NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Summary of Significant Accounting Policies
Basis of Presentation: The consolidated financial statements include the accounts of Bank of Marin Bancorp (“Bancorp”), a bank holding company, and its wholly-owned bank subsidiary, Bank of Marin (the “Bank”), a California state-chartered commercial bank. References to “we,” “our,” “us” mean Bancorp and the Bank that are consolidated for financial reporting purposes. All material intercompany transactions have been eliminated. We evaluated subsequent events through the date of filing with the Securities and Exchange Commission (“SEC”) and determined that there were no subsequent events that require additional recognition or disclosure.
The NorCal Community Bancorp Trusts I and II, respectively (the "Trusts"), were formed for the sole purpose of issuing trust preferred securities. Bancorp is not considered the primary beneficiary of the Trusts (variable interest entities), therefore the Trusts are not consolidated in our consolidated financial statements, but rather the subordinated debentures are shown as a liability on our consolidated statements of condition. Bancorp's investment in the securities of the Trusts is accounted for under the equity method and is included in interest receivable and other assets on the consolidated statements of condition. Refer to Note 7, Borrowings, for detail on the early redemption on October 7, 2018 of one subordinated debenture due to NorCal Community Bancorp Trust I.
Nature of Operations: Bancorp, headquartered in Novato, CA, conducts business primarily through its wholly-owned subsidiary, the Bank, which provides a wide range of financial services to customers who are predominantly professionals, small and middle-market businesses, and individuals who work and/or reside in Marin, Sonoma, Napa, San Francisco, Alameda and Contra Costa counties. Besides its headquarters located in Novato, CA, the Bank operates ten branches in Marin County, three in Napa County, one in San Francisco, five in Sonoma County, three in Alameda County, and one loan production office in Contra Costa County. Our accounting and reporting policies conform to Generally Accepted Accounting Principles ("GAAP"), general practice, and regulatory guidance within the banking industry. A summary of our significant policies follows.
Cash, Cash Equivalents and Restricted Cash include cash, due from banks, federal funds sold and other short-term investments with maturities of less than three months at the time of purchase. Restricted cash includes reserve requirements held with the Federal Reserve Bank of San Francisco.
Investment Securities are classified as "held-to-maturity," "trading securities" or "available-for-sale." Investments classified as held-to-maturity are those that we have the ability and intent to hold until maturity and are reported at cost, adjusted for the amortization or accretion of premiums or discounts. Investments held for resale in anticipation of short-term market movements are classified as trading securities and are reported at fair value, with unrealized gains and losses included in earnings. Investments that are neither held-to-maturity nor trading are classified as available-for-sale and are reported at fair value. Unrealized gains and losses for available-for-sale securities, net of related taxes, are reported as a separate component of comprehensive income and included in stockholders' equity until realized. For discussion of our methodology in determining fair value, see Note 9, Fair Value of Assets and Liabilities.
Securities transferred from the available-for-sale category to the held-to-maturity category are recorded at fair value at the date of transfer. Unrealized holding gains or losses on the dates of the transfer of securities from available-for-sale to held-to-maturity are included in the balance of accumulated other comprehensive income (loss), net of tax, in the consolidated balance sheets. These unrealized holding gains or losses on the dates of transfer are amortized over the remaining life of the securities as yield adjustments in a manner consistent with the amortization or accretion of the original purchase premium or discount on the associated security.
At each financial statement date, we assess whether declines in the fair values of held-to-maturity and available-for-sale securities below their costs are deemed to be other-than-temporary. We consider, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value. Evidence evaluated includes, but is not limited to, the remaining payment terms of the instrument and economic factors that are relevant to the collectability of the instrument, such as: current prepayment speeds, the current financial condition of the issuer(s), industry analyst reports, credit ratings, credit default rates, interest rate trends, the quality of any credit enhancement and the value of any underlying collateral.
For each security in an unrealized loss position ("impaired security"), we assess whether we intend to sell the security or if it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If we intend to sell the security or it is more likely than not we will be required to sell the security before recovery of its amortized cost basis, the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date is recognized against earnings.
For impaired securities that are not intended for sale and will not be required to be sold prior to recovery of our amortized cost basis, we determine if the impairment has a credit loss component. For both held-to-maturity and available-for-sale securities, if the amount of cash flows expected to be collected are less than the amortized cost, then other-than-temporary impairment shall be considered to have occurred and the credit loss component is recognized against earnings as the difference between present value of the expected future cash flows and the amortized cost. In determining the present value of the expected cash flows, we discount the expected cash flows at the effective interest rate implicit in the security at the date of purchase. The remaining difference between the fair value and the amortized basis is deemed to be due to factors that are not credit related and is recognized in other comprehensive income, net of applicable taxes.
For held-to-maturity securities, if there is no credit loss component, no impairment is recognized. The portion of other-than-temporary impairment recognized in other comprehensive income for credit impaired debt securities classified as held-to-maturity is accreted from other comprehensive income to the amortized cost of the debt security over the remaining life of the debt security in a prospective manner on the basis of the amount and timing of future estimated cash flows.
Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to yield using the effective interest method. For certain callable debt securities purchased at a premium, we amortize the premium to the earliest call date.
Dividend and interest income are recognized when earned. Realized gains and losses on the sale of securities and credit losses related to other-than-temporary impairment on available-for-sale and held-to-maturity securities are included in non-interest income as gains (losses) on investment securities, net. The specific identification method is used to calculate realized gains and losses on sales of securities.
Originated Loans are reported at the principal amount outstanding net of deferred fees (costs), charge-offs and the allowance for loan losses (“ALLL”). Interest income is accrued daily using the simple interest method. Loan origination fees and commitment fees, offset by certain direct loan origination costs, are deferred and amortized as yield adjustments over the contractual lives of the related loans. Loans are placed on non-accrual status when Management believes that there is substantial doubt as to the collection of principal or interest, generally when they become contractually past due by ninety days or more with respect to principal or interest, except for loans that are well-secured and in the process of collection. When loans are placed on non-accrual status, any accrued but uncollected interest is reversed from current-period interest income. We may return non-accrual loans to accrual status when one of the following occurs:
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The borrower has resumed paying the full amount of the principal and interest and we are satisfied with the borrower's financial position. In order to meet this test, we must have received repayment of all past due principal and interest, unless the amounts contractually due are reasonably assured of repayment within a reasonable period of time, and there has been a sustained period of repayment performance (generally, six consecutive monthly payments), according to the original contractual terms or modified terms for loans whose contractual terms have been restructured in a manner which grants a concession to a borrower experiencing financial difficulties (“troubled debt restructuring”).
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The loan has become well secured and is in the process of collection.
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Loan Charge-Off Policy: For all loan types excluding overdraft accounts, we generally make a charge-off determination at or before 90 days past due. A collateral-dependent loan is partially charged down to the fair value of collateral securing it if: (1) it is deemed uncollectable, or (2) it has been classified as a loss by either our internal loan review process or external examiners. A non-collateral-dependent loan is partially charged down to its net realizable value under the same circumstances. Overdraft accounts are generally charged off when they exceed 60 days past due.
Acquired Loans: Acquired loans are recorded at their estimated fair values at the acquisition date in accordance with Accounting Standards Code ("ASC") 805, Business Combinations, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded for acquired loans as of the acquisition date.
We estimated the fair value of acquired loans at the acquisition date based on a discounted cash flow methodology that considered factors including the type of loan and related collateral, risk classification, fixed or variable interest rate, term of loan, whether or not the loan was amortizing, and current discount rates. Loans, except for purchased credit impaired ("PCI") loans, were grouped together according to similar risk characteristics and treated in the aggregate when applying various valuation techniques. Expected cash flows incorporated our best estimate of key assumptions at the time, such as property values, default rates, loss severity and prepayment speeds. Discount rates were based on market rates for new originations of comparable loans, where available, and included adjustments for liquidity factors. To the extent comparable market rates were not readily available, a discount rate was derived based on the assumptions of market participants' cost of funds, servicing costs and return requirements for comparable risk assets. In either case, the discount rate did not include a factor for credit losses, as that had been considered in estimating the cash flows. The process of calculating fair values of acquired loans, including estimates of losses expected to be incurred over the estimated remaining lives of the loans at acquisition date and ongoing updates to Management's expectation of future cash flows, requires significant subjective judgments and assumptions. The economic environment and lack of market liquidity and transparency are factors that have influenced, and may continue to affect, these assumptions and estimates.
We acquired loans with evidence of significant credit quality deterioration subsequent to their origination and for which it was probable, at acquisition, that we would be unable to collect all contractually required payments. Management applied significant subjective judgment in determining which loans were PCI loans. Evidence of credit quality deterioration as of the purchase date may include data such as past due and non-accrual status, risk grades and charge-off history.
The difference between the undiscounted expected cash flows expected to be collected and the fair value at the acquisition date ("accretable difference") is accreted into interest income at a level yield of return over the estimated remaining life of the PCI loan, provided that the timing and amount of future cash flows is reasonably estimable. The accretable yield is affected by:
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Changes in interest rate indices for variable rate loans – Expected future cash flows are based on the variable rates in effect at the time of the regular evaluations of cash flows expected to be collected;
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Changes in prepayment assumptions – Prepayments affect the estimated life of the loans which may change the amount of interest income, and possibly principal, expected to be collected; and
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Changes in the expected principal and interest payments over the estimated life – Updates to expected cash flows are driven by the credit outlook and actions taken with borrowers. Changes in expected future cash flows from loan modifications are included in the regular evaluations of cash flows expected to be collected.
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The cash flows expected to be collected are updated each quarter based on current assumptions regarding default rates, loss severities, and other factors that are reflective of current financial conditions of the borrowers and the market conditions. Probable decreases in expected cash flows after acquisition result in impairment recorded as a specific allowance for loan losses or a charge-off to the allowance. Impairment is calculated as the present value of the expected future cash flows on the PCI loan, discounted at the loan's effective interest rate implicit in the loan.
The nonaccretable difference on the date of acquisition is defined as the difference between the contractually required payments and the cash flows expected to be collected, considering the result of prepayments, and is not recorded.
For purposes of accounting for the PCI loans from past business combinations, we elected not to apply the pooling method but to account for these loans individually. Disposals of loans, which may include sales of loans to third parties, receipt of payments in full by the borrower, or foreclosure of the collateral, result in removal of the loan from the PCI loan portfolio at its carrying amount. If a PCI loan pays off earlier than expected, a gain is recorded as interest income when the payoff amount exceeds the recorded investment.
For acquired loans not considered credit impaired ("non-PCI"), we recognize the entire fair value discount accretion as interest income, based on contractual cash flows using an effective interest rate method for term loans, and on a straight line basis for revolving lines. When a non-PCI loan is placed on non-accrual status subsequent to acquisition, accretion stops until the loan is returned to accrual status. The level of accretion on non-PCI loans varies from period to period due to maturities and early payoffs of these loans during the reporting periods. Subsequent to acquisition, if the probable and estimable losses for non-PCI loans exceed the amount of the remaining unaccreted discount, the excess is established as an allowance for loan losses. For further information regarding our acquired loans, see Note 3, Loans and Allowance for Loan Losses.
Allowance for Loan Losses is based upon estimates of loan losses and is maintained at a level considered adequate to provide for probable losses inherent in the loan portfolio. The allowance is increased by provisions for loan losses charged against earnings and reduced by charge-offs, net of recoveries.
In periodic evaluations of the adequacy of the allowance balance, Management considers current economic conditions, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, our past loan loss experience and other factors. The ALLL is based on estimates, and ultimate losses may vary from current estimates. Our Board of Directors' Asset/Liability Management Committee (“ALCO”) reviews the adequacy of the ALLL at least quarterly.
The overall allowance consists of 1) specific allowances for individually identified impaired loans ("ASC 310-10") and 2) general allowances for pools of loans ("ASC 450-20"), which incorporate quantitative (e.g., historical loan loss rates) and qualitative risk factors (e.g., portfolio growth and trends, credit concentrations, economic and regulatory factors, etc.).
The first component, specific allowances, results from the analysis of identified problem credits and the evaluation of sources of repayment including collateral, as applicable. Through Management's ongoing loan grading and credit monitoring process, individual loans are identified that have conditions indicating the borrower may be unable to pay all amounts due in accordance with the contractual terms. These loans are evaluated for impairment individually by Management. Management considers an originated loan to be impaired when it is probable we will be unable to collect all amounts due according to the contractual terms of the loan agreement. When the fair value of the impaired loan is less than the recorded investment in the loan, the difference is recorded as an impairment through the establishment of a specific allowance. For loans determined to be impaired, the extent of the impairment is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate at origination (for originated loans), based on the loan's observable market price, or based on the fair value of the collateral if the loan is collateral dependent or if foreclosure is imminent. Generally, with problem credits that are collateral dependent, we obtain appraisals of the collateral at least annually. We may obtain appraisals more frequently if we believe the collateral value is subject to market volatility, if a specific event has occurred to the collateral, or if we believe foreclosure is imminent.
The second component is an estimate of the probable inherent losses in each loan pool with similar characteristics. This analysis encompasses the entire loan portfolio, excluding individually identified impaired loans and acquired loans whose purchase discount has not been fully accreted. Under our allowance model, loans are evaluated on a pool basis by federal regulatory reporting codes ("CALL codes" or "segments"), which are further delineated by assigned credit risk ratings, as described in Note 3, Loans and Allowance for Loan Losses. Segments include the following:
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Loans secured by real estate:
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- 1-4 family residential construction loans
- Other construction loans and all land development and other land loans
- Secured by farmland (including residential and other improvements)
- Revolving, open-end loans secured by 1-4 family residential properties and extended under lines of credit
- Closed-end loans secured by 1-4 family residential properties, secured by first liens
- Closed-end loans secured by 1-4 family residential properties, secured by junior liens
- Secured by multifamily (5 or more) residential properties
- Loans secured by owner-occupied non-farm nonresidential properties
- Loans secured by other non-farm nonresidential properties
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Loans to finance agricultural production and other loans to farmers
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Commercial and industrial loans
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Loans to individuals for household, family and other personal expenditures (i.e., consumer loans)
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The model determines general allowances by loan segment based on quantitative (loss history) and qualitative risk factors. The quantitative risk factor for each segment utilizes the greater result of either the historical loss method or migration analysis loss method based on loss history beginning March 2010. Qualitative internal and external risk factors include, but are not limited to, the following:
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Changes in the nature and volume of the loan portfolio
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Changes in the volume and severity of past due loans, the volume of non-accruals loans, and the volume and severity of adversely classified or graded loans
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The existence and effect of individual loan and loan segment concentrations
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Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere
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Changes in the experience, ability, and depth of lending management and other relevant staff
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Changes in the quality of our systematic loan review processes
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Changes in economic and business conditions, and developments that affect the collectability of the portfolio
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Changes in the value of underlying collateral, where applicable
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The effect of other external factors such as legal and regulatory requirements on the level of estimated credit losses in the portfolio
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The effect of acquisitions of other loan portfolios on our infrastructure, including risk associated with entering new geographic areas as a result of such acquisitions
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The presence of specialized lending segments in the portfolio
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Under the historical loss method, quarterly loss rates are calculated for each segment by dividing annualized net charge-offs during each quarter by the quarter's average segment balances. The quarterly loss rates are averaged over the entire loss history period. Under the migration analysis method, loss rates are calculated at the risk grade and segment levels by dividing the net charge-off amount by the total segment balance at the beginning of each migration period where the charged-off loan in question was present. Migration loss rates are averaged for each risk grade and segment for the entire loss history period. For each segment, the loss rates that result in the larger of the migration loss reserves or segment historical loss reserves are applied to the current loan balances. Qualitative factors are combined with these quantitative factors at the segment level to arrive at the overall general allowances.
We establish specific allowances to account for credit deterioration for probable decreases in cash flows for PCI loans subsequent to acquisition. The estimated cash flows expected to be collected on PCI loans are updated quarterly and require the use of key assumptions and estimates based on factors such as the current economic environment, changes in collateral values, loan workout plans, changes in the probability of default, loss severities, and prepayments. Probable decreases in expected cash flows after acquisition result in impairment recorded as a specific allowance for loan losses or a charge-off to the allowance. Impairment is calculated as the present value of the expected future cash flows on the PCI loan, discounted at the loan's effective interest rate implicit in the loan.
While we believe we use the best information available to determine the allowance for loan losses, our results of operations could be significantly affected if circumstances differ substantially from the assumptions used in determining the allowance. A decline in local and national economic conditions, or significant changes in other assumptions, could result in a material increase in the allowance for loan losses and may adversely affect our financial condition and results of operations. In addition, the determination of the amount of the allowance for loan losses is subject to review by bank regulators as part of their routine examination process, which may result in the establishment of additional allowance for loan losses based upon their judgment of information available to them at the time of their examination.
For further information regarding the allowance for loan losses, see Note 3, Loans and Allowance for Loan Losses.
Allowance for Losses on Off-Balance Sheet Commitments: We make commitments to extend credit to meet the financing needs of our customers in the form of loans or standby letters of credit. We are exposed to credit loss in the event that a decline in credit quality of the borrower leads to nonperformance. We record an allowance for losses on these off-balance sheet commitments based on estimates of probability that these commitments will be drawn upon according to the historical utilization experience of different types of commitments and expected loss severity. This allowance is included in interest payable and other liabilities on the consolidated statements of condition.
Transfers of Financial Assets: We have entered into certain loan participation agreements with other organizations. We account for these transfers of financial assets as sales when control over the transferred financial assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets and liabilities have been isolated from us, (2) the transferee has the right to pledge or exchange the assets (or beneficial interests) it received, free of conditions that constrain it from taking advantage of that right, beyond a trivial benefit and (3) we do not maintain effective control over the transferred financial assets or third-party beneficial interests related to those transferred assets. No gain or loss has been recognized by us on the sale of these participation interests in 2019 and 2018.
Premises and Equipment: Premises and equipment consist of leasehold improvements, furniture, fixtures, software and equipment and are stated at cost, less accumulated depreciation and amortization, which are calculated on a straight-line basis. Furniture and fixtures are depreciated over eight years and equipment is generally depreciated over three to twenty years. Leasehold improvements are amortized over the lesser of their estimated useful lives or the terms of the leases. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation or amortization are removed from the accounts and any resulting gain or loss is recognized in income for the period. The cost of maintenance and repairs is charged to expense as incurred.
Business Combinations: Business combinations are accounted for under the acquisition method of accounting in accordance with ASC 805, Business Combinations. A business is defined as a set of activities and assets that is both self-sustaining and managed to provide a return to investors and generally has three elements: inputs, processes and outputs. Under the acquisition method, the acquiring entity in a business combination recognizes the acquired assets and assumed liabilities at their estimated fair values as of the date of acquisition. Any excess of the purchase price over the fair value of net assets and other identifiable intangible assets acquired is recorded as goodwill. To the extent the fair value of net assets acquired, including other identifiable assets, exceed the purchase price, a bargain purchase gain is recognized. Assets acquired and liabilities assumed from a business combination are recognized at fair value, if the fair value can be determined during the measurement period. Results of operations of an acquired business are included in the consolidated statements of operations from the date of acquisition. Business acquisition-related costs, including conversion and restructuring charges, are expensed as incurred. If substantially all of an acquisition is made up of one asset or several similar assets, or without a substantive process that together contributes to the ability to create outputs, the acquisition is accounted for as an asset acquisition and acquisition costs will be capitalized as part of the assets acquired, rather than expensed in a business combinations.
Goodwill and Other Intangible Assets: Goodwill is determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill that arises from a business combination is periodically evaluated for impairment at the reporting unit level, at least annually. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Core deposit intangible ("CDI") represents the estimated future benefit of deposits related to an acquisition and is booked separately from the related deposits and evaluated periodically for impairment. The CDI asset is amortized on an accelerated method over its estimated useful life of ten years. At December 31, 2019, the future estimated amortization expense for the CDI arising from our past acquisitions is as follows:
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(in thousands)
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2020
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2021
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2022
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2023
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2024
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Thereafter
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Total
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Core deposit intangible amortization
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$
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853
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$
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818
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$
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782
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$
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719
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$
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422
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$
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1,090
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$
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4,684
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We make a qualitative assessment of whether it is more likely than not that the fair value of a reporting unit where goodwill is assigned is less than its carrying amount. If we conclude that it is more likely than not that the fair value is more than its carrying amount, no impairment is recorded. Goodwill is tested for impairment on an interim basis if circumstances change or an event occurs between annual tests that would more likely than not reduce the fair value of the reporting unit below its carrying amount. The qualitative assessment includes adverse events or circumstances identified that could negatively affect the reporting units’ fair value as well as positive and mitigating events. Such indicators may include, among others, significant changes in legal factors or in the general business climate, significant changes in our stock price and market capitalization, unanticipated competition, and an action or assessment by a regulator. If the fair value of a reporting unit is less than its carrying amount, an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value is recognized. The loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.
Other Real Estate Owned ("OREO"): OREO is comprised of property acquired through foreclosure, in substance repossession or acceptance of deeds-in-lieu of foreclosure when the related loan receivable is de-recognized. OREO is recorded at fair value of the collateral less estimated costs to sell, establishing a new cost basis, and subsequently accounted for at the lower of cost or fair value less estimated costs to sell. Any shortfall of collateral value from the recorded investment of the related loan is recognized as loss at the time of foreclosure and is charged against the allowance for loan losses. Fair value of collateral is generally based on an independent appraisal of the property. Revenues and expenses associated with OREO, and subsequent adjustments to the fair value of the property and to the estimated costs of disposal, are realized and reported as a component of non-interest income and expense when incurred.
Bank Owned Life Insurance ("BOLI"): The Bank owns life insurance policies on certain key current and former officers. BOLI is recorded in interest receivable and other assets on the consolidated statements of condition at the amount that can be realized under the insurance contract at period-end, which is the cash surrender value adjusted for other charges or amounts due that are probable at settlement.
Federal Home Loan Bank of San Francisco ("FHLB") Stock: The Bank is a member of the FHLB. Members are required to own a certain amount of stock based on the level of borrowings and other factors. As of December 31, 2019, our investment in FHLB stock was carried at cost, as there was no impairment or changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. As of December 31, 2018, our investment in FHLB stock was carried at cost. We periodically evaluate FHLB stock for impairment based on ultimate recovery of par value. FHLB stock is included as part of interest receivable and other assets on the consolidated statements of condition. Both cash and stock dividends are reported as non-interest income.
Investments in Low Income Housing Tax Credit Funds: We have invested in limited partnerships that were formed to develop and operate affordable housing projects for low or moderate-income tenants throughout California. Our ownership percentage in each limited partnership ranges from 1.0% to 3.5%. We account for the investments in qualified affordable housing tax credit funds using the proportional amortization method, where the initial cost of the investment is amortized in proportion to the tax credits and other tax benefits received. Low income housing tax credits and other tax benefits received, net of the amortization of the investment is recognized as part of income tax benefit. Each of the partnerships must meet the regulatory minimum requirements for affordable housing for a minimum 15-year compliance period to fully utilize the tax credits. If the partnerships cease to qualify during the compliance period, the credit may be denied for any period in which the project is not in compliance and a portion of the credit previously taken is subject to recapture with interest. We record an impairment charge if the value of the future tax credits and other tax benefits is less than the carrying value of the investments.
Employee Stock Ownership Plan (“ESOP”): We recognize compensation cost for ESOP contributions when funds become committed for the purchase of Bancorp's common shares into the ESOP in the year in which the employees render service entitling them to the contribution. If we contribute stock, the compensation cost is the fair value of the shares when they are committed to be released (i.e., when the number of shares becomes known and formally approved). In 2019 and 2018, the Bank only made stock contributions to the ESOP.
Income Taxes: Income taxes reported in the consolidated financial statements are computed based on an asset and liability approach. We recognize the amount of taxes payable or refundable for the current year and we record deferred tax assets and liabilities for future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases using enacted tax rates in effect for the year in which the temporary differences are expected to reverse. We record net deferred tax assets to the extent it is more likely than not that they will be realized. In evaluating our ability to recover the deferred tax assets and the need to establish a valuation allowance against the deferred tax assets, Management considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies. In projecting future taxable income, Management develops assumptions including the amount of future state and federal pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates being used to manage the underlying business. Bancorp files consolidated federal and combined state income tax returns.
We recognize the financial statement effect of a tax position when it is more likely than not, based on the technical merits and all available evidence, that the position will be sustained upon examination, including the resolution through
protests, appeals or litigation processes. For tax positions that meet the more likely than not threshold, we measure and record the largest amount of tax benefit that is greater than fifty percent likely of being realized upon ultimate settlement with the taxing authority. The remainder of the benefits associated with tax positions taken is recorded as unrecognized tax benefits, along with any related interest and penalties. Interest and penalties related to unrecognized tax benefits are recorded in tax expense.
In deciding whether or not our tax positions taken meet the more likely than not recognition threshold, we must make judgments and interpretations about the application of inherently complex state and federal tax laws. To the extent tax authorities disagree with tax positions taken by us, our effective tax rates could be materially affected in the period of settlement with the taxing authorities. Revision of our estimate of accrued income taxes also may result from our own income tax planning, which may affect effective tax rates and results of operations for any reporting period.
We present an unrecognized tax benefit as a reduction of a deferred tax asset for a net operating loss ("NOL") carryforward, or similar tax loss or tax credit carryforward, rather than as a liability, when (1) the uncertain tax position would reduce the NOL or other carryforward under the tax law of the applicable jurisdiction and (2) we intend to and are able to use the deferred tax asset for that purpose. Otherwise, the unrecognized tax benefit is presented as a liability instead of being netted with deferred tax assets.
Earnings per share (“EPS”) are based upon the weighted average number of common shares outstanding during each year. The following table shows: 1) weighted average basic shares, 2) potentially dilutive weighted average common shares related to stock options and unvested restricted stock awards, and 3) weighted average diluted shares. Basic EPS are calculated by dividing net income by the weighted average number of common shares outstanding during each annual period, excluding unvested restricted stock awards. Diluted EPS are calculated using the weighted average number of potentially dilutive common shares. The number of potentially dilutive common shares included in year-to-date diluted EPS is a year-to-date weighted average of potentially dilutive common shares included in each quarterly diluted EPS computation. In computing diluted EPS, we exclude anti-dilutive shares such as options whose exercise prices exceed the current common stock price, as they would not reduce EPS under the treasury method. We have two forms of outstanding common stock: common stock and unvested restricted stock awards. Holders of unvested restricted stock awards receive non-forfeitable dividends at the same rate as common shareholders and they both share equally in undistributed earnings. Under the two-class method, the difference in EPS is nominal for these participating securities.
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(in thousands, except per share data)1
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2019
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2018
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Weighted average basic shares outstanding
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13,620
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13,864
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Potentially dilutive common shares related to:
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Stock options
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148
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136
|
|
Unvested restricted stock awards
|
26
|
|
29
|
|
Weighted average diluted shares outstanding
|
13,794
|
|
14,029
|
|
Net income
|
$
|
34,241
|
|
$
|
32,622
|
|
Basic EPS
|
$
|
2.51
|
|
$
|
2.35
|
|
Diluted EPS
|
$
|
2.48
|
|
$
|
2.33
|
|
Weighted average anti-dilutive shares not included in the calculation of diluted EPS
|
35
|
|
44
|
|
1 Share and per share data have been adjusted to reflect the two-for-one stock split effective November 27, 2018.
Share-Based Compensation: All share-based payments, including stock options and restricted stock, are recognized as stock-based compensation expense in the consolidated statements of comprehensive income based on the grant-date fair value of the award with a corresponding increase in common stock. The grant-date fair value of the award is amortized on a straight-line basis over the requisite service period, which is generally the vesting period. The stock-based compensation expense excludes stock grants to directors as compensation for their services, which are recognized as director expenses separately based on the grant-date value of the stock. We account for forfeitures as they occur. See Note 8, Stockholders' Equity and Stock Option Plans for further discussion.
We determine the fair value of stock options at the grant date using a Black-Scholes pricing model that takes into account the stock price at the grant date, exercise price, expected life of the option, volatility of the underlying stock, expected dividend yield and risk-free interest rate over the expected life of the option. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The risk-free rate for periods within the expected life of the option is based on the U.S. Treasury yield curve in effect at the
time of the grant. Expected volatility is based on the historical volatility of the common stock over the most recent period that is generally commensurate with the expected life of the options. The Black-Scholes option valuation model requires the input of highly subjective assumptions, including the expected life of the stock-based award and stock price volatility. The assumptions used represent Management's best estimates based on historical information, but these estimates involve inherent uncertainties and the application of Management's judgment. As a result, if other assumptions had been used, the recorded stock-based compensation expense could have been materially different from that recorded in the consolidated financial statements. The fair value of restricted stock is based on the stock price on the grant date.
We record excess tax benefits resulting from the exercise of non-qualified stock options, the disqualifying disposition of incentive stock options and vesting of restricted stock awards as tax benefits in the consolidated statements of comprehensive income with a corresponding decrease to current taxes payable. In addition, we reflect excess tax benefits as an operating activity in the consolidated statements of cash flows.
Cash paid for tax withholdings when shares are surrendered in a cashless stock option exchange is classified as a financing activity in the consolidated statements of cash flows.
In June 2018, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. This update simplifies the accounting for share-based payment transactions for acquiring goods and services from nonemployees, applying some of the same requirements as employee share-based payment transactions. The ASU will not affect the accounting for share-based payment awards to nonemployee directors, which will continue to be treated as employee share-based transactions under the current standards. ASU 2018-07 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. We adopted the requirements of this ASU effective January 1, 2019, which did not impact our financial condition or results of operations, as it is not our practice to issue stock-based awards to pay for goods and services from nonemployees, other than nonemployee directors.
Derivative Financial Instruments and Hedging Activities - Fair Value Hedges: All of our interest rate swap contracts are designated and qualified as fair value hedges. The terms of our interest rate swap contracts are closely aligned to the terms of the designated fixed-rate loans. The hedging relationships are tested for effectiveness on a quarterly basis using a qualitative approach. The qualitative analysis includes verification that there are no changes to the derivative's or hedged item's key terms and conditions and no adverse developments regarding risk of counterparty default, and validation that we continue to have fair value hedge designation. The interest rate swaps are carried on the consolidated statements of condition at their fair value in other assets (when the fair value is positive) or in other liabilities (when the fair value is negative). The changes in the fair value of the interest rate swaps are recorded in interest income. The unrealized gains or losses due to changes in fair value of the hedged fixed-rate loans due to changes in benchmark interest rates are recorded as an adjustment to the hedged loans and offset in interest income. For derivative instruments executed with the same counterparty under a master netting arrangement, we do not offset fair value amounts of interest rate swaps in liability positions with the ones in asset positions.
From time to time, we make firm commitments to enter into long-term fixed-rate loans with borrowers backed by yield maintenance agreements and simultaneously enter into forward interest rate swap agreements with correspondent banks to mitigate the change in fair value of the yield maintenance agreement. Prior to loan funding, yield maintenance agreements with net settlement features that meet the definition of a derivative are considered as non-designated hedges and are carried on the consolidated statements of condition at their fair value in other assets (when the fair value is positive) or in other liabilities (when the fair value is negative). The offsetting changes in the fair value of the forward swap and the yield maintenance agreement are recorded in interest income. When the fixed-rate loans are originated, the forward swaps are designated to offset the change in fair value in the loans. Subsequent to the point of the swap designations, the fair value of the related yield maintenance agreements at the designation date that was recorded in other assets is amortized using the effective yield method over the life of the respective designated loans.
The net effect of the change in fair value of interest rate swaps, the amortization of the yield maintenance agreement and the change in the fair value of the hedged loans due to changes in benchmark interest rates result in an insignificant amount recognized in interest income. For further detail, see Note 14, Derivative Financial Instruments and Hedging Activities.
In October 2018, the FASB issued ASU No. 2018-16, Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. This update adds an alternative fifth permissible U.S. benchmark rate to be used for hedge accounting purposes. The amendments should be adopted for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, on a prospective basis for qualifying new or re-designated hedging relationships entered into on or after the date of adoption. We adopted this ASU effective January 1, 2019, which did not impact our financial condition or results of operations, as we did not have new or re-designated hedging relationships since adoption.
Revenue Recognition: We utilize the following five-step model for non-financial instrument related revenue that is in scope for Topic 606, Revenue from Contracts with Customers: 1) identify the contract, 2) identify the performance obligations in the contract, 3) determine the transaction price, 4) allocate the transaction price to the performance obligations in the contract, and, 5) recognize revenue when (or as) the entity satisfies the performance obligation. Our main revenue streams in scope for Topic 606 include:
|
|
•
|
Wealth Management & Trust ("WM&T") fees - WM&T services include, but are not limited to: customized investment advisory and management; administrative services such as bill pay and tax reporting; trust administration, estate settlement, custody and fiduciary services. Performance obligations for investment advisory and management services are generally satisfied over time. Revenue is recognized monthly according to a tiered fee schedule based on the client's month-end market value of assets under our management. WM&T does not earn revenue based on performance or incentives. Costs associated with WM&T revenue-generating activities, such as payments to sub-advisors, are recorded separately as part of professional service expenses when incurred.
|
|
|
•
|
Deposit account service charges - Service charges on deposit accounts consist of monthly maintenance fees, business account analysis fees, business online banking fees, check order charges, and other deposit account-related fees. Performance obligations for monthly maintenance fees and account analysis fees are satisfied, and the related revenue recognized, when we complete our performance obligation each month. Performance obligations related to transaction-based services (such as check orders) are satisfied, and the related revenue recognized, at a point in time typically when the transaction is completed, except for business accounts subject to analysis where the transaction-based fees are part of the monthly account analysis fees.
|
|
|
•
|
Debit card interchange fees - We issue debit cards to our consumer and small business customers that allow them to purchase goods and services from merchants in person, online, or via mobile devices using funds held in their demand deposit accounts held with us. Debit cards issued to our customers are part of global electronic payment networks (such as Visa) who pass a portion of the merchant interchange fees to debit card-issuing member banks like us when our customers make purchases through their networks. Performance obligations for debit card services are satisfied and revenue is recognized daily as the payment networks process transactions. Because we act in an agent capacity, we recognize network costs on a net basis with interchange fees in non-interest income.
|
Advertising Costs are expensed as incurred. For the years ended December 31, 2019 and 2018, advertising costs totaled $775 thousand and $666 thousand, respectively.
Comprehensive Income (Loss) includes net income, changes in the unrealized gains or losses on available-for-sale investment securities, and amortization of net unrealized gains or losses on securities transferred from available-for-sale to held-to-maturity, net of related taxes, reported on the consolidated statements of comprehensive income and as components of stockholders' equity.
Fair Value Measurements: We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. We base our fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e., exit price notion) reflecting factors such as a liquidity premium. Securities available-for-sale and derivatives are recorded at fair value on a recurring basis. Our equity investments that do not have readily determinable fair values are recorded at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. FHLB stock and Visa Inc. Class B common stock are carried at cost as of December 31, 2019 and 2018, as there was no impairment or changes resulting from observable price changes in orderly transactions for an identical or similar investment of the same issuer. Additionally,
from time to time, we may be required to record certain assets and liabilities at fair value on a non-recurring basis, such as purchased loans and acquired deposits recorded at acquisition date, certain impaired loans, other real estate owned and securities held-to-maturity that are other-than-temporarily impaired. These non-recurring fair value adjustments typically involve write-downs of individual assets due to application of lower-of-cost or market accounting.
When we develop our fair value measurement process, we maximize the use of observable inputs. Whenever there is no readily available market data, we use our best estimates and assumptions in determining fair value, but these estimates involve inherent uncertainties and the application of Management's judgment. As a result, if other assumptions had been used, our recorded earnings or disclosures could have been materially different from those reflected in these consolidated financial statements.
Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant accounting estimates reflected in the consolidated financial statements include ALLL, other-than-temporary impairment of investment securities, accrued liabilities, accounting for income taxes and fair value measurements (including fair values of acquired assets and assumed liabilities at acquisition dates) as discussed in the Notes herein.
Other Recently Adopted Accounting Standards
In February 2018, the FASB issued ASU No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This amendment helped organizations address certain stranded income tax effects in accumulated other comprehensive income ("AOCI") resulting from the enactment of the Tax Cuts and Jobs Act of 2017. The ASU required financial statement preparers to disclose a description of the accounting policy for releasing income tax effects from AOCI, whether or not they elect to reclassify the stranded income tax effects from the Tax Cuts and Jobs Act of 2017, and information about the other income tax effects that are reclassified. The amendments are effective for all organizations for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. We early adopted this ASU in the first quarter of 2018 by reclassifying $638 thousand from AOCI to retained earnings. This amount represented the stranded income tax effects related to the unrealized loss on available-for-sale securities in AOCI on the date of the enactment of the Tax Cuts and Jobs Act of 2017.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (the "new lease accounting standard"). The amendments in this ASU intended to increase transparency and comparability among organizations by recognizing an operating lease or finance lease right-of-use asset for the lease term, and a lease liability, which is a lessee's obligation to make lease payments, recorded based on discounting future lease payments under the lease terms. This ASU generally applies to leasing arrangements exceeding a twelve-month term. ASU 2016-02 is effective for annual periods, including interim periods within those annual periods beginning after December 15, 2018 and requires a modified retrospective method of adoption. In July 2018, the FASB issued two amendments to ASU 2016-02: ASU No. 2018-10, Codification Improvements to Topic 842, Leases, which provided various corrections and clarifications to ASU 2016-02; and ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which permitted optional transition methods and provided lessors with a practical expedient for separating lease and non-lease components of a lease. The ASU allowed entities to apply either a modified retrospective approach at the beginning of the earliest period presented or at the beginning of the period of adoption through a cumulative-effect adjustment to retained earnings. We adopted the ASU under the latter approach.
As a result of the adoption of ASU 2016-02 on January 1, 2019, we recorded operating and finance lease right-of-use assets totaling $13.4 million, net of deferred rent and unaccreted lease incentives, operating and finance lease liabilities totaling $15.4 million, and no cumulative-effect adjustments to retained earnings. Under the standard's transition guidance, we elected the package of practical expedients, which allowed us to carry forward existing lease classifications and did not require us to reassess initial direct costs for any existing leases. In addition, we elected the hindsight practical expedient when determining the lease term (i.e., considering whether we are reasonably certain to exercise options to extend or terminate the lease). We made accounting policy elections not to separate non-lease components from lease components and to exclude short-term leases (i.e., lease term of 12 months or less at the commencement date) from right-of-use assets and lease liabilities for all lease classifications. See Note 12, Commitments and Contingencies for further information.
In March 2019, the FASB issued ASU No. 2019-01, Leases (Topic 842): Codification Improvements. This ASU addresses two lessor implementation issues and clarifies that lessees and lessors are exempt from certain interim disclosure requirements associated with adopting ASU 2016-02. The amendments related to the lessor implementation issues are effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early application is permitted. As the ASU's amendments applicable to us only relate to disclosures, the adoption of ASU 2019-01 did not impact our financial condition or results of operations.
Accounting Standards Not Yet Effective
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The standard will replace today's "incurred loss" model with a "current expected credit loss" ("CECL") model. The CECL model will apply to estimated credit losses on loans receivable, held-to-maturity debt securities, unfunded loan commitments, and certain other financial assets measured at amortized cost. The CECL model is based on lifetime expected losses, rather than incurred losses, and requires the recognition of credit loss expense in the consolidated statement of income and a related allowance for credit losses on the consolidated statement of condition at the time of origination or purchase of a loan receivable or held-to-maturity debt security. In addition, CECL will modify the accounting for purchased loans and will require that an allowance for credit losses be established at the date of acquisition. However, for purchased financial assets with a more-than-insignificant amount of credit deterioration since origination (“PCD assets”) that are measured at amortized cost, the initial allowance for credit losses is added to the purchase price rather than being reported as a credit loss expense. Subsequent changes in the allowance for credit losses on PCD assets are recognized through credit loss expense.
Under ASU 2016-13, available-for-sale debt securities are evaluated for impairment if fair value is less than amortized cost. Estimated credit losses are recorded through a credit loss expense and an allowance, rather than a write-down of the investment. Changes in fair value that are not credit-related will continue to be recorded in other comprehensive income. The ASU also expands the disclosure requirements regarding assumptions, models, and methods for estimating the allowance for loan losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.
Early CECL implementation activities focused on, among other things, capturing and validating data, segmenting the loan portfolio, evaluating various credit loss estimation methodologies, sourcing tools to forecast future economic conditions, running multiple loan loss driver analyses that correlate our credit loss experience with one or more economic factors, and evaluating the qualitative factor framework and assumptions. Based on these activities, we determined that our primary credit loss methodology will utilize a discounted cash flow approach that considers the probability of default and loss given default. Continuing implementation activities include model validation, drafting policies and disclosures, and evaluating, documenting and testing internal controls. Parallel testing occurred throughout 2019 and we estimate that our adoption of the CECL standards will result in a 5% to 15% increase to our allowance for credit losses, which will be recorded as a cumulative-effect adjustment to retained earnings, net of tax as of January 1, 2020.
In April 2019, the FASB issued ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments that clarifies and improves areas of guidance related to recently issued standards on credit losses, hedging and recognition and measurement. The provisions of this ASU are effective January 1, 2020 and contain various methods of adoption. We will evaluate this ASU in conjunction with ASU 2016-13 to determine its impact on our financial condition and results of operations. At this time, we do not expect the ASU to have a material impact on our financial condition or results of operations.
In May 2019, the FASB issued ASU No. 2019-05, Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief. This ASU allows an option for entities to irrevocably elect the fair value option on an instrument-by-instrument basis for eligible financial assets measured at amortized cost basis upon adoption of the credit loss standards. This amendment provides relief for those entities electing the fair value option on newly originated or purchased financial assets, while maintaining existing similar financial assets at amortized cost, avoiding the requirement to maintain dual measurement methods for similar assets. The fair value option does not apply to held-to-maturity debt securities. This ASU is effective for us in fiscal year 2020, including interim periods within the fiscal year. At this time, we do not expect to elect the fair value option for our financial assets.
In November 2019, the FASB issued ASU No. 2019-11, Codification Improvements to Topic 326, Financial Instruments - Credit Losses. This ASU, among other narrow -scope improvements, clarifies guidance around how to report expected recoveries. “Expected recoveries” describes a situation in which an organization recognizes a full or partial write-off of the amortized cost basis of a financial asset, but then later determines that the amount written off, or a portion of that amount, will in fact be recovered. This ASU permits organizations to record expected recoveries on PCD assets. Additionally, this ASU reinforces existing guidance that prohibits organizations from recording negative allowances for available-for-sale debt securities. ASU 2019-11 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The amendments should be applied on a modified retrospective basis by means of a cumulative-effect adjustment to the opening retained earnings balance in the statement of financial position as of the date of adoption. We adopted the requirements of this ASU on January 1, 2020 and do not expect the ASU to have a material impact on our financial condition or results of operations.
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this ASU remove, modify, and add disclosure requirements for the fair value reporting of assets and liabilities. The modifications and additions relate to Level 3 fair value measurements at the end of the reporting period. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Entities should disclose and describe the range and weighted-average of significant observable inputs used to develop Level 3 fair value measurements prospectively. We adopted the requirements of this ASU on January 1, 2020. As the ASU’s requirements only relate to disclosures, the amendments will not impact our financial condition or results of operations.
In August 2018, the FASB issued ASU No. 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This standard aligns the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software, regardless of whether they convey a license to the hosted software. The accounting for the service element of a hosting arrangement that is a service contract is not affected by this ASU. The amendments are effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. An entity has the option to apply amendments in the ASU either retrospectively or prospectively to all implementation costs incurred after the date of adoption. We adopted the requirements of this ASU on January 1, 2020. We do not expect that the ASU will have a material impact on our financial condition or results of operations.
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This ASU is intended to reduce the cost and complexity related to accounting for income taxes by removing certain exceptions to the guidance in Topic 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and simplifying aspects of the accounting for franchise taxes and enacted changes in tax laws or rates. This ASU is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. As this ASU is narrow in scope and applicability to us will likely be minimal, we do not expect that the ASU will have a material impact on our financial condition or results of operations.
In January 2020, the FASB issued ASU No. 2020-01, Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) - Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. Among other things, this ASU clarifies that a company should consider observable transactions that require a company to either apply or discontinue the equity method of accounting under Topic 323, for the purposes of applying the measurement alternative in accordance with Topic 321. This ASU is effective for fiscal years beginning after December 15, 2020. Early adoption is permitted. ASU No. 2020-01 should be applied prospectively at the beginning of the interim period that includes adoption. We do not expect that the ASU will have a material impact on our financial condition or results of operations.
Note 2: Investment Securities
Our investment securities portfolio consists of obligations of state and political subdivisions, U.S. corporations, U.S. federal government agencies such as Government National Mortgage Association ("GNMA") and Small Business Administration ("SBA"), U.S. government-sponsored enterprises ("GSEs") such as Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC), Federal Farm Credit Banks Funding Corporation and FHLB. We also invest in residential and commercial mortgage-backed securities ("MBS"/"CMBS") and collateralized mortgage obligations ("CMOs") issued or guaranteed by the GSEs, as reflected in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019
|
December 31, 2018
|
|
Amortized
|
|
Fair
|
|
Gross Unrealized
|
Amortized
|
|
Fair
|
|
Gross Unrealized
|
(in thousands)
|
Cost
|
|
Value
|
|
Gains
|
|
(Losses)
|
|
Cost
|
|
Value
|
|
Gains
|
|
(Losses)
|
|
Held-to-maturity:
|
|
|
|
|
|
|
|
|
Securities of U.S. government-sponsored enterprises:
|
|
|
|
|
|
|
|
|
MBS pass-through securities issued by FHLMC and FNMA
|
$
|
80,451
|
|
$
|
81,325
|
|
$
|
1,018
|
|
$
|
(144
|
)
|
$
|
88,606
|
|
$
|
85,804
|
|
$
|
7
|
|
$
|
(2,809
|
)
|
SBA-backed securities
|
7,999
|
|
8,264
|
|
265
|
|
—
|
|
8,720
|
|
8,757
|
|
37
|
|
—
|
|
CMOs issued by FNMA
|
10,210
|
|
10,492
|
|
282
|
|
—
|
|
11,447
|
|
11,327
|
|
—
|
|
(120
|
)
|
CMOs issued by FHLMC
|
31,477
|
|
32,157
|
|
685
|
|
(5
|
)
|
33,583
|
|
33,021
|
|
8
|
|
(570
|
)
|
CMOs issued by GNMA
|
3,763
|
|
3,816
|
|
53
|
|
—
|
|
3,739
|
|
3,769
|
|
30
|
|
—
|
|
Obligations of state and
political subdivisions
|
3,513
|
|
3,588
|
|
75
|
|
—
|
|
11,111
|
|
11,216
|
|
128
|
|
(23
|
)
|
Total held-to-maturity
|
137,413
|
|
139,642
|
|
2,378
|
|
(149
|
)
|
157,206
|
|
153,894
|
|
210
|
|
(3,522
|
)
|
Available-for-sale:
|
|
|
|
|
|
|
|
|
Securities of U.S. government-sponsored enterprises:
|
|
|
|
|
|
|
|
|
MBS pass-through securities issued by FHLMC and FNMA
|
98,502
|
|
100,071
|
|
1,617
|
|
(48
|
)
|
95,339
|
|
94,467
|
|
358
|
|
(1,230
|
)
|
SBA-backed securities
|
35,674
|
|
36,286
|
|
688
|
|
(76
|
)
|
50,722
|
|
50,781
|
|
465
|
|
(406
|
)
|
CMOs issued by FNMA
|
22,702
|
|
23,092
|
|
390
|
|
—
|
|
28,275
|
|
28,079
|
|
134
|
|
(330
|
)
|
CMOs issued by FHLMC
|
139,398
|
|
143,226
|
|
3,892
|
|
(64
|
)
|
145,979
|
|
144,836
|
|
454
|
|
(1,597
|
)
|
CMOs issued by GNMA
|
11,719
|
|
11,755
|
|
42
|
|
(6
|
)
|
11,294
|
|
11,021
|
|
1
|
|
(274
|
)
|
Debentures of government- sponsored agencies
|
48,389
|
|
49,046
|
|
727
|
|
(70
|
)
|
52,956
|
|
53,018
|
|
185
|
|
(123
|
)
|
Privately issued CMOs
|
—
|
|
—
|
|
—
|
|
—
|
|
295
|
|
297
|
|
2
|
|
—
|
|
Obligations of state and
political subdivisions
|
66,042
|
|
67,282
|
|
1,386
|
|
(146
|
)
|
79,046
|
|
77,960
|
|
134
|
|
(1,220
|
)
|
Corporate bonds
|
1,497
|
|
1,502
|
|
6
|
|
(1
|
)
|
2,004
|
|
2,005
|
|
15
|
|
(14
|
)
|
Total available-for-sale
|
423,923
|
|
432,260
|
|
8,748
|
|
(411
|
)
|
465,910
|
|
462,464
|
|
1,748
|
|
(5,194
|
)
|
Total investment securities
|
$
|
561,336
|
|
$
|
571,902
|
|
$
|
11,126
|
|
$
|
(560
|
)
|
$
|
623,116
|
|
$
|
616,358
|
|
$
|
1,958
|
|
$
|
(8,716
|
)
|
The amortized cost and fair value of investment debt securities by contractual maturity at December 31, 2019 and 2018 are shown below. Expected maturities may differ from contractual maturities if the issuers of the securities have the right to call or prepay obligations with or without call or prepayment penalties.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019
|
December 31, 2018
|
|
Held-to-Maturity
|
Available-for-Sale
|
Held-to-Maturity
|
Available-for-Sale
|
(in thousands)
|
Amortized Cost
|
|
Fair Value
|
|
Amortized Cost
|
|
Fair Value
|
|
Amortized Cost
|
|
Fair Value
|
|
Amortized Cost
|
|
Fair Value
|
|
Within one year
|
$
|
1,807
|
|
$
|
1,811
|
|
$
|
6,699
|
|
$
|
6,706
|
|
$
|
6,194
|
|
$
|
6,182
|
|
$
|
9,863
|
|
$
|
9,795
|
|
After one but within five years
|
2,256
|
|
2,296
|
|
48,706
|
|
49,619
|
|
5,481
|
|
5,492
|
|
84,871
|
|
84,435
|
|
After five years through ten years
|
56,221
|
|
57,544
|
|
208,806
|
|
214,277
|
|
59,231
|
|
58,120
|
|
252,274
|
|
250,055
|
|
After ten years
|
77,129
|
|
77,991
|
|
159,712
|
|
161,658
|
|
86,300
|
|
84,100
|
|
118,902
|
|
118,179
|
|
Total
|
$
|
137,413
|
|
$
|
139,642
|
|
$
|
423,923
|
|
$
|
432,260
|
|
$
|
157,206
|
|
$
|
153,894
|
|
$
|
465,910
|
|
$
|
462,464
|
|
Sales of investment securities and gross gains and losses are shown in the following table.
|
|
|
|
|
|
|
|
(in thousands)
|
2019
|
2018
|
Available-for-sale:
|
|
|
Sales proceeds
|
$
|
66,081
|
|
$
|
16,972
|
|
Gross realized gains
|
$
|
214
|
|
$
|
27
|
|
Gross realized losses
|
$
|
(159
|
)
|
$
|
(106
|
)
|
Pledged investment securities are shown in the following table:
|
|
|
|
|
|
|
|
(in thousands)
|
December 31, 2019
|
December 31, 2018
|
Pledged to the State of California:
|
|
|
Secure public deposits in compliance with the Local Agency Security Program
|
$
|
126,598
|
|
$
|
125,696
|
|
Collateral for trust deposits
|
742
|
|
734
|
|
Total investment securities pledged to the State of California
|
$
|
127,340
|
|
$
|
126,430
|
|
Collateral for Wealth Management and Trust Services ("WMTS') checking account
|
$
|
622
|
|
$
|
2,000
|
|
As part of our ongoing review of our investment securities portfolio, we reassessed the classification of certain securities issued by government sponsored agencies. During 2018, we transferred $27.4 million, from available-for-sale to held-to-maturity at fair value. We intend and have the ability to hold these securities to maturity. The net unrealized pre-tax loss of $278 thousand, remained in accumulated other comprehensive income and is amortized over the remaining life of the securities along with amortization of any prior transfers. Amortization of the net unrealized pre-tax loss totaled $445 thousand and $516 thousand in 2019 and 2018, respectively. There were no securities transferred from available-for-sale to held-to-maturity at fair value in 2019.
There were 40 and 229 securities in unrealized loss positions at December 31, 2019 and 2018, respectively. Those securities are summarized and classified according to the duration of the loss period in the tables below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019
|
< 12 continuous months
|
|
|
≥ 12 continuous months
|
|
|
Total securities
in a loss position
|
|
(in thousands)
|
Fair value
|
|
Unrealized loss
|
|
|
Fair value
|
|
Unrealized loss
|
|
|
Fair value
|
|
Unrealized loss
|
|
Held-to-maturity:
|
|
|
|
|
|
|
|
|
MBS pass-through securities issued by FHLMC and FNMA
|
$
|
14,203
|
|
$
|
(60
|
)
|
|
$
|
6,073
|
|
$
|
(84
|
)
|
|
$
|
20,276
|
|
$
|
(144
|
)
|
CMOs issued by FHLMC
|
—
|
|
—
|
|
|
1,725
|
|
(5
|
)
|
|
1,725
|
|
(5
|
)
|
Total held-to-maturity
|
14,203
|
|
(60
|
)
|
|
7,798
|
|
(89
|
)
|
|
22,001
|
|
(149
|
)
|
Available-for-sale:
|
|
|
|
|
|
|
|
|
MBS pass-through securities issued by FHLMC and FNMA
|
4,367
|
|
(34
|
)
|
|
4,464
|
|
(14
|
)
|
|
8,831
|
|
(48
|
)
|
SBA-backed securities
|
9,227
|
|
(14
|
)
|
|
2,448
|
|
(62
|
)
|
|
11,675
|
|
(76
|
)
|
CMOs issued by FHLMC
|
14,918
|
|
(58
|
)
|
|
2,981
|
|
(6
|
)
|
|
17,899
|
|
(64
|
)
|
CMOs issued by GNMA
|
7,139
|
|
(6
|
)
|
|
—
|
|
—
|
|
|
7,139
|
|
(6
|
)
|
Debentures of government-sponsored agencies
|
25,228
|
|
(70
|
)
|
|
—
|
|
—
|
|
|
25,228
|
|
(70
|
)
|
Obligations of state and political subdivisions
|
20,579
|
|
(145
|
)
|
|
659
|
|
(1
|
)
|
|
21,238
|
|
(146
|
)
|
Corporate bonds
|
500
|
|
(1
|
)
|
|
—
|
|
—
|
|
|
500
|
|
(1
|
)
|
Total available-for-sale
|
81,958
|
|
(328
|
)
|
|
10,552
|
|
(83
|
)
|
|
92,510
|
|
(411
|
)
|
Total temporarily impaired securities
|
$
|
96,161
|
|
$
|
(388
|
)
|
|
$
|
18,350
|
|
$
|
(172
|
)
|
|
$
|
114,511
|
|
$
|
(560
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2018
|
< 12 continuous months
|
|
|
> 12 continuous months
|
|
|
Total securities
in a loss position
|
|
(in thousands)
|
Fair value
|
|
Unrealized loss
|
|
|
Fair value
|
|
Unrealized loss
|
|
|
Fair value
|
|
Unrealized loss
|
|
Held-to-maturity:
|
|
|
|
|
|
|
|
|
MBS pass-through securities issued by FHLMC and FNMA
|
$
|
198
|
|
$
|
(9
|
)
|
|
$
|
83,990
|
|
$
|
(2,800
|
)
|
|
$
|
84,188
|
|
$
|
(2,809
|
)
|
CMOs issued by FNMA
|
—
|
|
—
|
|
|
11,327
|
|
(120
|
)
|
|
$
|
11,327
|
|
$
|
(120
|
)
|
CMOs issued by FHLMC
|
2,880
|
|
(3
|
)
|
|
28,171
|
|
(567
|
)
|
|
31,051
|
|
(570
|
)
|
Obligations of state and political subdivisions
|
—
|
|
—
|
|
|
3,565
|
|
(23
|
)
|
|
3,565
|
|
(23
|
)
|
Total held-to-maturity
|
3,078
|
|
(12
|
)
|
|
127,053
|
|
(3,510
|
)
|
|
130,131
|
|
(3,522
|
)
|
Available-for-sale:
|
|
|
|
|
|
|
|
|
MBS pass-through securities issued by FHLMC and FNMA
|
19,971
|
|
(128
|
)
|
|
50,077
|
|
(1,102
|
)
|
|
70,048
|
|
(1,230
|
)
|
SBA-backed securities
|
13,175
|
|
(122
|
)
|
|
20,123
|
|
(284
|
)
|
|
33,298
|
|
(406
|
)
|
CMOs issued by FNMA
|
2,345
|
|
(8
|
)
|
|
16,138
|
|
(322
|
)
|
|
18,483
|
|
(330
|
)
|
CMOs issued by FHLMC
|
24,094
|
|
(330
|
)
|
|
74,243
|
|
(1,267
|
)
|
|
98,337
|
|
(1,597
|
)
|
CMOs issued by GNMA
|
1,666
|
|
(7
|
)
|
|
9,112
|
|
(267
|
)
|
|
10,778
|
|
(274
|
)
|
Debentures of government- sponsored agencies
|
4,992
|
|
(8
|
)
|
|
11,349
|
|
(115
|
)
|
|
16,341
|
|
(123
|
)
|
Obligations of state and political subdivisions
|
15,290
|
|
(54
|
)
|
|
52,804
|
|
(1,166
|
)
|
|
68,094
|
|
(1,220
|
)
|
Corporate bonds
|
—
|
|
—
|
|
|
1,004
|
|
(14
|
)
|
|
1,004
|
|
(14
|
)
|
Total available-for-sale
|
81,533
|
|
(657
|
)
|
|
234,850
|
|
(4,537
|
)
|
|
316,383
|
|
(5,194
|
)
|
Total temporarily impaired securities
|
$
|
84,611
|
|
$
|
(669
|
)
|
|
$
|
361,903
|
|
$
|
(8,047
|
)
|
|
$
|
446,514
|
|
$
|
(8,716
|
)
|
As of December 31, 2019, the investment portfolio included 16 investment securities that had been in a continuous loss position for twelve months or more and 24 investment securities had been in a loss position for less than twelve months.
Securities issued by government-sponsored agencies, such as FNMA and FHLMC, usually have implicit credit support by the U.S. federal government. However, since 2008, FNMA and FHLMC have been under government conservatorship and, therefore, contractual cash flows for these investments carry explicit guarantees by the U.S. federal government. Securities issued by the SBA and GNMA have explicit credit guarantees by the U.S. federal government, which protects us from credit losses on the contractual cash flows of the securities.
Other temporarily impaired securities, including obligations of state and political subdivisions and corporate bonds, were deemed credit worthy after our internal analysis of the issuers' latest financial information, credit ratings by major credit agencies, and/or credit enhancements. Based on our comprehensive analyses, we determined that the decline in the fair values of these securities was primarily driven by factors other than credit, such as changes in market interest rates and liquidity spreads subsequent to purchase. At December 31, 2019, Management determined that it did not intend to sell investment securities with unrealized losses, and it is more than likely than not that we will not have to sell any of the securities with unrealized losses before recovery of their amortized cost. Therefore, we do not consider these investment securities to be other-than-temporarily impaired at December 31, 2019.
Non-Marketable Securities
As a member of the FHLB, we are required to maintain a minimum investment in FHLB capital stock determined by the Board of Directors of the FHLB. The minimum investment requirements can increase in the event we increase our total asset size or borrowings with the FHLB. Shares cannot be purchased or sold except between the FHLB and its members at the $100 per share par value. We held $11.7 million and $11.1 million of FHLB stock included in other assets on the consolidated statements of condition at December 31, 2019 and 2018, respectively. The carrying amounts of these investments are reasonable estimates of fair value because the securities are restricted to member banks and they do not have a readily determinable market value. Based on our analysis of FHLB’s financial condition and certain qualitative factors, we determined that the FHLB stock was not impaired at December 31, 2019 and 2018. On February 20, 2020, FHLB announced a cash dividend for the fourth quarter of 2019 at an annualized dividend rate of 7.00% to be distributed in mid-March 2020. Cash dividends paid on FHLB capital stock are recorded as non-interest income.
As a member bank of Visa U.S.A., we held 10,439 shares of Visa Inc. Class B common stock at both December 31, 2019 and 2018. These shares have a carrying value of zero and are restricted from resale to non-member banks of Visa U.S.A. until their conversion into Class A (voting) shares upon the termination of Visa Inc.'s Covered Litigation escrow account. Because of the restriction and the uncertainty on the conversion rate to Class A shares, these shares lack a readily determinable fair value. When converting this Class B common stock to Class A common stock based on the conversion rate of 1.6228, as of December 31, 2019 and 1.6298 as of December 31, 2018, and the closing stock price of Class A shares at those respective dates, the converted value of our shares of Class B common stock would have been $3.2 million and $2.2 million at December 31, 2019 and 2018, respectively. The conversion rate is subject to further adjustment upon the final settlement of the covered litigation against Visa Inc. and its member banks. As such, the fair value of these Class B shares can differ significantly from their converted values. For further information, refer to Note 12, Commitments and Contingencies.
In October 2018, we sold 6,500 shares of our holdings of Visa Inc. Class B common stock to a member bank of Visa U.S.A. The pre-tax gain from the sale, net of sales commission, was $956 thousand.
We invest in low income housing tax credit funds as a limited partner, which totaled $4.1 million and $4.6 million recorded in other assets as of December 31, 2019 and 2018, respectively. In 2019, we recognized $603 thousand of low income housing tax credits and other tax benefits, net of $515 thousand of amortization expense of low income housing tax credit investment, as a component of income tax expense. As of December 31, 2019, our unfunded commitments for these low income housing tax credit funds totaled $2.2 million. We did not recognize any impairment losses on these low income housing tax credit investments during 2019 or 2018, as the value of the future tax benefits exceeds the carrying value of the investments.
Note 3: 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% of total loans were secured by real estate at December 31, 2019 and 2018. At December 31, 2019 and 2018, 68% and 67%, respectively, of our loans were for commercial real estate, 84% and 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, 2019 and 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
|
|
December 31, 2019
|
|
|
|
|
|
|
|
|
30-59 days past due
|
$
|
1
|
|
$
|
—
|
|
$
|
1,001
|
|
$
|
—
|
|
$
|
279
|
|
$
|
—
|
|
$
|
7
|
|
$
|
1,288
|
|
60-89 days past due
|
—
|
|
—
|
|
—
|
|
—
|
|
98
|
|
—
|
|
95
|
|
193
|
|
90 days or more past due
|
—
|
|
—
|
|
—
|
|
—
|
|
167
|
|
—
|
|
—
|
|
167
|
|
Total past due
|
1
|
|
—
|
|
1,001
|
|
—
|
|
544
|
|
—
|
|
102
|
|
1,648
|
|
Current
|
246,686
|
|
308,824
|
|
945,316
|
|
61,095
|
|
115,480
|
|
136,657
|
|
27,580
|
|
1,841,638
|
|
Total loans 2
|
$
|
246,687
|
|
$
|
308,824
|
|
$
|
946,317
|
|
$
|
61,095
|
|
$
|
116,024
|
|
$
|
136,657
|
|
$
|
27,682
|
|
$
|
1,843,286
|
|
Non-accrual loans 1
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
168
|
|
$
|
—
|
|
$
|
58
|
|
$
|
226
|
|
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 December 31, 2019 or 2018. Amounts exclude accreting PCI loans of with carrying values totaling $2.0 million at December 31, 2019 and $2.1 million at 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 December 31, 2019 or 2018.
2 Amounts include net deferred loan origination costs of $983 thousand and $635 thousand at December 31, 2019 and 2018, respectively. Amounts are also net of unaccreted purchase discounts on non-PCI loans of $589 thousand and $708 thousand at December 31, 2019 and 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, a large majority 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 and capitalized as part of the loan balance. 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 with loans exceeding a certain dollar threshold 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, 2019 and 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
|
|
December 31, 2019
|
|
|
|
|
|
|
|
|
Pass
|
$
|
209,209
|
|
$
|
263,625
|
|
$
|
944,924
|
|
$
|
61,095
|
|
$
|
114,864
|
|
$
|
136,657
|
|
$
|
27,538
|
|
$
|
2,049
|
|
$
|
1,759,961
|
|
Special Mention
|
37,065
|
|
35,016
|
|
560
|
|
—
|
|
750
|
|
—
|
|
—
|
|
—
|
|
73,391
|
|
Substandard
|
409
|
|
9,042
|
|
—
|
|
—
|
|
339
|
|
—
|
|
144
|
|
—
|
|
9,934
|
|
Total loans
|
$
|
246,683
|
|
$
|
307,683
|
|
$
|
945,484
|
|
$
|
61,095
|
|
$
|
115,953
|
|
$
|
136,657
|
|
$
|
27,682
|
|
$
|
2,049
|
|
$
|
1,843,286
|
|
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. After meeting all of the conditions above, there was one commercial loan with a recorded investment of $3 thousand removed from TDR designation during 2019, and one TIC loan and one home equity loan with recorded investments totaling $247 thousand removed from TDR designation during 2018.
The following table summarizes the carrying amount of TDR loans by loan class as of December 31, 2019 and December 31, 2018.
|
|
|
|
|
|
|
|
(in thousands)
|
As of
|
Recorded investment in Troubled Debt Restructurings1
|
December 31, 2019
|
|
December 31, 2018
|
|
Commercial and industrial
|
$
|
1,223
|
|
$
|
1,506
|
|
Commercial real estate, owner-occupied
|
6,998
|
|
6,993
|
|
Commercial real estate, investor
|
1,770
|
|
1,821
|
|
Construction2
|
—
|
|
2,688
|
|
Home equity
|
251
|
|
251
|
|
Other residential
|
452
|
|
462
|
|
Installment and other consumer
|
639
|
|
685
|
|
Total
|
$
|
11,333
|
|
$
|
14,406
|
|
1 There were no acquired TDR loans as of December 31, 2019 or December 31, 2018. TDR loans on non-accrual status totaled $58 thousand at December 31, 2019 and $65 thousand at December 31, 2018.
2 The construction TDR loan outstanding as of December 31, 2018 paid off during 2019.
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, if applicable.
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 2019:
|
|
|
|
|
|
|
|
Commercial and industrial
|
1
|
|
$
|
298
|
|
$
|
298
|
|
$
|
150
|
|
TDRs modified during 2018:
|
|
|
|
|
|
|
|
Commercial and industrial
|
2
|
|
$
|
254
|
|
$
|
245
|
|
$
|
172
|
|
The loan modified during 2019 reflected a maturity extension and interest rate concession. The two loans modified during 2018 were to the same borrower and included maturity extensions and other changes to loan terms. During 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
|
|
December 31, 2019
|
|
|
|
|
|
|
|
Recorded investment in impaired loans:
|
|
|
|
|
|
|
With no specific allowance recorded
|
$
|
349
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
167
|
|
$
|
452
|
|
$
|
98
|
|
$
|
1,066
|
|
With a specific allowance recorded
|
874
|
|
6,998
|
|
1,770
|
|
—
|
|
251
|
|
—
|
|
541
|
|
10,434
|
|
Total recorded investment in impaired loans
|
$
|
1,223
|
|
$
|
6,998
|
|
$
|
1,770
|
|
$
|
—
|
|
$
|
418
|
|
$
|
452
|
|
$
|
639
|
|
$
|
11,500
|
|
Unpaid principal balance of impaired loans
|
$
|
1,209
|
|
$
|
6,992
|
|
$
|
1,764
|
|
$
|
—
|
|
$
|
417
|
|
$
|
451
|
|
$
|
638
|
|
$
|
11,471
|
|
Specific allowance
|
$
|
103
|
|
$
|
195
|
|
$
|
41
|
|
$
|
—
|
|
$
|
5
|
|
$
|
—
|
|
$
|
53
|
|
$
|
397
|
|
Average recorded investment in impaired loans during 2019
|
$
|
1,441
|
|
$
|
6,998
|
|
$
|
1,797
|
|
$
|
1,350
|
|
$
|
481
|
|
$
|
457
|
|
$
|
663
|
|
$
|
13,187
|
|
Interest income recognized on impaired loans during 2019 1
|
$
|
73
|
|
$
|
266
|
|
$
|
79
|
|
$
|
466
|
|
$
|
42
|
|
$
|
22
|
|
$
|
25
|
|
$
|
973
|
|
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
|
|
1 Interest income recognized on a cash basis of $417 thousand during 2019 was related to a principal payment applied to interest collected but unrecognized on a former non-accrual land development loan and the pay-off of four non-accruals. Interest income recognized on a cash basis of $135 thousand during 2018 was primarily related to the pay-off 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, 2019 or 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 December 31, 2019 and 2018, unused
commitments to extend credit on impaired loans, including performing loans to borrowers whose terms have been modified in TDRs, totaled $534 thousand 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 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, 2019
|
|
|
|
|
|
|
|
Beginning balance
|
$
|
2,436
|
|
$
|
2,407
|
|
$
|
7,703
|
|
$
|
756
|
|
$
|
915
|
|
$
|
800
|
|
$
|
310
|
|
$
|
494
|
|
$
|
15,821
|
|
Provision (reversal)
|
(49
|
)
|
55
|
|
768
|
|
(118
|
)
|
(65
|
)
|
173
|
|
(23
|
)
|
159
|
|
900
|
|
Charge-offs
|
(75
|
)
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(3
|
)
|
—
|
|
(78
|
)
|
Recoveries
|
22
|
|
—
|
|
12
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
34
|
|
Ending balance
|
$
|
2,334
|
|
$
|
2,462
|
|
$
|
8,483
|
|
$
|
638
|
|
$
|
850
|
|
$
|
973
|
|
$
|
284
|
|
$
|
653
|
|
$
|
16,677
|
|
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
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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, 2019
|
|
|
|
|
|
|
|
|
|
Ending ALLL related to loans collectively evaluated for impairment
|
$
|
2,231
|
|
$
|
2,267
|
|
$
|
8,442
|
|
$
|
638
|
|
$
|
845
|
|
$
|
973
|
|
$
|
231
|
|
$
|
653
|
|
$
|
16,280
|
|
Ending ALLL related to loans individually evaluated for impairment
|
103
|
|
195
|
|
41
|
|
—
|
|
5
|
|
—
|
|
53
|
|
—
|
|
397
|
|
Ending ALLL related to purchased credit-impaired loans
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
Total ALLL
|
$
|
2,334
|
|
$
|
2,462
|
|
$
|
8,483
|
|
$
|
638
|
|
$
|
850
|
|
$
|
973
|
|
$
|
284
|
|
$
|
653
|
|
$
|
16,677
|
|
Recorded Investment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collectively evaluated for impairment
|
$
|
245,460
|
|
$
|
300,685
|
|
$
|
943,714
|
|
$
|
61,095
|
|
$
|
115,535
|
|
$
|
136,205
|
|
$
|
27,043
|
|
$
|
—
|
|
$
|
1,829,737
|
|
Individually evaluated for impairment
|
1,223
|
|
6,998
|
|
1,770
|
|
—
|
|
418
|
|
452
|
|
639
|
|
—
|
|
11,500
|
|
Purchased credit-impaired
|
4
|
|
1,141
|
|
833
|
|
—
|
|
71
|
|
—
|
|
—
|
|
—
|
|
2,049
|
|
Total
|
$
|
246,687
|
|
$
|
308,824
|
|
$
|
946,317
|
|
$
|
61,095
|
|
$
|
116,024
|
|
$
|
136,657
|
|
$
|
27,682
|
|
$
|
—
|
|
$
|
1,843,286
|
|
Ratio of allowance for loan losses to total loans
|
0.95
|
%
|
0.80
|
%
|
0.90
|
%
|
1.04
|
%
|
0.73
|
%
|
0.71
|
%
|
1.03
|
%
|
NM
|
|
0.90
|
%
|
Allowance for loan losses to non-accrual loans
|
NM
|
|
NM
|
|
NM
|
|
NM
|
|
506
|
%
|
NM
|
|
490
|
%
|
NM
|
|
7,379
|
%
|
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
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
Total ALLL
|
$
|
2,436
|
|
$
|
2,407
|
|
$
|
7,703
|
|
$
|
756
|
|
$
|
915
|
|
$
|
800
|
|
$
|
310
|
|
$
|
494
|
|
$
|
15,821
|
|
Loans outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
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, 2019
|
December 31, 2018
|
(in thousands)
|
Unpaid Principal Balance
|
|
Carrying Value
|
|
Unpaid Principal Balance
|
|
Carrying Value
|
|
Commercial and industrial
|
$
|
34
|
|
$
|
4
|
|
$
|
89
|
|
$
|
31
|
|
Commercial real estate, owner occupied
|
1,194
|
|
1,141
|
|
1,247
|
|
1,187
|
|
Commercial real estate, investor
|
1,001
|
|
833
|
|
1,033
|
|
811
|
|
Home equity
|
188
|
|
71
|
|
210
|
|
83
|
|
Total purchased credit-impaired loans
|
$
|
2,417
|
|
$
|
2,049
|
|
$
|
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
|
Years ended
|
(in thousands)
|
December 31, 2019
|
|
December 31, 2018
|
|
Balance at beginning of period
|
$
|
934
|
|
$
|
1,254
|
|
Accretion
|
(234
|
)
|
(320
|
)
|
Balance at end of period
|
$
|
700
|
|
$
|
934
|
|
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 $1,133.4 million and $1,027.4 million at December 31, 2019 and 2018, respectively. In addition, we pledge eligible TIC loans, which totaled $115.7 million and $94.5 million at December 31, 2019 and 2018, 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, 2019 and 2018:
|
|
|
|
|
|
|
|
(in thousands)
|
2019
|
|
2018
|
|
Balance at beginning of year
|
$
|
10,635
|
|
$
|
11,852
|
|
Additions
|
—
|
|
863
|
|
Advances
|
—
|
|
—
|
|
Repayments
|
(2,320
|
)
|
(2,080
|
)
|
Reclassified due to a change in borrower status
|
18
|
|
—
|
|
Balance at end of year
|
$
|
8,333
|
|
$
|
10,635
|
|
Undisbursed commitments to related parties totaled $9.2 million and $9.1 million as of December 31, 2019 and 2018, respectively.
Note 4: Bank Premises and Equipment
A summary of Bank premises and equipment at December 31 follows:
|
|
|
|
|
|
|
|
(in thousands)
|
2019
|
|
2018
|
|
Leasehold improvements
|
$
|
15,287
|
|
$
|
15,024
|
|
Furniture and equipment
|
10,986
|
|
10,839
|
|
Subtotal
|
26,273
|
|
25,863
|
|
Accumulated depreciation and amortization
|
(20,203
|
)
|
(18,487
|
)
|
Bank premises and equipment, net
|
$
|
6,070
|
|
$
|
7,376
|
|
The amount of depreciation and amortization totaled $2.2 million and $2.1 million the years ended December 31, 2019 and 2018, respectively.
Note 5: Bank Owned Life Insurance
We own life insurance policies on the lives of certain current and former officers designated by the Board of Directors to fund our employee benefit programs. Death benefits provided under the specific terms of these insurance policies are estimated to be $88.4 million at December 31, 2019. The benefits to employees' beneficiaries are limited to each employee's active service period. The investment in bank owned life insurance policies are reported in interest receivable and other assets at their cash surrender value, net of surrender charges, of $41.6 million and $39.0 million at December 31, 2019 and 2018, respectively. The cash surrender value includes both the original premiums paid for the life insurance policies and the accumulated accretion of policy income since inception of the policies, net of mortality costs and other fees. Income of $1.2 million and $913 thousand was recognized on these life insurance policies in 2019 and 2018, respectively. We regularly monitor the financial information and credit ratings of our insurance carriers to ensure that they are credit worthy and comply with our policy.
Note 6: Deposits
A stratification of time deposits at December 31, 2019 and 2018 is presented in the following table:
|
|
|
|
|
|
|
|
(in thousands)
|
December 31, 2019
|
|
December 31, 2018
|
|
Time deposits of less than $100 thousand
|
$
|
29,931
|
|
$
|
34,638
|
|
Time deposits of $100 thousand to $250 thousand
|
39,377
|
|
51,690
|
|
Time deposits of more than $250 thousand
|
28,502
|
|
30,854
|
|
Total time deposits
|
$
|
97,810
|
|
$
|
117,182
|
|
Interest on time deposits was $595 thousand and $542 thousand in 2019 and 2018, respectively.
Scheduled maturities of time deposits at December 31, 2019 are presented as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
2020
|
|
2021
|
|
2022
|
|
2023
|
|
2024
|
|
Thereafter
|
|
Total
|
|
Scheduled maturities of time deposits
|
$
|
64,747
|
|
$
|
17,401
|
|
$
|
7,541
|
|
$
|
3,681
|
|
$
|
4,440
|
|
$
|
—
|
|
$
|
97,810
|
|
As of December 31, 2019, $126.6 million in securities were pledged as collateral for our local agency deposits.
Our deposit portfolio includes deposits offered through the Promontory Interfinancial Network that are comprised of Certificate of Deposit Account Registry Service® ("CDARS") balances included in time deposits and Insured Cash Sweep® ("ICS") balances included in money market deposits. In addition, we offer deposits through Reich & Tang Deposit Networks, LLC, comprised of Demand Deposit MarketplaceSM ("DDM") balances. Through these two networks we are able to offer our customers access to FDIC-insured deposit products in aggregate amounts exceeding current insurance limits. When we place funds through CDARS, ICS and DDM, on behalf of a customer, we have the option of receiving matching deposits through the network's reciprocal deposit program, or placing deposits "one-way" for which we receive no matching deposits. We consider the reciprocal deposits to be in-market deposits as distinguished from traditional out-of-market brokered deposits. The following table shows the composition of our network deposits for 2019 and 2018.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
December 31, 2019
|
December 31, 2018
|
|
Reciprocal
|
|
One-Way
|
|
Reciprocal
|
|
One-Way
|
|
CDARS
|
$
|
5,011
|
|
$
|
7,453
|
|
$
|
7,661
|
|
$
|
10,428
|
|
ICS
|
56,681
|
|
27,220
|
|
44,123
|
|
4,808
|
|
DDM
|
41,636
|
|
—
|
|
22,687
|
|
—
|
|
Total network deposits
|
$
|
103,328
|
|
$
|
34,673
|
|
$
|
74,471
|
|
$
|
15,236
|
|
The aggregate amount of deposit overdrafts that have been reclassified as loan balances was $155 thousand and $131 thousand at December 31, 2019 and 2018, respectively. Collectability of these overdrafts is subject to the same credit review process as other loans.
The Bank accepts deposits from shareholders, directors and employees in the normal course of business, and the terms are comparable to those with non-affiliated parties. The total deposits from directors and their businesses, and executive officers were $39.6 million and $33.3 million at December 31, 2019 and 2018, respectively.
Note 7: Borrowings and Other Obligations
Federal Funds Purchased – The Bank had unsecured lines of credit with correspondent banks for overnight borrowings totaling $92.0 million at December 31, 2019 and 2018. In general, interest rates on these lines approximate the federal funds target rate. We had no overnight borrowings under these credit facilities at December 31, 2019 or December 31, 2018.
Federal Home Loan Bank Borrowings – As of December 31, 2019 and 2018, the Bank had lines of credit with the FHLB totaling $648.0 million and $629.4 million, respectively, based on eligible collateral of certain loans. There were no
FHLB overnight borrowings at December 31, 2019. FHLB overnight borrowings were $7.0 million at a rate of 2.56% on December 31, 2018.
Federal Reserve Line of Credit – The Bank has a line of credit with the FRBSF secured by certain residential loans. At December 31, 2019 and 2018, the Bank had borrowing capacity under this line totaling $80.3 million and $69.7 million, respectively, and had no outstanding borrowings with the FRBSF.
Subordinated Debentures - As part of an acquisition, Bancorp assumed two subordinated debentures due to NorCal Community Bancorp Trusts I and II, established for the sole purpose of issuing trust preferred securities. The trust preferred securities were sold and issued in private transactions pursuant to an exemption from registration under the Securities Act of 1933, as amended. On October 7, 2018, Bancorp redeemed in full the subordinated debenture due to NorCal Community Bancorp Trust I, resulting in $916 thousand of accelerated accretion. The Trust II subordinated debenture was recorded at fair value totaling $2.14 million at acquisition date with a contractual balance of $4.12 million. The difference between the contractual balance and the fair value at acquisition date is accreted into interest expense over the life of the debenture. Accretion on the subordinated debentures totaled $68 thousand (Trust II) and $1.0 million (Trusts I and II) for the years ended December 31, 2019 and 2018, respectively. Bancorp has the option to defer payment of interest on the subordinated debenture for a period of up to five years, as long as there is no event of default. In the event of interest deferral, dividends to Bancorp common stockholders are prohibited. Bancorp has guaranteed, on a subordinated basis, distributions and other payments due on trust preferred securities totaling $4.0 million issued by Trust II, which have identical maturity, repricing and payment terms as the subordinated debenture.
The subordinated debenture due to NorCal Community Bancorp Trust II on March 15, 2036 with interest payable quarterly (repricing quarterly, based on 3-month LIBOR plus 1.40%, or 3.30% as of December 31, 2019) is redeemable in whole or in part on any interest payment date.
Other Obligations - The Bank leases certain equipment under finance leases, which are included in borrowings and other obligations in the consolidated statements of condition. See Note 12, Commitments and Contingencies, for additional information.
Borrowings and other obligations at December 31, 2019 and 2018 are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
(dollars in thousands)
|
Carrying Value
|
|
Average Balance
|
|
Average Rate
|
|
|
Carrying Value
|
|
Average Balance
|
|
Average Rate
|
|
|
FHLB overnight borrowings
|
$
|
—
|
|
$
|
2,656
|
|
2.55
|
%
|
|
$
|
7,000
|
|
$
|
105
|
|
2.03
|
%
|
|
Other obligations
|
$
|
212
|
|
$
|
279
|
|
2.85
|
%
|
|
$
|
—
|
|
$
|
—
|
|
—
|
%
|
|
Subordinated debentures
|
$
|
2,708
|
|
$
|
2,673
|
|
8.44
|
%
|
|
$
|
2,640
|
|
$
|
5,025
|
|
26.29
|
%
|
1
|
1 Subordinated debentures average rate in 2018 included the impact of the $916 thousand accelerated accretion due to early redemption of subordinated debentures due to NorCal Community Bancorp Trust I.
Note 8: Stockholders' Equity and Stock Plans
Stock Split
On October 22, 2018, Bancorp announced a two-for-one stock split, which occurred on November 27, 2018. All share and per share data have been adjusted to reflect the stock split effective November 27, 2018.
Share-Based Awards
On May 11, 2010, our shareholders approved the 2010 Director Stock Plan to pay director fees in shares of Bancorp common stock up to 300,000 shares. In addition to cash compensation, we issued 5,544 and 5,470 shares of common stock under the 2010 Director Stock Plan to directors in 2019 and 2018, respectively. As of December 31, 2019, 208,263 shares were available for future grants through the 2010 Director Stock Plan's May 12, 2020 expiration date.
On September 27, 2017, the Board of Directors adopted the 2017 Employee Stock Purchase Plan, effective July 1, 2017. Under the plan, our employees may purchase up to 385,370 of Bancorp's common shares through payroll deductions of between one percent and fifteen percent of pay in each pay period. Shares are purchased quarterly at
a five percent discount from the closing market price on the last day of the quarter. As of December 31, 2019, 382,515 shares were available for future purchases under the plan.
On March 17, 2017, the Board of Directors approved the 2017 Equity Plan, which was affirmed by Bancorp's shareholders on May 16, 2017 and replaced the 2007 Equity Plan. The Compensation Committee of the Board of Directors has the discretion to determine which employees, advisors and non-employee directors will receive an award, the timing of awards, the vesting schedule for each award, the type of award to be granted, the number of shares of Bancorp stock to be subject to each option and restricted stock award, and any other terms and conditions. As of December 31, 2019, there were 989,630 shares available for future grants to employees, advisors and non-employee directors.
Options are issued at an exercise price equal to the fair value of the stock at the date of grant. Options and restricted stock awarded to officers and employees during 2007 through 2014 vest 20% on each anniversary of the grant date for five years and expire ten years from the grant date. In general, option awards granted after 2014 for employees generally vest by one-third on each anniversary of the grant for three years and expire ten years from the grant date. Options granted to non-employee directors prior to 2016 vest 20% immediately and 20% on each anniversary of the grant date for four years and expire seven years from the grant date. Options granted to non-employee directors in 2016 vest by one-third on each anniversary of the grant for three years and expire ten years from the grant date. Options granted to non-employee directors after 2016 vest immediately and expire ten years from the grant date.
Stock options and restricted stock may be net settled in a cashless exercise by a reduction in the number of shares otherwise deliverable upon exercise or vesting in satisfaction of the exercise payment and/or applicable tax withholding requirements. During 2019, we withheld 7,795 shares totaling $326 thousand at a weighted-average price of $41.84 for cashless exercises. During 2018, we withheld 46,794 shares totaling $1.7 million at a weighted-average price of $36.28 for cashless exercises. Shares withheld under net settlement arrangements are available for future grants.
Performance-based stock awards (restricted stock) are issued to a selected group of employees. Stock award vesting is contingent upon the achievement of pre-established long-term performance goals set by the Compensation Committee of the Board of Directors. Performance is measured over a three-year period and cliff vested. These performance-based stock awards were granted at a maximum opportunity level, and based on the achievement of the pre-established goals, the actual payouts can range from 0% to 200% of the target award. For performance-based stock awards, an estimate is made of the number of shares expected to vest based on the probability that the performance criteria will be achieved to determine the amount of compensation expense to be recognized. The estimate is re-evaluated quarterly and total compensation expense is adjusted for any change in the current period.
A summary of stock option activity for the years ended December 31, 2019 and 2018 is presented in the following table. The intrinsic value of options outstanding and exercisable is calculated as the number of in-the-money options times the difference between the market price of our stock and the exercise prices of the in-the-money options as of each year-end period presented.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Shares
|
|
Weighted Average Exercise Price
|
|
Aggregate Intrinsic Value
(in thousands)
|
|
Weighted Average Grant-Date Fair Value
|
|
Weighted Average Remaining Contractual Term
(in years)
|
Options outstanding at December 31, 2017
|
517,936
|
|
$
|
20.42
|
|
$
|
7,075
|
|
|
|
5.34
|
Granted
|
74,096
|
|
33.97
|
|
|
|
$
|
7.17
|
|
|
Cancelled, expired or forfeited
|
(9,140
|
)
|
28.25
|
|
|
|
|
|
|
Exercised
|
(157,192
|
)
|
13.93
|
|
3,462
|
|
|
|
|
Options outstanding at December 31, 2018
|
425,700
|
|
25.01
|
|
6,910
|
|
|
|
5.85
|
Exercisable (vested) at December 31, 2018
|
311,050
|
|
22.57
|
|
5,809
|
|
|
|
4.94
|
Options outstanding at December 31, 2018
|
425,700
|
|
25.01
|
|
6,910
|
|
|
|
5.85
|
Granted
|
53,370
|
|
44.01
|
|
|
|
9.37
|
|
|
Cancelled, expired or forfeited
|
(13,580
|
)
|
38.88
|
|
|
|
|
|
|
Exercised
|
(48,108
|
)
|
16.11
|
|
1,247
|
|
|
|
|
Options outstanding at December 31, 2019
|
417,382
|
|
28.01
|
|
7,112
|
|
|
|
5.50
|
Exercisable (vested) at December 31, 2019
|
333,870
|
|
25.34
|
|
6,581
|
|
|
|
4.76
|
The following table summarizes non-vested restricted stock awards and changes during the years ended December 31, 2019 and 2018.
|
|
|
|
|
|
|
|
Number of Shares
|
|
Weighted Average Grant-Date Fair Value
|
|
Non-vested awards at December 31, 2017
|
91,216
|
|
$
|
28.16
|
|
Granted
|
37,040
|
|
33.58
|
|
Vested
|
(28,812
|
)
|
26.06
|
|
Cancelled or forfeited
|
(12,056
|
)
|
27.32
|
|
Non-vested awards at December 31, 2018
|
87,388
|
|
31.26
|
|
Granted
|
29,110
|
|
44.45
|
|
Vested
|
(28,099
|
)
|
27.88
|
|
Cancelled or forfeited
|
(18,333
|
)
|
32.34
|
|
Non-vested awards at December 31, 2019
|
70,066
|
|
37.81
|
|
A summary of the options outstanding and exercisable by price range as of December 31, 2019 is presented in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Options Outstanding as of December 31, 2019
|
|
Stock Options Exercisable as of December 31, 2019
|
Range of Exercise Prices
|
Stock Options Outstanding
|
|
Remaining Contractual Life (in years)
|
Weighted Average Exercise Price
|
|
|
Stock Options Exercisable
|
|
Weighted Average Exercise Price
|
|
$10.01 - $20.00
|
84,618
|
|
1.8
|
18.63
|
|
|
84,618
|
|
18.63
|
|
$20.01 - $30.00
|
166,454
|
|
4.8
|
23.88
|
|
|
166,454
|
|
23.88
|
|
$30.01 - $40.00
|
114,976
|
|
7.7
|
33.89
|
|
|
69,384
|
|
33.88
|
|
$40.01 - $50.00
|
51,334
|
|
8.9
|
43.71
|
|
|
13,414
|
|
41.61
|
|
|
417,382
|
|
|
|
|
|
333,870
|
|
|
|
We determine the fair value of stock options at the grant date using the Black-Scholes pricing model that takes into account the stock price at the grant date, exercise price, and the following assumptions (weighted-average shown).
|
|
|
|
|
|
|
Years ended December 31,
|
|
2019
|
|
2018
|
|
Risk-free interest rate
|
2.51
|
%
|
2.60
|
%
|
Expected dividend yield on common stock
|
1.75
|
%
|
1.76
|
%
|
Expected life in years
|
5.8
|
|
5.9
|
|
Expected price volatility
|
22.71
|
%
|
22.47
|
%
|
The fair value of stock options as of the grant date is recorded as a stock-based compensation expense in the consolidated statements of comprehensive income over the requisite service period, which is generally the vesting period, with a corresponding increase in common stock. Stock-based compensation also includes compensation expense related to the issuance of restricted stock awards. The grant-date fair value of the restricted stock awards, which equals the grant date price, is recorded as compensation expense over the requisite service period with a corresponding increase in common stock as the shares vest. Beginning in 2018, stock option and restricted stock awards issued include a retirement eligibility clause whereby the requisite service period is satisfied at the retirement eligibility date. For those awards, we accelerate the recording of stock-based compensation when the award holder is eligible to retire. However, retirement eligibility does not affect the vesting of the restricted stock or the exercisability of the stock options, which are based on the scheduled vesting period. Total compensation expense for stock options and restricted stock awards was $1.5 million and $1.7 million during 2019 and 2018, respectively, and the total recognized deferred tax benefits related thereto were $389 thousand and $404 thousand, respectively.
As of December 31, 2019, there was $783 thousand of total unrecognized compensation expense related to non-vested stock options and restricted stock awards, which is expected to be recognized over a weighted-average period of approximately 1.7 years. The total grant-date fair value of stock options vested during the years ended December 31, 2019 and 2018 was $473 thousand and $543 thousand, respectively. The total grant-date fair value of restricted stock awards vested during 2019 and 2018 was $1.2 million and $967 thousand, respectively.
We record excess tax benefits (deficiencies) resulting from the exercise of non-qualified stock options, the disqualifying disposition of incentive stock options and vesting of restricted stock awards as income tax benefits (expense) in the consolidated statements of comprehensive income with a corresponding decrease (increase) to current taxes payable. In 2019 and 2018, we recognized $145 thousand and $484 thousand, respectively, in excess tax benefits recorded as a reduction to income tax expense related to these types of transactions. The tax benefits realized from disqualifying dispositions of incentive stock options were recognized in tax expense to the extent of the book compensation cost recorded.
Dividends
Presented below is a summary of cash dividends paid in 2019 and 2018 to common shareholders, recorded as a reduction from retained earnings. On January 24, 2020, the Board of Directors declared a $0.22 per share cash dividend, paid February 14, 2020 to the shareholders of record at the close of business on February 7, 2020.
|
|
|
|
|
|
|
|
|
Years ended December 31,
|
(in thousands except per share data)
|
2019
|
|
2018
|
|
Cash dividends to common stockholders
|
$
|
10,958
|
|
$
|
8,860
|
|
Cash dividends per common share
|
$
|
0.80
|
|
$
|
0.64
|
|
The holders of unvested restricted stock awards are entitled to dividends on the same per-share ratio as holders of common stock. Tax benefits for dividends paid on unvested restricted stock awards are recorded as tax benefits in the consolidated statements of comprehensive income with a corresponding decrease to current taxes payable. Dividends on forfeited awards are included in stock-based compensation expense.
Under the California Corporations Code, payment of dividends by Bancorp to its shareholders is restricted to the amount of retained earnings immediately prior to the distribution or the amount of assets that exceeds the total liabilities immediately after the distribution. As of December 31, 2019, Bancorp's retained earnings and amount of total assets that exceeds total liabilities were $203.2 million and $336.8 million, respectively.
Under the California Financial Code, payment of dividends by the Bank to Bancorp is restricted to the lesser of retained earnings or the amount of undistributed net profits of the Bank from the three most recent fiscal years. Under this restriction, approximately $25.2 million of the Bank's retained earnings balance was available for payment of dividends to Bancorp as of December 31, 2019. Bancorp held $9.5 million in cash at December 31, 2019. This cash, combined with the $25.2 million dividends available to be distributed from the Bank, is considered adequate to cover Bancorp's estimated operational needs, cash dividends to shareholders in 2020, and the Share Repurchase Program discussed below.
Preferred Stock and Shareholder Rights Plan
On July 6, 2017, Bancorp adopted a new shareholder rights agreement (“Rights Agreement”), which replaced the existing Rights Agreement that expired on July 23, 2017. The Rights Agreement, which expires on July 23, 2022, is designed to discourage takeovers that involve abusive tactics or do not provide fair value to shareholders. The Rights Agreement defines the percentage of share ownership of an "acquiring person" as 10% of the outstanding common shares. Currently, each right entitles the registered holder to purchase from Bancorp one two-hundredth of a share of Series A Junior Participating Preferred Stock, no par value, of Bancorp at an initial price of $90 per one one-hundredth of a preferred share, subject to adjustment upon the occurrence of certain events. As of December 31, 2019, Bancorp was authorized to issue five million shares of preferred stock with no par value, one million shares of which have been designated as Series A Junior Participating Preferred Stock, with no par value under the Rights Agreement. In the event of a proposed merger, tender offer or other attempt to gain control of Bancorp that the Board of Directors does not approve, the Board of Directors may authorize the issuance of shares of common or preferred stock that would impede the completion of such a transaction. An effect of the possible issuance of common or preferred stock, therefore, may be to deter a future takeover attempt. The Board of Directors has no present plans or understandings for the issuance of any common or preferred stock in connection with the Rights Agreement.
Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income
We early adopted ASU No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, in the first quarter of 2018 and reclassified $638 thousand from AOCI to retained earnings. This amount represented the stranded income tax effects related to the unrealized loss on available-for-sale securities in AOCI on the date of the enactment of the Tax Cuts and Jobs Act of 2017. For more information on ASU No. 2018-02, refer to Note 1, Summary of Significant Accounting Policies.
Share Repurchase Program
On April 23, 2018, Bancorp announced that its Board of Directors approved a Share Repurchase Program under which Bancorp may repurchase up to $25.0 million of its outstanding common stock through May 1, 2019. Bancorp's Board of Directors subsequently extended the Share Repurchase Program through February 28, 2020. On January 24, 2020, Bancorp Board of Directors approved a new Share Repurchase Program under which Bancorp may repurchase up to $25.0 million of its outstanding common stock through February 28, 2022.
Under the Share Repurchase Program, Bancorp may purchase shares of its common stock through various means such as open market transactions, including block purchases, and privately negotiated transactions. The number of shares repurchased and the timing, manner, price and amount of any repurchases will be determined at Bancorp's discretion. Factors include, but are not limited to, stock price, trading volume and general market conditions, along with Bancorp’s general business conditions. The program may be suspended or discontinued at any time and does not obligate Bancorp to acquire any specific number of shares of its common stock.
As part of the Share Repurchase Program, Bancorp entered into a trading plan adopted in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The 10b5-1 trading plan permits common stock to be repurchased at times that might otherwise be prohibited under insider trading laws or self-imposed trading restrictions. The 10b5-1 trading plan is administered by an independent broker and is subject to price, market volume and timing restrictions.
During 2019 and 2018, Bancorp repurchased 356,000 and 171,217 shares totaling $15.0 million and $7.0 million, respectively, for a cumulative 527,217 shares totaling $22.0 million repurchased from May 1, 2018 through December 31, 2019.
Note 9: Fair Value of Assets and Liabilities
Fair Value Hierarchy and Fair Value Measurement
We group our assets and liabilities that are measured at fair value into three levels within the fair value hierarchy, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
Level 1: Valuations are based on unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2: Valuations are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations for which all significant assumptions are observable or can be corroborated by observable market data.
Level 3: Valuations are based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Values are determined using pricing models and discounted cash flow models and may include significant Management judgment and estimation.
Transfers between levels of the fair value hierarchy are recognized through our monthly and/or quarterly valuation process in the reporting period during which the event or circumstances that caused the transfer occurred. No such transfers occurred in the years presented.
The following table summarizes our assets and liabilities that were required to be recorded at fair value on a recurring basis.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
Description of Financial Instruments
|
Carrying Value
|
|
Quoted Prices in Active Markets for Identical Assets (Level 1)
|
|
Significant Other Observable Inputs (Level 2)
|
|
Significant Unobservable Inputs (Level 3)
|
|
Measurement Categories: Changes in Fair Value Recorded In1
|
December 31, 2019
|
|
|
|
|
|
Securities available for sale:
|
|
|
|
|
|
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies
|
$
|
278,144
|
|
$
|
—
|
|
$
|
278,144
|
|
$
|
—
|
|
OCI
|
SBA-backed securities
|
$
|
36,286
|
|
$
|
—
|
|
$
|
36,286
|
|
$
|
—
|
|
OCI
|
Debentures of government sponsored agencies
|
$
|
49,046
|
|
$
|
—
|
|
$
|
49,046
|
|
$
|
—
|
|
OCI
|
Obligations of state and political subdivisions
|
$
|
67,282
|
|
$
|
—
|
|
$
|
67,282
|
|
$
|
—
|
|
OCI
|
Corporate bonds
|
$
|
1,502
|
|
$
|
—
|
|
$
|
1,502
|
|
$
|
—
|
|
OCI
|
Derivative financial assets (interest rate contracts)
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
NI
|
Derivative financial liabilities (interest rate contracts)
|
$
|
1,178
|
|
$
|
—
|
|
$
|
1,178
|
|
$
|
—
|
|
NI
|
December 31, 2018
|
|
|
|
|
|
|
|
|
Securities available for sale:
|
|
|
|
|
|
|
|
|
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies
|
$
|
278,403
|
|
$
|
—
|
|
$
|
278,403
|
|
$
|
—
|
|
OCI
|
SBA-backed securities
|
$
|
50,781
|
|
$
|
—
|
|
$
|
50,781
|
|
$
|
—
|
|
OCI
|
Debentures of government sponsored agencies
|
$
|
53,018
|
|
$
|
—
|
|
$
|
53,018
|
|
$
|
—
|
|
OCI
|
Privately-issued collateralized mortgage obligations
|
$
|
297
|
|
$
|
—
|
|
$
|
297
|
|
$
|
—
|
|
OCI
|
Obligations of state and political subdivisions
|
$
|
77,960
|
|
$
|
—
|
|
$
|
77,960
|
|
$
|
—
|
|
OCI
|
Corporate bonds
|
$
|
2,005
|
|
$
|
—
|
|
$
|
2,005
|
|
$
|
—
|
|
OCI
|
Derivative financial assets (interest rate contracts)
|
$
|
161
|
|
$
|
—
|
|
$
|
161
|
|
$
|
—
|
|
NI
|
Derivative financial liabilities (interest rate contracts)
|
$
|
375
|
|
$
|
—
|
|
$
|
375
|
|
$
|
—
|
|
NI
|
1Other comprehensive income ("OCI") or net income ("NI").
Available-for-sale securities are recorded at fair value on a recurring basis. When available, quoted market prices (Level 1) are used to determine the fair value of available-for-sale securities. If quoted market prices are not available, we obtain pricing information from a reputable third-party service provider, who may utilize valuation techniques that use current market-based or independently sourced parameters, such as bid/ask prices, dealer-quoted prices, interest rates, benchmark yield curves, prepayment speeds, probability of default, loss severity and credit spreads (Level 2). Level 2 securities include obligations of state and political subdivisions, U.S. agencies or government-sponsored agencies' debt securities, mortgage-backed securities, government agency-issued, privately-issued collateralized mortgage obligations and corporate bonds. As of December 31, 2019 and 2018, there were no Level 1 or Level 3 securities.
Securities held-to-maturity may be written down to fair value (determined using the same techniques discussed above for securities available-for-sale) as a result of an other-than-temporary impairment, and we did not record any write-downs during 2019 or 2018.
On a recurring basis, derivative financial instruments are recorded at fair value, which is based on the income approach using observable Level 2 market inputs, reflecting market expectations of future interest rates as of the measurement date. Standard valuation techniques are used to calculate the present value of the future expected cash flows assuming an orderly transaction. Valuation adjustments may be made to reflect both our own credit risk and the counterparties’ credit risk in determining the fair value of the derivatives. Level 2 inputs for the valuations are limited to observable market prices for London Interbank Offered Rate (“LIBOR”) and Overnight Index Swap ("OIS") rates (for the very short term), quoted prices for LIBOR futures contracts, observable market prices for LIBOR and OIS swap rates, and one-month and three-month LIBOR basis spreads at commonly quoted intervals. Mid-market pricing of the inputs is used as a practical expedient in the fair value measurements. We project spot rates at reset days specified by each swap
contract to determine future cash flows, then discount to present value using OIS curves as of the measurement date. When the value of any collateral placed with counterparties is less than the interest rate derivative liability, a credit valuation adjustment ("CVA") is applied to reflect the credit risk we pose to counterparties. We have used the spread between the Standard & Poor's BBB rated U.S. Bank Composite rate and LIBOR for the closest maturity term corresponding to the duration of the swaps to derive the CVA. A similar credit risk adjustment, correlated to the credit standing of the counterparty, is made when collateral posted by the counterparty does not fully cover their liability to the Bank. For further discussion on our methodology in valuing our derivative financial instruments, refer to Note 14, Derivative Financial Instruments and Hedging Activities.
Certain financial assets may be measured at fair value on a non-recurring basis. These assets are subject to fair value adjustments that result from the application of the lower of cost or fair value accounting or write-downs of individual assets, such as impaired loans that are collateral dependent and other real estate owned ("OREO"). As of December 31, 2019 and 2018, we did not carry any assets measured at fair value on a non-recurring basis.
Disclosures about Fair Value of Financial Instruments
The table below is a summary of fair value estimates for financial instruments as of December 31, 2019 and 2018, excluding financial instruments recorded at fair value on a recurring basis (summarized in the first table in this note). The carrying amounts in the following table are recorded in the consolidated statements of condition under the indicated captions. Further, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements such as bank-owned life insurance policies ("BOLI") and non-maturity deposit liabilities. Additionally, we held shares of FHLB stock and Visa Inc. Class B common stock, both recorded at cost, as there was no impairment or changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer as of December 31, 2019 and 2018. See further discussion on values within Note 2, Investment Securities, above.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019
|
|
December 31, 2018
|
(in thousands)
|
Carrying Amounts
|
|
Fair Value
|
|
Fair Value Hierarchy
|
|
Carrying Amounts
|
|
Fair Value
|
|
Fair Value Hierarchy
|
Financial assets (recorded at amortized cost)
|
|
|
|
|
|
|
Cash and cash equivalents
|
$
|
183,388
|
|
$
|
183,388
|
|
Level 1
|
|
$
|
34,221
|
|
$
|
34,221
|
|
Level 1
|
Investment securities held-to-maturity
|
137,413
|
|
139,642
|
|
Level 2
|
|
157,206
|
|
153,894
|
|
Level 2
|
Loans, net
|
1,826,609
|
|
1,839,666
|
|
Level 3
|
|
1,748,043
|
|
1,700,971
|
|
Level 3
|
Interest receivable
|
7,732
|
|
7,732
|
|
Level 2
|
|
8,292
|
|
8,292
|
|
Level 2
|
Financial liabilities (recorded at amortized cost)
|
|
|
|
|
|
|
|
|
|
Time deposits
|
97,810
|
|
97,859
|
|
Level 2
|
|
117,182
|
|
116,584
|
|
Level 2
|
Federal Home Loan Bank borrowing
|
—
|
|
—
|
|
Level 2
|
|
7,000
|
|
7,000
|
|
Level 2
|
Subordinated debentures
|
2,708
|
|
3,182
|
|
Level 3
|
|
2,640
|
|
3,268
|
|
Level 3
|
Interest payable
|
134
|
|
134
|
|
Level 2
|
|
104
|
|
104
|
|
Level 2
|
Commitments - The value of unrecognized financial instruments is estimated based on the fee income associated with the commitments which, in the absence of credit exposure, is considered to approximate their settlement value. The fair value of commitment fees was not material as of December 31, 2019 and 2018.
Note 10: Benefit Plans
In 2003, we established a Deferred Compensation Plan that allows certain key Management personnel designated by the Board of Directors of the Bank to defer up to 80% of their salary and 100% of their annual bonus. The plan was amended in 2007 in order to comply with changes to Internal Revenue Code Section 409A. Under the amended plan, amounts deferred earn interest that is equal to the prime rate as published in the Wall Street Journal, on the first business day of the year, which was 5.50% on January 1, 2019 and 4.50% on January 1, 2018. Our deferred compensation obligation totaled $4.4 million and $3.8 million at December 31, 2019 and 2018, respectively, and is included in interest payable and other liabilities.
Our 401(k) Defined Contribution Plan (the “401(k) Plan”) commenced in May 1990 and is available to all regular employees at least eighteen years of age who complete ninety days of service, and enter the plan during one of the
four open enrollment dates (January 1, April 1, July 1, and October 1) of each year. Under the 401(k) Plan, employees can defer between 1% and 50% of their eligible compensation, up to the maximum amount allowed by the Internal Revenue Code. Contributions to the 401(k) Plan for the employer match vest at a rate of 20% per year over five years, per plan provisions. Starting 2017, the Bank increased the employer match to 70% of each participant's contribution, with a maximum of $5 thousand of matching contribution per participant per year. Employer contributions totaled $874 thousand and $851 thousand for the years ended December 31, 2019 and 2018, respectively.
In 1999, the 401(k) Plan was amended to include an employee stock ownership component and was renamed the Bank of Marin Employee Stock Ownership and Savings Plan (the “Plan”). Under the terms of the Plan, as amended, the Board of Directors determines a specific portion of the Bank's profits to be contributed to the employee stock ownership each year either in common stock or in cash for the purchase of Bancorp stock to be allocated to all eligible employees based on a percentage of their salaries, regardless of whether an employee is participating in the 401(k) plan or not. In January 2010, the Bank of Marin Employee Stock Ownership and Savings Plan was split into two plans: Bank of Marin 401(k) Plan and Bank of Marin Employee Stock Ownership Plan ("ESOP"). The same eligibility criteria apply under the ESOP, while employees' contributions are not permitted. For all participants, employer contributions vest over a five year service period, per plan provisions. After five years of service, all employer contributions vest immediately. The Bank of Marin 401(k) Plan was amended in early 2016 to incorporate recent changes in the pension laws, and was amended again in November 2016 to include a Roth 401(k) option.
Starting 2017, Bancorp issued shares of common stock and contributed them to the ESOP and recognized $1.2 million in expense in both 2019 and 2018, based on the quoted market price on the date of contribution. Cash dividends paid on Bancorp stock held by the ESOP are used to purchase additional shares in the open market. All shares of Bancorp stock held by the ESOP are included in the calculations of basic and diluted earnings per share. The employer contributions to the ESOP and the 401(k) Plan are included in salaries and benefits expense.
On January 1, 2011, we established a Salary Continuation Plan for a select group of Executive Management, who, upon retirement, will receive twenty-five percent of their estimated salary at retirement as salary continuation benefit payments that are fixed and will be made between seven to fifteen years, depending on the executives' service period at the Bank. Each participant will need to participate in this plan for five years before vesting begins. After five years, the participant will vest ratably in the benefit over the remaining period until age 65. This Plan is unfunded and nonqualified for tax purposes and for purposes of Title I of the Employee Retirement Income Security Act of 1974. As part of the acquisition of Bank of Napa in November 2017, we assumed the salary continuation agreements for four former executive officers of Bank of Napa, under which, fixed annual retirement benefit payments will be made for ten years beginning the first day of the month following the executive reaching the age of 65. At December 31, 2019 and 2018, respectively, our liability under the Salary Continuation Plan was $3.0 million and $2.7 million recorded in interest payable and other liabilities.
Note 11: Income Taxes
The current and deferred components of the income tax provision for each of the two years ended December 31 are as follows:
|
|
|
|
|
|
|
|
(in thousands)
|
2019
|
|
2018
|
|
Current tax provision
|
|
|
Federal
|
$
|
7,838
|
|
$
|
7,289
|
|
State
|
5,183
|
|
4,722
|
|
Total current
|
13,021
|
|
12,011
|
|
Deferred tax benefit
|
|
|
Federal
|
(907
|
)
|
(898
|
)
|
State
|
(461
|
)
|
(318
|
)
|
Total deferred
|
(1,368
|
)
|
(1,216
|
)
|
Total income tax provision
|
$
|
11,653
|
|
$
|
10,795
|
|
The following table shows the tax effect of our cumulative temporary differences as of December 31:
|
|
|
|
|
|
|
|
(in thousands)
|
2019
|
|
2018
|
|
Deferred tax assets:
|
|
|
Allowance for loan losses and off-balance sheet credit commitments
|
$
|
5,252
|
|
$
|
4,960
|
|
Operating and finance lease liabilities
|
3,792
|
|
—
|
|
Deferred compensation plan and salary continuation plan
|
2,188
|
|
1,940
|
|
Net operating loss carryforwards
|
1,914
|
|
2,271
|
|
Net unrealized losses on securities available-for-sale
|
—
|
|
1,800
|
|
Accrued but unpaid expenses
|
1,067
|
|
1,153
|
|
State franchise tax
|
1,015
|
|
993
|
|
Stock-based compensation
|
623
|
|
517
|
|
Depreciation and disposals on premises and equipment
|
562
|
|
584
|
|
Fair value adjustment on acquired loans
|
299
|
|
364
|
|
Deferred rent and lease incentives
|
—
|
|
224
|
|
Interest received on non-accrual loans
|
12
|
|
114
|
|
Other
|
154
|
|
215
|
|
Total gross deferred tax assets
|
16,878
|
|
15,135
|
|
Deferred tax liabilities:
|
|
|
Operating and finance lease right-of-use assets
|
(3,314
|
)
|
—
|
|
Net unrealized gains on securities available-for-sale
|
(1,738
|
)
|
—
|
|
Deferred loan origination costs and fees
|
(1,619
|
)
|
(2,360
|
)
|
Core deposit intangible assets
|
(1,385
|
)
|
(1,647
|
)
|
Unaccreted discount on subordinated debentures
|
(418
|
)
|
(439
|
)
|
Accretion on investment securities
|
(70
|
)
|
(67
|
)
|
Other
|
(172
|
)
|
(204
|
)
|
Total gross deferred tax liabilities
|
(8,716
|
)
|
(4,717
|
)
|
Net deferred tax assets
|
$
|
8,162
|
|
$
|
10,418
|
|
As of December 31, 2019, federal and California net operating loss carryforwards ("NOLs") of $2.7 million and $15.7 million, respectively, corresponded to the total $1.9 million deferred tax asset above. If not fully utilized, the federal NOLs will begin to expire in 2031, and the California NOLs will begin to expire in 2028. Based upon the level of historical taxable income and projections for future taxable income over the periods during which the deferred tax assets are expected to be deductible, Management believes it is more likely than not we will realize the benefit of the remaining deferred tax assets. Accordingly, no valuation allowance has been established as of December 31, 2019 or 2018.
The effective tax rate for 2019 and 2018 differs from the current federal statutory income tax rate as follows:
|
|
|
|
|
|
|
2019
|
|
2018
|
|
Federal statutory income tax rate
|
21.0
|
%
|
21.0
|
%
|
Increase (decrease) due to:
|
|
|
California franchise tax, net of federal tax benefit
|
8.2
|
%
|
8.0
|
%
|
Tax exempt interest on municipal securities and loans
|
(1.8
|
)%
|
(2.4
|
)%
|
Tax exempt earnings on bank owned life insurance
|
(0.6
|
)%
|
(0.4
|
)%
|
Low income housing and qualified zone academy bond tax credits
|
(0.4
|
)%
|
(0.5
|
)%
|
Stock-based compensation and excess tax benefits
|
(0.1
|
)%
|
(0.6
|
)%
|
Other
|
(0.9
|
)%
|
(0.2
|
)%
|
Effective Tax Rate
|
25.4
|
%
|
24.9
|
%
|
Bancorp and the Bank have entered into a tax allocation agreement, which provides that income taxes shall be allocated between the parties on a separate entity basis. The intent of this agreement is that each member of the consolidated group will incur no greater tax liability than it would have incurred on a stand-alone basis.
We file a consolidated return in the U.S. federal tax jurisdiction and a combined return in the State of California tax jurisdiction. There were no ongoing federal or state income tax examinations at the issuance of this report. We are no longer subject to examinations by tax authorities for years before 2016 for federal income tax and before 2015 for California. At December 31, 2019 and 2018, there were no unrecognized tax benefits, and neither the Bank nor Bancorp had accruals for interest and penalties related to unrecognized tax benefits.
Note 12: Commitments and Contingencies
Leases
We lease premises under long-term non-cancelable operating leases with remaining terms of 5 months to 12 years, most of which include escalation clauses and one or more options to extend the lease term, and some of which contain lease termination clauses. Lease terms may include certain renewal options that were considered reasonably certain to be exercised.
We lease certain equipment under finance leases with initial terms of 3 years to 5 years. The equipment finance leases do not contain renewal options, bargain purchase options or residual value guarantees.
The following table shows the balances of operating and finance lease right-of-use assets and lease liabilities as of December 31, 2019.
|
|
|
|
|
(in thousands)
|
December 31, 2019
|
|
Operating leases:
|
|
Operating lease right-of-use assets
|
$
|
11,002
|
|
Operating lease liabilities
|
$
|
12,615
|
|
Finance leases:
|
|
Finance lease right-of-use assets
|
$
|
379
|
|
Accumulated amortization
|
(170
|
)
|
Finance lease right-of-use assets, net1
|
$
|
209
|
|
Finance lease liabilities2
|
$
|
212
|
|
1 Included in premises and equipment in the consolidated statements of condition.
|
2 Included in borrowings and other obligations in the consolidated statements of condition.
|
The following table shows supplemental disclosures of noncash investing and financing activities for the year ended December 31, 2019.
|
|
|
|
|
(in thousands)
|
2019
|
Right-of-use assets obtained in exchange for operating lease liabilities
|
$
|
1,661
|
|
Right-of-use assets obtained in exchange for finance lease liabilities
|
$
|
31
|
|
Reclassification of deferred rent and unamortized lease incentives from other liabilities to operating lease right-of-use assets upon adoption of ASC 842
|
$
|
1,967
|
|
There were no lease-related noncash investing and financing activities for the year ended December 31, 2018.
The following table shows components of operating and finance lease cost for the year ended December 31, 2019.
|
|
|
|
|
(in thousands)
|
2019
|
Operating lease cost1
|
$
|
4,144
|
|
Finance lease cost:
|
|
Amortization of right-of-use assets2
|
$
|
172
|
|
Interest on finance lease liabilities3
|
8
|
|
Total finance lease cost
|
$
|
180
|
|
Total lease cost
|
$
|
4,324
|
|
1 Included in occupancy and equipment expense in the consolidated statements of comprehensive income.
|
|
2 Included in depreciation and amortization in the consolidated statements of comprehensive income.
|
|
3 Included in interest on borrowings and other obligations in the consolidated statements of comprehensive income.
|
|
Operating lease rent expense totaled $4.6 million for the year ended December 31, 2018.
The following table shows the future minimum lease payments, weighted average remaining lease terms, and weighted average discount rates under operating and finance lease arrangements as of December 31, 2019. Total minimum lease payments do not include obligations of approximately $13.6 million for operating lease modifications related to our existing headquarter offices and an operating lease agreement for a retail branch location that commenced subsequent to December 31, 2019. The discount rates used to calculate the present value of lease liabilities were based on the collateralized FHLB borrowing rates that were commensurate with lease terms and minimum payments on the later of the date we adopted the new lease accounting standards or lease commencement date.
|
|
|
|
|
|
|
|
|
(in thousands)
|
December 31, 2019
|
Year
|
Operating Leases
|
|
|
Finance Leases
|
|
2020
|
$
|
4,469
|
|
|
$
|
171
|
|
2021
|
2,806
|
|
|
36
|
|
2022
|
1,952
|
|
|
8
|
|
2023
|
1,464
|
|
|
1
|
|
2024
|
792
|
|
|
—
|
|
Thereafter
|
2,092
|
|
|
—
|
|
Total minimum lease payments
|
13,575
|
|
|
216
|
|
Amounts representing interest (present value discount)
|
(960
|
)
|
|
(4
|
)
|
Present value of net minimum lease payments (lease liability)
|
$
|
12,615
|
|
|
$
|
212
|
|
|
|
|
|
Weighted average remaining term (in years)
|
5.0
|
|
|
1.4
|
|
Weighted average discount rate
|
2.79
|
%
|
|
2.87
|
%
|
Litigation Matters
Bancorp may be party to legal actions that arise from time to time in the normal course of business. Bancorp's Management is not aware of any pending legal proceedings to which either it or the Bank may be a party or has recently been a party that will have a material adverse effect on the financial condition or results of operations of Bancorp or the Bank.
The Bank is responsible for a proportionate share of certain litigation indemnifications provided to Visa U.S.A. ("Visa") by its member banks in connection with Visa's lawsuits related to anti-trust charges and interchange fees ("Covered Litigation"). Our proportionate share of the litigation indemnification liability does not change or transfer upon the sale of our Class B Visa shares to member banks. Visa established an escrow account to pay for settlements or judgments in the Covered Litigation. Under the terms of the U.S. retrospective responsibility plan, when Visa funds the litigation escrow account, it triggers a conversion rate reduction of the Class B common stock to shares of Class A common stock, effectively reducing the aggregate value of the Class B common stock held by Visa's member banks like us.
In 2012, Visa had reached a $4.0 billion interchange multidistrict litigation class settlement agreement with plaintiffs representing a class of U.S. retailers. On September 17, 2018, Visa signed an amended settlement agreement with the putative class action plaintiffs of the U.S. interchange multidistrict litigation that superseded the 2012 settlement agreement. Visa's share of the settlement amount under the amended class settlement agreement increased to $4.1 billion. On September 27, 2019, Visa deposited an additional $300 million into the litigation escrow account. Certain merchants chose to opt out of the class settlement agreement and on December 13, 2019, the court entered the final judgment order approving the amended settlement agreement. On December 27, 2019, Visa received a takedown payment of approximately $467 million, which was deposited into the litigation escrow account with a corresponding increase in accrued litigation to address opt-out claims. The escrow balance of $1.6 billion as of December 31, 2019, combined with funds previously deposited with the court, are expected to cover the settlement payment obligations.
The outcome of the Covered Litigation affects the conversion rate of Visa Class B common stock held by us to Visa Class A common stock, as discussed above and in Note 2, Investment Securities. The final conversion rate might change depending on the final settlement payments, and the full effect on member banks is still uncertain. Litigation is ongoing and until the court approval process is complete, there is no assurance that Visa will resolve the claims as
contemplated by the amended class settlement agreement, and additional lawsuits may arise from individual merchants who opted out of the class settlement. However, until the escrow account is fully depleted and the conversion rate of Class B to Class A common stock is reduced to zero, no future cash settlement payments are required by the member banks, such as us, on the Covered Litigation. Therefore, we are not required to record any contingent liabilities for the indemnification related to the Covered Litigation, as we consider the probability of losses to be remote. For further information, including a discussion of a reduction to our holdings of Class B Visa shares, refer to Note 2, Investment Securities.
Note 13: Concentrations of Credit Risk
Concentration of credit risk is the risk associated with a lack of diversification, such as having substantial investments in a few individual issuers, thereby exposing us to greater risks resulting from adverse economic, political, regulatory, geographic, industrial or credit developments. Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash and cash equivalents, investment securities and loans.
Our cash in correspondent bank accounts, at times, may exceed FDIC insured limits. We place cash and cash equivalents with the Federal Reserve Bank and other high credit quality financial institutions, periodically monitor their credit worthiness and limit the amount of credit exposure to any one institution according to regulations. Concentrations of credit risk with respect to investment securities primarily related to the U.S. Government and GSEs, which accounted for $497.4 million, or 87% of our total investment portfolio at December 31, 2019 and $528.3 million, or 85% at December 31, 2018. Our largest investment security issued by a non-GSE issuer accounted for approximately 1% of our total investment portfolio at December 31, 2019.
We also manage our credit exposure related to our loan portfolio to avoid the risk of undue concentration of credits in a particular industry by reducing significant exposure to highly leveraged transactions or to any individual customer or counterparty, and by obtaining collateral as appropriate. No individual borrower accounts for more than 3% of loans held in the portfolio. The largest loan concentration group by industry of the borrowers is real estate, which accounts for 83% of our loan portfolio at both December 31, 2019 and 2018.
Note 14: Derivative Financial Instruments and Hedging Activities
We entered into interest rate swap agreements, primarily as an asset/liability management strategy, in order to mitigate the changes in the fair value of specified long-term fixed-rate loans (or firm commitments to enter into long-term fixed-rate loans) caused by changes in interest rates. These hedges allow us to offer long-term fixed rate loans to customers without assuming the interest rate risk of a long-term asset. Converting our fixed-rate interest payments to floating-rate interest payments, generally benchmarked to the one-month U.S. dollar LIBOR index, protects us against changes in the fair value of our loans associated with fluctuating interest rates.
Our credit exposure, if any, on interest rate swap asset positions is limited to the fair value (net of any collateral pledged to us) and interest payments of all swaps by each counterparty. Conversely, when an interest rate swap is in a liability position exceeding a certain threshold, we may be required to post collateral to the counterparty in an amount determined by the agreements. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values.
As of December 31, 2019, we had five interest rate swap agreements, which are scheduled to mature in June 2031, October 2031, July 2032, August 2037 and October 2037. All of our derivatives are accounted for as fair value hedges. The notional amounts of the interest rate contracts are equal to the notional amounts of the hedged loans. Our interest rate swap payments are settled monthly with counterparties. Accrued interest on the swaps totaled $6 thousand and $3 thousand as of December 31, 2019 and 2018, respectively. Information on our derivatives follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset derivatives
|
Liability derivatives
|
(in thousands)
|
December 31, 2019
|
|
December 31, 2018
|
|
December 31, 2019
|
|
December 31, 2018
|
|
Fair value hedges:
|
|
|
|
|
Interest rate contracts notional amount
|
$
|
—
|
|
$
|
8,895
|
|
$
|
16,956
|
|
$
|
9,016
|
|
Interest rate contracts fair value 1
|
$
|
—
|
|
$
|
161
|
|
$
|
1,178
|
|
$
|
375
|
|
1 See Note 9, Fair Value of Assets and Liabilities for valuation methodology.
The following table presents the carrying amount associated cumulative basis adjustment related to the application of fair value hedge accounting that is included in the carrying amount of hedged assets as of December 31, 2019 and 2018:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Carrying Amounts of Hedged Assets
|
Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Loans
|
(in thousands)
|
December 31, 2019
|
|
December 31, 2018
|
|
December 31, 2019
|
|
December 31, 2018
|
|
Loans
|
$
|
17,900
|
|
$
|
17,917
|
|
$
|
944
|
|
$
|
6
|
|
The following table presents the net gains (losses) recognized in interest income on loans on the consolidated statements of comprehensive income related to our derivatives designated as fair value hedges:
|
|
|
|
|
|
|
|
|
Years ended December 31,
|
(in thousands)
|
2019
|
|
2018
|
|
Interest and fees on loans 1
|
$
|
84,331
|
|
$
|
79,527
|
|
|
|
|
(Decrease) increase in value of designated interest rate swaps due to LIBOR interest rate movements
|
$
|
(964
|
)
|
$
|
452
|
|
Payment on interest rate swaps
|
(90
|
)
|
(149
|
)
|
Increase (decrease) in value of hedged loans
|
938
|
|
(425
|
)
|
Decrease in value of yield maintenance agreement
|
(13
|
)
|
(14
|
)
|
Net losses on fair value hedging derivatives recognized in interest income 2
|
$
|
(129
|
)
|
$
|
(136
|
)
|
1 Represents the income line item in the statements of comprehensive income in which the effects of fair value hedges are recorded.
2 Includes hedge ineffectiveness loss of $39 thousand and gain of $13 thousand for the years ended December 31, 2019, and 2018, respectively. Changes in value of swaps were included in the assessment of hedge effectiveness. Hedge ineffectiveness is the measure of the extent to which the change in the fair value of the hedging instruments does not exactly offset the change in the fair value of the hedged items from period to period.
Our derivative transactions with counterparties are under International Swaps and Derivative Association (“ISDA”) master agreements that include “right of set-off” provisions. “Right of set-off” provisions are legally enforceable rights to offset recognized amounts and there may be an intention to settle such amounts on a net basis. We do not offset such financial instruments for financial reporting purposes.
Information on financial instruments that are eligible for offset in the consolidated statements of condition follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Offsetting of Financial Assets and Derivative Assets
|
|
|
|
|
Gross Amounts Not Offset in the Statements of Condition
|
|
|
|
Gross Amounts
|
Net Amounts
|
|
|
|
|
Gross Amounts
|
Offset in the
|
of Assets Presented
|
|
|
|
|
of Recognized
|
Statements of
|
in the Statements
|
Financial
|
Cash Collateral
|
|
(in thousands)
|
Assets1
|
Condition
|
of Condition1
|
Instruments
|
Received
|
Net Amount
|
December 31, 2019
|
|
|
|
|
|
|
Derivatives by Counterparty:
|
|
|
|
|
|
|
Counterparty A
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
Total
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
|
|
|
|
|
|
|
December 31, 2018
|
|
|
|
|
|
|
Derivatives by Counterparty:
|
|
|
|
|
|
|
Counterparty A
|
$
|
161
|
|
$
|
—
|
|
$
|
161
|
|
$
|
(161
|
)
|
$
|
—
|
|
$
|
—
|
|
Total
|
$
|
161
|
|
$
|
—
|
|
$
|
161
|
|
$
|
(161
|
)
|
$
|
—
|
|
$
|
—
|
|
1 Amounts exclude accrued interest totaling less than $1 thousand at December 31, 2018.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Offsetting of Financial Liabilities and Derivative Liabilities
|
|
|
|
|
Gross Amounts Not Offset in the Statements of Condition
|
|
|
|
Gross Amounts
|
Net Amounts of
|
|
|
|
|
Gross Amounts
|
Offset in the
|
Liabilities Presented
|
|
|
|
|
of Recognized
|
Statements of
|
in the Statements of
|
Financial
|
Cash Collateral
|
|
(in thousands)
|
Liabilities2
|
Condition
|
Condition2
|
Instruments
|
Pledged
|
Net Amount
|
December 31, 2019
|
|
|
|
|
|
|
Derivatives by Counterparty:
|
|
|
|
|
|
|
Counterparty A
|
$
|
1,178
|
|
$
|
—
|
|
$
|
1,178
|
|
$
|
—
|
|
(1,178
|
)
|
$
|
—
|
|
Total
|
$
|
1,178
|
|
$
|
—
|
|
$
|
1,178
|
|
$
|
—
|
|
$
|
(1,178
|
)
|
$
|
—
|
|
|
|
|
|
|
|
|
December 31, 2018
|
|
|
|
|
|
|
Derivatives by Counterparty:
|
|
|
|
|
|
|
Counterparty A
|
$
|
375
|
|
$
|
—
|
|
$
|
375
|
|
$
|
(161
|
)
|
—
|
|
$
|
214
|
|
Total
|
$
|
375
|
|
$
|
—
|
|
$
|
375
|
|
$
|
(161
|
)
|
$
|
—
|
|
$
|
214
|
|
2 Amounts exclude accrued interest totaling $6 thousand and $3 thousand at December 31, 2019 and 2018, respectively.
Note 15: Regulatory Matters
We are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements as set forth in the following tables can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on our consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and the Bank’s prompt corrective action classification are also subject to qualitative judgments by the regulators about components of capital, risk weightings and other factors.
Management reviews capital ratios on a regular basis to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet our anticipated future needs. For all periods presented, the Bank’s ratios exceed the regulatory definition of “well capitalized” under the regulatory framework for prompt corrective action and Bancorp’s ratios exceed the required minimum ratios to be considered a well capitalized bank holding company. In addition, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action as of December 31, 2019. There are no conditions or events since that notification that Management believes have changed the Bank’s categories and we expect the Bank to remain well capitalized for prompt corrective action purposes.
In July 2013, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency ("Agencies") finalized regulatory capital rules known as “Basel III.” Fully phased in on January 1, 2019, Basel III required the Bank to maintain (i) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 8.5%, and (ii) a minimum ratio of common equity Tier 1 capital to risk-weighted assets of at least 7.0%, both inclusive of a 2.50% “capital conservation buffer." The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and was phased in over a four-year period (increasing by 0.625% each subsequent January 1, until it reached 2.50% on January 1, 2019). In August 2018, the Board of Governors of the Federal Reserve System changed the definition of a "Small Bank Holding Company" by increasing the asset threshold from $1.0 billion to $3.0 billion. As a result, Bancorp is no longer subject to separate minimum capital requirements. However, we disclose comparative capital ratios for Bancorp, which would have exceeded well-capitalized levels had Bancorp been subject to the same minimum capital requirements.
The Bancorp’s and Bank's capital adequacy ratios as of December 31, 2019 and 2018 are presented in the following tables. Bancorp's Tier 1 capital includes the subordinated debentures, which are not included at the Bank level.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital Ratios for Bancorp
(dollars in thousands)
|
Actual Ratio
|
|
Adequately Capitalized Threshold 1
|
|
Ratio to be a Well Capitalized Bank Holding Company
|
December 31, 2019
|
Amount
|
|
Ratio
|
|
|
Amount
|
|
Ratio
|
|
|
Amount
|
|
Ratio
|
|
Total Capital (to risk-weighted assets)
|
$
|
319,317
|
|
15.07
|
%
|
|
≥ $
|
222,430
|
|
≥ 10.500
|
%
|
|
≥ $
|
211,838
|
|
≥ 10.000
|
%
|
Tier 1 Capital (to risk-weighted assets)
|
$
|
301,553
|
|
14.24
|
%
|
|
≥ $
|
180,063
|
|
≥ 8.500
|
%
|
|
≥ $
|
169,471
|
|
≥ 8.000
|
%
|
Tier 1 Capital (to average assets)
|
$
|
301,553
|
|
11.66
|
%
|
|
≥ $
|
103,489
|
|
≥ 4.000
|
%
|
|
≥ $
|
129,361
|
|
≥ 5.000
|
%
|
Common Equity Tier 1 (to risk-weighted assets)
|
$
|
298,845
|
|
14.11
|
%
|
|
≥ $
|
148,287
|
|
≥ 7.000
|
%
|
|
≥ $
|
137,695
|
|
≥ 6.500
|
%
|
December 31, 2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Capital (to risk-weighted assets)
|
$
|
305,224
|
|
14.93
|
%
|
|
≥ $
|
201,943
|
|
≥ 9.875
|
%
|
|
≥ $
|
204,499
|
|
≥ 10.000
|
%
|
Tier 1 Capital (to risk-weighted assets)
|
$
|
288,445
|
|
14.10
|
%
|
|
≥ $
|
161,043
|
|
≥ 7.875
|
%
|
|
≥ $
|
163,599
|
|
≥ 8.000
|
%
|
Tier 1 Capital (to average assets)
|
$
|
288,445
|
|
11.54
|
%
|
|
≥ $
|
100,011
|
|
≥ 4.000
|
%
|
|
≥ $
|
125,013
|
|
≥ 5.000
|
%
|
Common Equity Tier 1 (to risk-weighted assets)
|
$
|
285,805
|
|
13.98
|
%
|
|
≥ $
|
130,368
|
|
≥ 6.375
|
%
|
|
≥ $
|
132,925
|
|
≥ 6.500
|
%
|
1 The adequately capitalized threshold includes the capital conservation buffer that was effective in 2018 and fully phased-in on January 1, 2019.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital Ratios for the Bank (dollars in thousands)
|
Actual Ratio
|
|
Adequately Capitalized Threshold 1
|
|
Ratio to be Well Capitalized under Prompt Corrective Action Provisions
|
December 31, 2019
|
Amount
|
|
Ratio
|
|
|
Amount
|
|
Ratio
|
|
|
Amount
|
|
Ratio
|
|
Total Capital (to risk-weighted assets)
|
$
|
309,875
|
|
14.63
|
%
|
|
≥ $
|
222,437
|
|
≥ 10.500
|
%
|
|
≥ $
|
211,844
|
|
≥ 10.000
|
%
|
Tier 1 Capital (to risk-weighted assets)
|
$
|
292,111
|
|
13.79
|
%
|
|
≥ $
|
180,068
|
|
≥ 8.500
|
%
|
|
≥ $
|
169,476
|
|
≥ 8.000
|
%
|
Tier 1 Capital (to average assets)
|
$
|
292,111
|
|
11.29
|
%
|
|
≥ $
|
103,488
|
|
≥ 4.000
|
%
|
|
≥ $
|
129,360
|
|
≥ 5.000
|
%
|
Common Equity Tier 1 (to risk-weighted assets)
|
$
|
292,111
|
|
13.79
|
%
|
|
≥ $
|
148,291
|
|
≥ 7.000
|
%
|
|
≥ $
|
137,699
|
|
≥ 6.500
|
%
|
December 31, 2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Capital (to risk-weighted assets)
|
$
|
285,969
|
|
13.98
|
%
|
|
≥ $
|
201,927
|
|
≥ 9.875
|
%
|
|
≥ $
|
204,483
|
|
≥ 10.000
|
%
|
Tier 1 Capital (to risk-weighted assets)
|
$
|
269,191
|
|
13.16
|
%
|
|
≥ $
|
161,031
|
|
≥ 7.875
|
%
|
|
≥ $
|
163,587
|
|
≥ 8.000
|
%
|
Tier 1 Capital (to average assets)
|
$
|
269,191
|
|
10.77
|
%
|
|
≥ $
|
99,994
|
|
≥ 4.000
|
%
|
|
≥ $
|
124,992
|
|
≥ 5.000
|
%
|
Common Equity Tier 1 (to risk-weighted assets)
|
$
|
269,191
|
|
13.16
|
%
|
|
≥ $
|
130,358
|
|
≥ 6.375
|
%
|
|
≥ $
|
132,914
|
|
≥ 6.500
|
%
|
1 The adequately capitalized threshold includes the capital conservation buffer that was effective in 2018 and fully phased-in on January 1, 2019.
|
Note 16: Financial Instruments with Off-Balance Sheet Risk
We make commitments to extend credit in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because various commitments will expire without being fully drawn, the total commitment amount does not necessarily represent future cash requirements.
Our credit loss exposure is equal to the contractual amount of the commitment in the event of nonperformance by the borrower. We use the same credit underwriting criteria for all credit exposure. The amount of collateral obtained, if deemed necessary by us, is based on Management's credit evaluation of the borrower. Collateral types pledged may include accounts receivable, inventory, other personal property and real property.
The contractual amount of undrawn loan commitments and standby letters of credit not reflected in the consolidated statements of condition are as follows:
|
|
|
|
|
|
|
|
(in thousands)
|
December 31, 2019
|
|
December 31, 2018
|
|
Commercial lines of credit
|
$
|
287,533
|
|
$
|
238,361
|
|
Revolving home equity lines
|
189,035
|
|
189,971
|
|
Undisbursed construction loans
|
41,033
|
|
46,229
|
|
Personal and other lines of credit
|
9,567
|
|
14,109
|
|
Standby letters of credit
|
1,964
|
|
2,636
|
|
Total commitments and standby letters of credit
|
$
|
529,132
|
|
$
|
491,306
|
|
We record an allowance for losses on these off-balance sheet commitments based on an estimate of probabilities of the utilization of these commitments according to our historical experience on different types of commitments and expected loss. The allowance for losses on off-balance sheet commitments totaled $1.1 million as of December 31, 2019 and $958 thousand as of December 31, 2018, which is recorded in interest payable and other liabilities in the consolidated statements of condition. Approximately 33% of the commitments expire in 2020, approximately 55% expire between 2021 and 2027 and approximately 12% expire thereafter.
Note 17: Condensed Bank of Marin Bancorp Parent Only Financial Statements
Presented below is financial information for Bank of Marin Bancorp, parent holding company only.
|
|
|
|
|
|
|
|
CONDENSED UNCONSOLIDATED STATEMENTS OF CONDITION
|
December 31, 2019 and 2018
|
(in thousands)
|
2019
|
2018
|
Assets
|
|
|
Cash and due from Bank of Marin
|
$
|
9,539
|
|
$
|
19,144
|
|
Investment in bank subsidiary
|
330,053
|
|
299,953
|
|
Other assets
|
332
|
|
331
|
|
Total assets
|
$
|
339,924
|
|
$
|
319,428
|
|
|
|
|
Liabilities and Stockholders' Equity
|
|
|
Subordinated debentures
|
$
|
2,708
|
|
$
|
2,640
|
|
Accrued expenses payable
|
71
|
|
51
|
|
Other liabilities
|
357
|
|
330
|
|
Total liabilities
|
3,136
|
|
3,021
|
|
Stockholders' equity
|
336,788
|
|
316,407
|
|
Total liabilities and stockholders' equity
|
$
|
339,924
|
|
$
|
319,428
|
|
|
|
|
|
|
|
|
|
CONDENSED UNCONSOLIDATED STATEMENTS OF INCOME
|
Years ended December 31, 2019 and 2018
|
(in thousands)
|
2019
|
2018
|
Income
|
|
|
Dividends from bank subsidiary
|
$
|
17,600
|
|
$
|
36,700
|
|
Miscellaneous Income
|
5
|
|
9
|
|
Total income
|
17,605
|
|
36,709
|
|
Expense
|
|
|
Interest expense
|
229
|
|
1,339
|
|
Non-interest expense
|
1,399
|
|
1,275
|
|
Total expense
|
1,628
|
|
2,614
|
|
Income before income taxes and equity in undistributed net income of subsidiary
|
15,977
|
|
34,095
|
|
Income tax benefit
|
480
|
|
770
|
|
Income before equity in undistributed net income of subsidiary
|
16,457
|
|
34,865
|
|
Earnings of bank subsidiary greater (less) than dividends received from bank subsidiary
|
17,784
|
|
(2,243
|
)
|
Net income
|
$
|
34,241
|
|
$
|
32,622
|
|
|
|
|
|
|
|
|
|
CONDENSED UNCONSOLIDATED STATEMENTS OF CASH FLOWS
|
Years ended December 31, 2019 and 2018
|
(in thousands)
|
2019
|
2018
|
Cash Flows from Operating Activities:
|
|
|
Net income
|
$
|
34,241
|
|
$
|
32,622
|
|
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
|
|
|
Earnings of bank subsidiary (greater) less than dividends received from bank subsidiary
|
(17,784
|
)
|
2,243
|
|
Net change in operating assets and liabilities:
|
|
|
Accretion of discount on subordinated debentures
|
68
|
|
1,025
|
|
Other assets
|
—
|
|
36
|
|
Other liabilities
|
80
|
|
(86
|
)
|
Noncash director compensation expense - common stock
|
30
|
|
23
|
|
Net cash provided by operating activities
|
16,635
|
|
35,863
|
|
Cash Flows from Investing Activities:
|
|
|
Capital contribution to subsidiary
|
(747
|
)
|
(667
|
)
|
Net cash used in investing activities
|
(747
|
)
|
(667
|
)
|
Cash Flows from Financing Activities:
|
|
|
Proceeds from stock options exercised and stock issued under employee and director stock purchase plans and ESPP
|
747
|
|
667
|
|
Repayment of subordinate debenture including execution costs
|
—
|
|
(4,137
|
)
|
Payment of tax withholdings for stock options exercised
|
(220
|
)
|
(99
|
)
|
Dividends paid on common stock
|
(10,958
|
)
|
(8,860
|
)
|
Stock repurchased, net of commissions
|
(15,062
|
)
|
(6,869
|
)
|
Net cash used by financing activities
|
(25,493
|
)
|
(19,298
|
)
|
Net increase (decrease) in cash and cash equivalents
|
(9,605
|
)
|
15,898
|
|
Cash and cash equivalents at beginning of period
|
19,144
|
|
3,246
|
|
Cash and cash equivalents at end of period
|
$
|
9,539
|
|
$
|
19,144
|
|
Supplemental schedule of non-cash investing and financing activities:
|
|
|
Stock issued in payment of director fees
|
$
|
231
|
|
$
|
204
|
|
Repurchase of stock not yet settled
|
$
|
103
|
|
$
|
143
|
|
Stock issued to ESOP
|
$
|
1,245
|
|
$
|
1,173
|
|
End of 2019 Audited Consolidated Financial Statements