Loans and Allowance for Loan Losses

Credit Quality of Loans

The following table shows outstanding loans by class and payment aging as of March 31, 2019 and December 31, 2018.



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
March 31, 2019
30-59 days past due	$	320	$	1,584	$	—	$	—	$	517	$	—	$	102	$	2,523
60-89 days past due	—		—		—		—		108		—		—		108
90 days or more past due	—		—		—		—		84		—		—		84
Total past due	320		1,584		—		—		709		—		102		2,715
Current	237,326		309,004		878,494		72,271		123,803		117,558		31,367		1,769,823
Total loans ²	$	237,646	$	310,588	$	878,494	$	72,271	$	124,512	$	117,558	$	31,469	$	1,772,538
Non-accrual loans ¹	$	309	$	—	$	—	$	—	$	346	$	—	$	64	$	719
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 loans ¹	$	319	$	—	$	—	$	—	$	313	$	—	$	65	$	697

¹ Includes no purchased credit impaired ("PCI") loans at March 31, 2019 and December 31, 2018. Amounts exclude accreting PCI loans of $2.1 million at March 31, 2019 and December 31, 2018 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, 2019 or December 31, 2018.

² Amounts include net deferred loan origination costs of $684 thousand and $635 thousand at March 31, 2019 and December 31, 2018, respectively. Amounts are also net of unaccreted purchase discounts on non-PCI loans of $666 thousand and $708 thousand at March 31, 2019 and December 31, 2018, 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 loan borrowers provide for interest reserves that are used for the payment of interest during the development and marketing periods. When a construction loan is placed on nonaccrual status before the depletion of the interest reserve, 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 March 31, 2019 and December 31, 2018.



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
March 31, 2019
Pass	$	226,164	$	294,713	$	875,562	$	69,580	$	122,578	$	117,558	$	31,312	$	2,098	$	1,739,565
Special Mention	10,312		4,613		2,116		—		1,121		—		—		—		18,162
Substandard	1,144		10,086		—		2,691		733		—		157		—		14,811
Total loans	$	237,620	$	309,412	$	877,678	$	72,271	$	124,432	$	117,558	$	31,469	$	2,098	$	1,772,538
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

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. There were no loans removed from TDR designation during 2019. During the three months ended March 31, 2018, one TIC loan with recorded investments totaling $150 thousand was removed from TDR designation after meeting all of the conditions above.

The following table summarizes the carrying amount of TDR loans by loan class as of March 31, 2019 and December 31, 2018.



(in thousands)
Recorded Investment in Troubled Debt Restructurings ¹	March 31, 2019		December 31, 2018
Commercial and industrial	$	1,198	$	1,506
Commercial real estate, owner-occupied	7,001		6,993
Commercial real estate, investor	1,812		1,821
Construction	2,691		2,688
Home equity	251		251
Other residential	460		462
Installment and other consumer ²	675		685
Total	$	14,088	$	14,406

¹There were no acquired TDR loans as of March 31, 2019 or December 31, 2018.

²There were two TDR loans on non-accrual status with recorded investments totaling $64 thousand and $65 thousand at March 31, 2019 and December 31, 2018, respectively.

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 March 31, 2019:
None	—	$	—	$	—	$	—
TDRs during the three months ended March 31, 2018:
None	—	$	—	$	—	$	—

During the first three months of 2019 and 2018, 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
March 31, 2019
Recorded investment in impaired loans:
With no specific allowance recorded	$	328	$	—	$	—	$	2,691	$	346	$	460	$	109	$	3,934
With a specific allowance recorded	1,179		7,001		1,812		—		251		—		566		10,809
Total recorded investment in impaired loans	$	1,507	$	7,001	$	1,812	$	2,691	$	597	$	460	$	675	$	14,743
Unpaid principal balance of impaired loans	$	1,489	$	6,993	$	1,801	$	2,687	$	595	$	459	$	674	$	14,698
Specific allowance	424		161		47		—		5		—		67		704
Average recorded investment in impaired loans during the quarter ended March 31, 2019	1,666		6,997		1,816		2,690		580		461		680		14,890
Interest income recognized on impaired loans during the quarter ended March 31, 2019¹	22		66		20		42		4		5		6		165
Average recorded investment in impaired loans during the quarter ended March 31, 2018	2,216		7,003		2,012		2,972		746		1,070		717		16,736
Interest income recognized on impaired loans during the quarter ended March 31, 2018¹	155		66		22		38		5		13		7		306

¹No interest income on impaired loans was recognized on a cash basis during the three months ended March 31, 2019. Interest income recognized on a cash basis totaled $128 thousand in the three months ended March 31, 2018 and was related to the pay-off of two non-accrual commercial PCI loans.



(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

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 March 31, 2019 or December 31, 2018. In addition, the recorded investment in impaired loans is net of purchase discounts or premiums on acquired loans and deferred fees and costs. At March 31, 2019 and December 31, 2018, unused commitments to extend credit on impaired loans, including performing loans to borrowers whose terms have been modified in TDRs, totaled $1.4 million and $1.1 million, 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 March 31, 2019
Beginning balance	$	2,436		$	2,407		$	7,703		$	756		$	915		$	800	$	310		$	494		$	15,821
Provision (reversal)	180			(49		)	63			(52		)	8			—		30			(180		)	—
Charge-offs	(9		)	—			—			—			—			—		—			—			(9		)
Recoveries	5			—			—			—			—			—		—			—			5
Ending balance	$	2,612		$	2,358		$	7,766		$	704		$	923		$	800	$	340		$	314		$	15,817
Three months ended March 31, 2018
Beginning balance	$	3,654		$	2,294		$	6,475		$	681		$	1,031		$	536	$	378		$	718		$	15,767
Provision (reversal)	35			(214		)	(20		)	16			(52		)	7		(27		)	255			—
Charge-offs	—			—			—			—			—			—		—			—			—
Recoveries	4			—			—			—			—			—		—			—			4
Ending balance	$	3,693		$	2,080		$	6,455		$	697		$	979		$	543	$	351		$	973		$	15,771



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
March 31, 2019
Ending ALLL related to loans collectively evaluated for impairment	$	2,188		$	2,197		$	7,719		$	704		$	918		$	800		$	273		$	314	$	15,113
Ending ALLL related to loans individually evaluated for impairment	424			161			47			—			5			—			67			—		704
Ending ALLL related to PCI loans	—			—			—			—			—			—			—			—		—
Ending balance	$	2,612		$	2,358		$	7,766		$	704		$	923		$	800		$	340		$	314	$	15,817
Recorded Investment:
Collectively evaluated for impairment	$	236,113		$	302,411		$	875,866		$	69,580		$	123,835		$	117,098		$	30,794		$	—	$	1,755,697
Individually evaluated for impairment	1,507			7,001			1,812			2,691			597			460			675			—		14,743
PCI loans	26			1,176			816			—			80			—			—			—		2,098
Total	$	237,646		$	310,588		$	878,494		$	72,271		$	124,512		$	117,558		$	31,469		$	—	$	1,772,538
Ratio of allowance for loan losses to total loans	1.10		%	0.76		%	0.88		%	0.97		%	0.74		%	0.68		%	1.08		%	NM		0.89		%
Allowance for loan losses to non-accrual loans	845		%	NM			NM			NM			267		%	NM			531		%	NM		2,200		%

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, 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	NM			NM			NM			NM			292		%	NM			NM			NM		2,270		%

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	March 31, 2019				December 31, 2018
(in thousands)	Unpaid Principal Balance		Carrying Value		Unpaid Principal Balance		Carrying Value
Commercial and industrial	$	78	$	26	$	89	$	31
Commercial real estate, owner occupied	1,233		1,176		1,247		1,187
Commercial real estate, investor	1,025		816		1,033		811
Home equity	205		80		210		83
Total purchased credit-impaired loans	$	2,541	$	2,098	$	2,579	$	2,112

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
(in thousands)	March 31, 2019			March 31, 2018
Balance at beginning of period	$	934		$	1,254
Accretion	(59		)	(112		)
Balance at end of period	$	875		$	1,142

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 $1,084.5 million and $1,027.4 million at March 31, 2019 and December 31, 2018, respectively. In addition, we pledge eligible TIC loans, which totaled $96.8 million and $94.5 million at March 31, 2019 and December 31, 2018, 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 $10.2 million at March 31, 2019, compared to $10.6 million at December 31, 2018. In addition, undisbursed commitments to related parties totaled $9.1 million at March 31, 2019 and December 31, 2018.