UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10‑Q

(MARK ONE)
☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
OR
☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                          to

Commission file number 000‑23877

Heritage Commerce Corp

(Exact name of Registrant as Specified in its Charter)

California (State or Other Jurisdiction of Incorporation or Organization)	77‑0469558 (I.R.S. Employer Identification No.)
150 Almaden Boulevard, San Jose, California (Address of Principal Executive Offices)	95113 (Zip Code)

(408) 947‑6900

(Registrant’s Telephone Number, Including Area Code)

N/A

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES ☒  NO ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S‑T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  YES ☒  NO ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐	Accelerated filer ☒	Non‑accelerated filer ☐ (Do not check if a smaller reporting company)	Smaller reporting company ☐
			Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Exchange Act).  YES ☐  NO ☒

The Registrant had 43,222,184 shares of Common Stock outstanding on July 30, 2018.

HERITAGE COMMERCE CORP

QUARTERLY REPORT ON FORM 10‑Q

TABLE OF CONTENTS

		Page No.
Cautionary Note on Forward‑Looking Statements		3
Part I. FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements (unaudited)	5
	Consolidated Balance Sheets	5
	Consolidated Statements of Income	6
	Consolidated Statements of Comprehensive Income	7
	Consolidated Statements of Changes in Shareholders’ Equity	8
	Consolidated Statements of Cash Flows	9
	Notes to Unaudited Consolidated Financial Statements	10
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	43
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	80
Item 4.	Controls and Procedures	80
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	81
Item 1A.	Risk Factors	81
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	81
Item 3.	Defaults Upon Senior Securities	81
Item 4.	Mine Safety Disclosures	81
Item 5.	Other Information	81
Item 6.	Exhibits	81
SIGNATURES		82

2

Cautionary Note Regarding Forward‑Looking Statements

This Report on Form 10‑Q contains various statements that may constitute forward‑looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended, Rule 3b‑6 promulgated thereunder and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements about our expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and may be forward‑looking. These forward‑looking statements often can be, but are not always, identified by the use of words such as “assume,” “expect,” “intend,” “plan,” “project,” “believe,” “estimate,” “predict,” “anticipate,” “may,” “might,” “should,” “could,” “goal,” “potential” and similar expressions. We base these forward‑looking statements on our current expectations and projections about future events, our assumptions regarding these events and our knowledge of facts at the time the statements are made. These statements include statements relating to our projected growth, anticipated future financial performance, and management’s long‑term performance goals, as well as statements relating to the anticipated effects on results of operations and financial condition.

These forward‑looking statements are subject to various risks and uncertainties that may be outside our control and our actual results could differ materially from our projected results. In addition, our past results of operations do not necessarily indicate our future results. The forward‑looking statements could be affected by many factors, including but not limited to:

· current and future economic and market conditions in the United States generally or in the communities we serve, including the effects of declines in property values, high unemployment rates and overall slowdowns in economic growth should these events occur;

effects of and changes in trade, monetary and fiscal policies and laws, including the interest rate policies of the Federal Open Market Committee of the Federal Reserve Board;

changes in inflation, interest rates, and market liquidity which may impact interest margins and impact funding sources;

volatility in credit and equity markets and its effect on the global economy;

changes in the competitive environment among financial or bank holding companies and other financial service providers;

changes in consumer and business spending and saving habits and the related effect on our ability to increase assets and to attract deposits;

our ability to develop and promote customer acceptance of new products and services in a timely manner;

risks associated with concentrations in real estate related loans;

other than temporary impairment charges to our securities portfolio;

changes in the level of nonperforming assets and charge offs and other credit quality measures, and their impact on the adequacy of the Company’s allowance for loan losses and the Company’s provision for loan losses;

· increased capital requirements  for our continual growth or as imposed by banking regulators, which may require us to raise capital at a time when capital is not available or favorable terms or at all;

regulatory limits on Heritage Bank of Commerce’s ability to pay dividends to the Company;

changes in our capital management policies, including those regarding business combinations, dividends, and share repurchases, among others;

3

operational issues stemming from, and/or capital spending necessitated by, the potential need to adapt to industry changes in information technology systems, on which we are highly dependent;

our ability to keep pace with technological changes, including our ability to identify and address cyber-security risks such as data security breaches, “denial of service” attacks, “hacking” and identity theft;

inability of our framework to manage risks associated with our business, including operational risk and credit risk;

risks of loss of funding of Small Business Administration or SBA loan programs, or changes in those programs;

compliance with governmental and regulatory requirements, including the Dodd-Frank Act and others relating to banking, consumer protection, securities , accounting and tax matters;

significant changes in applicable laws and regulations, including those concerning taxes, banking and securities;

effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters;

costs and effects of legal and regulatory developments, including resolution of legal proceedings or regulatory or other governmental inquiries, and the results of regulatory examinations or reviews;

availability of and competition for acquisition opportunities;

risks resulting from domestic terrorism;

risks of natural disasters (including earthquakes) and other events beyond our control;

· fully realizing cost savings and other benefits, and/or business disruption following the mergers of Tri-Valley Bank and United American Bank; and

our success in managing the risks involved in the foregoing factors.

Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events. You should consider any forward looking statements in light of this explanation, and we caution you about relying on forward-looking statements.

4

Part I—FINANCIAL INFORMATION

ITEM 1—CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

HERITAGE COMMERCE CORP

CONSOLIDATED BALANCE SHEETS (Unaudited)

	June 30,		December 31,
	2018		2017
	(Dollars in thousands)
Assets
Cash and due from banks	$	46,340	$	31,681
Other investments and interest-bearing deposits in other financial institutions		177,448		284,541
Total cash and cash equivalents		223,788		316,222
Securities available-for-sale, at fair value		335,923		391,852
Securities held-to-maturity, at amortized cost (fair value of $375,320 at June 30, 2018
and $394,292 at December 31, 2017)		388,603		398,341
Loans held-for-sale - SBA, at lower of cost or fair value, including deferred costs		5,745		3,419
Loans, net of deferred fees		1,956,633		1,582,667
Allowance for loan losses		(26,664)		(19,658)
Loans, net		1,929,969		1,563,009
Federal Home Loan Bank and Federal Reserve Bank stock and other investments, at cost		22,865		17,911
Company-owned life insurance		61,414		60,814
Premises and equipment, net		7,355		7,353
Goodwill		84,417		45,664
Other intangible assets		12,293		5,589
Accrued interest receivable and other assets		50,835		33,278
Total assets	$	3,123,207	$	2,843,452
Liabilities and Shareholders' Equity
Liabilities:
Deposits:
Demand, noninterest-bearing	$	1,002,053	$	989,753
Demand, interest-bearing		683,805		601,929
Savings and money market		827,304		684,131
Time deposits - under $250		72,030		51,710
Time deposits - $250 and over		81,379		138,634
CDARS - interest-bearing demand, money market and time deposits		17,048		16,832
Total deposits		2,683,619		2,482,989
Subordinated debt, net of issuance costs		39,275		39,183
Accrued interest payable and other liabilities		54,044		50,041
Total liabilities		2,776,938		2,572,213
Shareholders' equity:
Preferred stock, no par value; 10,000,000 shares authorized; none issued and outstanding
at June 30, 2018 and December 31, 2017		—		—
Common stock, no par value; 60,000,000 shares authorized; 43,222,184 shares issued
and outstanding at June 30, 2018 and 38,200,883 shares issued and
outstanding at December 31, 2017		299,224		218,355
Retained earnings		62,911		62,136
Accumulated other comprehensive loss		(15,866)		(9,252)
Total shareholders' equity		346,269		271,239
Total liabilities and shareholders' equity	$	3,123,207	$	2,843,452

See notes to unaudited consolidated financial statements

5

HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2018		2017		2018		2017
	(Dollars in thousands, except per share amounts)
Interest income:
Loans, including fees	$	26,355	$	21,207	$	48,639	$	41,605
Securities, taxable		3,767		3,442		7,629		6,319
Securities, exempt from Federal tax		560		565		1,120		1,131
Other investments, interest-bearing deposits
in other financial institutions and Federal funds sold		1,298		893		2,469		1,749
Total interest income		31,980		26,107		59,857		50,804
Interest expense:
Deposits		1,239		946		2,197		1,817
Subordinated debt		577		228		1,148		228
Total interest expense		1,816		1,174		3,345		2,045
Net interest income before provision for loan losses		30,164		24,933		56,512		48,759
Provision for loan losses		7,198		(46)		7,704		275
Net interest income after provision for loan losses		22,966		24,979		48,808		48,484
Noninterest income:
Service charges and fees on deposit accounts		972		801		1,874		1,541
Increase in cash surrender value of life insurance		237		420		600		842
Gain on sales of SBA loans		80		164		315		488
Servicing income		189		205		370		490
Gain (loss) on sales of securities		179		—		266		(6)
Other		1,123		703		1,550		1,233
Total noninterest income		2,780		2,293		4,975		4,588
Noninterest expense:
Salaries and employee benefits		14,806		9,209		24,583		18,695
Occupancy and equipment		1,262		1,216		2,368		2,284
Professional fees		(289)		673		395		1,744
Other		9,083		4,156		13,506		7,859
Total noninterest expense		24,862		15,254		40,852		30,582
Income before income taxes		884		12,018		12,931		22,490
Income tax (benefit) expense		(31)		4,569		3,207		8,503
Net income	$	915	$	7,449	$	9,724	$	13,987
Earnings per common share:
Basic	$	0.02	$	0.20	$	0.24	$	0.37
Diluted	$	0.02	$	0.19	$	0.24	$	0.36

See notes to unaudited consolidated financial statements

6

HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2018		2017		2018		2017
		(Dollars in thousands)
Net income	$	915	$	7,449	$	9,724	$	13,987
Other comprehensive income:
Change in net unrealized holding (losses) gains on available-for-sale
securities and I/O strips		(1,144)		1,591		(9,129)		2,436
Deferred income taxes		332		(668)		2,647		(1,023)
Change in net unamortized unrealized gain on securities available-for-
sale that were reclassified to securities held-to-maturity		(11)		(13)		(22)		(26)
Deferred income taxes		3		6		6		11
Reclassification adjustment for losses (gains) realized in income		(179)		—		(266)		6
Deferred income taxes		53		—		79		(2)
Change in unrealized (losses) gains on securities and I/O strips, net of
deferred income taxes		(946)		916		(6,685)		1,402
Change in net pension and other benefit plan liability adjustment		51		38		101		77
Deferred income taxes		(15)		(16)		(30)		(32)
Change in pension and other benefit plan liability, net of
deferred income taxes		36		22		71		45
Other comprehensive (loss) income		(910)		938		(6,614)		1,447
Total comprehensive income	$	5	$	8,387	$	3,110	$	15,434

See notes to unaudited consolidated financial statements

7

HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

	Six Months Ended June 30, 2018 and 2017
						Accumulated
						Other		Total
	Common Stock			Retained		Comprehensive		Shareholders’
	Shares	Amount		Earnings		Loss		Equity
	(Dollars in thousands)
Balance, January 1, 2017	37,941,007	$	215,237	$	52,527	$	(7,914)	$	259,850
Net income	—		—		13,987		—		13,987
Other comprehensive income	—		—		—		1,447		1,447
Issuance of restricted stock awards, net	81,886		—		—		—		—
Amortization of restricted stock awards,
net of forfeitures	—		450		—		—		450
Cash dividend declared $0.20 per share	—		—		(7,604)		—		(7,604)
Stock option expense, net of fortfeitures and taxes	—		441		—		—		441
Stock options exercised	97,370		660		—		—		660
Balance, June 30, 2017	38,120,263	$	216,788	$	58,910	$	(6,467)	$	269,231
Balance, January 1, 2018	38,200,883	$	218,355	$	62,136	$	(9,252)	$	271,239
Net income	—		—		9,724		—		9,724
Other comprehensive loss	—		—		—		(6,614)		(6,614)
Issuance of common shares to acquire
Tri-Valley Bank	1,889,613		30,725		—		—		30,725
Issuance of common shares to acquire
United American Bank	2,826,032		47,280		—		—		47,280
Issuance of restricted stock awards, net	97,818		—		—		—		—
Amortization of restricted stock awards,
net of forfeitures	—		511		—		—		511
Cash dividend declared $0.22 per share	—		—		(8,949)		—		(8,949)
Stock option expense, net of forfeitures and taxes	—		351		—		—		351
Stock options exercised	207,838		2,002		—		—		2,002
Balance, June 30, 2018	43,222,184	$	299,224	$	62,911	$	(15,866)	$	346,269

See notes to unaudited consolidated financial statements

8

HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

	Six Months Ended
	June 30,
	2018		2017
	(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	9,724	$	13,987
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of discounts and premiums on securities		2,120		2,079
(Gain) loss on sale of securities available-for-sale		(266)		6
Gain on sale of SBA loans		(315)		(488)
Proceeds from sale of SBA loans originated for sale		4,139		6,133
SBA loans originated for sale		(6,150)		(6,051)
Provision for loan losses		7,704		275
Increase in cash surrender value of life insurance		(600)		(842)
Depreciation and amortization		380		385
Amortization of other intangible assets		705		787
Stock option expense, net		351		441
Amortization of restricted stock awards, net		511		450
Amortization of subordinated debt issuance costs		92		—
Effect of changes in:
Accrued interest receivable and other assets		(2,724)		1,340
Accrued interest payable and other liabilities		1,004		(1,385)
Net cash provided by operating activities		16,675		17,117
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of securities available-for-sale		(15,193)		(87,612)
Purchase of securities held-to-maturity		(16,906)		(62,594)
Maturities/paydowns/calls of securities available-for-sale		30,343		25,788
Maturities/paydowns/calls of securities held-to-maturity		25,655		19,795
Proceeds from sales of securities available-for-sale		94,291		6,536
Net change in loans		(38,218)		(61,293)
Changes in Federal Home Loan Bank stock and other investments		(2,132)		(2,103)
Purchase of premises and equipment		(32)		(490)
Cash received in bank acquisition, net of cash paid		36,028		—
Net cash provided (used in) by investing activities		113,836		(161,973)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in deposits		(215,998)		112,591
Issuance of subordinated debt, net of issuance costs		—		39,119
Exercise of stock options		2,002		660
Payment of cash dividends		(8,949)		(7,604)
Net cash (used in) provided by financing activities		(222,945)		144,766
Net decrease in cash and cash equivalents		(92,434)		(90)
Cash and cash equivalents, beginning of period		316,222		266,103
Cash and cash equivalents, end of period	$	223,788	$	266,013
Supplemental disclosures of cash flow information:
Interest paid	$	3,306	$	1,842
Income taxes paid		8,663		8,086
Supplemental schedule of non-cash investing activity:
Due to broker for securities purchased	$	—	$	2,391
Transfer of loans held-for-sale to loan portfolio		—		2,391
Loans transferred to foreclosed assets				—
Summary of assets acquired and liabilities assumed through acquisitions:
Cash and cash equivalents, net of cash paid	$	36,028	$	—
Securities avaiable-for-sale		63,723		—
Net loans		336,446		—
Premises and equipment, net		350		—
Goodwill		38,753		—
Other intangible assets		7,409
Other assets, net		15,016		—
Deposits		(416,628)		—
Other borrowings		(62)		—
Other liabilities		(3,030)		—
Common stock issued to acquire Tri-Valley and United American Bank		78,005		—

See notes to unaudited consolidated financial statements

9

HERITAGE COMMERCE CORP

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2018

(Unaudited)

1) Basis of Presentation

The unaudited consolidated financial statements of Heritage Commerce Corp (the “Company” or “HCC”) and its wholly owned subsidiary, Heritage Bank of Commerce (“HBC”), have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain information and notes required by accounting principles generally accepted in the United States of America (“GAAP”) for annual financial statements are not included herein. The interim statements should be read in conjunction with the consolidated financial statements and notes that were included in the Company’s Form 10-K for the year ended December 31, 2017.

HBC is a commercial bank serving customers primarily located in Santa Clara, Alameda, Contra Costa, and San Benito counties of California. CSNK Working Capital Finance Corp. a California corporation, dba Bay View Funding (“Bay View Funding”) is a wholly owned subsidiary of HBC, and provides business-essential working capital factoring financing to various industries throughout the United States. No customer accounts for more than 10% of revenue for HBC or the Company. The Company reports its results for two segments: banking and factoring. The Company’s management uses segment results in its operating and strategic planning.

In management’s opinion, all adjustments necessary for a fair presentation of these consolidated financial statements have been included and are of a normal and recurring nature. All intercompany transactions and balances have been eliminated.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ significantly from these estimates.

The results for the three and six months ended June 30, 2018 are not necessarily indicative of the results expected for any subsequent period or for the entire year ending December 31, 2018.

Business Combinations

The Company accounts for acquisitions of businesses using the acquisition method of accounting. Under the acquisition method, assets acquired and liabilities assumed are recorded at their estimated fair values at the date of acquisition. Management utilizes various valuation techniques including discounted cash flow analyses to determine these fair values. Any excess of the purchase price over amounts allocated to the acquired assets, including identifiable intangible assets, and liabilities assumed is recorded as goodwill.

Goodwill and Other Intangible Assets

Goodwill resulted from the acquisition of Tri-Valley Bank (“Tri-Valley”) on April 6, 2018 and United American Bank (“United American”) on May 4, 2018, and from acquisitions in prior years. Goodwill represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified.

Other intangible assets consist of core deposit intangible assets and a below market value lease intangible asset, arising from the United American and Tri-Valley acquisitions. They are initially measured at fair value and then are amortized over their estimated useful lives. The core deposits intangible assets from the acquisitions of United American and Tri-Valley are being amortized on an accelerated method over ten years. The below market value lease intangible assets are being amortized on the straight line method over three years for United American and eleven years for Tri-Valley. 

10

Reclassifications

              Certain reclassifications of prior year balances have been made to conform to the current year presentation. These reclassifications had no impact on the Company’s consolidated financial position, results of operations or net change in cash and cash equivalents.

Adoption of New Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers”, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The standard replaces most existing revenue recognition guidance in GAAP. The new standard was effective for the Company on January 1, 2018. Adoption of the standard did not have a material impact on the Company’s consolidated financial statements and related disclosures as the Company’s primary sources of revenues are derived from interest and dividends earned on loans, investment securities, and other financial instruments that are not within the scope of the standard. The Company’s revenue recognition pattern for revenue streams within the scope of the standard, including but not limited to service charges on deposit accounts and gains/losses on the sale of other real estate owned (“OREO”), did not change significantly from current practice. The standard permits the use of either the full retrospective or modified retrospective transition method. The Company elected to use the modified retrospective transition method which requires application of the standard to uncompleted contracts at the date of adoption however, periods prior to the date of adoption were not retrospectively revised as the impact of the standard on uncompleted contracts at the date of adoption was not material. See Note 15 – Revenue Recognition for more information.

In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities.” The guidance affects the accounting for equity investments, financial liabilities under the fair value option and the presentation and disclosure requirements of financial instruments. The standard was effective for the Company on January 1, 2018 and resulted in the use of an exit price rather than an entrance price to determine the fair value of financial instruments not measured at fair value on a non-recurring basis in the consolidated balance sheets. See Note 10 – Fair Value regarding the valuation of the loan portfolio.

In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. The standard amended existing guidance to improve the presentation of net periodic pension cost and net periodic postretirement benefit cost. The amendments require that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit costs are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. The amendments allow only the service cost component to be eligible for capitalization. The Company adopted the new guidance on January 1, 2018, and there was no material impact to the financial statements.

Newly Issued, but not yet Effective Accounting Standards

In February 2016, the FASB issued ASU No. 2016-02, Leases. The standard requires a lessee to recognize assets and liabilities on the balance sheet for leases with lease terms greater than 12 months. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right of use asset representing its right to use the underlying asset for the lease term. When measuring assets and liabilities arising from a lease, a lessee (and a lessor) should include payments to be made in optional periods only if the lessee is reasonably certain to exercise an option to extend the lease or not to exercise an option to terminate the lease. Similarly, optional payments to purchase the underlying asset should be included in the measurement of lease assets and lease liabilities only if the lessee is reasonably certain to exercise that purchase option. Reasonably certain is a high threshold that is consistent with and intended to be applied in the same way as the reasonably assured threshold in the previous leases guidance. In addition, also consistent with the previous leases guidance, a lessee (and a lessor) should exclude most variable lease payments in measuring lease assets and lease liabilities, other than those that depend on an index or a rate or are in substance fixed payments. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize lease expense for such leases generally on a straight line basis over the lease term. The new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, and early adoption is permitted. We are

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currently evaluating the provisions of this ASU and have determined that the provisions of ASU No. 2016-02 will result in an increase in assets to recognize the present value of the lease obligations with a corresponding increase in liabilities; however, we do not expect this to have a material impact to the Company’s results of operations or cash flows.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments. The standard is the final guidance on the new current expected credit loss (“CECL”) model. The amendments in this update replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to estimate future credit loss estimates. As CECL encompasses all financial assets carried at amortized cost, the requirement that reserves be established based on an organization’s reasonable and supportable estimate of expected credit losses extends to held-to-maturity debt securities. The update amends the accounting for credit losses on available for sale securities, whereby credit losses will be presented as an allowance as opposed to a write down. In addition, CECL will modify the accounting for purchased loans with credit deterioration since origination, so that reserves are established at the date of acquisition for purchased loans. Lastly, the amendment requires enhanced disclosures on the significant estimates and judgments used to estimate credit losses, as well as on the credit quality and underwriting standards of an organization’s portfolio. These disclosures require organizations to present the currently required credit quality disclosures disaggregated by the year of origination or vintage. The guidance allows for a modified retrospective approach with a cumulative effect adjustment to the balance sheet upon adoption (charge to retained earnings instead of the income statement). The new guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2019, and early adoption is permitted. We have formed a committee that is assessing our data and system needs and are evaluating the impact of adopting the new guidance. The committee has also selected a vendor to assist in generating loan level cash flows and disclosures.  We expect to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements.

In January 2017, the FASB issued accounting standards ASU No. 2017-04, Simplifying the Test for Goodwill Impairment. The provisions of the update eliminate the existing second step of the goodwill impairment test which provides for the allocation of reporting unit fair value among existing assets and liabilities, with the net remaining amount representing the implied fair value of goodwill. In replacement of the existing goodwill impairment rule, the update will provide that impairment should be recognized as the excess of any of the reporting unit’s goodwill over the fair value of the reporting unit. Under the provisions of this update, the amount of the impairment is limited to the carrying value of the reporting unit’s goodwill. For public business entities that are SEC filers, the amendments of the update will become effective in fiscal years beginning after December 15, 2019. Management does not expect the requirements of this update to have a material impact on the Company’s financial position, results of operations or cash flows.

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2) Shareholders’ Equity and Earnings Per Share

Basic earnings per common share is computed by dividing net income by the weighted average common shares outstanding. Diluted earnings per share reflect potential dilution from outstanding stock options using the treasury stock method. There were 305,500 and 369,606 stock options for the three months ended June 30, 2018 and 2017, and 318,606 and 369,500 for the six months ended June 30, 2018 and 2017, respectively, considered to be antidilutive and excluded from the computation of diluted earnings per share. A reconciliation of these factors used in computing basic and diluted earnings per common share is as follows:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2018		2017		2018		2017
		(Dollars in thousands, except per share amounts)
Net income	$	915	$	7,449	$	9,724	$	13,987
Weighted average common shares outstanding for basic
earnings per common share		41,925,616		38,070,042		40,083,056		38,014,020
Dilutive effect of stock options outstanding, using
the treasury stock method		583,058		509,092		577,027		521,995
Shares used in computing diluted earnings per common share		42,508,674		38,579,134		40,660,083		38,536,015
Basic earnings per share	$	0.02	$	0.20	$	0.24	$	0.37
Diluted earnings per share	$	0.02	$	0.19	$	0.24	$	0.36

3) Accumulated Other Comprehensive Income (Loss) (“AOCI”)

The following table reflects the changes in AOCI by component for the periods indicated: