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, 2018 and December 31, 2017.



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, 2018
30-59 days past due	$	—	$	—	$	—	$	—	$	121	$	—	$	113	$	234
60-89 days past due	20		—		—		—		—		—		47		67
90 days or more past due	—		—		—		—		—		—		—		—
Total past due	20		—		—		—		121		—		160		301
Current	238,751		316,467		841,493		68,739		121,122		113,383		28,615		1,728,570
Total loans ³	$	238,771	$	316,467	$	841,493	$	68,739	$	121,243	$	113,383	$	28,775	$	1,728,871
Non-accrual loans ²	$	—	$	—	$	—	$	—	$	318	$	—	$	68	$	386
December 31, 2017
30-59 days past due	$	—	$	—	$	—	$	—	$	99	$	255	$	330	$	684
60-89 days past due	1,340		—		—		—		—		—		—		1,340
90 days or more past due	—		—		—		—		307		—		—		307
Total past due	1,340		—		—		—		406		255		330		2,331
Current	234,495		300,963		822,984		63,828		132,061		95,271		27,080		1,676,682
Total loans ³	$	235,835	$	300,963	$	822,984	$	63,828	$	132,467	$	95,526	$	27,410	$	1,679,013
Non-accrual loans ²	$	—	$	—	$	—	$	—	$	406	$	—	$	—	$	406

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 Includes no purchased credit impaired ("PCI") loans at September 30, 2018. Three PCI loans with unpaid balances totaling $131 thousand and no carrying values were not accreting interest at December 31, 2017. Amounts exclude accreting PCI loans totaling $2.1 million at both September 30, 2018 and December 31, 2017 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, 2018 or December 31, 2017.

³ Amounts include net deferred loan origination costs of $704 thousand and $818 thousand at September 30, 2018 and December 31, 2017, respectively. Amounts are also net of unaccreted purchase discounts on non-PCI loans of $922 thousand and $1.2 million at September 30, 2018 and December 31, 2017, respectively.

We generally make commercial loans 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 personal guarantees. We target stable businesses with guarantors who provide additional sources of repayment and have proven to be resilient in periods of economic stress.

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, the owners of the properties guarantee substantially all of our commercial real estate loans. Conditions in the real estate markets or in the general economy may adversely affect our commercial real estate loans. In the event of a vacancy, we expect guarantors to carry the loans until they find a replacement tenant. 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.

We generally make construction loans 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. Significant events can affect the construction industry, 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, other residential loans and floating homes, along with a small number of installment loans. Our other residential loans include tenancy-in-common fractional interest loans ("TIC") located almost entirely in San Francisco County. 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.

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. Our definitions of “Special Mention” risk graded loans, 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/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 non-accrual status and usually are collateral-dependent.

We regularly review our credits for accuracy of risk grades whenever we receive new information. Borrowers are generally required to submit financial information at regular intervals. Typically, 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. In addition, investor commercial real estate borrowers are usually required to submit rent rolls or property income statements annually. We monitor construction loans monthly and review them on an ongoing basis. We review home equity and other consumer loans based on delinquency status. We also review loans graded “Watch” or worse, regardless of loan type, 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, 2018 and December 31, 2017.



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, 2018
Pass	$	223,259	$	302,082	$	838,493	$	66,049	$	119,383	$	113,383	$	28,611	$	2,129	$	1,693,389
Special Mention	14,574		5,192		2,194		—		1,121		—		—		—		23,081
Substandard	899		7,995		—		2,690		653		—		164		—		12,401
Total loans	$	238,732	$	315,269	$	840,687	$	68,739	$	121,157	$	113,383	$	28,775	$	2,129	$	1,728,871
December 31, 2017
Pass	$	214,636	$	281,104	$	818,570	$	60,859	$	130,558	$	95,526	$	27,287	$	1,325	$	1,629,865
Special Mention	9,318		9,284		1,850		—		—		—		—		790		21,242
Substandard	11,816		9,409		1,774		2,969		1,815		—		123		—		27,906
Total loans	$	235,770	$	299,797	$	822,194	$	63,828	$	132,373	$	95,526	$	27,410	$	2,115	$	1,679,013

Troubled Debt Restructuring

Our loan portfolio includes certain loans modified in a troubled debt restructuring (“TDR”), where we have granted economic concessions 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.

We may remove a loan from TDR designation if it meets all of the following conditions:


•	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 same Management level that approved the upgrading of the loan classification must approve the removal of TDR status. During the nine months ended September 30, 2018, one TIC loan and one home equity loan with recorded investments totaling $247 thousand were removed from TDR designation after meeting all of the conditions noted above. There were no loans removed from TDR designation during 2017.

The following table summarizes the carrying amount of TDR loans by loan class as of September 30, 2018 and December 31, 2017.



(in thousands)
Recorded investment in Troubled Debt Restructurings ¹	September 30, 2018		December 31, 2017
Commercial and industrial	$	1,763	$	2,165
Commercial real estate, owner-occupied	6,997		6,999
Commercial real estate, investor	1,831		2,171
Construction	2,690		2,969
Home equity	251		347
Other residential	986		1,148
Installment and other consumer	695		721
Total	$	15,213	$	16,520

¹There were two TDR loans with recorded investments totaling $68 thousand on non-accrual status at September 30, 2018 and no TDR loans on non-accrual status at December 31, 2017. Includes no acquired loans on TDR status as of September 30, 2018 and December 31, 2017.

The following table presents information for loans modified in a TDR during the presented periods, including the number of modified contracts, the recorded investment in the loans prior to modification, and the recorded investment in the loans at period end 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
TDRs during the three months ended September 30, 2018:
None	—	$	—	$	—	$	—
TDRs during the three months ended September 30, 2017:
None	—	$	—	$	—	$	—



TDRs during the nine months ended September 30, 2018:
Commercial and industrial	2	$	254	$	245	$	235
TDRs during the nine months ended September 30, 2017:
Installment and consumer	1	$	50	$	50	$	49

The two loans that were modified during the nine months ended September 30, 2018 were to the same borrower and included loan extensions and other changes in loan terms. The modification during the nine months ended September 30, 2017 primarily involved an interest rate concession and other changes to loan terms. During the first nine months of 2018 and 2017, 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, 2018
Recorded investment in impaired loans:
With no specific allowance recorded	$	304	$	—	$	—	$	2,690	$	318	$	986	$	113	$	4,411
With a specific allowance recorded	1,459		6,997		1,831		—		251		—		582		11,120
Total recorded investment in impaired loans	$	1,763	$	6,997	$	1,831	$	2,690	$	569	$	986	$	695	$	15,531
Unpaid principal balance of impaired loans	$	1,751	$	6,993	$	1,824	$	2,688	$	567	$	985	$	694	$	15,502
Specific allowance	173		228		44		—		5		—		77		527
Average recorded investment in impaired loans during the quarter ended September 30, 2018	1,840		7,000		1,837		2,690		651		987		700		15,705
Interest income recognized on impaired loans during the quarter ended September 30, 2018¹	31		67		20		39		5		13		7		182
Average recorded investment in impaired loans during the nine months ended September 30, 2018	2,019		7,002		1,925		2,831		698		1,029		708		16,212
Interest income recognized on impaired loans during the nine months ended September 30, 2018 ¹	214		199		63		114		15		38		22		665
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, 2017¹	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

¹Interest income recognized on a cash basis totaling $6 thousand and $134 thousand during the three and nine months ended September 30, 2018 was primarily related to the pay-off of three non-accrual commercial PCI loans. No interest income on impaired loans was recognized on a cash basis during the three and nine months ended September 30, 2017.



(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, 2017
Recorded investment in impaired loans:
With no specific allowance recorded	$	309	$	—	$	—	$	2,689	$	406	$	995	$	46	$	4,445
With a specific allowance recorded	1,856		6,999		2,171		280		347		153		675		12,481
Total recorded investment in impaired loans	$	2,165	$	6,999	$	2,171	$	2,969	$	753	$	1,148	$	721	$	16,926
Unpaid principal balance of impaired loans	$	2,278	$	6,993	$	2,168	$	2,963	$	750	$	1,147	$	720	$	17,019
Specific allowance	$	50	$	188	$	159	$	7	$	6	$	1	$	102	$	513

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. 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 amounts on impaired loans at September 30, 2018 or December 31, 2017. 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, 2018 and December 31, 2017, unused commitments to extend credit on impaired loans, including performing loans to borrowers whose terms have been modified in TDRs, totaled $950 thousand and $935 thousand, respectively.

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, 2018
Beginning balance	$	2,597		$	2,339		$	7,390	$	508	$	952		$	746	$	325		$	956		$	15,813
Provision (reversal)	(245		)	83			46		157		(39		)	35		5			(42		)	—
Charge-offs	—			—			—		—		—			—		—			—			—
Recoveries	4			—			—		—		—			—		—			—			4
Ending balance	$	2,356		$	2,422		$	7,436	$	665	$	913		$	781	$	330		$	914		$	15,817
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



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, 2018
Allowance for loan losses:
Beginning balance	$	3,654		$	2,294	$	6,475		$	681		$	1,031		$	536	$	378		$	718		$	15,767
Provision (reversal)	(1,308		)	128		961			(16		)	(118		)	245		(88		)	196			—
Charge-offs	(3		)	—		—			—			—			—		(2		)	—			(5		)
Recoveries	13			—		—			—			—			—		42			—			55
Ending balance	$	2,356		$	2,422	$	7,436		$	665		$	913		$	781	$	330		$	914		$	15,817
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



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, 2018
Ending ALLL related to loans collectively evaluated for impairment	$	2,183		$	2,194		$	7,392		$	665		$	908		$	781		$	253		$	914	$	15,290
Ending ALLL related to loans individually evaluated for impairment	173			228			44			—			5			—			77			—		527
Ending ALLL related to PCI loans	—			—			—			—			—			—			—			—		—
Ending balance	$	2,356		$	2,422		$	7,436		$	665		$	913		$	781		$	330		$	914	$	15,817
Recorded Investment:
Collectively evaluated for impairment	$	236,969		$	308,272		$	838,856		$	66,049		$	120,588		$	112,397		$	28,080		$	—	$	1,711,211
Individually evaluated for impairment	1,763			6,997			1,831			2,690			569			986			695			—		15,531
PCI loans	39			1,198			806			—			86			—			—			—		2,129
Total	$	238,771		$	316,467		$	841,493		$	68,739		$	121,243		$	113,383		$	28,775		$	—	$	1,728,871
Ratio of allowance for loan losses to total loans	0.99		%	0.77		%	0.88		%	0.97		%	0.75		%	0.69		%	1.15		%	NM		0.91		%
Allowance for loan losses to non-accrual loans	NM			NM			NM			NM			287		%	NM			485		%	NM		4,098		%

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, 2017
Ending ALLL related to loans collectively evaluated for impairment	$	3,604		$	2,106		$	6,316		$	674		$	1,025		$	535		$	276		$	718	$	15,254
Ending ALLL related to loans individually evaluated for impairment	50			188			159			7			6			1			102			—		513
Ending ALLL related to purchased credit-impaired loans	—			—			—			—			—			—			—			—		—
Ending balance	$	3,654		$	2,294		$	6,475		$	681		$	1,031		$	536		$	378		$	718	$	15,767
Recorded Investment:
Collectively evaluated for impairment	$	233,605		$	292,798		$	820,023		$	60,859		$	131,620		$	94,378		$	26,689		$	—	$	1,659,972
Individually evaluated for impairment	2,165			6,999			2,171			2,969			753			1,148			721			—		16,926
Purchased credit-impaired	65			1,166			790			—			94			—			—			—		2,115
Total	$	235,835		$	300,963		$	822,984		$	63,828		$	132,467		$	95,526		$	27,410		$	—	$	1,679,013
Ratio of allowance for loan losses to total loans	1.55		%	0.76		%	0.79		%	1.07		%	0.78		%	0.56		%	1.38		%	NM		0.94		%
Allowance for loan losses to non-accrual loans	NM			NM			NM			NM			254		%	NM			NM			NM		3,883		%

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 three 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, 2018				December 31, 2017
(in thousands)	Unpaid Principal Balance		Carrying Value		Unpaid Principal Balance		Carrying Value
Commercial and industrial	$	106	$	39	$	276	$	65
Commercial real estate, owner occupied	1,259		1,198		1,297		1,166
Commercial real estate, investor	1,041		806		1,064		790
Home equity	215		86		231		94
Total purchased credit-impaired loans	$	2,621	$	2,129	$	2,868	$	2,115

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, 2018			September 30, 2017			September 30, 2018			September 30, 2017
Balance at beginning of period	$	1,059		$	1,306		$	1,254		$	1,476
Accretion	(63		)	(76		)	(258		)	(246		)
Balance at end of period	$	996		$	1,230		$	996		$	1,230

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 $1,031.5 million and $887.9 million at September 30, 2018 and December 31, 2017, respectively. In addition, we pledge a certain residential loan portfolio, which totaled $85.2 million and $67.6 million at September 30, 2018 and December 31, 2017, 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. Related party loans totaled $11.3 million at September 30, 2018 compared to $11.9 million at December 31, 2017. In addition, undisbursed commitments to related parties totaled $9.1 million at September 30, 2018 and December 31, 2017.