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Loans and Allowance for Credit Losses on Loans

6 Months Ended

Jun. 30, 2020

Allowance for Credit Losses on Loans

5) Loans and 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. Included in commercial loans are $324,550,000 of SBA Paycheck Protection Program ("PPP") loans.

Commercial Real Estate (“CRE”)

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 residential properties with five or more units. 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:


	June 30,		December 31,
	2020		2019

	(Dollars in thousands)
Loans held-for-investment:
Commercial	$	878,393	$	603,345
Real estate:
CRE - owner occupied		553,463		548,907
CRE - non-owner occupied		725,776		767,821
Land and construction		138,284		147,189
Home equity		112,679		151,775
Multifamily		169,637		180,623
Residential mortgages		95,033		100,759
Consumer and other		22,759		33,744
Loans		2,696,024		2,534,163
Deferred loan fees, net		(9,635)		(319)
Loans, net of deferred fees		2,686,389		2,533,844
Allowance for credit losses on loans⁽¹⁾		(45,444)		(23,285)
Loans, net	$	2,640,945	$	2,510,559

⁽¹⁾Allowance for credit losses on loans at June 30, 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.

Changes in the allowance for credit losses on loans were as follows for the three months ended June 30, 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	$	12,801	$	7,737	$	15,645	$	2,603	$	1,746	$	1,622	$	708	$	1,841	$	44,703
Charge-offs		(465)		—		—		—		—		—		—		—		(465)
Recoveries		46		1		—		13		31		—		—		1		92
Net (charge-offs) recoveries		(419)		1		—		13		31		—		—		1		(373)
Provision for credit losses on loans		797		809		(196)		(64)		74		206		117		(629)		1,114
End of period balance	$	13,179	$	8,547	$	15,449	$	2,552	$	1,851	$	1,828	$	825	$	1,213	$	45,444

Changes in the allowance for loan losses were as follows for the three months ended June 30, 2019:


	Commercial		Real Estate		Consumer		Total

	(Dollars in thousands)
Beginning of period balance	$	15,557	$	11,671	$	90	$	27,318
Charge-offs		(76)		—		—		(76)
Recoveries		87		42		—		129
Net recoveries		11		42		—		53
Provision (credit) for loan losses		(334)		(406)		—		(740)
End of period balance	$	15,234	$	11,307	$	90	$	26,631

Changes in the allowance for credit losses on loans were as follows for the six months ended June 30, 2020:


			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		(1,135)		—		—		—		—		—		—		(3)		(1,138)
Recoveries		255		1		—		32		54		—		—		1		343
Net (charge-offs) recoveries		(880)		1		—		32		54		—		—		(2)		(795)
Provision for credit losses on loans		7,269		1,552		3,777		1,062		476		575		147		(474)		14,384
End of period balance	$	13,179	$	8,547	$	15,449	$	2,552	$	1,851	$	1,828	$	825	$	1,213	$	45,444

Changes in the allowance for loan losses were as follows for the six months ended June 30, 2019:


	Commercial		Real Estate		Consumer		Total

	(Dollars in thousands)
Beginning of period balance	$	17,061	$	10,671	$	116	$	27,848
Charge-offs		(302)		—				(302)
Recoveries		802		84		—		886
Net recoveries		500		84		—		584
Provision (credit) for loan losses		(2,327)		552		(26)		(1,801)
End of period balance	$	15,234	$	11,307	$	90	$	26,631

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
					Consumer
	Commercial		Real Estate		and other		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		598,535		1,891,620		33,744		2,523,899
Total loan balance	$	603,345	$	1,897,074	$	33,744	$	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 June 30, 2020:


						Restructured
	Nonaccrual		Nonaccrual			and Loans
	with no Specific		with Specific			over 90 Days
	Allowance for		Allowance for			Past Due
	Credit		Credit			and Still
	Losses		Losses			Accruing	Total

	(Dollars in thousands)
Commercial	$	747	$	1,669	$	668	$	3,084
Real estate:
CRE - Owner Occupied		3,679		—		—		3,679
CRE - Non-Owner Occupied		—		—		—		—
Land and construction		—		—		—		—
Home equity		898		—		—		898
Multifamily		—		—		—		—
Residential mortgages		—		—		—		—
Consumer and other		—		1,464		—		1,464
Total	$	5,324	$	3,133	$	668	$	9,125

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:


	June 30, 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	$	5,195	$	1,873	$	988	$	8,056	$	870,337	$	878,393
Real estate:
CRE - Owner Occupied		—		—		29		29		553,434		553,463
CRE - Non-Owner Occupied		—		—		—		—		725,776		725,776
Land and construction		—		—		—		—		138,284		138,284
Home equity		—		—		898		898		111,781		112,679
Multifamily		—		—		—		—		169,637		169,637
Residential mortgages		—		—		—		—		95,033		95,033
Consumer and other		1,057		—		1,464		2,521		20,238		22,759
Total	$	6,252	$	1,873	$	3,379	$	11,504	$	2,684,520	$	2,696,024


	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 and other		—		—		—		—		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 $11,504,000 and $15,315,000 at June 30, 2020 and December 31, 2019, respectively, of which $2,844,000 and $7,413,000 were on nonaccrual, respectively. At June 30, 2020, there were also $5,613,000 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:

Special Mention. A Special Mention asset has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in a deterioration of the repayment prospects for the asset or in the credit position at some future date. Special Mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

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 June 30, 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 June 30, 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 purchase discounts, and plus 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
		2020		2019		2018		2017		2016		Prior		Basis		Total

	(Dollars in thousands)
Commercial:
Pass and Watch	$	404,010	$	47,578	$	36,471	$	19,571	$	10,601	$	15,674	$	292,448	$	826,353
Special Mention		30,835		-		-		-		320		-		2,607		33,762
Substandard		926		-		72		604		2,596		624		11,040		15,862
Substandard-Nonaccrual		1,449		59		340		-		178		61		329		2,416
Total		437,220		47,637		36,883		20,175		13,695		16,359		306,424		878,393

CRE - Owner Occupied:
Pass and Watch		78,779		79,282		78,384		60,021		52,486		140,208		16,443		505,603
Special Mention		37,899		-		232		-		-		2,619		-		40,750
Substandard		-		-		-		2,250		715		466		-		3,431
Substandard-Nonaccrual		3,102		548		-		-		-		29		-		3,679
Total		119,780		79,830		78,616		62,271		53,201		143,322		16,443		553,463

CRE - Non-Owner Occupied:
Pass and Watch		101,876		137,054		78,019		110,390		60,316		175,221		3,885		666,761
Special Mention		46,314		-		1,802		-		4,299		5,568		-		57,983
Substandard		1,032		-		-		-		-		-		-		1,032
Substandard-Nonaccrual		-		-		-		-		-		-		-		-
Total		149,222		137,054		79,821		110,390		64,615		180,789		3,885		725,776

Land and contruction:
Pass and Watch		60,938		47,934		14,255		1,560		-		1,383		2,225		128,295
Special Mention		8,406		-		-		-		-		-		-		8,406
Substandard		1,583		-		-		-		-		-		-		1,583
Substandard-Nonaccrual		-		-		-		-		-		-		-		-
Total		70,927		47,934		14,255		1,560		-		1,383		2,225		138,284

Home equity:
Pass and Watch		276		-		89		-		-		-		108,875		109,240
Special Mention		-		-		-		-		-		-		1,718		1,718
Substandard		-		-		-		-		-		143		680		823
Substandard-Nonaccrual		-		-		-		-		-		123		775		898
Total		276		-		89		-		-		266		112,048		112,679

Multifamily:
Pass and Watch		17,007		40,571		18,628		27,700		16,401		37,322		845		158,474
Special Mention		5,967		-		-		-		-		5,196		-		11,163
Substandard		-		-		-		-		-		-		-		-
Substandard-Nonaccrual		-		-		-		-		-		-		-		-
Total		22,974		40,571		18,628		27,700		16,401		42,518		845		169,637

Residential mortgage:
Pass and Watch		8,607		10,237		4,970		11,011		34,304		15,889		-		85,018
Special Mention		6,848		-		-		1,285		557		1,061		-		9,751
Substandard		-		-		-		-		-		264		-		264
Substandard-Nonaccrual		-		-		-		-		-		-		-		-
Total		15,455		10,237		4,970		12,296		34,861		17,214		-		95,033

Consumer and other:
Pass and Watch		16		3,018		1,567		23		135		1,028		15,427		21,214
Special Mention		81		-		-		-		-		-		-		81
Substandard		-		-		-		-		-		-		-		-
Substandard-Nonaccrual		-		-		1,464		-		-		-		-		1,464
Total		97		3,018		3,031		23		135		1,028		15,427		22,759

Total loans	$	815,951	$	366,281	$	236,293	$	234,415	$	182,908	$	402,879	$	457,297	$	2,696,024

The following table provides a summary of the loan portfolio by loan type and credit quality classification for the period indicated:


	December 31, 2019
	Nonclassified		Classified		Total

Commercial	$	599,143		4,202	$	603,345
Real estate:
CRE - Owner Occupied		538,229		10,678		548,907
CRE - Non-Owner Occupied		761,801		6,020		767,821
Land and construction		144,108		3,081		147,189
Home equity		149,131		2,644		151,775
Multifamily		180,623		—		180,623
Residential mortgages		100,262		497		100,759
Consumer and other		28,287		5,457		33,744
Total	$	2,501,584	$	32,579	$	2,534,163

The following table presents the amortized cost basis of collateral-dependent loans by loan classification at June 30, 2020:


		Collateral Type
		Real
		Estate		Business
		Property		Assets		Unsecured		Total

	(Dollars in thousands)
Commercial	$	60	$	1,478	$	131	$	1,669
Real estate:								-
CRE - Owner Occupied				-		-		-
CRE - Non-Owner Occupied		-		-		-		-
Land and construction		-		-		-		-
Home equity		-		-		-		-
Multifamily		-		-		-		-
Residential mortgages		-		-		-		-
Consumer and other		1,464		-		-		1,464
Total	$	1,524	$	1,478	$	131	$	3,133

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:



					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

The book balance of troubled debt restructurings at June 30, 2020 was $753,000, which included $597,000 of nonaccrual loans and $156,000 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 $9,000 and $20,000 of specific reserves were established with respect to these loans as of June 30, 2020 and December 31, 2019, respectively.

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


	During the Six Months Ended
		June 30, 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 and other		—		—		—
Total		3	$	13	$	13

There were no new loans modified as troubled debt restructurings during the three months ended June 30, 2020. There were no new loans modified as troubled debt restructurings during the three and six months ended June 30, 2019.

During the three and six months ended June 30, 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 June 30, 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.