Loans | Note 6 – Loans The following table presents the composition of the loan portfolio as of the dates indicated (dollars in thousands): December 31, 2016 Principal Net Unaccreted Net Deferred Fees Total Commercial and Industrial Loans: $ 505,374 $ (2,737 ) $ 502,637 Loans Secured by Real Estate: Owner-Occupied Nonresidential Properties 455,120 (3,798 ) 451,322 Other Nonresidential Properties 635,856 (5,693 ) 630,163 Construction, Land Development and Other Land 195,215 (1,156 ) 194,059 1-4 Family Residential Properties 129,261 (2,097 ) 127,164 Multifamily Residential Properties 110,336 (478 ) 109,858 Total Loans Secured by Real Estate 1,525,788 (13,222 ) 1,512,566 Other Loans: 35,246 (223 ) 35,023 Total Loans $ 2,066,408 $ (16,182 ) $ 2,050,226 December 31, 2015 Principal Net Unaccreted Net Deferred Fees Total Commercial and Industrial Loans: $ 543,192 $ (5,824 ) $ 537,368 Loans Secured by Real Estate: Owner-Occupied Nonresidential Properties 412,772 (4,793 ) 407,979 Other Nonresidential Properties 539,260 (6,092 ) 533,168 Construction, Land Development and Other Land 126,626 (794 ) 125,832 1-4 Family Residential Properties 117,400 (2,875 ) 114,525 Multifamily Residential Properties 72,222 (1,043 ) 71,179 Total Loans Secured by Real Estate 1,268,280 (15,597 ) 1,252,683 Other Loans: 43,218 (106 ) 43,112 Total Loans $ 1,854,690 $ (21,527 ) $ 1,833,163 Loans are made to commercial, non-profit organizations and consumers. Specific loan terms vary as to interest rate, repayment, and collateral requirements based on the type of loan requested and the credit worthiness of the prospective borrower. Credit risk tends to be geographically concentrated in Southern California where a majority of the Company’s loan customers are located. The Company’s extensions of credit are governed by its credit policies which are established to control the quality, structure and adherence to applicable laws. These policies are reviewed and approved by the Board of Directors on a regular basis. Commercial and Industrial Loans Commercial Real Estate Loans Construction and Land Development Loans Residential Loans Other Loans Acquired loans: Restructured loans Concentrations The Company makes commercial, construction, commercial real estate, and consumer home equity loans to customers primarily in Los Angeles, Riverside, Orange, San Bernardino and Ventura Counties. As an abundance of caution, the Company may require commercial real estate collateral on a loan classified as a commercial loan. At December 31, 2016, loans secured by real estate collateral accounted for approximately 74% of the loan portfolio. Of these loans, 96% are secured by first trust deed liens and 4% are secured by second trust deed liens. In addition, 30% are secured by owner-occupied non-residential properties. Loans secured by first trust deeds on commercial real estate generally have an initial loan to value ratio of not more than 75%, except for SBA guaranteed loans which may exceed this level. The Company’s policy for requiring collateral is to obtain collateral whenever it is available or desirable, depending upon the degree of risk in the proposed credit transaction. In addition, 20% of total loans have been secured by a UCC filing on the business property of the borrower. Approximately 5% of loans are unsecured. The Company’s loans are expected to be repaid from cash flows or from proceeds from the sale of selected assets of the borrowers. A substantial portion of the Company’s customers’ ability to honor their contracts is dependent on the economy in the area. The Company’s goal is to continue to maintain a diversified loan portfolio which are well collateralized and supported by sufficient cash flows. Small Business Administration Loans As part of the acquisition of PC Bancorp, the Company acquired loans that were originated under the guidelines of the Small Business Administration (“SBA”) program. The total portfolio of the SBA contractual loan balances being serviced by the Company at December 31, 2016 was $104 million, of which $75 million has been sold. Of the $29 million remaining on the Company’s books at December 31, 2016, $24 million is not guaranteed and $5 million is guaranteed by the SBA. In 2016, $14 million of SBA loans with contractual loan balances of $19 million were sold. Of the $4.8 million remaining on the Company’s books at December 31, 2016, $4.7 million is not guaranteed and $123 thousand is guaranteed. Allowance for Loan Loss The allowance for loan loss is established through a provision for loan losses charged to expense, which represents managements’ best estimate of probable losses that exist within the loan portfolio. The Allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Allowance consists of specific and general components. The specific component relates to loans that are categorized as impaired. For loans that are categorized as impaired, a specific allowance is established when the realizable value of the impaired loan is lower than the carrying value of that loan. Impairment is measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Company may measure impairment based on the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. In addition, the impaired loan is reevaluated at each subsequent reporting period. The general component covers non-impaired loans and is based on the historical loan loss experience of the portfolio loan segments for the past 20 quarters, however the Company considers the Uniform Bank Peer Group (“UBPR”) historical loss data to evaluate potential loss exposure for those loan segments where the Company had no meaningful historical loss experience. The Allowance also includes an assessment of the following qualitative factors: the results of any internal and external loan reviews and any regulatory examination, loan charge-off experience, estimated potential charge-off exposure on each classified loan, credit concentrations, changes in the value of collateral for collateral dependent loans, and any known impairment in the borrower’s ability to repay. The Company also evaluates environmental and other factors such as underwriting standards, staff experience, the nature and volume of loans and loan terms, business conditions, political and regulatory conditions, local and national economic trends. The quantitative portion of the Allowance is adjusted for qualitative factors to account for model imprecision and to incorporate the range of probable outcomes inherent in the estimates used for the Allowance. The Company conducts a critical evaluation of the credit quality of the loan portfolio and the adequacy of the Allowance on a quarterly basis. The level of the Allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the Allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the Allowance is dependent upon a variety of factors beyond the Company’s control, including among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. The following is a summary of activity for the allowance for loan loss for the dates and periods indicated (dollars in thousands): December 31, 2016 2015 2014 Allowance for loan loss at beginning of year $ 15,682 $ 12,610 $ 10,603 Provision for loan losses 3,264 5,080 2,239 Net (charge-offs) recoveries: Charge-offs (895 ) (2,510 ) (692 ) Recoveries 1,323 502 460 Net (charge-offs) recoveries 428 (2,008 ) (232 ) Allowance for loan loss at end of year $ 19,374 $ 15,682 $ 12,610 Net (charge-offs) recoveries to average loans 0.02 % (0.12 )% (0.02 )% Allowance for loan loss to total loans 0.94 % 0.86 % 0.78 % Allowance for loan loss to total loans accounted for at historical cost, which excludes loans and the related allowance for loans acquired through acquisition 1.18 % 1.25 % 1.39 % The following tables present, by portfolio segment, the changes in the allowance for loan loss and the recorded investment in loans as of the dates and for the periods indicated (dollars in thousands): Commercial and Industrial Construction, Land Development and Other Land Commercial Other Real Other Total Year ended – December 31, 2016 Allowance for loan loss – Beginning balance $ 5,924 $ 2,076 $ 6,821 $ 861 $ 15,682 Provision for loan losses 783 1,008 1,661 (188 ) 3,264 Net (charge-offs) recoveries: Charge-offs (895 ) — — — (895 ) Recoveries 1,318 — 5 — 1,323 Total net recoveries 423 — 5 — 428 Ending balance $ 7,130 $ 3,084 $ 8,487 $ 673 $ 19,374 Commercial and Industrial Construction, Land Development and Other Land Commercial Other Real Other Total Year ended – December 31, 2015 Allowance for loan loss – Beginning balance $ 5,864 $ 1,684 $ 4,802 $ 260 $ 12,610 Provision for loan losses 1,781 392 2,306 601 5,080 Net (charge-offs) recoveries: Charge-offs (2,218 ) — (292 ) — (2,510 ) Recoveries 497 — 5 — 502 Total net (charge-offs) (1,721 ) — (287 ) — (2,008 ) Ending balance $ 5,924 $ 2,076 $ 6,821 $ 861 $ 15,682 The following tables present both the allowance for loan loss and the associated loan balance classified by loan portfolio segment and by credit evaluation methodology (dollars in thousands): Commercial and Industrial Construction, Land and Other Land Commercial Other Real Other Total December 31, 2016 Allowance for loan loss: Individually evaluated for impairment $ — $ — $ — $ — $ — Collectively evaluated for impairment 7,130 3,084 8,487 673 19,374 Purchased credit impaired (loans acquired with deteriorated credit quality) — — — — — Total Allowance for Loan Loss $ 7,130 $ 3,084 $ 8,487 $ 673 $ 19,374 Loans receivable: Individually evaluated for impairment $ 378 $ — $ 245 $ — $ 623 Collectively evaluated for impairment 501,960 194,059 1,316,849 35,023 2,047,891 Purchased credit impaired (loans acquired with deteriorated credit quality) 299 — 1,413 — 1,712 Total Loans Receivable $ 502,637 $ 194,059 $ 1,318,507 $ 35,023 $ 2,050,226 Commercial and Industrial Construction, Land and Other Land Commercial Other Real Other Total December 31, 2015 Allowance for loan loss: Individually evaluated for impairment $ — $ — $ — $ — $ — Collectively evaluated for impairment 5,924 2,076 6,821 861 15,682 Purchased credit impaired (loans acquired with deteriorated credit quality) — — — — — Total Allowance for Loan Loss $ 5,924 $ 2,076 $ 6,821 $ 861 $ 15,682 Loans receivable: Individually evaluated for impairment $ 558 $ — $ 649 $ — $ 1,207 Collectively evaluated for impairment 536,333 125,832 1,124,667 43,112 1,829,944 Purchased credit impaired (loans acquired with deteriorated credit quality) 477 — 1,535 — 2,012 Total Loans Receivable $ 537,368 $ 125,832 $ 1,126,851 $ 43,112 $ 1,833,163 Credit Quality of Loans The Company utilizes an internal loan classification system as a means of reporting problem and potential problem loans. Under the Company’s loan risk rating system, loans are classified as “Pass,” with problem and potential problem loans as “Special Mention,” “Substandard,” “Doubtful” and “Loss”. All loans are monitored and individual loan risk ratings are changed any time the situation warrants. In addition, management regularly reviews problem loans to determine whether any loan requires a classification change, in accordance with the Company’s policy and applicable regulations. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled or at all. The internal loan classification risk grading system is based on experiences with similarly graded loans. The Company’s internally assigned grades are as follows: • Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral. There are several different levels of Pass rated credits, including “Watch” which is considered a transitory grade for pass rated loans that require greater monitoring. Loans not meeting the criteria of special mention, substandard, doubtful or loss that have been analyzed individually as part of the above described process are considered to be pass-rated loans. • Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected. Special Mention loans do not currently expose the Company to sufficient risk to warrant classification as a Substandard, Doubtful or Loss classification, but possess weaknesses that deserve management’s close attention. • Substandard – loans that have a well-defined weakness based on objective evidence and can be characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. • Doubtful – loans classified as doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. • Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted. The following tables present the risk category of loans by class of loans based on the most recent internal loan classification as of the dates indicated (dollars in thousands): December 31, 2016 Commercial Construction, Commercial Other Real Other Total Pass $ 456,885 $ 194,059 $ 1,288,154 $ 32,128 $ 1,971,226 Special Mention 12,774 — 7,557 — 20,331 Substandard 32,978 — 22,796 2,895 58,669 Doubtful — — — — — Total $ 502,637 $ 194,059 $ 1,318,507 $ 35,023 $ 2,050,226 December 31, 2015 Commercial Construction, Commercial Other Real Other Total Pass $ 503,006 $ 125,832 $ 1,101,548 $ 40,132 $ 1,770,518 Special Mention 16,041 — 6,494 43 22,578 Substandard 18,321 — 18,809 2,937 40,067 Doubtful — — — — — Total $ 537,368 $ 125,832 $ 1,126,851 $ 43,112 $ 1,833,163 Age Analysis of Past Due and Non-Accrual Loans The following tables present an aging analysis of the recorded investment in past due and non-accrual loans as of the dates indicated (dollars in thousands): December 31, 2016 31-60 Days Past Due 61-90 Days Past Due Greater 90 Days Past Due and Total Past Due and Total Non- Current Total Loans Commercial and Industrial $ — $ — $ — $ — $ 675 $ 501,962 $ 502,637 Construction, Land Development and Other Land — — — — — 194,059 194,059 Commercial and Other Real Estate 212 — — 212 447 1,317,848 1,318,507 Other — — — — — 35,023 35,023 Total $ 212 $ — $ — $ 212 $ 1,122 $ 2,048,892 $ 2,050,226 December 31, 2015 31-60 Days Past Due 61-90 Days Past Due Greater 90 Days Past Due and Total Past Due and Total Non- Current Total Loans Commercial and Industrial $ — $ — $ — $ — $ 1,032 $ 536,336 $ 537,368 Construction, Land Development and Other Land — — — — — 125,832 125,832 Commercial and Other Real Estate — — — — 1,019 1,125,832 1,126,851 Other — — — — — 43,112 43,112 Total $ — $ — $ — $ — $ 2,051 $ 1,831,112 $ 1,833,163 Included in the non-accrual column above are purchased credit impaired loans of $499 thousand and $844 thousand as of December 31, 2016 and 2015, respectively. Included in the current column are purchased credit impaired loans that have been returned to accrual status of $1.2 million and $1.2 million as of December 31, 2016 and 2015, respectively. Impaired Loans Impaired loans are evaluated by comparing the present value of the expected future cash flows discounted at the loan’s effective interest rate, or if the loan is collateral dependent, the fair value of the collateral less costs to sell, with the recorded investment of a loan. A valuation allowance is established for an impaired loan when the fair value of the loan is less than the recorded investment. In certain cases, portions of impaired loans are charged-off to the fair value instead of establishing a valuation allowance and are included, when applicable, in the table below as impaired loans “with no specific allowance recorded.” The valuation allowance disclosed below is included in the allowance for loan loss reported in the consolidated balance sheets as of December 31, 2016 and December 31, 2015. The following tables present, by loan portfolio segment, the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount, if applicable for the dates and periods indicated (dollars in thousands). These tables exclude purchased credit impaired loans (loans acquired in acquisitions with deteriorated credit quality) of $1.7 million and $2.0 million at December 31, 2016 and 2015, respectively. Year ended December 31, 2016 Recorded Unpaid Related Average Interest With no specific allowance recorded: Commercial and Industrial $ 378 $ 1,383 $ — $ 401 $ — Commercial and Other Real Estate 245 282 — 252 — With an allowance recorded: Commercial and Industrial — — — — — Commercial and Other Real Estate — — — — — Total Commercial and Industrial 378 1,383 — 401 — Commercial and Other Real Estate 245 282 — 252 — Total $ 623 $ 1,665 $ — $ 653 $ — Year ended December 31, 2015 Recorded Unpaid Related Average Interest With no specific allowance recorded: Commercial and Industrial $ 558 $ 1,027 $ — $ 672 $ — Commercial and Other Real Estate 649 692 — 70 — With an allowance recorded: Commercial and Industrial — — — — — Commercial and Other Real Estate — — — — — Total Commercial and Industrial 558 1,027 — 672 — Commercial and Other Real Estate 649 692 — 70 — Total $ 1,207 $ 1,719 $ — $ 742 $ — The following is a summary of additional information pertaining to impaired loans for the periods indicated (dollars in thousands): Year Ended December 31, 2016 2015 2014 Average recorded investment in impaired loans $ 653 $ 742 $ 4,991 Interest foregone on impaired loans $ 89 $ 265 421 Cash collections applied to reduce principal balance $ 351 $ 1,118 3,014 Interest income recognized on cash collections $ — $ — $ — Troubled Debt Restructuring The Company’s loan portfolio contains certain loans that have been modified in a Troubled Debt Restructuring (“TDR”), where economic concessions have been granted to borrowers experiencing financial difficulties. Loans are restructured in an effort to maximize collections. Economic concessions can include: reductions to the stated interest rate, payment extensions, principal forgiveness or other actions. The modification process includes evaluation of impairment based on the present value of expected future cash flows, discounted at the effective interest rate of the original loan agreement, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the loan collateral. In these cases, management uses the current fair value of the collateral, less selling costs, to evaluate the loan for impairment. If management determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs and unamortized premium or discount) impairment is recognized through a specific allowance or a charge-off. The following tables include the recorded investment and unpaid principal balances for troubled debt restructured loans at December 31, 2016, December 31, 2015 and December 31, 2014 (dollars in thousands). These tables include TDR loans that were purchased credit impaired (“PCI”). TDR loans that are non-PCI loans are included in Impaired Loans disclosures. As of December 31, 2016, there were two PCI loans that are considered to be TDR loans with a recorded investment of $105 thousand and unpaid principal balances of $273 thousand. Year ended December 31, 2016 Recorded Unpaid Interest Commercial and Industrial $ 408 $ 1,174 $ — Total $ 408 $ 1,174 $ — Year ended December 31, 2015 Recorded Unpaid Interest Commercial and Industrial $ 627 $ 1,363 $ — Total $ 627 $ 1,363 $ — Year ended December 31, 2014 Recorded Unpaid Interest Commercial and Industrial $ 530 $ 719 $ — Commercial and Other Real Estate 114 115 — Total $ 644 $ 834 $ — The following tables show the pre- and post-modification recorded investment in TDR loans by loan segment that have occurred during the periods indicated (dollars in thousands): Year ended December 31, 2016 Number Pre-Modification Post- Extended Maturity Date and Deferred Principal and Interest Payments: Commercial and Industrial 1 $ 650 $ 73 Total 1 $ 650 $ 73 Year ended December 31, 2015 Number Pre-Modification Post- Reduced Interest Rate and Lengthened Amortization: Commercial and Industrial 3 $ 1,335 $ 208 Total 3 $ 1,335 $ 208 Year ended December 31, 2014 Number Pre-Modification Post- Reduced Interest Rate and Lengthened Amortization: Commercial and Industrial 1 $ 224 $ 224 Commercial and Other Real Estate 1 114 114 Total 2 $ 338 $ 338 Loans are restructured in an effort to maximize collections. Impairment analyses are performed on the Company’s troubled debt restructured loans in conjunction with the normal allowance for loan loss process. The Company’s troubled debt restructured loans are analyzed to ensure adequate cash flow or collateral supports the outstanding loan balance. There were no commitments to lend additional funds to borrowers whose terms have been modified in troubled debt restructurings at December 31, 2016 or 2015. There have been no payment defaults in the year ended December 31, 2016 subsequent to modification on troubled debt restructured loans that have been modified within the last twelve months. Loans Acquired Through Acquisition The following table reflects the accretable net discount for loans acquired through acquisition, for the periods indicated (dollars in thousands): Year Ended December 31, 2016 2015 Balance, beginning of year $ 14,610 $ 21,402 Accretion, included in interest income (4,967 ) (6,274 ) Additions, due to acquisition — — Reclassifications to non-accretable yield (32 ) (518 ) Balance, end of year $ 9,611 $ 14,610 The above table reflects the fair value adjustment on the loans acquired from mergers that will be amortized to loan interest income based on the effective yield method over the remaining life of the loans. These amounts do not include the fair value adjustments on the purchased credit impaired loans acquired from mergers. Purchased Credit Impaired Loans PCI loans are acquired loans with evidence of deterioration of credit quality since origination and it is probable at the acquisition date, that the Company will not be able to collect all contractually required amounts. When the timing and/or amounts of expected cash flows on such loans are not reasonably estimable, no interest is accreted and the loan is reported as a non-accrual loan; otherwise, if the timing and amounts of expected cash flows for PCI loans are reasonably estimable, then interest is accreted and the loans are reported as accruing loans. The non-accretable difference represents the difference between the undiscounted contractual cash flows and the undiscounted expected cash flows, and also reflects the estimated credit losses in the acquired loan portfolio at the acquisition date and can fluctuate due to changes in expected cash flows during the life of the PCI loans. The following table reflects the outstanding balance and related carrying value of PCI loans as of the dates indicated (dollars in thousands): December 31, 2016 December 31, 2015 Unpaid Carrying Unpaid Carrying Commercial and Industrial $ 622 $ 299 $ 2,331 $ 477 Commercial and Other Real Estate 1,997 1,413 2,250 1,535 Other — — 61 — Total $ 2,619 $ 1,712 $ 4,642 $ 2,012 There is no related allowance for credit losses with the PCI loans as of December 31, 2016 and 2015 included in the tables above. The following table reflects the activities in the accretable net discount for PCI loans for the period indicated (dollars in thousands): Year Ended Year Ended Balance, beginning of year $ 246 $ 324 Accretion, included in interest income (85 ) (78 ) Reclassifications from non-accretable yield — — Balance, end of year $ 161 $ 246 |