PACIFIC MERCANTILE BANCORP
Forward Looking Statements
Statements contained in this Quarterly Report on Form 10-Q (this "Report") that
are not historical facts or that discuss our expectations, beliefs or views,
including those regarding our proposed merger with Banc of California, Inc.
("Banc of California "), our future financial performance and our business,
trends and expectations regarding the markets in which we operate, and our
future plans, including the credit exposure of certain loan products and other
components of our business that could be impacted by the COVID-19 pandemic,
constitute "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of
the Securities Exchange Act of 1934, as amended (the "Exchange Act").
Forward-looking statements can be identified by the fact that they do not relate
strictly to historical or current facts. Often, they include words such as
"believe," "expect," "anticipate," "intend," "plan," "estimate," "project,"
"forecast," or words of similar meaning, or future or conditional verbs such as
"will," "would," "should," "could," or "may." The information contained in such
forward-looking statements is based on current information available to us and
on assumptions that we make about future economic and market conditions and
other events over which we do not have control. In addition, our business and
the markets in which we operate are subject to a number of risks and
uncertainties. Such risks and uncertainties, and the occurrence of events in the
future or changes in circumstances that had not been anticipated, could cause
our financial condition or actual operating results in the future to differ
materially from our expected financial condition or operating results that are
set forth in the forward-looking statements contained in this Report and could,
therefore, also affect the price performance of our shares.
In addition to the risk of incurring loan losses and provision for loan losses,
which is an inherent risk of the banking business, these risks and uncertainties
include, but are not limited to, the following: the possibility that the merger
with Banc of California does not close when expected or at all because required
regulatory, shareholder or other approvals, financial tests or other conditions
to closing are not received or satisfied on a timely basis or at all; changes in
Banc of California's or our stock price before closing, including as a result of
the companies' financial performance prior to closing, general stock market
movements, and the performance of other financial companies and peer group
companies; the risk that the anticipated benefits of the merger may not be fully
realized or may take longer to realize than expected, including as a result of
changes in general economic and market conditions, interest and exchange rates,
monetary policy, laws and regulations and their enforcement, and the degree of
competition in the geographic and business areas in which Banc of California and
we operate; Banc of California's ability to promptly and effectively integrate
our businesses following the merger; the reaction to the transaction of the
companies' customers, employees and counterparties; diversion of management time
on merger-related issues; deteriorating economic conditions and macroeconomic
factors such as unemployment rates and the volume of bankruptcies, as well as
changes in monetary, fiscal or tax policy to address the impact of COVID-19, any
of which could cause us to incur additional loan losses and adversely affect our
results of operations in the future; the risk that the credit quality of our
borrowers declines; potential declines in the value of the collateral for
secured loans; the risk that steps we have taken to strengthen our overall
credit administration are not effective; the risk of a recession in the United
States economy, and domestic or international economic conditions, which could
cause us to incur additional loan losses and adversely affect our results of
operations in the future; the risk that our interest margins and, therefore, our
net interest income will be adversely affected by changes in prevailing interest
rates; the risk that we will not succeed in further reducing our remaining
nonperforming assets, in which event we would face the prospect of further loan
charge-offs and write-downs of other real estate owned and would continue to
incur expenses associated with the management and disposition of those assets;
the risk that we will not be able to manage our interest rate risks effectively,
in which event our operating results could be harmed; the prospect of changes in
government regulation of banking and other financial services organizations,
which could impact our costs of doing business and restrict our ability to take
advantage of business and growth opportunities; the risk that our efforts to
develop a robust commercial banking platform may not succeed; and the risk that
we may be unable to realize our expected level of increasing deposit inflows.
Many of the foregoing risks and uncertainties are, and will be, exacerbated by
the COVID-19 pandemic and any worsening of the global business and economic
environment as a result. Readers of this Report are encouraged to review the
additional information regarding these and other risks and uncertainties to
which our business is subject that is contained in Part I, Item 1A of our Annual
Report on Form 10-K for the year ended December 31, 2020 (as amended, the "2020
Form 10-K") that we filed with the Securities and Exchange Commission ("SEC") on
March 15, 2021 , as such information may be updated from time to time in
subsequent Quarterly Reports on Form 10-Q that we file with the SEC . We urge you
to read those risk factors in conjunction with your review of the following
discussion and analysis of our results of operations for the three months ended,
and our financial condition at, March 31, 2021 .
Due to the risks and uncertainties we face, readers are cautioned not to place
undue reliance on the forward-looking statements contained in this Report, which
speak only as of the date of this Report, or to make predictions about future
performance based solely on historical financial performance. We also disclaim
any obligation to update forward-looking
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Table of Contents statements contained in this Report as a result of new information, future events or otherwise, except as may otherwise be required by law. Recent Developments
OnMarch 22, 2021 ,Pacific Mercantile Bancorp entered into an Agreement and Plan of Merger (the "Merger Agreement") with Banc of California. The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein,Pacific Mercantile Bancorp will merge with and into Banc of California (the "Merger"), with Banc of California surviving the Merger. Promptly following the Merger, the Bank will merge with and into Banc of California's wholly-owned bank subsidiary,Banc of California, National Association , a national banking association (the "Bank Merger").Banc of California, National Association will be the surviving bank in the Bank Merger. The Merger Agreement was adopted and approved by the Board of Directors of each ofPacific Mercantile Bancorp and Banc of California. The closing of the Merger, which is expected to occur in the third quarter of 2021, is contingent upon shareholder approvals and receipt of necessary regulatory approvals, along with the satisfaction of other customary closing conditions.
Overview
The following discussion presents information about our consolidated results of operations, financial condition, liquidity and capital resources and should be read in conjunction with our consolidated financial statements and the notes thereto included in Item 1 above of this Report. Our principal operating subsidiary isPacific Mercantile Bank (the "Bank"), which is aCalifornia state chartered bank. The Bank accounts for substantially all of our consolidated revenues, expenses and income and our consolidated assets and liabilities. Accordingly, the following discussion focuses primarily on the Bank's results of operations and financial condition. As ofMarch 31, 2021 , our total assets, net loans and total deposits were$1.6 billion ,$1.2 billion and$1.4 billion , respectively. The Bank, which is headquartered inOrange County, California , approximately 40 miles south ofLos Angeles , conducts a commercial banking business inOrange ,Los Angeles ,San Bernardino andSan Diego counties inSouthern California . The Bank is also a member of theFederal Reserve System and its deposits are insured, to the maximum extent permitted by law, by theFederal Deposit Insurance Corporation (the "FDIC"). For the three months endedMarch 31, 2021 and 2020, we operated as one reportable segment, Commercial Banking. Unless the context otherwise requires, the "Company," "we," "our," "ours," and "us" refer toPacific Mercantile Bancorp and its consolidated subsidiaries. 40 -------------------------------------------------------------------------------- Table of Contents COVID-19 Impact The outbreak of the novel coronavirus ("COVID-19") and theFederal Reserve's response to the economic challenges have resulted in an uncertain and rapidly evolving economy. Governmental response to combat this pandemic has resulted in approximately 25% of our staff to shift to work remotely. Our business continuity plans have been activated by COVID-19 and we have been able to fully support our remote workforce and have the ability to support all employees in a remote work environment. These remote work arrangements have not adversely impacted our ability to serve our clients, and have not had an impact on our financial reporting systems or the internal controls we have over financial reporting, disclosures and related procedures. The most significant impact of COVID-19 on our business has been to the quality of our loan portfolio and to net interest income as short-term interest rates sharply declined. We have increased the qualitative factors used in the determination of the adequacy of our allowance for loan and lease loss in anticipation of the impact that COVID-19 will have on our clients and their ability to fulfill their obligations. We have no certainty that the provisions we made during 2020 will be sufficient to absorb the losses that stem from the impact of COVID-19 on our clients. As the longer term effects on our clients from the COVID-19 pandemic become more apparent, we may need to charge-off some or all of the balance on certain loans and make further provisions to increase our allowance for loan and lease losses. These potential additional provisions for loan and lease losses will have a direct impact upon our capital, including the potential need to reevaluate the need for a valuation allowance on our deferred tax asset. At this time, we don't expect that there would be any material impairment to the valuation of other long-lived assets, right of use assets, or our investment securities. The Bank is currently Well Capitalized under federal banking regulations that apply to allUnited States -based banks, with approximately$76 million of capital in excess of what is required for the Bank to be Well Capitalized using the ratio of Total Capital to Risk Weighted Assets. The Company has approximately$10 million of capital that it could contribute to the Bank should it be needed. In the event that future loan and leases loss and/or tax provisions reduce our capital surplus, we would be required to undertake measures to return the Bank's capital ratios to Well Capitalized levels, which could include but not be limited to raising additional capital or reducing the Bank's asset size. We believe that we would have access to equity and debt markets to secure additional capital for the Bank should the need arise, but we have no certainty regarding the extent of the availability of these markets at the time such need would arise. Increased demand for liquidity by our clients is another impact that we anticipate could occur should the COVID-19 effects be prolonged. As ofMarch 31, 2021 the Company and the Bank's on-balance sheet liquidity was very strong and combined with our contingent liquidity resources, we believe that the Bank has sufficient resources to meet the liquidity needs of our clients. In response to COVID-19, theFederal Reserve has made other provisions that could assist the Bank in satisfying its liquidity needs, such as reducing our reserve requirement to zero, expanding access to the discount window through collateral pledging and extension of term borrowings. 41 -------------------------------------------------------------------------------- Table of Contents Results of Operations Operating Results for the Three Months EndedMarch 31, 2021 and 2020
Our operating results for the three months ended
Three Months Ended March 31, 2021 vs. 2020
2021 2020 % Change
(Dollars in thousands)
Interest income $ 13,698 $ 14,769 (7.3) %
Interest expense 959 3,296 (70.9) %
Provision for loan and lease losses - 6,200 (100.0)
Noninterest income 1,738 1,095 58.7 %
Noninterest expense 9,664 9,720 (0.6) %
Income tax expense (benefit) 1,425 (991) (243.8) %
Net income (loss) $ 3,388 $ (2,361) (243.5) %
Interest Income
Three Months Ended March 31, 2021 and 2020
Total interest income decreased 7.3% to $13.7 million for the three months
ended March 31, 2021 from $14.8 million for the three months ended March 31,
2020 . This was primarily due to a decrease in interest earned on loans as a
result of a decrease in the average yield during the three months ended
March 31, 2021 as compared to the same period prior year. During the three
months ended March 31, 2021 and 2020, interest income on loans was $13.3 million
and $13.8 million , respectively, yielding 4.32% and 4.96% on average loan
balances of $1.25 billion and $1.12 billion , respectively. The decrease in
average loan yields is primarily attributable to the Board of Governors of the
Federal Reserve System ("Federal Reserve Board") cutting short-term interest
rates by 150 basis points near the end of the first quarter of 2020 in response
to the economic conditions caused by the outbreak of COVID, and is partially
offset by increased fee income and average loan balance related to our
participation in PPP.
During the three months ended March 31, 2021 and 2020, interest income from our
securities available-for-sale and stock was $315 thousand and $261 thousand ,
respectively, yielding 2.38% and 2.93% on average balances of $53.7 million and
$35.8 million , respectively. Interest income from our short-term investments,
including our Federal Funds sold and interest-bearing deposits, was $52 thousand
and $721 thousand for the three months ended March 31, 2021 and 2020,
respectively, yielding 0.10% and 1.31% on average balances of $201.5 million and
$220.6 million , respectively. The decrease in interest income from our
short-term investments was primarily attributable to the Federal Reserve Board
cutting short-term interest rates by 150 basis points near the end of the first
quarter of 2020 in response to the economic conditions caused by the outbreak of
COVID. As a result, total interest income on investments decreased for the three
months ended March 31, 2021 as compared to the three months ended March 31,
2020 .
Interest Expense
Three Months Ended March 31, 2021 and 2020
Total interest expense decreased 70.9% to $959 thousand for the three months
ended March 31, 2021 from $3.3 million for the three months ended March 31,
2020 . The decrease was primarily due to a decrease in our cost of funds from
1.57% at March 31, 2020 to 0.51% at March 31, 2021 , in addition to a decrease in
the average balance of interest-bearing liabilities from $846.1 million at
March 31, 2020 to $757.5 million at March 31, 2021 , which consisted of deposits,
borrowings and junior subordinated debentures. The decrease to our cost of funds
is primarily attributable to our ongoing focus on reducing costs of deposits by
monitoring and lowering interest rates in response to the current interest rate
environment and actively
managing our deposit portfolio away from higher costing money market deposits
and certificates of deposit and into noninterest bearing deposits. Interest
expense on our certificates of deposit for the three months ended March 31, 2021
and 2020 was $586 thousand and $1.6 million , respectively, with a cost of funds
of 1.16% and 2.30% on average balances of $204.6 million and $276.0 million ,
respectively.
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Net Interest Margin
One of the principal determinants of a bank's income is its net interest income,
which is the difference between (i) the interest that a bank earns on loans,
investment securities and other interest earning assets, on the one hand, and
(ii) its interest expense, which consists primarily of the interest it must pay
to attract and retain deposits and the interest that it pays on borrowings and
other interest-bearing liabilities, on the other hand. As a general rule, all
other things being equal, the greater the difference or "spread" between the
amount of our interest income and the amount of our interest expense, the
greater will be our net income; whereas, a decline in that difference or
"spread" will generally result in a decline in our net income.
A bank's interest income and interest expense are affected by a number of
factors, some of which are outside of its control, including national and local
economic conditions and the monetary policies of the Federal Reserve Board which
affect interest rates, competition in the market place for loans and deposits,
the demand for loans and the ability of borrowers to meet their loan payment
obligations. Net interest income, when expressed as a percentage of total
average interest earning assets, is a banking organization's "net interest
margin."
The following tables set forth information regarding our average balances,
yields on interest earning assets, interest expense on interest-bearing
liabilities, the interest rate spread and the interest rate margin for the three
months ended March 31, 2021 and 2020. Average balances are calculated based on
average daily balances.
Three Months Ended March 31,
2021 2020
Interest Average Interest Average
Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate
(Dollars in thousands)
Interest-earning assets
Short-term investments(1) $ 201,498 $ 52 0.10 % $ 220,598 $ 721 1.31 %
Securities available for sale and stock(2) 53,739 315 2.38 % 35,844 261 2.93 %
Loans(3) 1,250,846 13,331 4.32 % 1,116,999 13,787 4.96 %
Total interest-earning assets 1,506,083 13,698 3.69 % 1,373,441 14,769 4.32 %
Noninterest-earning assets
Cash and due from banks 17,800 16,774
All other assets 22,788 25,151
Total assets $ 1,546,671 $ 1,415,366
Interest-bearing liabilities:
Interest-bearing checking accounts $ 140,205 $ 27 0.08 % $ 103,355 $ 87 0.34 %
Money market and savings accounts 392,543 212 0.22 % 415,533 1,298 1.26 %
Certificates of deposit 204,600 586 1.16 % 276,045 1,580 2.30 %
Other borrowings 2,667 11 1.67 % 33,626 133 1.59 %
Junior subordinated debentures 17,527 123 2.85 % 17,527 198 4.54 %
Total interest bearing liabilities 757,542 959 0.51 % 846,086 3,296 1.57 %
Noninterest bearing liabilities
Demand deposits 610,905 398,547
Accrued expenses and other liabilities 17,248 19,704
Shareholders' equity 160,976 151,029
Total liabilities and shareholders' equity $ 1,546,671 $ 1,415,366
Net interest income $ 12,739 $ 11,473
Net interest income/spread 3.18 % 2.75 %
Net interest margin 3.43 % 3.36 %
(1)Short-term investments consist of Federal Funds sold and interest bearing
deposits that we maintain at other financial institutions.
(2)Stock consists of FHLB stock and FRBSF stock.
(3)Loans include the average balance of nonaccrual loans.
43-------------------------------------------------------------------------------- Table of Contents The following table sets forth changes in interest income, including loan fees, and interest paid in the three months endedMarch 31, 2021 and 2020 and the extent to which those changes were attributable to changes in (i) the volumes of or the rates of interest earned on interest-earning assets and (ii) the volumes of or the rates of interest paid on our interest-bearing liabilities. Three
Months Ended
Three Months Ended
Increase (Decrease) due to Changes in
Total Increase
Volume Rates (Decrease)
(Dollars in thousands)
Interest income
Short-term investments(1) $ (57) $ (612) $ (669)
Securities available for sale and stock(2) 112 (58) 54
Loans 1,547 (2,003) (456)
Total earning assets 1,602 (2,673) (1,071)
Interest expense
Interest-bearing checking accounts 23 (83) (60)
Money market and savings accounts (68) (1,018) (1,086)
Certificates of deposit (339) (655) (994)
Borrowings (127) 5 (122)
Junior subordinated debentures - (75) (75)
Total interest-bearing liabilities (511) (1,826) (2,337)
Net interest income $ 2,113 $ (847) $ 1,266
(1)Short-term investments consist of Federal Funds sold and interest bearing
deposits that we maintain at other financial institutions.
(2)Stock consists of FHLB stock and FRBSF stock.
Provision for Loan and Lease Losses
We maintain reserves to provide for loan losses that occur in the ordinary
course of the banking business. When it is determined that the payment in full
of a loan has become unlikely, the carrying value of the loan is reduced
("written down") to what management believes is its realizable value or, if it
is determined that a loan no longer has any realizable value, the carrying value
of the loan is written off in its entirety (a loan "charge-off"). Loan
charge-offs and write-downs are charged against our allowance for loan and lease
losses ("ALLL"). The amount of the ALLL is increased periodically to replenish
the ALLL after it has been reduced due to loan write-downs or charge-offs. The
ALLL also is increased or decreased periodically to reflect increases or
decreases in the volume of outstanding loans and to take account of changes in
the risk of probable loan losses due to financial performance of borrowers, the
value of collateral securing nonperforming loans or changing economic
conditions. Increases in the ALLL are made through a "provision for loan and
lease losses" that is recorded as an expense in the statement of operations.
Increases in the ALLL are also recognized through the recovery of charged-off
loans which are added back to the ALLL. As such, recoveries are a direct offset
for a provision for loan and lease losses that would otherwise be needed to
replenish or increase the ALLL.
We employ economic models and data that conform to bank regulatory guidelines
and reflect sound industry practices as well as our own historical loan loss
experience to determine the sufficiency of the ALLL and any provisions needed to
increase or replenish the ALLL. Those determinations involve judgments and
assumptions about current economic conditions and external events that can
impact the ability of borrowers to meet their loan obligations. However, the
duration and impact of these factors cannot be determined with any certainty. As
such, unanticipated changes in economic or market conditions, bank regulatory
guidelines or the sound practices that are used to determine the sufficiency of
the ALLL, could require us to record additional, and possibly significant,
provisions to increase the ALLL. This would have the effect of reducing
reportable income or, in the most extreme circumstance, creating a reportable
loss. In addition, the Federal Reserve Bank and the California Department of
Financial Protection and Innovation ("CDFPI"), as an integral part of their
regulatory oversight, periodically review the adequacy of our ALLL. These
agencies may require us to make additional provisions for perceived potential
loan losses, over and above the provisions that we have already made, the effect
of which would be to reduce our income or increase any losses we might incur.
We recorded no provision for loan and lease losses during the three months
ended March 31, 2021 as the level of allowance built earlier in the prior year
in anticipation of credits impacted by COVID-19 eventually migrating to
nonperforming status continued to be sufficient to reflect the actual migration
trends experienced in the portfolio. We recorded a provision for
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loan and lease losses of $6.2 million during the three months ended March 31,
2020 as a result of total charge-offs of $2.3 million , an increase in classified
and non-performing loans, and qualitative factor increases related to COVID-19.
See "-Financial Condition-Nonperforming Assets and Allowance for Loan and Lease
Losses" below in this Item 2 for additional information regarding the ALLL.
Noninterest Income
The following table identifies the components of and the percentage changes in
noninterest income during the three months ended March 31, 2021 and 2020:
Three Months Ended
Percentage
Amount Amount Change
2021 2020 2021 vs. 2020
(Dollars in thousands)
Service fees on deposits and other banking
services $ 819 $ 522 56.9 %
Net gain on sale of securities available for sale 140 - 100.0 %
Net (loss) gain on sale of other assets (45) 6 (850.0) %
Other noninterest income 824 567 45.3 %
Total noninterest income $ 1,738 $ 1,095 58.7 %
Three Months Ended
Noninterest income increased by$643 thousand , or 58.7%, for the three months endedMarch 31, 2021 as compared to the three months endedMarch 31, 2020 , primarily as a result of: •An increase of$297 thousand in service fees on loans and deposits and other banking services during the first quarter of 2021 as compared to the same quarter of the prior year; and •An increase of$257 thousand in other noninterest income which included credit card fee income and referral fees related to the outsourcing of PPP loan servicing; and •Net gain on sale of securities available for sale of$140 thousand in the current quarter that did not occur same period prior year; Noninterest Expense The following table sets forth the principal components and the amounts of, and the percentage changes in, noninterest expense during the three months endedMarch 31, 2021 and 2020. Three Months Ended March 31, 2021 2020 2021 vs. 2020 Amount Amount Percent Change (Dollars in thousands) Salaries and employee benefits$ 5,661 $ 6,069 (6.7) % Occupancy 656 671 (2.2) % Equipment and depreciation 495 452 9.5 % Data processing 562 645 (12.9) % FDIC expense 285 193 47.7 % Professional fees 882 861 2.4 % Merger related expenses 387 - 100.0 % Business development 121 172 (29.7) % Loan related expense 158 125 26.4 % Insurance 71 63 12.7 % Other operating expenses (1) 386 469 (17.7) % Total noninterest expense$ 9,664 $ 9,720 (0.6) %
(1)Other operating expenses primarily consist of telephone, investor relations, promotional, regulatory expenses, and correspondent bank fees.
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Three Months Ended March 31, 2021 and 2020
Noninterest expense decreased $56 thousand , or 0.6%, for the three months
ended March 31, 2021 as compared to the three months ended March 31, 2020 ,
primarily as a result of:
•A decrease of $408 thousand in salaries and employee benefits primarily related
to staffing changes made at the Bank during the second quarter of 2020; and
•A decrease of $83 thousand in data processing fees primarily related to lower
credit card volume; and
•A decrease of $83 thousand in other operating expenses due to cost savings
initiatives implemented during 2020; partially offset by
•Legal and accounting expenses of $387 thousand related to the proposed merger
with Banc of California; and
•An increase of $92 thousand in FDIC expenses based on an increased average
asset size that resulted from our participation in PPP.
Provision for Income Tax
For the three months endedMarch 31, 2021 , we had income tax expense of$1.4 million as a result of our operating income, compared to an income tax benefit of$991 thousand for the three months endedMarch 31, 2020 , as a result of our operating loss. During the three months endedMarch 31, 2021 andMarch 31, 2020 , management determined that there continued to be enough positive evidence to support no valuation allowance on our deferred tax asset, and based on this evaluation, concluded that the Company would be able to realize the deferred tax asset within the period that our operating losses may be carried forward. Positive evidence as ofMarch 31, 2021 included our three-year cumulative income position, forecasted net income for the year, and significant improvements in our asset quality during the quarter. In addition, negative evidence as ofMarch 31, 2020 such as an accumulated deficit, net loss for the quarter, and deterioration in asset quality were remedied over the course of the year, and resulted in retained earnings, net income, and significant decreases in nonaccrual and classified loans as ofMarch 31, 2021 . 46 -------------------------------------------------------------------------------- Table of Contents Financial Condition Assets Our total assets decreased by$8 million atMarch 31, 2021 compared toDecember 31, 2020 . The following table sets forth the composition of our interest earning assets at: December 31, March 31, 2021 2020 (Dollars in thousands) Interest-bearing deposits with financial institutions (1)$ 239,899 $ 274,245 Interest-bearing time deposits with financial institutions 1,597 1,597
7,910 7,910
Securities available for sale, at fair value 43,228 42,183
Loans (net of allowances of
1,209,587
(1)Includes interest-earning balances maintained at the FRBSF.
Investment Portfolio
Securities Available for Sale. Securities that we intend to hold for an
indefinite period of time, but which may be sold in response to changes in
liquidity needs, in interest rates, or in prepayment risks or other similar
factors, are classified as "securities available for sale". Such securities are
recorded on our balance sheet at their respective fair values and increases or
decreases in those values are recorded as unrealized gains or losses,
respectively, and are reported as other comprehensive income (loss) on our
accompanying consolidated statements of financial condition, rather than
included in or deducted from our earnings.
The following is a summary of the major components of securities available for
sale and a comparison of the amortized cost, estimated fair values and the gross
unrealized gains and losses attributable to those securities, as of March 31,
2021 and December 31, 2020 :
Gross Gross Estimated
Amortized Cost Unrealized Gain Unrealized Loss Fair Value
(Dollars in thousands)
Securities available for sale at March 31,
2021 :
Commercial mortgage backed securities
issued by U.S. Agencies $ 28,578 $
95 $ (1,283)
7,763 94 (3) 7,854
Corporate subordinated indentures 8,033 27 (76) 7,984
Total securities available for sale
216 $ (1,362)
Commercial mortgage backed securities issued by U.S. Agencies$ 20,585 $ 214 $ (126)$ 20,673 Residential mortgage backed securities issued by U.S. Agencies 14,061 379 (4) 14,436 Corporate subordinated indentures 7,035 42 (3) 7,074
Total securities available for sale
635 $ (133) $ 42,183
The amortized cost of securities available for sale at March 31, 2021 is shown
in the table below by contractual maturities taking into consideration
historical prepayments based on the prior twelve months of principal payments.
Expected maturities will differ from contractual maturities and historical
prepayments, particularly with respect to collateralized mortgage obligations,
if any, primarily because prepayment rates are affected by changes in conditions
in the interest rate market and, therefore, future prepayment rates may differ
from historical prepayment rates.
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March 31, 2021 Maturing in
One year or less Over one year through five years Over five years through ten years Over ten years Total
Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Amortized Average
Amortized Cost Yield Amortized Cost Yield Amortized Cost Yield Amortized Cost Yield Cost Yield
(Dollars in thousands)Securities available for sale:
Commercial mortgage backed securities issued byU.S. Agencies $ 896 0.84 %$ 4,823 1.29 %$ 10,664 1.13 %$ 12,195 1.40 %$ 28,578 1.27 % Residential mortgage-backed securities issued byU.S. Agencies 2,643 1.38 % 4,574 1.26 % 546 1.27 % - - % 7,763 1.30 % Corporate subordinated indentures - - 8,033 3.82 % - - - - % 8,033 3.82 % Total securities available for sale$ 3,539 1.24 %$ 17,430 2.45 %$ 11,210 1.14 %$ 12,195 1.40 %$ 44,374 1.73 % Loans The outbreak of COVID-19 will continue to have an impact on our loan portfolio as we experience a prolonged period of economic uncertainty that affects a broad range of industries in which our customers operate. Disruptions to our customers could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans. As a result of these risks, we have provided for additional losses in our provision for loan and lease losses with increased qualitative factors to reflect the current economic environment. Our participation in the PPP has allowed us to assist hundreds of our customers in securing funding from the SBA. The Bank was able to begin processing applications for PPP loans onApril 3, 2020 , the very first day the SBA began accepting applications, due to the preparations made by the Bank at the end of the first quarter. The Bank has been able to process loan applications for approximately$374 million , which was largely for the benefit of the Bank's existing clients who have been impacted by COVID-19. Our loan growth in the first quarter of 2021 is primarily due to these loans funded under the PPP. The following table sets forth the composition, by loan category, of our loan portfolio atMarch 31, 2021 andDecember 31, 2020 : March 31, 2021 December 31, 2020 Amount Percent Amount Percent (Dollars in thousands) Commercial loans, excluding PPP$ 321,319 25.8 % $ 337,427 27.6 % Commercial loans - PPP 280,562 22.5 % 229,728 18.8 % Commercial real estate loans - owner occupied 189,203 15.2 % 197,336 16.1 % Commercial real estate loans - all other 197,026 15.8 % 194,893 15.9 % Residential mortgage loans - multi-family 157,646 12.7 % 159,182 13.0 % Residential mortgage loans - single family 10,085 0.8 % 12,766 1.0 % Construction and land development loans 11,840 1.0 % 11,766 1.0 % Consumer loans 76,669 6.2 % 80,759 6.6 % Total loans 1,244,350 100.0 % 1,223,857 100.0 % Deferred loan origination costs, net 422 3,182 Allowance for loan and lease losses (17,127) (17,452) Loans, net$ 1,227,645 $ 1,209,587 Commercial loans are loans to businesses to finance capital purchases or improvements, or to provide cash flow for operations. Commercial real estate and residential mortgage loans are loans secured by trust deeds on real properties, including commercial properties and single family and multi-family residences. Construction loans are interim loans to finance specific construction projects. Land development loans are loans secured by non-arable bare land. Consumer loans include installment loans to consumers. 48 -------------------------------------------------------------------------------- Table of Contents The following table sets forth the maturity distribution of our loan portfolio (excluding single and multi-family residential mortgage loans and consumer loans) atMarch 31, 2021 : March 31, 2021 Over One Year One Year Through Over Five or Less Five Years Years Total (Dollars in thousands) Real estate loans(1) Floating rate$ 11,680 $ 23,318 $ 126,436 $ 161,434 Fixed rate 17,154 70,216 149,265 236,635 Commercial loans Floating rate 29,428 89,481 19,995 138,904 Fixed rate 71,254 370,111 21,612 462,977 Total$ 129,516 $ 553,126 $ 317,308 $ 999,950 (1)Does not include mortgage loans on single or multi-family residences or consumer loans, which totaled$167.7 million and$76.7 million , respectively, atMarch 31, 2021 . Nonperforming Assets and Allowance for Loan and Lease Losses Nonperforming Assets. Nonperforming loans consist of (i) loans on nonaccrual status which are loans on which the accrual of interest has been discontinued and include restructured loans when there has not been a history of past performance on debt service in accordance with the contractual terms of the restructured loans, and (ii) loans 90 days or more past due and still accruing interest. Nonperforming assets are comprised of nonperforming loans and other real estate owned ("OREO"), which consists of real properties that we have acquired by or in lieu of foreclosure and which we intend to offer for sale. Loans are placed on nonaccrual status when, in our opinion, the full timely collection of principal or interest is in doubt. Generally, the accrual of interest is discontinued when principal or interest payments become more than 90 days past due, unless we believe the loan is adequately collateralized and the loan is in the process of collection. However, in certain instances, we may place a particular loan on nonaccrual status earlier, depending upon the individual circumstances involved in that loan's delinquency. When a loan is placed on nonaccrual status, previously accrued but unpaid interest is reversed against current income. Subsequent collections of unpaid amounts on such a loan are applied to reduce principal when received, except when the ultimate collectability of principal is probable, in which case such payments are applied to interest and are credited to income. Nonaccrual loans may be restored to accrual status if and when principal and interest become current and full repayment is expected. Interest income is recognized on the accrual basis for impaired loans which, based on our nonaccrual policy, do not require nonaccrual treatment. The following table sets forth information regarding our nonperforming assets, as well as information regarding restructured loans, atMarch 31, 2021 andDecember 31, 2020 : At March
31, 2021 At
(Dollars in thousands)
Nonaccrual loans:
Commercial loans $ 19,426 $ 30,928
Commercial real estate 952 8,814
Consumer 181 174
Total nonaccrual loans $ 20,559 $ 39,916
Total nonaccrual loans to total loans 1.67 % 3.30 %
Loans past due 90 days and still accruing interest: Commercial loans
$ - $ 5,675
Total loans past due 90 days and still accruing interest $
- $ 5,675
Other nonperforming assets:
Other foreclosed assets 152 231
Total nonperforming assets $ 20,711 $ 40,147
Restructured loans:
Accruing loans $ 5,589 $ -
Nonaccruing loans (included in nonaccrual loans above) 3,495 6,712
Total restructured loans $ 9,084 $ 6,712
49-------------------------------------------------------------------------------- Table of Contents As the table above indicates, total nonperforming assets decreased by approximately 19.4 million, or 48%, to$20.7 million as ofMarch 31, 2021 from$40.1 million as ofDecember 31, 2020 . The decrease in our nonaccrual loans resulted primarily from$11.1 million of payoffs or pay downs on our nonaccrual loans,$10.4 million returning to accrual status,$538 thousand of charge-offs, partially offset by$2.7 million of additions during the three months endedMarch 31, 2021 . Information Regarding Impaired Loans. AtMarch 31, 2021 , loans deemed impaired totaled$26.1 million as compared to$39.9 million atDecember 31, 2020 . We had an average investment in impaired loans of$33.0 million for the three months endedMarch 31, 2021 , as compared to$17.9 million for the three months endedMarch 31, 2020 . The interest that would have been earned during the three months endedMarch 31, 2021 had the nonaccruing impaired loans remained current in accordance with their original terms was approximately$424 thousand . The following table sets forth the amount of impaired loans to which a portion of the ALLL has been specifically allocated, and the aggregate amount so allocated, in accordance with Accounting Standards Codification 310-10, and the amount of the ALLL and the amount of impaired loans for which no such allocations were made, in each case atMarch 31, 2021 andDecember 31, 2020 : March 31, 2021 December 31, 2020 % of % of Reserves for Reserves to Reserves for Reserves to Loans Loan Losses Loans Loans Loan Losses Loans (Dollars in thousands) Impaired loans with specific reserves$ 14,861 $ 1,962 13.2 %$ 19,958 $ 2,711 13.6 % Impaired loans without specific reserves 11,287 - - 19,958 - - Total impaired loans$ 26,148 $ 1,962 7.5 %$ 39,916 $ 2,711 6.8 % The$13.8 million decrease in impaired loans to$26.1 million atMarch 31, 2021 from$39.9 million atDecember 31, 2020 was primarily attributable to$11.1 million in principal payments,$10.4 million returned to accrual,$538 thousand charged-off, partially offset by$2.8 million in additions to impaired loans during the three months endedMarch 31, 2021 . Based on an internal analysis, using the current estimated fair values of the collateral or the discounted present values of the future estimated cash flows of the impaired loans, we concluded that, atMarch 31, 2021 ,$2.0 million specific reserves were required on our impaired loans and that all impaired loans were otherwise well secured and adequately collateralized. Allowance for Loan and Lease Losses. The ALLL totaled$17.1 million , representing 1.38% of total loans outstanding atMarch 31, 2021 , as compared to$17.5 million , or 1.43% of loans outstanding, atDecember 31, 2020 . Total loans atMarch 31, 2021 included$280.6 million of PPP loans that are 100% government guaranteed. The ALLL to total loans excluding the PPP loans at this date was 1.78%, which is a non-GAAP financial measure. The adequacy of the ALLL is determined through periodic evaluations of the loan portfolio and other factors that can reasonably be expected to affect the ability of borrowers to meet their loan obligations. Those factors are inherently subjective as the process for determining the adequacy of the ALLL involves some significant estimates and assumptions about such matters such as (i) economic conditions and trends and the amounts and timing of expected future cash flows of borrowers which can affect their ability to meet their loan obligations to us, (ii) the fair value of the collateral securing nonperforming loans, (iii) estimates of losses that we may incur on nonperforming loans, which are determined on the basis of historical loss experience and industry loss factors and bank regulatory guidelines, which are subject to change, and (iv) various qualitative factors. Since those factors are subject to changes in economic and other conditions and changes in regulatory guidelines or other circumstances over which we have no control, the amount of the ALLL may prove to be insufficient to cover all of the loan losses we might incur in the future. In such an event, it may become necessary for us to increase the ALLL from time to time to maintain its adequacy. Such increases are effectuated by means of a charge to income, referred to as the "provision for loan and lease losses", in our statements of our operations. See "-Results of Operations- Provision for Loan and Lease Losses, above in this Item 2. The amount of the ALLL is first determined by assigning reserve ratios for all loans. All nonaccrual loans and other loans classified as "Special Mention," "Substandard" or "Doubtful" ("classified loans" or "classification categories") and not fully collateralized are then assigned specific reserves within the ALLL, with greater reserve allocations made to loans deemed to be of a higher risk. These ratios are determined based on prior loss history and industry guidelines and loss factors, by type of loan, adjusted for current economic factors and current economic trends. Refer to Note 5, Loans and Allowance for Loan and Lease Losses, in Item 1 for definitions related to our internal asset quality indicators stated above. On a quarterly basis, we utilize a classification based loan loss migration model as well as review individual loans in determining the adequacy of the ALLL. Our loss migration analysis tracks a certain number of quarters of loan loss history and industry loss factors to determine historical losses by classification category for each loan type, except certain consumer loans 50 -------------------------------------------------------------------------------- Table of Contents (automobile, mortgage and credit cards), which are analyzed as homogeneous loan pools. These calculated loss factors are then applied to outstanding loan balances. We analyze impaired loans individually. In determining whether and the extent to which we will make adjustments to our loan loss migration model for purposes of determining the ALLL, we also consider a number of qualitative factors that can affect the performance and the collectability of the loans in our loan portfolio. Such qualitative factors include: •The effects of changes that we may make in our loan policies or underwriting standards on the quality of the loans and the risks in our loan portfolios; •Trends and changes in local, regional and national economic conditions, as well as changes in industry specific conditions, and any other reasonably foreseeable events that could affect the performance or the collectability of the loans in our loan portfolios; •Material changes that may occur in the mix or in the volume of the loans in our loan portfolios that could alter, whether positively or negatively, the risk profile of those portfolios; •Changes in management or loan personnel or other circumstances that could, either positively or negatively, impact the application of our loan underwriting standards, the monitoring of nonperforming loans or our loan collection efforts; and •External factors that, in addition to economic conditions, can affect the ability of borrowers to meet their loan obligations, such as fires, earthquakes and terrorist attacks. Determining the effects that these qualitative factors may have on the performance of each category of loans in our loan portfolio requires numerous judgments, assumptions and estimates about conditions, trends and events which may subsequently prove to have been incorrect due to circumstances outside of our control. Moreover, the effects of qualitative factors such as these on the performance of our loan portfolios are often difficult to quantify. As a result, we may sustain loan losses in any particular period that are sizable in relation to the ALLL or that may even exceed the ALLL. 51 -------------------------------------------------------------------------------- Table of Contents Set forth below is information regarding loan balances and the related ALLL, by portfolio type, for the three months endedMarch 31, 2021 and 2020. Consumer Construction and and Single land Family Commercial Real Estate Development Mortgages Unallocated Total (Dollars in thousands) ALLL for the three months ended March 31, 2021: Balance at beginning of year$ 11,255 $ 3,964 $ 137$ 2,096 $ -$ 17,452 Charge-offs (525) - - (13) - (538) Recoveries 209 - - 4 - 213 Provision (316) 489 29 (202) - - Balance at March 31, 2021$ 10,623 $ 4,453 $ 166$ 1,885 $ -$ 17,127 Allowance for loan and lease losses as a percentage of average total loans 1.37 % Allowance for loan and lease losses as a percentage of total outstanding loans 1.38 % Allowance for loan and lease losses as a percentage of nonaccrual loans 83.31 % Ratio of net charge-offs to average loans outstanding (annualized) 0.11 % ALLL for the three months ended March 31, 2020: Balance at beginning of year$ 8,883 $ 2,897 $ 34$ 1,797 $ -$ 13,611 Charge-offs (2,250) - - (64) - (2,314) Recoveries 19 - - 4 - 23 Provision 4,566 1,471 21 142 - 6,200 Balance at March 31, 2020$ 11,218 $ 4,368 $ 55$ 1,879 $ -$ 17,520 Allowance for loan and lease losses as a percentage of average total loans 1.57 % Allowance for loan and lease losses as a percentage of total outstanding loans 1.53 % Allowance for loan and lease losses as a percentage of nonaccrual loans 87.51 % Ratio of net charge-offs to average loans outstanding (annualized)
0.82 %
The ALLL decreased by$393 thousand fromMarch 31, 2020 toMarch 31, 2021 primarily as a result of charge-offs exceeding recoveries and decreases in classified and nonperforming loans during the three months endedMarch 31, 2021 . The reserve for loan losses may include an unallocated amount based upon our judgment as to possible credit losses inherent in the loan portfolio that may not have been captured by historical loss experience, qualitative factors, or specific evaluations of impaired loans. Unallocated reserves may be adjusted for factors including, but not limited to, unexpected or unusual events, volatile market and economic conditions, effects of changes or seasoning in methodologies, regulatory guidance and recommendations, or other factors that may impact borrower operating conditions and loss expectations. Management's judgment as to unallocated reserves is determined in the context of, but separate from, the historical loss trends and qualitative factors described above. The unallocated reserve for loan losses was zero atMarch 31, 2021 andDecember 31, 2020 . We classify our loan portfolios using asset quality ratings. The credit quality table in Note 5, Loans and Allowance for Loan and Lease Losses above in Item 1, provides a summary of loans by portfolio type and asset quality ratings as ofMarch 31, 2021 andDecember 31, 2020 . Loans totaled approximately$1.24 billion atMarch 31, 2021 , an increase of$20.5 million from$1.22 billion atDecember 31, 2020 . The disaggregation of the loan portfolio by risk rating in the credit quality table located in Note 5 reflects the following changes that occurred betweenDecember 31, 2020 andMarch 31, 2021 : •Loans rated "Pass" totaled$1.17 billion , an increase of$57.9 million from$1.11 billion atDecember 31, 2020 . The increase was primarily attributable to the$92.6 million of PPP loans funded during the first quarter in addition to upgrades from "Special Mention" of$6.9 million , partially offset by downgrades to "Special Mention" and "Substandard" of$1.0 million and$2.5 million , respectively, and pay downs of principal payments. 52 -------------------------------------------------------------------------------- Table of Contents •Loans rated "Special Mention" totaled$11.6 million , a decrease of$10.2 million from$21.8 million atDecember 31, 2020 . The decrease was primarily the result of$6.9 million upgraded to "Pass",$3.5 million of payoffs and principal payments,$790 thousand downgraded to "Substandard", partially offset by$1.0 million downgraded from "Pass". •Loans rated "Substandard" totaled$62.9 million , a decrease of$26.7 million from$89.6 million atDecember 31, 2020 . This decrease was primarily the result of$24.7 million in principal payments,$5.7 million in upgraded notes, partially offset by$2.5 million downgraded from "Pass" and$787 thousand downgraded from "Special Mention". The loans downgraded from the "Pass" rating had been rated "Watch", a rating within our "Pass" rating that receives more oversight and attention by management. •Loans rated "Doubtful" totaled$107 thousand atMarch 31, 2021 , a decrease from$641 thousand atDecember 31, 2020 . This decrease was the result of charge-offs of$525 thousand , partially offset by principal payments of$9 thousand . Our loss migration analysis currently utilizes a series of nineteen staggered 16-quarter migration periods. As a result, for purposes of determining applicable loss factors atMarch 31, 2021 , our migration analysis covered the period fromMarch 31, 2017 toMarch 31, 2021 . We believe this was consistent with and reasonably reflects current economic conditions, portfolio trends and the risks that were inherent in our loan portfolio atMarch 31, 2021 . The table below sets forth loan delinquencies, by quarter, for the five preceding quarters endedMarch 31, 2021 . December 31, September 30, March 31, 2021 2020 2020 June 30, 2020 March 31, 2020 Loans Delinquent: (Dollars in thousands) 90 days or more: Commercial loans $ 578$ 9,670 $ 7,814 $ 11,857 $ 3,671 Commercial real estate - 1,837 1,934 - - Residential mortgages - - - 375 - Consumer loans 45 - 145 180 94 623 11,507 9,893 12,412 3,765 30-89 days: Commercial loans 1,447 8,927 14,363 5,912 20,903 Commercial real estate - - 11,200 1,063 955 Land development loans - - - - - Consumer loans 102 65 53 200 579 1,549 8,992 25,616 7,175 22,437 Total Past Due(1)(2):$ 2,172 $ 20,499 $ 35,509 $ 19,587 $ 26,202
(1)Past due balances include nonaccrual loans.
As the above table indicates, total past due loans decreased by$18.3 million , to$2.2 million atMarch 31, 2021 from$20.5 million atDecember 31, 2020 . Loans past due 90 days or more decreased by$10.9 million , to$623 thousand atMarch 31, 2021 , from$11.5 million atDecember 31, 2020 . Loans 30-89 days past due decreased by$7.4 million to$1.5 million atMarch 31, 2021 from$9.0 million atDecember 31, 2020 primarily attributable to$6.7 million paid current and principal payments of$2.3 million , partially offset by$1.5 million of additions. Deposits Average Balances of and Average Interest Rates Paid on Deposits Set forth below are the average amounts of, and the average rates paid on, deposits for the three months endedMarch 31, 2021 and year endedDecember 31, 2020 : 53
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Three Months Ended March 31, 2021 Year Ended December 31, 2020
Average Average Average Average
Balance Rate Balance Rate
(Dollars in thousands)
Noninterest bearing demand deposits $ 610,905 - $ 588,557 -
Interest-bearing checking accounts 140,205 0.08 % 113,711 0.15 %
Money market and savings deposits 392,543 0.22 % 416,953 0.58 %
Time deposits(1) 204,600 1.16 % 248,801 1.98 %
Total deposits $ 1,348,253 0.25 % $ 1,368,022 0.55 %
(1)Comprised of time certificates of deposit in denominations of less than and
more than $250,000 .
Deposit Totals
Deposits totaled $1.4 billion at March 31, 2021 as compared to $1.4 billion at
December 31, 2020 . Deposit growth was primarily concentrated in interest bearing
and noninterest bearing demand deposits as a result of PPP loan funding. The
following table provides information regarding the mix of our deposits at
March 31, 2021 and December 31, 2020 :
At March 31, 2021 At December 31, 2020
% of Total % of Total
Amounts Deposits Amounts Deposits
(Dollars in thousands)
Deposits
Noninterest bearing demand deposits $ 649,407 46.9 % $ 647,115 46.8 %
Savings and other interest-bearing
transaction deposits 535,421 38.7 % 522,524 37.8 %
Time deposits(1) 198,943 14.4 % 213,708 15.4 %
Total deposits $ 1,383,771 100.0 % $ 1,383,347 100.0 %
(1)Comprised of time certificates of deposit in denominations of less than and
more than $250,000 .
Certificates of deposit in denominations of $250,000 or more, on which we pay
higher rates of interest than on other deposits, aggregated $84.9 million , or
6.1%, of total deposits at March 31, 2021 , as compared to $91.0 million , or
6.6%, of total deposits at December 31, 2020 .
Set forth below is a maturity schedule of domestic time certificates of deposit
outstanding at March 31, 2021 and December 31, 2020 :
March 31, 2021 December 31, 2020
Certificates of Certificates of Certificates of Certificates of
Deposit Under Deposit $250,000 Deposit Under Deposit $250,000
Maturities $ 250,000 or more $ 250,000 or more
(Dollars in thousands)
Three months or less $ 24,830 $ 19,134 $ 32,155 $ 31,986 Over three and through six months
25,250 27,819 22,352 18,206
Over six and through twelve months 20,802 14,290 40,222 30,572
Over twelve months 43,209 23,609 27,959 10,256
Total $ 114,091 $ 84,852 $ 122,688 $ 91,020
Other Assets and Other Liabilities
InFebruary 2016 , the FASB issued ASU 2016-02, "Leases (Topic 842)," which requires lessees to recognize the following for all leases (with the exception of short-term leases) at the commencement date: a lease liability measured on a discounted basis and a right-of-use asset a specified asset for the lease term. The new standard establishes a right-of-use model (ROU) that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer 54 -------------------------------------------------------------------------------- Table of Contents than 12 months. The new standard had a material effect on our financial statements related to the recognition of new ROU assets and lease liabilities on our balance sheet for our office operating leases. During the three months endedMarch 31, 2021 , we did not recognize additional operating liabilities or corresponding ROU assets based on the present value of the remaining minimum rental payments under current leasing standards for existing operating leases. Refer to the Note 1, Significant Accounting Policies and Note 6, Leases above in Item 1 for further detail. 55 -------------------------------------------------------------------------------- Table of Contents Liquidity We actively manage our liquidity needs to ensure that sufficient funds are available to meet our needs for cash, including to fund new loans and deposit withdrawals by our customers. We project the future sources and uses of funds and maintain liquid funds for unanticipated events such as the COVID-19 pandemic. Our primary sources of cash include cash we have on deposit at other financial institutions, payments from borrowers on their loans, proceeds from sales or maturities of securities held for sale, sales of residential mortgage loans, increases in deposits and increases in borrowings principally from the FHLB. The primary uses of cash include funding new loans and making advances on existing lines of credit, purchasing investments, including securities available for sale, funding new residential mortgage loans, funding deposit withdrawals and paying operating expenses. We maintain funds in overnight Federal Funds sold and other short-term investments to provide for short-term liquidity needs. We also have obtained credit lines from the FHLB and other financial institutions to meet any additional liquidity requirements we might have. See "-Contractual Obligations-Borrowings" below for additional information related to our borrowings from the FHLB. Our liquid assets, which included cash and due from banks, Federal Funds sold, interest earning deposits that we maintain with financial institutions and unpledged securities available for sale (excluding FRBSF and FHLB stock) totaled$261.6 million , which represented 17% of total assets, atMarch 31, 2021 . We believe that our cash and cash equivalent resources, together with available borrowings under our credit facilities, will be sufficient to meet normal operating requirements for at least the next twelve months, including to enable us to meet any increase in deposit withdrawals that might occur in the foreseeable future. We believe that during this period of uncertain economic conditions related to COVID, our liquidity position is strong, and will be closely monitored as conditions change. Cash Flow Provided by Operating Activities. During the three months endedMarch 31, 2021 , operating activities provided net cash of$1.3 million , primarily attributable to our net income of$3.4 million , partially offset by$1.0 million of accretion of deferred fees on loans, and a$1.0 million increase in accrued interest receivable. During the three months endedMarch 31, 2020 , operating activities provided net cash of$2.3 million , primarily attributable to our a$6.2 million non-cash adjustment related to our provision for loan and lease losses, partially offset by a$1.7 million decrease in other liabilities and$812 thousand increase to deferred taxes. Cash Flow Used In Investing Activities. During the three months endedMarch 31, 2021 , investing activities used net cash of$19.7 million , primarily attributable to a$17.1 million increase in loans, and$10.1 million purchase of securities, offset by$5.7 million in proceeds from the sale of securities and$1.8 million of cash provided from maturities of and principal payments on securities available for sale and other stock. During the three months endedMarch 31, 2020 , investing activities provided net cash of$17.2 million , primarily attributable to a$18.5 million increase in loans, offset by$1.4 million of cash provided from maturities of and principal payments on securities available for sale and other stock. Cash Flow Used In Financing Activities. During the three months endedMarch 31, 2021 , financing activities used net cash of$9.5 million , which was primarily a$10.0 million repayment of borrowings, partially offset by a$424 thousand decrease in our deposits. During the three months endedMarch 31, 2020 , financing activities provided net cash of$186.8 million which consisted of a$96.7 million increase in our deposits and net proceeds of$90 million in borrowings. Ratio of Loans to Deposits. The relationship between gross loans and total deposits can provide a useful measure of a bank's liquidity. Since repayment of loans tends to be less predictable than the maturity of investments and other liquid resources, the higher the loan-to-deposit ratio the less liquid are our assets. On the other hand, since we realize greater yields on loans than we do on investments, a lower loan-to-deposit ratio can adversely affect interest income and earnings. As a result, our goal is to achieve a loan-to-deposit ratio that appropriately balances the requirements of liquidity and the need to generate a fair return on our assets. AtMarch 31, 2021 andDecember 31, 2020 , the loan-to-deposit ratio was 90% and 88%, respectively. Capital Resources Regulatory Capital Requirements Applicable to Banking Institutions Under federal banking regulations that apply to allUnited States -based bank holding companies over$3 billion in total assets and all federally insured banks, the Bank (on a stand-alone basis) must meet specific capital adequacy requirements that, for the most part, involve quantitative measures, primarily in terms of the ratios of their capital to their assets, liabilities, and certain off-balance sheet items, calculated under regulatory accounting practices. The Company (on a consolidated basis) is below the reporting threshold of$3 billion in total assets and therefore is not subject to the same capital adequacy requirements. Under those regulations, each federally insured bank is determined by its primary federal bank regulatory agency to come within one of the following capital adequacy categories on the basis of its capital ratios: •well-capitalized •adequately capitalized 56
-------------------------------------------------------------------------------- Table of Contents •undercapitalized •significantly undercapitalized; or •critically undercapitalized Certain qualitative assessments also are made by a banking institution's primary federal regulatory agency that could lead the agency to determine that the banking institution should be assigned to a lower capital category than the one indicated by the quantitative measures used to assess the institution's capital adequacy. At each successive lower capital category, a banking institution is subject to greater operating restrictions and increased regulatory supervision by its federal bank regulatory agency. The following table sets forth the capital and capital ratios of the Bank (on a stand-alone basis) atMarch 31, 2021 , as compared to the regulatory requirements applicable to it. Applicable Federal Regulatory RequirementFor Capital To
be Categorized As
Adequacy Purposes Well-Capitalized
Amount Ratio Amount Ratio Amount Ratio
(Dollars in thousands)
Total Capital to Risk Weighted
Assets $ 187,050 16.8 % $ 133,331 At least 8.625% $ 111,678 At least 10.0%
Common Equity Tier 1 Capital to
Risk Weighted Assets $ 173,047 15.5 % $ 57,235 At least 5.125% $ 72,591 At least 6.5%
Tier 1 Capital to Risk Weighted
Assets $ 173,047 15.5 % $ 73,987 At least 6.625% $ 89,343 At least 8.0%
Tier 1 Capital to Average Assets $ 173,047 11.2 % $ 61,835 At least 4.0% $ 77,294 At least 5.0%
As the above table indicates, at March 31, 2021 , the Bank (on a stand-alone
basis) qualified as a "well-capitalized" institution under federally mandated
capital standards and federally established prompt corrective action
regulations. Since March 31, 2021 , there have been no events or circumstances
known to us which have changed or which are expected to result in a change in
the Bank's classifications as a well-capitalized institution.
In early July 2013 , the Federal Reserve Board and the FDIC issued final rules
implementing the Basel III regulatory capital framework and related Dodd-Frank
Wall Street Reform and Consumer Protection Act changes. The rules revise
minimum capital requirements and adjust prompt corrective action thresholds.
The final rules revise the regulatory capital elements, add a new common equity
Tier 1 capital ratio, increase the minimum Tier 1 capital ratio requirement, and
implement a new capital conservation buffer. The rules also permit certain
banking organizations to retain, through a one-time election, the existing
treatment for accumulated other comprehensive income. The final rules took
effect for community banks on January 1, 2015 , subject to a transition period
for certain parts of the rules. At March 31, 2021 , the Bank (on a stand-alone
basis) continued to qualify as a well-capitalized institution under the capital
adequacy guidelines described above.
On September 17, 2019 , the FDIC finalized a rule that introduces an optional
simplified measure of capital adequacy for qualifying community banking
organizations (i.e., the community bank leverage ratio (CBLR) framework), as
required by the Economic Growth, Regulatory Relief and Consumer Protection Act.
The CBLR framework is designed to reduce burden by removing the requirements for
calculating and reporting risk-based capital ratios for qualifying community
banking organizations that opt into the framework. In order to qualify for the
CBLR framework, a community banking organization must have a tier 1 leverage
ratio of greater than 9.0%, less than $10 billion in total consolidated assets,
and limited amounts of off-balance-sheet exposures and trading assets and
liabilities. A qualifying community banking organization that opts into the CBLR
framework and meets all requirements under the framework will be considered to
have met the well-capitalized ratio requirements under the Prompt Corrective
Action regulations and will not be required to report or calculate risk-based
capital. The Company will not opt into the CBLR framework for the Bank.
Dividend Policy and Share Repurchase Programs
57
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It is, and since the beginning of 2009 it has been, the policy of the Boards of
Directors of the Company and the Bank to preserve cash to enhance our capital
positions and the Bank's liquidity. In addition, we have agreed that the Bank
will not, without the FRB and the CDFPI's prior written approval, pay any
dividends to Bancorp. Accordingly, we do not expect to pay dividends or make
share repurchases for the foreseeable future.
The principal source of cash available to a bank holding company consists of
cash dividends from its bank subsidiaries. There are currently several
restrictions on the Bank's ability to pay us cash dividends. Government
regulations, including the laws of the State of California , as they pertain to
the payment of cash dividends by California state-chartered banks, limits the
amount of funds that the Bank is permitted to dividend to us. Further, Section
23(a) of the Federal Reserve Act limits the amounts that a bank may loan to its
bank holding company to an aggregate of no more than 10% of the bank
subsidiary's capital surplus and retained earnings and requires that such loans
be secured by specified assets of the bank holding company. We have committed to
obtaining approval from the FRB and the CDFPI prior to Bancorp paying any
dividends, or making any distributions representing interest, principal or other
sums on subordinated debentures or trust preferred securities. There can be no
assurance that our regulators will approve such payments or dividends in the
future. Refer to "Supervision and Regulation" in Item 1 of our 2020 Form 10-K
and Note 15, Shareholders' Equity in the notes to our consolidated financial
statements on our 2020 Form 10-K for more detail regarding the regulatory
restrictions on our and the Bank's ability to pay dividends. In addition, we
currently have sufficient cash on hand to meet our cash obligations. As a
result, we do not expect that these restrictions will impact our ability to meet
our cash obligations.
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Off-Balance Sheet Arrangements
Loan Commitments and Standby Letters of Credit. To meet the financing needs of
our customers in the normal course of business, we are a party to financial
instruments with off-balance sheet risk. These financial instruments include
commitments to extend credit and standby letters of credit. At March 31, 2021
and December 31, 2020 , we were committed to fund certain loans including letters
of credit amounting to approximately $341 million and $347 million ,
respectively.
Commitments to extend credit and standby letters of credit generally have fixed
expiration dates or other termination clauses and the customer may be required
to pay a fee and meet other conditions in order to draw on those commitments or
standby letters of credit. We expect, based on historical experience, that many
of the commitments will expire without being drawn upon and, therefore, the
total commitment amounts do not necessarily represent future cash requirements.
To varying degrees, commitments to extend credit involve elements of credit and
interest rate risk for us that are in excess of the amounts recognized in our
balance sheets. Our maximum exposure to credit loss in the event of
nonperformance by the customers to whom such commitments are made could
potentially be equal to the amount of those commitments. As a result, before
making such a commitment to a customer, we evaluate the customer's
creditworthiness using the same underwriting standards that we would apply if we
were approving loans to the customer. In addition, we often require the customer
to secure its payment obligations for amounts drawn on such commitments with
collateral such as accounts receivable, inventory, property, plant and
equipment, income-producing commercial properties, residential properties and
properties under construction. As a consequence, our exposure to credit and
interest rate risk on such commitments is not different in character or amount
than risks inherent in the outstanding loans in our loan portfolio.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee a payment obligation of a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan commitments to customers.
Contractual Obligations
Borrowings. At March 31, 2021 and December 31, 2020 , our borrowings consisted of
the following:
(Dollars in thousands) March 31, 2021 December 31, 2020
FHLB advances-short-term $ - $ 10,000
Total $ - $ 10,000
At March 31, 2021 , $439 million of loans were pledged to support our unfunded
borrowing capacity. At March 31, 2021 , we had unused borrowing capacity of $286
million with the FHLB. The highest amount of borrowings outstanding at any
month-end during the three months ended March 31, 2021 was $10.0 million from
the FHLB. The highest amount of borrowings outstanding at any month end in 2020
consisted of $124.0 million of borrowings from the FHLB. At March 31, 2021 and
December 31, 2020 , commercial and consumer loans of $130 million and $146
million , respectively, were pledged to secure borrowings from the FRB to support
our unfunded borrowing capacity of $94 million and $106 million , respectively.
Junior Subordinated Debentures. Pursuant to rulings of the Federal Reserve
Board , bank holding companies were permitted to issue long term subordinated
debt instruments that, subject to certain conditions, would qualify as and,
therefore, augment capital for regulatory purposes. At March 31, 2021 , we had
outstanding approximately $17.5 million principal amount of Debentures, of which
$17.0 million would qualify as additional Tier 1 capital for regulatory purposes
as of March 31, 2021 if we were to surpass the reporting threshold of $3 billion
in total assets.
Set forth below is certain information regarding the Debentures:
Original Issue Dates Principal Amount Interest Rates Maturity Dates(1)
September 2002 $ 7,217 LIBOR plus 3.40% September 2032
October 2004 10,310 LIBOR plus 2.00% October 2034
Total $ 17,527
(1)Subject to the receipt of prior regulatory approval, we may redeem the
Debentures, in whole or in part, without premium or penalty, at any time prior
to maturity.
These Debentures require quarterly interest payments, which are used to make
quarterly distributions required to be paid on the corresponding trust preferred
securities. Subject to certain conditions, we have the right, at our discretion,
to defer those interest payments, and the corresponding distributions on the
trust preferred securities, for up to five years. Exercise of
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this deferral right does not constitute a default of our obligations to pay the
interest on the Debentures or the corresponding distributions that are payable
on the trust preferred securities. We have committed to obtaining approval from
the FRB and the CDFPI prior to making any distributions representing interest,
principal or other sums on subordinated debentures or trust preferred
securities. Refer to "Supervision and Regulation" in Item 1 of our 2020 Form
10-K for further detail. As of March 31, 2021 , we were current on all interest
payments. There can be no assurance that our regulators will approve such
payments in the future.
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Critical Accounting Policies
Our consolidated financial statements are prepared in accordance with generally
accepted accounting principles in the United States ("GAAP") and general
practices in the banking industry. Certain of those accounting policies are
considered critical accounting policies, because they require us to make
assumptions and judgments regarding circumstances or trends that could affect
the carrying value of our material assets, such as, for example, assumptions
regarding economic conditions or trends that could impact our ability to fully
collect our loans or ultimately realize the carrying value of certain of our
other assets, such as securities available for sale and our deferred tax asset.
Those assumptions and judgments are based on current information available to us
regarding those economic conditions or trends or other circumstances. If adverse
changes were to occur in the conditions, trends or other events on which our
assumptions or judgments had been based, then under GAAP it could become
necessary for us to reduce the carrying values of any affected assets on our
balance sheet. In addition, because reductions in the carrying value of assets
are sometimes effectuated by or require charges to income, such reductions also
may have the effect of reducing our income.
There have been no significant changes during the three months ended March 31,
2021 to the items that we disclosed as our critical accounting policies and
estimates in Critical Accounting Policies within Management's Discussion and
Analysis of Financial Condition and Results of Operations included in our 2020
Form 10-K.
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