Heritage Commerce 10Q 2020 Q3 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 September 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.)
224 Airport Parkway, San Jose, California (Address of Principal Executive Offices)	95110 (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 59,914,987 shares of Common Stock outstanding on October 30, 2020

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HERITAGE COMMERCE CORP

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

		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	11

	Notes to Unaudited Consolidated Financial Statements	12

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	49

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	83

Item 4.	Controls and Procedures	83

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	84

Item 1A.	Risk Factors	84

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	86

Item 3.	Defaults Upon Senior Securities	86

Item 4.	Mine Safety Disclosures	86

Item 5.	Other Information	86

Item 6.	Exhibits	87

SIGNATURES		87

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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, including commercial real estate loans to borrowers associated with industries adversely impacted by the COVID-19 pandemic;

●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;

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●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;

●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 regulatory or other governmental inquiries, and the results of regulatory examinations or reviews;

●the expense and uncertain resolution of litigation matters whether occurring in the ordinary course of business or otherwise;

●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 rapidly changing uncertainties related to the 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;

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●the impact of the 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 (“PPP”) enacted thereunder, and the risks that borrowers may not have used funds appropriately or satisfied staffing or payment requirements to qualify for forgiveness of their loans in whole or part under PPP; and

●

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

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)


		September 30,		December 31,
		2020		2019

		(Dollars in thousands)
Assets
Cash and due from banks		$	33,353	$	49,447
Other investments and interest-bearing deposits in other financial institutions			926,915		407,923
Total cash and cash equivalents			960,268		457,370
Securities available-for-sale, at fair value			294,438		404,825
Securities held-to-maturity, at amortized cost, net of allowance for credit losses of $55 at September 30, 2020
(fair value of $303,996 at September 30, 2020 and $368,107 at December 31, 2019)			295,609		366,560
Loans held-for-sale - SBA, at lower of cost or fair value, including deferred costs			3,565		1,052
Loans, net of deferred fees			2,697,016		2,533,844
Allowance for credit losses on loans⁽¹⁾			(45,422)		(23,285)
Loans, net			2,651,594		2,510,559
Federal Home Loan Bank, Federal Reserve Bank stock and other investments, at cost			33,518		29,842
Company-owned life insurance			77,059		76,027
Premises and equipment, net			10,412		8,250
Goodwill			167,631		167,420
Other intangible assets			17,628		20,415
Accrued interest receivable and other assets			95,063		67,143
Total assets		$	4,606,785	$	4,109,463

Liabilities and Shareholders' Equity
Liabilities:
Deposits:
Demand, noninterest-bearing		$	1,698,027	$	1,450,873
Demand, interest-bearing			926,041		798,375
Savings and money market			1,108,252		982,430
Time deposits - under $250			46,684		54,361
Time deposits - $250 and over			92,276		99,882
CDARS - interest-bearing demand, money market and time deposits			19,121		28,847
Total deposits			3,890,401		3,414,768
Subordinated debt, net of issuance costs			39,693		39,554
Other short-term borrowings	��		—		328
Accrued interest payable and other liabilities			98,884		78,105
Total liabilities			4,028,978		3,532,755

Shareholders' equity:
Preferred stock, 0 par value; 10,000,000 shares authorized; NaN issued and outstanding
at September 30, 2020 and December 31, 2019			—		—
Common stock, 0 par value; 100,000,000 shares authorized at September 30, 2020 and
authorized at December 31, 2019; 59,914,987 shares issued
and outstanding at September 30, 2020 and 59,368,156 shares issued and
outstanding at December 31, 2019			493,126		489,745
Retained earnings			91,065		96,741
Accumulated other comprehensive loss			(6,384)		(9,778)
Total shareholders' equity			577,807		576,708
Total liabilities and shareholders' equity		$	4,606,785	$	4,109,463

⁽¹⁾Allowance for credit losses on loans at September 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				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019

	(Dollars in thousands, except per share amounts)
Interest income:
Loans, including fees	$	32,635	$	27,264	$	100,262	$	81,321
Securities, taxable		2,481		3,504		9,584		12,149
Securities, exempt from Federal tax		463		530		1,458		1,624
Other investments, interest-bearing deposits
in other financial institutions and Federal funds sold		673		1,952		3,022		5,094
Total interest income		36,252		33,250		114,326		100,188

Interest expense:
Deposits		1,504		2,042		4,904		5,873
Subordinated debt		583		583		1,737		1,731
Short-term borrowings		—		—		—		1
Total interest expense		2,087		2,625		6,641		7,605

Net interest income before provision for credit losses on loans⁽¹⁾		34,165		30,625		107,685		92,583
Provision (credit) for credit losses on loans⁽¹⁾		197		(576)		14,581		(2,377)
Net interest income after provision for credit losses on loans⁽¹⁾		33,968		31,201		93,104		94,960

Noninterest income:
Service charges and fees on deposit accounts		632		1,032		2,251		3,370
Increase in cash surrender value of life insurance		464		336		1,380		999
Gain on sales of SBA loans		400		156		467		331
Servicing income		187		139		575		480
Gain on sales of securities		—		330		270		878
Gain on the disposition of foreclosed assets		—		—		791		—
Other		912		625		2,132		1,793
Total noninterest income		2,595		2,618		7,866		7,851

Noninterest expense:
Salaries and employee benefits		11,967		10,467		38,470		31,935
Occupancy and equipment		2,283		1,550		5,821		4,634
Professional fees		1,352		789		3,942		2,360
Other		5,566		5,103		19,721		15,343
Total noninterest expense		21,168		17,909		67,954		54,272
Income before income taxes		15,395		15,910		33,016		48,539
Income tax expense		4,198		4,633		9,340		13,763
Net income	$	11,197	$	11,277	$	23,676	$	34,776

Earnings per common share:
Basic	$	0.19	$	0.26	$	0.40	$	0.81
Diluted	$	0.19	$	0.26	$	0.39	$	0.80

⁽¹⁾Provision for credit losses on loans for the three and nine months ended September 30, 2020, Provision (credit) for loan losses for the
three and nine months ended September 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				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019

		(Dollars in thousands)
Net income	$	11,197	$	11,277	$	23,676	$	34,776
Other comprehensive income:
Change in net unrealized holding (losses) gains on available-for-sale
securities and I/O strips		(1,783)		1,041		4,838		10,245
Deferred income taxes		517		(304)		(1,403)		(3,032)
Change in net unamortized unrealized gain on securities available-for-
sale that were reclassified to securities held-to-maturity		(13)		(13)		(39)		(52)
Deferred income taxes		4		4		12		16
Reclassification adjustment for gains realized in income		—		(330)		(270)		(878)
Deferred income taxes		—		98		79		260
Change in unrealized (losses) gains on securities and I/O strips, net of
deferred income taxes		(1,275)		496		3,217		6,559

Change in net pension and other benefit plan liability adjustment		101		11		251		34
Deferred income taxes		(30)		(3)		(74)		(10)
Change in pension and other benefit plan liability, net of
deferred income taxes		71		8		177		24
Other comprehensive (losses) income		(1,204)		504		3,394		6,583

Total comprehensive income	$	9,993	$	11,781	$	27,070	$	41,359

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

Net income	—		—		11,277		—		11,277
Other comprehensive income	—		—		—		504		504
Forfeiture of restricted stock awards, net	(6,000)		—		—		—		—
Amortization of restricted stock awards,
net of forfeitures and taxes	—		358		—		—		358
Cash dividend declared $0.12 per share	—		—		(5,221)		—		(5,221)
Stock option expense, net of forfeitures and taxes	—		163		—		—		163
Stock options exercised	17,000		157		—		—		157
Balance, September 30, 2019	43,509,406	$	302,983	$	98,161	$	(5,798)	$	395,346

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

	(Dollars in thousands)
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 loss	—		—		—		(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

Net income	—		—		11,197		—		11,197
Other comprehensive loss	—		—		—		(1,204)		(1,204)
Amortization of restricted stock awards,
net of forfeitures and taxes	—		439		—		—		439
Cash dividend declared $0.13 per share	—		—		(7,786)		—		(7,786)
Stock option expense, net of forfeitures and taxes	—		136		—		—		136
Stock options exercised	58,220		218		—		—		218
Balance, September 30, 2020	59,914,987	$	493,126	$	91,065	$	(6,384)	$	577,807

See notes to unaudited consolidated financial statements

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HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)


	Nine Months Ended
	September 30,
	2020		2019

	(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	23,676	$	34,776
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of discounts and premiums on securities		2,608		1,821
Gain on sale of securities available-for-sale		(270)		(878)
Gain on sale of SBA loans		(467)		(331)
Proceeds from sale of SBA loans originated for sale		6,465		4,692
SBA loans originated for sale		(8,511)		(5,977)
Gain on the disposition of foreclosed assets		(791)		—
Provision (credit) for credit losses on loans⁽¹⁾		14,581		(2,377)
Increase in cash surrender value of life insurance		(1,380)		(999)
Depreciation and amortization		712		598
Amortization of other intangible assets		2,787		1,661
Stock option expense, net		423		484
Amortization of restricted stock awards, net		1,250		932
Amortization of subordinated debt issuance costs		139		138
Gain on proceeds from company-owned life insurance		(20)		—
Effect of changes in:
Accrued interest receivable and other assets		(520)		1,863
Accrued interest payable and other liabilities		(5,453)		(3,120)
Net cash provided by operating activities		35,229		33,283

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of securities held-to-maturity		—		(8,386)
Maturities/paydowns/calls of securities available-for-sale		57,627		36,956
Maturities/paydowns/calls of securities held-to-maturity		68,839		42,255
Proceeds from sales of securities available-for-sale		56,598		98,733
Proceeds from the disposition of foreclosed assets		791		—
Net change in loans		(163,727)		12,136
Changes in Federal Home Loan Bank stock and other investments		(3,676)		(15)
Purchase of premises and equipment		(2,874)		(310)
Proceeds from redemption of company-owned life insurance		368		—
Net cash provided by investing activities		13,946		181,369

CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in deposits		475,633		51,458
Net change in short-term borrowings		(328)		—
Exercise of stock options		1,708		723
Payment of cash dividends		(23,290)		(15,618)
Net cash provided by financing activities		453,723		36,563
Net increase in cash and cash equivalents		502,898		251,215
Cash and cash equivalents, beginning of period		457,370		164,568
Cash and cash equivalents, end of period	$	960,268	$	415,783

Supplemental disclosures of cash flow information:
Interest paid	$	6,117	$	6,693
Income taxes paid, net		10,640		13,620

Supplemental schedule of non-cash activity:
Recording of right to use assets in exchange for lease obligations	$	26,654	$	9,566
Transfer of loans held-for-sale to loan portfolio		—		694

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

See notes to unaudited consolidated financial statements

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HERITAGE COMMERCE CORP

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

September 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. NaN 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. Material estimates that are particularly susceptible to significant change include the determination of the allowance for credit losses and any impairment of goodwill or intangible assets. It is reasonably possible the Company’s estimate of the allowance for credit losses and evaluation of impairment of goodwill or intangible assets could change as a result of the continued impact of the COVID-19 pandemic on the economy. The resulting change in these estimates could be material to the Company’s consolidated financial statements.

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

London Inter-Bank Offered Rate (“LIBOR”) Transition and Phase-Out

We have loans and borrowings that are tied to LIBOR benchmark interest rates. It is anticipated that the LIBOR index will be phased-out by the end of 2021 and the Federal Reserve Bank of New York has established the Secured Overnight Financing Rate (“SOFR”) as its recommended alternative to LIBOR. We have created a sub-committee of our Asset Liability Management Committee to address LIBOR transition and phase-out issues. We are currently reviewing loan documentation, technology systems and procedures we will need to implement for the transition.

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.

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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.

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 had no recognized allowance for loan losses until the estimated allowance exceeded the unaccreted discount.

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. 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. Any significant 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.

The cumulative-effect adjustment as a result of the adoption of this guidance was recorded, net of tax of $2,359,000, as a $6,062,000 reduction to retained earnings effective January 1, 2020.

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.

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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 1,741,568 and 826,036 weighted average stock options outstanding for the three months ended September 30, 2020, and 2019, respectively, and 1,507,437, and 826,036 outstanding for the nine months ended September 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				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019

	(Dollars in thousands, except per share amounts)
Net income	$	11,197	$	11,277	$	23,676	$	34,776

Weighted average common shares outstanding for basic
earnings per common share		59,589,243		43,258,983		59,432,178		43,189,710
Dilutive potential common shares		552,169		537,921		711,585		538,375
Shares used in computing diluted earnings per common share		60,141,412		43,796,904		60,143,763		43,728,085

Basic earnings per share	$	0.19	$	0.26	$	0.40	$	0.81
Diluted earnings per share	$	0.19	$	0.26	$	0.39	$	0.80

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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 September 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 July 1, 2020, net of taxes	$	6,112	$	280	$	(11,572)	$	(5,180)
Other comprehensive loss before reclassification,
net of taxes		(1,266)		—		(130)		(1,396)
Amounts reclassified from other comprehensive income (loss),
net of taxes		—		(9)		201		192
Net current period other comprehensive income (loss),
net of taxes		(1,266)		(9)		71		(1,204)

Ending balance September 30, 2020, net of taxes	$	4,846	$	271	$	(11,501)	$	(6,384)

Beginning balance July 1, 2019, net of taxes	$	1,083	$	317	$	(7,702)	$	(6,302)
Other comprehensive income (loss) before reclassification,
net of taxes		737		—		(8)		729
Amounts reclassified from other comprehensive income (loss),
net of taxes		(232)		(9)		16		(225)
Net current period other comprehensive income (loss),
net of taxes		505		(9)		8		504

Ending balance September 30, 2019, net of taxes	$	1,588	$	308	$	(7,694)	$	(5,798)

(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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	Nine Months Ended September 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		3,435		—		(136)		3,299
Amounts reclassified from other comprehensive income (loss),
net of taxes		(191)		(27)		313		95
Net current period other comprehensive income (loss),
net of taxes		3,244		(27)		177		3,394

Ending balance September 30, 2020, net of taxes	$	4,846	$	271	$	(11,501)	$	(6,384)

Beginning balance January 1, 2019, net of taxes	$	(5,007)	$	344	$	(7,718)	$	(12,381)
Other comprehensive income (loss) before reclassification,
net of taxes		7,213		—		(22)		7,191
Amounts reclassified from other comprehensive income (loss),
net of taxes		(618)		(36)		46		(608)
Net current period other comprehensive income (loss),
net of taxes		6,595		(36)		24		6,583

Ending balance September 30, 2019, net of taxes	$	1,588	$	308	$	(7,694)	$	(5,798)

(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
	September 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	$	—	$	330	Gain on sales of securities
		—		(98)	Income tax expense
		—		232	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		(184)		24
Actuarial losses		(101)		(46)
		(285)		(22)	Other noninterest expense
		84		6	Income tax benefit
		(201)		(16)	Net of tax
Total reclassification for the period	$	(192)	$	225


	Amounts Reclassified from
	AOCI(1)
	Nine Months Ended
	September 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	$	878	Gain on sales of securities
		(79)		(260)	Income tax expense
		191		618	Net of tax
Amortization of unrealized gain on securities
available-for-sale that were reclassified to securities
held-to-maturity		39		52	Interest income on taxable securities
		(12)		(16)	Income tax expense
		27		36	Net of tax
Amortization of defined benefit pension plan items ⁽¹⁾
Prior transition obligation		(154)		73
Actuarial losses		(291)		(138)
		(445)		(65)	Other noninterest expense
		132		19	Income tax benefit
		(313)		(46)	Net of tax
Total reclassification from AOCI for the period	$	(95)	$	608

(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
September 30, 2020	Cost		Gains		(Losses)		Losses		Value

	(Dollars in thousands)
Securities available-for-sale:
Agency mortgage-backed securities	$	197,921	$	5,688	$	—	$	—	$	203,609
U.S. Treasury		89,649		1,180		—		—		90,829
Total	$	287,570	$	6,868	$	—	$	—	$	294,438

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

	(Dollars in thousands)
Securities held-to-maturity:
Agency mortgage-backed securities	$	223,453	$	6,613	$	(1)	$	230,065	$	—
Municipals - exempt from Federal tax		72,211		1,720		—		73,931		(55)
Total	$	295,664	$	8,333	$	(1)	$	303,996	$	(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 September 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
September 30, 2020	Value		(Losses)		Value		(Losses)		Value		(Losses)

	(Dollars in thousands)
Securities held-to-maturity:
Agency mortgage-backed securities	$	245		(1)	$	—	$	—	$	245	$	(1)
Total	$	245	$	(1)	$	—	$	—	$	245	$	(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 0 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 September 30, 2020, the Company held 421 securities (122 available-for-sale and 299 held-to-maturity), of which one had fair value below amortized cost. At September 30, 2020, there were $245,000 of agency mortgage-backed securities held-to-maturity, at amortized cost, with an unrealized loss for less than 12 months. The total unrealized loss for securities less than 12 months was ($1,000) at September 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 September 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				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019

	(Dollars in thousands)
Proceeds	$	—	$	38,855	$	56,598	$	98,733
Gross gains		—		363		270		971
Gross losses		—		(33)		—		(93)

The amortized cost and estimated fair values of securities as of September 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 3 months or less	$	24,980	$	25,061
Due after 3 months through one year		59,758		60,708
Due after one through five years		4,911		5,060
Agency mortgage-backed securities		197,921		203,609
Total	$	287,570	$	294,438

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	Held-to-maturity
	Amortized		Estimated
	Cost		Fair Value

	(Dollars in thousands)
Due 3 months or less	$	910	$	911
Due after 3 months through one year		490		498
Due after one through five years		9,762		10,133
Due after five through ten years		30,900		31,574
Due after ten years		30,149		30,815
Agency mortgage-backed securities		223,453		230,065
Total	$	295,664	$	303,996

Securities with amortized cost of $38,777,000 and $32,773,000 as of September 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 nine months ended September 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 September 30, 2020	$	55

For the nine months ended September 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 bond ratings for the Company’s municipal investment securities at September 30, 2020 were consistent with the ratings at January 1, 2020.

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 $323,550,000 of SBA Paycheck Protection Program ("PPP") loans at September 30, 2020.

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.

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Land and Construction

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

Home Equity

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

Multifamily

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

Residential Mortgages

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

Consumer and Other

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

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


	September 30,		December 31,
	2020		2019

	(Dollars in thousands)
Loans held-for-investment:
Commercial	$	897,909	$	603,345
Real estate:
CRE - owner occupied		561,528		548,907
CRE - non-owner occupied		713,563		767,821
Land and construction		142,632		147,189
Home equity		111,468		151,775
Multifamily		169,791		180,623
Residential mortgages		91,077		100,759
Consumer and other		17,511		33,744
Loans		2,705,479		2,534,163
Deferred loan fees, net		(8,463)		(319)
Loans, net of deferred fees		2,697,016		2,533,844
Allowance for credit losses on loans⁽¹⁾		(45,422)		(23,285)
Loans, net	$	2,651,594	$	2,510,559

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

The loss estimates for each segment are derived using a discounted cash flow analysis that incorporates a forecast of economic factors that have historic correlation to loan losses. The most significant economic factor used in the calculation of estimated loan losses is the California unemployment rate which is used for each segment. California GDP, and California retail trade earnings, a 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. The allowance for credit losses for loans as of September 30, 2020 is primarily driven by the deterioration of projected economic conditions resulting from the COVID-19 pandemic with the change in California unemployment rate being the most significant driver.

Changes in the allowance for credit losses on loans were as follows for the three months ended September 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	$	13,179	$	8,547	$	15,449	$	2,552	$	1,851	$	1,828	$	825	$	1,213	$	45,444
Charge-offs		(502)		—		—		—		—		—		—		(96)		(598)
Recoveries		343		—		—		19		16		—		—		1		379
Net recoveries		(159)		—		—		19		16	—	—		—		(95)		(219)
Provision (credit) for credit losses on loans		(220)		736		(124)		(27)		14		21		(46)		(157)		197
End of period balance	$	12,800	$	9,283	$	15,325	$	2,544	$	1,881	$	1,849	$	779	$	961	$	45,422

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


	Commercial		Real Estate		Consumer		Total

	(Dollars in thousands)
Beginning of period balance	$	15,234	$	11,307	$	90	$	26,631
Charge-offs		(315)		—		(3)		(318)
Recoveries		115		43		—		158
Net recoveries		(200)		43		(3)		(160)
Provision (credit) for loan losses		(378)		(207)		9		(576)
End of period balance	$	14,656	$	11,143	$	96	$	25,895

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Changes in the allowance for credit losses on loans were as follows for the nine months ended September 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		(1,637)		—		—		—		—		—		—		(99)		(1,736)
Recoveries		598		1		—		51		70		—		—		2		722
Net (charge-offs) recoveries		(1,039)		1		—		51		70		—		—		(97)		(1,014)
Provision (credit) for credit losses on loans		7,049		2,288		3,653		1,035		490		596		101		(631)		14,581
End of period balance	$	12,800	$	9,283	$	15,325	$	2,544	$	1,881	$	1,849	$	779	$	961	$	45,422

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


	Commercial		Real Estate		Consumer		Total

	(Dollars in thousands)
Beginning of period balance	$	17,061	$	10,671	$	116	$	27,848
Charge-offs		(617)		—		(3)		(620)
Recoveries		917		127		—		1,044
Net recoveries		300		127		(3)		424
Provision (credit) for loan losses		(2,705)		345		(17)		(2,377)
End of period balance	$	14,656	$	11,143	$	96	$	25,895

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 September 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	$	973	$	1,935	$	601	$	3,509
Real estate:
CRE - Owner Occupied		4,328		—		—		4,328
Home equity		961		—		—		961
Consumer and other		—		1,464		—		1,464
Total	$	6,262	$	3,399	$	601	$	10,262

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


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

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

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


	September 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	$	4,419	$	925	$	951	$	6,295	$	891,614	$	897,909

Real estate:
CRE - Owner Occupied		3,301		—		29		3,330		558,198		561,528
CRE - Non-Owner Occupied		—		—		—		—		713,563		713,563
Land and construction		—		—		—		—		142,632		142,632
Home equity		—		—				—		111,468		111,468
Multifamily		—		—		—		—		169,791		169,791
Residential mortgages		—		—		—		—		91,077		91,077
Consumer and other		496		—		1,464		1,960		15,551		17,511
Total	$	8,216	$	925	$	2,444	$	11,585	$	2,693,894	$	2,705,479


	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 $11,585,000 and $15,315,000 at September 30, 2020 and December 31, 2019, respectively, of which $2,441,000 and $7,413,000 were on nonaccrual, respectively. At September 30, 2020, there were also $7,220,000 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.

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Credit Quality Indicators

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

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

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

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

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

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

Loss. Loans classified as loss are considered uncollectable or of so little value that their continuance as assets is not warranted. This classification does not necessarily mean that a loan has no recovery or salvage value; but rather, there is much doubt about whether, how much, or when the recovery would occur. Loans classified as loss are immediately charged off against the allowance for credit losses on loans. Therefore, there is 0 balance to report as of September 30, 2020 and December 31, 2019.

Loans may be reviewed at any time throughout a loan’s duration. If new information is provided, a new risk assessment may be performed if warranted.

Portfolios are reviewed prior to each quarter end. Those discussing the credits include Market Presidents/Department Managers, Team Leaders/Credit Officers, Credit Administration, including Credit Risk Management, and Executive Management. Portfolio reviews include additional break-out information for higher risk segments. This process now includes specific COVID-19 pandemic impact (covers loans such as deferments, PPP loans, and SBA 7(a) loans).

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Any loan graded a special mention or worse is detailed in reports and specifically discussed at a minimum prior to each quarter end. If the loan outstanding amount or relationship is greater than $250,000 (and graded a special mention or worse), it has a detailed report prepared/updated each quarter and is used as the basis for each discussion.

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 September 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	$	457,725	$	42,241	$	26,085	$	16,428	$	8,742	$	10,737	$	307,076	$	869,034
Special Mention		6,730		1,800		701		1,228		788		410		2,061		13,718
Substandard		4,681		-		57		513		2,383		79		4,536		12,249
Substandard-Nonaccrual		2,353		57		-		-		152		56		290		2,908
Total		471,489		44,098		26,843		18,169		12,065		11,282		313,963		897,909

CRE - Owner Occupied:
Pass		137,721		73,778		74,997		53,799		52,560		121,007		15,963		529,825
Special Mention		9,073		5,595		2,637		-		-		4,648		-		21,953
Substandard		1,592		-		402		2,969		-		459		-		5,422
Substandard-Nonaccrual		3,756		543		-		-		-		29		-		4,328
Total		152,142		79,916		78,036		56,768		52,560		126,143		15,963		561,528

CRE - Non-Owner Occupied:
Pass		152,894		131,920		74,919		104,221		58,363		166,232		2,598		691,147
Special Mention		19,159		-		-		-		485		349		-		19,993
Substandard		1,002		-		1,421		-		-		-		-		2,423
Substandard-Nonaccrual		-		-		-		-		-		-		-		-
Total		173,055		131,920		76,340		104,221		58,848		166,581		2,598		713,563

Land and construction:
Pass		94,467		35,396		6,344		-		-		1,351		3,715		141,273
Special Mention		-		-		-		-		-		-		-		-
Substandard		1,359		-		-		-		-		-		-		1,359
Substandard-Nonaccrual		-		-		-		-		-		-		-		-
Total		95,826		35,396		6,344		-		-		1,351		3,715		142,632

Home equity:
Pass		275		-		78		-		-		-		109,396		109,749
Special Mention		-		-		-		-		-		-		-		-
Substandard		-		-		-		-		-		143		615		758
Substandard-Nonaccrual		123		-		-		-		-		-		838		961
Total		398		-		78		-		-		143		110,849		111,468

Multifamily:
Pass		26,559		39,858		18,506		26,837		16,319		34,787		845		163,711
Special Mention		-		-		-		-		-		5,186		-		5,186
Substandard		894		-		-		-		-		-		-		894
Substandard-Nonaccrual		-		-		-		-		-		-		-		-
Total		27,453		39,858		18,506		26,837		16,319		39,973		845		169,791

Residential mortgage:
Pass		12,673		10,163		3,289		8,775		32,403		15,735		-		83,038
Special Mention		5,098		-		1,630		-				1,053		-		7,781
Substandard		-		-		-		-		-		258		-		258
Substandard-Nonaccrual		-		-		-		-		-		-		-		-
Total		17,771		10,163		4,919		8,775		32,403		17,046		-		91,077

Consumer and other:
Pass		12		539		1,500		21		128		1,008		12,839		16,047
Special Mention		-		-		-		-		-		-		-		-
Substandard		-		-		-		-		-		-		-		-
Substandard-Nonaccrual		-		-		1,464		-		-		-		-		1,464
Total		12		539		2,964		21		128		1,008		12,839		17,511

Total loans	$	938,146	$	341,890	$	214,030	$	214,791	$	172,323	$	363,527	$	460,772	$	2,705,479

Risk Grades:.
Pass	$	882,326	$	333,895	$	205,718	$	210,081	$	168,515	$	350,857	$	452,432	$	2,603,824
Special Mention		40,060		7,395		4,968		1,228		1,273		11,646		2,061		68,631
Substandard		9,528		-		1,880		3,482		2,383		939		5,151		23,363
Substandard-Nonaccrual		6,232		600		1,464		-		152		85		1,128		9,661
Grand Total	$	938,146	$	341,890	$	214,030	$	214,791	$	172,323	$	363,527	$	460,772	$	2,705,479

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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 September 30, 2020:


		Collateral Type
		Real
		Estate		Business
		Property		Assets		Unsecured		Total

	(Dollars in thousands)
Commercial	$	55	$	1,750	$	130	$	1,935
Consumer and other		1,464		-		-		1,464
Total	$	1,519	$	1,750	$	130	$	3,399

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. For loans which foreclosure is not probable, but for which repayment is expected to be provided substantially through the operation or sale of the collateral and the borrower is experiencing financial difficulty, management has elected the practical expedient under ASC 326 to estimate expected credit losses based on the fair value of collateral, 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 September 30, 2020 was $1,182,000, which included $1,033,000 of nonaccrual loans and $149,000 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 $357,000 and $20,000 of specific reserves were established with respect to these loans as of September 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 Three Months Ended
	September 30, 2020
				Pre-modification		Post-modification
		Number		Outstanding		Outstanding
		of		Recorded		Recorded
Troubled Debt Restructurings:		Contracts		Investment		Investment

	(Dollars in thousands)
Commercial		7	$	510	$	510
Total		7	$	510	$	510


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

	(Dollars in thousands)
Commercial		10	$	520	$	520
Total		10	$	520	$	520


	During the Nine Months Ended
		September 30, 2019
				Pre-modification		Post-modification
		Number		Outstanding		Outstanding
		of		Recorded		Recorded
Troubled Debt Restructurings:		Contracts		Investment		Investment

	(Dollars in thousands)
Commercial		2	$	9	$	9
Total		2	$	9	$	9

There were 7 new loans with total recorded investment of $510,000 that were modified as troubled debt restructurings during the three months ended September 30, 2020. There were 10 new loans with total recorded

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investment of $520,000 that were modified as troubled debt restructurings during the nine months ended September 30, 2020.

During the three and nine months ended September 30, 2020 there were 0 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 in 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 0 defaults on troubled debt restructurings, within twelve months following the modification, during the three months ended September 30, 2020 and 2019.

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

In accordance with new accounting guidance issued earlier this year by federal bank regulators, the Bank made accommodations for initial payment deferrals for a number of customers of up to 90 days, generally, with the potential, upon application, of an additional 90 days of payment deferral (180 days maximum). These short-term deferrals are not deemed to meet the criteria for reporting as troubled debt restructurings.

6) Business Combinations

On October 11, 2019, the Company completed its merger with Presidio Bank (“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 September 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 September 30, 2020 from December 31, 2019 was due to adjustments to accrued accounts payable.

7) Goodwill and Other Intangible Assets

Goodwill

At September 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 nine months 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 September 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 September 30, 2020.

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Other Intangible Assets

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


	September 30, 2020
	Gross
	Carrying		Accumulated
	Amount		Amortization		Total

	(Dollars in thousands)
Core deposit intangibles	$	25,023	$	(8,300)	$	16,723
Customer relationship and brokered relationship intangibles		1,900		(1,124)		776
Below market leases		770		(641)		129
Total	$	27,693	$	(10,065)	$	17,628


	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	$	456		(4)	$	166	$	43	$	52	$	4	$	181	$	47	$	945
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
	$	9,453	$	(78)	$	3,861	$	43	$	1,164	$	164	$	2,245	$	776	$	17,628

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 0 impairment of intangible assets at September 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 $27,842,000, and $24,302,000, at September 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 September 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:


	September 30,		December 31,
	2020		2019

	(Dollars in thousands)
Low income housing investments	$	5,457	$	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 September 30, 2020 and September 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 $630,000 and $319,000 for the nine months ended September 30, 2020 and September 30, 2019, and low income housing investment expense of $631,000 and $317,000, 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 0 Plan assets. The following table presents the amount of periodic cost recognized for the periods indicated:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019

	(Dollars in thousands)
Components of net periodic benefit cost:
Service cost	$	123	$	55	$	369	$	165
Interest cost		234		264		701		792
Amortization of prior transition obligation		199		—		199		—
Amortization of net actuarial loss		101		46		291		138
Net periodic benefit cost	$	657	$	365	$	1,560	$	1,095

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:


	September 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		185		278
Actuarial loss (gain)		(42)		1,017
Projected benefit obligation at end of period	$	8,341	$	8,198


	September 30,		December 31,
	2020		2019

	(Dollars in thousands)
Net actuarial loss	$	3,847	$	3,776
Prior transition obligation		992		1,059
Accumulated other comprehensive loss	$	4,839	$	4,835


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019

	(Dollars in thousands)
Amortization of prior transition obligation	$	(15)	$	(24)	$	(45)	$	(73)
Interest cost		62		69		185		209
Net periodic benefit cost	$	47	$	45	$	140	$	136

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 September 30, 2020
Available-for-sale securities:
Agency mortgage-backed securities	$	203,609		—	$	203,609		—
U.S. Treasury		90,829		90,829		—		—
I/O strip receivables		491		—		491		—

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 0 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.

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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 September 30, 2020 and December 31, 2019, there were 0 foreclosed assets on the balance sheet.

The carrying amounts and estimated fair values of financial instruments at September 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	$	960,268	$	960,268	$	—	$	—	$	960,268
Securities available-for-sale		294,438		90,829		203,609		—		294,438
Securities held-to-maturity		295,609		—		303,996		—		303,996
Loans (including loans held-for-sale), net		2,655,159		—		3,565		2,657,620		2,661,185
FHLB stock, FRB stock, and other
investments		33,518		—		—		—		N/A
Accrued interest receivable		10,704		520		1,761		8,423		10,704
I/O strips receivables		491		—		491		—		491
Liabilities:
Time deposits	$	143,452	$	—	$	141,926	$	—	$	141,926
Other deposits		3,746,949		—		3,746,949		—		3,746,949
Subordinated debt		39,693		—		38,893		—		38,893
Accrued interest payable		1,092		—		1,092		—		1,092

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

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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 nine months ended September 30, 2020, the Company granted 329,500 shares of nonqualified stock options and 168,117 shares of restricted stock. There were 2,396,382 shares available for the issuance of equity awards under the 2013 Plan as of September 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	(378,714)	$	4.51
Forfeited or expired	(101,661)	$	13.11
Outstanding at September 30, 2020	2,561,971	$	9.31	5.70	$	1,469,856
Vested or expected to vest	2,408,253			5.70	$	1,381,664
Exercisable at September 30, 2020	1,955,429			4.73	$	1,469,856

Information related to the equity plans for the periods indicated:


	Nine Months Ended
	September 30,
	2020		2019
Intrinsic value of options exercised	$	2,242,512	$	444,251
Cash received from option exercise	$	1,707,587	$	723,397
Tax benefit realized from option exercises	$	58,575	$	44,244
Weighted average fair value of options granted	$	1.15	$	1.91

As of September 30, 2020, there was $1,052,000 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 2.82 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:


	Nine Months Ended
	September 30,
	2020		2019
Expected life in months(1)	72		72
Volatility(1)	29	%	24	%
Weighted average risk-free interest rate(2)	0.53	%	2.23	%
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 September 30, 2020	298,700	$	10.83

As of September 30, 2020, there was $2,638,000 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 1.94 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 $307,000 at September 30, 2020. See “LIBOR Transition and Phase–Out” above.

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.

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 September 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 September 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.

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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 September 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 September 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 September 30, 2020	��
Total Capital	$	479,366	16.0	%	$	315,142	10.5	%
(to risk-weighted assets)
Tier 1 Capital	$	404,973	13.5	%	$	255,115	8.5	%
(to risk-weighted assets)
Common Equity Tier 1 Capital	$	404,973	13.5	%	$	210,095	7.0	%
(to risk-weighted assets)
Tier 1 Capital	$	404,973	9.3	%	$	174,521	4.0	%
(to average assets)

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


					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, except the Tier 1 Capital to average assets ratio.

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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 September 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 September 30, 2020
Total Capital	$	457,069	15.2	%	$	299,993	10.0	%	$	314,992	10.5	%
(to risk-weighted assets)
Tier 1 Capital	$	422,369	14.1	%	$	239,994	8.0	%	$	254,994	8.5	%
(to risk-weighted assets)
Common Equity Tier 1 Capital	$	422,369	14.1	%	$	194,995	6.5	%	$	209,995	7.0	%
(to risk-weighted assets)
Tier 1 Capital	$	422,369	9.7	%	$	218,066	5.0	%	$	174,453	4.0	%
(to average assets)

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

The Subordinated Debt, net of unamortized issuance costs, totaled $39,693,000 at September 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

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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 September 30, 2020, HBC would not be required to obtain regulatory approval, and the amount available for cash dividends is $29,996,000. 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 third, second and first quarters of 2020, for a total of $24,000,000.

14) Commitments and Loss Contingencies

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.

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 $1,185,077,000 at September 30, 2020, compared to $753,078,000 at September 30, 2019, and $1,120,638,000 at December 31, 2019. Unused commitments represented 44% outstanding gross loans at September 30, 2020, 40% at September 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:


	September 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	$	133,400	$	1,026,450	$	1,159,850	$	148,011	��	$	589,479	$	737,490	$	147,372	$	951,206	$	1,098,578
Standby letters of credit		4,089		21,138		25,227		2,244			13,344		15,588		11,445		10,615		22,060
	$	137,489	$	1,047,588	$	1,185,077	$	150,255		$	602,823	$	753,078	$	158,817	$	961,821	$	1,120,638

For the nine months ended September 30, 2020, there was an increase of $547,000 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 nine months of 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.

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

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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. 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
	September 30,
	2020		2019

	(Dollars in thousands)
Noninterest Income In-scope of Topic 606:
Service charges and fees on deposit accounts	$	632	$	1,032
Noninterest Income Out-of-scope of Topic 606		1,963		1,586
Total noninterest income	$	2,595	$	2,618


	Nine Months Ended
	September 30,
	2020		2019

	(Dollars in thousands)
Noninterest Income In-scope of Topic 606:
Service charges and fees on deposit accounts	$	2,251	$	3,370
Gain on the disposition of foreclosed assets		791		—
Total noninterest income in-scope of Topic 606		3,042		3,370
Noninterest Income Out-of-scope of Topic 606		4,824		4,481
Total noninterest income	$	7,866	$	7,851

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16) Noninterest Expense

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


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019

	(Dollars in thousands)
Salaries and employee benefits	$	11,967	$	10,467	$	38,470	$	31,935
Occupancy and equipment		2,283		1,550		5,821		4,634
Professional fees		1,352		789		3,942		2,360
Amortization of intangible assets		965		554		2,787		1,661
Software subscriptions		641		601		2,276		1,746
Insurance expense		591		479		1,625		1,354
Supplemental retirement plan cost		585		310		1,344		930
Data processing		463		454		2,218		1,865
Other		2,321		2,705		9,471		7,787
Total noninterest expense	$	21,168	$	17,909	$	67,954	$	54,272

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				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
	2020		2019		2020		2019

	(Dollars in thousands)
Salaries and employee benefits	$	—	$	—	$	356	$	—
Other		17		661		2,144		1,201
Total merger-related costs	$	17	$	661	$	2,500	$	1,201

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 September 30, 2020, operating lease ROU assets, included in other assets, and lease liabilities, included in other liabilities, totaled $37,000,000.

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


		Three Months Ended				Nine Months Ended
		September 30,				September 30,

		2020		2019		2020		2019

	(Dollars in thousands)
Operating Lease Cost (Cost resulting from lease payments)	$	1,664	$	1,035	$	5,166	$	3,129
Operating Lease - Operating Cash Flows (Fixed Payments)	$	1,463	$	1,040	$	4,032	$	3,066
Operating Lease - ROU assets	$	37,000	$	7,089	$	37,000	$	7,089
Operating Lease - Liabilities	$	37,000	$	7,089	$	37,000	$	7,089
Weighted Average Lease Term - Operating Leases		8.45 yrs		3.59 yrs		8.45 yrs		3.59 yrs
Weighted Average Discount Rate - Operating Leases		4.54%		5.24%		4.54%		5.24%

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


	(Dollars in thousands)
2020	$	1,539
2021		5,242
2022		5,668
2023		5,039
2024		4,692
Thereafter		23,061
Total undiscounted cash flows		45,241
Discount on cash flows		(8,241)
Total lease liability	$	37,000

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 completed the relocation of its corporate headquarters, San Jose Branch and factoring subsidiary, Bay View Funding to 224 Airport Parkway, San Jose, California in the third quarter of 2020.

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.

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

	(Dollars in thousands)
Interest income	$	33,820		2,432	$	36,252
Intersegment interest allocations		184		(184)		—
Total interest expense		2,087		—		2,087
Net interest income		31,917		2,248		34,165
Provision for credit losses on loans		169		28		197
Net interest income after provision		31,748		2,220		33,968
Noninterest income		2,412		183		2,595
Noninterest expense (2)		19,594		1,574		21,168
Intersegment expense allocations		72		(72)		—
Income before income taxes		14,638		757		15,395
Income tax (benefit) expense		3,974		224		4,198
Net income	$	10,664	$	533	$	11,197

Total assets	$	4,541,331	$	65,454	$	4,606,785
Loans, net of deferred fees	$	2,649,334	$	47,682	$	2,697,016
Goodwill	$	154,587	$	13,044	$	167,631


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

	(Dollars in thousands)
Interest income	$	30,371		2,879	$	33,250
Intersegment interest allocations		303		(303)		—
Total interest expense		2,625		—		2,625
Net interest income		28,049		2,576		30,625
Provision (credit) for loan losses		(1,019)		443		(576)
Net interest income after provision		29,068		2,133		31,201
Noninterest income		2,488		130		2,618
Noninterest expense (2)		16,204		1,705		17,909
Intersegment expense allocations		125		(125)		—
Income before income taxes		15,477		433		15,910
Income tax expense		4,505		128		4,633
Net income	$	10,972	$	305	$	11,277

Total assets	$	3,119,367	$	63,104	$	3,182,471
Loans, net of deferred fees	$	1,831,172	$	44,215	$	1,875,387
Goodwill	$	70,709	$	13,044	$	83,753

(1) Includes the holding company’s results of operations

(2) The banking segment’s noninterest expense includes merger-related costs of $17,000 and $661,000 for the third quarters of 2020 and 2019, respectively.

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	Nine Months Ended September 30, 2020
	Banking ⁽¹⁾		Factoring		Consolidated

	(Dollars in thousands)
Interest income	$	106,455	$	7,871	$	114,326
Intersegment interest allocations		686		(686)		—
Total interest expense		6,641		—		6,641
Net interest income		100,500		7,185		107,685
Provision for credit losses on loans		14,150		431		14,581
Net interest income after provision		86,350		6,754		93,104
Noninterest income		7,318		548		7,866
Noninterest expense (2)		63,113		4,841		67,954
Intersegment expense allocations		307		(307)		—
Income before income taxes		30,862		2,154		33,016
Income tax expense		8,703		637		9,340
Net income	$	22,159	$	1,517	$	23,676

Total assets	$	4,541,331	$	65,454	$	4,606,785
Loans, net of deferred fees	$	2,649,334	$	47,682	$	2,697,016
Goodwill	$	154,587	$	13,044	$	167,631


	Nine Months Ended September 30, 2019
	Banking ⁽¹⁾		Factoring		Consolidated

	(Dollars in thousands)
Interest income	$	91,388	$	8,800	$	100,188
Intersegment interest allocations		909		(909)		—
Total interest expense		7,605		—		7,605
Net interest income		84,692		7,891		92,583
Provision for loan losses		(2,655)		278		(2,377)
Net interest income after provision		87,347		7,613		94,960
Noninterest income		7,361		490		7,851
Noninterest expense (2)		49,189		5,083		54,272
Intersegment expense allocations		378		(378)		—
Income before income taxes		45,897		2,642		48,539
Income tax expense		12,982		781		13,763
Net income	$	32,915	$	1,861	$	34,776

Total assets	$	3,119,367	$	63,104	$	3,182,471
Loans, net of deferred fees	$	1,831,172	$	44,215	$	1,875,387
Goodwill	$	70,709	$	13,044	$	83,753

(1)

Includes the holding company’s results of operations

(2)

The banking segment’s noninterest expense includes merger-related costs of $2,500,000 and $1,201,000 for the first nine months of 2020 and 2019, respectively.

19) Subsequent Events

On October 22, 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 November 20, 2020, to shareholders of record at close of business day on November 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 September 30, 2020, net income was $11.2 million, or $0.19 per average diluted common share, compared to $11.3 million, or $0.26 per average diluted common share, for the three months ended September 30, 2019. The Company’s annualized return on average tangible assets was 1.02% and annualized return on average tangible equity was 11.41% for the three months ended September 30, 2020, compared to 1.49% and 15.08%, respectively, for the three months ended September 30, 2019.

For the nine months ended September 30, 2020, net income was $23.7 million, or $0.39 per average diluted common share, compared to $34.8 million, or $0.80 per average diluted common share, for the nine months ended September 30, 2019. The Company’s annualized return on average tangible assets was 0.73% and annualized return on average tangible equity was 8.12% for the nine months ended September 30, 2020, compared to 1.55% and 16.26%, respectively, for the nine months ended September 30, 2019.

Earnings for the first nine 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 COVID-19 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)

The overall impact of the pandemic on our local economy and communities continues to be felt. In our seven county Bay Area market, 331,000 jobs (9.2%) have been lost since the end of February 2020. The unemployment rate in the seven Bay Area counties we serve fell to 8.1% in September, down from 12.8% in April, but still higher than the 2.7% in February 2020.

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.

In response to two economic stimulus laws passed by Congress in the first half of the year, Heritage Bank of Commerce funded 1,105 PPP loans, with total principal balances of $333.4 million. During the second and third quarters of 2020, PPP loan pay offs totaled $9.8 million and the Bank ended the third quarter of 2020 with $323.6 million in outstanding PPP loan balances. These loans generated $1.4 million in interest income and $2.2 million in deferred fees, which were partially offset by ($245,000) in deferred costs expensed during the second and third quarters of 2020. At September 30, 2020, total loans included deferred fees on PPP loans of $9.0 million and deferred costs of $995,000.

In accordance with new accounting guidance issued earlier this year by federal bank regulators, the Bank made accommodations for initial payment deferrals for a number of customers of up to 90 days, generally, with the potential, upon application, of an additional 90 days of payment deferral (180 days maximum). The Bank also waived all normal applicable fees. The following table shows the deferments at September 30, 2020 by category for non-SBA loans:

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									% of
									Total
		Underlying Collateral							Non-PPP
				Business		Real			Related
		Unsecured		Assets		Estate		Total	Loans⁽³⁾

		(Dolllars in thousands)
Regular Payments Resumed	$	55	$	35,694	$	109,557	$	145,306	6%
Initial Deferments⁽¹⁾		-		962		17,334		18,296	1%
2nd Deferments⁽²⁾		-		3,503		19,553		23,056	1%
Total	$	55	$	40,159	$	146,444	$	186,658	8%

(1)

Initial deferments were generally for 3 months

(2)

2nd deferments were for an additional 3 months

(3)

Total Non-PPP Loans as of September 30, 2020

The Bank had elected to initially downgrade the risk grades of these loans to “Special Mention” status and upon return to regular monthly payment status, most have now been upgraded back to “Pass.” At the end of the third quarter of 2020, the pool of deferred loans in our portfolio were mostly tied to business borrowers from a broad range of industries and included $2.0 million in loan deferments to the healthcare industry and $7.8 million in loan deferments to the accommodation and food services industries (mostly hotels and restaurants). Of the $41.4 million of loans remaining in deferral, 89% are supported by some form of commercial or residential real estate. Commercial real estate (“CRE”) deferments of $24.2 million included $19.6 million of investor CRE and $4.6 million of owner-occupied CRE. Deferred loans secured by CRE had an average loan-to-value (“LTV”) ratio of 44.5% at the end of the third quarter of 2020. There was also $12.6 million of deferrments on residential real estate, primarily home equity lines, as of September 30, 2020. The majority of deferred loans are also supported by personal guarantees.

In addition to its portfolio of SBA PPP loans, the Bank also has a portfolio of SBA 7(a) loans totaling $49.6 million as of October 16, 2020. As part of the SBA’s Coronavirus debt relief efforts, beginning in April of 2020, the SBA commenced a six-month program to cover payments of principal, interest and any associated fees for these borrowers, which largely ended with the September payment. The following table reflects the status of these SBA 7(a) loans as of October 16, 2020:


			Number
		Dollars	of Loans

		(Dollars in thousands)
SBA 7(a) loans that borrowers made payments
by October 16, 2020	$	40,506	238
Payments Not Made / NSF / Returned		2,360	16
Due dates later in October		88	2
New loans / No payment due		435	1
C.A.R.E.S Payments		4,746	11
Request for Deferral		1,444	13	⁽¹⁾
Total Portfolio	$	49,579	281

(1) Of the 13 loan requests for deferral, 5 have made their October 2020 payments.

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Credit Quality and Performance

At September 30, 2020, nonperforming assets (“NPAs”) declined by ($3.9) million, or (28%), to $10.3 million, compared to $14.2 million at September 30, 2019, and increased by $434,000, or 4% from $9.8 million at December 31, 2019. Classified assets increased to $33.0 million, or 0.72% of total assets, at September 30, 2020, compared to $20.2 million, or 0.64% of total assets, at September 30, 2019, and $32.6 million, or 0.79% of total assets, at December 31, 2019.

There was a $197,000 provision for credit losses on loans for the third quarter of 2020, compared to a credit to the provision for loan losses of ($576,000) for the third quarter of 2019. There was a $14.6 million provision for credit losses on loans for the nine months ended September 30, 2020, compared to a ($2.4) million credit to the provision for loan losses for the nine months ended September 30, 2019.

The increase in the provision for credit losses on loans for the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019, was driven primarily by a significantly deteriorated economic outlook resulting from the COVID-19 pandemic. Most major economic forecasts, including the California Economic Forecast (“CEF”) used by the Bank in its CECL Model, show a significant decline in California Gross Domestic Product (“GDP”) and a substantial rise in unemployment for 2020. At January 1, 2020, the forecast for California GDP for 2020 was an annual increase in the low single digits and the forecasted California unemployment rate for 2020 was in the mid-single digits. In September 2020, the CEF forecast was revised for GDP in the negative low single digits and peak unemployment in the low double digits. The three loan classes where the largest increases in reserves were recorded under the CECL loss rate methodology were investor-owned CRE, construction & land, and commercial and industrial (“C&I”). Ongoing impacts of the CECL methodology will be dependent upon changes in economic conditions and forecasts, originated and acquired loan portfolio composition, portfolio duration, and other factors.

The Company continues to monitor portfolio loans made to commercial customers with businesses in higher risk sectors due to the COVID-19 pandemic. The following table provides a breakdown of such loans as a percentage of total loans at September 30, 2020, June 30, 2020, and March 31, 2020:


	% of Total		% of Total		% of Total
	Loans at		Loans at		Loans at
HIGHER RISK SECTORS	September 30, 2020		June 30, 2020		March 31, 2020
Health care and social assistance:
Offices of dentists	1.86	%	1.79	%	1.63	%
Other community housing services	0.74	%	0.76	%	0.70	%
Offices of physicians (except mental health specialists)	0.27	%	0.27	%	0.11	%
All others	2.15	%	2.21	%	1.84	%
Total health care and social assistance	5.02	%	5.03	%	4.28	%
Retail trade:
Gasoline stations with convenience stores	1.97	%	1.90	%	1.98	%
All others	2.44	%	2.44	%	2.18	%
Total retail trade	4.41	%	4.34	%	4.16	%
Accommodation and food services:
Full-service restaurants	1.40	%	1.38	%	0.86	%
Limited-service restaurants	0.74	%	0.79	%	0.63	%
Hotels (except casino hotels) and motels	0.92	%	0.89	%	0.94	%
All others	0.68	%	0.70	%	0.52	%
Total accommodation and food services	3.74	%	3.76	%	2.95	%
Educational services:
Elementary and secondary schools	0.57	%	0.65	%	0.15	%
Education support services	0.43	%	0.40	%	0.15	%
All others	0.17	%	0.24	%	0.17	%
Total educational services	1.17	%	1.29	%	0.47	%
Arts, entertainment, and recreation	1.27	%	1.26	%	1.09	%
Purchased participations in micro loan portfolio	0.68	%	0.80	%	0.95	%
Total higher risk sectors	16.29	%	16.48	%	13.90	%

The increase in higher risk sectors in the second and third quarters, compared to the first quarter of 2020, was primarily due to the addition of PPP loans during the second quarter of 2020.

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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 $17,000 for the third quarter of 2020 compared to $661,000 for the third quarter of 2019 and by $2.5 million for the first nine months of 2020, compared to $1.2 million for first nine 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.

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:


	September 30,		September 30,
	2020		2019

	(Dollars in thousands)
Total factored receivables	$	47,682	$	44,215
Average factored receivables
For the three months ended	$	40,300	$	47,614
For the nine months ended	$	44,101	$	47,271
Total full time equivalent employees		35		36

Third 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 12% to $34.2 million for the third quarter of 2020, compared to $30.6 million for the third quarter of 2019. Net interest income, before provision for credit losses on loans, increased 16% to $107.7 million for the first nine months of 2020, compared to $92.6 million for the first nine months of 2019.

●

The fully tax equivalent (“FTE”) net interest margin contracted 100 basis points to 3.24% for the third quarter of 2020, from 4.24% for the third quarter of 2019, primarily due to the impact of the 150 basis points decrease in the Federal funds rate in March 2020 resulting in a decline in the average yield of loans, investment securities, and overnight funds, partially offset by a decline in the cost of interest-bearing liabilities.

●

For the first nine months of 2020, the net interest margin the FTE net interest margin contracted 71 basis points to 3.62%, compared to 4.33% for the first nine months of 2019, primarily due to the impact of the 150 basis points decrease in the Federal funds rate in March 2020 resulting in decreases in the yields on loans, investment securities, and overnight funds, partially offset by a decline in the cost of interest-bearing liabilities.

●

The average yield on the loan portfolio decreased to 4.86% for the third quarter of 2020, compared to 5.83% for the third quarter of 2019, primarily due to the impact of the 150 basis points decrease in the Federal funds rate in March 2020 resulting in a decline in the average yield 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 yield on the loan portfolio decreased to 5.10% for the nine month period ended September 30, 2020 compared to 5.90% for the nine months ended September 30, 2019, primarily due to the impact of the 150 basis points decrease in the Federal funds rate in March 2020 resulting in decreases in the prime rate on

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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 accretion of the loan purchase discount into loan interest income from the acquisitions was $1.2 million for the third quarter of 2020, compared to $471,000 for the third quarter of 2019. The accretion of the loan

purchase discount into loan interest income from the acquisitions was $3.5 million for the first nine months of 2020, compared to $1.3 million for the first nine months of 2019.

●

The remaining net purchase discount on total loans acquired was $12.8 million at September 30, 2020.

●

The average cost of total deposits was 0.16% for the third quarter of 2020, compared to 0.31% for the third quarter of 2019. The average cost of total deposits was 0.18% for the first nine months of 2020, compared to 0.30% for the first nine months of 2019.

●

There was a $197,000 provision for credit losses on loans for the third quarter of 2020, compared to a credit to the provision for loan losses of ($576,000) for the third quarter of 2019.

●

For the nine months ended September 30, 2020, there was a $14.6 million provision for credit losses on loans, compared to a ($2.4) million credit to the provision for loan losses for the nine months ended September 30, 2019.

●

For the nine months ended September 30, 2020, noninterest income remained relatively flat from $7.9 million for the nine months ended September 30, 2019, as lower services charges and fees on deposit accounts were mostly offset by a higher increase in the cash surrender value of life insurance, a gain realized on a warrant exercised, and a gain on the disposition of foreclosed assets during the first nine months of 2020.

●

Total noninterest expense for the third quarter of 2020 increased to $21.2 million, compared to $17.9 million for the third quarter of 2019, primarily due to additional employees and operating costs added as a result of the Presidio merger, and higher salaries and employee benefits as a result of annual salary increases. Noninterest expense for the nine months ended September 30, 2020 increased to $68.0 million, compared to $54.3 million for the nine months ended September 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 third quarter of 2020 increased to 57.58%, compared to 53.87% for the third quarter of 2019. The efficiency ratio for the nine months ended September 30, 2020 was 58.81%, compared to 54.04% for the nine months ended September 30, 2019.

●

Income tax expense for the third quarter of 2020 was $4.2 million, compared to $4.6 million for the third quarter of 2019. The effective tax rate for the third quarter of 2020 was 27.3%, compared to 29.1% for the third quarter of 2019. Income tax expense for the nine months ended September 30, 2020 was $9.3 million, compared to $13.8 million for the nine months ended September 30, 2019. The effective tax rate for the nine months ended September 30, 2020 was 28.3%, compared to 28.4% for the nine months ended September 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 68% to $1.3 billion at September 30, 2020, from $748.9 million at September 30, 2019, and increased 46% from $862.2 million at December 31, 2019.

●

At September 30, 2020, securities held-to-maturity, at amortized cost, totaled $295.6 million, compared to $342.0 million at September 30, 2019, and $366.6 million, at December 31, 2019.

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●

Loans, excluding loans held-for-sale, increased $821.6 million or 44%, to $2.70 billion at September 30, 2020, compared to $1.88 billion at September 30, 2019, and increased $163.2 million or 6%, to $2.70 billion at September 30, 2020, compared to $2.53 billion at December 31, 2019. Total loans at September 30, 2020 included $323.6 million of PPP loans.

●

NPAs were $10.3 million, or 0.22% of total assets, at September 30, 2020, compared to $14.2 million, or 0.45% of total assets, at September 30, 2019, and $9.8 million, or 0.24% of total assets, at December 31, 2019. There were no foreclosed assets at September 30, 2020, September 30, 2019, and December 31, 2019.

●

Classified assets were $33.0 million, or 0.72% of total assets, at September 30, 2020, compared to $20.2 million, or 0.64% of total assets, at September 30, 2019, and $32.6 million, or 0.79% of total assets, at December 31, 2019.

●

Net charge-offs totaled $219,000 for the third quarter of 2020, compared to $160,000 for the third quarter of 2019. Net charge-offs totaled $1.0 million for the nine months ended September 30, 2020, compared to net recoveries of $424,000 for the nine months ended September 30, 2019.

●

The allowance for credit losses on loans (“ACLL”) at September 30, 2020 was $45.4 million, or 1.68% of total loans, representing 442.62% of total nonperforming loans. The allowance for loan losses (“ALLL”) at September 30, 2019 was $25.9 million, or 1.38% of total loans, representing 181.76% 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. The ACLL was 1.91% of total loans, excluding PPP loans, at September 30, 2020.

●

Total deposits increased $1.2 billion, or 45%, to $3.89 billion at September 30, 2020, compared to $2.69 billion at September 30, 2019. Total deposits increased $475.6 million or 14% from $3.41 billion at December 31, 2019. The large increase in deposits in the third quarter of 2020 was primarily from deposits by customers who had taken out PPP loans.

●

Deposits, excluding all time deposits and CDARS deposits, increased $1.2 billion, or 48%, to $3.73 billion at September 30, 2020, compared to $2.52 billion at September 30, 2019. Deposits, excluding all time deposits and CDARS deposits, at September 30, 2020 increased $500.6 million, or 15%, 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 3.28% at September 30, 2020, compared to 4.79% at September 30, 2019, and 4.10% at December 31, 2019.

●

The loan to deposit ratio was 69.32% at September 30, 2020, compared to 69.74% at September 30, 2019, and 74.20% at December 31, 2019.

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●

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 September 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		16.0	%		15.2	%		10.0	%		10.5	%
Tier 1 Risk-Based		13.5	%		14.1	%		8.0	%		8.5	%
Common Equity Tier 1 Risk-based		13.5	%		14.1	%		6.5	%		7.0	%
Leverage		9.3	%		9.7	%		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.

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
	September 30, 2020						September 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⁾	$	2,669,694	$	32,635	4.86	%	$	1,855,840	$	27,264	5.83	%
Securities — taxable		550,423		2,481	1.79	%		629,339		3,504	2.21	%
Securities — exempt from Federal tax⁽³⁾		72,625		586	3.21	%		83,403		671	3.19	%
Other investments, interest-bearing deposits
in other financial institutions and Federal funds sold		911,160		673	0.29	%		310,008		1,952	2.50	%
Total interest earning assets		4,203,902		36,375	3.44	%		2,878,590		33,391	4.60	%
Cash and due from banks		36,505						37,615
Premises and equipment, net		9,884						6,933
Goodwill and other intangible assets		185,879						94,441
Other assets		126,242						85,464
Total assets	$	4,562,412					$	3,103,043
Liabilities and shareholders’ equity:
Deposits:
Demand, noninterest-bearing	$	1,700,972					$	1,041,712

Demand, interest-bearing		934,892		506	0.22	%		670,203		571	0.34	%
Savings and money market		1,052,800		762	0.29	%		737,484		1,073	0.58	%
Time deposits — under $100		17,298		16	0.37	%		18,549		23	0.49	%
Time deposits — $100 and over		121,949		219	0.71	%		127,314		373	1.16	%
CDARS — interest-bearing demand, money
market and time deposits		18,741		1	0.02	%		16,990		2	0.05	%
Total interest-bearing deposits		2,145,680		1,504	0.28	%		1,570,540		2,042	0.52	%
Total deposits		3,846,652		1,504	0.16	%		2,612,252		2,042	0.31	%

Subordinated debt, net of issuance costs		39,663		583	5.85	%		39,477		583	5.86	%
Short-term borrowings		96		—	0.00	%		151		—	0.00	%
Total interest-bearing liabilities		2,185,439		2,087	0.38	%		1,610,168		2,625	0.65	%
Total interest-bearing liabilities and demand,
noninterest-bearing / cost of funds		3,886,411		2,087	0.21	%		2,651,880		2,625	0.39	%
Other liabilities		99,866						60,077
Total liabilities		3,986,277						2,711,957
Shareholders’ equity		576,135						391,086
Total liabilities and shareholders’ equity	$	4,562,412					$	3,103,043

Net interest income / margin				34,288	3.24	%				30,766	4.24	%
Less tax equivalent adjustment				(123)						(141)
Net interest income			$	34,165					$	30,625

(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 $1,441,000 for the third quarter of 2020 (of which $1,305,000 was from PPP loans), compared to $189,000 for the third 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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	Nine Months Ended						Nine Months Ended
	September 30, 2020						September 30, 2019
			Interest		Average				Interest		Average
	Average		Income /		Yield /		Average		Income /		Yield /
	Balance		Expense		Rate		Balance		Expense		Rate

Assets:
Loans, gross ⁽¹⁾⁽²⁾	$	2,623,672	$	100,262	5.10	%	$	1,842,870	$	81,321	5.90	%
Securities — taxable		610,590		9,584	2.10	%		692,369		12,149	2.35	%
Securities — exempt from Federal tax⁽³⁾		76,371		1,845	3.23	%		84,882		2,057	3.24	%
Other investments, interest-bearing deposits
in other financial institutions and Federal funds sold		671,753		3,022	0.60	%		249,473		5,094	2.73	%
Total interest earning assets⁽³⁾		3,982,386		114,713	3.85	%		2,869,594		100,621	4.69	%
Cash and due from banks		39,575						37,293
Premises and equipment, net		9,198						7,024
Goodwill and other intangible assets		186,697						94,976
Other assets		126,211						85,312
Total assets	$	4,344,067					$	3,094,199
Liabilities and shareholders’ equity:
Deposits:
Demand, noninterest-bearing	$	1,600,522					$	1,022,654

Demand, interest-bearing		875,501		1,573	0.24	%		686,144		1,801	0.35	%
Savings and money market		994,315		2,470	0.33	%		744,333		3,015	0.54	%
Time deposits — under $100		17,964		56	0.42	%		19,392		66	0.46	%
Time deposits — $100 and over		127,360		801	0.84	%		126,732		986	1.04	%
CDARS — interest-bearing demand, money
market and time deposits		16,894		4	0.03	%		14,151		5	0.05	%
Total interest-bearing deposits		2,032,034		4,904	0.32	%		1,590,752		5,873	0.49	%
Total deposits		3,632,556		4,904	0.18	%		2,613,406		5,873	0.30	%

Subordinated debt, net of issuance costs		39,617		1,737	5.86	%		39,414		1,731	5.87	%
Short-term borrowings		162		—	0.00	%		120		1	1.11	%
Total interest-bearing liabilities		2,071,813		6,641	0.43	%		1,630,286		7,605	0.62	%
Total interest-bearing liabilities and demand,
noninterest-bearing / cost of funds		3,672,335		6,641	0.24	%		2,652,940		7,605	0.38	%
Other liabilities		97,690						60,340
Total liabilities		3,770,025						2,713,280
Shareholders’ equity		576,042						380,919
Total liabilities and shareholders’ equity	$	4,346,067					$	3,094,199

Net interest income ⁽³⁾ / margin				108,072	3.62	%				93,016	4.33	%
Less tax equivalent adjustment ⁽³⁾				(387)						(433)
Net interest income			$	107,685					$	92,583

(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 $2,353,000 for the first nine months of 2020 (of which $1,942,000 was from PPP loans), compared to $490,000 for the first nine 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 September 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	$	9,963	$	(4,592)	$	5,371
Securities — taxable		(351)		(672)		(1,023)
Securities — exempt from Federal tax⁽¹⁾		(87)		2		(85)
Other investments, interest-bearing deposits
in other financial institutions and Federal funds sold		447		(1,726)		(1,279)
Total interest income on interest-earning assets		9,972		(6,988)		2,984

Expense from the interest-bearing liabilities:
Demand, interest-bearing		135		(200)		(65)
Savings and money market		224		(535)		(311)
Time deposits — under $100		(1)		(6)		(7)
Time deposits — $100 and over		(8)		(146)		(154)
CDARS — interest-bearing demand, money market
and time deposits		—		(1)		(1)
Subordinated debt, net of issuance costs		2		(2)		—
Short-term borrowings		—		—		—
Total interest expense on interest-bearing liabilities		352		(890)		(538)
Net interest income	$	9,620	$	(6,098)		3,522
Less tax equivalent adjustment						18
Net interest income					$	3,540

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

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	Nine Months Ended September 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	$	29,901	$	(10,960)	$	18,941
Securities — taxable		(1,301)		(1,264)		(2,565)
Securities — exempt from Federal tax⁽¹⁾		(208)		(4)		(212)
Other investments, interest-bearing deposits
in other financial institutions and Federal funds sold		1,901		(3,973)		(2,072)
Total interest income on interest-earning assets		30,293		(16,201)		14,092

Expense from the interest-bearing liabilities:
Demand, interest-bearing		340		(568)		(228)
Savings and money market		631		(1,176)		(545)
Time deposits — under $100		(5)		(5)		(10)
Time deposits — $100 and over		4		(189)		(185)
CDARS — interest-bearing demand, money market
and time deposits		1		(2)		(1)
Subordinated debt, net of issuance costs		8		(2)		6
Short-term borrowings		—		(1)		(1)
Total interest expense on interest-bearing liabilities		979		(1,943)		(964)
Net interest income	$	29,314	$	(14,258)		15,056
Less tax equivalent adjustment						46
Net interest income					$	15,102

(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 fully tax equivalent (“FTE”) net interest margin, expressed as a percentage of average earning assets, contracted 100 basis points to 3.24% for the third quarter of 2020, from 4.24% for the third quarter of 2019, primarily due to the impact of the 150 basis points decrease in the Federal funds rate in March 2020 resulting in a decline in the average yield of loans, investment securities, and overnight funds, partially offset by a decline in the cost of interest-bearing liabilities.

For the first nine months of 2020, the net interest margin contracted 71 basis points to 3.62%, compared to 4.33% for the first nine months of 2019, primarily due to the impact of the 150 basis points decrease in the Federal funds rate in March 2020 resulting in decreases in the yields on loans, investment securities, and overnight funds, partially offset by a decline in the cost of interest-bearing liabilities.

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
	September 30, 2020						September 30, 2019
	Average		Interest		Average		Average		Interest		Average
	Balance		Income		Yield		Balance		Income		Yield

	(Dollars in thousands)
Loans, core bank and asset-based lending	$	2,266,227	$	26,508	4.65	%	$	1,748,379	$	23,401	5.31	%
PPP loans		324,518		816	1.00	%		—		—	—
PPP fees, net		—		1,305	1.60	%		—		—	—
Bay View Funding factored receivables		40,300		2,431	24.00	%		47,614		2,879	23.99	%
Residential mortgages		29,399		180	2.44	%		34,639		229	2.62	%
Purchased CRE loans		22,603		195	3.43	%		30,567		284	3.69	%
Loan fair value mark / accretion		(13,353)		1,200	0.21	%		(5,359)		471	0.11	%
Total loans (includes loans held-for-sale)	$	2,669,694	$	32,635	4.86	%	$	1,855,840	$	27,264	5.83	%


	Nine Months Ended						Nine Months Ended
	September 30, 2020						September 30, 2019
	Average		Interest		Average		Average		Interest		Average
	Balance		Income		Yield		Balance		Income		Yield

	(Dollars in thousands)
Loans, core bank and asset-based lending	$	2,351,369	$	84,304	4.79	%	$	1,733,784	$	69,594	5.37	%
PPP loans		186,497		1,398	1.00	%		—		—	—
PPP fees, net		—		1,942	1.39	%		—		—	—
Bay View Funding factored receivables		44,102		7,871	23.84	%		47,271		8,800	24.89	%
Residential mortgages		31,224		607	2.60	%		35,840		714	2.66	%
Purchased CRE loans		25,152		655	3.48	%		31,788		869	3.65	%
Loan fair value mark / accretion		(14,672)		3,485	0.20	%		(5,813)		1,344	0.10	%
Total loans (includes loans held-for-sale)	$	2,623,672	$	100,262	5.10	%	$	1,842,870	$	81,321	5.90	%

The yield on the loan portfolio decreased to 5.10% for the first nine months of 2020, compared to 5.90% for the

first nine months of 2019, primarily due to the impact of the 150 basis points decrease in the Federal funds rate in March 2020 resulting in 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 average cost of total deposits was 0.16% for the third quarter of 2020, compared to 0.31% for the third quarter of 2019. The cost of total deposits was 0.18% for the first nine months of 2020, compared to 0.30% for the first nine months of 2019.

Net interest income, before provision for credit losses on loans, increased 12% to $34.2 million for the third quarter of 2020, compared to $30.6 million for the third quarter of 2019, primarily due to an increase in the average balance of loans resulting from the Presidio merger, additional interest and fee income from PPP loans, and an increase in

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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 16% to $107.7 million for the first nine months of 2020, compared to $92.6 million for the first nine months of 2019, primarily due to an increase in the average balance of loans resulting from 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 GDP and unemployment projections provided by the California Economic Forecast (“CEF”, www.CaliforniaForecast.com).

There was a $197,000 provision for credit losses on loans for the third quarter of 2020, compared to a credit to the provision for loan losses of ($576,000) for the third quarter of 2019. For the nine months ended September 30, 2020, there was a $14.6 million provision for credit losses on loans compared to a ($2.4) million credit to the provision for loan losses for the nine months ended September 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 1.68% of total loans at September 30, 2020. The allowance for loan losses was $25.9 million, or 1.38% of total loans at September 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 442.62% at September 30, 2020. The allowance for loan losses to total nonperforming loans was 181.76% at September 30, 2019, and 236.93% at December 31, 2019. Net charge-offs totaled $219,000 for the third quarter of 2020, compared to $160,000 for the third quarter of 2019. Net charge-offs totaled $1.0 million for the nine months ended September 30, 2020, compared to net recoveries of $424,000 for the nine months ended September 30, 2019.

Noninterest Income



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

	(Dollars in thousands)
Service charges and fees on deposit accounts	$	632	$	1,032	$	(400)	(39)	%
Increase in cash surrender value of life insurance		464		336		128	38	%
Gain on sales of SBA loans		400		156		244	156	%
Servicing income		187		139		48	35	%
Gain on sales of securities		—		330		(330)	(100)	%
Other		912		625		287	46	%
Total	$	2,595	$	2,618	$	(23)	(1)	%

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					Increase
	Nine Months Ended				(decrease)
	September 30,				2020 versus 2019
	2020		2019		Amount		Percent

	(Dollars in thousands)
Service charges and fees on deposit accounts	$	2,251	$	3,370	$	(1,119)	(33)	%
Increase in cash surrender value of life insurance		1,380		999		381	38	%
Gain on sales of SBA loans		467		331		136	41	%
Servicing income		575		480		95	20	%
Gain on sales of securities		270		878		(608)	(69)	%
Gain on the disposition of foreclosed assets		791		—		791	N/A
Other		2,132		1,793		339	19	%
Total	$	7,866	$	7,851	$	15	0	%

Total noninterest income remained relatively flat at $2.6 million for the third quarter of 2020, compared to the third quarter of 2019, as lower services charges and fees on deposit accounts were mostly offset by a higher gain on sales of SBA loans and a realized gain on warrants exercised during the third quarter of 2020. For the nine months ended September 30, 2020, noninterest income remained relatively flat from $7.9 million for the nine months ended September 30, 2019, as lower services charges and fees on deposit accounts were mostly offset by a higher increase in the cash surrender value of life insurance, a gain realized on a warrant exercised, and a gain on the disposition of foreclosed assets during the first nine months of 2020.

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 third quarter ended September 30, 2020, SBA loan sales resulted in a $400,000 gain, compared to a $156,000 gain on sales of SBA loans for the third quarter ended September 30, 2019. For the nine months ended September 30, 2020, SBA loan sales resulted in a $467,000 gain, compared to a $331,000 gain on sale of SBA loans for the nine months ended September 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)
	September 30,				2020 versus 2019
	2020		2019		Amount		Percent

	(Dollars in thousands)
Salaries and employee benefits	$	11,967	$	10,467	$	1,500	14	%
Occupancy and equipment		2,283		1,550		733	47	%
Professional fees		1,352		789		563	71	%
Amortization of intangible assets		965		554		411	74	%
Software subscriptions		641		601		40	7	%
Insurance expense		591		479		112	23	%
Supplemental retirement plan cost		585		310		275	89	%
Data processing		463		454		9	2	%
Other, excluding merger-related costs		2,304		2,044		260	13	%
Total noninterest expense, excluding merger-related costs		21,151		17,248		3,903	23	%
Other merger-related costs (1)		17		661		(644)	(97)	%
Total noninterest expense, inluding merger-related costs	$	21,168	$	17,909	$	3,259	18	%

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

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					Increase
	Nine Months Ended				(Decrease)
	September 30,				2020 versus 2019
	2020		2019		Amount		Percent

	(Dollars in thousands)
Salaries and employee benefits	$	38,114	$	31,935	$	6,179	19	%
Occupancy and equipment		5,821		4,634		1,187	26	%
Professional fees		3,942		2,360		1,582	67	%
Amortization of intangible assets		2,787		1,661		1,126	68	%
Software subscriptions		2,276		1,746		530	30	%
Insurance expense		1,625		1,354		271	20	%
Supplemental retirement plan cost		1,344		930		414	45	%
Data processing		2,218		1,865		353	19	%
Other, excluding merger-related costs		7,327		6,586		741	11	%
Total noninterest expense, excluding merger-related costs		65,454		53,071		12,383	23	%
Salaries and employee benefits merger-related costs (1)		356		—		356	N/A
Other merger-related costs (2)		2,144		1,201		943	79	%
Total noninterest expense, inluding merger-related costs	$	67,954	$	54,272	$	13,682	25	%

(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 September 30,
			Percent of				Percent of
	2020		Total		2019		Total

	(Dollars in thousands)
Salaries and employee benefits	$	11,967	56	%	$	10,467	58	%
Occupancy and equipment		2,283	11	%		1,550	9	%
Professional fees		1,352	6	%		789	4	%
Amortization of intangible assets		965	5	%		554	3	%
Software subscriptions		641	3	%		601	3	%
Insurance expense		591	3	%		479	3	%
Supplemental retirement plan cost		585	3	%		310	2	%
Data processing		463	2	%		454	3	%
Other, excluding merger-related costs		2,304	11	%		2,044	11	%
Total noninterest expense, excluding merger-related costs		21,151	100	%		17,248	96	%
Other merger-related costs (2)		17	0	%		661	4	%
Total noninterest expense, inluding merger-related costs	$	21,168	100	%	$	17,909	100	%

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	Nine Months Ended September 30,
			Percent				Percent
	2020		of Total		2019		of Total

	(Dollars in thousands)
Salaries and employee benefits	$	38,114	56	%	$	31,935	59	%
Occupancy and equipment		5,821	9	%		4,634	9	%
Professional fees		3,942	6	%		2,360	4	%
Amortization of intangible assets		2,787	4	%		1,661	3	%
Software subscriptions		2,276	3	%		1,746	3	%
Insurance expense		1,625	2	%		1,354	3	%
Supplemental retirement plan cost		1,344	2	%		930	2	%
Data processing		2,218	3	%		1,865	3	%
Other, excluding merger-related costs		7,327	11	%		6,586	12	%
Total noninterest expense, excluding merger-related costs		65,454	96	%		53,071	98	%
Salaries and employee benefits merger-related costs (1)		356	1	%		—	0	%
Other merger-related costs (2)		2,144	3	%		1,201	2	%
Total noninterest expense, inluding merger-related costs	$	67,954	100	%	$	54,272	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.

Total noninterest expense for the third quarter of 2020 increased to $21.2 million, compared to $17.9 million for the third quarter of 2019, primarily due to additional employees and operating costs as a result of the Presidio merger, and higher salaries and employee benefits as a result of annual salary increases. Noninterest expense for the nine months ended September 30, 2020 increased to $68.0 million, compared to $54.3 million for the nine months ended September 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. Full time equivalent employees were 342, 308, and 357 at September 30, 2020, September 30, 2019, and December 31, 2019, respectively

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				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019
Effective income tax rate	27.3	%	29.1	%	28.3	%	28.4	%

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 third quarter of 2020 was $4.2 million, compared to $4.6 million for the third quarter of 2019. The Company’s Federal and state income tax expense for the nine months ended September 30, 2020 was $9.3 million, compared to $13.8 million for the nine months ended September 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.

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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 $27.8 million at September 30, 2020, $21.7 million at September 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 September 30, 2020, September 30, 2019, and December 31, 2019 will be fully realized in future years.

FINANCIAL CONDITION

At September 30, 2020, total assets increased 45% to $4.61 billion, compared to $3.18 billion at September 30, 2019, and increased 12% from $4.11 billion at December 31, 2019.

Securities available-for-sale, at fair value, were $294.4 million at September 30, 2020, a decrease of (12%) from $333.1 million at September 30, 2019, and a decrease of (27%) from $404.8 million at December 31, 2019. Securities held-to-maturity, at amortized cost, were $295.6 million at September 30, 2020, a decrease of (14%) from $342.0 million at September 30, 2019, and a decrease of (19%) from $366.6 million at December 31, 2019.

Total deposits increased $1.2 billion, or 45%, to $3.89 billion at September 30, 2020, compared to $2.69 billion at September 30, 2019. The large increase in the Company’s deposits in the third quarter of 2020 was primarily tied to deposits by customers who had taken out PPP loans and deposits from the Presidio merger. Total deposits increased $475.6 million or 14% from $3.41 billion at December 31, 2019. Deposits, excluding all time deposits and CDARS deposits, increased $1.2 billion, or 48%, to $3.73 billion at September 30, 2020, compared to $2.52 billion at September 30, 2019. The large increase in the Company’s deposits in the third quarter of 2020 was primarily tied to deposits by customers who had taken out PPP loans and deposits from the Presidio merger. Deposits, excluding all time deposits and CDARS deposits increased $500.6 million or 15%, 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:


	September 30,				December 31,
	2020		2019		2019

	(Dollars in thousands)
Securities available-for-sale (at fair value):
Agency mortgage-backed securities	$	203,609	$	212,742	$	284,361
U.S. Treasury		90,829		120,359		120,464
Total	$	294,438	$	333,101	$	404,825
Securities held-to-maturity (at amortized cost):
Agency mortgage-backed securities	$	223,453	$	259,312	$	285,344
Municipals — exempt from Federal tax		72,211		82,721		81,216
Total	$	295,664	$	342,033	$	366,560

The following table summarizes the weighted average life and weighted average yields of securities at September 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		$	203,609	1.76	%	$	—	N/A		$	—	N/A		$	203,609	1.76	%
U.S. Treasury		85,769	2.82	%		5,060	2.95	%		—	N/A			—	N/A			90,829	2.83	%
Total	$	85,769	2.82	%	$	208,669	1.79	%	$	—	N/A		$	—	N/A		$	294,438	2.09	%

Securities held-to-maturity (at amortized cost):
Agency mortgage-backed securities	$	7,725	0.17	%	$	200,888	1.84	%	$	—	N/A		$	14,840	3.25	%	$	223,453	1.88	%
Municipals — exempt from Federal tax (1)		24,881	3.13	%		47,081	3.29	%		249	3.10	%		—	N/A			72,211	3.23	%
Total	$	32,606	2.43	%	$	247,969	2.12	%	$	249	3.10	%	$	14,840	3.25	%	$	295,664	2.21	%

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

The securities 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 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.

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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 59% of total assets at September 30, 2020 and September 30, 2019, and represented 62% at December 31, 2019. The ratio of loans to deposits was 69.32% at September 30, 2020, compared to 69.74% at September 30, 2019, and 74.20% at December 31, 2019.

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:


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

	(Dollars in thousands)
Commercial	$	574,359	21	%	$	507,879	27	%	$	603,345	24	%
SBA PPP loans		323,550	12	%		—	0	%		—	0	%
Real estate:
CRE - owner occupied		561,528	21	%		436,262	23	%		548,907	22	%
CRE - non-owner occupied		713,563	27	%		540,367	29	%		767,821	30	%
Land and construction		142,632	5	%		96,679	5	%		147,189	6	%
Home equity		111,468	4	%		85,840	5	%		151,775	6	%
Multifamily		169,791	6	%		94,258	5	%		180,623	7	%
Residential mortgages		91,077	3	%		92,611	5	%		100,759	4	%
Consumer and other		17,511	1	%		21,596	1	%		33,744	1	%
Total Loans		2,705,479	100	%		1,875,492	100	%		2,534,163	100	%
Deferred loan fees, net		(8,463)	—			(105)	—			(319)	—
Loans, net of deferred fees		2,697,016	100	%		1,875,387	100	%		2,533,844	100	%
Allowance for credit losses on loans		(45,422)				(25,895)				(23,285)
Loans, net	$	2,651,594			$	1,849,492			$	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 September 30, 2020, compared to 72% at September 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 three months ended September 30, 2020, loans were sold resulting in a gain on sales of SBA loans of $400,000, compared to $156,000 for the three months ended September

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30, 2019. During the nine months ended September 30, 2020, loans were sold resulting in a gain on sales of SBA loans of and $467,000, compared to $331,000 for the nine months ended September 30, 2019.

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 37 days for the first nine months of 2020 and 2019. The balance of the purchased receivables was $47.7 million at September 30, 2020, compared to $44.2 million at September 30, 2019 and $46.0 million at December 31, 2019.

The commercial loan portfolio increased $66.5 million, or 13%, to $574.4 million at September 30, 2020 from $507.9 million at September 30, 2019 and decreased ($28.9) million, or (5%), from $603.3 million at December 31, 2019. C&I line usage was 28% at September 30, 2020, compared to 35% at September 30, 2019 and December 31, 2019. In addition, the Company had $323.6 million in PPP loans at September 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 $125.3 million or 29% to $561.5 million at September 30, 2020, from $436.2 million at September 30, 2019, and increased $12.6 million, or 2% from $548.9 million at December 31, 2019. CRE non-owner occupied loans increased $173.2 million or 32% to $713.6 million, compared to $540.4 million at September 30, 2019, and decreased ($54.2) million, or (7%) from $767.8 million at December 31, 2019. At September 30, 2020, there was 44% 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 $46.0 million, or 48%, to $142.6 million at September 30, 2020, compared to $96.6 million at September 30, 2019, and decreased $(4.6) million, or (3%), 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 $25.7 million, or 30%, to $111.5 million at September 30, 2020, compared to $85.8 million at September 30, 2019, and decreased ($40.3) million, or (27%), from $151.8 million at December 31, 2019.

Residential mortgage loans decreased ($1.5) million, or (2%), to $91.1 million at September 30, 2020, compared to $92.6 million at September 30, 2019, and decreased ($9.7) million, or (10%) from $100.8 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 $96.1 million and $160.2 million at September 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 September 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 September 30, 2020, approximately 45% 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	$	439,385	$	410,509	$	48,015	$	897,909
Real estate:
CRE - owner occupied		126,370		245,529		189,629		561,528
CRE - non-owner occupied		254,508		143,550		315,505		713,563
Land and construction		127,767		5,503		9,362		142,632
Home equity		111,342		—		126		111,468
Multifamily		634		49,576		119,581		169,791
Residential mortgages		683		20,364		70,030		91,077
Consumer and other		9,441		6,573		1,497		17,511
Loans	$	1,070,130	$	881,604	$	753,745	$	2,705,479

Loans with variable interest rates	$	1,016,947	$	120,052	$	72,950	$	1,209,949
Loans with fixed interest rates		53,183		761,552		680,795		1,495,530
Loans	$	1,070,130	$	881,604	$	753,745	$	2,705,479

Loan Servicing

As of September 30, 2020 and 2019, $82.4 million and $87.2 million, respectively, in SBA loans were serviced by the Company for others. Activity for loan servicing rights was as follows:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019

	(Dollars in thousands)
Beginning of period balance	$	479	$	677	$	583	$	871
Additions		111		35		128		75
Amortization		(51)		(121)		(172)		(355)
End of period balance	$	539	$	591	$	539	$	591

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 September 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				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019

	(Dollars in thousands)
Beginning of period balance	$	482	$	572	$	503	$	568
Unrealized holding (loss) gain		9		(31)		(12)		(27)
End of period balance	$	491	$	541	$	491	$	541

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Credit Quality and Allowance for Credit Losses on Loans

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 $11.6 million and $15.3 million at September 30, 2020 and December 31, 2019, respectively, of which $2.4 million and $7.4 million were on nonaccrual, respectively. At September 30, 2020, there were also $7.2 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:


	September 30,						December 31,
	2020			2019			2019

	(Dollars in thousands)
Nonaccrual loans — held-for-investment	$	9,661		$	13,638		$	8,675
Restructured and loans 90 days past due and
still accruing		601			609			1,153
Total nonperforming loans		10,262			14,247			9,828
Foreclosed assets		—			—			—
Total nonperforming assets	$	10,262		$	14,247		$	9,828

Nonperforming assets as a percentage of loans
plus foreclosed assets		0.38	%		0.76	%		0.39	%
Nonperforming assets as a percentage of total assets		0.22	%		0.45	%		0.24	%

Nonperforming assets were $10.3 million, or 0.22% of total assets, at September 30, 2020, compared to $14.2 million, or 0.45% of total assets, at September 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 September 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	$	973	$	1,935	$	601	$	3,509
Real estate:		—		—		—		—
CRE - Owner Occupied		4,328		—		—		4,328
CRE - Non-Owner Occupied		—		—		—		—
Land and construction		—		—		—		—
Home equity		961		—		—		961
Multifamily		—		—		—		—
Residential mortgages		—		—		—		—
Consumer and other		—		1,464		—		1,464
Total	$	6,262	$	3,399	$	601	$	10,262

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 September 30, 2020:


		Collateral Type
		Real
		Estate		Business
		Property		Assets		Unsecured		Total

	(Dollars in thousands)
Commercial	$	55	$	1,750	$	130	$	1,935
Consumer and other		1,464		-		-		1,464
Total	$	1,519	$	1,750	$	130	$	3,399

Classified loans increased to $33.0 million, or 0.72% of total assets, at September 30, 2020, compared to $20.2 million, or 0.64% of total assets, at September 30, 2019 and decreased from $32.6 million, or 0.79% of total assets at December 31, 2019. Deferrals included in classified assets total $5.9 million at September 30, 2020. The increase in classified assets for the third quarter of 2020, compared to the third 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.

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.

Beginning January 1, 2020, we calculated allowance for credit losses on loans using CECL 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.

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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

Commercial Real Estate

Land and Construction

Home Equity

Multifamily

Residential Mortgages

Consumer and Other

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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 September 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	$	13,179	$	8,547	$	15,449	$	2,552	$	1,851	$	1,828	$	825	$	1,213	$	45,444
Charge-offs		(502)		-		-		-		-		-		-		(96)		(598)
Recoveries		343		-		-		19		16		-		-		1		379
Net (charge-offs) recoveries		(159)		-		-		19		16		-		-		(95)		(219)
Provision for credit losses on loans		(220)		736		(124)		(27)		14		21		(46)		(157)		197
End of period balance	$	12,800	$	9,283	$	15,325	$	2,544	$	1,881	$	1,849	$	779	$	961	$	45,422

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


	Commercial		Real Estate		Consumer		Total

	(Dollars in thousands)
Beginning of period balance	$	15,234	$	11,307	$	90	$	26,631
Charge-offs		(315)		-		(3)		(318)
Recoveries		115		43		-		158
Net recoveries		(200)		43		(3)		(160)
Credit for loan losses		(378)		(207)		9		(576)
End of period balance	$	14,656	$	11,143	$	96	$	25,895

Changes in the allowance for credit losses on loans were as follows for the nine months ended September 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		(1,637)		-		-		-		-		-		-		(99)		(1,736)
Recoveries		598		1		-		51		70		-		-		2		722
Net (charge-offs) recoveries		(1,039)		1		-		51		70		-		-		(97)		(1,014)
Provision for credit losses on loans		7,049		2,288		3,653		1,035		490		596		101		(631)		14,581
End of period balance	$	12,800	$	9,283	$	15,325	$	2,544	$	1,881	$	1,849	$	779	$	961	$	45,422

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


	Commercial		Real Estate		Consumer		Total

	(Dollars in thousands)
Beginning of period balance	$	17,061	$	10,671	$	116	$	27,848
Charge-offs		(617)		-		(3)		(620)
Recoveries		917		127		-		1,044
Net recoveries		300		127		(3)		424
Provision (credit) for loan losses		(2,705)		345		(17)		(2,377)
End of period balance	$	14,656	$	11,143	$	96	$	25,895

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


	September 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	$	12,800	33	%	$	14,656	27	%	$	10,453	24	%
Real estate:
CRE - owner occupied		9,283	21	%		3,988	23	%		3,825	22	%
CRE - non-owner occupied		15,325	27	%		3,521	29	%		3,760	30	%
Land and construction		2,544	5	%		1,658	5	%		2,621	6	%
Home equity		1,881	4	%		1,560	5	%		2,244	6	%
Multifamily		1,849	6	%		173	5	%		57	7	%
Residential mortgages		779	3	%		243	5	%		243	4	%
Consumer and other		961	1	%		96	1	%		82	1	%
Total	$	45,422	100	%	$	25,895	100	%	$	23,285	100	%

The allowance for credit losses on loans totaled $45.4 million, or 1.68% of total loans at September 30, 2020. The allowance for loan losses was $25.9 million, or 1.38% of total loans at September 30, 2019, and $23.3 million, or 0.92% of total loans at December 31, 2019. The allowance for credit losses on loans was 442.62% of nonperforming loans at September 30, 2020. The allowance for loan losses was 181.76% of nonperforming loans at September 30, 2019, and 236.93% of nonperforming loans at December 31, 2019. The allowance for credit losses on loans to total loans, excluding PPP loans, was 1.91% at September 30, 2020. The Company had net charge-offs of $219,000, or 0.03% of average loans, for the third quarter of 2020, compared to net charge-offs of $160,000, or 0.03% of average loans, for the third quarter of 2019. Net charge-offs totaled $1.0 million for the nine months ended September 30, 2020, compared to net recoveries of $424,000 for the nine months ended September 30, 2019.

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The following table shows the results of adopting CECL for the first nine 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
Net (charge-offs) during the third quarter of 2020		(219)
Portfolio changes during the third quarter of 2020		488
Qualitative and quantitative changes during the third
quarter of 2020 including changes in economic forecasts		(291)
ACLL at September 30, 2020	$	45,422

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 $37.0 million on its consolidated statement of financial condition at September 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.

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:


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

	(Dollars in thousands)
Demand, noninterest-bearing	$	1,698,027	44	%	$	1,094,953	41	%	$	1,450,873	42	%
Demand, interest-bearing		926,041	24	%		666,054	25	%		798,375	23	%
Savings and money market		1,108,252	28	%		761,471	28	%		982,430	29	%
Time deposits — under $250		46,684	1	%		53,560	2	%		54,361	2	%
Time deposits — $250 and over		92,276	2	%		95,543	3	%		99,882	3	%
CDARS — interest-bearing demand,
money market and time deposits		19,121	1	%		17,409	1	%		28,847	1	%
Total deposits	$	3,890,401	100	%	$	2,688,990	100	%	$	3,414,768	100	%

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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 September 30, 2020 and at December 31, 2019.

At September 30, 2020, the $19.1 million CDARS deposits comprised $13.8 million of interest-bearing demand deposits, $762,000 of money market accounts and $4.5 million of time deposits. At September 30, 2019, the $17.4 million CDARS deposits comprised $13.0 of million of interest-bearing demand deposits, $2.5 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 September 30, 2020:


	Balance		% of Total

	(Dollars in thousands)
Three months or less	$	41,209	43	%
Over three months through six months		15,580	16	%
Over six months through twelve months		28,830	30	%
Over twelve months		11,149	11	%
Total	$	96,768	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 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				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019
Return on average assets	0.98	%	1.44	%	0.73	%	1.50	%
Return on average tangible assets	1.02	%	1.49	%	0.76	%	1.55	%
Return on average equity	7.73	%	11.44	%	5.49	%	12.21	%
Return on average tangible equity	11.41	%	15.08	%	8.12	%	16.26	%
Average equity to average assets ratio	12.63	%	12.60	%	13.26	%	12.31	%

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

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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 69.32% at September 30, 2020, compared to 69.74% at September 30, 2019, and 74.20% at December 31, 2019.

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 September 30, 2020, September 30, 2019, and December 31, 2019. HBC had $237.0 million of loans pledged to the FHLB as collateral on an available line of credit of $177.7 million at September 30, 2020, none of which was outstanding. HBC also had $3.9 million of securities pledged to the FHLB as collateral on an available line of credit of $3.7 million at September 30, 2020, none of which was outstanding.

HBC can also borrow from the FRB’s discount window. HBC had $824.1 million of loans pledged to the FRB as collateral on an available line of credit of $463.4 million at September 30, 2020, none of which was outstanding.

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

The Company has a $10.0 million line of credit with a correspondent bank, of which none was outstanding at September 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 September 30, 2020, September 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.

It is anticipated that the LIBOR index will be phased-out by the end of 2021 and the Federal Reserve Bank of New York has established the Secured Overnight Financing Rate (“SOFR”) as its recommended alternative to LIBOR. We have created a sub-committee of our Asset Liability Management Committee to address LIBOR transition and phase-out issues. We are currently reviewing loan documentation, technology systems and procedures we will need to implement for the transition.

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.

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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:


	September 30,			September 30,			December 31,
	2020			2019			2019

	(Dollars in thousands)
Capital components:
Common equity Tier 1 capital	$	404,973		$	301,444		$	393,432
Additional Tier 1 capital		—			—			—
Tier 1 Capital		404,973			301,444			393,432
Tier 2 Capital		74,393			66,022			63,726
Total risk-based capital	$	479,366		$	367,466		$	457,158

Risk-weighted assets	$	3,001,350		$	2,270,997		$	3,136,252
Average assets for capital purposes	$	4,363,027		$	3,002,149		$	4,041,927

Capital ratios:
Total risk-based capital		16.0	%		16.2	%		14.6	%
Tier 1 risk-based capital		13.5	%		13.3	%		12.5	%
Common equity Tier 1 risk-based capital		13.5	%		13.3	%		12.5	%
Leverage(1)		9.3	%		10.0	%		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:


	September 30,			September 30,			December 31,
	2020			2019			2019

	(Dollars in thousands)
Capital components:
Common equity Tier 1 capital	$	422,369		$	319,572		$	411,585
Additional Tier 1 capital		—			—			—
Tier 1 Capital		422,369			319,572			411,585
Tier 2 Capital		34,700			26,515			24,172
Total risk-based capital	$	457,069		$	346,087		$	435,757

Risk-weighted assets	$	2,999,926		$	2,269,658		$	3,134,848
Average assets for capital purposes	$	4,361,322		$	3,000,792		$	4,040,265

Capital ratios:
Total risk-based capital		15.2	%		15.2	%		13.9	%
Tier 1 risk-based capital		14.1	%		14.1	%		13.1	%
Common equity Tier 1 risk-based capital		14.1	%		14.1	%		13.1	%
Leverage(1)		9.7	%		10.6	%		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 September 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 September 30, 2020, September 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 September 30, 2020, that management believes have changed the categorization of the Company or HBC as well-capitalized.

At September 30, 2020, the Company had total shareholders’ equity of $577.8 million, compared to $395.3 million at September 30, 2019, and $576.7 million at December 31, 2019. At September 30, 2020, total shareholders’ equity included $493.1 million in common stock, $91.1 million in retained earnings, and ($6.4) million of accumulated other comprehensive loss. The book value per share was $9.64 at September 30, 2020, compared to $9.09 at September 30, 2019, and $9.71 at December 31, 2019. The tangible book value per share was $6.55 at September 30, 2020, compared to $6.92 at September 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	September 30,		December 31,		September 30,
(in $000's, unaudited)	2020		2019		2019
Unrealized gain on securities available-for-sale	$	4,495	$	1,242	$	1,202
Remaining unamortized unrealized gain on securities
available-for-sale transferred to held-to-maturity		271		297		308
Split dollar insurance contracts liability		(4,839)		(4,835)		(3,794)
Supplemental executive retirement plan liability		(6,662)		(6,842)		(3,900)
Unrealized gain on interest-only strip from SBA loans		351		360		386
Total accumulated other comprehensive loss	$	(6,384)	$	(9,778)	$	(5,798)

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 September 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	$	54,287	43.6	%
+300	$	40,602	32.6	%
+200	$	26,851	21.6	%
+100	$	13,391	10.8	%
0	$	—	—	%
−100	$	(10,494)	(8.4)	%
−200	$	(20,934)	(16.8)	%

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 September 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 September 30, 2020, the period covered by this report on Form 10-Q.

During the three and nine months ended September 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

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beyond forbearance periods, which will adversely affect our net income;

●

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, if the U.S. economy experiences a recession as a result of the pandemic, our business could be materially and adversely affected. 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

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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 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

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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 September 30, 2020, formatted in Inline XBRL

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: November 5, 2020	/s/ KEITH A. WILTON
	Keith A. Wilton
	Chief Executive Officer

Date: November 5, 2020	/s/ Lawrence D. mcgovern
	Lawrence D. McGovern
	Chief Financial Officer

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Heritage Commerce (HTBK) 10-Q2020 Q3 Quarterly report

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