Heritage Commerce 10Q 2020 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


	Washington, D.C. 20549

	FORM 10-Q


(MARK ONE)
☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2020
OR
☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

Commission file number 000-23877

Heritage Commerce Corp

(Exact name of Registrant as Specified in its Charter)

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

(408) 947-6900

(Registrant’s Telephone Number, Including Area Code)

N/A

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

Securities registered pursuant to Section 12(b) of the Act:


Title of each class:	Trading Symbol:	Name of each exchange on which registered:
Common Stock, No Par Value	HTBK	The NASDAQ Stock Market LLC

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). YES ☒ NO ☐

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

Large accelerated filer ☐	Accelerated filer ☒	Non-accelerated filer ☐	Smaller reporting company ☐
			Emerging growth company ☐

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

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

The Registrant had 59,875,967 shares of Common Stock outstanding on July 31, 2020

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HERITAGE COMMERCE CORP

QUARTERLY REPORT ON FORM 10-Q

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		Page No.
Cautionary Note on Forward-Looking Statements		3

Part I. FINANCIAL INFORMATION

Item 1.	Consolidated Financial Statements (unaudited)	6

	Consolidated Balance Sheets	6

	Consolidated Statements of Income	7

	Consolidated Statements of Comprehensive Income	8

	Consolidated Statements of Changes in Shareholders’ Equity	9

	Consolidated Statements of Cash Flows	10

	Notes to Unaudited Consolidated Financial Statements	11

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	46

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	88

Item 4.	Controls and Procedures	88

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	89

Item 1A.	Risk Factors	89

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	91

Item 3.	Defaults Upon Senior Securities	91

Item 4.	Mine Safety Disclosures	91

Item 5.	Other Information	91

Item 6.	Exhibits	91

SIGNATURES		92

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Cautionary Note Regarding Forward-Looking Statements

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

These forward-looking statements are subject to various risks and uncertainties that may be outside our control and our actual results could differ materially from our projected results. Risks and uncertainties that could cause our financial performance to differ materially from our goals, plans, expectations and projections expressed in forward-looking statements include those set forth in our filings with the Securities and Exchange Commission (“SEC”), Item 1A of the Heritage Commerce Corp’s (“the Company”) Annual Report on Form 10-K for the year ended December 31, 2019, and the following:

●the rapidly changing uncertainties related to the novel Coronavirus (“COVID-19”) pandemic including, but not limited to, the potential adverse effect of the pandemic on the economy, our employees and customers, and our financial performance;

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

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

●our ability to anticipate interest rate changes and manage interest rate risk;

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

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

●our ability to effectively compete with other banks and financial services companies and the effects of competition in the financial services industry on our business;

●our ability to achieve loan growth and attract deposits;

●risks associated with concentrations in real estate related loans;

●the relative strength or weakness of the commercial and real estate markets where our borrowers are located, including related asset and market prices;

●other than temporary impairment charges to our securities portfolio;

●changes in the level of nonperforming assets and charge offs and other credit quality measures, and their impact on the adequacy of our allowance for credit losses and our provision for credit losses;

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

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●adverse impact of political instability;

●if the goodwill that we recorded in connection with a business acquisition becomes impaired, it could require charges to earnings, which would have a negative impact on our financial condition and results of operations;

●regulatory limits on Heritage Bank of Commerce’s ability to pay dividends to the Company; and therefore the Company’s ability to pay dividends to shareholders;

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

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

●our inability to attract, recruit, and retain qualified officers and other personnel could harm our ability to implement our strategic plan, impair our relationships with customers and adversely affect our business, results of operations and growth prospects;

●possible adjustment of the valuation of our deferred tax assets;

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

●inability to manage risks associated with our business, including operational risk and credit risk;

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

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

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

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

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

●availability of and competition for acquisition opportunities;

●risks resulting from riots and domestic terrorism;

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

●the impact of the federal Coronavirus Aid, Relief, and Economic Security Act and the significant additional lending activities undertaken by the Company in connection with the Small Business Administration’s Paycheck Protection Program enacted thereunder, including risks to the Company with respect to the uncertain application by the Small Business Administration of new borrower and loan eligibility, forgiveness and audit criteria; and

●

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

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

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Part I—FINANCIAL INFORMATION

ITEM 1—CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

HERITAGE COMMERCE CORP

CONSOLIDATED BALANCE SHEETS (Unaudited)


	June 30,		December 31,
	2020		2019

	(Dollars in thousands)
Assets
Cash and due from banks	$	40,108	$	49,447
Other investments and interest-bearing deposits in other financial institutions		885,792		407,923
Total cash and cash equivalents		925,900		457,370
Securities available-for-sale, at fair value		323,565		404,825
Securities held-to-maturity, at amortized cost, net of allowance for credit losses of $55 at June 30, 2020
(fair value of $332,452 at June 30, 2020 and $368,107 at December 31, 2019)		322,677		366,560
Loans held-for-sale - SBA, at lower of cost or fair value, including deferred costs		4,324		1,052
Loans, net of deferred fees		2,686,389		2,533,844
Allowance for credit losses on loans⁽¹⁾		(45,444)		(23,285)
Loans, net		2,640,945		2,510,559
Federal Home Loan Bank, Federal Reserve Bank stock and other investments, at cost		33,509		29,842
Company-owned life insurance		76,943		76,027
Premises and equipment, net		9,500		8,250
Goodwill		167,631		167,420
Other intangible assets		18,593		20,415
Accrued interest receivable and other assets		90,814		67,143
Total assets	$	4,614,401	$	4,109,463

Liabilities and Shareholders' Equity
Liabilities:
Deposits:
Demand, noninterest-bearing	$	1,714,058	$	1,450,873
Demand, interest-bearing		934,780		798,375
Savings and money market		1,091,740		982,430
Time deposits - under $250		49,493		54,361
Time deposits - $250 and over		93,822		99,882
CDARS - interest-bearing demand, money market and time deposits		16,333		28,847
Total deposits		3,900,226		3,414,768
Subordinated debt, net of issuance costs		39,646		39,554
Other short-term borrowings		—		328
Accrued interest payable and other liabilities		99,722		78,105
Total liabilities		4,039,594		3,532,755

Shareholders' equity:
Preferred stock, no par value; 10,000,000 shares authorized; none issued and outstanding
at June 30, 2020 and December 31, 2019		—		—
Common stock, no par value; 100,000,000 shares authorized at June 30, 2020 and
authorized at December 31, 2019; 59,856,767 shares issued
and outstanding at June 30, 2020 and 59,368,156 shares issued and
outstanding at December 31, 2019		492,333		489,745
Retained earnings		87,654		96,741
Accumulated other comprehensive loss		(5,180)		(9,778)
Total shareholders' equity		574,807		576,708
Total liabilities and shareholders' equity	$	4,614,401	$	4,109,463

⁽¹⁾Allowance for credit losses on loans at June 30, 2020, Allowance for loan losses at December 31, 2019

See notes to unaudited consolidated financial statements

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HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2020		2019		2020		2019

	(Dollars in thousands, except per share amounts)
Interest income:
Loans, including fees	$	32,845	$	27,251	$	67,627	$	54,058
Securities, taxable		3,155		4,136		7,103		8,645
Securities, exempt from Federal tax		484		546		995		1,094
Other investments, interest-bearing deposits
in other financial institutions and Federal funds sold		648		1,556		2,349		3,141
Total interest income		37,132		33,489		78,074		66,938

Interest expense:
Deposits		1,615		1,995		3,400		3,831
Subordinated debt		577		577		1,154		1,148
Short-term borrowings		—		1		—		1
Total interest expense		2,192		2,573		4,554		4,980

Net interest income before provision for credit losses on loans⁽¹⁾		34,940		30,916		73,520		61,958
Provision (credit) for credit losses on loans⁽¹⁾		1,114		(740)		14,384		(1,801)
Net interest income after provision for credit losses on loans⁽¹⁾		33,826		31,656		59,136		63,759

Noninterest income:
Service charges and fees on deposit accounts		650		1,177		1,619		2,338
Increase in cash surrender value of life insurance		458		333		916		663
Servicing income		205		150		388		341
Gain on sales of securities		170		548		270		548
Gain on the disposition of foreclosed assets		—		—		791		—
Gain on sales of SBA loans		—		36		67		175
Other		595		521		1,220		1,168
Total noninterest income		2,078		2,765		5,271		5,233

Noninterest expense:
Salaries and employee benefits		12,300		10,698		26,503		21,468
Occupancy and equipment		1,766		1,578		3,538		3,084
Professional fees		1,155		753		2,590		1,571
Other		5,791		5,416		14,155		10,240
Total noninterest expense		21,012		18,445		46,786		36,363
Income before income taxes		14,892		15,976		17,621		32,629
Income tax expense		4,274		4,623		5,142		9,130
Net income	$	10,618	$	11,353	$	12,479	$	23,499

Earnings per common share:
Basic	$	0.18	$	0.26	$	0.21	$	0.54
Diluted	$	0.18	$	0.26	$	0.21	$	0.54

⁽¹⁾Provision for credit losses on loans for the three and six months ended June 30, 2020, Provision (credit) for loan losses for the
three and six months ended June 30, 2019

See notes to unaudited consolidated financial statements

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HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2020		2019		2020		2019

		(Dollars in thousands)
Net income	$	10,618	$	11,353	$	12,479	$	23,499
Other comprehensive income:
Change in net unrealized holding (losses) gains on available-for-sale
securities and I/O strips		(556)		4,333		6,621		9,204
Deferred income taxes		161		(1,261)		(1,920)		(2,728)
Change in net unamortized unrealized gain on securities available-for-
sale that were reclassified to securities held-to-maturity		(13)		(13)		(26)		(39)
Deferred income taxes		4		4		8		12
Reclassification adjustment for gains realized in income		(170)		(548)		(270)		(548)
Deferred income taxes		50		162		79		162
Change in unrealized (losses) gains on securities and I/O strips, net of
deferred income taxes		(524)		2,677		4,492		6,063

Change in net pension and other benefit plan liability adjustment		75		11		150		23
Deferred income taxes		(22)		(3)		(44)		(7)
Change in pension and other benefit plan liability, net of
deferred income taxes		53		8		106		16
Other comprehensive (losses) income		(471)		2,685		4,598		6,079

Total comprehensive income	$	10,147	$	14,038	$	17,077	$	29,578

See notes to unaudited consolidated financial statements

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HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)


						Accumulated
						Other		Total
	Common Stock			Retained		Comprehensive		Shareholders’
	Shares	Amount		Earnings		Loss		Equity

	(Dollars in thousands)
Balance, January 1, 2019	43,288,750	$	300,844	$	79,003	$	(12,381)	$	367,466
Net income	—		—		12,146		—		12,146
Other comprehensive income	—		—		—		3,394		3,394
Amortization of restricted stock awards,
net of forfeitures and taxes	—		271		—		—		271
Cash dividend declared $0.12 per share	—		—		(5,196)		—		(5,196)
Stock option expense, net of forfeitures and taxes	—		166		—		—		166
Stock options exercised	35,003		269		—		—		269
Balance, March 31, 2019	43,323,753		301,550		85,953		(8,987)		378,516

Net income	—		—		11,353		—		11,353
Other comprehensive income	—		—		—		2,685		2,685
Issuance of restricted stock awards, net	134,653		—		—		—		—
Amortization of restricted stock awards,
net of forfeitures and taxes	—		303		—		—		303
Cash dividend declared $0.12 per share	—		—		(5,201)		—		(5,201)
Stock option expense, net of forfeitures and taxes	—		155		—		—		155
Stock options exercised	40,000		297		—		—		297
Balance, June 30, 2019	43,498,406	$	302,305	$	92,105	$	(6,302)	$	388,108


Balance, December 31, 2019	59,368,156	$	489,745	$	96,741	$	(9,778)	$	576,708
Cumulative effect of change in accounting principles (Note 1)	—		—		(6,062)		—		(6,062)
Balance, January 1, 2020	59,368,156		489,745		90,679		(9,778)		570,646
Net income	—		—		1,861		—		1,861
Other comprehensive income	—		—		—		5,069		5,069
Amortization of restricted stock awards,
net of forfeitures and taxes	—		348		—		—		348
Cash dividend declared $0.13 per share	—		—		(7,737)		—		(7,737)
Stock option expense, net of forfeitures and taxes	—		148		—		—		148
Stock options exercised	200,063		1,106		—		—		1,106
Balance, March 31, 2020	59,568,219		491,347	$	84,803		(4,709)		571,441

Net income	—		—		10,618		—		10,618
Other comprehensive income	—		—		—		(471)		(471)
Issuance of restricted stock awards, net	168,117		—		—		—		—
Amortization of restricted stock awards,
net of forfeitures and taxes	—		463		—		—		463
Cash dividend declared $0.13 per share	—		—		(7,767)		—		(7,767)
Stock option expense, net of forfeitures and taxes	—		139		—		—		139
Stock options exercised	120,431		384		—		—		384
Balance, June 30, 2020	59,856,767	$	492,333	$	87,654	$	(5,180)	$	574,807

See notes to unaudited consolidated financial statements

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HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)


	Six Months Ended
	June 30,
	2020		2019

	(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	12,479	$	23,499
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of discounts and premiums on securities		1,453		1,132
Gain on sale of securities available-for-sale		(270)		(548)
Gain on sale of SBA loans		(67)		(175)
Proceeds from sale of SBA loans originated for sale		916		2,528
SBA loans originated for sale		(4,121)		(4,906)
Provision (credit) for credit losses on loans⁽¹⁾		14,384		(1,801)
Increase in cash surrender value of life insurance		(916)		(663)
Depreciation and amortization		475		401
Amortization of other intangible assets		1,822		1,107
Stock option expense, net		287		321
Amortization of restricted stock awards, net		811		574
Amortization of subordinated debt issuance costs		92		92
Effect of changes in:
Accrued interest receivable and other assets		(23,437)		(186)
Accrued interest payable and other liabilities		21,963		(3,767)
Net cash provided by operating activities		25,871		17,608

CASH FLOWS FROM INVESTING ACTIVITIES:
Maturities/paydowns/calls of securities available-for-sale		30,810		24,868
Maturities/paydowns/calls of securities held-to-maturity		42,408		25,007
Proceeds from sales of securities available-for-sale		56,598		59,878
Net change in loans		(152,881)		9,222
Changes in Federal Home Loan Bank stock and other investments		(3,667)		(10)
Purchase of premises and equipment		(1,725)		(239)
Net cash provided (used in) by investing activities		(28,457)		118,726

CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in deposits		485,458		(15,059)
Net change in short-term borrowings		(328)		—
Exercise of stock options		1,490		566
Payment of cash dividends		(15,504)		(10,397)
Net cash used in financing activities		471,116		(24,890)
Net increase in cash and cash equivalents		468,530		111,444
Cash and cash equivalents, beginning of period		457,370		164,568
Cash and cash equivalents, end of period	$	925,900	$	276,012

Supplemental disclosures of cash flow information:
Interest paid	$	4,584	$	4,733
Income taxes paid (refunds), net		(524)		10,891

Supplemental schedule of non-cash activity:
Recording of right to use assets in exchange for lease obligations	$	—	$	9,566

⁽¹⁾Provision for credit losses on loans for the six months ended June 30, 2020, Provision (credit) for loan losses for the
six months ended June 30, 2019

See notes to unaudited consolidated financial statements

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HERITAGE COMMERCE CORP

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

1) Basis of Presentation

The unaudited consolidated financial statements of Heritage Commerce Corp (the “Company” or “HCC”) and its wholly owned subsidiary, Heritage Bank of Commerce (“HBC”), have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain information and notes required by accounting principles generally accepted in the United States of America (“GAAP”) for annual financial statements are not included herein. The interim statements should be read in conjunction with the consolidated financial statements and notes that were included in the Company’s Form 10-K for the year ended December 31, 2019.

HBC is a commercial bank serving customers primarily located in Alameda, Contra Costa, Marin, San Benito, San Francisco, San Mateo, and Santa Clara counties of California. CSNK Working Capital Finance Corp. a California corporation, dba Bay View Funding (“Bay View Funding”) is a wholly owned subsidiary of HBC, and provides business-essential working capital factoring financing to various industries throughout the United States. No customer accounts for more than 10% of revenue for HBC or the Company. The Company reports its results for 2 segments: banking and factoring. The Company’s management uses segment results in its operating and strategic planning.

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

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

The results for the three and six months ended June 30, 2020 are not necessarily indicative of the results expected for any subsequent period or for the entire year ending December 31, 2020.

COVID-19

Capital and Liquidity

While the Company believes that it has sufficient capital to withstand an extended economic recession brought about by COVID-19, its reported and regulatory capital ratios could be adversely impacted by credit losses. The Company relies on cash on hand as well as dividends from its subsidiary bank to service its debt. If the Company’s capital deteriorates such that its subsidiary bank is unable to pay dividends to it for an extended period of time, the Company may not be able to service its debt.

The Company maintains access to multiple sources of liquidity. Wholesale funding markets have remained open to us, but rates for short term funding have recently been volatile. If funding costs are elevated for an extended period of time, it could have an adverse effect on the Company’s net interest margin. If an extended recession caused large numbers of the Company’s deposit customers to withdraw their funds, the Company might become more reliant on volatile or more expensive sources of funding.

Asset Valuation

While certain valuation assumptions and judgments will change to account for pandemic-related circumstances such as widening credit spreads, the Company does not anticipate significant changes in methodology used to determine the fair value of assets measured in accordance with GAAP.

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The extent to which the COVID-19 pandemic will impact our business, results of operations and financial condition will depend on future developments, which are highly uncertain and difficult to predict. Those developments and factors include the duration and spread of the pandemic, its severity, the actions to contain the pandemic or address its impact, and how quickly and to what extent normal economic and operating conditions can resume. We do not yet know the full extent of the impact. However, the effects could have a material adverse impact on our business, asset valuations, financial condition and results of operations. Material adverse impacts may include all or a combination of valuation impairments on our intangible assets, investments, loans, or deferred tax assets.

Reclassifications

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

Adoption of New Accounting Standards

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in this update replace the incurred loss impairment methodology in prior GAAP with a methodology that reflects expected life-of-instrument credit losses and requires consideration of a broader range of reasonable and supportable information to estimate future credit loss estimates. As Current Expected Credit Losses (“CECL”) encompasses all financial assets carried at amortized cost, the requirement that reserves be established based on an organization’s reasonable and supportable estimate of expected credit losses extends to held-to-maturity debt securities. The Company adopted CECL on January 1, 2020, using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for the reporting periods after January 1, 2020, are presented under Topic 326, while prior period amounts continue to be reported in accordance with previously applicable GAAP.

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The following table shows the impact of adopting CECL on January 1, 2020:


		As Reported		Pre-		Impact of
		Under		Topic 326		Topic 326
		Topic 326		Adoption		Adoption

		(Dollars in thousands)
Assets:
Allowance for credit losses on debt securities
Held to maturity municipal securities	$	58	$	-	$	58
Loans
Commercial		6,790		10,453		(3,663)
CRE - owner occupied		6,994		3,825		3,169
CRE - non-owner occupied		11,672		3,760		7,912
Land and construction		1,458		2,621		(1,163)
Home equity		1,321		2,244		(923)
Multifamily		1,253		57		1,196
Residential mortgage		678		243		435
Consumer and other		1,689		82		1,607
Allowance for credit losses on loans	$	31,855	$	23,285	$	8,570

Liabilities:
Allowance for credit losses on off-balance sheet
credit exposures	$	679	$	886	$	(207)

For CECL modeling purposes, the Company uses forecast data for the state of California including Gross Domestic Product (“GDP”) and unemployment projections provided by the California Economic Forecast (“CEF”, www.CaliforniaForecast.com). At January 1, 2020, the forecast for California GDP for 2020 was an annual increase in the low single digits and the forecasted California unemployment rate for 2020 was in the mid single digits.

As of the implementation date of January 1, 2020, the Company recognized an increase of $8,570,000 to its allowance for credit losses for loans. The majority of this increase is related to loan portfolios acquired in our recent acquisitions that under the previous methodology were covered by the purchase discount on acquired loans. The cumulative-effect adjustment as a result of the adoption of this guidance was recorded, net of tax of $2.4 million, was a $6.1 million reduction to retained earnings effective January 1, 2020.

As of the implementation date, there was a $58,000 allowance for losses recorded on the Company’s held-to-maturity municipal investment securities portfolio. For the six month ended June 30, 2020, there was a reduction of $3,000 to the allowance for losses on the Company’s held-to-maturity municipal investment securities portfolio. This reduction was the result of a reduction in municipal securities amortized balances resulting from regular payments. The allowance for losses on held-to-maturity securities is based on historic loss rates of municipal securities by bond ratings and change in bond ratings of the municipal securities held by the Company will impact the reserve. The bond ratings for the Company’s municipal investment securities at June 30, 2020 were consistent with the ratings at January 1, 2020. Any ratings downgrades on these securities will impact the allowance for losses on these securities.

In the normal course of business, the Company makes commitments to extend credit to its customers as long as there are no violations of any conditions established in contractual arrangements. These commitments are obligations that represent a potential credit risk to the Company, yet are not reflected in any form within the Company’s consolidated balance sheets. As of the implementation date, there was a reduction of $207,000 to the allowance for losses recorded for the Company’s off-balance sheet credit exposures. The reduction in reserves for off-balance sheet credit exposures at implementation was primarily driven by applying a lower estimated CECL loss factor for unfunded commercial loan and construction loan commitments. For the six month ended June 30, 2020, there was an increase of $522,000 to the allowance for losses for the Company’s off-balance sheet credit exposures. The increase in the allowance for losses for off-balance sheet credit exposures in the first quarter 2020 was driven by increased loss factors in the CECL model for all loan segments with off-balance sheet exposures which resulted from deterioration in the economic forecast assumptions used in the CECL model.

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In January 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for Goodwill Impairment. The provisions of the update eliminate the existing second step of the goodwill impairment test which provides for the allocation of reporting unit fair value among existing assets and liabilities, with the net remaining amount representing the implied fair value of goodwill. In replacement of the existing goodwill impairment rule, the update will provide that impairment should be recognized as the excess of any of the reporting unit’s goodwill over the fair value of the reporting unit. Under the provisions of this update, the amount of the impairment is limited to the carrying value of the reporting unit’s goodwill. The amendments of the update became effective for the Company on January 1, 2020.

2) Earnings Per Share

Basic earnings per common share is computed by dividing net income by the weighted average common shares outstanding. Diluted earnings per share reflect potential dilution from outstanding stock options using the treasury stock method. There were 1,722,342 and 826,445 stock options for the three months ended June 30, 2020 and 2019, and 1,490,688, and 826,445 for the six months ended June 30, 2020 and 2019, respectively, considered to be antidilutive and excluded from the computation of diluted earnings per share. A reconciliation of these factors used in computing basic and diluted earnings per common share is as follows:


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2020		2019		2020		2019

	(Dollars in thousands, except per share amounts)
Net income	$	10,618	$	11,353	$	12,479	$	23,499

Weighted average common shares outstanding for basic
earnings per common share		59,420,592		43,202,562		59,353,759		43,155,360
Dilutive potential common shares		691,831		518,889		798,728		539,757
Shares used in computing diluted earnings per common share		60,112,423		43,721,451		60,152,487		43,695,117

Basic earnings per share	$	0.18	$	0.26	$	0.21	$	0.54
Diluted earnings per share	$	0.18	$	0.26	$	0.21	$	0.54

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

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


	Three Months Ended June 30, 2020 and 2019
			Unamortized
			Unrealized
	Unrealized		Gain on
	Gains (Losses) on		Available-
	Available-		for-Sale		Defined
	for-Sale		Securities		Benefit
	Securities		Reclassified		Pension
	and I/O		to Held-to-		Plan
	Strips		Maturity		Items(1)		Total

	(Dollars in thousands)
Beginning balance April 1, 2020, net of taxes	$	6,627	$	289	$	(11,625)	$	(4,709)
Other comprehensive loss before reclassification,
net of taxes		(395)		—		(10)		(405)
Amounts reclassified from other comprehensive income (loss),
net of taxes		(120)		(9)		63		(66)
Net current period other comprehensive income (loss),
net of taxes		(515)		(9)		53		(471)

Ending balance June 30, 2020, net of taxes	$	6,112	$	280	$	(11,572)	$	(5,180)

Beginning balance April 1, 2019, net of taxes	$	(1,603)	$	326	$	(7,710)	$	(8,987)
Other comprehensive income (loss) before reclassification,
net of taxes		3,072		—		(7)		3,065
Amounts reclassified from other comprehensive income (loss),
net of taxes		(386)		(9)		15		(380)
Net current period other comprehensive income (loss),
net of taxes		2,686		(9)		8		2,685

Ending balance June 30, 2019, net of taxes	$	1,083	$	317	$	(7,702)	$	(6,302)

(1)	This AOCI component is included in the computation of net periodic benefit cost (see Note 9—Benefit Plans) and includes split-dollar life insurance benefit plan.

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	Six Months Ended June 30, 2020 and 2019
			Unamortized
			Unrealized
	Unrealized		Gain on
	Gains (Losses) on		Available-
	Available-		for-Sale		Defined
	for-Sale		Securities		Benefit
	Securities		Reclassified		Pension
	and I/O		to Held-to-		Plan
	Strips		Maturity		Items(1)		Total

	(Dollars in thousands)
Beginning balance January 1, 2020, net of taxes	$	1,602	$	298	$	(11,678)	$	(9,778)
Other comprehensive income (loss) before reclassification,
net of taxes		4,701		—		(6)		4,695
Amounts reclassified from other comprehensive income (loss),
net of taxes		(191)		(18)		112		(97)
Net current period other comprehensive income (loss),
net of taxes		4,510		(18)		106		4,598

Ending balance June 30, 2020, net of taxes	$	6,112	$	280	$	(11,572)	$	(5,180)

Beginning balance January 1, 2019, net of taxes	$	(5,007)	$	344	$	(7,718)	$	(12,381)
Other comprehensive income (loss) before reclassification,
net of taxes		6,476		—		(14)		6,462
Amounts reclassified from other comprehensive income (loss),
net of taxes		(386)		(27)		30		(383)
Net current period other comprehensive income (loss),
net of taxes		6,090		(27)		16		6,079

Ending balance June 30, 2019, net of taxes	$	1,083	$	317	$	(7,702)	$	(6,302)

(1)	This AOCI component is included in the computation of net periodic benefit cost (see Note 9—Benefit Plans) and includes split-dollar life insurance benefit plan.

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	Amounts Reclassified from
	AOCI(1)
	Three Months Ended
	June 30,				Affected Line Item Where
Details About AOCI Components	2020		2019		Net Income is Presented

	(Dollars in thousands)
Unrealized gains on available-for-sale securities
and I/O strips	$	170	$	548	Gain on sales of securities
		(50)		(162)	Income tax expense
		120		386	Net of tax
Amortization of unrealized gain on securities available-
for-sale that were reclassified to securities
held-to-maturity		13		13	Interest income on taxable securities
		(4)		(4)	Income tax expense
		9		9	Net of tax

Amortization of defined benefit pension plan items ⁽¹⁾
Prior transition obligation		15		24
Actuarial losses		(105)		(46)
		(90)		(22)	Other noninterest expense
		27		7	Income tax benefit
		(63)		(15)	Net of tax
Total reclassification for the period	$	66	$	380


	Amounts Reclassified from
	AOCI(1)
	Six Months Ended
	June 30,				Affected Line Item Where
Details About AOCI Components	2020		2019		Net Income is Presented

	(Dollars in thousands)
Unrealized gains on available-for-sale securities
and I/O strips	$	270	$	548	Gain on sales of securities
		(79)		(162)	Income tax expense
		191		386	Net of tax
Amortization of unrealized gain on securities
available-for-sale that were reclassified to securities
held-to-maturity		26		39	Interest income on taxable securities
		(8)		(12)	Income tax expense
		18		27	Net of tax
Amortization of defined benefit pension plan items ⁽¹⁾
Prior transition obligation		30		49
Actuarial losses		(190)		(92)
		(160)		(43)	Other noninterest expense
		48		13	Income tax benefit
		(112)		(30)	Net of tax
Total reclassification from AOCI for the period	$	97	$	383

(1)	This AOCI component is included in the computation of net periodic benefit cost (see Note 9—Benefit Plans) and includes split-dollar life insurance benefit plan.

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4) Securities

The amortized cost and estimated fair value of securities were as follows for the periods indicated:


			Gross		Gross		Allowance		Estimated
	Amortized		Unrealized		Unrealized		for Credit		Fair
June 30, 2020	Cost		Gains		(Losses)		Losses		Value

	(Dollars in thousands)
Securities available-for-sale:
Agency mortgage-backed securities	$	225,429	$	6,906	$	—	$	—	$	232,335
U.S. Treasury		89,476		1,754		—		—		91,230
Total	$	314,905	$	8,660	$	—	$	—	$	323,565

			Gross		Gross		Estimated		Allowance
	Amortized		Unrecognized		Unrecognized		Fair		for Credit
June 30, 2020	Cost		Gains		(Losses)		Value		Losses

	(Dollars in thousands)
Securities held-to-maturity:
Agency mortgage-backed securities	$	249,070	$	7,895	$	(1)	$	256,964	$	—
Municipals - exempt from Federal tax		73,662		1,826		—		75,488		(55)
Total	$	322,732	$	9,721	$	(1)	$	332,452	$	(55)


			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair
December 31, 2019	Cost		Gains		(Losses)		Value

	(Dollars in thousands)
Securities available-for-sale:
Agency mortgage-backed securities	$	283,598	$	934	$	(171)	$	284,361
U.S. Treasury		118,939		1,525		—		120,464
Total	$	402,537	$	2,459	$	(171)	$	404,825

			Gross		Gross		Estimated
	Amortized		Unrecognized		Unrecognized		Fair
December 31, 2019	Cost		Gains		(Losses)		Value

	(Dollars in thousands)
Securities held-to-maturity:
Agency mortgage-backed securities	$	285,344	$	1,206	$	(968)	$	285,582
Municipals - exempt from Federal tax		81,216		1,313		(4)		82,525
Total	$	366,560	$	2,519	$	(972)	$	368,107

Securities with unrealized losses at June 30, 2020 and December 31, 2019, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position are as follows:


	Less Than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
June 30, 2020	Value		(Losses)		Value		(Losses)		Value		(Losses)

	(Dollars in thousands)
Securities held-to-maturity:
Agency mortgage-backed securities	$	512	$	(1)	$	—	$	—	$	512	$	(1)
Total	$	512	$	(1)	$	—	$	—	$	512	$	(1)

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	Less Than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
December 31, 2019	Value		(Losses)		Value		(Losses)		Value		(Losses)

	(Dollars in thousands)
Securities available-for-sale:
Agency mortgage-backed securities	$	100,816	$	(105)	$	27,534	$	(66)	$	128,350	$	(171)
Total	$	100,816	$	(105)	$	27,534	$	(66)	$	128,350	$	(171)

Securities held-to-maturity:
Agency mortgage-backed securities	$	50,060	$	(178)	$	88,128	$	(790)	$	138,188	$	(968)
Municipals - exempt from Federal tax		1,556		(4)		—		—		1,556		(4)
Total	$	51,616	$	(182)	$	88,128	$	(790)	$	139,744	$	(972)

There were no holdings of securities of any one issuer, other than the U.S. Government and its sponsored entities, in an amount greater than 10% of shareholders�� equity. At June 30, 2020, the Company held 425 securities (122 available-for-sale and 303 held-to-maturity), of which one had fair value below amortized cost. At June 30, 2020, there were $512,000 of agency mortgage-backed securities held-to-maturity, carried with an unrealized loss for less than 12 months. The total unrealized loss for securities less than 12 months was $1,000 at June 30, 2020. The unrealized loss was due to higher interest rates in comparison to when the security was purchased. The issuer is of high credit quality and all principal amounts are expected to be paid when securities mature. The fair value is expected to recover as the securities approach their maturity date and/or market rates decline. The Company does not believe that it is more likely than not that the Company will be required to sell a security in an unrealized loss position prior to recovery in value. Therefore, the Company does not consider these debt securities to have credit related losses as of June 30, 2020.

The agency mortgage-backed securities and U.S. Treasury securities are either explicitly or implicitly guaranteed by the U.S. government, are highly rated by major credit rating agencies, and have a long history of no credit losses.Therefore, for those securities, we do not record expected credit losses.

The proceeds from sales of securities and the resulting gains and losses were as follows for the periods indicated:


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2020		2019		2020		2019

	(Dollars in thousands)
Proceeds	$	30,085	$	59,878	$	56,598	$	59,878
Gross gains		170		608		270		608
Gross losses		—		(60)		—		(60)

The amortized cost and estimated fair values of securities as of June 30, 2020 are shown by contractual maturity below. The expected maturities will differ from contractual maturities if borrowers have the right to call or pre-pay obligations with or without call or pre-payment penalties. Securities not due at a single maturity date are shown separately.


	Available-for-sale
	Amortized		Estimated
	Cost		Fair Value

	(Dollars in thousands)
Due after 3 months through one year	$	74,608		75,861
Due after one through five years		14,868		15,369
Agency mortgage-backed securities		225,429		232,335
Total	$	314,905	$	323,565

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	Held-to-maturity
	Amortized		Estimated
	Cost		Fair Value

	(Dollars in thousands)
Due 3 months or less	$	530	$	531
Due after 3 months through one year		914		917
Due after one through five years		7,283		7,537
Due after five through ten years		33,354		34,201
Due after ten years		31,581		32,302
Agency mortgage-backed securities		249,070		256,964
Total	$	322,732	$	332,452

Securities with amortized cost of $43,398,000 and $32,773,000 as of June 30, 2020 and December 31, 2019 were pledged to secure public deposits and for other purposes as required or permitted by law or contract.

The table below presents a rollforward by major security type for the six months ended June 30, 2020 of the allowance for credit losses on debt securities held-to-maturity held at period end:


		Municipals
		(Dollars in thousands)
Beginning balance January 1, 2020	$	-
Impact of adopting Topic 326		58
Provision (credit) for credit loss		(3)
Ending balance June 30, 2020	$	55

5) Loans and Allowance for Credit Losses on Loans

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

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

Commercial

Commercial loans primarily rely on the identified cash flows of the borrower for repayment and secondarily on the underlying collateral provided by the borrower. However, the cash flows of the borrowers may not be as expected and the collateral securing these loans may vary in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable, inventory or equipment and may incorporate a personal guarantee; however, some loans may be unsecured. Included in commercial loans are $324,550,000 of SBA Paycheck Protection Program ("PPP") loans.

Commercial Real Estate (“CRE”)

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

Land and Construction

Land and construction loans are generally based on estimates of costs and value associated with the complete project. Construction loans usually involve the disbursement of funds with repayment substantially dependent on the

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success of the completion of the project. Sources of repayment for these loans may be permanent loans from HBC or other lenders, or proceeds from the sales of the completed project. These loans are monitored by on-site inspections and are considered to have higher risk than other real estate loans due to the final repayment dependent on numerous factors including general economic conditions.

Home Equity

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

Multifamily

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

Residential Mortgages

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

Consumer and Other

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

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


	June 30,		December 31,
	2020		2019

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

⁽¹⁾Allowance for credit losses on loans at June 30, 2020, Allowance for loan losses for the prior periods.

The loss estimates for each segment are derived using a discounted cash flow analysis that incorporates a forecast of economic factors that have historic correlation to loan losses. The most significant economic factor used in the

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calculation of estimated loan losses is the California unemployment rate which is used for each segment. California GDP, and California retail trade earnings, California home price index, and a commercial real estate value index are secondary economic factors used with California unemployment rate in various loan segments. A four quarter forecast of each economic factor is used for each loan segment and the economic factors are assumed to revert to the historic mean over an eight quarter period after the four quarter forecast period.

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


			CRE		CRE
			Owner		Non-owner		Land &		Home		Multi-		Residential		Consumer
	Commercial		Occupied		Occupied		Construction		Equity		Family		Mortgage		and Other		Total

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

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


	Commercial		Real Estate		Consumer		Total

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

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


			Owner		Non-owner		Land &		Home		Multi-		Residential		Consumer
	Commercial		Occupied		Occupied		Construction		Equity		Family		Mortgage		and Other		Total

	(Dollars in thousands)
Beginning of period balance	$	10,453	$	3,825	$	3,760	$	2,621	$	2,244	$	57	$	243	$	82	$	23,285
Adoption of Topic 326		(3,663)		3,169		7,912		(1,163)		(923)		1,196		435		1,607		8,570
Balance at adoption on January 1, 2020		6,790		6,994		11,672		1,458		1,321		1,253		678		1,689		31,855
Charge-offs		(1,135)		—		—		—		—		—		—		(3)		(1,138)
Recoveries		255		1		—		32		54		—		—		1		343
Net (charge-offs) recoveries		(880)		1		—		32		54		—		—		(2)		(795)
Provision for credit losses on loans		7,269		1,552		3,777		1,062		476		575		147		(474)		14,384
End of period balance	$	13,179	$	8,547	$	15,449	$	2,552	$	1,851	$	1,828	$	825	$	1,213	$	45,444

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


	Commercial		Real Estate		Consumer		Total

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

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


	December 31, 2019
					Consumer
	Commercial		Real Estate		and other		Total

	(Dollars in thousands)
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1,835	$	—	$	—	$	1,835
Collectively evaluated for impairment		8,618		12,750		82		21,450
Total allowance balance	$	10,453	$	12,750	$	82	$	23,285
Loans:
Individually evaluated for impairment	$	4,810	$	5,454	$	—	$	10,264
Collectively evaluated for impairment		598,535		1,891,620		33,744		2,523,899
Total loan balance	$	603,345	$	1,897,074	$	33,744	$	2,534,163

The following table presents the amortized cost basis of nonperforming loans and loans past due over 90 days and still accruing at June 30, 2020:


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

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

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


			Restructured
			and Loans
			over 90 Days
			Past Due
			and Still
	Nonaccrual		Accruing		Total

	(Dollars in thousands)
Commercial	$	3,444	$	1,153	$	4,597
Real estate:
CRE		5,094		—		5,094
Home equity		137		—		137
Total	$	8,675	$	1,153	$	9,828

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


	June 30, 2020
	30 - 59		60 - 89		90 Days or
	Days		Days		Greater		Total
	Past Due		Past Due		Past Due		Past Due		Current		Total

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


	December 31, 2019
	30 - 59		60 - 89		90 Days or
	Days		Days		Greater		Total
	Past Due		Past Due		Past Due		Past Due		Current		Total

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

Past due loans 30 days or greater totaled $11,504,000 and $15,315,000 at June 30, 2020 and December 31, 2019, respectively, of which $2,844,000 and $7,413,000 were on nonaccrual, respectively. At June 30, 2020, there were also $5,613,000 of loans less than 30 days past due included in nonaccrual loans held-for-investment. At December 31, 2019, there were also $1,262,000 loans less than 30 days past due included in nonaccrual loans held-for-investment. Management’s classification of a loan as “nonaccrual” is an indication that there is reasonable doubt as to the full recovery of principal or interest on the loan. At that point, the Company stops accruing interest income, and reverses any uncollected interest that had been accrued as income. The Company begins recognizing interest income only as cash interest payments are received and it has been determined the collection of all outstanding principal is not in doubt.

Credit Quality Indicators

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

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, and other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a quarterly basis. Nonclassified loans generally include those loans that are expected to be repaid in accordance with contractual loans terms. Loans categorized as special mention have

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potential weaknesses that may, if not checked or corrected, weaken the credit or inadequately protect the Company’s position at some future date. These loans pose elevated risk, but their weaknesses do not yet justify a substandard classification. Classified loans are those loans that are assigned a substandard, substandard-nonaccrual, or doubtful risk rating using the following definitions:

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

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

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

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

Loss. Loans classified as loss are considered uncollectable or of so little value that their continuance as assets is not warranted. This classification does not necessarily mean that a loan has no recovery or salvage value; but rather, there is much doubt about whether, how much, or when the recovery would occur. Loans classified as loss are immediately charged off against the allowance for credit losses on loans. Therefore, there is no balance to report as of June 30, 2020 and December 31, 2019.

The following table presents term loans amortized cost by vintage and loan grade classification, and revolving loans amortized cost by loan grade classification. The loan grade classifications are based on the Bank’s internal loan grading methodology. Loan grade categories for doubtful and loss rated loans are not included on the table below as there are no loans with those grades at June 30, 2020. The vintage year represents the period the loan was originated or in the case of renewed loans, the period last renewed. The amortized balance is the loan balance less any purchase discounts, and plus any loan purchase premiums. The loan categories are based on the loan segmentation in the Company's CECL reserve methodology based on loan purpose and type.

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														Revolving
														Loans
		Term Loans Amortized Cost Basis by Originated Period												Amortized
												2015 and		Cost
		2020		2019		2018		2017		2016		Prior		Basis		Total

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

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

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

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

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

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

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

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

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

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


	December 31, 2019
	Nonclassified		Classified		Total

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

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


		Collateral Type
		Real
		Estate		Business
		Property		Assets		Unsecured		Total

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

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

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



					Allowance
	Unpaid				for Loan
	Principal		Recorded		Losses
	Balance		Investment		Allocated

	(Dollars in thousands)
With no related allowance recorded:
Commercial	$	2,113	$	2,113	$	—
Real estate:
CRE		5,094		5,094		—
Home Equity		360		360		—
Total with no related allowance recorded		7,567		7,567		—

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

The book balance of troubled debt restructurings at June 30, 2020 was $753,000, which included $597,000 of nonaccrual loans and $156,000 of accruing loans. The book balance of troubled debt restructurings at December 31, 2019 was $1,039,000, which included $590,000 of nonaccrual loans and $449,000 of accruing loans. Approximately $9,000 and $20,000 of specific reserves were established with respect to these loans as of June 30, 2020 and December 31, 2019, respectively.

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


	During the Six Months Ended
		June 30, 2020
				Pre-modification		Post-modification
		Number		Outstanding		Outstanding
		of		Recorded		Recorded
Troubled Debt Restructurings:		Contracts		Investment		Investment

	(Dollars in thousands)
Commercial		3	$	13	$	13
Real estate:
CRE - owner occupied		—		—		—
CRE - non-owner occupied		—		—		—
Land and construction		—		—		—
Home equity		—		—		—
Multifamily		—		—		—
Residential mortgages		—		—		—
Consumer and other		—		—		—
Total		3	$	13	$	13

There were 0 new loans modified as troubled debt restructurings during the three months ended June 30, 2020. There were 0 new loans modified as troubled debt restructurings during the three and six months ended June 30, 2019.

During the three and six months ended June 30, 2020, there were no new loans modified as troubled debt restructurings in which the amount of principal or accrued interest owed from the borrower was forgiven or which resulted in a charge-off or change to the allowance for credit losses on loans.

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

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

6) Business Combinations

On October 11, 2019, the Company completed its merger with Presidio for an aggregate transaction value of $185,598,000. Shareholders of Presidio received a fixed exchange ratio at closing of 2.47 shares of the Company’s common stock for each share of Presidio common stock. Upon closing of the transaction, the Company issued 15,684,064 shares of the Company’s common stock to Presidio shareholders and holders of restricted stock units for a total value of $178,171,000 based on the Company’s closing stock price of $11.36 on the closing date of October 11, 2019. In addition, the consideration for Presidio stock options exchanged for the Company’s stock options totaled $7,426,000 and cash-in-lieu of fractional shares totaled $1,000 on October 11, 2019. Presidio’s results of operations have been included in the Company’s results of operations beginning October 12, 2019. The following table summarizes the consideration paid for Presidio:


	(Dollars in thousands)
Issuance of 15,684,064 shares of common stock
to Presidio shareholders and holders of restricted stock
(stock price = $11.36 on October 11, 2019)	$	178,171
Consideration for Presidio stock options exchanged for
Heritage Commerce Corp stock options		7,426
Cash paid for fractional shares		1
Total consideration	$	185,598

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The following table summarizes the estimated fair values of the Presidio assets acquired and liabilities assumed at the date of the merger.


	As					As
	Recorded		Fair			Recorded
	by		Value			at
	Presidio		Adjustments			Acquisition

	(Dollars in thousands)

Assets acquired:
Cash and cash equivalents	$	117,989	$	(1)	(a)	$	117,988
Securities available-for-sale		44,647		422	(b)		45,069
Securities held-to-maturity		463		—			463
Loans		698,493		(12,529)	(c)		685,964
Allowance for loan losses		(7,463)		7,463	(d)		—
Premises and equipment, net		1,756		—			1,756
Other intangible assets		—		11,147	(e)		11,147
Other assets, net		43,539		(1,378)	(f)		42,161
Total assets acquired	$	899,424	$	5,124			904,548

Liabilities assumed:
Deposits	$	774,260	$	(1)	(g)		774,259
Subordinated Debt		10,000		—	(h)		10,000
Other borrowings		442		—			442
Other liabilities		17,916		211	(i)		18,127
Total liabilities assumed	$	802,618	$	210			802,828
Net assets acquired							101,720
Purchase price							185,598
Goodwill recorded in the merger						$	83,878

Explanation of certain fair value related adjustments for the Presidio merger:

(a)Represents cash paid for fractional shares in the transaction.

(b)Represents the fair value adjustment on investment securities available-for-sale.

(c)Represents the fair value adjustment to the net book value of loans includes an interest rate mark and credit mark adjustment.

(d)Represents the elimination of Presidio’s allowance for loan losses.

(e)Represents intangible assets recorded to reflect the fair value of core deposits and an above market lease. The core deposit asset was recorded as an identifiable intangible asset and is amortized on an accelerated basis over the estimated average life of the deposit base. The above market lease liability will be accreted on the straight line method over 60 months.

(f)Represents an adjustment to net deferred tax assets resulting from the fair value adjustments related to the acquired assets, liabilities assumed and identifiable intangible assets recorded.

(g)Represents the fair value adjustment on time deposits, which was amortized as interest expense.

(h)The Company acquired $10,000,000 of subordinated debt from the Presidio transaction. The Presidio subordinated debt was redeemed on December 19, 2019.

(i)Represents adjustments to accrued accounts payable.

Presidio’s results of operations have been included in the Company’s results of operations beginning October 12, 2019.

The Company believes the merger provided the opportunity to combine independent business banking franchises with similar philosophies and cultures into a business bank based in San Jose, California that exceeds $4.0 billion. The pooling of the banks’ resources and knowledge enhance the Company’s capabilities, operational efficiencies, and community outreach. The Company also believes the combined bank is much better positioned to meet the needs of the Company’s customers, shareholders and the community.

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The acquisition was accounted for under the acquisition method of accounting. The fair value of net assets acquired includes fair value adjustments to certain receivables of which some were considered impaired and some were not considered impaired as of the acquisition date. The fair value adjustments were determined using discounted contractual cash flows, adjusted for expected losses and prepayments, where appropriate. The receivables that were not considered impaired at the acquisition date were not subject to the guidance relating to purchased credit impaired loans, which have shown evidence of credit deterioration since origination. There were 0 Purchased Credit Impaired Loans (“PCI”) as of December 31, 2019 and Pucharsed Credit Deteriorated (“PCD”) loans as of June 30, 2020.

Goodwill of $83,878,000 arising from the Presidio merger is largely attributable to synergies and cost savings resulting from combining the operations of the companies. As this transaction was structured as a tax-free exchange, the goodwill will not be deductible for tax purposes. Management’s preliminary valuation of the tangible and intangible assets acquired and liabilities assumed from the Presidio merger, which are based on assumptions that are subject to change, and the resulting allocation of the consideration paid for the allocation is reflected in the table above. Prior to the end of the one-year measurement period for finalizing the consideration paid allocation, if information becomes available which would indicate adjustments are required to the allocation, such adjustments will be included in the allocation in the reporting period in which the adjustment amounts are determined. Loan valuations may be adjusted based on new information obtained by the Company in future periods that may reflect conditions or events that existed on the acquisition date. Deferred tax assets may be adjusted for purchase accounting adjustments on open areas such as loans or upon filing final “stub” period tax returns for October 11, 2019 for Presidio. The increase in Presidio goodwill at June 30, 2020 from December 31, 2019 was due to adjustments to accrued accounts payable.

7) Goodwill and Other Intangible Assets

Goodwill

At June 30, 2020, the carrying value of goodwill was $167,631,000, which included $13,044,000 of goodwill related to its acquisition of Bay View Funding, $32,619,000 from its acquisition of Focus Business Bank (“Bank”), $13,819,000 from its acquisition of Tri-Valley, $24,271,000 from its acquisition of United American and $83,878,000 from Presidio.

Goodwill impairment exists when a reporting unit’s carrying value exceeds its fair value, which is determined through a qualitative assessment whether it is more likely than not that the fair value of equity of the reporting unit exceeds the carrying value (“Step Zero”). If the qualitative assessment indicates it is more likely than not that the fair value of equity of a reporting unit is less than book value, then a quantitative two-step impairment test is required. Step 1 includes the determination of the carrying value of the Company’s reporting units, including the existing goodwill and intangible assets, and estimating the fair value of each reporting unit.

We performed our required annual goodwill impairment test as of November 30, 2019 and there was no impairment. During the first and second quarters of 2020 bank stocks in general as well as our market capitalization have declined as a result of events surrounding the current COVID-19 pandemic outbreak. As a result, we completed a qualitative goodwill impairment test as of June 30, 2020. This qualitative analysis included a review of our earnings, asset quality trends , capital levels and the economic conditions of our markets. Based on this qualitative analysis we do not believe this decline is indicative of a permanent deterioration of the fundamental value of our Company. As such we do not believe that it is more likely than not a goodwill impairment exists at June 30, 2020.

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Other Intangible Assets

The Company’s intangible assets are summarized as follows for the periods indicated:

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	June 30, 2020
	Gross
	Carrying		Accumulated
	Amount		Amortization		Total

	(Dollars in thousands)
Core deposit intangibles	$	25,023	$	(7,446)	$	17,577
Customer relationship and brokered relationship intangibles		1,900		(1,076)		824
Below market leases		770		(578)		192
Total	$	27,693	$	(9,100)	$	18,593


	December 31, 2019
	Gross
	Carrying		Accumulated
	Amount		Amortization		Total

	(Dollars in thousands)
Core deposit intangibles	$	25,023	$	(5,846)	$	19,177
Customer relationship and brokered relationship intangibles		1,900		(981)		919
Below market leases		770		(451)		319
Total	$	27,693	$	(7,278)	$	20,415

Estimated amortization expense for the remainder of 2020, the next five years, and thereafter is as follows:



					United		United								Bay View Funding
	Presidio		Presidio		American		American		Tri-Valley		Tri-Valley		Focus		Customer &
	Core		Above		Core		Below		Core		Below		Core		Brokered		Total
	Deposit		Market		Deposit		Market		Deposit		Market		Deposit		Relationship		Amortization
Year	Intangible		Lease		Intangible		Lease		Intangible		Lease		Intangible		Intangible		Expense

						(Dollars in thousands)
2020	$	912		(9)	$	332	$	109	$	104	$	8	$	359	$	95		1,910
2021		1,447		(20)		602		—		184		18		596		190		3,017
2022		1,225		(20)		553		—		167		18		502		190		2,635
2023		1,118		(20)		521		—		158		18		420		190		2,405
2024		1,026		(14)		499		—		152		18		346		159		2,186
2025		970		—		478		—		145		18		200		—		1,811
Thereafter		3,211		—		1,042		—		306		70		—		—		4,629
	$	9,909	$	(83)	$	4,027	$	109	$	1,216	$	168	$	2,423	$	824	$	18,593

Impairment testing of the intangible assets is performed at the individual asset level. Impairment exists if the carrying amount of the asset is not recoverable and exceeds its fair value at the date of the impairment test. For intangible assets, estimates of expected future cash flows (cash inflows less cash outflows) that are directly associated with an intangible asset are used to determine the fair value of that asset. Management makes certain estimates and assumptions in determining the expected future cash flows from core deposit and customer relationship intangibles including account attrition, expected lives, discount rates, interest rates, servicing costs and other factors. Significant changes in these estimates and assumptions could adversely impact the valuation of these intangible assets. If an impairment loss exists, the carrying amount of the intangible asset is adjusted to a new cost basis. The new cost basis is then amortized over the remaining useful life of the asset. Based on its assessment, management concluded that there was no impairment of intangible assets at June 30, 2020 and December 31, 2019.

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8) Income Taxes

Some items of income and expense are recognized in one year for tax purposes, and another when applying generally accepted accounting principles, which leads to timing differences between the Company’s actual current tax liability and the amount accrued for this liability based on book income. These temporary differences comprise the “deferred” portion of the Company’s tax expense or benefit, which is accumulated on the Company’s books as a deferred tax asset or deferred tax liability until such time as they reverse.

Under generally accepted accounting principles, a valuation allowance is required if it is “more likely than not” that a deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence, including forecasts of future income, cumulative losses, applicable tax planning strategies, and assessments of current and future economic and business conditions.

The Company had net deferred tax assets of $27,223,000, and $24,302,000, at June 30, 2020 and December 31, 2019, respectively. After consideration of the matters in the preceding paragraph, the Company determined that it is more likely than not that the net deferred tax assets at June 30, 2020 and December 31, 2019 will be fully realized in future years.

The following table reflects the carrying amounts of the low income housing investments included in accrued interest receivable and other assets, and the future commitments included in accrued interest payable and other liabilities for the periods indicated:


	June 30,		December 31,
	2020		2019

	(Dollars in thousands)
Low income housing investments	$	5,668	$	6,126
Future commitments	$	625	$	625

The Company expects $28,000 of the future commitments to be paid in 2020, and $597,000 in 2021 through 2023.

For tax purposes, the Company had low income housing tax credits of $210,000 and $106,000 for the three months ended June 30, 2020 and June 30, 2019, and low income housing investment expense of $211,000 and $106,000, respectively. For tax purposes, the Company had low income housing tax credits of $420,000 and $213,000 for the six months ended June 30, 2020 and June 30, 2019, and low income housing investment expense of $420,000 and $211,000, respectively. The Company recognized low income housing investment expense as a component of income tax expense.

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9) Benefit Plans

Supplemental Retirement Plan

The Company has a supplemental retirement plan (the “Plan”) covering some current and some former key employees and directors. The Plan is a nonqualified defined benefit plan. Benefits are unsecured as there are no Plan assets. The following table presents the amount of periodic cost recognized for the periods indicated:


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2020		2019		2020		2019

	(Dollars in thousands)
Components of net periodic benefit cost:
Service cost	$	123	$	55	$	246	$	110
Interest cost		236		264		467		528
Amortization of net actuarial loss		105		46		190		92
Net periodic benefit cost	$	464	$	365	$	903	$	730

The components of net periodic benefit cost other than the service cost component are included in the line item “other noninterest expense” in the Consolidated Statements of Income.

Split-Dollar Life Insurance Benefit Plan

The Company maintains life insurance policies for some current and former directors and officers that are subject to split-dollar life insurance agreements. The following table sets forth the funded status of the split-dollar life insurance benefits for the periods indicated:


	June 30,		December 31,
	2020		2019

	(Dollars in thousands)
Change in projected benefit obligation:
Projected benefit obligation at beginning of year	$	8,198	$	6,903
Interest cost		124		278
Actuarial loss (gain)		—		1,017
Projected benefit obligation at end of period	$	8,322	$	8,198


	June 30,		December 31,
	2020		2019

	(Dollars in thousands)
Net actuarial loss	$	3,851	$	3,776
Prior transition obligation		1,014		1,059
Accumulated other comprehensive loss	$	4,865	$	4,835


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2020		2019		2020		2019

	(Dollars in thousands)
Amortization of prior transition obligation	$	(15)	$	(24)	$	(30)	$	(49)
Interest cost		62		70		124		140
Net periodic benefit cost	$	47	$	46	$	94	$	91

10) Fair Value

Accounting guidance establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

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Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data (for example, interest rates and yield curves observable at commonly quoted intervals, prepayment speeds, credit risks, and default rates).

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Financial Assets and Liabilities Measured on a Recurring Basis

The fair values of securities available-for sale-are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

The fair value of interest-only (“I/O”) strip receivable assets is based on a valuation model used by a third party. The Company is able to compare the valuation model inputs and results to widely available published industry data for reasonableness (Level 2 inputs).


			Fair Value Measurements Using
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
	Balance		(Level 1)		(Level 2)		(Level 3)

	(Dollars in thousands)
Assets at June 30, 2020
Available-for-sale securities:
Agency mortgage-backed securities	$	232,335		—	$	232,335		—
U.S. Treasury		91,230		91,230		—		—
I/O strip receivables		482		—		482		—

Assets at December 31, 2019
Available-for-sale securities:
Agency mortgage-backed securities	$	284,361		—	$	284,361		—
U.S. Treasury		120,464		120,464		—		—
I/O strip receivables		503		—		503		—

There were no transfers between Level 1 and Level 2 during the period for assets measured at fair value on a recurring basis.

Assets and Liabilities Measured on a Non-Recurring Basis

The fair value of collateral dependent loans individually evaluated with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. The appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Foreclosed assets are valued at the time the loan is foreclosed upon and the asset is transferred to foreclosed assets. The fair value is based primarily on third party appraisals, less costs to sell. The appraisals may utilize a single valuation approach or a combination of approaches including the comparable sales and income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. At June 30, 2020 and December 31, 2019, there were 0 foreclosed assets on the balance sheet.

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The carrying amounts and estimated fair values of financial instruments at June 30, 2020 are as follows:


			Estimated Fair Value
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Amounts		(Level 1)		(Level 2)		(Level 3)		Total

	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	925,900	$	925,900	$	—	$	—	$	925,900
Securities available-for-sale		323,565		91,230		232,335		—		323,565
Securities held-to-maturity		322,677		—		332,452		—		332,452
Loans (including loans held-for-sale), net		2,645,269		—		4,324		2,631,042		2,635,366
FHLB stock, FRB stock, and other
investments		33,509		—		—		—		N/A
Accrued interest receivable		10,041		369		1,778		7,894		10,041
I/O strips receivables		482		—		482		—		482
Liabilities:
Time deposits	$	150,261	$	—	$	146,776	$	—	$	146,776
Other deposits		3,749,965		—		3,749,965		—		3,749,965
Subordinated debt		39,646		—		38,946		—		38,946
Accrued interest payable		585		—		585		—		585

The carrying amounts and estimated fair values of the Company’s financial instruments at December 31, 2019:


			Estimated Fair Value
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Amounts		(Level 1)		(Level 2)		(Level 3)		Total

	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	457,370	$	457,370	$	—	$	—	$	457,370
Securities available-for-sale		404,825		120,464		284,361		—		404,825
Securities held-to-maturity		366,560		—		368,107		—		368,107
Loans (including loans held-for-sale), net		2,511,611		—		1,052		2,512,277		2,513,329
FHLB stock, FRB stock, and other
investments		29,842		—		—		—		N/A
Accrued interest receivable		10,915		446		2,218		8,251		10,915
I/O strips receivables		503		—		503		—		503
Liabilities:
Time deposits	$	168,034	$	—	$	158,704	$	—	$	158,704
Other deposits		3,246,734		—		3,246,734		—		3,246,734
Subordinated debt		39,554		—		40,404		—		40,404
Accrued interest payable		707		—		707		—		707

11) Equity Plan

The Company maintained an Amended and Restated 2004 Equity Plan (the “2004 Plan”) for directors, officers, and key employees. The 2004 Plan was terminated on May 23, 2013. On May 23, 2013, the Company’s shareholders approved the 2013 Equity Incentive Plan (the “2013 Plan”). On May 21, 2020, the shareholders approved an amendment to the Heritage Commerce Corp 2013 Equity Incentive Plan to increase the number of shares available from 3,000,000 to 5,000,000 shares. The equity plans provide for the grant of incentive and nonqualified stock options and restricted stock. The equity plans provide that the option price for both incentive and nonqualified stock options will be determined by the Board of Directors at no less than the fair value at the date of grant. Options granted vest on a schedule determined by the Board of Directors at the time of grant. Generally options vest over four years. All options expire no later than ten years from the date of grant. Restricted stock is subject to time vesting. For the six months ended June 30, 2020, the Company

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granted 329,500 shares of nonqualified stock options and 168,117 shares of restricted stock. There were 2,393,378 shares available for the issuance of equity awards under the 2013 Plan as of June 30, 2020.

The Presidio equity plans were assumed by the Company and the outstanding options issued under the Presidio equity plans were converted into the right to receive the Company’s shares at the exercise price pursuant to the formula defined in the merger agreement. Consideration for the assumed Presidio stock options exchanged for 1,176,757 shares of the Company’s stock options totaled $7,426,000.

Stock option activity under the equity plans is as follows:


				Weighted
		Weighted		Average
		Average		Remaining	Aggregate
	Number	Exercise		Contractual	Intrinsic
Total Stock Options	of Shares	Price		Life (Years)	Value
Outstanding at January 1, 2020	2,712,846	$	8.80
Granted	329,500	$	9.11
Exercised	(320,494)	$	4.65
Forfeited or expired	(94,516)	$	13.58
Outstanding at June 30, 2020	2,627,336	$	9.18	5.85	$	2,403,351
Vested or expected to vest	2,469,696			5.85	$	2,259,150
Exercisable at June 30, 2020	1,955,675			4.77	$	2,403,351

Information related to the equity plans for the periods indicated:


	Six Months Ended
	June 30,
	2020		2019
Intrinsic value of options exercised	$	2,057,914	$	392,127
Cash received from option exercise	$	1,489,991	$	566,197
Tax benefit realized from option exercises	$	33,783	$	102,786
Weighted average fair value of options granted	$	1.15	$	1.91

As of June 30, 2020, there was $1,187,000 of total unrecognized compensation cost related to nonvested stock options granted under the equity plans. That cost is expected to be recognized over a weighted-average period of approximately 3.02 years.

The fair value of each option grant is estimated on the date of grant using the Black Scholes option pricing model that uses the assumptions noted in the following table, including the weighted average assumptions for the option grants for the periods indicated:


	Six Months Ended
	June 30,
	2020		2019
Expected life in months(1)	72		72
Volatility(1)	29	%	24	%
Weighted average risk-free interest rate(2)	0.53	%	2.24	%
Expected dividends(3)	5.71	%	3.95	%

(1)	The expected life of employee stock options represents the weighted average period the stock options are expected to remain outstanding based on historical experience. Volatility is based on the historical volatility of the stock price over the same period of the expected life of the option.

(2)	Based on the U.S. Treasury constant maturity interest rate with a term consistent with the expected life of the option granted.

(3)	Each grant’s dividend yield is calculated by annualizing the most recent quarterly cash dividend and dividing that amount by the market price of the Company’s common stock as of the grant date

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Restricted stock activity under the equity plans is as follows:


		Weighted
		Average Grant
	Number	Date Fair
Total Restricted Stock Award	of Shares	Value
Nonvested shares at January 1, 2020	239,453	$	11.23
Granted	168,117	$	9.20
Vested	(108,870)	$	13.19
Forfeited or expired	—	$	—
Nonvested shares at June 30, 2020	298,700	$	12.22

As of June 30, 2020, there was $3,077,000 of total unrecognized compensation cost related to nonvested restricted stock awards granted under the equity plans. The cost is expected to be recognized over a weighted-average period of approximately 2.13 years.

12) Subordinated Debt

On May 26, 2017, the Company completed an underwritten public offering of $40,000,000 aggregate principal amount of its fixed-to-floating rate subordinated notes (“Subordinated Debt”) due June 1, 2027. The Subordinated Debt initially bears a fixed interest rate of 5.25% per year. Commencing on June 1, 2022, the interest rate on the Subordinated Debt resets quarterly to the three-month LIBOR rate plus a spread of 336.5 basis points, payable quarterly in arrears. Interest on the Subordinated Debt is payable semi-annually on June 1st and December 1st of each year through June 1, 2022 and quarterly thereafter on March 1st, June 1st, September 1st and December 1st of each year through the maturity date or early redemption date. The Company, at its option, may redeem the Subordinated Debt, in whole or in part, on any interest payment date on or after June 1, 2022 without a premium. Unamortized debt issuance cost totaled $354,000 at June 30, 2020.

It is understood that after December 31, 2021, the administrator in the United Kingdom with authority over the agency that currently publishes LIBOR (commonly known as the Intercontinental Exchange “ICE”), will no longer support that published index as a generally representative rate. Due to this, suggested contract language addressing the replacement of LIBOR has been published by the Alternative Rate Reference Committee (commonly known as “ARRC”) convened by, among others, the Federal Reserve Board. ARRC, since its inception, has supported the Secured Overnight Financing Rate (“SOFR”) as a replacement index. ARRC’s April 2019 version of its suggested contract includes both an “amendment approach” (i.e., inserting a mechanism for the parties to agree to a replacement index after the occurrence of certain events regarding LIBOR); and a “hardwired approach” (i.e., inserting a mechanism to automatically implement a replacement index after the occurrence of certain events regarding LIBOR). As of June 30, 2020, ARRC has released an update recommending lenders start using the “hardwired approach” by the end of the third quarter of 2020 for new financings.

With respect to such new financings, implementation of the ARRC’s proposed language (with variations as appropriate) into the documentation is contemplated. However, the events necessitating the replacement of LIBOR are not scheduled to occur until the end of 2021, and SOFR continues to be assessed from both financial and operational perspectives on an on-going basis, so it is expected that the “amendment approach” remains optimal for such documentation in the short term. With respect to existing financings tied to LIBOR, the existing terms of the documentation thereof will be the primary driver of how all issues related to LIBOR are dealt with, which necessarily means each will be evaluated and responded to on a case-by-case basis as necessary. Efforts are underway to coordinate with the counter-parties under such financings to address the issues, subject to the terms of the existing documentation and any mutually agreeable amendments thereto.

The Company acquired $10,000,000 of subordinated debt from the Presidio transaction with an interest rate of 8%, which was redeemed on December 19, 2019. As a result of the redemption of the Presidio subordinated debt, the Company paid a pre-payment penalty of $300,000 during the fourth quarter of 2019.

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13) Capital Requirements

The Company and its subsidiary bank are subject to various regulatory capital requirements administered by the 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 the Company’s financial statements and operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and HBC must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off balance sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. There are no conditions or events since June 30, 2020, that management believes have changed the categorization of the Company or HBC as “well-capitalized.”

The Company’s consolidated capital ratios and the HBC’s capital ratios exceeded the regulatory guidelines for a well-capitalized financial institution under the Basel III regulatory requirements at June 30, 2020.

As permitted by the interim final rule issued on March 27, 2020 by our federal regulatory agency, we elected the option to delay the estimated impact of the adoption of the CECL Standard in our regulatory capital for two years. This two-year delay is in addition to the three-year transition period the agency had already made available. The adoption will delay the effects of CECL on our regulatory capital for the next two years, after which the effects will be phased-in over a three-year period from January 1, 2022 through December 31, 2024. Under the interim final rule, the amount of adjustments to regulatory capital deferred until the phase-in period include both the initial impact of adoption of the CECL Standard at January 1, 2020 and 25% of subsequent changes in our allowance for credit losses during each quarter of the two-year period ending December 31, 2021.

Quantitative measures established by regulation to help ensure capital adequacy require the Company and HBC to maintain minimum amounts and ratios (set forth in the tables below) of total, Tier 1 capital, and common equity Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital to average assets (as defined). Management believes that, as of June 30, 2020 and December 31, 2019, the Company and HBC met all capital adequacy guidelines to which they were subject.

The Company’s consolidated capital amounts and ratios are presented in the following table, together with capital adequacy requirements, under the Basel III regulatory requirements as of June 30, 2020 and December 31, 2019.


					Required For
					Capital
					Adequacy
					Purposes
	Actual				Under Basel III
	Amount		Ratio		Amount		Ratio⁽¹⁾

	(Dollars in thousands)
As of June 30, 2020
Total Capital	$	473,095	15.9	%	$	313,273	10.5	%
(to risk-weighted assets)
Tier 1 Capital	$	396,142	13.3	%	$	253,602	8.5	%
(to risk-weighted assets)
Common Equity Tier 1 Capital	$	396,142	13.3	%	$	208,849	7.0	%
(to risk-weighted assets)
Tier 1 Capital	$	396,142	9.4	%	$	169,290	4.0	%
(to average assets)

(1)	Includes 2.5% capital conservation buffer, effective January 1, 2019, except the Tier 1 Capital to average assets ratio.

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					Required For
					Capital
					Adequacy
					Purposes
	Actual				Under Basel III
	Amount		Ratio		Amount		Ratio⁽¹⁾

		(Dollars in thousands)
As of December 31, 2019
Total Capital	$	457,158	14.6	%	$	329,306	10.5	%
(to risk-weighted assets)
Tier 1 Capital	$	393,432	12.5	%	$	266,581	8.5	%
(to risk-weighted assets)
Common Equity Tier 1 Capital	$	393,432	12.5	%	$	219,538	7.0	%
(to risk-weighted assets)
Tier 1 Capital	$	393,432	9.7	%	$	161,677	4.0	%
(to average assets)

(2)	Includes 2.5% capital conservation buffer, effective January 1, 2019, except the Tier 1 Capital to average assets ratio.

HBC’s actual capital amounts and ratios are presented in the following table, together with capital adequacy requirements, under the Basel III regulatory requirements as of June 30, 2020, and December 31, 2019.


									Required For
									Capital
					To Be Well-Capitalized				Adequacy
					Under Basel III PCA Regulatory				Purposes
	Actual				Requirements				Under Basel III
	Amount		Ratio		Amount		Ratio		Amount		Ratio⁽¹⁾

	(Dollars in thousands)
As of June 30, 2020
Total Capital	$	450,839	15.1	%	$	298,153	10.0	%	$	313,060	10.5	%
(to risk-weighted assets)
Tier 1 Capital	$	413,557	13.9	%	$	238,522	8.0	%	$	253,430	8.5	%
(to risk-weighted assets)
Common Equity Tier 1 Capital	$	413,557	13.9	%	$	193,799	6.5	%	$	208,707	7.0	%
(to risk-weighted assets)
Tier 1 Capital	$	413,557	9.8	%	$	211,518	5.0	%	$	169,214	4.0	%
(to average assets)

(1)	Includes 2.5% capital conservation buffer, effective January 1, 2019, except the Tier 1 Capital to average assets ratio.


									Required For
									Capital
					To Be Well-Capitalized				Adequacy
					Under Basel III PCA Regulatory				Purposes
	Actual				Requirements				Under Basel III
	Amount		Ratio		Amount		Ratio		Amount		Ratio⁽¹⁾

		(Dollars in thousands)
As of December 31, 2019
Total Capital	$	435,757	13.9	%	$	313,485	10.0	%	$	329,159	10.5	%
(to risk-weighted assets)
Tier 1 Capital	$	411,585	13.1	%	$	250,788	8.0	%	$	266,462	8.5	%
(to risk-weighted assets)
Common Equity Tier 1 Capital	$	411,585	13.1	%	$	203,765	6.5	%	$	219,439	7.0	%
(to risk-weighted assets)
Tier 1 Capital	$	411,585	10.2	%	$	202,013	5.0	%	$	161,611	4.0	%
(to average assets)

(1)	Includes 2.5% capital conservation buffer, effective January 1, 2019, except the Tier 1 Capital to average assets ratio.

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The Subordinated Debt, net of unamortized issuance costs, totaled $39,646,000 at June 30, 2020, and qualifies as Tier 2 capital for the Company under the guidelines established by the Federal Reserve Bank.

At a Special Meeting of Shareholders on August 27, 2019, the Company’s shareholders approved an amendment to the Company’s articles of incorporation to increase the number of authorized shares of common stock from 60,000,000 to 100,000,000 shares of common stock.

Under California General Corporation Law, the holders of common stock are entitled to receive dividends when and as declared by the Board of Directors, out of funds legally available. The California Financial Code provides that a state licensed bank may not make a cash distribution to its shareholders in excess of the lesser of the following: (i) the bank’s retained earnings; or (ii) the bank’s net income for its last three fiscal years, less the amount of any distributions made by the bank to its shareholders during such period. However, a bank, with the prior approval of the Commissioner of the California Department of Business Oversight—Division of Financial Institutions (“DBO”) may make a distribution to its shareholders of an amount not to exceed the greater of (i) a bank’s retained earnings; (ii) its net income for its last fiscal year; or (iii) its net income for the current fiscal year. Also with the prior approval of the Commissioner of the DBO and the shareholders of the bank, the bank may make a distribution to its shareholders, as a reduction in capital of the bank. In the event that the Commissioner determines that the shareholders’ equity of a bank is inadequate or that the making of a distribution by a bank would be unsafe or unsound, the Commissioner may order a bank to refrain from making such a proposed distribution. As of June 30, 2020, HBC would not be required to obtain regulatory approval, and the amount available for cash dividends is $37,996,000. Similar restrictions applied to the amount and sum of loan advances and other transfers of funds from HBC to the parent company. HBC distributed to HCC dividends of $8,000,000, during the second and first quarters of 2020, for a total of $16,000,000.

14) Loss Contingencies

The Company is involved in certain legal actions arising from normal business activities. Management, based upon the advice of legal counsel, believes the ultimate resolution of all pending legal actions will not have a material effect on the financial statements of the Company.

15) Revenue Recognition

On January 1, 2018, the Company adopted ASU No. 2014-09 (Topic 606) and all subsequent ASUs that modified Topic 606. Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with mortgage servicing rights, financial guarantees, gain on sale of securities, bank-owned life insurance, gain on sales of SBA loans, and certain credit card fees are also not in scope of the new guidance. Topic 606 is applicable to noninterest revenue streams such as deposit related fees, interchange fees, and merchant income. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers. The following noninterest income revenue streams are in-scope of Topic 606:

Service charges and fees on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), monthly service fees, check orders, and other deposit account related fees. We sometimes charge customers fees that are not specifically related to the customer accessing its funds, such as account maintenance or dormancy fees. The amount of deposit fees assessed varies based on a number of factors, such as the type of customer and account, the quantity of transactions, and the size of the deposit balance. We charge, and in some circumstances do not charge, fees to earn additional revenue and influence certain customer behavior. An example would be where we do not charge a monthly service fee, or do not charge for certain transactions, for customers that have a high deposit balance. Deposit fees are considered either transactional in nature (such as wire transfers, nonsufficient fund fees, and stop payment orders) or non-transactional (such as account maintenance and dormancy fees). These fees are recognized as earned or as transactions occur and services are provided. Check orders and other deposit account related fees are largely transactional based and, therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts.

The Company currently accounts for sales of foreclosed assets in accordance with Topic 360-20. In most cases the Company will seek to engage a real estate agent for the sale of foreclosed assets immediately upon foreclosure.

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However, in some cases, where there is clear demand for the property in question, the Company may elect to allow for a marketing period on no more than six months to attempt a direct sale of the property. We generally recognize the sale, and any associated gain or loss, of a real estate property when control of the property transfers. Any gains or losses from the sale are recorded to noninterest income/expense.

The following presents noninterest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the periods indicated:


	Three Months Ended
	June 30,
	2020		2019

	(Dollars in thousands)
Noninterest Income In-scope of Topic 606:
Service charges and fees on deposit accounts	$	650	$	1,177
Noninterest Income Out-of-scope of Topic 606		1,428		1,588
Total noninterest income	$	2,078	$	2,765


	Six Months Ended
	June 30,
	2020		2019

	(Dollars in thousands)
Noninterest Income In-scope of Topic 606:
Service charges and fees on deposit accounts	$	1,619	$	2,338
Gain on the disposition of foreclosed assets		791		—
Total noninterest income in-scope of Topic 606		2,410		2,338
Noninterest Income Out-of-scope of Topic 606		2,861		2,895
Total noninterest income	$	5,271	$	5,233

16) Noninterest Expense

The following table sets forth the various components of the Company’s noninterest expense for the periods indicated:


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2020		2019		2020		2019

	(Dollars in thousands)
Salaries and employee benefits	$	12,300	$	10,698	$	26,503	$	21,468
Occupancy and equipment		1,766		1,578		3,538		3,084
Professional fees		1,155		753		2,590		1,571
Data processing		779		732		1,755		1,411
Software subscriptions		746		556		1,635		1,145
Amortization of intangible assets		964		554		1,822		1,107
Insurance expense		516		439		1,034		875
Other		2,786		3,135		7,909		5,702
Total noninterest expense	$	21,012	$	18,445	$	46,786	$	36,363

The following table presents the merger-related costs included in other and salaries and employee benefits by category for the periods indicated:


	Three Months Ended				Six Months Ended
MERGER-RELATED COSTS	June 30,		June 30,		June 30,		June 30,
(in $000’s, unaudited)	2020		2019		2020		2019
Salaries and employee benefits	$	—	$	—	$	356	$	—
Other		59		540		2,127		540
Total merger-related costs	$	59	$	540	$	2,483	$	540

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17) Leases

On January 1, 2019, the Company adopted ASU No. 2016-02, Leases (Topic 842). Under the new guidance, the Company recognizes the following for all leases, at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use (“ROU”) asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. The Company is impacted as a lessee of the offices and real estate used for operations. The Company's lease agreements include options to renew at the Company's option. No lease extensions are reasonably certain to be exercised, therefore it was not considered in the calculation of the ROU asset and lease liability. As of June 30, 2020, operating lease ROU assets, included in other assets, and lease liabilities, included in other liabilities, totaled $37,137,000.

The following table presents the quantitative information for the Company’s leases for the periods indicated:


		Three Months Ended				Six Months Ended
		June 30,				June 30,

		2020		2019		2020		2019

	(Dollars in thousands)
Operating Lease Cost (Cost resulting from lease payments)	$	1,733	$	1,044	$	3,502	$	2,094
Operating Lease - Operating Cash Flows (Fixed Payments)	$	1,379	$	1,012	$	2,570	$	2,025
Operating Lease - ROU assets	$	37,137	$	7,425	$	37,137	$	7,425
Operating Lease - Liabilities	$	37,137	$	7,425	$	37,137	$	7,425
Weighted Average Lease Term - Operating Leases		8.50 years		3.40 years		8.50 years		3.40 years
Weighted Average Discount Rate - Operating Leases		4.53%		5.26%		4.53%		5.26%

The following maturity analysis shows the undiscounted cash flows due on the Company’s operating lease liabilities:


	(Dollars in thousands)
2020	$	3,040
2021		5,028
2022		5,448
2023		4,812
2024		4,574
Thereafter		22,664
Total undiscounted cash flows		45,566
Discount on cash flows		(8,429)
Total lease liability	$	37,137

The merger with Presidio resulted in the Company operating overlapping branch locations in the cities of Walnut Creek and San Mateo, California. Management has approved the consolidation of these branches in 2020 by vacating the HBC leased locations prior to the lease termination date, and moving the operations to the Presidio branch locations. The consolidation of these two branches into the Presidio locations resulted in the impairment of both leases at December 31, 2019. The lease impairment and write-off of fixed assets and tenant improvements totaled $434,000 for the Walnut Creek location, and $625,000 for the San Mateo location during the fourth quarter of 2019.

In June of 2019, the Company entered into a lease agreement for 54,910 square feet of office space in San Jose, California, commencing on February 1, 2020. The Company was able to complete the move of its Bay View Funding office during the first quarter of 2020, and had intended to move the main office of the Company during the second quarter of 2020 to this new location. However, due to delays and restrictions created by California's and Santa Clara County's Shelter-in-Place declarations because of COVID-19, the Company was only able to move a portion of the main offices to this new space in second quarter of 2020 and the remaining main office moves are anticipated to be completed in the third quarter of 2020.

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18) Business Segment Information

The following presents the Company’s operating segments. The Company operates through 2 business segments: Banking segment and Factoring segment. Transactions between segments consist primarily of borrowed funds. Intersegment interest expense is allocated to the Factoring segment based on the Company’s prime rate and funding costs. The provision for credit losses on loans is allocated based on the segment’s allowance for loan loss determination which considers the effects of charge-offs. Noninterest income and expense directly attributable to a segment are assigned to it. Taxes are paid on a consolidated basis and allocated for segment purposes. The Factoring segment includes only factoring originated by Bay View Funding.


	Three Months Ended June 30, 2020
	Banking(1)		Factoring		Consolidated

	(Dollars in thousands)
Interest income	$	34,570		2,562	$	37,132
Intersegment interest allocations		218		(218)		—
Total interest expense		2,192		—		2,192
Net interest income		32,596		2,344		34,940
Provision for credit losses on loans		1,107		7		1,114
Net interest income after provision		31,489		2,337		33,826
Noninterest income		1,883		195		2,078
Noninterest expense		19,336		1,676		21,012
Intersegment expense allocations		106		(106)		—
Income before income taxes		14,142		750		14,892
Income tax (benefit) expense		4,052		222		4,274
Net income	$	10,090	$	528	$	10,618

Total assets	$	4,546,199	$	68,202	$	4,614,401
Loans, net of deferred fees	$	2,644,480	$	41,909	$	2,686,389
Goodwill	$	154,587	$	13,044	$	167,631


	Three Months Ended June 30, 2019
	Banking(1)		Factoring		Consolidated

	(Dollars in thousands)
Interest income	$	30,521		2,968	$	33,489
Intersegment interest allocations		292		(292)		—
Total interest expense		2,573		—		2,573
Net interest income		28,240		2,676		30,916
Provision (credit) for loan losses		(744)		4		(740)
Net interest income after provision		28,984		2,672		31,656
Noninterest income		2,641		124		2,765
Noninterest expense		16,784		1,661		18,445
Intersegment expense allocations		132		(132)		—
Income before income taxes		14,973		1,003		15,976
Income tax expense		4,327		296		4,623
Net income	$	10,646	$	707	$	11,353

Total assets	$	3,045,378	$	62,653	$	3,108,031
Loans, net of deferred fees	$	1,827,936	$	49,831	$	1,877,767
Goodwill	$	70,709	$	13,044	$	83,753

(1)

Includes the holding company’s results of operations

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	Six Months Ended June 30, 2020
	Banking ⁽¹⁾		Factoring		Consolidated

	(Dollars in thousands)
Interest income	$	72,635	$	5,439	$	78,074
Intersegment interest allocations		502		(502)		—
Total interest expense		4,554		—		4,554
Net interest income		68,583		4,937		73,520
Provision for credit losses on loans		13,981		403		14,384
Net interest income after provision		54,602		4,534		59,136
Noninterest income		4,906		365		5,271
Noninterest expense		43,519		3,267		46,786
Intersegment expense allocations		235		(235)		—
Income before income taxes		16,224		1,397		17,621
Income tax expense		4,729		413		5,142
Net income	$	11,495	$	984	$	12,479

Total assets	$	4,546,199	$	68,202	$	4,614,401
Loans, net of deferred fees	$	2,644,480	$	41,909	$	2,686,389
Goodwill	$	154,587	$	13,044	$	167,631


	Six Months Ended June 30, 2019
	Banking ⁽¹⁾		Factoring		Consolidated

	(Dollars in thousands)
Interest income	$	61,017	$	5,921	$	66,938
Intersegment interest allocations		606		(606)		—
Total interest expense		4,980		—		4,980
Net interest income		56,643		5,315		61,958
Provision for loan losses		(1,636)		(165)		(1,801)
Net interest income after provision		58,279		5,480		63,759
Noninterest income		4,873		360		5,233
Noninterest expense		32,985		3,378		36,363
Intersegment expense allocations		253		(253)		—
Income before income taxes		30,420		2,209		32,629
Income tax expense		8,477		653		9,130
Net income	$	21,943	$	1,556	$	23,499

Total assets	$	3,045,378	$	62,653	$	3,108,031
Loans, net of deferred fees	$	1,827,936	$	49,831	$	1,877,767
Goodwill	$	70,709	$	13,044	$	83,753

(1)

Includes the holding company’s results of operations

19) Subsequent Events

On July 23, 2020, the Company announced that its Board of Directors declared a $0.13 per share quarterly cash dividend to holders of common stock. The dividend will be payable on August 20, 2020, to shareholders of record at close of business day on August 6, 2020.

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ITEM 2—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion provides information about the results of operations, financial condition, liquidity, and capital resources of Heritage Commerce Corp (the “Company” or “HCC”), its wholly-owned subsidiary, Heritage Bank of Commerce (“HBC” or the “Bank”), and HBC’s wholly-owned subsidiary, CSNK Working Capital Finance Corp., a California Corporation, dba Bay View Funding (“Bay View Funding”). This information is intended to facilitate the understanding and assessment of significant changes and trends related to our financial condition and the results of operations. This discussion and analysis should be read in conjunction with our consolidated financial statements and the accompanying notes presented elsewhere in this report. Unless we state otherwise or the context indicates otherwise, references to the “Company,” “Heritage,” “we,” “us,” and “our,” in this Report on Form 10-Q refer to Heritage Commerce Corp and its subsidiaries.

CRITICAL ACCOUNTING POLICIES

Critical accounting policies are discussed in our Form 10-K for the year ended December 31, 2019. Other than our methodology of estimating reserve for credit losses, there have been no changes in the Company's application of critical accounting policies since December 31, 2019.

Allowance for Credit Losses on Loans

As a result of our January 1, 2020, adoption of Accounting Standards Update (“ASU”) No. 2016-13, “Measurement of Credit Losses on Financial Instruments,” and its related amendments, our methodology for estimating the allowance for credit losses changed significantly from December 31, 2019. The standard replaced the “incurred loss” method with an “expected loss” method known as current expected credit loss (“CECL”). The CECL approach requires an estimate of the credit losses expected over the life of a loan (or pool of loans). It removes the incurred loss approach’s threshold that delayed the recognition of a credit loss until it was “probable” a loss event was “incurred.”

The estimate of expected credit losses under the CECL approach is based on relevant information about past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amounts. Historical loss experience is generally the starting point for estimating expected credit losses. We then consider whether the historical loss experience should be adjusted for asset-specific risk characteristics or current conditions at the reporting date that did not exist over the period from which historical experience was used. Finally, we consider forecasts about future economic conditions that are reasonable and supportable.

Management’s evaluation of the appropriateness of the allowance for credit losses is often the most critical of accounting estimates for a financial institution. Our determination of the amount of the allowance for credit losses is a critical accounting estimate as it requires significant reliance on the use of estimates and significant judgment as to the amount and timing of expected future cash flows on criticized loans, significant reliance on historical loss rates, consideration of our quantitative and qualitative evaluation of economic factors, and the reliance on our reasonable and supportable forecasts.

The allowance for credit losses attributable to each portfolio segment also includes an amount for inherent risks not reflected in the historical analyses. Relevant factors include, but are not limited to, concentrations of credit risk (geographic, large borrower, and industry), economic trends and conditions, changes in underwriting standards, experience and depth of lending staff, trends in delinquencies, and the level of criticized loans.

Going forward, the impact of utilizing the CECL approach to calculate the reserve for credit losses will be significantly influenced by the composition, characteristics and quality of our loan portfolio, as well as the prevailing economic conditions and forecasts utilized. Material changes to these and other relevant factors may result in greater volatility to the reserve for credit losses, and therefore, greater volatility to our reported earnings. See Note 5 to the Consolidated Financial Statements and the “Allowance for Credit Losses on Loans” section in Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) for more information on the Allowance.

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EXECUTIVE SUMMARY

This summary is intended to identify the most important matters on which management focuses when it evaluates the financial condition and performance of the Company. When evaluating financial condition and performance, management looks at certain key metrics and measures. The Company’s evaluation includes comparisons with peer group financial institutions and its own performance objectives established in the internal planning process.

The primary activity of the Company is commercial banking. The Company’s operations are located entirely in the general San Francisco Bay Area of California in the counties of Alameda, Contra Costa, Marin, San Benito, San Francisco, San Mateo, and Santa Clara. The largest city in this area is San Jose and the Company’s market includes the headquarters of a number of technology-based companies in the region known commonly as Silicon Valley. The Company’s customers are primarily closely held businesses and professionals.

Performance Overview

For the three months ended June 30, 2020, net income was $10.6 million, or $0.18 per average diluted common share, compared to $11.4 million, or $0.26 per average diluted common share, for the three months ended June 30, 2019. The

Company’s annualized return on average tangible assets was 1.01% and annualized return on average tangible equity was

11.06% for the three months ended June 30, 2020, compared to 1.53% and 15.94%, respectively, for the three months

ended June 30, 2019.

For the six months ended June 30, 2020, net income was $12.5 million, or $0.21 per average diluted common

share, compared to $23.5 million, or $0.54 per average diluted common share, for the six months ended June 30, 2019. The Company’s annualized return on average tangible assets was 0.62% and annualized return on average tangible equity was 6.45% for the six months ended June 30, 2020 compared to 1.58% and 16.89%, respectively, for the six months ended June 30, 2019.

Earnings for the first six months of 2020 were impacted by the effect of our $13.3 million pre-tax CECL related provision for credit losses on loans for the first quarter of 2020, driven by forecasted effects on economic activity from the Coronavirus pandemic, and $2.5 million of pre-tax merger-related costs, as discussed in more detail below. See “Coronavirus (COVID-19),” “Adoption of CECL,” and “Liquidity” below.

Coronavirus (COVID-19)

In mid-March, public health departments in the six largest counties in the San Francisco Bay Area, which account for most of the bank’s market footprint, imposed strict “Shelter-in-Place” orders for all residents. A few days later, the State of California issued a similar statewide order. Bay Area Counties and the state extended these orders through April, before easing restrictions in May and June. Following a resurgence in cases, on June 19, 2020, the state announced new health guidelines requiring the use of face coverings when in public or common spaces. On July 13, 2020, California expanded statewide indoor closures for businesses, encouraged the wearing of face masks and discouraged the gathering of individuals beyond immediate households. The Company has closely monitored the toll from the pandemic, including its economic impact. While the local response to COVID-19 appeared to have initially helped limit its spread, case numbers are once again increasing and the overall impact on our local economy may not be fully known. During the Pandemic, new jobless claims in California, through the week of July 25, totaled 9.3 million, while the state has lost a net 2.6 million jobs (14.0%). In the seven Bay Area counties we serve, 423,000 jobs (11.8%) have been lost. The State’s unemployment rate at the end of June stood at 15.1%, up from 5.3% at the end of March, while the unemployment rate in the seven Bay Area counties we serve increased to 12.0% from 3.4%.

The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) established a $349 billion loan program administered through the U.S. Small Business Administration (SBA), referred to as the paycheck protection program (PPP). Under the PPP, small businesses, sole proprietorships, independent contractors and self-employed individuals may apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. After the initial $349 billion in funds for the PPP was exhausted, an additional $310 billion in funding for PPP loans was authorized.

PPP borrowers who can demonstrate that the funding received has been used for certain purposes such as to cover payroll and rent costs and meet certain other requirements, can qualify for partial or full federal relief on loan

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principal and interest. The qualifying process for PPP borrowers to receive approval for loan forgiveness was recently finalized by the SBA and borrowers have until October 31, 2020 to apply for loan forgiveness. Borrowers who do not apply for or receive forgiveness, but who received loans under the CARES Act, are contractually obligated to begin making monthly repayments on principal and interest six months after their loans have funded.

The federal bank regulatory agencies, along with their state counterparts, have issued guidance in response to the COVID-19 pandemic and have taken a number of unprecedented steps to help banks navigate the pandemic and mitigate its impact. These include, without limitation: requiring banks to focus on business continuity and pandemic planning; adding pandemic scenarios to stress testing; encouraging bank use of capital buffers and reserves in lending programs; permitting certain regulatory reporting extensions; reducing margin requirements on swaps; permitting certain otherwise prohibited investments in investment funds; issuing guidance to encourage banks to work with customers affected by the pandemic and encourage loan workouts; and providing credit under the Community Reinvestment Act ("CRA") for certain pandemic related loans, investments and public service. Moreover, because of the need for social distancing measures, the agencies revamped the manner in which they conducted periodic examinations of their regular institutions, including making greater use of off-site reviews. The Federal Reserve also issued guidance encouraging banking institutions to utilize its discount window for loans and intraday credit extended by its Reserve Banks to help households and businesses impacted by the pandemic and announced numerous funding facilities. The FDIC has also acted to mitigate the deposit insurance assessment effects of participating in the PPP and the Federal Reserve's PPP Liquidity Facility and Money Market Mutual Fund Liquidity Facility.

By mid-April, the Bank had processed 597 PPP loan applications with potential outstanding balances of $225.3 million. On April 23, 2020, Congress passed separate economic stimulus legislation, which provided an additional $310 billion in funding for the PPP Loan Program that the Company was also able to utilize to further support our small business clients. In all, the Bank processed a total of 1,105 PPP loan applications, with total principal balances of $333.4 million. PPP loan pay offs totaled $8.8 million during the second quarter of 2020, and the Company ended the quarter with $324.6 million in outstanding PPP loan balances. These generated $582,000 in interest income and $722,000 in deferred fees, which was partially offset by ($54,000) in deferred costs expensed during the quarter. At June 30, 2020, total loans included deferred fees on PPP loans of $10.4 million and deferred costs of $1.2 million.

Subsequent to the passage of the CARES Act, federal bank regulators announced new accounting guidance for loan modifications by banks, which is intended to provide temporary credit accommodation through loan payment deferrals for customers whose businesses have experienced economic hardship due to the impact of the Coronavirus. The guidance also allows for the temporary suspension of requirements for such loans to be classified as troubled debt restructurings ("TDR") for accounting purposes. In response to customers’ needs, the Company made accommodations for initial payment deferrals of up to 90 days, generally, with the potential, upon application, for up to an additional 90 days of payment deferral (180 days maximum). The Company also waived all normal applicable fees. The following table shows the deferments at June 30, 2020 by category:


DEFERMENTS BY CATEGORY
(in $000’s, unaudited)
Pass and Watch	$	31,369
Special Mention		145,930
Classified		5,563
Total	$	182,862

Through June 30, 2020, the Company had approved 234 initial requests for payment deferrals on loans with balances totaling approximately $183 million, or 7%, of our loan portfolio. The Bank has elected to initially downgrade the risk grades of these loans to “Special Mention” status. At the end of the second quarter of 2020, the pool of deferred loans in our portfolio were primarily tied to business borrowers from a broad range of industries and included $34 million in loan deferments to the healthcare industry (mostly dentists) and $23 million in loan deferments to the accommodation and food services industries (mostly hotels and restaurants). Of the $183 million in deferred loans, 71% are supported by some form of real estate. Commercial real estate (“CRE”) deferments of $113 million included $75 million of investor CRE and $38 million of owner-occupied CRE. Deferred loans secured by CRE had an average loan-to-value (“LTV”) ratio of 41% at the end of the second quarter of 2020. The majority of deferred loans are also supported by personal guarantees.

The Bank had a portfolio of SBA 7(a) loans totaling $48.6 million, or 1.8% of its total loans, as of the end of the second quarter of 2020. As part of the SBA’s Coronavirus debt relief efforts, beginning in the April 2020, the SBA commenced a six-month program to cover payments of principal, interest and any associated fees for these borrowers.

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The CARES Act provides all banks with the option to elect either or both of the following from March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the termination of the national emergency declared by President Trump on March 13, 2020:

(i) to suspend the requirements under GAAP for loan modifications related to the COVID–19 pandemic that would otherwise be categorized as a TDR; and/or

(ii) to suspend any determination of a loan modified as a result of the effects of the COVID–19 pandemic as being a

TDR, including impairment for accounting purposes.

If a bank elects, which the Bank has, a suspension noted above, the suspension (i) will be effective for the term of the loan modification, but solely with respect to any modification, including a forbearance arrangement, an interest rate modification, a repayment plan, and any other similar arrangement that defers or delays the payment of principal or interest, that occurs during the applicable period for a loan that was not more than 30 days past due as of December 31, 2019; and (ii) will not apply to any adverse impact on the credit of a borrower that is not related to the COVID–19 pandemic.

In our initial response to the challenges posed by the COVID-19 pandemic last quarter, we implemented extensive business resumption plans, procedures and redundant systems which enabled 75% of our employees to work remotely, but still have access to the resources needed to fully assist our clients with their banking needs. In addition, our branch teams have been thorough and meticulous in implementing the public safety protocols required to safely meet the needs of visiting customers. All branches remain open to serve our customers and communities in accordance with the Coronavirus safety guidance provided by the Centers for Disease Control and Prevention (“CDC”) and the California Department of Public Health (“CDPH”).”

In regard to our new lease agreement for 54,910 square feet of office space in San Jose, California, which was entered into in 2019 and commenced on February 1, 2020, with recent easing of California’s and Santa Clara County’s Coronavirus related Shelter-in-Place restrictions, the Company now anticipates completing the move of its main office and San Jose branch to this new location by the end of the third quarter of 2020.

Credit Quality and Performance

At June 30, 2020, nonperforming assets (“NPAs”) decreased by ($7.9) million, or (46%), to $9.1 million, compared to $17.0 million at the end of the second quarter of 2019, and decreased by ($3.0) million, or (25%) from $12.1 million at the end of the first quarter of 2020. Classified assets increased to $31.5 million, or 0.68% of total assets, at June 30, 2020, compared to $31.2 million, or 1.00% of total assets, at June 30, 2019, and decreased from $39.6 million, or 0.97% of total assets, at March 31, 2020. The linked quarter decrease in classified assets for the second quarter of 2020, compared to the first quarter of 2020, resulted from multiple loan payoffs and paydowns that were partially offset by loan downgrades. Classified deferments totaled $5.6 million at the end of the second quarter of 2020. Special Mention loans increased to $164 million, or by $115 million, in the second quarter of 2020, compared to $49 million in the first quarter of 2020. Special Mention included $146 million in deferments and $18 million in other Special Mention loans at June 30, 2020, compared to $24 million in deferments and $25 million in other Special Mention loans at March 31, 2020. As previously noted, the Bank has opted to initially grade loan deferments as Special Mention and these grades will remain until loan payment performance resumes and/or information gained is sufficient to warrant a grade change. Exclusive of deferred loans at June 30, 2020, the $7 million decrease in other Special Mention loans from the linked quarter resulted from movement of numerous loans between grades with upgrade totals outweighing downgrades totals, some of which included loans that had been provided a deferment and have since been upgraded. Notably, many of our borrowers paid down their operating lines of credit during the second quarter of 2020. Consequently, the line utilization rate on commercial lines of credit declined to 27% at the end of the second quarter from 36% at the end of the first quarter of 2020 and 40% at the end of the second quarter of 2019.

The provision for credit losses on loans was $1.1 million for the second quarter of 2020, compared to a credit to the provision for loan losses of ($740,000) for the second quarter of 2019, and a provision for credit losses on loans of $13.3 million for the first quarter of 2020. The provision for credit losses on loans was $14.4 million for the six months ended June 30, 2020, compared to a ($1.8) million credit to the provision for loan losses for the six months ended June 30, 2019. At June 30, 2020, the allowance for credit losses on loans (“ACLL”) was $45.4 million, representing 1.69% of total

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loans, and 498.0% of nonperforming loans. The allowance for loan losses (“ALLL”) was $26.6 million at June 30, 2019, representing 1.42% of total loans and 156.5%, of nonperforming loans. The ACLL was $44.7 million at March 31, 2020, representing 1.75% of total loans, and 369.8% of nonperforming loans. The six basis points linked-quarter decline of the ACLL to total loans was largely due to the 5% increase in total loans for the second quarter of 2020, which primarily resulted from $324.6 million in new PPP loans with 100% SBA guarantees that do not require reserves. The higher provision for credit losses on loans for the three and six month ended June 30, 2020, compared to prior year periods was driven by the implementation of CECL, which uses an economic forecast that nowcincludes the impact of the COVID-19 pandemic.

The Company continues to monitor portfolio loans made to commercial customers with businesses in at-risk sectors as defined by the Company. The following table provides a breakdown of such loans as a percentage of total loans at June 30, 2020 and March 31, 2020:


	% of Total		% of Total
	Loans at		Loans at
HIGHER RISK SECTORS	June 30, 2020		March 31, 2020
Health care and social assistance:
Offices of dentists	1.79	%	1.63	%
Other community housing services	0.76	%	0.70	%
Offices of physicians (except mental health specialists)	0.27	%	0.11	%
All others	2.21	%	1.84	%
Total health care and social assistance	5.03	%	4.28	%
Retail trade:
Gasoline stations with convenience stores	1.90	%	1.98	%
All others	2.44	%	2.18	%
Total retail trade	4.34	%	4.16	%
Accommodation and food services:
Full-service restaurants	1.38	%	0.86	%
Limited-service restaurants	0.79	%	0.63	%
Hotels (except casino hotels) and motels	0.89	%	0.94	%
All others	0.70	%	0.52	%
Total accommodation and food services	3.76	%	2.95	%
Educational services:
Elementary and secondary schools	0.65	%	0.15	%
Education support services	0.40	%	0.15	%
All others	0.24	%	0.17	%
Total educational services	1.29	%	0.47	%
Arts, entertainment, and recreation	1.26	%	1.09	%
Purchased participations in micro loan portfolio	0.80	%	0.95	%
Total higher risk sectors	16.48	%	13.90	%

During the second quarter of 2020, the Company added education-related loans to those it had previously identified as at higher risk of credit loss. During the quarter, the percentage of loans to higher risk sectors increased linked quarter to 16.5% from 13.9% as a result of $91 million, or 3.4%, in new SBA PPP loan fundings to commercial clients in higher risk sectors.

Presidio Bank (“Presidio”) Merger

The Company completed its merger of its wholly-owned bank subsidiary Heritage Bank of Commerce with Presidio effective October 11, 2019 (the “merger date”). Presidio’s results of operations were included in the Company’s results of operations beginning October 12, 2019. The Presidio systems and integration conversion was successfully completed in the first quarter of 2020. Merger-related costs reduced pre-tax earnings by $59,000 for the second quarter of 2020, and $2.5 million for the first six months of 2020, compared to $540,000 for both the second quarter and first six months of 2019.

Presidio was a full-service California state-chartered commercial bank headquartered in San Francisco with branches in Palo Alto, San Francisco, San Mateo, San Rafael, and Walnut Creek, California.

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Factoring Activities - Bay View Funding

Based in San Jose, California, Bay View Funding provides business-essential working capital factoring financing to various industries throughout the United States. The following table reflects selected financial information for Bay View Funding for the periods indicated:


	June 30,		June 30,
	2020		2019

	(Dollars in thousands)
Total factored receivables	$	41,909	$	49,831
Average factored receivables
For the three months ended	$	44,574	$	45,708
For the six months ended	$	46,022	$	47,097
Total full time equivalent employees		36		37

Second Quarter 2020 Highlights

The following are important factors that impacted the Company’s results of operations:

●

Net interest income, before provision for credit losses on loans, increased 13% to $34.9 million for the second quarter of 2020, compared to $30.9 million for the second quarter of 2019. Net interest income, before provision for credit losses on loans, increased 19% to $73.5 million for the first six months of 2020, compared to $62.0 million for the first six months of 2019.

●

The fully tax equivalent (“FTE”) net interest margin contracted 92 basis points to 3.46% for the second quarter of 2020, from 4.38% for the second quarter of 2019, primarily due to a decline in the average yield of loans, investment securities, and overnight funds, partially offset by an increase in the average balance of loans, additional interest and fee income from PPP loans, and an increase in the accretion of the loan discount into loan interest income from our merger with Presidio.

●

For the first six months of 2019, the net interest margin the FTE net interest margin contracted 55 basis points to 3.83%, compared to 4.38% for the first six months of 2019, primarily due to the impact of decreases in the yields on loans, investment securities, and overnight funds, partially offset by an increase in the average balance of loans, additional interest and fee income from PPP loans, and an increase in the accretion of the loan discount into loan interest income from our merger with Presidio.

●

The average yield on the loan portfolio decreased to 4.92% for the second quarter of 2020, compared to 5.96% for the second quarter of 2019, primarily due to a decline in the average yield on loans and new average balances of lower yielding PPP loans, partially offset by an increase in the average balance loans from the merger with Presidio, and an increase in the accretion of the loan purchase discount into loan interest income from the acquisitions.

●

The average yield on the loan portfolio decreased to 5.23% for the six month ended June 30, 2020 compared to 5.94% for the six months ended June 30, 2019, primarily due to decreases in the prime rate on loans and new average balances of lower yielding PPP loans, partially offset an increase in the accretion of the loan purchase discount into loan interest income from the acquisitions.

●

The accretion of the loan purchase discount into loan interest income from the acquisitions was $963,000 for

the second quarter of 2020, compared to $419,000 for the second quarter of 2019. The accretion of the loan

purchase discount into loan interest income from the acquisitions was $2.3 million for the first six months of

2020, compared to $873,000 for the first six months of 2019.

●

The total net purchase discount on loans from the Focus Business Bank loan portfolio was $5.4 million on the acquisition date of August 20, 2015, of which $366,000 remains outstanding as of June 30, 2020. The total net purchase discount on loans from the Tri-Valley Bank loan portfolio was $2.6 million on the acquisition date of April 6, 2018, of which $1.2 million remains outstanding as of June 30, 2020. The total net purchase discount on loans from the United American Bank loan portfolio was $4.7 million on the

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acquisition date of May 4, 2018, of which $2.3 million remains outstanding as of June 30, 2020. The total net purchase discount on loans from Presidio loan portfolio was $12.5 million on the Presidio merger date, of which $10.1 million remains outstanding as of June 30, 2020. In aggregate, the remaining net purchase discount on total loans acquired was $14.0 million at June 30, 2020.

●

The average cost of total deposits was 0.17% for the second quarter of 2020, compared to 0.31% for the second quarter of 2019. The average cost of total deposits was 0.19% for the first six months of 2020, compared to 0.30% for the first six months of 2019.

●

Total noninterest income decreased to $2.1 million for the second quarter of 2020, compared to $2.8 million for the second quarter of 2019, primarily due to lower service charges and fees on deposit accounts, and lower gains on sales of securities. For the six months ended June 30, 2020, noninterest income increased to $5.3 million, compared to $5.2 million for the six months ended June 30, 2019, primarily as a result of a gain on disposition of foreclosed assets, partially offset by lower service charges and fees on deposit accounts during the six months ended June 30, 2020.

●

Total noninterest expense for the second quarter of 2020 increased to $21.0 million, compared to $18.4 million for the second quarter of 2019, primarily due to additional employees and operating costs added as a result of the Presidio merger, higher salaries and employee benefits as a result of annual salary increases. Noninterest expense for the six months ended June 30, 2020 increased to $46.8 million, compared to $36.4 million for the six months ended June 30, 2019, primarily due to higher salaries and employee benefits as a result of annual salary increases, and additional employees and operating costs added as a result of the Presidio merger.

●

The efficiency ratio for the second quarter of 2020 increased to 56.76%, compared to 54.76% for the second quarter of 2019. The efficiency ratio for the six months ended June 30, 2020 was 59.38%, compared to 54.12% for the six months ended June 30, 2019, primarily as a result of merger-related costs in the first quarter of 2020.

●

Income tax expense for the second quarter of 2020 was $4.3 million, compared to $4.6 million for the second quarter of 2019. The effective tax rate for the second quarter of 2020 was 28.7%, compared to 28.9% for the second quarter of 2019. Income tax expense for the six months ended June 30, 2020 was $5.1 million, compared to $9.1 million for the six months ended June 30, 2019. The effective tax rate for the six months ended June 30, 2020 was 29.2%, compared to 28.0% for the six months ended June 30, 2019.

The following are important factors in understanding our current financial condition and liquidity position:

●

Cash, other investments and interest-bearing deposits in other financial institutions and securities available-for-sale, at fair value, increased 90% to $1.2 billion at June 30, 2020, from $659.2 million at June 30, 2019, and increased 45% from $862.2 million at December 31, 2019.

●

At June 30, 2020, securities held-to-maturity, at amortized cost, totaled $322.7 million, compared to $351.4 million at June 30, 2019, and $366.6 million, at December 31, 2019.

●

Loans, excluding loans held-for-sale, increased $808.6 million or 43%, to $2.69 billion at June 30, 2020, compared to $1.88 billion at June 30, 2019, and increased $152.5 million or 6%, to $2.69 billion at June 30, 2020, compared to $2.53 billion at December 31, 2019. Total loans at June 30, 2020 included $324.6 million of PPP loans.

●

NPAs were $9.1 million, or 0.20% of total assets, at June 30, 2020, compared to $17.0 million, or 0.55% of total assets, at June 30, 2019, and $9.8 million, or 0.24% of total assets, at December 31, 2019. There were no foreclosed assets at June 30, 2020, June 30, 2019, and December 31, 2019.

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●

Classified assets increased to $31.5 million, or 0.68% of total assets, at June 30, 2020, compared to $31.2 million, or 1.00% of total assets, at June 30, 2019, and decreased from $32.6 million, or 0.79% of total assets, at December 31, 2019.

●

Net charge-offs totaled $373,000 for the second quarter of 2020, compared to net recoveries of $53,000 for the second quarter of 2019, and net charge-offs of $5.8 million for the fourth quarter of 2019. Net charge-offs of $5.8 million for the fourth quarter of 2019 primarily consisted of three lending relationships totaling $5.5 million, including one large relationship which was previously disclosed and specifically reserved for during the second and third quarters of 2018. The three lending relationships totaling $5.5 million in net charge-offs had a total of $4.7 million in specific reserves.

●

The ACLL at June 30, 2020 was $45.4 million, or 1.69% of total loans, representing 498.02% of total nonperforming loans. The ALLL at June 30, 2019 was $26.6 million, or 1.42% of total loans, representing 156.49% of total nonperforming loans. The ALLL at December 31, 2019 was $23.3 million, or 0.92% of total loans, representing 236.93% of total nonperforming loans.

●

Deposits, excluding all time deposits and CDARS deposits, increased $1.3 billion, or 52%, to $3.74 billion at June 30, 2020, compared to $2.47 billion at June 30, 2019. Deposits, excluding all time deposits and CDARS deposits, at June 30, 2020 increased $508.9 million, or 16%, compared to $3.23 billion at December 31, 2019.

●

The ratio of noncore funding (which consists of time deposits of $250,000 and over, CDARS deposits, brokered deposits, securities under an agreement to repurchase, subordinated debt, and short-term borrowings) to total assets was 3.25% at June 30, 2020, compared to 4.62% at June 30, 2019, and 4.10% at December 31, 2019.

●

The loan to deposit ratio was 68.88% at June 30, 2020, compared to 71.60% at June 30, 2019, and 74.20% at December 31, 2019.

●

The Company’s consolidated capital ratios exceeded regulatory guidelines and the HBC’s capital ratios exceeded the regulatory guidelines for a well-capitalized financial institution under the Basel III regulatory requirements at June 30, 2020.




							Well-capitalized
	Heritage			Heritage			Financial Institution			Basel III Minimum
	Commerce			Bank of			Basel III PCA Regulatory			Regulatory
Capital Ratios	Corp			Commerce			Guidelines			Requirement(1)
Total Risk-Based		15.9	%		15.1	%		10.0	%		10.5	%
Tier 1 Risk-Based		13.3	%		13.9	%		8.0	%		8.5	%
Common Equity Tier 1 Risk-based		13.3	%		13.9	%		6.5	%		7.0	%
Leverage		9.4	%		9.8	%		5.0	%		4.0	%

(1)	Basel III minimum regulatory requirements for both HCC and HBC include a 2.5% capital conservation buffer, except the leverage ratio.

Deposits

The composition and cost of the Company’s deposit base are important in analyzing the Company’s net interest margin and balance sheet liquidity characteristics. The Company’s depositors are generally located in its primary market area. Depending on loan demand and other funding requirements, the Company also obtains deposits from wholesale

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sources including deposit brokers. HBC is a member of the Certificate of Deposit Account Registry Service (“CDARS”) program. The CDARS program allows customers with deposits in excess of FDIC insured limits to obtain coverage on time deposits through a network of banks within the CDARS program. The Company has a policy to monitor all deposits that may be sensitive to interest rate changes to help assure that liquidity risk does not become excessive due to concentrations.

Total deposits increased $1.3 billion, or 49%, to $3.90 billion at June 30, 2020, compared to $2.62 billion at June 30, 2019, which included $787.7 million in deposits from Presidio, at fair value, and an increase of $490.0 million in the Company’s legacy deposits. Total deposits increased $485.5 million or 14% from $3.41 billion at December 31, 2019. Deposits, excluding all time deposits and CDARS deposits, increased $1.3 billion, or 52%, to $3.74 billion at June 30, 2020, compared to $2.47 billion at June 30, 2019. Deposits, excluding all time deposits and CDARS deposits, at June 30, 2020 increased $508.9 million, or 16% compared to $3.23 billion at December 31, 2019.

Liquidity

Our liquidity position refers to our ability to maintain cash flows sufficient to fund operations and to meet obligations and other commitments in a timely fashion. The Company manages liquidity to be able to meet unexpected sudden changes in levels of its assets or deposit liabilities without maintaining excessive amounts of balance sheet liquidity. Excess balance sheet liquidity can negatively impact the Company’s interest margin. At June 30, 2020, the Company had a strong liquidity position with $925.9 million in cash and cash equivalents and approximately $664.7 million in available borrowing capacity from various sources including the Federal Home Loan Bank (“FHLB”), the Federal Reserve Bank of San Francisco (“FRB”), Federal funds facilities with several financial institutions, and line of credit with a correspondent bank. The Company also had $610.6 million at fair value in unpledged securities available at June 30, 2020. Our loan to deposit ratio was 68.88% at June 30, 2020, compared to 71.60% at June 30, 2019, and 74.20% at December 31, 2019.

Lending

Our lending business originates principally through our branch offices located in our primary markets. In addition, Bay View Funding provides factoring financing throughout the United States. Loans, excluding loans held-for-sale, increased $808.6 million or 43%, to $2.69 billion at June 30, 2020, compared to $1.88 billion at June 30, 2019, and increased $152.5 million or 6%, to $2.69 billion at June 30, 2020, compared to $2.53 billion December 31, 2019. Total loans at June 30, 2020 included $324.6 million of PPP loans. The loan portfolio remains well-diversified with Commercial and Industrial (“C&I”) loans accounting for 21% of the loan portfolio at June 30, 2020, which included $41.9 million of factored receivables. PPP loans accounted for 12% of the loan portofolio. Commercial Real Estate (“CRE”) loans accounted for 48% of the total loan portfolio, of which 43% were occupied by businesses that own them. Land and construction loans accounted for 5% of total loans, consumer and home equity loans accounted for 5% of total loans, multifamily loans accounted for 6% of total loans, and residential mortgage loans accounted for the remaining 3% of total loans at June 30, 2020.

Net Interest Income

The management of interest income and expense is fundamental to the performance of the Company. Net interest income, the difference between interest income and interest expense, is the largest component of the Company’s total revenue. Management closely monitors both total net interest income and the net interest margin (net interest income divided by average earning assets). Net interest income, before provision for credit losses on loans, increased 13% to $34.9 million for the second quarter of 2020, compared to $30.9 million for the second quarter of 2019, primarily due to an increase in the average balance of loans due to the Presidio merger, additional interest and fee income from PPP loans, and an increase in the accretion of the loan discount into loan interest income from our merger with Presidio during the fourth quarter of 2019, partially offset by decreases in the prime interest rate and decreases in the yield on investment securities and overnight funds. Net interest income increased 19% to $73.5 million for the first six months of 2020, compared to $62.0 million for the first six months of 2019, primarily due to an increase in the average balance of loans due to the Presidio merger, additional interest and fee income from PPP loans, and an increase in the accretion of the loan discount into loan interest income from our merger with Presidio, partially offset by decreases in the prime rate, and decreases in the yield on investment securities and overnight funds.

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The Company through its asset and liability policies and practices seeks to maximize net interest income without exposing the Company to an excessive level of interest rate risk. Interest rate risk is managed by monitoring the pricing, maturity and repricing options of all classes of interest-bearing assets and liabilities. This is discussed in more detail under “Liquidity and Asset/Liability Management.” In addition, we believe there are measures and initiatives we can take to improve the net interest margin, including increasing loan rates, adding floors on floating rate loans, reducing nonperforming assets, managing deposit interest rates, and reducing higher cost deposits.

The net interest margin is also adversely impacted by the reversal of interest on nonaccrual loans and the reinvestment of loan payoffs into lower yielding investment securities and other short-term investments.

Management of Credit Risk

We continue to identify, quantify, and manage our problem loans. Early identification of problem loans and potential future losses helps enable us to resolve credit issues with potentially less risk and ultimate losses. We maintain an allowance for credit losses on loans in an amount that we believe is adequate to absorb probable incurred losses in the portfolio. While we strive to carefully manage and monitor credit quality and to identify loans that may be deteriorating, circumstances can change at any time for loans included in the portfolio that may result in future losses, that as of the date of the financial statements have not yet been identified as potential problem loans. Through established credit practices, we adjust the allowance for credit losses on loans accordingly. However, because future events are uncertain, there may be loans that will deteriorate, some of which could occur in an accelerated time-frame. As a result, future additions to the allowance for credit losses on loans may be necessary. Because the loan portfolio contains a number of commercial loans, commercial real estate, construction and land development loans with relatively large balances, deterioration in the credit quality of one or more of these loans may require a significant increase to the allowance for credit losses on loans. Future additions to the allowance may also be required based on changes in the financial condition of borrowers. Additionally, Federal and state banking regulators, as an integral part of their supervisory function, periodically review our allowance for credit losses on loans. These regulatory agencies may require us to recognize further provisions for credit losses on loans or charge-offs based upon their judgments, which may be different from ours. Any increase in the allowance for credit losses on loans would have an adverse effect, which may be material, on our financial condition and results of operation. Further discussion of the management of credit risk appears under “Credit Quality and Performance,” “Provision for Credit Losses on Loans,” and “Allowance for Credit Losses on Loans.”

Noninterest Income

While net interest income remains the largest single component of total revenues, noninterest income is an important component. A portion of the Company’s noninterest income is associated with its SBA lending activity, consisting of gains on the sale of loans sold in the secondary market and servicing income from loans sold with servicing retained. Other sources of noninterest income include loan servicing fees, service charges and fees, cash surrender value from company owned life insurance policies, and gains on the sale of securities.

Noninterest Expense

Management considers the control of operating expenses to be a critical element of the Company’s performance. Total noninterest expense for the second quarter of 2020 increased to $21.0 million, compared to $18.4 million for the second quarter of 2019, primarily due to additional employees and operating costs added as a result of the Presidio merger, higher salaries and employee benefits as a result of annual salary increases. Noninterest expense for the six months ended June 30, 2020 increased to $46.8 million, compared to $36.4 million for the six months ended June 30, 2019, primarily due to higher salaries and employee benefits as a result of annual salary increases, and additional employees and operating costs added as a result of the Presidio merger.

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Capital Management

As part of its asset and liability management process, the Company continually assesses its capital position to take into consideration growth, expected earnings, risk profile and potential corporate activities that it may choose to pursue.

RESULTS OF OPERATIONS

The Company earns income from two primary sources. The first is net interest income, which is interest income generated by earning assets less interest expense on interest-bearing liabilities. The second is noninterest income, which primarily consists of gains on the sale of loans, loan servicing fees, customer service charges and fees, the increase in cash surrender value of life insurance, and gains on the sale of securities. The majority of the Company’s noninterest expenses are operating costs that relate to providing a full range of banking and lending services to our customers.

Net Interest Income and Net Interest Margin

The level of net interest income depends on several factors in combination, including yields on earning assets, the cost of interest-bearing liabilities, the relative volumes of earning assets and interest-bearing liabilities, and the mix of products which comprise the Company’s earning assets, deposits, and other interest-bearing liabilities. To maintain its net interest margin the Company must manage the relationship between interest earned and paid.

The following Distribution, Rate and Yield table presents the average amounts outstanding for the major categories of the Company’s balance sheet, the average interest rates earned or paid thereon, and the resulting net interest margin on average interest earning assets for the periods indicated. Average balances are based on daily averages.

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Distribution, Rate and Yield


	Three Months Ended						Three Months Ended
	June 30, 2020						June 30, 2019
			Interest		Average				Interest		Average
	Average		Income /		Yield /		Average		Income /		Yield /
	Balance		Expense		Rate		Balance		Expense		Rate

	(Dollars in thousands)
Assets:
Loans, gross ⁽¹⁾⁽²⁾	$	2,687,093	$	32,845	4.92	%	$	1,835,474	$	27,251	5.96	%
Securities — taxable		611,709		3,155	2.07	%		707,710		4,136	2.34	%
Securities — exempt from Federal tax⁽³⁾		76,160		612	3.23	%		85,329		692	3.25	%
Other investments, interest-bearing deposits
in other financial institutions and Federal funds sold		700,711		648	0.37	%		216,164		1,556	2.89	%
Total interest earning assets		4,075,673		37,260	3.68	%		2,844,677		33,635	4.74	%
Cash and due from banks		37,716						37,051
Premises and equipment, net		9,096						7,050
Goodwill and other intangible assets		186,716						94,947
Other assets		125,037						86,318
Total assets	$	4,434,238					$	3,070,043
Liabilities and shareholders’ equity:
Deposits:
Demand, noninterest-bearing	$	1,660,547					$	1,001,914

Demand, interest-bearing		890,158		525	0.24	%		686,872		612	0.36	%
Savings and money market		1,009,078		794	0.32	%		744,475		1,034	0.56	%
Time deposits — under $100		17,825		18	0.41	%		19,267		22	0.46	%
Time deposits — $100 and over		127,877		277	0.87	%		126,303		326	1.04	%
CDARS — interest-bearing demand, money
market and time deposits		15,365		1	0.03	%		12,102		1	0.03	%
Total interest-bearing deposits		2,060,303		1,615	0.32	%		1,589,019		1,995	0.50	%
Total deposits		3,720,850		1,615	0.17	%		2,590,933		1,995	0.31	%

Subordinated debt, net of issuance costs		39,617		577	5.86	%		39,431		577	5.87	%
Short-term borrowings		62		—	0.00	%		104		1	3.86	%
Total interest-bearing liabilities		2,099,982		2,192	0.42	%		1,628,554		2,573	0.63	%
Total interest-bearing liabilities and demand,
noninterest-bearing / cost of funds		3,760,529		2,192	0.23	%		2,630,468		2,573	0.39	%
Other liabilities		100,770						58,970
Total liabilities		3,861,299						2,689,438
Shareholders’ equity		572,939						380,605
Total liabilities and shareholders’ equity	$	4,434,238					$	3,070,043

Net interest income / margin				35,068	3.46	%				31,062	4.38	%
Less tax equivalent adjustment				(128)						(146)
Net interest income			$	34,940					$	30,916

(1)	Includes loans held-for-sale. Nonaccrual loans are included in average balance.

(2)	Yield amounts earned on loans include fees and costs. The accretion of net deferred loan fees into loan interest income was $773,000 for the second quarter of 2020 (of which $637,000 was from PPP loans), compared to $210,000 for the second quarter of 2019.

(3)	Reflects the fully tax equivalent adjustment for Federal tax-exempt income based on a 21% tax rate.

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	Six Months Ended						Six Months Ended
	June 30, 2020						June 30, 2019
			Interest		Average				Interest		Average
	Average		Income /		Yield /		Average		Income /		Yield /
	Balance		Expense		Rate		Balance		Expense		Rate

Assets:
Loans, gross ⁽¹⁾⁽²⁾	$	2,600,409	$	67,627	5.23	%	$	1,836,277	$	54,058	5.94	%
Securities — taxable		641,004		7,103	2.23	%		724,406		8,645	2.41	%
Securities — exempt from Federal tax⁽³⁾		78,265		1,259	3.23	%		85,634		1,386	3.26	%
Other investments, interest-bearing deposits
in other financial institutions and Federal funds sold		550,734		2,349	0.86	%		218,704		3,141	2.90	%
Total interest earning assets⁽³⁾		3,870,412		78,338	4.07	%		2,865,021		67,230	4.73	%
Cash and due from banks		41,128						37,129
Premises and equipment, net		8,851						7,070
Goodwill and other intangible assets		187,110						95,249
Other assets		126,192						85,235
Total assets	$	4,233,693					$	3,089,704
Liabilities and shareholders’ equity:
Deposits:
Demand, noninterest-bearing	$	1,549,745					$	1,012,967

Demand, interest-bearing		845,479		1,067	0.25	%		694,246		1,230	0.36	%
Savings and money market		964,750		1,708	0.36	%		747,815		1,941	0.52	%
Time deposits — under $100		18,301		40	0.44	%		19,820		44	0.45	%
Time deposits — $100 and over		130,096		582	0.90	%		126,436		613	0.98	%
CDARS — interest-bearing demand, money
market and time deposits		15,960		3	0.04	%		12,709		3	0.05	%
Total interest-bearing deposits		1,974,586		3,400	0.35	%		1,601,026		3,831	0.48	%
Total deposits		3,524,331		3,400	0.19	%		2,613,993		3,831	0.30	%

Subordinated debt, net of issuance costs		39,594		1,154	5.86	%		39,408		1,148	5.87	%
Short-term borrowings		196		—	0.00	%		105		1	1.92	%
Total interest-bearing liabilities		2,014,376		4,554	0.45	%		1,640,539		4,980	0.61	%
Total interest-bearing liabilities and demand,
noninterest-bearing / cost of funds		3,564,121		4,554	0.26	%		2,653,506		4,980	0.38	%
Other liabilities		93,577						60,447
Total liabilities		3,657,698						2,713,953
Shareholders’ equity		575,995						375,751
Total liabilities and shareholders’ equity	$	4,233,693					$	3,089,704

Net interest income ⁽³⁾ / margin				73,784	3.83	%				62,250	4.38	%
Less tax equivalent adjustment ⁽³⁾				(264)						(292)
Net interest income			$	73,520					$	61,958

(1)Includes loans held-for-sale. Nonaccrual loans are included in average balance.

(2)	Yield amounts earned on loans include fees and costs. The accretion of net deferred loan fees into loan interest income was $912,000 for the first six months of 2020 (of which $637,000 was from PPP loans), compared to $301,000 for the first six months of 2019.

(3)	Reflects the fully tax equivalent adjustment for Federal tax-exempt income based on a 21% tax rate.

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Volume and Rate Variances

The Volume and Rate Variances table below sets forth the dollar difference in interest earned and paid for each major category of interest-earning assets and interest-bearing liabilities for the noted periods, and the amount of such change attributable to changes in average balances (volume) or changes in average interest rates. Volume variances are equal to the increase or decrease in the average balance times the prior period rate, and rate variances are equal to the increase or decrease in the average rate times the prior period average balance. Variances attributable to both rate and volume changes are equal to the change in rate times the change in average balance and are included below in the average volume column.


	Three Months Ended June 30,
	2020 vs. 2019
	Increase (Decrease)
	Due to Change in:
	Average		Average		Net
	Volume		Rate		Change

	(Dollars in thousands)
Income from the interest earning assets:
Loans, gross	$	10,392	$	(4,798)	$	5,594
Securities — taxable		(487)		(494)		(981)
Securities — exempt from Federal tax⁽¹⁾		(73)		(7)		(80)
Other investments, interest-bearing deposits
in other financial institutions and Federal funds sold		449		(1,357)		(908)
Total interest income on interest-earning assets		10,281		(6,656)		3,625

Expense from the interest-bearing liabilities:
Demand, interest-bearing		115		(202)		(87)
Savings and money market		202		(442)		(240)
Time deposits — under $100		(2)		(2)		(4)
Time deposits — $100 and over		4		(53)		(49)
CDARS — interest-bearing demand, money market
and time deposits		—		—		—
Subordinated debt, net of issuance costs		2		(2)		—
Short-term borrowings		—		(1)		(1)
Total interest expense on interest-bearing liabilities		321		(702)		(381)
Net interest income	$	9,960	$	(5,954)		4,006
Less tax equivalent adjustment						18
Net interest income					$	4,024

(1)	Reflects the fully tax equivalent adjustment for Federal tax-exempt income based on a 21% tax rate.

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	Six Months Ended June 30,
	2020 vs. 2019
	Increase (Decrease)
	Due to Change in:
	Average		Average		Net
	Volume		Rate		Change

	(Dollars in thousands)
Income from the interest earning assets:
Loans, gross	$	19,871	$	(6,302)	$	13,569
Securities — taxable		(930)		(612)		(1,542)
Securities — exempt from Federal tax⁽¹⁾		(116)		(11)		(127)
Other investments, interest-bearing deposits
in other financial institutions and Federal funds sold		1,414		(2,206)		(792)
Total interest income on interest-earning assets		20,239		(9,131)		11,108

Expense from the interest-bearing liabilities:
Demand, interest-bearing		204		(367)		(163)
Savings and money market		369		(602)		(233)
Time deposits — under $100		(3)		(1)		(4)
Time deposits — $100 and over		16		(47)		(31)
CDARS — interest-bearing demand, money market
and time deposits		—		—		—
Subordinated debt, net of issuance costs		6		—		6
Short-term borrowings		—		(1)		(1)
Total interest expense on interest-bearing liabilities		592		(1,018)		(426)
Net interest income	$	19,647	$	(8,113)		11,534
Less tax equivalent adjustment						28
Net interest income					$	11,562

(2)	Reflects the fully tax equivalent adjustment for Federal tax-exempt income based on a 21% tax rate.

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The Company’s net interest margin (“FTE”), expressed as a percentage of average earning assets, contracted 92 basis points to 3.46% for the second quarter of 2020, from 4.38% for the second quarter of 2019, primarily due to a decline in the average yield of loans, investment securities, and overnight funds, partially offset by an increase in the average balance of loans, additional interest and fee income from PPP loans, and an increase in the accretion of the loan discount into loan interest income from our merger with Presidio.

For the first six months of 2020, the net interest margin contracted 55 basis points to 3.83%, compared to 4.38% for the first six months of 2019, primarily due to the impact of decreases in the yields on loans, investment securities, and overnight funds, partially offset by an increase in the average balance of loans, additional interest and fee income from PPP loans, and an increase in the accretion of the loan discount into loan interest income from our merger with Presidio.

The following tables present the average balance of loans outstanding, interest income, and the average yield for the periods indicated:


	Three Months Ended						Three Months Ended
	June 30, 2020						June 30, 2019
	Average		Interest		Average		Average		Interest		Average
(in $000’s, unaudited)	Balance		Income		Yield		Balance		Income		Yield
Loans, core bank and asset-based lending	$	2,369,004	$	27,694	4.70	%	$	1,727,988	$	23,342	5.42	%
PPP loans		231,251		582	1.01	%		—		—	—	%
PPP fees, net		—		637	1.11	%		—		—	—	%
Bay View Funding factored receivables		44,574		2,562	23.12	%		45,708		2,967	26.04	%
Residential mortgages		31,219		197	2.54	%		36,136		234	2.60	%
Purchased CRE loans		25,542		210	3.31	%		31,484		290	3.69	%
Loan fair value mark / accretion		(14,497)		963	0.16	%		(5,842)		418	0.10	%
Total loans	$	2,687,093	$	32,845	4.92	%	$	1,835,474	$	27,251	5.96	%

The average yield on the loan portfolio decreased to 4.92% for the second quarter of 2020, compared to 5.96% for the second quarter of 2019, primarily due to decreases in the prime rate on loans, new average balances of lower yielding PPP loans, partially offset by an increase in the accretion of the loan purchase discount into loan interest income from the acquisitions.


	Six Months Ended						Six Months Ended
	June 30, 2020						June 30, 2019
	Average		Interest		Average		Average		Interest		Average
(in $000’s, unaudited)	Balance		Income		Yield		Balance		Income		Yield
Loans, core bank and asset-based lending	$	2,395,469	$	57,798	4.85	%	$	1,726,364	$	46,195	5.40	%
PPP loans		115,669		582	1.01	%		—		—	—	%
PPP fees, net		—		637	1.11	%		—		—	—	%
Bay View Funding factored receivables		46,022		5,439	23.77	%		47,097		5,921	25.35	%
Residential mortgages		32,147		427	2.67	%		36,451		485	2.68	%
Purchased CRE loans		26,441		459	3.49	%		32,409		584	3.63	%
Loan fair value mark / accretion		(15,339)		2,285	0.19	%		(6,044)		873	0.10	%
Total loans	$	2,600,409	$	67,627	5.23	%	$	1,836,277	$	54,058	5.94	%

The yield on the loan portfolio decreased to 5.23% for the first six months of 2019, compared to 5.94% for the

first six months of 2019, primarily due to decreases in the prime rate on loans and new average balances of lower yielding PPP loans, partially offset by an increase in the accretion of the loan purchase discount into loan interest income from the acquisitions.

The average cost of total deposits was 0.17% for the second quarter of 2020, compared to 0.31% for the second quarter of 2019. The cost of total deposits was 0.19% for the six months of 2020, compared to 0.30% for the first six months of 2019.

Net interest income, before provision for credit losses on loans, increased 13% to $34.9 million for the second quarter of 2020, compared to $30.9 million for the second quarter of 2019, primarily due to an increase in the average balance of loans due to the Presidio Bank merger, additional interest and fee income from PPP loans, and an increase in the accretion of the loan discount into loan interest income from our merger with Presidio during the fourth quarter of 2019, partially offset by decreases in the prime interest rate and decreases in the yield on investment securities and overnight funds. Net interest income increased 19% to $73.5 million for the first six months of 2020, compared to $62.0

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million for the first six months of 2019, primarily due to an increase in the average balance of loans due to the Presidio merger, additional interest and fee income from PPP loans, and an increase in the accretion of the loan discount into loan interest income from our merger with Presidio, partially offset by decreases in the prime rate, and decreases in the yield on investment securities and overnight funds.

Provision for Credit Losses on Loans

Credit risk is inherent in the business of making loans. The Company establishes an allowance for credit losses on loans through charges to earnings, which are presented in the statements of income as the provision for credit losses on loans. Specifically identifiable and quantifiable known losses are promptly charged off against the allowance. The provision for credit losses on loans is determined by conducting a quarterly evaluation of the adequacy of the Company’s allowance for credit losses on loans and charging the shortfall or excess, if any, to the current quarter’s expense. This has the effect of creating variability in the amount and frequency of charges to the Company’s earnings. The provision for credit losses on loans and level of allowance for each period are dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management’s assessment of the quality of the loan portfolio, the valuation of problem loans and the general economic conditions in the Company’s market area. The provision for credit losses on loans and level of allowance for each period are also dependent on forecast data for the state of California including Gross Domestic Product (“GDP”) and unemployment projections provided by the California Economic Forecast (“CEF”, www.CaliforniaForecast.com).

There was a $1.1 million provision for credit losses on loans for the second quarter of 2020, compared to a credit to the provision for loan losses of ($740,000) for the second quarter of 2019. For the six months ended June 30, 2020, there was a $14.4 million provision for credit losses on loans. There was a ($1.8) million credit to the provision for loan losses for the six months ended June 30, 2019. Provisions for credit losses on loans are charged to operations to bring the allowance for credit losses on loans to a level deemed appropriate by the Company based on the factors discussed under “Credit Quality and Performance” and “Allowance for Credit Losses on Loans.”

The allowance for credit losses on loans totaled $45.4 million, or 1.69% of total loans at June 30, 2020. The allowance for loan losses was $26.6 million, or 1.42% of total loans at June 30, 2019, and $23.3 million, or 0.92% of total loans at December 31, 2019. The allowance for credit losses on loans to total nonperforming loans was 498.02% at June 30, 2020. The allowance for loan losses to total nonperforming loans was 156.49% at June 30, 2019, and 236.93% at December 31, 2019. Net charge-offs totaled $373,000 for the second quarter of 2020, compared to net recoveries of $53,000 for the second quarter of 2019, and net charge-offs of $5.8 million for the fourth quarter of 2019. Net charge-offs of $5.8 million for the fourth quarter of 2019, primarily consisted of three lending relationships totaling $5.5 million, including one large relationship which was previously disclosed and specifically reserved for during the second and third quarters of 2018. The three lending relationships totaling $5.5 million in net charge-offs had a total of $4.7 million in specific reserves.

Noninterest Income



					Increase
	Three Months Ended				(decrease)
	June 30,				2020 versus 2019
	2020		2019		Amount		Percent

	(Dollars in thousands)
Service charges and fees on deposit accounts	$	650	$	1,177	$	(527)	(45)	%
Increase in cash surrender value of life insurance		458		333		125	38	%
Servicing income		205		150		55	37	%
Gain on sales of securities		170		548		(378)	(69)	%
Gain on sales of SBA loans		—		36		(36)	(100)	%
Other		595		521		74	14	%
Total	$	2,078	$	2,765	$	(687)	(25)	%

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					Increase
	Six Months Ended				(decrease)
	June 30,				2020 versus 2019
	2020		2019		Amount		Percent

	(Dollars in thousands)
Service charges and fees on deposit accounts	$	1,619	$	2,338	$	(719)	(31)	%
Increase in cash surrender value of life insurance		916		663		253	38	%
Servicing income		388		341		47	14	%
Gain on sales of securities		270		548		(278)	(51)	%
Gain on the disposition of foreclosed assets		791		—		791	N/A
Gain on sales of SBA loans		67		175		(108)	(62)	%
Other		1,220		1,168		52	4	%
Total	$	5,271	$	5,233	$	38	1	%

Historically, a portion of the Company’s noninterest income has been associated with its SBA lending activity, as gains on the sale of loans sold in the secondary market and servicing income from loans sold with servicing rights retained. For the second quarter ended June 30, 2020, no SBA loan were sold, compared to a $36,000 gain on sales of SBA loans for the second quarter ended June 30, 2019. For the six months ended June 30, 2020, SBA loan sales resulted in a $67,000 gain, compared to a $175,000 gain on sale of SBA loans for the six months ended June 30, 2019.

The servicing assets that result from the sales of SBA loans with servicing retained are amortized over the expected term of the loans using a method approximating the interest method. Servicing income generally declines as the respective loans are repaid.

Noninterest Expense

The following table sets forth the various components of the Company’s noninterest expense:



					Increase
	Three Months Ended				(Decrease)
	June 30,				2020 versus 2019
	2020		2019		Amount		Percent

	(Dollars in thousands)
Salaries and employee benefits	$	12,300	$	10,698	$	1,602	15	%
Occupancy and equipment		1,766		1,578		188	12	%
Professional fees		1,155		753		402	53	%
Data processing		779		732		47	6	%
Software subscriptions		746		556		190	34	%
Amortization of intangible assets		964		554		410	74	%
Insurance expense		516		439		77	18	%
Other, excluding merger-related costs		2,727		2,595		132	5	%
Total noninterest expense, excluding merger-related costs		20,953		17,905		3,048	17	%
Other merger-related costs (1)		59		540		(481)	(89)	%
Total noninterest expense, inluding merger-related costs	$	21,012	$	18,445	$	2,567	14	%

(1)	Included in the “Other noninterest expense” category in the Consolidated Statements of Income.

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					Increase
	Six Months Ended				(Decrease)
	June 30,				2020 versus 2019
	2020		2019		Amount		Percent

	(Dollars in thousands)
Salaries and employee benefits	$	26,147	$	21,468	$	4,679	22	%
Occupancy and equipment		3,538		3,084		454	15	%
Professional fees		2,590		1,571		1,019	65	%
Data processing		1,755		1,411		344	24	%
Software subscriptions		1,635		1,145		490	43	%
Amortization of intangible assets		1,822		1,107		715	65	%
Insurance expense		1,034		875		159	18	%
Other, excluding merger-related costs		5,782		5,162		620	12	%
Total noninterest expense, excluding merger-related costs		44,303		35,823		8,480	24	%
Salaries and employee benefits merger-related costs (1)		356		—		356	N/A
Other merger-related costs (2)		2,127		540		1,587	294	%
Total noninterest expense, inluding merger-related costs	$	46,786	$	36,363	$	10,423	29	%

(1)	Included in “Salaries and employee benefits” category in the Consolidated Statements of Income.

(2)	Included in the “Other noninterest expense” category in the Consolidated Statements of Income.

The following table indicates the percentage of noninterest expense in each category for the periods indicated:


	Three Months Ended June 30,
			Percent of				Percent of
	2020		Total		2019		Total

	(Dollars in thousands)
Salaries and employee benefits	$	12,300	59	%	$	10,698	58	%
Occupancy and equipment		1,766	8	%		1,578	9	%
Professional fees		1,155	5	%		753	4	%
Data processing		779	4	%		732	4	%
Software subscriptions		746	4	%		556	3	%
Amortization of intangible assets		964	5	%		554	3	%
Insurance expense		516	2	%		439	2	%
Other, excluding merger-related costs		2,727	13	%		2,595	14	%
Total noninterest expense, excluding merger-related costs		20,953	100	%		17,905	97	%
Other merger-related costs (2)		59	0	%		540	3	%
Total noninterest expense, inluding merger-related costs	$	21,012	100	%	$	18,445	100	%


	Six Months Ended June 30,
			Percent				Percent
	2020		of Total		2019		of Total

	(Dollars in thousands)
Salaries and employee benefits	$	26,147	56	%	$	21,468	59	%
Occupancy and equipment		3,538	8	%		3,084	9	%
Professional fees		2,590	6	%		1,571	4	%
Data processing		1,755	4	%		1,411	4	%
Software subscriptions		1,635	3	%		1,145	3	%
Amortization of intangible assets		1,822	4	%		1,107	3	%
Insurance expense		1,034	2	%		875	2	%
Other, excluding merger-related costs		5,782	12	%		5,162	14	%
Total noninterest expense, excluding merger-related costs		44,303	95	%		35,823	98	%
Salaries and employee benefits merger-related costs (1)		356	1	%		—	—
Other merger-related costs (2)		2,127	4	%		540	2	%
Total noninterest expense, inluding merger-related costs	$	46,786	100	%	$	36,363	100	%

(1)	Included in “Salaries and employee benefits” category in the Consolidated Statements of Income.

(2)	Included in the “Other noninterest expense” category in the Consolidated Statements of Income.

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Income Tax Expense

The Company computes its provision for income taxes on a quarterly basis. The effective tax rate is determined by applying the Company’s statutory income tax rates to pre-tax book income as adjusted for permanent differences between pre-tax book income and actual taxable income. These permanent differences include, but are not limited to, increases in the cash surrender value of life insurance policies, interest on tax-exempt securities, certain expenses that are not allowed as tax deductions, and tax credits.

The following table shows the Company’s effective income tax rates for the periods indicated:


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2020		2019		2020		2019
Effective income tax rate	28.7	%	28.9	%	29.2	%	28.0	%

The difference in the effective tax rate for the periods reported compared to the combined Federal and state statutory tax rate of 29.6% is primarily the result of the Company’s investment in life insurance policies whose earnings are not subject to taxes, tax credits related to investments in low income housing limited partnerships (net of low income housing investment losses), and tax-exempt interest income earned on municipal bonds.

The Company’s Federal and state income tax expense for the second quarter of 2020 was $4.3 million, compared to $4.6 million for the second quarter of 2019. The Company’s Federal and state income tax expense for the six months ended June 30, 2020 was $5.1 million, compared to $9.1 million for the six months ended June 30, 2019.

Some items of income and expense are recognized in one year for tax purposes, and another when applying generally accepted accounting principles, which leads to timing differences between the Company’s actual tax liability, and the amount accrued for this liability based on book income. These temporary differences comprise the “deferred” portion of the Company’s tax expense or benefit, which is accumulated on the Company’s books as a deferred tax asset or deferred tax liability until such time as they reverse.

Realization of the Company’s deferred tax assets is primarily dependent upon the Company generating sufficient future taxable income to obtain benefit from the reversal of net deductible temporary differences and the utilization of tax credit carryforwards and the net operating loss carryforwards for Federal and state income tax purposes. The amount of deferred tax assets considered realizable is subject to adjustment in future periods based on estimates of future taxable income. Under generally accepted accounting principles a valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax assets will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence, including forecasts of future income, cumulative losses, applicable tax planning strategies, and assessments of current and future economic and business conditions.

The Company had net deferred tax assets of $27.2 million at June 30, 2020, $22.8 million at June 30, 2019, and $24.3 million at December 31, 2019. After consideration of the matters in the preceding paragraph, the Company determined that it is more likely than not that the net deferred tax assets at June 30, 2020, June 30, 2019, and December 31, 2019 will be fully realized in future years.

Business Segment Information

The following presents the Company’s operating segments. Transactions between segments consist primarily of borrowed funds. Intersegment interest expense is allocated to the Factoring segment based on the Company’s prime rate

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and funding costs. The provision for credit losses on loans is allocated based on the segment’s allowance for loan loss determination which considers the effects of charge-offs. Noninterest income and expense directly attributable to a segment are assigned to it. Taxes are paid on a consolidated basis and allocated for segment purposes. The Factoring segment includes only factoring originated by Bay View Funding.


	Three Months Ended June 30, 2020
	Banking(1)		Factoring		Consolidated

	(Dollars in thousands)
Interest income	$	34,570	$	2,562	$	37,132
Intersegment interest allocations		218		(218)		—
Total interest expense		2,192		—		2,192
Net interest income		32,596		2,344		34,940
Provision for credit losses on loans		1,107		7		1,114
Net interest income after provision		31,489		2,337		33,826
Noninterest income		1,883		195		2,078
Noninterest expense		19,336		1,676		21,012
Intersegment expense allocations		106		(106)		—
Income before income taxes		14,142		750		14,892
Income tax expense		4,052		222		4,274
Net income	$	10,090	$	528	$	10,618

Total assets	$	4,546,199	$	68,202	$	4,614,401
Loans, net of deferred fees	$	2,644,480	$	41,909	$	2,686,389
Goodwill	$	154,587	$	13,044	$	167,631


	Three Months Ended June 30, 2019
	Banking(1)		Factoring		Consolidated

	(Dollars in thousands)
Interest income	$	30,521	$	2,968	$	33,489
Intersegment interest allocations		292		(292)		—
Total interest expense		2,573		—		2,573
Net interest income		28,240		2,676		30,916
Provision (credit) for loan losses		(744)		4		(740)
Net interest income after provision		28,984		2,672		31,656
Noninterest income		2,641		124		2,765
Noninterest expense		16,784		1,661		18,445
Intersegment expense allocations		132		(132)		—
Income before income taxes		14,973		1,003		15,976
Income tax expense		4,327		296		4,623
Net income	$	10,646	$	707	$	11,353

Total assets	$	3,045,378	$	62,653	$	3,108,031
Loans, net of deferred fees	$	1,827,936	$	49,831	$	1,877,767
Goodwill	$	70,709	$	13,044	$	83,753

(1)

Includes the holding company’s results of operations

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	Six Months Ended June 30, 2020
	Banking ⁽¹⁾		Factoring		Consolidated

	(Dollars in thousands)
Interest income	$	72,635	$	5,439	$	78,074
Intersegment interest allocations		502		(502)		—
Total interest expense		4,554		—		4,554
Net interest income		68,583		4,937		73,520
Provision for credit losses on loans		13,981		403		14,384
Net interest income after provision		54,602		4,534		59,136
Noninterest income		4,906		365		5,271
Noninterest expense		43,519		3,267		46,786
Intersegment expense allocations		235		(235)		—
Income before income taxes		16,224		1,397		17,621
Income tax expense		4,729		413		5,142
Net income	$	11,495	$	984	$	12,479

Total assets	$	4,546,199	$	68,202	$	4,614,401
Loans, net of deferred fees	$	2,644,480	$	41,909	$	2,686,389
Goodwill	$	154,587	$	13,044	$	167,631


	Six Months Ended June 30, 2019
	Banking ⁽¹⁾		Factoring		Consolidated

	(Dollars in thousands)
Interest income	$	61,017	$	5,921	$	66,938
Intersegment interest allocations		606		(606)		—
Total interest expense		4,980		—		4,980
Net interest income		56,643		5,315		61,958
Provision for loan losses		(1,636)		(165)		(1,801)
Net interest income after provision		58,279		5,480		63,759
Noninterest income		4,873		360		5,233
Noninterest expense⁽²⁾		32,985		3,378		36,363
Intersegment expense allocations		253		(253)		—
Income before income taxes		30,420		2,209		32,629
Income tax expense		8,477		653		9,130
Net income	$	21,943	$	1,556	$	23,499

Total assets	$	3,045,378	$	62,653	$	3,108,031
Loans, net of deferred fees	$	1,827,936	$	49,831	$	1,877,767
Goodwill	$	70,709	$	13,044	$	83,753

(1)

Includes the holding company’s results of operations

Banking. Our banking segment’s net income was $10.1 million for the three months ended June 30, 2020, compared to $10.6 million for the three months ended June 30, 2019. Our banking segment’s net income was $11.5 million for the six months ended June 30, 2020, compared to $21.9 million for the six months ended June 30, 2019. Earnings for the six months of 2020 were impacted by the effect of our first quarter $12.9 million pre-tax CECL related provision for credit losses on loans, driven by forecasted effects on economic activity from the Coronavirus pandemic, and $2.5 million of pre-tax merger-related costs. Net interest income increased to $32.6 million for the three months ended June 30, 2020, compared to $28.2 million for the three months ended June 30, 2019. Net interest income increased to $68.6 million for the six months ended June 30, 2020, compared to $56.6 million for the six months ended June 30, 2019. The increase in net interest income for the three and six months ended June 30, 2020, compared to the comparable periods in 2019, was primarily due to the impact of the increase in loans and deposits from the Presidio acquisition and additional interest and income from PPP loans. There was a $1.1 million provision for credit losses on loans for the three months ended June 30, 2020. There was a $14.0 million provision for credit losses on loans for the six months ended June 30, 2020. Noninterest income was $1.9 million for the three months ended June 30, 2020, compared to $2.6 million for the three months ended June 30, 2019. Noninterest income was $4.9 million for the six months ended June 30, 2020, and

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June 30, 2019. The increase in noninterest income for the three and six months ended June 30, 2020, compared to the comparable periods in 2019, was primarily due to a $791,000 gain on disposition of a foreclosed asset, partially offset by lower gains on sales of SBA loans. Noninterest expense increased to $19.3 million for the three months ended June 30, 2020, compared to $16.8 million for the three months ended June 30, 2019. Noninterest expense increased to $43.5 million for the six months ended June 30, 2020, compared to $33.0 million for the six months ended June 30, 2019. The increase in noninterest expense for the three and six months ended June 30, 2020, compared to the comparable periods in 2019, was primarily due to higher salaries and employee benefits as a result of annual salary increases, and additional employees added, operating costs of the Presidio merger and merger-related costs during the first quarter of 2020.

Factoring. Bay View Funding’s primary business operation is purchasing and collecting factored receivables. Factored receivables are receivables that have been transferred by the originating organization and typically have not been subject to previous collection efforts. In a factoring transaction Bay View Funding directly purchases the receivables generated by its clients at a discount to their face value. The transactions are structured to provide the clients with immediate working capital when there is a mismatch between payments to the client for a good and service and the payment of operating costs incurred to provide such good or service. The average life of the factored receivables was 38 days for the six months ended June 30, 2020, compared to 37 days for the six months ended June 30, 2019. Net interest income for the three months ended June 30, 2020, decreased to $2.3 million, compared to $2.7 million for the three months ended June 30, 2019. For the six months ended June 30, 2020, net interest income decreased to $4.9 million compared to $5.3 milion for the six months ended June 30, 2019. The decrease in net interest income for the three and six months ended June 30, 2020, compared to the comparable periods in 2019, was primarily due to a decrease in the average balance factored recveables.

FINANCIAL CONDITION

At June 30, 2020, total assets increased 48% to $4.6 billion, compared to $3.1 billion at June 30, 2019, and increased 12% from $4.1 billion at December 31, 2019.

Securities available-for-sale, at fair value, were $323.6 million at June 30, 2020, a decrease of (16%) from $383.2 million at June 30, 2019, and a decrease of (20%) from $404.8 million at December 31, 2019. Securities held-to-maturity, at amortized cost, were $322.7 million at June 30, 2020, a decrease of (8%) from $351.4 million at June 30, 2019, and a decrease of (12%) from $366.6 million at December 31, 2019.

Loans, excluding loans held-for-sale, increased $808.6 million or 43%, to $2.7 billion at June 30, 2020, compared to $1.9 billion at June 30, 2019, and increased $152.5 million or 6%, compared to $2.5 billion December 31, 2019. Total loans at June 30, 2020 included $324.6 million of PPP loans.

Total deposits increased $1.3 billion, or 49%, to $3.9 billion at June 30, 2020, compared to $2.6 billion at June 30, 2019, which included $787.7 million in deposits from Presidio, at fair value, and an increase of $490.0 million in the Company’s legacy deposits. Total deposits increased $485.5 million or 14% from $3.41 billion at December 31, 2019. Deposits, excluding all time deposits and CDARS deposits, increased $1.3 billion, or 52%, to $3.7 billion at June 30, 2020, compared to $2.5 billion at June 30, 2019, which included $772.4 million in deposits from Presidio, at fair value, and an increase of $503.2 million in the Company’s legacy deposits. Deposits, excluding all time deposits and CDARS deposits increased $508.9 million or 16%, compared to $3.23 billion at December 31, 2019.

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Securities Portfolio

The following table reflects the balances for each category of securities at the dates indicated:


	June 30,				December 31,
	2020		2019		2019

	(Dollars in thousands)
Securities available-for-sale (at fair value):
Agency mortgage-backed securities	$	232,335	$	242,647	$	284,361
U.S. Treasury		91,230		140,509		120,464
Total	$	323,565	$	383,156	$	404,825
Securities held-to-maturity (at amortized cost):
Agency mortgage-backed securities	$	249,070	$	267,514	$	285,344
Municipals — exempt from Federal tax		73,662		83,885		81,216
Total	$	322,732	$	351,399	$	366,560

The following table summarizes the weighted average life and weighted average yields of securities at June 30, 2020:


	Weighted Average Life
					After One and				After Five and
	Within One				Within Five				Within Ten				After Ten
	Year or Less				Years				Years				Years				Total
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield

	(Dollars in thousands)
Securities available-for-sale (at fair value):
Agency mortgage-backed securities	$	—	N/A		$	227,416	2.10	%	$	4,919	2.43	%	$	—	N/A		$	232,335	2.11	%
U.S. Treasury		75,861	2.81	%		15,369	2.96	%		—	N/A			—	N/A			91,230	2.84	%
Total	$	75,861	2.81	%	$	242,785	2.16	%	$	4,919	2.43	%	$	—	N/A		$	323,565	2.31	%

Securities held-to-maturity (at amortized cost):
Agency mortgage-backed securities	$	—	N/A	%	$	227,746	1.99	%	$	5,722	2.49	%	$	15,602	3.02	%	$	249,070	2.06	%
Municipals — exempt from Federal tax (1)		21,091	3.08	%		52,226	3.27	%		345	3.83	%		—	N/A	%		73,662	3.22	%
Total	$	21,091	3.08	%	$	279,972	2.23	%	$	6,067	2.56	%	$	15,602	3.02	%	$	322,732	2.33	%

(1)	Reflects tax equivalent adjustment for Federal tax exempt income based on a 21% tax rate.

The securities portfolio is the second largest component of the Company’s interest-earning assets, and the structure and composition of this portfolio is important to an analysis of the financial condition of the Company. The portfolio serves the following purposes: (i) it provides a source of pledged assets for securing certain deposits and borrowed funds, as may be required by law or by specific agreement with a depositor or lender; (ii) it provides liquidity to even out cash flows from the loan and deposit activities of customers; (iii) it can be used as an interest rate risk management tool, since it provides a large base of assets, the maturity and interest rate characteristics of which can be changed more readily than the loan portfolio to better match changes in the deposit base and other funding sources of the Company; and (iv) it is an alternative interest-earning use of funds when loan demand is weak or when deposits grow more rapidly than loans.

The Company’s portfolio may include: (i) U.S. Treasury securities and U.S. Government sponsored entities’ debt securities for liquidity and pledging; (ii) mortgage-backed securities, which in many instances can also be used for pledging, and which generally enhance the yield of the portfolio; (iii) municipal obligations, which provide tax free income and limited pledging potential; (iv) single entity issue trust preferred securities, which generally enhance the yield on the portfolio; (v) corporate bonds, which also enhance the yield on the portfolio; (vi) money market mutual funds; (vii) certificates of deposit; (viii) commercial paper; (ix) bankers acceptances; (x) repurchase agreements; (xi) collateralized mortgage obligations; and (xii) asset-backed securities.

The Company classifies its securities as either available-for-sale or held-to-maturity at the time of purchase. Accounting guidance requires available-for-sale securities to be marked to fair value with an offset to accumulated other

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comprehensive income (loss), a component of shareholders’ equity. Monthly adjustments are made to reflect changes in the fair value of the Company’s available-for-sale securities.

The investment securities available-for-sale, at fair value, totaled $323.6 million at June 30, 2020, compared to $383.1 million at June 30, 2019, and $404.8 million at December 31, 2019. At June 30, 2020, the Company’s securities available-for-sale portfolio was comprised of $232.4 million of agency mortgage-backed securities (all issued by U.S. Government sponsored entities), and $91.2 million of U.S. Treasury securities. The pre-tax unrealized gain on securities available-for-sale at June 30, 2020 was $8.7 million, compared to $915,000 at June 30, 2019, and $2.3 million at December 31, 2019. All other factors remaining the same, when market interest rates are rising, the Company will experience a lower unrealized gain (or a higher unrealized loss) on the securities portfolio. Investment securities available-for-sale from Presidio totaled $45.1 million, at fair value, at the Presidio merger date.

During the second quarter of 2020, the Company sold $30.1 million of US Treasury securities available-for-sale for a net gain of $159,000.

At June 30, 2020, investment securities held-to-maturity, at amortized cost, totaled $322.7 million, a decrease of (8%) from $351.4 million at June 30, 2019, and a decrease of (12%) from $366.6 million at December 31, 2019. At June 30, 2020, the Company’s securities held-to-maturity portfolio was comprised of $249.1 million of agency mortgage-backed securities, and $73.6 million of tax-exempt municipal bonds.

During the second quarter of 2020, $7.0 million of municipal bonds held-to-maturity were called, with a gain on sales of securities of $11,000.

As of the implementation date of CECL on January 1, 2020, there was a $58,000 allowance for losses recorded on the Company’s held-to-maturity municipal investment securities portfolio. For the six months ended June 30, 2020, there was a reduction of $3,000 to the allowance for losses on the Company’s held-to-maturity municipal investment securities portfolio, for an allowance of $55,000 at June 30, 2020.

The Company has not used interest rate swaps or other derivative instruments to hedge fixed rate loans or securities.

Loans

The Company’s loans represent the largest portion of invested assets, substantially greater than the securities portfolio or any other asset category, and the quality and diversification of the loan portfolio is an important consideration when reviewing the Company’s financial condition. Gross loans, excluding loans held-for-sale, represented 58% of total assets at June 30, 2020, represented 60% at June 30, 2019, and represented 62% at December 31, 2019. The ratio of loans to deposits was 68.88% at June 30, 2020, compared to 71.60% at June 30, 2019, and 74.20% at December 31, 2019.

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Loan Distribution

The Loan Distribution table that follows sets forth the Company’s gross loans, excluding loans held-for-sale, outstanding and the percentage distribution in each category at the dates indicated:


	June 30, 2020				June 30, 2019				December 31, 2019
	Balance		% to Total		Balance		% to Total		Balance		% to Total

	(Dollars in thousands)
Commercial	$	553,843	21	%	$	545,092	29	%	$	603,345	24	%
SBA PPP loans		324,550	12	%		—	N/A			—	N/A
Real estate:
CRE - owner occupied		553,463	21	%		421,970	23	%		548,907	22	%
CRE - non-owner occupied		725,776	27	%		517,604	28	%		767,821	30	%
Land and construction		138,284	5	%		97,753	5	%		147,189	6	%
Home equity		112,679	4	%		95,886	5	%		151,775	6	%
Multifamily		169,637	6	%		82,293	4	%		180,623	7	%
Residential mortgages		95,033	3	%		97,530	5	%		100,759	4	%
Consumer and other		22,759	1	%		19,863	1	%		33,744	1	%
Total Loans		2,696,024	100	%		1,877,991	100	%		2,534,163	100	%
Deferred loan fees, net		(9,635)	—			(224)	—			(319)	—
Loans, net of deferred fees		2,686,389	100	%		1,877,767	100	%		2,533,844	100	%
Allowance for credit losses on loans		(45,444)				(26,631)				(23,285)
Loans, net	$	2,640,945			$	1,851,136			$	2,510,559

The Company’s loan portfolio is concentrated in commercial loans, (primarily manufacturing, wholesale, and services oriented entities), and commercial real estate, with the remaining balance in land development and construction, home equity, purchased residential mortgages, and consumer loans. The Company does not have any concentrations by industry or group of industries in its loan portfolio, however, 66% of its gross loans were secured by real property at June 30, 2020, compared to 70% at June 30, 2019, and 75% at December 31, 2019. While no specific industry concentration is considered significant, the Company’s bank lending operations are substantially located in areas that are dependent on the technology and real estate industries and their supporting companies.

The Company has established concentration limits in its loan portfolio for commercial real estate loans, commercial loans, construction loans and unsecured lending, among others. The Company uses underwriting guidelines to assess the borrower’s historical cash flow to determine debt service, and we further stress test the debt service under higher interest rate scenarios. Financial and performance covenants are used in commercial lending to allow the Company to react to a borrower’s deteriorating financial condition should that occur.

The Company’s commercial loans are made for working capital, financing the purchase of equipment or for other business purposes. Commercial loans include loans with maturities ranging from thirty days to one year and “term loans” with maturities normally ranging from one to five years. Short-term business loans are generally intended to finance current transactions and typically provide for periodic principal payments, with interest payable monthly. Term loans normally provide for floating interest rates, with monthly payments of both principal and interest.

The Company is an active participant in the SBA and U.S. Department of Agriculture guaranteed lending programs, and has been approved by the SBA as a lender under the Preferred Lender Program. The Company regularly makes such guaranteed loans (collectively referred to as “SBA loans”). The guaranteed portion of these loans is typically sold in the secondary market depending on market conditions. When the guaranteed portion of an SBA loan is sold the Company retains the servicing rights for the sold portion. During the six months ended June 30, 2020 and 2019, loans were sold resulting in a gain on sales of SBA loans of $67,000 and $175,000, respectively.

The Company’s factoring receivables are from the operations of Bay View Funding whose primary business is purchasing and collecting factored receivables. Factored receivables are receivables that have been transferred by the originating organization and typically have not been subject to previous collection efforts. These receivables are acquired from a variety of companies, including but not limited to service providers, transportation companies, manufacturers, distributors, wholesalers, apparel companies, advertisers, and temporary staffing companies. The portfolio of factored receivables is included in the Company’s commercial loan portfolio. The average life of the factored receivables was 38 days for the first six months of 2020, compared to 37 days for the first six months of 2019. The balance of the purchased receivables was $41.9 million at June 30, 2020, compared to $49.8 million at June 30, 2019 and $46.0 million at December 31, 2019.

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The commercial loan portfolio increased $8.7 million, or 2%, to $553.8 million at June 30, 2020 from $545.1 million at June 30, 2019 and decreased ($49.5) million, or (8%), from $603.3 million at December 31, 2019. C&I line usage was 27% at June 30, 2020, compared to 40% at June 30, 2019 and 35% at December 31, 2019. In addition, the Company had $324.6 million in PPP loans at June 30, 2020.

The Company’s CRE loans consist primarily of loans based on the borrower’s cash flow and are secured by deeds of trust on commercial property to provide a secondary source of repayment. The Company generally restricts real estate term loans to no more than 75% of the property’s appraised value or the purchase price of the property depending on the type of property and its utilization. The Company offers both fixed and floating rate loans. Maturities for CRE loans are generally between five and ten years (with amortization ranging from fifteen to twenty five years and a balloon payment due at maturity), however, SBA and certain other real estate loans that can be sold in the secondary market may be granted for longer maturities.

The CRE owner-occupied loan portfolio increased $131.5 million or 31% to $553.5 million at June 30, 2020, from $422.0 million at June 30, 2019, and increased $4.6 million, or 1% from $548.9 million at December 31, 2019. CRE non-owner occupied loans increased $208.2 million or 40% to $725.8 million, compared to $517.6 million at June 30, 2019, and decreased ($42.0) million, or (5%) from $767.8 million at December 31, 2019. At June 30, 2020, there was 43% of the CRE loan portfolio secured by owner-occupied real estate.

The Company’s land and construction loans are primarily to finance the development/construction of commercial and single family residential properties. The Company utilizes underwriting guidelines to assess the likelihood of repayment from sources such as sale of the property or availability of permanent mortgage financing prior to making the construction loan. Construction loans are provided only in our market area, and the Company has extensive controls for the disbursement process. Land and construction loans increased $40.5 million, or 41%, to $138.3 million at June 30, 2020, compared to $97.8 million at June 30, 2019, and decreased $(8.9) million, or (6%), from $147.2 million at December 31, 2019.

The Company makes home equity lines of credit available to its existing customers. Home equity lines of credit are underwritten initially with a maximum 75% loan to value ratio. Home equity lines of credit increased $16.8 million, or 18%, to $112.7 million at June 30, 2020, compared to $95.9 million at June 30, 2019, and decreased ($39.1) million, or (26%), from $151.8 million at December 31, 2019.

Residential mortgage loans decreased ($2.5) million, or (3%), to $95.0 million at June 30, 2020, compared to $97.5 million at June 30, 2019, and decreased ($5.7) million, or (6%) from $100.7 million at December 31, 2019.

Additionally, the Company makes consumer loans for the purpose of financing automobiles, various types of consumer goods, and other personal purposes. Consumer loans generally provide for the monthly payment of principal and interest. Most of the Company’s consumer loans are secured by the personal property being purchased or, in the instances of home equity loans or lines, real property.

With certain exceptions, state chartered banks are permitted to make extensions of credit to any one borrowing entity up to 15% of the bank’s capital and reserves for unsecured loans and up to 25% of the bank’s capital and reserves for secured loans. For HBC, these lending limits were $95.6 million and $159.4 million at June 30, 2020, respectively.

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Loan Maturities

The following table presents the maturity distribution of the Company’s loans (excluding loans held-for-sale) as of June 30, 2020. The table shows the distribution of such loans between those loans with predetermined (fixed) interest rates and those with variable (floating) interest rates. Floating rates generally fluctuate with changes in the prime rate as reflected in the Western Edition of The Wall Street Journal. As of June 30, 2020, approximately 44% of the Company’s loan portfolio consisted of floating interest rate loans.


			Over One
	Due in		Year But
	One Year		Less than		Over
	or Less		Five Years		Five Years		Total

	(Dollars in thousands)
Commercial	$	480,746	$	379,250	$	18,397	$	878,393
Real estate:
CRE - owner occupied		138,915		288,351		126,197		553,463
CRE - non-owner occupied		203,612		240,284		281,880		725,776
Land and construction		131,995		2,797		3,492		138,284
Home equity		112,047		419		213		112,679
Multifamily		1,550		47,973		120,114		169,637
Residential mortgages		1,631		20,555		72,847		95,033
Consumer and other		19,702		1,349		1,708		22,759
Loans	$	1,090,198	$	980,978	$	624,848	$	2,696,024

Loans with variable interest rates	$	979,436	$	148,695	$	62,290	$	1,190,421
Loans with fixed interest rates		110,762		832,283		562,557		1,505,602
Loans	$	1,090,198	$	980,978	$	624,848	$	2,696,024

Loan Servicing

As of June 30, 2020 and 2019, $81.3 million and $94.0 million, respectively, in SBA loans were serviced by the Company for others. Activity for loan servicing rights was as follows:


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2020		2019		2020		2019

	(Dollars in thousands)
Beginning of period balance	$	539	$	807	$	583	$	871
Additions		—		9		17		40
Amortization		(60)		(139)		(121)		(234)
End of period balance	$	479	$	677	$	479	$	677

Loan servicing rights are included in accrued interest receivable and other assets on the unaudited consolidated balance sheets and reported net of amortization. There was no valuation allowance as of June 30, 2020 and 2019, as the fair value of the assets was greater than the carrying value.

Activity for the I/O strip receivable was as follows:


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2020		2019		2020		2019

	(Dollars in thousands)
Beginning of period balance	$	458	$	571	$	503	$	568
Unrealized holding (loss) gain		24		1		(21)		4
End of period balance	$	482	$	572	$	482	$	572

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Credit Quality

Financial institutions generally have a certain level of exposure to credit quality risk, and could potentially receive less than a full return of principal and interest if a debtor becomes unable or unwilling to repay. Since loans are the most significant assets of the Company and generate the largest portion of its revenues, the Company’s management of credit quality risk is focused primarily on loan quality. Banks have generally suffered their most severe earnings declines as a result of customers’ inability to generate sufficient cash flow to service their debts and/or downturns in national and regional economies and declines in overall asset values including real estate. In addition, certain debt securities that the Company may purchase have the potential of declining in value if the obligor’s financial capacity to repay deteriorates.

The Company’s policies and procedures identify market segments, set goals for portfolio growth or contraction, and establish limits on industry and geographic credit concentrations. In addition, these policies establish the Company’s underwriting standards and the methods of monitoring ongoing credit quality. The Company’s internal credit risk controls are centered in underwriting practices, credit granting procedures, training, risk management techniques, and familiarity with loan customers as well as the relative diversity and geographic concentration of our loan portfolio.

The Company’s credit risk may also be affected by external factors such as the level of interest rates, employment, general economic conditions, real estate values, and trends in particular industries or geographic markets. As an independent community bank serving a specific geographic area, the Company must contend with the unpredictable changes in the general California market and, particularly, primary local markets. The Company’s asset quality has suffered in the past from the impact of national and regional economic recessions, consumer bankruptcies, and depressed real estate values.

Nonperforming assets are comprised of the following: loans for which the Company is no longer accruing interest; restructured loans which have been current under six months; loans 90 days or more past due and still accruing interest (although they are generally placed on nonaccrual when they become 90 days past due, unless they are both well-secured and in the process of collection); and foreclosed assets. Past due loans 30 days or greater totaled $11.5 million and $15.3 million at June 30, 2020 and December 31, 2019, respectively, of which $2.8 million and $7.4 million were on nonaccrual, respectively. At June 30, 2020, there were also $5.6 million loans less than 30 days past due included in nonaccrual loans held-for-investment. At December 31, 2019, there were also $1.3 million loans less than 30 days past due included in nonaccrual loans held-for-investment.

Management’s classification of a loan as “nonaccrual” is an indication that there is reasonable doubt as to the full recovery of principal or interest on the loan. At that point, the Company stops accruing interest income, and reverses any uncollected interest that had been accrued as income. The Company begins recognizing interest income only as cash interest payments are received and it has been determined the collection of all outstanding principal is not in doubt. The loans may or may not be collateralized, and collection efforts are pursued. Loans may be restructured by management when a borrower has experienced some change in financial status causing an inability to meet the original repayment terms and where the Company believes the borrower will eventually overcome those circumstances and make full restitution. Foreclosed assets consist of properties acquired by foreclosure or similar means that management is offering or will offer for sale.

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The following table summarizes the Company’s nonperforming assets at the dates indicated:


	June 30,						December 31,
	2020			2019			2019

	(Dollars in thousands)
Nonaccrual loans — held-for-investment	$	8,457		$	15,695		$	8,675
Restructured and loans 90 days past due and
still accruing		668			1,323			1,153
Total nonperforming loans		9,125			17,018			9,828
Foreclosed assets		—			—			—
Total nonperforming assets	$	9,125		$	17,018		$	9,828

Nonperforming assets as a percentage of loans
plus foreclosed assets		0.34	%		0.91	%		0.39	%
Nonperforming assets as a percentage of total assets		0.20	%		0.55	%		0.24	%

Nonperforming assets were $9.1 million, or 0.20% of total assets, at June 30, 2020, compared to $17.0 million, or 0.55% of total assets, at June 30, 2019, and $9.8 million, or 0.24% of total assets, at December 31, 2019.

The following table presents the amortized cost basis of nonperforming loans and loans past due over 90 days and still accruing at June 30, 2020:



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

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

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


			Restructured
			and Loans
			over 90 Days
			Past Due
			and Still
	Nonaccrual		Accruing		Total

	(Dollars in thousands)
Commercial	$	3,444	$	1,153	$	4,597
Real estate:
CRE		5,094		—		5,094
Home equity		137		—		137
Total	$	8,675	$	1,153	$	9,828

Loans with a well-defined weakness, which are characterized by the distinct possibility that the Company will sustain a loss if the deficiencies are not corrected, are categorized as “classified.” Classified loans include all loans considered as substandard, substandard-nonaccrual, and doubtful and may result from problems specific to a borrower’s business or from economic downturns that affect the borrower’s ability to repay or that cause a decline in the value of the

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underlying collateral (particularly real estate). Loans held-for-sale are carried at the lower of cost or estimated fair value, and are not allocated an allowance for loan losses.

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


		Collateral Type
		Real
		Estate		Business
		Property		Assets		Unsecured		Total

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

The following table presents term loans amortized cost by vintage and loan grade classification, and revolving loans amortized cost by loan grade classification. The loan grade classifications are based on the Bank’s internal loan grading methodology. Loan grade categories for doubtful and loss rated loans are not included on the table below as there are no loans with those grades at June 30, 2020. The vintage year represents the period the loan was originated or in the case of renewed loans, the period last renewed. The amortized balance is the loan balance less any deferred loan fees, or any purchase discounts, and plus any deferred loan costs or any loan purchase premiums. The loan categories are based on the loan segmentation in the Company's CECL reserve methodology based on loan purpose and type.

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														Revolving
														Loans
		Term Loans Amortized Cost Basis by Originated Period												Amortized
												2015 and		Cost
		2020		2019		2018		2017		2016		Prior		Basis		Total

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

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

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

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

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

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

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

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

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

Classified loans increased to $31.5 million, or 0.68% of total assets, at June 30, 2020, compared to $31.2 million, or 1.00% of total assets, at June 30, 2019 and decreased from $32.6 million, or 0.79% of total assets at December 31, 2019. Deferrals included in classified assets total $5.6 million at June 30, 2020. The increase in classified assets for the second quarter of 2020, compared to the second quarter of 2019 was primarily due to two CRE secured and one commercial lending relationships that were moved to classified assets during the first quarter of 2020.

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In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed in accordance with the Company’s underwriting policy.

Allowance for Credit Losses on Loans

Beginning January 1, 2020, we calculated allowance for credit losses on loans using current expected credit losses methodology. As of January 1, 2020, the Company increased the allowance for credit losses on loans by $8.6 million since the Topic 326 covers credit losses over the expected life of a loan as well as considering future changes in macroeconomic conditions.

The allowance for credit loss estimation process involves procedures to appropriately consider the unique characteristics of its loan portfolio segments. These segments are further disaggregated into loan classes, the level at which credit risk is monitored. When computing the level of expected credit losses, credit loss assumptions are estimated using a model that categorizes loan pools based on loss history, delinquency status, and other credit trends and risk characteristics, including current conditions and reasonable and supportable forecasts about the future. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. In future periods evaluations of the overall loan portfolio, in light of the factors and forecasts then prevailing, may result in significant changes in the allowance and credit loss expense in those future periods.

The allowance level is influenced by loan volumes, loan risk rating migration or delinquency status, changes in historical loss experience, and other conditions influencing loss expectations, such as reasonable and supportable forecasts of economic conditions. The methodology for estimating the amount of expected credit losses reported in the allowance for credit losses has two basic components: first, an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans; and second, a pooled component for estimated expected credit losses for pools of loans that share similar risk characteristics.

Prior to January 1, 2020, we calculated allowance for loan losses using incurred losses methodology.

Loans are charged-off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance for credit losses on loans.

The following provides a summary of the risks associated with various segments of the Company’s loan portfolio, which are factors management regularly considers when evaluating the adequacy of the allowance:

●

Commercial loans consist primarily of commercial and industrial loans (business lines of credit), and other commercial purpose loans. Repayment of commercial and industrial loans is generally provided from the cash flows of the related business to which the loan was made. Adverse changes in economic conditions may result in a decline in business activity, which may impact a borrower’s ability to continue to make scheduled payments. The factored receivables at Bay View Funding are included in the Company’s commercial loan portfolio; however, they are evaluated for risk primarily based on the agings of the receivables. Faster turning receivables imply less risk and therefore warrant a lower associated allowance. Should the overall aging for the portfolio increase, this structure will by formula increase the allowance to reflect the increasing risk. Should the portfolio turn more quickly, it would reduce the associated allowance to reflect the reducing risk. PPP loans are included in commercial loans and are fully guaranteed by the SBA.

●

Real estate loans consist primarily of loans secured by commercial and residential real estate. Also included in this segment are land and construction loans and home equity lines of credit secured by real estate. As the majority of this segment is comprised of commercial real estate loans, risks associated with this segment lay primarily within these loan types. Adverse economic conditions may result in a decline in business activity and increased vacancy rates for commercial properties. These factors, in conjunction with a decline in real estate prices, may expose the Company to the potential for losses if a borrower cannot continue to service the loan with operating revenues, and the value of the property has declined to a level such that it no longer fully covers the Company’s recorded investment in the loan.

●

Consumer loans consist primarily of a large number of small loans and lines of credit. The majority of installment loans are made for consumer and business purchases. Weakened economic conditions may result

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in an increased level of delinquencies within this segment, as economic pressures may impact the capacity of such borrowers to repay their obligations.

As a result of the matters mentioned above, changes in the financial condition of individual borrowers, economic conditions, historical loss experience and the condition of the various markets in which collateral may be sold may all affect the required level of the allowance for credit losses on loans and the associated provision for credit losses on loans.

On an ongoing basis, we have engaged an outside firm to perform independent credit reviews of our loan portfolio. The Federal Reserve Board and the California Department of Business Oversight—Division of Financial Institutions also review the allowance for credit losses as an integral part of the examination process. Based on information currently available, management believes that the allowance for credit losses on loans is adequate. However, the loan portfolio can be adversely affected if California economic conditions and the real estate market in the Company’s market area were to weaken further. Also, any weakness of a prolonged nature in the technology industry would have a negative impact on the local market. The effect of such events, although uncertain at this time, could result in an increase in the level of nonperforming loans and increased loan losses, which could adversely affect the Company’s future growth and profitability. No assurance of the ultimate level of credit losses can be given with any certainty.

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


			CRE		CRE
			Owner		Non-owner		Land &		Home		Multi-		Residential		Consumer
	Commercial		Occupied		Occupied		Construction		Equity		Family		Mortgages		and Other		Total

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

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


	Commercial		Real Estate		Consumer		Total

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

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


			CRE		CRE
			Owner		Non-owner		Land &		Home		Multi-		Residential		Consumer
	Commercial		Occupied		Occupied		Construction		Equity		Family		Mortgages		and Other		Total

	(Dollars in thousands)
Beginning of period balance	$	10,453	$	3,825	$	3,760	$	2,621	$	2,244	$	57	$	243	$	82	$	23,285
Adoption of Topic 326		(3,663)		3,169		7,912		(1,163)		(923)		1,196		435		1,607		8,570
Balance at adoption on January 1, 2020		6,790		6,994		11,672		1,458		1,321		1,253		678		1,689		31,855
Charge-offs		(1,135)		-		-		-		-		-		-		(3)		(1,138)
Recoveries		255		1		-		32		54		-		-		1		343
Net (charge-offs) recoveries		(880)		1		-		32		54		-		-		(2)		(795)
Provision for credit losses on loans		7,269		1,552		3,777		1,062		476		575		147		(474)		14,384
End of period balance	$	13,179	$	8,547	$	15,449	$	2,552	$	1,851	$	1,828	$	825	$	1,213	$	45,444

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


	Commercial		Real Estate		Consumer		Total

	(Dollars in thousands)
Beginning of period balance	$	17,061	$	10,671	$	116	$	27,848
Charge-offs		(302)		0		0		(302)
Recoveries		802		84		0		886
Net recoveries		500		84		0		584
Provision (credit) for loan losses		(2,327)		552		(26)		(1,801)
End of period balance	$	15,234	$	11,307	$	90	$	26,631

The following table provides a summary of the allocation of the allowance for loan losses by class at the dates indicated. The allocation presented should not be interpreted as an indication that charges to the allowance for loan losses will be incurred in these amounts or proportions, or that the portion of the allowance allocated to each category represents the total amount available for charge-offs that may occur within these classes.

Allocation of Allowance for Credit Losses on Loans


	June 30,
	2020				2019				December 31, 2019
			Percent				Percent				Percent
			of Loans				of Loans				of Loans
			in each				in each				in each
			category				category				category
			to total				to total				to total
	Allowance		loans		Allowance		loans		Allowance		loans

	(Dollars in thousands)
Commercial	$	13,179	33	%	$	15,234	29	%	$	10,453	24	%
Real estate:
CRE - owner occupied		8,547	21	%		4,095	23	%		3,825	22	%
CRE - non-owner occupied		15,449	27	%		3,504	28	%		3,760	30	%
Land and construction		2,552	5	%		1,725	5	%		2,621	6	%
Home equity		1,851	4	%		1,697	5	%		2,244	6	%
Multifamily		1,828	6	%		43	4	%		57	7	%
Residential mortgages		825	3	%		243	5	%		243	4	%
Consumer and other		1,213	1	%		90	1	%		82	1	%
Total	$	45,444	100	%	$	26,631	100	%	$	23,285	100	%

The allowance for credit losses on loans totaled $45.4 million, or 1.69% of total loans at June 30, 2020. The allowance for loan losses was $26.6 million, or 1.42% of total loans at June 30, 2019, and $23.3 million, or 0.92% of total loans at December 31, 2019. The allowance for credit losses on loans was 498.02% of nonperforming loans at June 30, 2020. The allowance for loan losses was 156.49% of nonperforming loans at June 30, 2019, and 236.93% of nonperforming loans at December 31, 2019. The Company had net charge-offs of $373,000, or 0.06% of average loans, for the second quarter of 2020, compared to net recoveries of $53,000, or (0.01%) of average loans, for the second quarter of 2019, and net charge-offs $5.4 million, or 0.95% of average loans, for the fourth quarter of 2019. Net charge-offs of $5.8 million for the fourth quarter of 2019 primarily consisted of three lending relationships totaling $5.5 million in net

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charge-offs during the fourth quarter of 2019, including one large relationship which was previously disclosed and specifically reserved for during the second and third quarters of 2018. The three lending relationships totaling $5.5 million in net charge-offs had a total of $4.7 million in specific reserves.

The following table shows the results of adopting CECL for the first six months of 2020:


DRIVERS OF CHANGE IN ACLL UNDER CECL
(in $000’s, unaudited)
ALLL at December 31, 2019	$	23,285
Day 1 adjustment impact of adopting Topic 326		8,570
ACLL at January 1, 2020		31,855
Net (charge-offs) during the first quarter of 2020		(422)
Portfolio changes during the first quarter of 2020		1,216
Economic factors during the first quarter of 2020		12,054
ACLL at March 31, 2020		44,703
Net (charge-offs) during the second quarter of 2020		(373)
Portfolio changes during the second quarter of 2020		(4,282)
Qualitative and quantitative changes during the second
quarter of 2020 including changes in economic forecasts		5,396
ACLL at June 30, 2020	$	45,444

Leases

On January 1, 2019, the Company adopted Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842). Under the new guidance, the Company recognizes the following for all leases, at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use (“ROU”) asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. While the new standard impacts lessors and lessees, the Company is impacted as a lessee of the offices and real estate used for operations. The Company's lease agreements include options to renew at the Company's discretion. The extensions are not reasonably certain to be exercised, therefore it was not considered in the calculation of the ROU asset and lease liability. Total assets and total liabilities were $37.1 million on its consolidated statement of financial condition at June 30, 2020, as a result of recognizing right-of-use assets, included in other assets, and lease liabilities, included in other liabilities, related to non-cancelable operating lease agreements for office space.

Goodwill and Other Intangible Assets

Goodwill represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. The fair values of assets acquired and liabilities assumed are subject to adjustment during the first twelve months after the acquisition date if additional information becomes available to indicate a more accurate or appropriate value for an asset or liability. Total goodwill was $167.6 million at June 30, 2020, which consisted of $13.0 million related to the Bay View Funding acquisition, $32.6 million related to the Focus acquisition, $13.8 million related to the Tri-Valley acquisition, $24.3 million related to the United American acquisition, and $83.9 million from the Presidio merger. Total goodwill was $167.4 million at December 31, 2019, which consisted of, $13.0 million related to the Bay View Funding acquisition, $32.6 million related to the Focus acquisition, $13.8 million related to the Tri-Valley acquisition, $24.3 million related to the United American acquisition, and $83.7 million from the Presidio merger.

On October 11, 2019, the Company completed its merger with Presidio for an aggregate transaction value of $185.6 million. Shareholders of Presidio received a fixed exchange ratio at closing of 2.47 shares of the Company’s common stock for each share of Presidio common stock. Upon closing of the transaction, the Company issued 15,684,064 shares of the Company’s common stock to Presidio shareholders and holders of restricted stock units for a total value of $178.2 million based on the Company’s closing stock price of $11.36 on the closing date of October 11, 2019. In addition, the consideration for Presidio stock options exchanged for the Company’s stock options totaled $7.4 million and cash-in-lieu of fractional shares totaled $1,000 on October 11, 2019.

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do not believe that it is more likely than not a goodwill impairment exists at June 30, 2020. See note 13, Contingencies, for additional information on COVID-19 and its potential impact to us.

Deposits

The composition and cost of the Company’s deposit base are important components in analyzing the Company’s net interest margin and balance sheet liquidity characteristics, both of which are discussed in greater detail in other sections herein. The Company’s liquidity is impacted by the volatility of deposits from the propensity of that money to leave the institution for rate-related or other reasons. Deposits can be adversely affected if economic conditions weaken in California, and the Company’s market area in particular. Potentially, the most volatile deposits in a financial institution are jumbo certificates of deposit, meaning time deposits with balances that equal or exceed $250,000, as customers with balances of that magnitude are typically more rate-sensitive than customers with smaller balances.

The following table summarizes the distribution of deposits and the percentage of distribution in each category of deposits for the periods indicated:


	June 30, 2020				June 30, 2019				December 31, 2019
	Balance		% to Total		Balance		% to Total		Balance		% to Total

	(Dollars in thousands)
Demand, noninterest-bearing	$	1,714,058	44	%	$	994,082	38	%	$	1,450,873	42	%
Demand, interest-bearing		934,780	24	%		682,114	26	%		798,375	23	%
Savings and money market		1,091,740	28	%		788,832	30	%		982,430	29	%
Time deposits — under $250		49,493	1	%		53,351	2	%		54,361	2	%
Time deposits — $250 and over		93,822	2	%		88,519	3	%		99,882	3	%
CDARS — interest-bearing demand,
money market and time deposits		16,333	1	%		15,575	1	%		28,847	1	%
Total deposits	$	3,900,226	100	%	$	2,622,473	100	%	$	3,414,768	100	%

The Company obtains deposits from a cross-section of the communities it serves. The Company’s business is not generally seasonal in nature. Public funds were less than 1% of deposits and June 30, 2020 and at December 31, 2019.

Total deposits increased $1.3 billion, or 49%, to $3.90 billion at June 30, 2020, compared to $2.62 billion at June 30, 2019, which included $787.7 million in deposits from Presidio, at fair value, and an increase of $490.0 million in the Company’s legacy deposits. Total deposits increased $485.5 million or 14% from $3.41 billion at December 31, 2019. Deposits, excluding all time deposits and CDARS deposits, increased $1.3 billion, or 52%, to $3.74 billion at June 30, 2020, compared to $2.47 billion at June 30, 2019, which included $772.4 million in deposits from Presidio, at fair value, and an increase of $503.2 million in the Company’s legacy deposits. Deposits, excluding all time deposits and CDARS deposits, at June 30, 2020 increased $508.9 million, or 16% compared to $3.23 billion at December 31, 2019.

At June 30, 2020, the $16.3 million CDARS deposits comprised $8.7 million of interest-bearing demand deposits, $763,000 of money market accounts and $6.9 million of time deposits. At June 30, 2019, the $15.6 million CDARS deposits comprised $10.2 of million of interest-bearing demand deposits, $3.5 million of money market accounts and $1.9 million of time deposits. At December 31, 2019, the $28.8 million CDARS deposits comprised $12.9 million of interest-bearing demand deposits, $2.1 million of money market accounts and $13.8 million of time deposits.

The following table indicates the contractual maturity schedule of the Company’s time deposits of $250,000 and over, and all CDARS time deposits as of June 30, 2020:


	Balance		% of Total

	(Dollars in thousands)
Three months or less	$	40,209	40	%
Over three months through six months		22,577	23	%
Over six months through twelve months		24,592	24	%
Over twelve months		13,390	13	%
Total	$	100,768	100	%

The Company focuses primarily on providing and servicing business deposit accounts that are frequently over $250,000 in average balance per account. As a result, certain types of business clients that the Company serves typically

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carry average deposits in excess of $250,000. The account activity for some account types and client types necessitates appropriate liquidity management practices by the Company to help ensure its ability to fund deposit withdrawals.

Return on Equity and Assets

The following table indicates the ratios for return on average assets and average equity, and average equity to average assets for the periods indicated:


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2020		2019		2020		2019
Return on average assets	0.96	%	1.48	%	0.59	%	1.53	%
Return on average tangible assets	1.01	%	1.53	%	0.62	%	1.58	%
Return on average equity	7.45	%	11.96	%	4.36	%	12.61	%
Return on average tangible equity	11.06	%	15.94	%	6.45	%	16.89	%
Average equity to average assets ratio	12.92	%	12.40	%	13.61	%	12.16	%

Off-Balance Sheet Arrangements

In the normal course of business the Company makes commitments to extend credit to its customers as long as there are no violations of any conditions established in the contractual arrangements. These commitments are obligations that represent a potential credit risk to the Company, but are not reflected on the Company’s consolidated balance sheets. Total unused commitments to extend credit were $1.15 billion at June 30, 2020, compared to $714.5 million at June 30, 2019, and $1.1 billion at December 31, 2019. Unused commitments represented 43% outstanding gross loans at June 30, 2020, 38% at June 30, 2019, and 44% at December 31, 2019.

The effect on the Company’s revenues, expenses, cash flows and liquidity from the unused portion of the commitments to provide credit cannot be reasonably predicted because there is no certainty that lines of credit and letters of credit will ever be fully utilized. The following table presents the Company’s commitments to extend credit for the periods indicated:


	June 30,
	2020						2019						December 31, 2019
	Fixed		Variable				Fixed		Variable				Fixed		Variable
	Rate		Rate		Total		Rate		Rate		Total		Rate		Rate		Total

	(Dollars in thousands)
Unused lines of credit and commitments
to make loans	$	151,120	$	976,354	$	1,127,474	$	146,955	$	551,963	$	698,918	$	147,372	$	951,206	$	1,098,578
Standby letters of credit		4,374		15,537		19,911		2,245		13,381		15,626		11,445		10,615		22,060
	$	155,494	$	991,891	$	1,147,385	$	149,200	$	565,344	$	714,544	$	158,817	$	961,821	$	1,120,638

Liquidity and Asset/Liability Management

Liquidity refers to the Company’s ability to maintain cash flows sufficient to fund operations and to meet obligations and other commitments in a timely and cost effective fashion. At various times the Company requires funds to meet short-term cash requirements brought about by loan growth or deposit outflows, the purchase of assets, or liability repayments. An integral part of the Company’s ability to manage its liquidity position appropriately is the Company’s large base of core deposits, which are generated by offering traditional banking services in its service area and which have historically been a stable source of funds. To manage liquidity needs cash inflows must be properly timed to coincide with anticipated outflows or sufficient liquidity resources must be available to meet varying demands. The Company manages liquidity to be able to meet unexpected sudden changes in levels of its assets or deposit liabilities without maintaining excessive amounts of balance sheet liquidity. Excess balance sheet liquidity can negatively impact the Company’s interest margin. In order to meet short-term liquidity needs the Company utilizes overnight Federal funds purchase arrangements and other borrowing arrangements with correspondent banks, solicits brokered deposits if cost effective deposits are not available from local sources, and maintains collateralized lines of credit with the FHLB and FRB. In addition, the Company can raise cash for temporary needs by selling securities under agreements to repurchase and selling securities available-for-sale.

One of the measures of liquidity is our loan to deposit ratio. Our loan to deposit ratio was 68.88% at June 30, 2020, compared to 71.60% at June 30, 2019, and 74.20% at December 31, 2019.

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FHLB and FRB Borrowings and Available Lines of Credit

HBC has off-balance sheet liquidity in the form of Federal funds purchase arrangements with correspondent banks, including the FHLB and FRB. HBC can borrow from the FHLB on a short-term (typically overnight) or long-term (over one year) basis. HBC had no overnight borrowings from the FHLB at June 30, 2020, June 30, 2019, and December 31, 2019. HBC had $239.6 million of loans pledged to the FHLB as collateral on an available line of credit of $180.0 million at June 30, 2020, none of which was outstanding. HBC also had $4.6 million of securities pledged to the FHLB as collateral on an available line of credit of $4.4 million at June 30, 2020, none of which was outstanding.

HBC can also borrow from the FRB’s discount window. HBC had $745.4 million of loans pledged to the FRB as collateral on an available line of credit of $395.3 million at June 30, 2020, none of which was outstanding.

At June 30, 2020, HBC had Federal funds purchase arrangements available of $80.0 million. There were no Federal funds purchased outstanding at June 30, 2020, June 30, 2019, and December 31, 2019.

The Company has a $5.0 million line of credit with a correspondent bank, of which none was outstanding at June 30, 2020.

HBC may also utilize securities sold under repurchase agreements to manage its liquidity position. There were no securities sold under agreements to repurchase at June 30, 2020, June 30, 2019, and December 31, 2019.

Capital Resources

The Company uses a variety of measures to evaluate capital adequacy. Management reviews various capital measurements on a regular basis and takes appropriate action to ensure that such measurements are within established internal and external guidelines. The external guidelines, which are issued by the Federal Reserve and the FDIC, establish a risk adjusted ratio relating capital to different categories of assets and off balance sheet exposures.

On May 26, 2017, the Company completed an underwritten public offering of $40.0 million aggregate principal amount of its fixed-to-floating rate subordinated notes (“Subordinated Debt”) due June 1, 2027. The Subordinated Debt initially bears a fixed interest rate of 5.25% per year. Commencing on June 1, 2022, the interest rate on the Subordinated Debt resets quarterly to the three-month LIBOR rate plus a spread of 336.5 basis points, payable quarterly in arrears. Interest on the Subordinated Debt is payable semi-annually on June 1st and December 1st of each year through June 1, 2022 and quarterly thereafter on March 1st, June 1st, September 1st and December 1st of each year through the maturity date or early redemption date. The Company, at its option, may redeem the Subordinated Debt, in whole or in part, on any interest payment date on or after June 1, 2022 without a premium.

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with the counter-parties under such financings to address the issues, subject to the terms of the existing documentation and any mutually agreeable amendments thereto.

The Company acquired $10.0 million of subordinated debt from the Presidio transaction, which was redeemed on December 19, 2019. As a result of the redemption of the Presidio subordinated debt, the Company paid a pre-payment penalty of $300,000 during the fourth quarter of 2019.

The following table summarizes risk-based capital, risk-weighted assets, and risk-based capital ratios of the consolidated Company under the Basel III requirements for the periods indicated:


	June 30,			June 30,			December 31,
	2020			2019			2019

	(Dollars in thousands)
Capital components:
Common equity Tier 1 capital	$	396,142		$	293,492		$	393,432
Additional Tier 1 capital		—			—			—
Tier 1 Capital		396,142			293,492			393,432
Tier 2 Capital		76,953			66,750			63,726
Total risk-based capital	$	473,095		$	360,242		$	457,158

Risk-weighted assets	$	2,983,550		$	2,266,336		$	3,136,252
Average assets for capital purposes	$	4,232,259		$	2,971,636		$	4,041,927

Capital ratios:
Total risk-based capital		15.9	%		15.9	%		14.6	%
Tier 1 risk-based capital		13.3	%		13.0	%		12.5	%
Common equity Tier 1 risk-based capital		13.3	%		13.0	%		12.5	%
Leverage(1)		9.4	%		9.9	%		9.7	%

The following table summarizes risk based capital, risk-weighted assets, and risk-based capital ratios of HBC under the Basel III requirements for the periods indicated:


	June 30,			June 30,			December 31,
	2020			2019			2019

	(Dollars in thousands)
Capital components:
Common equity Tier 1 capital	$	413,557		$	311,055		$	411,585
Additional Tier 1 capital		—			—			—
Tier 1 Capital		413,557			311,055			411,585
Tier 2 Capital		37,282			27,289			24,172
Total risk-based capital	$	450,839		$	338,344		$	435,757

Risk-weighted assets	$	2,981,526		$	2,264,771		$	3,134,848
Average assets for capital purposes	$	4,230,356		$	2,970,101		$	4,040,265

Capital ratios:
Total risk-based capital		15.1	%		14.9	%		13.9	%
Tier 1 risk-based capital		13.9	%		13.7	%		13.1	%
Common equity Tier 1 risk-based capital		13.9	%		13.7	%		13.1	%
Leverage(1)		9.8	%		10.5	%		10.2	%

(1)	Tier 1 capital divided by quarterly average assets (excluding intangible assets and disallowed deferred tax assets).

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The following table presents the applicable well-capitalized regulatory guidelines and the standards for minimum capital adequacy requirements under Basel III and the regulatory guidelines for a “well–capitalized” financial institution under Prompt Corrective Action (“PCA”):




			Well-capitalized
			Financial
	Minimum		Institution PCA
	Regulatory		Regulatory
	Requirement(1)		Guidelines
Capital ratios:
Total risk-based capital	10.5	%	10.0	%
Tier 1 risk-based capital	8.5	%	8.0	%
Common equity Tier 1 risk-based capital	7.0	%	6.5	%
Leverage	4.0	%	5.0	%

(1)	Includes 2.5% capital conservation buffer, except the leverage capital ratio.

The Basel III capital rules introduce a new “capital conservation buffer,” for banking organizations to maintain a common equity Tier 1 ratio more than 2.5% above these minimum risk-weighted asset ratios. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the capital conservation buffer will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.

At June 30, 2020, the Company’s consolidated capital ratio exceeded regulatory guidelines and HBC’s capital ratios exceed the highest regulatory capital requirement of “well-capitalized” under Basel III prompt corrective action provisions. Quantitative measures established by regulation to help ensure capital adequacy require the Company and HBC to maintain minimum amounts and ratios of total risk-based capital, Tier 1 capital, and common equity Tier 1 (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average assets (as defined). Management believes that, as of June 30, 2020, June 30, 2019, and December 31, 2019, the Company and HBC met all capital adequacy guidelines to which they were subject. There are no conditions or events since June 30, 2020, that management believes have changed the categorization of the Company or HBC as well-capitalized.

At June 30, 2020, the Company had total shareholders’ equity of $574.8 million, compared to $388.1 million at June 30, 2019, and $576.7 million at December 31, 2019. At June 30, 2020, total shareholders’ equity included $492.3 million in common stock, $87.7 million in retained earnings, and ($5.2) million of accumulated other comprehensive loss. The book value per share was $9.60 at June 30, 2020, compared to $8.92 at June 30, 2019, and $9.71 at December 31, 2019. The tangible book value per share was $6.49 at June 30, 2020, compared to $6.75 at June 30, 2019, and $6.55 at December 31, 2019.

The following table reflects the components of accumulated other comprehensive loss, net of taxes, for the periods indicated:


ACCUMULATED OTHER COMPREHENSIVE LOSS	June 30,		December 31,		June 30,
(in $000's, unaudited)	2020		2019		2019
Unrealized gain on securities available-for-sale	$	5,767	$	1,242	$	675
Remaining unamortized unrealized gain on securities
available-for-sale transferred to held-to-maturity		280		298		317
Split dollar insurance contracts liability		(4,865)		(4,835)		(3,770)
Supplemental executive retirement plan liability		(6,707)		(6,843)		(3,932)
Unrealized gain on interest-only strip from SBA loans		345		360		408
Total accumulated other comprehensive loss	$	(5,180)	$	(9,778)	$	(6,302)

Market Risk

Market risk is the risk of loss of future earnings, fair values, or future cash flows that may result from changes in the price of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market risk

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sensitive instruments. Market risk is attributed to all market risk sensitive financial instruments, including securities, loans, deposits and borrowings, as well as the Company’s role as a financial intermediary in customer-related transactions. The objective of market risk management is to avoid excessive exposure of the Company’s earnings and equity to loss and to reduce the volatility inherent in certain financial instruments.

Interest Rate Management

Market risk arises from changes in interest rates, exchange rates, commodity prices and equity prices. The Company’s market risk exposure is primarily that of interest rate risk, and it has established policies and procedures to monitor and limit earnings and balance sheet exposure to changes in interest rates. The Company does not engage in the trading of financial instruments, nor does the Company have exposure to currency exchange rates.

The principal objective of interest rate risk management (often referred to as “asset/liability management”) is to manage the financial components of the Company in a manner that will optimize the risk/reward equation for earnings and capital in relation to changing interest rates. The Company’s exposure to market risk is reviewed on a regular basis by the Management’s Asset/Liability Committee and the Director’s Finance and Investment Committee. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income. Management realizes certain risks are inherent, and that the goal is to identify and manage the risks. Management uses two methodologies to manage interest rate risk: (i) a standard GAP analysis; and (ii) an interest rate shock simulation model.

The planning of asset and liability maturities is an integral part of the management of an institution’s net interest margin. To the extent maturities of assets and liabilities do not match in a changing interest rate environment, the net interest margin may change over time. Even with perfectly matched repricing of assets and liabilities, risks remain in the form of prepayment of loans or securities or in the form of delays in the adjustment of rates of interest applying to either earning assets with floating rates or to interest-bearing liabilities.

Interest rate changes do not affect all categories of assets and liabilities equally or at the same time. Varying interest rate environments can create unexpected changes in prepayment levels of assets and liabilities, which may have a significant effect on the net interest margin and are not reflected in the interest sensitivity analysis table. Because of these factors, an interest sensitivity GAP report may not provide a complete assessment of the exposure to changes in interest rates.

The Company uses modeling software for asset/liability management in order to simulate the effects of potential interest rate changes on the Company’s net interest margin, and to calculate the estimated fair values of the Company’s financial instruments under different interest rate scenarios. The program imports current balances, interest rates, maturity dates and repricing information for individual financial instruments, and incorporates assumptions on the characteristics of embedded options along with pricing and duration for new volumes to project the effects of a given interest rate change on the Company’s interest income and interest expense. Rate scenarios consisting of key rate and yield curve projections are run against the Company’s investment, loan, deposit and borrowed funds’ portfolios. These rate projections can be shocked (an immediate and parallel change in all base rates, up or down) and ramped (an incremental increase or decrease in rates over a specified time period), based on current trends and econometric models or stable economic conditions (unchanged from current actual levels).

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The following table sets forth the estimated changes in the Company’s annual net interest income that would result from the designated instantaneous parallel shift in interest rates noted, as of June 30, 2020. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.


	Increase/(Decrease) in
	Estimated Net
	Interest Income
	Amount		Percent

	(Dollars in thousands)
Change in Interest Rates (basis points)
+400	$	52,696	40.2	%
+300	$	39,454	30.1	%
+200	$	26,141	19.9	%
+100	$	13,108	10.0	%
0	$	—	—	%
−100	$	(11,345)	(8.7)	%
−200	$	(22,898)	(17.5)	%

This data does not reflect any actions that we may undertake in response to changes in interest rates such as changes in rates paid on certain deposit accounts based on local competitive factors, which could reduce the actual impact on net interest income.

As with any method of gauging interest rate risk, there are certain shortcomings inherent to the methodology noted above. The model assumes interest rate changes are instantaneous parallel shifts in the yield curve. In reality, rate changes are rarely instantaneous. The use of the simplifying assumption that short-term and long-term rates change by the same degree may also misstate historic rate patterns, which rarely show parallel yield curve shifts. Further, the model assumes that certain assets and liabilities of similar maturity or period to repricing will react in the same way to changes in rates. In reality, certain types of financial instruments may react in advance of changes in market rates, while the reaction of other types of financial instruments may lag behind the change in general market rates. Additionally, the methodology noted above does not reflect the full impact of annual and lifetime restrictions on changes in rates for certain assets, such as adjustable rate loans. When interest rates change, actual loan prepayments and actual early withdrawals from certificates may deviate significantly from the assumptions used in the model. Finally, this methodology does not measure or reflect the impact that higher rates may have on adjustable-rate loan clients’ ability to service their debt. All of these factors are considered in monitoring the Company’s exposure to interest rate risk.

ITEM 3—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information concerning quantitative and qualitative disclosure or market risk called for by Item 305 of Regulation S-K is included as part of Item 2 above.

ITEM 4—CONTROLS AND PROCEDURES

Disclosure Control and Procedures

The Company has carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of June 30, 2020. As defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), disclosure controls and procedures are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed or submitted under the Exchange Act are recorded, processed, summarized and reported on a timely basis. Disclosure controls are also designed to reasonably assure that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based upon their evaluation, our Chief Executive Officer and Chief Financial Officer concluded the Company’s disclosure controls were effective at June 30, 2020, the period covered by this report on Form 10-Q.

During the three and six months ended June 30, 2020, there were no changes in our internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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Part II—OTHER INFORMATION

ITEM 1—LEGAL PROCEEDINGS

ITEM 1A—RISK FACTORS

The following discussion supplements the discussion of risk factors affecting us as set forth in Part I, Item 1A. Risk Factors, on pages 25-51 of our 2019 Annual Report on Form 10-K. The discussion of risk factors, as so supplemented, provides a description of some of the important risk factors that could affect our actual results and could cause our results to vary materially from those expressed in public statements or documents. However, other factors besides those included in the discussion of risk factors, as so supplemented, or discussed elsewhere in other of our reports filed with or furnished to the SEC could affect our business or results. The readers should not consider any description of such factors to be a complete set of all potential risks that we may face.

Risks Relating to the Impact of COVID-19

The COVID-19 pandemic has had, and continues to have, a material impact on businesses around the world and the economic environments in which they operate. In March 2020, the United States declared a federal state of emergency in response to the COVID-19 pandemic, which continues to spread throughout the United States. The outbreak of this virus has disrupted global financial markets and negatively affected supply and demand across a broad range of industries. There are a number of factors associated with the outbreak and its impact on global economies including the United States that have had and could continue to have a material adverse effect on (among other things) the profitability, capital and liquidity of financial institutions such as the Company.

The COVID-19 pandemic has caused disruption to our customers, vendors and employees. California where we primarily operate has implemented restrictions on the movement of its citizens, with a resultant significant impact on economic activity in the state. The pandemic has resulted in temporary closures of many businesses and the institution of social distancing and sheltering in place requirements in California, including are primary market area. As a result, the demand for our products and services has been and may continue to be significantly impacted. The circumstances around this pandemic are evolving rapidly and will continue to impact our business in future periods. In the United States, the Federal Government has taken action to provide financial support to parts of the economy most impacted by the COVID-19 pandemic. The details of how these actions will impact our customers and therefore the impact on the Company remains uncertain at this stage. The actions taken by the U.S. Government and the Federal Reserve may indicate a view on the potential severity of a downturn and post recovery environment, which from a commercial, regulatory and risk perspective could be significantly different to past crises and persist for a prolonged period. The pandemic has led to a weakening in gross domestic product and employment in the United States, and the probability of a more adverse economic scenario for at least the short term is substantially higher than at December 31, 2019.

As the result of the COVID-19 pandemic and the related adverse local and national economic consequences, we could be subject to any of the following risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations:

●

demand for our products and services may decline, making it difficult to grow assets and income;

●

if the economy is unable to substantially reopen, and high levels of unemployment continue for an extended period of time, loan delinquencies, problem assets, and foreclosures may increase, resulting in increased charges and reduced income;

●

collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;

●

our allowance for credit losses on loans may have to be increased if borrowers experience financial difficulties beyond forbearance periods, which will adversely affect our net income;

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●

the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us;

●

as the result of the decline in the Federal Reserve Board’s target federal funds rate, the yield on our assets may decline to a greater extent than the decline in our cost of interest-bearing liabilities, reducing our net interest margin and spread and reducing net income;

●

a material decrease in net income or a net loss over several quarters could result in a decrease in the rate of our quarterly cash dividend;

●

a prolonged weakness in economic conditions resulting in a reduction of future projected earnings could result in our recording a valuation allowance against our current outstanding deferred tax assets;

●

the goodwill we recorded in connection with business acquisitions could become impaired and require charges to earnings;

●

we rely on third party vendors for certain services and the unavailability of a critical service due to the COVID-19 outbreak could have an adverse effect on us; and

●

Federal Deposit Insurance Corporation premiums may increase if the agency experiences additional resolution costs.

Our future success and profitability substantially depends on the management skills of our executive officers and directors, many of whom have held officer and director positions with us for many years. The unanticipated loss or unavailability of key employees due to the outbreak could harm our ability to operate our business or execute our business strategy. We may not be successful in finding and integrating suitable successors in the event of key employee loss or unavailability.

Furthermore, the U.S. economy is likely to experience a recession as a result of the pandemic, and our business could be materially and adversely affected by a prolonged recession. To the extent the pandemic adversely affects our business, financial condition, liquidity, or results of operations, it may also have the effect of heightening many of the other risks described in the section entitled “Risk Factors” in our 2019 Annual Report on Form 10-K and any subsequent Quarterly Reports on Form 10-Q. The extent of such impact will depend on the outcome of certain developments, including but not limited to, the duration and spread of the pandemic as well as its continuing impact on our customers, vendors and employees, all of which are uncertain.

As a participating lender in the U.S. Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”), the Company and the Bank are subject to additional risks of litigation from the Bank’s customers or other parties regarding the Bank’s processing of loans for the PPP and risks that the SBA may not fund some or all PPP loan guaranties.

On March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), which included a loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP. The PPP opened on April 3, 2020; however, because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there was some ambiguity in the laws, rules and guidance regarding the operation of the PPP, which exposes the Company to risks relating to noncompliance with the PPP.

Since the opening of the PPP, several other larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP and claims related to agent fees. The Company and the Bank may be exposed to the risk of similar litigation, from both customers and non-customers that approached the Bank regarding PPP loans, regarding its process and procedures used in processing applications for the PPP, or litigation from agents with respect to agent fees. If any such litigation is filed against the Company or the Bank and is not resolved in a manner favorable to the Company or the Bank, it may result in significant financial liability or adversely affect the

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Company’s reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP related litigation could have a material adverse impact on our business, financial condition and results of operations.

The Bank also has credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by the Bank, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded, or serviced by the Company, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from the Company.

ITEM 2—UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3—DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4—MINE SAFETY DISCLOSURES

None

ITEM 5—OTHER INFORMATION

None

ITEM 6—EXHIBITS


Exhibit		Description
3.1		Heritage Commerce Corp Restated Articles of Incorporation, (incorporated by reference to Exhibit 3.1 to the Registrant’s Annual Report on Form 10-K filed on March 16, 2009)
3.2		Certificate of Amendment of Articles of Incorporation of Heritage Commerce Corp as filed with the California Secretary of State on June 1, 2010 (incorporated by reference to Exhibit 3.2 to the Registrant’s Registration Statement on Form S-1 filed July 23, 2010).
3.3		Certificate of Amendment of Articles of Incorporation of Heritage Commerce Corp as filed with the Secretary of State on August 29, 2019 (incorporated by reference to Exhibit 3.3 to the Registrant’s Quarterly Report on Form 10-Q filed on November 11, 2019)
3.4		Heritage Commerce Corp Bylaws, as amended (incorporated by reference to the Registrant’s Current Report on Form 8-K filed on June 28, 2013)
31.1		Certification of Registrant’s Chief Executive Officer Pursuant To Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Registrant’s Chief Financial Officer Pursuant To Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of Registrant’s Chief Executive Officer Pursuant To 18 U.S.C. Section 1350
32.2		Certification of Registrant’s Chief Financial Officer Pursuant To 18 U.S.C. Section 1350
101.INS		XBRL Instance Document Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
101.SCH		XBRL Taxonomy Extension Schema
101.CAL		XBRL Taxonomy Extension Calculation Linkbas
101.DEF		XBRL Taxonomy Extension Definition Linkbase
101.LAB		XBRL Taxonomy Extension Label Linkbase
101.PRE		XBRL Taxonomy Extension Presentation Linkbase
104.		The cover page from Heritage Commerce Corp's Quarterly Report on Form 10-Q for the quarter ended June 30, 2020, formatted in Inline XBRL

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	Heritage Commerce Corp (Registrant)

Date: August 6, 2020	/s/ KEITH A. WILTON
	Keith A. Wilton
	Chief Executive Officer

Date: August 6, 2020	/s/ Lawrence D. mcgovern
	Lawrence D. McGovern
	Chief Financial Officer

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Heritage Commerce (HTBK) 10-Q2020 Q2 Quarterly report

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