Loans and Allowance for Loan Losses

Credit Quality of Loans

The following table shows outstanding loans by class and payment aging as of September 30, 2017 and December 31, 2016.



Loan Aging Analysis by Loan Class
(in thousands)	Commercial and industrial		Commercial real estate, owner-occupied		Commercial real estate, investor		Construction		Home equity		Other residential ¹		Installment and other consumer		Total
September 30, 2017
30-59 days past due	$	—	$	—	$	—	$	—	$	100	$	—	$	5	$	105
60-89 days past due	—		—		—		—		307		—		1		308
90 days or more past due	—		—		—		—		—		—		—		—
Total past due	—		—		—		—		407		—		6		413
Current	218,681		264,732		721,576		76,179		120,959		96,937		24,970		1,524,034
Total loans ³	$	218,681	$	264,732	$	721,576	$	76,179	$	121,366	$	96,937	$	24,976	$	1,524,447
Non-accrual loans ²	$	—	$	—	$	1,024	$	—	$	292	$	—	$	—	$	1,316
December 31, 2016
30-59 days past due	$	283	$	—	$	—	$	—	$	77	$	—	$	2	$	362
60-89 days past due	—		—		—		—		—		—		49		49
90 days or more past due	—		—		—		—		91		—		—		91
Total past due	283		—		—		—		168		—		51		502
Current	218,332		247,713		724,228		74,809		117,039		78,549		25,444		1,486,114
Total loans ³	$	218,615	$	247,713	$	724,228	$	74,809	$	117,207	$	78,549	$	25,495	$	1,486,616
Non-accrual loans ²	$	—	$	—	$	—	$	—	$	91	$	—	$	54	$	145

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 There were no purchased credit impaired ("PCI") loans that had stopped accreting interest at September 30, 2017 and December 31, 2016. Amounts exclude accreting PCI loans of $2.3 million and $2.9 million at September 30, 2017 and December 31, 2016, 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 September 30, 2017 or December 31, 2016.

³ Amounts include net deferred loan origination costs of $798 thousand and $883 thousand at September 30, 2017 and December 31, 2016, respectively. Amounts are also net of unaccreted purchase discounts on non-PCI loans of $1.3 million and $1.8 million at September 30, 2017 and December 31, 2016, respectively.

Our commercial loans are generally made to established small and mid-sized businesses to provide financing for their growth and working capital needs, equipment purchases and acquisitions. 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 and 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 and inventory, and typically include a personal guarantee. We target stable businesses with guarantors that have proven to be 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. Underwriting standards for commercial real estate loans include, but are not limited to, 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, guarantors are expected to carry the loans until a replacement tenant can 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 in anticipation of near-term development. These loans are underwritten after evaluation of the borrower's financial strength, reputation, prior track record, and independent appraisals. The construction industry can be affected 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 completed 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 and other residential tenancy-in-common fractional interest loans ("TIC"), floating homes and mobile homes along with a small number of installment loans. We originate consumer loans utilizing credit score information, debt-to-income ratio and loan-to-value ratio analysis. Diversification among consumer loan types, coupled with relatively small loan amounts that are spread across many individual borrowers, mitigates risk. Our other residential loans include TIC units located almost entirely in San Francisco County.

We use a risk rating system to evaluate asset quality, and to identify and monitor credit risk in individual loans, and in the loan 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 and Watch: 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 consequences. 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 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 non-accrual 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 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 worse, regardless of loan type, are reviewed no less than quarterly.

The following table represents an analysis of the carrying amount in loans, net of deferred fees and costs and purchase premiums or discounts, by internally assigned risk grades, including PCI loans, at September 30, 2017 and December 31, 2016.



Credit Risk Profile by Internally Assigned Risk Grade
(in thousands)	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
September 30, 2017
Pass	$	195,500	$	244,100	$	717,760	$	73,210	$	119,856	$	96,937	$	24,739	$	2,272	$	1,474,374
Special Mention	6,153		10,437		—		—		—		—		—		—		16,590
Substandard	16,991		9,055		2,818		2,969		1,413		—		237		—		33,483
Total loans	$	218,644	$	263,592	$	720,578	$	76,179	$	121,269	$	96,937	$	24,976	$	2,272	$	1,524,447
December 31, 2016
Pass	$	201,987	$	234,849	$	720,417	$	71,564	$	115,680	$	78,549	$	25,083	$	2,920	$	1,451,049
Special Mention	9,197		4,799		607		—		1,334		—		—		—		15,937
Substandard	7,391		6,993		1,498		3,245		91		—		412		—		19,630
Total loans	$	218,575	$	246,641	$	722,522	$	74,809	$	117,105	$	78,549	$	25,495	$	2,920	$	1,486,616

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 non-accrual status at the time of restructure may be returned to accruing status after Management considers the borrower’s sustained repayment performance for a reasonable period, generally six months, and obtains reasonable assurance of repayment and performance.

A loan may no longer be reported as a TDR if all of the following conditions are met:


•	The loan is subsequently refinanced or restructured at current market interest rates and the new terms are consistent with the treatment of creditworthy borrowers under regular underwriting standards;


•	The borrower is no longer considered to be in financial difficulty;


•	Performance on the loan is reasonably assured; and;


•	Existing loan did not have any forgiveness of principal or interest.

The removal of TDR status must be approved by the same Management level that approved the upgrading of the loan classification. There were no loans removed from TDR designation during 2017 and 2016.

The following table summarizes the carrying amount of TDR loans by loan class as of September 30, 2017 and December 31, 2016.



(in thousands)
Recorded investment in Troubled Debt Restructurings ¹	September 30, 2017		December 31, 2016
Commercial and industrial	$	2,050	$	2,207
Commercial real estate, owner-occupied	6,999		6,993
Commercial real estate, investor	2,193		2,256
Construction	2,969		3,245
Home equity	348		625
Other residential	1,159		1,965
Installment and other consumer	666		877
Total	$	16,384	$	18,168

¹There were no TDR loans on non-accrual status at September 30, 2017 and December 31, 2016.

The following table presents information for loans modified in a TDR during the presented periods, including the number of contracts modified, the recorded investment in the loans prior to modification, and the recorded investment in the loans after being restructured. The table excludes fully charged-off TDR loans and loans modified in a TDR and subsequently paid-off during the years presented.



(dollars in thousands)	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 September 30, 2017:
None	—	$	—	$	—	$	—
Troubled Debt Restructurings during the three months ended September 30, 2016:
None	—	$	—	$	—	$	—



Troubled Debt Restructurings during the nine months ended September 30, 2017:
Installment and consumer	1	$	50	$	50	$	49
Troubled Debt Restructurings during the nine months ended September 30, 2016:
Commercial real estate, investor	2	$	1,830	$	1,826	$	1,808
Home equity¹	1	87		222		222
Total	3	$	1,917	$	2,048	$	2,030
¹The home equity TDR modification during the second quarter of 2016 included debt consolidation, which increased the post-modification balance.

The modifications during the nine months ended September 30, 2017 and 2016 primarily involved interest rate concessions, renewals, and other changes to loan terms. During the first nine months of 2017 and 2016, 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 Loans

The following tables summarize information by class on impaired loans and their related allowances. 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)	Commercial and industrial		Commercial real estate, owner-occupied		Commercial real estate, investor		Construction		Home equity		Other residential		Installment and other consumer		Total
September 30, 2017
Recorded investment in impaired loans:
With no specific allowance recorded	$	311	$	—	$	1,024	$	2,691	$	292	$	998	$	47	$	5,363
With a specific allowance recorded	1,740		6,999		2,193		278		348		160		619		12,337
Total recorded investment in impaired loans	$	2,051	$	6,999	$	3,217	$	2,969	$	640	$	1,158	$	666	$	17,700
Unpaid principal balance of impaired loans	$	2,030	$	6,993	$	3,230	$	2,963	$	637	$	1,157	$	665	$	17,675
Specific allowance	35		84		369		5		6		2		85		586
Average recorded investment in impaired loans during the quarter ended September 30, 2017	2,063		7,000		3,236		3,104		607		1,164		802		17,976
Interest income recognized on impaired loans during the quarter ended September 30, 2017 ¹	27		67		22		39		5		14		9		183
Average recorded investment in impaired loans during the nine months ended September 30, 2017	2,100		6,998		3,010		3,174		660		1,367		871		18,180
Interest income recognized on impaired loans during the nine months ended September 30, 2017 ¹	74		199		65		110		19		48		29		544
Average recorded investment in impaired loans during the quarter ended September 30, 2016	3,352		7,169		3,146		3,238		1,140		1,981		1,113		21,139
Interest income recognized on impaired loans during the quarter ended September 30, 2016¹	44		67		1,385		32		38		22		12		1,600
Average recorded investment in impaired loans during the nine months ended September 30, 2016	3,802		7,081		3,397		3,238		1,098		1,993		1,179		21,788
Interest income recognized on impaired loans during the nine months ended September 30, 2016 ¹	142		133		1,489		105		48		67		37		2,021

¹No interest income on impaired loans was recognized on a cash basis during the three and nine months ended September 30, 2017. Interest income recognized on a cash basis totaled $1.4 million for the three and nine months ended September 30, 2016 and was primarily related to an interest recovery upon the pay-off of a partially charged-off non-accrual commercial real estate loan during the third quarter.



(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, 2016
Recorded investment in impaired loans:
With no specific allowance recorded	$	315	$	—	$	—	$	2,692	$	91	$	1,008	$	103	$	4,209
With a specific allowance recorded	1,892		6,993		2,256		553		624		957		829		14,104
Total recorded investment in impaired loans	$	2,207	$	6,993	$	2,256	$	3,245	$	715	$	1,965	$	932	$	18,313
Unpaid principal balance of impaired loans	$	2,177	$	6,993	$	2,252	$	3,238	$	713	$	1,965	$	932	$	18,270
Specific allowance	$	285	$	163	$	375	$	8	$	7	$	55	$	98	$	991

Management monitors delinquent loans continuously and identifies problem loans, generally loans graded substandard or worse, loans on non-accrual status and loans modified in a TDR, to be evaluated individually for impairment testing. Generally, the recorded investment in impaired loans is net of any charge-offs from estimated losses related to specifically-identified impaired loans when they are deemed uncollectible. There were no charged-off portions of impaired loans outstanding at September 30, 2017 and December 31, 2016. In addition, the recorded investment in impaired loans is net of purchase discounts or premiums on acquired loans and deferred fees and costs. At September 30, 2017 and December 31, 2016, respectively, unused commitments to extend credit on impaired loans, including performing loans to borrowers whose terms have been modified in TDRs, totaled $1.1 million and $1.6 million.

The following tables disclose activity in the allowance for loan losses ("ALLL") and the recorded investment in loans by class, as well as the related ALLL disaggregated by impairment evaluation method.



Allowance for Loan Losses Rollforward for the Period
(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
Three months ended September 30, 2017
Beginning balance	$	3,932		$	2,082		$	6,065		$	411	$	981		$	509	$	340		$	912		$	15,232
Provision (reversal)	612			(56		)	33			217		21			33		(5		)	(855		)	—
Charge-offs	(5		)	—			—			—		—			—		(1		)	—			(6		)
Recoveries	21			—			—			—		—			—		1			—			22
Ending balance	$	4,560		$	2,026		$	6,098		$	628	$	1,002		$	542	$	335		$	57		$	15,248
Three months ended September 30, 2016
Beginning balance	$	2,637		$	1,631		$	6,595		$	831	$	1,076		$	426	$	437		$	1,454		$	15,087
Provision (reversal)	828			(10		)	(2,416		)	105		(125		)	22		(73		)	119			(1,550		)
Charge-offs	—			—			—			—		—			—		—			—			—
Recoveries	29			—			2,146			—		1			—		—			—			2,176
Ending balance	$	3,494		$	1,621		$	6,325		$	936	$	952		$	448	$	364		$	1,573		$	15,713



Allowance for Loan Losses Rollforward for the Period
(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
Nine months ended September 30, 2017
Allowance for loan losses:
Beginning balance	$	3,248		$	1,753		$	6,320		$	781		$	973	$	454	$	372		$	1,541		$	15,442
Provision (reversal)	1,509			273			(222		)	(153		)	29		88		(40		)	(1,484		)	—
Charge-offs	(289		)	—			—			—			—		—		(3		)	—			(292		)
Recoveries	92			—			—			—			—		—		6			—			98
Ending balance	$	4,560		$	2,026		$	6,098		$	628		$	1,002	$	542	$	335		$	57		$	15,248
Nine months ended September 30, 2016
Allowance for loan losses:
Beginning balance	$	3,023		$	2,249		$	6,178		$	724		$	910	$	394	$	425		$	1,096		$	14,999
Provision (reversal)	388			(628		)	(2,009		)	212			40		54		(84		)	477			(1,550		)
Charge-offs	(9		)	—			—			—			—		—		(4		)	—			(13		)
Recoveries	92			—			2,156			—			2		—		27			—			2,277
Ending balance	$	3,494		$	1,621		$	6,325		$	936		$	952	$	448	$	364		$	1,573		$	15,713



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
September 30, 2017
Ending ALLL related to loans collectively evaluated for impairment	$	4,525		$	1,942		$	5,729		$	623		$	996		$	540		$	250		$	57	$	14,662
Ending ALLL related to loans individually evaluated for impairment	35			84			369			5			6			2			85			—		586
Ending ALLL related to purchased credit-impaired loans	—			—			—			—			—			—			—			—		—
Ending balance	$	4,560		$	2,026		$	6,098		$	628		$	1,002		$	542		$	335		$	57	$	15,248
Recorded Investment:
Collectively evaluated for impairment	$	216,594		$	256,593		$	717,361		$	73,210		$	120,629		$	95,778		$	24,310		$	—	$	1,504,475
Individually evaluated for impairment	2,050			6,999			3,217			2,969			640			1,159			666			—		17,700
Purchased credit-impaired	37			1,140			998			—			97			—			—			—		2,272
Total	$	218,681		$	264,732		$	721,576		$	76,179		$	121,366		$	96,937		$	24,976		$	—	$	1,524,447
Ratio of allowance for loan losses to total loans	2.09		%	0.77		%	0.85		%	0.82		%	0.83		%	0.56		%	1.34		%	NM		1.00		%
Allowance for loan losses to non-accrual loans	NM			NM			596		%	NM			343		%	NM			NM			NM		1,159		%

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
December 31, 2016
Ending ALLL related to loans collectively evaluated for impairment	$	2,963		$	1,590		$	5,945		$	773		$	966		$	399		$	274		$	1,541	$	14,451
Ending ALLL related to loans individually evaluated for impairment	285			163			375			8			7			55			98			—		991
Ending ALLL related to purchased credit-impaired loans	—			—			—			—			—			—			—			—		—
Ending balance	$	3,248		$	1,753		$	6,320		$	781		$	973		$	454		$	372		$	1,541	$	15,442
Recorded Investment:
Collectively evaluated for impairment	$	216,368		$	239,648		$	720,266		$	71,564		$	116,390		$	76,584		$	24,563		$	—	$	1,465,383
Individually evaluated for impairment	2,207			6,993			2,256			3,245			715			1,965			932			—		18,313
Purchased credit-impaired	40			1,072			1,706			—			102			—			—			—		2,920
Total	$	218,615		$	247,713		$	724,228		$	74,809		$	117,207		$	78,549		$	25,495		$	—	$	1,486,616
Ratio of allowance for loan losses to total loans	1.49		%	0.71		%	0.87		%	1.04		%	0.83		%	0.58		%	1.46		%	NM		1.04		%
Allowance for loan losses to non-accrual loans	NM			NM			NM			NM			1,071		%	NM			683		%	NM		10,650		%

NM - Not Meaningful

Purchased Credit-Impaired Loans

Acquired loans are considered credit-impaired if there is evidence of significant 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 bank 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 unpaid principal balance and related carrying value of PCI loans.



PCI Loans	September 30, 2017				December 31, 2016
(in thousands)	Unpaid Principal Balance		Carrying Value		Unpaid Principal Balance		Carrying Value
Commercial and industrial	$	37	$	37	$	45	$	40
Commercial real estate, owner occupied	1,309		1,140		1,344		1,072
Commercial real estate, investor	998		998		1,713		1,706
Home equity	236		97		248		102
Total purchased credit-impaired loans	$	2,580	$	2,272	$	3,350	$	2,920

The activities in the accretable yield, or income expected to be earned over the remaining lives of the PCI loans were as follows:



Accretable Yield	Three months ended						Nine months ended
(in thousands)	September 30, 2017			September 30, 2016			September 30, 2017			September 30, 2016
Balance at beginning of period	$	1,306		$	1,655		$	1,476		$	2,618
Removals ¹	—			—			—			(778		)
Accretion	(76		)	(89		)	(246		)	(274		)
Reclassifications from nonaccretable difference ²	—			—			—			—
Balance at end of period	$	1,230		$	1,566		$	1,230		$	1,566

¹Represents the accretable difference that is relieved when a loan exits the PCI population due to pay-off, 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 unpaid principal balances of $872.0 million and $869.2 million at September 30, 2017 and December 31, 2016, respectively. In addition, we pledge a certain residential loan portfolio, which totaled $67.5 million and $54.6 million at September 30, 2017 and December 31, 2016, respectively, to secure our borrowing capacity with the Federal Reserve Bank ("FRB"). Also see Note 6, Borrowings.

Related Party Loans

The Bank has, and expects to have in the future, banking transactions in the ordinary course of its business with directors, officers, principal shareholders and their businesses or associates. These transactions, including loans, are granted on substantially the same terms, including interest rates and collateral on loans, as those prevailing at the same time for comparable transactions with persons not related to us. Likewise, these transactions do not involve more than the normal risk of collectability or present other unfavorable features. During the first quarter of 2017, a new director joined our Board of Directors resulting in the reclassification of existing loans to the director's business to related party status. Related party loans totaled $8.7 million at September 30, 2017 compared to $2.0 million at December 31, 2016. In addition, undisbursed commitments to related parties totaled $9.2 million and $1.1 million at September 30, 2017 and December 31, 2016, respectively.