5) Allowance for Credit Losses on Loans

The allowance for credit losses on loans was calculated by pooling loans of similar credit risk characteristics and credit monitoring procedures. The loan portfolio is classified into eight segments of loans - commercial, commercial real estate – owner occupied, commercial real estate – non-owner occupied, land and construction, home equity, multifamily, residential mortgage and consumer and other.

The risk characteristics of each loan portfolio segment are as follows:

Commercial

Commercial loans primarily rely on the identified cash flows of the borrower for repayment and secondarily on the underlying collateral provided by the borrower. However, the cash flows of the borrowers may not be as expected and the collateral securing these loans may vary in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable, inventory or equipment and may incorporate a personal guarantee; however, some loans may be unsecured.

Commercial Real Estate

Commercial real estate loans rely primarily on the cash flows of the properties securing the loan and secondarily on the value of the property that is securing the loan. Commercial real estate loans comprise two segments differentiated by owner occupied commercial real estate and non-owner commercial real estate. Owner occupied commercial real estate loans are secured by commercial properties that are at least 50% occupied by the borrower or borrower affiliate. Non-owner occupied commercial real estate loans are secured by commercial properties that are less than 50% occupied by the borrower or borrower affiliate. Commercial real estate loans may be adversely affected by conditions in the real estate markets or in the general economy.

Land and Construction

Land and construction loans are generally based on estimates of costs and value associated with the complete project. Construction loans usually involve the disbursement of funds with repayment substantially dependent on the success of the completion of the project. Sources of repayment for these loans may be permanent loans from HBC or other lenders, or proceeds from the sales of the completed project. These loans are monitored by on-site inspections and are considered to have higher risk than other real estate loans due to the final repayment dependent on numerous factors including general economic conditions.

Home Equity

Home equity loans are secured by 1-4 family residences that are generally owner occupied. Repayment of these loans depends primarily on the personal income of the borrower and secondarily by the value of the property securing the loan which can be impacted by changes in economic conditions such as the unemployment rate and property values.

Multifamily

Multifamily loans are loans on 5+ residential properties. These loans rely primarily on the cash flows of the properties securing the loan for repayment and secondarily on the value of the properties securing the loan. The cash flows of these borrowers can fluctuate along with the values of the underlying property depending on general economic conditions.

Residential Mortgages

Residential mortgage loans are secured by 1-4 family residences which are generally owner-occupied. Repayment of these loans depends primarily on the personal income of the borrower and secondarily by the value of the property securing the loan which can be impacted by changes in economic conditions such as the unemployment rate and property values.

Consumer and Other

Consumer and other loans are secured by personal property or are unsecured and rely primarily on the income of the borrower for repayment and secondarily on the collateral value for secured loans. Borrower income and collateral value can vary dependent on economic conditions.

Loans by portfolio segment and the allowance for credit losses on loans were as follows for the periods indicated:


	March 31,		December 31,
	2020		2019
	(Dollars in thousands)
Loans held-for-investment:
Commercial	$	682,280	$	603,345
Real estate:
CRE - owner occupied		543,164		548,907
CRE - non-owner occupied		755,008		767,821
Land and construction		153,358		147,189
Home equity		117,768		151,775
Multifamily		172,875		180,623
Residential mortgages		96,271		100,759
Consumer and other		33,445		33,744
Loans		2,554,169		2,534,163
Deferred loan fees, net		(258)		(319)
Loans, net of deferred fees		2,553,911		2,533,844
Allowance for credit losses on loans(1)		(44,703)		(23,285)
Loans, net	$	2,509,208	$	2,510,559

(1)Allowance for credit losses on loans at March 31, 2020, Allowance for loan losses for the prior periods

The loss estimates for each segment are derived using a discounted cash flow analysis that incorporates a forecast of economic factors that have historic correlation to loan losses. The most significant economic factor used in the calculation of estimated loan losses is the California unemployment rate which is used for each segment. California GDP, and California retail trade earnings, California home price index, and a commercial real estate value index are secondary economic factors used with California unemployment rate in various loan segments. A four quarter forecast of each economic factor is used for each loan segment and the economic factors are assumed to revert to the historic mean over an eight quarter period after the four quarter forecast period.

As of the CECL implementation date of January 1, 2020, the Company recognized an increase of $8,570,000 to its allowance for credit losses for loans. The majority of this increase is related to loan portfolios acquired in our recent acquisitions that under the previous methodology where reserves were covered by the purchase discount on acquired loans. The cumulative-effect adjustment as a result of the adoption of CECL was recorded, net of tax of $2,357,000, as a $6,062,000 reduction to retained earnings effective January 1, 2020.

The provision for credit losses on loans was $13,270,000 for the first quarter 2020 which was primarily driven by a deteriorated economic forecast at March 31, 2020 compared to the economic forecast at January 1, 2020. At January 1, 2020 the forecast for California GDP for 2020 was an annual increase in the low single digits and the forecasted California unemployment rate for 2020 was in the mid single digits. The forecast at March 31, 2020 incorporates the impact of the Coronavirus pandemic and the California GDP forecast for 2020 was revised to negative low single digits and peak California unemployment in the low double digits. The total allowance for credit losses on loans at March 31, 2020 was $44,703,000.

Changes in the allowance for credit losses on loans were as follows for the three months ended March 31, 2020:


			CRE		CRE
			Owner		Non-owner		Land &		Home		Multi-		Residential		Consumer
	Commercial		Occupied		Occupied		Construction		Equity		Family		Mortgage		and Other		Total
	(Dollars in thousands)
Beginning of period balance	$	10,453	$	3,825	$	3,760	$	2,621	$	2,244	$	57	$	243	$	82	$	23,285
Adoption of Topic 326		(3,663)		3,169		7,912		(1,163)		(923)		1,196		435		1,607		8,570
Balance at adoption on January 1, 2020		6,790		6,994		11,672		1,458		1,321		1,253		678		1,689		31,855
Charge-offs		(670)		—		—		—		—		—		—		(3)		(673)
Recoveries		209		—		—		19		23		—		—		—		251
Net (charge-offs) recoveries		(461)		—		—		19		23		—		—		(3)		(422)
Provision for credit losses on loans		6,472		743		3,973		1,126		402		369		30		155		13,270
End of period balance	$	12,801	$	7,737	$	15,645	$	2,603	$	1,746	$	1,622	$	708	$	1,841	$	44,703

Changes in the allowance for loan losses were as follows for the three months ended March 31, 2019:


	Commercial		Real Estate		Consumer		Total
	(Dollars in thousands)
Beginning of period balance	$	17,061	$	10,671	$	116	$	27,848
Charge-offs		(226)		—		—		(226)
Recoveries		715		42		—		757
Net recoveries		489		42		—		531
Provision (credit) for loan losses		(1,993)		958		(26)		(1,061)
End of period balance	$	15,557	$	11,671	$	90	$	27,318

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment, based on the impairment method as follows at year‑end:


	December 31, 2019
	Commercial		Real Estate		Consumer		Total
	(Dollars in thousands)
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1,835	$	—	$	—	$	1,835
Collectively evaluated for impairment		8,618		12,750		82		21,450
Total allowance balance	$	10,453	$	12,750	$	82	$	23,285
Loans:
Individually evaluated for impairment	$	4,810	$	5,454	$	—	$	10,264
Collectively evaluated for impairment		626,737		1,877,280		19,882		2,523,899
Total loan balance	$	631,547	$	1,882,734	$	19,882	$	2,534,163

The following table presents the amortized cost basis of nonperforming loans and loans past due over 90 days and still accruing at March 31, 2020:


						Restructured
	Nonaccrual		Nonaccrual			and Loans
	with no		with			over 90 Days
	Allowance for		Allowance for			Past Due
	Credit		Credit			and Still
	Losses		Losses			Accruing	Total
	(Dollars in thousands)
Commercial	$	781	$	1,827	$	442	$	3,050
Real estate:
CRE - Owner Occupied		7,346		—		—		7,346
CRE - Non-Owner Occupied		—		—		—		—
Land and construction		—		—		—		—
Home equity		126		—		—		126
Multifamily		—		—		—		—
Residential mortgages		—		—		—		—
Consumer		—		1,566		—		1,566
Total	$	8,253	$	3,393	$	442	$	12,088

The following table presents nonperforming loans by class at December 31, 2019:


			Restructured
			and Loans
			over 90 Days
			Past Due
			and Still
	Nonaccrual		Accruing		Total
	(Dollars in thousands)
Commercial	$	3,444	$	1,153	$	4,597
Real estate:
CRE		5,094		—		5,094
Home equity		137		—		137
Total	$	8,675	$	1,153	$	9,828

The following tables presents the aging of past due loans by class for the periods indicated:


	March 31, 2020
	30 - 59		60 - 89		90 Days or
	Days		Days		Greater		Total
	Past Due		Past Due		Past Due		Past Due		Current		Total
	(Dollars in thousands)
Commercial	$	7,256	$	1,130	$	2,158	$	10,544	$	671,736	$	682,280
Real estate:
CRE - Owner Occupied		693		1,184		5,094		6,971		536,193		543,164
CRE - Non-Owner Occupied		—		—		—		—		755,008		755,008
Land and construction		—		—		—		—		153,358		153,358
Home equity		571		125		—		696		117,072		117,768
Multifamily		—		—		—		—		172,875		172,875
Residential mortgages		—		—		—		—		96,271		96,271
Consumer		—		—		—		—		33,445		33,445
Total	$	8,520	$	2,439	$	7,252	$	18,211	$	2,535,958	$	2,554,169


	December 31, 2019
	30 - 59		60 - 89		90 Days or
	Days		Days		Greater		Total
	Past Due		Past Due		Past Due		Past Due		Current		Total
	(Dollars in thousands)
Commercial	$	4,770	$	2,097	$	3,217	$	10,084	$	593,261	$	603,345
Real estate:
CRE - Owner Occupied		—		—		5,094		5,094		543,813		548,907
CRE - Non-Owner Occupied		—		—		—		—		767,821		767,821
Land and construction		—		—		—		—		147,189		147,189
Home equity		—		137		—		137		151,638		151,775
Multifamily		—		—		—		—		180,623		180,623
Residential mortgages		—		—		—		—		100,759		100,759
Consumer		—		—		—		—		33,744		33,744
Total	$	4,770	$	2,234	$	8,311	$	15,315	$	2,518,848	$	2,534,163

Past due loans 30 days or greater totaled $18,211,000 and $15,315,000 at March 31, 2020 and December 31, 2019, respectively, of which $7,711,000 and $7,413,000 were on nonaccrual, respectively. At March 31, 2020, there were also $3,935,000 of loans less than 30 days past due included in nonaccrual loans held-for-investment. At December 31, 2019, there were also $1,262,000 loans less than 30 days past due included in nonaccrual loans held-for-investment. Management’s classification of a loan as “nonaccrual” is an indication that there is reasonable doubt as to the full recovery of principal or interest on the loan. At that point, the Company stops accruing interest income, and reverses any uncollected interest that had been accrued as income. The Company begins recognizing interest income only as cash interest payments are received and it has been determined the collection of all outstanding principal is not in doubt.

Credit Quality Indicators

Concentrations of credit risk arise when a number of customers are engaged in similar business activities, or activities in the same geographic region, or have similar features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic conditions. The Company’s loan portfolio is concentrated in commercial (primarily manufacturing, wholesale, and service) and real estate lending, with the remaining balance in consumer loans. While no specific industry concentration is considered significant, the Company’s lending operations are located in the Company’s market areas that are dependent on the technology and real estate industries and their supporting companies. Thus, the Company’s borrowers could be adversely impacted by a downturn in these sectors of the economy which could reduce the demand for loans and adversely impact the borrowers’ ability to repay their loans.

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, and other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a quarterly basis. Nonclassified loans generally include those loans that are expected to be repaid in accordance with contractual loans terms. Loans categorized as special mention have potential weaknesses that may, if not checked or corrected, weaken the credit or inadequately protect the Company’s position at some future date. These loans pose elevated risk, but their weaknesses do not yet justify a substandard classification. Classified loans are those loans that are assigned a substandard, substandard-nonaccrual, or doubtful risk rating using the following definitions:

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well‑defined weakness or weaknesses that will jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Substandard‑Nonaccrual. Loans classified as substandard‑nonaccrual are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any, and it is probable that the Company will not receive payment of the full contractual principal and interest. Loans so classified have a well‑defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. In addition, the Company no longer accrues interest on the loan because of the underlying weaknesses.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loss. Loans classified as loss are considered uncollectable or of so little value that their continuance as assets is not warranted. This classification does not necessarily mean that a loan has no recovery or salvage value; but rather, there is much doubt about whether, how much, or when the recovery would occur. Loans classified as loss are immediately charged off against the allowance for credit losses on loans. Therefore, there is no balance to report as of March 31, 2020 and December 31, 2019.

The following table presents term loans amortized cost by vintage and loan grade classification, and revolving loans amortized cost by loan grade classification. The loan grade classifications are based on the Bank’s internal loan grading methodology. Loan grade categories for doubtful and loss rated loans are not included on the table below as there are no loans with those grades at March 31, 2020. The vintage year represents the period the loan was originated or in the case of renewed loans, the period last renewed. The amortized balance is the loan balance less any deferred loan fees, or any purchase discounts, and plus any deferred loan costs or any loan purchase premiums. The loan categories are based on the loan segmentation in the Company's CECL reserve methodology based on loan purpose and type.


														Revolving
														Loans
		Term Loans Amortized Cost Basis by Originated Period												Amortized
												2015 and		Cost
		3/31/2020		12/31/2019		12/31/2018		12/31/2017		12/31/2016		Prior		Basis		Total
	(Dollars in thousands)
Commercial:
Pass	$	64,965	$	54,854	$	37,330	$	18,556	$	12,307	$	11,754	$	348,529	$	548,295
Watch		4,115		6,482		8,093		6,756		3,861		6,461		48,902		84,670
Special Mention		2,370		7,724		5,419		4,993		5,763		537		2,905		29,711
Substandard		55		368		23		519		2,890		107		13,034		16,996
Substandard-Nonaccrual		600		435		943		-		282		53		295		2,608
Total		72,105		69,863		51,808		30,824		25,103		18,912		413,665		682,280

CRE - Owner Occupied:
Pass		31,231		87,203		73,534		66,267		53,059		137,935		16,604		465,833
Watch		5,216		6,901		9,735		8,204		5,020		20,652		-		55,728
Special Mention		334		769		235		2,850		550		4,377		-		9,115
Substandard		-		510		-		3,440		720		472		-		5,142
Substandard-Nonaccrual		-		265		-		-		-		7,081		-		7,346
Total		36,781		95,648		83,504		80,761		59,349		170,517		16,604		543,164

CRE - Non-Owner Occupied:
Pass		57,046		152,841		90,155		123,087		69,165		237,623		3,577		733,494
Watch		-		3,379		1,460		521		7,074		6,657		-		19,091
Special Mention		-		61		-		-		-		1,373		-		1,434
Substandard		-		-		-		-		-		989		-		989
Substandard-Nonaccrual		-		-		-		-		-		-		-		-
Total		57,046		156,281		91,615		123,608		76,239		246,642		3,577		755,008

Land and contruction:
Pass		44,780		49,617		28,182		1,560		-		1,398		1,581		127,118
Watch		7,613		12,922		-		-		-		-		-		20,535
Special Mention		4,122		-		-		-		-		-		-		4,122
Substandard		1,583		-		-		-		-		-		-		1,583
Substandard-Nonaccrual		-		-		-		-		-		-		-		-
Total		58,098		62,539		28,182		1,560		-		1,398		1,581		153,358

Home equity:
Pass		-		-		824		-		-		-		109,085		109,909
Watch		-		-		-		281		-		-		5,750		6,031
Special Mention		-		-		-		-		-		-		100		100
Substandard		-		-		-		-		-		146		1,456		1,602
Substandard-Nonaccrual		-		-		-		-		-		126		-		126
Total		-		-		824		281		-		272		116,391		117,768

Multifamily:
Pass		9,939		48,689		18,764		30,371		18,187		43,011		844		169,805
Watch		-		-		-		-		846		401		-		1,247
Special Mention		-		1,225		-		598		-		-		-		1,823
Substandard		-		-		-		-		-		-		-		-
Substandard-Nonaccrual		-		-		-		-		-		-		-		-
Total		9,939		49,914		18,764		30,969		19,033		43,412		844		172,875

Residential mortgage:
Pass		1,722		11,744		4,205		11,992		37,569		19,047		-		86,279
Watch		-		439		1,688		-		1,912		1,846		-		5,885
Special Mention		-		691		-		1,295		561		1,069		-		3,616
Substandard		-		222		-		-		-		269		-		491
Substandard-Nonaccrual		-		-		-		-		-		-		-		-
Total		1,722		13,096		5,893		13,287		40,042		22,231		-		96,271

Consumer:
Pass		15		2,980		1,589		24		14		1,051		24,941		30,614
Watch		-		37		-		-		131		-		1,013		1,181
Special Mention		-		84		-		-		-		-		-		84
Substandard		-		-		-		-		-		-		-		-
Substandard-Nonaccrual		-		-		1,566		-		-		-		-		1,566
Total		15		3,101		3,155		24		145		1,051		25,954		33,445

Total loans	$	235,706	$	450,442	$	283,745	$	281,314	$	219,911	$	504,435	$	578,616	$	2,554,169

The following table presents the amortized cost basis of collateral-dependent loans by loan classification at March 31, 2020:


		Collateral Type
		Real
		Estate		Business
		Property		Assets		Unsecured		Total
	(Dollars in thousands)
Commercial	$	1,600	$	575	$	1,252	$	3,427
Real estate:								-
CRE - Owner Occupied		5,094		-		-		5,094
CRE - Non-Owner Occupied		-		-		-		-
Land and construction		-		-		-		-
Home equity		-		-		-		-
Multifamily		-		-		-		-
Residential mortgages		-		-		-		-
Consumer		-		-		-		-
Total	$	6,694	$	575	$	1,252	$	8,521

When management determines that foreclosures are probable, expected credit losses for collateral-dependent loans are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate. The class of loan represents the primary collateral type associated with the loan. Significant quarter over quarter changes are reflective of changes in nonaccrual status and not necessarily associated with credit quality indicators like appraisal value.

The following table details the allowance for loan losses and recorded investment in loans by loan classification as of December 31, 2019, as determined in accordance with ASC 310 prior to adoption of Topic 326:


	December 31, 2019
					Allowance
	Unpaid				for Loan
	Principal		Recorded		Losses
	Balance		Investment		Allocated
	(Dollars in thousands)
With no related allowance recorded:
Commercial	$	2,113	$	2,113	$	—
Real estate:
CRE		5,094		5,094		—
Home Equity		360		360		—
Total with no related allowance recorded		7,567		7,567		—

With an allowance recorded:
Commercial		2,697		2,697		1,835
Total with an allowance recorded		2,697		2,697		1,835
Total	$	10,264	$	10,264	$	1,835

Classified loans were $39,603,000, or 0.97% of total assets, at March 31, 2020, compared to $25,200,000, or 0.81% of total assets, at March 31, 2019 and $32,579,000, or 0.79% of total assets, at December 31, 2019. The increase in classified assets for the first quarter of 2020, compared to the fourth quarter of 2019 was primarily due to two CRE secured and one commercial lending relationships that were move to classified assets during the first quarter of 2020.

The book balance of troubled debt restructurings at March 31, 2020 was $1,015,000, which included $573,000 of nonaccrual loans and $442,000 of accruing loans. The book balance of troubled debt restructurings at December 31, 2019 was $1,039,000, which included $590,000 of nonaccrual loans and $449,000 of accruing loans. Approximately $12,000 and $20,000 of specific reserves were established with respect to these loans as of March 31, 2020 and December 31, 2019, respectively.

The following table presents loans by class modified as troubled debt restructurings for the periods indicated:


	During the Three Months Ended
		March 31, 2020
				Pre-modification		Post-modification
		Number		Outstanding		Outstanding
		of		Recorded		Recorded
Troubled Debt Restructurings:		Contracts		Investment		Investment
	(Dollars in thousands)
Commercial		3	$	13	$	13
Real estate:
CRE - owner occupied		—		—		—
CRE - non-owner occupied		—		—		—
Land and construction		—		—		—
Home equity		—		—		—
Multifamily		—		—		—
Residential mortgages		—		—		—
Consumer		—		—		—
Total		3	$	13	$	13

There were no new loans modified as troubled debt restructurings during the three months ended March 31, 2019.

During the three months ended March 31, 2020, there were no new loans modified as troubled debt restructurings in which the amount of principal or accrued interest owed from the borrower was forgiven or which resulted in a charge-off or change to the allowance for credit losses on loans.

A loan is considered to be in payment default when it is 30 days contractually past due under the modified terms. There were no defaults on troubled debt restructurings, within twelve months following the modification, during the three months ended March 31, 2020 and 2019.

A loan that is a troubled debt restructuring on nonaccrual status may return to accruing status after a period of at least six months of consecutive payments in accordance with the modified terms.

Following the passage of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) by Congress at the end of March, which included the $349 billion Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) to fund short-term loans for small businesses, on April 23, 2020, Congress passed the Paycheck Protection Program and Health Care Enhancement Act which included an additional $310 billion in funding for the PPP. The Company, which began taking loan applications from its small business clients immediately after the program began, received an overwhelming response. As of April 27, 2020, the Company had processed a total of 1,060 PPP loan applications with potential outstanding balances of $330 million.

In addition, with the March 13, 2020 declaration of a National State of Emergency and passage of the CARES Act, on March 22, 2020, federal bank regulators announced guidance that offers temporary relief from troubled debt restructuring (“TDR”) accounting for loan payment deferrals for certain customers whose businesses are experiencing economic hardship due to Coronavirus. In response to these customer’s needs, we have made accommodations for initial payment deferrals of up to 90 days with the potential for up to an additional 90 days, if requested and depending on the circumstances. All applicable fees have been waived. As of April 27, 2020, we had received 319 requests for payment deferrals, with balances totaling approximately $170 million, or 7%, of our loan portfolio ranging across many different industries but primarily for dentists and physicians ($35 million) and commercial real estate ($54 million). Substantially all loans to borrowers requesting deferrals were supported by personal guarantees.