Loans and Allowance for Loan Losses

Credit Quality of Loans

Virtually all of our loans are from customers located in California, primarily in Marin, Alameda, Sonoma, San Francisco, Napa, and Contra Costa counties. Approximately 88% and 87% of total loans were secured by real estate at December 31, 2018 and 2017, respectively. At December 31, 2018 and 2017, 67% of our loans were for commercial real estate, 85% of which were secured by real estate located in Marin, Sonoma, Alameda, San Francisco and Napa counties (California).

The following table shows outstanding loans by class and payment aging as of December 31, 2018 and 2017.



Loan Aging Analysis by Class
(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, 2018
30-59 days past due	$	5	$	—	$	1,004	$	—	$	—			$	112	$	1,121
60-89 days past due	—		—		—		—		—		—		—		—
90 days or more past due	—		—		—		—		—		—		—		—
Total past due	5		—		1,004		—		—		—		112		1,121
Current	230,734		313,277		872,406		76,423		124,696		117,847		27,360		1,762,743
Total loans ²	$	230,739	$	313,277	$	873,410	$	76,423	$	124,696	$	117,847	$	27,472	$	1,763,864
Non-accrual loans¹	$	319	$	—	$	—	$	—	$	313	$	—	$	65	$	697
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 ²	$	235,835	$	300,963	$	822,984	$	63,828	$	132,467	$	95,526	$	27,410	$	1,679,013
Non-accrual loans ¹	$	—	$	—	$	—	$	—	$	406	$	—	$	—	$	406

¹ Includes no purchased credit impaired ("PCI") loans at December 31, 2018. Three purchased credit impaired loans with unpaid balances totaling $131 thousand and no carrying values were not accreting interest at December 31, 2017. Amounts exclude accreting PCI loans of $2.1 million and December 31, 2018 and 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 December 31, 2018 or 2017.

² Amounts include net deferred loan origination costs of $635 thousand and $818 thousand at December 31, 2018 and 2017, respectively. Amounts are also net of unaccreted purchase discounts on non-PCI loans of $708 thousand and $1.2 million at December 31, 2018 and 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, substantially all of our loans are guaranteed by the owners of the properties. 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.

Construction loans are generally made to developers and builders to finance construction, renovation and occasionally land acquisitions in anticipation of near-term development. Construction loans are structured with interest reserves that are used for the payment of interest during the development and marketing periods and capitalized as part of the loan balance. If we determine that a construction loan is impaired before the depletion of the interest reserve, then we apply the interest funded by the interest reserve against the loan's principal balance. These loans are underwritten after evaluation of the borrower's financial strength, reputation, prior track record, and independent appraisals. We monitor all construction projects to determine whether they are on schedule, completed as planned and in accordance with the approved construction budgets. 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 do not originate sub-prime residential mortgage loans, nor is it our practice to underwrite loans commonly referred to as "Alt-A mortgages," the characteristics of which are reduced documentation, borrowers with low FICO scores or collateral with high loan-to-value ratios.

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. We review home equity and other consumer loans based on delinquency. 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 December 31, 2018 and 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
December 31, 2018
Pass	$	219,625	$	299,998	$	870,443	$	73,735	$	122,844	$	117,847	$	27,312	$	2,112	$	1,733,916
Special Mention	9,957		4,106		2,156		—		1,121		—		—		—		17,340
Substandard	1,126		7,986		—		2,688		648		—		160		—		12,608
Total loans	$	230,708	$	312,090	$	872,599	$	76,423	$	124,613	$	117,847	$	27,472	$	2,112	$	1,763,864
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 loan classification upgrade must approve the removal of TDR status. During 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 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 December 31, 2018 and December 31, 2017.



(in thousands)	As of
Recorded investment in Troubled Debt Restructurings¹	December 31, 2018		December 31, 2017
Commercial and industrial	$	1,506	$	2,165
Commercial real estate, owner-occupied	6,993		6,999
Commercial real estate, investor	1,821		2,171
Construction	2,688		2,969
Home equity	251		347
Other residential	462		1,148
Installment and other consumer²	685		721
Total	$	14,406	$	16,520

¹Includes no acquired TDR loans as of December 31, 2018 or December 31, 2017.

²There were two TDR loans on non-accrual status with recorded investments totaling $65 thousand at December 31, 2018 and no TDR loans on non-accrual status at 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 modified during 2018:
Commercial and industrial	2	$	254	$	245	$	172
TDRs modified during 2017:
Installment and other consumer	1	$	50	$	50	$	47

The modifications during 2018 and 2017 primarily involved maturity or payment extensions, interest rate concessions, renewals, and other changes to loan terms. During 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
December 31, 2018
Recorded investment in impaired loans:
With no specific allowance recorded	$	303	$	—	$	—	$	2,688	$	313	$	462	$	111	$	3,877
With a specific allowance recorded	1,522		6,993		1,821		—		251		—		574		11,161
Total recorded investment in impaired loans	$	1,825	$	6,993	$	1,821	$	2,688	$	564	$	462	$	685	$	15,038
Unpaid principal balance of impaired loans	$	1,813	$	6,993	$	1,812	$	2,688	$	562	$	461	$	684	$	15,013
Specific allowance	$	466	$	189	$	45	$	—	$	5	$	—	$	73	$	778
Average recorded investment in impaired loans during 2018	$	1,980	$	7,000	$	1,904	$	2,803	$	671	$	915	$	704	$	15,977
Interest income recognized on impaired loans during 2018 ¹	$	239	$	266	$	83	$	156	$	19	$	45	$	29	$	837
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
Average recorded investment in impaired loans during 2017	$	2,113	$	6,998	$	2,842	$	3,132	$	679	$	1,324	$	841	$	17,929
Interest income recognized on impaired loans during 2017 ¹	$	202	$	266	$	87	$	147	$	24	$	62	$	37	$	825
¹Interest income recognized on a cash basis totaled $135 thousand and $100 thousand in 2018 and 2017, respectively, and was primarily related to the payoff of non-accrual commercial PCI loans.

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 amounts on impaired loans at December 31, 2018 or 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 December 31, 2018 and 2017, 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 $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 Year Ended
(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
Year ended December 31, 2018
Beginning balance	$	3,654		$	2,294	$	6,475	$	681		$	1,031		$	536	$	378		$	718		$	15,767
Provision (reversal)	(1,232		)	113		1,228		75			(116		)	264		(108		)	(224		)	—
Charge-offs	(3		)	—		—		—			—			—		(2		)	—			(5		)
Recoveries	17			—		—		—			—			—		42			—			59
Ending balance	$	2,436		$	2,407	$	7,703	$	756		$	915		$	800	$	310		$	494		$	15,821
Year ended December 31, 2017
Beginning balance	$	3,248		$	1,753	$	6,320	$	781		$	973		$	454	$	372		$	1,541		$	15,442
Provision (reversal)	584			541		155		(100		)	58			82		3			(823		)	500
Charge-offs	(289		)	—		—		—			—			—		(4		)	—			(293		)
Recoveries	111			—		—		—			—			—		7			—			118
Ending balance	$	3,654		$	2,294	$	6,475	$	681		$	1,031		$	536	$	378		$	718		$	15,767



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, 2018
Ending ALLL related to loans collectively evaluated for impairment	$	1,970		$	2,218		$	7,658		$	756		$	910		$	800		$	237		$	494	$	15,043
Ending ALLL related to loans individually evaluated for impairment	466			189			45			—			5			—			73			—		778
Ending ALLL related to purchased credit-impaired loans	—			—			—			—			—			—			—			—		—
Ending balance	$	2,436		$	2,407		$	7,703		$	756		$	915		$	800		$	310		$	494	$	15,821
Recorded Investment:
Collectively evaluated for impairment	$	228,883		$	305,097		$	870,778		$	73,735		$	124,049		$	117,385		$	26,787		$	—	$	1,746,714
Individually evaluated for impairment	1,825			6,993			1,821			2,688			564			462			685			—		15,038
Purchased credit-impaired	31			1,187			811			—			83			—			—			—		2,112
Total	$	230,739		$	313,277		$	873,410		$	76,423		$	124,696		$	117,847		$	27,472		$	—	$	1,763,864
Ratio of allowance for loan losses to total loans	1.06		%	0.77		%	0.88		%	0.99		%	0.73		%	0.68		%	1.13		%	NM		0.90		%
Allowance for loan losses to non-accrual loans	764		%	NM			NM			NM			292		%	NM			477		%	NM		2,270		%

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
Loans outstanding:
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 non-accrual 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	December 31, 2018				December 31, 2017
(in thousands)	Unpaid Principal Balance		Carrying Value		Unpaid Principal Balance		Carrying Value
Commercial and industrial	$	89	$	31	$	276	$	65
Commercial real estate, owner occupied	1,247		1,187		1,297		1,166
Commercial real estate, investor	1,033		811		1,064		790
Home equity	210		83		231		94
Total purchased credit-impaired loans	$	2,579	$	2,112	$	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	Years ended
(in thousands)	December 31, 2018			December 31, 2017
Balance at beginning of period	$	1,254		$	1,476
Additions	—			109
Accretion	(320		)	(331		)
Balance at end of period	$	934		$	1,254

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 $1,027.4 million and $887.9 million at December 31, 2018 and 2017, respectively. In addition, we pledge eligible TIC loans, which totaled $94.5 million and $67.6 million at December 31, 2018 and 2017, respectively, to secure our borrowing capacity with the Federal Reserve Bank (“FRB”). Also, see Note 7, 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.

The following table shows changes in net loans to related parties for each of the two years ended December 31, 2018 and 2017:



(in thousands)	2018			2017
Balance at beginning of year	$	11,852		$	1,988
Additions	863			3,186
Advances	—			74
Repayments	(2,080		)	(128		)
Reclassified due to a change in borrower status¹	—			6,732
Balance at end of year	$	10,635		$	11,852

¹During 2017, two new directors joined our Board of Directors resulting in the reclassification of existing loans to those directors and their businesses to related party status.

Undisbursed commitments to related parties totaled $9.1 million as of both December 31, 2018 and 2017.