Loans and Allowance for Loan Losses

Credit Quality of Loans

Outstanding loans by class and payment aging as of March 31, 2015 and December 31, 2014 are as follows:



Loan Aging Analysis by Class as of March 31, 2015 and December 31, 2014
(dollars in thousands; 2015 unaudited)	Commercial and industrial			Commercial real estate, owner-occupied			Commercial real estate, investor			Construction			Home equity			Other residential ¹			Installment and other consumer			Total
March 31, 2015
30-59 days past due	$	13		$	—		$	—		$	—		$	295		$	161		$	184		$	653
60-89 days past due	296			—			—			—			—			—			—			296
Greater than 90 days past due (non-accrual) ²	373			1,403			2,354			5,107			166			—			79			9,482
Total past due	682			1,403			2,354			5,107			461			161			263			10,431
Current	195,760			233,934			651,494			51,943			112,816			73,214			16,892			1,336,053
Total loans ³	$	196,442		$	235,337		$	653,848		$	57,050		$	113,277		$	73,375		$	17,155		$	1,346,484
Non-accrual loans to total loans	0.2		%	0.6		%	0.4		%	9.0		%	0.1		%	—		%	0.5		%	0.7		%
December 31, 2014
30-59 days past due	$	183		$	—		$	—		$	—		$	646		$	—		$	180		$	1,009
60-89 days past due	—			—			—			—			—			—			—			—
Greater than 90 days past due (non-accrual) ²	—			1,403			2,429			5,134			280			—			104			9,350
Total past due	183			1,403			2,429			5,134			926			—			284			10,359
Current	210,040			229,202			671,070			43,279			109,862			73,035			16,504			1,352,992
Total loans ³	$	210,223		$	230,605		$	673,499		$	48,413		$	110,788		$	73,035		$	16,788		$	1,363,351
Non-accrual loans to total loans	—		%	0.6		%	0.4		%	10.6		%	0.3		%	—		%	0.6		%	0.7		%

¹ Our residential loan portfolio does not include sub-prime loans, nor is it our practice to underwrite loans commonly referred to as "Alt-A mortgages", the characteristics of which are loans lacking full documentation, borrowers having low FICO scores or higher loan-to-value ratios.

² Amounts include $1.4 million of Purchased Credit Impaired ("PCI") loans that have stopped accreting interest at both March 31, 2015 and December 31, 2014. Amounts exclude accreting PCI loans of $3.7 million and $3.8 million at March 31, 2015 and December 31, 2014, respectively, as we have a reasonable expectation about future cash flows to be collected and we continue to recognize accretable yield on these loans in interest income. There were no accruing loans past due more than ninety days at March 31, 2015 or December 31, 2014.

³ Amounts include net deferred loan costs of $651 thousand and $487 thousand at March 31, 2015 and December 31, 2014, respectively. Amounts are also net of unaccreted purchase discounts on non-PCI loans of $4.2 million and $4.4 million at March 31, 2015 and December 31, 2014, respectively.

Our commercial loans are generally made to established small and mid-sized businesses to provide financing for their working capital needs, equipment purchases, acquisitions, or refinancings. Management examines historical, current, and projected cash flows to determine the ability of the borrower to repay obligations as agreed. Commercial loans are made based primarily on the identified cash flows of the borrower and secondarily on the underlying collateral or guarantor support. The cash flows of borrowers, however, may not occur as expected, and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed, such as accounts receivable or inventory, and include a personal guarantee. Some short-term loans may be made on an unsecured basis. We target stable local businesses with guarantors that have proven to be more resilient in periods of economic stress. Typically, the guarantors provide an additional source of repayment for most of our credit extensions.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans discussed above. We underwrite these loans to be repaid from cash flow and to be supported by real property collateral. Repayment of commercial real estate loans is largely dependent on the successful operation of the property securing the loan, or of the business conducted on the property securing the loan. Underwriting standards for commercial real estate loans include, but are not limited to, conservative debt coverage and loan-to-value ratios. Furthermore, substantially all of our loans are guaranteed by the owners of the properties. Commercial real estate loans may be adversely affected by conditions in the real estate markets or in the general economy. In the event of a vacancy, strong guarantors have historically carried the loans until a replacement tenant could be found. The owner's substantial equity investment provides a strong economic incentive to continue to support the commercial real estate projects. As such, we have generally experienced a relatively low level of loss and delinquencies in this portfolio.

Construction loans are generally made to developers and builders to finance construction, renovation and occasionally land acquisitions. These loans are underwritten after evaluation of the borrower's financial strength, reputation, prior track record, and independent appraisals. The construction industry can be impacted by significant events, including: the inherent volatility of real estate markets and vulnerability to delays due to weather, change orders, inability to obtain construction permits, labor or material shortages, and price changes. Estimates of construction costs and value associated with the complete project may be inaccurate. Repayment of construction loans is largely dependent on the ultimate success of the project.

Consumer loans primarily consist of home equity lines of credit, other residential (tenancy-in-common, or “TIC”) loans, and installment and other consumer loans. We originate consumer loans utilizing credit score information, debt-to-income ratio and loan-to-value ratio analysis. Diversification, coupled with relatively small loan amounts that are spread across many individual borrowers, mitigates risk. Additionally, trend reports are reviewed by Management on a regular basis. Underwriting standards for home equity lines of credit include, but are not limited to, a conservative loan-to-value ratio, the number of such loans a borrower can have at one time, and documentation requirements. Our residential loan portfolio includes TIC units in San Francisco. These loans tend to have more equity in their properties than conventional residential mortgages, which mitigates risk. Installment and other consumer loans include mostly floating home loans and mobile home loans along with a small number of installment loans.

We use a risk rating system to evaluate asset quality, and to identify and monitor credit risk in individual loans, and ultimately in the portfolio. Definitions of loans that are risk graded “Special Mention” or worse are consistent with those used by the Federal Deposit Insurance Corporation ("FDIC"). Our internally assigned grades are as follows:

Pass – Loans to borrowers of acceptable or better credit quality. Borrowers in this category demonstrate fundamentally sound financial positions, repayment capacity, credit history and management expertise. Loans in this category must have an identifiable and stable source of repayment and meet the Bank’s policy regarding debt service coverage ratios. These borrowers are capable of sustaining normal economic, market or operational setbacks without significant financial impacts. Negative external industry factors are generally not present. The loan may be secured, unsecured or supported by non-real estate collateral for which the value is more difficult to determine and/or marketability is more uncertain. This category also includes “Watch” loans, where the primary source of repayment has been delayed. “Watch” is intended to be a transitional grade, with either an upgrade or downgrade within a reasonable period.

Special Mention - Potential weaknesses that deserve close attention. If left uncorrected, those potential weaknesses may result in deterioration of the payment prospects for the asset. Special Mention assets do not present sufficient risk to warrant adverse classification.

Substandard - Inadequately protected by either the current sound worth and paying capacity of the obligor or the collateral pledged, if any. A Substandard asset has a well-defined weakness or weaknesses that jeopardize(s) the liquidation of the debt. Substandard assets are characterized by the distinct possibility that we will sustain some loss if such weaknesses or deficiencies are not corrected. Well-defined weaknesses include adverse trends or developments of the borrower’s financial condition, managerial weaknesses and/or significant collateral deficiencies.

Doubtful - Critical weaknesses that make collection or liquidation in full improbable. There may be specific pending events that work to strengthen the asset; however, the amount or timing of the loss may not be determinable. Pending events generally occur within one year of the asset being classified as Doubtful. Examples include: merger, acquisition, or liquidation; capital injection; guarantee; perfecting liens on additional collateral; and refinancing. Such loans are placed on nonaccrual status and usually are collateral-dependent.

We regularly review our credits for accuracy of risk grades whenever new information is received. Borrowers are required to submit financial information at regular intervals:


•	Generally, commercial borrowers with lines of credit are required to submit financial information with reporting intervals ranging from monthly to annually depending on credit size, risk and complexity.


•	Investor commercial real estate borrowers are generally required to submit rent rolls or property income statements at least annually.


•	Construction loans are monitored monthly, and reviewed on an ongoing basis.


•	Home equity and other consumer loans are reviewed based on delinquency.


•	Loans graded “Watch” or more severe, regardless of loan type, are reviewed no less than quarterly.

The following table represents an analysis of loans by internally assigned grades, including the PCI loans, at March 31, 2015 and December 31, 2014:



(in thousands; 2015 unaudited)	Commercial and industrial		Commercial real estate, owner-occupied		Commercial real estate, investor		Construction		Home equity		Other residential		Installment and other consumer		Purchased credit-impaired		Total
Credit Risk Profile by Internally Assigned Grade:
March 31, 2015
Pass	$	181,842	$	211,551	$	640,656	$	50,305	$	111,227	$	71,768	$	16,816	$	2,202	$	1,286,367
Special Mention	9,424		10,281		3,853		1,078		321		—		—		1,031		25,988
Substandard	4,974		10,876		7,175		5,657		1,662		1,607		339		1,839		34,129
Total loans	$	196,240	$	232,708	$	651,684	$	57,040	$	113,210	$	73,375	$	17,155	$	5,072	$	1,346,484

December 31, 2014
Pass	$	197,659	$	205,820	$	651,548	$	41,710	$	107,933	$	70,987	$	16,101	$	2,210	$	1,293,968
Special Mention	6,776		10,406		13,304		1,008		322		—		190		1,140		33,146
Substandard	5,464		11,763		6,473		5,684		2,466		2,048		497		1,842		36,237
Total loans	$	209,899	$	227,989	$	671,325	$	48,402	$	110,721	$	73,035	$	16,788	$	5,192	$	1,363,351

Troubled Debt Restructuring

Our loan portfolio includes certain loans that have been modified in a Troubled Debt Restructuring (“TDR”), where economic concessions have been granted to borrowers experiencing financial difficulties. These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. TDRs on nonaccrual status at the time of restructure may be returned to accruing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months, and there is reasonable assurance of repayment and performance.

When a loan is modified, Management evaluates any possible impairment based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral. In these cases Management uses the current fair value of the collateral, less selling costs, instead of discounted cash flows. If Management determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs and unamortized premium or discount), impairment is recognized through a specific allowance or a charge-off of the loan.

A loan may no longer be reported as a TDR if it is subsequently refinanced or restructured at market terms through the normal underwriting process, the borrower is no longer considered to be in financial difficulty and performance on the loan is reasonably assured. The removal of TDR status must be approved by the same management level that approved the upgrading of the loan classification. During the first quarter of 2015, a loan with a recorded investment of $108 thousand was removed from TDR designation. There were no loans removed from TDR designation during 2014.

The table below summarizes outstanding TDR loans by loan class as of March 31, 2015 and December 31, 2014. The summary includes both TDRs that are on non-accrual status and those that continue to accrue interest.



(in thousands; 2015 unaudited)	As of
Recorded investment in Troubled Debt Restructurings ¹	March 31, 2015		December 31, 2014

Commercial and industrial	$	3,477	$	3,584
Commercial real estate, owner-occupied	8,427		8,459
Commercial real estate, investor	522		524
Construction	5,657		5,684
Home equity	561		694
Other residential	2,037		2,045
Installment and other consumer	1,636		1,713
Total	$	22,317	$	22,703

¹Includes $15.6 million and $15.9 million of TDR loans that were accruing interest as of March 31, 2015 and December 31, 2014, respectively. Includes $1.6 million and $1.8 million of acquired loans at March 31, 2015 and December 31, 2014, respectively.

The table below presents the following information for loans modified in a TDR during the quarter ended March 31, 2014: number of contracts modified, the recorded investment in the loans prior to modification, and the recorded investment in the loans after the loans were restructured. The table below excludes fully paid-off and fully charged-off TDR loans. There were no loans modified in a TDR during 2015.



(dollars in thousands; unaudited)	Number of Contracts Modified	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment at period end
Troubled Debt Restructurings during the three months ended March 31, 2014:
Commercial and industrial	3	$	1,420	$	1,405	$	1,405
Home equity	1	150		150		150
Installment and other consumer	3	170		168		169
Total	7	$	1,740	$	1,723	$	1,724

Modifications during the three months ended March 31, 2014 primarily involved maturity extensions and interest rate concessions. During the first three months of 2015 and 2014, there were no defaults on loans that had been modified in a TDR within the prior twelve-month period. We report defaulted TDRs based on a payment default definition of more than ninety days past due.

Impaired Loan Balances and Their Related Allowance by Major Classes of Loans

The tables below summarize information on impaired loans and their related allowance. Total impaired loans include non-accrual loans, accruing TDR loans and accreting PCI loans that have experienced post-acquisition declines in cash flows expected to be collected.



(in thousands; unaudited)	Commercial and industrial		Commercial real estate, owner-occupied		Commercial real estate, investor		Construction		Home equity		Other residential		Installment and other consumer		Total
March 31, 2015
Recorded investment in impaired loans:
With no specific allowance recorded	$	1,318	$	5,545	$	2,875	$	5,107	$	263	$	1,024	$	295	$	16,427
With a specific allowance recorded	2,533		2,882		—		560		298		1,012		1,398		8,683
Total recorded investment in impaired loans	$	3,851	$	8,427	$	2,875	$	5,667	$	561	$	2,036	$	1,693	$	25,110
Unpaid principal balance of impaired loans:
With no specific allowance recorded	$	1,315	$	6,545	$	4,867	$	7,797	$	263	$	1,024	$	295	$	22,106
With a specific allowance recorded	2,604		2,882		—		745		298		1,012		1,398		8,939
Total unpaid principal balance of impaired loans	$	3,919	$	9,427	$	4,867	$	8,542	$	561	$	2,036	$	1,693	$	31,045
Specific allowance	$	652	$	32	$	—	$	3	$	1	$	85	$	188	$	961

Average recorded investment in impaired loans during the quarter ended March 31, 2015	$	3,718	$	8,443	$	2,915	$	5,681	$	627	$	2,041	$	1,743	$	25,168
Interest income recognized on impaired loans during the quarter ended March 31, 2015	$	62	$	66	$	6	$	9	$	5	$	23	$	19	$	190
Average recorded investment in impaired loans during the quarter ended March 31, 2014	$	5,945	$	5,484	$	3,283	$	6,524	$	577	$	2,054	$	1,884	$	25,751
Interest income recognized on impaired loans during the quarter ended March 31, 2014	$	118	$	83	$	7	$	21	$	4	$	23	$	18	$	274



(in thousands)	Commercial and industrial		Commercial real estate, owner-occupied		Commercial real estate, investor		Construction		Home equity		Other residential		Installment and other consumer		Total

December 31, 2014
Recorded investment in impaired loans:
With no specific allowance recorded	$	1,141	$	5,577	$	2,954	$	5,134	$	393	$	1,026	$	239	$	16,464
With a specific allowance recorded	2,443		2,882		—		561		300		1,019		1,554		$	8,759
Total recorded investment in impaired loans	$	3,584	$	8,459	$	2,954	$	5,695	$	693	$	2,045	$	1,793	$	25,223
Unpaid principal balance of impaired loans:
With no specific allowance recorded	$	1,186	$	6,577	$	4,945	$	7,824	$	880	$	1,026	$	239	$	22,677
With a specific allowance recorded	2,524		2,882		—		749		300		1,019		1,554		9,028
Total recorded investment in impaired loans	$	3,710	$	9,459	$	4,945	$	8,573	$	1,180	$	2,045	$	1,793	$	31,705
Specific allowance	$	694	$	65	$	—	$	3	$	—	$	92	$	284	$	1,138
Average recorded investment in impaired loans during 2014	5,354		6,604		3,138		6,471		741		1,744		1,857		25,909
Interest income recognized on impaired loans during 2014	378		288		28		85		19		74		76		948

The gross interest income that would have been recorded, had non-accrual loans been current, totaled $231 thousand and $205 thousand in the quarters ended March 31, 2015, and March 31, 2014, respectively. PCI loans are excluded from the foregone interest data above as their accretable yield interest recognition is independent from the underlying contractual loan delinquency status. See “Purchased Credit-Impaired Loans” below for further discussion.

Management monitors delinquent loans continuously and identifies problem loans, generally loans graded substandard or worse, to be evaluated individually for impairment testing. Generally, we charge off our estimated losses related to specifically-identified impaired loans when it is deemed uncollectible. The charged-off portion of impaired loans outstanding at March 31, 2015 totaled approximately $5.4 million. At March 31, 2015, there were $1.2 million outstanding commitments to extend credit on impaired loans, including loans to borrowers whose terms have been modified in TDRs.

The following tables disclose loans by major portfolio category and activity in the ALLL, as well as the related ALLL disaggregated by impairment evaluation method.



Allowance for Loan Losses Rollforward for the Period
(in thousands; unaudited)	Commercial and industrial			Commercial real estate, owner-occupied			Commercial real estate, investor			Construction			Home equity		Other residential			Installment and other consumer			Unallocated		Total

For the three months ended March 31, 2015
Allowance for loan losses:
Beginning balance	$	2,837		$	1,924		$	6,672		$	839		$	859	$	433		$	566		$	969	$	15,099
Provision (reversal)	(275		)	170			(383		)	(61		)	63		(3		)	(99		)	588		—
Charge-offs	(2		)	—			—			—			—		—			(6		)	—		(8		)
Recoveries	60			—			3			—			1		—			1			—		65
Ending balance	$	2,620		$	2,094		$	6,292		$	778		$	923	$	430		$	462		$	1,557	$	15,156

For the three months ended March 31, 2014
Allowance for loan losses:
Beginning balance	$	3,056		$	2,012		$	6,196		$	633		$	875	$	317		$	629		$	506	$	14,224
Provision (reversal)	(255		)	(27		)	268			100			11		92			(142		)	103		150
Charge-offs	(61		)	—			—			(197		)	—		—			(3		)	—		(261		)
Recoveries	32			—			5			—			1		—			81			—		119
Ending balance	$	2,772		$	1,985		$	6,469		$	536		$	887	$	409		$	565		$	609	$	14,232



Allowance for Loan Losses and Recorded Investment in Loans
(dollars in thousands; unaudited)	Commercial and industrial			Commercial real estate, owner-occupied			Commercial real estate, investor			Construction			Home equity			Other residential			Installment and other consumer			Unallocated		Total

As of March 31, 2015:
Ending ALLL related to loans collectively evaluated for impairment	$	1,968		$	2,062		$	6,292		$	775		$	922		$	345		$	274		$	1,557	$	14,195
Ending ALLL related to loans individually evaluated for impairment	$	648		$	32		$	—		$	—		$	1		$	85		$	188		$	—	$	954
Ending ALLL related to purchased credit-impaired loans	$	4		$	—		$	—		$	3		$	—		$	—		$	—		$	—	$	7

Loans outstanding:
Collectively evaluated for impairment	$	192,557		$	225,684		$	648,809		$	51,383		$	112,649		$	71,339		$	15,462		$	—	$	1,317,883
Individually evaluated for impairment¹	3,683			7,024			2,875			5,657			561			2,036			1,693			—		23,529
Purchased credit-impaired	202			2,629			2,164			10			67			—			—			—		5,072
Total	$	196,442		$	235,337		$	653,848		$	57,050		$	113,277		$	73,375		$	17,155		$	—	$	1,346,484
Ratio of allowance for loan losses to total loans	1.33		%	0.89		%	0.96		%	1.36		%	0.81		%	0.59		%	2.69		%	NM		1.13		%
Allowance for loan losses to non-accrual loans	702		%	149		%	267		%	15		%	556		%	NM			585		%	NM		160		%

¹ Total excludes $1.6 million of PCI loans that have experienced post-acquisition declines in cash flows expected to be collected. These loans are included in the "purchased credit-impaired" amount in the next line below.

NM - Not Meaningful



Allowance for Loan Losses and Recorded Investment in Loans
(dollars in thousands)	Commercial and industrial			Commercial real estate, owner-occupied			Commercial real estate, investor			Construction			Home equity			Other residential			Installment and other consumer			Unallocated		Total

As of December 31, 2014:
Ending ALLL related to loans collectively evaluated for impairment	$	2,143		$	1,859		$	6,672		$	836		$	859		$	341		$	282		$	969	$	13,961
Ending ALLL related to loans individually evaluated for impairment	$	690		$	65		$	—		$	—		$	—		$	92		$	284		$	—	$	1,131
Ending ALLL related to purchased credit-impaired loans	$	4		$	—		$	—		$	3		$	—		$	—		$	—		$	—	$	7

Loans outstanding:
Collectively evaluated for impairment	$	206,603		$	220,933		$	668,371		$	42,718		$	110,028		$	70,990		$	14,995		$	—	$	1,334,638
Individually evaluated for impairment¹	3,296			7,056			2,954			5,684			693			2,045			1,793			—		23,521
Purchased credit-impaired	324			2,616			2,174			11			67			—			—			—		5,192
Total	$	210,223		$	230,605		$	673,499		$	48,413		$	110,788		$	73,035		$	16,788		$	—	$	1,363,351
Ratio of allowance for loan losses to total loans	1.35		%	0.83		%	0.99		%	1.73		%	0.78		%	0.59		%	3.37		%	NM		1.11		%
Allowance for loan losses to non-accrual loans	NM			137		%	275		%	16		%	307		%	NM			544		%	NM		161		%

¹ Total excludes $1.7 million PCI loans that have experienced credit deterioration post-acquisition, which are included in the "purchased credit-impaired" amount in the next line below.

NM - Not Meaningful

Purchased Credit-Impaired Loans

We evaluated loans purchased in acquisitions in accordance with accounting guidance in ASC 310-30 related to loans acquired with deteriorated credit quality. Acquired loans are considered credit-impaired if there is evidence of deterioration of credit quality since origination and it is probable, at the acquisition date, that we will be unable to collect all contractually required payments receivable. Management has determined certain loans purchased in our two acquisitions to be PCI loans based on credit indicators such as nonaccrual status, past due status, loan risk grade, loan-to-value ratio, etc. Revolving credit agreements (e.g., home equity lines of credit and revolving commercial loans) are not considered PCI loans as cash flows cannot be reasonably estimated.

The following table reflects the outstanding balance and related carrying value of PCI loans as of March 31, 2015 and December 31, 2014.



	March 31, 2015				December 31, 2014
PCI Loans (in thousands; 2015 unaudited)	Unpaid principal balance		Carrying value		Unpaid principal balance		Carrying value
Commercial and industrial	$	301	$	202	$	479	$	324
Commercial real estate	6,806		4,793		6,831		4,790
Construction	132		10		136		11
Home equity	230		67		232		67
Total purchased credit-impaired loans	$	7,469	$	5,072	$	7,678	$	5,192

The activities in the accretable yield, or income expected to be earned, for PCI loans were as follows:



Accretable Yield	Three months ended
(dollars in thousands, unaudited)	March 31, 2015			March 31, 2014
Balance at beginning of period	$	4,027		$	3,649
Removals ¹	(77		)	—
Accretion	(119		)	(180		)
Reclassifications from nonaccretable difference ²	—			1,832
Balance at end of period	$	3,831		$	5,301

¹ Represents the accretable difference that is relieved when a loan exits the PCI population due to payoff, full charge-off, or transfer to repossessed assets, etc.

²Primarily relates to changes in expected credit performance and changes in expected timing of cash flows.

Pledged Loans

Our FHLB line of credit is secured under terms of a blanket collateral agreement by a pledge of certain qualifying loans with an unpaid principal balance of $863.6 million and $868.1 million at March 31, 2015 and December 31, 2014, respectively. Our FHLB line of credit totaled $446.7 million and $450.6 million at March 31, 2015 and December 31, 2014, respectively. In addition, we pledge a certain residential loan portfolio, which totaled $30.9 million and $27.7 million at March 31, 2015 and December 31, 2014, respectively, to secure our borrowing capacity with the Federal Reserve Bank (“FRB”). Also see Note 6 below.