Part I

Special Note Regarding Forward-Looking Statements

This report includes forward-looking statements within the meaning of the Securities Exchange Act of 1934 (“Exchange Act”) and the Private Securities Litigation Reform Act of 1995. These statements are based on management’s current beliefs and assumptions, and on information available to management as of the date of this document. Forward-looking statements include the information concerning possible or assumed future results of operations of the Company set forth under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Forward-looking statements may also include statements in which words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” “considers” or similar expressions or conditional verbs such as “will,” “should,” “would” and “could” and other comparable words or phrases of a future- or forward-looking nature, are intended to identify such forward-looking statements. Forward-looking statements are not guarantees of future performance. They involve risks, uncertainties and assumptions. The Company’s actual future results and shareholder values may differ materially from those anticipated and expressed in these forward-looking statements. Many of the factors that will determine these results and values are beyond the Company’s ability to control or predict. Except as specifically noted herein all references to the “Company” refer to Bank of Commerce Holdings, a California corporation, and its consolidated subsidiaries.

The following factors, among others, could cause our actual results to differ materially from those expressed in such forward-looking statements:

Additional factors that could cause actual results to differ materially from those expressed in the forward-looking statements are discussed in the sections entitled “RISK FACTORS,” BUSINESS” and in “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” in this Form 10-K.

If our assumptions regarding one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements contained in this document and in the information incorporated by reference in this document. Therefore, we caution you not to place undue reliance on our forward-looking information and statements. We do not undertake any obligation to publicly correct, revise, or update any forward-looking statement if we later become aware that actual results are likely to differ materially from those expressed in such forward-looking statement, except as required under federal securities laws.

ItemItem 1 - Business

Bank of Commerce Holdings (“Company,” “Holding Company,” “we,” or “us”) is a corporation organized under the laws of California and a bank holding company (“BHC”) registered under the Bank Holding Company Act of 1956, as amended (“BHC Act”) with its principal offices in Sacramento, California..California. The Holding Company’s principal business is to serve as a holding company for ReddingMerchants Bank of Commerce (the “Bank” and together with the Holding Company, the “Company”) which operates under three separate names (Redding Bank of Commerce, Sacramento Bank of Commerce, a division of Redding Bank of Commerce and The Merchants Bank of Sacramento, a division of Redding Bank of Commerce) and Bank of Commerce Mortgage (inactive). The Bank, which previously operated under three separate names, changed its name for all operations to Merchants Bank of Commerce effective May 20, 2019. We have an unconsolidated subsidiary in Bank of Commerce Holdings Trust II, which was organized in connection with our prior issuance of trust-preferred securities. Our common stock is traded on the NASDAQ Global Market under the symbol “BOCH.”

We commenced banking operations in 1982 and grew organically to four branches before purchasing five Bank of America branches in 2016. With our recent acquisition of Merchants Holding Company, we now operate ten full service facilities and one limited service facility in northern California. We also operate a “cyber office” as identified in our summary of deposits reporting filed with the FDIC. We provide a wide range of financial services and products for business and retail customers which are competitive with those traditionally offered by banks of similar size in California. As of December 31, 2018,2019, we operated under one primary business segment: Community Banking. Additional information regarding operating segments can be found in Note 2 Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in this document.

We continuously seek expansion opportunities through internal growth, strategic alliances, acquisitions, establishing new offices or the delivery of new products and services. Periodically, we reevaluate the short and long-term profitability of all of our lines of business, and do not hesitate to reduce or eliminate unprofitable locations or lines of business. We remain a viable, independent bank committed to enhancing shareholder value. This commitment has been fostered by proactive management and dedication to staff, customers and the markets we serve.

On January 31, 2019, we completed the acquisition of Merchants Holding Company (“Merchants”), to extend our presence in the Sacramento marketplace. Merchants, headquartered in Sacramento, California, was the parent company of The Merchants National Bank of Sacramento (“Merchants Bank”), a 97-year-old bank with approximately $211.7 million in assets as of January 31, 2019. See Note 2321 Acquisition in the Notes to Consolidated Financial Statements.

On May 10, 2017, we closed an underwritten public offering of 2,738,096 shares of our common stock at a public offering price of $10.50 per share, with net proceeds of approximately $26.8 million, after underwriting discounts and estimated expenses.for more information on this acquisition.

Our governance structure enables us to manage all major aspects of our business effectively through an integrated process that includes financial, strategic, risk and leadership planning. Our management processes, structures and policies and procedures help to ensure compliance with laws and regulations and provide clear lines of authority for decision-making and accountability. Results are important, but we are equally concerned with how we achieve those results. Our core values and our commitment to high ethical standards are material to sustaining public trust and confidence in our Company.

Our primary business strategy is to provide comprehensive banking and related services to businesses, not-for-profit organizations, professional service providers and consumers in northern California. We continue to emphasize the diversity of our product lines and high levels of personal service. Through our technology, we offer convenient access typically associated with larger financial institutions, while maintaining the local decision-making authority and market knowledge, typical of a local community bank. Management intends to continue to pursue our business strategy through the following initiatives:

Utilize the Strength of Our Management Team. We believe the experience, depth and knowledge of our management team represent one of our greatest strengths and competitive advantages.

Leverage Our Existing Foundation for Additional Growth. Based on certain infrastructure investments, we believe that we will be able to take advantage of certain economies of scale typically enjoyed by larger organizations to expand our operations both organically and through strategic cost-effective avenues. We believe that the investments we have made in data processing, our staff, our risk and compliance function, and our branch network will support a much larger asset base. We are committed, however, to control any additional growth within acceptable risk limits and to maintain appropriate capital ratios.

Maintain Local Decision-Making and Accountability. We believe we have a competitive advantage over larger national and regional financial institutions by providing superior customer service with experienced, knowledgeable management, localized decision-making capabilities and prompt credit decisions. We believe that our customers want to deal directly with the people who make the ultimate credit decisions and have provided our Bank officers and relationship managers with authority commensurate with their experience and responsibilities, which we believe strikes the right balance between local decision-making and sound banking practice.

Focus on Asset Quality and Strong Underwriting. We consider asset quality to be of primary importance and have taken measures to ensure that credit risks are managed effectively to safeguard shareholder value. As part of our efforts, we utilize a third party loan review service to evaluate our loan portfolio on a quarterly basis and recommend action on certain loans if deemed appropriate.

Build a Stable Core Deposit Base. We continue to focus on increasing a stable core deposit base of business and retail customers. Our Branch Acquisition in 2016 allowed us to reduce our historic reliance on Federal Home Loan Bank of San Francisco borrowings and our former reliance on nonlocal time deposits. Our recently completed acquisition of Merchants Bank further enhanced our core deposit base by adding $152.2 million in demand and savings accounts. We intend to continue our practice of developing full deposit relationships with each of our loan customers, their business partners, and key employees.

Principal Market

We operate under the name ReddingMerchants Bank of Commerce except in northern California from Sacramento to Yreka along the greater Sacramento region where we operate under the names Sacramento Bank of Commerce, a division of Redding Bank of Commerce and The Merchants Bank of Sacramento, a division of Redding Bank of Commerce.Interstate 5 corridor.

Principal Products and Services

Most of our current customers are small to medium-sized businesses and retail consumers. No single person or group of persons provides a material portion of the Bank’s deposits or loans, the loss of any one or more of which would have a materially adverse effect on the business of the Bank.

We provide a wide range of financial services and products for businesses and consumers. The services we offer include those traditionally offered by banks of similar size and character in California. Our principal deposit products include the following types of accounts; checking, interest-bearing checking, money market, savings and certificates of deposit. We also offer sweep arrangements, commercial loans, construction loans, term loans, consumer loans, safe deposit boxes, and electronic banking services. We currently do not offer trust services or international banking services.

The majority of the loans we originate are direct loans made to individualssmall businesses and small businessesindividuals in our principal market. We accept as collateral for loans, real estate, listed and unlisted securities, savings and time deposits, automobiles, machinery and equipment and other general business assets such as accounts receivable and inventory. In addition to direct lending, our loan portfolio includes loans that were purchased as pools of loans, or participations where a portion of a loan was originated by another lending institution.

Regulatory Capital

Our regulators measure our capital adequacy by using a risk-based capital framework and by monitoring compliance with minimum leverage ratio guidelines. The guidelines are “risk-based,” meaning that they are designed to make capital requirements more sensitive to differences in risk profiles among banks and bank holding companies.

As of December 31, 2018,2019, the most recent notification from the FDIC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since the notification that management believes have changed the Bank’s risk category. See Item 7 - Management’s Discussion And Analysis Of Financial Condition And Results Of Operations and Note 1817 Regulatory Capital in the Notes to Consolidated Financial Statements in this document for a discussion of the regulatory capital guidelines.

Competition

We engage in the highly competitive financial services industry. Generally, our market and our lines of activity involve competition with other banks, thrifts, credit unions and other non-bank financial institutions, such as investment banking firms, investment advisory firms, brokerage firms, investment companies and insurance entities which offer financial services, located both domestically and through alternative delivery channels such as the Internet. Many of these competitors enjoy fewer regulatory constraints and some may have lower cost structures. Our ability to compete is focused on various factors such as customer service, interest rates on loans and deposits, lending limits, customer convenience and technological advances.

Securities firms, insurance companies and brokerage houses that elect to become financial holding companies may acquire banks and other financial institutions. Combinations of this type will significantly change the competitive environment in which we conduct business.

In order to compete with major banks and other competitors in our primary service areas, we rely upon;

Employees

As of December 31, 2018,2019, we employed 197214 full-time equivalent employees. None of the employees are subject to a collective bargaining agreement and management believes its relations with employees to be good. Information regarding employment agreements with our executive officers is contained in Item 11 – Executive Compensation below, which is incorporated by reference to our proxy statement for the 20192020 annual meeting of shareholders.

Government Supervision and Regulation

Supervision and Regulation

The Holding Company and the Bank are subject to extensive regulation under federal and state law. In general, this regulatory framework is designed to protect depositors, the federal deposit insurance fund (the “DIF”) and the federal and state banking system as a whole; it does not exist for the protection of shareholders. As the breadth and scope of regulatory requirements increase, our costs to identify, monitor and comply with these requirements increase, as well.

This section provides a general overview of the federal and state regulatory framework applicable to the Holding Company and the Bank. It is not intended to summarize all applicable laws and regulations. To the extent that this section describes statutory and regulatory provisions, it is qualified by reference to those provisions. These statutes and regulations, as well as related policies, continue to be subject to change (or interpretation) by Congress, state legislatures and federal and state regulators. Numerous changes to the statutes, regulations and regulatory policies applicable to us (including their interpretation or implementation) have been proposed but cannot be predicted and could have a material effect on our business or operations.

The Holding Company is subject to regulation and supervision by the Federal Reserve (as a bank holding company) and regulation by the State of California (as a California corporation). The Holding Company is also subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, both asof which are administered by the SEC. As a listed company on the NASDAQ Global Market, the Holding Company is subject to the rules of the NASDAQ for listed companies. The Bank is subject to regulation and examination by the Federal Deposit Insurance Corporation (“FDIC”) and by the California Department of Business Oversight (“CDBO”).

Federal Bank Holding Company Regulation

General

As a bank holding company, the Holding Company is subject to regulation under the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and to inspection, examination and supervision by its primary regulator, the Board of Governors of the Federal Reserve System (“Federal Reserve” or “FRB”). In general, the BHC Act limits the business of bank holding companies to owning or controlling banks and engaging in other activities closely related to the business of banking. In addition, the Holding Company must file reports with the Federal Reserve and provide the Federal Reserveagency with such additional information as it may require.

Holding Company Bank Ownership

The BHC Act requires every bank holding company to obtain the prior approval of the Federal Reserve before (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares; (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company.

Holding Company Control of Nonbanks

With some exceptions, the BHC Act also prohibits a bank holding company from acquiring or retaining direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities that, by federal statute, agency regulation or by order, have been identified as activities closely related to the business of banking or of managing or controlling banks.

Transactions with Affiliates

Subsidiary banks of a bank holding company are subject to restrictions imposed by the Federal Reserve Act on extensions of credit to the holding company or its subsidiaries, on investments in their securities and on the use of their securities as collateral for loans to any borrower. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) further expanded the definition of an “affiliate” and treats credit exposure arising from derivative transactions, securities lending, and borrowing transactions as a covered transaction under the regulations. It also expands the scope of covered transactions required to be collateralized, requires collateral to be maintained at all times for covered transactions required to be collateralized, and places limits on acceptable collateral. These regulations and restrictions may limit the Holding Company’s ability to obtain funds from the Bank for its cash needs, including funds for payment of dividends, interest and operational expenses.

Tying Arrangements

We are also prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services. For example, with certain exceptions, neither the Holding Company nor its subsidiaries may condition an extension of credit to a customer on either (i) a requirement that the customer obtain additional services provided by us; or (ii) an agreement by the customer to refrain from obtaining other services from a competitor.

Support of Subsidiary Banks

Under Federal Reserve policy and the Dodd-Frank Act, the Holding Company is required to act as a source of financial and managerial strength to the Bank. This means that the Holding Company is required to commit, as necessary, capital and resources to support the Bank, including at times when the Holding Company may not be in a financial position to provide such resources, or when it may not be in the Holding Company's or its shareholders' best interests to do so. Any capital loans a bank holding company makes to its subsidiary banks are subordinate to deposits and to certain other indebtedness of those subsidiary banks.

State Law Restrictions

As a California corporation, the Holding Company is subject to certain limitations and restrictions under applicable California corporate law. For example, state law restrictions in California include limitations and restrictions relating to indemnification of directors, distributions to shareholders, transactions involving directors, officers or interested shareholders, maintenance of books, records and minutes and observance of certain corporate formalities.

Federal and State Regulation of the Bank

General

Deposits in the Bank, a California chartered commercial bank, are insured by the FDIC. As a result, the Bank is subject to primary supervision, periodic examination and regulation by the CDBO and the FDIC. These agencies have the authority to prohibit banks from engaging in what they believe constitute unsafe or unsound banking practices. The federal laws that apply to the Bank regulate, among other things, the scope of its business, its investments, its reserves against deposits, the timing of the availability of deposited funds, and the nature, amount of, and collateral for loans. Federal laws also regulate community reinvestment and insider credit transactions and impose safety and soundness standards. In addition to these federal laws, the Bank is also subject to the laws of the State of California.

Consumer Protection

Although the Bank is not supervised directly by the Consumer Financial Protection Bureau (“CFPB”), our consumer banking activities are subject to regulation by the CFPB. The Bank is subject to a variety of federal and state consumer protection laws and regulations that govern its relationships and interactions with consumers including laws and regulations that impose certain disclosure requirements and regulate the manner in which we take deposits, make and collect loans, and provide other services. In recent years, examination and enforcement by state and federal banking agencies for non-compliance with consumer protection laws and their implementing regulations have increased and become more intense. Failure to comply with these laws and regulations may subject the Bank to various penalties, including but not limited to, enforcement actions, injunctions, fines, civil monetary penalties, criminal penalties, punitive damages, and the loss of certain contractual rights. The Bank has established a compliance system to ensure consumer protection.

Community Reinvestment

The Community Reinvestment Act of 1977 (the “CRA”) requires that, in connection with examinations of financial institutions within their jurisdiction,jurisdictions, federal bank regulators evaluate the record of financial institutions in meeting the credit needs of itstheir local communities, including low and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. A bank’s community reinvestment record is also considered by the applicable banking agencies in evaluating mergers, acquisitions and applications to open a branch or facility. In some cases, a bank's failure to comply with the CRA or CRA protests filed by interested parties during applicable comment periods, can result in the denial or delay of such transactions. The Bank received a "satisfactory" rating in its most recent CRA examination.

Insider Credit Transactions

Banks are also subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to executive officers, directors, principal shareholders or any related interests of such persons. ExtensionsThese extensions of credit (i) must be made on substantially the same terms (including interest rates and collateral) and follow credit underwriting procedures that are at least as stringent as those prevailing at the time for comparable transactions with persons not related to the lending bank; and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. Banks are also subject to certain lending limits and restrictions on overdrafts to insiders. A violation of these restrictions may result in the assessment of substantial civil monetary penalties, regulatory enforcement actions, and other regulatory sanctions. The Dodd-Frank Act and federal regulations place additional restrictions on loans to insiders and generally prohibit loans to senior officers other than for certain specified purposes.

Regulation of Management

Federal law (i) sets forth circumstances under which officers or directors of a bank may be removed by the institution’s federal supervisory agency; (ii) as discussed above, places restraints on lending by a bank to its executive officers, directors, principal shareholders, and their related interests; and (iii) generally prohibits management personnel of a bank from serving as directors or in other management positions of another financial institution whose assets exceed a specified amount or which has an office within a specified geographic area.

Safety and Soundness Standards

Certain non-capital safety and soundness standards are also imposed upon banks. These standards cover, among other things, internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, such other operational and managerial standards as the agency determines to be appropriate, and standards for asset quality, earnings and stock valuation. In addition, each insured depository institution must implement a comprehensive written information security program that includes administrative, technical, and physical safeguards appropriate to the institution’s size and complexity and the nature and scope of its activities. The information security program must be designed to ensure the security and confidentiality of customer information, protect against unauthorized access to or use of such information and ensure the proper disposal of customer and consumer information. An institution that fails to meet these standards may be required to submit a compliance plan, or be subject to regulatory sanctions, including restrictions on growth. The Bank has established policies and risk management procedures to ensure the safety and soundness of the Bank.

State Law Restrictions

California state-chartered banks are subject to various requirements relating to operations and administration (including the maintenance of branch offices and automated teller machines), capital and reserve requirements, declaration of dividends, deposit taking, shareholder rights and duties, borrowing limits, and investment and lending activities.

Under California law, the amount a bank generally may borrow may not exceed its shareholders’ equity without the consent of the CDBO, except for borrowings from the Federal Home Loan Bank of San Francisco and the Federal Reserve Bank. The Bank is required to invest its funds as limited by California law and in investments that are legal investments for banks, subject to any other limitations under general law. The Commissioner of the CDBO may take possession of the Bank if certain conditions exist, such as insufficient shareholders’ equity, unsafe or unauthorized operations, or violations of law.

Interstate Banking and Branching

The Dodd-Frank Act eliminated interstate branching restrictions that were implemented as part of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ("Interstate Act"), and removed many restrictions on de novo interstate branching by state and federally chartered banks. Federal regulators now have authority to approve applications by such banks to establish de novo branches in states other than the bank's home state if the host state's banks could establish a branch at the same location. The Interstate Act requires regulators to consult with community organizations before permitting an interstate institution to close a branch in a low-income area. Federal banking agency regulations prohibit banks from using their interstate branches primarily for deposit production, and the federal banking agencies have implemented a loan-to-deposit ratio screen to ensure compliance with this prohibition.

Cash Dividends

Our ability to pay cash dividends is dependent on having sufficient cash and satisfying various regulatory and contractual requirements and restrictions. Our principal source of cash is dividends received from the Bank. Regulatory authorities may prohibit banks and bank holding companies from paying dividends in a manner that would constitute an unsafe or unsound banking practice or would reduce capital below an amount necessary to meet minimum applicable regulatory capital requirements. Basel IllIII (discussed below) introduces additional restrictions on dividends.

Our ability to pay dividends from the Bank to the Holding Company is also subject to certain requirements under California law. Banks chartered under California law generally may only pay a cash dividend to the extent such payment does not exceed the lesser of (i) retained earnings of the bank or (ii) the bank's net income for its last three fiscal years less any distributions to shareholders during such period. As a result, future dividends from the Bank to the Holding Company will generally depend on the level of earnings at the Bank.

The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies which expresses the view that although no specific regulations restrict dividend payments by bank holding companies other than state corporate laws, a bank holding company should not pay cash dividends unless the company's net income for the past year is sufficient to cover both the cash dividends and a prospective rate of earnings retention that is consistent with the bank holding company's capital needs, asset quality and overall financial condition.

On December 10, 2015, we issued and sold $10.0 million in aggregate principal amount of fixed to floating rate Subordinated Notes pursuant to a private placement with certain institutional investors. On that same date we also entered into a loan agreement pursuant to which we obtained $10.0 million in senior debt secured by a pledge of all of the stock of the Bank. The Subordinated Notes and debt agreements limit the payment of cash dividends to our common shareholders if the Company is not well capitalized, or if there is an event of default as described by the agreements.agreement.

Capital Adequacy and Prompt Corrective Action

Banks and bank holding companies are subject to various regulatory capital requirements administered by state and federal regulatory agencies, which involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting, and other factors. The capital requirements are intended to ensure that institutions have adequate capital given the risk levels of assets and off-balance sheet financial instruments and are applied separately to the Holding Company and the Bank.

Federal regulations require insured depository institutions and bank holding companies to meet several minimum capital standards, including: (i) a common equity Tier 1 capital to risk-based assets ratio of 4.5%; (ii) a Tier 1 capital to risk-based assets ratio of 6%; (iii) a total capital to risk-based assets ratio of 8%; and (iv) a 4% Tier 1 capital to total assets leverage ratio. These minimum capital requirements became effective in January 2015 and were the result of final rules implementing certain regulatory amendments based on the recommendation of the Basel Committee on Banking Supervision and certain requirements of the Dodd-Frank Act (the "Final Rules").The. The Final Rules also require a new capital conservation buffer designed to absorb losses during periods of economic stress, change the risk-weights of certain assets for purposes of the risk-based capital ratios and phase out certain instruments as qualifying capital.

The Final Rules also contain revisions to the prompt corrective action framework, which is designed to place restrictions on an insured depository institution if its capital levels begin to show signs of weakness. Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions will be required to meet the following increased capital level requirements to qualify as “well capitalized”: (i) a Tier 1 common equity capital ratio of at least 6.5%; (ii) a Tier 1 capital ratio of at least 8%; (iii) a total capital ratio of at least 10%; (iv) a Tier 1 leverage ratio of at least 5%; and (v) not be subject to any order or written directive requiring a specific capital level. The FDIC’s rules (as amended by the Final Rules) contain other capital classification categories, such as “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized,” each of which are based on certain capital ratios. An institution may be downgraded to a category lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition, or if the institution receives an unsatisfactory examination rating. As of December 31, 2018,2019, the most recent notification from the FDIC categorized the Bank as “well capitalized”.

The application of the Final Rules may result in lower returns on invested capital, require the raising of additional capital or require regulatory action if the Bank were unable to comply with such requirements. In addition, management may be required to modify its business strategy due to the changes to the asset risk-weights for risk-based capital calculations and the requirement to meet the capital conservation buffers. The imposition of liquidity requirements in connection with these rules could also cause the Bank to increase its holdings of liquid assets, change its business strategy, and make other changes to the terms of its funding.

The Crapo Bill,so-called “Crapo Bill” (i.e., the Economic Growth, Regulatory Relief, and Consumer Protection Act) was signed into law by President Trump in May 2018, simplifies2018. The Crapo Bill simplified the regulatory capital rules for financial institutions and their holding companies with total consolidated assets of less than $10 billion and instructed the federal banking regulators to establish a single “CommunityCommunity Bank Leverage Ratio”Ratio (“CBLR”) of between 8% and 10%. On November 21, 2018,September 17, 2019, the FDIC publishedissued its final rule relating to the CBLR framework. To qualify for the framework, a proposed Community Bank Leverage Ratiocommunity banking organization must have a tier 1 leverage ratio of greater than 9%. Any, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying depository institution or its holding companycommunity banking organization that exceedsopts into the Community Bank Leverage RatioCBLR framework (and meets all requirements under the framework) will be considered to have met generally applicable leverage and risk-based regulatory capitalthe well-capitalized ratio requirements and considered to be “well capitalized” under the prompt corrective action rules discussed above.  It is difficult at this timeabove and will not be required to predict whenreport or how the new standards under the Crapo Billcalculate risk-based capital. The CBLR framework will ultimately be appliedavailable for banks to us or what specific impact the Crapo Bill (and any implementing rules and regulations) will have on community banks.use in their March 31, 2020 call reports.

Regulatory Oversight and Examination

Inspections

The Federal Reserve conducts periodic inspections of bank holding companies, which are performed both onsite and offsite. The supervisory objectives of the Federal Reserve's inspection program are to ascertain whether the financial strength of the bank holding company is being maintained on an ongoing basis and to determine the effects or consequences of transactions between a bank holding company or its non-banking subsidiaries and its subsidiary banks. For holding companies under $10.0$10 billion in assets, the inspection type and frequency typically varies depending on asset size, complexity of the organization, and the bank holding company’s rating at its last inspection.

Examinations

Banks are subject to periodic examinations by their primary regulator.regulators. The Bank’s primary regulator is the FDIC. In assessing a bank's condition, bank examinations have evolved from reliance on transaction testing in assessing a bank’s condition to a risk-focused approach. These examinations are extensive and cover the entire breadth of operations of the bank. Generally, safety and soundness examinations occur on a 12-month cycle. Examinations alternate between the federal and state bank regulatory agencies, and in some cases they may occur on a combined schedule. The frequency of consumer compliance and CRA examinations is linked to the size of the institution and its compliance and CRA ratings at its most recent examinations. However, the examination authority of the Federal Reserve and the FDIC allows them to examine supervised institutions as frequently as deemed necessary based on the condition of the bank or as a result of certain triggering events.

Commercial Real Estate Ratios

The federal banking regulators recently issued guidance reminding financial institutions to re-examine existing regulations regarding concentrations in commercial real estate lending. The purpose of the guidance is to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The banking agencies are directed to examine each bank’s exposure to commercial real estate loans that are dependent on cash flow from the real estate held as collateral and to focus their supervisory resources on institutions that may have significant commercial real estate loan concentration risk. The guidance provides that the strength of an institution’s lending and risk management practices with respect to such concentrations will be taken into account in evaluating capital adequacy and does not specifically limit a bank’s commercial real estate lending to a specified concentration level.

Corporate Governance and Accounting

The Sarbanes-Oxley Act of 2002 (the “SOX Act”) addresses, among other things, corporate governance, auditing and accounting, enhanced and timely disclosure of corporate information, and penalties for non-compliance. Generally the SOX Act (i) requires chief executive officers and chief financial officers to certify to the accuracy of periodic reports filed with the SEC; (ii) imposes specific and enhanced corporate disclosure requirements; (iii) accelerates the time frame for reporting of insider transactions and periodic disclosures by public companies; (iv) requires companies to adopt and disclose information about corporate governance practices, including whether or not they have adopted a code of ethics for senior financial officers and whether the audit committee includes at least one “audit committee financial expert”, and (v) requires the SEC, based on certain enumerated factors, to regularly and systematically review corporate filings.

As a publicly reporting company, the Holding Company is subject to the requirements of the SOX Act and related rules and regulations issued by the SEC and NASDAQ. After enactment of the SOX Act, the Holding Companywe updated itsour policies and procedures to comply with the SOX Act's requirements and hashave found that such compliance, including compliance with Section 404 relating to the Holding Company's internal controls over financial reporting, has resulted in additional expenses for the Holding Company. The Holding Companyexpenses. We will continue to incur additional expenses in connection with itsour ongoing compliance with these requirements.

Anti-Money Laundering and Anti-Terrorism

The Bank Secrecy Act and the USA Patriot Act of 2001

The Bank Secrecy Act (the “BSA”) requires all financial institutions to (among other requirements) establish a risk-based system of internal controls reasonably designed to prevent money laundering and the financing of terrorism. The BSA also sets forth various recordkeeping and reporting requirements (such as reporting suspicious activities that may signal criminal activity), and certain due diligence and "know your customer" documentation requirements. These requirements were recently expanded, and banks are now required to establish and maintain written procedures that are reasonably designed to identify and verify beneficial owners of legal entity customers, as well (and to include such procedures in their anti-money laundering compliance programs).

Further, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, intended to combat terrorism, was renewed with certain amendments in 2006 (the “Patriot Act”). The Patriot Act, in relevant part, (i) prohibits banks from providing correspondent accounts directly to foreign shell banks; (ii) imposes due diligence requirements on banks opening or holding accounts for foreign financial institutions or wealthy foreign individuals; (iii) requires financial institutions to establish an anti-money-laundering compliance program; and (iv) eliminates civil liability for persons who file suspicious activity reports. The Patriot Act also includes provisions providing the government with power to investigate terrorism, including expanded government access to bank account records. Regulators are directed to consider a bank holding company’s and a bank’s effectiveness in combating money laundering when reviewing and ruling on applications under the BHC Act and the Bank Merger Act. The Holding Company and the Bank have established compliance programs designed to comply with the requirements of the BSA and Patriot Act.

Financial Services Modernization

Gramm-Leach-Bliley Act of 1999

The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 (the “GLBA”) brought about significant changes to the laws affecting banks and bank holding companies. Generally, the GLBA (i) repeals historical restrictions on preventing banks from affiliating with securities firms; (ii) provides a uniform framework for the activities of banks, savings institutions and their holding companies; (iii) broadens the activities that may be conducted by national banks and banking subsidiaries of bank holding companies; (iv) provides an enhanced framework for protecting the privacy of consumer information and requires notification to consumers of bank privacy policies; and (v) addresses a variety of other legal and regulatory issues affecting both day-to-day operations and long-term activities of financial institutions. The Bank is subject to FDIC regulations implementing the privacy protection provisions of the GLBA. These regulations require a bank to disclose its privacy policy, including informing consumers of the bank’s information sharing practices and their right to opt out of certain practices.

Deposit Insurance

FDIC Insured Deposits

The Bank’s deposits are insured under the Federal Deposit Insurance Act, up to the maximum applicable limits and are subject to deposit insurance assessments by the FDIC, which are designed to tie what banks pay for deposit insurance to the risks they pose. The Dodd-Frank Act redefined the assessment base used for calculating deposit insurance assessments by requiring the FDIC to determine assessments based on assets instead of deposits. Assessments are now based on the average consolidated total assets less average tangible equity capital of a financial institution. In addition, the Dodd-Frank Act (i) raised the minimum designated reserve ratio (the FDIC is required to set the reserve ratio each year) of the Deposit Insurance Fund (DIF)(“DIF”) from 1.15% to 1.35%; (ii) required that the DIF reserve ratio meet 1.35% by 2020; and (iii) eliminated the requirement that the FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds. The FDIC has established a higher reserve ratio of 2.00% as a long-term goal beyond what is required by statute. The Dodd-Frank Act made banks with $10 billion or more in total assets responsible for the increase from 1.15% to 1.35%. On by imposing a surcharge on those institutions. The surcharge continued through September 30, 2018, when the DIF reached 1.36%, which was ahead of Dodd Frank’s 2020 deadline to meet the 1.35% reserve ratio. As a result, certain institutions will receive credits for the portions of their regular assessments that contributed to growth in the reserve ratio between 1.15% and 1.35%, to be applied when the reserve ratio is at or above 1.38%. No institution may pay a dividend if it is in default on its federal deposit insurance assessment. The FDIC may also prohibit any insured institution from engaging in any activity determined by regulation or order to pose a serious risk to the DIF.

Safety and Soundness

The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. Management is not aware of any existing circumstances that would result in termination of the Bank's deposit insurance.

Insurance of Deposit Accounts

The Dodd-Frank Act permanently increased FDIC deposit insurance from $100,000 to $250,000 per depositor. The FDIC insurance coverage limit applies per depositor, per insured depository institution for each account ownership category.

Brokered Deposits

On November 13, 2015,December 12, 2019, the FDIC updated guidance on identifying, accepting and reportingissued a proposed rule to modernize its brokered deposit regulations that apply to less than well capitalized insured depository institutions. This proposal would establish a new framework for analyzing whether deposits (“Deposit Guidance”), which appears to adopt an expansive view on what constitutes “facilitating theplaced through deposit placement ofarrangements qualify as brokered deposits.” To the extent the FDIC takes a broader view of what constitutes “brokered deposits”, this could impact our use of brokered deposits in the future. Under Further, under FDIC deposit insurance rules, banks may be assessed higher premiums if they have a high level of brokered deposits. For calendar quarters prior to April 1, 2018, CDARS and ICS reciprocal deposits were considered to be brokered deposits by regulatory authorities and were reported as such on quarterly Call Reports. WithHowever, with the passage of Thethe Crapo bill, however, theseBill, those CDARS and ICS reciprocal deposits are no longer classified as brokered.brokered deposits. At December 31, 2018,2019, we have $83.7had $64.0 million in deposits which are part of the CDARS and ICS programs.

The Dodd-Frank Act

General

The Dodd-Frank Act was signed into law in July of 2010. The Dodd-Frank Act significantly changed the bank regulatory structure and is affecting the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies, including the Holding Company and the Bank. Some of the provisions of the Dodd-Frank Act that may impact the Company'sbusiness and operations of the Holding Company and the Bank's business and operationsBank are summarized below.

Corporate Governance

The Dodd-Frank Act requires publicly traded companies to provide their shareholders with (i) a non-binding shareholder vote on executive compensation, (ii) a non-binding shareholder vote on the frequency of such vote, (iii) disclosure of “golden parachute” arrangements in connection with specified change in control transactions, and (iv) a non-binding shareholder vote on golden parachute arrangements in connection with these change in control transactions. In 2015, the SEC adopted a rule mandated by the Dodd-Frank Act that requires a public company to disclose the ratio of the compensation of its Chief Executive Officer ("CEO") to the median compensation of its employees. This rule is intended to provide shareholders with information that they can use to evaluate a CEO's compensation.

Prohibition Against Charter Conversions of Troubled Institutions

The Dodd-Frank Act generally prohibits a depository institution from converting from a state to federal charter, or vice versa, while it is the subject to an enforcement action unless the depository institution seeks prior approval from its primary regulator and complies with specified procedures to ensure compliance with the enforcement action.

Consumer Financial Protection Bureau

The Dodd-Frank Act established the CFPB and empowered it to exercise broad rulemaking, supervision and enforcement authority for a wide range of consumer protection laws. The Bank is subject to consumer protection regulations issued by the CFPB, but as a financial institution with assets of less than $10.0$10 billion, the Bank is generally not subject to supervision and examination by the CFPB. The CFPB has issued and continues to propose and issue numerous regulations that willmay increase the compliance burden of the Bank. Significant recent CFPB developments that may affect the Bank’s operations and compliance costs include:

Repeal of Demand Deposit Interest Prohibition

The Dodd-Frank Act repealed federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts.

Board Composition

In 2018, the California “Women on Boards” bill was signed into law to advance equitable gender representation on certain California corporate boards. California is the first state in the nation to require all publicly-held domestic or foreign corporations whose principal executive offices are located in California to have at least one female director on their boards by December 31, 2019 (either by filling an open seat or by adding a seat). One or two more women directors may be required, depending upon the size of the public company’s board by December 31, 2021. We had one female serving on our board as of December 31, 2019, and we will continue to advance equitable gender representation by adding females to our board in accordance with California’s Women on Boards bill.

Recent and Proposed Legislation

The economic and political environment of the past several years has led to a number of proposed legislative, governmental and regulatory initiatives that may significantly impact the banking industry. Other regulatory initiatives by federal and state agencies may also significantly impact our business. We cannot predict whether these or any other proposals will be enacted or the ultimate impact of any such initiatives on our operations, competitive situation, financial conditions, or results of operations. While recent history has demonstrated that new legislation or changes to existing laws or regulations typically result in a greater compliance burden (and therefore increase the general costs of doing business), the current Administration has expressed a desire to reduce regulatory burden.

In May of 2018, President Trump signed into law the Crapo Bill discussed above, which will modify or removemodified and removed certain financial reform rules and regulations, including some of those implemented under the Dodd-Frank Act in an effort to provide regulatory relief to certain financial institutions. While the Crapo Bill maintains most of the regulatory structure established by the Dodd-Frank Act, it amendsamended certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion and for large banks with assets of more than $50 billion. Many of these changes could result in meaningful regulatory changes for community banks.

TheFor example, the Crapo Bill simplifiessimplified the regulatory capital rules for financial institutions and their holding companies with total consolidated assets of less than $10 billion, by instructingand the federal banking regulatorsFDIC issued its final rule relating to establish a single “Community Bank Leverage Ratio” of between 8% and 10%. Any qualifying depository institution or its holding company that exceeds the “Community Bank Leverage Ratio” will be considered to have met generally applicable leverage and risk-based regulatory capital requirements and any qualifying depository institution that exceeds the new ratio will be considered to be “well capitalized” under the prompt corrective action rules discussed above. In addition, theCBLR framework on September 17, 2019. The Crapo Bill includesalso included regulatory relief for community banks regarding regulatory examination cycles, call reports, the Volcker Rule (proprietary trading prohibitions), mortgage disclosures and risk weights for certain high-risk commercial real estate Itestate. However, it is difficult at this time to predict when or how the new standards under the Crapo Bill will ultimately be applied to us or what specific impact the Crapo Bill (and any further implementing rules and regulations) will have on community banks.

Effects of Federal Government Monetary Policy

The Holding Company’sOur earnings and growth are affected not only by general economic conditions, but also by the fiscal and monetary policies of the federal government, particularly the Federal Reserve. The Federal Reserve implements national monetary policy to promote maximum employment, stable prices, and moderate long-term interest rates. Through its open market operations in U.S. government securities, control of the discount rate applicable to borrowings, establishment of reserve requirements against certain deposits, and control of the interest rate applicable to excess reserve balances and reverse repurchase agreements, the Federal Reserve influences the availability and cost of money and credit and, ultimately, a range of economic variables including employment, output, and the prices of goods and services. The nature and impact of future changes in monetary policies and their impact on the Holding Company and the Bank cannot be predicted with certainty.

Available Information

The Company files annual, quarterly and current reports, proxy statements and other business and financial information with the SEC. The SEC maintains an Internet site that contains the Company's SEC filings, as well as reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, located at http://www.sec.gov. These filings are also accessible free of charge at the Company's website at www.bankofcommerceholdings.com as soon as reasonably practicable after filing with the SEC. By making this reference to the Company's website, the Company does not intend to incorporate into this report any information contained in the website. The website should not be considered part of this report.

Our principal executive office is located at 555 Capitol Mall, Suite 1255, Sacramento, California 95814 and the telephone number is (800) 421-2575.

Annual Disclosure Statement

This Annual Report on Form 10-K also serves as the annual disclosure statement of the Bank pursuant to Part 350 of the FDIC’s rules and regulations. This statement has not been reviewed or confirmed for accuracy or relevance by the FDIC.

ItemItem 1a - Risk Factors

Company

The following is a discussion of what the Company believes are the most significant risks and uncertainties that may affect the Company's business, financial condition and future results.

National and global economic and geopolitical conditions could adversely affect our future results of operations or market price of our stock.

Our business is impacted by factors such as economic, political and market conditions, broad trends in industry and finance, changes in government monetary and fiscal policies, inflation, and market volatility, all of which are beyond our control. National and global economies are constantly in flux, as evidenced by recent market volatility resulting from, among other things, a relatively new presidential administration and new tax and economic policies associated therewith, the uncertain future relationship between the European Union and United Kingdom, and the ever-changing landscape of the energy industry. Future economic conditions cannot be predicted, and any renewed deterioration in the economies of the nation as a whole or in our market could have an adverse effect, which could be material, on our business, financial condition, results, operations and prospects, and could cause the market price of our stock to decline.

Our business is subject to geographic risks that could adversely impact our results of operations and financial condition.

We conduct banking operations principally in northern California. As a result, our business results are dependent in large part upon the business activity, population, income levels, deposits and real estate activity in northern California. Any future deterioration in economic conditions, particularly within our geographic region, could result in the following consequences, any of which could have a material adverse effect on our business, prospects, financial condition and results of operations:

Our inability to successfully manage our growth or implement our growth strategy could affect our results of operations and financial condition.

We may not be able to successfully implement our growth strategy if we are unable to expand market share in our existing market or identify attractive new markets, locations or opportunities to expand in the future. In addition, our ability to manage growth successfully will depend on whether we can maintain adequate capital levels, maintain cost controls, effectively manage asset quality and successfully integrate any expanded business divisions or acquired businesses into our operations.

As we continue to implement our growth strategy by opening new branches or acquiring branches or banks, we expect to incur increased personnel, occupancy, and other operating expenses. In the case of new branches, we must absorb higher expenses while we begin to generate new deposits. In the case of acquired branches, we must absorb higher expenses while we begin deploying the newly assumed deposit liabilities. With either new branches opened or branches acquired, there could be a lag time involved in deploying new deposits into attractively priced loans and other higher yielding earning assets. Thus, expansion could depress earnings in the short-term, even if an efficiently executed branching strategy leads to long-term financial benefits.

The value of goodwill and other intangible assets may decline in the future

We have goodwill and core deposit intangible assets from business acquisitions. A significant decline in the expected future cash flows, a significant adverse change in the business climate, slower growth rates or a significant and sustained decline in the price of our common stock could necessitate taking charges in the future related to the impairment of goodwill or other intangible assets. If we were to conclude that a write-down of goodwill or other intangible assets is necessary, we would record the appropriate charge, which could have a material adverse effect on our business, financial condition and results of operations.

The loan portfolio includes a significant amount of purchased loans and a significant amount of loans serviced by other companies.

Purchased loans included in the loan portfolio totaled $126.4$93.6 million or 13%9% of gross portfolio loans as of December 31, 2018.2019. The loans were purchased as a pool of loans, individual loans or as purchased participations from other institutions. The majority of the loans are located outside our principal market. The loans were purchased under several different contracts and, $82.6$61.0 million or 9%6% of our gross portfolio loans are serviced by two unrelated third party servicing companies. A disruption to the operations of either of the loan servicing companies could reduce the value of the assets that we own. In addition, if we were forced to service these loans ourselves, we would incur additional monitoring and servicing costs due to the geographic disbursement of the portfolio, which would adversely affect our noninterest expense.

We have a concentration risk in real estate related loans.

A substantial portion of our lending is tied to real estate. As of December 31, 2018,2019, approximately 81%83% of our loan portfolio was secured by real estate as follows:

A large percentage of our loan portfolio is comprised of commercial real estate loans which generally carry larger loan balances and historically have involved a greater degree of financial and credit risks than residential first mortgage loans. These loans are primarily made based on and repaid from the cash flow of the borrower (which may be unpredictable) and secondarily on the underlying collateral provided by the borrower. Any decline in the economy in general, material increases in interest rates, changes in tax policies, tightening credit or refinancing markets, or a decline in real estate values in our principal market areas in particular, could have an adverse impact on the repayment of these loans. Further, our ability to recover on these loans by selling or disposing of the underlying real estate collateral would be adversely impacted by any decline in real estate values, which increases the likelihood that we would suffer losses on defaulted loans secured by real estate beyond the amounts provided for in the ALLL. Any increase in net charge-offs and in the ALLL could also have a material adverse effect on our business, financial condition, and results of operations and prospects.

Nonperforming assets take significant time to resolve and adversely affect our results of operations and financial condition.

We generally do not record interest income on nonperforming loans or other real estate owned, thereby adversely affecting our income, and increasing our loan administration costs. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, which may result in a loss. An increase in the level of nonperforming assets increases our risk profile and consequently may impact the capital levels our regulators believe are appropriate.

While we reduce problem assets through loan sales, workouts, restructurings and otherwise, decreases in the value of the underlying collateral or in these borrowers’ performance or financial condition, whether or not due to economic and market conditions beyond our control, could adversely affect our business, results of operations and financial condition. In addition, the resolution of nonperforming assets requires significant commitments of time from management and our directors, which can be detrimental to the performance of their other responsibilities. We expect the level of non-performing assets and losses relating to such assets to continue to decline, however there can be no assurance that we will not experience future increases in nonperforming assets.

Future loan and lease losses may exceed the allowance for loan and lease losses.

We have established an allowance for possible losses expected in connection with loans in the credit portfolio. This allowance reflects estimates of the collectability of certain identified loans, as well as an overall risk assessment of gross loans outstanding.

The determination of the amount of the allowance for loan and lease losses is subjective. Although the method for determining the amount of the allowance uses criteria such as risk ratings and historical loss rates, these factors may not be adequate predictors of future loan performance. Accordingly, we cannot offer assurances that these estimates ultimately will prove correct or that the loan and lease loss allowance will be sufficient to protect against losses that ultimately may occur. If the allowance for loan and lease losses proves to be inadequate, we will need to make additional provisions to the allowance, which is accounted for as charges to income, which would adversely impact results of operations and financial condition. Moreover, federal and state banking regulators, as an integral part of their supervisory function, periodically review our loan portfolio and the adequacy of our allowance. These regulatory authorities may require us to recognize further loan loss provisions or charge-offs based upon their judgments, which may be different from our judgments. Any increase in the allowance could have an adverse effect, which could be material, on our financial condition and results of operations.

The Financial Accounting Standards Board has adopted a newAdditionally, the changes in accounting standard update (“ASU”) 2016-13 which for us will be effective January 1, 2020. This standard, referred to as Current Expected Credit Loss, or CECL, will require us to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for credit losses. Thisstandards described immediately below will change the current historical method of providing allowances for credit losses that are probable, and may require us to increase our allowance for loan losses and may greatly increase the types of data we would need to collect and review to determine the appropriate levelamount of the allowance for loan and lease losses.

Changes in how we provide for credit losses may have a material impact on our financial condition or results of operations.

In June 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-13, Measurement of Credit Losses on Financial Instruments. The ASU introduces a new impairment model based on current expected credit losses (“CECL”) rather than incurred losses. The CECL model will apply to most financial assets measured at amortized cost, including loans receivable, loan commitments and held-to-maturity debt securities.

Under the CECL model, we would recognize an impairment allowance equal to our current estimate of expected credit losses for financial instruments as of the end of the reporting period. Measuring expected credit losses will likely be a significant challenge for all entities, including us. Additionally, to estimate expected credit losses, we have incurred one-time and recurring costs, some of which are related to system changes and data collection.

Further, the impairment allowance measured under a CECL model could differ materially from the impairment allowance measured under our incurred loss model. To initially apply the CECL amendments, for most debt instruments, we would record a cumulative-effect adjustment to its statement of financial condition as of the beginning of the first reporting period in which the guidance is effective (a modified retrospective approach). The amendments in ASU 2016-13 are effective for us as of January 1, 2023, and are required to be adopted through a modified retrospective approach, with a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the ASU is effective.

The impact of certain provisions of the CECL model regarding loan portfolios of acquired financial institutions could result in earnings volatility, as any adjustments to the ALLL with respect to the acquired loans are required to be made immediately subsequent to the acquisition.

More information on this ASU can be found under the heading Recent Accounting Pronouncements, in Note 2 Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements.

Defaults may negatively impact us.

Risk arises from the possibility that losses will be sustained if a significant number of borrowers, guarantors and related parties fail to perform in accordance with the terms of their loans. We have adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the adequacy of the allowance for loan and lease losses, which management believes are appropriate to minimize risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying the loan portfolio. These policies and procedures, however, may not prevent unexpected losses that could materially affect our results of operations.

Interest rate fluctuations, which are out of our control, could harm profitability.

Our income is highly dependent on “interest rate spreads” (i.e., the difference between the interest income earned on our interest-earning assets such as loans and securities, and the interest expense paid on our interest-bearing liabilities such as deposits and borrowings). The underlying interest rates are highly sensitive to many factors, many of which are beyond our control, including general economic conditions, inflation, recession and the policies of various governmental and regulatory agencies, in particular, the Federal Reserve Board. The Federal Reserve raised its target Federal funds rate in .25% increments three times during 2017 and four times during 2018. In recent years, we originated higher volumes of longer term fixed rate loans. These loans, combined with the structure of our investment portfolio and funding mix caused the Company to become slightly to moderately liability sensitive.sensitive to rising interest rates. However, our loan and investment portfolio contain a significant amount of floating rate assets which reprice faster in a decreasing rate environment than our liabilities and cause the Company to be slightly asset sensitive to falling rates.

The interest rates we pay on deposits and the interest rates we earn on loans are determined in large part by the rates paid and charged by our competitors. In addition, changes in monetary policy including changes in interest rates influence the origination of loans, the purchase of investments and the generation of deposits. These changes affect the rates received on loans and securities and paid on deposits, which could have a material adverse effect on our business, financial condition and results of operations.

We may be impacted by the retirement of LIBOR as a reference rate.

In July 2017, the United Kingdom Financial Conduct Authority announced that the London Interbank Offered Rate (“LIBOR”) may no longer be published after 2021. LIBOR is used extensively in the U.S and globally as a “benchmark” or “reference rate” for various commercial and financial contracts. In response, the Alternative Reference Rates Committee (“ARRC”), made up of financial and capital market institutions, was convened to address the replacement of LIBOR in the U.S. The ARRC identified a potential successor to LIBOR in the Secured Overnight Financing Rate (“SOFR”) and crafted a plan to facilitate the transition. However, there are significant conceptual and technical differences between LIBOR and SOFR. The Financial Stability Oversight Committee has stated that the end or waning use of LIBOR has the potential to significantly disrupt trading in many important types of financial contracts.

At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, subordinated debentures or other securities or financial arrangements. The replacement of LIBOR with one or more alternative rates may impact the availability and cost of hedging instruments and borrowings, including the rates we pay on our subordinated debentures and derivative financial instruments. If LIBOR rates are no longer available, and we are required to implement substitute indices for the calculation of interest rates under contracts or financial instruments to which we are a party, we may incur significant expenses in effecting the transition.

Changes in the fair value of our securities may reduce our shareholders’ equity and net income.

We increase or decrease our shareholders’ equity by the amount of change in the unrealized gain or loss (the difference between the fair value and the amortized cost) of our available-for-sale securities portfolio, net of related tax, under the category of accumulated other comprehensive income (loss). A decline in the fair value of this portfolio will result in a decline in reported shareholders’ equity, as well as book value per common share. This decrease will occur even though the securities are not sold. In the case of debt securities, if these securities are never sold and there are no credit impairments, the decrease will be recovered over the life of the securities. In the event there are credit loss related impairments, the credit loss component is recognized in earnings.

We own shares of Federal Home Loan Bank of San Francisco stock which are recorded in other assets. The stock is carried at cost and subject to recoverability testing under applicable accounting standards. As of December 31, 2018,2019, we did not recognize an impairment charge related to our Federal Home Loan Bank of San Francisco stock holdings; however, potential negative changes to the financial condition of the Federal Home Loan Bank of San Francisco could require us to recognize an impairment charge with respect to such stock holdings. Any such impairment charge would have an adverse impact on our results of operations and financial condition.

We own investments in Qualified Zone Academy Bonds (“QZAB”) which are recorded in other assets. The investments are carried at cost and are subject to recoverability testing under applicable accounting standards. As of December 31, 2018,2019, we did not recognize an impairment charge related to our QZAB investment holdings; however, potential negative changes to the financial condition of the issuing institutions could require us to recognize an impairment charge with respect to such holdings in the future. Any such impairment charge would have an adverse impact on our results of operations and financial condition.

Credit quality for private label mortgage backed securities we hold may deteriorate creating additional credit risk in our investment portfolio.

Our securities portfolio contains private label mortgage backed securities. These securities have more credit risk than the securities in our portfolio that are obligations of the U.S. Government or obligations guaranteed by the U.S. Government. We monitor the credit characteristics of the underlying mortgages to identify potential credit losses, if any, in the portfolio. If there is a decline in fair value due to credit quality concerns for a security we may be required to recognize an other-than-temporarily-impairment in earnings. Our Investment Policy requires that securities at the time of purchase, be rated A3/A- or higher by Moody’s, S&P and Fitch rating agencies.

Conditions in the financial markets may limit our access to additional funding to meet our liquidity needs.

Liquidity is essential to our business, as we must maintain sufficient funds to respond to the needs of depositors and borrowers. An inability to raise funds through deposits, repurchase agreements, federal funds purchased, Federal Home Loan Bank of San Francisco advances, the sale or pledging as collateral of securities, loans, and other assets could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could negatively affect our access to liquidity sources include negative operating results, a decrease in the level of our business activity due to a market downturn or negative regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as severe disruption of the financial markets or negative news and expectations about the prospects for the financial services industry as a whole. An inability to borrow funds to meet our liquidity needs could have an adverse impact on our results of operations and financial condition.

The condition of other financial institutions could negatively affect us.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, public perceptions and other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks and other institutional clients.

Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to us. Any such losses could have a material adverse effect on our financial condition and results of operations.

Competition in our market areas may limit future success.

Community banking is a highly competitive business and a consolidating industry. We compete for loans and deposits with other commercial banks, savings and loans, credit unions, finance, insurance and other non-depository companies operating in our market areas. Some of our competitors are not subject to the same regulations and restrictions as are we, and some of our competitors have greater financial resources. If we are unable to effectively compete in our market areas, the Company's business, results of operations, and prospects could be adversely affected.

Derivative financial instruments subject the Company to credit and market risk

We may use derivatives to hedge the risk of changes in market interest rates in order to limit the impact on earnings and cash flows relating to specific groups of assets and liabilities. Our use of derivatives in our risk management activities could expose the Company to mark-to-market losses if interest rates move in a materially different way than we expected when we entered into the related derivative contracts. In addition, we would be exposed to credit risk should the counterparty fail to perform under the terms of the derivative contracts. This could cause us to forfeit the payments due to us or result in settlement delays with the attendant credit and operational risk as well as increased costs to us. Derivative contracts may contain a provision which allows the counterparty to terminate the derivative contract if we failed to maintain our status as a well/adequately capitalized institution or if specific regulatory events occurred. If these contracts were terminated by the counterparty, we would be required to settle our obligations under the agreements, which could also cause operational risk and increased costs to us.

We rely heavily on our management team and the loss of key officers may adversely affect operations.

We are dependent on the successful recruitment and retention of highly qualified personnel. Our ability to implement our business strategies is closely tied to the strengths of our chief executive officer and other key officers. Additionally, business banking, one of our principal lines of business, is dependent on relationship banking in which our personnel develop professional relationships with small business owners and officers of larger business customers who are responsible for the financial management of the companies they represent. If management team members or other key employees were to leave the Company and become employed by a competing bank, we could potentially lose business customers. In addition, we rely on our customer service staff to effectively serve the needs of our customers. The loss of key employees to competitors or otherwise could have an adverse effect on our results of operation and financial condition.

Our future performance will depend on our ability to respond to technological change.

The financial services industry is experiencing rapid technological changes with frequent introductions of new technology-driven products and services. Effective use of technology increases efficiency and enables financial institutions to better serve customers and reduce costs. Many of our competitors have substantially greater resources to invest in technological improvements than we do. Our future success will depend, to some degree, on our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as create additional efficiencies in our operations, We may not be able to effectively implement new technology-driven products or service, or be successful in marketing such products and services. Additionally, the implementation of technological changes and upgrades to maintain current systems and integrate new ones may cause services interruptions, transaction processing errors and system conversion delays and may cause us to fail to comply with applicable laws. There can be no assurance that we will be able to successfully manage the risks associated with increased dependency on technology.

Internal control systems could fail to detect certain events.

We are subject to many operating risks, including, without limitation, data processing system failures and errors, and customer or employee fraud. There can be no assurance that such an event will not occur, and if such an event is not prevented or detected by our internal controls and does occur, and it is uninsured or is in excess of applicable insurance limits, it could have a significant adverse impact on our reputation in the business community and our business, financial condition, and results of operations.

Our operations could be interrupted if third party technology service providers experience difficulty, terminate their services or fail to comply with banking regulations.

We depend, and will continue to depend to a significant extent, on a number of relationships with third party technology service providers. Specifically, we utilize software and hardware systems for transaction processing, essential web hosting, debit and credit card processing, merchant bankcard processing, internet banking systems and other processing services from third party service providers. If these third party service providers experience difficulties or terminate their services, and we are unable to replace them with other qualified service providers, our operations could be interrupted. If an interruption were to continue for a significant period of time, our business, financial condition and results of operations could be materially adversely affected.

Confidential customer information transmitted through the Bank’s online banking service is vulnerable to security breaches and computer viruses which could expose the Bank to litigation and adversely affect its reputation and ability to generate deposits.

We provide our customers the ability to bank online. We rely heavily on the secure processing, storage and transmission of confidential and other information on our computer systems and networks. The secure transmission of confidential information over the Internet is a critical element of online banking. Our network could be vulnerable to unauthorized access, computer hacking, cyber-attacks, electronic fraudulent activity, attempted theft of financial assets, computer viruses, phishing schemes and other security problems. We cannot guarantee that any such failures, interruption or security breaches will not occur, or if they do occur, that they will be adequately addressed. While we have certain protective policies and procedures in place, the nature and sophistication of the threats continue to evolve. We may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, alleviate problems caused by security breaches or viruses or to modify and enhance our protective measures. To the extent that our activities or the activities of our customers involve the storage and transmission of confidential information, security breaches and viruses could expose us to claims, litigation and other possible liabilities. Any inability to prevent cyber-attacks, security breaches or computer viruses could also cause existing customers to lose confidence in our systems and could adversely affect our reputation and our ability to generate deposits.

We are subject to extensive regulation which could adversely affect our business.

Our operations are subject to extensive regulation by federal, state and local governmental authorities and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of our operations. Because our business is highly regulated, the laws, rules and regulations applicable to us are subject to modification and change. There are currently proposed laws, rules and regulations that, if adopted, would impact our operations. For more information on these issues, refer to the material set forth above under the heading "Government Supervision and Regulation."

The requirements imposed by our regulators and other laws, rules or regulations applicable to us are designed to ensure the integrity of the financial markets and to protect customers and other third parties that transact business with us, and are not designed to protect our shareholders. Consequently, these regulations may: (1) make compliance much more difficult or expensive, (2) restrict our ability to originate, broker or sell loans or accept certain deposits, (3) further limit or restrict the amount of commissions, interest or other charges earned on loans originated or sold by us, or (4) otherwise adversely affect our business or prospects for business. Moreover, banking regulators have significant discretion and authority to address what regulators perceive to be unsafe or unsound practices or violations of laws or regulations by financial institutions and holding companies in the performance of their supervisory and enforcement duties. The exercise of regulatory authority by banking regulators over us may have a negative impact on our financial condition and results of operations. Additionally, in order to conduct certain activities, including acquisitions, we are required to obtain regulatory approval. There can be no assurance that any required approvals can be obtained, or obtained without conditions or on a timeframe acceptable to us.

Changes in accounting standards may impact how we report our consolidated financial condition and consolidated results of operations.

Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time, the FASB changes the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be difficult to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in a restatement of prior period financial statements.

Natural disasters and other uncontrollable events, such as earthquakes, volcanic eruptions, tsunami, wildfires, droughts, floods, mudslides, hurricanes, tornados and other geologic processes could harm our business.

We are susceptible to the risks of natural disasters such as earthquakes, volcanic eruptions, tsunami, wildfires, droughts, floods, mudslides, hurricanes, tornados and other geologic processes. Historically, California has been vulnerable to natural disasters, and in 2017, California experienced extensive rainfall resulting in significant flooding and landslides, followed later in the year by the largest and most destructive wildfire season in state history. Natural disasters could harm our operations directly through interference with communications, including the interruption or loss of our websites, which would prevent us from gathering deposits, originating loans and processing and controlling our flow of business, as well as through the destruction of facilities and our operational, financial and management information systems. California has also historically experienced energy shortages, which, if they recur, could impair our business operation and the value of real estate in the areas affected.

Although we have implemented several back-up systems and protections and maintain business interruption insurance, these measures may not protect us fully from the effects of a natural disaster. The occurrence of natural disasters or energy shortages in California could have a material adverse effect on our business, prospects, financial condition and results of operations. 

A natural disaster outside California could negatively impact our purchased loan portfolio or our third party loan servicers.

Our purchased loan portfolio includes a significant amount of loans made to borrowers outside California. We also rely on third party loan servicers located outside of California. Therefore, we are susceptible to the risks of natural disasters outside California. Natural disasters could impact the operations of our loan servicers directly through interference with communications, including the interruption or loss of websites, destruction of facilities, operational, financial and management information systems which could prevent them from servicing our portfolio. Natural disasters outside California could also impact the underlying collateral and borrower’s ability to repay the loans for our purchased loan portfolios.

The economic effects of the coronavirus disease 2019 or similar pandemic diseases could adversely affect our future results of operations or the market price of our stock

.

Although the scope of the recent outbreak of the coronavirus disease 2019 cannot be predicted, either internationally or within the United States, it has already resulted in significant volatility in world and national trading markets.  Any significant spread of the coronavirus disease 2019 or similar disease within the United States could have an adverse effect on the national economy generally, the markets that we serve, our future results of operations or the market price of our stock.

No assurance can be given that the Subordinated Notes will continue to qualify as Tier 2 Capital.

We believe that our Subordinated Notes meet the requirements of Tier 2 Capital in accordance with the Final Rules and current statutory guidance provided by the Federal Reserve Board. The Federal Reserve Board does not provide prior approval for the Subordinated Notes to be classified as Tier 2 Capital however, we did not receive any indication that the Subordinated Notes did not qualify as tier 2 capital during our most recent examination process with the Federal Reserve Bank of San FranciscoFrancisco. In the event that the Subordinated Notes do not qualify, the Federal Reserve Bank of San Francisco may require the Holding Company to amend certain terms and conditions of the Subordinated Notes in order for such instruments to qualify as Tier 2 Capital. Under the terms of the Subordinated Notes, the Holding Company also has the option to redeem the Subordinated Notes upon the occurrence of such an event.

We cannot give any assurance as to whether the applicable requirements for Tier 2 Capital will change in the future. Even if the Subordinated Notes initially meet the requirements of Tier 2 Capital under the current regulations, if changes are made in the future, and unless the Subordinated Notes are grandfathered into the new regulations, they could become disqualified as Tier 2 Capital.

Our deposits are subject to volatility

Our depositors can always choose to withdraw their deposits from the Bank and place them into alternative investments, which might cause an increase in our funding costs and reduce our net interest income. Checking, savings and money market account balances can decrease when customers perceive that alternative investments provide a better risk/return tradeoff.

At December 31, 2018,2019, time certificates of deposit in excess of $250,000, excluding brokered time deposits, represented approximately 5% of our total deposit balances. Because these deposits are not covered by FDIC deposit insurance, they are considered volatile and could be subject to withdrawal. Withdrawal of a material amount of such deposits could adversely affect our liquidity, profitability, business prospects, results of operations and cash flows. Our 25 largest deposit relationships account for 24%21% of our deposits.

Our exposure to operational, technological, and organization risk may adversely affect us.

Similar to other financial institutions, we are exposed to many types of operational and technological risk, including reputation, legal and compliance risk. Our ability to grow and compete is dependent on our ability to build or acquire the necessary operational and technological infrastructure and to manage the cost of that infrastructure while we expand and integrate acquired businesses. Operational risk can manifest itself in many ways, such as errors related to failed or inadequate processes, faulty or disabled computer systems, occurrences of fraud by employees or persons outside our company, and exposure to external events. We are dependent on our operational infrastructure to help manage these risks. From time to time, we may need to change or upgrade our technological infrastructure. We may experience disruption, and we may face additional exposure to these risks during the course of making such changes. If we acquire another financial institution or bank branch operations, we would face additional challenges when integrating different operational platforms, causing integration efforts to be more disruptive and /or more costly than anticipated.

Shareholders

In addition to risks and uncertainties that may affect the Company’s business, financial condition and the future results, shareholders may also be subject to the following risks:

There can be no assurance we will be able to continue paying cash dividends on our common stock at recent levels.

We may not be able to continue paying quarterly cash dividends commensurate with recent levels, given that the ability to pay cash dividends on our common stock depends on a variety of factors. The payment of dividends is subject to government regulation in that regulatory authorities may prohibit banks and bank holding companies from paying dividends that would constitute an unsafe or unsound banking practice. The Federal Reserve Board generally prohibits a bank holding company from declaring or paying a cash dividend which would impose undue pressure on the capital of subsidiary banks or would be funded only through borrowing or other arrangements that might adversely affect a financial services holding company’s financial position. The Board of Governors of the Federal Reserve System policy is that a bank holding company should not continue its existing rate of cash dividends on its common stock unless its net income is sufficient to fully fund each dividend and its prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition. The power of the board of directors of an insured depository institution to declare a cash dividend or other distribution with respect to capital is subject to statutory and regulatory restrictions which limit the amount available for such distribution depending upon the earnings, financial condition and cash needs of the institution, as well as general business conditions.

Our ability to pay cash dividends to our shareholders is dependent on our receipt of cash dividends from our subsidiary Bank. In addition to the restrictions imposed under federal law, banks chartered under California law generally may only pay a cash dividend to the extent such payment does not exceed the lesser of (i) retained earnings of the bank or (ii) the bank’s net income for its last three fiscal years less any distributions to shareholders during such period. The Bank is also prohibited from paying a dividend to the holding company if it is in default on its federal deposit insurance assessment.

The price of our common stock may fluctuate significantly, and this may make it difficult for you to resell shares of our common stock owned by you at times or at prices you find attractive.

Stock price volatility may make it difficult for you to resell your common stock at the time and prices you find attractive. Our stock price can fluctuate significantly in response to a variety of factors including, among other things:

General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause our stock price to decrease regardless of operating results as evidenced by the recent volatility and disruption of capital and credit markets.

Our common stock is traded on the NASDAQ Global Market under the trading symbol “BOCH” and historically has been a low trading volume stock. The limited trading market for our common stock may cause fluctuations in the market value of our common stock to be exaggerated, leading to price volatility in excess of that which would occur in a more active trading market of our common stock. Future sales of substantial amounts of common stock in the public market, or the perception that such sales may occur, could adversely affect the prevailing market price of the common stock. In addition, even if a more active market in our common stock develops, we cannot assure you that such a market will continue.

Anti-takeover provisions in our articles of incorporation could make a third party acquisition of us difficult.

In order to approve a merger or similar business combination with the owner of 20% or more of our common stock (an “Interested Shareholder”), our Articles of Incorporation contain provisions that require a supermajority vote of 66.7% of the outstanding shares of the common stock (excluding the shares held by the Interested Shareholder or its affiliates). These provisions further require that the per share consideration to be paid in such a transaction be equal or exceed the greater of (1) the highest per share price paid by the Interested Shareholder (a) within two years of the transaction proposal announcement date, or (b) the date the Interested Shareholder acquired a 20% -plus ownership interest (if the acquisition occurred less than two years before the transaction announcement) and (2) the fair market value of the Common Stock on (a) the transaction proposal announcement date, or (b) the date the Interested Shareholder acquired a 20% -plus ownership interest (if the acquisition occurred less than two years before the transaction announcement).

These provisions could result in the Company becoming a less attractive target for a would-be acquirer. As a consequence, it is possible that shareholders would lose an opportunity to be paid a premium for their shares in an acquisition transaction, even in circumstances where such action is favored by a majority of the Company's shareholders.

There may be future sales or other dilutions of our equity which may adversely affect the market price of our common stock.

We are not restricted from issuing additional shares of common stock, including securities that are convertible into or exchangeable for, or that represent the right to receive our common stock. In addition, we are not prohibited from issuing additional securities which are senior to our common stock. Because our decision to issue securities in any future offering will depend in part on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of any future offerings.

Future issuance of shares of our common stock, including those that may be issued in connection with our various stock option and equity compensation plans, in acquisitions or in any other offering of our common stock for cash, could have a dilutive effect on the tangible book value of our common stock and could adversely affect our market price. Any future issuances of shares of our common stock may be dilutive to existing shareholders.

The holders of our trust preferred securities have rights that are senior to those of our holders of common stock and that may impact our ability to pay dividends on our common stock to our common shareholders.

At December 31, 2017,2019, our subsidiary Bank of Commerce Holdings Trust II had outstanding $10.3 million[$10.3 million] of trust preferred securities. These securities are effectively senior to shares of common stock due to the priority of the underlying junior subordinated debentures. As a result, we must make dividend payments on our trust preferred securities before any dividends can be paid on our common stock; moreover, in the event of our bankruptcy, dissolution, or liquidation, all obligations outstanding with respect to our trust preferred securities must be satisfied before any distributions can be made to our shareholders. While we have the right to defer dividends on the trust preferred securities for a period of up to five years, no dividends may be paid to our common shareholders during that time if any such election has been made.

Our senior and subordinated debt agreements haveagreement has provisions that may impact our ability to pay dividends on our common stock to our common shareholders

On December 10, 2015, we issued and sold $10.0 million in aggregate principal amount of fixed to floating rate Subordinated Notes pursuant to a private placement with certain institutional investors. Also on December 10, 2015, we entered into a loan agreement pursuant to which we obtained $10.0 million in senior debt secured by a pledge of all of the stock of the Bank. The Notes and debt agreements limit the payment of cash dividends to our common shareholders if the Company is not well capitalized or if there is an event of default as described by the agreements.agreement.

ItemItem 1b - Unresolved Staff Comments

None to report.

ItemItem 2 - Properties

ItemItem 3 - Legal Proceedings

We are subject to various pending and threatened legal actions arising in the ordinary course of business and, if necessary, maintain reserves for losses from legal actions that are both probable and estimable. There are no legal proceedings adverse to the Company that we believe will have a material effect on our consolidated financial position or results of operations.

ItemItem 4 - Mine Safety Disclosures

Not applicable.

PartPart II

ItemItem 5 - Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

The principal market on which our common stock is traded is the NASDAQ Global Market. The Holding Company’s common stock is listed under the trading symbol “BOCH.” There were 2,3402,368 shareholders of the Holding Company’s common stock as of December 31, 2018,2019, including those held in street name, and the market price on that date was $10.96$11.57 per share.

Cash Dividends

We declared cash dividends of $0.15$0.19 and $0.12$0.15 during the years ended December 31, 20182019 and 2017,2018, respectively. Our ability to pay dividends is subject to certain regulatory requirements. The Federal Reserve Board generally prohibits a bank holding company from declaring or paying a cash dividend which would impose undue pressure on the capital of subsidiary banks or would be funded only through borrowing or other arrangements that might adversely affect a financial services holding company’s financial position. The Board of Governors of the Federal Reserve System policy is that a bank holding company should not continue its existing rate of cash dividends on its common stock unless its net income is sufficient to fully fund each dividend and its prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition. The power of the board of directors of an insured depository institution to declare a cash dividend or other distribution with respect to capital is subject to statutory and regulatory restrictions which limit the amount available for such distribution depending upon the earnings, financial condition and cash needs of the institution, as well as general business conditions.

Our ability to pay dividends is subject to certain contractual requirements. Our trust preferred securities senior and subordinated debt agreements contain provisions that prohibit us from declaring or paying a dividend if the Company is not “well-capitalized” for regulatory purposes or there exists an event of default as defined by the agreements.

Securities Authorized for Issuance Under Equity Compensation PlansPurchases of equity securities

We currently maintainOn September 18, 2019, we announced that our Board of Directors had authorized a stock purchase program. The stock purchase program authorizes the Company to purchase up to one equity-based compensation plan whichmillion shares of its common stock over a period ending March 31, 2020 and was approved byeffective immediately. Purchases may be made in the shareholdersopen market, including in 2008block trades, or through privately negotiated transactions, from time to time when management determines that market conditions and amended in 2010other factors warrant such purchases. There is no guarantee as to the exact number of shares to be purchased, and 2012. The following table sets forththe stock purchase program may be modified, suspended, or terminated without prior notice. On February 21, 2020 we announced that our equity-based compensation plan,Board of Directors increased the number of shares that may be purchased from 1,000,000 to 1,500,000 shares of common stock, subjectand extended the program by one year to outstanding options,March 31, 2021. The following table provides information regarding purchases under the weighted-average exercise price of outstanding options, and the number of shares available for future award grants as of December 31, 2018.program.

							(c)
		(a)			(b)		Number of Securities Remaining
		Number of Securities To Be		Weighted Average			Available For Future Issuance Under
		Issued Upon Exercise of		Exercise Price of			Equity Compensation Plans (Excluding
Plan Category		Outstanding Options		Outstanding Options			Securities Reflected In Column (a))
Equity compensation plans approved by security holders		97,400		$	5.02		151,699
Equity compensation plans not approved by security holders		None			None		None
Total		97,400		$	5.02		151,699

		Total Number Of				Average Price				Total Number of Shares				Maximum Number Of
		Common Shares				Paid Per				Purchased As Part Of				Shares That May Yet Be
Period		Purchased				Common Share 1				Publicly Announced Plan				Purchased Under The Plan
10/1/19-10/31/19			71,499			$	11.13				71,499				1,428,501
11/1/19-11/30/19			13,493			$	11.26				13,493				1,415,008
12/1/19-12/31/19			5,509			$	11.28				5,509				1,409,499
Total			90,501			$	11.16				90,501

1 - Average price paid per common share includes commissions.

 

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Stock Performance Graph

The following graph compares the Holding Company’s cumulative total return to shareholders during the past five years with that of the NASDAQ Composite Stock Index and the SNL Securities $1.000 billion - $5.000 billion Bank Asset-Size Index (the “SNL Securities Index”). The stock price performance shown on the following graph is not necessarily indicative of future performance of our common stock.

Bank of Commerce Holdings

Five – Year Performance Graph ⁽¹⁾

(1) Assumes $100 invested on December 31, 2013, in the Holding Company’s common stock, the NASDAQ Composite Index, and the SNL Securities Index. The model assumes reinvestment of dividends. Source: SNL Securities (share prices for the Holding Company’s common stock was furnished to SNL Securities through the NASDAQ).

19BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

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ItemItem 6 - Selected Financial Data

 

The selected consolidated financial data set forth below for the five years ended December 31, 2018,2019, have been derived from the Company’s audited Consolidated Financial Statements and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s audited Consolidated Financial Statements and notes thereto, included elsewhere in this report.

 

Amounts in thousands (except ratios and per share data)		2018				2017				2016				2015				2014				2019				2018				2017				2016				2015
Statements of income
Interest income		$	52,701			$	45,949			$	41,009			$	38,753			$	36,693			$	59,563			$	52,701			$	45,949			$	41,009			$	38,753
Net interest income		$	47,546			$	41,362			$	36,231			$	33,770			$	32,601			$	53,535			$	47,546			$	41,362			$	36,231			$	33,770
Provision for loan and lease losses		$	—			$	950			$	—			$	—			$	3,175			$	—			$	—			$	950			$	—			$	—
Noninterest income		$	4,019			$	4,824			$	3,486			$	3,183			$	4,307			$	4,184			$	4,019			$	4,824			$	3,486			$	3,183
Noninterest expense		$	32,206			$	30,964			$	32,500			$	24,905			$	26,426			$	37,255			$	32,206			$	30,964			$	32,500			$	24,905
Net income available to common shareholders		$	15,730			$	7,344			$	5,259			$	8,295			$	5,527			$	14,961			$	15,730			$	7,344			$	5,259			$	8,295
Balance sheets
Total assets		$	1,307,104			$	1,269,421			$	1,140,992			$	1,015,441			$	997,192			$	1,479,616			$	1,307,104			$	1,269,421			$	1,140,992			$	1,015,441
Average total assets		$	1,288,841			$	1,198,251			$	1,079,750			$	992,731			$	973,807			$	1,458,112			$	1,288,841			$	1,198,251			$	1,079,750			$	992,731
Total gross loans		$	946,251			$	879,835			$	804,211			$	716,639			$	660,898			$	1,032,903			$	946,251			$	879,835			$	804,211			$	716,639
Allowance for loan and lease losses		$	12,292			$	11,925			$	11,544			$	11,180			$	10,820			$	12,231			$	12,292			$	11,925			$	11,544			$	11,180
Total deposits		$	1,131,716			$	1,102,732			$	1,004,666			$	803,735			$	789,035			$	1,267,171			$	1,131,716			$	1,102,732			$	1,004,666			$	803,735
Total shareholders’ equity		$	138,321			$	127,264			$	94,106			$	90,522			$	103,602			$	174,478			$	138,321			$	127,264			$	94,106			$	90,522
Ratios 1
Return on average assets 2			1.22	%			0.61	%			0.49	%			0.86	%			0.59	%			1.03	%			1.22	%			0.61	%			0.49	%			0.86	%
Return on average shareholders’ equity 3			12.08	%			6.34	%			5.68	%			8.10	%			5.59	%			9.09	%			12.08	%			6.34	%			5.68	%			8.10	%
Average equity to average assets			10.10	%			9.67	%			8.57	%			10.68	%			10.51	%			11.29	%			10.10	%			9.67	%			8.57	%			10.68	%
Common equity tier 1 capital ratio 4			12.79	%			12.26	%			9.43	%			10.06	%			n/a				13.19	%			12.79	%			12.26	%			9.43	%			10.06	%
Tier 1 capital ratio 4			13.71	%			13.23	%			10.42	%			11.16	%			13.91	%			14.04	%			13.71	%			13.23	%			10.42	%			11.16	%
Total capital ratio 4			15.82	%			15.44	%			12.68	%			13.52	%			15.16	%			15.97	%			15.82	%			15.44	%			12.68	%			13.52	%
Tier 1 leverage ratio 4			11.21	%			10.86	%			9.13	%			10.03	%			11.60	%			11.30	%			11.21	%			10.86	%			9.13	%			10.03	%
Net interest margin 5			3.93	%			3.78	%			3.71	%			3.77	%			3.71	%			3.94	%			3.90	%			3.68	%			3.60	%			3.64	%
Average earning assets to total average assets			94.67	%			93.85	%			93.34	%			93.43	%			93.81	%			93.29	%			94.67	%			93.85	%			93.34	%			93.43	%
Nonperforming assets to total assets 6			0.32	%			0.46	%			1.06	%			1.53	%			2.22	%			0.38	%			0.32	%			0.46	%			1.06	%			1.53	%
Net (recoveries) charge-offs to average loans			(0.04	%)			0.07	%			(0.05	%)			(0.05	%)			1.04	%
Net charge-offs (recoveries) to average loans																							0.01	%			(0.04	)%			0.07	%			(0.05	)%			(0.05	)%
Allowance for loan and lease losses to gross loans			1.30	%			1.36	%			1.44	%			1.56	%			1.64	%			1.18	%			1.30	%			1.36	%			1.44	%			1.56	%
Nonperforming loans to allowance for loan and lease losses			33.73	%			48.63	%			98.64	%			126.09	%			200.30	%			45.92	%			33.73	%			48.63	%			98.64	%			126.09	%
Efficiency ratio 7			62.5	%			67.0	%			81.8	%			67.4	%			71.6	%			64.5	%			62.5	%			67.0	%			81.8	%			67.4	%
Share data
Average common shares outstanding – basic			16,248				15,207				13,367				13,331				13,475				17,956				16,248				15,207				13,367				13,331
Average common shares outstanding – diluted			16,332				15,310				13,425				13,365				13,520				18,024				16,332				15,310				13,425				13,365
Book value per common share		$	8.47			$	7.82			$	7.00			$	6.76			$	6.29			$	9.62			$	8.47			$	7.82			$	7.00			$	6.76
Book value per common share - tangible 8		$	8.36			$	7.70			$	6.83			$	6.76			$	6.29			$	8.71			$	8.36			$	7.70			$	6.83			$	6.76
Basic earnings per share		$	0.97			$	0.48			$	0.39			$	0.62			$	0.41			$	0.83			$	0.97			$	0.48			$	0.39			$	0.62
Diluted earnings per share		$	0.96			$	0.48			$	0.39			$	0.62			$	0.41			$	0.83			$	0.96			$	0.48			$	0.39			$	0.62
Cash dividends per common share		$	0.15			$	0.12			$	0.12			$	0.12			$	0.12			$	0.19			$	0.15			$	0.12			$	0.12			$	0.12

 

1 - Regulatory Capital Ratios and Asset Quality Ratios are end of period ratios. With the exception of end of period ratios, all ratios are based on average daily balances during the indicated period.

2 - Return on average assets is net income (which included preferred stock costs in 2015 and 2014)2015) divided by average total assets.

3 - Return on average shareholders' equity is net income (which included preferred stock costs in 2015 and 2014)2015) divided by average shareholders’ equity.

4 - See Item 7 - Management’s Discussion And Analysis Of Financial Condition And Results Of Operations and Note 1817 Regulatory Capital in the Notes to Consolidated Financial Statements in this document for a discussion of the regulatory capital guidelines.

5 - Net interest margin equalsis net interest income onexpressed as a tax equivalent basis, divided bypercentage of average interest-earning assets.

6 - Nonperforming assets include all nonperforming loans (nonaccrual loans, loans 90 days past due and still accruing interest and restructured loans that are nonperforming) and real estate acquired by foreclosure or transfer to OREO.

7 - The efficiency ratio is calculated by dividing noninterest expense by the sum of net interest income and noninterest income and presented based on results from continuing operations.

8 - Tangible book value per share is computed by dividing total shareholders’ equity less goodwill and core depositother intangible assets, net by shares outstanding. Management believes that tangible book value per share is meaningful because it is a measure that the Company and investors commonly use to assess capital adequacy.

 

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BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

ItemItem 7 - Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

 

The following discussion and analysis of our financial condition as of December 31, 2018,2019 and 2017,2018 and results of operations for each of thethose years in the three-year period ended December 31, 2018 should be read in conjunctiontogether with our Consolidated Financial Statements and related notes, included in Part II Item 8 of this report. Average balances, including balances used in calculating certain financial ratios, are generally comprised of average daily balances.

 

The disclosures set forth in this item are qualified by important factors detailed in Part I captioned Forward-Looking Statements and Item 1A captioned Risk Factors of this report and other cautionary statements set forth elsewhere in the report.

 

This section of this Form 10-K generally discusses 2019 and 2018 items and year-to-year comparisons between 2019 and 2018. Discussions of 2017 items and year-to-year comparisons between 2018 and 2017 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2018.

EXECUTIVE OVERVIEW

 

Net Incomeincome for the three years ended December 31, 2019 and 2018 2017was $15.0 million or $0.83 per share diluted and 2016 was $15.7 million or $0.96 per share diluted, $7.3 million or $0.48 per share-diluted, and $5.3 million or $0.39 per share-diluted, respectively. 

The current year includes the benefits of our January 31, 2019 acquisition of The Merchants National Bank of Sacramento (“Merchants”). In May, we successfully converted all of Merchant’s computer records onto our core system. As previously announced, the Company’s subsidiary bank, which had been operating under multiple names, simultaneously changed the name for all locations to Merchants Bank of Commerce. During 2019 acquisition related costs totaled $2.2 million and costs related to the name change totaled $503 thousand. All significant costs for these two projects have now been absorbed.

Financial performance for all three years2018 and 2017 includes “selected tax items” which complicates reporting period comparisons. The 2018 results include a $1.5 million decrease in our income tax provision composed of a $988 thousand reversal of our reserve for uncertain tax position and a $484 thousand benefit as a result of our cost segregation study and tangible property review. The 2017 results include a $2.5 million increase in our income tax provision as a result of the Tax Cuts and Jobs Act of 2017. The 2016 results also include a write-down of a $363 deferred tax asset. Management believes that our financial results are more comparative excluding the impact of these selected tax items.

 

Non-GAAP Financial Measures

 

In addition to results presented in accordance with generally accepted accounting principles in the United States of America (GAAP), this Annual Report on Form 10-K contains certain non-GAAP financial measures. We believe that these non-GAAP financial measures provide investors with information useful in understanding the Company’s financial performance; however, readers of this document are urged to review these non-GAAP financial measures in conjunction with the GAAP results as reported.

 

SELECTED NON-GAAP FINANCIAL INFORMATION - UNAUDITED

(amounts in thousands except per share data)

SELECTED NON-GAAP FINANCIAL INFORMATION - UNAUDITED													SELECTED NON-GAAP FINANCIAL INFORMATION - UNAUDITED
(amounts in thousands except per share data)													(amounts in thousands except per share data)
		For The Twelve Months Ended												For The Twelve Months Ended
Reconciliation of Net Income (GAAP) to Net Income		December 31,												December 31,
Excluding Selected Tax Items (non-GAAP):		2018				2017				2016				2019				2018				2017
Net income (GAAP)		$	15,730			$	7,344			$	5,259			$	14,961			$	15,730			$	7,344
Selected tax items:
Reversal of uncertain tax position (GAAP)			(988	)			—				—				—				(988	)			—
Benefit from cost segregation study and tangible property review (GAAP)			(484	)			—				—				—				(484	)			—
Deferred tax asset write-down (GAAP)			—				2,490				363				—				—				2,490
Total selected tax items			(1,472	)			2,490				363				—				(1,472	)			2,490
Net income excluding selected tax items (non-GAAP)		$	14,258			$	9,834			$	5,622			$	14,961			$	14,258			$	9,834
Earnings per share - diluted (GAAP)		$	0.96			$	0.48			$	0.39			$	0.83			$	0.96			$	0.48
Effect of selected tax items			(0.09	)			0.16				0.03				—				(0.09	)			0.16
Earnings per share - diluted excluding selected tax items (non-GAAP)		$	0.87			$	0.64			$	0.42			$	0.83			$	0.87			$	0.64
Non-GAAP Ratios:
Return on average assets excluding selected tax items			1.11	%			0.82	%			0.52	%
Return on average equity excluding selected tax items			10.95	%			8.48	%			6.07	%
Effective tax rate excluding selected tax items			26.3	%			31.1	%			22.1	%
GAAP Information:
Return on average assets			1.22	%			0.61	%			0.49	%			1.03	%			1.22	%			0.61	%
Return on average equity			12.08	%			6.34	%			5.68	%			9.09	%			12.08	%			6.34	%
Effective tax rate			18.7	%			48.5	%			27.1	%			26.9	%			18.7	%			48.5	%
Non-GAAP Information:
Return on average assets excluding selected tax items															1.03	%			1.11	%			0.82	%
Return on average equity excluding selected tax items															9.09	%			10.95	%			8.48	%
Effective tax rate excluding selected tax items															26.9	%			26.3	%			31.1	%

 

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Significant itemsFinancial Highlights for the year ended December 31, 20182019 were as follows:

 

Performance

●

Net income of $15.7$15.0 million was an increasea decrease of $8.4 million (114%$769 thousand (5%) from $7.3$15.7 million earned during the same period in the prior year. Earnings of $0.96$0.83 per share – diluted was an increasedecrease of $0.48 (100%$0.13 (14%) from $0.48$0.96 per share – diluted earned during the same period in the prior year and reflects the impact of 2,738,096the following:

o

1,834,142 shares of common stock sold and issued induring the secondfirst quarter of 2017.

●	Expenses associated with2019 as part of our acquisition of Merchants Holding Company totaled $844 thousand.and

o

90,501 shares of common stock repurchased during the fourth quarter of 2019 as part of our previously announced share repurchase program.

●	Net interest income increased $6.2$6.0 million (15%(13%) to $53.5 million compared to $47.5 million for the same period in the prior year.

●	Net interest margin improved to 3.94% compared to $41.4 million3.90% for the same period in the prior year.

●	Return on average assets improveddecreased to 1.03% compared to 1.22% compared to 0.61%for the same period in the prior year.

●	Return on average equity improveddecreased to 9.09% compared to 12.08% compared to 6.34%for the same period in the prior year.

●	Average loans totaled $915.4 million,$1.021 billion, an increase of $97.2$105 million (12%) compared to average loans for the same period in the prior year.

●	Average earning assets totaled $1.220$1.360 billion, an increase of $96$140 million (9%(11%) compared to average earning assets for the same period in the prior year.

●	Average deposits totaled $1.098$1.245 billion, an increase of $57$146 million (5%(13%) compared to average deposits for the same period in the prior year.

o

Average non-maturing deposits totaled $930.2 million,$1.084 billion, an increase of $94.4$154 million (11%(17%) compared to average non-maturing depositsthe same period in the prior year.

o

Average certificates of deposit totaled $168.2$160.6 million, a decrease of $37.5$7.6 million (18%(5%) compared to average certificates of depositsame period in the prior year.

●	The Company’s efficiency ratio was 62.5%64.5% compared to 67.0%62.5% during the same period in the prior year.

o

The Company’s efficiency ratio of 64.5% for 2019 includes $2.2 million in acquisition costs and $503 thousand in name change costs. The efficiency ratio excluding these non-recurring costs is 59.9%.

o

The Company’s efficiency ratio of 62.5% for 2018 includes $844 thousand in acquisition costs. The efficiency ratio excluding these non-recurring costs is 60.8%.

 

Capital

●	Declared cash dividends of $0.19 per share for 2019 compared to $0.15 per share in 2018 compared to $0.12 per share in 2017. 2018.

●

Book value per common share was $9.62 at December 31, 2019 compared to $8.47 at December 31, 2018 compared to $7.82 at December 31, 2017.2018. Tangible book value per common share (non-GAAP) which excludes goodwill and core deposit intangiblesother intangible assets, net from shareholders’ equity was $8.71 at December 31, 2019 compared to $8.36 at December 31, 2018 compared to $7.70 at December 31, 2017.2018. Management believes that tangible book value per share is meaningful because it is a measure that the Company and investors commonly use to assess capital adequacy.

●	Average total equity increased by $14.3$34.4 million (12%(26%) to $164.6 million for the year ended December 31, 2019, compared to $130.2 million for the year ended December 31, 2018, compared to $115.9 million for the year ended December 31, 2017.2018.

●	The Bank maintained capital levels in excess of the “well-capitalized” standards for the year endedat December 31, 2018.2019 under the regulatory framework for prompt corrective action.

 

Credit Quality

●

Nonperforming assets at December 31, 20182019 totaled $4.2$5.7 million or 0.32%0.38% of total assets, a decreasean increase of $1.7$1.5 million (28%) since December 31, 2017.2018. The increase was primarily caused by loans to one commercial real estate borrower that were in nonaccrual status and had zero calculated impairment at December 31, 2019.

●

There was no provision for loan and lease losses during the current year, as a result of continued improved asset quality and net loan loss recoveries. The Company recorded a provisioncharge-offs totaled $61 thousand for loan and lease losses of $950 thousand during the year ended December 31, 2017 reflecting growth in the loan portfolio.year.

 

Vision and Objectives

 

We seek to provide competitive, long-term returns to our shareholders while serving the financial needs of the communities in our market. Management strives to provide those returns while exercising prudent risk management practices and maintaining adequate levels of capital and reserves.

 

Our vision is to remain independent, expanding our presence with organic growth and the addition of new strategically important locations. We will pursue attractive opportunities to enter related lines of business and to acquire financial institutions with complementary lines of business when it is beneficial to do so. During 20182019, with the purchase of Merchants, our organic growth in average assets totaled $90.6$169.3 million or 8%13%.

 

Our long-term success rests on the shoulders of the leadership team and its ability to effectively enhance the performance of the Company. As a financial services company, we are in the business of taking and managing risks. Whether we are successful depends largely upon whether we take the right risks and are rewarded appropriately for those risks. Our governance structure enables us to manage all major aspects of our business effectively through an integrated process that includes financial, strategic, risk and leadership planning.

 

We define risks to include not only credit, market and liquidity risk, the traditional concerns for financial institutions, but also operational risks, including risks related to systems, processes or external events, as well as legal, regulatory and reputation risks. Our management processes, structures, and policies help to ensure compliance with laws and regulations and provide clear lines for decision-making and accountability. Results are important, but equally important is how we achieve those results. Our core values and commitment to high ethical standards are essential to maintaining and to sustaining public trust and confidence in our Company.

 

SOURCES OF INCOME

We derive our income primarily from net interest income, which is the difference between the interest income we receive on interest-earning assets and the interest expense we pay on interest-bearing liabilities. Net interest income is impacted by many factors that are beyond our control, including general economic conditions and the policies of various governmental and regulatory agencies, the Federal Reserve Board in particular. In recent years, we originated higher volumes of longer term fixed rate loans. These loans, combined with the structure of our investment portfolio, the use of floors in the pricing of our variable rate loans and funding mix caused the Company to become neutral to slightly to moderately liability sensitive, which could negatively impact earnings in a rapidly rising interest rate environment.

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Net interest income reflects both the amount of earning assets we hold and our net interest margin, which is the difference between the yields we receive on our earning assets and the interest rates we pay to fund those assets. As a result, changes in either our net interest margin or the amount of earning assets we hold will affect our net interest income and earnings.

Increases or decreases in interest rates could adversely affect our net interest margin. Although our asset yields and funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, and cause our net interest margin to expand or contract. Many of our assets are tied to indexes, which adjust in response to changes in interest rates.

Changes in the slope of the yield curve, and the spread between short-term and long-term interest rates could also reduce our net interest margin. Normally, the yield curve is upward sloping, which means that short-term rates are lower than long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets.

We assess our interest rate risk by estimating the effect of interest rate changes on our earnings under various simulated scenarios. The scenarios differ based on assumptions including the direction, magnitude and speed of interest rate changes, and the slope of the yield curve.

There is always the risk that changes in interest rates could reduce our net interest income and earnings in material amounts, especially if actual conditions turn out to be materially different than simulated scenarios. For example, if interest rates rise or fall faster than we assumed or the slope of the yield curve changes, we may incur significant losses on debt securities we hold as investments. To reduce our interest rate risk, we may rebalance our investment and loan portfolios, refinance our debt and take other strategic actions, which may result in losses or expenses.

The following table summarizes as of December 31, 2018 when loans are projected to reprice by year and by rate index.

																						Year 6
																						Through				Beyond
(Amounts in thousands)		Year 1				Year 2				Year 3				Year 4				Year 5				Year 10				Year 10				Total
Rate Index:
Fixed		$	45,584			$	36,111			$	57,493			$	35,954			$	60,277			$	136,951			$	14,546			$	386,916
Prime			102,971				6,468				5,050				7,154				5,484				5,287				—				132,414
5 Year Treasury			40,138				27,910				65,426				74,377				66,077				43,898				—				317,826
7 Year Treasury			884				923				7,098				9,343				523				19,414				—				38,185
1 Year LIBOR			24,345				—				—				—				—				—				—				24,345
Other Indexes			4,975				5,372				4,839				2,181				5,853				18,622				2,504				44,346
Nonaccrual			1,791				314				276				255				247				830				433				4,146
Total		$	220,688			$	77,098			$	140,182			$	129,264			$	138,461			$	225,002			$	17,483			$	948,178

We also earn noninterest income. Sources of noninterest income include fees earned on deposit related services, ATM and point of sale fees, payroll and benefit processing fees, earnings on bank-owned life insurance, gains on sale of available-for-sale securities, and dividends on Federal Home Loan Bank of San Francisco stock.

 

RESULTS OF OPERATIONS

 

The following discussion and analysis provides a comparison of the results of operations for the threetwo years ended December 31, 2018.2019. This discussion should be read in conjunction with the Consolidated Financial Statements and related notes.

 

Overview

 

The current year includes the benefits of our January 31, 2019 acquisition of Merchants. In May, we successfully converted all of Merchant’s computer records onto our core system. As previously announced, the Company’s subsidiary bank, which had been operating under multiple names, simultaneously changed the name for all locations to Merchants Bank of Commerce. During 2019 acquisition related costs totaled $2.2 million and costs related to the name change totaled $503 thousand. All significant costs for these two projects have now been absorbed.

The Year Ended December 31, 20182019 Compared to the Year Ended December 31, 20172018

 

Net income was $15.0 million for the year ended December 31, 2019, compared to $15.7 million for the year ended December 31, 2018, compared to $7.3 million for the year ended December 31, 2017.2018. For 2018,2019, increases in net interest income a decrease in the provision for loan and lease lossesnoninterest income were offset by increased noninterest expenses and a decreased provision for income taxes were partially offset by decreased noninterest income and increased noninterest expenses.taxes.

 

Diluted earnings per share were $0.96$0.83 for the year ended December 31, 20182019 compared with $0.48$0.96 for the same period a year previous.

 

We declared cash dividends of $0.19 per share in 2019 and $0.15 per share in 2018 and $0.12 per share in 2017.2018. In determining the amount of dividend to be paid, we give consideration to capital preservation objectives, expected asset growth, projected earnings, the overall dividend pay-out ratio and the dividend yield.

 

The Year Ended December 31, 2017 Compared to the Year Ended December 31, 2016

Net income was $7.3 million for the year ended December 31, 2017, compared to $5.3 million for the year ended December 31, 2016. For 2017, increases in net interest income, noninterest income and decreases in noninterest expense were offset by an increased provision for loan and lease losses and an increased provision for income taxes.

Diluted earnings per share were $0.48 for the year ended December 31, 2017 compared with $0.39 for the same period a year previous. Changes in earnings per share are the result of changes in net income and the issuance of 2,738,096 shares common stock during 2017.

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We declared cash dividends of $0.12 per share in both 2017 and 2016.

Return on Average Assets and Return on Average Equity

 

The following table presents the return on average assets and return on average equity for the years ended December 31, 2019, 2018 2017 and 2016.2017. For each of the periods presented, the table includes the calculated ratios based on reported net income as shown in the Consolidated Statements of Income incorporated in this document.

 

		2018				2017				2016				2019				2018				2017
Return on average assets			1.22	%			0.61	%			0.49	%			1.03	%			1.22	%			0.61	%
Return on average equity			12.08	%			6.34	%			5.68	%			9.09	%			12.08	%			6.34	%

 

Net Interest Income and Net Interest Margin

 

Net interest income is our largest source of operating income. Net interest income for the years ended December 31, 2019 and 2018 2017was $53.5 million and 2016 was $47.5 million, $41.4 million and $36.2 million, respectively.

The Year Ended December 31, 2018 Compared to the Year Ended December 31, 2017

 

Interest income for the year ended December 31, 20182019 was $52.7$59.6 million, an increase of $6.8$6.9 million or 15%13% compared to a year previous. The increase in interest income was derived primarily from our loan portfolio ($5.85.6 million) and, our investment securities portfolio ($7291.1 million) and our interest bearing cash balances ($160 thousand). Both portfoliosAll of our earning assets benefited from increases in both volume and yield.

 

Interest expense for the year ended December 31, 20182019 was $5.2$6.0 million, an increase of $568$873 thousand or 12%17% compared to a year previous.

 

●

Interest on interest-bearing deposits increased $126 thousand$1.3 million during 2018.2019. Average interest-bearing core deposit balances increased $52.0$85.6 million while average time deposit balances decreased $37.5$7.6 million. The cost of all interest-bearing deposits was 0.54% for 2019 compared with 0.43% for 2018 compared with 0.42% for 2017.2018.

●

Interest on senior and subordinated term debt decreased $88$271 thousand during 2018 and reflects principal repayments made on2019. During the second quarter of 2019, we completed the early repayment of our variable senior debt during the year.debt.

●

Interest on FHLB term debt increased $432decreased $188 thousand during 2018.2019. FHLB term debt averaged $9.6 million in 2019 and $22.5 million in 2018, but only $302 thousand in 2017.2018. In addition, the cost of FHLB term debt was 2.56% in 2019 compared with 1.94% in 2018 compared with .99% in 2017.2018.

●

Interest on junior subordinated debentures increased $98$41 thousand during 2018.2019.

 

The net interest margin for the year ended December 31, 20182019 was 3.90%3.94% an increase of 22four basis points as compared to 2017. Our net interest margin was enhanced during 2018 by our efforts to deploy liquidity from strong core deposit growth into loan originations, the purchase of intermediate term available for sale securities and the accelerated repayment of our senior debt.

The benefit of our actions resulted in a 23 basis point increase in the yield on average interest-earning assets. The net interest margin on a fully tax-equivalent basis was 3.93% for the year ended December 31, 2018, an increase of 16 basis points as compared to the same period a year previous. The tax equivalent yields for 2018 were calculated using a 21% tax rate while the tax equivalent yields for 2017 were calculated using a 34% tax rate.2018.

 

Maintaining our net interest margin in the future will continue to be challenging as current market pressures increaseare anticipated to cause our yield on deposit rates.

The Year Ended December 31, 2017 Comparedaverage interest-earning assets to the Year Ended December 31, 2016

Interest income for the year ended December 31, 2017 was $45.9 million, an increase of $4.9 million or 12% compared to a year previous. The increase in interest income was derived primarily from our loan portfolio ($3.7 million) and our investment securities portfolio ($823 thousand). Both portfolios benefited from increased volume. The loan portfolio also benefited from increases in yield however, yields decreased for the investment portfolio.

Interest expense for the year ended December 31, 2017 was $4.6 million, a decrease of $191 thousand or 4% compared to the prior year.

●

Interest on interest-bearing deposits increased $256 thousand during 2017. Average interest-bearing core deposit balances increased $67.1 million while average time deposit balances decreased $15.4 million. The cost of all deposits decreased by one basis point to 0.30% for 2017 compared to the prior year.

	●	Interest on senior and subordinated term debt decreased $9 thousand during 2017 and reflects principal repayments made on senior debt during the year.
	●	Interest on FHLB term debt decreased $482 thousand during 2017. FHLB term debt averaged $302 thousand in 2017 compared to $17.9 million in 2016. For 2016, interest on Federal Home Loan Bank of San Francisco borrowings includes the effect of hedge losses reclassified out other comprehensive income. During March of 2016, we terminated all of our interest rate swaps (active and forward starting, the “hedging” instrument) and simultaneously paid off the $75.0 million Federal Home Loan Bank of San Francisco borrowing (the “hedged instrument”).

●

Interest on junior subordinated debentures increased $52 thousand during 2017.

The net interest margin on a fully tax-equivalent basis was 3.78% for the year ended December 31, 2017, an increase of seven basis points as compared to the same period a year previous. The increase in our net interest margin resulted mostly from a decrease in the cost of funding average earning assets. These lower funding costs are the result of reductions in term debt and the termination of an interest rate hedge in 2016.decline.

 

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The following table presents condensed average balance sheet information, together with interest income and yields earned on average interest-earning assets, and interest expense and rates paid on average interest-bearing liabilities for the years ended December 31, 2018, 2017 and 2016.

 

Average Balances, Interest Income/Expense and Yields Earned/Rates Paid

 

		Years Ended December 31,																																				Years Ended December 31,
		2018												2017												2016												2019												2018												2017
		Average								Yield/				Average								Yield/				Average								Yield/				Average								Yield/				Average								Yield/				Average								Yield/
(Amounts in thousands)		Balance				Interest(1)				Rate(5)				Balance				Interest(1)				Rate(5)				Balance				Interest(1)				Rate(5)				Balance				Interest(1)				Rate(5)				Balance				Interest(1)				Rate(5)				Balance				Interest(1)				Rate(5)
Interest-earning assets:
Net loans (2)		$	915,360			$	44,955				4.91	%		$	818,119			$	39,112				4.78	%		$	752,938			$	35,435				4.71	%		$	1,020,801			$	50,534				4.95	%		$	915,360			$	44,955				4.91	%		$	818,119			$	39,112				4.78	%
Taxable securities			207,407				5,165				2.49	%			165,333				3,921				2.37	%			120,884				2,986				2.47	%			246,723				6,673				2.70	%			207,407				5,165				2.49	%			165,333				3,921				2.37	%
Tax-exempt securities(3)			50,330				1,629				3.24	%			74,231				2,144				2.89	%			75,303				2,256				3.00	%			38,706				1,244				3.21	%			50,330				1,629				3.24	%			74,231				2,144				2.89	%
Interest-bearing deposits in other banks			47,038				952				2.02	%			66,872				772				1.15	%			58,668				332				0.57	%			54,095				1,112				2.06	%			47,038				952				2.02	%			66,872				772				1.15	%
Average interest-earning assets			1,220,135				52,701				4.32	%			1,124,555				45,949				4.09	%			1,007,793				41,009				4.07	%			1,360,325				59,563				4.38	%			1,220,135				52,701				4.32	%			1,124,555				45,949				4.09	%
Cash and due from banks			20,468												18,301												15,831												22,806												20,468												18,301
Premises and equipment, net			13,952												15,567										��		15,078												15,598												13,952												15,567
Goodwill and core deposit intangible, net			1,917												2,136												1,888
Goodwill and other intangible assets, net																																							15,565												1,917												2,136
Other assets			32,369												37,692												39,160												43,818												32,369												37,692
Average total assets		$	1,288,841											$	1,198,251											$	1,079,750											$	1,458,112											$	1,288,841											$	1,198,251
Interest-bearing liabilities:
Demand - interest-bearing		$	238,328				414				0.17	%		$	209,792				274				0.13	%		$	172,011				201				0.12	%		$	242,516				480				0.20	%		$	238,328				414				0.17	%		$	209,792				274				0.13	%
Money market accounts		$	250,685				646				0.26	%		$	224,913				470				0.21	%		$	202,159				322				0.16	%
Savings accounts			109,025				288				0.26	%			111,376				200				0.18	%			104,771				174				0.17	%
Money market																																							304,340				1,599				0.53	%			250,685				646				0.26	%			224,913				470				0.21	%
Savings																																							136,733				493				0.36	%			109,025				288				0.26	%			111,376				200				0.18	%
Certificates of deposit			168,183				1,910				1.14	%			205,648				2,188				1.06	%			221,074				2,179				0.99	%			160,550				1,977				1.23	%			168,183				1,910				1.14	%			205,648				2,188				1.06	%
Federal Home Loan Bank of San Francisco borrowings			22,466				435				1.94	%			302				3				0.99	%			17,856				484				2.71	%			9,644				247				2.56	%			22,466				435				1.94	%			302				3				0.99	%
Other borrowings			15,143				1,077				7.11	%			17,981				1,165				6.48	%			19,430				1,183				6.09	%			10,895				806				7.40	%			15,143				1,077				7.11	%			17,981				1,165				6.48	%
Junior subordinated debentures			10,310				385				3.73	%			10,310				287				2.78	%			10,310				235				2.28	%			10,310				426				4.13	%			10,310				385				3.73	%			10,310				287				2.78	%
Average interest-bearing liabilities			814,140				5,155				0.63	%			780,322				4,587				0.59	%			747,611				4,778				0.64	%			874,988				6,028				0.69	%			814,140				5,155				0.63	%			780,322				4,587				0.59	%
Noninterest-bearing demand			332,197												289,735												226,368												400,588												332,197												289,735
Other liabilities			12,286												12,293												13,217												17,894												12,286												12,293
Shareholders’ equity			130,218												115,901												92,554												164,642												130,218												115,901
Average liabilities and shareholders’ equity		$	1,288,841											$	1,198,251											$	1,079,750											$	1,458,112											$	1,288,841											$	1,198,251
Net interest income and net interest margin(4)						$	47,546				3.90	%						$	41,362				3.68	%						$	36,231				3.60	%						$	53,535				3.94	%						$	47,546				3.90	%						$	41,362				3.68	%
Tax equivalent net interest margin (3)											3.93	%											3.78	%											3.71	%

 

(1)																																				Interest income on loans includes deferred fees and costs of approximately $657 thousand and $465 thousand and $546 thousand and $1.1 million for the years ended December 31, 2019, 2018 2017 and 20162017, respectively.

(2)																																				Net loans includes average nonaccrual loans of $11.7 million and $4.2 million $8.9 million and $10.6$8.9 million for the years 2019, 2018 2017, and 2016,2017, respectively.

(3)

Tax-exemptInterest income has been adjusted to taxand yields on tax-exempt securities are not presented on a taxable equivalent basis at a 21% for 2018 and at a 34% tax rate for 2017 and 2016. The amount of such adjustments was an addition to recorded income of approximately $433 thousand, $1.1 million and $1.2 million for the years 2018, 2017 and 2016, respectively.basis.

(4)

Net interest margin is net interest income expressed as a percentage of average interest-earning assets. Net interest income for the year ended December 31, 2019 included $620 thousand in accretion of the discount on the loans acquired from Merchants Holding Company, which improved the net interest margin by 6 basis points.

(5)																																				Yields and rates are calculated by dividing the income or expense by the average balance of the respective assets or liabilities.liabilities, respectively.

 

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The following table sets forth a summary of the changes in tax equivalent net interest income due to changes in average asset and liability balances (volume variance) and changes in average rates (rate variance) for 2019 compared to 2018 and 2018 compared to 2017 and 2017 compared to 2016.2017. Changes in tax equivalent interest income and expense, which are not specifically attributable to either volume or rate, are allocated proportionately between both variances. Interest income and yields on tax-exempt securities are not presented on a taxable equivalent basis.

 

Analysis of Changes in Net Interest Income

 

		Years Ended December 31,																								Years Ended December 31,
		2018 over 2017												2017 over 2016												2019 over 2018												2018 over 2017
(Amounts in thousands)		Volume				Rate				Net Change				Volume				Rate				Net Change				Volume				Rate				Net Change				Volume				Rate				Net Change
Increase (decrease) in interest income:
Net loans		$	4,752			$	1,091			$	5,843			$	3,109			$	568			$	3,677			$	5,217			$	362			$	5,579			$	4,752			$	1,091			$	5,843
Taxable securities			1,040				204				1,244				1,049				(114	)			935				1,037				471				1,508				1,040				204				1,244
Tax-exempt securities (1)			(990	)			(196	)			(1,186	)			(48	)			(122	)			(170	)			(374	)			(11	)			(385	)			(823	)			308				(515	)
Interest-bearing deposits in other banks			(117	)			297				180				52				388				440				145				15				160				(117	)			297				180
Total increase (decrease)			4,685				1,396				6,081				4,162				720				4,882				6,025				837				6,862				4,852				1,900				6,752
Increase (decrease) in interest expense:
Interest-bearing demand and money market			101				215				316				93				128				221				7				59				66				41				99				140
Savings accounts			(4	)			92				88				11				15				26
Money market																											163				790				953				58				118				176
Savings																											84				121				205				(4	)			92				88
Certificates of deposit			(441	)			163				(278	)			(65	)			74				9				(78	)			145				67				(441	)			163				(278	)
Federal Home Loan Bank of San Francisco borrowings			426				6				432				(482	)			1				(481	)			(433	)			245				(188	)			426				6				432
Other borrowings			(231	)			143				(88	)			(129	)			111				(18	)			(316	)			45				(271	)			(231	)			143				(88	)
Junior subordinated debentures			—				98				98				—				52				52				—				41				41				—				98				98
Total increase			(149	)			717				568				(572	)			381				(191	)			(573	)			1,446				873				(151	)			719				568
Net increase (decrease)		$	4,834			$	679			$	5,513			$	4,734			$	339			$	5,073			$	6,598			$	(609	)		$	5,989			$	5,003			$	1,181			$	6,184

(1) Tax-exemptInterest income has been adjusted to taxon tax-exempt securities are not presented on a taxable equivalent basis at a 21% for 2018 and at a 34% tax rate for 2017 and 2016.basis.

 

Noninterest Income

 

The following table presents the key components of noninterest income for the years ended December 31, 2019, 2018 2017 and 2016.2017.

 

		Years Ended December 31,
		2018 Compared to 2017																2017 Compared to 2016
										Change				Change												Change				Change
(Amounts in thousands)		2018				2017				Amount				Percent				2017				2016				Amount				Percent
Noninterest income:
Service charges on deposit accounts		$	682			$	542			$	140				26	%		$	542			$	413			$	129				31	%
ATM and point of sale fees			1,131				1,093				38				3	%			1,093				995				98				10	%
Payroll and benefit processing fees			652				658				(6	)			(1	%)			658				593				65				11	%
Life insurance			512				1,050				(538	)			(51	%)			1,050				613				437				71	%
Gains on sales of investment securities, net			44				137				(93	)			(68	%)			137				244				(107	)			(44	%)
Other-than-temporary impairment on investment securities			—				—				—				—	%			—				(546	)			546				100	%
Federal Home Loan Bank of San Francisco dividends			480				318				162				51	%			318				644				(326	)			(51	%)
Gain (loss) on sale of OREO			73				368				(295	)			(80	%)			368				(109	)			477				438	%
Insured cash sweep fees			—				197				(197	)			(100	%)			197				3				194				6,467	%
Other			445				461				(16	)			(3	%)			461				636				(175	)			(28	%)
Total noninterest income		$	4,019			$	4,824			$	(805	)			(17	%)		$	4,824			$	3,486			$	1,338				38	%

The Year Ended December 31, 2018 Compared to the Year Ended December 31, 2017

		Years Ended December 31,
		2019 Compared to 2018																2018 Compared to 2017
										Change				Change												Change				Change
(Amounts in thousands)		2019				2018				Amount				Percent				2018				2017				Amount				Percent
Noninterest income:
Service charges on deposit accounts		$	730			$	682			$	48				7	%		$	682			$	542			$	140				26	%
ATM and point of sale fees			1,158				1,131				27				2	%			1,131				1,093				38				3	%
Payroll and benefit processing fees			669				652				17				3	%			652				658				(6	)			(1	)%
Life insurance			536				512				24				5	%			512				1,050				(538	)			(51	)%
Gains on sales of investment securities, net			186				44				142				323	%			44				137				(93	)			(68	)%
Federal Home Loan Bank of San Francisco dividends			507				480				27				6	%			480				318				162				51	%
Gain (loss) on sale of OREO			62				73				(11	)			(15	)%			73				368				(295	)			(80	)%
Insured cash sweep fees			—				—				—				—	%			—				197				(197	)			(100	)%
Other			336				445				(109	)			(24	)%			445				461				(16	)			(3	)%
Total noninterest income		$	4,184			$	4,019			$	165				4	%		$	4,019			$	4,824			$	(805	)			(17	)%

 

Noninterest income in 20182019 was $4.0$4.2 million, a decreasean increase of $805$165 thousand or 17%4% compared to 2017.2018. During 20172018, we recognized income from life insurance death benefit proceeds, gains on sale of OREO and fees from ICS one-way sales totaling $894 thousand that did not recur in 2018. These decreases were partially offset by increased service charges on deposit accounts of $140 thousand and a $96 thousand special dividend on Federal Home Loan Bank of San Francisco stock.stock that did not recur in 2019.

 

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The Year Ended December 31, 2017 Compared to the Year Ended December 31, 2016

Noninterest income in 2017 was $4.8 million, an increase of $1.3 million or 38% compared to 2016.

●	Our branch and offsite ATM acquisition completed late in the first quarter of 2016, enhanced 2017 point of sale and ATM fees by $98 thousand and enhanced service charges on deposit accounts by $129 thousand.

●	During 2017 we received life insurance death benefit proceeds of $502 thousand.

●	During 2016, we recorded a $546 thousand other-than-temporary impairment on an investment security.

●	During 2016 we received a special dividend on Federal Home Loan Bank of San Francisco of $152 thousand.

●	During 2017 gains on sale of OREO properties were $368 thousand, compared to a loss of $109 thousand in 2016. Net gains on sale of OREO property in 2017 were primarily derived from one nonfarm nonresidential property.

●	During 2017 we received fees totaling $197 thousand from ICS one-way sales, which were nominal in 2016.

●	The major components of other noninterest income are fees earned on merchant bankcard processing, check orders, safe deposit box rental and wire transfers. However during 2016 we also recorded a $176 thousand gain on payoff of an impaired loan.

 

Noninterest Expense

 

The following table presents the key components of noninterest expense for the years ended December 31, 2019, 2018 2017 and 2016.2017.

 

		Years Ended December 31,
		2018 Compared to 2017																2017 Compared to 2016
										Change				Change												Change				Change
(Amounts in thousands)		2018				2017				Amount				Percent				2017				2016				Amount				Percent
Noninterest expense:
Salaries & related benefits		$	18,709			$	17,819			$	890				5	%		$	17,819			$	16,425			$	1,394				8	%
Premises & equipment			4,047				4,242				(195	)			(5	%)			4,242				3,869				373				10	%
Federal Deposit Insurance Corporation insurance premium			376				318				58				18	%			318				615				(297	)			(48	%)
Data processing fees			1,933				1,749				184				11	%			1,749				1,675				74				4	%
Professional service fees			1,431				1,398				33				2	%			1,398				1,690				(292	)			(17	%)
Telecommunications			594				879				(285	)			(32	%)			879				751				128				17	%
Acquisition costs			844				—				844				100	%			—				580				(580	)			(100	%)
Loss on cancellation of interest rate swap			—				—				—				—	%			—				2,325				(2,325	)			(100	%)
Other			4,272				4,559				(287	)			(6	%)			4,559				4,570				(11	)			(0	%)
Total noninterest expense		$	32,206			$	30,964			$	1,242				4	%		$	30,964			$	32,500			$	(1,536	)			(5	%)

The Year Ended December 31, 2018 Compared with the Year Ended December 31, 2017

		Years Ended December 31,
		2019 Compared to 2018																2018 Compared to 2017
										Change				Change												Change				Change
(Amounts in thousands)		2019				2018				Amount				Percent				2018				2017				Amount				Percent
Noninterest expense:
Salaries & related benefits		$	20,804			$	18,709			$	2,095				11	%		$	18,709			$	17,819			$	890				5	%
Premises & equipment			3,752				3,983				(231	)			(6	)%			3,983				4,178				(195	)			(5	)%
Federal Deposit Insurance Corporation insurance premium			91				376				(285	)			(76	)%			376				318				58				18	%
Data processing			2,535				1,997				538				27	%			1,997				1,813				184				10	%
Professional services			1,539				1,431				108				8	%			1,431				1,398				33				2	%
Telecommunications			737				594				143				24	%			594				879				(285	)			(32	)%
Acquisition and merger			2,193				844				1,349				160	%			844				—				844				100	%
Other			5,604				4,272				1,332				31	%			4,272				4,559				(287	)			(6	)%
Total noninterest expense		$	37,255			$	32,206			$	5,049				16	%		$	32,206			$	30,964			$	1,242				4	%

 

Noninterest expense for the year ended December 31, 20172019 was $32.2$37.3 million, an increase of $1.2$5.0 million or 4%16% compared to 2017.2018.

 

For the year ended December 31, 20182019 compared to the prior year:

 

●	Salaries and related benefit costs increased $890$2.1 million thousand primarily as a result of additional employees hired in our Sacramento market.from the Merchants acquisition.

●	Acquisition costsFederal Deposit Insurance Corporation insurance premium decreased $285 thousand due to Small Bank Assessment Credits from the FDIC in 2018 totaled $844 thousand while there were none in 2017.

The Year Ended December 31, 2017 Compared with the Year Ended December 31, 2016

Noninterest expense for the year ended December 31, 2017 was $31.0 million, a decrease of $1.5 million or 5% compared to 2016.

For the year ended December 31, 2017 compared to the prior year:

●	Expenses associated with our branch acquisition ($580 thousand) in 2016 and cancellation of our interest rate swap ($2.3 million) in 2016 did not recur.2019.

●	Salaries and occupancy costs increased $1.8 million including $438 thousand directlyCosts related to the branch and offsite ATM locations acquired latename change totaled $503 thousand in the first quarter of 2016.2019.

●	During 2017 a $208Amortization of the core deposit intangible for the deposits acquired from Merchants totaled $499 thousand software development project was terminated and written off.in 2019.

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●	Premises and equipment costs decreased $231 thousand due to accelerated or final depreciation on certain assets recognized during 2018.

 

Income Taxes

 

Our provision for income taxes includes both federal and state income taxes and reflects the application of federal and state statutory rates to our income before taxes. The following table reflects our tax provision and the related effective tax rate for the periods indicated.

 

		Years Ended December 31,												Years Ended December 31,
(Amounts in thousands)		2018				2017				2016				2019				2018				2017
Income before provision for income taxes		$	19,359			$	14,272			$	7,217			$	20,464			$	19,359			$	14,272
Provision for income taxes		$	3,629			$	6,928			$	1,958			$	5,503			$	3,629			$	6,928
Effective tax rate			18.7	%			48.5	%			27.1	%			26.9	%			18.7	%			48.5	%

 

The following table presents a reconciliation of income taxes computed at the federal statutory rate to the actual effective rate for the years ended December 31, 2019, 2018, 2017, and 2016.2017.

 

		2018				2017				2016				2019				2018				2017
Income tax at the federal statutory rate			21.0	%			34.0	%			34.0	%			21.0	%			21.0	%			34.0	%
Deferred tax asset write-down			—	%			17.5	%			5.0	%
State franchise tax, net of federal tax benefit			8.3	%			6.5	%			6.1	%			8.6	%			8.3	%			6.5	%
Amortization of affordable housing credit partnerships			2.7	%			4.8	%			8.1	%			2.4	%			2.7	%			4.8	%
Officer life insurance			(0.6	%)			(2.5	%)			(2.9	%)			(0.5	)%			(0.6	)%			(2.5	)%
Tax-exempt interest			(1.8	%)			(5.2	%)			(10.9	%)			(1.3	)%			(1.8	)%			(5.2	)%
Affordable housing credits and benefits			(3.8	%)			(5.7	%)			(11.7	%)			(3.5	)%			(3.8	)%			(5.7	)%
Accelerated depreciation - cost segregation study			(2.5	%)			—	%			—	%			—	%			(2.5	)%			—	%
Reversal of uncertain tax position			(5.1	%)			—	%			—	%			—	%			(5.1	)%			—	%
Deferred tax asset write-down															—	%			—	%			17.5	%
Other			0.5	%			(0.8	%)			(0.7	%)			0.2	%			0.5	%			(0.8	)%
Effective Tax Rate			18.7	%			48.5	%			27.1	%			26.9	%			18.7	%			48.5	%

 

Cost Segregation Study and Tangible Property Review

 

We completed a cost segregation study and a tangible property review during 2018, which shortened the depreciable lives of certain assets and accelerateaccelerated the tax depreciation deduction on our 2017 federal income tax return. We recorded an expense of $293 thousand in other noninterest expense and a benefit to our 2018 book provision for income taxes of $484 thousand in the fourth quarter of 2018 upon completion of these projects.

 

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Amended Tax Returns

 

In September of 2016, we filed amended federal and state tax returns for tax years 2011, 2012, 2013, and 2014. The amendments were filed to properly recognize tax events in years 2011 and 2013 that were improperly recognized in years 2011 through 2014. The IRS rejected the 2011 amended tax return citing the statute for assessment had expired. Accordingly, in early 2017, $988 thousand of taxes due to the taxing authorities pursuant to the 2011 amended federal tax return was returned to us. We maintained the liability for the taxes due on the rejected 2011 tax return which created an uncertain tax position. During 2018, the statute of limitations on the 2014 amended federal tax return passed, we reversed the reserve for our uncertain tax position and recognized the $988 thousand in our provision for income taxes which reduced our effective tax rate.

 

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FINANCIAL CONDITION

 

Consolidated Balance Sheets

 

As of December 31, 2018,2019, we had total consolidated assets of $1.307$1.480 billion, gross loans of $946.3 million,$1.033 billion, allowance for loan and lease losses (“ALLL”) of $12.3$12.2 million, total deposits of $1.132$1.267 billion, and shareholders’ equity of $138.3$174 million.

 

We continued to maintain a strong liquidity position during the reporting period. As of December 31, 2018,2019, we maintained noninterest-bearing cash positions at the Federal Reserve Bank and correspondent banks in the amount of $23.7$21.3 million. We also held interest-bearing deposits in the amount of $23.7$59.3 million.

 

Available-for-sale investment securities totaled $287.0 million at December 31, 2019, compared with $257.0 million at December 31, 2018, compared with $266.9 million at December 31, 2017.2018. Our available-for-sale investment portfolio provides a secondary source of liquidity to fund other higher yielding asset opportunities, such as loan originations and wholesale loan purchases.

originations. During 2018,2019, we purchased 37 securities with a par value of $57.1$96.8 million and weighted average yield of 3.40% and sold 45the Merchants acquisition added securities with a par value of $29.7$107.4 million. During 2019, we sold securities with a par value of $118.0 million and weighted average yield of 2.51%. The sales and call activity on securities resultedresulting in $43.7$186 thousand in net realized gains for the year ended December 31, 2018.gains. During 20182019, we also received $31.5$64.2 million in proceeds from principal payments, calls and maturities within the available-for-sale securities portfolio.

 

At December 31, 2018,2019, our net unrealized lossesgains on available-for-sale securities were $4.3$3.7 million compared with $452 thousand$4.3 million net unrealized losses at December 31, 2017.2018. The changes in the net unrealized losses on the investment securities portfolio areto net unrealized gains was primarily due todriven by significant changes in market interest rates.

 

We recorded gross loan balances of $1.033 billion at December 31, 2019, compared with $946.3 million at December 31, 2018, compared with $879.8 million at December 31, 2017, an increase of $66.4$87 million. The increase in gross loans occurred primarilyincluded $80.1 million in loans received from the Bank’s Sacramento marketplace and is the resultacquisition of past investments in our SBA division and in our expanded Sacramento commercial banking group.Merchants.

 

The ALLL at December 31, 2018 increased $3672019 decreased $61 thousand to $12.3$12.2 million compared to $11.9$12.3 million at December 31, 2017. As a result of continued improved asset quality, and net loan loss recoveries, no provision for loan and lease losses was necessary during the year ended December 31, 2018. A provision for loan and lease losses of $950 thousand was recorded during the year ended December 31, 2017. Net loan loss recoveries were $367 thousand during the year ended December 31, 2018, compared with net loan charge-offs of $569 thousand during the prior year. At December 31, 2018,2019, relying on our ALLL methodology, which uses criteria such as risk factors and historical loss rates, and given the ongoing improvements in asset quality, we believe the ALLL is adequate. There is, however, no assurance that future loan and lease losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses.

 

Nonperforming loans, which include nonaccrual loans and accruing loans past due over 90 days, decreasedincreased by $1.7$1.5 million to $5.6 million, or 0.54% of gross loans, as of December 31, 2019, compared to $4.1 million, or 0.44% of gross loans as of December 31, 2018, compared to $5.8 million, or 0.66% of gross loans as of December 31, 2017.2018. The decreaseincrease in nonperforming loans was primarily duecaused by loans to repayments totaling $1.2 million from one commercial loan and one commercial real estate loan.borrower that were placed on nonaccrual and had zero calculated impairment at December 31, 2019.

 

Past due loans as of December 31, 2018 increased2019 decreased to $13.9$4.9 million, compared to $2.3$13.9 million as of December 31, 2017.2018. The increasedecrease in past due loans was primarily due to threethe sale of a $9.9 million nonaccrual commercial real estate loans totaling $12.1 million.loan. We believe that risk grading for past due and nonperforming loans appropriately reflects the risk associated with the past due loans. See Note 5 Loans in the Notes to Consolidated Financial Statements in this document for further detail on the ALLL and the loan portfolio.

 

Premises and equipment totaled $15.9 million at December 31, 2019, an increase of $2.8 million compared to $13.1 million at December 31, 2018, a decrease of $1.62018. The increase included $2.2 million compared to $14.7 million at December 31, 2017. The decrease was primarily due to provision for depreciationin premises and amortization recognized during the current year.equipment acquired from Merchants.

 

Our OREO balance at December 31, 20182019 was $31$35 thousand compared to $35$31 thousand at December 31, 2017.2018. For the year ended December 31, 2018,2019, we transferred fivethree foreclosed properties in the amount of $140$74 thousand to OREO. During 2018,2019, we sold fivethree properties with balances of $144$70 thousand for a net gain of $73$62 thousand. See Note 8, Other Real Estate Owned in the Notes to Consolidated Financial Statements in this document, for further details relating to our OREO portfolio.

 

Bank-owned life insurance increased $512 thousand$1.3 million during the year ended December 31, 20182019 to $22.4$23.7 million compared to $21.9$22.4 million at December 31, 2017.2018. The increase included $755 thousand in bank-owned life insurance acquired from Merchants.

 

Our net deferred tax assets were $4.6 million at December 31, 2019 compared to $7.0 million at December 31, 20182018. The decrease was primarily due to unrealized gains in the investment portfolio and core deposit intangibles related to the acquisition of Merchants.

Goodwill and other intangible assets, net increased $14.7 million during the year ended December 31, 2019 to $16.5 million compared to $6.5$1.8 million at December 31, 2017.2018. The increase was due to $11.0 million of goodwill and $4.1 million in net core deposit intangibles related to the acquisition of Merchants.

 

Other assets which include the Bank’s investment in qualified zone academy bonds, Federal Home Loan Bank of San Francisco stock, right-of-use lease asset and low income housing tax credit partnerships totaled $28.6 million at December 31, 2019 compared to $22.5 million at December 31, 2018 compared to $21.32018. The increase included $1.5 million at December 31, 2017.in Federal Home Loan Bank of San Francisco stock acquired from Merchants and a $4.0 million (net of $458 thousand recognized previously as part of the single lease cost) right-of-use lease asset recorded upon the adoption of ASU No. 2016-02.

 

Total deposits at December 31, 2018,2019, increased $29$135 million or 3%12% to $1.132$1.267 billion compared to December 31, 2017.2018.

 

●

Total non-maturing deposits increased $65.9$136.1 million or 7% compared to the same date a year ago.December 31, 2018.

o

The Merchants Holding Company acquisition provided an additional $152.2 million in non-maturing deposits.

●

Certificates of deposit decreased $36.9 million or 19%$596 thousand compared to December 31, 2018.

o

The Merchants Holding Company acquisition provided an additional $38.0 million in certificates of deposit.

o

During the same date a year ago.of 2019, $21.8 million of wholesale time deposits matured and were not renewed.

 

Other liabilities which include the Bank’s supplemental executive retirement plan, operating leases and funding obligation for investments in qualified affordable housing partnerships increased $563 thousand$4.3 million to $13.4$17.7 million as of December 31, 20182019 compared to $12.8$13.4 million at December 31, 2017.2018. The increase included the $4.4 million operating lease liability recorded upon the adoption of ASU No. 2016-02.

 

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Investment Securities

 

The composition of our investment securities portfolio reflects management’s investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of interest income.

 

The investment securities portfolio also:

 

●

Partially mitigates interest rate risk;

●

Diversifies the credit risk inherent in the loan portfolio;

●

Provides a vehicle for the investment of excess liquidity;

●

Provides a source of liquidity when pledged as collateral for lines of credit;

●

Is used as collateral for certain public funds.

 

Our available-for-sale investment securities totaled $287.0 million at December 31, 2019, compared to $257.0 million at December 31, 2018, compared2018. The Merchants acquisition added 231 securities with a par value of $107.4 million to $266.9 million at December 31, 2017.our investment securities portfolio. During the year ended December 31, 2018, we deployed liquidity provided by strong core deposit growth into organic loan originations, interest-bearing deposits at other banks and purchases of available for sale securities.

During the fourthfirst quarter of 2017,2019, we reclassified the entire HTMsold a portion of our investment securities portfolio to AFS. At the dateprovide liquidity for our seasonal decline in deposit balances and our planned reduction of the reclassification the HTM securities portfolio was carried at an amortized costwholesale certificates of $30.3 million. The reclassification of securities between categories was accounted for at fair value. At the date of the reclassification, the securities had a fair value of $31.4 million and unrealized holding gains of $1.2 million which were recorded in other comprehensive income. We reclassified the held-to-maturity securities portfolio to available-for-sale to provide increased flexibility to support the loan pipeline and take advantage of opportunities to improve the overall structure and yield of the investment portfolio. As a result of this transfer we are precluded from classifying any investment securities as held-to-maturity for two years from the date of the transfer. deposit.

The following table presents the carrying value of the investment securities portfolio by classification and major type as of December 31, for each of the last three years.

 

(Amounts in thousands)		2018				2017				2016
Available-for-sale securities: (1)
U.S. government & agencies		$	40,087			$	40,369			$	10,354
Obligations of state and political subdivisions			50,530				78,844				59,428
Residential mortgage-backed securities and collateralized mortgage obligations			138,503				114,592				69,604
Corporate securities			2,922				4,992				16,116
Commercial mortgage-backed securities			24,762				26,641				15,514
Other asset-backed securities			124				1,505				3,158
Total		$	256,928			$	266,943			$	174,174
Held-to-maturity securities: (1)
Obligations of state and political subdivisions		$	—			$	—			$	31,187

(1) Available-for-sale securities are reported at fair value, and held-to-maturity securities are reported at amortized cost.

(Amounts in thousands)		2019				2018				2017
Available-for-sale securities:
U.S. government & agencies		$	38,733			$	40,087			$	40,369
Obligations of state and political subdivisions			42,098				50,530				78,844
Residential mortgage-backed securities and collateralized mortgage obligations			180,835				138,503				114,592
Corporate securities			2,966				2,922				4,992
Commercial mortgage-backed securities			19,307				24,762				26,641
Other asset-backed securities			3,011				124				1,505
Total		$	286,950			$	256,928			$	266,943

 

The following table presents information regarding the amortized cost, and maturity structure of the investment portfolio at December 31, 2018.2019.

 

										Maturities								Maturities																																Maturities								Maturities
		Maturities								Over One Through								Over Five Through								Maturities																Maturities								Over One Through								Over Five Through								Maturities
		Within One Year								Five Years								Ten Years								Over Ten Years								Total								Within One Year								Five Years								Ten Years								Over Ten Years								Total
(Amounts in thousands)		Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield
Available-for-sale securities:(1)
U.S. government & agencies		$	—				—	%		$	3,940				2.83	%		$	7,235				3.43	%		$	29,040				2.81	%		$	40,215				2.93	%		$	1,250				3.01	%		$	51				3.01	%		$	18,143				3.33	%		$	18,847				2.97	%		$	38,291				3.14	%
Obligations of state and political subdivisions			34				5.52	%			11,276				3.42	%			21,345				3.38	%			17,382				3.05	%			50,037				3.27	%			902				3.31	%			11,011				3.55	%			14,107				3.02	%			14,682				3.25	%			40,702				3.25	%
Residential mortgage-backed securities and collateralized mortgage obligations			20				3.66	%			63,558				2.87	%			74,434				2.96	%			4,343				3.83	%			142,355				2.95	%			2,385				2.23	%			126,361				2.77	%			34,995				2.96	%			15,373				2.84	%			179,114				2.80	%
Corporate securities			—				—	%			2,022				3.75	%			1,000				2.30	%			—				—	%			3,022				3.27	%			2,005				3.01	%			1,000				2.00	%			—				—	%			—				—	%			3,005				2.67	%
Commercial mortgage-backed securities			—				—	%			—				—	%			4,237				2.22	%			21,209				2.71	%			25,446				2.63	%			—				—	%			1,019				2.43	%			7,406				2.42	%			10,701				2.78	%			19,126				2.62	%
Other asset-backed securities			—				—	%			—				—	%			—				—	%			123				4.40	%			123				4.40	%			—				—	%			—				—	%			—				—	%			3,019				2.82	%			3,019				2.82	%
Total		$	54				5.56	%		$	80,796				2.97	%		$	108,251				3.04	%		$	72,097				2.90	%		$	261,198				2.98	%		$	6,542				2.77	%		$	139,442				2.82	%		$	74,651				3.01	%		$	62,622				2.96	%		$	283,257				2.90	%

(1) The maturities for the collateralized mortgage obligations and mortgage-backed securities are presented by expected average life, rather than contractual maturity. The yield on tax-exempt securities has not been adjusted to a tax-equivalent yield basis.

 

Loan Portfolio

 

Loan Concentrations

 

Historically, we have concentrated our loan origination activities primarily within El Dorado, Placer, Sacramento, and Shasta counties in California. In recent years, our loan origination activity has expanded to include other portions of California and northern Nevada. We manage our credit risk through various diversifications of our loan portfolio, the application of sound underwriting policies and procedures, and ongoing credit monitoring practices. Generally, the loans are secured by real estate or other assets located in California. Repayment is expected from the borrower’s cash flows or cash flows from real estate investments.

 

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The following table presents the composition of the loan portfolio as of December 31 for each of the last five years.

 

(Amounts in thousands)		As of December 31,
Loan Portfolio		2018				%				2017				%				2016				%				2015				%				2014				%
Commercial		$	135,543				14	%		$	142,405				16	%		$	146,881				18	%		$	125,394				17	%		$	150,253				23	%
Commercial real estate:
Real estate – construction and land development			22,563				2	%			15,902				2	%			36,792				5	%			28,319				4	%			30,099				5	%
Real estate – commercial non-owner occupied			433,708				46	%			377,668				43	%			292,615				36	%			228,174				32	%			195,563				30	%
Real estate – commercial owner occupied			204,622				22	%			192,023				22	%			174,298				22	%			178,910				25	%			138,644				20	%
Residential real estate:
Real estate – residential - ITIN			37,446				4	%			41,188				5	%			45,566				6	%			49,106				7	%			52,830				8	%
Real estate – residential - 1-4 family mortgage			34,366				4	%			30,377				3	%			20,425				3	%			17,268				2	%			14,183				2	%
Real estate – residential - equity lines			26,958				3	%			30,347				3	%			35,953				4	%			39,595				6	%			43,954				7	%
Consumer and other			51,045				5	%			49,925				6	%			51,681				6	%			49,873				7	%			35,372				5	%
Gross loans			946,251				100	%			879,835				100	%			804,211				100	%			716,639				100	%			660,898				100	%
Deferred fees and costs			1,927								1,710								1,324								870								157
Loans, net of deferred fees and costs			948,178								881,545								805,535								717,509								661,055
Allowance for loan and lease losses			(12,292	)							(11,925	)							(11,544	)							(11,180	)							(10,820	)
Net loans		$	935,886							$	869,620							$	793,991							$	706,329							$	650,235

(Amounts in thousands)		As of December 31,
Loan Portfolio		2019				%				2018				%				2017				%				2016				%				2015				%
Commercial		$	141,197				14	%		$	135,543				14	%		$	142,405				16	%		$	146,881				18	%		$	125,394				17	%
Commercial real estate:
Real estate – construction and land development			26,830				3	%			22,563				2	%			15,902				2	%			36,792				5	%			28,319				4	%
Real estate – commercial non-owner occupied			493,920				48	%			433,708				46	%			377,668				43	%			292,615				36	%			228,174				32	%
Real estate – commercial owner occupied			218,833				21	%			204,622				22	%			192,023				22	%			174,298				22	%			178,910				25	%
Residential real estate:
Real estate – residential - ITIN			33,039				3	%			37,446				4	%			41,188				5	%			45,566				6	%			49,106				7	%
Real estate – residential - 1-4 family mortgage			63,661				6	%			34,366				4	%			30,377				3	%			20,425				3	%			17,268				2	%
Real estate – residential - equity lines			22,099				2	%			26,958				3	%			30,347				3	%			35,953				4	%			39,595				6	%
Consumer and other			33,324				3	%			51,045				5	%			49,925				6	%			51,681				6	%			49,873				7	%
Gross loans			1,032,903				100	%			946,251				100	%			879,835				100	%			804,211				100	%			716,639				100	%
Deferred fees and costs			2,162								1,927								1,710								1,324								870
Loans, net of deferred fees and costs			1,035,065								948,178								881,545								805,535								717,509
Allowance for loan and lease losses			(12,231	)							(12,292	)							(11,925	)							(11,544	)							(11,180	)
Net loans		$	1,022,834							$	935,886							$	869,620							$	793,991							$	706,329

 

The following table sets forth the maturity and fixed or variable rate distribution of our loan portfolio as of December 31, 2018.2019.

 

						After One
		Within One				Through				After Five
(Amounts in thousands)		Year				Five Years				Years				Total
Commercial		$	43,879			$	51,101			$	41,451			$	136,431
Commercial real estate:
Real estate - construction and land development			3,967				4,422				14,124				22,513
Real estate - commercial non-owner occupied			8,540				101,646				322,991				433,177
Real estate - commercial owner occupied			7,992				23,759				174,047				205,798
Residential real estate:
Real estate - residential - ITIN			—				—				37,446				37,446
Real estate - residential - 1-4 family mortgage			25				2,583				31,847				34,455
Real estate - residential - equity lines			51				2,387				24,843				27,281
Consumer and other			504				49,342				1,231				51,077
Gross loans		$	64,958			$	235,240			$	647,980			$	948,178
Loans due after one year with:
Fixed rates			45,584			$	189,835				151,496				386,915
Variable rates			19,374				45,405				496,484				561,263
Total			64,958			$	235,240			$	647,980			$	948,178

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						After One
		Within One				Through				After Five
(Amounts in thousands)		Year				Five Years				Years				Total
Commercial		$	66,951			$	65,288			$	9,792			$	142,031
Commercial real estate:
Real estate - construction and land development			4,374				11,089				11,273				26,736
Real estate - commercial non-owner occupied			37,145				204,633				251,714				493,492
Real estate - commercial owner occupied			25,638				85,196				109,423				220,257
Residential real estate:
Real estate - residential - ITIN			3,401				13,411				16,227				33,039
Real estate - residential - 1-4 family mortgage			6,301				20,544				36,918				63,763
Real estate - residential - equity lines			718				2,002				19,678				22,398
Consumer and other			1,296				2,348				29,705				33,349
Loans, net of deferred fees and costs		$	145,824			$	404,511			$	484,730			$	1,035,065
Loans with:
Fixed rates			49,959			$	190,871				199,155				439,985
Variable rates			95,865				213,640				285,575				595,080
Total			145,824			$	404,511			$	484,730			$	1,035,065

 

Loans with unique credit characteristics

ITIN Loans

 

We own a pool of Individual Tax Identification Number (“ITIN”) residential mortgage loans. The ITIN loans are geographically disbursed throughout the United States and are made to legal United States residents who do not possess a social security number. The ITIN loan portfolio is serviced by a third party. The majority of the ITIN loans are variable rate loans and may have an increased default risk in a rising rate environment. Worsening economic conditions in the United States may cause us to suffer higher default rates on our ITIN loans and reduce the value of the assets that we hold as collateral. In addition, if we become responsible for servicing of these ITIN loans, then we may realize additional monitoring, servicing and appraisal costs due to the geographic disbursement of the portfolio which will adversely affect our noninterest expense.

 

SFC Loans

Between May of 2014 and December of 2018, we purchased unsecured retail installment home improvement loans that were originated by Service Finance Company, LLC (SFC). The loans were made through a network of over 8,000 approved home improvement dealers throughout the United States and Puerto Rico. Loans within the portfolio have a wide range of terms, interest rates and purchase discounts or premiums. Some of the loans contain promotional periods designed to allow the consumer to use the financing as a cash flow tool. The loans are serviced by SFC and have an average FICO credit score over 750. The servicing agreement with SFC will remain in effect until payment in full of the unpaid principal balance of the loans. In addition, if we become responsible for servicing of these loans, then we may realize additional monitoring and servicing costs due to the geographic disbursement of the portfolio which would adversely affect our noninterest expense.

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Purchased Loans

 

In addition to loans we have originated or acquired through our acquisition of Merchants, the loan portfolio includes purchased loan pools and purchased participations. Purchased loans are recorded at their fair value at the acquisition date. Additional information regarding the individual purchased loan pools can be found in Note 6 Purchase of Financial Assets in the Notes to Consolidated Financial Statements in this document.

 

The following table presents the recorded investment in purchased loansloan pools and purchased participations at December 31, 20182019 and 2017.2018.

 

		For The Years Ended
		December 31,
(Amounts in thousands)		2018								2017
Loan Type		Balance				% of Gross Loan Portfolio				Balance				% of Gross Loan Portfolio
Commercial		$	66				—	%		$	108				—	%
Commercial real estate			29,096				3	%			30,195				3	%
Residential real estate			51,164				5	%			56,735				6	%
Consumer and other			46,049				5	%			47,836				5	%
Total purchased loans		$	126,375				13	%		$	134,874				14	%

During the second quarter of 2018 we terminated an agreement to purchase a maximum par value of $50.0 million in unsecured consumer home improvement loans from a third party originator. 

		For The Years Ended December 31,
		2019								2018
(Amounts in thousands) Loan Type		Balance				% of Gross Loan Portfolio				Balance				% of Gross Loan Portfolio
Commercial		$	—				—	%		$	66				—	%
Commercial real estate			19,506				2	%			29,096				3	%
Residential real estate			45,494				4	%			51,164				5	%
Consumer and other			28,579				3	%			46,049				5	%
Total purchased loans		$	93,579				9	%		$	126,375				13	%

 

Asset Quality

 

Nonperforming Assets

 

Our loan portfolio is heavily concentrated in real estate and a significant portion of our borrowers’ ability to repay their loans is dependent upon the professional services, commercial real estate market and the residential real estate development industry sectors. Loans secured by real estate or other assets primarily located in California are expected to be repaid from cash flows of the borrower or proceeds from the sale of collateral. As such, our dependence on real estate secured loans could increase the risk of loss in our loan portfolio in a market of declining real estate values. Furthermore, declining real estate values would negatively impact holdings of OREO.

 

We manage asset quality and mitigate credit risk through the application of policies designed to promote sound underwriting and loan monitoring practices. Our Loan Committee is charged with monitoring asset quality, establishing credit policies and procedures and enforcing the consistent application of these policies and procedures across the Bank. The provision for loan and lease losses charged to earnings is based upon management’s judgment of the amount necessary to maintain the allowance at a level adequate to absorb probable incurred losses. The amount of provision charge is dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management’s assessment of loan portfolio quality, general economic conditions that can impact the value of collateral, and other trends. The evaluation of these factors is performed through an analysis of the adequacy of the ALLL. Reviews of nonperforming, past due loans and larger credits, designed to identify potential charges to the ALLL, and to determine the adequacy of the allowance, are conducted on a monthly basis. These reviews consider such factors as the financial strength of borrowers, the value of the applicable collateral, loan and lease loss experience, estimated loan and lease losses, growth in the loan portfolio, prevailing economic conditions and other factors.

 

A loan is considered impaired when, based on current information and events, we determine it is probable that we will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. Generally, when we identify a loan as impaired, we measure the loan for potential impairment using discount cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of collateral, less selling costs. The starting point for determining the fair value of collateral is through obtaining external appraisals. Generally, external appraisals are updated every twelve months. We obtain appraisals from a pre-approved list of independent, third party, local appraisal firms. Approval and addition to the list is based on experience, reputation, character, consistency and knowledge of the respective real estate market. At a minimum, it is ascertained that the appraiser is: (1) currently licensed in the state in which the property is located, (2) is experienced in the appraisal of properties similar to the property being appraised, (3) is actively engaged in the appraisal work, (4) has knowledge of current real estate market conditions and financing trends, (5) is reputable, and (6) is not on Freddie Mac’s nor our Exclusionary List of appraisers and brokers. In most cases, appraisals will be reviewed by another independent third party to ensure the quality of the appraisal and the expertise and independence of the appraiser. Upon receipt and review, an external appraisal is utilized to measure a loan for potential impairment.

 

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Our impairment analysis documents the date of the appraisal used in the analysis, whether the officer preparing the report deems it current, and, if not, allows for internal valuation adjustments with justification. Typical justified adjustments might include discounts for continued market deterioration subsequent to appraisal date, adjustments for the release of collateral contemplated in the appraisal, or the value of other collateral or consideration not contemplated in the appraisal. An appraisal over one year old in most cases will be considered stale dated and an updated or new appraisal will be required. Any adjustments from appraised value to net realizable value are detailed and justified in the impairment analysis, which is reviewed and approved by our Chief Credit Officer. Although an external appraisal is the primary source to value collateral dependent loans, we may also utilize values obtained through purchase and sale agreements, negotiated short sales, broker price opinions, or the sales price of the note. These alternative sources of value are used only if deemed to be more representative of value based on updated information regarding collateral resolution. Impairment analyses are updated, reviewed and approved on a quarterly basis at or near the end of each reporting period. Based on these processes, we do not believe there are significant time lapses for the recognition of additional provision for loan and lease losslosses or charge-offs from the date they become known.

 

Loans are classified as nonaccrual when collection of principal or interest is doubtful; generally these are loans that are past due as to maturity or payment of principal or interest by 90 days or more, unless such loans are well-secured and in the process of collection. Additionally, all loans that are impaired are considered for nonaccrual status. Loans placed on nonaccrual will typically remain onin nonaccrual status until all principal and interest payments are brought current and the prospects for future payments in accordance with the loan agreement appear certain.

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Upon acquisition of real estate collateral, typically through the foreclosure process, we promptly begin to market the property for sale. If we do not receive offers or indications of interest within a reasonable timeframe, we will review market conditions to assess the pricing level that would enable us to sell the property. At the time of foreclosure, OREO is recorded at fair value less costs to sell (“cost”), which becomes the property’s new basis. Unless a current appraisal is available, an appraisal will be ordered prior to a loan migrating to OREO. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the ALLL. After foreclosure, management periodically performs valuations and the property is carried at the lower of the cost or fair value less expected selling costs. We obtain updated appraisals on OREO property every six to twelve months. Valuation adjustments recorded in a period are primarily based on (1) updated appraisals received during the period, or (2) management’s authorization to reduce the selling price of the property during the period.

 

The following table summarizes our nonperforming assets as of December 31 for each of the last five years.

 

(Amounts in thousands)		As of December 31,																				As of December 31,
Nonperforming Assets		2018				2017				2016				2015				2014				2019				2018				2017				2016				2015
Commercial		$	959			$	1,603			$	2,749			$	1,994			$	5,112			$	61			$	959			$	1,603			$	2,749			$	1,994
Commercial real estate:
Real estate - commercial non-owner occupied			548				—				1,196				5,488				6,909				—				548				—				1,196				5,488
Real estate - commercial owner occupied			—				600				784				1,071				2,787				3,103				—				600				784				1,071
Total commercial real estate			548				600				1,980				6,559				9,696				3,103				548				600				1,980				6,559
Residential real estate:
Real estate - residential - ITIN			2,388				2,909				3,576				3,649				4,647				2,221				2,388				2,909				3,576				3,649
Real estate - residential - 1-4 family mortgage			185				606				1,914				1,775				2,135				191				185				606				1,914				1,775
Real estate - residential - equity lines			43				45				917				—				24				—				43				45				917				—
Total residential real estate			2,616				3,560				6,407				5,424				6,806				2,412				2,616				3,560				6,407				5,424
Consumer and other			23				36				250				32				35				40				23				36				250				32
Total nonaccrual loans			4,146				5,799				11,386				14,009				21,649				5,616				4,146				5,799				11,386				14,009
90 days past due and still accruing			—				—				—				88				23				—				—				—				—				88
Total nonperforming loans			4,146				5,799				11,386				14,097				21,672				5,616				4,146				5,799				11,386				14,097
Other real estate owned			31				35				759				1,423				502				35				31				35				759				1,423
Total nonperforming assets		$	4,177			$	5,834			$	12,145			$	15,520			$	22,174			$	5,651			$	4,177			$	5,834			$	12,145			$	15,520
Nonperforming loans to gross loans			0.44	%			0.66	%			1.42	%			1.97	%			3.28	%			0.54	%			0.44	%			0.66	%			1.42	%			1.97	%
Nonperforming assets to total assets			0.32	%			0.46	%			1.06	%			1.53	%			2.22	%			0.38	%			0.32	%			0.46	%			1.06	%			1.53	%

 

We regularly perform thorough reviews of the commercial real estate portfolio, including semi-annual stress testing. These reviews are performed on both our non-owner and owner occupied credits. These reviews are completed to verify leasing status, to ensure the accuracy of risk ratings, and to develop proactive action plans with borrowers on projects. Stress testing is performed to determine the effect of rising cap rates, interest rates, and vacancy rates on the portfolio. Based on our analysis, we believe we are effectively managing the risks in this portfolio. There can be no assurance that declines in economic conditions, such as potential increases in retail or office vacancy rates, will not exceed the projected assumptions utilized in stress testing resulting in additional nonperforming loans in the future.

 

Loans are reported as troubled debt restructurings when we grant a concession(s) to a borrower experiencing financial difficulties that we would not otherwise consider. Examples of such concessions include a reduction in the loan rate, forgiveness of principal or accrued interest, extending the maturity date(s) significantly, or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, restructured loans are impaired as we will not collect all amounts due, either principal or interest, in accordance with the terms of the original loan agreement. Impairment reserves on non-collateral dependent troubled debt restructured loans are measured by comparing the present value of expected future cash flows of the restructured loans, discounted at the effective interest rate of the original loan agreement to the loans carrying value. These impairment reserves are recognized as a specific component to be provided for in the ALLL.

 

As of December 31, 2018,2019, we had $9.6$6.5 million in troubled debt restructurings compared to $10.9$9.6 million as of December 31, 2017.2018. As of December 31, 2018,2019, we had 10698 restructured loans that qualified as troubled debt restructurings, of which all94 loans were performing according to their restructured terms. Troubled debt restructurings represented 1.01%0.63% of gross loans as of December 31, 2018,2019, compared with 1.24%1.01% at December 31, 2017.2018.

 

Impaired loans of $6.9$4.8 million and $7.3$6.9 million were classified as accruing troubled debt restructurings at December 31, 20182019 and December 31, 2017,2018, respectively. For a restructured loan to be on accrual status, the loan’s collateral coverage must generally be greater than or equal to 100% of the loan balance, the loan payments must be current, and the borrower must demonstrate the ability to make payments from a verified source of cash flow. As of December 31, 2018 and2019, we had no obligations to lend additional funds on any restructured loans. As of December 31, 2017,2018, we had one restructured commercial line of credit in nonaccrual status that had $313 thousand and $33 thousand in available credit, respectively.credit.

 

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The following table sets forth a summary of our restructured loans that qualify as troubled debt restructurings for each of the last five years.

 

(Amounts in thousands)		As of December 31,																				As of December 31,
Troubled Debt Restructurings		2018				2017				2016				2015				2014				2019				2018				2017				2016				2015
Accruing troubled debt restructurings
Commercial		$	1,224			$	1,551			$	776			$	49			$	1,485			$	595			$	1,224			$	1,551			$	776			$	49
Commercial real estate:
Real estate - commercial non-owner occupied			795				803				808				824				840				—				795				803				808				824
Real estate - commercial owner occupied			—				—				—				—				858
Residential real estate:
Real estate - residential - ITIN			4,484				4,614				5,033				5,458				5,462				3,957				4,484				4,614				5,033				5,458
Real estate - residential - equity lines			363				380				454				558				579				231				363				380				454				558
Total accruing troubled debt restructurings			6,866				7,348				7,071				6,889				9,224				4,783				6,866				7,348				7,071				6,889
Nonaccruing troubled debt restructurings
Commercial			877				863				1,940				863				2,136				47				877				863				1,940				863
Commercial real estate:
Real estate - commercial non-owner occupied			—				—				—				4,292				6,909				—				—				—				—				4,292
Real estate - commercial owner occupied			—				—				—				1,071				2,488				—				—				—				—				1,071
Residential real estate:
Real estate - residential - ITIN			1,793				2,396				2,691				2,538				2,420				1,593				1,793				2,396				2,691				2,538
Real estate - residential - 1-4 family mortgage			—				296				335				219				242				—				—				296				335				219
Consumer and other			23				26				29				32				35				40				23				26				29				32
Total nonaccruing troubled debt restructurings			2,693				3,581				4,995				9,015				14,230				1,680				2,693				3,581				4,995				9,015
Total troubled debt restructurings
Commercial			2,101				2,414				2,716				912				3,621				642				2,101				2,414				2,716				912
Commercial real estate:
Real estate - commercial non-owner occupied			795				803				808				5,116				7,749				—				795				803				808				5,116
Real estate - commercial owner occupied			—				—				—				1,071				3,346				—				—				—				—				1,071
Residential real estate:
Real estate - residential - ITIN			6,277				7,010				7,724				7,996				7,882				5,550				6,277				7,010				7,724				7,996
Real estate - residential - 1-4 family mortgage			—				296				335				219				242				—				—				296				335				219
Real estate - residential - equity lines			363				380				454				558				579				231				363				380				454				558
Consumer and other			23				26				29				32				35				40				23				26				29				32
Total troubled debt restructurings		$	9,559			$	10,929			$	12,066			$	15,904			$	23,454			$	6,463			$	9,559			$	10,929			$	12,066			$	15,904
Total troubled debt restructuring to gross loans outstanding at period end			1.01	%			1.24	%			1.50	%			2.22	%			3.55	%			0.63	%			1.01	%			1.24	%			1.50	%			2.22	%

 

Allowance for Loan and Lease Losses and Reserve for Unfunded Commitments

 

The ALLL at December 31, 2018 increased $3672019 decreased $61 thousand to $12.3$12.2 million compared to $11.9$12.3 million at December 31, 2017.2018. As a result of continued improved asset quality, no provision for loan and lease losses was necessary during the year ended December 31, 2018. A provision for loan2019 and lease losses of $950 thousand was recorded during the year ended December 31, 2017.2018.

 

WeThe loans acquired from Merchants were recorded net loan loss recoveriesat fair value, which included a discount for credit risk adjustments, which is not a part of $367 thousandthe ALLL. No ALLL is required for these acquired loans on the year ended December 31, 2018 compared to net loan charge-offsdate of $569 thousand for the year ended December 31, 2017. Recoveries of $1.6 million during the year ended December 31, 2018 occurred primarily from two commercial loans partially offset by charge-offs occurred primarily from purchased consumer loans for $837 thousand. Ouracquisition. As a result, our ALLL as a percentage of gross loans outstanding was 1.30% and 1.36%declined to 1.18% as of December 31, 2018, and2019 compared to 1.30% as of December 31, 2017, respectively.2018.

 

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The following table summarizes the ALLL roll forward for each of the five years ended December 31. This table also includes impaired loan information for each of the five years as of December 31.

 

		For the Years Ended December 31,																				For the Years Ended December 31,
(Amounts in thousands)		2018				2017				2016				2015				2014				2019				2018				2017				2016				2015
Beginning balance ALLL		$	11,925			$	11,544			$	11,180			$	10,820			$	14,172			$	12,292			$	11,925			$	11,544			$	11,180			$	10,820
Provision for loan and lease loss charged to expense			—				950				—				—				3,175				—				—				950				—				—
Loans charged off			(1,248	)			(1,502	)			(2,784	)			(2,376	)			(7,319	)			(1,500	)			(1,248	)			(1,502	)			(2,784	)			(2,376	)
Loan and lease loss recoveries			1,615				933				3,148				2,736				792				1,439				1,615				933				3,148				2,736
Ending balance ALLL			12,292				11,925				11,544				11,180				10,820				12,231				12,292				11,925				11,544				11,180

 

		At December 31,																				At December 31,
		2018				2017				2016				2015				2014				2019				2018				2017				2016				2015
Nonaccrual loans:
Commercial			959				1,603				2,749				1,994				5,112				61				959				1,603				2,749				1,994
Real estate - commercial non-owner occupied			548				—				1,196				5,488				6,909				—				548				—				1,196				5,488
Real estate - commercial owner occupied			—				600				784				1,071				2,787				3,103				—				600				784				1,071
Real estate - residential - ITIN			2,388				2,909				3,576				3,649				4,647				2,221				2,388				2,909				3,576				3,649
Real estate - residential - 1-4 family mortgage			185				606				1,914				1,775				2,135				191				185				606				1,914				1,775
Real estate - residential - equity lines			43				45				917				—				24				—				43				45				917				—
Consumer and other			23				36				250				32				35				40				23				36				250				32
Total nonaccrual loans			4,146				5,799				11,386				14,009				21,649				5,616				4,146				5,799				11,386				14,009
Accruing troubled-debt restructured loans
Accruing troubled-debt restructured loans:
Commercial			1,224				1,551				776				49				1,485				595				1,224				1,551				776				49
Real estate - commercial non-owner occupied			795				803				808				824				840				—				795				803				808				824
Real estate - commercial owner occupied			—				—				—				—				858
Real estate - residential - ITIN			4,484				4,614				5,033				5,458				5,462				3,957				4,484				4,614				5,033				5,458
Real estate - residential - equity lines			363				380				454				558				579				231				363				380				454				558
Total accruing restructured loans			6,866				7,348				7,071				6,889				9,224				4,783				6,866				7,348				7,071				6,889
All other accruing impaired loans			—				—				337				492				535				—				—				—				337				492
Total impaired loans			11,012				13,147				18,794				21,390				31,408				10,399				11,012				13,147				18,794				21,390
Gross loans outstanding		$	946,251			$	879,835			$	804,211			$	716,639			$	660,898			$	1,032,903			$	946,251			$	879,835			$	804,211			$	716,639
Ratio of ALLL to gross loans outstanding			1.30	%			1.36	%			1.44	%			1.56	%			1.64	%			1.18	%			1.30	%			1.36	%			1.44	%			1.56	%
Nonaccrual loans to gross loans outstanding			0.44	%			0.66	%			1.42	%			1.95	%			3.28	%			0.54	%			0.44	%			0.66	%			1.42	%			1.95	%

 

As of December 31, 2018,2019, impaired loans totaled $11.0$10.4 million, of which $4.1$5.6 million were in nonaccrual status. Of the total impaired loans, $6.9$6.2 million or 105100 were ITIN loans with an average balance of approximately $65$62 thousand per loan. The remaining impaired loans consist of sevenfour commercial loans, two commercial real estate loans, onetwo residential mortgage, onemortgages, two consumer loanloans and eightfive home equity loans.

 

At December 31, 2018,2019, impaired loans had a corresponding specific allowance of $1.2 million.$324 thousand. The specific allowance on impaired loans represents the impairment reserves on performing restructured loans, other accruing loans, and nonaccrual loans.

 

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The following table sets forth the allocation of the ALLL for each of the five years as of December 31.

 

		At December 31,
(Amounts in thousands)		2018								2017								2016								2015								2014								At December 31,
ALLL		Amount				Percent				Amount				Percent				Amount				Percent				Amount				Percent				Amount				Percent				2019				%				2018				%				2017				%				2016				%				2015				%
Commercial		$	2,205				18	%		$	2,397				20	%		$	2,748				24	%		$	2,373				21	%		$	3,503				33	%		$	1,822				15	%		$	2,205				18	%		$	2,397				20	%		$	2,748				24	%		$	2,373				21	%
Commercial real estate:
Real estate - construction and land development			107				1	%			82				1	%			177				2	%			246				2	%			388				4	%			131				1	%			107				1	%			82				1	%			177				2	%			246				2	%
Real estate - commercial non-owner occupied			5,169				42	%			4,698				40	%			3,637				32	%			3,014				27	%			2,139				19	%			5,907				47	%			5,169				42	%			4,698				40	%			3,637				32	%			3,014				27	%
Real estate - commercial owner occupied			1,840				15	%			1,734				15	%			1,865				16	%			2,643				24	%			2,348				22	%			2,058				17	%			1,840				15	%			1,734				15	%			1,865				16	%			2,643				24	%
Residential real estate:
Real estate - residential - ITIN			660				5	%			602				5	%			973				8	%			998				9	%			836				8	%			569				5	%			660				5	%			602				5	%			973				8	%			998				9	%
Real estate - residential - 1-4 family mortgage			162				1	%			151				1	%			106				1	%			111				1	%			155				1	%			185				2	%			162				1	%			151				1	%			106				1	%			111				1	%
Real estate - residential - equity lines			351				3	%			416				3	%			637				5	%			469				4	%			679				6	%			278				2	%			351				3	%			416				3	%			637				5	%			469				4	%
Consumer and other			1,356				11	%			1,435				12	%			955				8	%			770				7	%			450				4	%			933				8	%			1,356				11	%			1,435				12	%			955				8	%			770				7	%
Unallocated			442				4	%			410				3	%			446				4	%			556				5	%			322				3	%			348				3	%			442				4	%			410				3	%			446				4	%			556				5	%
Total ALLL		$	12,292				100	%		$	11,925				100	%		$	11,544				100	%		$	11,180				100	%		$	10,820				100	%		$	12,231				100	%		$	12,292				100	%		$	11,925				100	%		$	11,544				100	%		$	11,180				100	%

 

The unallocated portion of ALLL provides for coverage of credit losses inherent in the loan portfolio but not captured in the credit loss factors that are utilized in the risk grading-based component, or in the specific reserve component of the ALLL, and acknowledges the inherent imprecision of all loss prediction models. As of December 31, 2018,2019, the unallocated allowance amount represented 4%3% of the ALLL, compared to 3%4% at December 31, 2017.2018. While the ALLL composition is an indication of specific amounts or loan categories in which future charge-offs may occur, actual amounts may differ.

 

Natural Disasters

Wildfires

We have extended credit to borrowers in California where devastating fires have recently caused widespread destruction, especially in the Redding area. A thorough review has been performed on the Bank’ loan portfolio and we have determined that the Bank does not have heightened exposure to losses due to the fires, and no adjustment to the ALLL for the fires was required.

Hurricanes

Many of the loans that we have acquired from third party originators were made to borrowers who are located throughout the United States, other than in California. Some of those borrowers reside in portions of North Carolina, South Carolina, Missouri, Texas, Florida, Georgia and Puerto Rico where hurricanes caused severe damage during the third quarters of 2018 and 2017. The loans that were affected are primarily ITIN loans which are secured by 1st deeds of trust and consumer home improvement loans which are unsecured. These loans are not serviced by us and we are dependent on third party servicers for collection efforts, processing payment deferral requests and obtaining loss information. We have not seen any significant increase in losses as a result of the hurricanes.

Reserve for Unfunded Commitments

 

The reserve for unfunded commitments, which is included in Other Liabilities on the Consolidated Balance Sheets, was $695 thousand at December 31, 20182019 and 2017.2018. The adequacy of the reserve for unfunded commitments is reviewed on a quarterly basis, based upon changes in the amount of commitments, loss experience, and economic conditions. When necessary, theAny provision expenseadjustment is recorded in other noninterest expenseOther Expenses in the Consolidated Statements of Income.

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Deposits

 

Total deposits as of December 31, 20182019 were $1.132$1.267 billion compared to $1.103$1.132 billion at December 31, 2017,2018, an increase of $29$135 million or 3%12%. The following table presents the deposit balances by major category as of December 31 for the last two years.

 

(Amounts in thousands)		2018								2017								At December 31,
Deposits		Amount				Percentage				Amount				Percentage				2019				%				2018				%
Noninterest-bearing demand		$	347,199				31	%		$	305,650				28	%		$	432,680				34	%		$	347,199				31	%
Interest-bearing demand			252,202				22	%			260,221				24	%			239,258				19	%			252,202				22	%
Money market accounts			265,093				23	%			236,769				21	%
Savings accounts			114,840				10	%			110,837				10	%
Money market																			307,559				24	%			265,093				23	%
Savings																			135,888				11	%			114,840				10	%
Certificates of deposit, $100,000 or greater			119,376				11	%			148,438				13	%			120,282				10	%			119,376				11	%
Certificates of deposit, less than $100,000			33,006				3	%			40,817				4	%			31,504				2	%			33,006				3	%
Total		$	1,131,716				100	%		$	1,102,732				100	%		$	1,267,171				100	%		$	1,131,716				100	%

 

The following table sets forth the distribution of our year-to-date average daily balancesdeposits and their respective average rates for the periods indicated.

 

		Years Ended December 31,																								Years Ended December 31,
		2018								2017								2016								2019								2018								2017
(Amounts in thousands)		Average Balance				Rate				Average Balance				Rate				Average Balance				Rate				Average Balance				Average Rate				Average Balance				Average Rate				Average Balance				Average Rate
Interest-bearing demand		$	238,328				0.17	%		$	209,792				0.13	%		$	172,011				0.12	%		$	242,516				0.20	%		$	238,328				0.17	%		$	209,792				0.13	%
Money market accounts			250,685				0.26	%			224,913				0.21	%			202,159				0.16	%
Savings accounts			109,025				0.26	%			111,376				0.18	%			104,771				0.17	%
Money market																											304,340				0.53	%			250,685				0.26	%			224,913				0.21	%
Savings																											136,733				0.36	%			109,025				0.26	%			111,376				0.18	%
Certificates of deposit			168,183				1.14	%			205,648				1.06	%			221,074				0.99	%			160,550				1.23	%			168,183				1.14	%			205,648				1.06	%
Interest-bearing deposits			766,221				0.43	%			751,729				0.42	%			700,015				0.41	%			844,139				0.54	%			766,221				0.43	%			751,729				0.42	%
Noninterest-bearing demand			332,197								289,735								226,368								400,588								332,197								289,735
Total deposits			1,098,418				0.24	%			1,041,464				0.26	%			926,383				0.28	%		$	1,244,727				0.37	%		$	1,098,418				0.30	%		$	1,041,464				0.30	%
Federal Home Loan Bank of San Francisco borrowings(1)			22,466				1.94	%			302				0.99	%			17,856				2.71	%
Other borrowings, net			15,143				7.11	%			17,981				6.48	%			19,430				6.08	%
Junior subordinated debentures			10,310				3.73	%			10,310				2.78	%			10,310				2.28	%
Total borrowings		$	47,919				3.96	%		$	28,593				5.09	%		$	47,596				4.00	%

 

(1) For 2016, the Bank’s effective weighted average interest rate on Federal Home Loan Bank of San Francisco borrowings includes the effect of hedge losses reclassified out other comprehensive income. During March of 2016, we terminated all of our interest rate swaps (active and forward starting, the “hedging” instrument) and simultaneously paid off the $75.0 million Federal Home Loan Bank of San Francisco borrowing (the “hedged instrument”)

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Deposit Maturity Schedule

 

The following table sets forth the maturities of certificates of deposit in the amounts of $100,000 or more as of December 31, 2018.2019.

 

(Amounts in thousands)
Maturing in:		2018				2019
Three months or less		$	35,494			$	20,991
Three through six months			13,836				22,871
Six through twelve months			13,556				28,714
Over twelve months			56,490				47,706
Total		$	119,376			$	120,282

 

We have an agreement with Promontory Interfinancial Network LLC (“Promontory”) allowingwhich facilitates provision of FDIC deposit insurance to balances in excess of current FDIC deposit insurance limits. Promontory’s Certificate of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep (“ICS”) products use a deposit-matching program to exchange Bank deposits in excess of the current deposit insurance limits for excess balances at other participating banks, on a dollar-for-dollar basis that would be fully insured at the Bank.(reciprocal arrangement). These products are designed to enhance our ability to attract and retain customers and increase deposits, by providing additional FDIC coverage to customers. CDARS and ICS deposits can also be reciprocal or one-way.

For calendar quarters prior to April 1, 2018, CDARS/ ICS reciprocal deposits were considered to be brokered deposits by regulatory authorities and were reported as sucharranged on quarterly Call Reports. With passage of The Economic Growth, Regulatory Relief and Consumer Protection Act in May 2018, this is no longer so.

Included in our certificate of deposit balances are $22.0 million of subscription time deposits obtained in years past through online deposit listing services. We no longer utilize online deposit listing services. As they mature, these legacy deposits are not being renewed.

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BANK OF COMMERCE HOLDINGS & SUBSIDIARIESa non-reciprocal basis.

 

Borrowings

The following table sets forth the distribution of our year-to-date average balances for borrowings and their respective average rates for the periods indicated.

		Years Ended December 31,
		2019								2018								2017
		Average Balance				Average Rate				Average Balance				Average Rate				Average Balance				Average Rate
Federal Home Loan Bank of San Francisco borrowings		$	9,644				2.56	%		$	22,466				1.94	%		$	302				0.99	%
Other borrowings, net			10,895				7.40	%			15,143				7.11	%			17,981				6.48	%
Junior subordinated debentures			10,310				4.13	%			10,310				3.73	%			10,310				2.78	%
Total borrowings		$	30,849				4.80	%		$	47,919				3.96	%		$	28,593				5.09	%

 

Term Debt

 

At December 31, 2018,2019, we had term debt outstanding with a carrying value of $13.4$10.0 million compared to $17.0$13.4 million at December 31, 2017.2018. Term debt consisted of the following:

 

Federal Home Loan Bank of San Francisco Borrowings

 

As of December 31, 20182019 and 2017,2018, the Bank had no Federal Home Loan Bank of San Francisco advances outstanding. The average balances outstanding on Federal Home Loan Bank of San Francisco term advances during 2019 and 2018 were $9.6 million and 2017 were $22.5 million, and $302 thousand, respectively. See Note 1210 Term Debt in the Notes to Consolidated Financial Statements for information on our Federal Home Loan Bank of San Francisco borrowings.

 

Senior Debt

 

In December of 2015, we entered into a senior debt loan agreement to borrow $10.0 million. TheDuring the second quarter of 2019, we completed the early repayment and termination of this variable-rate debt is secured by a pledge from the Holding Company of all of the outstanding stock of Redding Bank of Commerce, matures in 2020, and at December 31, 2018 had a balance of $3.5 million net of unamortized debt issuance costs. Interest on the senior debt is paid at a variable rate equal to three month LIBOR plus 400 basis points, resetting monthly. The effective interest rate at December 31, 2018, was 6.51%.agreement.

 

Subordinated Debt

 

In December of 2015, we issued $10.0 million of fixed to floating rate Subordinated Notes. The subordinated debt initially bears interest at 6.88% per annum for a five-year term. Thereafter, interest on the subordinated debt will be paid at a variable rate equal to three month LIBOR plus 526 basis points, resetting quarterly. At December 31, 2018,2019 the subordinated debt had a balance of $9.9$10.0 million net of unamortized debt issuance costs. The notes are due in 2025.

 

Junior Subordinated Debentures

 

Bank of Commerce Holdings Trust II

 

During July of 2005, we participated in a $10.0 million private placement of fixed rate trust-preferred securities (the "Trust-Preferred Securities") through a wholly owned Delaware trust affiliate, Bank of Commerce Holdings Trust II (the "Trust II"). Trust II simultaneously issued $310 thousand common securities to the Holding Company. Rates paid on the Trust-Preferred Securities have transitioned from fixed to floating and are now paid on a quarterly basis at a rate equal to three month LIBOR plus 158 basis points (4.37%point 3.47% at December 31, 2018).

2019. The Trust-Preferred Securities mature on September 15, 2035, and the covenants allow for redemption of the securities at our option during any quarter prior to maturity.

 

The proceeds from the sale of the Trust-Preferred Securities were used by Trust II to purchase from the Holding Company the aggregate principal amount of $10.3 million of the Holding Company’s junior subordinate debentures (the "Notes"). The net proceeds to the Holding Company from the sale of the Notes to Trust II were partially distributed to the Bank. The proceeds from the Notes qualify as Tier 1 capital under Federal Reserve Board guidelines.

 

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SOURCES OF INCOME

We derive our income primarily from net interest income, which is the difference between the interest income we receive on interest-earning assets and the interest expense we pay on interest-bearing liabilities. Net interest income is impacted by many factors that are beyond our control, including general economic conditions and the policies of various governmental and regulatory agencies, the Federal Reserve Board in particular. In recent years, we originated higher volumes of longer term fixed rate loans. These loans, combined with the structure of our investment portfolio and funding mix caused the Company to become slightly to moderately liability sensitive to rising interest rates. However, our floating rate assets reprice faster than our liabilities in a decreasing rate environment and cause the Company to be slightly asset sensitive to falling rates.

Net interest income reflects both the amount of earning assets we hold and our net interest margin, which is the difference between the yields we receive on our earning assets and the interest rates we pay to fund those assets. As a result, changes in either our net interest margin or the amount of earning assets we hold will affect our net interest income and earnings.

Increases or decreases in interest rates could adversely affect our net interest margin. Although our asset yields and funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, and cause our net interest margin to expand or contract. Many of our assets are tied to indexes, which adjust in response to changes in interest rates.

Changes in the slope of the yield curve, and the spread between short-term and long-term interest rates could also reduce our net interest margin. Normally, the yield curve is upward sloping, which means that short-term rates are lower than long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets.

We assess our interest rate risk by estimating the effect of interest rate changes on our earnings under various simulated scenarios. The scenarios differ based on assumptions including the direction, magnitude and speed of interest rate changes, and the slope of the yield curve.

There is always the risk that changes in interest rates could reduce our net interest income and earnings in material amounts, especially if actual conditions turn out to be materially different than simulated scenarios. For example, if interest rates rise or fall faster than we assumed or the slope of the yield curve changes, we may incur significant losses on debt securities we hold as investments. To reduce our interest rate risk, we may rebalance our investment and loan portfolios, refinance our debt and take other strategic actions, which may result in losses or expenses.

The following table summarizes as of December 31, 2019 when loans are projected to reprice by year and by rate index.

																						Years 6
																						Through				Beyond
(Amounts in thousands)		Year 1				Year 2				Year 3				Year 4				Year 5				Year 10				Year 10				Total
Rate Index:
Fixed		$	49,959			$	52,191			$	33,501			$	72,871			$	32,308			$	166,641			$	32,514			$	439,985
Variable:
Prime			92,508				5,534				9,682				4,616				6,759				4,752				—				123,851
5 Year Treasury			24,733				66,548				83,684				66,329				77,812				54,490				—				373,596
7 Year Treasury			858				7,024				9,292				480				5,597				13,828				—				37,079
1 Year LIBOR			20,988				—				—				—				—				—				—				20,988
Other Indexes			4,146				2,946				2,062				1,733				5,716				16,730				617				33,950
Nonaccrual			625				551				529				513				492				1,988				918				5,616
Total		$	193,817			$	134,794			$	138,750			$	146,542			$	128,684			$	258,429			$	34,049			$	1,035,065

Non Interest Income

We also earn noninterest income. Sources of noninterest income include fees earned on deposit related services, ATM and point of sale fees, payroll and benefit processing fees, earnings on bank-owned life insurance, gains on sale of available-for-sale securities, and dividends on Federal Home Loan Bank of San Francisco stock. Most of these sources of income do not vary significantly from quarter to quarter. Possible exceptions include gains on sale of available-for-sale securities and death proceeds from bank-owned life insurance.

LIQUIDITY AND CASH FLOW

 

ReddingMerchants Bank of Commerce

 

On January 31, 2019 we completed the acquisition of Merchants Holding Company located in Sacramento, California. The transaction was attractive to us because it expanded our presence in the Sacramento market, provided a new source of low cost core deposits and a quality loan portfolio. The acquisition provided approximately $104.5 million of additional liquidity ($119.8 cash and investment securities less $15.3 million paid to Merchants shareholders). Management elected to sell securities with a par value of $118.0 million during 2019 to provide liquidity for our decline in deposit balances and our planned reduction of wholesale certificates of deposit. The sales also included the elimination of certain securities acquired from Merchants Holding Company that did not fit our investment strategy.

 

The principal objective of our liquidity management program is to maintain our ability to meet the day-to-day cash flow requirements of our customers who either wish to withdraw funds on deposit or to draw upon their credit facilities.

 

We monitor the sources and uses of funds on a daily basis to maintain an acceptable liquidity position. One source of funds includes public deposits. We may be required to collateralize a portion of public deposits that exceed FDIC insurance limitations based on the state of California’s risk assessment of the Bank. Public deposits represent 2% of total deposits at December 31, 20182019 and December 31, 2017.2018.

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In addition to liquidity provided by core deposits, loan repayments and cash flows from securities, the Bank can borrow on established conditional federal funds lines of credit, sell securities, borrow on a secured basis from the Federal Home Loan Bank of San Francisco, borrow on a secured basis from the Federal Reserve Bank, or issue subscription / brokered certificates of deposit.

 

At December 31, 2018,2019, the Bank had the following credit arrangements:

 

●

We have an available line of credit with the Federal Home Loan Bank of San Francisco of $395.5$460.5 million; credit availability is subject to certain collateral requirements, namely the amount of pledged loans and investment securities.

●

We have an available line of credit with the Federal Reserve Bank of $17.3$22.3 million subject to collateral requirements, namely the amount of pledged loans.

●

We have entered into nonbinding federal funds line of credit agreements with three financial institutions. The available credit on these lines totaled $35.0 million at December 31, 20182019 and had interest rates ranging from 2.64%1.80% to 3.28%2.58%. Advances under the lines are subject to funds availability, continued borrower eligibility, and may have consecutive day usage restrictions.

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Bank of Commerce Holdings

 

The Holding Company is a separate entity from the Bank and must provide for its own liquidity. At December 31, 2018 we held $19.4 million from our May 2017 public offering. In January2019, the Holding Company had cash balances of 2019, we paid $15.3 million of that cash for the Merchants acquisition.$6.8 million. Our principal source of cash is dividends received from the Bank. During 2018,2019, the Bank paid a dividend of $4.0$12.5 million to the Holding Company. There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to the Holding Company in the future.

 

Consolidated StatementsStatement of Cash Flows

 

Net cash of $16.6 million was provided by operating activities for the year ended December 31, 2019. As disclosed in the Consolidated Statements of Cash Flows, net cash of $20.7 million was provided by operating activities for the year ended December 31, 2018. The primary difference between net income and cash provided by operating activities, arewas non-cash items including depreciation and amortization of $3.9 million and a decrease in deferred income tax expense of $595 thousand.including:

●

$2.1 million in depreciation, accretion and amortization

 

Net cash of $63.6$79.1 million usedprovided by investing activities during the year ended December 31, 2019 consisted principally of:

●

$117.3 million in proceeds from sale of investment securities.

●

$64.2 million in proceeds from maturities and payments of investment securities.

These sources of $57.6 million in purchases of available-for-sale investment securities and $66.2 million in net loan purchases and originationscash were partially offset by $30.2 million in proceeds from saleby:

●

$97.7 million in purchases of available-for-sale investment securities and $31.5 million in proceeds from maturities and payments of available-for-sale securities.

●

$2.9 million of net cash paid for the acquisition of Merchants.

 

Net cash of $23.2$62.5 million providedused by financing activities during the year ended December 31, 2019 principally consisted principally of a $65.9of:

●

$16.2 million decrease in deposits excluding $152.2 million in deposits provided by the acquisition of Merchants.

●

$38.6 million decrease in certificates excluding $38.0 million in certificates provided by the acquisition of Merchants.

●

$3.5 million increase in demand and savings deposits partially offset by a decrease in certificates of deposit of $36.9 million and $3.6 million in net repayment of term debt.

●

$3.2 million dividends paid on common stock

 

CAPITAL RESOURCES

 

We use equityEquity capital is available to support organic and strategic growth, pay dividends and pay dividends.repurchase shares. The objective of effective capital management is to produce above marketcompetitive long-term returns for our shareholders. Our sources of capital include retained earnings, common and preferred stock issuance, and issuance of subordinated debt or trust notes.

 

REGULATORY CAPITAL GUIDELINES 

 

Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank holding companies and banks. The guidelines are “risk-based,” meaning that they are designed to make capital requirements more sensitive to differences in risk profiles among banks and bank holding companies. On July 2, 2013, the federal banking agencies approved the finalThe current rules (the “Final Rules”) implementing the Basel Committee's December 2010 final capital framework (commonly known as Basel III). The Final Rules substantially amended the regulatory risk-based capital rules applicable to the Holding Company and the Bank. The phase-in period for the Final Rules ended January 1, 2019.

Generally speaking, the Final Rules did the following:

●	Created “Common Equity Tier 1 Capital Ratio,” which is a measure of regulatory capital closer to pure tangible common equity than the previous Tier 1 definition;

●	Established a required minimum risk-based capital ratio for “Common Equity Tier 1 Capital Ratio” at 4.5%;

●	Increased the required minimum risk-based “Tier 1 Capital Ratio” to 6.0%:

●	Increased the required minimum risk-based “Total Capital Ratio” to 8.0%;

●	Increased the required minimum “Tier 1 Leverage Ratio” to 4.0%;

●	Added a 2.50% capital conversation buffer to the minimum “Common Equity Tier 1 Capital Ratio”, “Tier 1 Capital Ratio” and “Total Capital Ratio”; and

●	Allowed for permanent grandfathering of non-qualifying instruments, such as our trust-preferred securities, subject to a limit of 25% of Tier 1 capital.

The Final Rules require the Bank and the Company to meet thea capital conservation buffer requirement in order to avoid constraints on capital distributions, such as dividends and equity repurchases, and certain bonus compensation for executive officers. The capital conservation buffer of 2.50% is added to the minimum capital ratios. And was phased in between 2016 and 2019. For 2018, the partially phased in buffer is 1.875%.

 

TheseThe Basel III minimum capital rules also changerequirements plus the risk-weightsconservation buffer exceed the prior regulatory “well-capitalized” capital thresholds by 0.5 percentage points. This 0.5 percentage-point cushion allows institutions to dip into a portion of certain assetstheir capital conservation buffer before reaching a status that is considered less than well capitalized for purposes of the risk-based capital ratios and phase out certain instruments as qualifying capital. The Final Rules also contain revisions to the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, if their capital levels begin to show signs of weakness.purposes.

 

UnderFor certain qualifying institutions, the prompt corrective action requirements, which are designedFDIC has substituted a Community Bank Leverage Ratio in lieu of the Basel III capital requirements. The FDIC has set the Community Bank Leverage Ratio at 9%. The ratio will be defined as the ratio of Tier 1 capital to complement the capital conservation buffer, insured depository institutions are required toaverage total consolidated assets. Banks that meet the following increased capital level requirements in ordercriteria will only be required to qualify as “well-capitalized:”report one ratio effective January 1, 2020:

 

●

a “Common Equity Tier 1 Capital Ratio” of at least 6.5%;Community Bank Leverage Ratio above 9%,

●

a “Tier 1 Capital Ratio” of at least 8%;Consolidated assets less than $10 billion,

●	a “Total Capital Ratio” of at least 10%;

●	a “Tier 1 Leverage Ratio”Off-balance-sheet exposures of at least 5%;25% or less of consolidated assets and

●

not be subject to any orderTotal trading assets and liabilities of 5% or written directive requiring a specific capital level.less of assets.

 

The FDIC's rules (as amended by the Final Rules) also contain other capital classification categories, such as "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized," which are based on an institution's specific capital ratios.

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As instructed by the Crapo Bill, the FDIC recently published a proposed Community Bank Leverage Ratio of 9%. Any qualifying depository institution or its holding company that exceeds the Community Bank Leverage Ratio will be considered to have met generally applicable leverage and risk-based regulatory capital requirements and considered to be “well capitalized” under the prompt corrective action rules discussed above.  It is difficult at this time to predict when or how the new standards underrules. Based on management’s review and analysis of Basel III and the Crapo Bill, management believes that the Holding Company and the Bank will ultimately be applied to us or what specific impactexceed the Crapo Bill (and any implementing rules and regulations) will have on community banks.standards under these rules.

 

CAPITAL ADEQUACY

 

Overall capital adequacy is monitored on a day-to-day basis by management and reported to our Board of Directors on a monthly basis. Our regulators measure capital adequacy by using a risk-based capital framework and by monitoring compliance with minimum leverage ratio guidelines. Based on management’s review and analysis of Basel III, management believes that the Holding Company and the Bank will exceed the standards under these new rules.

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As of December 31, 2018,2019, the most recent notification from the FDIC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since the notification that management believes have changed the Bank’s risk category. The Holding Company and the Bank’s capital amounts and ratios as of December 31, 2018,2019, are presented in the following table.

 

 

		December 31, 2018																								December 31, 2019
																		Applicable				Minimum																				Applicable				Minimum
										Well				Minimum				2018 Capital				Capital												Well				Minimum				2019 Capital				Capital Requirement
						Actual				Capitalized				Capital				Conservation				Ratio plus Capital								Actual				Capitalized				Capital				Conservation				Plus Capital
(Amounts in thousands)		Capital				Ratio				Requirement				Requirement				Buffer				Conservation Buffer				Capital				Ratio				Requirement				Requirement				Buffer				Conservation Buffer
Holding Company:
Common equity tier 1 capital ratio		$	139,488				12.79	%			n/a				4.500	%			1.875	%			6.375	%		$	156,587				13.19	%			n/a				4.50	%			2.50	%			7.00	%
Tier 1 capital ratio		$	149,488				13.71	%			n/a				6.000	%			1.875	%			7.875	%		$	166,587				14.04	%			n/a				6.00	%			2.50	%			8.50	%
Total capital ratio		$	172,475				15.82	%			n/a				8.000	%			1.875	%			9.875	%		$	189,513				15.97	%			n/a				8.00	%			2.50	%			10.50	%
Tier 1 leverage ratio		$	149,488				11.21	%			n/a				4.000	%			n/a				4.000	%		$	166,587				11.30	%			n/a				4.00	%			n/a				4.00	%
Bank:
Common equity tier 1 capital ratio		$	144,245				13.23	%			6.500	%			4.500	%			1.875	%			6.375	%		$	170,568				14.39	%			6.50	%			4.50	%			2.50	%			7.00	%
Tier 1 capital ratio		$	144,245				13.23	%			8.000	%			6.000	%			1.875	%			7.875	%		$	170,568				14.39	%			8.00	%			6.00	%			2.50	%			8.50	%
Total capital ratio		$	157,232				14.42	%			10.000	%			8.000	%			1.875	%			9.875	%		$	183,494				15.48	%			10.00	%			8.00	%			2.50	%			10.50	%
Tier 1 leverage ratio		$	144,245				10.81	%			5.000	%			4.000	%			n/a				4.000	%		$	170,568				11.58	%			5.00	%			4.00	%			n/a				4.00	%

 

On December 10, 2015, the Holding Company issued $10.0 million in aggregate principal amount of Subordinated Notes to certain institutional investors. The Subordinated Notes qualify as Tier 2 Capital under the Final Rules. See Item 1a - Risk Factors, in our Annual Report on Form 10-K for the year ended December 31, 20182019 for further detail on potential risks relating to the Subordinated Notes.

 

During 2016,Capital ratios for the Holding Company include the benefit derived from issuing 1,834,142 shares of common stock valued at $19.6 million during the first quarter of 2019 as part of our acquisition of Merchants.

On September 18, 2019, we announced that our Board of Directors had authorized a branch acquisition,stock purchase program. The stock purchase program authorizes the Company to purchase up to one million shares of its common stock over a period ending March 31, 2020 and is effective immediately. Purchases may be made in the open market, including in block trades, or through privately negotiated transactions, from time to time when management determines that market conditions and other factors warrant such purchases. There is no guarantee as to the exact number of shares to be purchased, and the stock purchase program may be modified, suspended, or terminated without prior notice. On February 21, 2020 we recorded aannounced that our Board of Directors increased the number of shares that may be repurchased from 1,000,000 to 1,500,000 shares of common stock, and extended the program by one year to March 31, 2021. During the fourth quarter of 2019, we repurchased 90,501 shares under the plan.

Goodwill and other intangible assets, net totaled $16.5 million at December 31. 2019 and primarily consisted of goodwill and core deposit intangibles recorded as part of previous acquisitions. See Note 7, Goodwill and Other Intangiblesin the Notes to Consolidated Financial Statements in this document for additional detail goodwill and other intangible of $1.8 million and goodwill of $665 thousand.assets. When calculating capital ratios, goodwill and a portion of the core deposit intangiblesother intangible assets, net are subtracteddeducted from Tier 1 capital. TheUnder the Basel III risk based capital rules, the deduction for core deposit intangibles iswas initially subject to a phase in period under the Basel III risk based capital rules. During 2017, 80% of the core deposit intangible was deducted from Tier 1 capitalwhich has now expired.

Goodwill and 100% will be deducted thereafter. Both of theseother intangible assets, net are subtracteddeducted from tangible equity as part of the calculation of tangible book value per share.

 

Capital ratios for the Holding Company include the benefit of $26.8 million net proceeds from the sale of 2,738,096 shares of common stock in the second quarter of 2017.

CASH DIVIDENDS AND PAYOUT RATIOS PER COMMON SHARE

During the quarters ended June 30, 2018, September 30, 2018 and December 31, 2018, we declared quarterly dividends of $0.04 per common share. During the quarter ended March 31, 2018 and the years ended December 31, 2017 and 2016, we declared quarterly cash dividends of $0.03 per common share.

These dividends were made pursuant to our existing dividend policy and in consideration of, among other things, earnings, regulatory capital levels, capital preservation and expected growth. The dividend rate is reassessed periodically by the Board of Directors in accordance with the Company’s dividend policy. There is no assurance that future cash dividends on common shares will be declared or increased.

 

The following table presents cash dividends declared and dividend pay-out ratios (dividends declared per common share divided by basic earnings per common share) for the years ended December 31. These dividends were made pursuant to our existing dividend policy and in consideration of, among other things, earnings, regulatory capital levels, capital preservation and expected growth. The dividend rate will be reassessed periodically by the Board of Directors in accordance with the dividend policy. There is no assurance that future cash dividends on common shares will be declared or increased.

 

		2018				2017				2016				2019				2018				2017
Dividends declared per common share		$	0.15			$	0.12			$	0.12
Dividends declared per common share for the quarter ended March 31,														$	0.04			$	0.03			$	0.03
Dividends declared per common share for the quarter ended June 30,															0.05				0.04				0.03
Dividends declared per common share for the quarter ended September 30,															0.05				0.04				0.03
Dividends declared per common share for the quarter ended December 31,															0.05				0.04				0.03
Total														$	0.19			$	0.15			$	0.12
Dividend payout ratio			15	%			25	%			31	%			23	%			15	%			25	%

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TANGIBLE BOOK VALUE PER SHARE

We have recorded goodwill and other intangible assets, net of $16.5 million which are subtracted from equity as part of the calculation of tangible book value per share. Management believes that tangible book value per share is meaningful because it is a measure that the Company and investors commonly use to assess the value of the Company. Tangible book value per common share was $8.71 at December 31, 2019 compared to $8.36 at December 31, 2018.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

Information regarding Off-Balance Sheet Arrangements is included in Note 15,14, Commitments and Contingencies in the Notes to Consolidated Financial Statements in this document.

 

CONCENTRATION OF CREDIT RISK

 

Information regarding Concentration of Credit Risk is included in Note 15,14, Commitments and Contingencies, in the Notes to Consolidated Financial Statements incorporated in this document.

 

LENDING TRANSACTIONS WITH RELATED PARTIES

 

The business we conduct with directors, officers, significant shareholders and other related parties (collectively, “Related Parties”) is restricted and governed by various laws and regulations, including 12 CFR Part 215 (Regulation O). Furthermore, it is our policy to conduct business with Related Parties on an arm’s length basis at current market prices with terms and conditions no more favorable than we provide in the normal course of business. See Note 25,23, Related Party Transactions in the Notes to Consolidated Financial Statements in this document for additional detail on lending transactions with related parties.

 

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IMPACT OF INFLATION

 

Inflation affects our financial position as well as operating results. It is our opinion that the effectseffect of inflation on our financial statements for the threetwo years ended December 31, 2018 on the financial statements have2019 has not been material.

CONTRACTUAL OBLIGATIONS AS OF DECEMBER 31, 2018:

The following table presents a summary of significant contractual obligations as of December 31, 2018, which mature as indicated.

		Less Than												More Than				Indeterminate
(Amounts in thousands)		One Year				1 - 3 Years				3 – 5 Years				5 Years				Maturity				Total
Deposits (1)		$	83,928			$	55,331			$	13,098			$	25			$	979,334			$	1,131,716
Term debt (2)			1,000				2,496				—				10,000				—				13,496
Junior subordinated debentures (3)			—				—				—				10,310				—				10,310
Operating lease obligations			866				1,783				1,142				1,032				—				4,823
Total		$	85,794			$	59,610			$	14,240			$	21,367			$	979,334			$	1,160,345

(1) Represents interest-bearing and noninterest-bearing checking, money market, savings and certificate of deposit accounts. (2) Represents senior debt and subordinated debt. (3) Represents the issued amount of all junior subordinated debentures.

 

RISK MANAGEMENT

 

Overview

 

Through our corporate governance structure, risk and return are evaluated to produce sustainable revenues, reduce risk of earnings volatility and increase shareholder value. The financial services industry is exposed to four major categories or types of risks; liquidity, credit, market and operational. Liquidity risk is the inability to meet liability maturities and withdrawals, fund asset growth and otherwise meet contractual obligations at reasonable market rates. Credit risk is the inability of a customer to meet their repayment obligations or the inability of a bond issuer to meet their contractual repayment obligations. Market risk is the fluctuation in asset and liability values caused by changes in market prices and yields, and operational risk is the potential for losses resulting from events involving people, processes, technology, legal issues, external events, regulation, or reputation.

 

Board Committees

 

Our corporate governance structure begins with our Board of Directors. The Board of Directors evaluates risk through the Chief Risk Officer and our Enterprise Risk Management reporting and monitoring process (ERM). Our ERM is updated quarterly and compares our risk appetite and key risk indicators to actual results and to peer data. The Board of Directors also evaluates risk through a number of Board Committees including the following:

 

●	Audit and Qualified Legal Compliance Committee reviews the scope and coverage of internal and external audit activities.

●	Loan Committee reviews credit risks in the loan portfolio and the adequacy of the Allowance for Loan and Lease Losses (“ALLL”).

●	Asset/Liability Management Committee (“ALCO”) reviews liquidity risk, credit risk in the investment bond portfolio and market risk.

●	Nominating and Corporate Governance Committee evaluates corporate governance structure, committee performance and evaluates recommendations for the appointment of director nominees.

●	Technology Committee provides oversight with respect to technology and innovation and the related risk assessment and risk management process.

 

These committees review reports from management, our auditors, and other outside sources. On the basis of materials that are available to them and on which they rely, the committees review the performance of our management and personnel, and establish policies, but neither the committees nor their individual members (in their capacities as members of the Board of Directors) is responsible for daily operations of the Company.

 

Management Committees

 

To ensure that our risk management goals and objectives are accomplished, oversight of our risk taking and risk management activities are conducted through a number of management committees comprised of members of management including the following.following:

 

●

The Senior Management Committee establishes short and long-term strategies and operating plans. The committee establishes performance measures and reviews performance to plan on a monthly basis. The committee is also responsible for evaluating operational risk assessments and approving and implementing mitigating action plans.

●	The Asset Liability Roundtable establishes and monitors liquidity ranges, pricing, maturities, investment goals, and interest spread on balance sheet accounts.

●	The SOX 404 Compliance Committee has established the master plan for full documentation of our internal controls and compliance with Section 404 of the Sarbanes-Oxley Act of 2002.

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Risk Management Controls

 

We use various controls and our ERM to manage risk exposure within the Company. Budgeting and variance analyses and key performance indicators provide an early indication of unfavorable results or heightened risk levels. Models are used to estimate market risk and net interest income sensitivity. Segmentation analysis is an important tool used to estimate expected and unexpected credit losses. Compliance with regulatory guidelines plays a significant role in risk management as well as corporate culture and the actions of management. Our code of ethics provides guidelines for all employees to use to ensure that they conduct themselves with the highest integrity in the delivery of service to our clients.

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Liquidity Risk Management

 

Liquidity Risk

 

Liquidity risk is the inability to meet liability maturities, deposit withdrawals, fund asset growth or otherwise meet contractual obligations at reasonable market rates. Liquidity management involves maintaining ample and diverse funding capacity, liquid assets and other sources of cash to accommodate fluctuations in asset and liability levels due to business shocks or unanticipated events. ALCO is responsible for establishing our liquidity policy and the Bank’s internal ALCO Roundtable group is responsible for planning and executing the funding activities and strategies.

 

The Bank’s liquid assets consist of cash and amounts due from banks, cash from repayments and maturities of loans, short-term money market investments, sales of available-for-sale securities and cash flows from principal repayment and maturities of investments. Liquidity is generated from liabilities through deposit growth and term debt borrowings. Deposit marketing strategies are reviewed for consistency with liquidity policy objectives.

 

The Bank has secondary sources of liquidity available from correspondent banking lines of credit, a secured line of credit with the Federal Reserve Bank and a secured borrowing line with the Federal Home Loan Bank of San Francisco. While these sources are expected to continue to provide significant amounts of secondary liquidity in the future, their availability, as well as the possible use of other sources, is dependent on future economic and market conditions, pledging of acceptable collateral and maintenance of required minimum capital ratios.

 

At December 31, 2018 the Holding Company held $19.4 million from our May 2017 public offering. In January of 2019, we paid $15.3 million of that cash for the Merchants acquisition. The Holding Company’s principal source of cash is dividends received from the Bank, which it has consistently received for many years. See Item 1A Risk Factors and Note 1817 Regulatory Capital in the Notes to Consolidated Financial Statements in this document for a discussion of the restrictions on the Bank’s ability to pay dividends.

 

To accommodate future growth and business needs, we develop an annual capital expenditure budget during strategic planning sessions. Based on our budgets and forecasts, we believe that our earnings, acquisition of core deposits and wholesale borrowing arrangements will be sufficient to support liquidity needs in 2018.2020.

 

Term Debt

 

Federal Home Loan Bank of San Francisco borrowings

 

We periodically utilize Federal Home Loan Bank of San Francisco advances as a source of wholesale funding to provide temporary liquidity. As of December 31, 20182019 and 2017,2018, the Bank had no Federal Home Loan Bank of San Francisco advances outstanding. See Note 1210 Term Debt in the Notes to Consolidated Financial Statements for information on our Federal Home Loan Bank of San Francisco borrowings and our remaining line of credit.

 

During the fourth quarter of 2015, the Holding Company redeemed $20.0 million of preferred stock by entering into a senior debt loan agreement to borrow $10.0 million from another financial institution and issuing $10.0 million of Subordinated Notes. The details are as follows:

Senior Debt

 

In December of 2015, the Holding Company, entered into a senior debt loan agreement to borrow $10.0 million. During the second quarter of 2019, we completed the early repayment and termination of this debt agreement. The original loan terms required monthly principal installments of $83 thousand, plus accrued and unpaid interest, commencing on January 1, 2016 and continuing to and including December 10, 2020. A final scheduled payment of $5.0 million is due on the maturity date of December 10, 2020. The loan maycould be prepaid in whole or in part at any time without any prepayment premium or penalty. The principal amount of the loan bearsbore interest at a variable rate, resetting monthly that iswas equal to the sum of the then current three month LIBOR plus 400 basis points. The Holding Company incurred senior debt issuance costs of $15 thousand which are being amortized over the life of the loan as additional interest expense. We have elected to accelerate repayment of this debt.

 

Subordinated Debt

 

In December of 2015, the Holding Company issued $10.0 million in aggregate principal amount of fixed to floating rate Subordinated Notes due December 10, 2025. The Subordinated Debt initially bears interest at 6.88% per annum for a five-year term, payable semi-annually. Thereafter, interest on the Subordinated Debt will be paid at a variable rate equal to three month LIBOR plus 526 basis points, payable quarterly until the maturity date. The notes qualify as Tier 2 capital under the capital adequacy rules and regulations issued by the Federal Reserve. The Holding Company incurred subordinated debt issuance costs of $210 thousand which are being amortized over the initial five year term as additional interest expense.

 

Term debt at December 31, 2019, 2018 2017 and 20162017 consisted of the following:

 

 

(Amounts in thousands)		2018				2017				2016				2019				2018				2017
Senior debt		$	3,496			$	7,096			$	8,917			$	—			$	3,496			$	7,096
Less unamortized debt issuance cost			(2	)			(6	)			(12	)			—				(2	)			(6	)
Subordinated debt			10,000				10,000				10,000				10,000				10,000				10,000
Less unamortized debt issuance cost			(89	)			(132	)			(172	)			(43	)			(89	)			(132	)
Total term debt at December 31,		$	13,405			$	16,958			$	18,733			$	9,957			$	13,405			$	16,958

 

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The following table presents the weighted average contractual interest rates on outstanding borrowings during the years ended December 31, 2019, 2018 2017 and 2016.2017.

 

 

		2018				2017				2016				2019				2018				2017
Federal Home Loan Bank of San Francisco borrowings			1.94	%			0.88	%			0.51	%			2.57	%			1.94	%			0.88	%
Senior debt			6.18	%			5.21	%			4.68	%			6.73	%			6.18	%			5.21	%
Subordinated debt			6.88	%			6.88	%			6.88	%			6.88	%			6.88	%			6.88	%

 

The following table presents the maximum outstanding balance at any month end, average balance during the year and effective weighted average interest rate during the year on outstanding term debt for the years ended December 31, 2019, 2018 2017 and 2016.2017.

 

 

(Amounts in thousands)		2018				2017				2016
Federal Home Loan Bank of San Francisco borrowings:
Maximum outstanding at any month end		$	70,000			$	10,000			$	80,000
Average balance during the year		$	22,466	��		$	302			$	17,856
Effective weighted average interest rate during year(1)			1.94	%			0.99	%			2.71	%
Senior debt net of unamortized debt issuance costs:
Maximum outstanding at any month end		$	6,890			$	8,822			$	9,819
Average balance during the year		$	5,239			$	8,132			$	9,400
Effective weighted average interest rate during year			6.51	%			5.34	%			4.79	%
Subordinated debt net of unamortized debt issuance costs:
Maximum outstanding at any month end		$	9,911			$	9,868			$	9,829
Average balance during the year		$	9,890			$	9,849			$	9,811
Effective weighted average interest rate during year			7.38	%			7.38	%			7.38	%
(1) For 2016, the Bank’s effective weighted average interest rate on Federal Home Loan Bank of San Francisco borrowings includes the effect of hedge losses reclassified out other comprehensive income. During March of 2016, we terminated all of our interest rate swaps (active and forward starting, the “hedging” instrument) and simultaneously paid off the $75.0 million Federal Home Loan Bank of San Francisco borrowing (the “hedged instrument”)

(Amounts in thousands)		2019				2018				2017
Federal Home Loan Bank of San Francisco borrowings:
Maximum outstanding at any month end		$	40,000			$	70,000			$	10,000
Average balance during the year		$	9,644			$	22,466			$	302
Effective weighted average interest rate during year			2.56	%			1.94	%			0.99	%
Senior debt net of unamortized debt issuance costs:
Maximum outstanding at any month end		$	3,195			$	6,890			$	8,822
Average balance during the year		$	960			$	5,239			$	8,132
Effective weighted average interest rate during year			7.22	%			6.51	%			5.34	%
Subordinated debt net of unamortized debt issuance costs:
Maximum outstanding at any month end		$	9,957			$	9,911			$	9,868
Average balance during the year		$	9,934			$	9,890			$	9,849
Effective weighted average interest rate during year			7.38	%			7.38	%			7.38	%

 

Credit Risk Management

 

Credit risk arises from the inability of a loan customer to meet their repayment obligations or the inability of a bond issuer to meet their contractual repayment obligations. Credit risk exists in our outstanding loans, letters of credit, Federal Home Loan Bank of San Francisco affordable housing grant sponsorships, unfunded loan commitments, deposits with other institutions and investment bond portfolio. In all of these areas we manage credit risk based on the risk profile of the borrower/grantee/issuer, repayment sources and the nature of the underlying collateral given current events and conditions. We rely on various controls including our underwriting standards, loan policies, internal loan monitoring, ALLL methodology and credit reviews to manage credit risk.

 

Concentrations of credit risk

 

We grant real estate construction, commercial, and installment loans to customers throughout northern California. In our judgment, a concentration exists in real estate related loans, which represented approximately 81%83% and 77%81% of our gross loan portfolio at December 31, 20182019 and December 31, 2017.2018.

 

Commercial real estate concentrations are managed to assure wide geographic and business diversity. Although management believes such concentrations have no more than the normal risk of collectability, a substantial decline in the economy in general, material increases in interest rates, changes in tax policies, tightening credit or refinancing markets, or a decline in real estate values in our principal market areas in particular, could have an adverse impact on the repayment of these loans. Personal and business incomes, proceeds from the sale of real property, or proceeds from refinancing, represent the primary sources of repayment for a majority of these loans.

 

We recognize the credit risks inherent in dealing with other depository institutions. Accordingly, to prevent excessive exposure to other depository institutions in aggregate or to any single correspondent, we have established general standards for selecting correspondent banks as well as internal limits for allowable exposure to other depository institutions in aggregate or to any single correspondent. In addition, we have an investment policy that sets forth limitations that apply to all investments with respect to credit rating and concentrations with an issuer.

 

Loan portfolio

 

Credit risk management for the loan portfolio begins with an assessment of the credit risk profile of each individual borrower based on an analysis of the borrower’s financial position in light of current industry, economic or geopolitical trends. As part of the overall credit risk assessment of a borrower, each credit is assigned a risk grade and is subject to approval based on our existing credit approval standards. Risk grading is a significant factor in determining the adequacy of the ALLL.

 

Credit decisions are made by our Credit Administration subject to certain limitations and, when those limitations are encountered, the approvals are made by the Board Loan Committee. Credit risk is continuously monitored by Credit Administration for possible adjustment of a loan risk grade if there has been a change in the borrower’s ability to perform under the terms of their obligation. Additionally, we may manage the size of our credit exposure through loan sales and loan participation agreements.

 

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Our specific underwriting standards and methods for each principal line of lending include industry-accepted analysis and modeling and certain proprietary techniques. Our underwriting criteria are designed to comply with applicable regulatory guidelines, including required loan-to-value ratios. Our credit administration policies contain mandatory lien position and debt service coverage requirements, and we generally require a guarantee from individuals owning 20% or more of the borrowing entity. Our evaluations of our borrowers’ are facilitated by management’s knowledge of local market conditions and periodic reviews by a consultant of our credit administration policies.

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Allowance for loan and lease losses

 

The ALLL represents management’s best estimate of probable losses in the loan portfolio. Within the allowance, reserves are allocated to segments of the portfolio based on specific formula components. Changes to the ALLL are reported in the Consolidated Statements of Income in the line item provision for loan and lease losses.

 

We perform periodic and systematic detailed evaluations of our lending portfolio to identify and estimate the inherent risks and assess the overall collectability. We evaluate the following:

 

●	General conditions such as the portfolio composition, size and maturities of various segmented portions of the portfolio such as secured, unsecured, construction, and Small Business Administration.

●	Concentrations of borrowers, industries, geographical sectors, loan product, loan classes and collateral types.

●	Volume and trends in the aggregate of loan delinquencies, nonaccruals, and watch, criticized and classified loans

 

Our ALLL is the accumulation of various components that are calculated based upon independent methodologies. All components of the ALLL represent an estimation based on certain observable data that management believes most reflects the underlying credit losses being estimated. Changes in the amount of each component of the ALLL are directionally consistent with changes in the observable data, taking into account the interaction of the components over time.

 

An essential element of the methodology for determining the ALLL is our credit risk evaluation process, which includes credit risk grading of individual, commercial, construction, commercial real estate, and consumer loans. Loans are assigned credit risk grades based on our assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrower’s current financial information, historical payment experience, credit documentation, public information, and other information specific to each individual borrower. Loans are reviewed on an annual or rotational basis or as management becomes aware of information affecting the borrower’s ability to fulfill its obligations. Credit risk grades carry a dollar weighted risk percentage.

 

For individually impaired loans, we measure impairment based on the present value of expected future principal and interest cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan’s observable market price or the fair value of collateral, if the loan is collateral dependent. When developing the estimate of future cash flows for a loan, we consider all available information reflecting past events and current conditions, including the effect of existing environmental factors. In addition to the ALLL, an allowance for unfunded loan commitments and letters of credit is determined using estimates of the probability of funding and the associated inherent credit risk. This reserve is carried as a liability on the Consolidated Balance Sheets.

 

We make provisions to the ALLL as necessary through charges to operations that are reflected in our Consolidated Statements of Income as provision for loan and lease loss expense. When a loan is deemed uncollectible, it is charged against the allowance. Any recoveries of previously charged off loans and leases are credited back to the allowance. There is no precise method of predicting specific losses or amounts that ultimately may be charged off on particular categories of the loan and lease portfolio.

 

Various regulatory agencies periodically review our ALLL as an integral part of their examination process. Such agencies may require us to provide additions to the allowance based on their judgment of information available to them at the time of their examination. There is uncertainty concerning future economic trends. Accordingly, it is not possible to predict the effect future economic trends may have on the level of the provisions for loan and lease losses in future periods. The ALLL should not be interpreted as an indication that charge-offs in future periods will occur in the stated amounts or proportions.

 

Federal Home Loan Bank of San Francisco Affordable Housing Grant and Access to Housing and Economic Assistance for Development Grant Sponsorships

 

As part of satisfying our CRA responsibilities, we are a sponsor for various nonprofit organizations which receive cash grants from the Federal Home Loan Bank of San Francisco. Those grants require the nonprofit organization to comply with stipulated conditions of the grant over specified periods of time which typically vary from 10 to 15 years. If the nonprofit organization fails to comply, Federal Home Loan Bank of San Francisco can require us to refund the amount of the grant to Federal Home Loan Bank of San Francisco. To mitigate this contingent credit risk, Credit Administration underwrites the financial strength of the nonprofit organization and reviews their systems of internal control to determine, as best as is possible, that they will not fail to comply with the conditions of the grant.

 

Securities Portfolio

 

To manage credit risk in the securities portfolio, we have an investment policy that sets forth limitations that apply to all investments with respect to credit rating and concentrations with an issuer. We perform a pre-purchase analysis on all bonds not secured by the U.S. Government or Agency of the U.S. Government to ensure that the investment meets our credit risk requirements and repayment expectations. We perform annual and quarterly credit reviews to ensure our investments continue to meet our credit risk requirements and repayment expectations.

 

Deposits With Other Institutions

 

We recognize the credit risks inherent in dealing with other depository institutions. Accordingly, to prevent excessive exposure to other depository institutions in aggregate or to any single correspondent, we have established general standards for selecting correspondent banks as well as internal limits for allowable exposure to other depository institutions in aggregate or to any single correspondent.

 

Market Risk Management

 

General

 

Market risk is the potential loss due to adverse changes in market prices and interest rates. Market risk is inherent in our operating positions and activities including customers’ loans, deposit accounts, securities and long-term debt. Loans and deposits generate income and expense, respectively, and the value of cash flows changes based on general economic levels, and most importantly, the level of interest rates.

 

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The goal for managing our assets and liabilities is to maximizeoptimize shareholder value and earnings while maintaining a high quality balance sheet without exposing the Company to undue interest rate risk. The absolute level and volatility of interest rates can have a significant impact on our profitability. Market risk arises from exposure to changes in interest rates, exchange rates, commodity prices, and other relevant market rate or price risk. We do not operate a trading account, and do not hold a position with exposure to foreign currency exchange.

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We face market risk through interest rate volatility. Net interest income, or margin risk, is measured based on rate shocks over varying time horizons versus a current stable interest rate environment. Assumptions used in these calculations are similar to those used in the planning and budgeting model. The overall interest rate risk position and strategies are reviewed on an ongoing basis with ALCO.

 

Securities Portfolio

 

The securities portfolio is central to our asset liability management strategies. The decision to purchase or sell securities is based upon our assessment of current and projected economic and financial conditions, including the interest rate environment, liquidity, changes in a security’s credit rating, the risk weighting of a security and other regulatory requirements. We classify our securities as “available-for-sale” or “held-to-maturity” at the time of purchase. We do not engage in trading activities. Securities held-to-maturity are carried at amortized cost. Securities available-for-sale may be sold to implement our asset liability management strategies and in response to changes in interest rates, prepayment rates, and similar factors. Securities available-for-sale are recorded at fair value and unrealized gains or losses, net of income taxes, are reported as a component of accumulated other comprehensive income (loss), in a separate component of shareholders’ equity. Gain or loss on sale of securities is calculated on the specific identification method.

 

Operational Risk Management

 

Operational risk is the potential for loss resulting from events involving people, processes, technology, legal or regulatory issues, external events, and reputation. In keeping with the corporate governance structure, the Senior Leadership committee is responsible for operational risk controls. Operational risks are managed through specific policies and procedures, controls and monitoring tools. Examples of these include reconciliation processes, transaction monitoring and analysis and system audits. Operational risks fall into two major categories, business specific and company-wide. The Senior Leadership committee works to ensure consistency in policies, processes and assessments. With respect to company-wide risks, the Senior Leadership committee works directly with members of our Board of Directors to develop policies and procedures for information security, business resumption plans, compliance and legal issues.

 

SUMMARY OF CRITICAL ACCOUNTING POLICIES

 

Our significant accounting policies are described in Note 2 Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in this document. Some of these significant accounting policies are considered critical and require management to make difficult, subjective or complex judgments or estimates. Management believes that the following policies would be considered critical under the SEC’s definition.

 

Valuation of Investments and Impairment of Securities

 

At the time of purchase, we designate a security as held-to-maturity or available-for-sale, based on our investment objectives, operational needs and intent to hold. We do not engage in trading activity. Securities designated as held-to-maturity are carried at amortized cost. We have the ability and intent to hold these securities to maturity. Securities designated as available-for-sale may be sold to implement our asset/liability management strategies and in response to changes in interest rates, prepayment rates and similar factors. Securities designated as available-for-sale are recorded at fair value and unrealized gains or losses, net of income taxes, are reported as part of accumulated other comprehensive income (loss), a separate component of shareholders’ equity. Gains or losses on sale of securities are based on the specific identification method. The market value and underlying rating of the security is monitored to identify changes in quality.

 

Securities may be adjusted to reflect changes in valuation as a result of other-than-temporary declines in value. Investments with fair values that are less than amortized cost are considered impaired. Impairment may result from either a decline in the financial condition of the issuing entity or, in the case of fixed rate investments, from changes in interest rates. At each financial statement date, management assesses each investment to determine if impaired investments are temporarily impaired or if the impairment is other-than-temporary based upon the positive and negative evidence available. Evidence evaluated includes, but is not limited to, industry analyst reports, credit market conditions, and interest rate trends.

 

When an investment is other-than-temporarily impaired, we assess whether we intend to sell the security, or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis less any current-period credit losses. If we intend to sell the security or if it is more likely than not that we will be required to sell security before recovery of the amortized cost basis, the entire amount of other-than-temporary impairment is recognized in earnings.

 

For debt securities that are considered other-than-temporarily impaired and that we do not intend to sell and will not be required to sell prior to recovery of our amortized cost basis, we separate the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is calculated as the difference between the investment’s amortized cost basis and the present value of its expected future cash flows.

 

The remaining differences between the investment’s fair value and the present value of future expected cash flows is deemed to be due to factors that are not credit related and is recognized in other comprehensive income. Significant judgment is required in the determination of whether other-than-temporary impairment has occurred for an investment. We follow a consistent and systematic process for determining other-than-temporary impairment loss. We have designated the ALCO responsible for the other-than-temporary evaluation process.

 

The ALCO’s assessment of whether other-than-temporary impairment loss should be recognized incorporates both quantitative and qualitative information including, but not limited to: (1) the length of time and the extent of which the fair value has been less than amortized cost, (2) the financial condition and near term prospects of the issuer, (3) our intent and ability to retain the investment for a period of time sufficient to allow for an anticipated recovery in value, (4) whether the debtor is current on interest and principal payments, and (5) general market conditions and industry or sector specific outlook. See Note 4 Securities in the Notes to Consolidated Financial Statements in this document for further detail on other-than-temporary impairment and the securities portfolio.

 

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Allowance for Loan and Lease Losses

 

The ALLL is based upon estimates of loan and lease losses and is maintained at a level considered adequate to provide for probable losses inherent in the outstanding loan portfolio. The allowance is increased by provisions charged to expense and reduced by net charge-offs. In periodic evaluations of the adequacy of the allowance balance, management considers our past loan and lease loss experience by type of credit, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, current economic conditions and other factors.

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Management reviews the ALLL on a monthly basis and conducts a formal assessment of the adequacy of the ALLL on a quarterly basis. These assessments include the periodic re-grading of classified loans based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the interest rate environment and other factors as warranted. Loans are initially graded when originated. Loans are reviewed as they are renewed, when there is a new loan to the same borrower and/or when identified facts demonstrate heightened risk of default. Confirmation of the quality of our grading process is obtained by independent reviews conducted by outside consultants specifically hired for this purpose and by periodic examination by various bank regulatory agencies. Management monitors delinquent loans continuously and identifies problem loans to be evaluated individually for impairment testing. For loans that are determined impaired, formal impairment measurement is performed at least quarterly on a loan-by-loan basis.

 

Our method for assessing the appropriateness of the allowance includes specific allowances for identified problem loans, an allowance factor for categories of credits and allowances for changing environmental factors (e.g., portfolio trends, concentration of credit, growth, economic factors). Allowances for identified problem loans are based on specific analysis of individual credits. Loss estimation factors for unimpaired loan categories are based on analysis of historical losses adjusted for changing environmental factors applicable to each loan category. Allowances for changing environmental factors are management's best estimate of the probable impact these changes would have on the loan portfolio as a whole. See Note 5 Loans in the Notes to Consolidated Financial Statements in this document for further detail on the ALLL and the loan portfolio.

 

Income Taxes

 

Income taxes reported in the consolidated financial statements are computed based on an asset and liability approach. We recognize the amount of taxes payable or refundable for the current year, and deferred tax assets and liabilities for the expected future tax consequences that have been recognized in the consolidated financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the consolidated financial statements and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We record net deferred tax assets to the extent it is more likely than not that they will be realized. In evaluating our ability to recover the deferred tax assets, management considers all available positive and negative evidence, including projected future taxable income, tax planning strategies and recent financial operations.

 

In projecting future taxable income, management develops assumptions including the amount of future state and federal pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates being used to manage the underlying business. We file consolidated federal and state income tax returns.

 

ASC 740-10-55 Income Taxes requires a two-step process that separates recognition from measurement of tax positions. We recognize the financial statement effect of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination by a taxing authority. The measurement process is applied only after satisfying the recognition requirement and determines what amount of a tax position will be sustainable upon a potential examination or settlement. If upon measuring, the tax position produces a range of potential tax benefits, we may claim the highest tax benefit from that range as long as it is over 50% likely to be realized using a probability analysis.

 

We believe that all of the tax positions we have taken, meet the more likely than not recognition threshold. To the extent tax authorities disagree with these tax positions, our effective tax rates could be materially affected in the period of settlement with the taxing authorities. See Note 2119 Income Taxes in the Notes to Consolidated Financial Statements in this document for further detail on our income taxes.

 

Fair Value Measurements

 

We use fair value measurements to record fair value adjustments to certain assets and liabilities, and to determine fair value disclosures. We base our fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Securities available-for-sale and derivatives are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record certain assets at fair value on a nonrecurring basis, such as certain impaired loans held for investment, (“OREO”), core deposit intangible and goodwill. These nonrecurring fair value adjustments typically involve write-downs of individual assets due to application of lower of cost or market accounting.

 

We have established and documented a process for determining fair value. We maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. Whenever there is no readily available market data, we use our best estimate and assumptions in determining fair value, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result, if other assumptions had been used, our recorded earnings or disclosures could have been materially different from those reflected in these consolidated financial statements. Additional information on our use of fair value measurements and our related valuation methodologies is provided in Note 2018 Fair Values in the Notes to Consolidated Financial Statements incorporated in this document.

 

ItemItem 7a - Quantitative and Qualitative Disclosures about Market Risk

 

Market risk is the risk that values of assets and liabilities or revenues will be adversely affected by changes in market conditions such as interest rates. The risk is inherent in the financial instruments associated with our operations and activities including loans, deposits, securities, short-term borrowings and long-term debt. We do not operate a securities trading account and do not hold a position with exposure to foreign currency exchange or commodities. Market-sensitive assets and liabilities are generated through loans and deposits associated with our banking business, our asset liability management process, and credit risk mitigation activities. Traditional loan and deposit products are reported at amortized cost for assets or the amount owed for liabilities. These positions are subject to changes in economic value based on varying market conditions. Interest rate risk is the effect of changes in economic value of our loans and deposits, as well as our other interest rate sensitive instruments and is reflected in the levels of future income and expense produced by these positions versus levels that would be generated by current levels of interest rates. We seek to mitigate interest rate risk as part of the asset liability management process.

 

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The Board of Directors has overall responsibility for our interest rate risk management policies. We have an Asset/Liability Management Committee (“ALCO”) which establishes and monitors guidelines to control our sensitivity of earnings to changes in interest rates. Our internal ALCO Roundtable group forecasts net interest income using different rate scenarios via a simulation model. This group updates the net interest income forecast for changing assumptions and differing outlooks based on economic and market conditions.

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The simulation model includes expected re-pricing characteristics of our rate sensitive assets and liabilities. These re-pricing characteristics recognize the relative sensitivity of assets and liabilities to changes in market interest rates, as demonstrated through current and historical experience and recognizing the timing differences of rate changes. In the simulation of net interest margin and net interest income the forecast balance sheet is processed against nine possible rate scenarios. These nine rate scenarios include a flat rate environment, which assumes interest rates are unchanged in the future and eight additional rate ramp scenarios ranging from +400 to -400 basis points in 100 basis point increments. The model does not simulate for rates below zero.

 

The formal policies and practices we have adopted to monitor and manage interest rate risk exposure rely on measuring risk in two ways: (1) the impact of changes in rates on net interest income, and (2) the impact of changes in rates on the fair value of equity. In moderately rising interest rate scenarios the model indicates that the company is slightly liability sensitive. In more rapidly rising interest rate scenarios however, the model indicates that the company is somewhat more liability sensitive.

 

TheOn March 3, 2020, the Federal Reserve currently haslowered the federal funds rate targetedtarget range to between 225100 and 250125 basis points. Accordingly, wepoints in response to risks posed by the coronavirus disease 2019. We are focused primarily on the effects of increasingsmall changes in interest rate shocks on our net interest income during a rising rate environment.rates, either up or down. The most recent model results as of December 31, 2018,2019, indicate the estimated annualized decrease in net interest income attributable to a 100 or 200 basis point increase in the federal funds rate was $627$441 thousand and $2.5$2.2 million, respectively. The model also shows an annualized decrease in net interest income attributable to a 300 or 400 basis point increase in the fed funds rate of $5.1$4.7 million and $7.0$6.5 million, respectively. In a declining rate environment, the most recent model results as of December 31, 2018,2019, indicate the estimated annualized reduction in net interest income attributable to a 100 or 200 basis point decline in the federal funds rate was $291$66 thousand and $1.4 million,$530 thousand, respectively. Given that the model assumes a static balance sheet, relies on historic betas and assumes immediate parallel rate changes, no assurance can be given that future performance will mirror the model.

 

We believe that the short duration of our rate-sensitive assets and liabilities contributes to our ability to re-price a significant amount of our rate-sensitive assets and liabilities and mitigate the impact of rate changes in excess of 100, 200, 300, or 400 basis points. The model’s primary benefit to management is its assistance in evaluating the impact that future strategies with respect to our mix and level of rate-sensitive assets and liabilities will have on our net interest income.

 

Our approach to managing interest rate risk may include the use of derivatives, including interest rate swaps, caps and floors. This helps to minimize significant, unplanned fluctuations in earnings, fair values of assets and liabilities and cash flows caused by interest rate volatility. This approach involves a financial instrument with the same characteristics of certain assets and liabilities so that changes in interest rates do not have a significant adverse effect on the net interest margin and cash flows. As a result of interest rate fluctuations, hedged assets and liabilities will gain or lose market value. In a fair value hedging strategy, the effect of this unrealized gain or loss will generally be offset by income or loss on the derivatives linked to the hedged assets and liabilities. For a cash flow hedge, the change in the fair value of the derivative to the extent that it is effective is recorded through other comprehensive income.

At inception, the relationship between hedging instruments and hedged items is formally documented with our risk management objective, strategy and our evaluation of effectiveness of the hedge transactions. This includes linking all derivatives designated as fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific transactions. Periodically, as required, we formally assess whether the derivative we designated in the hedging relationship is expected to be and has been highly effective in offsetting changes in fair values or cash flows of the hedged item.

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The following table sets forth as of December 31, 20182019 the distribution of re-pricing opportunities for our earning assets and interest-bearing liabilities. It also reports the GAP (different volumes of rate sensitive assets and liabilities) re-pricing interest-earning assets and interest-bearing liabilities at different time intervals, the cumulative GAP, the ratio of rate sensitive assets to rate sensitive liabilities for each re-pricing interval, and the cumulative GAP to total assets.

 

 

		Gap Analysis																				Gap Analysis
		Within 3				3 Months To				One Year To				Over Five								Within 3				3 Months To				One Year To				Over Five
(Amounts in thousands)		Months				One Year				Five Years				Years				Total				Months				One Year				Five Years				Years				Total
Interest-earning assets
AFS securities		$	42,558			$	22,482			$	86,813			$	105,075			$	256,928			$	51,424			$	41,679			$	116,161			$	77,686			$	286,950
Other investments			23,673				—				—				—				23,673				49,266				—				—				—				49,266
Loans, net of deferred fees and costs			90,325				130,363				485,005				242,485				948,178				83,955				109,862				548,770				292,478				1,035,065
Total earning assets			156,556				152,845				571,818				347,560			$	1,228,779				184,645				151,541				664,931				370,164			$	1,371,281
Interest-bearing liabilities
Demand - interest-bearing			252,202				—				—				—			$	252,202				239,258				—				—				—			$	239,258
Money market accounts			265,093				—				—				—				265,093
Savings accounts			114,840				—				—				—				114,840
Money market																							307,559				—				—				—				307,559
Savings																							135,888				—				—				—				135,888
Certificates of deposit			45,373				38,725				68,259				25				152,382				27,926				63,975				59,847				38				151,786
Term debt and junior subordinated debentures, net			11,198				2,560				9,957				—				23,715				10,298				9,969				—				—				20,267
Total interest-bearing deposits and borrowings		$	688,706			$	41,285			$	78,216			$	25			$	808,232			$	720,929			$	73,944			$	59,847			$	38			$	854,758
Re-pricing GAP		$	(532,150	)		$	111,560			$	493,602			$	347,535			$	420,547			$	(536,284	)		$	77,597			$	605,084			$	370,126			$	516,523
Cumulative re-pricing GAP		$	(532,150	)		$	(420,590	)		$	73,012			$	420,547			$	—			$	(536,284	)		$	(458,687	)		$	146,397			$	516,523
Gap ratio			0.23				3.70				7.31				13,902.40				1.52				0.26				2.05				11.11				9,741.16				1.60
Cumulative gap ratio			0.23				0.42				1.09				1.52				—				0.26				0.42				1.17				1.60
Gap as % of earning assets			(43	%)			9	%			40	%			28	%			34	%			(39	)%			6	%			44	%			27	%			38	%
Cumulative GAP as % of earning assets			(43	%)			(34	%)			6	%			34	%			—	%			(39	)%			(33	)%			11	%			38	%

 

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ItemItem 8 - Financial Statements and Supplementary Data

 

Index to Consolidated Financial Statements

 

 

 

	Page
Report of Independent Registered Public Accounting Firm	5046
Management’s Report on Internal Control Over Financial Reporting	5147
Consolidated Balance Sheets as of December 31, 20182019 and 20172018	5248
Consolidated Statements of Income for the years ended December 31, 2018, 20172019 and 20162018	5349
Consolidated Statements of Comprehensive Income for the years ended December 31, 2018, 20172019 and 20162018	5450
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2018, 20172019 and 20162018	5551
Consolidated Statements of Cash Flows for the years ended December 31, 2018, 20172019 and 20162018	5652
Notes to Consolidated Financial Statements	5954

 

 

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Report of Independent Registered Public Accounting Firm

 

TheTo the Board of Directors and Shareholders

Bank of Commerce Holdings

 

Opinions on the Financial Statements and Internal Control over Financial Reporting

 

We have audited the accompanying consolidated balance sheets of Bank of Commerce Holdings and subsidiaries (the “Company”) as of December 31, 20182019 and 2017,2018, the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the periodthen ended, December 31, 2018, and the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2018,2019, based on criteria established in Internal Control– Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 20182019 and 2017,2018, and the consolidated results of its operations and its cash flows for each of the three years in the periodthen ended, December 31, 2018, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018,2019, based on criteria established in Internal Control–Integrated Framework (2013) issued by COSO.

 

Basis for Opinions

 

The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on theCompany’sthe Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

 

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

Definition and Limitations of Internal Control Over Financial Reporting

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

 

/s/ Moss Adams LLP

Sacramento, California

March 12, 20196, 2020

We have served as the Company’s auditor since 2004.

 

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To the Shareholders:

 

Management’sManagement’s Report on Internal Control over Financial Reporting

 

Management of Bank of Commerce Holdings and its subsidiaries (“the Company”) is responsible for establishing and maintaining internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Company’s internal control system is designed to provide reasonable assurance to our management and Board of Directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that:

 

●	Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company’s assets;

●

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with the authorizations of management and directors of the Company; and

●	Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018.2019. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework (2013). Based on our assessment and those criteria, we believe that, as of December 31, 2018,2019, the Company maintained effective internal control over financial reporting.

 

The Company’s independent registered public accounting firm has audited the Company’s consolidated financial statements that are included in this annual report and the effectiveness of our internal control over financial reporting as of December 31, 20182019 and issued their Report of Independent Registered Public Accounting Firm, which appears on the previous page. The audit report expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018.2019.

 

 

/s/ Randall S. Eslick

Randall S. Eslick, President and Chief Executive Officer

/s/ James A. Sundquist

James A. Sundquist, EVP and Chief Financial Officer

 

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ConsolidatedConsolidated Balance Sheets

December 31, 20182019 and 20172018

 

(Amounts in thousands, except share information)		2018				2017				2019				2018
Assets:
Cash and due from banks		$	23,692			$	17,979			$	21,338			$	23,692
Interest-bearing deposits in other banks			23,673				48,991				59,266				23,673
Total cash and cash equivalents			47,365				66,970				80,604				47,365
Securities available-for-sale, at fair value			256,928				266,943				286,950				256,928
Loans, net of deferred fees and costs			948,178				881,545				1,035,065				948,178
Allowance for loan and lease losses			(12,292	)			(11,925	)			(12,231	)			(12,292	)
Net loans			935,886				869,620				1,022,834				935,886
Premises and equipment, net			13,119				14,748				15,906				13,119
Other real estate owned			31				35				35				31
Life insurance			22,410				21,898				23,701				22,410
Deferred tax asset, net			7,039				6,505				4,553				7,039
Goodwill and core deposit intangible, net			1,841				2,030
Goodwill											11,671				665
Other intangible assets, net											4,809				1,176
Other assets			22,485				20,672				28,553				22,485
Total assets		$	1,307,104			$	1,269,421			$	1,479,616			$	1,307,104
Liabilities and shareholders' equity:
Liabilities:
Demand - noninterest-bearing		$	347,199			$	305,650			$	432,680			$	347,199
Demand - interest-bearing			252,202				260,221				239,258				252,202
Money market accounts			265,093				236,769
Savings accounts			114,840				110,837
Money market											307,559				265,093
Savings											135,888				114,840
Certificates of deposit			152,382				189,255				151,786				152,382
Total deposits			1,131,716				1,102,732				1,267,171				1,131,716
Term debt:
Other borrowings			13,496				17,096				10,000				13,496
Less unamortized debt issuance costs			(91	)			(138	)			(43	)			(91	)
Net term debt			13,405				16,958				9,957				13,405
Junior subordinated debentures			10,310				10,310				10,310				10,310
Other liabilities			13,352				12,157				17,700				13,352
Total liabilities			1,168,783				1,142,157				1,305,138				1,168,783
Commitments and contingencies (Note 15)
Commitments and contingencies (Note 14)
Shareholders’ equity:
Common stock, no par value, 50,000,000 shares authorized; issued and outstanding - 16,333,502 as of December 31, 2018 and 16,271,563 as of December 31, 2017			52,284				51,830
Common stock, no par value, 50,000,000 shares authorized; issued and outstanding - 18,137,167 as of December 31, 2019 and 16,333,502 as of December 31, 2018											71,311				52,284
Retained earnings			89,045				75,700				100,566				89,045
Accumulated other comprehensive loss, net of tax			(3,008	)			(266	)
Accumulated other comprehensive income (loss), net of tax											2,601				(3,008	)
Total shareholders’ equity			138,321				127,264				174,478				138,321
Total liabilities and shareholders’ equity		$	1,307,104			$	1,269,421			$	1,479,616			$	1,307,104

 

See accompanying Notes to Consolidated Financial Statements.

 

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ConsolidatedConsolidated Statements of Income

For the years ended December 31, 2019 and2018

(Amounts in thousands, except per share information)		2019				2018
Interest income:
Interest and fees on loans		$	50,534			$	44,955
Interest on taxable securities			6,673				5,165
Interest on tax-exempt securities			1,244				1,629
Interest on interest-bearing deposits in other banks			1,112				952
Total interest income			59,563				52,701
Interest expense:
Interest on demand - interest-bearing			480				414
Interest on money market			1,599				646
Interest on savings			493				288
Interest on certificates of deposit			1,977				1,910
Interest on Federal Home Loan Bank of San Francisco borrowings			247				435
Interest on other borrowings			806				1,077
Interest on junior subordinated debentures			426				385
Total interest expense			6,028				5,155
Net interest income			53,535				47,546
Provision for loan and lease losses			—				—
Net interest income after provision for loan and lease losses			53,535				47,546
Noninterest income:
Service charges on deposit accounts			730				682
ATM and point of sale fees			1,158				1,131
Payroll and benefit processing fees			669				652
Life insurance			536				512
Gain on sale of investment securities, net			186				44
Federal Home Loan Bank of San Francisco dividends			507				480
Gain on sale of OREO			62				73
Other income			336				445
Total noninterest income			4,184				4,019
Noninterest expense:
Salaries and related benefits			20,804				18,709
Premises and equipment			3,752				3,983
Federal Deposit Insurance Corporation insurance premium			91				376
Data processing			2,535				1,997
Professional services			1,539				1,431
Telecommunications			737				594
Acquisition and merger			2,193				844
Other expenses			5,604				4,272
Total noninterest expense			37,255				32,206
Income before provision for income taxes			20,464				19,359
Provision for income taxes			5,503				3,629
Net income		$	14,961			$	15,730
Earnings per share - basic		$	0.83			$	0.97
Weighted average shares - basic			17,956				16,248
Earnings per share - diluted		$	0.83			$	0.96
Weighted average shares - diluted			18,024				16,332

See accompanying Notes to Consolidated Financial Statements.

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Consolidated Statements of Comprehensive Income

For the years ended December 31, 2019 and 2018

(Amounts in thousands)		2019				2018
Net income		$	14,961			$	15,730
Available-for-sale securities:
Changes in unrealized gain (loss) arising during the period			8,149				(3,774	)
Income taxes			(2,409	)			1,115
Change in unrealized gain (loss), net of tax			5,740				(2,659	)
Reclassification adjustment for realized gains included in net income			(186	)			(44	)
Income taxes			55				13
Realized gains, net of tax			(131	)			(31	)
Net change in unrealized gain (loss) on available-for-sale securities			5,609				(2,690	)
Other comprehensive income (loss)			5,609				(2,690	)
Comprehensive income – Bank of Commerce Holdings		$	20,570			$	13,040

See accompanying Notes to Consolidated Financial Statements.

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Consolidated Statements of Shareholders’ Equity

For the years ended December 31, 2018, 2017 and 201620192019

 

(Amounts in thousands, except per share information)		2018				2017				2016
Interest income:
Interest and fees on loans		$	44,955			$	39,112			$	35,435
Interest on taxable securities			5,165				3,921				2,986
Interest on tax-exempt securities			1,629				2,144				2,256
Interest on interest-bearing deposits in other banks			952				772				332
Total interest income			52,701				45,949				41,009
Interest expense:
Interest on demand - interest-bearing			414				274				201
Interest on money market accounts			646				470				322
Interest on savings accounts			288				200				174
Interest on certificates of deposit			1,910				2,188				2,179
Interest on Federal Home Loan Bank of San Francisco borrowings			435				3				484
Interest on other borrowings			1,077				1,165				1,183
Interest on junior subordinated debentures			385				287				235
Total interest expense			5,155				4,587				4,778
Net interest income			47,546				41,362				36,231
Provision for loan and lease losses			—				950				—
Net interest income after provision for loan and lease losses			47,546				40,412				36,231
Noninterest income:
Service charges on deposit accounts			682				542				413
ATM and point of sale fees			1,131				1,093				995
Fees on payroll and benefit processing			652				658				593
Life insurance			512				1,050				613
Gains on sale of investment securities, net			44				137				244
Impairment losses on investment securities			—				—				(546	)
Federal Home Loan Bank of San Francisco dividends			480				318				644
Gain (loss) on sale of OREO			73				368				(109	)
Insured cash sweep fees			—				197				3
Other income			445				461				636
Total noninterest income			4,019				4,824				3,486
Noninterest expense:
Salaries and related benefits			18,709				17,819				16,425
Premises and equipment			4,047				4,242				3,869
Federal Deposit Insurance Corporation insurance premium			376				318				615
Data processing fees			1,933				1,749				1,675
Professional service fees			1,431				1,398				1,690
Telecommunications			594				879				751
Acquisition costs			844				—				580
Loss on cancellation of interest rate swap			—				—				2,325
Other expenses			4,272				4,559				4,570
Total noninterest expense			32,206				30,964				32,500
Income before provision for income taxes			19,359				14,272				7,217
Provision for income taxes			3,629				6,928				1,958
Net income		$	15,730			$	7,344			$	5,259
Earnings per share - basic		$	0.97			$	0.48			$	0.39
Weighted average shares - basic			16,248				15,207				13,367
Earnings per share - diluted		$	0.96			$	0.48			$	0.39
Weighted average shares - diluted			16,332				15,310				13,425

														Accumulated Other
						Common								Comprehensive
		Common				Stock				Retained				Income (Loss)
(Amounts in thousands except per share information)		Shares				Amount				Earnings				Net of Tax				Total
Balance at December 31, 2017			16,272			$	51,830			$	75,700			$	(266	)		$	127,264
2018
Net income			—				—				15,730				—				15,730
Reclassification of accumulated other comprehensive income due to tax rate change			—				—				52				(52	)			—
Other comprehensive loss, net of tax			—				—				—				(2,690	)			(2,690	)
Comprehensive income			—				—				—				—				13,040
Dividends declared on common stock ($0.15 per share)			—				—				(2,437	)			—				(2,437	)
Stock compensation grants			5				45				—				—				45
Restricted stock granted, net			20				—				—				—				—
Stock options exercised			37				216				—				—				216
Compensation expense associated with stock options			—				8				—				—				8
Compensation expense associated with restricted stock, net of cash paid for shares surrendered for tax-withholding purposes			—				185				—				—				185
Balance at December 31, 2018			16,334			$	52,284			$	89,045			$	(3,008	)			138,321
2019
Net income			—				—				14,961				—				14,961
Other comprehensive income, net of tax			—				—				—				5,609				5,609
Comprehensive income			—				—				—				—				20,570
Dividends declared on common stock ($0.19 per share)			—				—				(3,440	)			—				(3,440	)
Stock issued for Merchants acquisition			1,834				19,607				—				—				19,607
Repurchase of common stock			(91	)			(1,010	)			—				—				(1,010	)
Stock compensation grants			6				58				—				—				58
Restricted stock granted, net			43				—				—				—				—
Stock options exercised			11				52				—				—				52
Compensation expense associated with restricted stock, net of cash paid for shares surrendered for tax-withholding purposes			—				320				—				—				320
Balance at December 31, 2019			18,137			$	71,311			$	100,566			$	2,601			$	174,478

 

See accompanying Notes to Consolidated Financial Statements.

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Consolidated Statements of Cash Flows

For the years ended December 31, 2019 and2018

(Amounts in thousands)		2019				2018
Cash flows from operating activities:
Net income		$	14,961			$	15,730
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for depreciation and amortization			1,367				1,738
Amortization of core deposit intangibles			720				221
Amortization of debt issuance costs			48				48
Compensation expense associated with stock options			—				8
Compensation expense associated with restricted stock			414				288
Tax benefits from vesting of restricted stock			(9	)			(46	)
Net gain on sale or call of securities			(186	)			(44	)
Amortization of premiums and accretion of discounts on investment securities, net			1,477				1,845
Amortization of premiums and accretion of discounts on acquired loans, net			(1,598	)			(355	)
Gain on sale of OREO			(62	)			(73	)
Increase in cash surrender value of life insurance			(536	)			(512	)
Deferred compensation and salary continuation plan payments			(1,507	)			(905	)
Increase in deferred compensation and salary continuation plans			1,853				972
Increase in deferred loan fees and costs			(235	)			(217	)
Decrease in deferred income taxes			154				595
Decrease in other assets			1,079				345
(Decrease) increase in other liabilities			(1,292	)			1,094
Net cash provided by operating activities			16,648				20,732
Cash flows from investing activities:
Proceeds from maturities and payments of available-for-sale securities			64,183				31,538
Proceeds from sale of available-for-sale securities			117,299				30,235
Purchases of available-for-sale securities			(97,741	)			(57,616	)
Investment in qualified affordable housing partnerships			(6	)			(38	)
Net purchase of Federal Home Loan Bank of San Francisco stock			(34	)			(1,355	)
Loan originations, net of principal repayments			(32,707	)			(57,690	)
Net repayment on (purchase of) purchased loans			32,796				(8,499	)
Purchase of premises and equipment			(1,958	)			(351	)
Proceeds from the sale of OREO			132				217
Acquisition of Merchants Holding Company, net of cash paid			(2,875	)			—
Net cash provided (used) by investing activities			79,089				(63,559	)
Cash flows from financing activities:
Net (decrease) increase in demand deposits, money market and savings		$	(16,162	)		$	65,857
Net decrease in certificates of deposit			(38,599	)			(36,873	)
Advances on term debt			180,160				230,160
Repayment of term debt			(183,656	)			(233,761	)
Proceeds from stock options exercised			52				216
Repurchase of common stock			(1,010	)			—
Cash paid for common stock surrendered for tax-withholding purposes			(94	)			(103	)
Cash dividends paid on common stock			(3,189	)			(2,274	)
Net cash (used in) provided by financing activities			(62,498	)			23,222
Net increase (decrease) cash and cash equivalents			33,239				(19,605	)
Cash and cash equivalents at the beginning of year			47,365				66,970
Cash and cash equivalents at the end of year		$	80,604			$	47,365

 

See accompanying Notes to Consolidated Financial Statements.

 

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Consolidated Statements of Comprehensive Income

For the years ended December 31, 20182017 and 2016

(Amounts in thousands)		2018				2017				2016
Net income		$	15,730			$	7,344			$	5,259
Available-for-sale securities:
Unrealized losses arising during the period			(3,774	)			(179	)			(3,286	)
Unrealized gains from securities transferred from held-to-maturity to available-for-sale			—				1,208				—
Income taxes			1,115				(423	)			1,353
Change in unrealized (losses) gains, net of tax			(2,659	)			606				(1,933	)
Reclassification adjustment for realized gains included in net income			(44	)			(137	)			(224	)
Income taxes			13				55				92
Realized gains, net of tax			(31	)			(82	)			(132	)
Reclassification adjustment for other-than-temporary impairment included in net income			—				—				546
Income taxes			—				—				(225	)
Realized impairment, net of tax			—				—				321
Net change in unrealized (losses) gains on available-for-sale securities			(2,690	)			524				(1,744	)
Held-to-maturity securities:
Accretion of held-to-maturity fair value adjustment from other comprehensive income to interest income			—				(56	)			(97	)
Income taxes			—				23				40
Net accretion of held-to-maturity fair value adjustment from other comprehensive income to interest income			—				(33	)			(57	)
Fair value adjustment for held-to-maturity securities transferred to available-for-sale			—				(167	)			—
Income taxes			—				69				—
Fair value adjustment for held-to-maturity securities transferred to available-for-sale			—				(98	)			—
Net change in fair value adjustment on held-to-maturity securities			—				(131	)			(57	)
Derivatives:
Unrealized losses arising during the period			—				—				(348	)
Income taxes			—				—				143
Change in unrealized losses, net of tax			—				—				(205	)
Reclassification adjustment for net losses on derivatives included in net income			—				—				2,721
Income taxes			—				—				(1,120	)
Reclassification adjustment for net losses on derivatives included in net income, net of tax			—				—				1,601
Net change in unrealized losses on derivatives			—				—				1,396
Other comprehensive (loss) income			(2,690	)			393				(405	)
Comprehensive income – Bank of Commerce Holdings		$	13,040			$	7,737			$	4,854

See accompanying Notes to Consolidated Financial Statements.

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Consolidated Statements of Shareholders’ Equity

For the years ended December 31, 2016, 2017 and 2018Cash Flows (Continued)

 

8

														Accumulated Other
						Common								Comprehensive
		Common				Stock				Retained				Income (Loss)
(Amounts in thousands except per share information)		Shares				Amount				Earnings				Net of Tax				Total
Balance at December 31, 2015			13,385			$	24,214			$	66,562			$	(254	)		$	90,522
2016
Net income			—				—				5,259				—				5,259
Other comprehensive loss, net of tax			—				—				—				(405	)			(405	)
Comprehensive income			—				—				—				—				4,854
Dividends declared on common stock ($0.12 per share)			—				—				(1,603	)			—				(1,603	)
Restricted stock granted, net			53				84				—				—				84
Stock options exercised			2				10				—				—				10
Compensation expense associated with stock options			—				24				—				—				24
Compensation expense associated with restricted stock, net of cash paid for shares surrendered for tax-withholding purposes			—				215				—				—				215
Balance at December 31, 2016			13,440			$	24,547			$	70,218			$	(659	)		$	94,106
2017
Net income			—				—				7,344				—				7,344
Other comprehensive loss, net of tax			—				—				—				393				393
Comprehensive income			—				—				—				—				7,737
Dividends declared on common stock ($0.12 per share)			—				—				(1,862	)			—				(1,862	)
Stock issued pursuant to public offering, net of underwriting discounts and expenses of $1.7 million			2,738				26,778				—				—				26,778
Stock compensation grants			5				41								—				41
Restricted stock granted, net			37				—				—				—				—
Stock options exercised			52				245				—				—				245
Compensation expense associated with stock options			—				23				—				—				23
Compensation expense associated with restricted stock, net of cash paid for shares surrendered for tax-withholding purposes			—				196				—				—				196
Balance at December 31, 2017			16,272			$	51,830			$	75,700			$	(266	)		$	127,264
2018
Net income			—				—				15,730				—				15,730
Reclassification of accumulated other comprehensive income due to tax rate change			—				—				52				(52	)			—
Other comprehensive loss, net of tax			—				—				—				(2,690	)			(2,690	)
Comprehensive income			—				—				—				—				13,040
Dividends declared on common stock ($0.15 per share)			—				—				(2,437	)			—				(2,437	)
Stock compensation grants			5				45				—				—				45
Restricted stock granted, net			20				—				—				—				—
Stock options exercised			37				216				—				—				216
Compensation expense associated with stock options			—				8				—				—				8
Compensation expense associated with restricted stock, net of cash paid for shares surrendered for tax-withholding purposes			—				185				—				—				185
Balance at December 31, 2018			16,334			$	52,284			$	89,045			$	(3,008	)		$	138,321

(Amounts in thousands)
Supplemental disclosures of cash flow activity:		2019				2018
Cash paid during the period for:
Income taxes		$	6,007			$	2,727
Interest		$	6,029			$	5,171
Operating leases		$	897			$	809
Supplemental disclosures of non cash investing activities:
Transfer of loans to other real estate owned		$	74			$	140
Unrealized gain (loss) on investment securities available-for-sale, net of gains included in net income		$	7,963			$	(3,818	)
Changes in net deferred tax asset related to changes in unrealized (gain) loss on investment securities available-for-sale			(2,354	)			1,128
Changes in accumulated other comprehensive income (loss) due to changes in unrealized (loss) gain on investment securities available-for-sale		$	5,609			$	(2,690	)
Reclassification of accumulated other comprehensive income due to tax rate change		$	—			$	52
Supplemental disclosures of non cash financing activities:
Stock issued under employee plans		$	58			$	45
Cash dividend declared on common stock and payable after period-end		$	902			$	651
Right-of-use lease asset recorded on new leases		$	267			$	—
Right-of-use lease asset recorded on adoption of ASU No. 2016-03		$	3,905			$	—
Lease liability recorded on adoption of ASU No. 2016-02		$	4,363			$	—
Transactions Related to Acquisition:
Assets acquired - fair value		$	215,055			$	—
Goodwill		$	11,006			$	—
Liabilities assumed - fair value		$	191,154			$	—

 

See accompanying Notes to Consolidated Financial Statements.

 

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Consolidated Statements of Cash Flows

For the years ended December 31, 2018, 2017 and 2016

(Amounts in thousands)		2018				2017				2016
Cash flows from operating activities:
Net income		$	15,730			$	7,344			$	5,259
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan and lease losses			—				950				—
Provision for depreciation and amortization			1,738				2,061				1,908
Amortization of core deposit intangible			221				221				185
Amortization of debt issuance costs			48				45				40
Compensation expense associated with stock options			8				23				24
Compensation expense associated with restricted stock			288				273				215
Tax benefits from vesting of restricted stock			(46	)			(53	)			—
Net gains on sale or call of securities			(44	)			(137	)			(244	)
Other-than-temporary impairment on investment securities			—				—				546
Amortization of investment premiums and accretion of discounts, net			1,845				2,031				1,715
Accretion of held-to-maturity fair value adjustments			—				(56	)			(97	)
Loss on cancellation of interest rate swap			—				—				2,325
Write-down of other real estate owned			—				52				66
(Gain) loss on sale of other real estate owned			(73	)			(368	)			109
Increase in cash surrender value of life insurance			(512	)			(548	)			(613	)
Life insurance death benefit			—				(502	)			—
Increase (decrease) in deferred compensation and salary continuation plans			67				18				(19	)
Increase in deferred loan fees and costs			(217	)			(386	)			(454	)
Decrease in deferred income taxes			595				271				132
Deferred tax asset write-down			—				2,490				363
(Increase) decrease in other assets			(10	)			863				118
Increase (decrease) in other liabilities			1,094				(961	)			306
Net cash provided by operating activities			20,732				13,631				11,884
Cash flows from investing activities:
Proceeds from maturities and payments of available-for-sale securities			31,538				23,551				31,685
Proceeds from sale of available-for-sale securities			30,235				64,349				51,025
Purchases of available-for-sale securities			(57,616	)			(150,888	)			(104,134	)
Proceeds from maturities and payments of held-to-maturity securities			—				1,098				4,963
Investment in Qualified Zone Academy Bonds			—				(1,000	)			(2,000	)
Investment in qualified affordable housing partnerships			(38	)			(124	)			(697	)
Net purchase of Federal Home Loan Bank of San Francisco stock			(1,355	)			(72	)			—
Loan originations, net of principal repayments			(57,690	)			(76,016	)			(105,892	)
Net (purchase of) repayment on purchased loans			(8,499	)			(1,158	)			18,666
Purchase of premises and equipment			(351	)			(584	)			(2,873	)
Proceeds from the sale of other real estate owned			217				2,111				636
Proceeds from life insurance policy			—				2,249				—
Payments to derivative counterparties for the termination of interest rate swaps			—				—				(2,578	)
Acquisition of branches, net of cash paid			—				—				142,411
Net cash (used) provided by investing activities			(63,559	)			(136,484	)			31,212

See accompanying Notes to Consolidated Financial Statements.

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Consolidated Statements of Cash Flows (Continued)

(Amounts in thousands)		2018				2017				2016
Cash flows from financing activities:
Net increase in demand deposits, money market accounts and savings accounts		$	65,857			$	124,201			$	84,722
Net decrease in certificates of deposit			(36,873	)			(26,135	)			(32,838	)
Advances on term debt			230,160				30,260				55,000
Repayment of term debt			(233,761	)			(32,080	)			(131,172	)
Proceeds from stock options exercised			216				245				10
Net proceeds from issuance of common stock			—				26,778				—
Cash paid for shares surrendered for tax-withholding purposes			(103	)			(77	)			—
Cash dividends paid on common stock			(2,274	)			(1,776	)			(1,603	)
Net cash provided by (used in) financing activities			23,222				121,416				(25,881	)
Net (decrease) increase cash and cash equivalents			(19,605	)			(1,437	)			17,215
Cash and cash equivalents at the beginning of year			66,970				68,407				51,192
Cash and cash equivalents at the end of year		$	47,365			$	66,970			$	68,407

See accompanying Notes to Consolidated Financial Statements.

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Consolidated Statements of Cash Flows (Continued)

(Amounts in thousands)		2018				2017				2016
Supplemental disclosures of cash flow activity:
Cash paid during the period for:
Income taxes		$	2,727			$	3,846			$	2,705
Interest		$	5,171			$	4,581			$	5,142
Supplemental disclosures of non cash investing activities:
Transfer of loans to other real estate owned		$	140			$	981			$	147
Changes in unrealized (loss) gain on investment securities available-for-sale		$	(3,818	)		$	892			$	(2,964	)
Changes in net deferred tax asset related to changes in unrealized loss (gain) on investment securities available-for-sale			1,128				(368	)			1,220
Changes in accumulated other comprehensive (loss) income due to changes in unrealized (loss) gain on investment securities available-for-sale		$	(2,690	)		$	524			$	(1,744	)
Accretion of held-to-maturity fair value adjustment from other comprehensive income to interest income		$	—			$	(56	)		$	(97	)
Changes in deferred tax related to accretion of held-to-maturity investment securities			—				23				—
Changes in accumulated other comprehensive income (loss) due to accretion of held-to-maturity investment securities			—				(33	)			(97	)
Fair value adjustment for held to maturities securities transferred to available-for-sale			—				(167	)			—
Changes in deferred tax related to transfer of held-to-maturity investment securities to available-for-sale			—				69				—
Net fair value adjustment for held-to-maturity securities transferred to available-for-sale			—				(98	)			—
Changes in accumulated other comprehensive income (loss) related held-to-maturity investment securities		$	—			$	(131	)		$	(97	)
Reclassification of accumulated other comprehensive income due to tax rate change		$	52			$	—				—
Changes in unrealized loss on derivatives		$	—			$	—			$	(348	)
Changes in net deferred tax asset related to changes in unrealized loss on derivatives			—				—				143
Changes in accumulated other comprehensive income (loss) due to changes in unrealized loss on derivatives		$	—			$	—			$	(205	)
Reclassification of losses on derivatives		$	—			$	—			$	2,721
Changes in net deferred tax asset related to reclassification of losses on derivatives			—				—				(1,120	)
Changes in accumulated other comprehensive income (loss) due to reclassification of losses on derivatives		$	—			$	—			$	1,601
Supplemental disclosures of non cash financing activities:
Vested and granted restricted stock issued under employee plans		$	—			$	—			$	84
Stock issued under employee plans		$	45			$	41			$	—
Transfer of investment securities from HTM to AFS		$	—			$	30,330			$	—
Cash dividend declared on common stock and payable after period-end		$	651			$	486			$	401
Transactions Related to Acquisition:
Assets acquired - fair value		$	—			$	—			$	155,230
Goodwill		$	—			$	—			$	665
Liabilities assumed - fair value		$	—			$	—			$	149,239

See accompanying Notes to Consolidated Financial Statements.

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Notes to Consolidated Financial Statements

Notes to Consolidated Financial Statements

 

 

NOTE 1. THE BUSINESS OF THE COMPANY

 

Bank of Commerce Holdings (“Company,” “Holding Company,” “we,” or “us”), is a corporation organized under the laws of California and a bank holding company (“BHC”) registered under the Bank Holding Company Act of 1956, as amended (“BHC Act”) with its principal offices in Sacramento, California. The Holding Company’s principal business is to serve as a holding company for ReddingMerchants Bank of Commerce (the “Bank” and together with the Holding Company, the “Company”) which operates under three separate names (Redding Bank of Commerce, Sacramento Bank of Commerce, a division of Redding Bank of Commerce and The Merchants Bank of Sacramento, a division of Redding Bank of Commerce) and for Bank of Commerce Mortgage (inactive). The Bank, which previously operated under three separate names, changed its name for all operations to Merchants Bank of Commerce effective May 20, 2019. The Company has an unconsolidated subsidiary in Bank of Commerce Holdings Trust II. The Bank is principally supervised and regulated by the California Department of Business Oversight (“CDBO”) and the Federal Deposit Insurance Corporation (“FDIC”). Substantially all of the Company’s activities are carried out through the Bank. The Bank was incorporated as a California banking corporation on November 25, 1981 and opened for business on October 22, 1982.

 

We operate ten full service offices and one limited service office and consider northern California to be our major market. We also operate a “cyber office” as identified in our summary of deposits reporting filed with the FDIC. The services offered by the Bank include those traditionally offered by banks of similar size and character in California. Our principal deposit products include the following types of accounts; checking, interest-bearing checking, savings, money market deposits and certificates of deposit. We also offer sweep arrangements, commercial loans, construction loans, consumer loans, safe deposit boxes, collection services and electronic banking services. The primary focus of the Bank is to provide banking services to the communities in our major market area, including Small Business Administration loans and payroll processing. The Bank does not offer trust services or international banking services. Our customers are mostly retail customers and small to medium sized businesses.businesses and retail customers.

 

On January 31, 2019, we completed the acquisition of Merchants Holding Company (“Merchants”), to extend our presence in the Sacramento marketplace. Merchants, headquartered in Sacramento, California, was the parent company of The Merchants National Bank of Sacramento (“Merchants Bank”), a 97-year-old bank with approximately $211.7 million in assets as of January 31, 2019. Merchants Bank operated one full service branch and one limited service branch in the Sacramento metropolitan area. See Note 2321 Acquisition in these Notes to Consolidated Financial Statements for additional information on the acquisition.

 

 

 

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Application of new accounting guidance

ASU No. 2016-02

In February of 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This update was issued to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements on a retrospective basis. The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. All leases create an asset and a liability for the lessee in accordance with FASB Concepts Statement No. 6, Elements of Financial Statements, and, therefore, recognition of those lease assets and lease liabilities represents an improvement over previous GAAP, which did not require lease assets and lease liabilities to be recognized for most leases.

Methods and timing of adoption – For public companies, the amendments in this update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. In July of 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842). The standard contained improvements to ASU No. 2016-02 that permitted presentation on a prospective basis.

Financial statement impact – We implemented the new leasing standard on January 1, 2019 on a prospective basis and recorded a new lease asset and related lease liability of approximately $4.4 million related to our current operating leases. The right-of-use asset was also reduced by $458 thousand for amounts recognized previously as part of the single lease cost.

We determine if an arrangement is a lease at inception. Operating leases are included in Other Assetsand Other Liabilitiesin our Consolidated BalanceSheets. Operating lease right-of-use assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most of our leases do not provide an incremental borrowing rate, we use the borrowing rates for terms similar to the lease terms available under our existing line of credit with the Federal Home Loan Bank of San Francisco as our incremental borrowing rate in determining the present value of future payments. Our lease terms may include options to extend or terminate the lease which we recognize when it is reasonably certain that we will exercise that option. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.

Recent Accounting Pronouncement

ASU No. 2016-13

Description - In June of 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments are intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates.

Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances.

The ASU requires enhanced disclosures to help investors and other financial statement users to better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. In addition, the ASU amends the accounting guidance for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.

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Notes to Consolidated Financial Statements

Methods and timing of adoption – The FASB has voted to delay until January 2023 the implementation of the ASU No. 2016-13 for smaller reporting companies as defined by the SEC. The FASB affirmed that the one-time determination of whether an entity is eligible to be an smaller reporting company will be based on an entity’s most recent assessment in accordance with SEC regulations as of the date that a final update on effective dates is issued (for example, November 20, 2019). We qualify as a smaller reporting company and in light of this very recent delay, management has not yet determined when to implement the new ASU or the expected financial impact.

Basis of Financial Statement Presentation

 

The Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and with prevailing practices within the banking and securities industries. In preparing such financial statements, management is required to make certain estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the balance sheet and the reported amounts of revenues and expenses for the reporting periods. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change relate to the valuation of investments and impairments of securities, the determination of the allowance for loan and lease losses (“ALLL”), income taxes, the valuation of other real estate owned (“OREO”), and fair value measurements. Certain amounts for prior periods have been reclassified to conform to the current financial statement presentation. The results of reclassifications are not considered material and have no effect on previously reported equity or net income.

 

Principles of Consolidation

 

The accompanying Consolidated Financial Statements include the accounts of the Holding Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. As of December 31, 20182019 and 2017,2018, the Company had one wholly-owned trust formed in 2005 to issue trust preferred securities and related common securities. We have not consolidated the accounts of the Trust in our Consolidated Financial Statements in accordance with Financial Accounting Standards Board Accounting Standards Codification (“FASB”) ASC 810, Consolidation (“ASC 810”). We are not considered the primary beneficiary of the Trust (variable interest entity). As a result, the junior subordinated debentures issued by the Holding Company to the Trust are reflected on the Company’s Consolidated Balance Sheets.

 

Application of new accounting guidance

ASU No. 2014-09

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This ASU will replace most existing revenue recognition guidance in GAAP when it becomes effective. ASU 2014-09 was initially effective for the Company's reporting period beginning on January 1, 2017. However, in August of 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers - Deferral of the Effective Date, which defers the effective date by one year. For financial reporting purposes, the standard allows for either a full retrospective or modified retrospective adoption. The FASB has also issued additional updates to provide further clarification to specific implementation issues associated with ASU 2014-09. These updates include ASU 2016-08, Principal versus Agent Considerations, ASU 2016-10, Identifying Performance Obligations and Licensing, ASU 2016-12, Narrow-Scope Improvements and Practical Expedients, and ASU 2016-20, Technical Corrections and Improvements to Topic 606. We adopted the standard on January 1, 2018, using the modified retrospective method, which resulted in no cumulative effect and no other adjustment or significant impact to the timing of revenue recognition.

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Notes to Consolidated Financial Statements

Under Topic 606, we must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) we satisfy the performance obligations.

Our primary sources of revenue are derived from interest and dividends earned on loans, investment securities, and other financial instruments that are not within the scope of Topic 606. We have evaluated the nature of our contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary. For revenue sources that are within the scope of Topic 606, we fully satisfy our performance obligations and recognize revenue in the period it is earned as services are rendered. Transaction prices are typically fixed; charged on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with our customers.

All of our revenue from contracts with customers in the scope of ASC 606 is recognized in Non-Interest Income. Sources of revenue from contracts with customers that are in the scope of ASC 606 include the following:

●

Service Charges on Deposit accounts - We earn monthly account fees and transaction-based fees from our customers for services rendered on deposit accounts. Fees charged to deposit accounts on a monthly basis are recognized as the performance obligation is satisfied at the end of the service period.

●

Transaction-based fees are based on specific services provided to our customer. The performance obligation is completed as the transaction occurs and the fees are recognized at the time each specific service is provided to the customer.

●

ATM and Point of Sale fees – We earn fees when debit cards we issued are used in transactions through card processing networks. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the cardholders’ account. The fees are recognized monthly.

●

Fees on Payroll and benefit processing – We earn fees by processing payroll and benefit payments for our business customers. The performance obligation is satisfied and the fees are recognized as each transaction is processed charged to the customer account.

ASU No. 2016-01

In January of 2016, the FASB issued ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The new guidance is intended to improve the recognition and measurement of financial instruments. This ASU requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. In addition, the amendment requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes and requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements. This ASU also eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The amendment also requires a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument specific credit risk (also referred to as "own credit") when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. We adopted the standard on January 1, 2018. Adoption of the standard resulted in the use of an exit price rather than an entrance price to determine the fair value of loans not measured at fair value on a non-recurring basis in the consolidated balance sheets. See Note 20 – Fair Values for further information regarding the valuation of these loans.

ASU No. 2018-02

In February of 2018, FASB issued ASU 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220). The amendments in this update allow a reclassification from retained earnings to accumulated other comprehensive income for stranded tax effects resulting from the Tax Cuts and Jobs Act. However, because the amendments only relate to the reclassification of the income tax effects of the Tax Cuts and Jobs Act, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected. The amendments in this update are effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption of the amendments in this update is permitted, including adoption in any interim period. The amendments in this update should be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. We elected the early adoption of ASU 2018-02 as of January 1, 2018 and reclassified $52 thousand from accumulated other comprehensive income to retained earnings.

Subsequent Events

 

We have evaluated events and transactions subsequent to December 31, 20182019 for potential recognition or disclosure. See Note 23 Acquisition in these Notes to Consolidated Financial Statements in this document for further details on the acquisition of Merchants Holding Company completed on January 31, 2019.

 

Cash and Cash Equivalents

 

For purposes of reporting cash flows, cash and cash equivalents include amounts due from correspondent banks including interest-bearing deposits in correspondent banks and the Federal Reserve Bank.

 

Investment Securities

 

Securities are classified as held-to-maturity if we have both the intent and ability to hold those securities to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted for amortization of premium and accretion of discount, computed by the effective interest method over their contractual lives. Unrealized holding gains or losses are excluded from other comprehensive income (loss). Realized gains or losses, determined on the basis of the cost of specific securities sold or called, are included in earnings. Dividend and interest income are recognized when earned.

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Notes to Consolidated Financial Statements

 

Securities are classified as available-for-sale if we intend and have the ability to hold those securities for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available-for-sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Securities available-for-sale are carried at fair value. Unrealized holding gains or losses are included in other comprehensive income (loss) as a separate component of shareholders’ equity, net of tax. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings. Premiums and discounts are amortized or accreted over the estimated life of the related investment security as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned.

 

Transfers of securities from available-for-sale to held-to-maturity are accounted for at fair value as of the date of the transfer. The difference between the fair value and the amortized cost at the date of transfer is considered a premium or discount and is accounted for accordingly. Any unrealized gain or loss at the date of the transfer is reported in other comprehensive income (loss), and is amortized over the estimated remaining life of the security as an adjustment of yield in a manner consistent with the amortization of any premium or discount, and will offset or mitigate the effect on interest income of the amortization of the premium or discount for that held-to-maturity security. Transfers of securities from held-to-maturity to available-for-sale to are accounted for at fair value at the date of the reclassification. Any remaining unamortized fair value adjustments are reclassified from other comprehensive income (loss) and the unrealized holding gain (loss) at the date of transfer is recorded in other comprehensive income net of tax.

 

We review investment securities on an ongoing basis for the presence of other-than-temporary impairment or permanent impairment, taking into consideration current market conditions, fair value in relationship to cost, extent and nature of the change in fair value, issuer rating changes and trends, whether we intend to sell a security or if it is more likely than not that we will be required to sell the security before recovery of our amortized cost basis of the investment, which may be maturity, and other factors. For debt securities, if we intend to sell the security or it is more likely than not we will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an other-than-temporary impairment. If we do not intend to sell the security and it is more likely than not we will not be required to sell the security but we do not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential other-than-temporary impairment. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income (loss). Impairment losses related to all other factors are presented as separate categories within other comprehensive income (loss). For investment securities held-to-maturity, this amount is accreted over the remaining life of the debt security prospectively based on the amount and timing of future estimated cash flows. The accretion of the other-than-temporary impairment amount recorded in other comprehensive income (loss) will increase the carrying value of the investment, and would not affect earnings. If there is an indication of additional credit losses the security is re-evaluated according to the procedures described above.

 

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Notes to Consolidated Financial Statements

Loans

 

Loans are stated at the principal amounts outstanding, net of deferred loan fees, deferred loan costs, and the ALLL. Interest on loans is accrued daily based on the principal outstanding. Loan origination and commitment fees and certain origination costs are deferred and the net amount is amortized or accreted over the contractual life of the loans as an adjustment of their yield.

 

A loan is impaired when, based on current information and events, management believes it is probable that we will not be able to collect all amounts due according to the original contractual terms of the loan agreement.contract. Impairment is measured based upon the present value of expected future cash flows discounted at the loan’s effective rate, the loan’s observable market price, or the fair value of collateral if the loan is collateral dependent. Interest on impaired loans is recognized on a cash basis, and only when the principal is not considered impaired. The CCO reviews and approves loans recommended for impaired status or their removal from impaired status.

 

Our practice is to place an asset onin nonaccrual status when one of the following events occurs: (1) any installment of principal or interest is 90 days or more past due (unless in management’s opinion the loan is well-secured and in the process of collection), (2) management determines the ultimate collection of the original principal or interest to be unlikely or, (3) the terms of the loan have been renegotiated due to a serious weakening of the borrower’s financial condition. Accruals are resumed on loans only when they are brought fully current with respect to interest and principal and when the loan is estimated to be fully collectible. One exception to the 90 days past due policy for nonaccruals is our purchased pool of home equity loans and purchased consumer loans. For these specific loan pools, we will charge-off any loans that goare more than 90 days past due. We believe that at the time these loans become 90 days past due, it is likely that we will not collect the remaining principal balance on the loan. In accordance with this policy, we do not expect to classify any of the loans from these pools as nonaccrual.

 

Nonperforming loans are loans which may be on nonaccrual, 90 days past due and still accruing, or have been restructured.

 

Restructured loans are those loans where concessions in terms have been granted because of the borrower’s financial or legal difficulties. Interest is generally accrued on such loans in accordance with the new terms, after a period of sustained performance by the borrower.

 

Purchased Loans

 

Purchased loans are recorded at their fair value at the acquisition date. Credit discounts are included in the determination of fair value; therefore, an ALLL is not recorded at the acquisition date.

 

Allowance for Loan and Lease Losses

 

The adequacy of the ALLL is monitored on a regular basis and is based on management’s evaluation of numerous factors. These factors include the quality of the current loan portfolio; the trend in the loan portfolio’s risk ratings; current economic conditions; loan concentrations; loan growth rates; past-due and non-performing trends; evaluation of specific loss estimates for all impaired loans; historical charge-off and recovery experience; and other pertinent information.

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Notes to Consolidated Financial Statements

 

We perform regular credit reviews of the loan portfolio to determine the credit quality of the portfolio and the adherence to underwriting standards. When loans are originated, they are assigned a risk rating that is reassessed periodically during the term of the loan through the credit review process. Our risk rating methodology assigns risk ratings ranging from 1 to 8, where a higher rating represents higher risk. The 8 risk rating categories are a primary factor in determining an appropriate amount for the ALLL. Our Chief Credit Officer (CCO) is responsible for regularly reviewing the ALLL methodology, including loss factors, and ensuring that it is designed and applied in accordance with generally accepted accounting principles. The Board of Directors reviews and approves the adequacy of the ALLL quarterly.

 

We have divided the loan portfolio into sub-categories of similar type loans. Each category is assigned an historical loss factor and additional qualitative factors. The sub-categories are also further segmented by risk rating. Each risk rating is assigned an additional loss factor to account for the additional risk in those loans with higher risk levels.

 

Regular credit reviews of the portfolio also identify loans that are considered potentially impaired. Potentially impaired loans are referred to the CCO who reviews and approves designated loans as impaired. A loan is considered impaired when, based on current information and events, we determine that it is probable that we will not be able to collect all amounts due according to the original loan contract, including scheduled interest payments. When we identify a loan as impaired, we measure the impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of the collateral, less selling costs, instead of discounted cash flows. If we determine that the value of the impaired loan is less than the recorded investment in the loan when using the cash flow method, we recognize this impairment reserve as a specific component to be provided for in the ALLL. If the value of the impaired loan is less than the recorded investment in the loan when using the collateral dependent method, we charge-off the impaired balance. The combination of the risk rating-based allowance component and the impairment reserve allowance component leads to an allocated ALLL.

 

We may also maintain an unallocated allowance amount to provide for other credit losses inherent in a loan and lease portfolio that may not have been contemplated in the credit loss factors. This unallocated amount generally comprises less than 4% of the allowance, but may be maintained at higher levels during times of economic conditions characterized by unstable real estate values. The unallocated amount is reviewed quarterly based on trends in credit losses, the results of credit reviews and overall economic trends.

 

As adjustments to the ALLL become necessary, they are reported in earnings in the periods in which they become known as a charge or credit to the provision for loan and lease losses. Loans, or portions thereof, deemed uncollectible are charged to the ALLL. Recoveries on loans previously charged-off, are added to the ALLL.

 

We believe that the ALLL was adequate as of December 31, 2018.2019. There is, however, no assurance that future loan and lease losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses. In addition, bank regulatory authorities, as part of their periodic examination of the Company, may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review. Approximately 81%83% of our loan portfolio is secured by real estate, and a significant decline in real estate market values may require an increase in the ALLL.

 

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Notes to Consolidated Financial Statements

Reserve for Unfunded Commitments

 

A reserve for unfunded commitments is maintained at a level that, in our opinion, is adequate to absorb probable losses associated with our commitment to lend funds under existing agreements such as letters or lines of credit. We determine the adequacy of the reserve for unfunded commitments based upon the category of loan, current economic conditions, the risk characteristics of the various categories of commitments and other relevant factors. The reserve is based on estimates, and ultimate losses may vary from the current estimates.

 

These estimates are evaluated on a regular basis and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. Draws on unfunded commitments that are considered uncollectible at the time funds are advanced are charged to the reserve for unfunded commitments. Provisions for unfunded commitment losses, and recoveries on loan and lease commitments previously charged off, are added to the reserve for unfunded commitments, which is included in the Other Liabilities line item of the Consolidated Balance Sheets. See Note 15,14, Commitments and Contingencies in these Notes to Consolidated Financial Statements for additional disclosures on the reserve for unfunded commitments.

 

Premises and Equipment

 

Premises and equipment are recorded at cost. Depreciation for equipment is provided over the estimated useful lives of the related assets, generally three to seven years, using the straight-line method for financial statement purposes. Depreciation for premises is provided over the estimated useful life up to 39 years, on a straight-line basis. We use other depreciation methods (generally accelerated depreciation methods) for tax purposes where appropriate. Amortization of leasehold improvements is computed using the straight-line method over the shorter of the remaining lease term or the estimated useful lives of the improvements. Repairs and maintenance are expensed as incurred. Expenditures that increase the value or productive capacity of assets are capitalized. When premises and equipment are retired, sold, or otherwise disposed of, the asset’s carrying amount and related accumulated depreciation are removed from the accounts and any gain or loss is recorded in other noninterest income or other noninterest expense in the Consolidated Statements of Income, respectively.

 

Goodwill and Other Intangibles

 

Intangible assets are comprised of goodwill and other intangibles acquired in business combinations. Goodwill and intangible assets with indefinite useful lives are not amortized. Intangible assets with definite useful lives are amortized to their estimated residual values over their respective estimated useful lives, and also reviewed for impairment. Amortization of intangible assets is included in non-interest expense in the Consolidated Statements of Income. We perform a goodwillan impairment analysis on an annual basis.basis for goodwill and other intangible assets. Additionally, we perform a goodwillan impairment evaluationanalysis on an interim basis when events or circumstances indicate impairment potentially exists.

 

Other Real Estate Owned (‘OREO”)

 

OREO Represents real estate of which we have taken control in partial or full satisfaction of loans. At the time of foreclosure, OREO is recorded at fair value less costs to sell, plus costs for improvements that prepare the property for sale, which becomes the property’s new basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the ALLL. After foreclosure, management periodically performs valuations and the property is carried at the lower of the cost or fair value less expected selling costs. Subsequent valuation adjustments are recognized under the line item other expenses in the Consolidated Statements of Income. Revenue and expenses incurred from OREO property are recorded in noninterest income or noninterest expense, in the Consolidated Statements of Income, respectively.

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Notes to Consolidated Financial Statements

 

Income Taxes

 

Income taxes reported in the Consolidated Financial Statements are computed based on an asset and liability approach. We recognize the amount of taxes payable or refundable for the current year, and deferred tax assets and liabilities for the expected future tax consequences. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We record net deferred tax assets to the extent it is more likely than not that they will be realized. In evaluating our ability to recover the deferred tax assets, management considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations.

 

In projecting future taxable income, management develops assumptions including the amount of future state and federal pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates being used to manage the underlying business. We file consolidated federal and combined state income tax returns.

 

We recognize the financial statement effect of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. For tax positions that meet the more likely than not threshold, we may recognize only the largest amount of tax benefit that is greater than fifty percent likely to be realized upon ultimate settlement with the taxing authority. We believe that all of our tax positions taken meet the more likely than not recognition threshold. To the extent tax authorities disagree with these tax positions, our effective tax rates could be materially affected in the period of settlement with the taxing authorities.Interest and penalties related to unrecognized tax benefits are recorded in other noninterest expense.

See Note 21,19, Income Taxes in these Notes to Consolidated Financial Statements for more information on income taxes. Interest and penalties related to unrecognized tax benefits are recorded in other noninterest expense. 

 

Business CombinationsRevenue Recognition

 

Our primary sources of revenue are derived from interest and dividends earned on loans, investment securities, and other financial instruments that are not within the scope of Topic 606 (Revenue from Contracts with Customers). We record acquisitionshave evaluated the nature of businesses usingour contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the acquisition methodConsolidated Statements of accounting. UnderIncome was not necessary. For revenue sources that are within the acquisition method, assets acquiredscope of Topic 606, we fully satisfy our performance obligations and liabilities assumedrecognize revenue in the period it is earned as services are recorded at their estimated fair values atrendered. Transaction prices are typically fixed; charged on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the date of acquisition. Management utilizes various valuation techniques and third party evaluations to determine these fair values. Any excesstransaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the purchase price over amounts allocated to the acquired assets including identifiable intangible assetsamount and liabilities assumed is recorded as goodwill.timing of revenue from contracts with our customers.

 

Derivative Financial Instruments and Hedging Activities

Prior to March

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Table of 2016, we used derivatives to hedge the risk of changes in market interest rates to limit the impact on earnings and cash flows relating to specific groups of assets and liabilities. All of our derivative instruments were designated in qualifying hedge accounting relationships. In accordance with applicable accounting standards, all derivative financial instruments, whether designated for hedge accounting or not, are required to be recorded on the Consolidated Balance Sheets as assets or liabilities and measured at fair value. Additionally, we generally reported derivative financial instruments on a gross basis. However, in certain instances we reported our position on a net basis where we had asset and liability derivative positions with a single counterparty, we had a legally enforceable right of offset, and we intended to settle the position on a net basis. For additional detail on derivative instruments and hedging activities, refer to Note 19, Derivatives in these Contents

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

Notes to Consolidated Financial Statements.

All of our revenue from contracts with customers in the scope of ASC 606 is recognized in Non-Interest Income. Sources of revenue from contracts with customers that are in the scope of ASC 606 include the following:

●	Service Charges on Deposit accounts - We earn monthly account fees and transaction-based fees from our customers for services rendered on deposit accounts. Fees charged to deposit accounts on a monthly basis are recognized as the performance obligation is satisfied at the end of the service period.

●	Transaction-based fees are based on specific services provided to our customer. The performance obligation is completed as the transaction occurs and the fees are recognized at the time each specific service is provided to the customer.

●	ATM and Point of Sale fees – We earn fees when debit cards we issued are used in transactions through card processing networks. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the cardholders’ account. The fees are recognized monthly.

●	Fees on Payroll and benefit processing – We earn fees by processing payroll and benefit payments for our business customers. The performance obligation is satisfied and the fees are recognized as each transaction is processed.

Share Based Payments

 

AtWe have one active stock-based compensation plan that provides for equity awards including stock, stock options, restricted stock units and restricted stock to eligible employees and directors. The Bank of Commerce Holdings 2019 Equity Incentive Plan, was approved by the inception of a hedging relationship, we designate each qualifying derivative financial instrument as either a hedge ofHolding Company’s shareholders on May 21, 2019 and replaced the fair value of a specifically identified asset or liability (fair value hedge) or; as a hedge of the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge). We formally document all relationships between hedging instrumentsAmended and hedged items and risk management objectives for undertaking various hedge transactions. Both at the hedge’s inception and on an ongoing basis, we formally assess whether the derivatives that are used in hedging relationships are highly effective in offsetting changes in fair values or cash flows of hedged items.Restated 2010 Equity Incentive Plan.

 

Changes in the fair value of derivative financial instruments that are designated and qualify as fair value hedges alongIn accordance with the gain or loss on the hedged asset or liability attributable to the hedged risk, are recorded in the current period earnings. For qualifying cash flow hedges, the effective portion of the change in the fair value of the derivative financial instruments is recorded in accumulated other comprehensive income (loss), as a component of equity, and recognizedFASB ASC 718, Stock Compensation, we recognize in the Consolidated Statements of Income when the hedged cash flows affect earnings.grant-date fair value of stock, stock options, restricted stock and other equity-based forms of compensation issued to employees over the employees’ requisite service period. We account for forfeitures as they occur.

 

The hedge accounting treatment described herein is no longer applied if a derivative financial instrument is terminated or the hedge designation is removed or is assessed to be no longer highly effective. For these terminated fair value hedges, any changesof each option grant is estimated as of the grant date using the Black-Scholes option-pricing model using the following assumptions:

●	Volatility represents the historical volatility in the Holding Company’s common stock price, for a period consistent with the expected life of the option.

●	Risk free rate was derived from the U.S. Treasury rate at the time of the grant, which coincides with the expected life of the option.

●	Expected dividend yield is based on dividend trends and the market value of the Holding Company’s common stock at the time of grant.

●	Annual dividend rate is the ratio of the expected annual dividends to the Holding Company’s common stock price on the grant date.

●	Assumed forfeiture rate based on expected forfeiture rates.

●	Expected life is estimated based on the history of the Holding Company’s stock option holders and expectations regarding future forfeitures giving consideration to the contractual terms and vesting schedules, and represents the period of time that options granted are expected to be outstanding.

The fair value of stock grants and restricted stock grants are estimated as of the grant date using the fair value of the Company’s stock at the date of the grant.

Advertising Costs

For the years ended December 31, 2019 and 2018, advertising costs were $160 thousand and $47 thousand, respectively. Advertising costs are expensed as incurred.

Earnings per Share

Earnings per share is an important measure of our performance for investors and other users of financial statements. Certain of our securities, such as stock options or restricted stock, permit the holders to become common shareholders or add to the hedgednumber of shares of common stock already held. Because there is potential reduction, called dilution, of earnings per share figures inherent in our capital structure, we are required to present a dual presentation of earnings per share - basic earnings per share and diluted earnings per share.

Basic earnings per share excludes dilution and is computed by dividing income by the weighted-average number of common shares outstanding for the period, excluding unvested restricted stock awards which do not have voting rights or share in dividends. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Holding Company. The computation of diluted earnings per share does not assume conversion, exercise, or contingent issuance of securities that would have an anti-dilutive effect on earnings per share.

We present both basic and diluted earnings per share on the face of the Consolidated Statements of Income. In addition, a detailed presentation of the earnings per share calculation is provided in Note 22, Earnings Per Common Share in these Notes to Consolidated Financial Statements.

Fair Value Measurements

FASB ASC 820, Fair Value Measurements and Disclosures, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FASB ASC 820 establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect our estimates about market data. In general, fair values determined by Level 1 inputs utilize quoted prices for identical assets or liabilities traded in active markets that we have the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, remaineither directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as part of the basis ofinterest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and are recognized into income over the remaining life ofinclude situations where there is little, if any, market activity for the asset or liability. For terminated cash flow hedges, unless it is probable thatIn certain cases, the forecasted cash flows will not occur within a specified period, any changes ininputs used to measure fair value may fall into different levels of the derivative financial instrument previously recognized remain in other comprehensive income, as a component of equity, and are reclassified into earningsfair value hierarchy. In such cases, the level in the same periodfair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the hedged cash flows affect earnings.fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

 

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BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

Notes to Consolidated Financial Statements

Operating Segments

 

Public enterprises are required to report certain information about their operating segments in a complete set of financial statements to shareholders. They are also required to report certain enterprise-wide information about their products and services, their activities in different geographic areas, and their reliance on major customers. The basis for determining operating segments is the manner in which management operates the business. As of December 31, 2018,2019, we operated under one primary business segment: Community Banking.

 

Share Based PaymentsBusiness Combinations

 

We have one active stock-based compensation plan that provides for equity awards including stock, stock options, restricted stock units and restricted stock to eligible employees and directors. The 2008 Stock Option Plan was approved by the Holding Company’s shareholders on May 15, 2007 (“the Plan”). The Plan was amended and restated by the 2010 Equity Incentive Plan which was approved by the Holding Company’s shareholders on May 18, 2010. A further amendment and restatementrecord acquisitions of the Plan was approved by the Holding Company’s shareholders on May 15, 2012.

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Notes to Consolidated Financial Statements

In accordance with FASB ASC 718, Stock Compensation, we recognize in the Consolidated Statements of Income the grant-date fair value of stock, stock options, restricted stock and other equity-based forms of compensation issued to employees over the employees’ requisite service period. We account for forfeitures as they occur. 

The fair value of each option grant is estimated as of the grant datebusinesses using the Black-Scholes option-pricing model usingacquisition method of accounting. Under the following assumptions:

●	Volatility represents the historical volatility in the Holding Company’s common stock price, for a period consistent with the expected life of the option.

●	Risk free rate was derived from the U.S. Treasury rate at the time of the grant, which coincides with the expected life of the option.

●	Expected dividend yield is based on dividend trends and the market value of the Holding Company’s common stock at the time of grant.

●	Annual dividend rate is the ratio of the expected annual dividends to the Holding Company’s common stock price on the grant date.

●	Assumed forfeiture rate based on expected forfeiture rates.

●

Expected life isacquisition method, assets acquired and liabilities assumed are recorded at their estimated based on the history of the Holding Company’s stock option holders and expectations regarding future forfeitures giving consideration to the contractual terms and vesting schedules, and represents the period of time that options granted are expected to be outstanding.

The fair value of each stock grant and restricted stock grant is estimated as of the grant date using the fair value of the Company’s stockvalues at the date of acquisition. Management utilizes various valuation techniques and third party evaluations to determine these fair values. Any excess of the grant.

Earnings per Share

Earnings per share is an important measure of our performance for investors and other users of financial statements. Certain of our securities, such as stock options or restricted stock, permit the holders to become common shareholders or addpurchase price over amounts allocated to the number of shares of common stock already held. Because there is potential reduction, called dilution, of earnings per share figures inherent in our capital structure, we are required to present a dual presentation of earnings per share - basic earnings per share and diluted earnings per share.

Basic earnings per share excludes dilution and is computed by dividing income by the weighted-average number of common shares outstanding for the period, excluding unvested restricted stock awards which do not have voting rights or share in dividends. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Holding Company. The computation of diluted earnings per share does not assume conversion, exercise, or contingent issuance of securities that would have an anti-dilutive effect on earnings per share.

We present both basic and diluted earnings per share on the face of the Consolidated Statements of Income. In addition, a detailed presentation of the earnings per share calculation is provided in Note 24, Earnings Per Common Share in these Notes to Consolidated Financial Statements.

Advertising Costs

For the years ended December 31, 2018, 2017, and 2016, advertising costs were $47 thousand, $61 thousand, and $171 thousand, respectively. Advertising costs are expensed as incurred.

Fair Value Measurements

FASB ASC 820, Fair Value Measurements and Disclosures, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FASB ASC 820 establishes a three-level hierarchy for disclosure ofacquired assets including identifiable intangible assets and liabilities assumed is recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect our estimates about market data. In general, fair values determined by Level 1 inputs utilize quoted prices for identical assets or liabilities traded in active markets that we have the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.goodwill.

Recent Accounting Pronouncements

ASU No. 2016-13

Description - In June of 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments are intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates.

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Notes to Consolidated Financial Statements

Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances.

The ASU requires enhanced disclosures to help investors and other financial statement users to better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. In addition, the ASU amends the accounting guidance for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.

Methods and timing of adoption – The amendment is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early application will be permitted for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.

Expected financial statement impact – We are currently evaluating the provisions of the ASU and have formed a committee for the purpose of developing a model that is compliant with the requirements under the ASU. The committee is also gathering pertinent data, consulting with outside professionals and evaluating our IT systems to create reasonable and supportable forecasts. The committee has determined that we do not currently own any securities that will be required to maintain an allowance as a result of implementing the ASU. Management expects to recognize a one–time cumulative effect adjustment to the allowance for loan and lease losses as of the first reporting period in which the new standard is effective. An estimate of the magnitude of the one-time adjustment or the overall impact of this standard has not yet been determined.

ASU No. 2016-02

Description - In February of 2016, the FASB issued ASU No. 2016-02, Leases (Topic 812). This Update was issued to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. All leases create an asset and a liability for the lessee in accordance with FASB Concepts Statement No. 6, Elements of Financial Statements, and, therefore, recognition of those lease assets and lease liabilities represents an improvement over previous GAAP, which did not require lease assets and lease liabilities to be recognized for most leases.

Methods and timing of adoption – For public companies, the amendments in this update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.

Expected financial statement impact – We have performed an analysis of our existing leases and expect to recognize a new lease asset and related lease liability of approximately $4.8 million as we implement this ASU.

 

 

 

NOTE 3. RESTRICTIONS ON CASH AND DUE FROM BANKS

 

We have a Fed Funds line of credit with one correspondent bank which requires us to hold compensating cash balances of $450 thousand. We maintained the required compensating balance of $450 thousand at December 31, 2018throughout 2019 and December 31, 2017.2018.

 

The Bank is required by federal regulations to set aside specified amounts of cash as reserves against transaction and time deposits. The cash reserve required as of December 31, 20182019 and December 31, 20172018 was $1.4$1.8 million and $1.7$1.4 million, respectively which was satisfied by vault cash balances.

 

 

 

NOTE 4. SECURITIES

 

The following table presents the amortized costs, unrealized gains, unrealized losses and estimated fair values of our investment securities as of December 31, 2018,2019, and December 31, 2017.2018.

		As of December 31, 2019
						Gross				Gross
		Amortized				Unrealized				Unrealized				Estimated
(Amounts in thousands)		Costs				Gains				Losses				Fair Value
Available-for-sale securities:
U.S. government & agencies		$	38,291			$	469			$	(27	)		$	38,733
Obligations of state and political subdivisions			40,702				1,422				(26	)			42,098
Residential mortgage-backed securities and collateralized mortgage obligations			179,114				2,163				(442	)			180,835
Corporate securities			3,005				6				(45	)			2,966
Commercial mortgage-backed securities			19,126				221				(40	)			19,307
Other asset-backed securities			3,019				—				(8	)			3,011
Total		$	283,257			$	4,281			$	(588	)		$	286,950

 

		As of December 31, 2018
						Gross				Gross
		Amortized				Unrealized				Unrealized				Estimated
(Amounts in thousands)		Costs				Gains				Losses				Fair Value
Available-for-sale securities:
U.S. government & agencies		$	40,215			$	202			$	(330	)		$	40,087
Obligations of state and political subdivisions			50,037				1,082				(589	)			50,530
Residential mortgage-backed securities and collateralized mortgage obligations			142,355				129				(3,981	)			138,503
Corporate securities			3,022				—				(100	)			2,922
Commercial mortgage-backed securities			25,446				17				(701	)			24,762
Other asset-backed securities			123				1				—				124
Total		$	261,198			$	1,431			$	(5,701	)		$	256,928

 

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Notes to Consolidated Financial Statements

		As of December 31, 2017
						Gross				Gross
		Amortized				Unrealized				Unrealized				Estimated
(Amounts in thousands)		Costs				Gains				Losses				Fair Value
Available-for-sale securities:
U.S. government & agencies		$	40,319			$	196			$	(146	)		$	40,369
Obligations of state and political subdivisions			77,412				1,910				(478	)			78,844
Residential mortgage-backed securities and collateralized mortgage obligations			116,061				69				(1,538	)			114,592
Corporate securities			5,079				18				(105	)			4,992
Commercial mortgage-backed securities			26,995				24				(378	)			26,641
Other asset-backed securities			1,529				4				(28	)			1,505
Total		$	267,395			$	2,221			$	(2,673	)		$	266,943

During the fourth quarter of 2017, we reclassified the held-to-maturity securities portfolio to available-for-sale. As a result of this transfer we are precluded from classifying any investment securities as held-to-maturity for two years from the date of the transfer. Management does not expect to designate acquired securities as held-to-maturity in the near future.

 

The following table presents the expected maturities of investment securities at December 31, 2018.2019.

 

		Available-For-Sale								Available-For-Sale
(Amounts in thousands)		Amortized Cost				Fair Value				Amortized Cost				Fair Value
Amounts maturing in:
One year or less		$	54			$	54			$	6,542			$	6,567
One year through five years			80,796				79,726				139,442				141,580
Five years through ten years			108,251				105,923				74,651				75,295
After ten years			72,097				71,225				62,622				63,508
Total		$	261,198			$	256,928			$	283,257			$	286,950

 

The amortized cost and fair value of residential mortgage-backed securities, collateralized mortgage obligations and commercial mortgage securities are presented by their expected average life, rather than contractual maturity, because repayment of the underlying loans may be repaidaccelerated without prepayment penalties.

 

At December 31, 20182019 and 2017,2018, securities with a fair value of $68.8$81.4 million and $62.6$68.8 million, respectively, were pledged as collateral to secure public fund deposits, Federal Home Loan Bank of San Francisco borrowings and for other purposes as required by law.

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Notes to Consolidated Financial Statements

 

The following table presents the cash proceeds from sales of investment securities and the associated gross realized gains and gross realized losses that have been included in earnings for the years ended December 31, 2018, 20172019 and 2016.2018.

 

		For Years Ended December 31,												For Years Ended December 31,
(Amounts in thousands)		2018				2017				2016				2019				2018
Proceeds from sales of investment securities		$	30,235			$	64,349			$	51,025			$	117,299			$	30,235
Gross realized gains on sales of investment securities:
Gross realized gains on sales of investments securities:
U.S. government & agencies		$	—			$	—			$	25			$	49			$	—
Obligations of state and political subdivisions			262				161				188				482				262
Residential mortgage-backed securities and collateralized mortgage obligations			—				52				17				108				—
Corporate securities			1				79				105				—				1
Commercial mortgage-backed securities			—				3				4				34				—
Other asset-backed securities			—				20				13
Total gross realized gains on sales of investment securities			263				315				352				673				263
Gross realized losses on sales of investment securities
U.S. government & agencies			(43	)			—				(13	)			(16	)			(43	)
Obligations of state and political subdivisions			(71	)			(102	)			(3	)			(95	)			(71	)
Residential mortgage-backed securities and collateralized mortgage obligations			(40	)			(56	)			(64	)			(321	)			(40	)
Corporate securities			—				(3	)			(27	)
Commercial mortgage-backed securities			(19	)			(17	)			(1	)			(54	)			(19	)
Other asset-backed securities			(46	)			—				—				(1	)			(46	)
Total gross realized losses on sales of investments securities			(219	)			(178	)			(108	)
Total gross realized losses on sales of investment securities															(487	)			(219	)
Gains on sales of investment securities, net		$	44			$	137			$	244			$	186			$	44

 

Investment securities that were in an unrealized loss position as of December 31, 20182019 and December 31, 20172018 are presented in the following tables, based on the length of time individual securities have been in an unrealized loss position.

 

		As of December 31, 2018																								As of December 31, 2019
		Less Than 12 Months								12 Months or More								Total								Less Than 12 Months								12 Months or More								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized				Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
(Amounts in thousands)		Value				Losses				Value				Losses				Value				Losses				Value				Losses				Value				Losses				Value				Losses
Available-for-sale securities:
U.S. government & agencies		$	7,223			$	(39	)		$	12,274			$	(291	)		$	19,497			$	(330	)		$	6,473			$	(25	)		$	380			$	(2	)		$	6,853			$	(27	)
Obligations of states and political subdivisions			5,545				(40	)			16,320				(549	)			21,865				(589	)			2,249				(26	)			—				—				2,249				(26	)
Residential mortgage-backed securities and collateralized mortgage obligations			21,791				(183	)			93,038				(3,798	)			114,829				(3,981	)			31,817				(207	)			22,166				(235	)			53,983				(442	)
Corporate securities			—				—				2,922				(100	)			2,922				(100	)			—				—				955				(45	)			955				(45	)
Commercial mortgage-backed securities			1,548				(7	)			20,176				(694	)			21,724				(701	)			1,464				(1	)			4,549				(39	)			6,013				(40	)
Other asset-backed securities																											3,011				(8	)			—				—				3,011				(8	)
Total temporarily impaired securities		$	36,107			$	(269	)		$	144,730			$	(5,432	)		$	180,837			$	(5,701	)		$	45,014			$	(267	)		$	28,050			$	(321	)		$	73,064			$	(588	)

 

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Notes to Consolidated Financial Statements

 

		As of December 31, 2017																								As of December 31, 2018
		Less Than 12 Months								12 Months or More								Total								Less Than 12 Months								12 Months or More								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized				Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
(Amounts in thousands)		Value				Losses				Value				Losses				Value				Losses				Value				Losses				Value				Losses				Value				Losses
Available-for-sale securities:
U.S. government & agencies		$	18,140			$	(102	)		$	2,131			$	(44	)		$	20,271			$	(146	)		$	7,223			$	(39	)		$	12,274			$	(291	)		$	19,497			$	(330	)
Obligations of states and political subdivisions			15,030				(255	)			8,368				(223	)			23,398				(478	)			5,545				(40	)			16,320				(549	)			21,865				(589	)
Residential mortgage-backed securities and collateralized mortgage obligations			75,323				(827	)			31,036				(711	)			106,359				(1,538	)			21,791				(183	)			93,038				(3,798	)			114,829				(3,981	)
Corporate securities			—				—				2,934				(105	)			2,934				(105	)			—				—				2,922				(100	)			2,922				(100	)
Commercial mortgage-backed securities			11,162				(151	)			10,026				(227	)			21,188				(378	)			1,548				(7	)			20,176				(694	)			21,724				(701	)
Other asset-backed securities			1,157				(28	)			—				—				1,157				(28	)
Total temporarily impaired securities		$	120,812			$	(1,363	)		$	54,495			$	(1,310	)		$	175,307			$	(2,673	)		$	36,107			$	(269	)		$	144,730			$	(5,432	)		$	180,837			$	(5,701	)

 

At December 31, 20182019 and December 31, 2017,2018, the number of securities in an unrealized loss position was 16363 and 138,163, respectively. In the opinion of management, these securities are considered only temporarily impaired due to changes in market interest rates or widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral. Our Investment Policy requires securities at the time of purchase to be rated A3/A- or higher by Moody’s, S&P and Fitch rating agencies. Management monitors the published credit ratings of our investment portfolio for material rating or outlook changes. For all private-label securities collateralized by mortgages, management also monitors the credit characteristics of the underlying mortgages to identify potential credit losses, if any, in the portfolio. Because the decline in fair value is not due to credit quality concerns, and because we have no plans to sell the securities before the recovery of their amortized cost, and we believe the bank has the ability to hold the securities to maturity these investments are not considered other-than-temporarily impaired.

 

The following table presents the characteristics of our securities that are in unrealized loss positions at December 31, 20182019 and December 31, 2017.2018.

 

		Characteristics of securities in unrealized loss positions at
Available-for-sale securities:		December 31, 20182019 and December 31, 20172018
U.S. government & agencies		Direct obligations of the U.S. Government or obligations guaranteed by U.S. Government agencies.
Obligations of states and political subdivisions		General obligation issuances or revenue securities secured by revenues from specific sources issued by municipalities and political subdivisions located within the U.S.
Residential mortgage-backed securities and collateralized mortgage obligations		Obligations of U.S. government sponsored entities or non-governmental entities collateralized by high quality mortgages on residential properties. Issuances by non-governmental entities usually include good credit enhancements. Of the residential mortgage-backed securities and collateralized mortgage obligations that we owned at December 31, 20182019 and December 31, 2017,2018, 79% and 66% and 56% were issued or guaranteed by U.S. government sponsored entities, respectively.
Corporate securities		Debt obligations generally issued or guaranteed by large U.S. corporate institutions.
Commercial mortgage-backed securities		Obligations of U.S. government sponsored entities or non-governmental entities collateralized by high quality mortgages on commercial properties. Issuances by non-governmental entities usually include good credit enhancements. Of the commercial mortgage-backed securities that we owned at December 31, 20182019 and December 31, 20172018, 100% and 90% were issued or guaranteed by U.S. government sponsored entities.entities, respectively.
Other asset-backed securities		Obligations secured by high quality loans with good credit enhancements issued by non-governmental issuers.

 

Other-Than-Temporary Impairment

For the years ended December 31, 2018 and 2017, we did not recognize any other-than-temporary impairment losses. We recognized one impairment loss of $546 thousand during the year ended December 31, 2016.

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Notes to Consolidated Financial Statements

 

 

NOTE 5. LOANS

 

Outstanding loan balances consist of the following at December 31, 2018,2019, and December 31, 2017.2018.

 

		As of
(Amounts in thousands)		December 31,								As of December 31
Loan Portfolio		2018				2017				2019				2018
Commercial		$	135,543			$	142,405			$	141,197			$	135,543
Commercial real estate:
Real estate – construction and land development			22,563				15,902				26,830				22,563
Real estate – commercial non-owner occupied			433,708				377,668				493,920				433,708
Real estate – commercial owner occupied			204,622				192,023				218,833				204,622
Residential real estate:
Real estate – residential - Individual Tax Identification Number ("ITIN")			37,446				41,188				33,039				37,446
Real estate – residential - 1-4 family mortgage			34,366				30,377				63,661				34,366
Real estate – residential - equity lines			26,958				30,347				22,099				26,958
Consumer and other			51,045				49,925				33,324				51,045
Gross loans			946,251				879,835				1,032,903				946,251
Deferred fees and costs			1,927				1,710				2,162				1,927
Loans, net of deferred fees and costs			948,178				881,545				1,035,065				948,178
Allowance for loan and lease losses			(12,292	)			(11,925	)			(12,231	)			(12,292	)
Net loans		$	935,886			$	869,620			$	1,022,834			$	935,886

 

Certain loans are pledged as collateral with the Federal Home Loan Bank of San Francisco and the Federal Reserve Bank. Pledged loans totaled $436.1$542.1 million and $420.0$490.2 million at December 31, 20182019 and December 31, 2017,2018, respectively.

 

When we purchase loans they are typically purchased at a discount to enhance yield and compensate for credit risk. We have no purchased credit impaired loans as of December 31, 2019, and December 31, 2018. Gross loan balances in the table above include net purchase discounts of $2.5$1.5 million and $2.8$2.5 million as of December 31, 2018,2019, and December 31, 2017,2018, respectively.

 

Gross loan balances in the table above at December 31, 2019 include a fair value discount of $1.7 million for loans acquired from Merchants during the first quarter of 2019. We recorded $620 thousand in accretion of the discount for these loans during the year ended December 31, 2019.

Past Due Loans

 

Past due loans (gross), segregated by loan portfolio were as follows, as of December 31, 2018,2019, and December 31, 2017.2018.

 

										Greater																Recorded																												Recorded
(Amounts in thousands)		30-59				60-89				Than 90																Investment >				30-59				60-89				90 or Greater																Investment >
Past Due Loans at		Days Past				Days Past				Days Past				Total Past												90 Days and				Days Past				Days Past				Days Past				Total Past												90 Days and
December 31, 2018		Due				Due				Due				Due				Current				Total				Accruing
December 31, 2019																														Due				Due				Due				Due				Current				Total				Accruing
Commercial		$	—			$	—			$	—			$	—			$	135,543			$	135,543			$	—			$	71			$	—			$	—			$	71			$	141,126			$	141,197			$	—
Commercial real estate:
Real estate - construction and land development			—				—				—				—				22,563				22,563				—				—				—				—				—				26,830				26,830				—
Real estate - commercial non-owner occupied			10,878				—				548				11,426				422,282				433,708				—				—				—				—				—				493,920				493,920				—
Real estate - commercial owner occupied			688				—				—				688				203,934				204,622				—				655				—				3,103				3,758				215,075				218,833				—
Residential real estate:
Real estate - residential - ITIN			184				279				259				722				36,724				37,446				—				371				323				43				737				32,302				33,039				—
Real estate - residential - 1-4 family mortgage			—				—				185				185				34,181				34,366				—				—				—				—				—				63,661				63,661				—
Real estate - residential - equity lines			90				—				—				90				26,868				26,958				—				100				—				—				100				21,999				22,099				—
Consumer and other			534				263				—				797				50,248				51,045				—				200				50								250				33,074				33,324				—
Total		$	12,374			$	542			$	992			$	13,908			$	932,343			$	946,251			$	—			$	1,397			$	373			$	3,146			$	4,916			$	1,027,987			$	1,032,903			$	—

 

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BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

Notes to Consolidated Financial Statements

 

										Greater																Recorded																												Recorded
(Amounts in thousands)		30-59				60-89				Than 90																Investment >				30-59				60-89				90 or Greater																Investment >
Past Due Loans at		Days Past				Days Past				Days Past				Total Past												90 Days and				Days Past				Days Past				Days Past				Total Past												90 Days and
December 31, 2017		Due				Due				Due				Due				Current				Total				Accruing
December 31, 2018																														Due				Due				Due				Due				Current				Total				Accruing
Commercial		$	—			$	—			$	—			$	—			$	142,405			$	142,405			$	—			$	—			$	—			$	—			$	—			$	135,543			$	135,543			$	—
Commercial real estate:
Real estate - construction and land development			—				—				—				—				15,902				15,902				—				—				—				—				—				22,563				22,563				—
Real estate - commercial non-owner occupied			—				—				—				—				377,668				377,668				—				10,878				—				548				11,426				422,282				433,708				—
Real estate - commercial owner occupied			142				—				—				142				191,881				192,023				—				688				—				—				688				203,934				204,622				—
Residential real estate:
Real estate - residential - ITIN			555				122				462				1,139				40,049				41,188				—				184				279				259				722				36,724				37,446				—
Real estate - residential - 1-4 family mortgage			290				173				—				463				29,914				30,377				—				—				—				185				185				34,181				34,366				—
Real estate - residential - equity lines			141				—				—				141				30,206				30,347				—				90				—				—				90				26,868				26,958				—
Consumer and other			281				123				—				404				49,521				49,925				—				534				263				—				797				50,248				51,045				—
Total		$	1,409			$	418			$	462			$	2,289			$	877,546			$	879,835			$	—			$	12,374			$	542			$	992			$	13,908			$	932,343			$	946,251			$	—

 

Nonaccrual Loans

 

Nonaccrual loans, segregated by loan portfolio, were as follows as of December 31, 2018,2019, and December 31, 2017.2018.

 

 

		As of
(Amounts in thousands)		December 31,								As of December 31
Nonaccrual Loans		2018				2017				2019				2018
Commercial		$	959			$	1,603			$	61			$	959
Commercial real estate:
Real estate - commercial non-owner occupied			548				—				—				548
Real estate - commercial owner occupied			—				600				3,103				—
Residential real estate:
Real estate - residential - ITIN			2,388				2,909				2,221				2,388
Real estate - residential - 1-4 family mortgage			185				606				191				185
Real estate - residential - equity lines			43				45				—				43
Consumer and other			23				36				40				23
Total		$	4,146			$	5,799			$	5,616			$	4,146

 

Had nonaccrual loans performed in accordance with their contractual terms, we would have recognized additional interest income, net of tax, of approximately $166 thousand, $226$254 thousand and $353$166 thousand for the years ended December 31, 2018, 2017,2019 and 2016,2018, respectively.

 

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BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

Notes to Consolidated Financial Statements

 

Impaired Loans

 

A loan is considered impaired when, based on current information and events, we determine it is probable that we will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. The following tables summarize impaired loans by loan portfolio as of December 31, 2018,2019, and December 31, 2017.2018.

 

		As of December 31, 2018												As of December 31, 2019
						Unpaid												Unpaid
(Amounts in thousands)		Recorded				Principal				Related				Recorded				Principal				Related
Impaired Loans		Investment				Balance				Allowance				Investment				Balance				Allowance
With no related allowance recorded:
Commercial		$	51			$	69			$	—			$	94			$	251			$	—
Commercial real estate:
Real estate - commercial non-owner occupied			548				548				—
Real estate - commercial owner-occupied															3,103				3,103				—
Residential real estate:
Real estate - residential - ITIN			6,138				7,676				—				5,723				7,386				—
Real estate - residential - 1-4 family mortgage			185				223				—				191				313				—
Real estate - residential - equity lines			43				48				—
Total with no related allowance recorded		$	6,965			$	8,564			$	—			$	9,111			$	11,053			$	—
With an allowance recorded:
Commercial		$	2,132			$	2,256			$	748			$	562			$	563			$	159
Commercial real estate:
Real estate - commercial non-owner occupied			795				795				209
Residential real estate:
Real estate - residential - ITIN			734				772				91				455				455				38
Real estate - residential - equity lines			363				363				182				231				231				116
Consumer and other			23				23				7				40				40				11
Total with an allowance recorded		$	4,047			$	4,209			$	1,237			$	1,288			$	1,289			$	324
By loan portfolio:
Commercial		$	2,183			$	2,325			$	748			$	656			$	814			$	159
Commercial real estate			1,343				1,343				209				3,103				3,103				—
Residential real estate			7,463				9,082				273				6,600				8,385				154
Consumer and other			23				23				7				40				40				11
Total impaired loans		$	11,012			$	12,773			$	1,237			$	10,399			$	12,342			$	324

 

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Notes to Consolidated Financial Statements

 

		As of December 31, 2017												As of December 31, 2018
						Unpaid												Unpaid
(Amounts in thousands)		Recorded				Principal				Related				Recorded				Principal				Related
Impaired Loans		Investment				Balance				Allowance				Investment				Balance				Allowance
With no related allowance recorded:
Commercial		$	672			$	1,205			$	—			$	51			$	69			$	—
Commercial real estate:
Real estate - commercial owner-occupied			600			$	665				—				548			$	548				—
Residential real estate:
Real estate - residential - ITIN			5,895				7,516				—				6,138				7,676				—
Real estate - residential - 1-4 family mortgage			414				897				—				185				223				—
Real estate - residential - equity lines			45				49				—				43				48				—
Total with no related allowance recorded		$	7,626			$	10,332			$	—			$	6,965			$	8,564			$	—
With an allowance recorded:
Commercial		$	2,482			$	2,540			$	690			$	2,132			$	2,256			$	748
Commercial real estate:
Real estate - commercial non-owner occupied			803				803				77				795				795				209
Residential real estate:
Real estate - residential - ITIN			1,628				1,678				199				734				772				91
Real estate - residential - 1-4 family mortgage			192				226				2
Real estate - residential - equity lines			380				380				190				363				363				182
Consumer and other			36				36				11				23				23				7
Total with an allowance recorded		$	5,521			$	5,663			$	1,169			$	4,047			$	4,209			$	1,237
By loan portfolio:
Commercial		$	3,154			$	3,745			$	690			$	2,183			$	2,325			$	748
Commercial real estate			1,403				1,468				77				1,343				1,343				209
Residential real estate			8,554				10,746				391				7,463				9,082				273
Consumer and other			36				36				11				23				23				7
Total impaired loans		$	13,147			$	15,995			$	1,169			$	11,012			$	12,773			$	1,237

 

The following table summarizes average recorded investment and interest income recognized on impaired loans by loan portfolio for the years ended December 31, 2018, 20172019 and 2016.2018.

 

		2018								2017								2016								2019								2018
		Average				Interest				Average				Interest				Average				Interest				Average				Interest				Average				Interest
(Amounts in thousands)		Recorded				Income				Recorded				Income				Recorded				Income				Recorded				Income				Recorded				Income
Average Recorded Investment and Interest Income		Investment				Recognized				Investment				Recognized				Investment				Recognized				Investment				Recognized				Investment				Recognized
Commercial		$	2,455			$	78			$	3,211			$	46			$	2,605			$	23			$	1,201			$	51			$	2,455			$	78
Commercial real estate:
Real estate - commercial non-owner occupied			890				46				1,548				46				2,013				47				9,400				30				890				46
Real estate - commercial owner- occupied			—				—				670				2				1,281				25				259				—				—				—
Residential real estate:																															��
Real estate - residential - ITIN			7,198				170				7,961				162				8,939				165				6,574				161				7,198				170
Real estate - residential - 1-4 family mortgage			218				—				1,019				—				1,788				—				193				—				218				—
Real estate - residential - equity lines			415				20				1,104				19				1,535				26				288				18				415				20
Consumer and other			31				—				72				—				162				—				25				—				31				—
Total		$	11,207			$	314			$	15,585			$	275			$	18,323			$	286			$	17,940			$	260			$	11,207			$	314

The increase in the average recorded investment in impaired loans for 2019 compared to 2018 was due to a $9.9 million commercial real estate loan which was placed in nonaccrual status in the first quarter and sold in the fourth quarter of 2019.

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Notes to Consolidated Financial Statements

 

The impaired loans on which these interest income amounts were recognized are primarily accruing troubled debt restructured loans. Loans are reported as troubled debt restructurings when we grant a concession(s) to a borrower experiencing financial difficulties that we would not otherwise consider. Examples of such concessions include a reduction in the loan rate, forgiveness of principal or accrued interest, extending the maturity date(s) significantly, or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, troubled debt restructured loans are impaired as we will not collect all amounts due, either principal or interest, in accordance with the terms of the original loan agreement.

 

Troubled Debt Restructurings

 

At December 31, 20182019 and December 31, 2017,2018, impaired loans of $6.9$4.8 million and $7.3$6.9 million, respectively, were classified as performing restructured loans.

 

For a restructured loan to be on accrual status, the loan’s collateral coverage must generally be greater than or equal to 100% of the loan balance, the loan payments must be current, and the borrower must demonstrate the ability to make payments from a verified source of cash flow. As of December 31, 2018 and 2017,2019, we had no obligations to lend additional funds on any restructured loans. As of December 31, 2018, we had only one restructured commercial line of credit in nonaccrual status that had $313 thousand and $33 thousand in available credit.

 

As of December 31, 2018,2019, we had $9.6$6.5 million in troubled debt restructurings compared to $10.9$9.6 million as of December 31, 2017.2018. As of December 31, 2018,2019, we had 10698 loans that qualified as troubled debt restructurings, of which all94 loans were performing according to their restructured terms. Troubled debt restructurings represented 1.01%0.63% of gross loans as of December 31, 2018,2019, compared with 1.24%1.01% at December 31, 2017.

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2018.

 

The types of modifications offered can generally be described in the following categories:

 

Rate – A modification in which the interest rate is changed.

 

Maturity – A modification in which the maturity date is changed.

 

Payment deferral – A modification in which a portion of the principal is deferred.

 

Principal reduction – A modification in which a portion of the owing principal is decreased.

 

We do not have any newly restructured loans or modifications for the year ended December 31, 2018. The following tables presenttable presents the period ended balances of newly restructured loans and the types of modifications that occurred during the yearsyear ended December 31, 2017 and 20162019. We did not have any newly restructured loans or modifications for the year ended December 31, 2018.

		For The Year Ended December 31, 2017
										Rate &
(Amounts in thousands)		Rate &				Principal				Payment								Payment
Troubled Debt Restructuring Modification Types		Maturity				Reduction				Deferral				Maturity				Deferral				Total
Residential real estate:
Real estate - residential - ITIN		$	—			$	—			$	60			$	—			$	—			$	60
Total		$	—			$	—			$	60			$	—			$	—			$	60

 

 

		For The Year Ended December 31, 2016																								For The Year Ended December 31, 2019
						Rate &																								Rate &
(Amounts in thousands)		Rate &				Payment				Principal								Payment								Rate &				Payment
Troubled Debt Restructuring Modification Types		Maturity				Deferral				Reduction				Maturity				Deferral				Total				Maturity				Deferral				Maturity				Total
Commercial		$	905			$	—			$	—			$	1,120			$	—			$	2,025			$	—			$	—			$	47			$	47
Residential real estate:
Real estate - residential - ITIN			—				—				81				—				197				278
Real estate - residential - 1-4 family mortgage			144				—				—				—				—				144
Consumer and other																											20				—				—				20
Total		$	1,049			$	—			$	81			$	1,120			$	197			$	2,447			$	20			$	—			$	47			$	67

 

For the yearsyear ended December 31, 2017, and 2016,2019, the tablestable below provideprovides information regarding the number of loans where the contractual terms have been restructured.

 

		2017
						Pre-Modification				Post-Modification
(Amounts in thousands)		Number of				Outstanding Recorded				Outstanding Recorded
Troubled Debt Restructurings		Contracts				Investment				Investment
Residential real estate:
Real estate - residential - ITIN			1			$	81			$	61
Total			1			$	81			$	61

 

		2016
						Pre-Modification				Post-Modification
(Amounts in thousands)		Number of				Outstanding Recorded				Outstanding Recorded
Troubled Debt Restructurings		Contracts				Investment				Investment
Commercial			4			$	2,244			$	2,266
Residential real estate:
Real estate - residential - ITIN			3				372				342
Real estate - residential - 1-4 family mortgage			1				144				144
Total			8			$	2,760			$	2,752

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		2019
						Pre-Modification				Post-Modification
(Amounts in thousands)		Number of				Outstanding Recorded				Outstanding Recorded
Troubled Debt Restructurings		Contracts				Investment				Investment
Commercial			1			$	99			$	99
Consumer and other			1				20				20
Total			2			$	119			$	119

 

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

NotesWe had one $20 thousand consumer loan that was modified as a troubled debt restructuring during the 12 months ended December 31, 2019, for which there was a subsequent payment default during the period from date of restructuring to Consolidated Financial Statements

December 31, 2019. There were no loans modified as troubled debt restructuring during the 12 months ended December 31, 2018 2017 and 2016, for which there was a subsequent payment default during the twelve months endedperiod from the date of restructuring to December 31, 2018, 2017 and 2016, respectively.2018.

 

Performing and Nonperforming Loans

 

We define a performing loan as a loan where any installment of principal or interest is not 90 days or more past due, and management believes the ultimate collection of original contractual principal and interest is likely. We define a nonperforming loan as an impaired loan, which may be on nonaccrual, or is 90 days past due and still accruing, or has been restructured and does not comply with its modified terms, and our ultimate collection of original contractual principal and interest is uncertain.

 

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Performing and nonperforming loans, segregated by loan portfolio, are as follows at December 31, 20182019 and 2017.2018.

(Amounts in thousands)		December 31, 2019
Performing and Nonperforming Loans		Performing				Nonperforming				Total
Commercial		$	141,136			$	61			$	141,197
Commercial real estate:
Real estate - construction and land development			26,830				—				26,830
Real estate - commercial non-owner occupied			493,920				—				493,920
Real estate - commercial owner occupied			215,730				3,103				218,833
Residential real estate:
Real estate - residential - ITIN			30,818				2,221				33,039
Real estate - residential - 1-4 family mortgage			63,470				191				63,661
Real estate - residential - equity lines			22,099				—				22,099
Consumer and other			33,284				40				33,324
Total		$	1,027,287			$	5,616			$	1,032,903

 

(Amounts in thousands)		December 31, 2018
Performing and Nonperforming Loans		Performing				Nonperforming				Total
Commercial		$	134,584			$	959			$	135,543
Commercial real estate:
Real estate - construction and land development			22,563				—				22,563
Real estate - commercial non-owner occupied			433,160				548				433,708
Real estate - commercial owner occupied			204,622				—				204,622
Residential real estate:
Real estate - residential - ITIN			35,058				2,388				37,446
Real estate - residential - 1-4 family mortgage			34,181				185				34,366
Real estate - residential - equity lines			26,915				43				26,958
Consumer and other			51,022				23				51,045
Total		$	942,105			$	4,146			$	946,251

(Amounts in thousands)		December 31, 2017
Performing and Nonperforming Loans		Performing				Nonperforming				Total
Commercial		$	140,802			$	1,603			$	142,405
Commercial real estate:
Real estate - construction and land development			15,902				—				15,902
Real estate - commercial non-owner occupied			377,668				—				377,668
Real estate - commercial owner occupied			191,423				600				192,023
Residential real estate:
Real estate - residential - ITIN			38,279				2,909				41,188
Real estate - residential - 1-4 family mortgage			29,771				606				30,377
Real estate - residential - equity lines			30,302				45				30,347
Consumer and other			49,889				36				49,925
Total		$	874,036			$	5,799			$	879,835

 

Credit Quality Ratings

 

Management assigns a credit quality rating (risk grade) to each loan. The foundation or primary factor in determining the appropriate credit quality rating is the degree of a debtor’s willingness and ability to perform as agreed. In conjunction with evaluating the performing versus nonperforming nature of our loan portfolio, management evaluates the following credit risk and other relevant factors in determining the appropriate credit quality indicator (rating) for each loan portfolio:

 

Pass Grade: A Pass loan is a strong credit with no existing or known weaknesses that may require management’s close attention. Some pass loans require short-term enhanced monitoring to determine when the credit relationship would merit either an upgrade or a downgrade. Loans classified as Pass Grade specifically demonstrate:

 

●

Strong Cash Flows – borrower’s cash flows must meet or exceed our minimum debt service coverage ratio.

●

Collateral Margin – generally, the borrower must have pledged an acceptable collateral class with an adequate collateral margin.

●

Qualitative Factors – in addition to meeting our minimum cash flow and collateral requirements, a number of other qualitative factors are also factored into assigning a Pass Grade including the borrower’s level of leverage (debt to equity), prospects, history and experience in their industry, credit history, and any other relevant factors including a borrower’s character.

 

Those borrowers who qualify for unsecured loans must fully demonstrate above average cash flows and strong secondary sources of repayment to mitigate the lack of unpledged collateral.

 

Watch Grade: The credit is acceptable but the borrower has experienced a temporary setback or adverse information has been received, and may exhibit one or more of the characteristics shown in the list below. This risk grade could apply to credits on a temporary basis pending a full review. Credits with this risk grade will require more handling time and increased management. The list below contains characteristics of this risk grade, but individually do not automatically cause the loan to be assigned a Watch Grade.

 

●

The primary source of repayment may be weakening causing greater reliance on the secondary source of repayment or

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●

The primary source of repayment is adequate, but the secondary source of repayment is insufficient

●

In-depth financial analysis would compare to the lower quartile in two or more of the major components of the Risk Management Association Annual Statement Studies

●

Volatile or deteriorating collateral

●

Management decisions may be called into question

●

Delinquencies in bank credits or other financial/trade creditors

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●

Frequent overdrafts

●

Significant change in management/ownership

 

Special Mention Grade: Credits in this grade are potentially weak and deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects of the credit. Special Mention credits are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. The list below exhibits the characteristics of this grade, but individually do not automatically cause the borrower to be assigned a grade of Special Mention:

 

●

Inadequate or incomplete loan documentation or perfection of collateral, or any other deviation from prudent lending practices

●

Credit is structured in a manner in which the timing of the repayment source does not match the payment schedule or maturity, materially jeopardizing repayment

●

Current economic or market conditions exist which may affect the borrower's ability to perform or affect the Bank's collateral position

●

Adverse trends in the borrower's operations or continued deterioration in the borrower’s financial condition that has not yet reached a point where the retirement of debt is jeopardized. A credit in this grade should have favorable prospects of the deteriorating financial trends reversing within a reasonable timeframe.

●

The borrower is less than cooperative or unable to produce current and adequate financial information

 

Substandard Grade: A Substandard credit is inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard credits have a well-defined weakness or weaknesses that jeopardize the liquidation or timely collection of the debt. Substandard credits are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. However, a potential loss does not have to be recognizable in an individual credit for it to be considered a substandard credit. As such, substandard credits may or may not be graded as impaired.

 

The following represents, but is not limited to, the potential characteristics of a Substandard Grade and do not necessarily generate automatic reclassification into this loan grade:

 

●

Sustained or substantial deteriorating financial trends,

●

Unresolved management problems,

●

Collateral is insufficient to repay debt; collateral is not sufficiently supported by independent sources, such as asset-based financial audits, appraisals, or equipment evaluations,

●

Improper perfection of lien position, which is not readily correctable,

●

Unanticipated and severe decline in market values,

●

High reliance on secondary source of repayment,

●

Legal proceedings, such as bankruptcy or a divorce, which has substantially decreased the borrower’s capacity to repay the debt,

●

Fraud committed by the borrower,

●

IRS liens that take precedence,

●

Forfeiture statutes for assets involved in criminal activities,

●

Protracted repayment terms outside of policy that are for longer than the same type of credit in our portfolio,

●

Any other relevant quantitative or qualitative factor that negatively affects the current net worth and paying capacity of the borrower or of the collateral pledged, if any.

 

Doubtful Grade: A Doubtful loan has all the weaknesses inherent in one classified 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. The possibility of loss is extremely high, but because of certain pending factors that may work to the advantage and strengthening of the credit, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors may include, but are not limited to:

 

●

Proposed merger(s),

●

Acquisition or liquidation procedures,

●

Capital injection,

●

Perfecting liens on additional collateral,

●

Refinancing plans.

 

Generally, a Doubtful Grade does not remain outstanding for a period greater than six months. Within six months, the pending events should have been resolved. Based on resolution of the pending events, the credit grade should have improved or the principal balance charged against the ALLL.

 

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Notes to Consolidated Financial Statements

 

The following table summarizes loans by internal risk grades and by loan class as of December 31, 2018,2019, and December 31, 2017.2018

 

 

		December 31, 2018																								December 31, 2019
										Special																								Special
(Amounts in thousands)		Pass				Watch				Mention				Substandard				Doubtful				Total				Pass				Watch				Mention				Substandard				Doubtful				Total
Commercial		$	118,643			$	15,247			$	—			$	1,653			$	—			$	135,543			$	125,222			$	14,974			$	833			$	168			$	—			$	141,197
Commercial real estate:
Real estate - construction and land development			22,539				24				—				—				—				22,563				26,810				20				—				—				—				26,830
Real estate - commercial non-owner occupied			409,157				21,698				—				2,853				—				433,708				454,493				32,902				5,424				1,101				—				493,920
Real estate - commercial owner occupied			179,154				14,075				—				11,393				—				204,622				195,950				7,224				1,220				14,439				—				218,833
Residential real estate:
Real estate - residential - ITIN			31,805				—				—				5,641				—				37,446				28,609				—				—				4,430				—				33,039
Real estate - residential - 1-4 family mortgage			33,388				793				—				185				—				34,366				62,485				985				—				191				—				63,661
Real estate - residential - equity lines			25,336				1,313				—				309				—				26,958				22,012				—				—				87				—				22,099
Consumer and other			51,016				—				—				29				—				51,045				33,283				—				—				41				—				33,324
Total		$	871,038			$	53,150			$	—			$	22,063			$	—			$	946,251			$	948,864			$	56,105			$	7,477			$	20,457			$	—			$	1,032,903

 

		December 31, 2017																								December 31, 2018
										Special																								Special
(Amounts in thousands)		Pass				Watch				Mention				Substandard				Doubtful				Total				Pass				Watch				Mention				Substandard				Doubtful				Total
Commercial		$	117,087			$	22,213			$	40			$	3,065			$	—			$	142,405			$	118,643			$	15,247			$	—			$	1,653			$	—			$	135,543
Commercial real estate:
Real estate - construction and land development			14,762				—				1,140				—				—				15,902				22,539				24				—				—				—				22,563
Real estate - commercial non-owner occupied			364,230				9,160				2,900				1,378				—				377,668				409,157				21,698				—				2,853				—				433,708
Real estate - commercial owner occupied			171,005				15,198				3,907				1,913				—				192,023				179,154				14,075				—				11,393				—				204,622
Residential real estate:
Real estate - residential - ITIN			34,923				—				—				6,265				—				41,188				31,805				—				—				5,641				—				37,446
Real estate - residential - 1-4 family mortgage			28,981				791				—				605				—				30,377				33,388				793				—				185				—				34,366
Real estate - residential - equity lines			28,457				1,501				63				326				—				30,347				25,336				1,313				—				309				—				26,958
Consumer and other			49,887				—				2				36				—				49,925				51,016				—				—				29				—				51,045
Total		$	809,332			$	48,863			$	8,052			$	13,588			$	—			$	879,835			$	871,038			$	53,150			$	—			$	22,063			$	—			$	946,251

 

The recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure was $245$100 thousand at December 31, 2018.2019.

 

Allowance for Loan and Lease Losses

 

The following tables below summarize the ALLL by portfolio for the years ended December 31, 2018, 20172019 and 2016.

2018.

 

 

		As of December 31, 2018																								As of December 31, 2019
(Amounts in thousands)						Commercial				Residential																				Commercial				Residential
ALLL by Loan Portfolio		Commercial				Real Estate				Real Estate				Consumer				Unallocated				Total				Commercial				Real Estate				Real Estate				Consumer				Unallocated				Total
Beginning balance		$	2,397			$	6,514			$	1,169			$	1,435			$	410			$	11,925			$	2,205			$	7,116			$	1,173			$	1,356			$	442			$	12,292
Charge-offs			(132	)			—				(226	)			(890	)			—				(1,248	)			(238	)			(233	)			(181	)			(848	)			—				(1,500	)
Recoveries			865				—				435				315				—				1,615				927				—				261				251				—				1,439
Provision			(925	)			602				(205	)			496				32				—				(1,072	)			1,213				(221	)			174				(94	)			—
Ending balance		$	2,205			$	7,116			$	1,173			$	1,356			$	442			$	12,292			$	1,822			$	8,096			$	1,032			$	933			$	348			$	12,231

 

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		As of December 31, 2017
(Amounts in thousands)						Commercial				Residential
ALLL by Loan Portfolio		Commercial				Real Estate				Real Estate				Consumer				Unallocated				Total
Beginning balance		$	2,747			$	5,680			$	1,716			$	955			$	446			$	11,544
Charge-offs			(51	)			—				(483	)			(968	)			—				(1,502	)
Recoveries			512				27				178				216				—				933
Provision			(811	)			807				(242	)			1,232				(36	)			950
Ending balance		$	2,397			$	6,514			$	1,169			$	1,435			$	410			$	11,925

		As of December 31, 2016																								As of December 31, 2018
(Amounts in thousands)						Commercial				Residential																				Commercial				Residential
ALLL by Loan Portfolio		Commercial				Real Estate				Real Estate				Consumer				Unallocated				Total				Commercial				Real Estate				Real Estate				Consumer				Unallocated				Total
Beginning balance		$	2,493			$	5,784			$	1,577			$	770			$	556			$	11,180			$	2,397			$	6,514			$	1,169			$	1,435			$	410			$	11,925
Charge-offs			(1,106	)			(37	)			(829	)			(812	)			—				(2,784	)			(132	)			—				(226	)			(890	)			—				(1,248	)
Recoveries			427				2,480				114				127				—				3,148				865				—				435				315				—				1,615
Provision			933				(2,547	)			854				870				(110	)			—				(925	)			602				(205	)			496				32				—
Ending balance		$	2,747			$	5,680			$	1,716			$	955			$	446			$	11,544			$	2,205			$	7,116			$	1,173			$	1,356			$	442			$	12,292

 

The following tables summarize the ALLL and the recorded investment in loans and leases as of December 31, 2018, 20172019 and 2016.2018.

		As of December 31, 2019
						Commercial				Residential
(Amounts in thousands)		Commercial				Real Estate				Real Estate				Consumer				Unallocated				Total
ALLL:
Individually evaluated for impairment		$	159			$	—			$	154			$	11			$	—			$	324
Collectively evaluated for impairment			1,663				8,096				878				922				348				11,907
Total			1,822				8,096				1,032				933				348				12,231
Gross loans:
Individually evaluated for impairment		$	656			$	3,103			$	6,600			$	40			$	—			$	10,399
Collectively evaluated for impairment			140,541				736,480				112,199				33,284				—				1,022,504
Total gross loans		$	141,197			$	739,583			$	118,799			$	33,324			$	—			$	1,032,903

 

 

		As of December 31, 2018
						Commercial				Residential
(Amounts in thousands)		Commercial				Real Estate				Real Estate				Consumer				Unallocated				Total
ALLL:
Individually evaluated for impairment		$	748			$	209			$	273			$	7			$	—			$	1,237
Collectively evaluated for impairment			1,457				6,907				900				1,349				442				11,055
Total			2,205				7,116				1,173				1,356				442				12,292
Gross loans:
Individually evaluated for impairment		$	2,183			$	1,343			$	7,463			$	23			$	—			$	11,012
Collectively evaluated for impairment			133,360				659,550				91,307				51,022				—				935,239
Total gross loans		$	135,543			$	660,893			$	98,770			$	51,045			$	—			$	946,251

 

		As of December 31, 2017
						Commercial				Residential
(Amounts in thousands)		Commercial				Real Estate				Real Estate				Consumer				Unallocated				Total
ALLL:
Individually evaluated for impairment		$	690			$	77			$	391			$	11			$	—			$	1,169
Collectively evaluated for impairment			1,707				6,437				778				1,424				410				10,756
Total			2,397				6,514				1,169				1,435				410				11,925
Gross loans:
Individually evaluated for impairment		$	3,154			$	1,403			$	8,554			$	36			$	—			$	13,147
Collectively evaluated for impairment			139,251				584,190				93,358				49,889				—				866,688
Total gross loans		$	142,405			$	585,593			$	101,912			$	49,925			$	—			$	879,835

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Notes to Consolidated Financial Statements

		As of December 31, 2016
						Commercial				Residential
(Amounts in thousands)		Commercial				Real Estate				Real Estate				Consumer				Unallocated				Total
ALLL:
Individually evaluated for impairment		$	641			$	85			$	721			$	14			$	—			$	1,461
Collectively evaluated for impairment			2,106				5,595				995				941				446				10,083
Total			2,747				5,680				1,716				955				446				11,544
Gross loans:
Individually evaluated for impairment		$	3,525			$	3,125			$	11,894			$	250			$	—			$	18,794
Collectively evaluated for impairment			143,356				500,580				90,050				51,431				—				785,417
Total gross loans		$	146,881			$	503,705			$	101,944			$	51,681			$	—			$	804,211

The ALLL totaled $12.3$12.2 million or 1.30% of total gross loans at December 31, 20182019 and $11.9$12.3 million or 1.36% at December 31, 2017.2018. The loans acquired from Merchants were recorded at fair value, which included a discount for credit risk adjustments, which is not a part of the ALLL. No ALLL is required for these acquired loans on the date of acquisition. As a result, our ALLL as a percentage of gross loans declined to 1.18% as of December 31, 2019 compared to 1.30% as of December 31, 2018. As of December 31, 20182019 and December 31, 2017,2018, we had commitments to extend credit of $235.8$275.1 million and $227.7$235.8 million, respectively. The reserve for unfunded commitments recorded in Other Liabilities in the Consolidated Balance Sheets at December 31, 20182019 and 20172018 was $695 thousand.

 

The ALLL is based upon estimates of future loan and lease losses and is maintained at a level considered adequate to provide for probable losses inherent in the outstanding loan portfolio. Our ALLL methodology incorporates management’s current judgments, and reflects management’s estimate of future loan and lease losses and risks inherent in the loan portfolio in accordance with ASC Topic 450 Contingencies and ASC Topic 310 Receivables.

 

The allowance is increased by provisions charged to expense and reduced by net charge-offs. In periodic evaluations of the adequacy of the allowance balance, management considers past loan and lease loss experience by type of credit, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay, the estimated value of any underlying collateral, current economic conditions and other factors. We formally assess the adequacy of the ALLL on a monthlyquarterly basis. These assessments include the periodic re-grading of classified loans based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the interest rate environment and other factors as warranted. Loans are initially rated when originated. They are reviewed as they are renewed, when there is a new loan to the same borrower and/or when identified facts demonstrate heightened risk of default. Confirmation of the quality of our grading process is obtained by independent reviews conducted by outside consultants specifically hired for this purpose and by periodic examination by various bank regulatory agencies.

 

Management monitors delinquent loans continuously and identifies problem loans

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Notes to be evaluated individually for impairment testing. For loans that are determined impaired, a formal impairment measurement is performed at least quarterly on a loan-by-loan basis.

Consolidated Financial Statements

 

Our method for assessing the appropriateness of the allowance includes specific allowances for identified problem loans, an allowance factor for categories of credits and allowances for changing environmental factors (e.g., portfolio trends, concentration of credit, growth, economic factors). Allowances for identified problem loans are based on specific analysis of individual credits. Loss estimation factors for loan categories are based on analysis of local economic factors applicable to each loan category. Allowances for changing environmental factors are management’s best estimate of the probable impact these changes have had on the loan portfolio as a whole.

 

We believe that the ALLL was adequate as of December 31, 2018.2019. There is, however, no assurance that future loan and lease losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses. In addition, bank regulatory authorities, as part of their periodic examination of the Company, may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review.

 

As of December 31, 2018, 81%2019, 83% of our gross loan portfolio is secured by real estate, and a significant decline in real estate market values may require an increase in the ALLL. Deterioration in economic conditions particularly in our markets may adversely affect our loan portfolio and may lead to additional charges to the provision for loan and lease losses.

 

ImpairedManagement monitors delinquent loans continuously and identifies problem loans to be evaluated individually for impairment testing. For loans that are individually evaluated for impairment.determined impaired, a formal impairment measurement is performed at least quarterly on a loan-by-loan basis. If the measurement of each impaired loans’ value is less than the recorded investment in the loan, we recognize this impairment and adjust the carrying value of the loan to fair value through the ALLL. For collateral dependent loans, this can be accomplished by charging off the impaired portion of the loan based on the underlying value of the collateral. For non-collateral dependent loans, we establish a specific component within the ALLL based on the present value of the future cash flows. If we determine the sources of repayment will not result in a reasonable probability that the carrying value of a loan can be recovered, the amount of a loan’s specific impairment is charged off against the ALLL. Impairment reserves on non-collateral dependent restructured loans are measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s carrying value. These impairment reserves are recognized as a specific component to be provided for in the ALLL.

 

The unallocated portion of the ALLL provides for coverage of credit losses inherent in the loan portfolio but not captured in the credit loss factors that are utilized in the risk rating-based component, or in the specific impairment reserve component of the ALLL, and acknowledges the inherent imprecision of all loss prediction models. As of December 31, 2018,2019, the unallocated allowance amount represented 4%3% of the ALLL, compared to 3%4% at December 31, 2017.2018.

 

While the ALLL composition is an indication of specific amounts or loan categories in which future charge-offs may occur, actual amounts may differ.

 

We have lending policies and procedures in place with the objective of optimizing loan income within an accepted risk tolerance level. We review and approve these policies and procedures annually. Monitoring and reporting systems supplement the review process with regular frequency as related to loan production, loan quality, concentrations of credit, potential problem loans, loan delinquencies, and nonperforming loans.

 

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Notes to Consolidated Financial Statements

The following is a brief summary, by loan type, of management’s evaluation of the general risk characteristics and underwriting standards:

 

Commercial Loans – Commercial loans are underwritten after evaluating the borrower’s financial ability to maintain profitability including future expansion objectives. In addition, the borrower’s qualitative qualities are evaluated, such as management skills and experience, ethical traits, and overall business acumen. Commercial loans are primarily extended based on the cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The borrower’s cash flow may deviate from initial projections, and the value of collateral securing these loans may change.

 

Most commercial loans are generally secured by the assets being financed and other business assets such as accounts receivable or inventory. Management may also incorporate a personal guarantee; however, some short-term loans may be extended on an unsecured basis. Repayment of commercial loans secured by accounts receivable may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

 

Commercial Real Estate (“CRE”) Loans – CRE loans are subject to similar underwriting standards and processes as commercial loans. CRE loans are viewed predominantly as cash flow loans and secondarily as loans collateralized by real estate. Generally, CRE lending involves larger principal amounts with repayment largely dependent on the successful operation of the property securing the loan or the business conducted on the collateralized property. CRE loans tend to be more adversely affected by conditions in the real estate markets or by general economic conditions.

 

The properties securing the CRE portfolio are diverse in terms of type and primary source of repayment. This diversity helps reduce our exposure to adverse economic events that affect any single industry. We monitor and evaluate CRE loans based on occupancy status (investor versus owner occupied), collateral, geography, and risk grade criteria.

 

Generally, CRE loans are made to developers and builders that are secured by non-owner occupied properties require the borrower to have had an existing relationship with the Company and a proven record of success. Construction loans are underwritten utilizing feasibility studies, sensitivity analysis of absorption and lease rates, and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of cost and value associated with the complete project (as-is value). These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment largely dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property, or an interim loan commitment from the Company until permanent financing is secured. These loans are closely monitored by on-site inspections, and are considered to have higher inherent risks than other CRE loans due to their ultimate repayment sensitivity to interest rate changes, governmental regulation of real property, general economic conditions, and the availability of long-term financing.

 

Residential Real Estate Loans – We do not originate consumer real estate mortgage loans. The majority of our loans secured by non owner occupied residential real estate are made either as part of a commercial relationship and subject to similar underwriting standards and processes as the CRE portfolio, or loans that were purchased in a prior year as part of a pool of loans. Purchased loan pools are evaluated based on risk characteristics established for each segmented group of loans. These characteristics include a significant emphasis on historical losses within each loan group, inherent risks for each, and specific loan class characteristics such as trends related to nonaccrual loans, past due loans, criticized loans, net charge-offs or recoveries, among other relevant credit risk factors. Residential equity lines of credit are included in the discussion of consumer loans below.

 

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We originate some single family residence construction loans. The loan amounts are no greater than $1 million and are short term real estate secured financing for the construction of a single family residence to be occupied by the owner. The loans have a draw down feature with interest only payments, and a balloon payment at the 12-month maturity. All of these loans are refinanced and paid-off by the borrower’s permanent mortgage lender who provided the initial pre-approved mortgage financing. These loans are underwritten utilizing financial analysis of the borrower and are generally based upon estimates of cost and value associated with the complete project (as-is value). These estimates may be inaccurate. The loan disbursement and monitoring process is controlled utilizing similar processes as our CRE construction loans.

 

Consumer Loans – Our consumer loan originations are generally limited to home equity loans with nominal originations in unsecured personal loans. The portfolio also includes unsecured consumer home improvement loans and residential solar panel loans secured by UCC filings. We are highly dependent on third party credit scoring analysis to supplement the internal underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by management and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time, and documentation requirements.

 

We maintain an independent loan review program that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to the Board of Directors, Loan Committee and Audit Committee. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as our policies and procedures.

 

Management’s continuing evaluation of all known relevant quantitative and qualitative internal and external risk factors provides the foundation for the three major components of the ALLL: (1) historical valuation allowances established in accordance with ASC 450, Contingencies (“ASC 450”) for groups of similarly situated loan pools; (2) general valuation allowances established in accordance with ASC 450 that are based on qualitative credit risk factors; and (3) specific valuation allowances established in accordance with ASC 310, Receivables (“ASC 310”) that are based on estimated probable losses on specific impaired loans. All three components are aggregated and constitute the ALLL; while portions of the allowance may be allocated to specific credits, the allowance net of specific reserves is available for the remaining credits that management deems as “loss.” It is our policy to classify a credit as loss with a concurrent charge-off when management considers the credit uncollectible and of such little value that its continuance as a bankable asset is not warranted. A loss classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer recognizing the likely credit loss of a valueless asset even though partial recovery may occur in the future.

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Notes to Consolidated Financial Statements

 

Our loan portfolio is evaluated by general loan class including commercial, commercial real estate (which includes construction and other real estate), residential real estate (which includes 1-4 family and home equity loans), consumer and other loans. In accordance with ASC 450, historical valuation allowances are established for loan pools with similar risk characteristics common to each loan grouping. These loan pools are similarly risk-graded and each portfolio is evaluated by identifying all relevant risk characteristics that are common to these segmented groups of loans. These characteristics include a significant emphasis on historical losses within each loan group, inherent risks for each, and specific loan class characteristics such as trends related to nonaccrual loans, past due loans, criticized loans, net charge-offs or recoveries, among other relevant credit risk factors. We periodically review and update our historical loss ratios based on net charge-off experience for each loan and lease class. Other credit risk factors are also reviewed periodically and adjusted as necessary to account for any changes in potential loss exposure.

 

General valuation allowances, as prescribed by ASC 450, are based on qualitative factors such as changes in asset quality trends, concentrations of credit or changes in concentrations of credit, changes in underwriting standards, changes in experience or depth of lending staff or management, the effectiveness of loan grading and the internal loan review function, and any other relevant factors. Management evaluates each qualitative component quarterly to determine the associated risks to the quality of our loan portfolio.

 

 

 

NOTE 6. PURCHASE OF FINANCIAL ASSETS

During the second quarter of 2018 we terminated an agreement to purchase a maximum par value of $50.0 million in unsecured consumer home improvement loans from a third party originator. Prior to the termination, as we received principal payments on these purchased loans, new loans were purchased and the outstanding par value remained at approximately $50.0 million.

Since inception through December 31, 2018, we have paid aggregate cash totaling $137.3 million, and received aggregate cash repayments of $92.1 million for $45.2 million in net loans outstanding. The acquired loans were purchased without recourse or servicing rights and were recorded at fair value at the time of the purchase.

NOTE 7. PREMISES AND EQUIPMENT

 

The following table presents the major components of premises and equipment at December 31, 20182019 and 2017.2018.

 

(Amounts in thousands)
Premises and Equipment		2018				2017				2019				2018
Land		$	2,063			$	2,063			$	2,523			$	2,063
Land improvements			241				241				243				241
Bank buildings			13,076				12,976				15,222				13,076
Furniture, fixtures and equipment			12,682				12,639				13,341				12,682
Software			1,624				1,634				1,624				1,624
Assets not yet placed in service			72				337				860				72
Total premises and equipment			29,758				29,890				33,813				29,758
Less: accumulated depreciation and amortization			(16,639	)			(15,142	)			(17,907	)			(16,639	)
Premises and equipment, net		$	13,119			$	14,748			$	15,906			$	13,119

 

We record depreciation expense on a straight-line basis for all depreciable assets. Depreciation expense totaled $1.7 million, $2.1$1.4 million and $1.9$1.7 million, for the years ended December 31, 2018, 20172019 and 2016,2018, respectively. We have entered into a number of non-cancelable lease agreements with respect to various premises. See Note 15,12, Commitments and Contingencies in these Notes to Consolidated Financial StatementsLeases for more information regarding rental expense, rent income and minimum annual rental commitments under non-cancelable lease agreements.

 

 

NOTE 8. OTHER REAL ESTATE OWNED (OREO)

OREO represents real estate to which we have taken legal title in partial or full satisfaction of loans and properties originally acquired for branch expansion but no longer intended to be used for that purpose. OREO is recorded at fair value less costs to sell. Additional expenditures for improvements that increase the fair value of the property as it is prepared for sale are added to the property’s cost basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the ALLL. Thereafter, management periodically performs valuations and the property is carried at the lower of the cost or fair value less expected selling costs. Subsequent valuation adjustments and net expenses incurred from OREO property are recorded in noninterest expense, in the Consolidated Statements of Income.

The following table presents the changes in OREO for the years ended December 31, 2018, 2017, and 2016.

(Amounts in thousands)		Years Ended December 31,
OREO		2018				2017				2016
Balance at beginning of year		$	35			$	759			$	1,423
Additions			140				1,071				189
Dispositions			(144	)			(1,743	)			(745	)
Valuation adjustments			—				(52	)			(108	)
Total		$	31			$	35			$	759

For the year ended December 31, 2018, we transferred five foreclosed properties in the amount of $140 thousand to OREO. During this period, we sold five properties with balances of $144 thousand for a net gain of $73 thousand. The December 31, 2018 OREO balance consists of one 1-4 family residential real estate property in the amount of $31 thousand.

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Notes to Consolidated Financial Statements

 

NOTE 9.7. INTANGIBLE ASSETSGOODWILL AND OTHER INTANGIBLES

In February of 2019, as part of our Merchants acquisition, we recorded a core deposit intangible of $4.4 million and goodwill of $11.0 million. The core deposit intangible is being amortized on a straight-line basis over the estimated useful life of the deposits, which is eight years, with no expected residual value. For tax purposes, the core deposit intangible and goodwill are not being amortized.

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In December of 2018, we purchased a domain name for $32 thousand. The purchase of the domain name created an intangible asset with an indefinite life that is not being amortized for book purposes. For tax purposes the domain name is being amortized over 15 years.

 

In March of 2016, as part of our branch acquisition, we recorded a core deposit intangible of $1.8 million and goodwill of $665 thousand. The core deposit intangible is being amortized on a straight-line basis over the estimated useful life of the deposits, which is eight years, with no expected residual value. For tax purposes, the core deposit intangible and goodwill are being amortized over 15 years.

Goodwill is calculated as the amount of cash paid in excess of the fair value of the net assets acquired in the transaction. Goodwill is not amortized, but is annually reviewed for impairment. No impairment of goodwill was deemed necessary based on the 2019 and 2018 annual reviews.

The acquired core deposit base providesdeposits provide value as a source of below market rate funds and the realization of interest cost savings is a fundamental rationale for assuming these deposit liabilities. The cost savings is defined as the difference between the cost of funds on our new deposits (i.e., interest and net maintenance costs) and the cost of an equal amount of funds from an alternative source having a similar term as the new deposit base. Our core deposit intangible wasintangibles were recorded at fair value which was derived by using the income approach and representsrepresent the present value of the cost savings over the projected term of our new deposit base.

 

The core deposit intangible is being amortized on a straight-line basis over the estimated useful lifeGoodwill and Other Intangibles, net consisted of the deposits, which is eight years, with no expected residual value. For tax purposes, the core deposit intangible is being amortized over 15 years.

As offollowing at December 31, 2018, we have recorded the following amounts related to the core deposit intangible.2019 and 2018.

 

 

(Amounts in thousands)		December 31,
Intangibles		2018
Gross carrying amount		$	1,804
Accumulated amortization			(628	)
Core deposit intangible, net		$	1,176

(Amounts in thousands)
Goodwill and Other Intangibles		2019				2018
Goodwill		$	11,671			$	665
Core deposit intangibles			6,125				1,772
Domain name			32				32
Accumulated amortization			(1,348	)			(628	)
Goodwill and other intangibles, net		$	16,480			$	1,841

 

The following table sets forth, as of December 31, 2018,2019, the total estimated future amortization of intangible assets:

 

(Amounts in thousands)
For the year ended December 31,		Amount				Amount
2019		$	225
2020			225			$	766
2021			225				766
2022			225				766
2023			225				766
2024 and thereafter			51
2024							580
2025 and thereafter							1,133
Total		$	1,176			$	4,777

Goodwill is calculated as the amount of cash paid in excess of the fair value of the net assets acquired in the transaction. Goodwill is not amortized, but is annually reviewed for impairment. No impairment of goodwill was deemed necessary based on the 2018 annual review for impairment. For tax purposes, goodwill is being amortized over 15 years.

 

 

 

NOTE 108. OTHER ASSETS

 

Other assets consist of the following at December 31, 20182019 and 2017.2018.

 

(Amounts in thousands)		2018				2017				2019				2018
Federal Home Loan Bank of San Francisco stock		$	5,892			$	4,537			$	7,380			$	5,892
Qualified Zone Academy Bonds			4,740				4,740				4,740				4,740
Interest receivable			4,609				4,462				4,678				4,609
Right-of-use lease											3,464				—
Investments in affordable housing partnerships			3,020				3,529				2,529				3,020
Income taxes receivable											1,925				541
Investment in CRA fund											1,066				1,036
Prepaid expenses			1,075				1,132				991				1,075
Investment in CRA fund			1,036				1,011
SBA payments in process											701				411
Loan servicing receivables			625				643				415				625
SBA payments in process			411				179
Investment in Bank of Commerce Holdings Trust II			310				310				310				310
Other			767				129				354				226
Total		$	22,485			$	20,672			$	28,553			$	22,485

 

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Notes to Consolidated Financial Statements

 

 

NOTE 119. INTEREST-BEARING DEPOSITS

 

The following table presents the major types of interest-bearing deposits at December 31, 20182019 and 2017.2018.

 

(Amounts in thousands)		As of December 31,								As of December 31,
Interest-bearing deposits		2018				2017				2019				2018
Demand - interest-bearing		$	252,202			$	260,221
Money market accounts			265,093				236,769
Savings accounts			114,840				110,837
Interest-bearing demand										$	239,258			$	252,202
Money market											307,559				265,093
Savings											135,888				114,840
Certificates of deposit, less than $250,000			96,510				130,681				82,769				96,510
Certificates of deposit, $250,000 and over			55,872				58,574				69,017				55,872
Total interest-bearing deposits		$	784,517			$	797,082			$	834,491			$	784,517

 

The following table presents interest expense for the major types of interest-bearing deposits for the years ended December 31, 2018, 20172019 and 2016.2018.

 

(Amounts in thousands)		For the year ended December 31,												For the year ended December 31,
Deposit Interest Expense		2018				2017				2016				2019				2018
Demand - interest-bearing		$	414			$	274			$	201
Money market accounts			646				470				322
Savings accounts			288				200				174
Interest-bearing demand														$	480			$	414
Money market															1,599				646
Savings															493				288
Certificates of deposit, less than $250,000			1,100				1,429				1,537				1,127				1,100
Certificates of deposit, $250,000 and over			810				759				642				850				810
Total interest-bearing deposits		$	3,258			$	3,132			$	2,876			$	4,549			$	3,258

 

The following table presents the scheduled maturities of all certificates of deposit as of December 31, 2018.2019.

 

(Amounts in thousands)
Amounts due in:
2019		$	83,928
Due in:						Amount
2020			28,912			$	91,880
2021			26,419				40,670
2022			9,676				12,236
2023			3,422				3,330
2024							3,632
Thereafter			25				38
Total certificates of deposit		$	152,382			$	151,786

 

The following table presents the scheduled maturities of certificates of deposit of $250 thousand or more as of December 31, 2018.2019.

 

(Amounts in thousands)
Amounts due in:
Due in:						Amount
Three months or less		$	9,144			$	11,493
Over three months through six months			5,405				14,830
Over six months through twelve months			5,583				16,117
Over twelve months			35,740				26,577
Total certificates of deposit of $250 thousand or more		$	55,872			$	69,017

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NOTE 12.10. TERM DEBT

 

Term debt at December 31, 20182019 and 20172018 consisted of the following.

 

(Amounts in thousands)		2018				2017				2019				2018
Senior debt		$	3,496			$	7,096			$	—			$	3,496
Unamortized debt issuance costs			(2	)			(6	)			—				(2	)
Subordinated debt			10,000				10,000				10,000				10,000
Unamortized debt issuance costs			(89	)			(132	)			(43	)			(89	)
Net term debt		$	13,405			$	16,958			$	9,957			$	13,405

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Notes to Consolidated Financial Statements

 

Future contractual maturities of term debt at December 31, 20182019 are as follows.

 

(Amounts in thousands)		2019				2020				2021				2022				2023				Thereafter				Total				2020				2021				2022				2023				2024				Thereafter				Total
Senior debt		$	1,000			$	2,496			$	—			$	—			$	—			$	—			$	3,496
Subordinated debt			—				—				—				—				—				10,000				10,000			$	—			$	—			$	—			$	—			$	—			$	10,000			$	10,000
Total future maturities		$	1,000			$	2,496			$	—			$	—			$	—			$	10,000			$	13,496			$	—			$	—			$	—			$	—			$	—			$	10,000			$	10,000

 

Federal Home Loan Bank of San Francisco Borrowings

 

We have an available line of credit with the Federal Home Loan Bank of San Francisco of $395.5$460.5 million subject to certain collateral requirements, namely the amount of pledged loans and investment securities. The line of credit is secured by an investment in Federal Home Loan Bank of San Francisco stock, certain real estate secured loans that have been specifically pledged to the Federal Home Loan Bank of San Francisco pursuant to collateral requirements, and certain pledged securities held in the Bank’s investment securities portfolio.

 

The Bank had no borrowings outstanding under secured lines of credit from the Federal Home Loan Bank of San Francisco at December 31, 20182019 and December 31, 2017.2018. The average balance outstanding on Federal Home Loan Bank of San Francisco term advances during the year ended December 31, 20182019 and year ended December 31, 20172018 was $22.5$9.6 million and $302 thousand$22.5 million, respectively. The maximum amount outstanding from the Federal Home Loan Bank of San Francisco at any month end during the year ended December 31, 20182019 and year ended December 31, 20172018 was $70.0$40.0 million and $10.0$70.0 million, respectively.

 

As of December 31, 2018,2019, the Bank was required to hold an investment in Federal Home Loan Bank of San Francisco stock of $5.9$7.4 million recorded in Other Assets in the Consolidated Balance Sheets.Sheets. Our investments in Federal Home Loan Bank of San Francisco stock are restricted investment securities, carried at cost, evaluated for impairment, and excluded from securities accounted for under ASC Topic 320 and ASC Topic 321.

 

We have pledged $449.5$516.4 million of our commercial real estate and residential real estate loans as collateral for the line of credit with the Federal Home Loan Bank of San Francisco. As of December 31, 2018,2019, we also pledged $30.9$28.8 million in securities to the Federal Home Loan Bank of San Francisco.

 

Senior Debt

 

In December of 2015, the Holding Company entered into a senior debt loan agreement to borrow $10.0 million from another financial institution. During the second quarter of 2019, we completed the early repayment and termination of this variable-rate debt agreement. The original loan terms required monthly principal installments of $83 thousand, plus accrued and unpaid interest, commencing on January 1, 2016, continuing to, and including December 10, 2020 and a final scheduled payment of $5.0 million due on the maturity date of December 10, 2020. The loan maywas secured by a pledge from the Holding Company of all of the outstanding stock of Merchants Bank of Commerce. The loan could be prepaid in whole or in part at any time without any prepayment penalty. The principal amount of the loan bearsbore interest at a variable rate, resetting monthly that iswas equal to the sum of the current three-month LIBOR plus 400 basis points. In December of 2015, the Holding Company incurred senior debt issuance costs of $15 thousand, which arewere being amortized over the initial term of the loan as additional interest expense. The loan is secured by a pledge from the Holding Company of all of the outstanding stock of Redding Bank of Commerce.

 

Subordinated Debt

 

In December of 2015, the Holding Company issued $10.0 million in aggregate principal amount of fixed to floating rate Subordinated Notes due in 2025. The Subordinated Debt initially bears interest at 6.88% per annum for a five-year term, payable semi-annually. Thereafter, interest on the Subordinated Debt will be paid at a variable rate equal to three month LIBOR plus 526 basis points, payable quarterly until the maturity date. In December of 2015, the Holding Company incurred subordinated debt issuance costs of $210 thousand, which are being amortized over the initial five-year-term as additional interest expense.

 

The Subordinated Debt is subordinate and junior in right of payment to the prior payment in full of all existing and future claims of creditors and depositors of the Holding Company and its subsidiaries, whether now outstanding or subsequently created. The Subordinated Debt ranks equally with all other unsecured subordinated debt, except any which by its terms is expressly stated to be subordinated to the Subordinated Debt. The Subordinated Debt ranks senior to all preferred stock and common stock of the Holding Company and all future junior subordinated debt obligations. The Subordinated Debt is recorded as term debt on the Holding Company’s balance sheet; however, for regulatory purposes, it is treated as Tier 2 capital by the Holding Company.

 

The Subordinated Debt will mature on December 10, 2025 but may be prepaid at the Holding Company’s option and with regulatory approval at any time on or after five years after the Closing Date or at any time upon certain events, such as a change in the regulatory capital treatment of the Subordinated Debt or the interest on the Subordinated Debt is no longer deductible by the Holding Company for United States federal income tax purposes.

 

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Federal Funds

 

We have entered into nonbinding federal funds line of credit agreements with three financial institutions to support short-term liquidity needs. The lines totaled $35.0 million at December 31, 20182019 and had interest rates ranging from 2.64%1.80% to 3.28%2.58%. Advances under the lines are subject to funds availability, continued borrower eligibility, and may have consecutive day usage restrictions. The credit arrangements are reviewed and renewed annually. At December 31, 20182019 and 2017,2018, we had no outstanding federal funds purchased balances and no outstanding advances on any of the Bank’s lines of credit.

 

Federal Reserve Bank

 

We have an available line of credit with the Federal Reserve Bank totaling $17.3$22.3 million subject to collateral requirements, namely the amount of certain pledged loans. As of December 31, 2019, we have pledged $25.7 million of our commercial loans as collateral for the credit line with the Federal Reserve Bank.

 

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NOTE 1311. JUNIOR SUBORDINATED DEBENTURES

 

The Company has one wholly-owned trust formed in 2005 to issue trust preferred securities and related common securities. The following table presents information about the Trust as of December 31, 20182019 and 2017.2018.

 

(Amounts in thousands)

Issued

Effective

Redemption

Trust Name

Issue Date

Issued Amount

Rate

Effective Rate

Maturity Date

Redemption Date

Issue Date

Amount

Rate

Rate

Maturity Date

Date

Bank of Commerce Holdings Trust II

July 29, 2005

$

10,310

Floating (2)

(1)

September 15, 2035

(3)

July 29, 2005

$

10,310

Floating (1)

(2)

September 15, 2035

(3)

(1) Effective rate as of December 31, 2018 and 2017 of 4.37% and 3.17%, respectively.

(2) Contractual interest rate of junior subordinated debentures based on three month LIBOR plus 1.58% adjusted quarterly.

(2) Effective rate as of December 31, 2019 and 2018 of 3.47% and 4.37%, respectively.

(3) Redeemable at the Company’s option on any March 15, June 15, September 15, or December 15.

 

The $10.3 million of junior subordinated debentures issued to Trust II as of December 31, 20182019 and 2017,2018, are reflected in the Consolidated Balance Sheets. The common stock issued by Trust II in the amount of $310 thousand is recorded in Other Assets in the Consolidated Balance Sheets, at December 31, 20182019 and 2017.2018. All of the debentures issued to Trust II, less the common stock of Trust II, qualified as Tier 1 capital as of December 31, 20182019 and 2017,2018, under guidance issued by the Federal Reserve Board.

 

 

 

NOTE 1412. OTHER LIABILITIESLEASES

 

Other liabilities consist of the following at December 31, 2018 and 2017.

(Amounts in thousands)		2018				2017
Deferred compensation – directors fees		$	3,846			$	3,823
Salary continuation			3,462				3,387
Severance payable			760				790
Accrued employee incentives			1,522				1,170
Reserve for unfunded commitments			695				695
Dividend payable on common stock			651				486
Delayed equity contributions - affordable housing tax credit partnerships			343				361
Deferred income			283				315
Other loan servicing liabilities			188				235
Other			1,602				895
Total		$	13,352			$	12,157

NOTE 15. COMMITMENTS AND CONTINGENCIES

Lease Commitments – We lease nineten sites under non-cancelable operating leases. The leases contain various provisions for increases in rental rates based on predetermined escalation schedules. Substantially all of the leases include the option to extend or terminate the lease term one or more times following expiration of the initial term.term at a rental rate established in the lease. For leases where we are reasonably certain that we will exercise the option to renew the lease, we have recognized those options in our right-of-use lease asset and liability. We had no other (financing, short-term or variable) lease arrangements during the current period or the prior year.

We have applied ASC Topic 842 as of January 1, 2019 and elected the practical expedients package for all of our leases. In accordance with the practical expedients package we were not required to reassess whether any expired or existing contracts are leases or contain leases. We were also not required to reassess the lease classification for existing or expired leases between operating and finance leases. On January 1, 2019, we recorded $4.4 million in Other Liabilities representing the present value of the remaining minimum lease payments and we recorded an offsetting right-of-use asset in Other Assets. The present value calculation uses a discount rate, which is based on our incremental borrowing rate. The right-of-use asset was also reduced by $458 thousand on January 1, 2019 for amounts recognized under the previous accounting requirements. During the year ended December 31, 2019, we recorded $267 thousand in Other Liabilities and an offsetting right-of-use asset in Other Assets for additional office space leased during the year. The table below presents information regarding our leases as of December 31, 2019.

 

(Amounts in thousands)		December 31, 2019
Right-of-use lease asset		$	3,464
Lease liability		$	3,855
Weighted Average Remaining Lease Term			5.54
Weighted Average Discount Rate			2.96	%

Lease expenses are recorded on a straight-line basis over the life of each lease. Lease expense and cash paid on leases are presented in the table below for the periods indicated.

84

		For the year ended December 31,
(Amounts in thousands)		2019				2018
Operating lease expense		$	830			$	793
Cash paid for operating leases		$	897			$	809

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Notes to Consolidated Financial Statements

The following table sets forth rent expense and rent income for the years ended December 31, 2018 and 2017.

		December 31,
(Amounts in thousands)		2018				2017				2016
Rent income(1)		$	—			$	46			$	78
Rent expense			922				841				707
Net rent expense		$	922			$	795			$	629

(1) Rental income is derived from OREO properties

 

The following table sets forth, as of December 31, 2018,2019, the future minimum lease cash payments under non-cancelable operating leases and a reconciliation of the undiscounted cash flows to the operating lease liability.

(Amounts in thousands)
Due in:		Amount
2020		$	961
2021			979
2022			888
2023			342
2024			295
Thereafter			737
Total undiscounted future minimum lease cash payments			4,202
Present value adjustment			(347	)
Lease liability		$	3,855

Our election to utilize the practical expedients package did not result in the recognition of any additional leases, changes in lease terms, changes in classification or in the assessment of initial direct costs. ASC 842 was applied as a change in accounting principle and did not result in any adjustment to equity. The significant judgment made in applying the requirements in ASC Topic 842 is the determination of the incremental borrowing rate for the lease. We used the borrowing rates for terms similar to the lease terms available under our existing line of credit with the Federal Home Loan Bank of San Francisco as our incremental borrowing rate.

 

 

(Amounts in thousands)
Amounts due in:
2019		$	866
2020			884
2021			899
2022			807
2023			335
Thereafter			1,032
Total		$	4,823

NOTE 13. OTHER LIABILITIES

Other liabilities consist of the following at December 31, 2019 and 2018.

(Amounts in thousands)		2019				2018
Salary continuation		$	4,691			$	3,462
Deferred compensation – directors fees			3,873				3,846
Leases			3,855				459
Accrued employee incentives			967				1,522
Dividend payable on common stock			902				651
Severance payable			818				760
Reserve for unfunded commitments			695				695
Delayed equity contributions - affordable housing tax credit partnerships			338				343
Other loan servicing liabilities			162				188
Deferred income			99				283
Other			1,300				1,143
Total		$	17,700			$	13,352

NOTE 14. COMMITMENTS AND CONTINGENCIES

 

Financial Instruments with Off-Balance Sheet Risk

 

Our consolidated financial statements do not reflect various commitments and contingent liabilities that arise in the normal course of our business and involve elements of credit, liquidity, and interest rate risk. In the normal course of business we are party to financial instruments with off-balance sheet credit risk to meet the financing needs of our customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. These instruments involve elements of credit and interest rate risk similar to the amounts recognized in the Consolidated Balance Sheets. The contract or notional amounts of these instruments reflect the extent of our involvement in particular classes of financial instruments.

 

The following table presents a summary of our commitments and contingent liabilities at December 31.

 

(Amounts in thousands)		2018				2017				2019				2018
Commitments to extend credit		$	223,882			$	217,714			$	267,248			$	223,882
Standby letters of credit			8,548				6,692				4,406				8,548
Affordable housing grants			3,338				3,338
Affordable housing grant sponsorships											3,338				3,338
Access to housing and economic assistance for development grant sponsorships											110				100
Total commitments and contingent liabilities		$	235,768			$	227,744			$	275,102			$	235,868

 

We were not required to perform on any financial guarantees for the years ended December 31, 20182019 and 2017.2018. At December 31, 2018,2019, approximately $8.4$3.7 million of standby letters of credit expire within one year, and $118$744 thousand expire thereafter.

 

Affordable Housing GrantsGrant and Access to Housing and Economic Assistance for Development Grant Sponsorships

 

In fulfilling our CRA responsibilities, we are a sponsor for various nonprofit organizations that receive cash grants from the Federal Home Loan Bank of San Francisco. Those grants require the nonprofit organization to comply with stipulated conditions of the grant over specified periods of time which typically vary from 10 to 15 years. If the nonprofit organization fails to comply, Federal Home Loan Bank of San Francisco can require us to refund the amount of the grant to Federal Home Loan Bank of San Francisco. To mitigate this contingent credit risk, Credit Administration underwrites the financial strength of the nonprofit organization and reviews their systems of internal control to determine, as best as possible, that they will not fail to comply with the conditions of the grant.

 

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Reserve for Unfunded Commitments

 

The reserve for unfunded commitments, which is included in Other Liabilities on the Consolidated Balance Sheets, was $695 thousand at December 31, 20182019 and 2017.2018. The adequacy of the reserve for unfunded commitments is reviewed on a quarterly basis, based upon changes in the amount of commitments, loss experience, and economic conditions. When necessary, the provision expense is recorded in other noninterest expense in the Consolidated Statements of Income.

 

Death Benefit Agreement

 

The Company has entered into agreements with certain employees to pay a cash benefit to designated beneficiaries following the death of the employee. The payment will be made only if, at the time of death, the deceased employee was employed by the Bank and the Bank owned a life insurance policy on the employee’s life. Depending on specific facts and circumstances, the payment amount can vary up to a maximum of $225 thousand per employee and may be taxable to the recipient. Neither the employee nor the designated recipient has a claim against the Bank’s life insurance policy on the employee’s life.

 

Legal Proceedings

 

We are involved in various pending and threatened legal actions arising in the ordinary course of business and if necessary, we maintain reserves for losses from legal actions, which are both probable and estimable. In our opinion, the disposition of claims currently pending will not have a material adverse effect on our financial position or results of operations.

 

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Concentrations of Credit Risk

 

We grant many loans collateralized by real estate. In our judgment, a concentration exists in real estate related loans, which represented approximately 81%83% and 77%81% of our gross loan portfolio at December 31, 20182019 and December 31, 2017,2018, respectively. We underwrite real estate loans in accordance with loan policies that set underwriting criteria, including property types, loan-to-value limits and minimum debt service coverage ratios. We employ a variety of real estate concentration risk management tools including monitoring of limits on concentration levels, limits by property type and geography, annual property reviews including site visits and portfolio stress testing.

 

Although we believe such concentrations have no more than the normal risk of collectability, a substantial decline in the economy in general, material increases in interest rates, changes in tax policies, tightening credit or refinancing markets, or a decline in real estate values in our principal market areas in particular, could have an adverse impact on the repayment of these loans. Business and personal incomes, cash flows from rental operations, proceeds from the sale of real property, or proceeds from refinancing, represent the primary sources of repayment for a majority of these loans.

 

We recognize the credit risks inherent in dealing with other depository institutions. Accordingly, to prevent excessive exposure to other depository institutions in aggregate or individually, we have established general standards for selecting correspondent banks as well as internal limits for allowable exposure to other depository institutions in aggregate or individually. In addition, we have an investment policy that sets forth limitations that apply to all investments with respect to credit rating and concentrations with an issuer.

 

 

 

NOTE 16.15. EMPLOYEE BENEFITS AND RETIREMENT PLANS

 

Profit sharing401(k) plan – In 1985, we adopted a profit sharing 401(k) plan for eligible employees to be funded out of the earnings of the Company. The employees’ contributions are limited to the maximum amount allowable under IRS Section 402(G). The Company’s safe harbor contributions include a matching contribution of 100% of the first 3% of salary deferred and 50% of the next 2% of salary deferred. Discretionary contributions are also permitted. We made matching contributions aggregating $549 thousand, $494$627 thousand and $457$549 thousand for the years ended December 31, 2019 and 2018, 2017 and 2016, respectively. NoDiscretionary contributions are also permitted however, there were no discretionary contributions were made over the threetwo year reporting period.

 

Salary continuation plan – In April of 2001, theThe Board of Directors has approved the implementation of the Supplemental Executive Retirement Plan (SERP), which is a non-qualified executive benefit plan under which we agree to pay certain executives covered by the SERP plan additional benefits in the future in return for continued satisfactory performance.

 

Benefits under the salary continuation plan differ by participating executive and include a benefit generally payable commencing upon a designated retirement date for a fixed period of ten years, disability or termination of employment, and a death benefit for the participants’ designated beneficiaries. Whole life insurance policies were purchased as an investment to provide for our contractual obligation to pay pre-retirement death benefits and to recover our cost of providing benefits. The executive is the insured under the policy, while we are the owner and beneficiary.

 

The Company accrues for these future benefits from the effective date of the agreements until the executives’ expected final payment date. The amount of accrued benefits approximates the present value of the benefits expected to be provided at retirement. Compensation expense under the salary continuation plan totaled $532 thousand, $577$547 thousand and $551$532 thousand for the years ended December 31, 2018, 20172019 and 2016,2018, respectively. As of December 31, 2018,2019, and 2017,2018, the vested benefit payable was $3.5$4.7 million and $3.4$3.5 million, respectively. We use the FTSE Pension Liability Index as a guideline to establish the discount rate used to present value the benefits under the salary continuation plan.

During the first quarter of 2019 as part of our acquisition of Merchants we recorded an additional salary continuation liability of $968 thousand.

 

Directors deferred fee compensation – On December 19, 2013, the Board of Directors adopted a Directors Deferred Compensation Plan, which was amended and restated on February 20, 2018, (the “2013 Plan”) to replace the Directors Deferred Compensation Plan dated January 1, 1993 as amended (the “1993 Plan”). Both plans allow the eligible Director to voluntarily elect to defer some or all of his or her current fees in exchange for the Company’s promise to pay a deferred benefit. The deferred fees are credited with interest and the accrued liability is paid to the Director atfollowing retirement. Directors must stop the deferral of compensation once their total deferred benefit reaches $500 thousand.

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The interest rate in the 2013 Plan is equal to the Bloomberg 20-year Investment Grade Financial Institutions Index (IGFII) rate (or a similar reference rate we select if that rate is not published) in effect on the interest accrual date, plus two percent. The 2013 Plan is only available to independent directors and, as a nonqualified deferred compensation plan, is not subject to nondiscrimination requirements applicable to qualified plans. No deferred compensation is payable to a director until separation from service, whereupon all such compensation, together with interest thereon shall be provided to such Director, or his beneficiary within thirty (30) days. The Director may designate payments to be made in a lump sum or in monthly installments over a period not to exceed 120 months.

 

Although deferrals under the 1993 Plan have ceased, the 1993 Plan remains in effect for all amounts previously deferred in the plan. The interest rate in the 1993 Plan is equal to the Wall Street Journal prime plus 3.00% or at a fixed rate of 10%. Under the 1993 Plan, at retirement, Directors are granted the option of continuing to accrue interest on deferred payments at a variable rate of Wall Street Journal prime plus 3.00% or at a fixed rate of 10%.fees. The Director may designate payments to be made in a lump sum or in monthly installments over a period not to exceed 180120 months.

 

Deferred compensation expense recorded in other noninterest expense totaled $309 thousand, $292$324 thousand and $281$309 thousand for the years ended December 31, 2018, 2017,2019 and 2016,2018, respectively. As of December 31, 2018,2019, and 2017,2018, the vested benefit payable recorded in Other Liabilities in the Consolidated Balance Sheets was $3.8$3.9 million.

 

 

 

NOTE 17.16. SHAREHOLDERS’ EQUITY AND STOCK PLANS

 

On January 31, 2019 we issued 1,834,142 shares of common stock, and paid $15.3 million in cash as part of our acquisition of Merchants Holding Company (“Merchants”). at which point Merchants shareholders now hold,held, in the aggregate, approximately 10% of our outstanding common stock. The acquisition added $190.2 million in deposits, $85.3 million in loans $190.2 million in deposits and $107.4 million in investment securities after fair value adjustments to our bank as ofon January 31, 2019. See Note 2321 Acquisition in these Notes to Consolidated Financial Statements for additional information on the acquisition

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acquisition.

 

On May 10, 2017, we completed the sale of 2,738,096 shares of our common stock at a public offering price of $10.50 and received net proceeds of $26.8 million. These proceeds were used to fund our acquisition of Merchants Holding Company and to repay certain borrowings.

 

During the fourth quarter of 2019 we paid $1.0 million to repurchase 90,501 shares of common stock as part of our previously announced share repurchase program.

Stock Plans – The 2008 Stock OptionBank of Commerce Holdings 2019 Equity Incentive Plan (the “Plan”), was approved by the Holding Company’s shareholders on May 15, 2007 (“21, 2019 and replaced the Plan”). The Plan was amendedAmended and restated by theRestated 2010 Equity Incentive Plan which was approved by the Holding Company’s shareholders on May 18, 2010. A further  amendment and restatement of the Plan was approved by the Holding Company’s shareholders on May 15, 2012.Plan. The Plan provides for equity awards including options, stock options, restricted stockappreciation rights, and restricted stock units which may constitute incentive stock options (“ISO”) under Section 422(a)awards to employees and non-employee directors of the Internal Revenue Code of 1986, as amended, or non-statutory stock options (“NSO”) to key personnel of the Company, including Directors. The Plan provides that ISO and NSO under the Plan may not be granted at less than 100% of fair market value of the Holding Company’s common stock on the date of the grant.Company. Vesting may be accelerated in case of an option holder’sa participant’s death or disability, and retirement or in case of a change ofin control. At December 31, 2018, approximately 152 thousand2019, 486,900 common shares were available for future grants under the Plan.

 

We recognized $46$9 thousand in tax benefits from vesting of restricted stock and $216 thousand in proceeds from stock options exercised during the year ended December 31, 2018.2019. Proceeds from exercise of stock options exercised were $245$52 thousand and $10$216 thousand for the years ended December 31, 20172019 and 2016,2018, respectively.

 

Stock Option Activity

 

There were no new stock options awarded during the three years ended December 31, 2018. The following tables summarize information about stock option activity for the years ended December 31, 2018, 20172019, and 2016.2018.

 

						Weighted								Weighted												Aggregate				Weighted Average
						Average				Aggregate				Average				Number				Weighted Average				Intrinsic Value				Remaining
		Number				Exercise				Intrinsic				Remaining				of Shares				Exercise Price				At Time Of Grant				Contractual Term
		of Shares				Price				Value				Contractual Term
Options outstanding December 31, 2016			188,900			$	5.08			$	834,625				5.66
Exercised			(51,900	)		$	4.73			$	245,450				4.42
Forfeited			(2,500	)		$	4.05			$	n/a				n/a
Options outstanding December 31, 2017			134,500			$	5.24			$	704,350				4.76				134,500			$	5.24			$	704,350				4.76
Exercised			(37,100	)		$	5.82			$	215,685				2.96				(37,100	)		$	5.82			$	215,685				n/a
Forfeited			—			$	—			$	n/a				n/a
Options outstanding December 31, 2018			97,400			$	5.02			$	488,665				4.11				97,400			$	5.02			$	488,665				4.11
Exercised																			(11,000	)		$	4.70			$	51,670				n/a
Options outstanding December 31, 2019																			86,400			$	5.06			$	436,995				3.09
Exercisable at December 31, 2018			93,400			$	4.98			$	465,345				4.03				93,400			$	5.02			$	488,665				4.11
Exercisable at December 31, 2019																			86,400			$	5.06			$	436,995				3.09

 

		For the Years Ended December 31,
(Amounts in thousands, except per share information)		2018				2017				2016
Stock option expense		$	8			$	23			$	24

		At December 31,
		2018				2017				2016
Unrecognized compensation costs related to non-vested stock option payments		$	—			$	17			$	29
Number of exercisable shares			93				119				157

There were no new stock options awarded during the two years ended December 31, 2019 and there are no unrecognized compensation costs for stock options. There was no stock option expense for the current year compared to $8 thousand for the year ended December 31, 2018. Stock options vestvested at 20% per year from the date of the grant. The unrecognized compensation costsgrant and, at December 31, 2019, all options are expected to be recognized over a weighted average period of two years.fully vested.

 

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Notes to Consolidated Financial Statements

 

Restricted Stock Activity

 

The following tables summarize information about unvested restricted shares and restricted shares granted for the years ended December 31, 2018, 20172019 and 2016.2018.

 

						Weighted								Weighted																Weighted Average
						Average				Aggregate				Average				Number				Weighted Average				Aggregate				Remaining
		Number				Grant				Intrinsic				Remaining				of Shares				Grant Price				Intrinsic Value				Contractual Term
		of Shares				Price				Value				Contractual Term
Unvested restricted shares December 31, 2016			67,180			$	5.84			$	638,210				1.38
Granted			45,070			$	10.35			$	466,328				1.32
Vested			(37,761	)		$	5.79			$	218,600				n/a
Unvested restricted shares December 31, 2017			74,489			$	8.60			$	640,255				1.03				74,489			$	8.60			$	640,255				1.03
Granted			29,913			$	11.50			$	344,000				1.07				29,913			$	11.50			$	344,000				1.07
Vested			(37,634	)		$	7.53			$	283,433				n/a				(37,634	)		$	7.53			$	283,433				n/a
Unvested restricted shares December 31, 2018			66,768			$	10.50			$	700,820				0.97				66,768			$	10.50			$	700,820				0.97
Granted																			57,292			$	11.02			$	631,336				1.32
Vested																			(27,243	)		$	11.14			$	303,593				n/a
Forfeited																			(5,096	)		$	11.12			$	56,659				n/a
Unvested restricted shares December 31, 2019																			91,721			$	10.91			$	1,000,954				1.12

 

 

		For the Years Ended December 31,												For the Years Ended December 31,
(Amounts in thousands, except per share information)		2018				2017				2016				2019				2018
Restricted stock compensation expense		$	185			$	196			$	215			$	414			$	288
Restricted stock awards weighted average grant date fair value per share		$	11.50			$	10.35			$	5.74			$	11.02			$	11.50

 

		At December 31,
		2018				2017				2016
Unrecognized compensation costs related to non-vested restricted stock payments		$	470			$	414			$	205

		At December 31,
		2019				2018
Unrecognized compensation costs related to non-vested restricted stock payments		$	642			$	470

 

Restricted shares vest over a three to five year service period. Unvested restricted shares have no dividend or voting rights. The unrecognized compensation costs for unvested restricted shares  are expected to be recognized over a weighted average period of two years.one year.

 

Stock Grant Activity

 

The following tables summarize information about shares granted as employee compensation for the years ended December 31, 20182019 and 2017.2018. Stock grants are fully vested and expensed in the period awarded

 

						Weighted				Stock												Stock Grant
						Average				Grant				Number				Weighted Average				Compensation
		Number				Grant				Compensation				of Shares				Grant Price				Expense
		of Shares				Price				Expense
Shares granted during the year ended December 31, 2019															6,169			$	11.04			$	68,106
Shares granted during the year ended December 31, 2018			4,653			$	11.50			$	53,510				4,653			$	11.50			$	53,510
Shares granted during the year ended December 31, 2017			4,868			$	10.05			$	48,923

 

Dividends

 

Presented below is a summary of cash dividends paid to common shareholders, recorded as a reduction of retained earnings. The holders of unvested restricted stock awards are not entitled to dividends on unvested shares. On December 19, 2018,18, 2019, we declared a cash dividend of $0.04$0.05 per share, payable on January 11, 201910, 2020 to shareholders of record at the close of business on January 2,December 31, 2019.

 

		For the Years Ended December 31,
(Amounts in thousands, except per share information)		2019				2018
Cash dividends paid to common shareholders		$	3,189			$	2,274
Cash dividends paid per common share		$	0.19			$	0.15

 

		For the Years Ended December 31,
(Amounts in thousands, except per share information)		2018				2017				2016
Cash dividends paid to common shareholders		$	2,274			$	1,776			$	1,603
Cash dividends paid per common share		$	0.14			$	0.12			$	0.12

Our principal source of cash for the Holding Company is dividends received from the Bank, which are subject to government regulation and limitations on the Bank’s ability to pay dividends. We also have trust preferred securities and subordinated debt agreements with provisions that may impact our ability to pay dividends on our common stock to our common shareholders.

 

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NOTE 18.17. REGULATORY CAPITAL

 

The Holding Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that if undertaken, could have a direct material effect on our Consolidated Financial Statements.

Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices.

On July 2, 2013, the federal banking agencies substantially amended the regulatory risk-based capital rules applicable to the Holding Company and the Bank. Effective January 1, 2015 the new rules created “Common equity tier 1,” a new measure of regulatory capital closer to pure tangible common equity than the present Tier 1 definition; The required minimum risk-based capital ratio for Common equity tier 1 is 4.5 percent and with a 2.5 percent capital conservation buffer. The capital conservation buffer of 2.5 percent was phased in between 2016 and 2019.

The new capital rules required the Bank to meet the capital conservation buffer requirement by 2019 in order to avoid constraints on capital distributions, such as dividends and equity repurchases, and certain bonus compensation for executive officers. These new capital rules also change the risk-weights of certain assets for purposes of the risk-based capital ratios and phase out certain instruments as qualifying capital.

 

The capital amounts and the Bank’s prompt corrective action classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulation to ensure capital adequacy, require the Company and the Bank to maintain minimum amounts and ratios set forth in the following table as defined in the regulations. Management believes as of December 31, 20182019 that the Company and the Bank met all capital adequacy requirements to which they are subject.

 

TheIn May 2018 the Crapo Bill,bill was signed into law in May 2018, simplifieswhich simplified the regulatory capital rules for financial institutions and their holding companies with total consolidated assets of less than $10 billion and instructed the federal banking regulators to establish a single “Community Bank Leverage Ratio” of between 8% and 10%. On November 21, 2018, the FDIC published a proposed Community Bank Leverage Ratio of(“CBLR”) which has been set at 9%. Any qualifying depository institution or its holding company that exceeds the Community Bank Leverage Ratio will be considered to have met generally applicable leverage and risk-based regulatory capital requirements and considered to be “well capitalized” under the prompt corrective action rules discussed above. It is difficult at this time to predict when or how the new standards under the Crapo Bill will ultimately be applied to us or what specific impact the Crapo Bill (and any implementing rules and regulations) will have on community banks.

 

As of December 31, 2018,2019, the most recent notification from the FDIC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized”, an institution must maintain minimum ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank’s capital rating category.

 

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The Holding Company’s and the Bank’s actual capital amounts and ratios as of December 31, 20182019 and 20172018 are presented in the following table.

 

										Well								Minimum								Applicable				Minimum Capital																Well								Minimum								Applicable				Minimum Capital
										Capitalized								Capital								Capital				Ratio plus Capital																Capitalized								Capital								Capital				Requirement plus Capital
		Capital				Actual				Requirement								Requirement								Conservation				Conservation Buffer								Capital				Actual				Requirement								Requirement								Conservation				Conservation Buffer
(Amounts in thousands)		Amount				Ratio				Amount				Ratio				Amount				Ratio				Buffer				Amount				Ratio				Amount				Ratio				Amount				Ratio				Amount				Ratio				Buffer				Amount				Ratio
At December 31, 2019:
Company
Common equity tier 1 capital ratio																																						$	156,587				13.19	%			n/a				n/a			$	53,409				4.50	%			2.50	%		$	83,081				7.00	%
Tier 1 capital ratio																																						$	166,587				14.04	%			n/a				n/a			$	71,212				6.00	%			2.50	%		$	100,884				8.50	%
Total capital ratio																																						$	189,513				15.97	%			n/a				n/a			$	94,949				8.00	%			2.50	%		$	124,621				10.50	%
Tier 1 leverage ratio																																						$	166,587				11.30	%			n/a				n/a			$	58,945				4.00	%			n/a			$	58,945				4.00	%
Bank
Common equity tier 1 capital ratio																																						$	170,568				14.39	%		$	77,072				6.50	%		$	53,358				4.50	%			2.50	%		$	83,001				7.00	%
Tier 1 capital ratio																																						$	170,568				14.39	%		$	94,858				8.00	%		$	71,144				6.00	%			2.50	%		$	100,787				8.50	%
Total capital ratio																																						$	183,494				15.48	%		$	118,573				10.00	%		$	94,858				8.00	%			2.50	%		$	124,502				10.50	%
Tier 1 leverage ratio																																						$	170,568				11.58	%		$	73,646				5.00	%		$	58,917				4.00	%			n/a			$	58,917				4.00	%
At December 31, 2018:
Company
Common equity tier 1 capital ratio		$	139,488				12.79	%			n/a				n/a			$	49,072				4.50	%			1.875	%		$	69,519				6.375	%		$	139,488				12.79	%			n/a				n/a			$	49,072				4.50	%			1.875	%		$	69,519				6.375	%
Tier 1 capital ratio		$	149,488				13.71	%			n/a				n/a			$	65,429				6.00	%			1.875	%		$	85,876				7.875	%		$	149,488				13.71	%			n/a				n/a			$	65,429				6.00	%			1.875	%		$	85,876				7.875	%
Total capital ratio		$	172,475				15.82	%			n/a				n/a			$	87,239				8.00	%			1.875	%		$	107,686				9.875	%		$	172,475				15.82	%			n/a				n/a			$	87,239				8.00	%			1.875	%		$	107,686				9.875	%
Tier 1 leverage ratio		$	149,488				11.21	%			n/a				n/a			$	53,079				4.00	%			n/a			$	53,079				4.000	%		$	149,488				11.21	%			n/a				n/a			$	53,079				4.00	%			n/a			$	53,079				4.00	%
Bank
Common equity tier 1 capital ratio		$	144,245				13.23	%		$	70,856				6.50	%		$	49,054				4.50	%			1.875	%		$	69,493				6.375	%		$	144,245				13.23	%		$	70,856				6.50	%		$	49,054				4.50	%			1.875	%		$	69,493				6.375	%
Tier 1 capital ratio		$	144,245				13.23	%		$	87,207				8.00	%		$	65,405				6.00	%			1.875	%		$	85,844				7.875	%		$	144,245				13.23	%		$	87,207				8.00	%		$	65,405				6.00	%			1.875	%		$	85,844				7.875	%
Total capital ratio		$	157,232				14.42	%		$	109,009				10.00	%		$	87,207				8.00	%			1.875	%		$	107,646				9.875	%		$	157,232				14.42	%		$	109,009				10.00	%		$	87,207				8.00	%			1.875	%		$	107,646				9.875	%
Tier 1 leverage ratio		$	144,245				10.81	%		$	66,712				5.00	%		$	53,369				4.00	%			n/a			$	53,369				4.000	%		$	144,245				10.81	%		$	66,712				5.00	%		$	53,369				4.00	%			n/a			$	53,369				4.00	%
At December 31, 2017:
Company
Common equity tier 1 capital ratio		$	125,745				12.26	%			n/a				n/a			$	46,169				4.50	%			1.25	%		$	58,994				5.750	%
Tier 1 capital ratio		$	135,745				13.23	%			n/a				n/a			$	61,559				6.00	%			1.25	%		$	74,384				7.250	%
Total capital ratio		$	158,365				15.44	%			n/a				n/a			$	82,079				8.00	%			1.25	%		$	94,903				9.250	%
Tier 1 leverage ratio		$	135,745				10.86	%			n/a				n/a			$	50,008				4.00	%			n/a			$	50,008				4.000	%
Bank
Common equity tier 1 capital ratio		$	129,139				12.58	%		$	66,703				6.50	%		$	46,179				4.50	%			1.25	%		$	59,006				5.750	%
Tier 1 capital ratio		$	129,139				12.58	%		$	82,096				8.00	%		$	61,572				6.00	%			1.25	%		$	74,399				7.250	%
Total capital ratio		$	141,760				13.81	%		$	102,620				10.00	%		$	82,096				8.00	%			1.25	%		$	94,923				9.250	%
Tier 1 leverage ratio		$	129,139				10.33	%		$	62,486				5.00	%		$	49,989				4.00	%			n/a			$	49,989				4.000	%

Our principal source of cash is dividends received from the Bank, which are subject to government regulation and limitations on the Bank’s ability to pay dividends. We also have trust preferred securities, senior debt and subordinated debt agreements with provisions that may impact our ability to pay dividends on our common stock to our common shareholders.

NOTE 19. DERIVATIVES

During March of 2016, we paid off a $75.0 million Federal Home Loan Bank of San Francisco borrowing (the “hedged instrument”) and terminated all of our interest rate swaps (active and forward starting). Prior to the time of termination, a $2.3 million unrealized pretax loss on swaps was carried in Other Liabilities in our Consolidated Balance Sheets. At termination, we immediately reclassified the loss to noninterest expense.

For derivative financial instruments accounted for as hedging instruments, we formally designate and document, at inception, the financial instrument as a hedge of a specific underlying exposure, the risk management objective, and the manner in which the effectiveness of the hedge will be assessed. We formally assess both at inception and at each reporting period thereafter, whether the derivative financial instruments used in hedging transactions are effective in offsetting changes in cash flows of the related underlying exposures. Any ineffective portion of the changes in cash flow of the instruments is recognized immediately into earnings.

ASC 815-10, Derivatives and Hedging (“ASC 815”) requires companies to recognize all derivative instruments as assets or liabilities at fair value in the Consolidated Balance Sheets. In accordance with ASC 815, we designated our interest rate swaps as cash flow hedges of certain active and forecasted variable rate Federal Home Loan Bank of San Francisco advances. Changes in the fair value of the hedging instrument, except any ineffective portion, were recorded in accumulated other comprehensive income (loss) until earnings were impacted by the hedged instrument. No components of our hedging instruments were excluded from the assessment of hedge effectiveness in hedging exposure to variability in cash flows.

Classification of the gain or loss in the Consolidated Statements of Income upon release from accumulated other comprehensive income (loss) is the same as that of the underlying exposure. We discontinue the use of hedge accounting prospectively when (1) the derivative instrument is no longer effective in offsetting changes in fair value or cash flows of the underlying hedged item; (2) the derivative instrument expires, is sold, terminated, or exercised; or (3) designating the derivative instrument as a hedge is no longer appropriate. When we discontinue hedge accounting because it is no longer probable that an anticipated transaction will occur in the originally expected period, or within an additional two-month period thereafter, changes to fair value that were recorded in accumulated other comprehensive loss are recognized immediately in earnings.

 

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Notes to Consolidated Financial Statements

The following table summarizes the losses recorded during the years ended December 31, 2016 and their locations within the Consolidated Statements of Income.

(Amounts in thousands)
Description		Consolidated Statement of Operations		2016
Interest rate swap (1)		Interest on term debt		$	396
Forward starting interest rate swap - terminated (2)		Other noninterest expense			2,325
Total				$	2,721

 

(1) Losses represent tax effected amounts reclassified from accumulated other comprehensive loss pertaining to net settlement recorded during the period on active interest rate swaps. (2) Losses represent tax effected amounts reclassified from accumulated other comprehensive loss pertaining to the terminated active and forward starting interest rate swaps.

The losses on all derivative instruments (active and forward starting interest rate swaps) designated as cash flow hedges recorded in accumulated other comprehensive loss and reclassified into earnings during the year ended December 31, 2016 was $1.6 million, net of tax.

 

NOTE 20.18. FAIR VALUES

 

The following table presentstables present estimated fair values of our financial instruments as of December 31, 20182019 and 2017,2018, whether or not recognized or recorded at fair value in the Consolidated Balance Sheets.Sheets. The table indicates the fair value hierarchy of the valuation techniques we utilized to determine such fair value. Non-financial assets and non-financial liabilities defined by the FASB ASC 820, Fair Value Measurement, such as Bank premises and equipment, deferred taxes and other liabilities are excluded from the table. In addition, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements of FASB ASC 825, Financial Instruments, such as bank-owned life insurance policies. The prior period fair values for loans disclosed are not determined in a manner consistent with the current period fair values disclosed because of a change in the methodology due to the adoption of ASU 2016-01 as described in Note 2 Summary of Significant Accounting Policies in these Notes to Consolidated Financial Statements.

(Amounts in thousands)		Carrying				Fair Value Measurements Using
December 31, 2019		Amounts				Level 1				Level 2				Level 3
Financial assets
Cash and cash equivalents		$	80,604			$	80,604			$	—			$	—
Securities available-for-sale		$	286,950			$	—			$	286,950			$	—
Net loans		$	1,022,834			$	—			$	—			$	1,025,520
Federal Home Loan Bank of San Francisco stock		$	7,380			$	7,380			$	—			$	—
Financial liabilities
Deposits		$	1,267,171			$	—			$	1,267,153			$	—
Term Debt		$	9,957			$	—			$	10,006			$	—
Junior subordinated debenture		$	10,310			$	—			$	13,471			$	—

 

(Amounts in thousands)		Carrying				Fair Value Measurements Using
December 31, 2018		Amounts				Level 1				Level 2				Level 3
Financial assets
Cash and cash equivalents		$	47,365			$	47,365			$	—			$	—
Securities available-for-sale		$	256,928			$	—			$	256,928			$	—
Net loans		$	935,886			$	—			$	—			$	936,697
Federal Home Loan Bank of San Francisco stock		$	5,892			$	5,892			$	—			$	—
Financial liabilities
Deposits		$	1,131,716			$	—			$	1,129,795			$	—
Term Debt		$	13,405			$	—			$	13,323			$	—
Junior subordinated debenture		$	10,310			$	—			$	14,183			$	—

(Amounts in thousands)		Carrying				Fair Value Measurements Using
December 31, 2017		Amounts				Level 1				Level 2				Level 3
Financial assets
Cash and cash equivalents		$	66,970			$	66,970			$	—			$	—
Securities available-for-sale		$	266,943			$	—			$	266,943			$	—
Net loans		$	869,620			$	—			$	—			$	873,660
Federal Home Loan Bank of San Francisco stock		$	4,536			$	4,536			$	—			$	—
Financial liabilities
Deposits		$	1,102,732			$	—			$	1,101,523			$	—
Term Debt		$	16,958			$	—			$	16,918			$	—
Junior subordinated debenture		$	10,310			$	—			$	10,206			$	—

 

Fair Value Hierarchy

 

Level 1 valuations utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access.

 

Level 2 valuations utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 valuations include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

 

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Level 3

 

Valuations are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques.

 

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety.

 

We maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

 

The following tables present information about our assets and liabilities measured at fair value on a recurring basis, and indicate the fair value hierarchy of the valuation techniques we utilized to determine such fair value, as of December 31, 2018 and December 31, 2017.

(Amounts in thousands)		Fair Value at December 31, 2018
Recurring Basis		Total				Level 1				Level 2				Level 3
Available-for-sale securities
U.S. government and agencies		$	40,087			$	—			$	40,087			$	—
Obligations of states and political subdivisions			50,530				—				50,530				—
Residential mortgage-backed securities and collateralized mortgage obligations			138,503				—				138,503				—
Corporate securities			2,922				—				2,922				—
Commercial mortgage-backed securities			24,762				—				24,762				—
Other investment securities			124				—				124				—
Total assets measured at fair value		$	256,928			$	—			$	256,928			$	—

(Amounts in thousands)		Fair Value at December 31, 2017
Recurring Basis		Total				Level 1				Level 2				Level 3
Available-for-sale securities
U.S. government and agencies		$	40,369			$	—			$	40,369			$	—
Obligations of states and political subdivisions			78,844				—				78,844				—
Residential mortgage-backed securities and collateralized mortgage obligations			114,592				—				114,592				—
Corporate securities			4,992				—				4,992				—
Commercial mortgage-backed securities			26,641				—				26,641				—
Other investment securities			1,505				—				1,505				—
Total assets measured at fair value		$	266,943			$	—			$	266,943			$	—

Recurring Items

 

Debt Securities – The available-for-sale securities amount in the recurring fair value table above represents securities that have been adjusted to their fair values. For these securities, we obtain fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions among other things. We have determined that the source of these fair values falls within Level 2 of the fair value hierarchy.

 

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The following tables present information about our assets and liabilities measured at fair value on a recurring basis, and indicate the fair value hierarchy of the valuation techniques we utilized to determine such fair value, as of December 31, 2019 and December 31, 2018.

(Amounts in thousands)		Fair Value at December 31, 2019
Recurring Basis		Total				Level 1				Level 2				Level 3
Available-for-sale securities
U.S. government and agencies		$	38,733			$	—			$	38,733			$	—
Obligations of states and political subdivisions			42,098				—				42,098				—
Residential mortgage-backed securities and collateralized mortgage obligations			180,835				—				180,835				—
Corporate securities			2,966				—				2,966				—
Commercial mortgage-backed securities			19,307				—				19,307				—
Other investment securities			3,011				—				3,011				—
Total assets measured at fair value		$	286,950			$	—			$	286,950			$	—

(Amounts in thousands)		Fair Value at December 31, 2018
Recurring Basis		Total				Level 1				Level 2				Level 3
Available-for-sale securities
U.S. government and agencies		$	40,087			$	—			$	40,087			$	—
Obligations of states and political subdivisions			50,530				—				50,530				—
Residential mortgage-backed securities and collateralized mortgage obligations			138,503				—				138,503				—
Corporate securities			2,922				—				2,922				—
Commercial mortgage-backed securities			24,762				—				24,762				—
Other investment securities			124				—				124				—
Total assets measured at fair value		$	256,928			$	—			$	256,928			$	—

Transfers Between Fair Value Hierarchy Levels

 

Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstance that caused the transfer. There were no transfers between levels of the fair value hierarchy during the years ended December 31, 20182019 or 2017.2018.

 

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basisitems

 

We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis. These adjustments to fair value generally result from the application of lower of cost or fair value accounting or write-downs of individual assets due to impairment.

Collateral Dependent Loans - When we identify a collateral dependent loan as impaired, we measure the impairment using the current fair value of the collateral, less selling costs. Depending on the characteristics of a loan, the fair value of collateral is generally estimated by obtaining external appraisals. If we determine that the value of the impaired loan is less than the recorded investment in the loan, we recognize this impairment and adjust the carrying value of the loan to fair value through the ALLL. When the fair value of the collateral is based on an appraisal or other estimate and there is no observable market price, we record the impaired loan as nonrecurring Level 3 fair value.

OREO - The OREO amounts below represent impaired real estate that has been adjusted to fair value during the respective reporting period. The loss represents impairments on OREO for fair value adjustments based on the fair value of the real estate. The determination of fair value is based on recent appraisals of the foreclosed properties, which take into account recent sales prices adjusted for unobservable inputs, such as opinions provided by local real estate brokers and other real estate experts. OREO fair values are adjusted for estimated selling costs of 41% based off the adjusted fair value of the property. We record OREO as a nonrecurring Level 3 fair value.

The following tables present information about our assets and liabilities at December 31, 20182019 and December 31, 20172018 measured at fair value on a nonrecurring basis for which a nonrecurring change in fair value has been recorded during the reporting period.

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The amounts disclosed below present the fair values at the time the nonrecurring fair value measurements were made, and not necessarily the fair values as of the date reported upon.

 

(Amounts in thousands)		Fair Value at December 31, 2018																Fair Value at December 31, 2019
Nonrecurring basis		Total				Level 1				Level 2				Level 3				Total				Level 1				Level 2				Level 3
Collateral dependent impaired loans																		$	33			$	—			$	—			$	33
Other real estate owned		$	31			$	—			$	—			$	31				35				—				—				35
Total assets measured at fair value		$	31			$	—			$	—			$	31			$	68			$	—			$	—			$	68

 

(Amounts in thousands)		Fair Value at December 31, 2017
Nonrecurring basis		Total				Level 1				Level 2				Level 3
Collateral dependent impaired loans		$	60			$	—			$	—			$	60
Other real estate owned			35				—				—				35
Total assets measured at fair value		$	95			$	—			$	—			$	95

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(Amounts in thousands)		Fair Value at December 31, 2018
Nonrecurring basis		Total				Level 1				Level 2				Level 3
Other real estate owned		$	31			$	—			$	—			$	31
Total assets measured at fair value		$	31			$	—			$	—			$	31

 

The following table presents the losses resulting from nonrecurring fair value adjustments for the years ended December 31, 2018, 20172019 and 20162018 related to assets outstanding at December 31, 2018, 2017,2019 and 2016.2018.

 

(Amounts in thousands)		December 31,												December 31,
Fair value adjustments		2018				2017				2016				2019				2018
Collateral dependent impaired loans		$	—			$	20			$	1,183			$	66			$	—
Other real estate owned			21				38				77				43				21
Total		$	21			$	58			$	1,260			$	109			$	21

 

For the year ended December 31, 2018,2019, collateral dependent impaired loans with a carrying value of $99 thousand were written down to their fair value of $33 thousand resulting in a $66 thousand adjustment to the ALLL.

For the year ended December 31, 2019, one property is included in the OREO balance with an aggregate carrying value of $52$78 thousand that was written down to fair value of $31$35 thousand, resulting in a $21$43 thousand adjustment to ALLL.

 

The loan amounts above represent impaired, collateral dependent loans that have been adjusted to fair value during the respective reporting period. When we identify a collateral dependent loan as impaired, we measure the impairment using the current fair value of the collateral, less selling costs. Depending on the characteristics of a loan, the fair value of collateral is generally estimated by obtaining external appraisals. If we determine that the value of the impaired loan is less than the recorded investment in the loan, we recognize this impairment and adjust the carrying value of the loan to fair value through the ALLL.

 

The OREO amount above represents impaired real estate that has been adjusted to fair value during the respective reporting period. The loss represents impairments on OREO for fair value adjustments based on the fair value of the real estate. The determination of fair value is based on recent appraisals of the foreclosed properties, which take into account recent sales prices adjusted for unobservable inputs, such as opinions provided by local real estate brokers and other real estate experts. OREO fair values are adjusted for estimated selling costs that are based off the adjusted fair value are 42% for the remaining properties in OREO. We record OREO as a nonrecurring Level 3 fair value.

Limitations

 

Fair value estimates are made at a specific point in time, based on relevant market information and other information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time, our entire holdings of a particular financial instrument. Because no market exists for a significant portion of our financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature, involve uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

 

Fair value estimates are based only on current on and off-balance sheet financial instruments without attempting to estimate theinstruments. Our fair value ofestimates do not include any adjustment for anticipated future business and the value of assets and liabilities that are not considered financial instruments.business. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.

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NOTE 2119. INCOME TAXES

 

The following table presents components of income tax expense included in the Consolidated Statements of Income for each of the past threetwo years.

 

(Amounts in thousands)		Current				Deferred				Total				Current				Deferred				Total
Year ended December 31, 2019:
Federal														$	2,732			$	47			$	2,779
State															2,126				107				2,233
Affordable housing partnership amortization															491				—				491
Total														$	5,349			$	154			$	5,503
Year ended December 31, 2018:
Federal		$	773			$	292			$	1,065			$	773			$	292			$	1,065
State			1,733				303				2,036				1,733				303				2,036
Affordable housing partnership amortization			528				—				528				528				—				528
		$	3,034			$	595			$	3,629
Year ended December 31, 2017:
Federal		$	2,005			$	2,837			$	4,842
State			1,474				(76	)			1,398
Affordable housing partnership amortization			688				—				688
		$	4,167			$	2,761			$	6,928
Year ended December 31, 2016:
Federal		$	283			$	409			$	692
State			582				86				668
Affordable housing partnership amortization			598				—				598
Total		$	1,463			$	495			$	1,958			$	3,034			$	595			$	3,629

 

Our effective tax rate is calculated as our provision for income taxes divided by income before provision for income taxes. Income tax expense attributable to income before income taxes differed from the amounts computed by applying the U.S. federal income tax rate of 21% for 20182019 and 34% for 2017 and 20162018 to income before income taxes.

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The following table presents a reconciliation of income taxes computed at the federal statutory rate to the actual effective rate for the years ended December 31, 2018, 2017,2019 and 2016.2018.

 

		2018				2017				2016				2019				2018
Income tax at the federal statutory rate			21.0	%			34.0	%			34.0	%			21.0	%			21.0	%
Deferred tax asset write-down			—	%			17.5	%			5.0	%
State franchise tax, net of federal tax benefit			8.3	%			6.5	%			6.1	%			8.6	%			8.3	%
Amortization of affordable housing credit partnerships			2.7	%			4.8	%			8.1	%			2.4	%			2.7	%
Officer life insurance			(0.6	%)			(2.5	%)			(2.9	%)			(0.5	)%			(0.6	)%
Tax-exempt interest			(1.8	%)			(5.2	%)			(10.9	%)			(1.3	)%			(1.8	)%
Affordable housing credits and benefits			(3.8	%)			(5.7	%)			(11.7	%)			(3.5	)%			(3.8	)%
Accelerated depreciation - cost segregation study			(2.5	%)			—	%			—	%			—	%			(2.5	)%
Reversal of uncertain tax position			(5.1	%)			—	%			—	%			—	%			(5.1	)%
Other			0.5	%			(0.8	%)			(0.7	%)			0.2	%			0.5	%
Effective Tax Rate			18.7	%			48.5	%			27.1	%			26.9	%			18.7	%

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The following table reflects the effects of temporary differences that give rise to the components of the net deferred tax asset as of December 31, 20182019 and 2017.2018.

 

(Amounts in thousands)		2018				2017				2019				2018
Deferred tax assets:
Allowance for loan and lease losses		$	3,634			$	3,526			$	3,616			$	3,634
Deferred compensation plan and salary continuation plan			2,385				2,365				2,773				2,385
Acquired loan fair value											494				—
State franchise tax			474				291				457				474
Acquisition costs			274				274				274				274
Net unrealized loss on securities available-for-sale			1,262				134
Unrealized loss on securities available-for-sale											—				1,262
Interest received on non-accrual loans			86				105				92				86
Lease liability											1,024				—
Other			403				484				700				403
Total deferred tax assets			8,518				7,179				9,430				8,518
Deferred tax liabilities:
Deferred loan origination costs and fees			(579	)			(619	)			(568	)			(579	)
Unrealized gains on securities available-for-sale											(582	)			—
Core deposit intangible											(1,139	)			—
Basis difference in fixed assets			(874	)			—				(1,336	)			(874	)
Lease asset											(1,024	)			—
Other			(26	)			(55	)			(228	)			(26	)
Total deferred tax liabilities			(1,479	)			(674	)			(4,877	)			(1,479	)
Net deferred tax asset		$	7,039			$	6,505			$	4,553			$	7,039

 

We are not required to establish a valuation allowance for the deferred tax assets as management believes it is more likely than not that the deferred tax assets of $8.5$9.4 million and $7.2$8.5 million at December 31, 20182019 and 2017,2018, respectively will be realized principally through future reversals of existing taxable temporary differences. We further believe that future taxable income will be sufficient to realize the benefits of temporary deductible differences that cannot be realized through the reversal of future temporary taxable differences.

 

We have investments in Qualified Zone Academy Bonds (“QZAB”) of $4.7 million at December 31, 20182019 and 20172018 recorded in Other Assets in the Consolidated Balance Sheets.Sheets. We also have investments in QZAB of $1.0 million at December 31, 20182019 and 20172018 recorded in Securities available-for-sale in the Consolidated Balance Sheets. The investments provide funds for capital improvements at local schools and are repaid at maturity in 2031, 2033 and 2046. In exchange for the investment we receive a federal tax credit at a rate determined at the settlement of the investment by the US Treasury. We account for the benefit for these tax credit investments using the deferred cost reduction method.

 

For the years ended December 31, 2018 and 2017, we expect to carryforward a California capital loss in the amount of $53 thousand which will expire in 2020.

See Note 2220 Qualified Affordable Housing Partnership Investments in these Notes to Consolidated Financial Statements, for further details on our affordable housing project investments.

 

We have no unrecognized tax benefits at December 31, 2018 compared to $988 thousand at December 31, 2017. 2019 or 2018.

 

We file income tax returns in the U.S. federal jurisdiction, and the State of California. Income tax returns filed are subject to examination by the U.S. federal, state, and local income tax authorities. While no income tax returns are currently being examined, we are no longer subject to tax examination by tax authorities for years prior to fiscal year 20152016 for federal tax returns and fiscal year 20142015 for state and local tax returns.

 

During 2018, we completed a cost segregation study and a tangible property review, to shorten the depreciable lives of certain assets and accelerate the tax depreciation deduction on our 2017 federal income tax return. As a result, we recorded a benefit to our 2018 book provision for income taxes of $484 thousand.

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In September of 2016, we filed amended federal and state tax returns for tax years 2011, 2012, 2013, and 2014. The amendments were filed to properly recognize tax events in years 2011 and 2013 that were improperly recognized in years 2011 through 2014. The IRS rejected the 2011 amended tax return citing the statute for assessment had expired. Accordingly, $988 thousand of taxes due to the taxing authorities pursuant to the 2011 amended federal tax return was returned to us. The statute of limitations on the 2014 amended federal tax return passed in 2018 and we reversed our uncertain tax position and recognized the $988 thousand benefit in our provision for income taxes.

 

The following table presents our uncertain tax position at December 31, 2018 and 2017.2018.

 

 

(Amounts in thousands)		2018				2017				2018
Balance, beginning of period		$	988			$	988			$	988
Tax positions resolved during the year			(988	)			—				(988	)
Balance, end of period		$	—			$	988			$	—

 

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NOTE 2220. QUALIFIED AFFORDABLE HOUSING PARTNERSHIP INVESTMENTS

 

Our investmentsWe have invested in four separate Qualified Affordable Housing Partnerships that generate Low Income Housing Tax Credits (“LIHTC”) and deductible operating losses totaled $3.0 million at December 31, 2018. These investments are recorded in Other Assets with a corresponding funding obligation of $343 thousand recorded in Other Liabilities in our Consolidated Balance Sheets. We have invested in four separate LIHTC partnerships,, which provide the Company with CRA credit. Additionally, the investments in LIHTC partnerships provide us with tax credits and with operating loss tax benefits over an approximately 18-year period. None of the original investments will be repaid. The tax credits and the operating loss tax benefits that are generated by each of the properties are expected to exceed the total value of the investments we made and provide returns on the investments of between 3% and 5%. over the life of the investment. None of the original investments will be repaid.

Our investments in LIHTC totaled $2.5 million at December 31, 2019. These investments are recorded in Other Assets with a corresponding funding obligation of $338 thousand recorded in Other Liabilities in our Consolidated Balance Sheets. The investments in LIHTC partnerships are being accounted for using the proportional amortization method, under which we amortize the initial cost of an investment in proportion to the amount of the tax credits and other tax benefits received, and recognize the net investment performance in the Consolidated Statements of Income as a component of income tax expense.

 

The following table presentstables present our original investment in LIHTC partnerships, the current recorded investment balance, and the unfunded liability balance of each investment at December 31, 20182019 and 2017.2018. In addition, the table reflects the tax credits and tax benefits, amortization of the investment and the net impact to our income tax provision for the years ended December 31, 20182019 and 2017.2018.

 

		At December 31, 2018												For the year ended December 31, 2018												At December 31, 2019												For the year ended December 31, 2019
		Original				Current				Unfunded				Tax Credits				Amortization				Net				Original				Current				Unfunded				Tax Credits				Amortization				Net
(Amounts in thousands)		Investment				Recorded				Liability				and				of				Income Tax				Investment				Recorded				Liability				and				of				Income Tax
Qualified Affordable Housing Partnerships		Value				Investment				Obligation				Benefits				Investments				Benefit				Value				Investment				Obligation				Benefits				Investments				Benefit
Raymond James California Housing Opportunities Fund II		$	2,000			$	1,022			$	28			$	200			$	179			$	21			$	2,000			$	852			$	22			$	199			$	170			$	29
WNC Institutional Tax Credit Fund 38, L.P.			1,000				489				—				126				100				26				1,000				400				—				108				89				19
Merritt Community Capital Corporation Fund XV, L.P.			2,500				1,270				315				226				206				20				2,500				1,067				316				224				203				21
California Affordable Housing Fund			2,454				239				—				31				43				(12	)			2,454				210				—				25				29				(4	)
Total		$	7,954			$	3,020			$	343			$	583			$	528			$	55			$	7,954			$	2,529			$	338			$	556			$	491			$	65

 

 

 

		At December 31, 2017												For the year ended December 31, 2017												At December 31, 2018												For the year ended December 31, 2018
		Original				Current				Unfunded				Tax Credits				Amortization				Net				Original				Current				Unfunded				Tax Credits				Amortization				Net
(Amounts in thousands)		Investment				Recorded				Liability				and				of				Income Tax				Investment				Recorded				Liability				and				of				Income Tax
Qualified Affordable Housing Partnerships		Value				Investment				Obligation				Benefits				Investments				Benefit				Value				Investment				Obligation				Benefits				Investments				Benefit
Raymond James California Housing Opportunities Fund II		$	2,000			$	1,182			$	20			$	227			$	179			$	48			$	2,000			$	1,022			$	28			$	200			$	179			$	21
WNC Institutional Tax Credit Fund 38, L.P.			1,000				589				—				131				108				23				1,000				489				—				126				100				26
Merritt Community Capital Corporation Fund XV, L.P.			2,500				1,476				341				252				237				15				2,500				1,270				315				226				206				20
California Affordable Housing Fund			2,454				282				—				171				164				7				2,454				239				—				31				43				(12	)
Total		$	7,954			$	3,529			$	361			$	781			$	688			$	93			$	7,954			$	3,020			$	343			$	583			$	528			$	55

 

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The following table presents our generated tax credits and tax benefits from investments in qualified affordable housing partnerships for the years ended December 31, 2018, 20172019 and 2016.2018.

 

		For the Years Ended December 31,																								For the Years Ended December 31,
		2018								2017								2016								2019								2018
(Amounts in thousands)		Generated				Tax Benefits from				Generated				Tax Benefits from				Generated				Tax Benefits from				Generated				Tax Benefits from				Generated				Tax Benefits from
Qualified Affordable Housing Partnerships		Tax Credits				Taxable Losses				Tax Credits				Taxable Losses				Tax Credits				Taxable Losses				Tax Credits				Taxable Losses				Tax Credits				Taxable Losses
Raymond James California Housing Opportunities Fund II		$	170			$	30			$	176			$	51			$	184			$	54			$	170			$	29			$	170			$	30
WNC Institutional Tax Credit Fund 38, L.P.			111				15				114				17				107				36				93				15				111				15
Merritt Community Capital Corporation Fund XV, L.P.			192				34				200				52				206				60				192				32				192				34
California Affordable Housing Fund			5				26				126				45				158				47				—				25				5				26
Total		$	478			$	105			$	616			$	165			$	655			$	197			$	455			$	101			$	478			$	105

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Our generated tax credits and benefits were partially offset by the amortization of the principal investment balances of $528 thousand, $688 thousand and $598 thousand for the years ended December 31, 2018, 2017 and 2016, respectively.

 

The following table reflects the anticipated net income tax benefit and (expense) at December 31, 2018,2019, that is expected to be recognized over the remaining lives of the investments and has been updated to reflect the lower tax rate in the Tax Cuts and Jobs Act enacted on December 22, 2017.investments.

 

 

(Amounts in thousands)
Qualified Affordable Housing Partnerships:		Raymond James				WNC Institutional				Merritt Community				California				Total				Raymond James				WNC Institutional				Merritt Community				California				Total
Anticipated income tax benefit, net less		California Housing				Tax Credit				Capital Corporation				Affordable Housing				Income Tax				California Housing				Tax Credit				Capital Corporation				Affordable Housing				Income Tax
amortization of investments		Opportunities Fund II				Fund 38, L.P.				Fund XV, L.P				Fund				Benefit, Net				Opportunities Fund II				Fund 38, L.P.				Fund XV, L.P				Fund				Benefit, Net
2019		$	19			$	17			$	4			$	(14	)		$	26
2020			19				17				4				(14	)			26			$	14			$	12			$	3			$	(10	)		$	19
2021			19				16				4				(14	)			25				19				16				4				(14	)			25
2022			19				14				3				(13	)			23				19				14				3				(13	)			23
2023 and thereafter			32				27				6				(31	)			34
2023																							18				13				3				(36	)			(2	)
2024 and thereafter																							16				14				4				—				34
Total		$	108			$	91			$	21			$	(86	)		$	134			$	86			$	69			$	17			$	(73	)		$	99

 

 

 

NOTE 2321. ACQUISITION

 

On January 31, 2019 we completed the acquisition of Merchants Holding Company (“Merchants”), to extend our presence in the Sacramento marketplace. Merchants, headquartered in Sacramento, California, was the parent company of The Merchants National Bank of Sacramento (“Merchants Bank”), a 97-year-old bank with approximately $211.7 million in assets as of January 31, 2019. Merchants Bank operated one full service branch and one limited service branch in the Sacramento metropolitan area. In May of 2019, we successfully converted all of Merchant’s computer records onto our core system.

 

We paid $15.3 million in cash and issued 1,834,142 shares of common stock to Merchants shareholders who now hold,held, in the aggregate, approximately 10% of our outstanding common stock.stock on January 31, 2019. One former member of the Merchants board now serves on our board of directors. The acquisition, after fair value adjustments added $85.3 million in loans, $190.2 million in deposits, and $107.4 million in investment securities after fair value adjustmentsand $85.3 million in loans to our bankBank as of January 31, 2019.

 

The acquisition of Merchants constituted a business combination and has been accounted for using the acquisition method of accounting. The assets acquired and liabilities assumed, both tangible and intangible, were recorded at their fair values as of the acquisition date in accordance with ASC 805, Business Combinations. Due to the timing of the acquisition, fair values related to loans, deferred tax assets, other assets and other liabilities are preliminary and subject to refinement as additional information regarding the closing date fair values becomes available. The Bank engaged third party specialists to assist in valuing certain assets, including investment securities, loans, real estate and the core deposit intangible that resulted from the acquisition. The acquisition was treated as a "reorganization" within the definition of section 368(a) of the Internal Revenue Code and is generally considered tax-free for U.S. federal income tax purposes.

 

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The acquisition of Merchants constituted a business combination and has been accounted for using the acquisition method of accounting. The assets acquired and liabilities assumed, both tangible and intangible, were recorded at their fair values as of the acquisition date in accordance with ASC 805, Business Combinations. Due to the timing of the acquisition, fair values related to loans, deferred tax assets, other assets and other liabilities are preliminary and subject to refinement as additional information regarding the closing date fair values becomes available. The Bank engaged third party specialists to assist in valuing certain assets, including investment securities, loans, real estate and the core deposit intangible that resulted from the acquisition. The acquisition was treated as a "reorganization" within the definition of section 368(a) of the Internal Revenue Code and is generally considered tax-free for U.S. federal income tax purposes.

The preliminary calculation of goodwill recorded during the first quarter of 2019 is detailed below.

 

						Preliminary
		As Recorded by				Fair Value and Other  Acquisition								As Recorded by				Fair Value And
		Merchants				Related				As Recorded by				Merchants				Other Acquisition				As Recorded by
(Amounts in thousands)		Holding Company				Adjustments				the Company				Holding Company				Related Adjustments				the Company
Consideration paid:
Cash										$	15,300											$	15,300
Stock 1,834,142 shares at $10.69 per share											19,607												19,607
Total consideration										$	34,907											$	34,907
Assets acquired:
Cash and fed funds sold		$	12,425			$	—			$	12,425			$	12,425			$	—			$	12,425
Investment securities			107,931				(551	)			107,380				107,931				(551	)			107,380
Loans, gross			87,570				(2,292	)			85,278				87,570				(2,292	)			85,278
Allowance for loan and lease losses			(1,286	)			1,286				—				(1,286	)			1,286				—
Interest receivable			688				—				688				688				—				688
Premises and equipment, net			378				1,856				2,234				378				1,856				2,234
Deferred tax asset, net			1,374				(1,287	)			87
Deferred tax assets, net															1,374				(1,352	)			22
Federal Home Loan Bank of San Francisco stock			1,454				—				1,454				1,454				—				1,454
Life insurance			755				—				755				755				—				755
Other assets			371				(10	)			361				371				95				466
Core deposit intangible			—				4,353				4,353				—				4,353				4,353
Total assets acquired		$	211,660			$	3,355			$	215,015			$	211,660			$	3,395			$	215,055
Liabilities assumed:
Demand and savings deposits		$	152,213			$	—			$	152,213
Demand, money market and savings														$	152,213			$	—			$	152,213
Certificates of deposit			38,003				—				38,003				38,003				—				38,003
Total deposits			190,216				—				190,216				190,216				—				190,216
Other liabilities			916				15				931				916				22				938
Total liabilities assumed		$	191,132			$	15			$	191,147			$	191,132			$	22			$	191,154
Net identifiable assets acquired over liabilities assumed		$	20,528			$	3,340			$	23,868			$	20,528			$	3,373			$	23,901
Goodwill										$	11,039											$	11,006

 

Goodwill

 

As a result of the Merchants acquisition, we have recorded a provisional amount of goodwill totaling $11.0 million, which representsmillion. Goodwill reflects the expected value of Merchants reputation in the community, stable customer base and expected synergies created through the combined operations with our Company and was calculated as the excess of the total purchase price paid over the fair value of the assets acquired, net of the fair values of liabilities assumed. TheWe perform a goodwill recorded is preliminary and subject to refinement as additional information regarding the closing date fair values becomes available. We are in the process of obtaining and reviewing valuation reports for the acquired loans and completing the final federal and state income tax returns for Merchants. We also expect that there may be additional fair value adjustments to the other assets and other liabilities as work to finalize the entries to record the transaction. Goodwill is amortized over 15 years for tax purposes.

Goodwill reflects the expected value of Merchants reputation in the community, stable customer base and expected synergies created through the combined operations with our company.impairment analysis on an annual basis. Additionally, we perform a goodwill impairment evaluation on an interim basis when events or circumstances indicate impairment potentially exists.

 

The following is a description of the methods used to determine the fair values of significant assets and liabilities whose fair values are different from their carrying amounts on Merchants' books at acquisition date presented above.

 

Investment Securities

 

Fair values for securities were obtained from an independent pricing service and arewere based on quoted market prices, where available. If quoted market prices were not available, fair value estimates were based on observable inputs including quoted market prices for similar instruments, quoted market prices that arewere not in an active market, other inputs that arewere observable in the market or a discounted cash flow model.

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Loans

 

We engaged a third party to assist us in determining the fair values for the loans acquired from Merchants based upon the present values of the expected cash flows and market-derived discount rates. There were no loans acquired with evidence of deterioration of credit quality since origination for which we believe it is probable that we will be unable to collect all contractually required payments receivable. The amounts recognizedA fair value discount of $2.3 million was recorded for loans have been determined only provisionally. Due toacquired from Merchants and is being accreted over the timinglife of the transaction, we are stillloans as a yield adjustment. We recorded $620 thousand in the process of evaluating the fair valueaccretion of the acquired loans.discount for these loans during the year ended December 31, 2019.

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Premises and Equipment

 

We engaged an independent licensed appraiser to determine the fair value of the acquired branch located in Sacramento. The fair value of tangible personal property was not material.

 

Deferred Tax Assets

 

The deferredDeferred income tax assets arewere recorded to reflect the differences indifference between the carrying values of the acquired assets and liabilities for financial reporting purposes and the basis for federal income tax purposes atusing the company’sCompany’s statutory federal and state income tax rate. The amounts recognizedrates. During 2019 the final tax returns were completed for Merchants and the net deferred tax assets have been determined only provisionally, and will not be finalized until the 2018 and 2019 tax returns for Merchants have been completed..were adjusted to fair value.

 

Core Deposit Intangible

 

We recorded aengaged an independent third party to assist us in determining the core deposit intangible asset of $4.4 million for theassociated with non-maturity deposits acquired in the Merchants acquisition during the first quarter of 2019.from Merchants. The core deposit intangible represents the estimated future benefits of acquired deposits and is booked separately from the related deposits. The value of the core deposit intangible asset was determined using a discounted cash flow approach to arrive at the cost differential between the core deposits (non-maturity deposits such as transaction, savings and money market accounts) and alternative funding sources. It was calculated as the present value of the difference in cash flows between maintaining the core deposits (interest and net maintenance costs) and the cost of an equal amount of funds with a similar term from an alternative source. The core deposit intangible is being amortized on an accelerateda straight line basis over an estimated eight-year life, and is evaluated periodically for impairment. No impairment loss was recognized in 2018. At2019. Core deposit intangible amortization from this acquisition is not deductible for tax purposes. We recorded amortization of the core deposit intangible totaling $499 thousand during the year ended December 31, 2018, the2019. The future estimated amortization expense on the CDIcore deposit intangible from the Merchants acquisition at December 31, 2019 is as follows:

 

(Amounts in thousands)		2019				2020				2021				2022				2023				Thereafter				Total				2020				2021				2022				2023				2024				Thereafter				Total
Core deposit intangible amortization		$	499			$	544			$	544			$	544			$	544			$	1678			$	4,353			$	544			$	544			$	544			$	544			$	544			$	1134			$	3,854

 

Pro Forma Results of Operations

 

The following table presents pro forma information of the combined entity as if the acquisition occurred on January 1, 2016.2018. The pro forma information does not necessarily reflect the results of operations that would have resulted had the acquisition been completed at the beginning of the periods presented, nor is it indicative of the results of operations in future periods. Furthermore, cost savings and other business synergies related to the acquisition are not reflected in the pro forma amounts.

 

														For the Twelve Months Ended
Pro forma revenue and earnings														December 31,
(Amounts in thousands)		2018				2017				2016				2019				2018
Net interest income		$	52,948			$	46,592			$	41,287			$	53,730			$	52,948
Net income		$	16,313	(1)		$	8,069			$	6,566
Net income (1)														$	14,924			$	16,313

(1) Net income for 2018 includes acquisition-related costs for both entities of $1.3 million and $2.2 million for both entities2018 and 2019, respectively.

 

It is impracticable to separately provide information regarding the amount of revenue and earnings from Merchants included in our Consolidated Statement of Income because the operations of Merchants were substantially comingled with the operations of the Company as of the acquisition date.

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NOTE 2422. EARNINGS PER COMMON SHARE

 

The following table presents a computation of basic and diluted earnings per share for the years ended December 31, 2018, 20172019 and 2016.2018.

 

(Amounts in thousands, except per share information)
Earnings Per Share		2018				2017				2016				2019				2018
Numerators:
Net income		$	15,730			$	7,344			$	5,259			$	14,961			$	15,730
Denominators:
Weighted average number of common shares outstanding - basic (1)			16,248				15,207				13,367				17,956				16,248
Effect of potentially dilutive common shares (2)			84				103				58				68				84
Weighted average number of common shares outstanding - diluted			16,332				15,310				13,425				18,024				16,332
Earnings per common share:
Basic		$	0.97			$	0.48			$	0.39			$	0.83			$	0.97
Diluted		$	0.96			$	0.48			$	0.39			$	0.83			$	0.96
Anti-dilutive options not included in earnings per share calculation			—				—				45				—				—
Anti-dilutive restricted shares not included in diluted earnings per share calculation			—				7				—				—				—

(1) Excludes unvested restricted shares because they do not have dividend or voting rights.

(2) Represents the effects of the assumed exercise of stock options and vesting of non-participating restricted shares.

 

On January 31,During the fourth quarter of 2019 we completed our acquisition of Merchants Holding Company, the parent company of The Merchants National Bank of Sacramento in a stock and cash transaction. We paid $15.3 million in cash and issued 1,834,142 shares of BOCH common stock for all of the outstanding shares of Merchants common stock,

On May 10, 2017, the Company announced the closing of its underwritten public offering, at the public offering price of $10.50 per share. The total number ofrepurchased 90,501 shares of common stock sold by the Company was 2,738,096 shares. Net proceeds raised in the offering, after underwriting discounts and expensesas part of the offering, were $26.8 million.our previously announced share repurchase program.

 

 

 

NOTE 2523. RELATED PARTY TRANSACTIONS

 

Some of the directors and executive officers (and their associated or affiliated companies) were customers of and had banking transactions with us in the ordinary course of our business and we expect to have such transactions in the future. All deposits, loans and commitments to fund loans included in such transactions were made in compliance with the applicable laws on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons of similar creditworthiness.

 

The following table presents a summary of aggregate activity involving related party borrowers for the years ended December 31, 20182019 and 2017.2018.

 

(Amounts in thousands)		2018				2017				2019				2018
Balance at beginning of year		$	13,230			$	13,424			$	9,490			$	13,230
New loan additions											3,513				—
Advances on existing lines of credit			31,281				29,166				213				31,281
Principal repayments			(34,150	)			(29,360	)			(9,449	)			(34,150	)
Reclassifications (1)			(871	)			—				—				(871	)
Balance at end of year		$	9,490			$	13,230			$	3,767			$	9,490

(1) Represents loans that were once considered related party but are no longer considered related party, or loans that were not related party that subsequently became related party loans.

 

At December 31, 20182019 and 2017,2018, deposits of related parties amounted to $11.8$12.0 million and $6.7$11.8 million, respectively. As of December 31, 20182019 and 2017,2018, there were no related party loans which were past due or adversely classified. At December 31, 20182019 and 20172018 there was $9.9$11.1 million, and $12.4$9.9 million, respectively, in outstanding loan commitments to related parties. In our opinion, these transactions did not involve more than a normal risk of collectability or present other unfavorable terms.

 

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NOTE 2624. PARENT COMPANY FINANCIAL STATEMENTS

 

Condensed Balance Sheets

Year ended December 31,

 

 

(Amounts in thousands)		2018				2017				2019				2018
Assets:
Cash		$	19,425			$	23,984			$	6,814			$	19,425
Investment in:
Redding Bank of Commerce			143,078				130,658
Merchants Bank of Commerce											188,459				143,078
Bank of Commerce Mortgage			(64	)			(64	)			(64	)			(64	)
Bank of Commerce Holdings Trust II			310				310				310				310
Other assets			157				169				423				157
Total Assets		$	162,906			$	155,057			$	195,942			$	162,906
Liabilities and shareholders' equity:
Term debt:
Senior debt, net		$	3,494			$	7,090			$	—			$	3,494
Subordinated debt, net			9,911				9,868				9,957				9,911
Junior subordinated debentures			10,310				10,310				10,310				10,310
Other liabilities			870				525				1,197				870
Total liabilities			24,585				27,793				21,464				24,585
Shareholders’ equity			138,321				127,264				174,478				138,321
Total liabilities and shareholders’ equity		$	162,906			$	155,057			$	195,942			$	162,906

 

 

Condensed Statements of Income

Year Ended December 31, 

(Amounts in thousands)		2018				2017				2016				2019				2018
Income:
Other income		$	12			$	9			$	7			$	13			$	12
Dividends from subsidiaries			4,000				2,200				4,200				12,500				4,000
Total income			4,012				2,209				4,207				12,513				4,012
Expenses:
Management fees paid to subsidiaries			303				278				259				310				303
Interest expense			1,461				1,452				1,409				1,233				1,461
Noninterest expense			1,433				474				345				844				1,433
Total expenses			3,197				2,204				2,013				2,387				3,197
Income before income taxes and equity in undistributed net income of subsidiaries			815				5				2,194				10,126				815
Income tax expense			1				1				1				1				1
Income before equity in undistributed net income of subsidiaries			814				4				2,193				10,125				814
Equity in undistributed net income of subsidiaries			14,916				7,340				3,066				4,836				14,916
Net income		$	15,730			$	7,344			$	5,259			$	14,961			$	15,730

 

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Condensed Statements of Cash Flows

Year Ended December 31,

 

 

 

 

 

 

 

 

 

 

 

(Amounts in thousands)		2018				2017				2016				2019				2018
Cash flows from operating activities:
Net income		$	15,730			$	7,344			$	5,259			$	14,961			$	15,730
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed net income of subsidiaries			(14,916	)			(7,340	)			(3,066	)			(4,836	)			(14,916	)
Amortization of debt issuance costs			49				44				40				48				49
Provision for depreciation and amortization			22				6				—				18				18
Decrease in other assets			69				32				6
Increase (decrease) in other liabilities			227				59				(137	)
Decrease (increase) in other assets															13				(7	)
(Decrease) increase in other liabilities															(164	)			227
Net cash provided by operating activities			1,181				145				2,102				10,040				1,101
Cash flows from investing activities:
Purchases of premises and equipment			(80	)			(82	)			—
Cash received from acquisition of Merchants Holding Company															292				—
Cash paid for acquisition of Merchants Holding Company															(15,300	)			—
Net cash used by investing activities			(80	)			(82	)			—				(15,008	)			—
Cash flows from financing activities:
Repayment of term debt			(3,602	)			(1,819	)			(1,001	)			(3,496	)			(3,602	)
Repurchase of common stock															(1,010	)			—
Cash dividends paid on common stock			(2,274	)			(1,776	)			(1,603	)			(3,189	)			(2,274	)
Proceeds from stock options exercised			216				245				10				52				216
Net proceeds from issuance of common stock			—				26,778				—
Net cash provided by (used in) financing activities			(5,660	)			23,428				(2,594	)
Net increase (decrease) in cash and cash equivalents			(4,559	)			23,491				(492	)
Net cash used in financing activities															(7,643	)			(5,660	)
Net decrease in cash and cash equivalents															(12,611	)			(4,559	)
Cash and cash equivalents at the beginning of year			23,984				493				985				19,425				23,984
Cash and cash equivalents at the end of year		$	19,425			$	23,984			$	493			$	6,814			$	19,425
Supplemental disclosures of non cash financing activities:
Stock issued under employee plans		$	45			$	41			$	—			$	58			$	45
Vested and granted restricted stock issued under employee plans		$	—			$	—			$	84

 

 

 

 

 

NOTE 27. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

The following tables present the summary of results for the eight quarters ended December 31, 2018.

2018

		March 31,				June 30,				September 30,				December 31,				Four
(Amounts in thousands, except for share information)		2018				2018				2018				2018				Quarters
Net interest income		$	11,345			$	11,580			$	12,127			$	12,494			$	47,546
Noninterest income			982				962				943				1,132				4,019
Noninterest expense			8,033				7,671				7,634				8,868				32,206
Income before provision for income tax			4,294				4,871				5,436				4,758				19,359
Provision for income tax			1,053				1,253				1,404				(81	)			3,629
Income available to common shareholders		$	3,241			$	3,618			$	4,032			$	4,839			$	15,730
Earnings per share - basic		$	0.20			$	0.22			$	0.25			$	0.30			$	0.97
Weighted average shares - basic			16,225				16,245				16,252				16,265				16,248
Earnings per share - diluted		$	0.20			$	0.22			$	0.25			$	0.30			$	0.96
Weighted average shares - diluted			16,310				16,325				16,342				16,345				16,332

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2017

		March 31,				June 30,				September 30,				December 31,				Four
(Amounts in thousands, except for share information)		2017				2017				2017				2017				Quarters
Net interest income		$	9,734			$	10,175			$	10,584			$	10,869			$	41,362
Provision for loan and lease losses			200				300				—				450				950
Noninterest income			1,471				995				1,076				1,282				4,824
Noninterest expense			7,990				7,726				7,357				7,891				30,964
(Loss) income before provision for income tax			3,015				3,144				4,303				3,810				14,272
Provision for income tax			763				935				1,427				3,803				6,928
(Loss) income available to common shareholders		$	2,252			$	2,209			$	2,876			$	7			$	7,344
(Loss) earnings per share - basic		$	0.17			$	0.15			$	0.18			$	—			$	0.48
Weighted average shares - basic			13,416				15,014				16,191				16,195				15,207
(Loss) earnings per share - diluted		$	0.17			$	0.15			$	0.18			$	—			$	0.48
Weighted average shares - diluted			13,521				15,113				16,288				16,306				15,310

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ItemItem 9 - Changes In and Disagreements with Accountants on Accounting and Financial Disclosure

 

There have been no changes in or disagreements with accountants or auditors on accounting and financial disclosure.

 

 

ItemItem 9a - Controls and Procedures

 

Disclosure Controls and Procedures

 

As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including its President and Chief Executive Officer and its Chief Financial Officer, of the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based on that evaluation, the President and Chief Executive Officer and the Chief Financial Officer concluded that these disclosure controls and procedures were effective.

 

Disclosure controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving an entity’s disclosure objectives. The likelihood of achieving such objectives is affected by limitations inherent in disclosure controls and procedures. These include the fact that human judgment in decision-making can be faulty and that breakdowns in internal controls can occur because of human failures such as simple errors, mistakes or intentional circumvention of the established processes.

 

Report on Internal Control over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the Company’s Chief Executive Officer and the Chief Financial Officer and implemented by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America.

 

The Company’s internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

On a quarterly basis, we carry out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Principal Financial Officer (whom is also our Principal Accounting Officer) of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934. As of December 31, 2018,2019, our management, including our Chief Executive Officer, and Principal Financial Officer, concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us that is required to be included in our periodic SEC filings.

 

Although we change and improve our internal controls over financial reporting on an ongoing basis, we do not believe that any such changes occurred in the fourth quarter of 20182019 that materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

This annual report includes an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting.

 

 

ItemItem 9b - Other Information

 

NoneThe Boards of Directors of the Company and the Bank recently approved Second Amendments (each, an “Amendment”) to report.our Employment Agreements with Randall S. Eslick, our President and Chief Executive Officer, James A. Sundquist, our Executive Vice President and Chief Financial Officer, and Robert H. Muttera, our Executive Vice President and Chief Credit Officer (the “Executives”). Under each Amendment, each Executive’s employment with the Company and the Bank will continue for a period of three (3) years and, on the third anniversary, the Executive’s Employment Agreement will automatically extend for a period of one (1) year (unless otherwise agreed between the parties). Under Mr. Sundquist’s Amendment, Mr. Sundquist will also be entitled to receive retention bonuses in the amount of $25,000 in July 2021, $75,000 in July 2022, and $50,000 in July 2023 (provided he is still employed on those dates and has satisfactorily performed his job). Under Mr. Eslick’s Amendment, Mr. Eslick’s Employment Agreement was also amended to increase the amount payable to Mr. Eslick in the event of a Change in Control from 2x to 2.99x his Total Compensation Package (as defined in his Employment Agreement).

 

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PartPart III

 

ItemItem 10 - Directors, Executive Officers Andand Corporate Governance

 

The response to this item is incorporated by reference to Bank of Commerce Holdings Proxy Statement for the 20192020 Annual Meeting of shareholders (the “Proxy Statement”) under the captions “Section“Information about the Director Nominees”, “Director Qualifications and Nominations for Directors”, “The Board and Governance Matters”, “Committees of the Board of Directors”, “Report of the Audit and Qualified Legal Compliance Committee”, “Director Independence, Certain Relationships and Related Transactions”, “Named Executive Officers of the Company”, “Delinquent Section 16(a) Beneficial Ownership Reporting Compliance”Reports”, “Voting Securities and Ownership of Certain Beneficial Holders”, “Certain Relationships and Related Transactions“Code of Conduct, Code of Ethics, and Director Independence”, and “Committees of the Board of Directors”Corporate Governance Documents”.

 

ItemItem 11 - Executive Compensation

 

The response to this item is incorporated by reference to the Proxy Statement, under the captions “Information on Director and Executive Compensation” and “Compensation Discussion and Analysis”, “Executive Compensation”, “Report of the Executive Compensation Committee on Executive Compensation”, and “Director Compensation”.

 

ItemItem 12 - Security Ownership Ofof Certain Beneficial Owners Andand Management Andand Related Shareholder Matters

 

The response to this item is incorporated by reference to the Proxy Statement, under the caption “Voting Securities and Ownership of Certain Beneficial Holders”.

 

ItemItem 13 - Certain Relationships and Related Transactions and Director Independence

 

The response to this item is incorporated by reference to the Proxy Statement.Statement, under the caption “Certain Relationships and Related Transactions”.

 

ItemItem 14 - Principal Accounting Fees and Services

 

The response to this item is incorporated by reference to the Proxy Statement, under the caption “Report of the Audit and Qualified Legal Compliance Committee.”

 

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PartPart IV

 

ItemItem 15 - Exhibits and Financial Statement Schedules

 

(a)	The following documents are filed as a part of this Form 10-K:

(1)

Financial Statements:

Reference is made to the Index to Consolidated Financial Statements under Item 8 in Part II of this Form 10-K.

	(2)	Reference is made to the Index to Consolidated Financial Statements under Item 8 in Part II of this Form 10-K.
	(2)	Financial Statement Schedules:

All schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.

	(3)	All schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
	(3)	Exhibits:

 

(Material Contracts Listed as 10.1 - 10.19)

Exhibit No.	Exhibit Description	Form	SEC File No.	Original Exhibit No.	Filing Date	Filed Herewith
3.1	Restated Articles of Incorporation	10-Q	000-25135	3.1	8/5/2016
3.2	Amended and Restated Bylaws	8-K	000-25135	3.2	12/20/2017
4.1	Promissory Note between Bank of Commerce Holdings and NexBank SSB, dated December 10, 2015	8-K	000-25135	4.1	12/14/2015
4.2	Form of 6.875% Fixed to Floating Rate Subordinated Note due December 10, 2025	8-K	000-25135	4.2	12/14/2015
10.1*	1993 Directors Deferred Compensation Plan	10-12G	000-25135	10.7	12/4/1998
10.2*	Form of Deferred Compensation Agreement used in connection with 1993 Directors Deferred Compensation Plan	10-12G	000-25135	10.8	12/4/1998
10.3*	Amendments to the 1993 Deferred Compensation Plan	10-K	000-25135	10.8	3/11/2014
10.4*	Amended and Restated 2010 Equity Incentive Plan (“2010 Equity Incentive Plan”)	DEF 14A	000-25135	Appendix A	3/9/2012
10.5*	Form of Stock Option Agreement used in connection with 2010 Equity Incentive Plan	10-K	000-25135	10.7	3/8/2016
10.6*	Form of Notice of Exercise of Stock Option used in connection with 2010 Equity Incentive Plan	10-K	000-25135	10.8	3/8/2016
10.7*	Form of Restricted Stock Agreement used in connection with 2010 Equity Incentive Plan	10-K	000-25135	10.9	3/8/2016
10.8*	Form of Stock Grant Agreement used in connection with 2010 Equity Incentive Plan	10-K	000-25135	10.10	3/8/2016
10.9*	Amended and Restated Salary Continuation Agreement with Randall S. Eslick, dated November 19, 2013	10-K	000-25135	10.10	3/11/2014
10.10*	Amended and Restated Salary Continuation Agreement with Samuel D. Jimenez, dated December 17, 2013	10-K	000-25135	10.12	3/11/2014
10.11*	Salary Continuation Agreement with Robert H. Muttera, dated January 17, 2014	10-K	000-25135	10.18	3/11/2014
10.12*	Amendment to the Salary Continuation Agreements	10-Q	000-25135	10.1	4/28/2017
10.13*	Amended and Restated 2013 Directors Deferred Compensation Plan and Participant Election Form	10-K	000-25135	10.12	3/9/2018
10.14	Loan Agreement by and between Bank of Commerce Holdings and NexBank SSB, dated December 10, 2015	8-K	000-25135	10.1	12/14/2015
10.15	Pledge and Security Agreement between Bank of Commerce Holdings and NexBank SSB, dated December 10, 2015	8-K	000-25135	10.2	12/14/2015
10.16	Subordinated Note Purchase Agreement between Bank of Commerce Holdings and The Purchasers named Herein, dated December 10, 2015	8-K	000-25135	10.3	12/14/2015
10.17*	Amended and Restated Employment Agreement with Randall S. Eslick dated February 21, 2017.	10-K	000-25135	10.20	3/15/2017

Exhibit No.	Exhibit Description	Form	SEC File No.	Original Exhibit No.	Filing Date	Filed Herewith
3.1	Restated Articles of Incorporation	10-Q	000-25135	3.1	8/5/2016
3.2	Amended and Restated Bylaws	8-K	000-25135	3.2	8/21/2019
4.1	Form of 6.875% Fixed to Floating Rate Subordinated Note due December 10, 2025	8-K	000-25135	4.2	12/14/2015
4.2	Description of Bank of Commerce Holdings’ Securities Registered Pursuant to Section 12 of the Securities Exchange Act					X
10.1*	1993 Directors Deferred Compensation Plan	10-12G	000-25135	10.7	12/4/1998
10.2*	Form of Deferred Compensation Agreement used in connection with 1993 Directors Deferred Compensation Plan	10-12G	000-25135	10.8	12/4/1998
10.3*	Amendments to Form of 1993 Deferred Compensation Plan	10-K	000-25135	10.8	3/11/2014
10.4*	Amended and Restated 2013 Directors Deferred Compensation Plan and Participant Election Form	10-K	000-25135	10.12	3/9/2018
10.5*	Amended and Restated 2010 Equity Incentive Plan (“2010 Equity Incentive Plan”)	DEF 14A	000-25135	Appendix A	3/9/2012
10.6*	Form of Stock Option Agreement used in connection with 2010 Equity Incentive Plan	10-K	000-25135	10.7	3/8/2016
10.7*	Form of Notice of Exercise of Stock Option used in connection with 2010 Equity Incentive Plan	10-K	000-25135	10.8	3/8/2016
10.8*	Form of Restricted Stock Agreement used in connection with 2010 Equity Incentive Plan	10-K	000-25135	10.9	3/8/2016
10.9*	Form of Stock Grant Agreement used in connection with 2010 Equity Incentive Plan	10-K	000-25135	10.10	3/8/2016
10.10*	Bank of Commerce Holdings 2019 Equity Incentive Plan	8-K	000-25135	10.1	5/23/19
10.11*	Form of Restricted Stock Agreement for 2019 Equity Incentive Plan					X
10.12*	Amended and Restated Salary Continuation Agreement with Randall S. Eslick, dated November 19, 2013	10-K	000-25135	10.10	3/11/14
10.13*	Salary Continuation Agreement with Robert H. Muttera, dated January 17, 2014	10-K	000-25135	10.18	3/11/2014
10.14*	Amendment to the Salary Continuation Agreements	10-Q	000-25135	10.1	4/28/2017
10.15*	Amended and Restated Employment Agreement with Randall S. Eslick dated February 21, 2017.	10-K	000-25135	10.20	3/15/2017
10.16*	Amended and Restated Employment Agreement with James A. Sundquist dated February 21, 2017.	10-K	000-25135	10-21	3/15/17
10.17*	Amended and Restated Employment Agreement with Robert H. Muttera dated February 21, 2017.	10-K	000-25135	10-23	3/15/17

 

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10.18*	Amended and Restated Employment Agreement with James A. Sundquist dated February 21, 2017.	10-K	000-25135	10.21	3/15/2017
10.19*	Amended and Restated Employment Agreement with Samuel D. Jimenez dated February 21, 2017.	10-K	000-25135	10.22	3/15/2017
10.20*	Amended and Restated Employment Agreement with Robert H. Muttera dated February 21, 2017.	10-K	000-25135	10.23	3/15/2017
10.21*	Form of Indemnification Agreement	8-K	000-25135	10.1	12/20/2017
10.22*	Amendment to Amended and Restated Employment Agreement with Randall S. Eslick dated May 3, 2018	10-Q	000-25135	10.1	5/4/2018
10.23*	Amendment to Amended and Restated Employment Agreement with James A. Sundquist dated May 3, 2018	10-Q	000-25135	10.2	5/4/2018
10.24*	Amendment to Amended and Restated Employment Agreement with Samuel D. Jimenez dated May 3, 2018	10-Q	000-25135	10.3	5/4/2018
10.25*	Amendment to Amended and Restated Employment Agreement with Robert H. Muttera dated May 3, 2018	10-Q	000-25135	10.4	5/4/2018
14	Code of Ethics for Senior Financial Officers	8-K	000-25135	14.1	5/21/2015
21.1	Subsidiaries of the Company					X
23.1	Consent of Moss Adams LLP					X
24	Power of Attorney (included on signature page to this report)					X
31.1	Certification of Randall S. Eslick pursuant to Exchange Act Rule 13a-14(a) or 15d — 14(a) as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002					X
31.2	Certification of James A. Sundquist pursuant to Exchange Act Rule 13a-14(a) or 15d — 14(a) as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002					X
32.1	Certification pursuant to Section 1350					X
101.INS	XBRL Instance Document					X
101.SCH	XBRL Taxonomy Extension Schema Document					X
101.CAL	XBRL Taxonomy Calculation Linkbase Document					X
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document					X
101.LAB	XBRL Taxonomy Label Linkbase Document					X
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document					X
* Executive Contract, Compensatory Plan or Arrangement

10.18*	Amendment to Amended and Restated Employment Agreement with Randall S. Eslick dated May 3, 2018	10-Q	000-2513	10.1	5/4/2018
10.19*	Amendment to Amended and Restated Employment Agreement with James A. Sundquist dated May 3, 2018	10-Q	000-2513	10.2	5/4/201/
10.20*	Amendment to Amended and Restated Employment Agreement with Robert H. Muttera dated May 3, 2018	10-Q	000-2513	10.4	5/4/2018
10.21*	Second Amendment to Employment Agreement with Randall S. Eslick dated March 6, 2020					X
10.22*	Second Amendment to Employment Agreement with James A. Sundquist dated March 6, 2020					X
10.23*	Second Amendment to Employment Agreement with Robert H. Muttera dated March 6, 2020					X
10.24*	Severance and Release Agreement with Samuel D. Jimenez effective January 28, 2020					X
10.25*	Form of Indemnification Agreement	8-K	000-2513	10.1	12/20/2017
10.26*	Subordinated Note Purchase Agreement between Bank of Commerce Holdings and The Purchasers named Herein, dated December 10, 2015	8-K	000-2513	10.3	12/14/2015
21.1	Subsidiaries of the Company					X
23.1	Consent of Moss Adams LLP					X
24	Power of Attorney (included on signature page to this report)					X
31.1	Certification of Randall S. Eslick pursuant to Exchange Act Rule 13a-14(a) or 15d — 14(a) as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002					X
31.2	Certification of James A. Sundquist pursuant to Exchange Act Rule 13a-14(a) or 15d — 14(a) as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002					X
32.1	Certification pursuant to Section 1350					X
101.INS	XBRL Instance Document					X
101.SCH	XBRL Taxonomy Extension Schema Document					X
101.CAL	XBRL Taxonomy Calculation Linkbase Document					X
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document					X
101.LAB	XBRL Taxonomy Label Linkbase Document					X
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document					X
* Executive Contract, Compensatory Plan or Arrangement

 

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SignSignaturesatures

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 12, 2019.6, 2020.

 

		BANK OF COMMERCE HOLDINGS
	By	/s/ Randall S. Eslick
		Randall S. Eslick
		President and Chief Executive Officer

 

 

POWERPOWER OF ATTORNEY

 

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Randall S. Eslick and James A. Sundquist, and each of them, his true and lawful attorneys-in-fact, each with full power of substitution, for him in any and all capacities, to sign any amendments to this report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact or their substitute or substitutes may do or cause to be done by virtue hereof.

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.

 

 

 

Name		Title		Date
/s/ Randall S. Eslick		President and Chief Executive Officer Director (Principal Executive Officer)		March 12, 20196, 2020
/s/ James A. Sundquist		Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)		March 12, 20196, 2020
/s/ Lyle L. Tullis		Chairman of the Board		March 12, 20196, 2020
/s/ Orin N. Bennett		Director		March 12, 20196, 2020
/s/ Gary R. Burks		Director		March 12, 20196, 2020
/s/ Joseph Q. Gibson		Director		March 12, 20196, 2020
/s/ Jon W. Halfhide		Director		March 12, 20196, 2020
/s/ David J. Inderkum		Director		March 12, 20196, 2020
/s/ Linda J. Miles		Director		March 12, 20196, 2020
/s/ Karl L. Silberstein		Director		March 12, 20196, 2020
/s/ Terence J. Street		Director		March 12, 20196, 2020

8

 

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