming
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status continued to be sufficient to reflect the actual migration trends
experienced in the portfolio. We recorded a provision for loan and lease losses
of $2.9 million and $9.1 million during the three and six months ended June 30,
2020 as a result of total charge-offs of $2.2 million and $4.5 million ,
respectively, increases in classified and non-performing loans, and qualitative
factor increases related to COVID-19.
See "-Financial Condition-Nonperforming Assets and Allowance for Loan and Lease
Losses" below in this Item 2 for additional information regarding the ALLL.
Noninterest Income
The following table identifies the components of and the percentage changes in
noninterest income during the three and six months ended June 30, 2021 and
2020:
Three Months Ended June 30, Six Months Ended June 30,
Percentage Percentage
Amount Amount Change Amount Amount Change
2021 2020 2021 vs. 2020 2021 2020 2021 vs. 2020
(Dollars in thousands)
Service fees on deposits and other
banking services $ 814 $ 625 30.2 % $ 1,634 $ 1,147 42.5 %
Net gain on sale of securities available for sale 396 - 100.0 % 536 - 100.0 % Net loss on sale of other assets (47) (53) (11.3) % (93) (47) 97.9 % Net gain on sale of loans 878 - 100.0 % 878 - 100.0 % Other noninterest income 824 599 37.6 % 1,648 1,165 41.5 % Total noninterest income$ 2,865 $ 1,171 144.7 %$ 4,603 $ 2,265 103.2 %
Three Months Ended
Noninterest income increased by$1.7 million , or 144.7%, for the three months endedJune 30, 2021 as compared to the three months endedJune 30, 2020 , primarily as a result of: •Net gain on sale of loans of$878 thousand during the three months endedJune 30, 2021 , primarily related to the outsourcing of our commercial credit card product that did not occur same period prior year, and •Net gain on sale of securities available for sale of$396 thousand in the current quarter that did not occur same period prior year, and •An increase of$225 thousand in other noninterest income which included credit card fee income and referral fees related to the outsourcing of PPP loan servicing, and •An increase of$189 thousand in service fees on loans and deposits and other banking services during the second quarter of 2021 as compared to the same quarter of the prior year.
Six Months Ended
Noninterest income increased$2.3 million , or 103.2%, for the six months endedJune 30, 2021 as compared to the six months endedJune 30, 2020 , primarily as a result of: •Net gain on sale of loans of$878 thousand during the six months endedJune 30, 2021 , primarily related to the outsourcing of our commercial credit card product that did not occur same period prior year, and •Net gain on sale of securities available for sale of$536 thousand in the current year that did not occur same period prior year, and •An increase of$487 thousand in service fees on loans and deposits and other banking services during the six months endedJune 30, 2021 as compared to the same period of the prior year, and •An increase of$483 thousand in other noninterest income which included credit card fee income and referral fees related to the outsourcing of PPP loan servicing. Noninterest Expense The following table sets forth the principal components and the amounts of, and the percentage changes in, noninterest expense during the three and six months endedJune 30, 2021 and 2020. 47
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Three Months Ended June 30, Six Months Ended June 30,
2021 2020 2021 vs. 2020 2021 2020 2021 vs. 2020
Amount Amount Percent Change Amount Amount Percent Change
(Dollars in thousands)
Salaries and employee benefits
1.0 %$ 11,178 $ 11,531 (3.1) % Occupancy 753 668 12.7 % 1,409 1,339 5.2 % Equipment and depreciation 485 508 (4.5) % 980 959 2.2 % Data processing 506 592 (14.5) % 1,068 1,236 (13.6) % FDIC expense 80 210 (61.9) % 365 403 (9.4) % Professional fees 680 702 (3.1) % 1,562 1,563 (0.1) % Merger related expenses 584 - 100.0 % 971 - 100.0 % Business development 144 137 5.1 % 265 309 (14.2) % Loan related expense 15 152 (90.1) % 172 277 (37.9) % Insurance 71 63 12.7 % 141 126 11.9 % Other operating expenses (1) 358 440 (18.6) % 746 908 (17.8) % Total noninterest expense$ 9,193 $ 8,934 2.9 %$ 18,857 $ 18,651 1.1 %
(1)Other operating expenses primarily consist of telephone, investor relations, promotional, regulatory expenses, and correspondent bank fees.
Three Months Ended
Noninterest expense increased$259 thousand , or 2.9%, for the three months endedJune 30, 2021 as compared to the three months endedJune 30, 2020 , primarily as a result of: •Accounting and legal expenses of$584 thousand related to the proposed merger with Banc of California, and •An increase of$85 thousand in occupancy expense related to expired tenant improvement credits also related to the proposed merger with Banc of California, partially offset by •A decrease of$290 thousand in other noninterest expense primarily related to business development and other operating expenses, and •A decrease of$130 thousand inFDIC insurance expense based on an adjustment to the assessment rate based on a decrease in average asset size and improved asset quality. Six Months EndedJune 30, 2021 and 2020 Noninterest expense increased$206 thousand , or 1.1%, for the six months endedJune 30, 2021 as compared to the six months endedJune 30, 2020 , primarily as a result of: •Accounting and legal expense of$971 thousand related to the proposed merger with Banc of California, partially offset by •A decrease of$353 thousand in salaries and employee benefits primarily related to the staffing changes made at the Bank during the second quarter of 2020, and •A decrease of$464 thousand in other noninterest expense primarily related to business development and other operating expenses. Provision for Income Tax For the three and six months endedJune 30, 2021 , we had income tax expense of$1.5 million and$2.9 million , respectively, as a result of our operating income, compared to an income tax expense of$800 thousand and income tax benefit of$190 thousand , respectively, for the three and six months endedJune 30, 2020 , as a result of our operating income for the quarter and operating loss year-to-date. During the three and six months endedJune 30, 2021 andJune 30, 2020 , management determined that there continued to be enough positive evidence to support no valuation allowance on our deferred tax asset, and based on this evaluation, concluded that the Company would be able to realize the deferred tax asset within the period that our operating losses may be carried forward. Positive evidence as ofJune 30, 2021 included our three-year cumulative income position, forecasted net income for the year, and significant improvements in our asset quality during the year. In addition, negative evidence as ofJune 30, 2020 such as an accumulated deficit, net loss year-to-date, and deterioration in asset quality 48 -------------------------------------------------------------------------------- Table of Contents were remedied over the course of the following year, and resulted in retained earnings, net income, and significant decreases in nonaccrual and classified loans as ofJune 30, 2021 . 49
-------------------------------------------------------------------------------- Table of Contents Financial Condition Assets Our total assets decreased by$53 million atJune 30, 2021 compared toDecember 31, 2020 . The following table sets forth the composition of our interest earning assets at: December 31, June 30, 2021 2020 (Dollars in thousands) Interest-bearing deposits with financial institutions (1)$ 344,357 $ 274,245 Interest-bearing time deposits with financial institutions 1,597 1,597
7,898 7,910
Securities available for sale, at fair value 24,321 42,183
Loans (net of allowances of
1,209,587
(1)Includes interest-earning balances maintained at the FRBSF.
Investment Portfolio
Securities Available for Sale. Securities that we intend to hold for an
indefinite period of time, but which may be sold in response to changes in
liquidity needs, in interest rates, or in prepayment risks or other similar
factors, are classified as "securities available for sale". Such securities are
recorded on our balance sheet at their respective fair values and increases or
decreases in those values are recorded as unrealized gains or losses,
respectively, and are reported as other comprehensive income (loss) on our
accompanying consolidated statements of financial condition, rather than
included in or deducted from our earnings.
The following is a summary of the major components of securities available for
sale and a comparison of the amortized cost, estimated fair values and the gross
unrealized gains and losses attributable to those securities, as of June 30,
2021 and December 31, 2020 :
Gross Gross Estimated
Amortized Cost Unrealized Gain Unrealized Loss Fair Value
(Dollars in thousands)
Securities available for sale at June 30,
2021 :
Commercial mortgage backed securities
issued by U.S. Agencies $ 24,580 $ - $ (589) $ 23,991
Residential mortgage backed securities
issued by U.S. Agencies 331 2 (3) 330
Corporate subordinated indentures - - - -
Total securities available for sale
2 $ (592) $ 24,321
Securities available for sale at
December 31, 2020:
Commercial mortgage backed securities
issued by U.S. Agencies $ 20,585 $ 214 $ (126) $ 20,673
Residential mortgage backed securities
issued by U.S. Agencies 14,061 379 (4) 14,436
Corporate subordinated indentures 7,035 42 (3) 7,074
Total securities available for sale
635 $ (133) $ 42,183
The amortized cost of securities available for sale at June 30, 2021 is shown in
the table below by contractual maturities taking into consideration historical
prepayments based on the prior twelve months of principal payments. Expected
maturities will differ from contractual maturities and historical prepayments,
particularly with respect to collateralized mortgage obligations, if any,
primarily because prepayment rates are affected by changes in conditions in the
interest rate market and, therefore, future prepayment rates may differ from
historical prepayment rates.
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June 30, 2021 Maturing in
One year or less Over one year through five years Over five years through ten years Over ten years Total
Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Amortized Average
Amortized Cost Yield Amortized Cost Yield Amortized Cost Yield Amortized Cost Yield Cost Yield
(Dollars in thousands)Securities available for sale:
Commercial mortgage backed securities issued byU.S. Agencies $ 366 1.30 %$ 2,322 1.22 % $ 9,809 1.10 %$ 12,083 1.41 %$ 24,580
1.26 %
Residential mortgage-backed
securities issued by U.S.
Agencies 331 1.68 % - - % - - % - - % 331 1.30 %
Total securities available for
sale $ 697 1.48 % $ 2,322 1.22 % $ 9,809 1.10 % $ 12,083 1.41 % $ 24,911 1.27 %
Loans
The outbreak of COVID-19 will continue to have an impact on our loan portfolio
as we experience a prolonged period of economic uncertainty that affects a broad
range of industries in which our customers operate. Disruptions to our customers
could result in increased risk of delinquencies, defaults, foreclosures and
losses on our loans. As a result of these risks, we have provided for additional
losses in our provision for loan and lease losses with increased qualitative
factors to reflect the current economic environment. Our participation in the
PPP has allowed us to assist hundreds of our customers in securing funding from
the SBA. The Bank was able to begin processing applications for PPP loans on
April 3, 2020 , the very first day the SBA began accepting applications, due to
the preparations made by the Bank at the end of the first quarter 2020. The Bank
has been able to process loan applications for approximately $390 million , which
was largely for the benefit of the Bank's existing clients who have been
impacted by COVID-19. The decrease in our loan portfolio in the second quarter
of 2021 is primarily due to the forgiveness of these PPP loans by the SBA.
The following table sets forth the composition, by loan category, of our loan
portfolio at June 30, 2021 and December 31, 2020 :
June 30, 2021 December 31, 2020
Amount Percent Amount Percent
(Dollars in thousands)
Commercial loans, excluding PPP $ 284,416 25.6 % $ 337,427 27.6 %
Commercial loans - PPP 177,961 16.0 % 229,728 18.8 %
Commercial real estate loans - owner occupied 186,522 16.8 % 197,336 16.1 %
Commercial real estate loans - all other 204,486 18.4 % 194,893 15.9 %
Residential mortgage loans - multi-family 160,563 14.4 % 159,182 13.0 %
Residential mortgage loans - single family 9,511 0.9 % 12,766 1.0 %
Construction and land development loans 11,907 1.1 % 11,766 1.0 %
Consumer loans 76,325 6.8 % 80,759 6.6 %
Total loans 1,111,691 100.0 % 1,223,857 100.0 %
Deferred loan origination costs, net 1,756 3,182
Allowance for loan and lease losses (17,268) (17,452)
Loans, net $ 1,096,179 $ 1,209,587
Commercial loans are loans to businesses to finance capital purchases or
improvements, or to provide cash flow for operations. Commercial real estate and
residential mortgage loans are loans secured by trust deeds on real properties,
including commercial properties and single family and multi-family residences.
Construction loans are interim loans to finance specific construction projects.
Land development loans are loans secured by non-arable bare land. Consumer loans
include installment loans to consumers.
The following table sets forth the maturity distribution of our loan portfolio
(excluding single and multi-family residential mortgage loans and consumer
loans) at June 30, 2021 :
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June 30, 2021
Over One
Year
One Year Through Over Five
or Less Five Years Years Total
(Dollars in thousands)
Real estate loans(1)
Floating rate $ 16,651 $ 20,618 $ 118,212 $ 155,481
Fixed rate 15,183 82,432 149,819 247,434
Commercial loans
Floating rate 24,982 85,101 21,513 131,596
Fixed rate 142,363 168,010 20,408 330,781
Total $ 199,179 $ 356,161 $ 309,952 $ 865,292
(1)Does not include mortgage loans on single or multi-family residences or
consumer loans, which totaled $170.1 million and $76.3 million , respectively, at
June 30, 2021 .
Nonperforming Assets and Allowance for Loan and Lease Losses
Nonperforming Assets. Nonperforming loans consist of (i) loans on nonaccrual
status which are loans on which the accrual of interest has been discontinued
and include restructured loans when there has not been a history of past
performance on debt service in accordance with the contractual terms of the
restructured loans, and (ii) loans 90 days or more past due and still accruing
interest. Nonperforming assets are comprised of nonperforming loans and other
real estate owned ("OREO"), which consists of real properties that we have
acquired by or in lieu of foreclosure and which we intend to offer for sale.
Loans are placed on nonaccrual status when, in our opinion, the full timely
collection of principal or interest is in doubt. Generally, the accrual of
interest is discontinued when principal or interest payments become more than 90
days past due, unless we believe the loan is adequately collateralized and the
loan is in the process of collection. However, in certain instances, we may
place a particular loan on nonaccrual status earlier, depending upon the
individual circumstances involved in that loan's delinquency. When a loan is
placed on nonaccrual status, previously accrued but unpaid interest is reversed
against current income. Subsequent collections of unpaid amounts on such a loan
are applied to reduce principal when received, except when the ultimate
collectability of principal is probable, in which case such payments are applied
to interest and are credited to income. Nonaccrual loans may be restored to
accrual status if and when principal and interest become current and full
repayment is expected. Interest income is recognized on the accrual basis for
impaired loans which, based on our nonaccrual policy, do not require nonaccrual
treatment.
The following table sets forth information regarding our nonperforming assets,
as well as information regarding restructured loans, at June 30, 2021 and
December 31, 2020 :
At June
30, 2021 At
(Dollars in thousands)
Nonaccrual loans:
Commercial loans $ 22,936 $ 30,928
Commercial real estate 830 8,814
Consumer 138 174
Total nonaccrual loans $ 23,904 $ 39,916
Total nonaccrual loans to total loans 2.18 % 3.30 %
Loans past due 90 days and still accruing interest: Commercial loans
$ - $ 5,675
Total loans past due 90 days and still accruing interest $
- $ 5,675
Other nonperforming assets:
Other foreclosed assets 137 231
Total nonperforming assets $ 24,041 $ 40,147
Restructured loans:
Accruing loans $ 5,434 $ -
Nonaccruing loans (included in nonaccrual loans above) 3,340 6,712
Total restructured loans $ 8,774 $ 6,712
As the table above indicates, total nonperforming assets decreased by
approximately 16.1 million, or 40%, to
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primarily from $22.6 million of payoffs or pay downs on our nonaccrual loans and
$540 thousand of charge-offs, partially offset by $7.1 million of additions
during the six months ended June 30, 2021 .
Information Regarding Impaired Loans. At June 30, 2021 , loans deemed impaired
totaled $29.3 million as compared to $39.9 million at December 31, 2020 . We had
an average investment in impaired loans of $31.8 million for the six months
ended June 30, 2021 , as compared to $20.1 million for the six months ended
June 30, 2020 . The interest that would have been earned during the six months
ended June 30, 2021 had the nonaccruing impaired loans remained current in
accordance with their original terms was approximately $664 thousand .
The following table sets forth the amount of impaired loans to which a portion
of the ALLL has been specifically allocated, and the aggregate amount so
allocated, in accordance with Accounting Standards Codification 310-10, and the
amount of the ALLL and the amount of impaired loans for which no such
allocations were made, in each case at June 30, 2021 and December 31, 2020 :
June 30, 2021 December 31, 2020
% of % of
Reserves for Reserves to Reserves for Reserves to
Loans Loan Losses Loans Loans Loan Losses Loans
(Dollars in thousands)
Impaired loans with specific
reserves $ 19,055 $ 7,908 41.5 % $ 19,958 $ 2,711 13.6 %
Impaired loans without specific
reserves 10,283 - - 19,958 - -
Total impaired loans $ 29,338 $ 7,908 27.0 % $ 39,916 $ 2,711 6.8 %
The $10.6 million decrease in impaired loans to $29.3 million at June 30, 2021
from $39.9 million at December 31, 2020 was primarily attributable to $12.5
million in principal payments, $4.6 million returned to accrual, $538 thousand
charged-off, partially offset by $7.1 million in additions to impaired loans
during the six months ended June 30, 2021 . Based on an internal analysis, using
the current estimated fair values of the collateral or the discounted present
values of the future estimated cash flows of the impaired loans, we concluded
that, at June 30, 2021 , $7.9 million specific reserves were required on our
impaired loans and that all impaired loans were otherwise well secured and
adequately collateralized.
Allowance for Loan and Lease Losses. The ALLL totaled $17.3 million ,
representing 1.55% of total loans outstanding at June 30, 2021 , as compared to
$17.5 million , or 1.43% of loans outstanding, at December 31, 2020 . Total loans
at June 30, 2021 included $178.0 million of PPP loans that are 100% government
guaranteed. The ALLL to total loans excluding the PPP loans at this date was
1.85%, which is a non-GAAP financial measure.
The adequacy of the ALLL is determined through periodic evaluations of the loan
portfolio and other factors that can reasonably be expected to affect the
ability of borrowers to meet their loan obligations. Those factors are
inherently subjective as the process for determining the adequacy of the ALLL
involves some significant estimates and assumptions about such matters such as
(i) economic conditions and trends and the amounts and timing of expected future
cash flows of borrowers which can affect their ability to meet their loan
obligations to us, (ii) the fair value of the collateral securing nonperforming
loans, (iii) estimates of losses that we may incur on nonperforming loans, which
are determined on the basis of historical loss experience and industry loss
factors and bank regulatory guidelines, which are subject to change, and
(iv) various qualitative factors. Since those factors are subject to changes in
economic and other conditions and changes in regulatory guidelines or other
circumstances over which we have no control, the amount of the ALLL may prove to
be insufficient to cover all of the loan losses we might incur in the future. In
such an event, it may become necessary for us to increase the ALLL from time to
time to maintain its adequacy. Such increases are effectuated by means of a
charge to income, referred to as the "provision for loan and lease losses", in
our statements of our operations. See "-Results of Operations- Provision for
Loan and Lease Losses, above in this Item 2.
The amount of the ALLL is first determined by assigning reserve ratios for all
loans. All nonaccrual loans and other loans classified as "Special Mention,"
"Substandard" or "Doubtful" ("classified loans" or "classification categories")
and not fully collateralized are then assigned specific reserves within the
ALLL, with greater reserve allocations made to loans deemed to be of a higher
risk. These ratios are determined based on prior loss history and industry
guidelines and loss factors, by type of loan, adjusted for current economic
factors and current economic trends. Refer to Note 5, Loans and Allowance for
Loan and Lease Losses, in Item 1 for definitions related to our internal asset
quality indicators stated above.
On a quarterly basis, we utilize a classification based loan loss migration
model as well as review individual loans in determining the adequacy of the
ALLL. Our loss migration analysis tracks a certain number of quarters of loan
loss history and industry loss factors to determine historical losses by
classification category for each loan type, except certain consumer loans
(automobile, mortgage and credit cards), which are analyzed as homogeneous loan
pools. These calculated loss factors are then applied to outstanding loan
balances. We analyze impaired loans individually.
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In determining whether and the extent to which we will make adjustments to our
loan loss migration model for purposes of determining the ALLL, we also consider
a number of qualitative factors that can affect the performance and the
collectability of the loans in our loan portfolio. Such qualitative factors
include:
•The effects of changes that we may make in our loan policies or underwriting
standards on the quality of the loans and the risks in our loan portfolios;
•Trends and changes in local, regional and national economic conditions, as well
as changes in industry specific conditions, and any other reasonably foreseeable
events that could affect the performance or the collectability of the loans in
our loan portfolios;
•Material changes that may occur in the mix or in the volume of the loans in our
loan portfolios that could alter, whether positively or negatively, the risk
profile of those portfolios;
•Changes in management or loan personnel or other circumstances that could,
either positively or negatively, impact the application of our loan underwriting
standards, the monitoring of nonperforming loans or our loan collection efforts;
and
•External factors that, in addition to economic conditions, can affect the
ability of borrowers to meet their loan obligations, such as fires, earthquakes
and terrorist attacks.
Determining the effects that these qualitative factors may have on the
performance of each category of loans in our loan portfolio requires numerous
judgments, assumptions and estimates about conditions, trends and events which
may subsequently prove to have been incorrect due to circumstances outside of
our control. Moreover, the effects of qualitative factors such as these on the
performance of our loan portfolios are often difficult to quantify. As a result,
we may sustain loan losses in any particular period that are sizable in relation
to the ALLL or that may even exceed the ALLL.
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Set forth below is information regarding loan balances and the related ALLL, by
portfolio type, for the six months ended June 30, 2021 and 2020.
Consumer
Construction and and Single
land Family
Commercial Real Estate Development Mortgages Unallocated Total
(Dollars in thousands)
ALLL for the six months ended June
30, 2021:
Balance at beginning of year $ 11,255 $ 3,964 $ 137 $ 2,096 $ - $ 17,452
Charge-offs (525) - - (15) - (540)
Recoveries 273 29 - 54 - 356
Provision 1,283 (1,235) 24 (72) - -
Balance at June 30, 2021 $ 12,286 $ 2,758 $ 161 $ 2,063 $ - $ 17,268
Allowance for loan and lease losses
as a percentage of average total
loans 1.40 %
Allowance for loan and lease losses
as a percentage of total outstanding
loans 1.55 %
Allowance for loan and lease losses
as a percentage of nonaccrual loans 72.24 %
Ratio of net charge-offs to average
loans outstanding (annualized) 0.03 %
ALLL for the six months ended June
30, 2020:
Balance at beginning of year $ 8,883 $ 2,897 $ 34 $ 1,797 $ - $ 13,611
Charge-offs (4,478) - - (84) - (4,562)
Recoveries 60 - - 7 - 67
Provision 7,022 1,836 43 149 - 9,050
Balance at June 30, 2020 $ 11,487 $ 4,733 $ 77 $ 1,869 $ - $ 18,166
Allowance for loan and lease losses
as a percentage of average total
loans 1.48 %
Allowance for loan and lease losses
as a percentage of total outstanding
loans 1.33 %
Allowance for loan and lease losses
as a percentage of nonaccrual loans 73.60 %
Ratio of net charge-offs to average
loans outstanding (annualized) 0.74 %
The ALLL decreased by$898 thousand fromJune 30, 2020 toJune 30, 2021 primarily as a result of charge-offs exceeding recoveries and decreases in classified and nonperforming loans during the six months endedJune 30, 2021 . The reserve for loan losses may include an unallocated amount based upon our judgment as to possible credit losses inherent in the loan portfolio that may not have been captured by historical loss experience, qualitative factors, or specific evaluations of impaired loans. Unallocated reserves may be adjusted for factors including, but not limited to, unexpected or unusual events, volatile market and economic conditions, effects of changes or seasoning in methodologies, regulatory guidance and recommendations, or other factors that may impact borrower operating conditions and loss expectations. Management's judgment as to unallocated reserves is determined in the context of, but separate from, the historical loss trends and qualitative factors described above. The unallocated reserve for loan losses was zero atJune 30, 2021 andDecember 31, 2020 . We classify our loan portfolios using asset quality ratings. The credit quality table in Note 5, Loans and Allowance for Loan and Lease Losses above in Item 1, provides a summary of loans by portfolio type and asset quality ratings as ofJune 30, 2021 andDecember 31, 2020 . Loans totaled approximately$1.11 billion atJune 30, 2021 , a decrease of$112.2 million from$1.22 billion atDecember 31, 2020 . The disaggregation of the loan portfolio by risk rating in the credit quality table located in Note 5 reflects the following changes that occurred betweenDecember 31, 2020 andJune 30, 2021 : •Loans rated "Pass" totaled$1.05 billion , a decrease of$63.4 million from$1.11 billion atDecember 31, 2020 . The decrease was primarily attributable to the$146.5 million of PPP loans forgiven during the six months endedJune 30, 2021 in addition to downgrades to "Special Mention" and "Substandard" of$9.5 million and$3.7 million , respectively, and pay downs of principal payments, partially offset by upgrades from "Special Mention" of$10.2 million . 55 -------------------------------------------------------------------------------- Table of Contents •Loans rated "Special Mention" totaled$9.9 million , a decrease of$11.9 million from$21.8 million atDecember 31, 2020 . The decrease was primarily the result of$10.2 million upgraded to "Pass",$9.6 million of payoffs and principal payments,$1.8 million downgraded to "Substandard", partially offset by$9.5 million downgraded from "Pass". •Loans rated "Substandard" totaled$48.9 million , a decrease of$40.7 million from$89.6 million atDecember 31, 2020 . This decrease was primarily the result of$36.0 million in principal payments,$7.0 million in upgraded notes, and$4.4 million downgraded to "Doubtful", partially offset by$3.7 million downgraded from "Pass" and$1.8 million downgraded from "Special Mention". The loans downgraded from the "Pass" rating had been rated "Watch", a rating within our "Pass" rating that receives more oversight and attention by management. •Loans rated "Doubtful" totaled$4.5 million atJune 30, 2021 , an increase from$641 thousand atDecember 31, 2020 . This increase was the result of$4.4 million downgraded from "Substandard", partially offset by principal payments of$23 thousand . Our loss migration analysis currently utilizes a series of nineteen staggered 16-quarter migration periods. As a result, for purposes of determining applicable loss factors atJune 30, 2021 , our migration analysis covered the period fromJune 30, 2017 toJune 30, 2021 . We believe this was consistent with and reasonably reflects current economic conditions, portfolio trends and the risks that were inherent in our loan portfolio atJune 30, 2021 . The table below sets forth loan delinquencies, by quarter, for the five preceding quarters endedJune 30, 2021 . December 31, September 30, June 30, 2021 March 31, 2021 2020 2020 June 30, 2020 Loans Delinquent: (Dollars in thousands) 90 days or more: Commercial loans $ 541 $ 578$ 9,670 $ 7,814 $ 11,857 Commercial real estate - - 1,837 1,934 - Residential mortgages - - - - 375 Consumer loans 45 45 - 145 180 586 623 11,507 9,893 12,412 30-89 days: Commercial loans 2,819 1,447 8,927 14,363 5,912 Commercial real estate - - 11,200 1,063 Land development loans - - - - - Consumer loans 39 102 65 53 200 2,858 1,549 8,992 25,616 7,175 Total Past Due(1)(2):$ 3,444 $ 2,172 $ 20,499 $ 35,509 $ 19,587
(1)Past due balances include nonaccrual loans.
As the above table indicates, total past due loans decreased by$17.1 million , to$3.4 million atJune 30, 2021 from$20.5 million atDecember 31, 2020 . Loans past due 90 days or more decreased by$10.9 million , to$586 thousand atJune 30, 2021 , from$11.5 million atDecember 31, 2020 . Loans 30-89 days past due decreased by$6.1 million to$2.9 million atJune 30, 2021 from$9.0 million atDecember 31, 2020 primarily attributable to$7.8 million paid current and principal payments of$2.6 million , partially offset by$4.4 million of additions. Deposits Average Balances of and Average Interest Rates Paid on Deposits Set forth below are the average amounts of, and the average rates paid on, deposits for the six months endedJune 30, 2021 and year endedDecember 31, 2020 : 56
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Six Months Ended June 30, 2021 Year Ended December 31, 2020
Average Average Average Average
Balance Rate Balance Rate
(Dollars in thousands)
Noninterest bearing demand deposits $ 614,675 - $ 588,557 -
Interest-bearing checking accounts 166,805 0.08 % 113,711 0.15 %
Money market and savings deposits 380,388 0.21 % 416,953 0.58 %
Time deposits(1) 198,419 1.06 % 248,801 1.98 %
Total deposits $ 1,360,287 0.22 % $ 1,368,022 0.55 %
(1)Comprised of time certificates of deposit in denominations of less than and
more than $250,000 .
Deposit Totals
Deposits totaled $1.3 billion at June 30, 2021 as compared to $1.4 billion at
December 31, 2020 . The decrease in deposits was primarily concentrated in
noninterest bearing demand deposits related to PPP loan forgiveness, and
certificates of deposit as a result of our ongoing focus to actively manage our
deposit portfolio away from higher costing deposits. The following table
provides information regarding the mix of our deposits at June 30, 2021 and
December 31, 2020 :
At June 30, 2021 At December 31, 2020
% of Total % of Total
Amounts Deposits Amounts Deposits
(Dollars in thousands)
Deposits
Noninterest bearing demand deposits $ 623,215 46.7 % $ 647,115 46.8 %
Savings and other interest-bearing
transaction deposits 528,100 39.6 % 522,524 37.8 %
Time deposits(1) 183,802 13.8 % 213,708 15.4 %
Total deposits $ 1,335,117 100.0 % $ 1,383,347 100.0 %
(1)Comprised of time certificates of deposit in denominations of less than and
more than $250,000 .
Certificates of deposit in denominations of $250,000 or more, on which we pay
higher rates of interest than on other deposits, aggregated $79.1 million , or
5.9%, of total deposits at June 30, 2021 , as compared to $91.0 million , or 6.6%,
of total deposits at December 31, 2020 .
Set forth below is a maturity schedule of domestic time certificates of deposit
outstanding at June 30, 2021 and December 31, 2020 :
June 30, 2021 December 31, 2020
Certificates of Certificates of Certificates of Certificates of
Deposit Under Deposit $250,000 Deposit Under Deposit $250,000
Maturities $ 250,000 or more $ 250,000 or more
(Dollars in thousands)
Three months or less $ 26,335 $ 29,480 $ 32,155 $ 31,986 Over three and through six months
26,012 21,627 22,352 18,206
Over six and through twelve months 30,369 21,056 40,222 30,572
Over twelve months 21,986 6,937 27,959 10,256
Total $ 104,702 $ 79,100 $ 122,688 $ 91,020
Other Assets and Other Liabilities
InFebruary 2016 , the FASB issued ASU 2016-02, "Leases (Topic 842)," which requires lessees to recognize a lease liability and a right-of-use asset on the balance sheet for all leases with a term longer than twelve months, which includes our office operating leases. During the six months endedJune 30, 2021 , we did not recognize additional operating liabilities or corresponding ROU assets based on the present value of the remaining minimum rental payments under current leasing 57
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Liquidity
We actively manage our liquidity needs to ensure that sufficient funds are
available to meet our needs for cash, including to fund new loans and deposit
withdrawals by our customers. We project the future sources and uses of funds
and maintain liquid funds for unanticipated events such as the COVID-19
pandemic. Our primary sources of cash include cash we have on deposit at other
financial institutions, payments from borrowers on their loans, proceeds from
sales or maturities of securities held for sale, sales of residential mortgage
loans, increases in deposits and increases in borrowings principally from the
FHLB. The primary uses of cash include funding new loans and making advances on
existing lines of credit, purchasing investments, including securities available
for sale, funding new residential mortgage loans, funding deposit withdrawals
and paying operating expenses. We maintain funds in overnight Federal Funds sold
and other short-term investments to provide for short-term liquidity needs. We
also have obtained credit lines from the FHLB and other financial institutions
to meet any additional liquidity requirements we might have. See "-Contractual
Obligations-Borrowings" below for additional information related to our
borrowings from the FHLB.
Our liquid assets, which included cash and due from banks, Federal Funds sold,
interest earning deposits that we maintain with financial institutions and
unpledged securities available for sale (excluding FRBSF and FHLB stock) totaled
$363.3 million , which represented 24% of total assets, at June 30, 2021 . We
believe that our cash and cash equivalent resources, together with available
borrowings under our credit facilities, will be sufficient to meet normal
operating requirements for at least the next twelve months, including to enable
us to meet any increase in deposit withdrawals that might occur in the
foreseeable future. We believe that during this period of uncertain economic
conditions related to COVID-19, our liquidity position is strong, and will be
closely monitored as conditions change.
Cash Flow Provided By or Used In Operating Activities. During the six months
ended June 30, 2021 , operating activities used net cash of $294 thousand ,
primarily attributable to a $3.5 million increase in other assets, a $2.5
million increase in other liabilities, $1.7 million of net accretion of deferred
fees on loans, $878 thousand net gain on sale of loans, $536 thousand net gain
on sale of securities, partially offset by our net income of $7.3 million , $1.0
million of accretion of deferred fees on loans, and a $1.5 million increase in
accrued interest receivable. During the six months ended June 30, 2020 ,
operating activities provided net cash of $3.1 million , primarily attributable
to our a $9.1 million non-cash adjustment related to our provision for loan and
lease losses, partially offset by a $1.7 million increase in deferred taxes, net
accretion of deferred loan fees of $1.5 million , and a $1.5 million decrease in
other liabilities.
Cash Flow Provided By or Used In Investing Activities. During the six months
ended June 30, 2021 , investing activities provided net cash of $133.0 million ,
primarily attributable to a $115.7 million decrease in loans, $24.6 million in
proceeds from the sale of securities, and $2.8 million of cash provided from
maturities of and principal payments on securities available for sale and other
stock, partially offset by the purchase of $10.1 million of securities,. During
the six months ended June 30, 2020 , investing activities used net cash of $237.2
million , primarily attributable to a $240.2 million increase in loans, offset by
$3.0 million of cash provided from maturities of and principal payments on
securities available for sale and other stock.
Cash Flow Provided By or Used In Financing Activities. During the six months
ended June 30, 2021 , financing activities used net cash of $57.5 million , which
was primarily a $48.2 million decrease in our deposits and a $10.0 million
repayment of borrowings. During the six months ended June 30, 2020 , financing
activities provided net cash of $273.0 million which consisted of a $229.0
million increase in our deposits, which was primarily the result of PPP loans
funded by the SBA, and net proceeds of $44.0 million in borrowings.
Ratio of Loans to Deposits. The relationship between gross loans and total
deposits can provide a useful measure of a bank's liquidity. Since repayment of
loans tends to be less predictable than the maturity of investments and other
liquid resources, the higher the loan-to-deposit ratio the less liquid are our
assets. On the other hand, since we realize greater yields on loans than we do
on investments, a lower loan-to-deposit ratio can adversely affect interest
income and earnings. As a result, our goal is to achieve a loan-to-deposit ratio
that appropriately balances the requirements of liquidity and the need to
generate a fair return on our assets. At June 30, 2021 and December 31, 2020 ,
the loan-to-deposit ratio was 83% and 88%, respectively.
Capital Resources
Regulatory Capital Requirements Applicable to Banking Institutions
Under federal banking regulations that apply to all United States -based bank
holding companies over $3 billion in total assets and all federally insured
banks, the Bank (on a stand-alone basis) must meet specific capital adequacy
requirements that, for the most part, involve quantitative measures, primarily
in terms of the ratios of their capital to their assets, liabilities, and
certain off-balance sheet items, calculated under regulatory accounting
practices. The Company (on a consolidated basis) is below the reporting
threshold of $3 billion in total assets and therefore is not subject to the same
capital adequacy requirements.
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Under those regulations, each federally insured bank is determined by its
primary federal bank regulatory agency to come within one of the following
capital adequacy categories on the basis of its capital ratios:
•well-capitalized
•adequately capitalized
•undercapitalized
•significantly undercapitalized; or
•critically undercapitalized
Certain qualitative assessments also are made by a banking institution's primary
federal regulatory agency that could lead the agency to determine that the
banking institution should be assigned to a lower capital category than the one
indicated by the quantitative measures used to assess the institution's capital
adequacy. At each successive lower capital category, a banking institution is
subject to greater operating restrictions and increased regulatory supervision
by its federal bank regulatory agency.
The following table sets forth the capital and capital ratios of the Bank (on a
stand-alone basis) at June 30, 2021 , as compared to the regulatory requirements
applicable to it.
Applicable Federal Regulatory Requirement
For Capital To be Categorized As
Adequacy Purposes Well-Capitalized
Amount Ratio Amount Ratio Amount Ratio
(Dollars in thousands)
Total Capital to Risk Weighted
Assets $ 191,233 18.0 % $ 135,506 At least 8.625% $ 106,375 At least 10.0%
Common Equity Tier 1 Capital to
Risk Weighted Assets $ 177,882 16.7 % $ 54,517 At least 5.125% $ 69,144 At least 6.5%
Tier 1 Capital to Risk Weighted
Assets $ 177,882 16.7 % $ 70,474 At least 6.625% $ 85,100 At least 8.0%
Tier 1 Capital to Average Assets $ 177,882 11.3 % $ 62,843 At least 4.0% $ 78,554 At least 5.0%
As the above table indicates, at June 30, 2021 , the Bank (on a stand-alone
basis) qualified as a "well-capitalized" institution under federally mandated
capital standards and federally established prompt corrective action
regulations. Since June 30, 2021 , there have been no events or circumstances
known to us which have changed or which are expected to result in a change in
the Bank's classifications as a well-capitalized institution.
In early July 2013 , the Federal Reserve Board and the FDIC issued final rules
implementing the Basel III regulatory capital framework and related Dodd-Frank
Wall Street Reform and Consumer Protection Act changes. The rules revise
minimum capital requirements and adjust prompt corrective action thresholds.
The final rules revise the regulatory capital elements, add a new common equity
Tier 1 capital ratio, increase the minimum Tier 1 capital ratio requirement, and
implement a new capital conservation buffer. The rules also permit certain
banking organizations to retain, through a one-time election, the existing
treatment for accumulated other comprehensive income. The final rules took
effect for community banks on January 1, 2015 , subject to a transition period
for certain parts of the rules. At June 30, 2021 , the Bank (on a stand-alone
basis) continued to qualify as a well-capitalized institution under the capital
adequacy guidelines described above.
On September 17, 2019 , the FDIC finalized a rule that introduces an optional
simplified measure of capital adequacy for qualifying community banking
organizations (i.e., the community bank leverage ratio (CBLR) framework), as
required by the Economic Growth, Regulatory Relief and Consumer Protection Act.
The CBLR framework is designed to reduce burden by removing the requirements for
calculating and reporting risk-based capital ratios for qualifying community
banking organizations that opt into the framework. In order to qualify for the
CBLR framework, a community banking organization must have a tier 1 leverage
ratio of greater than 9.0%, less than $10 billion in total consolidated assets,
and limited amounts of off-balance-sheet exposures and trading assets and
liabilities. A qualifying community banking organization that opts into the CBLR
framework and meets all requirements under the framework will be considered to
have met the well-capitalized ratio requirements under the Prompt Corrective
Action regulations and will not be required to report or calculate risk-based
capital. The Company will not opt into the CBLR framework for the Bank.
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Dividend Policy and Share Repurchase Programs
It is, and since the beginning of 2009 it has been, the policy of the Boards of
Directors of the Company and the Bank to preserve cash to enhance our capital
positions and the Bank's liquidity. In addition, we have agreed that the Bank
will not, without the FRB and the CDFPI's prior written approval, pay any
dividends to Bancorp. Accordingly, we do not expect to pay dividends or make
share repurchases for the foreseeable future.
The principal source of cash available to a bank holding company consists of
cash dividends from its bank subsidiaries. There are currently several
restrictions on the Bank's ability to pay us cash dividends. Government
regulations, including the laws of the State of California , as they pertain to
the payment of cash dividends by California state-chartered banks, limits the
amount of funds that the Bank is permitted to dividend to us. Further, Section
23(a) of the Federal Reserve Act limits the amounts that a bank may loan to its
bank holding company to an aggregate of no more than 10% of the bank
subsidiary's capital surplus and retained earnings and requires that such loans
be secured by specified assets of the bank holding company. We have committed to
obtaining approval from the FRB and the CDFPI prior to Bancorp paying any
dividends, or making any distributions representing interest, principal or other
sums on subordinated debentures or trust preferred securities. There can be no
assurance that our regulators will approve such payments or dividends in the
future. Refer to "Supervision and Regulation" in Item 1 of our 2020 Form 10-K
and Note 15, Shareholders' Equity in the notes to our consolidated financial
statements on our 2020 Form 10-K for more detail regarding the regulatory
restrictions on our and the Bank's ability to pay dividends. In addition, we
currently have sufficient cash on hand to meet our cash obligations. As a
result, we do not expect that these restrictions will impact our ability to meet
our cash obligations.
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Off-Balance Sheet Arrangements
Loan Commitments and Standby Letters of Credit. To meet the financing needs of
our customers in the normal course of business, we are a party to financial
instruments with off-balance sheet risk. These financial instruments include
commitments to extend credit and standby letters of credit. At June 30, 2021 and
December 31, 2020 , we were committed to fund certain loans including letters of
credit amounting to approximately $314 million and $347 million , respectively.
Commitments to extend credit and standby letters of credit generally have fixed
expiration dates or other termination clauses and the customer may be required
to pay a fee and meet other conditions in order to draw on those commitments or
standby letters of credit. We expect, based on historical experience, that many
of the commitments will expire without being drawn upon and, therefore, the
total commitment amounts do not necessarily represent future cash requirements.
To varying degrees, commitments to extend credit involve elements of credit and
interest rate risk for us that are in excess of the amounts recognized in our
balance sheets. Our maximum exposure to credit loss in the event of
nonperformance by the customers to whom such commitments are made could
potentially be equal to the amount of those commitments. As a result, before
making such a commitment to a customer, we evaluate the customer's
creditworthiness using the same underwriting standards that we would apply if we
were approving loans to the customer. In addition, we often require the customer
to secure its payment obligations for amounts drawn on such commitments with
collateral such as accounts receivable, inventory, property, plant and
equipment, income-producing commercial properties, residential properties and
properties under construction. As a consequence, our exposure to credit and
interest rate risk on such commitments is not different in character or amount
than risks inherent in the outstanding loans in our loan portfolio.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee a payment obligation of a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan commitments to customers.
Contractual Obligations
Borrowings. At June 30, 2021 and December 31, 2020 , our borrowings consisted of
the following:
(Dollars in thousands) June 30, 2021 December 31, 2020
FHLB advances-short-term $ - $ 10,000
Total $ - $ 10,000
At June 30, 2021 , $413 million of loans were pledged to support our unfunded
borrowing capacity. At June 30, 2021 , we had unused borrowing capacity of $281
million with the FHLB. The highest amount of borrowings outstanding at any
month-end during the three months ended June 30, 2021 was zero from the FHLB.
The highest amount of borrowings outstanding at any month end in 2020 consisted
of $124.0 million of borrowings from the FHLB. At June 30, 2021 and December 31,
2020 , commercial and consumer loans of $124 million and $146 million ,
respectively, were pledged to secure borrowings from the FRB to support our
unfunded borrowing capacity of $84 million and $106 million , respectively.
Junior Subordinated Debentures. Pursuant to rulings of the Federal Reserve
Board , bank holding companies were permitted to issue long term subordinated
debt instruments that, subject to certain conditions, would qualify as and,
therefore, augment capital for regulatory purposes. At June 30, 2021 , we had
outstanding approximately $17.5 million principal amount of Debentures, of which
$17.0 million would qualify as additional Tier 1 capital for regulatory purposes
as of June 30, 2021 if we were to surpass the reporting threshold of $3 billion
in total assets.
Set forth below is certain information regarding the Debentures:
Original Issue Dates Principal Amount Interest Rates Maturity Dates(1)
September 2002 $ 7,217 LIBOR plus 3.40% September 2032
October 2004 10,310 LIBOR plus 2.00% October 2034
Total $ 17,527
(1)Subject to the receipt of prior regulatory approval, we may redeem the
Debentures, in whole or in part, without premium or penalty, at any time prior
to maturity.
These Debentures require quarterly interest payments, which are used to make
quarterly distributions required to be paid on the corresponding trust preferred
securities. Subject to certain conditions, we have the right, at our discretion,
to defer those interest payments, and the corresponding distributions on the
trust preferred securities, for up to five years. Exercise of
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this deferral right does not constitute a default of our obligations to pay the
interest on the Debentures or the corresponding distributions that are payable
on the trust preferred securities. We have committed to obtaining approval from
the FRB and the CDFPI prior to making any distributions representing interest,
principal or other sums on subordinated debentures or trust preferred
securities. Refer to "Supervision and Regulation" in Item 1 of our 2020 Form
10-K for further detail. As of June 30, 2021 , we were current on all interest
payments. There can be no assurance that our regulators will approve such
payments in the future.
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Critical Accounting Policies
Our consolidated financial statements are prepared in accordance with generally
accepted accounting principles in the United States ("GAAP") and general
practices in the banking industry. Certain of those accounting policies are
considered critical accounting policies, because they require us to make
assumptions and judgments regarding circumstances or trends that could affect
the carrying value of our material assets, such as, for example, assumptions
regarding economic conditions or trends that could impact our ability to fully
collect our loans or ultimately realize the carrying value of certain of our
other assets, such as securities available for sale and our deferred tax asset.
Those assumptions and judgments are based on current information available to us
regarding those economic conditions or trends or other circumstances. If adverse
changes were to occur in the conditions, trends or other events on which our
assumptions or judgments had been based, then under GAAP it could become
necessary for us to reduce the carrying values of any affected assets on our
balance sheet. In addition, because reductions in the carrying value of assets
are sometimes effectuated by or require charges to income, such reductions also
may have the effect of reducing our income.
There have been no significant changes during the six months ended June 30, 2021
to the items that we disclosed as our critical accounting policies and estimates
in Critical Accounting Policies within Management's Discussion and Analysis of
Financial Condition and Results of Operations included in our 2020 Form 10-K.
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