Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-K
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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 0-25135
Bank of Commerce Holdings
(Exact name of Registrant as specified in its charter)
California | 94-2823865 |
(State or jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
| | |
555 Capitol Mall, Suite 1255 | |
Sacramento, California | 95814 |
(Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: (800) 421-2575
Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
Common Stock | BOCH | NASDAQ |
Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ☐ No ☒
Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.
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 | ☐ | | Non-accelerated filer | ☒ |
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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.
As of the last day of the second fiscal quarter of 2020, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $119,198,229 based on the closing sale price of $7.58 as reported on the NASDAQ Global Market as of June 30 2020.
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date.
The number of shares of the registrant’s no par value Common Stock outstanding as of February 22, 2021 was 16,868,089.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement of the registrant for its 2021 Annual Meeting of Shareholders, which will be subsequently filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this report relates, are incorporated by reference into Part III of this Annual Report on Form 10-K.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Bank of Commerce Holdings Form 10-K
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Part I
Special Note Regarding Forward-Looking Statements
This report includes forward-looking statements within the meaning of the Securities Exchange Act of 1934 (“Exchange Act”) and the Private Securities Litigation Reform Act of 1995. These statements are based on management’s current beliefs and assumptions, and on information available to management as of the date of this document. Forward-looking statements include the information concerning possible or assumed future results of operations of the Company set forth under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Forward-looking statements may also include statements in which words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” “considers” or similar expressions or conditional verbs such as “will,” “should,” “would” and “could” and other comparable words or phrases of a future- or forward-looking nature, are intended to identify such forward-looking statements. Forward-looking statements are not guarantees of future performance. They involve risks, uncertainties and assumptions. The Company’s actual future results and shareholder values may differ materially from those anticipated and expressed in these forward-looking statements. Many of the factors that will determine these results and values are beyond the Company’s ability to control or predict. Except as specifically noted herein all references to the “Company” refer to Bank of Commerce Holdings, a California corporation, and its consolidated subsidiaries.
The following factors, among others, could cause our actual results to differ materially from those expressed in such forward-looking statements:
● | The strength of the United States economy in general and the strength of the local economies in California in which we conduct operations; |
● | The effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System, or the Federal Reserve Board; |
● | Increased regulation of the banking industry through legislative action and revised rules and standards applied by the Federal Reserve Board, the Federal Deposit Insurance Corporation and the California Department of Financial Protection and Innovation; |
● | Developments and changes in Federal, state or local laws and regulations addressing the effects of the COVID-19 pandemic; |
● | The economic effects of COVID-19 or similar pandemic diseases could adversely affect our future results of operations or the market price of our stock; |
● | Changes affecting the Small Business Administration (“SBA”), including how such changes may impact the status of our outstanding Paycheck Protection Program (“PPP”) loans; |
● | Our inability to successfully manage our growth or implement our growth strategy; |
● | Volatility in the capital or credit markets; |
● | Our inability to transition from LIBOR to a substitute index; |
● | Changes in the financial performance and/or condition of our borrowers; |
● | Our concentration in real estate lending; |
● | Changes in the cost and scope of insurance from the Federal Deposit Insurance Corporation and other third parties; |
● | Changes in consumer spending, borrowing and savings habits; |
● | Deterioration in the reputation of banks and the financial services industry could adversely affect the Company's ability to obtain and retain customers; |
● | Changes in the level of our nonperforming assets and loan charge-offs; |
● | Deterioration in values of real estate in California and the United States generally, both residential and commercial; |
● | Possible other-than-temporary impairment of securities held by us; |
● | Possible impairment of goodwill or core deposit intangibles; |
| ● | Our inability to timely develop competitive new products and services and/or resistance to the acceptance of these products and services by new and existing customers; |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
● | The willingness of customers to substitute competitors’ products and services for our products and services; |
● | Technological changes could expose us to new risks, including potential systems failures or fraud; |
● | The effect of changes in accounting policies and practices, as may be adopted from time-to-time by bank regulatory agencies, the Securities and Exchange Commission (“SEC”), the Public Company Accounting Oversight Board, the Financial Accounting Standards Board (“FASB”) or other accounting standards setters; |
● | The risks presented by public stock market volatility, which could adversely affect the market price of the Company's common stock and the ability to grow the Company through acquisitions or raise capital in the future; |
● | Our inability to attract deposits and other sources of liquidity at acceptable costs; |
● | Changes in the competitive environment among financial and bank holding companies and other financial service providers, including Fintech companies; |
● | Consolidation in the financial services industry resulting in larger financial institutions with greater resources and decreasing opportunities to pursue acquisitions; |
● | The loss of critical personnel and the challenge of hiring qualified personnel at reasonable compensation levels; |
● | Natural disasters, such as earthquakes, volcanic eruptions, tsunami, wildfires, droughts, floods, mudslides, hurricanes, tornados and other geologic processes; |
● | A natural disaster outside California, could negatively impact our purchased loan portfolio or our third party loan servicers; |
● | Unauthorized computer access, computer hacking, cyber-attacks, electronic fraudulent activity, attempted theft of financial assets, computer viruses, phishing schemes and other security problems; |
● | Geopolitical conditions, including acts or threats of war or terrorism, actions taken by the United States or other governments in response to acts or threats of war or terrorism and/or military conflicts, which could impact business and economic conditions in the United States and abroad; |
● | Our inability to manage the risks involved in the foregoing; and |
● | The effects of any reputational damage to the Company resulting from any of the foregoing. |
Additional factors that could cause actual results to differ materially from those expressed in the forward-looking statements are discussed in the sections entitled “RISK FACTORS,” BUSINESS” and in “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” in this Form 10-K.
If our assumptions regarding one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements contained in this document and in the information incorporated by reference in this document. Therefore, we caution you not to place undue reliance on our forward-looking information and statements. We do not undertake any obligation to publicly correct, revise, or update any forward-looking statement if we later become aware that actual results are likely to differ materially from those expressed in such forward-looking statement, except as required under federal securities laws.
Item 1 - Business
Bank of Commerce Holdings (“Company,” “Holding Company,” “we,” or “us”) is a corporation organized under the laws of California and a bank holding company (“BHC”) registered under the Bank Holding Company Act of 1956, as amended (“BHC Act”) with its principal offices in Sacramento, California. The Holding Company’s principal business is to serve as a holding company for Merchants Bank of Commerce (the “Bank” and together with the Holding Company, the “Company”) and Bank of Commerce Mortgage (inactive). The Bank, which previously operated under three separate names, changed its name for all operations to Merchants Bank of Commerce effective May 20, 2019. We have an unconsolidated subsidiary in Bank of Commerce Holdings Trust II, which was organized in connection with our prior issuance of trust-preferred securities. Our common stock is traded on the NASDAQ Global Market under the symbol “BOCH.”
We commenced banking operations in 1982 and grew organically to four branches before purchasing five Bank of America branches in 2016 and acquiring Merchants Holding Company in 2019. In December of 2020, we expanded to San Francisco’s North Bay markets through the opening of a Loan Production Office (“LPO”) in Santa Rosa. We now operate ten full service facilities, one limited service facility and one loan production office in northern California. We also operate a “cyber office” as identified in our summary of deposits reporting filed with the FDIC. We provide a wide range of financial services and products for business and retail customers which are competitive with those traditionally offered by banks of similar size in California. As of December 31, 2020, we operated under one primary business segment: Community Banking. Additional information regarding operating segments can be found in Note 2 Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in this document.
We continuously seek expansion opportunities through internal growth, strategic alliances, acquisitions, establishing new offices or the delivery of new products and services. Periodically, we reevaluate the short and long-term profitability of all of our lines of business, and do not hesitate to reduce or eliminate unprofitable locations or lines of business. We remain a viable, independent bank committed to enhancing shareholder value. This commitment has been fostered by proactive management and dedication to staff, customers and the markets we serve.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
On January 31, 2019, we completed the acquisition of Merchants Holding Company, to extend our presence in the Sacramento marketplace. Merchants Holding Company, headquartered in Sacramento, California, was the parent company of The Merchants National Bank of Sacramento (“Merchants National Bank of Sacramento”), a 97-year-old bank with approximately $211.7 million in assets as of January 31, 2019. See Note 21 Acquisition in the Notes to Consolidated Financial Statements for more information on this acquisition.
Our governance structure enables us to manage all major aspects of our business effectively through an integrated process that includes financial, strategic, risk and leadership planning. Our management processes, structures and policies and procedures help to ensure compliance with laws and regulations and provide clear lines of authority for decision-making and accountability. Results are important, but we are equally concerned with how we achieve those results. Our core values and our commitment to high ethical standards are material to sustaining public trust and confidence in our Company.
Our primary business strategy is to provide comprehensive banking and related services to businesses, not-for-profit organizations, professional service providers and consumers in northern California. We continue to emphasize the diversity of our product lines and high levels of personal service. Through our technology, we offer convenient access typically associated with larger financial institutions, while maintaining the local decision-making authority and market knowledge, typical of a local community bank. Management intends to continue to pursue our business strategy through the following initiatives:
Utilize the Strength of Our Management Team. We believe the experience and depth of knowledge of our management team represents one of our greatest strengths and competitive advantages.
Leverage Our Existing Foundation for Additional Growth. Based on certain infrastructure investments, we believe that we will be able to take advantage of certain economies of scale typically enjoyed by larger organizations to expand our operations both organically and through strategic cost-effective opportunities. We have made investments in data processing, our staff, our risk and compliance function, and our branch network to support a much larger asset base. We are committed, however, to limit additional growth within acceptable risk parameters and to maintain appropriate capital ratios.
Maintain Local Decision-Making and Accountability. We believe we have a competitive advantage over larger national and regional financial institutions by providing superior customer service with experienced, knowledgeable management, localized decision-making capabilities and prompt credit decisions.
Focus on Asset Quality and Strong Underwriting. We consider asset quality to be of primary importance and have taken measures to ensure that credit risks are managed effectively to safeguard shareholder value. As part of our efforts, we utilize a third party loan review service to evaluate our loan portfolio on a semiannual basis and recommend action on specific loans if deemed appropriate.
Build a Stable Core Deposit Base. We continue to focus on increasing our stable core deposit base of business and retail customers. Our branch acquisition in 2016 allowed us to reduce our historic reliance on Federal Home Loan Bank of San Francisco (“FHLB”) borrowings and our former reliance on nonlocal time deposits. Our acquisition of Merchants National Bank of Sacramento in 2019 further enhanced our core deposit base by adding $152.2 million in demand and savings accounts. We intend to continue our practice of pursuing full deposit relationships with each of our loan customers, their business partners, and key employees.
Principal Market
We operate under the name Merchants Bank of Commerce in northern California along the Interstate 5 corridor from Sacramento to Yreka and in the wine region north of San Francisco.
Principal Products and Services
Most of our current customers are small to medium-sized businesses and retail consumers. No single person or group of persons provides a material portion of the Bank’s deposits or loans, the loss of any one or more of which would have a materially adverse effect on the business of the Bank.
We provide a wide range of financial services and products for businesses and consumers. The services we offer include those traditionally offered by banks of similar size and character in California. Our principal deposit products include the following types of accounts; checking, interest-bearing checking, money market, savings and certificates of deposit. We also offer sweep arrangements, commercial loans, construction loans, term loans, consumer loans, safe deposit boxes, and electronic banking services. We currently do not offer trust services or international banking services.
The majority of the loans we originate are direct loans made to small businesses and individuals in our principal market. We accept as collateral for loans, real estate, listed and unlisted securities, savings and time deposits, automobiles, machinery and equipment and other general business assets such as accounts receivable and inventory. In addition to direct lending, our loan portfolio includes loans that were purchased as pools of loans, or participations where a portion of a loan was originated by another lending institution.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Regulatory Capital
Our regulators measure our capital adequacy and compliance with minimum leverage ratio guidelines. As of December 31, 2020, the most recent notification from the FDIC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since the notification that management believes have changed the Bank’s risk category. See Item 7 - Management’s Discussion And Analysis Of Financial Condition And Results Of Operations and Note 17 Regulatory Capital in the Notes to Consolidated Financial Statements in this document for a discussion of the regulatory capital guidelines.
Competition
We engage in the highly competitive financial services industry. Generally, our market and our lines of activity involve competition with other banks, thrifts, credit unions and other non-bank financial institutions, such as investment advisory firms, brokerage firms, investment companies and insurance entities which offer financial services, both in “brick and mortar” locations and through alternative delivery channels such as the Internet. Many of these competitors enjoy fewer regulatory constraints and some may have lower cost structures. Our ability to compete is focused on various factors such as physical locations, customer service, interest rates, lending limits, customer convenience and technological convenience.
Securities firms, insurance companies and brokerage houses that elect to become financial holding companies may acquire banks and other financial institutions. Combinations of this type have significantly changed the competitive environment in which we conduct business.
In order to compete with major banks and other competitors in our primary service areas, we rely upon;
● | The experience of our executive and senior officers; |
● | Our specialized services and local promotional activities; |
● | The personal contacts made by our officers, directors and employees; |
● | Third party referral sources. |
Human Capital Disclosure
As of December 31, 2020, we employed 206 full-time equivalent employees. None of the employees are subject to a collective bargaining agreement and management believes its relations with employees to be good. See Note 15 Employee Benefits and Retirement Plans in the Notes to Consolidated Financial Statements in this document for further detail on employee relations. Information regarding employment agreements with our executive officers is contained in Item 11 – Executive Compensation below, which is incorporated by reference to our proxy statement for the 2021 annual meeting of shareholders.
At our Company, we have a strong commitment to human capital resource management. Our employees are central to everything we do and critical to our long-term success as a company. Accordingly, we are committed to ensuring our Company is a rewarding place to work. We deliver on this commitment by being an inclusive workplace for all of our employees, creating opportunities for growth and development, recognizing and rewarding performance, and supporting our employees' physical, emotional and financial wellness.
Diversity and Inclusion
Being a diverse and inclusive company is one of our core values. We are strengthened by the diverse backgrounds, experiences and perspectives of our employees and we strive to ensure our workforce represents the communities we serve - in thought, style, experience, culture, race, ethnicity, gender identity, and sexual orientation. At our Company, we strive for diversity and inclusion at all levels.
Fair Wages and Benefits
Paying fair and competitive wages and supporting employee wellness are critical components of being a rewarding place to work. We pay our employees competitively based on market rates for their roles and how they perform, and we regularly benchmark against other companies within our industry to ensure our pay is competitive in the market for comparable roles. Our Company is committed to compensating all of our employees fairly and equitably based on performance, with equal pay for equal work, regardless of race or gender.
Emergency Preparedness
It is our goal to maintain essential business services and operations during any incident or emergency while providing safety for customers and employees. Emergencies may arise from severe weather or natural disaster, mass casualty, fire, bomb threats, acts of terrorism, pandemic or other events. We are dedicated to supporting our communities through the emergencies by providing loan assistance and donations of essential items.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
We have developed the following internal policies to provide guidance during a business disruption:
● | Business Continuity Program (BCP); |
● | Pandemic Planning; |
● | Physical Safety & Security Management Policy; and |
● | Teleworking Policy. |
Volunteering
Taking action to improve the well-being of others is a community responsibility and a commitment we have upheld since our founding. We are committed to being a socially responsible employer by fostering an environment of diversity and inclusion across our business and supporting our local communities. We provide direct financial support to those in need and also provide support to employees who generously give their time and talent to local civic and nonprofit organizations in the communities where we operate.
Environmental and Social Governance
We consider responsible growth and environmental and social governance leadership to be integral parts of our business. Responsible growth means we strive to grow and be successful in the marketplace by developing strong relationship with clients and by providing top tier service while maintaining our commitment to environmental and social stewardship. We realize that we must do this in a way that appropriately manages risk, ensures our growth is sustainable and enables us to continue to invest in our people, company and communities. Our commitment to environmental and social stewardship requires us to balance our pursuit of business opportunities against the need to address our state’s significant environmental and social challenges. In part, it defines how we deploy our capital and resources, forms our business practices and helps determine how and when we use our voice in support of our values. Integrated across our lines of business, our environmental and social focus reflects how we hold ourselves accountable and allows us to create shared success with our clients and communities.
On February 16, 2021, we adopted an Environmental and Social Risk Policy (“ESRP”) Framework. The ESRP Framework outlines our approach to environmental and social issues, and how that approach aligns with our fundamental business strategy of responsible growth. The ESRP Framework addresses issues including risk management, governance structure, public disclosure, external standards and enforcement. Moving forward, we will review this framework in light of feedback from stakeholders, future materiality assessments, market developments, evolving best practices and regulatory developments.
Government Supervision and Regulation
Supervision and Regulation
The Holding Company and the Bank are subject to extensive regulation under federal and state law. In general, this regulatory framework is designed to protect depositors, the federal deposit insurance fund (the “DIF”) and the federal and state banking system as a whole; it does not exist for the protection of shareholders. As the breadth and scope of regulatory requirements increase, our costs to identify, monitor and comply with these requirements increase, as well.
This section provides a general overview of the federal and state regulatory framework applicable to the Holding Company and the Bank. It is not intended to summarize all applicable laws and regulations. To the extent this section describes statutory and regulatory provisions, it is qualified by reference to those provisions. These statutes and regulations, as well as related policies, continue to be subject to change (or interpretation) by Congress, state legislatures and federal and state regulators. Numerous changes to the statutes, regulations and regulatory policies applicable to us (including their interpretation or implementation) have been proposed but cannot be predicted and could have a material effect on our business or operations.
The Holding Company is subject to regulation and supervision by the Federal Reserve (as a bank holding company) and regulation by the State of California (as a California corporation). The Holding Company is also subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, both of which are administered by the SEC. As a listed company on the NASDAQ Global Market, the Holding Company is subject to the rules of the NASDAQ for listed companies. The Bank is subject to regulation and examination by the Federal Deposit Insurance Corporation (“FDIC”) and by the California Department of Financial Protection and Innovation (“CDFPI”).
Bank Holding Company Regulation – Federal and State
General
As a bank holding company, the Holding Company is subject to regulation under the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and to inspection, examination and supervision by its primary regulator, the Board of Governors of the Federal Reserve System (“Federal Reserve” or “FRB”). In general, the BHC Act limits the business of bank holding companies to owning or controlling banks and engaging in other activities closely related to the business of banking. In addition, the Holding Company must file reports with the Federal Reserve and provide the agency with such additional information as it may require.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Holding Company Bank Ownership
The BHC Act requires every bank holding company to obtain the prior approval of the Federal Reserve before (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares; (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company.
Holding Company Control of Nonbanks
With some exceptions, the BHC Act also prohibits a bank holding company from acquiring or retaining direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities that, by federal statute, agency regulation or order, have been identified as activities closely related to the business of banking or of managing or controlling banks.
Transactions with Affiliates
Subsidiary banks of a bank holding company are subject to restrictions imposed by the Federal Reserve Act on extensions of credit to the holding company or its subsidiaries, on investments in their securities and on the use of their securities as collateral for loans to any borrower. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) further expanded the definition of an “affiliate” and treats credit exposure arising from derivative transactions, securities lending, and borrowing transactions as a covered transaction under the regulations. It also expands the scope of covered transactions required to be collateralized, requires collateral to be maintained at all times for covered transactions required to be collateralized, and places limits on acceptable collateral. These regulations and restrictions may limit the Holding Company’s ability to obtain funds from the Bank for its cash needs, including funds for payment of dividends, interest and operational expenses.
Tying Arrangements
We are also prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services. For example, with certain exceptions, neither the Holding Company nor its subsidiaries may condition an extension of credit to a customer on either (i) a requirement that the customer obtain additional services provided by us; or (ii) an agreement by the customer to refrain from obtaining other services from a competitor.
Support of Subsidiary Banks
Under Federal Reserve policy and the Dodd-Frank Act, the Holding Company is required to act as a source of financial and managerial strength to the Bank. This means that the Holding Company is required to commit, as necessary, capital and resources to support the Bank, including at times when the Holding Company may not be in a financial position to provide such resources, or when it may not be in the Holding Company's or its shareholders' best interests to do so. Any capital loans a bank holding company makes to its subsidiary banks are subordinate to deposits and to certain other indebtedness of those subsidiary banks.
State Law Restrictions
As a California corporation, the Holding Company is subject to certain limitations and restrictions under applicable California corporate law. For example, state law restrictions in California include limitations and restrictions relating to indemnification of directors, distributions to shareholders, transactions involving directors, officers or interested shareholders, maintenance of books, records and minutes and observance of certain corporate formalities.
Bank Regulation – Federal and State
General
Deposits in the Bank, a California chartered commercial bank, are insured by the FDIC. As a result, the Bank is subject to supervision and periodic examination and regulation by the CDFPI and the FDIC. These agencies have the authority to prohibit banks from engaging in what they believe to be unsafe or unsound banking practices. The federal laws that apply to the Bank regulate, among other things, the scope of its business, its investments, its reserves against deposits, the timing of the availability of deposited funds, and the nature, amount of, and collateral for loans. Federal laws also regulate community reinvestment and insider transactions and impose safety and soundness standards. In addition to these federal laws, the Bank is also subject to the laws of the State of California.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Consumer Protection
Although the Bank is not supervised directly by the Consumer Financial Protection Bureau (“CFPB”), our consumer banking activities are subject to regulation by the CFPB. The Bank is subject to a variety of federal and state consumer protection laws and regulations that govern its relationships and interactions with consumers including laws and regulations that impose certain disclosure requirements and regulate the manner in which we take deposits, make and collect loans, and provide other services. In recent years, examination and enforcement by state and federal banking agencies for non-compliance with consumer protection laws and their implementing regulations have increased and become more intense. Failure to comply with these laws and regulations may subject the Bank to various penalties, including but not limited to, enforcement actions, injunctions, fines, civil monetary penalties, criminal penalties, punitive damages, and the loss of certain contractual rights. The Bank has established a compliance system to ensure consumer protection.
Community Reinvestment
The Community Reinvestment Act of 1977 (the “CRA”) requires that, in connection with examinations of financial institutions within their jurisdictions, federal bank regulators evaluate the record of financial institutions in meeting the credit needs of their local communities, including low and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. A bank’s community reinvestment record is also considered by the applicable banking agencies in evaluating mergers, acquisitions and applications to open a branch or facility. In some cases, a bank's failure to comply with the CRA or CRA protests filed by interested parties during applicable comment periods, can result in the denial or delay of such transactions. The Bank received a "satisfactory" rating in its most recent CRA examination.
Insider Credit Transactions
Banks are also subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to executive officers, directors, principal shareholders or any related interests of such persons. These extensions of credit (i) must be made on substantially the same terms (including interest rates and collateral) and follow credit underwriting procedures that are at least as stringent as those prevailing at the time for comparable transactions with persons not related to the lending bank; and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. Banks are also subject to certain lending limits and restrictions on overdrafts to insiders. A violation of these restrictions may result in the assessment of substantial civil monetary penalties, regulatory enforcement actions, and other regulatory sanctions. The Dodd-Frank Act and federal regulations place additional restrictions on loans to insiders and generally prohibit loans to senior officers other than for certain specified purposes.
Regulation of Management
Federal law (i) sets forth circumstances under which officers or directors of a bank may be removed by the institution’s federal supervisory agency; (ii) as discussed above, places restraints on lending by a bank to its executive officers, directors, principal shareholders, and their related interests; and (iii) generally prohibits management personnel of a bank from serving as directors or in other management positions of another financial institution whose assets exceed a specified amount or which has an office within a specified geographic area.
Safety and Soundness Standards
Safety and soundness standards unrelated to capital are also imposed upon banks. These standards cover, among other things, internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, such other operational and managerial standards as the agency determines to be appropriate, and standards for asset quality, earnings and stock valuation. In addition, each insured depository institution must implement a comprehensive written information security program that includes administrative, technical, and physical safeguards appropriate to the institution’s size and complexity and the nature and scope of its activities. The information security program must be designed to ensure the security and confidentiality of customer information, protect against unauthorized access to or use of such information and ensure the proper disposal of customer and consumer information. An institution that fails to meet these standards may be required to submit a compliance plan, or be subject to regulatory sanctions, including restrictions on growth. The Bank has established policies and risk management procedures to ensure the safety and soundness of the Bank.
State Law Restrictions
California state-chartered banks are subject to various requirements relating to operations and administration (including the maintenance of branch offices and automated teller machines), capital and reserve requirements, declaration of dividends, deposit taking, shareholder rights and duties, borrowing limits, and investment and lending activities.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Under California law, the amount a bank generally may borrow may not exceed its shareholders’ equity without the consent of the CDFPI, except for borrowings from the FHLB and the Federal Reserve Bank. The Bank is required to invest its funds as limited by California law in investments that are legal investments for banks, subject to any other limitations under general law. The Commissioner of the CDFPI may take possession of the Bank if certain conditions exist, such as insufficient shareholders’ equity, unsafe or unauthorized operations, or violations of law.
Interstate Banking and Branching
The Dodd-Frank Act eliminated interstate branching restrictions that were implemented as part of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ("Interstate Act"), and removed many restrictions on de novo interstate branching by state and federally chartered banks. Federal regulators now have authority to approve applications by such banks to establish de novo branches in states other than the bank's home state if the host state's banks could establish a branch at the same location. The Interstate Act requires regulators to consult with community organizations before permitting an interstate institution to close a branch in a low-income area. Federal banking agency regulations prohibit banks from using their interstate branches primarily for deposit production, and the federal banking agencies have implemented a loan-to-deposit ratio screen to ensure compliance with this prohibition.
Cash Dividends
Our ability to pay cash dividends to our shareholders is dependent on having sufficient cash and satisfying various regulatory and contractual requirements and restrictions. Our principal source of cash is dividends received from the Bank. Regulatory authorities prohibit banks and bank holding companies from paying dividends if such payment would constitute an unsafe or unsound banking practice or would reduce capital below an amount necessary to meet minimum applicable regulatory capital requirements. Basel III (discussed below) introduces additional restrictions on dividends.
Our ability to pay dividends from the Bank to the Holding Company is also subject to certain requirements under California law. Banks chartered under California law generally may only pay a cash dividend to the extent such payment does not exceed the lesser of (i) retained earnings of the bank or (ii) the bank's net income for its last three fiscal years less any distributions to shareholders during such period. As a result, future dividends from the Bank to the Holding Company will generally depend on the level of earnings at the Bank.
The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies which expresses the view that although no specific regulations restrict dividend payments by bank holding companies other than state corporate laws, a bank holding company should not pay cash dividends unless the company's net income for the past year is sufficient to cover both the cash dividends and a prospective rate of earnings retention that is consistent with the bank holding company's capital needs, asset quality and overall financial condition.
On December 10, 2015, we issued and sold $10.0 million in aggregate principal amount of fixed to floating rate Subordinated Notes. The Subordinated Notes limit the payment of cash dividends to our common shareholders if the Company is not well capitalized, or if there is an event of default as described by the note agreement.
Capital Adequacy and Prompt Corrective Action
Banks and bank holding companies are subject to various regulatory capital requirements administered by state and federal regulatory agencies, which involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting, and other factors. The capital requirements are intended to ensure that institutions have adequate capital given the risk levels of assets and off-balance sheet financial instruments and are applied separately to the Holding Company and the Bank.
Under the guidelines of Basel III, federal regulations require insured depository institutions and bank holding companies to meet certain capital standards (these standards include a capital conservation buffer), including: (i) a common equity Tier 1 capital to risk-based assets ratio of 7%; (ii) a Tier 1 capital to risk-based assets ratio of 8.50%; (iii) a total capital to risk-based assets ratio of 10.5%; and (iv) a 4% Tier 1 capital to total assets leverage ratio. These minimum capital requirements became effective in January 2015 and were the result of final rules implementing certain regulatory amendments based on the recommendation of the Basel Committee on Banking Supervision and certain requirements of the Dodd-Frank Act (the "Final Rules").
The Final Rules contain revisions to the prompt corrective action framework, which is designed to place restrictions on an insured depository institution if its capital levels begin to show signs of weakness. Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions are required to meet the following capital level requirements to qualify as “well capitalized”: (i) a Tier 1 common equity capital ratio of at least 6.5%; (ii) a Tier 1 capital ratio of at least 8%; (iii) a total capital ratio of at least 10%; (iv) a Tier 1 leverage ratio of at least 5%; and (v) not be subject to any order or written directive requiring a specific capital level. The FDIC’s rules (as amended by the Final Rules) contain other capital classification categories, such as “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized,” each of which are based on certain capital ratios. Undercapitalized institutions are subject to certain mandatory restrictions, including on capital distributions and growth. Significantly undercapitalized and critically undercapitalized institutions are subject to additional restrictions. An institution may be downgraded to a category lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition, or if the institution receives an unsatisfactory examination rating. As of December 31, 2020, the most recent notification from the FDIC categorized the Bank as “well capitalized”.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
The so-called “Crapo Bill” (i.e., the Economic Growth, Regulatory Relief, and Consumer Protection Act) was signed into law by President Trump in May 2018. The Crapo Bill simplified the regulatory capital rules for financial institutions and their holding companies with total consolidated assets of less than $10 billion and instructed the federal banking regulators to establish a single Community Bank Leverage Ratio (“CBLR”) of between 8% and 10%. On September 17, 2019, the FDIC issued its final rule relating to the CBLR framework and established the CBLR at 9% for qualifying financial institutions. A qualifying institution that opts into the CBLR framework (and meets all requirements under the framework) will be considered to have met the well-capitalized ratio requirements under the prompt corrective action rules discussed above and will not be required to report or calculate risk-based capital. We are a qualifying institution; however, we have opted to continue reporting under the Basel III requirements. We can opt-in to use the Community Bank Leverage Ratio at any time in the future.
Regulatory Oversight and Examination
Inspections
The Federal Reserve conducts periodic inspections of bank holding companies to ascertain whether the financial strength of the bank holding company is being maintained on an ongoing basis and to determine the effects or consequences of transactions between a bank holding company or its non-banking subsidiaries and its subsidiary banks. For holding companies under $10 billion in assets, the inspection type and frequency typically varies depending on the complexity of the organization, and the bank holding company’s rating at its last inspection. The most recent inspection of the holding company was conducted in January of 2020.
Examinations
The Bank is subject to periodic examinations by its regulators, the FDIC and the CDFPI. In assessing a bank's condition, bank examinations have evolved from reliance on transaction testing in assessing a bank’s condition to a risk-focused approach. These examinations are extensive and cover the entire breadth of operations of the bank. Generally, safety and soundness examinations occur on an 18-month cycle. Examinations alternate between the federal and state bank regulatory agencies, and in some cases they may occur on a combined schedule. The frequency of consumer compliance and CRA examinations is linked to the size of the institution and its compliance and CRA ratings at its most recent examinations. However, the examination authority of the Federal Reserve and the FDIC allows them to examine supervised institutions as frequently as deemed necessary based on the condition of the bank or as a result of certain triggering events.
Commercial Real Estate Ratios
The federal banking regulators have issued guidance reminding financial institutions to re-examine existing regulations regarding concentrations in commercial real estate lending. The purpose of the guidance is to encourage banks to develop risk management practices and maintain capital levels commensurate with the level and nature of their real estate concentrations. The banking agencies are directed to examine each bank’s exposure to commercial real estate loans that are dependent on cash flows from the real estate held as collateral and to focus their supervisory resources on institutions that may have significant commercial real estate loan concentration risk. The guidance provides that the strength of an institution’s lending and risk management practices with respect to such concentrations will be taken into account in evaluating capital adequacy but does not specifically limit a bank’s commercial real estate lending to a specified concentration level.
Corporate Governance and Accounting
The Sarbanes-Oxley Act of 2002 (the “SOX Act”) addressed, among other things, corporate governance, auditing and accounting, enhanced and timely disclosure of corporate information, and penalties for non-compliance. Generally the SOX Act, among other matters, (i) requires chief executive officers and chief financial officers to certify to the accuracy and completeness of periodic reports filed with the SEC, and to certain matters relating to disclosure and accounting controls at public companies; (ii) imposes specific and enhanced corporate disclosure requirements; (iii) accelerates the time frame for reporting of insider transactions and periodic disclosures by public companies; and (iv) requires companies to adopt and disclose information about corporate governance practices.
As a public reporting company with the SEC, we are subject to the requirements of the SOX Act and related rules and regulations issued by the SEC and NASDAQ.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Anti-Money Laundering and Anti-Terrorism
The Bank Secrecy Act and the USA Patriot Act of 2001
The Bank Secrecy Act (the “BSA”) requires all financial institutions to (among other requirements) establish a risk-based system of internal controls reasonably designed to prevent money laundering and the financing of terrorism. The BSA also sets forth various recordkeeping and reporting requirements (such as reporting suspicious activities that may signal criminal activity), and certain due diligence and "know your customer" documentation requirements. These requirements have been expanded, and banks are now required to establish and maintain written procedures that are designed to identify and verify beneficial owners of legal entity customers.
Further, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, intended to combat terrorism, was renewed with certain amendments in 2006 (the “Patriot Act”). The Patriot Act, in relevant part, (i) prohibits banks from providing correspondent accounts directly to foreign shell banks; (ii) imposes due diligence requirements on banks opening or holding accounts for foreign financial institutions or wealthy foreign individuals; (iii) requires financial institutions to establish an anti-money-laundering compliance program; and (iv) eliminates civil liability for persons who file suspicious activity reports. The Patriot Act also includes provisions providing the government with power to investigate terrorism, including expanded government access to bank account records. Regulators are directed to consider a bank holding company’s and a bank’s effectiveness in combating money laundering when reviewing and ruling on applications under the BHC Act and the Bank Merger Act. The Holding Company and the Bank have established compliance programs designed to comply with the requirements of the BSA and Patriot Acts.
Financial Services Modernization
Gramm-Leach-Bliley Act of 1999
The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 (the “GLBA”) brought about significant changes to the laws affecting banks and bank holding companies. Generally, the GLBA (i) repealed historical restrictions on preventing banks from affiliating with securities firms; (ii) provided a uniform framework for the activities of banks, savings institutions and their holding companies; (iii) broadened the activities that may be conducted by national banks and banking subsidiaries of bank holding companies; (iv) provided an enhanced framework for protecting the privacy of consumer information and requires notification to consumers of bank privacy policies; and (v) addressed a variety of other legal and regulatory issues affecting both day-to-day operations and long-term activities of financial institutions. The Bank is subject to FDIC regulations implementing the privacy protection provisions of the GLBA. These regulations require a bank to disclose its privacy policy, including informing consumers of the bank’s information sharing practices and their right to opt out of certain practices.
The Dodd-Frank Act
General
The Dodd-Frank Act was signed into law in July of 2010. It significantly changed the bank regulatory structure and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies, including the Holding Company and the Bank. Some of the provisions of the Dodd-Frank Act that impact us are summarized below.
Corporate Governance
The Dodd-Frank Act requires publicly traded companies to provide their shareholders with (i) a non-binding shareholder vote on executive compensation, (ii) a non-binding shareholder vote on the frequency of such vote, (iii) disclosure of “golden parachute” arrangements in connection with specified change in control transactions, and (iv) a non-binding shareholder vote on golden parachute arrangements in connection with these change in control transactions. In 2015, the SEC adopted a rule mandated by the Dodd-Frank Act that requires a public company to disclose the ratio of the compensation of its Chief Executive Officer ("CEO") to the median compensation of its employees. This rule is intended to provide shareholders with information that they can use to evaluate a CEO's compensation.
Prohibition Against Charter Conversions of Troubled Institutions
The Dodd-Frank Act generally prohibits a depository institution from converting from a state to federal charter, or vice versa, while it is the subject to an enforcement action unless the depository institution seeks prior approval from its primary regulator and complies with specified procedures to ensure compliance with the enforcement action.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Consumer Financial Protection Bureau
The Dodd-Frank Act established the CFPB and empowered it to exercise broad rulemaking, supervision and enforcement authority for a wide range of consumer protection laws. The Bank is subject to consumer protection regulations issued by the CFPB, but as a financial institution with assets of less than $10 billion, the Bank is generally not subject to direct supervision and examination by the CFPB. The CFPB has issued and continues to propose and issue regulations that may increase the compliance burden of the Bank including:
| | ● | Positions taken by the CFPB on fair lending, including applying the disparate impact theory which could make it more difficult for lenders to charge different rates or to apply different terms to loans to different customers. |
| | ● | The CFPB’s final rule amending Regulation C, which implements the Home Mortgage Disclosure Act, requiring most lenders to report expanded information in order for the CFPB to more effectively monitor fair lending concerns and other information shortcomings identified by the CFPB. |
| | ● | Positions taken by the CFPB regarding the Electronic Fund Transfer Act and Regulation E, which require companies to obtain consumer authorizations before automatically debiting a consumer’s account for pre-authorized electronic funds transfers. |
| | ● | Focused efforts on enforcing certain compliance obligations the CFPB deems a priority, such as automobile and student loan servicing, debt collection, mortgage origination and servicing, remittances, and fair lending, among others. |
Repeal of Demand Deposit Interest Prohibition
The Dodd-Frank Act repealed federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts.
Board Composition
In 2018, the California “Women on Boards” bill was signed into law to advance equitable gender representation on certain California corporate boards. California is the first state in the nation to require all publicly-held domestic or foreign corporations whose principal executive offices are located in California to have at least one female director on their boards by December 31, 2019. Based on the size of our board, we will be required to have three women directors as of December 31, 2021. We had one female serving on our board as of December 31, 2020, and in support of equitable gender representation we will be adding two additional female directors to our board in 2021.
In 2020, California’s Assembly Bill (“AB”) 979 was signed into law to increase diversity to California corporate boards. The bill requires public companies to have at least one director who is from an underrepresented community on their board by December 31, 2021 and, for companies with nine or more directors, to have a minimum of three directors from underrepresented communities on the board by December 31, 2022. The bill defines members of underrepresented communities to include those who self-identify as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native, or as gay, lesbian, bisexual, or transgender. We strive to be a diverse and inclusive company, and we intend to add additional directors from underrepresented communities to our board in accordance with this bill.
Recent and Proposed Legislation
The economic and political environment in recent years has led to a number of proposed legislative, governmental and regulatory initiatives that may significantly impact the banking industry. We cannot predict whether these or any other proposals will be enacted or the ultimate impact of any such initiatives on our operations, competitive situation, financial condition, or results of operations. Past history has demonstrated that new legislation or changes to existing laws or regulations typically result in a greater compliance burden which increases the general cost of doing business. The new administration under President Biden has expressed a general intent to regulate the financial services industry more strictly than the administration of his predecessor.
COVID-19 Legislation and Regulation
Governments at the federal, state, and local levels continue to take steps to address the impact of the COVID-19 pandemic. On March 27, 2020, the historic $2 trillion federal stimulus package known as the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was signed into law, which included $350 billion in stimulus for small businesses under the so-called “Paycheck Protection Program,” along with direct stimulus payments (i.e., “economic impact payments” or “stimulus checks”) for many eligible Americans. The initial amounts available under the Paycheck Protection Program were quickly exhausted in less than two weeks, which prompted Congress to allocate additional funding. On April 24, 2020, the Paycheck Protection Program and Health Care Enforcement Act was signed into law to replenish funding to the Paycheck Protection Program and to provide other spending for hospitals and virus testing. Further, on July 3, 2020, the President extended the deadline for potential borrowers to apply for Paycheck Protection Program funds until August 8, 2020. And recently, on December 21, 2020, Congress passed the Consolidated Appropriations Act, which was signed into law by the President on December 27th, and included another $284 billion to fund an expansion of the Paycheck Protection Program, subject to certain changes in eligibility requirements and program design. During 2020, the Bank funded 606 PPP loans totaling $163.5 million. The Bank is currently taking additional loan applications, and making new loans, under the program, as most recently updated. The legislative and regulatory landscape surrounding the COVID-19 pandemic continues to change, and neither the Holding Company nor the Bank can predict with certainty the impact it will have on our operations or business.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Deposit Insurance
FDIC Insured Deposits
The Bank’s deposits are insured under the Federal Deposit Insurance Act, up to the maximum applicable limits and are subject to deposit insurance assessments by the FDIC, which are designed to tie what banks pay for deposit insurance to the risks they pose. The Dodd-Frank Act redefined the assessment base used for calculating deposit insurance assessments by requiring the FDIC to determine assessments based on assets instead of deposits. Assessments are now based on the average consolidated total assets less average tangible equity capital of a financial institution. No institution may pay a dividend if it is in default on its federal deposit insurance assessment. The FDIC may also prohibit any insured institution from engaging in any activity determined by regulation or order to pose a serious risk to the Depositors Insurance Fund.
Safety and Soundness
The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. Management is not aware of any existing circumstances that would result in termination of the Bank's deposit insurance.
Insurance of Deposit Accounts
The Dodd-Frank Act permanently increased FDIC deposit insurance from $100,000 to $250,000 per depositor. The FDIC insurance coverage limit applies per depositor, per insured depository institution for each account ownership category.
Available Information
The Company files annual, quarterly and current reports, proxy statements and other business and financial information with the SEC. The SEC maintains an Internet site that contains the Company's SEC filings, as well as reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, located at http://www.sec.gov. These filings are also accessible free of charge at the Company's website at www.bankofcommerceholdings.com as soon as reasonably practicable after filing with the SEC. By making this reference to the Company's website, the Company does not intend to incorporate into this report any information contained in the website. The website should not be considered part of this report.
Our principal executive office is located at 555 Capitol Mall, Suite 1255, Sacramento, California 95814 and the telephone number is (800) 421-2575.
Annual Disclosure Statement
This Annual Report on Form 10-K serves as the annual disclosure statement of the Bank pursuant to Part 350 of the FDIC’s rules and regulations. This statement has not been reviewed or confirmed for accuracy or relevance by the FDIC.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Item 1A - Risk Factors
The following is a discussion of what the Company believes are the material risks and uncertainties that may affect the Company's business, financial condition and future results.
Credit and Lending Risk
The loan portfolio includes purchased loans and loans serviced by other companies.
Purchased loans included in the loan portfolio totaled $72.6 million or 6% of gross portfolio loans as of December 31, 2020. The loans were purchased under several different contracts as a pool of loans, individual loans or as purchased participations from other institutions. The majority of the loans are located outside our principal market. Additionally, $46.9 million or 4% of our gross portfolio loans are serviced by two unrelated third party servicing companies. A disruption to the operations of either of the loan servicing companies could reduce the value of the assets we own. In addition, if we were forced to service these loans ourselves, we would incur additional monitoring and servicing costs due to the geographic disbursement of the portfolio, which would adversely affect our noninterest expense.
We have a concentration risk in real estate related loans.
A substantial portion of our lending is tied to real estate. As of December 31, 2020, approximately 77% (86% excluding Paycheck Protection Program loans) of our loan portfolio was secured by real estate as follows:
● | 45% commercial real estate non-owner occupied, |
● | 18% commercial real estate owner occupied, |
● | 5% residential 1-4 family mortgage, |
● | 3% residential ITIN, |
● | 2% residential equity lines and |
● | 4% construction and land development. |
A large percentage of our loan portfolio is comprised of commercial real estate loans which generally carry larger loan balances and historically have involved a greater degree of financial and credit risk than residential first mortgage loans. Repayment of these loans is primarily dependent on cash flows of the borrower (which may be unpredictable) and secondarily on the underlying collateral provided by the borrower. Any decline in the economy in general, material increases in interest rates, changes in tax policies, tightening credit or refinancing markets, or a decline in real estate values could have an adverse impact on the repayment of these loans. Further, our ability to sell or dispose of the underlying real estate collateral would be adversely impacted by any decline in real estate values. This increases the likelihood that we could suffer losses on defaulted loans secured by real estate beyond the amounts provided for in the ALLL, which could have a material adverse effect on our business, financial condition, and results of operations.
Nonperforming assets take significant time to resolve and adversely affect our results of operations and financial condition.
We do not record interest income on nonperforming loans or other real estate owned which adversely affects our income. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, which may result in a loss. The resolution of nonperforming assets requires significant commitments of time and increases our loan administration costs. While nonperforming assets are not currently elevated, there can be no assurance that we will not experience future increases in nonperforming assets. An increase in the level of nonperforming assets increases our risk profile and consequently may impact the capital levels our regulators believe are appropriate.
Future loan and lease losses may exceed the allowance for loan and lease losses.
We have established an allowance for possible losses from loans in the credit portfolio. This allowance reflects estimates of the collectability of certain identified loans, as well as an overall risk assessment of gross loans outstanding.
The determination of the amount of the allowance for loan and lease losses is subjective. Although the method for determining the amount of the allowance uses criteria such as risk ratings and historical loss rates, these factors may not be adequate predictors of future loan performance. Accordingly, we cannot offer assurances that these estimates ultimately will prove correct or that the allowance for loan and lease losses will be sufficient to protect against losses that ultimately may occur. If the allowance for loan and lease losses proves to be inadequate, we will need to make additional provisions to the allowance, which are accounted for as charges to income, which would adversely impact results of operations and financial condition. Moreover, federal and state banking regulators, as an integral part of their supervisory function, periodically review our loan portfolio and the adequacy of our allowance. These regulatory authorities may require us to recognize further loan loss provisions or charge-offs based upon their judgments, which may be different from our judgments. Any increase in the allowance could have an adverse effect, which could be material, on our financial condition and results of operations.
Changes in how we provide for credit losses may have a material impact on our financial condition or results of operations.
In June 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-13, Measurement of Credit Losses on Financial Instruments. The ASU introduces a new impairment model based on current expected credit losses (“CECL”) in substitution for our current “incurred loss” methodology. The CECL model will apply to most financial assets measured at amortized cost, including loans receivable, loan commitments and held-to-maturity debt securities.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Under the CECL model, we would recognize an impairment allowance equal to our current estimate of expected credit losses for financial instruments as of the end of the reporting period. Measuring expected credit losses will likely be a significant challenge for all entities, including us. Additionally, in preparing to implement CECL, we have incurred one-time and recurring costs, some of which are related to system changes and data collection.
Further, the impairment allowance measured under a CECL model is expected to differ materially from the impairment allowance measured under our existing “incurred loss” model. To initially apply the CECL amendments, for most debt instruments, we would record a cumulative-effect adjustment to our statement of financial condition as of the beginning of the first reporting period in which the guidance is effective (a modified retrospective approach). Amendments to ASU 2016-13 permit us to delay implementation of CECL until January 1, 2023.
The impact of certain provisions of the CECL model regarding loan portfolios of acquired financial institutions could result in earnings volatility, as any adjustments to the ALLL with respect to the acquired loans are required to be made immediately subsequent to the acquisition.
More information on this ASU can be found under the heading Recent Accounting Pronouncements, in Note 2 Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements.
Defaults may negatively impact us.
Risk arises from the possibility that losses will be sustained if borrowers, guarantors or related parties fail to perform in accordance with the terms of their loans. We have adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the adequacy of the allowance for loan and lease losses, which management believes are appropriate to minimize credit risk. These policies and procedures, however, may not prevent unexpected losses that could materially affect our results of operations.
Credit quality for private label mortgage backed securities we hold may deteriorate creating additional credit risk in our investment portfolio.
Our securities portfolio contains private label mortgage backed securities. These securities have more credit risk than the securities in our portfolio that are obligations of the U.S. Government or obligations guaranteed by the U.S. Government. We monitor the credit characteristics of the underlying mortgages to identify potential credit losses, if any, in the portfolio. If there is a decline in fair value due to credit quality concerns for a security we may be required to recognize an other-than-temporarily-impairment in earnings. Our Investment Policy requires that securities at the time of purchase, be rated A3/A- or higher by Moody’s, S&P and Fitch rating agencies.
The condition of other financial institutions could negatively affect us.
Financial services institutions are interrelated as a result of trading, clearing, counterparty, public perceptions and other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks and other institutional clients.
Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to us. Any such losses could have a material adverse effect on our financial condition and results of operations.
The Bank is subject to environmental liability risk associated with our lending activities.
A significant portion of our loan portfolio is secured by real estate, and we could become subject to environmental liabilities with respect to one or more of these properties. During the ordinary course of business, we may foreclose on and take title to properties securing defaulted loans and there is a risk that hazardous or toxic substances could be found on these properties. If hazardous conditions or toxic substances are found on these properties, we may be liable for remediation costs, as well as for personal injury and property damage, civil fines and criminal penalties regardless of when the hazardous conditions or toxic substances first affected the property. Environmental laws may require us to incur substantial expenses to address unknown liabilities and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review before initiating any foreclosure on nonresidential real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on us.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Liquidity Risk
Our deposits are subject to volatility
Our depositors can always choose to withdraw their deposits from the Bank and place them elsewhere, which could cause an increase in our funding costs and reduce our net interest income. Checking, savings and money market account balances can decrease when customers perceive that alternative investments provide a better risk/return tradeoff.
At December 31, 2020, time certificates of deposit in excess of $250,000, represented approximately 4% of our total deposit balances. Because these deposits are not covered by FDIC deposit insurance, they are considered volatile and could be subject to withdrawal. Withdrawal of a material amount of such deposits could adversely affect our liquidity, profitability, business prospects, results of operations and cash flows. We do not hold any brokered deposits. Our 25 largest deposit relationships account for 21% of our deposits.
Conditions in the financial markets may limit our access to additional funding to meet our liquidity needs.
Liquidity is essential to our business, as we must maintain sufficient funds to respond to the needs of depositors and borrowers. An inability to raise funds through deposits, repurchase agreements, federal funds purchased, Federal Home Loan Bank of San Francisco (“FHLB”) advances, or the sale of securities, loans, and other assets could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could negatively affect our access to liquidity sources include negative operating results, a decrease in the level of our business activity due to a market downturn or negative regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as severe disruption of the financial markets or negative news and expectations about the prospects for the financial services industry as a whole. An inability to borrow funds to meet our liquidity needs could have an adverse impact on our results of operations and financial condition.
Interest Rate Risk
Interest rate fluctuations, which we do not control, could harm profitability.
Our income is highly dependent on “interest rate spreads” (i.e., the difference between the interest income earned on our interest-earning assets such as loans and securities, and the interest expense paid on our interest-bearing liabilities such as deposits and borrowings). The underlying interest rates are highly sensitive to many factors, many of which are beyond our control, including rates paid and charged by our competitors, general economic conditions, inflation, recession and the policies of various governmental and regulatory agencies, in particular, the Federal Reserve Board. In addition, changes in monetary policy including changes in interest rates influence the origination of loans, the purchase of investments and the generation of deposits. These changes affect the rates received on loans and securities and paid on deposits, which could have a material adverse effect on our business, financial condition and results of operations.
The majority of our loans are fixed rate loans or variable rate loans that are already at their floor rate. This has mitigated the impact of declining interest rates on loan yields during 2020. Our longer-term fixed rate loans and funding mix have caused the Company to become slightly to moderately liability sensitive to rising interest rates; which will remain true until sufficient rate rise allows variable rate loans to move higher off their floors. Our investment portfolio is expected to reprice more rapidly than our liabilities in a decreasing rate environment and cause the Company to be slightly asset sensitive to falling rates.
We may be impacted by the retirement of LIBOR as a reference rate.
In July 2017, the United Kingdom Financial Conduct Authority announced that the London Interbank Offered Rate (“LIBOR”) may no longer be published after 2021. LIBOR is used extensively in the U.S and globally as a “benchmark” or “reference rate” for various commercial and financial contracts. In response, the Alternative Reference Rates Committee (“ARRC”), made up of financial and capital market institutions, was convened to address the replacement of LIBOR in the U.S. The ARRC identified a potential successor to LIBOR in the Secured Overnight Financing Rate (“SOFR”) and crafted a plan to facilitate the transition. However, there are significant conceptual and technical differences between LIBOR and SOFR. The Financial Stability Oversight Committee has stated that the end or waning use of LIBOR has the potential to significantly disrupt trading in many important types of financial contracts.
At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, subordinated debentures or other securities or financial arrangements. The replacement of LIBOR with one or more alternative rates may impact the availability and cost of hedging instruments and borrowings, including the rates we pay on our subordinated debt and trust preferred securities. If LIBOR rates are no longer available, and we are required to implement substitute indices for the calculation of interest rates under contracts or financial instruments to which we are a party, we may incur significant expenses in effecting the transition.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Changes in the fair value of our securities portfolio may reduce our shareholders’ equity and net income.
We increase or decrease our shareholders’ equity by the amount of change in the unrealized gain or loss (the difference between the fair value and the amortized cost) of our available-for-sale securities portfolio, net of related tax, under the category of accumulated other comprehensive income (loss). Generally changes in unrealized gain or loss result from changes in market interest rates. A decline in the fair value of the AFS portfolio will result in a decline in reported shareholders’ equity, as well as book value per common share. This decrease will occur even though the securities are not sold. If these securities are never sold and there are no credit impairments, the decrease will be recovered over the life of the securities. In the event there are credit loss related impairments, the credit loss component is recognized in earnings.
Derivative financial instruments subject the Company to credit and market risk
We may use derivatives to hedge the risk of changes in market interest rates in order to limit the impact on earnings and cash flows relating to specific groups of assets and liabilities. Our use of derivatives in our risk management activities could expose the Company to mark-to-market losses if interest rates move in a materially different way than we expected when we entered into the related derivative contracts. In addition, we would be exposed to credit risk should the counterparty fail to perform under the terms of the derivative contracts. This could cause us to forfeit the payments due to us or result in settlement delays with the attendant credit and operational risk as well as increased costs. Derivative contracts may contain a provision which allows the counterparty to terminate the derivative contract if we fail to maintain our status as a well/adequately capitalized institution or if specific regulatory events occur. If these contracts were terminated by the counterparty, we would be required to settle our obligations under the agreements, which could also cause operational risk and increased costs.
Operational Risk
We rely heavily on our management team and the loss of key officers may adversely affect operations.
We are dependent on the successful recruitment and retention of highly qualified personnel. Our ability to implement our business strategies is closely tied to the strengths of our chief executive officer and other key officers. Additionally, business banking, one of our principal lines of business, is dependent on relationship banking in which our personnel develop professional relationships with small business owners and officers of larger business customers who are responsible for the financial management of the companies they represent. If management team members or other key employees were to leave the Company and become employed by a competing bank, we could potentially lose business customers. In addition, we rely on our customer service staff to effectively serve the needs of our customers. The loss of key employees to competitors or otherwise could have an adverse effect on our results of operation and financial condition.
Internal control systems could fail to detect certain events.
We are subject to many operating risks, including, without limitation, data processing system failures and errors, and customer or employee fraud. There can be no assurance that such an event will not occur, and if such an event is not prevented or detected by our internal controls and does occur, and it is uninsured or is in excess of applicable insurance limits, it could have a significant adverse impact on our reputation in the business community and our business, financial condition, and results of operations.
Changes in accounting standards may impact how we report our consolidated financial condition and consolidated results of operations.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time, the FASB changes the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be difficult to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in a restatement of prior period financial statements.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
We could suffer operational, reputational and financial harm if we fail to properly anticipate and manage risk.
We rely on financial models and strategies to forecast losses, project revenue, measure and assess capital requirements for credit, market, operational and strategic risks, and assess and control our operations and financial condition. These models require oversight, ongoing monitoring, and periodic reassessment. Models are subject to inherent limitations due to the use of historical trends and simplifying assumptions, uncertainty regarding economic and financial outcomes, and emerging risks from the use of applications that may rely on artificial intelligence. Our models and strategies may not be adequate due to limited historical data and shocks caused by extreme or unanticipated market changes, especially during severe market downturns or stress events. Regardless of the steps we take to ensure effective controls, governance, monitoring and testing, and implement new risk management tools, we could suffer operational, reputational and financial harm if our models and strategies and other risk management tools fail to properly anticipate and manage current and evolving risks.
Cyber, Third Party and Technology Risk
Confidential customer information transmitted through the Bank’s online banking service is vulnerable to security breaches and computer viruses which could expose the Bank to litigation and adversely affect its reputation and ability to generate deposits.
We provide our customers the ability to bank online. We rely heavily on the secure processing, storage and transmission of confidential and other information on our computer systems and networks. The secure transmission of confidential information over the Internet is a critical element of online banking. Our network could be vulnerable to unauthorized access, computer hacking, cyber-attacks, electronic fraudulent activity, attempted theft of financial assets, computer viruses, phishing schemes and other security problems. We cannot guarantee that any such failures, interruption or security breaches will not occur, or if they do occur, that they will be adequately addressed. While we have certain protective policies and procedures in place, the nature and sophistication of the threats continue to evolve. We may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, alleviate problems caused by security breaches or viruses or to modify and enhance our protective measures. To the extent that our activities or the activities of our customers involve the storage and transmission of confidential information, security breaches and viruses could expose us to claims, litigation and other possible liabilities. Any inability to prevent cyber-attacks, security breaches or computer viruses could also cause existing customers to lose confidence in our systems and could adversely affect our reputation and our ability to generate deposits.
Our operations could be interrupted if third party technology service providers experience difficulty, terminate their services or fail to comply with banking regulations.
We depend, and will continue to depend to a significant extent, on a number of relationships with third party technology service providers. Specifically, we utilize software and hardware systems for transaction processing, essential web hosting, debit and credit card processing, merchant bankcard processing, internet banking systems and other processing services from third party service providers. If these third party service providers experience difficulties or terminate their services, and we are unable to replace them with other qualified service providers, our operations could be interrupted. If an interruption were to continue for a significant period of time, our business, financial condition and results of operations could be materially adversely affected.
Our future performance will depend on our ability to respond to technological change.
The financial services industry is experiencing rapid technological changes with frequent introductions of new technology-driven products and services. Effective use of technology increases efficiency and enables financial institutions to better serve customers and reduce costs. Many of our competitors have substantially greater resources to invest in technological improvements than we do. Our future success will depend, to some degree, on our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as create additional efficiencies in our operations, We may not be able to effectively implement new technology-driven products or service, or be successful in marketing such products and services. Additionally, the implementation of technological changes and upgrades to maintain current systems and integrate new ones may cause services interruptions, transaction processing errors and system conversion delays and may cause us to fail to comply with applicable laws. There can be no assurance that we will be able to successfully manage the risks associated with increased dependency on technology.
Our exposure to operational, technological, and organization risk may adversely affect us.
Similar to other financial institutions, we are exposed to many types of operational and technological risk, including reputation, legal and compliance risk. Our ability to grow and compete is dependent on our ability to build or acquire the necessary operational and technological infrastructure and to manage the cost of that infrastructure while we expand and integrate acquired businesses. Operational risk can manifest itself in many ways, such as errors related to failed or inadequate processes, faulty or disabled computer systems, occurrences of fraud by employees or persons outside our company, and exposure to external events. We are dependent on our operational infrastructure to help manage these risks. From time to time, we may need to change or upgrade our technological infrastructure. We may experience disruption, and we may face additional exposure to these risks during the course of making such changes. If we acquire another financial institution or bank branch operations, we would face additional challenges when integrating different operational platforms, causing integration efforts to be more disruptive and /or more costly than anticipated.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
We face competition from technologies used to support and enable banking and financial services.
Emerging technologies and advances and the growth of e-commerce have lowered geographic and monetary barriers of other financial institutions, made it easier for non-depository institutions to offer products and services that traditionally were banking products and allowed non-traditional financial service providers and technology companies to compete with traditional financial service companies in providing electronic and internet-based financial solutions and services, including electronic securities trading, marketplace lending, financial data aggregation and payment processing, including real-time payment platforms. Further, clients may choose to conduct business with other market participants who engage in business or offer products in areas we deem speculative or risky, such as cryptocurrencies. Increased competition may negatively affect our earnings by creating pressure to lower prices or credit standards on our products and services requiring additional investment to improve the quality and delivery of our technology and/or reducing our market share, or affecting the willingness of our clients to do business with us.
Legal, Regulatory and Compliance Risk
We are subject to extensive regulation which could adversely affect our business.
Our operations are subject to extensive regulation by federal, state and local governmental authorities and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of our operations. Because our business is highly regulated, the laws, rules and regulations applicable to us are subject to modification and change. There are currently proposed laws, rules and regulations that, if adopted, would impact our operations. For more information on these issues, refer to the material set forth above under the heading "Government Supervision and Regulation."
The requirements imposed by our regulators and other laws, rules or regulations applicable to us are designed to ensure the integrity of the financial markets and to protect customers and other third parties that transact business with us, and are not designed to protect our shareholders. Consequently, these regulations may: (1) make compliance much more difficult or expensive, (2) restrict our ability to originate, broker or sell loans or accept certain deposits, (3) further limit or restrict the amount of commissions, interest or other charges earned on loans originated or sold by us, or (4) otherwise adversely affect our business or prospects for business. Moreover, banking regulators have significant discretion and authority to address what regulators perceive to be unsafe or unsound practices or violations of laws or regulations by financial institutions and holding companies in the performance of their supervisory and enforcement duties. The exercise of regulatory authority by banking regulators over us may have a negative impact on our financial condition and results of operations. Additionally, in order to conduct certain activities, including acquisitions, we are required to obtain regulatory approval. There can be no assurance that any required approvals can be obtained, or obtained without conditions or on a timeframe acceptable to us.
No assurance can be given that the Subordinated Notes will continue to qualify as Tier 2 Capital.
We believe that our Subordinated Notes meet the requirements of Tier 2 Capital in accordance with the Final Rules and current statutory guidance provided by the Federal Reserve Board. The Federal Reserve Board does not provide prior approval for the Subordinated Notes to be classified as Tier 2 Capital however, we did not receive any indication that the Subordinated Notes did not qualify as tier 2 capital during our most recent examination process with the Federal Reserve Bank of San Francisco. In the event that the Subordinated Notes do not qualify, the Federal Reserve Bank of San Francisco may require the Holding Company to amend certain terms and conditions of the Subordinated Notes in order for such instruments to qualify as Tier 2 Capital. Under the terms of the Subordinated Notes, the Holding Company also has the option to redeem the Subordinated Notes upon the occurrence of such an event.
We cannot give any assurance as to whether the applicable requirements for Tier 2 Capital will change in the future. Even if the Subordinated Notes initially meet the requirements of Tier 2 Capital under the current regulations, if changes are made in the future, and unless the Subordinated Notes are grandfathered into the new regulations, they could become disqualified as Tier 2 Capital.
Strategic and Other Risk
Federal Government Monetary Policy could impact our earnings
Our earnings and growth are affected not only by general economic conditions, but also by the fiscal and monetary policies of the federal government, particularly the Federal Reserve. The Federal Reserve implements national monetary policy to promote maximum employment, stable prices, and moderate long-term interest rates. Through its open market operations in U.S. government securities, control of the discount rate applicable to borrowings, establishment of reserve requirements against certain deposits, and control of the interest rate applicable to excess reserve balances and reverse repurchase agreements, the Federal Reserve influences the availability and cost of money and credit and, ultimately, a range of economic variables including employment, output, and the prices of goods and services. The nature and impact of future changes in monetary policies and their impact on the Holding Company and the Bank cannot be predicted with certainty.
Changes in the fair value of our other investments may reduce our shareholders’ equity and net income.
We own shares of FHLB stock which are recorded in other assets. The stock is carried at cost and subject to recoverability testing under applicable accounting standards. As of December 31, 2020, we did not recognize an impairment charge related to our FHLB stock holdings; however, potential negative changes to the financial condition of the FHLB could require us to recognize an impairment charge with respect to such stock holdings. Any such impairment charge would have an adverse impact on our results of operations and financial condition.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
We own investments in Qualified Zone Academy Bonds (“QZAB”) which are recorded in other assets. The investments are carried at cost and are subject to recoverability testing under applicable accounting standards. As of December 31, 2020, we did not recognize an impairment charge related to our QZAB investment holdings; however, potential negative changes to the financial condition of the issuing institutions could require us to recognize an impairment charge with respect to such holdings in the future. Any such impairment charge would have an adverse impact on our results of operations and financial condition.
Our inability to successfully manage our growth or implement our growth strategy could affect our results of operations and financial condition.
We may not be able to successfully implement our growth strategy if we are unable to expand market share in our existing market or identify attractive new markets, locations or opportunities to expand in the future. In addition, our ability to manage growth successfully will depend on whether we can maintain adequate capital levels, maintain cost controls, effectively manage asset quality and successfully integrate any expanded business divisions or acquired businesses into our operations.
As we continue to implement our growth strategy by opening new branches or acquiring branches or banks, we expect to incur increased personnel, occupancy, and other operating expenses. In the case of new branches, we must absorb higher expenses while we begin to generate new deposits. In the case of acquired branches, we must absorb higher expenses while we begin deploying the newly assumed deposit liabilities. With either new branches opened or branches acquired, there could be a lag time involved in deploying new deposits into attractively priced loans and other higher yielding earning assets. Thus, expansion could depress earnings in the short-term, even if an efficiently executed branching strategy leads to long-term financial benefits.
Competition in our market areas may limit future success.
Community banking is a highly competitive business and a consolidating industry. We compete for loans and deposits with other commercial banks, savings and loans, credit unions, finance, insurance and other non-depository companies operating in our market areas. Some of our competitors are not subject to the same regulations and restrictions as are we, and some of our competitors have greater financial resources. If we are unable to effectively compete in our market areas, the Company's business, results of operations, and prospects could be adversely affected.
The value of goodwill and other intangible assets may decline in the future
We have goodwill and core deposit intangible assets from business acquisitions. A significant decline in the expected future cash flows, a significant adverse change in the business climate, slower growth rates or a significant and sustained decline in the price of our common stock could necessitate taking charges in the future related to the impairment of goodwill or other intangible assets. If we were to conclude that a write-down of goodwill or other intangible assets is necessary, we would record the appropriate charge, which could have a material adverse effect on our business, financial condition and results of operations.
Our business is subject to geographic risks that could adversely impact our results of operations and financial condition.
We conduct banking operations principally in northern California. As a result, our business results are dependent in large part upon the business activity, population, income levels, deposits and real estate activity in northern California. Any future deterioration in economic conditions, particularly within our geographic region, could result in the following consequences, any of which could have a material adverse effect on our business, prospects, financial condition and results of operations:
● | Loan delinquencies may increase causing increases in our provision for loan and lease losses and in our Allowance for Loan and Lease Losses (“ALLL”); |
● | Financial sector regulators may adopt more restrictive practices or interpretations of existing regulations, or adopt new regulations; |
● | Collateral for loans made by the Bank, especially real estate related, may decline in value, which in turn could reduce a client’s borrowing power, and reduce the value of assets and collateral associated with our loans held for investment; |
● | Consumer confidence levels may decline and cause adverse changes in payment patterns, resulting in increased delinquencies and default rates on loans and other credit facilities and decreased demand for our products and services; |
● | Demand for loans and other products and services may decrease; |
● | Low cost or non-interest-bearing deposits may decrease; and |
● | Performance of the underlying loans in the private label mortgage backed securities we hold may deteriorate, potentially causing other-than-temporary impairment markdowns to our investment portfolio. |
The effects of the COVID-19 pandemic could adversely affect our customers’ future results of operations and/or the market price of our stock.
The COVID-19 pandemic continues to rapidly evolve, as do federal, state and local efforts to address it. Both the direct effects of the pandemic and the resulting United States governmental responses are of an unprecedented scope as it impacts both the health and the economy of our country and the world at large. No one can predict the extent or duration of the pandemic, or its effect on the markets that we serve. Further, the ongoing efforts and impact of the government in mitigating the health and the economic effects of the pandemic cannot currently be predicted, whether on our business or as to the economy as a whole. The pandemic has thus far resulted in significant volatility in international and United States markets, which could adversely affect the market price of our stock. To date, the pandemic has resulted in significant business disruption and volatility in the international and domestic markets, which has led to increased volatility in the market price of our stock and stocks in general.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
The Company believes it is well positioned to mitigate the potential financial impact of the COVID-19 pandemic with a strong liquidity and capital position. The Company has implemented several measures to manage through the pandemic, including:
| | ● | launched a pandemic team that addresses the daily impact to our business; |
| | ● | proactively reaching out to, and working with customers, to assess their needs and provide funding, flexible repayment options or modifications as necessary; |
| | ● | designated a “command center” that supports employees so they can work with customers to provide the PPP loans; |
| | ● | increased monitoring of credit quality and portfolio risk for industries determined to have elevated risk; and |
| | ● | developed safety measures for the health of our employees including elimination of unnecessary business travel, social distancing precautions, additional wellness and education programs, and preventative cleaning practices. |
Nonetheless, any future deterioration in economic conditions in the markets the Bank serves as a consequence of the pandemic, or a failure of the economy to recover from pandemic related disruptions as quickly as anticipated, could have a material adverse effect on our business, financial condition, results of operations and prospects.
Natural disasters and other uncontrollable events, such as earthquakes, volcanic eruptions, tsunami, wildfires, droughts, floods, mudslides, hurricanes, tornados and other geologic processes could harm our business.
We are susceptible to the risks of natural disasters such as earthquakes, volcanic eruptions, tsunami, wildfires, droughts, floods, mudslides, hurricanes, tornados and other geologic processes. Natural disasters could harm our operations directly through interference with communications, including the interruption or loss of our websites, which would prevent us from gathering deposits, originating loans and processing and controlling our flow of business, as well as through the destruction of facilities and our operational, financial and management information systems. California has also historically experienced energy shortages, which, if they recur, could impair our business operation and the value of real estate in the areas affected.
Although we have implemented several back-up systems and protections and maintain business interruption insurance, these measures may not protect us fully from the effects of a natural disaster. The occurrence of natural disasters or energy shortages in California could have a material adverse effect on our business, prospects, financial condition and results of operations.
A natural disaster outside California could negatively impact our purchased loan portfolio or our third party loan servicers.
Our purchased loan portfolio includes a significant amount of loans made to borrowers outside California. We also rely on third party loan servicers located outside of California. Therefore, we are susceptible to the risks of natural disasters outside California. Natural disasters could impact the operations of our loan servicers directly through interference with communications, including the interruption or loss of websites, destruction of facilities, operational, financial and management information systems which could prevent them from servicing our portfolio. Natural disasters outside California could also impact the underlying collateral and borrower’s ability to repay the loans for our purchased loan portfolios.
National and global economic and geopolitical conditions could adversely affect our future results of operations or market price of our stock.
Our business is impacted by factors such as economic, political and market conditions, broad trends in industry and finance, changes in government monetary and fiscal policies, inflation, and market volatility, all of which are beyond our control. National and global economies are constantly in flux, as evidenced by recent market volatility resulting from, among other things, a relatively new presidential administration and new tax and economic policies associated therewith, the uncertain future relationship between the European Union and United Kingdom, and the ever-changing landscape of the energy industry. Future economic conditions cannot be predicted, and any renewed deterioration in the economies of the nation as a whole or in our market could have an adverse effect, which could be material, on our business, financial condition, results, operations and prospects, and could cause the market price of our stock to decline.
Shareholders’ Risk
In addition to risks and uncertainties that may affect the Company’s business, financial condition and the future results, shareholders may also be subject to the following risks:
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
There can be no assurance we will be able to continue paying cash dividends on our common stock at recent levels.
We may not be able to continue paying quarterly cash dividends commensurate with recent levels, given that the ability to pay cash dividends on our common stock depends on a variety of factors. The payment of dividends is subject to government regulation in that regulatory authorities may prohibit banks and bank holding companies from paying dividends that would constitute an unsafe or unsound banking practice. The Federal Reserve Board generally prohibits a bank holding company from declaring or paying a cash dividend which would impose undue pressure on the capital of subsidiary banks or would be funded only through borrowing or other arrangements that might adversely affect a financial services holding company’s financial position. The Board of Governors of the Federal Reserve System policy is that a bank holding company should not continue its existing rate of cash dividends on its common stock unless its net income is sufficient to fully fund each dividend and its prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition. The power of the board of directors of an insured depository institution to declare a cash dividend or other distribution with respect to capital is subject to statutory and regulatory restrictions which limit the amount available for such distribution depending upon the earnings, financial condition and cash needs of the institution, as well as general business conditions.
Our ability to pay cash dividends to our shareholders is dependent on our receipt of cash dividends from our subsidiary Bank. In addition to the restrictions imposed under federal law, banks chartered under California law generally may only pay a cash dividend to the extent such payment does not exceed the lesser of (i) retained earnings of the bank or (ii) the bank’s net income for its last three fiscal years less any distributions to shareholders during such period. The Bank is also prohibited from paying a dividend to the holding company if it is in default on its federal deposit insurance assessment.
The price of our common stock may fluctuate significantly, and this may make it difficult for you to resell shares of our common stock owned by you at times or at prices you find attractive.
Our stock price can fluctuate significantly in response to a variety of factors including, among other things:
● | Actual or anticipated variations in quarterly results of operations; |
● | Recommendations by securities analysts; |
● | Operating and stock price performance of other companies that investors deem comparable to us; |
● | News reports relating to trends, concerns and other issues in the financial services industry, including the failures of other financial institutions; |
● | Perceptions in the marketplace regarding the Company and/or our competitors; |
● | Public sentiments toward the financial services and banking industry generally; |
● | New technology used, or services offered, by competitors; |
● | Significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving the Company or our competitors; |
● | Changes in government regulations; and |
● | Geopolitical conditions such as acts or threats of terrorism or military conflicts. |
General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause our stock price to decrease regardless of operating results.
Our common stock is traded on the NASDAQ Global Market under the trading symbol “BOCH” and historically has been a low trading volume stock. The limited trading market for our common stock may cause fluctuations in the market value of our common stock to be exaggerated, leading to price volatility in excess of that which would occur in a more active trading market. Future sales of substantial amounts of common stock in the public market, or the perception that such sales may occur, could adversely affect the prevailing market price of our common stock. In addition, even if a more active market in our common stock develops, we cannot assure you that such a market will continue.
Anti-takeover provisions in our articles of incorporation could make a third party acquisition of us difficult.
In order to approve a merger or similar business combination with the owner of 20% or more of our common stock (an “Interested Shareholder”), our Articles of Incorporation contain provisions that require a supermajority vote of 66.7% of the outstanding shares of the common stock (excluding the shares held by the Interested Shareholder or its affiliates). These provisions further require that the per share consideration to be paid in such a transaction be equal to or exceed the greater of (1) the highest per share price paid by the Interested Shareholder (a) within two years of the transaction proposal announcement date, or (b) the date the Interested Shareholder acquired a 20% -plus ownership interest (if the acquisition occurred less than two years before the transaction announcement) and (2) the fair market value of the Common Stock on (a) the transaction proposal announcement date, or (b) the date the Interested Shareholder acquired a 20% -plus ownership interest (if the acquisition occurred less than two years before the transaction announcement).
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
These provisions could result in the Company becoming a less attractive target for a would-be acquirer. As a consequence, it is possible that shareholders would lose an opportunity to be paid a premium for their shares in an acquisition transaction, even in circumstances where such action is favored by a majority of the Company's shareholders.
There may be future sales or other dilutions of our equity which may adversely affect the market price of our common stock.
We are not restricted from issuing additional shares of common stock, including securities that are convertible into or exchangeable for, or that represent the right to receive our common stock. In addition, we are not prohibited from issuing securities which are senior to our common stock. Because our decision to issue securities in the future will depend in part on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of any future offerings.
Future issuance of shares of our common stock, including those that may be issued in connection with our various stock option and equity compensation plans, in acquisitions or in any other offering of our common stock for cash, could have a dilutive effect on the tangible book value of our common stock, may be dilutive to existing shareholders and could adversely affect the market price of our stock.
The holders of our trust preferred securities have rights that are senior to those of our holders of common stock and that may impact our ability to pay dividends on our common stock to our common shareholders.
At December 31, 2020, our subsidiary Bank of Commerce Holdings Trust II had outstanding $10.3 million of trust preferred securities. These securities are effectively senior to shares of common stock due to the priority of the underlying junior subordinated debentures. As a result, we must make interest payments on our trust preferred securities before any dividends can be paid on our common stock; moreover, in the event of our bankruptcy, dissolution, or liquidation, all obligations outstanding with respect to our trust preferred securities must be satisfied before any distributions can be made to our shareholders. While we have the right to defer interest on the trust preferred securities for a period of up to five years, no dividends may be paid to our common shareholders during that time if any such election has been made.
Our subordinated debt agreement has provisions that may impact our ability to pay dividends on our common stock to our common shareholders
On December 10, 2015, we issued and sold $10.0 million in aggregate principal amount of fixed to floating rate Subordinated Notes. The Notes limit the payment of cash dividends to our common shareholders if the Company is not well capitalized or if there is an event of default as described by the note agreement.
25
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Item 1B - Unresolved Staff Comments
None to report.
Item 2 - Properties
● | The Company’s principal executive office is located at 555 Capitol Mall, Suite 1255, Sacramento, California 95814. |
● | The Bank owns eight and leases space for two, full service banking offices in northern California. |
● | The Bank has one limited service branch in Carmichael, Sacramento, California. |
● | The Bank leases space for one loan production office in Santa Rosa, California. |
● | The Bank leases space to operate one free standing remote ATM in northern California. |
● | The Bank has office space in leased and bank owned locations in Redding, California and leased office space in Roseville, California for administration and back office operations. |
Item 3 - Legal Proceedings
We are subject to various pending and threatened legal actions arising in the ordinary course of business and, if necessary, maintain reserves for losses from legal actions that are both probable and estimable. There are no legal proceedings adverse to the Company that we believe will have a material effect on our consolidated financial position or results of operations.
Item 4 - Mine Safety Disclosures
Not applicable.
Part II
Item 5 - Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
The principal market on which our common stock is traded is the NASDAQ Global Market. The Holding Company’s common stock is listed under the trading symbol “BOCH.” There were 2,314 shareholders of the Holding Company’s common stock as of December 31, 2020, including those held in street name, and the market price on that date was $9.90 per share.
Cash Dividends
We declared cash dividends of $0.21 and $0.19 during the years ended December 31, 2020 and 2019, respectively. Our ability to pay dividends is subject to certain regulatory requirements. The Federal Reserve Board generally prohibits a bank holding company from declaring or paying a cash dividend which would impose undue pressure on the capital of subsidiary banks or would be funded only through borrowing or other arrangements that might adversely affect a financial services holding company’s financial position. The Board of Governors of the Federal Reserve System policy is that a bank holding company should not continue its existing rate of cash dividends on its common stock unless its net income is sufficient to fully fund each dividend and its prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition. The power of the board of directors of an insured depository institution to declare a cash dividend or other distribution with respect to capital is subject to statutory and regulatory restrictions which limit the amount available for such distribution depending upon the earnings, financial condition and cash needs of the institution, as well as general business conditions.
Our ability to pay dividends is subject to certain contractual requirements. Our trust preferred securities and subordinated debt agreements contain provisions that prohibit us from declaring or paying a dividend if the Company is not “well-capitalized” for regulatory purposes or there exists an event of default as defined by the agreements.
Purchases of equity securities
During the fourth quarter of 2020, we announced a share repurchase program to repurchase up to 1.0 million shares of common stock over a period ending December 31, 2021. As of March 5, 2021, no shares have been repurchased under this program.
In late 2019, we announced a share repurchase program to repurchase for 1.0 million shares of common shares, which was later increased to 1.5 million common shares. Between October of 2019 and April 2020, all 1.5 million shares were repurchased at a total cost of $13.6 million including commissions, or an average of $9.11 per share.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
The following table presents the monthly purchases for the years ended December 31, 2020 and 2019.
| | | | | | | | | | | Total Number Of | | | Maximum Number Of | |
| | | Total Number Of | | | Average Price | | | Common Shares | | | Common Shares | |
| | | Common Shares | | | Paid Per | | | Purchased As Part Of | | | That May Yet Be | |
Period | | Purchased | | | Common Share (1) | | | Publicly Announced Plan | | | Purchased Under The Plan | |
2019 | | | | | | | | | | | | | | | | |
October | | | 71,499 | | | $ | 11.13 | | | | 71,499 | | | | 1,428,501 | |
November | | | 13,493 | | | $ | 11.26 | | | | 13,493 | | | | 1,415,008 | |
December | | | 5,509 | | | $ | 11.28 | | | | 5,509 | | | | 1,409,499 | |
Total for 2019 | | | 90,501 | | | $ | 11.16 | | | | 90,501 | | | | | |
| | | | | | | | | | | | | | | | | |
2020 | | | | | | | | | | | | | | | | |
January | | | 36,810 | | | $ | 11.16 | | | | 36,810 | | | | 1,372,689 | |
February | | | 378,700 | | | $ | 11.25 | | | | 378,700 | | | | 993,989 | |
March | | | 936,412 | | | $ | 8.07 | | | | 936,412 | | | | 57,577 | |
April | | | 57,577 | | | $ | 7.36 | | | | 57,577 | | | | — | |
Total for 2020 | | | 1,409,499 | | | $ | 8.98 | | | | 1,409,499 | | | | | |
Total | | | 1,500,000 | | | $ | 9.11 | | | | 1,500,000 | | | | | |
(1) Average price paid per common share includes commissions. |
27
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Item 6 - Selected Financial Data
The selected consolidated financial data set forth below for the five years ended December 31, 2020, have been derived from the Company’s audited Consolidated Financial Statements and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s audited Consolidated Financial Statements and notes thereto, included elsewhere in this report.
Amounts in thousands (except ratios and per share data) | | 2020 | | | 2019 | | | 2018 | | | 2017 | | | 2016 | |
Statements of income | | | | | | | | | | | | | | | | | | | | |
Interest income | | $ | 60,079 | | | $ | 59,563 | | | $ | 52,701 | | | $ | 45,949 | | | $ | 41,009 | |
Net interest income | | $ | 55,455 | | | $ | 53,535 | | | $ | 47,546 | | | $ | 41,362 | | | $ | 36,231 | |
Provision for loan and lease losses | | $ | 5,250 | | | $ | — | | | $ | — | | | $ | 950 | | | $ | — | |
Noninterest income | | $ | 4,052 | | | $ | 4,184 | | | $ | 4,019 | | | $ | 4,824 | | | $ | 3,486 | |
Noninterest expense | | $ | 34,977 | | | $ | 37,255 | | | $ | 32,206 | | | $ | 30,964 | | | $ | 32,500 | |
Net income available to common shareholders | | $ | 14,164 | | | $ | 14,961 | | | $ | 15,730 | | | $ | 7,344 | | | $ | 5,259 | |
| | | | | | | | | | | | | | | | | | | | | |
Balance sheets | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 1,763,954 | | | $ | 1,479,616 | | | $ | 1,307,104 | | | $ | 1,269,421 | | | $ | 1,140,992 | |
Average total assets | | $ | 1,640,519 | | | $ | 1,458,112 | | | $ | 1,288,841 | | | $ | 1,198,251 | | | $ | 1,079,750 | |
Total gross loans | | $ | 1,139,732 | | | $ | 1,032,903 | | | $ | 946,251 | | | $ | 879,835 | | | $ | 804,211 | |
Allowance for loan and lease losses | | $ | 16,910 | | | $ | 12,231 | | | $ | 12,292 | | | $ | 11,925 | | | $ | 11,544 | |
Total deposits | | $ | 1,542,779 | | | $ | 1,267,171 | | | $ | 1,131,716 | | | $ | 1,102,732 | | | $ | 1,004,666 | |
Total shareholders’ equity | | $ | 177,702 | | | $ | 174,478 | | | $ | 138,321 | | | $ | 127,264 | | | $ | 94,106 | |
| | | | | | | | | | | | | | | | | | | | | |
Ratios 1 | | | | | | | | | | | | | | | | | | | | |
Return on average assets 2 | | | 0.86 | % | | | 1.03 | % | | | 1.22 | % | | | 0.61 | % | | | 0.49 | % |
Return on average shareholders’ equity 3 | | | 8.27 | % | | | 9.09 | % | | | 12.08 | % | | | 6.34 | % | | | 5.68 | % |
Common equity tier 1 capital ratio 4 | | | 13.12 | % | | | 13.19 | % | | | 12.79 | % | | | 12.26 | % | | | 9.43 | % |
Tier 1 capital ratio 4 | | | 13.97 | % | | | 14.04 | % | | | 13.71 | % | | | 13.23 | % | | | 10.42 | % |
Total capital ratio 4 | | | 16.06 | % | | | 15.97 | % | | | 15.82 | % | | | 15.44 | % | | | 12.68 | % |
Tier 1 leverage ratio 4 | | | 9.46 | % | | | 11.30 | % | | | 11.21 | % | | | 10.86 | % | | | 9.13 | % |
Tangible common equity ratio 5 | | | 9.27 | % | | | 10.80 | % | | | 10.46 | % | | | 9.88 | % | | | 8.07 | % |
Net interest margin 6 | | | 3.60 | % | | | 3.94 | % | | | 3.90 | % | | | 3.68 | % | | | 3.60 | % |
Average earning assets to total average assets | | | 93.79 | % | | | 93.29 | % | | | 94.67 | % | | | 93.85 | % | | | 93.34 | % |
Nonperforming assets to total assets 7 | | | 0.40 | % | | | 0.38 | % | | | 0.32 | % | | | 0.46 | % | | | 1.06 | % |
Net charge-offs (recoveries) to average loans | | | 0.05 | % | | | 0.01 | % | | | (0.04 | )% | | | 0.07 | % | | | (0.05 | )% |
Allowance for loan and lease losses to gross loans | | | 1.48 | % | | | 1.18 | % | | | 1.30 | % | | | 1.36 | % | | | 1.44 | % |
Nonperforming loans to allowance for loan and lease losses | | | 41.47 | % | | | 45.92 | % | | | 33.73 | % | | | 48.63 | % | | | 98.64 | % |
Efficiency ratio 8 | | | 58.8 | % | | | 64.5 | % | | | 62.5 | % | | | 67.0 | % | | | 81.8 | % |
| | | | | | | | | | | | | | | | | | | | | |
Share data | | | | | | | | | | | | | | | | | | | | |
Average common shares outstanding – basic | | | 16,918 | | | | 17,956 | | | | 16,248 | | | | 15,207 | | | | 13,367 | |
Average common shares outstanding – diluted | | | 16,963 | | | | 18,024 | | | | 16,332 | | | | 15,310 | | | | 13,425 | |
Book value per common share | | $ | 10.58 | | | $ | 9.62 | | | $ | 8.47 | | | $ | 7.82 | | | $ | 7.00 | |
Book value per common share - tangible 5 | | $ | 9.64 | | | $ | 8.71 | | | $ | 8.36 | | | $ | 7.70 | | | $ | 6.83 | |
Basic earnings per share | | $ | 0.84 | | | $ | 0.83 | | | $ | 0.97 | | | $ | 0.48 | | | $ | 0.39 | |
Diluted earnings per share | | $ | 0.83 | | | $ | 0.83 | | | $ | 0.96 | | | $ | 0.48 | | | $ | 0.39 | |
Cash dividends declared per common share | | $ | 0.21 | | | $ | 0.19 | | | $ | 0.15 | | | $ | 0.12 | | | $ | 0.12 | |
1 - With the exception of end of period ratios, all ratios are based on average daily balances during the indicated period. |
2 - Return on average assets is net income divided by average total assets. |
3 - Return on average shareholders' equity is net income divided by average shareholders’ equity. |
4 - See Item 7 - Management’s Discussion And Analysis Of Financial Condition And Results Of Operations and Note 17 Regulatory Capital in the Notes to Consolidated Financial Statements in this document for a discussion of the regulatory capital guidelines. |
5 - We believe the tangible common equity ratio and tangible book value per share are meaningful measures that the Company and investors commonly use to assess the value and capital levels of the Company. Tangible common shareholders' equity is calculated as total shareholders' equity less goodwill and other intangible assets, net. Tangible assets are total assets less goodwill and other intangible assets, net. The tangible common equity ratio is calculated as tangible common shareholders' equity divided by tangible assets. Tangible book value is calculated as tangible common shareholders' equity divided by the number of shares outstanding. The tangible common equity, tangible common equity ratio and tangible book value are considered a non-GAAP financial measures and should be viewed in conjunction with the total shareholders' equity, total shareholders' equity ratio and book value per share. |
6 - Net interest margin is net interest income expressed as a percentage of average interest-earning assets. |
7 - Nonperforming assets include all nonperforming loans (nonaccrual loans, loans 90 days past due and still accruing interest and restructured loans that are nonperforming) and real estate acquired by foreclosure or transfer to OREO. |
8 - The efficiency ratio is calculated by dividing noninterest expense by the sum of net interest income and noninterest income and presented based on results from continuing operations. |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition as of December 31, 2020 and 2019 and results of operations for those years should be read together with our Consolidated Financial Statements and related notes, included in Part II Item 8 of this report. Average balances, including balances used in calculating certain financial ratios, are comprised of average daily balances.
The disclosures set forth in this item are qualified by important factors detailed in Part I captioned Forward-Looking Statements and Item 1A captioned Risk Factors of this report and other cautionary statements set forth elsewhere in the report.
This section of this Form 10-K generally discusses 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2019.
EXECUTIVE OVERVIEW
Net income for the years ended December 31, 2020 and 2019 was $14.2 million or $0.83 per share diluted and $15.0 million or $0.83 per share-diluted, respectively.
The current year includes the financial impact caused by COVID-19 pandemic. We participated in the PPP, funding 606 PPP loans totaling $163.5 million and we granted 278 payment deferrals on loans totaling $127.3 million to help our borrowers. Due to the economic uncertainty caused by the pandemic, we recorded a $5.3 million provision for loan lease and losses. We also experienced an unprecedented increase in deposit balances as all PPP loan funds were deposited into customer accounts at our bank and as a result of customer behavior which was focused on cash accumulation.
During the fourth quarter of 2020, most of our borrowers who received loan payment deferrals have resumed making payments. Deferrals outstanding remained on loans totaling $9.5 million at December 31, 2020 and our COVID-19 credit concerns have moderated.
During 2020, nonrecurring costs totaled $1.1 million associated with the termination of a technology management services contract and an employment severance agreement. We also repurchased 1,409,499 shares of common stock.
The prior year includes benefits from our acquisition of Merchants National Bank of Sacramento and our name change of our subsidiary bank. During 2019, acquisition related costs totaled $2.2 million and costs related to the name change totaled $503 thousand.
Financial Highlights for the year ended December 31, 2020 were as follows:
Performance
● | Net income of $14.2 million was a decrease of $797 thousand (5%) from $15.0 million earned during the prior year. Earnings of $0.83 per share – diluted was unchanged compared to the prior year and reflects the impact of the following: |
| | o | 1.5 million shares of common stock repurchased between October of 2019 and April of 2020. |
| | o | $5.3 million provision for loan and lease losses for the current year. |
| | o | $1.1 million in non-recurring costs during the first quarter of 2020 associated with the termination of a technology management services contract and an employment severance agreement; both previously announced. |
| | o | $2.7 million in non-recurring costs recorded during the year ended December 31, 2019 associated with our January 31, 2019 acquisition of The Merchants National Bank of Sacramento and the name change of our subsidiary bank. |
● | Net interest income increased $1.9 million (4%) to $55.5 million compared to $53.5 million in the prior year. |
● | Net interest margin declined to 3.60% compared to 3.94% in the prior year. |
● | Return on average assets decreased to 0.86% compared to 1.03% in the prior year. |
● | Return on average equity decreased to 8.27% compared to 9.09% in the prior year. |
● | Average loans totaled $1.149 billion, an increase of $129 million (13%) compared to average loans in the prior year. |
● | Average earning assets totaled $1.539 billion, an increase of $178 million (13%) compared to average earning assets in the prior year. |
● | Average deposits totaled $1.423 billion, an increase of $179 million (14%) compared to average deposits in the prior year. |
| | o | Average non-maturing deposits totaled $1.281 billion, an increase of $197 million (18%) compared to the prior year. |
| | o | Average certificates of deposit totaled $142.1 million, a decrease of $18.5 million (12%) compared to the prior year. |
● | The Company’s efficiency ratio was 58.8% compared to 64.5% in the prior year. |
| | o | The Company’s efficiency ratio of 58.8% for 2020 includes $1.1 million of non-recurring costs. The efficiency ratio excluding these costs was 56.9%. |
| | o | The Company’s efficiency ratio of 64.5% for 2019 includes $2.7 million of non-recurring costs. The efficiency ratio excluding these costs was 59.9%. |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Capital
● | Declared cash dividends of $0.21 per share for 2020 compared to $0.19 per share in 2019. |
● | Book value per common share was $10.58 at December 31, 2020 compared to $9.62 at December 31, 2019. Tangible book value per common share (non-GAAP) which excludes goodwill and other intangible assets, net from shareholders’ equity was $9.64 at December 31, 2020 compared to $8.71 at December 31, 2019. Management believes that tangible book value per share is meaningful because it is a measure that the Company and investors commonly use to assess capital adequacy. |
● | Average total equity increased by $6.6 million (4%) to $171.3 million for the year ended December 31, 2020, compared to $164.6 million for the year ended December 31, 2019. |
● | The Bank maintained capital levels in excess of the “well-capitalized” standards at December 31, 2020 under the regulatory framework for prompt corrective action. |
Credit Quality
● | Nonperforming assets at December 31, 2020 totaled $7.0 million or 0.40% of total assets, an increase of $1.4 million since December 31, 2019. The increase in nonperforming assets results primarily from two commercial loans totaling $1.4 million and a $640 thousand commercial real estate loan, all of which are well secured, that were placed on nonaccrual status during the year ending December 31, 2020. |
● | The Company recorded a provision for loan and lease losses of $5.3 million during the year ended December 31, 2020 based on our analysis of the economic effects of COVID-19. |
Vision and Objectives
We seek to provide competitive, long-term returns to our shareholders while serving the financial needs of the communities in our northern California market. Management strives to provide those returns while exercising prudent risk management practices and maintaining adequate levels of capital and reserves.
We are focused on expanding our presence through organic growth and the addition of new strategically important locations. We will pursue attractive opportunities to enter related lines of business and to acquire financial institutions with complementary lines of business when it is beneficial to do so. During 2020, our growth in average assets of $182.4 million or 13% was aided by the Small Business Administration’s (“SBA”) Paycheck Protection Program (“PPP”).
Our long-term success rests on the shoulders of the leadership team and its ability to effectively enhance the performance of the Company. As a financial services company, we are in the business of taking and managing risks. Whether we are successful depends largely upon whether we take the right risks and are rewarded appropriately for those risks. Our governance structure enables us to effectively manage all major aspects of our business through an integrated process that includes financial, strategic, risk and leadership planning.
Our risks include not only credit, market and liquidity risk, the traditional concerns for financial institutions, but also operational risks, (including risks related to systems, processes or external events) as well as legal, regulatory and reputation risks. Our management processes, structures, and policies help to ensure compliance with laws and regulations and provide clear lines of authority for decision-making and accountability. Results are important, but equally important is how we achieve those results. Our core values and commitment to high ethical standards are essential to maintaining public trust and confidence in our Company.
30
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
RESULTS OF OPERATIONS
The following discussion and analysis provides a comparison of the results of operations for the years ended December 31, 2020 and December 31, 2019. This discussion should be read in conjunction with the Consolidated Financial Statements and related notes.
Overview
The current year includes the financial impacts of COVID-19 and the resulting economic downturn. During the year, we made changes to our qualitative factors (Q-Factors) that resulted in recording a $5.3 million provision for loan lease and losses. We participated in the PPP, which contributed to a substantial increase in our loan and deposit balances, and the Federal Reserve cut interest rates, which contributed to a decrease in our net interest margin.
The Year Ended December 31, 2020 Compared to the Year Ended December 31, 2019
Net income was $14.2 million for the year ended December 31, 2020, compared to $15.0 million for the year ended December 31, 2019. For 2020, increases in net interest income, decreases in noninterest expense and provision for income taxes were offset by an increase in the provision for loan and lease losses and decreases in noninterest income.
Diluted earnings per share were $0.83 for the year ended December 31, 2020 and 2019.
We declared cash dividends of $0.21 per share in 2020 and $0.19 per share in 2019. In determining the amount of dividend to be paid, we give consideration to capital preservation objectives, the Company’s risk profile, expected asset growth, projected earnings, and the overall dividend pay-out ratio.
Return on Average Assets and Return on Average Equity
The following table presents the return on average assets and return on average equity for the years ended December 31, 2020 and 2019. For each of the periods presented, the table includes the calculated ratios based on reported net income as shown in the Consolidated Statements of Income incorporated in this document.
| | | 2020 | | | 2019 | |
Return on average assets | | | 0.86 | % | | | 1.03 | % |
Return on average equity | | | 8.27 | % | | | 9.09 | % |
Net Interest Income and Net Interest Margin
Net interest income is our largest source of operating income. During 2020, in response to the economic effects of the COVID-19 pandemic, the Federal Reserve cut interest rates by 150 to 175 basis points, which contributed to a significant decrease in our net interest margin. During 2020, we also experienced significant increases in deposit balances. All PPP loan funds were deposited into customer accounts at our bank and customer behavior has emphasized savings during the economic slowdown. We purchased municipal bonds and moderate-term mortgage backed securities to deploy much of this increased liquidity.
The net interest margin for the year ended December 31, 2020 was 3.60%, a decrease of 34 basis points as compared to 2019.
Maintaining our net interest margin in the future will be challenging as current market pressures are anticipated to cause our yield on interest-earning assets to continue to decline.
Net interest income for the years ended December 31, 2020 and 2019 was $55.5 million and $53.5 million, respectively.
Interest and loan fee income for the year ended December 31, 2020 was $60.1 million, an increase of $516 thousand or 1% compared to a year previous.
| | ● | During 2020, we recognized $664 thousand in accelerated fee income on PPP loans forgiven or repaid. These accelerated loan fees increased the average yield on loans by six basis points. |
| | ● | For the year, PPP loans had an average balance of $111.3 million and yield of 2.95% (2.35% excluding accelerated fee income). |
| | ● | Excluding PPP loans, interest and fees on loans during 2020 decreased $1.3 million compared to 2019. Average loan balances increased $17.3 million but the average yield decreased 20 basis points. |
| | ● | Interest on investment securities decreased $620 thousand due to a 38 basis point decrease in average yield partially offset by $18.8 million increase in average securities balances. |
| | ● | Interest on interest-bearing deposits due from banks decreased $872 thousand due to a 178 basis point decrease in average yield that was partially offset by a $30.9 million increase in average interest-bearing deposit balances. |
Interest expense for the year ended December 31, 2020 was $4.6 million, a decrease of $1.4 million or 23% compared to a year previous.
| | ● | Interest expense on interest-bearing deposits decreased $909 thousand. Average interest-bearing core deposit balances increased $96.9 million while average certificate of deposit balances decreased $18.5 million. The average rate paid on interest-bearing deposits decreased 15 basis points. |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
| | ● | Interest expense on FHLB borrowings decreased $242 thousand. Average FHLB borrowing balances decreased $1.3 million from $9.6 million to $8.3 million and the average rate paid decreased 250 basis points. |
| | ● | Interest expense on other term debt decreased $75 thousand. The average debt balance decreased $914 thousand and the average rate paid decreased eight basis points. |
| | o | During the second quarter of 2019, we completed the early repayment of our variable rate senior debt. |
| | ● | Interest expense on junior subordinated debentures decreased $178 thousand. The average debt balance was unchanged, while the average rate paid decreased 172 basis points. |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Average Balances, Interest Income/Expense and Yields Earned/Rates Paid
The following table presents average balance sheet information, together with interest income and yields earned on average interest-earning assets, and interest expense and rates paid on average interest-bearing liabilities for the years ended December 31, 2020, 2019 and 2018.
| | | Years Ended December 31, | |
| | | 2020 | | | 2019 | | | 2018 | |
| | | Average | | | | | | | Yield/ | | | Average | | | | | | | Yield/ | | | Average | | | | | | | Yield/ | |
(Dollars in thousands) | | Balance | | | Interest(1) | | | Rate(6) | | | Balance | | | Interest(1) | | | Rate(6) | | | Balance | | | Interest(1) | | | Rate(6) | |
Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Loans, net of PPP (2) | | $ | 1,038,069 | | | $ | 49,262 | | | | 4.75 | % | | $ | 1,020,801 | | | $ | 50,534 | | | | 4.95 | % | | $ | 915,360 | | | $ | 44,955 | | | | 4.91 | % |
PPP loans (3) | | | 111,306 | | | | 3,280 | | | | 2.95 | % | | | — | | | | — | | | | — | % | | | — | | | | — | | | | — | % |
Taxable securities | | | 245,336 | | | | 5,679 | | | | 2.31 | % | | | 246,723 | | | | 6,673 | | | | 2.70 | % | | | 207,407 | | | | 5,165 | | | | 2.49 | % |
Tax-exempt securities (4) | | | 58,912 | | | | 1,618 | | | | 2.75 | % | | | 38,706 | | | | 1,244 | | | | 3.21 | % | | | 50,330 | | | | 1,629 | | | | 3.24 | % |
Interest-bearing deposits in other banks | | | 84,982 | | | | 240 | | | | 0.28 | % | | | 54,095 | | | | 1,112 | | | | 2.06 | % | | | 47,038 | | | | 952 | | | | 2.02 | % |
Average interest-earning assets | | | 1,538,605 | | | | 60,079 | | | | 3.90 | % | | | 1,360,325 | | | | 59,563 | | | | 4.38 | % | | | 1,220,135 | | | | 52,701 | | | | 4.32 | % |
Cash and due from banks | | | 22,339 | | | | | | | | | | | | 22,806 | | | | | | | | | | | | 20,468 | | | | | | | | | |
Premises and equipment, net | | | 15,426 | | | | | | | | | | | | 15,598 | | | | | | | | | | | | 13,952 | | | | | | | | | |
Goodwill | | | 11,671 | | | | | | | | | | | | 10,758 | | | | | | | | | | | | 665 | | | | | | | | | |
Other intangibles, net | | | 4,412 | | | | | | | | | | | | 4,807 | | | | | | | | | | | | 1,252 | | | | | | | | | |
Other assets | | | 48,066 | | | | | | | | | | | | 43,818 | | | | | | | | | | | | 32,369 | | | | | | | | | |
Average total assets | | $ | 1,640,519 | | | | | | | | | | | $ | 1,458,112 | | | | | | | | | | | $ | 1,288,841 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Demand - interest-bearing | | $ | 264,652 | | | | 313 | | | | 0.12 | % | | $ | 242,516 | | | | 480 | | | | 0.20 | % | | $ | 238,328 | | | | 414 | | | | 0.17 | % |
Money market | | | 372,939 | | | | 1,246 | | | | 0.33 | % | | | 304,340 | | | | 1,599 | | | | 0.53 | % | | | 250,685 | | | | 646 | | | | 0.26 | % |
Savings | | | 142,857 | | | | 340 | | | | 0.24 | % | | | 136,733 | | | | 493 | | | | 0.36 | % | | | 109,025 | | | | 288 | | | | 0.26 | % |
Certificates of deposit | | | 142,067 | | | | 1,741 | | | | 1.23 | % | | | 160,550 | | | | 1,977 | | | | 1.23 | % | | | 168,183 | | | | 1,910 | | | | 1.14 | % |
Federal Home Loan Bank of San Francisco ("FHLB") borrowings | | | 8,347 | | | | 5 | | | | 0.06 | % | | | 9,644 | | | | 247 | | | | 2.56 | % | | | 22,480 | | | | 435 | | | | 1.94 | % |
Other borrowings | | | 9,981 | | | | 731 | | | | 7.32 | % | | | 10,895 | | | | 806 | | | | 7.40 | % | | | 15,129 | | | | 1,077 | | | | 7.12 | % |
Junior subordinated debentures | | | 10,310 | | | | 248 | | | | 2.41 | % | | | 10,310 | | | | 426 | | | | 4.13 | % | | | 10,310 | | | | 385 | | | | 3.73 | % |
Average interest-bearing liabilities | | | 951,153 | | | | 4,624 | | | | 0.49 | % | | | 874,988 | | | | 6,028 | | | | 0.69 | % | | | 814,140 | | | | 5,155 | | | | 0.63 | % |
Noninterest-bearing demand | | | 500,862 | | | | | | | | | | | | 400,588 | | | | | | | | | | | | 332,197 | | | | | | | | | |
Other liabilities | | | 17,217 | | | | | | | | | | | | 17,894 | | | | | | | | | | | | 12,286 | | | | | | | | | |
Shareholders’ equity | | | 171,287 | | | | | | | | | | | | 164,642 | | | | | | | | | | | | 130,218 | | | | | | | | | |
Average liabilities and shareholders’ equity | | $ | 1,640,519 | | | | | | | | | | | $ | 1,458,112 | | | | | | | | | | | $ | 1,288,841 | | | | | | | | | |
Net interest income and net interest margin (5) | | | | | | $ | 55,455 | | | | 3.60 | % | | | | | | $ | 53,535 | | | | 3.94 | % | | | | | | $ | 47,546 | | | | 3.90 | % |
(1) Interest income on loans, net of PPP includes net fees and costs of approximately $720 thousand, $657 thousand and $465 thousand for the years ended December 31, 2020, 2019 and 2018, respectively. Interest income on PPP loans includes net fees and costs of $2.2 million for the year ended December 31, 2020. |
(2) Loans, net of PPP includes average nonaccrual loans of $6.2 million, $11.7 million and $4.2 million for the years 2020, 2019 and 2018, respectively. |
(3) PPP loans represent average gross loans and excludes deferred fees and costs. |
(4) Interest income and yields on tax-exempt securities are not presented on a taxable equivalent basis. |
(5) Net interest margin is net interest income expressed as a percentage of average interest-earning assets. Net interest income for the years ended December 31, 2020 and 2019 included $753 thousand and $620 thousand, respectively, in accretion of the discount on the loans acquired from Merchants Holding Company, which improved the net interest margin by six basis points. |
(6) Yields and rates are calculated by dividing the income or expense by the average balance of the assets or liabilities, respectively. |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
The following table sets forth a summary of the changes in net interest income due to changes in average balances (volume variance) and changes in average rates (rate variance) for 2020 compared to 2019 and 2019 compared to 2018. Changes in interest income and expense which are not specifically attributable to either volume or rate, are allocated proportionately between both variances. Interest income and yields on tax-exempt securities are presented on a nominal basis; not on a tax equivalent basis.
Analysis of Changes in Net Interest Income
| | | Years Ended December 31, | |
| | | 2020 over 2019 | | | 2019 over 2018 | |
(Amounts in thousands) | | Volume | | | Rate | | | Net Change | | | Volume | | | Rate | | | Net Change | |
Increase (decrease) in interest income: | | | | | | | | | | | | | | | | | | | | | | | | |
Loans, net of PPP | | $ | 1,842 | | | $ | (3,114 | ) | | $ | (1,272 | ) | | $ | 5,217 | | | $ | 362 | | | $ | 5,579 | |
PPP loans | | | 3,280 | | | | — | | | | 3,280 | | | | — | | | | — | | | | — | |
Taxable securities | | | (37 | ) | | | (957 | ) | | | (994 | ) | | | 1,037 | | | | 471 | | | | 1,508 | |
Tax-exempt securities (1) | | | 518 | | | | (144 | ) | | | 374 | | | | (374 | ) | | | (11 | ) | | | (385 | ) |
Interest-bearing deposits in other banks | | | 1,707 | | | | (2,579 | ) | | | (872 | ) | | | 145 | | | | 15 | | | | 160 | |
Total increase (decrease) | | | 7,310 | | | | (6,794 | ) | | | 516 | | | | 6,025 | | | | 837 | | | | 6,862 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Increase (decrease) in interest expense: | | | | | | | | | | | | | | | | | | | | | | | | |
Demand - interest-bearing | | | 49 | | | | (216 | ) | | | (167 | ) | | | 7 | | | | 59 | | | | 66 | |
Money market | | | 574 | | | | (927 | ) | | | (353 | ) | | | 163 | | | | 790 | | | | 953 | |
Savings | | | 23 | | | | (176 | ) | | | (153 | ) | | | 84 | | | | 121 | | | | 205 | |
Certificates of deposit | | | (227 | ) | | | (9 | ) | | | (236 | ) | | | (78 | ) | | | 145 | | | | 67 | |
FHLB borrowings | | | (29 | ) | | | (213 | ) | | | (242 | ) | | | (433 | ) | | | 245 | | | | (188 | ) |
Other borrowings | | | (67 | ) | | | (8 | ) | | | (75 | ) | | | (316 | ) | | | 45 | | | | (271 | ) |
Junior subordinated debentures | | | — | | | | (178 | ) | | | (178 | ) | | | — | | | | 41 | | | | 41 | |
Total increase (decrease) | | | 323 | | | | (1,727 | ) | | | (1,404 | ) | | | (573 | ) | | | 1,446 | | | | 873 | |
Net increase (decrease) | | $ | 6,987 | | | $ | (5,067 | ) | | $ | 1,920 | | | $ | 6,598 | | | $ | (609 | ) | | $ | 5,989 | |
(1) Interest income on tax-exempt securities is not presented on a tax equivalent basis. |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Noninterest Income
The following table presents the key components of noninterest income for the years ended December 31, 2020, 2019 and 2018.
| | | Years Ended December 31, | |
| | | 2020 Compared to 2019 | | | 2019 Compared to 2018 | |
| | | | | | | | | | | Change | | | Change | | | | | | | | | | | Change | | | Change | |
(Dollars in thousands) | | 2020 | | | 2019 | | | Amount | | | Percent | | | 2019 | | | 2018 | | | Amount | | | Percent | |
Noninterest income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Service charges on deposit accounts | | $ | 636 | | | $ | 730 | | | $ | (94 | ) | | | (13 | )% | | $ | 730 | | | $ | 682 | | | $ | 48 | | | | 7 | % |
ATM and point of sale fees | | | 1,134 | | | | 1,158 | | | | (24 | ) | | | (2 | )% | | | 1,158 | | | | 1,131 | | | | 27 | | | | 2 | % |
Payroll and benefit processing fees | | | 647 | | | | 669 | | | | (22 | ) | | | (3 | )% | | | 669 | | | | 652 | | | | 17 | | | | 3 | % |
Life insurance | | | 521 | | | | 536 | | | | (15 | ) | | | (3 | )% | | | 536 | | | | 512 | | | | 24 | | | | 5 | % |
Gain on sale of investment securities, net | | | 482 | | | | 186 | | | | 296 | | | | 159 | % | | | 186 | | | | 44 | | | | 142 | | | | 323 | % |
FHLB dividends | | | 369 | | | | 507 | | | | (138 | ) | | | (27 | )% | | | 507 | | | | 480 | | | | 27 | | | | 6 | % |
Gain (loss) on sale of OREO | | | (23 | ) | | | 62 | | | | (85 | ) | | | (137 | )% | | | 62 | | | | 73 | | | | (11 | ) | | | (15 | )% |
Loss on disposal of equipment | | | (132 | ) | | | — | | | | (132 | ) | | | (100 | )% | | | — | | | | — | | | | — | | | | — | % |
Other | | | 418 | | | | 336 | | | | 82 | | | | 24 | % | | | 336 | | | | 445 | | | | (109 | ) | | | (24 | )% |
Total noninterest income | | $ | 4,052 | | | $ | 4,184 | | | $ | (132 | ) | | | (3 | )% | | $ | 4,184 | | | $ | 4,019 | | | $ | 165 | | | | 4 | % |
Noninterest Expense
The following table presents the key components of noninterest expense for the years ended December 31, 2020, 2019 and 2018.
| | | Years Ended December 31, | |
| | | 2020 Compared to 2019 | | | 2019 Compared to 2018 | |
| | | | | | | | | | | Change | | | Change | | | | | | | | | | | Change | | | Change | |
(Dollars in thousands) | | 2020 | | | 2019 | | | Amount | | | Percent | | | 2019 | | | 2018 | | | Amount | | | Percent | |
Noninterest expense: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Salaries & related benefits | | $ | 23,827 | | | $ | 22,714 | | | $ | 1,113 | | | | 5 | % | | $ | 22,714 | | | $ | 20,653 | | | $ | 2,061 | | | | 10 | % |
Loan origination costs | | | (2,565 | ) | | | (1,910 | ) | | | (655 | ) | | | (34 | )% | | | (1,910 | ) | | | (1,944 | ) | | | 34 | | | | 2 | % |
Premises & equipment | | | 3,597 | | | | 3,752 | | | | (155 | ) | | | (4 | )% | | | 3,752 | | | | 3,983 | | | | (231 | ) | | | (6 | )% |
FDIC insurance premium | | | 332 | | | | 91 | | | | 241 | | | | 265 | % | | | 91 | | | | 376 | | | | (285 | ) | | | (76 | )% |
Data processing fees | | | 2,281 | | | | 2,535 | | | | (254 | ) | | | (10 | )% | | | 2,535 | | | | 1,997 | | | | 538 | | | | 27 | % |
Professional services | | | 1,437 | | | | 1,539 | | | | (102 | ) | | | (7 | )% | | | 1,539 | | | | 1,431 | | | | 108 | | | | 8 | % |
Telecommunications | | | 658 | | | | 737 | | | | (79 | ) | | | (11 | )% | | | 737 | | | | 594 | | | | 143 | | | | 24 | % |
Acquisition and merger | | | — | | | | 2,193 | | | | (2,193 | ) | | | (100 | )% | | | 2,193 | | | | 844 | | | | 1,349 | | | | 160 | % |
Other | | | 5,410 | | | | 5,604 | | | | (194 | ) | | | (3 | )% | | | 5,604 | | | | 4,272 | | | | 1,332 | | | | 31 | % |
Total noninterest expense | | $ | 34,977 | | | $ | 37,255 | | | $ | (2,278 | ) | | | (6 | )% | | $ | 37,255 | | | $ | 32,206 | | | $ | 5,049 | | | | 16 | % |
Noninterest expense for the year ended December 31, 2020 totaled $35.0 million, a decrease of $2.3 million or 6% compared to 2019. Decreases in noninterest expense included the following items:
● | $655 thousand deferred loan origination costs benefit as a result of the 606 loans we originated under the PPP. |
● | $2.7 million in non-recurring costs recorded during 2019 associated with our acquisition of Merchants National Bank of Sacramento and the name change subsidiary bank. |
The decreases were partially offset by $1.1 million increase in salaries and related benefit, which included:
● | Increased incentive accruals. |
● | Hiring three relationship managers to open a loan production office in Santa Rosa. |
● | Increase in vacation accrual costs during 2020. Our employees have used less of their vacation benefits in the current year due to travel restrictions imposed in response to the COVID-19 pandemic. |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Income Taxes
Our provision for income taxes includes both federal and state income taxes and reflects the application of federal and state statutory rates to our income before taxes. The lower effective tax rate in 2018 includes a $1.5 million decrease in our income tax provision composed of a $988 thousand reversal of our reserve for uncertain tax position and a $484 thousand benefit as a result of our cost segregation study and tangible property review.
| | | Years Ended December 31, | |
(Dollars in thousands) | | 2020 | | | 2019 | | | 2018 | |
Income Taxes: | | | | | | | | | | | | |
Income before provision for income taxes | | $ | 19,280 | | | $ | 20,464 | | | $ | 19,359 | |
Provision for income taxes | | $ | 5,116 | | | $ | 5,503 | | | $ | 3,629 | |
Effective tax rate | | | 26.5 | % | | | 26.9 | % | | | 18.7 | % |
The following table presents a reconciliation of income taxes computed at the federal statutory rate to the actual effective rate for the years ended December 31, 2020, 2019, and 2018.
| | | 2020 | | | 2019 | | | 2018 | |
Income tax at the federal statutory rate | | | 21.0 | % | | | 21.0 | % | | | 21.0 | % |
State franchise tax, net of federal tax benefit | | | 8.4 | % | | | 8.6 | % | | | 8.3 | % |
Amortization of LIHTC partnerships | | | 3.1 | % | | | 2.4 | % | | | 2.7 | % |
Officer life insurance | | | (0.6 | )% | | | (0.5 | )% | | | (0.6 | )% |
Tax-exempt interest | | | (1.8 | )% | | | (1.3 | )% | | | (1.8 | )% |
LIHTC partnership credits and benefits | | | (3.9 | )% | | | (3.5 | )% | | | (3.8 | )% |
Accelerated depreciation - cost segregation study | | | — | % | | | — | % | | | (2.5 | )% |
Reversal of uncertain tax position | | | — | % | | | — | % | | | (5.1 | )% |
Other | | | 0.3 | % | | | 0.2 | % | | | 0.5 | % |
Effective tax rate | | | 26.5 | % | | | 26.9 | % | | | 18.7 | % |
36
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
FINANCIAL CONDITION
Consolidated Balance Sheets
As of December 31, 2020, we had total consolidated assets of $1.764 billion, gross loans of $1.140 billion, allowance for loan and lease losses (“ALLL”) of $16.9 million, total deposits of $1.543 billion, and shareholders’ equity of $178 million.
As of December 31, 2020, we maintained noninterest-bearing cash positions at the Federal Reserve Bank and correspondent banks in the amount of $19.9 million. We also held interest-bearing deposits in the amount of $87.1 million. Management has been challenged to invest the rapidly increasing liquidity generated by growth in deposits and loan repayments.
Available-for-sale investment securities totaled $446.9 million at December 31, 2020, compared with $287.0 million at December 31, 2019. During 2020, we purchased securities with a par value of $288 million. During 2020, we sold securities with a par value of $54.2 million resulting in $482 thousand in net realized gains. During 2020, we also received $88.5 million in proceeds from principal payments, calls and maturities within the available-for-sale securities portfolio.
At December 31, 2020, our net unrealized gains on available-for-sale securities were $10.6 million compared with $3.7 million net unrealized gains at December 31, 2019. The changes in net unrealized gains was due to changes in market interest rates.
We recorded gross loan balances of $1.140 billion at December 31, 2020, compared with $1.033 billion at December 31, 2019, an increase of $107 million. The increase in gross loans occurred from loans originated from the PPP, which had a balance of $130.8 million at December 31, 2020. Loans, exclusive of PPP declined $24.0 million during the year.
Nonperforming loans, which include nonaccrual loans and accruing loans past due over 90 days, increased by $1.4 million to $7.0 million, or 0.62% of gross loans (0.70% of gross loans excluding PPP loans), as of December 31, 2020, compared to $5.6 million, or 0.54% of gross loans as of December 31, 2019. The increase in nonperforming assets results primarily from two commercial loans totaling $1.4 million and a $640 thousand commercial real estate loan, all of which are well secured, that were placed on nonaccrual status during the year ending December 31, 2020.
Past due loans as of December 31, 2020 increased $498 thousand to $5.4 million, compared to $4.9 million as of December 31, 2019. The increase in past due loans was primarily due to two commercial loans totaling $1.4 million. We believe that risk grading for past due and nonperforming loans appropriately reflects the risk associated with those loans.
In response to the COVID-19 pandemic, we granted loan payment deferrals to help our borrowers. Without these deferrals, past due loan totals would have been higher at December 31, 2020. A detailed discussion of the loan payment deferrals is provided later in this document under the heading “Troubled Debt Restructuring Guidance”.
As part of the SBA coronavirus debt relief efforts, the SBA made six months of principal and interest payments on all SBA 7(a) loans. Without these payments, past due loan totals would have been higher at December 31, 2020. A detailed discussion of program is provided later in this document under the heading “SBA Loan Payments”.
The ALLL at December 31, 2020 increased $4.7 million to $16.9 million compared to $12.2 million at December 31, 2019. We recorded a $5.3 million provision for loan lease and losses during the year ended December 31, 2020 due to the economic uncertainty caused by COVID-19. At December 31, 2020, relying on our ALLL methodology, which uses criteria such as credit grading, historical loss rates, and qualitative factors we believe the ALLL is adequate. There is, however, no assurance that future loan and lease losses will not exceed the levels provided for in the ALLL and could result in additional charges to the provision for loan and lease losses. A detailed discussion of the ALLL is provided later in this document under the heading “Allowance for Loan and Lease Losses”. Also, see Note 5 Loans in the Notes to Consolidated Financial Statements for further information on the ALLL and the loan portfolio.
Premises and equipment totaled $15.0 million at December 31, 2020, a decrease of $907 thousand compared to $15.9 million at December 31, 2019. During the year, we invested $1.1 million in premises and equipment.
Our OREO balance at December 31, 2020 was $8 thousand compared to $35 thousand at December 31, 2019. For the year ended December 31, 2020, we transferred into OREO one foreclosed property in the amount of $8 thousand and sold one property out of OREO with a balance of $35 thousand for a net loss of $23 thousand.
Bank-owned life insurance increased $505 thousand during the year ended December 31, 2020 to $24.2 million compared to $23.7 million at December 31, 2019. During 2020, no new policies were purchased, no policies surrendered and no death benefits were received.
Our net deferred tax assets were $4.0 million at December 31, 2020 compared to $4.6 million at December 31, 2019. The decrease was due to the deferred tax effect of unrealized gains in the investment portfolio partially offset by the deferred tax effect of the provision for loan and lease losses.
Goodwill and other intangible assets, net decreased $765 thousand during the year ended December 31, 2020 to $15.7 million compared to $16.5 million at December 31, 2019 due to amortization of core deposit intangibles. We concluded that goodwill was not impaired during 2020. A detailed discussion of our impairment analysis is presented below under the heading “Goodwill and Other Intangibles”.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Other assets, which include the Bank’s investment in qualified zone academy bonds, FHLB stock, right-of-use lease asset and low income housing tax credit partnerships totaled $28.2 million at December 31, 2020 compared to $28.6 million at December 31, 2019. The increase included one new $1.0 million Low Income Housing Tax Credit (“LIHTC”) partnership investment.
Total deposits at December 31, 2020, increased $276 million or 22% to $1.543 billion compared to December 31, 2019.
| | ● | Total non-maturing deposits increased $291.7 million compared to December 31, 2019. The increase in non-maturing deposits was due to PPP loan program disbursements and changes in customer behavior, which is placing greater emphasis on savings. |
| | ● | Certificates of deposit decreased $16.1 million compared to December 31, 2019. The decrease in certificates of deposits reflect our decision to reduce reliance on public deposits and depositor reaction to the low interest rate environment. |
Other liabilities which include the Bank’s liability for Supplemental Executive Retirement Plan (“SERP”), deferred director compensation, operating leases and funding obligations for investments in LIHTC partnerships increased $463 thousand to $18.2 million as of December 31, 2020 compared to $17.7 million at December 31, 2019.
Investment Securities
The composition of our investment securities portfolio reflects management’s objective of pursuing yield and a relatively stable source of interest income while maintaining an appropriate level of liquidity.
The investment securities portfolio also:
| | ● | Partially mitigates interest rate risk; |
| | ● | Diversifies the credit risk inherent in the loan portfolio; |
| | ● | Provides a vehicle for the investment of excess liquidity; |
| | ● | Provides a source of liquidity when pledged as collateral for lines of credit or certain public funds. |
The carrying value of our available-for-sale investment securities totaled $446.9 million at December 31, 2020, compared to $287.0 million at December 31, 2019. During 2020, we deployed significant excess cash into our investment portfolio. Investment purchases were comprised primarily of longer duration municipal bonds and lower coupon mortgage backed securities. During the year ended December 31, 2020, we purchased securities with a par value of $288 million and weighted average yield of 1.82% (1.96% tax equivalent). During the year ended December 31, 2020, we sold securities with a par value of $54.2 million and weighted average yield of 2.21% (2.32% tax equivalent).
The following table presents the available-for-sale investment securities portfolio at fair value as of December 31, for each of the last three years.
(Amounts in thousands) | | 2020 | | | 2019 | | | 2018 | |
Available-for-sale securities: | | | | | | | | | | | | |
U.S. government & agencies | | $ | 32,994 | | | $ | 38,733 | | | $ | 40,087 | |
Obligations of state and political subdivisions | | | 108,366 | | | | 42,098 | | | | 50,530 | |
Residential mortgage-backed securities and collateralized mortgage obligations | | | 240,478 | | | | 180,835 | | | | 138,503 | |
Corporate securities | | | — | | | | 2,966 | | | | 2,922 | |
Commercial mortgage-backed securities | | | 28,074 | | | | 19,307 | | | | 24,762 | |
Other asset-backed securities | | | 36,968 | | | | 3,011 | | | | 124 | |
Total | | $ | 446,880 | | | $ | 286,950 | | | $ | 256,928 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
The following table presents information regarding the amortized cost, and contractual maturity structure of the investment portfolio at December 31, 2020.
| | | | | | | | | | | Maturities | | | Maturities | | | | | | | | | | | | | | | | | |
| | | Maturities | | | Over One Through | | | Over Five Through | | | Maturities | | | | | | | | | |
| | | Within One Year | | | Five Years | | | Ten Years | | | Over Ten Years | | | Total | |
(Dollars in thousands) | | Amount | | | Yield | | | Amount | | | Yield | | | Amount | | | Yield | | | Amount | | | Yield | | | Amount | | | Yield | |
Available-for-sale securities: (1) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
U.S. government & agencies | | $ | 39 | | | | 2.92 | % | | $ | 1,080 | | | | 2.30 | % | | $ | 15,956 | | | | 2.39 | % | | $ | 15,089 | | | | 2.08 | % | | $ | 32,164 | | | | 2.24 | % |
Obligations of state and political subdivisions | | | 456 | | | | 3.29 | % | | | 9,030 | | | | 3.78 | % | | | 13,134 | | | | 2.66 | % | | | 80,804 | | | | 2.41 | % | | | 103,424 | | | | 2.56 | % |
Residential mortgage-backed securities and collateralized mortgage obligations | | | 18,096 | | | | 0.72 | % | | | 92,163 | | | | 2.24 | % | | | 90,786 | | | | 1.53 | % | | | 35,784 | | | | 1.56 | % | | | 236,829 | | | | 1.75 | % |
Commercial mortgage-backed securities | | | — | | | | — | % | | | 1,736 | | | | 2.48 | % | | | 8,048 | | | | 1.89 | % | | | 17,671 | | | | 1.94 | % | | | 27,455 | | | | 1.96 | % |
Other asset-backed securities | | | — | | | | — | % | | | — | | | | — | % | | | — | | | | — | % | | | 36,377 | | | | 1.47 | % | | | 36,377 | | | | 1.47 | % |
Total | | $ | 18,591 | | | | 0.79 | % | | $ | 104,009 | | | | 2.38 | % | | $ | 127,924 | | | | 1.78 | % | | $ | 185,725 | | | | 1.99 | % | | $ | 436,249 | | | | 1.97 | % |
(1) The maturities for the collateralized mortgage obligations and mortgage-backed securities are presented by expected average life, rather than contractual maturity. The yield on tax-exempt securities has not been adjusted to a tax-equivalent yield basis. |
While every investment security has a contractual maturity, many have cash flows that differ from the contractual terms and result in earlier maturities. The following table presents the expected average life of investment securities at December 31, 2020.
| | | Available-For-Sale | |
(Amounts in thousands) | | Amortized Cost | | | Fair Value | |
Average expected life: | | | | | | | | |
One year or less | | $ | 23,654 | | | $ | 23,961 | |
After one year through five years | | | 164,773 | | | | 170,536 | |
After five years through ten years | | | 206,274 | | | | 210,574 | |
After ten years | | | 41,548 | | | | 41,809 | |
Total | | $ | 436,249 | | | $ | 446,880 | |
Loan Portfolio
Loan Concentrations
Historically, we have concentrated our loan origination activities primarily within the California counties of El Dorado, Placer, Sacramento, and Shasta. In recent years, our loan origination activity has expanded to include other portions of California and northern Nevada. We manage our credit risk through various diversifications (borrower industry, geography, collateral type) of our loan portfolio, the application of sound underwriting policies and procedures, and ongoing credit monitoring practices. Generally, our loans are secured by real estate or other assets located in California. Repayment is expected from the borrower’s cash flows or cash flows from real estate investments.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
The following table presents the composition of the loan portfolio as of December 31 for each of the last five years.
| | | As of December 31, | |
(Dollars in thousands) | | 2020 | | | % | | | 2019 | | | % | | | 2018 | | | % | | | 2017 | | | % | | | 2016 | | | % | |
Loan Portfolio: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial | | $ | 115,559 | | | | 10 | % | | $ | 141,197 | | | | 14 | % | | $ | 135,543 | | | | 14 | % | | $ | 142,405 | | | | 16 | % | | $ | 146,881 | | | | 18 | % |
PPP | | | 130,814 | | | | 11 | % | | | — | | | | — | % | | | — | | | | — | % | | | — | | | | — | % | | | — | | | | — | % |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 44,549 | | | | 4 | % | | | 26,830 | | | | 3 | % | | | 22,563 | | | | 2 | % | | | 15,902 | | | | 2 | % | | | 36,792 | | | | 5 | % |
Non-owner occupied | | | 512,832 | | | | 45 | % | | | 493,920 | | | | 48 | % | | | 433,708 | | | | 46 | % | | | 377,668 | | | | 43 | % | | | 292,615 | | | | 36 | % |
Owner occupied | | | 210,155 | | | | 18 | % | | | 218,833 | | | | 21 | % | | | 204,622 | | | | 22 | % | | | 192,023 | | | | 22 | % | | | 174,298 | | | | 22 | % |
Residential real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
ITIN | | | 29,035 | | | | 3 | % | | | 33,039 | | | | 3 | % | | | 37,446 | | | | 4 | % | | | 41,188 | | | | 5 | % | | | 45,566 | | | | 6 | % |
1-4 family mortgage | | | 55,925 | | | | 5 | % | | | 63,661 | | | | 6 | % | | | 34,366 | | | | 4 | % | | | 30,377 | | | | 3 | % | | | 20,425 | | | | 3 | % |
Equity lines | | | 18,894 | | | | 2 | % | | | 22,099 | | | | 2 | % | | | 26,958 | | | | 3 | % | | | 30,347 | | | | 3 | % | | | 35,953 | | | | 4 | % |
Consumer and other | | | 21,969 | | | | 2 | % | | | 33,324 | | | | 3 | % | | | 51,045 | | | | 5 | % | | | 49,925 | | | | 6 | % | | | 51,681 | | | | 6 | % |
Gross loans | | | 1,139,732 | | | | 100 | % | | | 1,032,903 | | | | 100 | % | | | 946,251 | | | | 100 | % | | | 879,835 | | | | 100 | % | | | 804,211 | | | | 100 | % |
Deferred fees and costs | | | 229 | | | | | | | | 2,162 | | | | | | | | 1,927 | | | | | | | | 1,710 | | | | | | | | 1,324 | | | | | |
Loans, net of deferred fees and costs | | | 1,139,961 | | | | | | | | 1,035,065 | | | | | | | | 948,178 | | | | | | | | 881,545 | | | | | | | | 805,535 | | | | | |
Allowance for loan and lease losses | | | (16,910 | ) | | | | | | | (12,231 | ) | | | | | | | (12,292 | ) | | | | | | | (11,925 | ) | | | | | | | (11,544 | ) | | | | |
Net loans | | $ | 1,123,051 | | | | | | | $ | 1,022,834 | | | | | | | $ | 935,886 | | | | | | | $ | 869,620 | | | | | | | $ | 793,991 | | | | | |
The following table sets forth the contractual maturity of our loan portfolio as of December 31, 2020.
| | | | | | | After One | | | After Five | | | After | | | | | |
| | | Within One | | | Through | | | Through | | | Fifteen | | | | | |
(Amounts in thousands) | | Year | | | Five Years | | | Fifteen Years | | | Years | | | Total | |
Loan Portfolio: | | | | | | | | | | | | | | | | | | | | |
Commercial | | $ | 45,713 | | | $ | 63,325 | | | $ | 6,521 | | | $ | — | | | $ | 115,559 | |
PPP | | | 130,814 | | | | — | | | | — | | | | — | | | | 130,814 | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 12,020 | | | | 11,870 | | | | 3,224 | | | | 17,435 | | | | 44,549 | |
Non-owner occupied | | | 43,739 | | | | 193,437 | | | | 254,280 | | | | 21,376 | | | | 512,832 | |
Owner occupied | | | 22,513 | | | | 81,573 | | | | 104,176 | | | | 1,893 | | | | 210,155 | |
Residential real estate: | | | | | | | | | | | | | | | | | | | | |
ITIN | | | 3,331 | | | | 13,173 | | | | 12,164 | | | | 367 | | | | 29,035 | |
1-4 family mortgage | | | 4,286 | | | | 20,051 | | | | 28,963 | | | | 2,625 | | | | 55,925 | |
Equity lines | | | 1,063 | | | | 552 | | | | 587 | | | | 16,692 | | | | 18,894 | |
Consumer and other | | | 1,077 | | | | 1,906 | | | | 2 | | | | 18,984 | | | | 21,969 | |
Gross loans | | | 264,556 | | | | 385,887 | | | | 409,917 | | | | 79,372 | | | | 1,139,732 | |
Deferred fees and costs | | | — | | | | — | | | | — | | | | — | | | | 229 | |
Loans, net of deferred fees and costs | | $ | 264,556 | | | $ | 385,887 | | | $ | 409,917 | | | $ | 79,372 | | | $ | 1,139,961 | |
Loans with: | | | | | | | | | | | | | | | | | | | | |
Fixed rates | | | 189,331 | | | $ | 155,902 | | | | 184,308 | | | | 2,203 | | | | 531,744 | |
Variable rates | | | 75,225 | | | | 229,985 | | | | 225,609 | | | | 77,169 | | | | 607,988 | |
Deferred fees and costs | | | — | | | | — | | | | — | | | | — | | | | 229 | |
Total | | $ | 264,556 | | | $ | 385,887 | | | $ | 409,917 | | | $ | 79,372 | | | $ | 1,139,961 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
The following table presents our fixed and variable interest rate loans at December 31, 2020.
(Amounts in thousands) | | Fixed | | | Variable | | | Total | |
Loan Portfolio: | | | | | | | | | | | | |
Commercial | | $ | 68,736 | | | $ | 46,823 | | | $ | 115,559 | |
PPP | | | 130,814 | | | | — | | | | 130,814 | |
Commercial real estate: | | | | | | | | | | | | |
Construction and land development | | | 15,654 | | | | 28,895 | | | | 44,549 | |
Non-owner occupied | | | 201,051 | | | | 311,781 | | | | 512,832 | |
Owner occupied | | | 45,844 | | | | 164,311 | | | | 210,155 | |
Residential real estate: | | | | | | | | | | | | |
ITIN | | | 8,551 | | | | 20,484 | | | | 29,035 | |
1-4 family mortgage | | | 38,383 | | | | 17,542 | | | | 55,925 | |
Equity lines | | | 1,053 | | | | 17,841 | | | | 18,894 | |
Consumer and other | | | 21,658 | | | | 311 | | | | 21,969 | |
Gross loans | | $ | 531,744 | | | $ | 607,988 | | | $ | 1,139,732 | |
Deferred fees and costs | | | — | | | | 229 | | | | 229 | |
Loans, net of deferred fees and costs | | $ | 531,744 | | | $ | 608,217 | | | $ | 1,139,961 | |
Loans with unique credit characteristics
ITIN Loans
We own a pool of Individual Tax Identification Number (“ITIN”) residential mortgage loans which are geographically disbursed throughout the United States and are made to legal United States residents who do not possess a social security number. The ITIN loan portfolio is serviced by a third party. The majority of the ITIN loans are variable rate loans and may have an increased default risk in a rising rate environment. As with all loans, worsening economic conditions in the United States could cause us to suffer higher default rates on our ITIN loans and reduce the value of the assets that we hold as collateral. If in the future, we become responsible for servicing these loans, we may realize additional monitoring, servicing and appraisal costs due to the geographic disbursement of the portfolio which would adversely affect our noninterest expense. As of December 31, 2020, we have granted 63 COVID-19 related payment deferrals for ITIN loans with balances totaling $3.8 million. Payment deferrals are limited to no more than six months.
SFC Loans
Between May of 2014 and December of 2018, we purchased unsecured retail installment home improvement loans that were originated by Service Finance Company, LLC (“SFC”). The loans were made through a network of over 8,000 approved home improvement dealers throughout the United States and Puerto Rico. Loans within the portfolio have a wide range of terms, interest rates and purchase discounts or premiums and at origination were made to borrowers with FICO scores of 750 or higher. Principal repayments on these loans totaled $10.0 million for the year ended December 31, 2020. The loans are serviced by a third party. If in the future, we become responsible for servicing these loans, we may realize additional monitoring and servicing costs due to the geographic disbursement of the portfolio which would adversely affect our noninterest expense. As of December 31, 2020, we have granted 8 COVID-19 related payment deferrals for SFC loans with balances totaling $127 thousand.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
PPP Loans
We have 487 PPP loans totaling $130.8 million at December 31, 2020. Loan fee income net of loan origination costs is earned over the 24-month life of the loans as a part of the loan yield. During the fourth quarter of 2020, 119 PPP loans totaling $32.7 million were repaid. When a PPP loan is repaid prior to maturity, all unamortized fees and costs associated with the loan are accelerated into income. During the fourth quarter of 2020, we recognized $664 thousand in accelerated fee income. At December 31, 2020, net fees totaling $2.2 million remain to be earned in future quarters. The following tables provide additional information on PPP loans by industry and by loan size at December 31, 2020.
| | | At December 31, 2020 | |
(Dollars in thousands) | | Number | | | Balance | |
Industry: | | | | | | | | |
Construction | | | 75 | | | $ | 55,644 | |
Healthcare and Social Assistance | | | 81 | | | | 15,520 | |
Professional, Scientific and Tech Services | | | 58 | | | | 7,708 | |
Accommodation and Food Services | | | 47 | | | | 8,800 | |
Admin, Support, Waste Management and Remediation Services | | | 15 | | | | 4,988 | |
Primary Metal Manufacturing | | | 14 | | | | 5,037 | |
Retail Trade | | | 49 | | | | 6,710 | |
Other | | | 148 | | | | 26,407 | |
Total | | | 487 | | | $ | 130,814 | |
| | | At December 31, 2020 | |
(Dollars in thousands) | | Balance | | | Number | | | Average Loan Size | |
Loan Size: | | | | | | | | | | | | |
$50,000 or less | | $ | 4,220 | | | | 181 | | | $ | 23 | |
$50,001 to $150,000 | | | 11,884 | | | | 143 | | | | 83 | |
$150,001 to $350,000 | | | 19,150 | | | | 85 | | | | 225 | |
$350,001 to $1,999,999 | | | 52,004 | | | | 66 | | | | 788 | |
$2,000,000 or greater | | | 43,556 | | | | 12 | | | | 3,630 | |
Total | | $ | 130,814 | | | | 487 | | | $ | 269 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
During the third quarter of 2020, the SBA began accepting applications for PPP loan forgiveness. The bank has 60 days to review and approve an application before submitting it to SBA, and the SBA then has 90 days to process it for forgiveness. The following table presents the status of our PPP loans as borrowers apply for forgiveness.
| | | At December 31, 2020 | |
(Dollars in thousands) | | Balance | | | Number | | | Average Loan Size | |
Borrower has not started application | | $ | 33,459 | | | | 185 | | | $ | 181 | |
Borrower is working on application | | | 31,277 | | | | 136 | | | | 230 | |
Borrower has completed application and bank is reviewing it | | | 43,872 | | | | 105 | | | | 418 | |
Bank has approved application and submitted it to the SBA | | | 22,087 | | | | 44 | | | | 502 | |
Remaining balance for loans partially repaid by SBA | | | 119 | | | | 17 | | | | 7 | |
PPP loans not fully repaid | | | 130,814 | | | | 487 | | | | 269 | |
| | | | | | | | | | | | | |
Repayments (1) | | | 32,679 | | | | 119 | | | | 275 | |
Total PPP loans originated by bank | | $ | 163,493 | | | | 606 | | | $ | 270 | |
(1) Includes 119 loans fully repaid by SBA or borrower totaling $29.5 million and partial repayment by SBA totaling $3.2 million for 17 borrowers who participated in the SBA Economic Injury Disaster Loan (“EIDL”) program. |
Purchased Loans
In addition to loans we have originated or loans we acquired in conjunction with our acquisition of Merchants National Bank of Sacramento, the loan portfolio includes purchased loan pools and purchased participations. Purchased loan pools and participations are recorded at their fair value at the acquisition date.
The following table presents the recorded investment in purchased loan pools and purchased participations at December 31, 2020 and 2019. The purchased loans presented in the table include the ITIN and SFC loans discussed under the heading “Loans with Unique Credit Characteristics”.
| | | For The Years Ended December 31, | |
| | | 2020 | | | 2019 | |
(Dollars in thousands) | | Balance | | | % of Gross Loan Portfolio | | | Balance | | | % of Gross Loan Portfolio | |
Loan Type: | | | | | | | | | | | | | | | | |
Commercial real estate | | $ | 14,027 | | | | 1 | % | | $ | 19,506 | | | | 2 | % |
Residential real estate | | | 40,242 | | | | 3 | % | | | 45,494 | | | | 4 | % |
Consumer and other | | | 18,369 | | | | 2 | % | | | 28,579 | | | | 3 | % |
Total purchased loans | | $ | 72,638 | | | | 6 | % | | $ | 93,579 | | | | 9 | % |
Asset Quality
Nonperforming Assets
Our loan portfolio is heavily concentrated in real estate and the ability for a significant portion of our borrowers to repay their loans is dependent upon the professional services, commercial real estate market and the residential real estate development industry sectors. Loans secured by real estate or other assets primarily located in California are expected to be repaid from cash flows of the borrower or proceeds from the sale of collateral. As such, our dependence on real estate secured loans increases the risk of loss in our loan portfolio when a market experiences declining real estate values. Furthermore, declining real estate values would negatively impact holdings of OREO.
We manage asset quality and mitigate credit risk through the application of policies designed to promote sound underwriting and loan monitoring practices. Our Loan Committee is charged with monitoring asset quality, establishing credit policies and procedures and enforcing the consistent application of these policies and procedures across the Bank. The provision for loan and lease losses charged to earnings is based upon management’s judgment of the amount necessary to maintain the allowance at a level adequate to provide for probable losses inherent in the outstanding loan and lease portfolio. The amount of provision charge is dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management’s assessment of loan portfolio quality, general economic conditions that can impact the value of collateral, and other trends. The evaluation of these factors is performed through an analysis of the adequacy of the ALLL. Reviews of nonperforming, past due loans and larger credits, designed to identify potential charges to the ALLL, and to determine the adequacy of the allowance, are conducted on a quarterly basis. These reviews consider such factors as the financial strength of borrowers, the value of the applicable collateral, loan and lease loss experience, estimated loan and lease losses, growth in the loan portfolio, prevailing economic conditions and other factors.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
A loan is considered impaired when, based on current information and events, we determine it is probable that we will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. Generally, when we identify a loan as impaired, we measure the loan for potential impairment using discount cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of collateral, less selling costs. The starting point for determining the fair value of collateral is through obtaining independent appraisals. Generally, these appraisals are updated every twelve months. We obtain appraisals from a pre-approved list of independent, third party, local appraisal firms. Approval and addition to the list is based on experience, reputation, character, consistency and knowledge of the respective real estate market. At a minimum, it is ascertained that the appraiser is: (1) currently licensed in the state in which the property is located, (2) is experienced in the appraisal of properties similar to the property being appraised, (3) is actively engaged in the appraisal work, (4) has knowledge of current real estate market conditions and financing trends, (5) is reputable, and (6) is not on Freddie Mac’s nor our Exclusionary List of appraisers and brokers. In most cases, appraisals will be reviewed by another independent third party to ensure the quality of the appraisal and the expertise and independence of the appraiser. Upon receipt and review, the external appraisal is utilized to measure a loan for potential impairment.
Our impairment analysis documents the date of the appraisal used in the analysis, whether the officer preparing the report deems it current, and, if not, allows for internal valuation adjustments with justification. Typical justified adjustments might include discounts for continued market deterioration subsequent to appraisal date, adjustments for the release of collateral contemplated in the appraisal, or the value of other collateral or consideration not contemplated in the appraisal. An appraisal over one year old in most cases will be considered stale dated and an updated or new appraisal will be required. Any adjustments from appraised value to net realizable value are detailed and justified in the impairment analysis, which is reviewed and approved by our Chief Credit Officer. Although an external appraisal is the primary source to value collateral dependent loans, we may also utilize values obtained through purchase and sale agreements, negotiated short sales, broker price opinions, or the sales price of the note. These alternative sources of value are used only if deemed to be more representative of value based on updated information regarding collateral resolution. Impairment analyses are updated, reviewed and approved on a quarterly basis at or near the end of each reporting period. Based on these processes, we do not believe there are significant time lapses for the recognition of additional provision for loan and lease losses or charge-offs from the date they become known.
Loans are classified as nonaccrual when collection of principal or interest is doubtful; generally these are loans that are past due as to maturity or payment of principal or interest by 90 days or more, unless such loans are well-secured and in the process of collection. Additionally, all loans that are impaired are considered for nonaccrual status. Loans placed on nonaccrual will typically remain in nonaccrual status until all principal and interest payments are brought current and the prospects for future payments in accordance with the loan agreement appear certain.
Upon acquisition of real estate collateral, typically through the foreclosure process, we promptly begin to market the property for sale. If we do not receive offers or indications of interest within a reasonable timeframe, we will review market conditions to assess the pricing level that would enable us to sell the property. At the time of foreclosure, OREO is recorded at fair value less costs to sell (“cost”), which becomes the property’s new basis. Unless a current appraisal is available, an appraisal will be ordered prior to a loan migrating to OREO. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the ALLL. After foreclosure, management periodically performs valuations and the property is carried at the lower of the cost or fair value less expected selling costs. We obtain updated appraisals on OREO property every six to twelve months. Valuation adjustments recorded in a period are primarily based on (1) updated appraisals received during the period, or (2) management’s authorization to reduce the selling price of the property during the period.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
The following table summarizes our nonperforming assets as of December 31 for each of the last five years.
| | | As of December 31, | |
(Dollars in thousands) | | 2020 | | | 2019 | | | 2018 | | | 2017 | | | 2016 | |
Nonperforming Assets: | | | | | | | | | | | | | | | | | | | | |
Commercial | | $ | 1,535 | | | $ | 61 | | | $ | 959 | | | $ | 1,603 | | | $ | 2,749 | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | |
Non-owner occupied | | | — | | | | — | | | | 548 | | | | — | | | | 1,196 | |
Owner occupied | | | 3,734 | | | | 3,103 | | | | — | | | | 600 | | | | 784 | |
Total commercial real estate | | | 3,734 | | | | 3,103 | | | | 548 | | | | 600 | | | | 1,980 | |
Residential real estate: | | | | | | | | | | | | | | | | | | | | |
ITIN | | | 1,585 | | | | 2,221 | | | | 2,388 | | | | 2,909 | | | | 3,576 | |
1-4 family mortgage | | | 141 | | | | 191 | | | | 185 | | | | 606 | | | | 1,914 | |
Equity lines | | | — | | | | — | | | | 43 | | | | 45 | | | | 917 | |
Total residential real estate | | | 1,726 | | | | 2,412 | | | | 2,616 | | | | 3,560 | | | | 6,407 | |
Consumer and other | | | 18 | | | | 40 | | | | 23 | | | | 36 | | | | 250 | |
Total nonaccrual loans | | | 7,013 | | | | 5,616 | | | | 4,146 | | | | 5,799 | | | | 11,386 | |
90 days past due and still accruing | | | — | | | | — | | | | — | | | | — | | | | — | |
Total nonperforming loans | | | 7,013 | | | | 5,616 | | | | 4,146 | | | | 5,799 | | | | 11,386 | |
Other real estate owned | | | 8 | | | | 35 | | | | 31 | | | | 35 | | | | 759 | |
Total nonperforming assets | | $ | 7,021 | | | $ | 5,651 | | | $ | 4,177 | | | $ | 5,834 | | | $ | 12,145 | |
| | | | | | | | | | | | | | | | | | | | | |
Nonperforming loans to gross loans | | | 0.62 | % | | | 0.54 | % | | | 0.44 | % | | | 0.66 | % | | | 1.42 | % |
Nonperforming loans to gross loans (excluding PPP) (1) | | | 0.70 | % | | | 0.54 | % | | | 0.44 | % | | | 0.66 | % | | | 1.42 | % |
Nonperforming assets to total assets | | | 0.40 | % | | | 0.38 | % | | | 0.32 | % | | | 0.46 | % | | | 1.06 | % |
(1) Nonperforming loans to gross loans (excluding PPP) is computed by dividing nonperforming loans by total gross loans excluding gross PPP loans. Management believes that the ratio excluding PPP loans is meaningful when comparing to periods that do not include PPP loans, which are guaranteed by the SBA, and are expected to be forgiven and repaid by the SBA over the next year. |
We regularly perform thorough reviews of the commercial real estate portfolio, including semi-annual stress testing. These reviews are performed on both our non-owner and owner occupied credits. These reviews are completed to verify leasing status, to ensure the accuracy of risk ratings, and to develop proactive action plans with borrowers on projects. Stress testing is performed to determine the effect of rising cap rates, interest rates, and vacancy rates on the portfolio. Based on our analysis, we believe we are effectively managing the risks in this portfolio. There can be no assurance that declines in economic conditions, such as potential increases in retail or office vacancy rates, will not exceed the projected assumptions utilized in stress testing resulting in additional nonperforming loans in the future.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
The following table sets forth a summary of our restructured loans that qualify as troubled debt restructurings for each of the last five years.
| | | As of December 31, | |
(Dollars in thousands) | | 2020 | | | 2019 | | | 2018 | | | 2017 | | | 2016 | |
Troubled Debt Restructurings: | | | | | | | | | | | | | | | | | | | | |
Accruing troubled debt restructurings | | | | | | | | | | | | | | | | | | | | |
Commercial | | $ | 498 | | | $ | 595 | | | $ | 1,224 | | | $ | 1,551 | | | $ | 776 | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | |
Non-owner occupied | | | — | | | | — | | | | 795 | | | | 803 | | | | 808 | |
Residential real estate: | | | | | | | | | | | | | | | | | | | | |
ITIN | | | 3,466 | | | | 3,957 | | | | 4,484 | | | | 4,614 | | | | 5,033 | |
Equity lines | | | 126 | | | | 231 | | | | 363 | | | | 380 | | | | 454 | |
Consumer and other | | | — | | | | — | | | | — | | | | — | | | | — | |
Total accruing troubled debt restructurings | | | 4,090 | | | | 4,783 | | | | 6,866 | | | | 7,348 | | | | 7,071 | |
| | | | | | | | | | | | | | | | | | | | | |
Nonaccruing troubled debt restructurings | | | | | | | | | | | | | | | | | | | | |
Commercial | | | — | | | | 47 | | | | 877 | | | | 863 | | | | 1,940 | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | |
Owner occupied | | | 640 | | | | — | | | | — | | | | — | | | | — | |
Residential real estate: | | | | | | | | | | | | | | | | | | | | |
ITIN | | | 1,349 | | | | 1,593 | | | | 1,793 | | | | 2,396 | | | | 2,691 | |
1-4 family mortgage | | | — | | | | — | | | | — | | | | 296 | | | | 335 | |
Consumer and other | | | 18 | | | | 40 | | | | 23 | | | | 26 | | | | 29 | |
Total nonaccruing troubled debt restructurings | | | 2,007 | | | | 1,680 | | | | 2,693 | | | | 3,581 | | | | 4,995 | |
| | | | | | | | | | | | | | | | | | | | | |
Total troubled debt restructurings | | | | | | | | | | | | | | | | | | | | |
Commercial | | | 498 | | | | 642 | | | | 2,101 | | | | 2,414 | | | | 2,716 | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | |
Non-owner occupied | | | — | | | | — | | | | 795 | | | | 803 | | | | 808 | |
Owner occupied | | | 640 | | | | — | | | | — | | | | — | | | | — | |
Residential real estate: | | | | | | | | | | | | | | | | | | | | |
ITIN | | | 4,815 | | | | 5,550 | | | | 6,277 | | | | 7,010 | | | | 7,724 | |
1-4 family mortgage | | | — | | | | — | | | | — | | | | 296 | | | | 335 | |
Equity lines | | | 126 | | | | 231 | | | | 363 | | | | 380 | | | | 454 | |
Consumer and other | | | 18 | | | | 40 | | | | 23 | | | | 26 | | | | 29 | |
Total troubled debt restructurings | | $ | 6,097 | | | $ | 6,463 | | | $ | 9,559 | | | $ | 10,929 | | | $ | 12,066 | |
| | | | | | | | | | | | | | | | | | | | | |
Total troubled debt restructuring to gross loans outstanding at period end | | | 0.53 | % | | | 0.63 | % | | | 1.01 | % | | | 1.24 | % | | | 1.50 | % |
Total troubled debt restructuring to gross loans outstanding at period end (excluding PPP) (1) | | | 0.60 | % | | | 0.63 | % | | | 1.01 | % | | | 1.24 | % | | | 1.50 | % |
(1) Troubled debt restructuring to gross loans (excluding PPP) is computed by dividing troubled debt restructurings by total gross loans excluding gross PPP loans. Management believes that the ratio excluding PPP loans is meaningful when comparing to periods that do not include PPP loans, which are guaranteed by the SBA, and are expected to be forgiven and repaid by the SBA over the next year. | |
Loans are reported as troubled debt restructurings when we grant a concession(s) to a borrower experiencing financial difficulties that we would not otherwise consider. Examples of such concessions include a reduction in the loan rate, forgiveness of principal or accrued interest, extending the maturity date(s) significantly, or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, troubled debt restructured loans are impaired as we will not collect all amounts due, either principal or interest, in accordance with the terms of the original loan agreement. Impairment reserves on non-collateral dependent troubled debt restructured loans are measured by comparing the present value of expected future cash flows of the restructured loans, discounted at the effective interest rate of the original loan agreement to the loans carrying value. These impairment reserves are recognized as a specific component to be provided for in the ALLL.
As of December 31, 2020, we had $6.1 million in troubled debt restructurings compared to $6.5 million as of December 31, 2019. As of December 31, 2020, we had 91 loans that were classified as troubled debt restructurings, of which 89 loans were performing according to their restructured terms. Troubled debt restructurings represented 0.53% of gross loans (0.60% of gross loans excluding PPP loans) as of December 31, 2020, compared with 0.63% at December 31, 2019. One new loan for $640 thousand was classified as troubled debt restructuring during the year ended December 31, 2020.
Impaired loans of $4.1 million and $4.8 million were classified as accruing troubled debt restructurings at December 31, 2020 and December 31, 2019, respectively. For a restructured loan to be on accrual status, the loan’s collateral coverage must generally be greater than or equal to 100% of the loan balance, the loan payments must be current, and the borrower must demonstrate the ability to make payments from a verified source of cash flow. As of December 31, 2020 and 2019, we had no obligations to lend additional funds on any restructured loans.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Troubled Debt Restructuring Guidance
Financial institution regulators and the CARES Act have changed the treatment of short-term loan modifications for borrowers impacted by COVID-19. The change provides that modifications made in response to COVID-19, to borrowers under certain circumstances, should not be considered a troubled debt restructuring.
We have responded to the needs of our borrowers in accordance with the CARES Act and regulatory guidance to grant short-term COVID-19 related loan modifications. These modified loans are not troubled debt restructurings and are not considered to be past due or non-performing. We have granted payment deferrals ranging from one to six months determined on a case-by-case basis considering the nature of the business and the impact of COVID-19. Some borrowers on a case by case basis have been granted multiple payment deferrals but the deferrals in total are limited to no more than six months.
In accordance with the CARES Act and interagency guidance, these loans are generally classified based on their past due status prior to their deferral period, so they are classified as performing loans that accrue interest. Accrued and unpaid interest during the deferral period will be collected on a regular repayment schedule at the end of the deferral period.
Since March of 2020, we have granted 278 payment deferrals on loans totaling $127.3 million. As of December 31, 2020 previously deferred loans totaling $115.6 million have resumed making payments or have paid off. Three loans that were previously deferred totaling $2.1 million were past due at December 31, 2020 and have been moved to nonaccrual status. Two of those loans totaling $1.4 million were made to one commercial borrower and are guaranteed under the California Capital Access Program for Small Business. The third loan for $640 thousand is a commercial real estate loan that was changed to a troubled debt restructured loan in the second quarter of 2020.
The following tables present approved loan payment deferrals that are in effect at December 31, 2020. For the loans with payment deferrals at December 31, 2020, one borrower also received a PPP loan through our SBA department.
| | | Payments Scheduled to Resume In The Three Months Ended | |
| | | March 31, 2021 | |
(Dollars in thousands) | | Number | | | Amount | |
Length of 1st deferral granted: | | | | | | | | |
3 months | | | 4 | | | $ | 1,304 | |
6 months | | | 3 | | | | 484 | |
Length of 2nd deferral granted: | | | | | | | | |
2 months | | | 2 | | | | 714 | |
3 months | | | 2 | | | | 3,053 | |
Loans serviced by others (1) | | | 71 | | | | 3,959 | |
Total | | | 82 | | | $ | 9,514 | |
(1) Loans serviced by others are small residential mortgages and consumer home improvement loans which are deferred on a short-term basis up to a maximum of six months. These loans are geographically disbursed throughout the United States and serviced by a third party. |
| | | Payments Scheduled to Resume In The Three Months Ended | |
| | | March 31, 2021 | |
(Dollars in thousands) | | Number | | | Amount | |
Industry: | | | | | | | | |
Health care and social assistance | | | 1 | | | $ | 12 | |
Other services | | | 1 | | | | 2,032 | |
Restaurants, bars and caterers | | | 2 | | | | 1,695 | |
Other industries | | | 7 | | | | 1,816 | |
Loans serviced by others (1) | | | 71 | | | | 3,959 | |
Total | | | 82 | | | $ | 9,514 | |
(1) Loans serviced by others are small residential mortgages and consumer home improvement loans which are deferred on a short-term basis up to a maximum of six months. These loans are geographically disbursed throughout the United States and serviced by a third party. |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
SBA Loan Payments
As part of the SBA coronavirus debt relief efforts, the SBA made six months of principal and interest payments on all SBA 7(a) loans that were in regular servicing status at March 27, 2020 and for new SBA 7(a) loans originated between March 27, 2020 and September 27, 2020. At December 31, 2020, our loan portfolio included $31.7 million of SBA 7(a) loans (generally 75% guaranteed). Borrowers resumed responsibility for making their payments on these 7(a) loans in October 2020.
On December 27, 2020, the SBA extended their debt relief program. All qualifying loans approved by the SBA prior the CARES Act will receive an additional three months of principal and interest payments starting in February 2021. After the three-month period, borrowers who are considered underserved will receive an additional five months of principal and interest payments. Newly approved loans from February 1, 2021 through September 30, 2021, will receive six months of principal and interest payments.
Allowance for Loan and Lease Losses
We monitor credit quality and the general economic environment to ensure that the ALLL is maintained at a level that is adequate to cover estimated credit losses in the loan and lease portfolio. Our review of ALLL adequacy utilizes both quantitative and qualitative factors. The quantitative analysis relies on historical loss rates which have been quite low in recent years and which, unfortunately, may not be indicative of potential losses related to a pandemic such as we are currently experiencing with COVID-19. In response to quantitative data deficiencies, we have placed much greater reliance on qualitative factors (Q-Factors).
During the year ended December 31, 2020, our review of the adequacy of our allowance for loan and lease losses (ALLL) focused on our Q-Factors for:
● | “Changes in international, national, regional and local conditions” and |
● | “Changes in the volume and severity of past due loans and other similar conditions”. |
We considered concentrations of credit in industries that are more likely to be significantly impacted by the effects of COVID-19. We evaluated our C&I portfolio by NAICS code and our CRE portfolio for concentrations of tenants and businesses in higher risk industries or for loans with higher LTVs. We also completed analyses on individual borrowers who may be higher risk. After completing this work, we significantly increased our Q-Factors for “changes in the volume and severity of past due loans and other similar conditions” and “changes in international, national, regional and local conditions”.
During the fourth quarter of 2020, most of our borrowers who received COVID-19 loan payment deferrals have resumed making payments and our COVID-19 credit concerns have moderated; nonaccrual loans decreased due to the repayment of a $1.1 million commercial real estate loan and classified assets decreased due to repayment of $7.2 million from one commercial real estate borrower.
Our ALLL methodology, adjusted for the revised Q-Factors discussed above and the improvements in loan quality metrics necessitated an ALLL of $16.9 million at December 31, 2020, an increase of 38% compared to our ALLL of $12.2 million at December 31, 2019. A provision for loan and lease losses of $5.3 million was recorded for the year ended December 31, 2020. There was no provision for loan and lease loss during the same period a year ago. Our ALLL as a percentage of gross loans was 1.48% as of December 31, 2020 compared to 1.18% as of December 31, 2019. Excluding PPP loans (on which we have no expectation of loss) our ALLL as a percentage of gross loans was 1.68% as of December 31, 2020.
Management believes the Company’s ALLL is adequate at December 31, 2020. There is, however, no assurance that future loan and lease losses will not exceed the levels provided for in the ALLL and could possibly result in future charges to the provision for loan and lease losses.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
The following table summarizes the ALLL roll forward for each of the five years ended December 31. This table also includes impaired loan information for each of the five years as of December 31.
| | | For the Years Ended December 31, | |
(Dollars in thousands) | | 2020 | | | 2019 | | | 2018 | | | 2017 | | | 2016 | |
ALLL: | | | | | | | | | | | | | | | | | | | | |
ALLL beginning balance | | $ | 12,231 | | | $ | 12,292 | | | $ | 11,925 | | | $ | 11,544 | | | $ | 11,180 | |
Provision for loan and lease loss charged to expense | | | 5,250 | | | | — | | | | — | | | | 950 | | | | — | |
Loans charged off | | | (1,113 | ) | | | (1,500 | ) | | | (1,248 | ) | | | (1,502 | ) | | | (2,784 | ) |
Loan and lease loss recoveries | | | 542 | | | | 1,439 | | | | 1,615 | | | | 933 | | | | 3,148 | |
ALLL ending balance | | | 16,910 | | | | 12,231 | | | | 12,292 | | | | 11,925 | | | | 11,544 | |
| | | At December 31, | |
| | | 2020 | | | 2019 | | | 2018 | | | 2017 | | | 2016 | |
Nonaccrual loans: | | | | | | | | | | | | | | | | | | | | |
Commercial | | | 1,535 | | | | 61 | | | | 959 | | | | 1,603 | | | | 2,749 | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | |
Non-owner occupied | | | — | | | | — | | | | 548 | | | | — | | | | 1,196 | |
Owner occupied | | | 3,734 | | | | 3,103 | | | | — | | | | 600 | | | | 784 | |
Residential real estate: | | | | | | | | | | | | | | | | | | | | |
ITIN | | | 1,585 | | | | 2,221 | | | | 2,388 | | | | 2,909 | | | | 3,576 | |
1-4 family mortgage | | | 141 | | | | 191 | | | | 185 | | | | 606 | | | | 1,914 | |
Equity lines | | | — | | | | — | | | | 43 | | | | 45 | | | | 917 | |
Consumer and other | | | 18 | | | | 40 | | | | 23 | | | | 36 | | | | 250 | |
Total nonaccrual loans | | | 7,013 | | | | 5,616 | | | | 4,146 | | | | 5,799 | | | | 11,386 | |
Accruing troubled-debt restructured loans: | | | | | | | | | | | | | | | | | | | | |
Commercial | | | 498 | | | | 595 | | | | 1,224 | | | | 1,551 | | | | 776 | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | |
Non-owner occupied | | | — | | | | — | | | | 795 | | | | 803 | | | | 808 | |
Residential real estate: | | | | | | | | | | | | | | | | | | | | |
ITIN | | | 3,466 | | | | 3,957 | | | | 4,484 | | | | 4,614 | | | | 5,033 | |
Equity lines | | | 126 | | | | 231 | | | | 363 | | | | 380 | | | | 454 | |
Consumer and other | | | — | | | | — | | | | — | | | | — | | | | — | |
Total accruing restructured loans | | | 4,090 | | | | 4,783 | | | | 6,866 | | | | 7,348 | | | | 7,071 | |
| | | | | | | | | | | | | | | | | | | | | |
All other accruing impaired loans | | | — | | | | — | | | | — | | | | — | | | | 337 | |
Total impaired loans | | | 11,103 | | | | 10,399 | | | | 11,012 | | | | 13,147 | | | | 18,794 | |
| | | | | | | | | | | | | | | | | | | | | |
Gross loans outstanding | | $ | 1,139,732 | | | $ | 1,032,903 | | | $ | 946,251 | | | $ | 879,835 | | | $ | 804,211 | |
| | | | | | | | | | | | | | | | | | | | | |
ALLL to gross loans outstanding | | | 1.48 | % | | | 1.18 | % | | | 1.30 | % | | | 1.36 | % | | | 1.44 | % |
ALLL to gross loans outstanding (excluding PPP) (1) | | | 1.68 | % | | | 1.18 | % | | | 1.30 | % | | | 1.36 | % | | | 1.44 | % |
Nonaccrual loans to gross loans outstanding | | | 0.62 | % | | | 0.54 | % | | | 0.44 | % | | | 0.66 | % | | | 1.42 | % |
Nonaccrual loans to gross loans outstanding (excluding PPP) (2) | | | 0.70 | % | | | 0.54 | % | | | 0.44 | % | | | 0.66 | % | | | 1.42 | % |
(1) ALLL to gross loans outstanding (excluding PPP) is computed by dividing the ALLL by total gross loans excluding gross PPP loans. Management believes that the ratio excluding PPP loans is meaningful when comparing to periods that do not include PPP loans, which are guaranteed by the SBA, and are expected to be forgiven and repaid by the SBA over the next year. |
(2) Nonaccrual loans to gross loans outstanding (excluding PPP) is computed by dividing the nonaccrual loans by total gross loans excluding gross PPP loans. Management believes that the ratio excluding PPP loans is meaningful when comparing to periods that do not include PPP loans, which are guaranteed by the SBA, and are expected to be forgiven and repaid by the SBA over the next year. |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
The following tables summarizes the allowance, reserve for unfunded commitments and discount on acquired loans for each of the five years ended December 31.
| | | For the Years Ended December 31, | |
(Dollars in thousands) | | 2020 | | | 2019 | | | 2018 | | | 2017 | | | 2016 | |
ALLL | | $ | 16,910 | | | $ | 12,231 | | | $ | 12,292 | | | $ | 11,925 | | | $ | 11,544 | |
Reserve for unfunded commitments | | | 800 | | | | 695 | | | | 695 | | | | 695 | | | | 695 | |
Discount on acquired loans (1) | | | 920 | | | | 1,672 | | | | — | | | | — | | | | — | |
Total allowances, reserve and discount | | $ | 18,630 | | | $ | 14,598 | | | $ | 12,987 | | | $ | 12,620 | | | $ | 12,239 | |
| | | | | | | | | | | | | | | | | | | | | |
Gross loans | | | 1,139,732 | | | | 1,032,903 | | | | 946,251 | | | | 879,835 | | | | 804,211 | |
PPP loans (2) | | | 130,814 | | | | — | | | | — | | | | — | | | | — | |
Total gross loans, net of PPP loans | | $ | 1,008,918 | | | $ | 1,032,903 | | | $ | 946,251 | | | $ | 879,835 | | | $ | 804,211 | |
| | | | | | | | | | | | | | | | | | | | | |
ALLL to gross loans outstanding (3) | | | 1.48 | % | | | 1.18 | % | | | 1.30 | % | | | 1.36 | % | | | 1.44 | % |
ALLL to gross loans outstanding (excluding PPP) (4) | | | 1.68 | % | | | 1.18 | % | | | 1.30 | % | | | 1.36 | % | | | 1.44 | % |
Total allowance, reserves and discount as a percentage of total gross loans, net of PPP loans (2) (4) | | | 1.85 | % | | | 1.41 | % | | | 1.37 | % | | | 1.43 | % | | | 1.52 | % |
(1) Discount on acquired loans includes fair value discount for loans acquired from Merchants Holding Company in January 2019. |
(2) PPP loans are fully guaranteed by SBA and no allowance, reserve or discount is provided for them. |
(3) ALLL to gross loans outstanding (excluding PPP) is computed by dividing the ALLL by total gross loans excluding gross PPP loans. Management believes that the ratio excluding PPP loans is meaningful when comparing to periods that do not include PPP loans, which are guaranteed by the SBA, and are expected to be forgiven and repaid by the SBA over the next year. |
(4) Total allowance, reserves and discount is computed by dividing total allowance, reserve and discount by total gross loans, net of PPP loans. Management believes that the ratio excluding PPP loans is meaningful when comparing to periods that do not include PPP loans, which are guaranteed by the SBA, and are expected to be forgiven and repaid by the SBA over the next year. |
The following table sets for the ratio of net charge-offs to average loans outstanding for the five years ended December 31.
| | | For the Years Ended December 31, | |
| | | 2020 | | | 2019 | | | 2018 | | | 2017 | | | 2016 | |
Loan Portfolio: | | | | | | | | | | | | | | | | | | | | |
Commercial | | | 0.25 | % | | | (0.10 | )% | | | (0.54 | )% | | | (0.31 | )% | | | 0.48 | % |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | |
Non-owner occupied | | | — | % | | | (0.01 | )% | | | — | % | | | — | % | | | (0.77 | )% |
Owner occupied | | | 0.05 | % | | | — | % | | | — | % | | | (0.01 | )% | | | (0.28 | )% |
Residential real estate: | | | | | | | | | | | | | | | | | | | | |
ITIN | | | (0.20 | )% | | | 0.01 | % | | | 0.48 | % | | | 0.38 | % | | | 0.16 | % |
1-4 family mortgage | | | (0.03 | )% | | | 0.03 | % | | | (0.59 | )% | | | (0.03 | )% | | | (0.05 | )% |
Equity lines | | | (0.04 | )% | | | 0.11 | % | | | 0.71 | % | | | 0.43 | % | | | 1.46 | % |
Consumer and other | | | 0.80 | % | | | 0.62 | % | | | 1.18 | % | | | 1.47 | % | | | 1.29 | % |
Total | | | 0.05 | % | | | 0.01 | % | | | (0.04 | )% | | | 0.07 | % | | | (0.05 | )% |
At December 31, 2020, impaired loans had a corresponding specific allowance of $192 thousand. The specific allowance on impaired loans represents the impairment reserves on performing restructured loans, other accruing loans, and nonaccrual loans.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
The following table sets forth the allocation of the ALLL for each of the five years as of December 31.
| | | At December 31, | |
(Dollars in thousands) | | 2020 | | | % | | | 2019 | | | % | | | 2018 | | | % | | | 2017 | | | % | | | 2016 | | | % | |
ALLL: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial | | $ | 2,402 | | | | 14 | % | | $ | 1,822 | | | | 15 | % | | $ | 2,205 | | | | 18 | % | | $ | 2,397 | | | | 20 | % | | $ | 2,748 | | | | 24 | % |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 449 | | | | 3 | % | | | 131 | | | | 1 | % | | | 107 | | | | 1 | % | | | 82 | | | | 1 | % | | | 177 | | | | 2 | % |
Non-owner occupied | | | 8,643 | | | | 50 | % | | | 5,907 | | | | 47 | % | | | 5,169 | | | | 42 | % | | | 4,698 | | | | 40 | % | | | 3,637 | | | | 32 | % |
Owner occupied | | | 2,803 | | | | 17 | % | | | 2,058 | | | | 17 | % | | | 1,840 | | | | 15 | % | | | 1,734 | | | | 15 | % | | | 1,865 | | | | 16 | % |
Residential real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
ITIN | | | 617 | | | | 4 | % | | | 569 | | | | 5 | % | | | 660 | | | | 5 | % | | | 602 | | | | 5 | % | | | 973 | | | | 8 | % |
1-4 family mortgage | | | 386 | | | | 2 | % | | | 185 | | | | 2 | % | | | 162 | | | | 1 | % | | | 151 | | | | 1 | % | | | 106 | | | | 1 | % |
Equity lines | | | 321 | | | | 2 | % | | | 278 | | | | 2 | % | | | 351 | | | | 3 | % | | | 416 | | | | 3 | % | | | 637 | | | | 5 | % |
Consumer and other | | | 683 | | | | 4 | % | | | 933 | | | | 8 | % | | | 1,356 | | | | 11 | % | | | 1,435 | | | | 12 | % | | | 955 | | | | 8 | % |
Unallocated | | | 606 | | | | 4 | % | | | 348 | | | | 3 | % | | | 442 | | | | 4 | % | | | 410 | | | | 3 | % | | | 446 | | | | 4 | % |
Total ALLL | | $ | 16,910 | | | | 100 | % | | $ | 12,231 | | | | 100 | % | | $ | 12,292 | | | | 100 | % | | $ | 11,925 | | | | 100 | % | | $ | 11,544 | | | | 100 | % |
The unallocated portion of ALLL provides for coverage of credit losses inherent in the loan portfolio but not captured in the credit loss factors that are utilized in the risk grading-based component, or in the specific reserve component of the ALLL, and acknowledges the inherent imprecision of all loss prediction models. As of December 31, 2020, the unallocated allowance amount represented 4% of the ALLL, compared to 3% at December 31, 2019. While the ALLL composition is an indication of specific amounts or loan categories in which future charge-offs may occur, actual amounts may differ.
Reserve for Unfunded Commitments
The reserve for unfunded commitments, which is included in Other Liabilities in the Consolidated Balance Sheets, was $800 thousand and $695 thousand at December 31, 2020 and December 31, 2019, respectively. The adequacy of the reserve for unfunded commitments is reviewed on a quarterly basis. Based upon changes in the amount of commitments, loss experience, and economic conditions we recorded $105 thousand of provision expense during the year ended December 31, 2020. When necessary, provision adjustments are recorded in Other Expenses in the Consolidated Statements of Income.
Goodwill and Other Intangibles
Goodwill and other intangible assets, net totaled $15.7 million at December 31, 2020 and primarily consisted of goodwill and core deposit intangibles recorded as part of previous acquisitions. Goodwill is evaluated for impairment annually and any such impairment is recognized in the period identified. A more frequent assessment of possible goodwill impairment is performed whenever we identify certain triggering events or circumstances that would more likely than not indicate that the fair value of the Bank is less than the carrying amount of the Bank’s equity. The triggering events to be considered include a deterioration in general economic conditions, decreased overall financial performance of the Company, and a sustained decrease in the Company’s stock price.
During 2020, as a result of the pandemic and the related impacts on the economy and financial markets, we determined that it was appropriate to assess goodwill for impairment at the end of each quarter. At March 31, 2020, June 30, 2020 and September 30, 2020 through both qualitative and quantitative analysis, we determined that goodwill was not impaired.
Throughout the fourth quarter of 2020, our stock price traded above tangible book value and our earnings compared favorably to pre-pandemic periods and to our projections. Pandemic related credit concerns moderated during the fourth quarter, most loans with payment deferrals resumed making payments, there was limited deterioration in our credit quality indicators and anticipated loan losses have not materialized. We used a third party valuation specialist to assist management in performing a quantitative test to assess goodwill for impairment during the fourth quarter of 2020. The fair value of the Company was calculated using a weighted average of the results from two valuation approaches: an income approach and a market approach. The indicated fair value of the Bank was determined to be in excess of the carrying amount of the Bank’s equity by approximately 3% and management concluded that goodwill was not impaired at December 31, 2021.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Deposits
Total deposits as of December 31, 2020 were $1.543 billion compared to $1.267 billion at December 31, 2019, an increase of $276 million or 22%. The following table presents deposit balances by major category as of December 31 for the last two years. The increase in non-maturing deposits was due to PPP loan program disbursements and changes in customer behavior, which is placing greater emphasis on savings. The decrease in certificates of deposit reflect our decision to reduce reliance on public deposits and depositor reaction to the low interest rate environment.
| | | At December 31, | |
(Dollars in thousands) | | 2020 | | | % | | | 2019 | | | % | |
Deposits: | | | | | | | | | | | | | | | | |
Noninterest-bearing demand | | $ | 541,033 | | | | 34 | % | | $ | 432,680 | | | | 34 | % |
Interest-bearing demand | | | 290,251 | | | | 19 | % | | | 239,258 | | | | 19 | % |
Money market | | | 425,121 | | | | 28 | % | | | 307,559 | | | | 24 | % |
Savings | | | 150,695 | | | | 10 | % | | | 135,888 | | | | 11 | % |
Certificates of deposit, $250,000 or greater | | | 57,462 | | | | 4 | % | | | 69,017 | | | | 5 | % |
Certificates of deposit, less than $250,000 | | | 78,217 | | | | 5 | % | | | 82,769 | | | | 7 | % |
Total | | $ | 1,542,779 | | | | 100 | % | | $ | 1,267,171 | | | | 100 | % |
The following table sets forth the distribution of average deposits and their respective average rates for the periods indicated.
| | | Years Ended December 31, | |
| | | 2020 | | | 2019 | | | 2018 | |
(Dollars in thousands) | | Average Balance | | | Average Rate | | | Average Balance | | | Average Rate | | | Average Balance | | | Average Rate | |
Deposits: | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing demand | | $ | 264,652 | | | | 0.12 | % | | $ | 242,516 | | | | 0.20 | % | | $ | 238,328 | | | | 0.17 | % |
Money market | | | 372,939 | | | | 0.33 | % | | | 304,340 | | | | 0.53 | % | | | 250,685 | | | | 0.26 | % |
Savings | | | 142,857 | | | | 0.24 | % | | | 136,733 | | | | 0.36 | % | | | 109,025 | | | | 0.26 | % |
Certificates of deposit | | | 142,067 | | | | 1.23 | % | | | 160,550 | | | | 1.23 | % | | | 168,183 | | | | 1.14 | % |
Interest-bearing deposits | | | 922,515 | | | | 0.39 | % | | | 844,139 | | | | 0.54 | % | | | 766,221 | | | | 0.43 | % |
Noninterest-bearing demand | | | 500,862 | | | | | | | | 400,588 | | | | | | | | 332,197 | | | | | |
Total deposits | | $ | 1,423,377 | | | | 0.26 | % | | $ | 1,244,727 | | | | 0.37 | % | | $ | 1,098,418 | | | | 0.30 | % |
We have an agreement with IntraFi Network (“IntraFi”), formally known as Promontory Interfinancial Network LLC (“Promontory”) which facilitates provision of FDIC deposit insurance to balances in excess of current FDIC deposit insurance limits. IntraFi’s Certificate of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep (“ICS”) products use a deposit-matching program to exchange Bank deposits in excess of the current deposit insurance limits for excess balances at other participating banks, on a dollar-for-dollar basis (reciprocal arrangement). These products are designed to enhance our ability to attract and retain customers and increase deposits, by providing additional FDIC coverage to customers. CDARS and ICS deposits can also be arranged on a non-reciprocal basis.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Deposit Maturity Schedule
The following table sets forth the maturities of certificates of deposit in amounts of $250,000 or more as of December 31, 2020.
(Amounts in thousands) | | 2020 | |
Maturing in: | | | | |
Three months or less | | $ | 10,682 | |
Over three through six months | | | 7,457 | |
Over six through twelve months | | | 16,795 | |
Over twelve months | | | 22,528 | |
Total | | $ | 57,462 | |
Our uninsured deposits, which are the portion of deposit accounts that exceed the FDIC insurance limit (currently $250,000), approximated $795 million and $606 million at December 31, 2020 and 2019, respectively. These amounts were estimated based on the same methodologies and assumptions used for regulatory reporting purposes.
Borrowings
The following table sets forth our year-to-date average balances for borrowings and their respective average rates for the periods indicated.
| | | Years Ended December 31, | |
| | | 2020 | | | 2019 | | | 2018 | |
(Dollars in thousands) | | Average Balance | | | Average Rate | | | Average Balance | | | Average Rate | | | Average Balance | | | Average Rate | |
Borrowings: | | | | | | | | | | | | | | | | | | | | | | | | |
FHLB borrowings | | $ | 8,347 | | | | 0.06 | % | | $ | 9,644 | | | | 2.56 | % | | $ | 22,480 | | | | 1.94 | % |
Subordinated debt, net | | | 9,981 | | | | 7.32 | % | | | 9,935 | | | | 7.38 | % | | | 9,890 | | | | 7.38 | % |
Senior debt, net | | | — | | | | — | % | | | 960 | | | | 7.60 | % | | | 5,239 | | | | 6.51 | % |
Junior subordinated debentures | | | 10,310 | | | | 2.41 | % | | | 10,310 | | | | 4.13 | % | | | 10,310 | | | | 3.73 | % |
Total borrowings | | $ | 28,638 | | | | 3.45 | % | | $ | 30,849 | | | | 4.80 | % | | $ | 47,919 | | | | 3.96 | % |
Term Debt
At December 31, 2020, we had term debt outstanding with a carrying value of $15.0 million compared to $10.0 million at December 31, 2019. Term debt consisted of the following:
Federal Home Loan Bank of San Francisco Borrowings
In December of 2015, we issued $10.0 million of fixed to floating rate Subordinated Notes. The Subordinated Debt initially bore interest at a fixed rate of 6.88% per annum through December 19, 2020. Thereafter, interest on the Subordinated Debt will be paid at a variable rate equal to three month LIBOR plus 526 basis points resetting quarterly. At December 31, 2020, the Subordinated Debt had a balance of $10.0 million net of unamortized debt issuance costs. The notes are due in 2025.
Subordinated Debt
In December of 2015, we issued $10.0 million of fixed to floating rate Subordinated Notes. The Subordinated Debt initially bore interest at a fixed rate of 6.88% per annum through December 19, 2020. Thereafter, interest on the Subordinated Debt will be paid at a variable rate equal to three month LIBOR plus 526 basis points resetting quarterly. At December 31, 2020, the Subordinated Debt had a balance of $10.0 million net of unamortized debt issuance costs. The notes are due in 2025.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Senior Debt
In December of 2015, we entered into a senior debt loan agreement to borrow $10.0 million. During the second quarter of 2019, we completed the early repayment and termination of this variable-rate debt agreement.
Junior Subordinated Debentures
Bank of Commerce Holdings Trust II
During July of 2005, we participated in a $10.0 million private placement of fixed rate trust-preferred securities (the "Trust-Preferred Securities") through a wholly owned Delaware trust affiliate, Bank of Commerce Holdings Trust II (the "Trust II"). Trust II simultaneously issued $310 thousand common securities to the Holding Company. Rates paid on the Trust-Preferred Securities have transitioned from fixed to floating and are now paid on a quarterly basis at a rate equal to three month LIBOR plus 158 basis points (1.80% at December 31, 2020). The Trust-Preferred Securities mature on September 15, 2035, and the covenants allow for redemption of the securities at our option during any quarter prior to maturity.
The proceeds from the sale of the Trust-Preferred Securities were used by Trust II to purchase from the Holding Company the aggregate principal amount of $10.3 million of the Holding Company’s junior subordinate debentures (the "Notes"). The net proceeds to the Holding Company from the sale of the Notes to Trust II were partially distributed to the Bank. The proceeds from the Notes qualify as Tier 1 capital under Federal Reserve Board guidelines.
54
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
SOURCES OF INCOME
Interest Income
We derive our income primarily from net interest income, which is the difference between the interest income we receive on interest-earning assets and the interest expense we pay on interest-bearing liabilities. Net interest income is impacted by many factors that are beyond our control, including general economic conditions and the policies of various governmental and regulatory agencies, the Federal Reserve Board in particular. Aside from changes in market interest rates, the current net interest margin will be affected by the following:
● | The majority of our loans are fixed rate loans or variable rate loans that are already at their floor rate. This has mitigated the impact of declining interest rates on loan yields during 2020. The yield on loans, exclusive of PPP loans, has declined 20 basis points from 4.95% for the year ended December 31, 2019 to 4.75% for the year ended December 31, 2020. |
● | We have 487 PPP loans totaling $130.8 million which bear an interest rate of 1.00%. The yield on PPP loans is highly dependent on fees earned typically over the 24-month duration of the loans. For the year ended December 31, 2020, the average yield for PPP loans was 2.95%, including $2.1 million, in fees. At December 31, 2020, $2.2 million in unamortized fee income remains to be earned over the remaining contractual term of the loans. If the PPP loans are forgiven and repaid before the end of the 24-month loan term, we accelerate recognition of the unamortized loan fee, which increases the average yield. During 2020, we recognized $664 thousand in accelerated fee income. |
● | The impact of declining interest rates has been more immediate on our investment portfolio and our interest-bearing deposits in other banks. Much of our investment portfolio is collateralized by residential and commercial real estate mortgages. The rapid decline interest rates earlier in the year facilitated the refinance of many of these mortgages, which accelerated bond repayments and accelerated amortization of bond premiums, lowering yields. Additionally, the accelerated cash flows from the investment portfolio were reinvested at substantially lower yields. Yield on taxable securities declined from 2.70% for the year ended December 31, 2019 to 2.31% for the year ended December 31, 2020. |
● | During 2020, in response to the economic effects of the COVID-19 pandemic, the Federal Reserve cut its interest rates by 150 to 175 basis points. Our average yield on interest bearing deposits in other banks decreased 178 basis points for the current year compared to the prior year. We have also experienced significant increased deposit balances due to PPP loan program disbursements and changes in customer behavior. We expect to invest this excess liquidity into loans or our investment portfolio, which should enhance our net interest margin and net interest income. |
● | Cash flows from our loan and investment portfolio are being reinvested in the current market at significantly lower rates. Recent bond purchases have centered on longer duration investments such as longer maturity municipal bonds and lower coupon and moderate-term mortgage backed securities. |
Net interest income reflects both the amount of earning assets we hold and our net interest margin, which is the difference between the yields we receive on our earning assets and the interest rates we pay to fund those assets. As a result, changes in either our net interest margin or the amount of earning assets we hold will affect our net interest income and earnings.
Increases or decreases in interest rates could adversely affect our net interest margin. Although our asset yields and funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, and cause our net interest margin to expand or contract. Many of our assets are tied to indexes, which adjust in response to changes in interest rates.
When market interest rates begin to increase in the future, we anticipate that our interest rate risk position will be neutral to moderately liability sensitive which will remain true until sufficient rate rise allows variable rate loans to move higher off their floors.
The low interest rate environment combined with excess liquidity from increased deposits being invested in lower yielding assets has contributed to our lower net interest margin. Because many of our liabilities are already priced near historic lows with little room for further reductions, if interest rates decline, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets. We assess our interest rate risk by estimating the effect of interest rate changes on our earnings under various simulated scenarios. The scenarios differ based on assumptions including the direction, magnitude and speed of interest rate changes, and the slope of the yield curve.
There is always the risk that changes in interest rates could reduce our net interest income and earnings in material amounts, especially if actual conditions turn out to be materially different than simulated scenarios. To reduce our interest rate risk, we may rebalance our investment and loan portfolios, refinance our debt or take other strategic actions, which may result in losses or expenses.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
The following table summarizes as of December 31, 2020 when loans are projected to reprice by year and by rate index.
| | | | | | | | | | | | | | | | | | | | | | | Years 6 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | Through | | | Beyond | | | | | |
(Amounts in thousands) | | Year 1 | | | Year 2 | | | Year 3 | | | Year 4 | | | Year 5 | | | Year 10 | | | Year 10 | | | Total | |
Rate Index: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Fixed | | $ | 189,331 | | | $ | 39,766 | | | $ | 58,323 | | | $ | 29,333 | | | $ | 28,480 | | | $ | 164,817 | | | $ | 21,694 | | | $ | 531,744 | |
Variable: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Prime | | | 77,139 | | | | 6,390 | | | | 3,408 | | | | 6,882 | | | | 9,595 | | | | 1,232 | | | | — | | | | 104,646 | |
5 Year Treasury | | | 51,142 | | | | 65,555 | | | | 58,578 | | | | 75,057 | | | | 109,165 | | | | 54,938 | | | | — | | | | 414,435 | |
7 Year Treasury | | | 3,242 | | | | 4,866 | | | | 479 | | | | 5,601 | | | | 13,839 | | | | — | | | | — | | | | 28,027 | |
1 Year LIBOR | | | 22,509 | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 22,509 | |
Other Indexes | | | 2,996 | | | | 2,404 | | | | 1,775 | | | | 5,567 | | | | 7,041 | | | | 10,632 | | | | 1,172 | | | | 31,587 | |
Total variable | | | 157,028 | | | | 79,215 | | | | 64,240 | | | | 93,107 | | | | 139,640 | | | | 66,802 | | | | 1,172 | | | | 601,204 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Nonaccrual | | | 1,047 | | | | 1,030 | | | | 987 | | | | 694 | | | | 496 | | | | 2,018 | | | | 741 | | | | 7,013 | |
Total | | $ | 347,406 | | | $ | 120,011 | | | $ | 123,550 | | | $ | 123,134 | | | $ | 168,616 | | | $ | 233,637 | | | $ | 23,607 | | | $ | 1,139,961 | |
For variable rate loans, the following table summarizes those that are at or above their floor rate, and those that do not possess a contractual floor rate.
| | | At December 31, 2020 | |
| | | Loans At | | | Loans Above | | | | | |
(Amounts in thousands) | | Floor Rate | | | Floor Rate | | | Total | |
Variable rate loans with floors: | | | | | | | | | | | | |
Prime | | $ | 54,833 | | | $ | 5,914 | | | $ | 60,747 | |
5 year Treasury | | | 342,105 | | | | 46,964 | | | | 389,069 | |
7 Year Treasury | | | 28,027 | | | | — | | | | 28,027 | |
1 Year LIBOR | | | — | | | | 717 | | | | 717 | |
Other Indexes | | | 18,290 | | | | 833 | | | | 19,123 | |
| | | $ | 443,255 | | | $ | 54,428 | | | | 497,683 | |
| | | | | | | | | | | | | |
Variable rate loans without floors: | | | | | | | | | | | | |
Prime | | | | | | | | | | | 43,899 | |
5 year Treasury | | | | | | | | | | | 25,366 | |
1 Year LIBOR | | | | | | | | | | | 21,792 | |
Other Indexes | | | | | | | | | | | 12,464 | |
| | | | | | | | | | | | 103,521 | |
| | | | | | | | | | | | | |
Total accruing variable rate loans | | | | | | | | | | $ | 601,204 | |
| | | | | | | | | | | | | |
Nonaccrual | | | | | | | | | | | 7,013 | |
Total variable rate loans | | | | | | | | | | $ | 608,217 | |
Non Interest Income
We also earn noninterest income. Sources of noninterest income include fees earned on deposit related services, ATM and point of sale fees, payroll and benefit processing fees, earnings on bank-owned life insurance, gains on sale of available-for-sale securities, and dividends on FHLB stock. Most of these sources of income do not vary significantly from quarter to quarter. Possible exceptions include gains on sale of available-for-sale securities and death proceeds from bank-owned life insurance.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
LIQUIDITY AND CASH FLOW
Merchants Bank of Commerce
We have experienced a significant increase in deposit balances during 2020 as all PPP loan funds were deposited into customer accounts at our bank and as a result of modified customer behavior which during the year was focused on cash accumulation. Through December 31, 2020, we have not experienced any unusual pressure on our deposit balances or on our liquidity position as a result of the COVID-19 pandemic. Should this change, in addition to our primary sources of liquidity, the Bank has credit arrangements as discussed below.
The principal objective of our liquidity management program is to maintain our ability to meet the day-to-day cash flow requirements of our customers who wish either to withdraw funds on deposit or to draw upon their credit facilities. We monitor the sources and uses of funds on a daily basis to maintain an acceptable liquidity position.
In addition to liquidity provided by core deposits, loan repayments and cash flows from securities, the Bank can borrow on a secured basis from the FHLB, borrow on a secured basis from the Federal Reserve Bank, borrow on established conditional federal funds lines of credit, sell securities, or issue subscription / brokered certificates of deposit.
At December 31, 2020, the Bank had the following credit arrangements:
| | ● | Line of credit with the FHLB of $370.2 million is subject to collateral requirements, namely the amount of pledged loans and investment securities. |
| | ● | Line of credit with the Federal Reserve Bank of $6.5 million is subject to collateral requirements, namely the amount of pledged loans. |
| | ● | Nonbinding unsecured federal funds line of credit agreements with three financial institutions. The available credit on these lines totaled $75.0 million at December 31, 2020 and had interest rates ranging from 0.12% to 0.30%. Advances under the lines are subject to funds availability, continued borrower eligibility, and may have consecutive day usage restrictions. |
| | ● | Federal Reserve Bank Paycheck Protection Program Liquidity Facility (“PPPLF”) from the Federal Reserve Bank. The credit facility provides term funding for loans made under the SBA’s PPP. Advances under the program will be collateralized with PPP loans, bear a fixed rate of interest of 0.35% and are to be repaid as the underlying loans are paid down, forgiven, or sold to SBA. We have not utilized any of the liquidity provided by the PPPLF. |
Bank of Commerce Holdings
The Holding Company is a separate entity from the Bank and must provide for its own liquidity. At December 31, 2020, the Holding Company had cash balances of $3.9 million. Our principal source of cash is dividends received from the Bank. During 2020, the Bank paid dividends of $15.0 million to the Holding Company, most of which were used to repurchase common stock. There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to the Holding Company in the future.
Consolidated Statement of Cash Flows
Net cash of $22.8 million was provided by operating activities for the year ended December 31, 2020. As disclosed in the Consolidated Statements of Cash Flows The primary difference between net income and cash provided by operating activities, was non-cash items including:
● | $5.3 million provision for loan and lease losses. |
● | $2.0 million in depreciation, accretion and amortization. |
● | $1.9 million in deferred loan fees and costs. |
Net cash of $260.8 million was used by investing activities during the year ended December 31, 2020 consisted principally of:
● | $298.1 million in purchases of investment securities. |
● | $127.0 million in net loan originations. |
These uses of cash were partially offset by:
● | $88.5 million in proceeds from maturities and payments of investment securities. |
● | $56.0 million in proceeds from sale of investment securities. |
● | $20.9 million in repayments on purchased loan pools. |
Net cash of $264.4 million was provided by financing activities during the year ended December 31, 2020 principally consisted of:
● | $291.7 million increase in non-maturing deposits. |
● | $5.0 million in advances net of repayments from our line of credit with the FHLB. |
These sources were partially offset by:
● | $16.1 million decrease in certificates of deposit. |
● | $12.7 million repurchase of common stock. |
● | $3.4 million dividends paid on common stock. |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
CAPITAL RESOURCES
Equity capital is available to support organic and strategic growth, pay dividends and repurchase shares. The objective of effective capital management is to produce competitive long-term returns for our shareholders while ensuring that adequate capital is maintained relative to the Company’s risk profile. Our sources of capital include retained earnings, common and preferred stock issuance, and issuance of subordinated debt or trust notes.
REGULATORY CAPITAL GUIDELINES
Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank holding companies and banks. The guidelines are “risk-based,” meaning that they are designed to make capital requirements more sensitive to differences in risk profiles among banks and bank holding companies. The current rules (commonly known as Basel III) require the Bank and the Company to meet a capital conservation buffer requirement in order to avoid constraints on capital distributions, such as dividends and equity repurchases, and certain bonus compensation for executive officers. The capital conservation buffer of 2.50% is added to the minimum capital ratios.
The Basel III minimum capital requirements plus the conservation buffer exceed the prior regulatory “well-capitalized” capital thresholds by 0.5 percentage points. This 0.5 percentage-point cushion allows institutions to dip into a portion of their capital conservation buffer before reaching a status that is considered less than well capitalized for prompt corrective action purposes.
As of January 1, 2020 for certain qualifying institutions, the FDIC accepts compliance with a Community Bank Leverage Ratio in lieu of the Basel III capital requirements. We are a qualifying institution; however, we have opted to continue reporting under the Basel III requirements. We can opt-in to use the Community Bank Leverage Ratio at any time in the future.
CAPITAL ADEQUACY
Overall capital adequacy is monitored on a day-to-day basis by management and reported to our Board of Directors on a monthly basis.
As of December 31, 2020, the most recent notification from the FDIC categorized the Bank as “well capitalized” under the regulatory framework for Prompt Corrective Action (“FDIC PCA”). There are no conditions or events since the notification that management believes have changed the Bank’s risk category. The Holding Company and the Bank’s capital amounts and ratios as of December 31, 2020, are presented in the following table.
| | | December 31, 2020 | |
| | | | | | | | | | | FDIC PCA | | | BASEL III | |
| | | | | | | | | | | Well | | | Minimum | | | Capital | | | Minimum Capital | |
| | | | | | | Actual | | | Capitalized | | | Capital | | | Conservation | | | Ratio plus Capital | |
(Dollars in thousands) | | Capital | | | Ratio | | | Requirement | | | Requirement | | | Buffer | | | Conservation Buffer | |
Holding Company: | | | | | | | | | | | | | | | | | | | | | | | | |
Common equity tier 1 capital ratio | | $ | 155,542 | | | | 13.12 | % | | | n/a | | | | 4.50 | % | | | 2.50 | % | | | 7.00 | % |
Tier 1 capital ratio | | $ | 165,542 | | | | 13.97 | % | | | n/a | | | | 6.00 | % | | | 2.50 | % | | | 8.50 | % |
Total capital ratio | | $ | 190,393 | | | | 16.06 | % | | | n/a | | | | 8.00 | % | | | 2.50 | % | | | 10.50 | % |
Tier 1 leverage ratio | | $ | 165,542 | | | | 9.46 | % | | | n/a | | | | 4.00 | % | | | n/a | | | | 4.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Bank: | | | | | | | | | | | | | | | | | | | | | | | | |
Common equity tier 1 capital ratio | | $ | 172,612 | | | | 14.58 | % | | | 6.50 | % | | | 4.50 | % | | | 2.50 | % | | | 7.00 | % |
Tier 1 capital ratio | | $ | 172,612 | | | | 14.58 | % | | | 8.00 | % | | | 6.00 | % | | | 2.50 | % | | | 8.50 | % |
Total capital ratio | | $ | 187,450 | | | | 15.83 | % | | | 10.00 | % | | | 8.00 | % | | | 2.50 | % | | | 10.50 | % |
Tier 1 leverage ratio | | $ | 172,612 | | | | 9.86 | % | | | 5.00 | % | | | 4.00 | % | | | n/a | | | | 4.00 | % |
On December 10, 2015, the Holding Company issued $10.0 million in aggregate principal amount of Subordinated Notes to certain institutional investors. The Subordinated Notes qualify as Tier 2 Capital under the Final Rules. See Item 1A - Risk Factors, in our Annual Report on Form 10-K for the year ended December 31, 2020 for further detail on potential risks relating to the Subordinated Notes.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Goodwill and other intangible assets, net totaled $15.7 million at December 31, 2020 and primarily consisted of goodwill and core deposit intangibles recorded as part of previous acquisitions. See Note 7, Goodwill and Other Intangibles in the Notes to Consolidated Financial Statements in this document for additional detail goodwill and other intangible assets. When calculating capital ratios, goodwill and other intangible assets, net are deducted from Tier 1 capital.
During the fourth quarter of 2020, we announced a share repurchase program to repurchase up to 1.0 million shares of common stock over a period ending December 31, 2021. As of March 5, 2021, no shares have been repurchased under this program.
In late 2019, we announced a share repurchase program to repurchase 1.0 million common shares which was later increased to 1.5 million common shares. Between October of 2019 and April of 2020, all 1.5 million shares were repurchased at a total cost of $13.6 million including commissions, or an average of $9.11 per share.
We are participating in the PPP administered through the SBA. The growth in our assets resulting from the PPP has impacted our Tier 1 Leverage capital ratio as we have not utilized the liquidity available to us from the PPPLF and its associated beneficial capital treatment. We have not utilized the PPPLF because we have sufficient organic liquidity from other sources.
CASH DIVIDENDS AND PAYOUT RATIOS PER COMMON SHARE
The following table presents cash dividends declared and dividend pay-out ratios (dividends declared per common share divided by basic earnings per common share) for the years ended December 31, 2020, 2019 and 2018. These dividends were made pursuant to our existing dividend policy and in consideration of, among other things, earnings, regulatory capital levels, our risk profile, capital preservation and expected growth. The dividend rate is reassessed periodically by the Board of Directors in accordance with the dividend policy. There is no assurance that future cash dividends on common shares will be declared or increased.
| | | 2020 | | | 2019 | | | 2018 | |
Dividends declared per common share for the quarter ended March 31, | | $ | 0.05 | | | $ | 0.04 | | | $ | 0.03 | |
Dividends declared per common share for the quarter ended June 30, | | | 0.05 | | | | 0.05 | | | | 0.04 | |
Dividends declared per common share for the quarter ended September 30, | | | 0.05 | | | | 0.05 | | | | 0.04 | |
Dividends declared per common share for the quarter ended December 31, | | | 0.06 | | | | 0.05 | | | | 0.04 | |
Total | | $ | 0.21 | | | $ | 0.19 | | | $ | 0.15 | |
| | | | | | | | | | | | | |
Dividend payout ratio | | | 25 | % | | | 15 | % | | | 15 | % |
TANGIBLE BOOK VALUE PER SHARE AND TANGIBLE COMMON EQUITY RATIO
We believe the tangible common equity ratio and tangible book value per share are meaningful measures that the Company and investors commonly use to assess the value and capital levels of the Company.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
The following table provides a reconciliation of shareholders' equity (GAAP) to tangible common equity (non-GAAP), and total assets (GAAP) to tangible assets (non-GAAP) as of December 31, 2020 and December 31, 2019.
| | | December 31, | | | December 31, | |
(Dollars in thousands except ratio and per share data) | | 2020 | | | 2019 | |
Tangible common shareholders' equity: | | | | | | | | |
Total shareholders' equity (GAAP) | | $ | 177,702 | | | $ | 174,478 | |
Subtract: | | | | | | | | |
Goodwill (GAAP) | | | 11,671 | | | | 11,671 | |
Other intangible assets, net (GAAP) | | | 4,044 | | | | 4,809 | |
Tangible common shareholders' equity (non-GAAP) | | $ | 161,987 | | | $ | 157,998 | |
| | | | | | | | | |
Total assets (GAAP) | | $ | 1,763,954 | | | $ | 1,479,616 | |
Subtract: | | | | | | | | |
Goodwill (GAAP) | | | 11,671 | | | | 11,671 | |
Other intangible assets, net (GAAP) | | | 4,044 | | | | 4,809 | |
Tangible assets (non-GAAP) | | $ | 1,748,239 | | | $ | 1,463,136 | |
| | | | | | | | | |
Common equity ratio (GAAP) | | | 10.07 | % | | | 11.79 | % |
Tangible common equity ratio (non-GAAP) | | | 9.27 | % | | | 10.80 | % |
Book value per share (GAAP) | | $ | 10.58 | | | $ | 9.62 | |
Tangible book value per share (non-GAAP) | | $ | 9.64 | | | $ | 8.71 | |
Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although we believe these non-GAAP financial measures are frequently used by stakeholders in the evaluation of a company, they have limitations as analytical tools, and should not be considered in isolation or as a substitute for analyses of results as reported under GAAP.
Tangible common shareholders’ equity is calculated as total shareholders' equity less goodwill and other intangible assets, net. Tangible assets are total assets less goodwill and other intangible assets, net. The tangible common equity ratio is calculated as tangible common shareholders' equity divided by tangible assets. Tangible book value is calculated as tangible common shareholders’ equity divided by the number of shares outstanding. The tangible common equity, tangible common equity ratio and tangible book value are considered a non-GAAP financial measures and should be viewed in conjunction with the total shareholders' equity, total shareholders' equity ratio and book value per share.
OFF-BALANCE SHEET ARRANGEMENTS
Information regarding Off-Balance Sheet Arrangements is included in Note 14, Commitments and Contingencies in the Notes to Consolidated Financial Statements in this document.
CONCENTRATION OF CREDIT RISK
Information regarding Concentration of Credit Risk is included in Note 14, Commitments and Contingencies, in the Notes to Consolidated Financial Statements incorporated in this document.
LENDING TRANSACTIONS WITH RELATED PARTIES
The business we conduct with directors, officers, significant shareholders and other related parties (collectively, “Related Parties”) is restricted and governed by various laws and regulations, including 12 CFR Part 215 (Regulation O). Furthermore, it is our policy to conduct business with Related Parties on an arm’s length basis at current market prices with terms and conditions no more favorable than we provide in the normal course of business. See Note 23, Related Party Transactions in the Notes to Consolidated Financial Statements in this document for additional detail on lending transactions with related parties.
IMPACT OF INFLATION
Inflation affects our financial position as well as operating results. It is our opinion that the effect of inflation on our financial statements for the years ended December 31, 2020 and December 31, 2019 has not been material.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
RISK MANAGEMENT
Overview
Through our corporate governance structure, risk and return are evaluated to produce sustainable revenues, reduce risk of earnings volatility and increase shareholder value. The financial services industry is exposed to four major categories or types of risks; liquidity, credit, market and operational. Liquidity risk is the possibility that we will be unable to meet liability maturities and withdrawals, fund asset growth and otherwise meet contractual obligations at reasonable market rates. Credit risk is the potential inability of a customer to meet their repayment obligations or the inability of a bond issuer to meet their contractual repayment obligations. Market risk is the possibility asset and liability values will fluctuate in response to changes in market prices and yields, and operational risk is the potential for losses resulting from events involving people, processes, technology, legal issues, external events, regulation, or reputation.
Board Committees
Our corporate governance structure begins with our Board of Directors. The Board of Directors evaluates risk through the Chief Risk Officer and our Enterprise Risk Management reporting and monitoring process (ERM). Our ERM is evaluated quarterly and compares our risk appetite and key risk indicators to actual results and to peer data. The Board of Directors also evaluates risk through a number of Board Committees including the following:
● | Audit and Qualified Legal Compliance Committee reviews the scope and coverage of internal and external audit activities. |
● | Loan Committee reviews credit risks in the loan portfolio and the adequacy of the Allowance for Loan and Lease Losses (“ALLL”). |
● | Asset/Liability Management Committee (“ALCO”) reviews liquidity risk, credit risk in the investment bond portfolio and market risk. |
● | Nominating and Corporate Governance Committee evaluates corporate governance structure, committee performance and evaluates recommendations for the appointment of director nominees. |
● | Technology Committee provides oversight with respect to technology and innovation and the related risk assessment and risk management process. |
These committees review reports from management, our auditors, and other outside sources. On the basis of materials that are available to them and on which they rely, the committees review the performance of our management and personnel, and establish policies, but neither the committees nor their individual members (in their capacities as members of the Board of Directors) is responsible for daily operations of the Company.
Management Committees
To ensure that our risk management goals and objectives are accomplished, oversight of our risk taking and risk management activities are conducted through a number of management committees comprised of members of management including the following:
● | The Senior Management Committee establishes short and long-term strategies and operating plans. The committee establishes performance measures and reviews performance to plan on a monthly basis. The committee is also responsible for evaluating operational risk assessments and approving and implementing mitigating action plans. |
● | The Asset Liability Roundtable establishes and monitors liquidity ranges, pricing, maturities, investment goals, and interest spread on balance sheet accounts. |
● | The SOX 404 Compliance Committee has established the master plan for full documentation of our internal controls and compliance with Section 404 of the Sarbanes-Oxley Act of 2002. |
● | The Environmental, Social and Governance (“ESG”) Committee. On February 16, 2021, we adopted an Environmental and Social Risk Policy Framework and created an ESG committee to strengthen our oversight of environmental and social governance issues. The ESG Committee reports to the Nominating and Corporate Governance Committee of the Board of Directors on ESG activities and practices, and also periodically updates the Board of Directors as to progress in achieving our ESG goals. |
Risk Management Controls
We use various controls and our ERM to manage risk exposure within the Company. Budgeting and variance analyses and key performance indicators provide an early indication of unfavorable results or heightened risk levels. Models are used to estimate market risk and net interest income sensitivity. Segmentation analysis is an important tool used to estimate expected and unexpected credit losses. Compliance with regulatory guidelines plays a significant role in risk management as well as corporate culture and the actions of management. Our code of ethics provides guidelines for all employees to use to ensure that they conduct themselves with the highest integrity in the delivery of service to our clients.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Liquidity Risk Management
Liquidity Risk
Liquidity risk is the possibility that we will be unable to meet liability maturities, deposit withdrawals, fund asset growth or otherwise meet contractual obligations at reasonable market rates. Liquidity management involves maintaining ample and diverse funding capacity, liquid assets and other sources of cash to accommodate fluctuations in asset and liability levels due to business shocks or unanticipated events. ALCO is responsible for establishing our liquidity policy and the Bank’s internal ALCO Roundtable group is responsible for planning and executing the funding activities and strategies.
The Bank’s liquid assets consist of cash and amounts due from banks, cash from repayments and maturities of loans, short-term money market investments, sales of available-for-sale securities and cash flows from investments. Liquidity is generated from liabilities through deposit growth and term debt borrowings. Deposit marketing strategies are reviewed for consistency with liquidity policy objectives.
The Bank has secondary sources of liquidity available from correspondent banking lines of credit, a secured line of credit with the Federal Reserve Bank and a secured borrowing line with the FHLB. While these sources are expected to continue to provide significant amounts of secondary liquidity in the future, their availability, as well as the possible use of other sources, is dependent on future economic and market conditions, pledging of acceptable collateral and maintenance of required minimum capital ratios.
The Holding Company’s principal source of cash is dividends received from the Bank, which it has consistently received for many years. See Item 1A Risk Factors and Note 17 Regulatory Capital in the Notes to Consolidated Financial Statements in this document for a discussion of the restrictions on the Bank’s ability to pay dividends.
To accommodate future growth and business needs, we develop an annual capital expenditure budget during strategic planning sessions. Based on our budgets and forecasts, we believe that our earnings, acquisition of core deposits and wholesale borrowing arrangements will be sufficient to support liquidity needs in 2021.
Term Debt
Federal Home Loan Bank of San Francisco borrowings
We periodically utilize FHLB advances as a source of wholesale funding to provide temporary liquidity. As of December 31, 2020, the Bank had $5.0 million in FHLB advances outstanding. There were no FHLB advances outstanding at December 31, 2019. See Note 10 Term Debt in the Notes to Consolidated Financial Statements for information on our FHLB borrowings.
Subordinated Debt
In December of 2015, the Holding Company issued $10.0 million in aggregate principal amount of fixed to floating rate Subordinated Notes due in 2025. The Subordinated Debt initially bore interest at a fixed rate of 6.88% per annum through December 19, 2020, payable semi-annually. Thereafter, interest on the Subordinated Debt will be paid at a variable rate equal to three month LIBOR plus 526 basis points, payable quarterly until the maturity date. In December of 2015, the Holding Company incurred subordinated debt issuance costs of $210 thousand, which were amortized over the initial five-year-term as additional interest expense.
Senior Debt
In December of 2015, the Holding Company, entered into a senior debt loan agreement to borrow $10.0 million. During the second quarter of 2019, we completed the early repayment and termination of this debt agreement.
Term debt at December 31, 2020, 2019 and 2018 consisted of the following:
(Amounts in thousands) | | 2020 | | | 2019 | | | 2018 | |
Term Debt: | | | | | | | | | | | | |
FHLB borrowings | | $ | 5,000 | | | $ | — | | | $ | — | |
Subordinated debt | | | 10,000 | | | | 10,000 | | | | 10,000 | |
Less unamortized debt issuance cost | | | — | | | | (43 | ) | | | (89 | ) |
Senior debt | | | — | | | | — | | | | 3,496 | |
Less unamortized debt issuance cost | | | — | | | | — | | | | (2 | ) |
Total term debt at December 31, | | $ | 15,000 | | | $ | 9,957 | | | $ | 13,405 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
The following table presents the weighted average contractual interest rates on outstanding borrowings during the years ended December 31, 2020, 2019 and 2018.
| | | 2020 | | | 2019 | | | 2018 | |
Rates: | | | | | | | | | | | | |
FHLB borrowings | | | 0.06 | % | | | 2.56 | % | | | 1.94 | % |
Subordinated debt | | | 6.88 | % | | | 6.88 | % | | | 6.88 | % |
Senior debt | | | — | % | | | 6.73 | % | | | 6.18 | % |
The following table presents the maximum outstanding balance at any month end, average balance during the year and effective weighted average interest rate during the year on outstanding term debt for the years ended December 31, 2020, 2019 and 2018.
(Dollars in thousands) | | 2020 | | | 2019 | | | 2018 | |
Term Debt: | | | | | | | | | | | | |
FHLB borrowings: | | | | | | | | | | | | |
Maximum balance outstanding at any month end | | $ | 40,000 | | | $ | 40,000 | | | $ | 70,000 | |
Average balance outstanding during the year | | $ | 8,347 | | | $ | 9,644 | | | $ | 22,480 | |
Effective weighted average interest rate during year | | | 0.06 | % | | | 2.56 | % | | | 1.94 | % |
Subordinated debt net of unamortized debt issuance costs: | | | | | | | | | | | | |
Maximum balance outstanding at any month end | | $ | 10,000 | | | $ | 9,957 | | | $ | 9,911 | |
Average balance outstanding during the year | | $ | 9,981 | | | $ | 9,935 | | | $ | 9,890 | |
Effective weighted average interest rate during year | | | 7.38 | % | | | 7.38 | % | | | 7.38 | % |
Senior debt net of unamortized debt issuance costs: | | | | | | | | | | | | |
Maximum balance outstanding at any month end | | $ | — | | | $ | 3,195 | | | $ | 6,890 | |
Average balance outstanding during the year | | $ | — | | | $ | 960 | | | $ | 5,239 | |
Effective weighted average interest rate during year | | | — | % | | | 7.22 | % | | | 6.51 | % |
Credit Risk Management
Credit risk is the possibility that a loan customer will be unable to meet their repayment obligations or that a bond issuer will be unable to meet their contractual repayment obligations. Credit risk exists in our outstanding loans, letters of credit, FHLB affordable housing grant sponsorships, unfunded loan commitments, deposits with other institutions and investment bond portfolio. In all of these areas we manage credit risk based on the risk profile of the borrower/grantee/issuer, repayment sources and the nature of the underlying collateral given current events and conditions. We rely on various controls including our underwriting standards, loan policies, internal loan monitoring, ALLL methodology and credit reviews to manage credit risk.
Concentrations of credit risk
We grant real estate construction, commercial, and installment loans to customers throughout northern California. In our judgment, a concentration exists in real estate related loans, which represented approximately 77% (86% of our gross loan portfolio excluding PPP loans) at December 31, 2020 and 83% of our gross loan portfolio at December 31, 2019.
Commercial real estate concentrations are managed to assure wide geographic and business diversity. Although management believes such concentrations have no more than the normal risk of collectability, a substantial decline in the economy in general, material increases in interest rates, changes in tax policies, tightening credit or refinancing markets, or a decline in real estate values in our principal market areas in particular, could have an adverse impact on the repayment of these loans. Personal and business incomes, proceeds from the sale of real property, or proceeds from refinancing, represent the primary sources of repayment for a majority of these loans.
We recognize the credit risks inherent in dealing with other depository institutions. Accordingly, to prevent excessive exposure to other depository institutions in aggregate or to any single correspondent, we have established general standards for selecting correspondent banks as well as internal limits for allowable exposure to other depository institutions in aggregate or to any single correspondent. In addition, we have an investment policy that sets forth limitations that apply to all investments with respect to credit rating and concentrations with an issuer.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Loan portfolio
Credit risk management for the loan portfolio begins with an assessment of the credit risk profile of each individual borrower based on an analysis of the borrower’s financial position in light of current industry, economic or geopolitical trends. As part of the overall credit risk assessment of a borrower, each credit is assigned a risk grade and is subject to approval based on our existing credit approval standards. Risk grading is a significant factor in determining the adequacy of the ALLL.
Credit decisions are made by our Credit Administration subject to certain limitations and, when those limitations are encountered, the approvals are made by the Board Loan Committee. Credit risk is continuously monitored by Credit Administration for possible adjustment of a loan risk grade if there has been a change in the borrower’s ability to perform under the terms of their obligation. Additionally, we may manage the size of our credit exposure through loan sales and loan participation agreements.
Our specific underwriting standards and methods for each principal line of lending include industry-accepted analysis and modeling and certain proprietary techniques. Our underwriting criteria are designed to comply with applicable regulatory guidelines, including required loan-to-value ratios. Our credit administration policies contain mandatory lien position and debt service coverage requirements, and we generally require a guarantee from individuals owning 20% or more of the borrowing entity. Our evaluations of our borrowers’ are facilitated by management’s knowledge of local market conditions and periodic reviews by a consultant of our credit administration policies.
Allowance for loan and lease losses
The ALLL represents management’s best estimate of probable losses in the loan portfolio. Within the allowance, reserves are allocated to segments of the portfolio based on specific formula components. Changes to the ALLL are reported in the Consolidated Statements of Income in the line item provision for loan and lease losses.
We perform periodic and systematic detailed evaluations of our lending portfolio to identify and estimate the inherent risks and assess the overall collectability. We evaluate the following:
● | General conditions such as the portfolio composition, size and maturities of various segmented portions of the portfolio such as secured, unsecured, construction, and Small Business Administration. |
● | Concentrations of borrowers, industries, geographical sectors, loan product, loan classes and collateral types. |
● | Volume and trends in the aggregate of loan delinquencies, nonaccruals, and watch, criticized and classified loans |
Our ALLL is the accumulation of various components that are calculated based upon independent methodologies. All components of the ALLL represent an estimation based on certain observable data that management believes most reflects the underlying credit losses being estimated. Changes in the amount of each component of the ALLL are directionally consistent with changes in the observable data, taking into account the interaction of the components over time.
An essential element of the methodology for determining the ALLL is our credit risk evaluation process, which includes credit risk grading of individual, commercial, construction, commercial real estate, and consumer loans. Loans are assigned credit risk grades based on our assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrower’s current financial information, historical payment experience, credit documentation, public information, and other information specific to each individual borrower. Loans are reviewed on an annual or rotational basis or as management becomes aware of information affecting the borrower’s ability to fulfill its obligations. Each credit risk grade is assigned a loss percentage when calculating the adequacy of the ALLL.
For individually impaired loans, we measure impairment based on the present value of expected future principal and interest cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan’s observable market price or the fair value of collateral, if the loan is collateral dependent. When developing the estimate of future cash flows for a loan, we consider all available information reflecting past events and current conditions, including the effect of existing environmental factors. In addition to the ALLL, an allowance for unfunded loan commitments and letters of credit is determined using estimates of the probability of funding and the associated inherent credit risk. This reserve is carried as a liability on the Consolidated Balance Sheets.
We make provisions to the ALLL as necessary through charges to operations that are reflected in our Consolidated Statements of Income as provision for loan and lease loss expense. When a loan is deemed uncollectible, it is charged against the allowance. Any recoveries of previously charged off loans and leases are credited back to the allowance. There is no precise method of predicting specific losses or amounts that ultimately may be charged off on particular categories of the loan and lease portfolio.
Various regulatory agencies periodically review our ALLL as an integral part of their examination process. Such agencies may require us to provide additions to the allowance based on their judgment of information available to them at the time of their examination. There is uncertainty concerning future economic trends. Accordingly, it is not possible to predict the effect future economic trends may have on the level of the provisions for loan and lease losses in future periods. The ALLL should not be interpreted as an indication that charge-offs in future periods will occur in the stated amounts or proportions.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Federal Home Loan Bank of San Francisco Affordable Housing Grant and Access to Housing and Economic Assistance for Development Grant Sponsorships
As part of satisfying our CRA responsibilities, we are a sponsor for various nonprofit organizations which receive cash grants from the FHLB. Those grants require the nonprofit organization to comply with stipulated conditions of the grant over specified periods of time which typically vary from 10 to 15 years. If the nonprofit organization fails to comply, FHLB can require us to refund the amount of the grant to FHLB. To mitigate this contingent credit risk, Credit Administration underwrites the financial strength of the nonprofit organization and reviews their systems of internal control to determine, as best as is possible, that they will not fail to comply with the conditions of the grant.
Investment Securities Portfolio
To manage credit risk in the investment securities portfolio, we have an investment policy that sets forth limitations that apply to all investments with respect to credit rating and concentrations with an issuer. We perform a pre-purchase analysis on all bonds not secured by the U.S. Government or Agency of the U.S. Government to ensure that the investment meets our credit risk requirements and repayment expectations. We perform annual and quarterly credit reviews to ensure our investments continue to meet our credit risk requirements and repayment expectations.
Deposits With Other Institutions
We recognize the credit risks inherent in dealing with other depository institutions. Accordingly, to prevent excessive exposure to other depository institutions in aggregate or to any single correspondent, we have established general standards for selecting correspondent banks as well as internal limits for allowable exposure to other depository institutions in aggregate or to any single correspondent.
Market Risk Management
General
Market risk is the potential loss due to adverse changes in market prices and interest rates. Market risk is inherent in our operating positions and activities including customers’ loans, deposit accounts, securities and long-term debt. Loans and deposits generate income and expense, respectively, and the value of cash flows changes based on general economic levels, and most importantly, the level of interest rates.
The goal for managing our assets and liabilities is to optimize shareholder value and earnings while maintaining a high quality balance sheet without exposing the Company to undue interest rate risk. The absolute level and volatility of interest rates can have a significant impact on our profitability. Market risk arises from exposure to changes in interest rates, exchange rates, commodity prices, and other relevant market rate or price risk. We do not operate a trading account, and do not hold a position with exposure to foreign currency exchange.
We face market risk through interest rate volatility. Net interest income, or margin risk, is measured based on rate shocks over varying time horizons versus a current stable interest rate environment. Assumptions used in these calculations are similar to those used in the planning and budgeting model. The overall interest rate risk position and strategies are reviewed on an ongoing basis with ALCO.
Investment Securities Portfolio
The investment securities portfolio is central to our asset liability management strategies. The decision to purchase or sell securities is based upon our assessment of current and projected economic and financial conditions, including the interest rate environment, liquidity, changes in a security’s credit rating, the risk weighting of a security and other regulatory requirements. We classify our securities as “available-for-sale” or “held-to-maturity” at the time of purchase. We do not engage in trading activities. Securities held-to-maturity are carried at amortized cost. Securities available-for-sale may be sold to implement our asset liability management strategies and in response to changes in interest rates, prepayment rates, and similar factors. Securities available-for-sale are recorded at fair value and unrealized gains or losses, net of income taxes, are reported as a component of accumulated other comprehensive income (loss), in a separate component of shareholders’ equity. Gain or loss on sale of securities is calculated on the specific identification method.
Operational Risk Management
Operational risk is the potential for loss resulting from events involving people, processes, technology, legal or regulatory issues, external events, and reputation. In keeping with the corporate governance structure, the Senior Leadership committee is responsible for operational risk controls. Operational risks are managed through specific policies and procedures, controls and monitoring tools. Examples of these include reconciliation processes, transaction monitoring and analysis and system audits. Operational risks fall into two major categories, business specific and company-wide. The Senior Leadership committee works to ensure consistency in policies, processes and assessments. With respect to company-wide risks, the Senior Leadership committee works directly with members of our Board of Directors to develop policies and procedures for information security, business resumption plans, compliance and legal issues.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
SUMMARY OF CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are described in Note 2 Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in this document. Some of these significant accounting policies are considered critical and require management to make difficult, subjective or complex judgments or estimates. Management believes that the following policies would be considered critical under the SEC’s definition.
Valuation of Investments and Impairment of Securities
At the time of purchase, we designate a security as held-to-maturity or available-for-sale, based on our investment objectives, operational needs and intent to hold. We do not engage in trading activity. Securities designated as held-to-maturity are carried at amortized cost. We have the ability and intent to hold these securities to maturity. Securities designated as available-for-sale may be sold to implement our asset/liability management strategies and in response to changes in interest rates, prepayment rates and similar factors. Securities designated as available-for-sale are recorded at fair value and unrealized gains or losses, net of income taxes, are reported as part of accumulated other comprehensive income (loss), a separate component of shareholders’ equity. Gains or losses on sale of securities are based on the specific identification method. The market value and credit rating of each security is monitored to identify changes in asset quality.
Security values may be adjusted to reflect changes in valuation as a result of other-than-temporary declines in value. Investments with fair values that are less than amortized costs are considered impaired. Impairment may result from either a decline in the financial condition of the issuing entity or from changes in interest rates. At each financial statement date, management assesses each investment to determine if impaired investments are temporarily impaired or if the impairment is other-than-temporary based upon the positive and negative evidence available. Evidence evaluated includes, but is not limited to, industry analyst reports, credit market conditions, and interest rate trends.
When an investment is other-than-temporarily impaired, we assess whether we intend to sell the security, or it is more-likely-than-not that we will be required to sell the security before recovery of its amortized cost basis less any current-period credit losses. If we intend to sell the security or if it is more-likely-than-not that we will be required to sell security before recovery of the amortized cost basis, the entire amount of other-than-temporary impairment is recognized in earnings.
For debt securities that are considered other-than-temporarily impaired and that we do not intend to sell and will not be required to sell prior to recovery of our amortized cost basis, we separate the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is calculated as the difference between the investment’s amortized cost basis and the present value of its expected future cash flows.
The remaining differences between the investment’s fair value and the present value of future expected cash flows is deemed to be due to factors that are not credit related and is recognized in other comprehensive income. Significant judgment is required in the determination of whether other-than-temporary impairment has occurred for an investment. We follow a consistent and systematic process for determining other-than-temporary impairment loss. We have designated the ALCO responsible for the other-than-temporary evaluation process.
The ALCO’s assessment of whether an other-than-temporary impairment loss should be recognized incorporates both quantitative and qualitative information including, but not limited to: (1) the length of time and the extent of which the fair value has been less than amortized cost, (2) the financial condition and near term prospects of the issuer, (3) our intent and ability to retain the investment for a period of time sufficient to allow for an anticipated recovery in value, (4) whether the debtor is current on interest and principal payments, and (5) general market conditions and industry or sector specific outlook. See Note 4 Securities in the Notes to Consolidated Financial Statements in this document for further detail on other-than-temporary impairment and the securities portfolio.
Allowance for Loan and Lease Losses
The ALLL is based upon estimates of loan and lease losses and is maintained at a level considered adequate to provide for probable losses inherent in the outstanding loan and lease portfolio. The allowance is increased by provisions charged to expense and reduced by net charge-offs. In periodic evaluations of the adequacy of the allowance balance, management considers our past loan and lease loss experience by type of credit, known and inherent risks in the portfolio, adverse situations that may affect a borrower's ability to repay, the estimated value of any underlying collateral, current economic conditions and other factors.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Management reviews the ALLL on a monthly basis and conducts a formal assessment of the adequacy of the ALLL on a quarterly basis. These assessments include the periodic re-grading of classified loans based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the interest rate environment and other factors as warranted. Loans are initially graded when originated. Loans are reviewed as they are renewed, when there is a new loan to the same borrower and/or when identified facts demonstrate heightened risk of default. Confirmation of the quality of our grading process is obtained by independent reviews conducted by outside consultants specifically hired for this purpose and by periodic examination by various bank regulatory agencies. Management monitors delinquent loans continuously and identifies problem loans to be evaluated individually for impairment testing. For loans that are determined impaired, formal impairment measurement is performed at least quarterly on a loan-by-loan basis.
Our method for assessing the appropriateness of the allowance includes specific allowances for identified problem loans, an allowance factor for categories of credits and allowances for changing environmental factors (e.g., portfolio trends, concentration of credit, growth, economic factors). Allowances for identified problem loans are based on specific analysis of individual credits. Loss estimation factors for unimpaired loan categories are based on analysis of historical losses adjusted for changing environmental factors applicable to each loan category. Allowances for changing environmental factors are management's best estimate of the probable impact these changes would have on the loan portfolio as a whole. See Note 5 Loans in the Notes to Consolidated Financial Statements in this document for further detail on the ALLL and the loan portfolio.
Valuation of Goodwill
Goodwill results from a business combination, and is calculated as the amount of consideration paid in excess of the fair value of the net assets acquired in a transaction. Goodwill is considered to have an indefinite life and is therefore not amortized. It is reviewed annually for impairment, or more frequently if required by circumstances known as triggering events. The impairment analysis requires management to make subjective judgments. Events and factors that may significantly affect the estimates include, among others, significant adverse change in the business climate, slower growth rates or a significant and sustained decline in the price of our common stock.
We perform our analysis of goodwill at the reporting unit level analyzing factors that would impact the estimated fair value of the reporting unit compared to its carrying value. We first assess qualitative factors to determine whether the existence of events and circumstances indicate that it is more likely than not that goodwill is impaired. If the qualitative assessment results indicate that it is more likely than not that the fair value of any reporting unit is less than its carrying amount, then the quantitative impairment test is performed. Various valuation methodologies are considered when completing the quantitative impairment test to determine the estimated fair value of the reporting unit which is then compared to its carrying value, including goodwill. If the fair value of the our Company (our only reporting unit) is less than its carrying amount, an impairment charge would be taken for the amount by which the carrying amount exceeds the reporting unit's fair value, not to exceed the total amount of goodwill allocated to the reporting unit.
Income Taxes
Income taxes reported in the consolidated financial statements are computed based on an asset and liability approach. We recognize the amount of taxes payable or refundable for the current year, and deferred tax assets and liabilities for the expected future tax consequences that have been recognized in the consolidated financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the consolidated financial statements and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We record net deferred tax assets to the extent it is more-likely-than-not that they will be realized. In evaluating our ability to recover the deferred tax assets, management considers all available positive and negative evidence, including projected future taxable income, tax planning strategies and recent financial operations.
In projecting future taxable income, management develops assumptions including the amount of future state and federal pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates being used to manage the underlying business. We file consolidated federal and state income tax returns.
ASC 740-10-55 Income Taxes requires a two-step process that separates recognition from measurement of tax positions. We recognize the financial statement effect of a tax position when it is more-likely-than-not, based on the technical merits, that the position will be sustained upon examination by a taxing authority. The measurement process is applied only after satisfying the recognition requirement and determines what amount of a tax position will be sustainable upon a potential examination or settlement. If upon measuring, the tax position produces a range of potential tax benefits, we may claim the highest tax benefit from that range as long as it is over 50% likely to be realized using a probability analysis.
We believe that all of the tax positions we have taken, meet the more likely than not recognition threshold. To the extent tax authorities disagree with these tax positions, our effective tax rates could be materially affected in the period of settlement with the taxing authorities. See Note 19 Income Taxes in the Notes to Consolidated Financial Statements in this document for further detail on our income taxes.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Fair Value Measurements
We use fair value measurements to record fair value adjustments to certain assets and liabilities, and to determine fair value disclosures. We base our fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Securities available-for-sale and derivatives are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record certain assets at fair value on a nonrecurring basis, such as certain impaired loans held for investment, (“OREO”), core deposit intangible and goodwill. These nonrecurring fair value adjustments typically involve write-downs of individual assets due to application of lower of cost or market accounting.
We have established and documented a process for determining fair value. We maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. Whenever there is no readily available market data, we use our best estimate and assumptions in determining fair value, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result, if other assumptions had been used, our recorded earnings or disclosures could have been materially different from those reflected in these consolidated financial statements. Additional information on our use of fair value measurements and our related valuation methodologies is provided in Note 18 Fair Values in the Notes to Consolidated Financial Statements incorporated in this document.
Item 7A - Quantitative and Qualitative Disclosures about Market Risk
Market risk is the potential loss due to adverse changes in market prices and interest rates. Market risk is inherent in our operating positions and activities including customers’ loans, deposit accounts, securities and long-term debt. We do not operate a securities trading account and do not hold a position with exposure to foreign currency exchange or commodities. Market-sensitive assets and liabilities are generated through loans and deposits associated with our banking business, our asset liability management process, and credit risk mitigation activities. Traditional loan and deposit products are reported at amortized cost for assets or the amount owed for liabilities. These positions are subject to changes in economic value based on varying market conditions. Interest rate risk is the effect of changes in economic value of our loans and deposits, as well as our other interest rate sensitive instruments and is reflected in the levels of future income and expense produced by these positions versus levels that would be generated by current levels of interest rates. We seek to mitigate interest rate risk as part of the asset liability management process.
The Board of Directors has overall responsibility for our interest rate risk management policies. We have an Asset/Liability Management Committee (“ALCO”) which establishes and monitors guidelines to control our sensitivity of earnings to changes in interest rates. Our internal ALCO Roundtable group forecasts net interest income using different rate scenarios via a simulation model. This group updates the net interest income forecast for changing assumptions and differing outlooks based on economic and market conditions.
The simulation model includes expected re-pricing characteristics of our rate sensitive assets and liabilities. These re-pricing characteristics recognize the relative sensitivity of assets and liabilities to changes in market interest rates, as demonstrated through current and historical experience and recognizing the timing differences of rate changes. In the simulation of net interest margin and net interest income the forecast balance sheet is processed against nine possible rate scenarios. These nine rate scenarios include a flat rate environment, which assumes interest rates are unchanged in the future and eight additional rate ramp scenarios ranging from +400 to -400 basis points in 100 basis point increments. The model does not simulate for rates below zero.
The formal policies and practices we have adopted to monitor and manage interest rate risk exposure rely on measuring risk in two ways: (1) the impact of changes in rates on net interest income, and (2) the impact of changes in rates on the fair value of equity. In moderately rising interest rate scenarios the model indicates that the company is slightly liability sensitive. In more rapidly rising interest rate scenarios however, the model indicates that the company is somewhat more liability sensitive.
During the year ended December 31, 2020, in response to the economic effects of the COVID-19 pandemic, the Federal Reserve cut its interest rates by 150 to 175 basis points. The Federal Reserve has provided guidance that it does not intend to lower rates below 0% and that it expects interest rates to remain low for an extended period of time in pursuit of maximum employment and inflation at a rate of 2%. Acknowledging this guidance, the Bank is primarily focused on strategies for an extended low rate environment.
We model the estimated annualized change to our net interest income for changes in interest rates. The model assumes a static balance sheet, relies on historic betas and assumes immediate parallel rate changes and no assurance can be given that future performance will mirror the model. The most recent model results reflecting annualized increases and decreases in net interest income as of December 31, 2020 are presented below.
(Amounts in thousands) | | December 31, 2020 | |
Change in Federal Funds Rate: | | Estimated Annualized Change in Net Interest Income | |
Up 400 basis points | | $ | (9,300 | ) |
Up 300 basis points | | $ | (5,500 | ) |
Up 200 basis points | | $ | (843 | ) |
Up 100 basis points | | $ | 318 | |
Down 100 basis points | | $ | (37 | ) |
Down 200 basis points | | $ | (297 | ) |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Our Company is dynamic while the model assumes a static balance sheet. We believe that the maturity structure of our rate-sensitive assets and liabilities contributes to our ability to re-price a significant amount of our rate-sensitive assets and liabilities and mitigate the impact of rate changes in excess of 100 basis points. The model’s primary benefit to management is its assistance in evaluating the impact that future strategies with respect to our mix and level of rate-sensitive assets and liabilities will have on our net interest income.
Our approach to managing interest rate risk may include the use of derivatives, including interest rate swaps, caps and floors. This helps to minimize significant, unplanned fluctuations in earnings, fair values of assets and liabilities and cash flows caused by interest rate volatility. This approach utilizes a financial instrument with the same characteristics of certain assets and liabilities so that changes in interest rates do not have a significant adverse effect on the net interest margin and cash flows.
The following table sets forth as of December 31, 2020 the distribution of re-pricing opportunities for our earning assets and interest-bearing liabilities. It also reports the GAP (different volumes of rate sensitive assets and liabilities) re-pricing interest-earning assets and interest-bearing liabilities at different time intervals, the cumulative GAP, the ratio of rate sensitive assets to rate sensitive liabilities for each re-pricing interval, and the cumulative GAP to total assets.
| | | Gap Analysis | |
| | | Within 3 | | | 3 Months To | | | One Year To | | | Over Five | | | | | |
(Dollars in thousands) | | Months | | | One Year | | | Five Years | | | Years | | | Total | |
Interest-earning assets | | | | | | | | | | | | | | | | | | | | |
AFS securities | | $ | 86,823 | | | $ | 67,449 | | | $ | 136,656 | | | $ | 155,952 | | | $ | 446,880 | |
Other investments | | | 87,111 | | | | — | | | | — | | | | — | | | | 87,111 | |
Loans, net of deferred fees and costs | | | 108,135 | | | | 239,271 | | | | 535,311 | | | | 257,244 | | | | 1,139,961 | |
Total earning assets | | $ | 282,069 | | | $ | 306,720 | | | $ | 671,967 | | | $ | 413,196 | | | $ | 1,673,952 | |
| | | | | | | | | | | | | | | | | | | | | |
Interest-bearing liabilities | | | | | | | | | | | | | | | | | | | | |
Demand - interest-bearing | | $ | 290,251 | | | $ | — | | | $ | — | | | $ | — | | | $ | 290,251 | |
Money market | | | 425,121 | | | | — | | | | — | | | | — | | | | 425,121 | |
Savings | | | 150,695 | | | | — | | | | — | | | | — | | | | 150,695 | |
Certificates of deposit | | | 27,167 | | | | 62,152 | | | | 46,343 | | | | 17 | | | | 135,679 | |
Term debt and junior subordinated debentures, net | | | 10,310 | | | | 15,000 | | | | — | | | | — | | | | 25,310 | |
Total interest-bearing deposits and borrowings | | $ | 903,544 | | | $ | 77,152 | | | $ | 46,343 | | | $ | 17 | | | $ | 1,027,056 | |
| | | | | | | | | | | | | | | | | | | | | |
Re-pricing GAP | | $ | (621,475 | ) | | $ | 229,568 | | | $ | 625,624 | | | $ | 413,179 | | | $ | 646,896 | |
Cumulative re-pricing GAP | | $ | (621,475 | ) | | $ | (391,907 | ) | | $ | 233,717 | | | $ | 646,896 | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
Gap ratio | | | 0.31 | | | | 3.98 | | | | 14.50 | | | | 24,305.65 | | | | 1.63 | |
Cumulative gap ratio | | | 0.31 | | | | 0.60 | | | | 1.23 | | | | 1.63 | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
Gap as % of earning assets | | | (37 | )% | | | 14 | % | | | 37 | % | | | 25 | % | | | 39 | % |
Cumulative GAP as % of earning assets | | | (37 | )% | | | (23 | )% | | | 14 | % | | | 39 | % | | | | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Item 8 - Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
70
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
Bank of Commerce Holdings
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Bank of Commerce Holdings and subsidiaries (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for the years then ended, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2020 and 2019, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting in accordance with the standards of the PCAOB. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting in accordance with the standards of the PCAOB. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing a separate opinion on the critical audit matters or on the accounts or disclosures to which they relate.
Allowance for loan losses:
As described in Notes 2 and 5 to the consolidated financial statements, the Company’s allowance for loan and lease losses balance was $16.9 million at December 31, 2020, and is based on the Company’s continuing evaluation of all known relevant quantitative and qualitative internal and external risk factors. The historical valuation allowances are based on estimated probable losses for similarly situated loan pools. The Company divides the loan portfolio into sub-categories of similar type loans. Each category is assigned a historical loss factor and additional qualitative factors. The sub-categories are also further segmented by risk rating. Each risk rating is assigned an additional loss factor to account for the additional risk in those loans with higher risk levels. The Company performs regular credit reviews of the loan portfolio to determine the credit quality of the portfolio and assigns risk ratings. These risk ratings are a primary factor in determining an appropriate amount of the allowance for loan and lease losses. The general valuation allowances are based on qualitative factors such as changes in asset quality trends, concentrations of credit or changes in concentrations of credit, changes in underwriting standards, changes in experience or depth of lending staff or management, the effectiveness of loan grading and the internal loan review function, changes in economic conditions, and any other relevant factors. Management evaluates each qualitative component quarterly to determine the associated risks to the quality of our loan portfolio.
We identified management’s risk ratings of loans and the estimation of qualitative credit risk factors, both of which are used in the allowance for loan losses calculation, as critical audit matters because these estimates and underlying assumptions require significant management judgment in the evaluation of the credit quality and the estimation of incurred losses inherent within the loan portfolio as of the balance sheet date and in turn led to a high degree of auditor judgment and subjectivity in performing the procedures and evaluating the related audit evidence.
The primary procedures we performed to address this critical audit matter included:
● | Obtaining an understanding of internal controls relating to management’s calculation of the allowance for loan losses. |
● | Testing the design, implementation, and operating effectiveness of controls over the accuracy of risk ratings of loans. |
● | Testing a risk-based targeted selection of loans to gain substantive evidence that the Company is appropriately rating these loans in accordance with its policies, and that the risk ratings for the loans are reasonable. |
● | Obtaining management’s analysis and supporting documentation related to the qualitative credit risk factors, and testing whether the qualitative credit risk factors used in the calculation of the allowance for loan losses are supported by the analysis provided by management and are used in a manner consistent with management’s established policies and procedures. |
● | Performing an independent sensitivity analysis to evaluate the reasonableness of the qualitative credit risk factors used by management to account for inherent losses that are not captured in the calculation of the allowance for loan losses based on historical loss rates alone. |
● | Testing the appropriateness of the methodology and assumptions used in the calculation of the allowance for loan losses, and testing the calculation itself, including completeness and accuracy of the data used in the calculation, application of the loan risk ratings determined by management and used in the calculation, application of the qualitative credit risk factors determined by management and used in the calculation, and recalculation of the allowance for loan losses balance. |
Goodwill:
As described in Notes 2 and 7 to the consolidated financial statements, the Company’s goodwill balance was $11.7 million at December 31, 2020. Goodwill results from business combinations and is calculated as the amount of consideration paid in excess of the fair value of the net assets acquired in business combination transactions. Goodwill is subject to impairment testing on an annual basis, or on an interim basis when events and circumstances indicate impairment potentially exists. In conjunction with the Company’s annual evaluation of goodwill impairment, management performed a quantitative evaluation of goodwill impairment. The Company used a third-party valuation specialist to assist management in performing the impairment test. The fair value utilized in the analysis was calculated based on the weighted average of the results from two valuation approaches – an income approach and a market approach.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
We identified goodwill impairment as the critical audit matter because the methods and underlying assumptions in performing a quantitative test involves high levels of management judgment and in turn led to a high degree of auditor judgment and subjectivity in performing procedures and evaluating audit evidence related to management’s valuation methods and significant assumptions.
The primary procedures we performed to address this critical audit matter included:
| ● | Obtaining an understanding of internal controls relating to the review of the goodwill impairment analysis. |
● | Testing completeness and accuracy of the data used in the goodwill impairment analysis. |
● | Testing whether the cash flow projections utilized in the discounted cash flow calculations are supported by management’s analysis. |
● | Utilizing a valuation specialist to evaluate the reasonableness and appropriateness of cash flow projections, discount rate, cost savings, and data sources utilized in the analysis, including consideration of key factors, alternative assumptions, and the consistency of assumptions with supporting data, historical information, and understanding of the industry. |
● | Utilizing a valuation specialist to evaluate the reasonableness and appropriateness of the market approach and comparison companies utilized in the analysis. |
/s/ Moss Adams LLP |
| |
Sacramento, California |
March 5, 2021 |
| |
We have served as the Company’s auditor since 2004. |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
To the Shareholders:
Management’s Report on Internal Control over Financial Reporting
Management of Bank of Commerce Holdings and its subsidiaries (“the Company”) is responsible for establishing and maintaining internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Company’s internal control system is designed to provide reasonable assurance to our management and Board of Directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that:
● | Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company’s assets; |
● | Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with the authorizations of management and directors of the Company; and |
● | Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. |
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework (2013). Based on our assessment and those criteria, we believe that, as of December 31, 2020, the Company maintained effective internal control over financial reporting.
The Company’s independent registered public accounting firm has audited the Company’s consolidated financial statements that are included in this annual report as of December 31, 2020 and issued their Report of Independent Registered Public Accounting Firm, which appears on the previous page.
/s/ Randall S. Eslick |
Randall S. Eslick, President and Chief Executive Officer |
| |
/s/ James A. Sundquist |
James A. Sundquist, EVP and Chief Financial Officer |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2020 and 2019
(Amounts in thousands, except share information) | | 2020 | | | 2019 | |
Assets: | | | | | | | | |
Cash and due from banks | | $ | 19,875 | | | $ | 21,338 | |
Interest-bearing deposits in other banks | | | 87,111 | | | | 59,266 | |
Total cash and cash equivalents | | | 106,986 | | | | 80,604 | |
| | | | | | | | | |
Securities available-for-sale, at fair value | | | 446,880 | | | | 286,950 | |
| | | | | | | | | |
Loans, net of deferred fees and costs | | | 1,139,961 | | | | 1,035,065 | |
Allowance for loan and lease losses | | | (16,910 | ) | | | (12,231 | ) |
Net loans | | | 1,123,051 | | | | 1,022,834 | |
| | | | | | | | | |
Premises and equipment, net | | | 14,999 | | | | 15,906 | |
Life insurance | | | 24,206 | | | | 23,701 | |
Deferred tax asset, net | | | 3,954 | | | | 4,553 | |
Goodwill | | | 11,671 | | | | 11,671 | |
Other intangible assets, net | | | 4,044 | | | | 4,809 | |
Other assets | | | 28,163 | | | | 28,588 | |
Total assets | | $ | 1,763,954 | | | $ | 1,479,616 | |
| | | | | | | | | |
Liabilities and shareholders' equity: | | | | | | | | |
Liabilities: | | | | | | | | |
Demand - noninterest-bearing | | $ | 541,033 | | | $ | 432,680 | |
Demand - interest-bearing | | | 290,251 | | | | 239,258 | |
Money market | | | 425,121 | | | | 307,559 | |
Savings | | | 150,695 | | | | 135,888 | |
Certificates of deposit | | | 135,679 | | | | 151,786 | |
Total deposits | | | 1,542,779 | | | | 1,267,171 | |
| | | | | | | | | |
Term debt: | | | | | | | | |
Federal Home Loan Bank of San Francisco ("FHLB") borrowings | | | 5,000 | | | | 0 | |
Other borrowings | | | 10,000 | | | | 10,000 | |
Less unamortized debt issuance costs | | | 0 | | | | (43 | ) |
Net term debt | | | 15,000 | | | | 9,957 | |
| | | | | | | | | |
Junior subordinated debentures | | | 10,310 | | | | 10,310 | |
Other liabilities | | | 18,163 | | | | 17,700 | |
Total liabilities | | | 1,586,252 | | | | 1,305,138 | |
| | | | | | | | | |
Commitments and contingencies (Note 14) | | | | | | | | |
Shareholders’ equity: | | | | | | | | |
Common stock, no par value, 50,000,000 shares authorized; issued and outstanding - 16,800,662 as of December 31, 2020 and 18,137,167 as of December 31, 2019 | | | 58,988 | | | | 71,311 | |
Retained earnings | | | 111,226 | | | | 100,566 | |
Accumulated other comprehensive income | | | 7,488 | | | | 2,601 | |
Total shareholders’ equity | | | 177,702 | | | | 174,478 | |
Total liabilities and shareholders’ equity | | $ | 1,763,954 | | | $ | 1,479,616 | |
See accompanying Notes to Consolidated Financial Statements.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Consolidated Statements of Income
For the years ended December 31, 2020 and 2019
(Amounts in thousands, except per share information) | | 2020 | | | 2019 | |
Interest income: | | | | | | | | |
Interest and fees on loans | | $ | 52,542 | | | $ | 50,534 | |
Interest on taxable securities | | | 5,679 | | | | 6,673 | |
Interest on tax-exempt securities | | | 1,618 | | | | 1,244 | |
Interest on interest-bearing deposits in other banks | | | 240 | | | | 1,112 | |
Total interest income | | | 60,079 | | | | 59,563 | |
Interest expense: | | | | | | | | |
Interest on demand - interest-bearing | | | 313 | | | | 480 | |
Interest on money market | | | 1,246 | | | | 1,599 | |
Interest on savings | | | 340 | | | | 493 | |
Interest on certificates of deposit | | | 1,741 | | | | 1,977 | |
Interest on FHLB borrowings | | | 5 | | | | 247 | |
Interest on other borrowings | | | 731 | | | | 806 | |
Interest on junior subordinated debentures | | | 248 | | | | 426 | |
Total interest expense | | | 4,624 | | | | 6,028 | |
Net interest income | | | 55,455 | | | | 53,535 | |
Provision for loan and lease losses | | | 5,250 | | | | 0 | |
Net interest income after provision for loan and lease losses | | | 50,205 | | | | 53,535 | |
Noninterest income: | | | | | | | | |
Service charges on deposit accounts | | | 636 | | | | 730 | |
ATM and point of sale fees | | | 1,134 | | | | 1,158 | |
Payroll and benefit processing fees | | | 647 | | | | 669 | |
Life insurance | | | 521 | | | | 536 | |
Gain on sale of investment securities, net | | | 482 | | | | 186 | |
FHLB dividends | | | 369 | | | | 507 | |
(Loss) gain on sale of OREO | | | (23 | ) | | | 62 | |
Other income | | | 286 | | | | 336 | |
Total noninterest income | | | 4,052 | | | | 4,184 | |
Noninterest expense: | | | | | | | | |
Salaries and related benefits | | | 21,262 | | | | 20,804 | |
Premises and equipment | | | 3,597 | | | | 3,752 | |
FDIC insurance premium | | | 332 | | | | 91 | |
Data processing | | | 2,281 | | | | 2,535 | |
Professional services | | | 1,437 | | | | 1,539 | |
Telecommunications | | | 658 | | | | 737 | |
Acquisition and merger | | | 0 | | | | 2,193 | |
Other expenses | | | 5,410 | | | | 5,604 | |
Total noninterest expense | | | 34,977 | | | | 37,255 | |
Income before provision for income taxes | | | 19,280 | | | | 20,464 | |
Provision for income taxes | | | 5,116 | | | | 5,503 | |
Net income | | $ | 14,164 | | | $ | 14,961 | |
| | | | | | | | | |
Earnings per share - basic | | $ | 0.84 | | | $ | 0.83 | |
Weighted average shares - basic | | | 16,918 | | | | 17,956 | |
Earnings per share - diluted | | $ | 0.83 | | | $ | 0.83 | |
Weighted average shares - diluted | | | 16,963 | | | | 18,024 | |
See accompanying Notes to Consolidated Financial Statements.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Consolidated Statements of Comprehensive Income
For the years ended December 31, 2020 and 2019
(Amounts in thousands) | | 2020 | | | 2019 | |
Net income | | $ | 14,164 | | | $ | 14,961 | |
| | | | | | | | | |
Available-for-sale securities: | | | | | | | | |
Change in unrealized gain arising during the period | | | 7,420 | | | | 8,149 | |
Income taxes | | | (2,193 | ) | | | (2,409 | ) |
Change in unrealized gain, net of tax | | | 5,227 | | | | 5,740 | |
| | | | | | | | | |
Reclassification adjustment for realized gains included in net income | | | (482 | ) | | | (186 | ) |
Income taxes | | | 142 | | | | 55 | |
Realized gains, net of tax | | | (340 | ) | | | (131 | ) |
| | | | | | | | | |
Net change in unrealized gains on available-for-sale securities | | | 4,887 | | | | 5,609 | |
| | | | | | | | | |
Other comprehensive income | | | 4,887 | | | | 5,609 | |
Comprehensive income – Bank of Commerce Holdings | | $ | 19,051 | | | $ | 20,570 | |
See accompanying Notes to Consolidated Financial Statements.
77
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Consolidated Statements of Shareholders’ Equity
For the years ended December 31, 2020 and 2019
| | | | | | | | | | | | | | | Accumulated Other | | | | | |
| | | | | | | Common | | | | | | | Comprehensive | | | | | |
| | | Common | | | Stock | | | Retained | | | Income (Loss) | | | | | |
(Amounts in thousands except per share information) | | Shares | | | Amount | | | Earnings | | | Net of Tax | | | Total | |
Balance at December 31, 2018 | | | 16,334 | | | $ | 52,284 | | | $ | 89,045 | | | $ | (3,008 | ) | | $ | 138,321 | |
| | | | | | | | | | | | | | | | | | | | | |
2019 | | | | | | | | | | | | | | | | | | | | |
Net income | | | — | | | | 0 | | | | 14,961 | | | | 0 | | | | 14,961 | |
Other comprehensive income, net of tax | | | — | | | | 0 | | | | 0 | | | | 5,609 | | | | 5,609 | |
Comprehensive income | | | — | | | | 0 | | | | 0 | | | | 0 | | | | 20,570 | |
Dividends declared on common stock ($0.19 per share) | | | — | | | | 0 | | | | (3,440 | ) | | | — | | | | (3,440 | ) |
Stock issued for Merchants acquisition | | | 1,834 | | | | 19,607 | | | | 0 | | | | 0 | | | | 19,607 | |
Repurchase of common stock | | | (91 | ) | | | (1,010 | ) | | | 0 | | | | 0 | | | | (1,010 | ) |
Stock compensation grants | | | 6 | | | | 58 | | | | 0 | | | | 0 | | | | 58 | |
Restricted stock granted, net of forfeitures | | | 51 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
Stock options exercised | | | 11 | | | | 52 | | | | 0 | | | | 0 | | | | 52 | |
Shares surrendered for tax-withholding purposes | | | (8 | ) | | | (94 | ) | | | 0 | | | | 0 | | | | (94 | ) |
Compensation expense associated with restricted stock | | | — | | | | 414 | | | | 0 | | | | 0 | | | | 414 | |
Balance at December 31, 2019 | | | 18,137 | | | $ | 71,311 | | | $ | 100,566 | | | $ | 2,601 | | | | 174,478 | |
| | | | | | | | | | | | | | | | | | | | | |
2020 | | | | | | | | | | | | | | | | | | | | |
Net income | | | — | | | | 0 | | | | 14,164 | | | | 0 | | | | 14,164 | |
Other comprehensive income, net of tax | | | — | | | | 0 | | | | 0 | | | | 4,887 | | | | 4,887 | |
Comprehensive income | | | — | | | | 0 | | | | 0 | | | | 0 | | | | 19,051 | |
Dividends declared on common stock ($0.21 per share) | | | — | | | | 0 | | | | (3,504 | ) | | | 0 | | | | (3,504 | ) |
Repurchase of common stock | | | (1,409 | ) | | | (12,653 | ) | | | 0 | | | | 0 | | | | (12,653 | ) |
Restricted stock granted, net of forfeitures | | | 85 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
Shares surrendered for tax-withholding purposes | | | (12 | ) | | | (129 | ) | | | 0 | | | | 0 | | | | (129 | ) |
Compensation expense associated with restricted stock | | | — | | | | 459 | | | | 0 | | | | 0 | | | | 459 | |
Balance at December 31, 2020 | | | 16,801 | | | $ | 58,988 | | | $ | 111,226 | | | $ | 7,488 | | | $ | 177,702 | |
See accompanying Notes to Consolidated Financial Statements.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Consolidated Statements of Cash Flows
For the years ended December 31, 2020 and 2019
(Amounts in thousands) | | 2020 | | | 2019 | |
Cash flows from operating activities: | | | | | | | | |
Net income | | $ | 14,164 | | | $ | 14,961 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | |
Provision for loan and lease losses | | | 5,250 | | | | 0 | |
Provision for unfunded commitments | | | 105 | | | | 0 | |
Provision for depreciation and amortization | | | 1,239 | | | | 1,367 | |
Amortization of core deposit intangibles | | | 766 | | | | 720 | |
Amortization of debt issuance costs | | | 43 | | | | 48 | |
Compensation expense associated with restricted stock | | | 459 | | | | 414 | |
Tax benefits from vesting of restricted stock | | | 0 | | | | (9 | ) |
Net gain on sale or call of securities | | | (482 | ) | | | (186 | ) |
Amortization of premiums and accretion of discounts on investments, net | | | 1,536 | | | | 1,477 | |
Amortization of premiums and accretion of discounts on acquired loans, net | | | (1,374 | ) | | | (1,598 | ) |
Loss on disposal of fixed assets | | | 132 | | | | 0 | |
Loss (gain) on sale of OREO | | | 23 | | | | (62 | ) |
Increase in cash surrender value of life insurance | | | (521 | ) | | | (536 | ) |
Deferred compensation and salary continuation plan payments | | | (811 | ) | | | (1,507 | ) |
Increase in deferred compensation and salary continuation plans | | | 840 | | | | 1,853 | |
Net increase (decrease) in deferred loan fees and costs | | | 1,932 | | | | (235 | ) |
(Increase) decrease in deferred income taxes | | | (1,452 | ) | | | 154 | |
(Increase) decrease in other assets | | | (260 | ) | | | 1,079 | |
Increase (decrease) in other liabilities | | | 1,184 | | | | (1,292 | ) |
Net cash provided by operating activities | | | 22,773 | | | | 16,648 | |
| | | | | | | | | |
Cash flows from investing activities: | | | | | | | | |
Proceeds from maturities of and payments on available-for-sale securities | | | 88,464 | | | | 64,183 | |
Proceeds from sale of available-for-sale securities | | | 56,017 | | | | 117,299 | |
Purchases of available-for-sale securities | | | (298,119 | ) | | | (97,741 | ) |
Investment in LIHTC partnerships | | | (19 | ) | | | (6 | ) |
Net purchase of FHLB stock | | | 0 | | | | (34 | ) |
Loan originations, net of principal repayments | | | (126,974 | ) | | | (32,707 | ) |
Net repayment on loan pools | | | 20,941 | | | | 32,796 | |
Purchase of premises and equipment | | | (1,133 | ) | | | (1,958 | ) |
Proceeds from the sale of OREO | | | 12 | | | | 132 | |
Acquisition of Merchants Holding Company, net of cash paid | | | 0 | | | | (2,875 | ) |
Net cash (used) provided by investing activities | | | (260,811 | ) | | | 79,089 | |
| | | | | | | | | |
Cash flows from financing activities: | | | | | | | | |
Net increase (decrease) in demand, money market and savings deposits | | $ | 291,715 | | | $ | (16,162 | ) |
Net decrease in certificates of deposit | | | (16,107 | ) | | | (38,599 | ) |
Advances on term debt | | | 50,160 | | | | 180,160 | |
Repayment of term debt | | | (45,160 | ) | | | (183,656 | ) |
Proceeds from stock options exercised | | | 0 | | | | 52 | |
Repurchase of common stock | | | (12,653 | ) | | | (1,010 | ) |
Cash paid for shares surrendered for tax-withholding purposes | | | (129 | ) | | | (94 | ) |
Cash dividends paid on common stock | | | (3,406 | ) | | | (3,189 | ) |
Net cash provided (used) by financing activities | | | 264,420 | | | | (62,498 | ) |
Net increase cash and cash equivalents | | | 26,382 | | | | 33,239 | |
Cash and cash equivalents at the beginning of year | | | 80,604 | | | | 47,365 | |
Cash and cash equivalents at the end of year | | $ | 106,986 | | | $ | 80,604 | |
See accompanying Notes to Consolidated Financial Statements.
79
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)
(Amounts in thousands) | | 2020 | | | 2019 | |
Supplemental disclosures of cash flow activity: | | | | | | | | |
Cash paid during the period for: | | | | | | | | |
Income taxes | | $ | 3,967 | | | $ | 6,007 | |
Interest | | $ | 4,663 | | | $ | 6,029 | |
Operating leases | | $ | 950 | | | $ | 897 | |
Supplemental disclosures of non-cash investing activities: | | | | | | | | |
Transfer of loans to other real estate owned | | $ | 8 | | | $ | 74 | |
Investment in LIHTC partnerships | | $ | 1,000 | | | $ | 0 | |
| | | | | | | | | |
Unrealized gain on investment securities available-for-sale, net of gains included in net income | | $ | 6,938 | | | $ | 7,963 | |
Changes in net deferred tax asset related to changes in unrealized gain on investment securities available-for-sale | | | (2,051 | ) | | | (2,354 | ) |
Changes in accumulated other comprehensive income due to net unrealized gain on investment securities available-for-sale | | $ | 4,887 | | | $ | 5,609 | |
| | | | | | | | | |
Supplemental disclosures of non-cash financing activities: | | | | | | | | |
Stock compensation grants | | $ | 0 | | | $ | 58 | |
Cash dividend declared on common stock and payable after period-end | | $ | 1,000 | | | $ | 902 | |
Disclosures related to the acquisition of Merchants Holding Company: | | | | | | | | |
Consideration paid | | $ | 0 | | | $ | 34,907 | |
Assets acquired - fair value | | $ | 0 | | | $ | 215,055 | |
Goodwill | | $ | 0 | | | $ | 11,006 | |
Liabilities assumed - fair value | | $ | 0 | | | $ | 191,154 | |
See accompanying Notes to Consolidated Financial Statements.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Notes to Consolidated Financial Statements
NOTE 1. THE BUSINESS OF THE COMPANY
Bank of Commerce Holdings (“Company,” “Holding Company,” “we,” or “us”), is a corporation organized under the laws of California and a bank holding company (“BHC”) registered under the Bank Holding Company Act of 1956, as amended (“BHC Act”) with its principal offices in Sacramento, California. The Holding Company’s principal business is to serve as a holding company for Merchants Bank of Commerce (the “Bank” and together with the Holding Company, the “Company”) and for Bank of Commerce Mortgage (inactive). The Bank, which previously operated under three separate names, changed its name for all operations to Merchants Bank of Commerce effective May 20, 2019. The Company has an unconsolidated subsidiary in Bank of Commerce Holdings Trust II. The Bank is principally supervised and regulated by the California Department of Financial Protection and Innovation (“CDFPI”) and the Federal Deposit Insurance Corporation (“FDIC”). Substantially all of the Company’s activities are carried out through the Bank. The Bank was incorporated as a California banking corporation on November 25, 1981 and opened for business on October 22, 1982.
We operate 10 full service offices, one limited service office and one loan production office and consider northern California to be our major market. We also operate a “cyber office” as identified in our summary of deposits reporting filed with the FDIC. The services offered by the Bank include those traditionally offered by banks of similar size and character in California. Our principal deposit products include the following types of accounts; checking, interest-bearing checking, savings, money market deposits and certificates of deposit. We also offer sweep arrangements, commercial loans, construction loans, consumer loans, safe deposit boxes, collection services and electronic banking services. The primary focus of the Bank is to provide banking services to the communities in our major market area, including Small Business Administration loans and payroll processing. The Bank does not offer trust services or international banking services. Our customers are mostly small to medium sized businesses and retail customers.
On December 1, 2020, we opened a Loan Production Office (“LPO”) in Santa Rosa, California, to extend our presence into San Francisco’s North Bay markets.
On January 31, 2019, we completed the acquisition of Merchants Holding Company, to extend our presence in the Sacramento marketplace. Merchants Holding Company, headquartered in Sacramento, California, was the parent company of The Merchants National Bank of Sacramento (“Merchants National Bank of Sacramento”), a 97-year-old bank with approximately $211.7 million in assets as of January 31, 2019. Merchants National Bank of Sacramento operated 1 full service branch and one limited service branch in the Sacramento metropolitan area. See Note 21 Acquisition in these Notes to Consolidated Financial Statements for additional information on the acquisition.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Application of new accounting guidance
ASU No. 2018-13
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this ASU remove, modify, and add disclosure requirements for the fair value reporting of assets and liabilities. The modifications and additions relate to Level 3 fair value measurements at the end of the reporting period. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. We adopted the requirements of this ASU on January 1, 2020 and added disclosure about significant observable inputs used to develop Level 3 fair value measurements prospectively. As the ASU’s requirements only relate to disclosures, the amendments will not impact our financial condition or results of operations.
ASU No. 2017-04
In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The amendment simplifies how an entity is required to test goodwill for impairment and eliminated Step 2 from the goodwill impairment test. We adopted the new standard on January 1, 2020, with no material impact on our financial statements.
Coronavirus Aid, Relief, and Economic Security Act
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted in response to the Coronavirus Disease 2019 (COVID-19) pandemic. The CARES Act provides optional temporary relief from troubled debt restructuring and impairment accounting requirements for loan modifications related to the COVID-19 pandemic. Banking regulators issued similar guidance, which also clarified that a COVID-19-related modification should not be considered a TDR if the borrower was current on payments at the time the underlying loan modification program was implemented and if the modification was considered to be short-term.
We have responded to the needs of our borrowers in accordance with the CARES Act and regulatory guidance to grant short-term COVID-19 related loan modifications. These modified loans are not troubled debt restructurings and are not considered to be past due or non-performing. We have granted payment deferrals ranging from one to six months determined on a case-by-case basis considering the nature of the business and the impact of COVID-19. Some borrowers on a case by case basis have been granted multiple payment deferrals but the deferrals in total are limited to no more than six months.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Recent Accounting Pronouncement
ASU No. 2016-13
Description - In June of 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments are intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates.
Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. The ASU requires enhanced disclosures to help investors and other financial statement users to better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. In addition, the ASU amends the accounting guidance for credit losses on securities and purchased financial assets with credit deterioration.
Methods and timing of adoption – The FASB has voted to delay until January 2023 the implementation of the ASU No. 2016-13 for smaller reporting companies as defined by the SEC. We qualify as a smaller reporting company and in light of this delay, we have postponed the implementation of the ASU and have not determined when it will be implemented or the financial impact.
ASU No. 2020-04
Description – In March of 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The guidance provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference London Inter-Bank Offered Rate ("LIBOR") or another reference rate expected to be discontinued. The last expedient is a one-time election to sell or transfer debt securities classified as held to maturity. The expedients are in effect from March 12, 2020, through December 31, 2022. We have formed a committee to evaluate the impact of the LIBOR transition and this ASU on the Company's consolidated financial statements and to facilitate the transition.
Basis of Financial Statement Presentation
The Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and with prevailing practices within the banking and securities industries. In preparing such financial statements, management is required to make certain estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the balance sheet and the reported amounts of revenues and expenses for the reporting periods. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change relate to the valuation of investments and impairments of securities, the determination of the allowance for loan and lease losses (“ALLL”), income taxes, the valuation of other real estate owned (“OREO”), and fair value measurements. Certain amounts for prior periods have been reclassified to conform to the current financial statement presentation. The results of reclassifications are not considered material and have no effect on previously reported equity or net income.
Principles of Consolidation
The accompanying Consolidated Financial Statements include the accounts of the Holding Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. As of December 31, 2020 and 2019, the Company had one wholly-owned trust formed in 2005 to issue trust preferred securities and related common securities. We have not consolidated the accounts of the Trust in our Consolidated Financial Statements in accordance with Financial Accounting Standards Board Accounting Standards Codification (“FASB”) ASC 810, Consolidation (“ASC 810”). We are not considered the primary beneficiary of the Trust (variable interest entity). As a result, the junior subordinated debentures issued by the Holding Company to the Trust are reflected on the Company’s Consolidated Balance Sheets.
Subsequent Events
We have evaluated events and transactions subsequent to December 31, 2020 for potential recognition or disclosure.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include amounts due from correspondent banks including interest-bearing deposits in correspondent banks and the Federal Reserve Bank.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Investment Securities
Securities are classified as held-to-maturity if we have both the intent and ability to hold those securities to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted for amortization of premium and accretion of discount, computed by the effective interest method over their contractual lives. Unrealized holding gains or losses are excluded from other comprehensive income (loss). Realized gains or losses, determined on the basis of the cost of specific securities sold or called, are included in earnings. Dividend and interest income are recognized when earned.
Securities are classified as available-for-sale if we intend and have the ability to hold those securities for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available-for-sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Securities available-for-sale are carried at fair value. Unrealized holding gains or losses are included in other comprehensive income (loss) as a separate component of shareholders’ equity, net of tax. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings. Premiums and discounts are amortized or accreted over the estimated life of the related investment security as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned.
Transfers of securities from available-for-sale to held-to-maturity are accounted for at fair value as of the date of the transfer. The difference between the fair value and the amortized cost at the date of transfer is considered a premium or discount and is accounted for accordingly. Any unrealized gain or loss at the date of the transfer is reported in other comprehensive income (loss), and is amortized over the estimated remaining life of the security as an adjustment of yield in a manner consistent with the amortization of any premium or discount, and will offset or mitigate the effect on interest income of the amortization of the premium or discount for that held-to-maturity security. Transfers of securities from held-to-maturity to available-for-sale to are accounted for at fair value at the date of the reclassification. Any remaining unamortized fair value adjustments are reclassified from other comprehensive income (loss) and the unrealized holding gain (loss) at the date of transfer is recorded in other comprehensive income net of tax.
We review investment securities on an ongoing basis for the presence of other-than-temporary impairment or permanent impairment, taking into consideration current market conditions, fair value in relationship to cost, extent and nature of the change in fair value, issuer rating changes and trends, whether we intend to sell a security or if it is more likely than not that we will be required to sell the security before recovery of our amortized cost basis of the investment, which may be maturity, and other factors. For debt securities, if we intend to sell the security or it is more likely than not we will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an other-than-temporary impairment. If we do not intend to sell the security and it is more likely than not we will not be required to sell the security but we do not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential other-than-temporary impairment. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income (loss). Impairment losses related to all other factors are presented as separate categories within other comprehensive income (loss). For investment securities held-to-maturity, this amount is accreted over the remaining life of the debt security prospectively based on the amount and timing of future estimated cash flows. The accretion of the other-than-temporary impairment amount recorded in other comprehensive income (loss) will increase the carrying value of the investment, and would not affect earnings. If there is an indication of additional credit losses the security is re-evaluated according to the procedures described above.
Loans
Loans are stated at the principal amounts outstanding, net of deferred loan fees, deferred loan costs, and the ALLL. Interest on loans is accrued daily based on the principal outstanding. Loan origination and commitment fees and certain origination costs are deferred and the net amount is amortized or accreted over the contractual life of the loans as an adjustment of their yield.
A loan is impaired when, based on current information and events, management believes it is probable that we will not be able to collect all amounts due according to the loan contract. Impairment is measured based upon the present value of expected future cash flows discounted at the loan’s effective rate, the loan’s observable market price, or the fair value of collateral if the loan is collateral dependent. Interest on impaired loans is recognized on a cash basis, and only when the principal is not considered impaired. The Chief Credit Officer reviews and approves loans recommended for impaired status or their removal from impaired status.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Our practice is to place an asset in nonaccrual status when one of the following events occurs: (1) any installment of principal or interest is 90 days or more past due (unless in management’s opinion the loan is well-secured and in the process of collection), (2) management determines the ultimate collection of the original principal or interest to be unlikely or, (3) the terms of the loan have been renegotiated due to a serious weakening of the borrower’s financial condition. Accruals are resumed on loans only when they are brought fully current with respect to interest and principal and when the loan is estimated to be fully collectible. One exception to the 90 days past due policy for nonaccruals is our purchased pool of home equity loans and purchased consumer loans. For these specific loan pools, we will charge-off any loans that are more than 90 days past due. We believe that at the time these loans become 90 days past due, it is likely that we will not collect the remaining principal balance on the loan. In accordance with this policy, we do not expect to classify any of the loans from these pools as nonaccrual.
Nonperforming loans are loans which may be on nonaccrual, 90 days past due and still accruing, or have been restructured.
Restructured loans are those loans where concessions in terms have been granted because of the borrower’s financial or legal difficulties. Interest is generally accrued on such loans in accordance with the new terms, after a period of sustained performance by the borrower.
Financial institution regulators and the CARES Act have changed the treatment of short-term loan modifications for borrowers impacted by COVID-19. The change provides that modifications made in response to COVID-19, to borrowers under certain circumstances, should not be considered a troubled debt restructuring.
Purchased Loans
Purchased loans are recorded at their fair value at the acquisition date. Credit discounts are included in the determination of fair value; therefore, an ALLL is not recorded at the acquisition date.
Allowance for Loan and Lease Losses
The adequacy of the ALLL is monitored on a regular basis and is based on management’s evaluation of numerous factors. These factors include the quality of the current loan portfolio; the trend in the loan portfolio’s risk ratings; current economic conditions; loan concentrations; loan growth rates; past-due and non-performing trends; evaluation of specific loss estimates for all impaired loans; historical charge-off and recovery experience; and other pertinent information.
We perform regular credit reviews of the loan portfolio to determine the credit quality of the portfolio and the adherence to underwriting standards. When loans are originated, they are assigned a risk rating that is reassessed periodically during the term of the loan through the credit review process. Our risk rating methodology assigns risk ratings ranging from 1 to 8, where a higher rating represents higher risk. The 8 risk rating categories are a primary factor in determining an appropriate amount for the ALLL. Our Chief Credit Officer is responsible for regularly reviewing the ALLL methodology, including loss factors, and ensuring that it is designed and applied in accordance with generally accepted accounting principles. The Board of Directors reviews and approves the adequacy of the ALLL quarterly.
We have divided the loan portfolio into sub-categories of similar type loans. Each category is assigned an historical loss factor and additional qualitative factors. The sub-categories are also further segmented by risk rating. Each risk rating is assigned an additional loss factor to account for the additional risk in those loans with higher risk levels.
Regular credit reviews of the portfolio also identify loans that are considered potentially impaired. Potentially impaired loans are referred to the Chief Credit Officer who reviews and approves designated loans as impaired. A loan is considered impaired when, based on current information and events, we determine that it is probable that we will not be able to collect all amounts due according to loan contract, including scheduled interest payments. When we identify a loan as impaired, we measure the impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of the collateral, less selling costs, instead of discounted cash flows. If we determine that the value of the impaired loan is less than the recorded investment in the loan when using the cash flow method, we recognize this impairment reserve as a specific component to be provided for in the ALLL. If the value of the impaired loan is less than the recorded investment in the loan when using the collateral dependent method, we charge-off the impaired balance. The combination of the risk rating-based allowance component and the impairment reserve allowance component leads to an allocated ALLL.
We may also maintain an unallocated allowance amount to provide for other credit losses inherent in a loan and lease portfolio that may not have been contemplated in the credit loss factors. This unallocated amount generally comprises 4% or less of the allowance, but may be maintained at higher levels during times of economic conditions characterized by unstable real estate values. The unallocated amount is reviewed quarterly based on trends in credit losses, the results of credit reviews and overall economic trends.
As adjustments to the ALLL become necessary, they are reported in earnings in the periods in which they become known as a charge or credit to the provision for loan and lease losses. Loans, or portions thereof, deemed uncollectible are charged to the ALLL. Recoveries on loans previously charged-off, are added to the ALLL.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
We believe that the ALLL was adequate as of December 31, 2020. There is, however, no assurance that future loan and lease losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses. In addition, bank regulatory authorities, as part of their periodic examination of the Company, may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review. Approximately 77% of our loan portfolio is secured by real estate, and a significant decline in real estate market values may require an increase in the ALLL.
Reserve for Unfunded Commitments
A reserve for unfunded commitments is maintained at a level that, in our opinion, is adequate to absorb probable losses associated with our commitment to lend funds under existing agreements such as letters or lines of credit. We determine the adequacy of the reserve for unfunded commitments based upon the category of loan, current economic conditions, the risk characteristics of the various categories of commitments and other relevant factors. The reserve is based on estimates, and ultimate losses may vary from the current estimates.
These estimates are evaluated on a regular basis and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. Draws on unfunded commitments that are considered uncollectible at the time funds are advanced are charged to the reserve for unfunded commitments. Provisions for unfunded commitment losses, and recoveries on loan and lease commitments previously charged off, are added to the reserve for unfunded commitments, which is included in the Other Liabilities line item of the Consolidated Balance Sheets. See Note 14, Commitments and Contingencies in these Notes to Consolidated Financial Statements for additional disclosures on the reserve for unfunded commitments.
Leases
We determine if an arrangement is a lease at inception. Operating leases are included in Other Assets and Other Liabilities in our Consolidated Balance Sheets. Operating lease right-of-use assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most of our leases do not provide an incremental borrowing rate, we use borrowing rates available under our existing line of credit with the FHLB for periods similar to the lease terms as our incremental borrowing rate to determine the present value of future lease payments. Our lease terms may include options to extend or terminate the lease which we recognize when it is reasonably certain that we will exercise that option. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.
Premises and Equipment
Premises and equipment are recorded at cost. Depreciation for equipment is provided over the estimated useful lives of the related assets, generally three to seven years, using the straight-line method for financial statement purposes. Depreciation for premises is provided over the estimated useful life up to 39 years, on a straight-line basis. We use other depreciation methods (generally accelerated depreciation methods) for tax purposes where appropriate. Amortization of leasehold improvements is computed using the straight-line method over the shorter of the remaining lease term or the estimated useful lives of the improvements. Repairs and maintenance are expensed as incurred. Expenditures that increase the value or productive capacity of assets are capitalized. When premises and equipment are retired, sold, or otherwise disposed of, the asset’s carrying amount and related accumulated depreciation are removed from the accounts and any gain or loss is recorded in other noninterest income or other noninterest expense in the Consolidated Statements of Income, respectively.
Goodwill and Other Intangibles
Intangible assets are comprised of goodwill and other intangibles acquired in business combinations. Goodwill and intangible assets with indefinite useful lives are not amortized. Intangible assets with definite useful lives are amortized to their estimated residual values over their respective estimated useful lives, and also reviewed for impairment. Amortization of intangible assets is included in non-interest expense in the Consolidated Statements of Income. We perform an impairment analysis on an annual basis for goodwill and other intangible assets. Additionally, we perform an impairment analysis on an interim basis when events or circumstances indicate impairment potentially exists.
Other Real Estate Owned (‘OREO”)
OREO represents real estate of which we have taken control in partial or full satisfaction of loans. At the time of foreclosure, OREO is recorded at fair value less costs to sell, plus costs for improvements that prepare the property for sale, which becomes the property’s new basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the ALLL. After foreclosure, management periodically performs valuations and the property is carried at the lower of the cost or fair value less expected selling costs. Subsequent valuation adjustments are recognized under the line item other expenses in the Consolidated Statements of Income. Revenue and expenses incurred from OREO property are recorded in noninterest income or noninterest expense, in the Consolidated Statements of Income, respectively.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Income Taxes
Income taxes reported in the Consolidated Financial Statements are computed based on an asset and liability approach. We recognize the amount of taxes payable or refundable for the current year, and deferred tax assets and liabilities for the expected future tax consequences. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We record net deferred tax assets to the extent it is more likely than not that they will be realized. In evaluating our ability to recover the deferred tax assets, management considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations.
In projecting future taxable income, management develops assumptions including the amount of future state and federal pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates being used to manage the underlying business. We file consolidated federal and combined state income tax returns.
We recognize the financial statement effect of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. For tax positions that meet the more likely than not threshold, we may recognize only the largest amount of tax benefit that is greater than fifty percent likely to be realized upon ultimate settlement with the taxing authority. We believe that all of our tax positions taken meet the more likely than not recognition threshold. To the extent tax authorities disagree with these tax positions, our effective tax rates could be materially affected in the period of settlement with the taxing authorities. Interest and penalties related to unrecognized tax benefits are recorded in other noninterest expense. See Note 19, Income Taxes in these Notes to Consolidated Financial Statements for more information on income taxes.
Revenue Recognition
Our primary sources of revenue are derived from interest and dividends earned on loans, investment securities, and other financial instruments that are not within the scope of Topic 606 (Revenue from Contracts with Customers). We have evaluated the nature of our contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary. For revenue sources that are within the scope of Topic 606, we fully satisfy our performance obligations and recognize revenue in the period it is earned as services are rendered. Transaction prices are typically fixed; charged on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with our customers.
All of our revenue from contracts with customers in the scope of ASC 606 is recognized in Non-Interest Income. Sources of revenue from contracts with customers that are in the scope of ASC 606 include the following:
| | ● | Service Charges on Deposit accounts - We earn monthly account fees and transaction-based fees from our customers for services rendered on deposit accounts. Fees charged to deposit accounts on a monthly basis are recognized as the performance obligation is satisfied at the end of the service period. |
| | ● | Transaction-based fees are based on specific services provided to our customer. The performance obligation is completed as the transaction occurs and the fees are recognized at the time each specific service is provided to the customer. |
| | ● | ATM and Point of Sale fees – We earn fees when debit cards we issued are used in transactions through card processing networks. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the cardholders’ account. The fees are recognized monthly. |
| | ● | Fees on Payroll and benefit processing – We earn fees by processing payroll and benefit payments for our business customers. The performance obligation is satisfied and the fees are recognized as each transaction is processed. |
Share Based Payments
We have one active stock-based compensation plan that provides for equity awards including stock, stock options, restricted stock units and restricted stock to eligible employees and directors. The Bank of Commerce Holdings 2019 Equity Incentive Plan, was approved by the Holding Company’s shareholders on May 21, 2019 and replaced the Amended and Restated 2010 Equity Incentive Plan.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
In accordance with FASB ASC 718, Stock Compensation, we recognize in the Consolidated Statements of Income the grant-date fair value of stock, stock options, restricted stock and other equity-based forms of compensation issued to employees over the employees’ requisite service period. We account for forfeitures as they occur.
The fair value of each option grant is estimated as of the grant date using the Black-Scholes option-pricing model using the following assumptions:
● | Volatility represents the historical volatility in the Holding Company’s common stock price, for a period consistent with the expected life of the option. |
● | Risk free rate was derived from the U.S. Treasury rate at the time of the grant, which coincides with the expected life of the option. |
● | Expected dividend yield is based on dividend trends and the market value of the Holding Company’s common stock at the time of grant. |
● | Annual dividend rate is the ratio of the expected annual dividends to the Holding Company’s common stock price on the grant date. |
● | Assumed forfeiture rate based on expected forfeiture rates. |
● | Expected life is estimated based on the history of the Holding Company’s stock option holders and expectations regarding future forfeitures giving consideration to the contractual terms and vesting schedules, and represents the period of time that options granted are expected to be outstanding. |
The fair value of stock grants and restricted stock grants are estimated as of the grant date using the fair value of the Company’s stock at the date of the grant.
Advertising Costs
For the years ended December 31, 2020 and 2019, advertising costs were $57 thousand and $160 thousand, respectively. Advertising costs are expensed as incurred.
Earnings per Share
Earnings per share is an important measure of our performance for investors and other users of financial statements. Certain of our securities, such as stock options or restricted stock, permit the holders to become common shareholders or add to the number of shares of common stock already held. Because there is potential reduction, called dilution, of earnings per share figures inherent in our capital structure, we are required to present a dual presentation of earnings per share - basic earnings per share and diluted earnings per share.
Basic earnings per share excludes dilution and is computed by dividing income by the weighted-average number of common shares outstanding for the period, excluding unvested restricted stock awards which do not have voting rights or share in dividends. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Holding Company. The computation of diluted earnings per share does not assume conversion, exercise, or contingent issuance of securities that would have an anti-dilutive effect on earnings per share.
We present both basic and diluted earnings per share on the face of the Consolidated Statements of Income. In addition, a detailed presentation of the earnings per share calculation is provided in Note 22, Earnings Per Common Share in these Notes to Consolidated Financial Statements.
Fair Value Measurements
FASB ASC 820, Fair Value Measurements and Disclosures, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FASB ASC 820 establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect our estimates about market data. In general, fair values determined by Level 1 inputs utilize quoted prices for identical assets or liabilities traded in active markets that we have the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Operating Segments
Public enterprises are required to report certain information about their operating segments in a complete set of financial statements to shareholders. They are also required to report certain enterprise-wide information about their products and services, their activities in different geographic areas, and their reliance on major customers. The basis for determining operating segments is the manner in which management operates the business. As of December 31, 2020, we operated under one primary business segment: Community Banking.
Business Combinations
We record acquisitions of businesses using the acquisition method of accounting. Under the acquisition method, assets acquired and liabilities assumed are recorded at their estimated fair values at the date of acquisition. Management utilizes various valuation techniques and third party evaluations to determine these fair values. Any excess of the purchase price over amounts allocated to the acquired assets including identifiable intangible assets and liabilities assumed is recorded as goodwill.
NOTE 3. RESTRICTIONS ON CASH AND DUE FROM BANKS
We have a Fed Funds line of credit with one correspondent bank which requires us to hold compensating cash balances of $450 thousand. We maintained the required compensating balance of $450 thousand throughout 2020 and 2019.
As of March 26, 2020, the Federal Reserve Board eliminated reserve requirements for all depository institutions. The cash reserve required as of December 31, 2019 was $1.8 million, which was satisfied by vault cash balances.
NOTE 4. SECURITIES
The following table presents the amortized costs, unrealized gains, unrealized losses and estimated fair values of our investment securities as of December 31, 2020, and December 31, 2019.
| | | As of December 31, 2020 | |
| | | | | | | Gross | | | Gross | | | | | |
| | | Amortized | | | Unrealized | | | Unrealized | | | Estimated | |
(Amounts in thousands) | | Costs | | | Gains | | | Losses | | | Fair Value | |
Available-for-sale securities: | | | | | | | | | | | | | | | | |
U.S. government & agencies | | $ | 32,164 | | | $ | 838 | | | $ | (8 | ) | | $ | 32,994 | |
Obligations of state and political subdivisions | | | 103,424 | | | | 4,971 | | | | (29 | ) | | | 108,366 | |
Residential mortgage-backed securities and collateralized mortgage obligations | | | 236,829 | | | | 3,895 | | | | (246 | ) | | | 240,478 | |
Commercial mortgage-backed securities | | | 27,455 | | | | 637 | | | | (18 | ) | | | 28,074 | |
Other asset-backed securities | | | 36,377 | | | | 592 | | | | (1 | ) | | | 36,968 | |
Total | | $ | 436,249 | | | $ | 10,933 | | | $ | (302 | ) | | $ | 446,880 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
| | | As of December 31, 2019 | |
| | | | | | | Gross | | | Gross | | | | | |
| | | Amortized | | | Unrealized | | | Unrealized | | | Estimated | |
(Amounts in thousands) | | Costs | | | Gains | | | Losses | | | Fair Value | |
Available-for-sale securities: | | | | | | | | | | | | | | | | |
U.S. government & agencies | | $ | 38,291 | | | $ | 469 | | | $ | (27 | ) | | $ | 38,733 | |
Obligations of state and political subdivisions | | | 40,702 | | | | 1,422 | | | | (26 | ) | | | 42,098 | |
Residential mortgage-backed securities and collateralized mortgage obligations | | | 179,114 | | | | 2,163 | | | | (442 | ) | | | 180,835 | |
Corporate securities | | | 3,005 | | | | 6 | | | | (45 | ) | | | 2,966 | |
Commercial mortgage-backed securities | | | 19,126 | | | | 221 | | | | (40 | ) | | | 19,307 | |
Other asset-backed securities | | | 3,019 | | | | 0 | | | | (8 | ) | | | 3,011 | |
Total | | $ | 283,257 | | | $ | 4,281 | | | $ | (588 | ) | | $ | 286,950 | |
The following table presents the contractual maturities of investment securities at December 31, 2020. Expected maturities may differ from contractual maturities if the issuers of the securities have the right to call or prepay obligations with or without call or prepayment penalties.
| | | Available-For-Sale | |
(Amounts in thousands) | | Amortized Cost | | | Fair Value | |
Amounts maturing in: | | | | | | | | |
One year or less | | $ | 18,591 | | | $ | 18,892 | |
After one year through five years | | | 104,009 | | | | 107,911 | |
After five years through ten years | | | 127,924 | | | | 129,469 | |
After ten years | | | 185,725 | | | | 190,608 | |
Total | | $ | 436,249 | | | $ | 446,880 | |
The amortized costs and fair values of residential mortgage-backed securities, collateralized mortgage obligations and commercial mortgage securities are presented by their expected average life, rather than contractual maturity, because the underlying loans may be repaid without prepayment penalties.
At December 31, 2020 and 2019, securities with a fair value of $67.8 million and $81.4 million, respectively, were pledged as collateral to secure public fund deposits, FHLB borrowings and for other purposes as required by law.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
The following table presents the cash proceeds from sales of investment securities and the associated gross realized gains and gross realized losses that have been included in earnings for the years ended December 31, 2020 and 2019.
| | | For Years Ended December 31, | |
(Amounts in thousands) | | 2020 | | | 2019 | |
Investment Securities: | | | | | | | | |
Proceeds from sales of investment securities | | $ | 56,017 | | | $ | 117,299 | |
| | | | | | | | | |
Gross realized gains on sales of investments securities: | | | | | | | | |
U.S. government & agencies | | $ | 0 | | | $ | 49 | |
Obligations of state and political subdivisions | | | 339 | | | | 482 | |
Residential mortgage-backed securities and collateralized mortgage obligations | | | 226 | | | | 108 | |
Corporate securities | | | 12 | | | | 0 | |
Commercial mortgage-backed securities | | | 38 | | | | 34 | |
Total gross realized gains on sales of investment securities | | | 615 | | | | 673 | |
| | | | | | | | | |
Gross realized losses on sales of investment securities | | | | | | | | |
U.S. government & agencies | | | (14 | ) | | | (16 | ) |
Obligations of state and political subdivisions | | | (7 | ) | | | (95 | ) |
Residential mortgage-backed securities and collateralized mortgage obligations | | | (112 | ) | | | (321 | ) |
Commercial mortgage-backed securities | | | 0 | | | | (54 | ) |
Other asset-backed securities | | | 0 | | | | (1 | ) |
Total gross realized losses on sales of investment securities | | | (133 | ) | | | (487 | ) |
Gains on sales of investment securities, net | | $ | 482 | | | $ | 186 | |
Investment securities that were in an unrealized loss position as of December 31, 2020 and December 31, 2019 are presented in the following tables, based on the length of time individual securities have been in an unrealized loss position.
| | | As of December 31, 2020 | |
| | | Less Than 12 Months | | | 12 Months or More | | | Total | |
| | | Fair | | | Unrealized | | | Fair | | | Unrealized | | | Fair | | | Unrealized | |
(Amounts in thousands) | | Value | | | Losses | | | Value | | | Losses | | | Value | | | Losses | |
Available-for-sale securities: | | | | | | | | | | | | | | | | | | | | | | | | |
U.S. government & agencies | | $ | 0 | | | $ | 0 | | | $ | 1,615 | | | $ | (8 | ) | | $ | 1,615 | | | $ | (8 | ) |
Obligations of state and political subdivisions | | | 7,921 | | | | (29 | ) | | | 0 | | | | 0 | | | | 7,921 | | | | (29 | ) |
Residential mortgage-backed securities and collateralized mortgage obligations | | | 68,512 | | | | (241 | ) | | | 249 | | | | (5 | ) | | | 68,761 | | | | (246 | ) |
Commercial mortgage-backed securities | | | 5,400 | | | | (18 | ) | | | 0 | | | | 0 | | | | 5,400 | | | | (18 | ) |
Other asset-backed securities | | | 2,106 | | | | 0 | | | | 930 | | | | (1 | ) | | | 3,036 | | | | (1 | ) |
Total temporarily impaired securities | | $ | 83,939 | | | $ | (288 | ) | | $ | 2,794 | | | $ | (14 | ) | | $ | 86,733 | | | $ | (302 | ) |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
| | | As of December 31, 2019 | |
| | | Less Than 12 Months | | | 12 Months or More | | | Total | |
| | | Fair | | | Unrealized | | | Fair | | | Unrealized | | | Fair | | | Unrealized | |
(Amounts in thousands) | | Value | | | Losses | | | Value | | | Losses | | | Value | | | Losses | |
Available-for-sale securities: | | | | | | | | | | | | | | | | | | | | | | | | |
U.S. government & agencies | | $ | 6,473 | | | $ | (25 | ) | | $ | 380 | | | $ | (2 | ) | | $ | 6,854 | | | $ | (27 | ) |
Obligations of state and political subdivisions | | | 2,249 | | | | (26 | ) | | | 0 | | | | 0 | | | | 2,249 | | | | (26 | ) |
Residential mortgage-backed securities and collateralized mortgage obligations | | | 31,817 | | | | (206 | ) | | | 22,166 | | | | (235 | ) | | | 53,982 | | | | (442 | ) |
Corporate securities | | | 0 | | | | 0 | | | | 955 | | | | (45 | ) | | | 955 | | | | (45 | ) |
Commercial mortgage-backed securities | | | 1,464 | | | | (1 | ) | | | 4,549 | | | | (39 | ) | | | 6,013 | | | | (40 | ) |
Other asset-backed securities | | | 3,011 | | | | (8 | ) | | | 0 | | | | 0 | | | | 3,011 | | | | (8 | ) |
Total temporarily impaired securities | | $ | 45,014 | | | $ | (266 | ) | | $ | 28,050 | | | $ | (321 | ) | | $ | 73,064 | | | $ | (588 | ) |
At December 31, 2020 and December 31, 2019, the number of securities in an unrealized loss position was 47 and 63, respectively. In the opinion of management, these securities are considered only temporarily impaired due to changes in market interest rates or widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral. Our investment policy requires securities at the time of purchase to be rated A3/A- or higher by Moody’s, S&P and Fitch rating agencies. Management monitors the published credit ratings of our investment portfolio for material rating or outlook changes. For all private-label securities collateralized by mortgages, management also monitors the credit characteristics of the underlying mortgages to identify potential credit losses, if any, in the portfolio. Because the decline in fair value is not due to credit quality concerns, and because we have no plans to sell the securities before the recovery of their amortized cost, and because the Bank has the ability to hold the securities to maturity these investments are not considered other-than-temporarily impaired.
The following table presents the characteristics of our securities that are in unrealized loss positions at December 31, 2020 and December 31, 2019.
| | | Characteristics of securities in unrealized loss positions at |
Available-for-sale securities: | | December 31, 2020 and December 31, 2019 |
U.S. government & agencies | | Direct obligations of the U.S. government or obligations guaranteed by U.S. government agencies such as the SBA. |
Obligations of state and political subdivisions | | General obligation issuances or revenue securities issued by municipalities and political subdivisions located within the U.S. secured by revenues from specific sources. |
Residential mortgage-backed securities and collateralized mortgage obligations | | Obligations issued by U.S. government sponsored entities or non-governmental entities collateralized by high quality mortgages on residential properties. Issuances by non-governmental entities usually include good credit enhancements. Of the residential mortgage-backed securities and collateralized mortgage obligations that we owned at December 31, 2020 and December 31, 2019, 86% and 79%, respectively, were issued or guaranteed by U.S. government sponsored entities. |
Corporate securities | | Debt obligations generally issued or guaranteed by large U.S. corporate institutions. |
Commercial mortgage-backed securities | | Obligations issued by U.S. government sponsored entities or non-governmental entities collateralized by high quality mortgages on commercial properties. Issuances by non-governmental entities usually include good credit enhancements. Of the commercial mortgage-backed securities that we owned at December 31, 2020 and December 31, 2019, 100% were issued or guaranteed by U.S. government sponsored entities. |
Other asset-backed securities | | Obligations issued by non-governmental issuers secured by high quality loans with good credit enhancements. |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 5. LOANS
Outstanding loan balances consist of the following at December 31, 2020, and December 31, 2019.
| | | As of December 31 | |
(Amounts in thousands) | | 2020 | | | 2019 | |
Loan Portfolio: | | | | | | | | |
Commercial | | $ | 115,559 | | | $ | 141,197 | |
Paycheck Protection Program ("PPP") | | | 130,814 | | | | 0 | |
Commercial real estate: | | | | | | | | |
Construction and land development | | | 44,549 | | | | 26,830 | |
Non-owner occupied | | | 512,832 | | | | 493,920 | |
Owner occupied | | | 210,155 | | | | 218,833 | |
Residential real estate: | | | | | | | | |
Individual Tax Identification Number ("ITIN") | | | 29,035 | | | | 33,039 | |
1-4 family mortgage | | | 55,925 | | | | 63,661 | |
Equity lines | | | 18,894 | | | | 22,099 | |
Consumer and other | | | 21,969 | | | | 33,324 | |
Gross loans | | | 1,139,732 | | | | 1,032,903 | |
Deferred fees and costs | | | 229 | | | | 2,162 | |
Loans, net of deferred fees and costs | | | 1,139,961 | | | | 1,035,065 | |
Allowance for loan and lease losses | | | (16,910 | ) | | | (12,231 | ) |
Net loans | | $ | 1,123,051 | | | $ | 1,022,834 | |
Gross loan balances in the table above include discounts on purchased loans and adjustments made to fair value loans using the acquisition method of accounting.
Discounts on purchased loans - Gross loan balances include net purchase discounts of $879 thousand and $1.5 million as of December 31, 2020, and December 31, 2019, respectively. When we purchase loans, they are typically purchased at a discount to enhance yield and compensate for credit risk. We have no purchased credit impaired loans as of December 31, 2020, and December 31, 2019.
Fair value adjustment - Gross loan balances include a net fair value discount of $920 thousand and $1.7 million at December 31, 2020 and December 31, 2019, respectively for loans acquired in conjunction with our acquisition of Merchants National Bank of Sacramento during the first quarter of 2019. We recorded $753 thousand and $260 thousand in accretion of the net discount for these loans during the year ended December 31, 2020 and December 31, 2019, respectively.
Pledged Loans
Certain loans are pledged as collateral for lines of credit with the FHLB and the Federal Reserve Bank. Pledged loans totaled $523.5 million and $542.1 million at December 31, 2020 and December 31, 2019, respectively.
In April of 2020, we received approval to participate in the Federal Reserve Bank Paycheck Protection Program Liquidity Facility (“PPPLF”). The credit facility provides term funding for loans made under the Small Business Administration’s (“SBA”) PPP. We have not utilized PPPLF, if we take advances under the PPPLF, they will be collateralized with PPP loans.
Short-Term Loan Modifications
We have made short-term COVID-19 related loan payment deferrals on 82 loans totaling $9.5 million at December 31, 2020. In accordance with the CARES Act and regulatory guidance, these modified loans are not troubled debt restructurings and are not considered to be past due or non-performing. The payment deferral periods range from one to six months as determined on a case-by-case basis considering the borrower’s circumstances and the impact of COVID-19. Without these deferrals, past due loan totals would have been higher at December 31, 2020. The payment deferral periods for these loans end during the first quarter of 2021. We cannot predict the impact to past due loan totals once the deferral periods end.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Past Due Loans
Past due loans (gross), segregated by loan portfolio were as follows, as of December 31, 2020, and December 31, 2019.
| | | | | | | | | | | | | | | | | | | | | | | | | | | Recorded | |
| | | 30-59 | | | 60-89 | | | 90 or Greater | | | | | | | | | | | | | | | Investment > | |
| | | Days Past | | | Days Past | | | Days Past | | | Total Past | | | | | | | | | | | 90 Days and | |
(Amounts in thousands) | | Due | | | Due | | | Due | | | Due | | | Current | | | Total | | | Accruing | |
Past Due Loans at December 31, 2020 | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial | | $ | 0 | | | $ | 0 | | | $ | 1,413 | | | $ | 1,413 | | | $ | 114,146 | | | $ | 115,559 | | | $ | 0 | |
PPP | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 130,814 | | | | 130,814 | | | | 0 | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 44,549 | | | | 44,549 | | | | 0 | |
Non-owner occupied | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 512,832 | | | | 512,832 | | | | 0 | |
Owner occupied | | | 640 | | | | 0 | | | | 2,993 | | | | 3,633 | | | | 206,522 | | | | 210,155 | | | | 0 | |
Residential real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
ITIN | | | 40 | | | | 0 | | | | 169 | | | | 209 | | | | 28,826 | | | | 29,035 | | | | 0 | |
1-4 family mortgage | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 55,925 | | | | 55,925 | | | | 0 | |
Equity lines | | | 60 | | | | 0 | | | | 0 | | | | 60 | | | | 18,834 | | | | 18,894 | | | | 0 | |
Consumer and other | | | 82 | | | | 17 | | | | 0 | | | | 99 | | | | 21,870 | | | | 21,969 | | | | 0 | |
Total | | $ | 822 | | | $ | 17 | | | $ | 4,575 | | | $ | 5,414 | | | $ | 1,134,318 | | | $ | 1,139,732 | | | $ | 0 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | Recorded | |
| | | 30-59 | | | 60-89 | | | 90 or Greater | | | | | | | | | | | | | | | Investment > | |
| | | Days Past | | | Days Past | | | Days Past | | | Total Past | | | | | | | | | | | 90 Days and | |
(Amounts in thousands) | | Due | | | Due | | | Due | | | Due | | | Current | | | Total | | | Accruing | |
Past Due Loans at December 31, 2019 | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial | | $ | 71 | | | $ | 0 | | | $ | 0 | | | $ | 71 | | | $ | 141,126 | | | $ | 141,197 | | | $ | 0 | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 26,830 | | | | 26,830 | | | | 0 | |
Non-owner occupied | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 493,920 | | | | 493,920 | | | | 0 | |
Owner occupied | | | 655 | | | | 0 | | | | 3,103 | | | | 3,758 | | | | 215,075 | | | | 218,833 | | | | 0 | |
Residential real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
ITIN | | | 371 | | | | 323 | | | | 43 | | | | 737 | | | | 32,302 | | | | 33,039 | | | | 0 | |
1-4 family mortgage | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 63,661 | | | | 63,661 | | | | 0 | |
Equity lines | | | 100 | | | | 0 | | | | 0 | | | | 100 | | | | 21,999 | | | | 22,099 | | | | 0 | |
Consumer and other | | | 200 | | | | 50 | | | | 0 | | | | 250 | | | | 33,074 | | | | 33,324 | | | | 0 | |
Total | | $ | 1,397 | | | $ | 373 | | | $ | 3,146 | | | $ | 4,916 | | | $ | 1,027,987 | | | $ | 1,032,903 | | | $ | 0 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Nonaccrual Loans
Nonaccrual loans, segregated by loan portfolio, were as follows as of December 31, 2020, and December 31, 2019.
| | | As of December 31 | |
(Amounts in thousands) | | 2020 | | | 2019 | |
Nonaccrual Loans: | | | | | | | | |
Commercial | | $ | 1,535 | | | $ | 61 | |
Commercial real estate: | | | | | | | | |
Owner occupied | | | 3,734 | | | | 3,103 | |
Residential real estate: | | | | | | | | |
ITIN | | | 1,585 | | | | 2,221 | |
1-4 family mortgage | | | 141 | | | | 191 | |
Consumer and other | | | 18 | | | | 40 | |
Total | | $ | 7,013 | | | $ | 5,616 | |
Had nonaccrual loans performed in accordance with their contractual terms, we would have recognized additional interest income, net of tax, of approximately $284 thousand and $254 thousand for the years ended December 31, 2020 and 2019, respectively.
94
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Impaired Loans
A loan is considered impaired when, based on current information and events, we determine it is probable that we will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. The following tables summarize impaired loans by loan portfolio as of December 31, 2020, and December 31, 2019.
| | | As of December 31, 2020 | |
| | | | | | | Unpaid | | | | | |
| | | Recorded | | | Principal | | | Related | |
(Amounts in thousands) | | Investment | | | Balance | | | Allowance | |
Impaired Loans: | | | | | | | | | | | | |
With no related allowance recorded: | | | | | | | | | | | | |
Commercial | | $ | 1,577 | | | $ | 1,932 | | | $ | — | |
Commercial real estate: | | | | | | | | | | | | |
Owner occupied | | | 3,734 | | | | 3,860 | | | | — | |
Residential real estate: | | | | | | | | | | | | |
ITIN | | | 4,876 | | | | 6,500 | | | | — | |
1-4 family mortgage | | | 141 | | | | 202 | | | | — | |
Total with no related allowance recorded | | $ | 10,328 | | | $ | 12,494 | | | $ | — | |
| | | | | | | | | | | | | |
With an allowance recorded: | | | | | | | | | | | | |
Commercial | | $ | 456 | | | $ | 456 | | | $ | 114 | |
Residential real estate: | | | | | | | | | | | | |
ITIN | | | 175 | | | | 175 | | | | 11 | |
Equity lines | | | 126 | | | | 126 | | | | 63 | |
Consumer and other | | | 18 | | | | 18 | | | | 4 | |
Total with an allowance recorded | | $ | 775 | | | $ | 775 | | | $ | 192 | |
| | | | | | | | | | | | | |
By loan portfolio: | | | | | | | | | | | | |
Commercial | | $ | 2,033 | | | $ | 2,388 | | | $ | 114 | |
Commercial real estate | | | 3,734 | | | | 3,860 | | | | 0 | |
Residential real estate | | | 5,318 | | | | 7,003 | | | | 74 | |
Consumer and other | | | 18 | | | | 18 | | | | 4 | |
Total impaired loans | | $ | 11,103 | | | $ | 13,269 | | | $ | 192 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
| | | As of December 31, 2019 | |
| | | | | | | Unpaid | | | | | |
| | | Recorded | | | Principal | | | Related | |
(Amounts in thousands) | | Investment | | | Balance | | | Allowance | |
Impaired Loans: | | | | | | | | | | | | |
With no related allowance recorded: | | | | | | | | | | | | |
Commercial | | $ | 94 | | | $ | 251 | | | $ | — | |
Commercial real estate: | | | | | | | | | | | | |
Owner occupied | | | 3,103 | | | $ | 3,103 | | | | — | |
Residential real estate: | | | | | | | | | | | | |
ITIN | | | 5,723 | | | | 7,386 | | | | — | |
1-4 family mortgage | | | 191 | | | | 313 | | | | — | |
Total with no related allowance recorded | | $ | 9,111 | | | $ | 11,053 | | | $ | — | |
| | | | | | | | | | | | | |
With an allowance recorded: | | | | | | | | | | | | |
Commercial | | $ | 562 | | | $ | 563 | | | $ | 159 | |
Residential real estate: | | | | | | | | | | | | |
ITIN | | | 455 | | | | 455 | | | | 38 | |
Equity lines | | | 231 | | | | 231 | | | | 116 | |
Consumer and other | | | 40 | | | | 40 | | | | 11 | |
Total with an allowance recorded | | $ | 1,288 | | | $ | 1,289 | | | $ | 324 | |
| | | | | | | | | | | | | |
By loan portfolio: | | | | | | | | | | | | |
Commercial | | $ | 656 | | | $ | 814 | | | $ | 159 | |
Commercial real estate | | | 3,103 | | | | 3,103 | | | | 0 | |
Residential real estate | | | 6,600 | | | | 8,385 | | | | 154 | |
Consumer and other | | | 40 | | | | 40 | | | | 11 | |
Total impaired loans | | $ | 10,399 | | | $ | 12,342 | | | $ | 324 | |
The following table summarizes average recorded investment and interest income recognized on impaired loans by loan portfolio for the years ended December 31, 2020 and 2019.
| | | 2020 | | | 2019 | |
| | | Average | | | Interest | | | Average | | | Interest | |
| | | Recorded | | | Income | | | Recorded | | | Income | |
(Amounts in thousands) | | Investment | | | Recognized | | | Investment | | | Recognized | |
Average Recorded Investment and Interest Income: | | | | | | | | | | | | | | | | |
Commercial | | $ | 1,092 | | | $ | 61 | | | $ | 1,201 | | | $ | 51 | |
Commercial real estate: | | | | | | | | | | | | | | | | |
Non-owner occupied | | | 443 | | | | 0 | | | | 9,400 | | | | 30 | |
Owner occupied | | | 3,452 | | | | 0 | | | | 259 | | | | 0 | |
Residential real estate: | | | | | | | | | | | | | | | | |
ITIN | | | 5,419 | | | | 139 | | | | 6,574 | | | | 161 | |
1-4 family mortgage | | | 164 | | | | 0 | | | | 193 | | | | 0 | |
Equity lines | | | 178 | | | | 12 | | | | 288 | | | | 18 | |
Consumer and other | | | 28 | | | | 0 | | | | 25 | | | | 0 | |
Total | | $ | 10,776 | | | $ | 212 | | | $ | 17,940 | | | $ | 260 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
The impaired loans on which these interest income amounts were recognized are primarily accruing troubled debt restructured loans. Loans are reported as troubled debt restructurings when we grant a concession(s) to a borrower experiencing financial difficulties that we would not otherwise consider. Examples of such concessions include a reduction in the loan rate, forgiveness of principal or accrued interest, extending the maturity date(s), or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, restructured loans are impaired as we will not collect all amounts due, either principal or interest, in accordance with the terms of the original loan agreement.
The recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure was $80 thousand and $100 thousand at December 31, 2020 and December 31, 2019, respectively.
Troubled Debt Restructurings
As of December 31, 2020, we had $6.1 million in troubled debt restructurings compared to $6.5 million as of December 31, 2019. As of December 31, 2020, we had 91 loans that were classified as troubled debt restructurings, of which 89 loans were performing according to their restructured terms. Troubled debt restructurings represented 0.53% of gross loans (0.60% of gross loans excluding PPP loans) as of December 31, 2020, compared with 0.63% at December 31, 2019.
At December 31, 2020 and December 31, 2019, impaired loans of $4.1 million and $4.8 million, respectively, were classified as performing restructured loans.
For a troubled debt restructured loan to be on accrual status, the loan’s collateral coverage must generally be greater than or equal to 100% of the loan balance, the loan payments must be current, and the borrower must demonstrate the ability to make payments from a verified source of cash flow. As of December 31, 2020 and December 31, 2019, we had no obligations to lend additional funds on any troubled debt restructured loans. There was 1 new troubled debt restructuring on one $640 thousand commercial real estate loan during the year ended December 31, 2020. The borrower was impacted by COVID-19 but the loan did not qualify to be exempt from TDR status under the new TDR guidance issued by the financial institution regulators or under the CARES Act.
The types of modifications offered can generally be described in the following categories:
Rate – A modification in which the interest rate is changed.
Maturity – A modification in which the maturity date is changed.
Payment deferral – A modification in which a portion of the principal is deferred.
Principal reduction – A modification in which a portion of the owing principal is decreased.
The following tables present the period ended balances of newly restructured loans and the types of modifications that occurred during the year ended December 31, 2020 and 2019.
| | | For The Year Ended December 31, 2020 | |
| | | Rate & | | | | | | | Payment | | | | | |
(Amounts in thousands) | | Maturity | | | Maturity | | | Deferral | | | Total | |
Troubled Debt Restructuring: | | | | | | | | | | | | | | | | |
Commercial real estate: | | | | | | | | | | | | | | | | |
Owner occupied | | $ | 0 | | | $ | 0 | | | $ | 640 | | | $ | 640 | |
Total | | $ | 0 | | | $ | 0 | | | $ | 640 | | | $ | 640 | |
| | | For The Year Ended December 31, 2019 | |
| | | Rate & | | | | | | | Payment | | | | | |
(Amounts in thousands) | | Maturity | | | Maturity | | | Deferral | | | Total | |
Troubled Debt Restructuring: | | | | | | | | | | | | | | | | |
Commercial | | $ | 0 | | | $ | 47 | | | $ | 0 | | | $ | 47 | |
Consumer and other | | | 20 | | | | 0 | | | | 0 | | | | 20 | |
Total | | $ | 20 | | | $ | 47 | | | $ | 0 | | | $ | 67 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
For the years ended December 31, 2020 and 2019, the table below provides information regarding the number of loans where the contractual terms have been restructured in a manner, which grants a concession to a borrower experiencing financial difficulties.
| | | For The Year Ended December 31, 2020 | | | For The Year Ended December 31, 2019 | |
| | | | | | | Pre- | | | Post- | | | | | | | Pre- | | | Post- | |
| | | | | | | Modification | | | Modification | | | | | | | Modification | | | Modification | |
| | | | | | | Outstanding | | | Outstanding | | | | | | | Outstanding | | | Outstanding | |
| | | Number of | | | Recorded | | | Recorded | | | Number of | | | Recorded | | | Recorded | |
(Dollars in thousands) | | Contracts | | | Investment | | | Investment | | | Contracts | | | Investment | | | Investment | |
Troubled Debt Restructurings: | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial | | | 0 | | | $ | 0 | | | $ | 0 | | | | 1 | | | $ | 99 | | | $ | 99 | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | | | | | |
Owner occupied | | | 1 | | | | 654 | | | | 654 | | | | 0 | | | | 0 | | | | 0 | |
Consumer and other | | | 0 | | | | 0 | | | | 0 | | | | 1 | | | | 20 | | | | 20 | |
Total | | | 1 | | | $ | 654 | | | $ | 654 | | | | 2 | | | $ | 119 | | | $ | 119 | |
The following table presents loans modified as troubled debt restructuring within the previous 12 months for which was a payment default during the twelve months ended December 31, 2020 and 2019.
| | | 2020 | | | 2019 | |
| | | Number of | | | Recorded | | | Number of | | | Recorded | |
(Dollars in thousands) | | Contracts | | | Investment | | | Contracts | | | Investment | |
Troubled Debt Restructurings: | | | | | | | | | | | | | | | | |
Commercial real estate: | | | | | | | | | | | | | | | | |
Owner occupied | | | 1 | | | $ | 640 | | | | 0 | | | $ | 0 | |
Consumer and other | | | 0 | | | | 0 | | | | 1 | | | | 20 | |
Total | | | 1 | | | $ | 640 | | | | 1 | | | $ | 20 | |
Performing and Nonperforming Loans
We define a performing loan as a loan where any installment of principal or interest is not 90 days or more past due, and management believes the ultimate collection of original contractual principal and interest is likely. We define a nonperforming loan as an impaired loan, which may be on nonaccrual, or is 90 days past due and still accruing, or has been restructured and does not comply with its modified terms, and our ultimate collection of original contractual principal and interest is uncertain.
Performing and nonperforming loans, segregated by loan portfolio, are as follows at December 31, 2020 and 2019.
| | | December 31, 2020 | |
(Amounts in thousands) | | Performing | | | Nonperforming | | | Total | |
Performing and Nonperforming Loans: | | | | | | | | | | | | |
Commercial | | $ | 114,024 | | | $ | 1,535 | | | $ | 115,559 | |
PPP | | | 130,814 | | | | 0 | | | | 130,814 | |
Commercial real estate: | | | | | | | | | | | | |
Construction and land development | | | 44,549 | | | | 0 | | | | 44,549 | |
Non-owner occupied | | | 512,832 | | | | 0 | | | | 512,832 | |
Owner occupied | | | 206,421 | | | | 3,734 | | | | 210,155 | |
Residential real estate: | | | | | | | | | | | | |
ITIN | | | 27,450 | | | | 1,585 | | | | 29,035 | |
1-4 family mortgage | | | 55,784 | | | | 141 | | | | 55,925 | |
Equity lines | | | 18,894 | | | | 0 | | | | 18,894 | |
Consumer and other | | | 21,951 | | | | 18 | | | | 21,969 | |
Total | | $ | 1,132,719 | | | $ | 7,013 | | | $ | 1,139,732 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
| | | December 31, 2019 | |
(Amounts in thousands) | | Performing | | | Nonperforming | | | Total | |
Performing and Nonperforming Loans: | | | | | | | | | | | | |
Commercial | | $ | 141,136 | | | $ | 61 | | | $ | 141,197 | |
Commercial real estate: | | | | | | | | | | | | |
Construction and land development | | | 26,830 | | | | 0 | | | | 26,830 | |
Non-owner occupied | | | 493,920 | | | | 0 | | | | 493,920 | |
Owner occupied | | | 215,730 | | | | 3,103 | | | | 218,833 | |
Residential real estate: | | | | | | | | | | | | |
ITIN | | | 30,818 | | | | 2,221 | | | | 33,039 | |
1-4 family mortgage | | | 63,470 | | | | 191 | | | | 63,661 | |
Equity lines | | | 22,099 | | | | 0 | | | | 22,099 | |
Consumer and other | | | 33,284 | | | | 40 | | | | 33,324 | |
Total | | $ | 1,027,287 | | | $ | 5,616 | | | $ | 1,032,903 | |
Credit Quality Ratings
Management assigns a credit quality rating (risk grade) to each loan. The foundation or primary factor in determining the appropriate credit quality rating is the degree of a debtor’s willingness and ability to perform as agreed. In conjunction with evaluating the performing versus nonperforming nature of our loan portfolio, management evaluates the following credit risk and other relevant factors in determining the appropriate credit quality indicator (rating) for each loan portfolio:
Pass Grade: A Pass loan is a strong credit with no existing or known weaknesses that may require management’s close attention. Some pass loans require short-term enhanced monitoring to determine when the credit relationship would merit either an upgrade or a downgrade. Loans classified as Pass Grade specifically demonstrate:
● | Strong Cash Flows – borrower’s cash flows must meet or exceed our minimum debt service coverage ratio. |
● | Collateral Margin – generally, the borrower must have pledged an acceptable collateral class with an adequate collateral margin. |
● | Qualitative Factors – in addition to meeting our minimum cash flow and collateral requirements, a number of other qualitative factors are also factored into assigning a Pass Grade including the borrower’s level of leverage (debt to equity), prospects, history and experience in their industry, credit history, and any other relevant factors including a borrower’s character. |
Those borrowers who qualify for unsecured loans must fully demonstrate above average cash flows and strong secondary sources of repayment to mitigate the lack of unpledged collateral.
Watch Grade: The credit is acceptable but the borrower has experienced a temporary setback or adverse information has been received, and may exhibit one or more of the characteristics shown in the list below. This risk grade could apply to credits on a temporary basis pending a full review. Credits with this risk grade will require more handling time and increased management. The list below contains characteristics of this risk grade, but individually do not automatically cause the loan to be assigned a Watch Grade.
● | The primary source of repayment may be weakening causing greater reliance on the secondary source of repayment or |
● | The primary source of repayment is adequate, but the secondary source of repayment is insufficient |
● | In-depth financial analysis would compare to the lower quartile in two or more of the major components of the Risk Management Association Annual Statement Studies |
● | Volatile or deteriorating collateral |
● | Management decisions may be called into question |
● | Delinquencies in bank credits or other financial/trade creditors |
● | Frequent overdrafts |
● | Significant change in management/ownership |
Special Mention Grade: Credits in this grade are potentially weak and deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects of the credit. Special Mention credits are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. The list below exhibits the characteristics of this grade, but individually do not automatically cause the borrower to be assigned a grade of Special Mention:
● | Inadequate or incomplete loan documentation or perfection of collateral, or any other deviation from prudent lending practices |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
● | Credit is structured in a manner in which the timing of the repayment source does not match the payment schedule or maturity, materially jeopardizing repayment |
● | Current economic or market conditions exist which may affect the borrower's ability to perform or affect the Bank's collateral position |
● | Adverse trends in the borrower's operations or continued deterioration in the borrower’s financial condition that has not yet reached a point where the retirement of debt is jeopardized. A credit in this grade should have favorable prospects of the deteriorating financial trends reversing within a reasonable timeframe. |
● | The borrower is less than cooperative or unable to produce current and adequate financial information |
Substandard Grade: A Substandard credit is inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard credits have a well-defined weakness or weaknesses that jeopardize the liquidation or timely collection of the debt. Substandard credits are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. However, a potential loss does not have to be recognizable in an individual credit for it to be considered a substandard credit. As such, substandard credits may or may not be graded as impaired.
The following represents, but is not limited to, the potential characteristics of a Substandard Grade and do not necessarily generate automatic reclassification into this loan grade:
● | Sustained or substantial deteriorating financial trends, |
● | Unresolved management problems, |
● | Collateral is insufficient to repay debt; collateral is not sufficiently supported by independent sources, such as asset-based financial audits, appraisals, or equipment evaluations, |
● | Improper perfection of lien position, which is not readily correctable, |
● | Unanticipated and severe decline in market values, |
● | High reliance on secondary source of repayment, |
● | Legal proceedings, such as bankruptcy or a divorce, which has substantially decreased the borrower’s capacity to repay the debt, |
● | Fraud committed by the borrower, |
● | IRS liens that take precedence, |
● | Forfeiture statutes for assets involved in criminal activities, |
● | Protracted repayment terms outside of policy that are for longer than the same type of credit in our portfolio, |
● | Any other relevant quantitative or qualitative factor that negatively affects the current net worth and paying capacity of the borrower or of the collateral pledged, if any. |
Doubtful Grade: A Doubtful loan has all the weaknesses inherent in one classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain pending factors that may work to the advantage and strengthening of the credit, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors may include, but are not limited to:
● | Proposed merger(s), |
● | Acquisition or liquidation procedures, |
● | Capital injection, |
● | Perfecting liens on additional collateral, |
● | Refinancing plans. |
Generally, a Doubtful Grade does not remain outstanding for a period greater than six months. Within six months, the pending events should have been resolved. Based on resolution of the pending events, the credit grade should have improved or the principal balance charged against the ALLL.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
The following table summarizes loans by internal risk grades and by loan class as of December 31, 2020, and December 31, 2019.
| | | December 31, 2020 | |
| | | | | | | | | | | Special | | | | | | | | | | | | | |
(Amounts in thousands) | | Pass | | | Watch | | | Mention | | | Substandard | | | Doubtful | | | Total | |
Loan Portfolio: | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial | | $ | 102,067 | | | $ | 8,549 | | | $ | 540 | | | $ | 4,403 | | | $ | 0 | | | $ | 115,559 | |
PPP | | | 130,814 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 130,814 | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 41,767 | | | | 2,782 | | | | 0 | | | | 0 | | | | 0 | | | | 44,549 | |
Non-owner occupied | | | 453,930 | | | | 46,092 | | | | 12,810 | | | | 0 | | | | 0 | | | | 512,832 | |
Owner occupied | | | 155,418 | | | | 47,698 | | | | 414 | | | | 6,625 | | | | 0 | | | | 210,155 | |
Residential real estate: | | | | | | | | | | | | | | | | | | | | | | | | |
ITIN | | | 25,558 | | | | 0 | | | | 0 | | | | 3,477 | | | | 0 | | | | 29,035 | |
1-4 family mortgage | | | 54,288 | | | | 195 | | | | 0 | | | | 1,442 | | | | 0 | | | | 55,925 | |
Equity lines | | | 18,894 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 18,894 | |
Consumer and other | | | 21,952 | | | | 0 | | | | 0 | | | | 17 | | | | 0 | | | | 21,969 | |
Total | | $ | 1,004,688 | | | $ | 105,316 | | | $ | 13,764 | | | $ | 15,964 | | | $ | 0 | | | $ | 1,139,732 | |
| | | December 31, 2019 | |
| | | | | | | | | | | Special | | | | | | | | | | | | | |
(Amounts in thousands) | | Pass | | | Watch | | | Mention | | | Substandard | | | Doubtful | | | Total | |
Loan Portfolio: | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial | | $ | 125,222 | | | $ | 14,974 | | | $ | 833 | | | $ | 168 | | | $ | 0 | | | $ | 141,197 | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 26,810 | | | | 20 | | | | 0 | | | | 0 | | | | 0 | | | | 26,830 | |
Non-owner occupied | | | 454,493 | | | | 32,902 | | | | 5,424 | | | | 1,101 | | | | 0 | | | | 493,920 | |
Owner occupied | | | 195,950 | | | | 7,224 | | | | 1,220 | | | | 14,439 | | | | 0 | | | | 218,833 | |
Residential real estate: | | | | | | | | | | | | | | | | | | | | | | | | |
ITIN | | | 28,609 | | | | 0 | | | | 0 | | | | 4,430 | | | | 0 | | | | 33,039 | |
1-4 family mortgage | | | 62,485 | | | | 985 | | | | 0 | | | | 191 | | | | 0 | | | | 63,661 | |
Equity lines | | | 22,012 | | | | 0 | | | | 0 | | | | 87 | | | | 0 | | | | 22,099 | |
Consumer and other | | | 33,283 | | | | 0 | | | | 0 | | | | 41 | | | | 0 | | | | 33,324 | |
Total | | $ | 948,864 | | | $ | 56,105 | | | $ | 7,477 | | | $ | 20,457 | | | $ | 0 | | | $ | 1,032,903 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Allowance for Loan and Lease Losses
The following tables below summarize the ALLL by portfolio for the years ended December 31, 2020 and 2019.
| | | As of December 31, 2020 | |
| | | | | | | Paycheck | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | Protection | | | Commercial | | | Residential | | | | | | | | | | | | | |
(Amounts in thousands) | | Commercial | | | Program (1) | | | Real Estate | | | Real Estate | | | Consumer | | | Unallocated | | | Total | |
ALLL by Loan Portfolio: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Beginning balance | | $ | 1,822 | | | $ | 0 | | | $ | 8,096 | | | $ | 1,032 | | | $ | 933 | | | $ | 348 | | | $ | 12,231 | |
Charge-offs | | | (353 | ) | | | 0 | | | | (144 | ) | | | (66 | ) | | | (550 | ) | | | 0 | | | | (1,113 | ) |
Recoveries | | | 24 | | | | 0 | | | | 34 | | | | 154 | | | | 330 | | | | 0 | | | | 542 | |
Provision | | | 909 | | | | 0 | | | | 3,909 | | | | 204 | | | | (30 | ) | | | 258 | | | | 5,250 | |
Ending balance | | $ | 2,402 | | | $ | 0 | | | $ | 11,895 | | | $ | 1,324 | | | $ | 683 | | | $ | 606 | | | $ | 16,910 | |
(1) PPP loans are fully guaranteed by SBA and no allowance is provided for them. |
| | | As of December 31, 2019 | |
| | | | | | | Paycheck | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | Protection | | | Commercial | | | Residential | | | | | | | | | | | | | |
(Amounts in thousands) | | Commercial | | | Program | | | Real Estate | | | Real Estate | | | Consumer | | | Unallocated | | | Total | |
ALLL by Loan Portfolio: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Beginning balance | | $ | 2,205 | | | $ | 0 | | | $ | 7,116 | | | $ | 1,173 | | | $ | 1,356 | | | $ | 442 | | | $ | 12,292 | |
Charge-offs | | | (238 | ) | | | 0 | | | | (233 | ) | | | (181 | ) | | | (848 | ) | | | 0 | | | | (1,500 | ) |
Recoveries | | | 927 | | | | 0 | | | | 0 | | | | 261 | | | | 251 | | | | 0 | | | | 1,439 | |
Provision | | | (1,072 | ) | | | 0 | | | | 1,213 | | | | (221 | ) | | | 174 | | | | (94 | ) | | | 0 | |
Ending balance | | $ | 1,822 | | | $ | 0 | | | $ | 8,096 | | | $ | 1,032 | | | $ | 933 | | | $ | 348 | | | $ | 12,231 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
While the ALLL composition is an indication of specific amounts or loan categories in which future charge-offs may occur, actual amounts may differ. The unallocated portion of the ALLL provides for coverage of credit losses inherent in the loan portfolio but not captured in the credit loss factors that are utilized in the risk rating-based component, or in the specific impairment reserve component of the ALLL, and acknowledges the inherent imprecision of all loss prediction models. As of December 31, 2020, the unallocated allowance amount represented 4% of the ALLL compared to 3% at December 31, 2019. The following tables summarize the ALLL and the recorded investment in loans and leases as of December 31, 2020 and 2019.
| | | As of December 31, 2020 | |
| | | | | | | Paycheck | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | Protection | | | Commercial | | | Residential | | | | | | | | | | | | | |
(Amounts in thousands) | | Commercial | | | Program (1) | | | Real Estate | | | Real Estate | | | Consumer | | | Unallocated | | | Total | |
ALLL: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Individually evaluated for impairment | | $ | 114 | | | $ | 0 | | | $ | 0 | | | $ | 74 | | | $ | 4 | | | $ | 0 | | | $ | 192 | |
Collectively evaluated for impairment | | | 2,288 | | | | 0 | | | | 11,895 | | | | 1,250 | | | | 679 | | | | 606 | | | | 16,718 | |
Total | | | 2,402 | | | $ | 0 | | | | 11,895 | | | | 1,324 | | | | 683 | | | | 606 | | | | 16,910 | |
Gross loans: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Individually evaluated for impairment | | $ | 2,033 | | | $ | 0 | | | $ | 3,734 | | | $ | 5,318 | | | $ | 18 | | | $ | 0 | | | $ | 11,103 | |
Collectively evaluated for impairment | | | 113,526 | | | | 130,814 | | | | 763,802 | | | | 98,536 | | | | 21,951 | | | | 0 | | | | 1,128,629 | |
Total gross loans | | $ | 115,559 | | | $ | 130,814 | | | $ | 767,536 | | | $ | 103,854 | | | $ | 21,969 | | | $ | 0 | | | $ | 1,139,732 | |
(1) PPP loans are fully guaranteed by SBA and no allowance is provided for them. |
| | | As of December 31, 2019 | |
| | | | | | | Paycheck | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | Protection | | | Commercial | | | Residential | | | | | | | | | | | | | |
(Amounts in thousands) | | Commercial | | | Program | | | Real Estate | | | Real Estate | | | Consumer | | | Unallocated | | | Total | |
ALLL: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Individually evaluated for impairment | | $ | 159 | | | $ | 0 | | | $ | 0 | | | $ | 154 | | | $ | 11 | | | $ | 0 | | | $ | 324 | |
Collectively evaluated for impairment | | | 1,663 | | | | 0 | | | | 8,096 | | | | 878 | | | | 922 | | | | 348 | | | | 11,907 | |
Total | | | 1,822 | | | | 0 | | | | 8,096 | | | | 1,032 | | | | 933 | | | | 348 | | | | 12,231 | |
Gross loans: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Individually evaluated for impairment | | $ | 656 | | | $ | 0 | | | $ | 3,103 | | | $ | 6,600 | | | $ | 40 | | | $ | 0 | | | $ | 10,399 | |
Collectively evaluated for impairment | | | 140,541 | | | | 0 | | | | 736,480 | | | | 112,199 | | | | 33,284 | | | | 0 | | | | 1,022,504 | |
Total gross loans | | $ | 141,197 | | | $ | 0 | | | $ | 739,583 | | | $ | 118,799 | | | $ | 33,324 | | | $ | 0 | | | $ | 1,032,903 | |
The ALLL totaled $16.9 million or 1.48% of total gross loans (1.68% of gross loans excluding PPP loans) at December 31, 2020 and $12.2 million or 1.18% at December 31, 2019. As of December 31, 2020 and December 31, 2019, we had commitments to extend credit of $267.8 million and $275.1 million, respectively. The reserve for unfunded commitments recorded in Other Liabilities in the Consolidated Balance Sheets at December 31, 2020 and 2019 was $800 thousand and $695 thousand, respectively.
We believe that the ALLL was adequate as of December 31, 2020. There is, however, no assurance that future loan and lease losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses. In addition, bank regulatory authorities, as part of their periodic examination of the Company, may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review.
COVID‐19
We anticipated that the COVID‐19 pandemic would result in economic recession and increased loan losses, particularly in certain hard hit industries such as travel and hospitality, retail and energy sectors. As a result, we significantly increased our qualitative credit risk factors for “changes in international, national, regional and local conditions” and “changes in the volume and severity of past due loans and other similar conditions”. This resulted in recording a $5.3 million provision for loan and lease losses during the year ended December 31, 2020. During the fourth quarter of 2020, most of our loan payment deferrals have resumed making payments.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
ALLL Methodology
We have lending policies and procedures in place with the objective of optimizing loan income within an accepted risk tolerance level. We review and approve these policies and procedures annually. Monitoring and reporting systems supplement the review process with regular frequency as related to loan production, loan quality, concentrations of credit, potential problem loans, loan delinquencies, and nonperforming loans.
We formally assess the adequacy of the ALLL on a quarterly basis. The ALLL is based upon estimates of future loan and lease losses and is maintained at a level considered adequate to provide for probable losses inherent in the outstanding loan and lease portfolio. Our ALLL methodology incorporates management’s current judgments, and reflects management’s estimate of future loan and lease losses and risks inherent in the loan portfolio in accordance with ASC Topic 450 Contingencies (“ASC 450”) and ASC Topic 310 Receivables (“ASC 310”).
Management’s assessment of the ALLL is based on our continuing evaluation of all known relevant quantitative and qualitative internal and external risk factors provides the foundation for the four major components of the ALLL:
| | (1) | Historical valuation allowances established in accordance with ASC 450, for groups of similarly situated loan pools. |
| | (2) | General valuation allowances established in accordance with ASC 450, that are based on qualitative credit risk factors (e.g., portfolio trends, concentration of credit, growth, economic factors). Loss estimation factors are based on analysis of local economic factors. Allowances for changing environmental factors are management’s best estimate of the probable impact these changes have had on the loan portfolio as a whole. |
| | (3) | Specific valuation allowances established in accordance with ASC 310, that are based on estimated probable losses on specific impaired loans. |
| | (4) | Unallocated valuation allowances established in accordance with ASC 310 and ASC 450, that are based on credit losses inherent in the loan portfolio but not contemplated in the credit loss factors. |
All four components are aggregated and constitute the ALLL; while portions of the allowance may be allocated to specific credits, the allowance net of specific reserves is available for the remaining credits that management deems as “loss.” It is our policy to classify a credit as loss with a concurrent charge-off when management considers the credit uncollectible and of such little value that its continuance as a bankable asset is not warranted. A loss classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer recognizing the likely credit loss of a valueless asset even though partial recovery may occur in the future.
The allowance is increased by provisions charged to expense and reduced by net charge-offs. In periodic evaluations of the adequacy of the allowance balance, management considers past loan and lease loss experience by type of credit, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay, the estimated value of any underlying collateral, current economic conditions and other factors.
Our assessment of the adequacy of the ALLL includes the periodic re-grading of classified loans based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the interest rate environment and other factors as warranted. Loans are initially rated when originated. They are reviewed as they are renewed, when there is a new loan to the same borrower and/or when identified facts demonstrate heightened risk of default.
Our loan portfolio is evaluated by general loan class including commercial, commercial real estate (which includes construction and other real estate), residential real estate (which includes 1-4 family and home equity loans), consumer and other loans. In accordance with ASC 450, historical valuation allowances are established for loan pools with similar risk characteristics common to each loan grouping. These loan pools are similarly risk-graded and each portfolio is evaluated by identifying all relevant risk characteristics that are common to these segmented groups of loans. These characteristics include a significant emphasis on historical losses within each loan group, inherent risks for each, and specific loan class characteristics such as trends related to nonaccrual loans, past due loans, criticized loans, net charge-offs or recoveries, among other relevant credit risk factors. We periodically review and update our historical loss ratios based on net charge-off experience for each loan and lease class. Other credit risk factors are also reviewed periodically and adjusted as necessary to account for any changes in potential loss exposure.
General valuation allowances, as prescribed by ASC 450, are based on qualitative factors such as changes in asset quality trends, concentrations of credit or changes in concentrations of credit, changes in underwriting standards, changes in experience or depth of lending staff or management, the effectiveness of loan grading and the internal loan review function, changes in economic conditions, and any other relevant factors. Management evaluates each qualitative component quarterly to determine the associated risks to the quality of our loan portfolio.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Impaired loans
Management monitors delinquent loans continuously and identifies problem loans to be evaluated individually for impairment testing. For loans that are determined impaired, a formal impairment measurement is performed at least quarterly on a loan-by-loan basis. If the measurement of each impaired loans’ value is less than the recorded investment in the loan, we recognize this impairment and adjust the carrying value of the loan to fair value through the ALLL. For collateral dependent loans, this can be accomplished by charging off the impaired portion of the loan based on the underlying value of the collateral. For non-collateral dependent loans, we establish a specific component within the ALLL based on the present value of the future cash flows. If we determine the sources of repayment will not result in a reasonable probability that the carrying value of a loan can be recovered, the amount of a loan’s specific impairment is charged off against the ALLL. Impairment reserves on non-collateral dependent restructured loans are measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s carrying value. These impairment reserves are recognized as a specific component to be provided for in the ALLL.
Risk Characteristics and Underwriting
The following is a brief summary, by loan type, of management’s evaluation of the general risk characteristics and underwriting standards:
Commercial Loans – Commercial loans are underwritten after evaluating the borrower’s financial ability to maintain profitability including future expansion objectives. In addition, the borrower’s qualitative qualities are evaluated, such as management skills and experience, ethical traits, and overall business acumen. Commercial loans are primarily extended based on the cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The borrower’s cash flow may deviate from initial projections, and the value of collateral securing these loans may change.
Most commercial loans are generally secured by the assets being financed and other business assets such as accounts receivable or inventory. Management may also incorporate a personal guarantee; however, some short-term loans may be extended on an unsecured basis. Repayment of commercial loans secured by accounts receivable may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
PPP Loans - The PPP launched in April of 2020 to provide small businesses assistance in the form of forgivable 100% guaranteed U.S. SBA loans. We have actively participated in the PPP and at December 31, 2020, we have 487 loans totaling $130.8 million. This financial support of our customers’ businesses may help moderate other Commercial and Commercial Real Estate loan losses. The loans are underwritten following the guidelines and approval process from the SBA and pose essentially no credit risk to the loan portfolio.
Commercial Real Estate (“CRE”) Loans – CRE loans are subject to similar underwriting standards and processes as commercial loans. CRE loans are viewed predominantly as cash flow loans and secondarily as loans collateralized by real estate. Generally, CRE lending involves larger principal amounts with repayment largely dependent on the successful operation of the property securing the loan or the business conducted on the collateralized property. CRE loans tend to be more adversely affected by conditions in the real estate markets or by general economic conditions.
The properties securing the CRE portfolio are diverse in terms of type and primary source of repayment. This diversity helps reduce our exposure to adverse economic events that affect any single industry. We monitor and evaluate CRE loans based on occupancy status (investor versus owner occupied), collateral, geography, and risk grade criteria.
Generally, CRE loans are made to developers and builders that are secured by non-owner occupied properties require the borrower to have had an existing relationship with the Company and a proven record of success. Construction loans are underwritten utilizing feasibility studies, sensitivity analysis of absorption and lease rates, and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of cost and value associated with the complete project (as-is value). These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment largely dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property, or an interim loan commitment from the Company until permanent financing is secured. These loans are closely monitored by on-site inspections, and are considered to have higher inherent risks than other CRE loans due to their ultimate repayment sensitivity to interest rate changes, governmental regulation of real property, general economic conditions, and the availability of long-term financing.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Residential Real Estate Loans – We do not originate consumer real estate mortgage loans. The majority of our loans secured by non owner occupied residential real estate are made either as part of a commercial relationship and subject to similar underwriting standards and processes as the CRE portfolio, or loans that were purchased in a prior year as part of a pool of loans. Purchased loan pools are evaluated based on risk characteristics established for each segmented group of loans. These characteristics include a significant emphasis on historical losses within each loan group, inherent risks for each, and specific loan class characteristics such as trends related to nonaccrual loans, past due loans, criticized loans, net charge-offs or recoveries, among other relevant credit risk factors. Residential equity lines of credit are included in the discussion of consumer loans below.
We originate some single-family residence construction loans. The loan amounts are no greater than $1 million and are short-term real estate secured financing for the construction of a single-family residence to be occupied by the owner. The loans have a draw down feature with interest only payments, and a balloon payment at the 12-month maturity. All of these loans are refinanced and paid-off by the borrower’s permanent mortgage lender who provided the initial pre-approved mortgage financing. These loans are underwritten utilizing financial analysis of the borrower and are generally based upon estimates of cost and value associated with the complete project (as-is value). These estimates may be inaccurate. The loan disbursement and monitoring process is controlled utilizing similar processes as our CRE construction loans.
Consumer Loans – Our consumer loan originations are generally limited to home equity loans with nominal originations in unsecured personal loans. The portfolio also includes unsecured consumer home improvement loans and residential solar panel loans secured by UCC filings. We are highly dependent on third party credit scoring analysis to supplement the internal underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by management and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time, and documentation requirements.
Concentrations of Credit Risks
As of December 31, 2020, approximately 77% of our gross loan portfolio (86% excluding PPP loans) is secured by real estate, and a significant decline in real estate market values may require an increase in the ALLL. Deterioration in economic conditions particularly in our markets may adversely affect our loan portfolio and may lead to additional charges to the provision for loan and lease losses.
Credit review
Confirmation of the quality of our loan grading process is obtained by independent reviews conducted by outside consultants specifically hired for this purpose and by periodic examination by various bank regulatory agencies. We maintain an independent loan review program that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to the Board of Directors, Loan Committee and Audit Committee. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as our policies and procedures.
Reserve For Unfunded Commitments
The reserve for unfunded commitments, which is included in Other Liabilities in the Consolidated Balance Sheets, was $800 thousand and $695 thousand at December 31, 2020 and December 31, 2019, respectively. The adequacy of the reserve for unfunded commitments is reviewed on a quarterly basis. Based upon changes in the amount of commitments, loss experience, and economic conditions we recorded $105 thousand of provision expense for the year ended December 31, 2020. The provision expense is recorded in other noninterest expense in the Consolidated Statements of Income.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 6. PREMISES AND EQUIPMENT
The following table presents the major components of premises and equipment at December 31, 2020 and 2019.
(Amounts in thousands) | | 2020 | | | 2019 | |
Premises and Equipment: | | | | | | | | |
Land | | $ | 2,523 | | | $ | 2,523 | |
Land improvements | | | 252 | | | | 243 | |
Bank buildings | | | 15,176 | | | | 15,222 | |
Furniture, fixtures and equipment | | | 14,129 | | | | 13,341 | |
Assets not yet placed in service | | | 34 | | | | 860 | |
Total premises and equipment | | | 32,114 | | | | 32,189 | |
Less: accumulated depreciation and amortization | | | (17,115 | ) | | | (16,283 | ) |
Premises and equipment, net | | $ | 14,999 | | | $ | 15,906 | |
We record depreciation expense on a straight-line basis for all depreciable assets. Depreciation expense totaled $1.2 million and $1.4 million for the years ended December 31, 2020 and 2019, respectively. We have entered into a number of non-cancelable lease agreements with respect to various premises. See Note 12, Leases in these Notes to Consolidated Financial Statements for minimum annual rental commitments under non-cancelable lease agreements.
NOTE 7. GOODWILL AND OTHER INTANGIBLES
Goodwill and other intangibles, net consisted of the following at December 31, 2020 and 2019.
(Amounts in thousands) | | 2020 | | | 2019 | |
Goodwill and Other Intangibles: | | | | | | | | |
Goodwill | | $ | 11,671 | | | $ | 11,671 | |
Core deposit intangibles | | | 6,125 | | | | 6,125 | |
Domain name | | | 32 | | | | 32 | |
Accumulated amortization | | | (2,113 | ) | | | (1,348 | ) |
Goodwill and other intangibles, net | | $ | 15,715 | | | $ | 16,480 | |
Goodwill
Goodwill results from a business combination, and is calculated as the amount of consideration paid in excess of the fair value of the net assets acquired in a transaction. Goodwill is considered to have an indefinite life and is therefore not amortized. It is reviewed annually for impairment, or more frequently if required by circumstances known as triggering events. At December 31, 2020, goodwill totaled $11.7 million. The Company used a third party valuation specialist to assist management in performing a quantitative test to assess goodwill for impairment during the fourth quarter of 2020. A goodwill impairment was not indicated.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Core Deposit Intangibles
Acquired core deposits provide value as a source of below market rate funds and the realization of interest cost savings is a fundamental rationale for assuming these deposit liabilities. The cost savings is defined as the difference between the cost of funds on our new deposits (i.e., interest and net maintenance costs) and the cost of an equal amount of funds from an alternative source having a similar term as the new deposit base. Our core deposit intangibles were recorded at fair value which was derived using the income approach and represent the present value of the cost savings over the projected term of our new deposit base. The core deposit intangible is being amortized on a straight-line basis over an estimated eight-year life, and is evaluated annually for impairment.
The following table sets forth, as of December 31, 2020, the total estimated future amortization of intangible assets:
(Amounts in thousands) | | Amount | |
Amortization: | | | | |
2021 | | $ | 766 | |
2022 | | | 766 | |
2023 | | | 766 | |
2024 | | | 581 | |
2025 | | | 544 | |
2026 and thereafter | | | 589 | |
Total | | $ | 4,012 | |
NOTE 8. OTHER ASSETS
Other assets consist of the following at December 31, 2020 and 2019.
(Amounts in thousands) | | 2020 | | | 2019 | |
Other Assets: | | | | | | | | |
FHLB stock | | $ | 7,380 | | | $ | 7,380 | |
Interest receivable | | | 7,279 | | | | 4,678 | |
Qualified Zone Academy Bonds | | | 4,740 | | | | 4,740 | |
Investment in LIHTC partnerships | | | 2,927 | | | | 2,529 | |
Right-of-use leases | | | 2,547 | | | | 3,464 | |
Prepaid expenses | | | 1,157 | | | | 991 | |
Investment in CRA fund | | | 1,085 | | | | 1,066 | |
Income tax receivable | | | 0 | | | | 1,925 | |
Other | | | 1,048 | | | | 1,815 | |
Total | | $ | 28,163 | | | $ | 28,588 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 9. INTEREST-BEARING DEPOSITS
The following table presents the major types of interest-bearing deposits at December 31, 2020 and 2019.
| | | As of December 31, | |
(Amounts in thousands) | | 2020 | | | 2019 | |
Interest-bearing deposits: | | | | | | | | |
Interest-bearing demand | | $ | 290,251 | | | $ | 239,258 | |
Money market | | | 425,121 | | | | 307,559 | |
Savings | | | 150,695 | | | | 135,888 | |
Certificates of deposit, less than $250,000 | | | 78,217 | | | | 82,769 | |
Certificates of deposit, $250,000 and over | | | 57,462 | | | | 69,017 | |
Total interest-bearing deposits | | $ | 1,001,746 | | | $ | 834,491 | |
The following table presents interest expense for the major types of interest-bearing deposits for the years ended December 31, 2020 and 2019.
| | | For the year ended December 31, | |
(Amounts in thousands) | | 2020 | | | 2019 | |
Deposit Interest Expense: | | | | | | | | |
Interest-bearing demand | | $ | 313 | | | $ | 480 | |
Money market | | | 1,246 | | | | 1,599 | |
Savings | | | 340 | | | | 493 | |
Certificates of deposit, less than $250,000 | | | 805 | | | | 1,127 | |
Certificates of deposit, $250,000 and over | | | 936 | | | | 850 | |
Total interest expense | | $ | 3,640 | | | $ | 4,549 | |
The following table presents the scheduled maturities of all certificates of deposit as of December 31, 2020.
(Amounts in thousands) | | Amount | |
Due in: | | | | |
2021 | | $ | 89,413 | |
2022 | | | 21,113 | |
2023 | | | 15,451 | |
2024 | | | 3,988 | |
2025 | | | 5,446 | |
Thereafter | | | 268 | |
Total certificates of deposit | | $ | 135,679 | |
The following table presents the scheduled maturities of certificates of deposit of $250 thousand or more as of December 31, 2020.
(Amounts in thousands) | | Amount | |
Due in: | | | | |
Three months or less | | $ | 10,682 | |
Over three months through six months | | | 7,457 | |
Over six months through twelve months | | | 16,795 | |
Over twelve months | | | 22,528 | |
Total certificates of deposit of $250 thousand or more | | $ | 57,462 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 10. TERM DEBT
Term debt at December 31, 2020 and 2019 consisted of the following.
(Amounts in thousands) | | 2020 | | | 2019 | |
Term Debt: | | | | | | | | |
FHLB borrowings | | $ | 5,000 | | | $ | 0 | |
Subordinated debt | | | 10,000 | | | | 10,000 | |
Unamortized debt issuance costs | | | 0 | | | | (43 | ) |
Net term debt | | $ | 15,000 | | | $ | 9,957 | |
Future contractual maturities of term debt at December 31, 2020 are as follows.
(Amounts in thousands) | | 2021 | | | 2022 | | | 2023 | | | 2024 | | | 2025 | | | Thereafter | | | Total | |
Future Maturities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
FHLB borrowings | | $ | 5,000 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 5,000 | |
Subordinated debt | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 10,000 | | | | 0 | | | | 10,000 | |
Total future maturities | | $ | 5,000 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 10,000 | | | $ | 0 | | | $ | 15,000 | |
Federal Home Loan Bank of San Francisco Borrowings
We have an available line of credit with the FHLB of $370.2 million subject to certain collateral requirements, namely the amount of pledged loans and investment securities. The line of credit is secured by an investment in FHLB stock, certain real estate secured loans that have been specifically pledged to the FHLB pursuant to collateral requirements, and certain pledged securities held in the Bank’s investment securities portfolio.
The Bank had $5.0 million in borrowings from the FHLB at December 31, 2020. The borrowings are due in May of 2021 and bear no interest under a program offered by the FHLB during the second quarter of 2020 in response to COVID-19 liquidity concerns. There were no borrowings outstanding from the FHLB at December 31, 2019. The average balance outstanding on FHLB term advances during the years ended December 31, 2020 and 2019 was $8.3 million and $9.6 million, respectively. The maximum amount outstanding from the FHLB at any month end during each of the years ended December 31, 2020 and 2019 was $40.0 million.
As of December 31, 2020, the Bank was required to hold an investment in FHLB stock of $7.4 million recorded in Other Assets in the Consolidated Balance Sheets. Our investments in FHLB stock are restricted investment securities, carried at cost, evaluated for impairment, and excluded from securities accounted for under ASC Topic 320 and ASC Topic 321.
As of December 31, 2020, we have pledged $511.8 million of our commercial real estate and residential real estate loans and $29.5 million in securities as collateral for the line of credit with the FHLB.
Subordinated Debt
In December of 2015, the Holding Company issued $10.0 million in aggregate principal amount of fixed to floating rate Subordinated Notes due in 2025. The Subordinated Debt initially bore interest at a fixed rate of 6.88% per annum through December 19, 2020, payable semi-annually. Thereafter, interest on the Subordinated Debt will be paid at a variable rate equal to three month LIBOR plus 526 basis points, payable quarterly until the maturity date. In December of 2015, the Holding Company incurred subordinated debt issuance costs of $210 thousand, which were amortized over the initial five-year-term as additional interest expense.
The Subordinated Debt is subordinate and junior in right of payment to the prior payment in full of all existing and future claims of creditors and depositors of the Holding Company and its subsidiaries, whether now outstanding or subsequently created. The Subordinated Debt ranks equally with all other unsecured subordinated debt, except any which by its terms is expressly stated to be subordinated to the Subordinated Debt. The Subordinated Debt ranks senior to all preferred stock and common stock of the Holding Company and all future junior subordinated debt obligations. The Subordinated Debt is recorded as term debt on the Holding Company’s balance sheet; however, for regulatory purposes, it is treated as Tier 2 capital by the Holding Company.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
The Subordinated Debt will mature on December 10, 2025 but may be prepaid at the Holding Company’s option and with regulatory approval at any time on or after five years after the closing date or at any time upon certain events, such as a change in the regulatory capital treatment of the Subordinated Debt or the interest on the Subordinated Debt is no longer deductible by the Holding Company for United States federal income tax purposes.
Federal Funds
We have entered into nonbinding federal funds line of credit agreements with three financial institutions to support short-term liquidity needs. The lines totaled $75.0 million at December 31, 2020 and had interest rates ranging from 0.12% to 0.30%. Advances under the lines are subject to funds availability, continued borrower eligibility, and may have consecutive day usage restrictions. The credit arrangements are reviewed and renewed annually. At December 31, 2020 and 2019, we had 0 outstanding advances on any of the Bank’s federal funds lines of credit.
Federal Reserve Bank
We have an available line of credit with the Federal Reserve Bank totaling $6.5 million at December 31, 2020, subject to collateral requirements, namely the amount of pledged loans. At December 31, 2020 and 2019, we had 0 outstanding advances on our line of credit with the Federal Reserve Bank. As of December 31, 2020, we have pledged $11.7 million of our commercial loans as collateral for the credit line with the Federal Reserve Bank.
In April of 2020, we received approval from the Federal Reserve Bank to participate in the Paycheck Protection Program Liquidity Facility (“PPPLF”). The credit facility provides term funding for loans made under the PPP. Advances under the PPPLF are collateralized with PPP loans, bear a fixed rate of interest at 0.35% and are to be repaid as the underlying loans are paid down, forgiven, or sold to the SBA. Participating institutions receive preferential capital treatment for loans that are funded with this borrowing facility. To date, we have not utilized the liquidity available to us under the PPPLF and its associated beneficial capital treatment.
NOTE 11. JUNIOR SUBORDINATED DEBENTURES
The Company has one wholly-owned trust formed in 2005 to issue trust preferred securities and related common securities. The following table presents information about the Trust as of December 31, 2020 and 2019.
(Amounts in thousands) | | | | | | | | | | | | | |
| | | | | Issued | | | | Effective | | | | Redemption |
Trust Name | | Issue Date | | Amount | | Rate | | Rate | | Maturity Date | | Date |
Bank of Commerce Holdings Trust II | | July 29, 2005 | | $ | 10,310 | | Floating (1) | | (2) | | September 15, 2035 | | (3) |
(1) Contractual interest rate of junior subordinated debentures based on three month LIBOR plus 1.58% adjusted quarterly. |
(2) Effective rate as of December 31, 2020 and 2019 of 1.80% and 3.47%, respectively. |
(3) Redeemable at the Company’s option on any March 15, June 15, September 15, or December 15. |
The $10.3 million of junior subordinated debentures issued to Trust II as of December 31, 2020 and 2019, are reflected in the Consolidated Balance Sheets. The common stock issued by Trust II in the amount of $310 thousand is recorded in Other Assets in the Consolidated Balance Sheets, at December 31, 2020 and 2019. All of the debentures issued to Trust II, less the common stock of Trust II, qualified as Tier 1 capital as of December 31, 2020 and 2019, under guidance issued by the Federal Reserve Board.
NOTE 12. LEASES
We lease nine locations under non-cancelable operating leases. The leases contain various provisions for increases in rental rates based on predetermined escalation schedules. Substantially all of the leases include the option to extend or terminate the lease term one or more times following expiration of the initial term at a rental rate established in the lease. For leases where we are reasonably certain that we will exercise the option to renew the lease, we have recognized those options in our right-of-use lease asset and liability. We had no other (financing, short-term or variable) lease arrangements during the current period or the prior year.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
We have applied ASC Topic 842 as of January 1, 2019 and elected the practical expedients package for all of our leases. In accordance with the practical expedients package we were not required to reassess whether any expired or existing contracts are leases or contain leases. We were also not required to reassess the lease classification for existing or expired leases between operating and finance leases.
We have recorded a liability in Other Liabilities in our Consolidated Balance Sheets representing the present value of the remaining minimum lease payments and we have recorded an offsetting right-of-use asset in Other Assets in our Consolidated Balance Sheets. The present value calculation uses a discount rate, which is based on our incremental borrowing rate. The right-of-use asset was also reduced for amounts recognized under the previous accounting requirements. During the year ended December 31, 2020, we recorded $48 thousand in Other Liabilities and an offsetting right-of-use asset in Other Assets for an additional office space leased during the year. The table below presents information regarding our leases as of December 31, 2020 and 2019.
(Dollars in thousands) | | 2020 | | | 2019 | |
Leases: | | | | | | | | |
Right-of-use lease asset | | $ | 2,547 | | | $ | 3,464 | |
Lease liability | | $ | 2,848 | | | $ | 3,855 | |
Weighted Average Remaining Lease Term (in years) | | | 4.29 | | | | 5.54 | |
Weighted Average Discount Rate | | | 2.93 | % | | | 2.96 | % |
Lease expenses are recorded on a straight-line basis over the life of each lease. Lease expense and cash paid on leases are presented in the table below for the periods indicated.
| | | For the year ended December 31, | |
(Amounts in thousands) | | 2020 | | | 2019 | |
Leases: | | | | | | | | |
Operating lease expense | | $ | 856 | | | $ | 830 | |
Cash paid for operating leases | | $ | 950 | | | $ | 897 | |
The following table sets forth, as of December 31, 2020, the future minimum lease cash payments under non-cancelable operating leases and a reconciliation of the undiscounted cash flows to the operating lease liability.
(Amounts in thousands) | | Amount | |
Due in: | | | | |
2021 | | $ | 977 | |
2022 | | | 885 | |
2023 | | | 327 | |
2024 | | | 280 | |
2025 | | | 218 | |
Thereafter | | | 358 | |
Total undiscounted future minimum lease cash payments | | | 3,045 | |
Present value adjustment | | | (197 | ) |
Lease liability | | $ | 2,848 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
The following table shows supplemental disclosures of non-cash financing activities for the period presented below.
| | | For the year ended December 31, | |
(Amounts in thousands) | | 2020 | | | 2019 | |
Right-of-use lease asset recorded on new leases | | $ | 48 | | | $ | 267 | |
Right-of-use lease asset recorded on adoption of ASU No. 2016-02 | | $ | 0 | | | $ | 3,905 | |
Lease liability recorded on adoption of ASU No. 2016-02 | | $ | 0 | | | $ | 4,363 | |
Our election to utilize the practical expedients package did not result in the recognition of any additional leases, changes in lease terms, changes in classification or in the assessment of initial direct costs. ASC 842 was applied as a change in accounting principle and did not result in any adjustment to equity. The significant judgments made in applying the requirements in ASC Topic 842 is the determination of the incremental borrowing rate for the lease and determining the length of the lease beyond non-cancellable periods. We used the borrowing rates available under our existing line of credit with the FHLB for terms similar to the lease terms as our incremental borrowing rate. We recognize renewal periods beyond the non-cancellable term of the lease for periods when we are reasonably certain to exercise our option to extend the term of the lease.
NOTE 13. OTHER LIABILITIES
Other liabilities consist of the following at December 31, 2020 and 2019.
(Amounts in thousands) | | 2020 | | | 2019 | |
Other Liabilities: | | | | | | | | |
Salary continuation | | $ | 4,881 | | | $ | 4,691 | |
Deferred compensation – directors fees | | | 3,946 | | | | 3,873 | |
Leases | | | 2,848 | | | | 3,855 | |
Accrued employee incentives | | | 1,320 | | | | 967 | |
Delayed equity contributions - LIHTC partnerships | | | 1,319 | | | | 338 | |
Dividend payable on common stock | | | 1,000 | | | | 902 | |
Other | | | 2,849 | | | | 3,074 | |
Total | | $ | 18,163 | | | $ | 17,700 | |
NOTE 14. COMMITMENTS AND CONTINGENCIES
Financial Instruments with Off-Balance Sheet Risk
Our consolidated financial statements do not reflect various commitments and contingent liabilities that arise in the normal course of our business and involve elements of credit, liquidity, and interest rate risk. In the normal course of business, we are party to financial instruments with off-balance sheet credit risk to meet the financing needs of our customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. These instruments involve elements of credit and interest rate risk similar to the amounts recognized in the Consolidated Balance Sheets. The contract or notional amounts of these instruments reflect the extent of our involvement in particular classes of financial instruments.
The following table presents a summary of our commitments and contingent liabilities at December 31, 2020 and 2019.
(Amounts in thousands) | | 2020 | | | 2019 | |
Commitments: | | | | | | | | |
Commitments to extend credit | | $ | 259,980 | | | $ | 267,248 | |
Standby letters of credit | | | 4,423 | | | | 4,406 | |
Affordable housing grant sponsorships | | | 3,338 | | | | 3,338 | |
Access to housing and economic assistance for development grant sponsorships | | | 90 | | | | 110 | |
Total commitments and contingent liabilities | | $ | 267,831 | | | $ | 275,102 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
We were not required to perform on any financial guarantees for the years ended December 31, 2020 and 2019. At December 31, 2020, approximately $4.1 million of standby letters of credit expire within one year, and $322 thousand expire thereafter.
Affordable Housing Grant and Access to Housing and Economic Assistance for Development Grant Sponsorships
In fulfilling our CRA responsibilities, we are a sponsor for various nonprofit organizations that receive cash grants from the FHLB. Those grants require the nonprofit organization to comply with stipulated conditions of the grant over specified periods of time which typically vary from 10 to 15 years. If the nonprofit organization fails to comply, FHLB can require us to refund the amount of the grant to FHLB. To mitigate this contingent credit risk, our Credit Administration underwrites the financial strength of the nonprofit organization and reviews their systems of internal control to determine, as best as possible, that they will comply with the conditions of the grant.
Death Benefit Agreement
The Company has entered into agreements with certain employees to pay a cash benefit to designated beneficiaries following the death of the employee. The payment will be made only if, at the time of death, the deceased employee was employed by the Bank and the Bank owned a life insurance policy on the employee’s life. Depending on specific facts and circumstances, the payment amount can vary up to a maximum of $225 thousand per employee and may be taxable to the beneficiary. Neither the employee nor the designated beneficiaries have a claim against the Bank’s life insurance policy on the employee’s life.
Legal Proceedings
We are involved in various pending and threatened legal actions arising in the ordinary course of business and if necessary, we maintain reserves for losses from legal actions, which are both probable and estimable. In our opinion, the disposition of claims currently pending will not have a material adverse effect on our financial position or results of operations.
Concentrations of Credit Risk
We grant many loans collateralized by real estate. In our judgment, a concentration exists in real estate related loans, which represented approximately 77% of our gross loan portfolio (86% excluding PPP loans) and 83% of our gross loan portfolio at December 31, 2020 and December 31, 2019, respectively. We underwrite real estate loans in accordance with loan policies that set underwriting criteria, including property types, loan-to-value limits and minimum debt service coverage ratios. We employ a variety of real estate concentration risk management tools including monitoring of limits on concentration levels, limits by property type and geography, annual property reviews including site visits and portfolio stress testing.
Although we believe such concentrations have no more than the normal risk of collectability, a substantial decline in the economy in general, material increases in interest rates, changes in tax policies, tightening credit or refinancing markets, or a decline in real estate values in our principal market areas in particular, could have an adverse impact on the repayment of these loans. Business and personal incomes, cash flows from rental operations, proceeds from the sale of real property, or proceeds from refinancing, represent the primary sources of repayment for a majority of these loans.
We recognize the credit risks inherent in dealing with other depository institutions. Accordingly, to prevent excessive exposure to other depository institutions in aggregate or individually, we have established general standards for selecting correspondent banks as well as internal limits for allowable exposure to other depository institutions in aggregate or individually. In addition, we have an investment policy that sets forth limitations that apply to all investments with respect to credit rating and concentrations with an issuer.
NOTE 15. EMPLOYEE BENEFITS AND RETIREMENT PLANS
401(k) plan – In 1985, we adopted a profit sharing 401(k) plan for eligible employees to be funded out of the earnings of the Company. The employees’ contributions are limited to the maximum amount allowable under IRS Section 402(G). The Company’s safe harbor contributions include a matching contribution of 100% of the first 3% of salary deferred and 50% of the next 2% of salary deferred. We made matching contributions aggregating $659 thousand and $627 thousand for the years ended December 31, 2020 and 2019, respectively. Discretionary contributions are also permitted however, 0 discretionary contributions were made in 2019 or 2020.
Salary continuation plan – The Board of Directors has approved a Supplemental Executive Retirement Plan (SERP), which is a non-qualified executive benefit plan under which we agree to pay certain executives specified benefits in the future in return for material contributions to the continued growth, development, and business success of the Company.
Benefits under the SERP differ by participating executive and include a benefit generally payable commencing upon a qualifying termination of employment and a death benefit for the participants’ designated beneficiaries. Whole life insurance policies were purchased as an investment to provide for our contractual obligation to pay pre-retirement death benefits and to recover our cost of providing benefits. Under these policies, the executive is the insured, but we are the owner and beneficiary.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
The Company accrues the SERP benefits over the period from the effective date of the agreements until the executives’ expected final payment date. The accrued benefits approximate the present value of the benefits to be provided at retirement. SERP compensation expense totaled $437 thousand and $547 thousand for the years ended December 31, 2020 and 2019, respectively. As of December 31, 2020, and 2019, the vested benefit payable was $4.9 million and $4.7 million, respectively. We use the FTSE Pension Liability Index as a guideline to establish the discount rate used to calculate the present value of benefits.
During the first quarter of 2019 as part of our acquisition of Merchants Holding Company, we assumed an additional salary continuation liability of $968 thousand.
Directors deferred fee compensation – On December 19, 2013, the Board of Directors adopted a Directors Deferred Compensation Plan, which was amended and restated on February 20, 2018, (the “2013 Plan”) to replace the Directors Deferred Compensation Plan dated January 1, 1993 as amended (the “1993 Plan”). Both plans allow the eligible Director to voluntarily elect to defer some or all of his or her current fees in exchange for the Company’s promise to pay a deferred benefit. The deferred fees are credited with interest and the accrued liability is paid to the Director upon separation from service. Directors must stop the deferral of compensation once their total deferred benefit reaches $500 thousand.
The interest rate in the 2013 Plan is equal to the Bloomberg 20-year Investment Grade Financial Institutions Index (IGFII) rate (or a similar reference rate we select if that rate is not published) in effect on the interest accrual date, plus two percent. The 2013 Plan is only available to independent directors and, as a nonqualified deferred compensation plan, is not subject to nondiscrimination requirements applicable to qualified plans. No deferred compensation is payable to a director until separation from service, whereupon all such compensation, together with interest thereon, shall be paid in accordance with the terms of the respective plan in one lump sum or in installments if the Director made such an election.
Although deferrals under the 1993 Plan have ceased, the 1993 Plan remains in effect for all amounts previously deferred in the plan. The interest rate in the 1993 Plan is equal to the Wall Street Journal prime plus 3.00%, with an option to change to a fixed rate of 10%, at the Director’ election, immediately preceding separation of service.
Deferred compensation expense recorded in other noninterest expense totaled $284 thousand and $324 thousand for the years ended December 31, 2020 and 2019, respectively. As of December 31, 2020, and 2019, the vested benefit payable recorded in Other Liabilities in the Consolidated Balance Sheets was $3.9 million.
NOTE 16. SHAREHOLDERS’ EQUITY AND STOCK PLANS
During the fourth quarter of 2020, we announced a share repurchase program to repurchase up to 1.0 million shares of common stock over a period ending December 31, 2021. As of December 31, 2020, 0 shares have been repurchased under this program.
In late 2019, we announced a share repurchase program to repurchase 1.0 million common shares which was later increased to 1.5 million common shares. Between October of 2019 and April of 2020, all 1.5 million shares were repurchased at a total cost of $13.6 million including commissions, or an average of $9.11 per share.
On January 31, 2019, we issued 1,834,142 shares of common stock, and paid $15.3 million in cash as part of our acquisition of Merchants Holding Company at which date Merchants Holding Company shareholders held, in the aggregate, approximately 10% of our outstanding common stock. The acquisition added $190.2 million in deposits, $85.3 million in loans and $107.4 million in investment securities on January 31, 2019. See Note 21 Acquisition in these Notes to Consolidated Financial Statements for additional information on the acquisition.
Stock Plans – The Bank of Commerce Holdings 2019 Equity Incentive Plan (the “Plan”), was approved by the Holding Company’s shareholders on May 21, 2019 and replaced the Amended and Restated 2010 Equity Incentive Plan. The Plan provides for equity awards including options, stock appreciation rights, and restricted awards to employees and non-employee directors of the Company. Vesting may be accelerated in case of a participant’s death or disability, or in case of a change in control. At December 31, 2020, 395,755 common shares were available for future grants under the Plan.
We did not recognize any tax benefits from vesting of restricted stock during the year ended December 31, 2020. We recognized $9 thousand in tax benefits from vesting of restricted stock during the year ended December 31, 2019. Proceeds from exercise of stock options exercised were $52 thousand for the year ended December 31, 2019.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Stock Option Activity
The following tables summarize information about stock option activity for the years ended December 31, 2020, and 2019.
| | | | | | | | | | | Weighted Average | |
| | | Number | | | Weighted Average | | | Remaining | |
| | | of Shares | | | Exercise Price | | | Contractual Term | |
Options outstanding December 31, 2018 | | | 97,400 | | | $ | 5.02 | | | | 4.11 | |
Exercised | | | (11,000 | ) | | $ | 4.70 | | | | n/a | |
Options outstanding December 31, 2019 | | | 86,400 | | | $ | 5.06 | | | | 3.09 | |
Options outstanding December 31, 2020 | | | 86,400 | | | $ | 5.06 | | | | 2.09 | |
| | | | | | | | | | | | | |
Exercisable at December 31, 2019 | | | 86,400 | | | $ | 5.06 | | | | 3.09 | |
Exercisable at December 31, 2020 | | | 86,400 | | | $ | 5.06 | | | | 2.09 | |
There were no new stock options, stock option expense or unrecognized compensation costs related to stock options for the two years ended December 31, 2020. At December 31, 2020, all options are fully vested. The aggregate intrinsic value of the options outstanding at December 31, 2020 was $418 thousand and represents amount by which the fair value of the underlying stock exceeds the exercise price of the exercisable options.
Restricted Stock Activity
The following tables summarize information about unvested restricted shares and restricted shares granted for the years ended December 31, 2020 and 2019.
| | | | | | | Weighted Average | |
| | | Number | | | Value At | |
| | | of Shares | | | Date of Grant | |
Unvested restricted shares December 31, 2018 | | | 66,768 | | | $ | 10.50 | |
Granted | | | 57,292 | | | $ | 11.02 | |
Vested | | | (27,243 | ) | | $ | 11.14 | |
Forfeited | | | (5,096 | ) | | $ | 11.12 | |
Unvested restricted shares December 31, 2019 | | | 91,721 | | | $ | 10.91 | |
Granted | | | 96,145 | | | $ | 8.49 | |
Vested | | | (41,460 | ) | | $ | 10.67 | |
Forfeited | | | (11,396 | ) | | $ | 9.46 | |
Unvested restricted shares December 31, 2020 | | | 135,010 | | | $ | 9.39 | |
| | | For the Years Ended December 31, | |
(Amounts in thousands, except per share information) | | 2020 | | | 2019 | |
Restricted stock compensation expense | | $ | 459 | | | $ | 414 | |
Restricted stock awards weighted average grant date fair value per share | | $ | 8.49 | | | $ | 11.02 | |
| | | At December 31, | |
| | | 2020 | | | 2019 | |
Unrecognized compensation costs related to non-vested restricted stock payments | | $ | 895 | | | $ | 642 | |
Restricted shares vest over a three to five year service period. Unvested restricted shares have no dividend or voting rights. The unrecognized compensation costs for unvested restricted shares are expected to be recognized over a weighted average period of two years.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Stock Grant Activity
There were no shares granted as employee compensation for the year ended December 31, 2020. The following table summarizes information about shares granted as employee compensation for the year ended December 31, 2019. Stock grants are fully vested and expensed in the period awarded.
| | | | | | | | | | | Stock Grant | |
| | | Number | | | Weighted Average | | | Compensation | |
| | | of Shares | | | Grant Price | | | Expense | |
Shares granted during the year ended December 31, 2019 | | | 6,169 | | | $ | 11.04 | | | $ | 68,106 | |
Dividends
Presented below is a summary of cash dividends paid to common shareholders, recorded as a reduction of retained earnings. The holders of unvested restricted stock awards are not entitled to dividends on unvested shares. On December 16, 2020, we declared a cash dividend of $0.06 per share, payable on January 8, 2021 to shareholders of record at the close of business on December 29, 2020.
| | | For the Years Ended December 31, | |
(Amounts in thousands, except per share information) | | 2020 | | | 2019 | |
Cash dividends paid to common shareholders | | $ | 3,406 | | | $ | 3,189 | |
Cash dividends declared per common share | | $ | 0.21 | | | $ | 0.19 | |
The principal source of cash for the Holding Company is dividends received from the Bank. Our ability to pay cash dividends from the Holding Company to our common shareholders is dependent on having sufficient cash and satisfying various regulatory and contractual requirements and restrictions. The Federal Reserve Board generally prohibits a bank holding company from declaring or paying a cash dividend which would impose undue pressure on the capital of subsidiary banks or would be funded only through borrowing or other arrangements that might adversely affect a financial services holding company’s financial position. The Board of Governors of the Federal Reserve System policy is that a bank holding company should not continue its existing rate of cash dividends on its common stock unless its net income is sufficient to fully fund each dividend and its prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition.
We also have trust preferred securities and subordinated debt agreements with provisions that may impact our ability to pay dividends on our common stock to our common shareholders.
NOTE 17. REGULATORY CAPITAL
The Holding Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that if undertaken, could have a direct material effect on our Consolidated Financial Statements.
The capital amounts and the Bank’s prompt corrective action classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulation to ensure capital adequacy, require the Company and the Bank to maintain minimum amounts and ratios set forth in the following table as defined in the regulations. Management believes as of December 31, 2020 that the Company and the Bank met all capital adequacy requirements to which they are subject.
As of January 1, 2020 for certain qualifying institutions, the FDIC accepts compliance with a Community Bank Leverage Ratio in lieu of the Basel III capital requirements. We are a qualifying institution however, we have opted to continue reporting under the Basel III requirements. We can opt-in to the Community Bank Leverage Ratio at any time in the future.
As of December 31, 2020, the most recent notification from the FDIC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized”, an institution must maintain minimum ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank’s capital rating category.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
The Holding Company’s and the Bank’s actual capital amounts and ratios as of December 31, 2020 and 2019 are presented in the following table.
| | | | | | | | | | | FDIC PCA | | | BASEL III | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Minimum Capital | |
| | | | | | | | | | | Well | | | Minimum | | | | | | | Requirement | |
| | | | | | | | | | | Capitalized | | | Capital | | | Capital | | | plus Capital | |
| | | Capital | | | Actual | | | Requirement | | | Requirement | | | Conservation | | | Conservation Buffer | |
(Dollars in thousands) | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | | | Buffer | | | Amount | | | Ratio | |
At December 31, 2020: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Company | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Common equity tier 1 capital ratio | | $ | 155,542 | | | | 13.12 | % | | | n/a | | | | n/a | | | $ | 53,336 | | | | 4.50 | % | | | 2.50 | % | | $ | 82,967 | | | | 7.00 | % |
Tier 1 capital ratio | | $ | 165,542 | | | | 13.97 | % | | | n/a | | | | n/a | | | $ | 71,115 | | | | 6.00 | % | | | 2.50 | % | | $ | 100,746 | | | | 8.50 | % |
Total capital ratio | | $ | 190,393 | | | | 16.06 | % | | | n/a | | | | n/a | | | $ | 94,820 | | | | 8.00 | % | | | 2.50 | % | | $ | 124,451 | | | | 10.50 | % |
Tier 1 leverage ratio | | $ | 165,542 | | | | 9.46 | % | | | n/a | | | | n/a | | | $ | 70,019 | | | | 4.00 | % | | | n/a | | | $ | 70,019 | | | | 4.00 | % |
Bank | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Common equity tier 1 capital ratio | | $ | 172,612 | | | | 14.58 | % | | $ | 76,973 | | | | 6.50 | % | | $ | 53,289 | | | | 4.50 | % | | | 2.50 | % | | $ | 82,894 | | | | 7.00 | % |
Tier 1 capital ratio | | $ | 172,612 | | | | 14.58 | % | | $ | 94,736 | | | | 8.00 | % | | $ | 71,052 | | | | 6.00 | % | | | 2.50 | % | | $ | 100,657 | | | | 8.50 | % |
Total capital ratio | | $ | 187,450 | | | | 15.83 | % | | $ | 118,420 | | | | 10.00 | % | | $ | 94,736 | | | | 8.00 | % | | | 2.50 | % | | $ | 124,341 | | | | 10.50 | % |
Tier 1 leverage ratio | | $ | 172,612 | | | | 9.86 | % | | $ | 87,541 | | | | 5.00 | % | | $ | 70,033 | | | | 4.00 | % | | | n/a | | | $ | 70,033 | | | | 4.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
At December 31, 2019: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Company | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Common equity tier 1 capital ratio | | $ | 156,587 | | | | 13.19 | % | | | n/a | | | | n/a | | | $ | 53,409 | | | | 4.50 | % | | | 2.50 | % | | $ | 83,081 | | | | 7.00 | % |
Tier 1 capital ratio | | $ | 166,587 | | | | 14.04 | % | | | n/a | | | | n/a | | | $ | 71,212 | | | | 6.00 | % | | | 2.50 | % | | $ | 100,884 | | | | 8.50 | % |
Total capital ratio | | $ | 189,513 | | | | 15.97 | % | | | n/a | | | | n/a | | | $ | 94,949 | | | | 8.00 | % | | | 2.50 | % | | $ | 124,621 | | | | 10.50 | % |
Tier 1 leverage ratio | | $ | 166,587 | | | | 11.30 | % | | | n/a | | | | n/a | | | $ | 58,945 | | | | 4.00 | % | | | n/a | | | $ | 58,945 | | | | 4.00 | % |
Bank | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Common equity tier 1 capital ratio | | $ | 170,568 | | | | 14.39 | % | | $ | 77,072 | | | | 6.50 | % | | $ | 53,358 | | | | 4.50 | % | | | 2.50 | % | | $ | 83,001 | | | | 7.00 | % |
Tier 1 capital ratio | | $ | 170,568 | | | | 14.39 | % | | $ | 94,858 | | | | 8.00 | % | | $ | 71,144 | | | | 6.00 | % | | | 2.50 | % | | $ | 100,787 | | | | 8.50 | % |
Total capital ratio | | $ | 183,494 | | | | 15.48 | % | | $ | 118,573 | | | | 10.00 | % | | $ | 94,858 | | | | 8.00 | % | | | 2.50 | % | | $ | 124,502 | | | | 10.50 | % |
Tier 1 leverage ratio | | $ | 170,568 | | | | 11.58 | % | | $ | 73,646 | | | | 5.00 | % | | $ | 58,917 | | | | 4.00 | % | | | n/a | | | $ | 58,917 | | | | 4.00 | % |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 18. FAIR VALUES
The following tables present estimated fair values of our financial instruments as of December 31, 2020 and 2019, whether or not recognized or recorded at fair value in the Consolidated Balance Sheets. The table indicates the fair value hierarchy of the valuation techniques we utilized to determine such fair value. Non-financial assets and non-financial liabilities defined by the FASB ASC 820, Fair Value Measurement, such as Bank premises and equipment, deferred taxes and other liabilities are excluded from the table. In addition, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements of FASB ASC 825, Financial Instruments, such as bank-owned life insurance policies.
| | | Carrying | | | Fair Value Measurements Using | |
(Amounts in thousands) | | Amounts | | | Level 1 | | | Level 2 | | | Level 3 | |
December 31, 2020 | | | | | | | | | | | | | | | | |
Financial assets | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 106,986 | | | $ | 106,986 | | | $ | 0 | | | $ | 0 | |
Securities available-for-sale | | $ | 446,880 | | | $ | 0 | | | $ | 446,880 | | | $ | 0 | |
Net loans | | $ | 1,123,051 | | | $ | 0 | | | $ | 0 | | | $ | 1,138,095 | |
FHLB stock | | $ | 7,380 | | | $ | 7,380 | | | $ | 0 | | | $ | 0 | |
Financial liabilities | | | | | | | | | | | | | | | | |
Deposits | | $ | 1,542,779 | | | $ | 0 | | | $ | 1,544,009 | | | $ | 0 | |
Term debt | | $ | 15,000 | | | $ | 0 | | | $ | 15,536 | | | $ | 0 | |
Junior subordinated debenture | | $ | 10,310 | | | $ | 0 | | | $ | 10,552 | | | $ | 0 | |
| | | Carrying | | | Fair Value Measurements Using | |
(Amounts in thousands) | | Amounts | | | Level 1 | | | Level 2 | | | Level 3 | |
December 31, 2019 | | | | | | | | | | | | | | | | |
Financial assets | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 80,604 | | | $ | 80,604 | | | $ | 0 | | | $ | 0 | |
Securities available-for-sale | | $ | 286,950 | | | $ | 0 | | | $ | 286,950 | | | $ | 0 | |
Net loans | | $ | 1,022,834 | | | $ | 0 | | | $ | 0 | | | $ | 1,025,520 | |
FHLB stock | | $ | 7,380 | | | $ | 7,380 | | | $ | 0 | | | $ | 0 | |
Financial liabilities | | | | | | | | | | | | | | | | |
Deposits | | $ | 1,267,171 | | | $ | 0 | | | $ | 1,267,153 | | | $ | 0 | |
Term debt | | $ | 9,957 | | | $ | 0 | | | $ | 10,006 | | | $ | 0 | |
Junior subordinated debenture | | $ | 10,310 | | | $ | 0 | | | $ | 13,471 | | | $ | 0 | |
Fair Value Hierarchy
Level 1 valuations utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access.
Level 2 valuations utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 valuations include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 valuations are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
We maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. The following table presents the quantitative information used to fair value our net loans at December 31, 2020.
Quantitative Information about Level 3 Fair Value Measurements | | |
Unobservable Inputs | | Range (Weighted Average) | |
Probability of Default (PD) | | 0% | - | 100% | - (2.89%) | |
Loss Given Default (LGD) | | 0% | - | 75.53% | - (12.07%) | |
Prepayment Rate | | 0% | - | 27.77% | - (10.75%) | |
Discount Rate | | 1% | - | 9.8% | - (4.01%) | |
Recurring Items
Debt Securities – The available-for-sale securities amount in the recurring fair value table above represents securities that have been adjusted to their fair values. For these securities, we obtain fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions among other things. We have determined that the source of these fair values falls within Level 2 of the fair value hierarchy.
The following tables present information about our assets and liabilities measured at fair value on a recurring basis, and indicate the fair value hierarchy of the valuation techniques we utilized to determine such fair value, as of December 31, 2020 and December 31, 2019.
(Amounts in thousands) | | Fair Value at December 31, 2020 | |
Recurring Basis | | Total | | | Level 1 | | | Level 2 | | | Level 3 | |
Available-for-sale securities: | | | | | | | | | | | | | | | | |
U.S. government and agencies | | $ | 32,994 | | | $ | 0 | | | $ | 32,994 | | | $ | 0 | |
Obligations of state and political subdivisions | | | 108,366 | | | | 0 | | | | 108,366 | | | | 0 | |
Residential mortgage-backed securities and collateralized mortgage obligations | | | 240,478 | | | | 0 | | | | 240,478 | | | | 0 | |
Commercial mortgage-backed securities | | | 28,074 | | | | 0 | | | | 28,074 | | | | 0 | |
Other asset-backed securities | | | 36,968 | | | | 0 | | | | 36,968 | | | | 0 | |
Total assets measured at fair value | | $ | 446,880 | | | $ | 0 | | | $ | 446,880 | | | $ | 0 | |
(Amounts in thousands) | | Fair Value at December 31, 2019 | |
Recurring Basis | | Total | | | Level 1 | | | Level 2 | | | Level 3 | |
Available-for-sale securities: | | | | | | | | | | | | | | | | |
U.S. government and agencies | | $ | 38,733 | | | $ | 0 | | | $ | 38,733 | | | $ | 0 | |
Obligations of state and political subdivisions | | | 42,098 | | | | 0 | | | | 42,098 | | | | 0 | |
Residential mortgage-backed securities and collateralized mortgage obligations | | | 180,835 | | | | 0 | | | | 180,835 | | | | 0 | |
Corporate securities | | | 2,966 | | | | 0 | | | | 2,966 | | | | 0 | |
Commercial mortgage-backed securities | | | 19,307 | | | | 0 | | | | 19,307 | | | | 0 | |
Other asset-backed securities | | | 3,011 | | | | 0 | | | | 3,011 | | | | 0 | |
Total assets measured at fair value | | $ | 286,950 | | | $ | 0 | | | $ | 286,950 | | | $ | 0 | |
Transfers Between Fair Value Hierarchy Levels
Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstance that caused the transfer. There were no transfers between levels of the fair value hierarchy during the years ended December 31, 2020 or 2019.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Nonrecurring items
We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis. These adjustments to fair value generally result from the application of lower of cost or fair value accounting or write-downs of individual assets due to impairment.
Collateral Dependent Loans - The loan amounts below represent impaired, collateral dependent loans that have been adjusted to fair value during the respective reporting period. When we identify a collateral dependent loan as impaired, we measure the impairment using the current fair value of the collateral, less selling costs. Depending on the characteristics of a loan, the fair value of collateral is generally estimated by obtaining external appraisals. If we determine that the value of the impaired loan is less than the recorded investment in the loan, we recognize this impairment and adjust the carrying value of the loan to fair value through the ALLL. When the fair value of the collateral is based on an appraisal or other estimate and there is no observable market price, we record the impaired loan as nonrecurring Level 3 fair value. Impaired loan valuations are adjusted for estimated selling costs ranging from 8% to 10% based off the adjusted fair value of the property.
OREO - The OREO amounts below represent impaired real estate that has been adjusted to fair value during the respective reporting period. The loss represents impairments on OREO for fair value adjustments based on the fair value of the real estate. The determination of fair value is based on recent appraisals of the foreclosed properties, which take into account recent sales prices adjusted for unobservable inputs, such as opinions provided by local real estate brokers and other real estate experts. OREO fair values are adjusted for estimated selling costs of 52% based off the adjusted fair value of the property. We record OREO as a nonrecurring Level 3 fair value.
The following tables present information about our assets and liabilities at December 31, 2020 and December 31, 2019 measured at fair value on a nonrecurring basis for which a nonrecurring change in fair value has been recorded during the reporting period. The amounts disclosed below present the fair values at the time the nonrecurring fair value measurements were made, and not necessarily the fair values as of the date reported upon.
| | | Fair Value at December 31, 2020 | |
(Amounts in thousands) | | Total | | | Level 1 | | | Level 2 | | | Level 3 | |
Nonrecurring basis: | | | | | | | | | | | | | | | | |
Collateral dependent impaired loans | | $ | 2,755 | | | $ | 0 | | | $ | 0 | | | $ | 2,755 | |
Other real estate owned | | | 8 | | | | 0 | | | | 0 | | | | 8 | |
Total assets measured at fair value | | $ | 2,763 | | | $ | 0 | | | $ | 0 | | | $ | 2,763 | |
| | | Fair Value at December 31, 2019 | |
(Amounts in thousands) | | Total | | | Level 1 | | | Level 2 | | | Level 3 | |
Nonrecurring basis: | | | | | | | | | | | | | | | | |
Collateral dependent impaired loans | | $ | 33 | | | $ | 0 | | | $ | 0 | | | $ | 33 | |
Other real estate owned | | | 35 | | | | 0 | | | | 0 | | | | 35 | |
Total assets measured at fair value | | $ | 68 | | | $ | 0 | | | $ | 0 | | | $ | 68 | |
The following table presents the losses resulting from nonrecurring fair value adjustments for the years ended December 31, 2020 and 2019 related to assets outstanding at December 31, 2020 and 2019.
| | | December 31, | |
(Amounts in thousands) | | 2020 | | | 2019 | |
Fair value adjustments: | | | | | | | | |
Collateral dependent impaired loans | | $ | 463 | | | $ | 66 | |
Other real estate owned | | | 6 | | | | 43 | |
Total | | $ | 469 | | | $ | 109 | |
For the year ended December 31, 2020, collateral dependent impaired loans with a carrying value of $3.2 million were written down to their estimated fair value of $2.8 million resulting in a $463 thousand adjustment to the ALLL.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
For the year ended December 31, 2019, collateral dependent impaired loans with a carrying value of $99 thousand were written down to their estimated fair value of $33 thousand resulting in a $66 thousand adjustment to the ALLL.
For the year ended December 31, 2020, 1 loan with an aggregate carrying value of $14 thousand was written down to its estimated fair value of $8 thousand, resulting in a $6 thousand adjustment to the ALLL when the underlying property was transferred to OREO.
For the year ended December 31, 2019, 1 loan with an aggregate carrying value of $78 thousand was written down to its estimated fair value of $35 thousand, resulting in a $43 thousand adjustment to the ALLL when the underlying property was transferred to OREO.
Limitations
Fair value estimates are made at a specific point in time, based on relevant market information and other information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time, our entire holdings of a particular financial instrument. Because no market exists for a significant portion of our financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature, involve uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based only on current on and off-balance sheet financial instruments. Our fair value estimates do not include any adjustment for anticipated future business. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.
NOTE 19. INCOME TAXES
The following table presents components of income tax expense included in the Consolidated Statements of Income for each of the past two years.
(Amounts in thousands) | | Current | | | Deferred | | | Total | |
Income Taxes: | | | | | | | | | | | | |
Year ended December 31, 2020: | | | | | | | | | | | | |
Federal | | $ | 3,402 | | | $ | (946 | ) | | $ | 2,456 | |
State | | | 2,564 | | | | (506 | ) | | | 2,058 | |
LIHTC partnership amortization | | | 602 | | | | — | | | | 602 | |
Total | | $ | 6,568 | | | $ | (1,452 | ) | | $ | 5,116 | |
| | | | | | | | | | | | | |
Year ended December 31, 2019: | | | | | | | | | | | | |
Federal | | $ | 2,732 | | | $ | 47 | | | $ | 2,779 | |
State | | | 2,126 | | | | 107 | | | | 2,233 | |
LIHTC partnership amortization | | | 491 | | | | — | | | | 491 | |
Total | | $ | 5,349 | | | $ | 154 | | | $ | 5,503 | |
Our effective tax rate is calculated as our provision for income taxes divided by income before provision for income taxes. Income tax expense attributable to income before income taxes differed from the amounts computed by applying the U.S. federal income tax rate of 21% for 2020 and 2019 to income before income taxes.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
The following table presents a reconciliation of income taxes computed at the federal statutory rate to the actual effective rate for the years ended December 31, 2020 and 2019.
| | | 2020 | | | 2019 | |
Income tax at the federal statutory rate | | | 21.0 | % | | | 21.0 | % |
State franchise tax, net of federal tax benefit | | | 8.4 | % | | | 8.6 | % |
Amortization of LIHTC partnerships | | | 3.1 | % | | | 2.4 | % |
Officer life insurance | | | (0.6 | )% | | | (0.5 | )% |
Tax-exempt interest | | | (1.8 | )% | | | (1.3 | )% |
LIHTC partnership credits and benefits | | | (3.9 | )% | | | (3.5 | )% |
Other | | | 0.3 | % | | | 0.2 | % |
Effective tax rate | | | 26.5 | % | | | 26.9 | % |
The following table reflects the effects of temporary differences that give rise to the components of the net deferred tax asset as of December 31, 2020 and 2019.
(Amounts in thousands) | | 2020 | | | 2019 | |
Deferred tax assets: | | | | | | | | |
Allowance for loan and lease losses | | $ | 4,999 | | | $ | 3,616 | |
Deferred compensation plan and salary continuation plan | | | 2,802 | | | | 2,773 | |
Lease liability | | | 842 | | | | 1,024 | |
State franchise tax | | | 543 | | | | 457 | |
Acquisition costs | | | 274 | | | | 274 | |
Acquired loan fair value | | | 272 | | | | 494 | |
Interest received on non-accrual loans | | | 143 | | | | 92 | |
Other | | | 624 | | | | 700 | |
Total deferred tax assets | | | 10,499 | | | | 9,430 | |
| | | | | | | | | |
Deferred tax liabilities: | | | | | | | | |
Deferred loan origination costs and fees | | | (694 | ) | | | (568 | ) |
Lease asset | | | (753 | ) | | | (1,024 | ) |
Core deposit intangible | | | (979 | ) | | | (1,139 | ) |
Basis difference in fixed assets | | | (1,349 | ) | | | (1,336 | ) |
Unrealized gains on securities available-for-sale | | | (2,665 | ) | | | (582 | ) |
Other | | | (105 | ) | | | (228 | ) |
Total deferred tax liabilities | | | (6,545 | ) | | | (4,877 | ) |
| | | | | | | | | |
Net deferred tax asset | | $ | 3,954 | | | $ | 4,553 | |
We have not established a valuation allowance for deferred tax assets as management believes it is more likely than not that the deferred tax assets of $10.5 million and $9.4 million at December 31, 2020 and 2019, respectively will be realized through future reversals of existing taxable temporary differences. We further believe that future taxable income will be sufficient to realize the benefits of temporary deductible differences that cannot be realized through the future reversal of temporary taxable differences.
We have investments in Qualified Zone Academy Bonds (“QZAB”) of $4.7 million at December 31, 2020 and 2019 recorded in Other Assets in the Consolidated Balance Sheets. We also have investments in QZAB of $985 thousand and $1.0 million at December 31, 2020 and 2019, respectively, recorded in Securities available-for-sale in the Consolidated Balance Sheets. The investments provide funds for capital improvements at local schools and will be repaid at maturity in 2031, 2033 and 2046. In exchange for the investment, we receive a federal tax credit at a rate determined at the settlement of the investment by the US Treasury. We account for the benefit for these tax credit investments using the deferred cost reduction method.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
See Note 20 Low Income Housing Tax Credit Partnerships in these Notes to Consolidated Financial Statements, for further details on our affordable housing project investments.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted in response to the COVID-19 pandemic. The CARES Act, among other things, permits NOL carryovers and carrybacks to offset 100% of taxable income for taxable years beginning before 2021. In addition, the CARES Act allow NOLs incurring in 2018, 2019 and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. The Company has evaluated the impact of the CARES Act and determined that none of the changes would result in a material income tax benefit to the Company.
On December 27, 2020, the Consolidated Appropriations Act, 2021 was signed into law and extends several provisions of the CARES Act. As of December 31, 2020, the Company has determined that neither this Act nor changes to income tax laws or regulations in other jurisdictions have a significant impact on our effective tax rate.
We have no unrecognized tax benefits at December 31, 2020 or 2019.
We file income tax returns in the U.S. federal jurisdiction, and the State of California. Income tax returns filed are subject to examination by the U.S. federal and state income tax authorities. While no income tax returns are currently being examined, we are no longer subject to tax examination by tax authorities for years prior to fiscal year 2017 for federal tax returns and fiscal year 2016 for state and local tax returns.
NOTE 20. LOW INCOME HOUSING TAX CREDIT PARTNERSHIPS
We have invested in five separate Low Income Housing Tax Credit (“LIHTC”) partnerships, which provide the Company with CRA credit. Additionally, the investments in LIHTC partnerships provide us with tax credits and with operating loss tax benefits over an approximately 23-year period. The tax credits and the operating loss tax benefits that are generated by each of the properties are expected to exceed the total value of the investments we made and provide returns on the investments of between 2% and 6% over the lives of the investments.
Our investments in LIHTC partnerships totaled $2.9 million at December 31, 2020. These investments are recorded in Other Assets with a corresponding funding obligation of $1.3 million recorded in Other Liabilities in our Consolidated Balance Sheets. None of the original investments will be repaid. The investments in LIHTC partnerships are being accounted for using the proportional amortization method, under which we amortize the initial cost of an investment in proportion to the amount of the tax credits and other tax benefits received, and recognize the net investment performance in the Consolidated Statements of Income as a component of income tax expense. During the first quarter of 2020, we invested $1.0 million in an additional LIHTC partnership, Boston Capital.
The following tables present our original investment in LIHTC partnerships, the current recorded investment balance, and the unfunded liability balance of each investment at December 31, 2020 and 2019. In addition, the tables reflect the tax credits and tax benefits, amortization of the investment and the net impact to our income tax provision for the years ended December 31, 2020 and 2019.
| | | At December 31, 2020 | | | For the year ended December 31, 2020 | |
| | | Original | | | Current | | | Unfunded | | | Tax Credits | | | Amortization | | | Net | |
(Amounts in thousands) | | Investment | | | Recorded | | | Liability | | | and | | | of | | | Income Tax | |
LIHTC Partnerships: | | Commitment | | | Investment | | | Obligation | | | Benefits | | | Investments | | | Benefit | |
Raymond James California Housing Opportunities Fund II | | $ | 2,000 | | | $ | 676 | | | $ | 16 | | | $ | 191 | | | $ | 176 | | | $ | 15 | |
WNC Institutional Tax Credit Fund 38, L.P. | | | 1,000 | | | | 311 | | | | 0 | | | | 101 | | | | 90 | | | | 11 | |
Merritt Community Capital Corporation Fund XV, L.P. | | | 2,500 | | | | 841 | | | | 316 | | | | 213 | | | | 226 | | | | (13 | ) |
California Affordable Housing Fund | | | 2,454 | | | | 152 | | | | 0 | | | | 31 | | | | 57 | | | | (26 | ) |
Boston Capital | | | 1,000 | | | | 947 | | | | 987 | | | | 66 | | | | 53 | | | | 13 | |
Total | | $ | 8,954 | | | $ | 2,927 | | | $ | 1,319 | | | $ | 602 | | | $ | 602 | | | $ | 0 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
| | | At December 31, 2019 | | | For the year ended December 31, 2019 | |
| | | Original | | | Current | | | Unfunded | | | Tax Credits | | | Amortization | | | Net | |
(Amounts in thousands) | | Investment | | | Recorded | | | Liability | | | and | | | of | | | Income Tax | |
LIHTC Partnerships: | | Commitment | | | Investment | | | Obligation | | | Benefits | | | Investments | | | Benefit | |
Raymond James California Housing Opportunities Fund II | | $ | 2,000 | | | $ | 852 | | | $ | 22 | | | $ | 199 | | | $ | 170 | | | $ | 29 | |
WNC Institutional Tax Credit Fund 38, L.P. | | | 1,000 | | | | 400 | | | | 0 | | | | 108 | | | | 89 | | | | 19 | |
Merritt Community Capital Corporation Fund XV, L.P. | | | 2,500 | | | | 1,067 | | | | 316 | | | | 224 | | | | 203 | | | | 21 | |
California Affordable Housing Fund | | | 2,454 | | | | 210 | | | | 0 | | | | 25 | | | | 29 | | | | (4 | ) |
Total | | $ | 7,954 | | | $ | 2,529 | | | $ | 338 | | | $ | 556 | | | $ | 491 | | | $ | 65 | |
The following table presents our generated tax credits and tax benefits from investments in LIHTC partnerships for the years ended December 31, 2020 and 2019.
| | | For the Years Ended December 31, | |
| | | 2020 | | | 2019 | |
| | | Generated | | | Tax Benefits from | | | Generated | | | Tax Benefits from | |
(Amounts in thousands) | | Tax Credits | | | Taxable Losses | | | Tax Credits | | | Taxable Losses | |
LIHTC Partnerships: | | | | | | | | | | | | | | | | |
Raymond James California Housing Opportunities Fund II | | $ | 170 | | | $ | 21 | | | $ | 170 | | | $ | 29 | |
WNC Institutional Tax Credit Fund 38, L.P. | | | 88 | | | | 13 | | | | 93 | | | | 15 | |
Merritt Community Capital Corporation Fund XV, L.P. | | | 191 | | | | 22 | | | | 192 | | | | 32 | |
California Affordable Housing Fund | | | 0 | | | | 31 | | | | 0 | | | | 25 | |
Boston Capital | | | 46 | | | | 20 | | | | 0 | | | | 0 | |
Total | | $ | 495 | | | $ | 107 | | | $ | 455 | | | $ | 101 | |
The following table reflects the anticipated net income tax benefit and (expense) at December 31, 2020, that is expected to be recognized over the remaining lives of the investments.
(Amounts in thousands) | | | | | | | | | | | | | | | | | | | | | | | | |
LIHTC Partnerships: | | | | | | | | | | | | | | | | | | 2025 | | | | | |
Anticipated income tax benefit, less | | | | | | | | | | | | | | | | | | and | | | | | |
amortization of investments | | 2021 | | | 2022 | | | 2023 | | | 2024 | | | thereafter | | | Total | |
Raymond James California Housing Opportunities Fund II | | $ | 15 | | | $ | 14 | | | $ | 11 | | | $ | 6 | | | $ | 10 | | | $ | 56 | |
WNC Institutional Tax Credit Fund 38, L.P. | | | 10 | | | | 9 | | | | 8 | | | | 5 | | | | 6 | | | | 38 | |
Merritt Community Capital Corporation Fund XV, L.P. | | | (13 | ) | | | (13 | ) | | | (9 | ) | | | (2 | ) | | | (12 | ) | | | (49 | ) |
California Affordable Housing Fund | | | (11 | ) | | | (58 | ) | | | 0 | | | | 0 | | | | 0 | | | | (69 | ) |
Boston Capital | | | 23 | | | | 24 | | | | 23 | | | | 23 | | | | 148 | | | | 241 | |
Total income tax benefit, net | | $ | 24 | | | $ | (24 | ) | | $ | 33 | | | $ | 32 | | | $ | 152 | | | $ | 217 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 21. ACQUISITION
On January 31, 2019, we completed the acquisition of Merchants Holding Company, to extend our presence in the Sacramento marketplace. Merchants Holding Company, headquartered in Sacramento, California was the parent company of The Merchants National Bank of Sacramento (“Merchants National Bank of Sacramento”), a 97-year-old bank with approximately $211.7 million in assets as of January 31, 2019. Merchants National Bank of Sacramento operated one full service branch and one limited service branch in the Sacramento metropolitan area. In May of 2019, we successfully converted all of the computer records onto our core system.
We paid $15.3 million in cash and issued 1,834,142 shares of common stock to Merchants Holding Company shareholders who held, in the aggregate, approximately 10% of our outstanding common stock on January 31, 2019. One former member of the Merchants Holding Company board now serves on our board of directors. The acquisition, after fair value adjustments added $190.2 million in deposits, $107.4 million in investment securities and $85.3 million in loans to our Bank as of January 31, 2019.
The acquisition of Merchants Holding Company constituted a business combination and was accounted for using the acquisition method of accounting. The assets acquired and liabilities assumed, both tangible and intangible, were recorded at their fair values as of the acquisition date in accordance with ASC 805, Business Combinations. The Bank engaged third party specialists to assist in valuing certain assets, including investment securities, loans, real estate and the core deposit intangible that resulted from the acquisition. The acquisition was treated as a "reorganization" within the definition of section 368(a) of the Internal Revenue Code and is generally considered tax-free for U.S. federal income tax purposes.
The calculation of goodwill recorded during 2019 is detailed below.
| | | As Recorded by | | | Fair Value And | | | | | |
| | | Merchants | | | Other Acquisition | | | As Recorded by | |
(Amounts in thousands) | | Holding Company | | | Related Adjustments | | | the Company | |
Consideration paid: | | | | | | | | | | | | |
Cash | | | | | | | | | | $ | 15,300 | |
Stock 1,834,142 shares at $10.69 per share | | | | | | | | | | | 19,607 | |
Total consideration | | | | | | | | | | $ | 34,907 | |
| | | | | | | | | | | | | |
Assets acquired: | | | | | | | | | | | | |
Cash and fed funds sold | | $ | 12,425 | | | $ | — | | | $ | 12,425 | |
Investment securities | | | 107,931 | | | | (551 | ) | | | 107,380 | |
Loans, gross | | | 87,570 | | | | (2,292 | ) | | | 85,278 | |
Allowance for loan and lease losses | | | (1,286 | ) | | | 1,286 | | | | 0 | |
Interest receivable | | | 688 | | | | — | | | | 688 | |
Premises and equipment, net | | | 378 | | | | 1,856 | | | | 2,234 | |
Deferred tax assets, net | | | 1,374 | | | | (1,352 | ) | | | 22 | |
FHLB stock | | | 1,454 | | | | — | | | | 1,454 | |
Life insurance | | | 755 | | | | — | | | | 755 | |
Other assets | | | 371 | | | | 95 | | | | 466 | |
Core deposit intangible | | | 0 | | | | 4,353 | | | | 4,353 | |
Total assets acquired | | $ | 211,660 | | | $ | 3,395 | | | $ | 215,055 | |
| | | | | | | | | | | | | |
Liabilities assumed: | | | | | | | | | | | | |
Demand, money market and savings | | $ | 152,213 | | | $ | — | | | $ | 152,213 | |
Certificates of deposit | | | 38,003 | | | | — | | | | 38,003 | |
Total deposits | | | 190,216 | | | | — | | | | 190,216 | |
Other liabilities | | | 916 | | | | 22 | | | | 938 | |
Total liabilities assumed | | $ | 191,132 | | | $ | 22 | | | $ | 191,154 | |
Net identifiable assets acquired over liabilities assumed | | $ | 20,528 | | | $ | 3,373 | | | $ | 23,901 | |
Goodwill | | | | | | | | | | $ | 11,006 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Goodwill
As a result of the Merchants Holding Company acquisition, we recorded goodwill totaling $11.0 million. Goodwill reflects the expected value of Merchants Holding Company’s reputation in the community, stable customer base and expected synergies created through the combined operations with our Company and was calculated as the excess of the total purchase price paid over the fair value of the assets acquired, net of the fair value of liabilities assumed.
The following is a description of the methods used to determine the fair value of significant assets and liabilities whose fair values are different from their carrying amounts on Merchants Holding Company’s books at acquisition date presented above.
Investment Securities
Fair values for securities were obtained from an independent pricing service and were based on quoted market prices, where available. If quoted market prices were not available, fair value estimates were based on observable inputs including quoted market prices for similar instruments, quoted market prices that were not in an active market, other inputs that were observable in the market or a discounted cash flow model.
Loans
We engaged a third party to assist us in determining the fair values for the loans acquired from Merchants Holding Company based upon the present values of the expected cash flows and market-derived discount rates. There were no loans acquired with evidence of deterioration of credit quality since origination for which we believe it is probable that we will be unable to collect all contractually required payments receivable. A net fair value discount of $2.3 million was recorded for loans acquired in conjunction with our acquisition of Merchants Holding Company and is being accreted over the life of the loans as a yield adjustment. We recorded $753 thousand and $620 thousand in accretion of the net discount for these loans during the year ended December 31, 2020 and 2019, respectively.
Premises and Equipment
We engaged an independent licensed appraiser to determine the fair value of the acquired branch located in Sacramento. The fair value of tangible personal property was not material.
Deferred Tax Assets
Deferred income tax assets were recorded to reflect the difference between the carrying values of the acquired assets and liabilities for financial reporting purposes and the basis for income tax purposes using the Company’s statutory federal and state income tax rates. During 2019, the final tax returns were completed for Merchants Holding Company and the net deferred tax assets were adjusted to fair value.
Core Deposit Intangible
We engaged an independent third party to assist us in determining the core deposit intangible asset of $4.4 million associated with non-maturity deposits acquired from Merchants Holding Company. The core deposit intangible represents the estimated future benefits of acquired deposits and is booked separately from the related deposits. The value of the core deposit intangible asset was determined using a discounted cash flow approach to arrive at the cost differential between the core deposits (non-maturity deposits such as transaction, savings and money market accounts) and alternative funding sources. It was calculated as the present value of the difference in cash flows between maintaining the core deposits (interest and net maintenance costs) and the cost of an equal amount of funds with a similar term from an alternative source. The core deposit intangible is being amortized on a straight-line basis over an estimated eight-year life, and is evaluated annually for impairment. NaN impairment loss was recognized in 2020 or 2019. Core deposit intangible amortization from this acquisition is not deductible for tax purposes. We recorded amortization of the core deposit intangible totaling $544 thousand and $499 thousand during the year ended December 31, 2020 and 2019, respectively. The future estimated amortization expense on the CDI from the Merchants Holding Company’s acquisition at December 31, 2020 is as follows:
(Amounts in thousands) | | 2021 | | | 2022 | | | 2023 | | | 2024 | | | 2025 | | | Thereafter | | | Total | |
Core deposit intangible amortization | | $ | 544 | | | $ | 544 | | | $ | 544 | | | $ | 544 | | | $ | 544 | | | $ | 590 | | | $ | 3,310 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Pro Forma Results of Operations
The following table presents pro forma information of the combined entity as if the acquisition occurred on January 1, 2019. The pro forma information does not necessarily reflect the results of operations that would have resulted had the acquisition been completed at the beginning of the periods presented, nor is it indicative of the results of operations in future periods. Furthermore, cost savings and other business synergies related to the acquisition are not reflected in the pro forma amounts.
| | | For the Twelve Months Ended | |
| | | December 31, | |
(Amounts in thousands) | | 2019 | |
Pro forma revenue and earnings: | | | | |
Net interest income | | $ | 53,730 | |
Net income (1) | | $ | 14,924 | |
(1) Net income includes acquisition-related costs for both entities of $2.2 million for 2019. |
It is impracticable to separately provide information regarding the amount of revenue and earnings from Merchants Holding Company included in our Consolidated Statement of Income because the operations of Merchants Holding Company were substantially comingled with the operations of the Company as of the acquisition date.
NOTE 22. EARNINGS PER COMMON SHARE
The following table presents a computation of basic and diluted earnings per share for the years ended December 31, 2020 and 2019.
| | | For the Year Ended December 31, | |
(Amounts in thousands, except per share information) | | 2020 | | | 2019 | |
Earnings Per Share: | | | | | | | | |
Numerators: | | | | | | | | |
Net income | | $ | 14,164 | | | $ | 14,961 | |
Denominators: | | | | | | | | |
Weighted average number of common shares outstanding - basic (1) | | | 16,918 | | | | 17,956 | |
Effect of potentially dilutive common shares (2) | | | 45 | | | | 68 | |
Weighted average number of common shares outstanding - diluted | | | 16,963 | | | | 18,024 | |
Earnings per common share: | | | | | | | | |
Basic | | $ | 0.84 | | | $ | 0.83 | |
Diluted | | $ | 0.83 | | | $ | 0.83 | |
Anti-dilutive restricted shares not included in diluted earnings per share calculation | | | 39 | | | | 0 | |
(1) Excludes unvested restricted shares because they do not have dividend or voting rights. | |
(2) Represents the effects of the assumed exercise of stock options and vesting of non-participating restricted shares. | |
In late 2019, we announced a share repurchase program to repurchase 1.0 million common shares which was later increased to 1.5 million common shares. Between October of 2019 and April 2020, all 1.5 million shares were repurchased at a total cost of $13.6 million including commissions, or an average of $9.11 per share.
During the fourth quarter of 2020, we announced a share repurchase program to repurchase up to 1.0 million shares of common stock over a period ending December 31, 2021. As of December 31, 2020, 0 shares have been repurchased under this program.
NOTE 23. RELATED PARTY TRANSACTIONS
Some of the directors and executive officers (and their associated or affiliated companies) are customers of and have banking transactions with us in the ordinary course of our business and we expect to have such transactions in the future. All deposits, loans and commitments to fund loans included in such transactions were made in compliance with the applicable laws on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons of similar creditworthiness.
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
The following table presents a summary of aggregate activity involving related party borrowers for the years ended December 31, 2020 and 2019.
(Amounts in thousands) | | 2020 | | | 2019 | |
Related Party Loans: | | | | | | | | |
Balance at beginning of year | | $ | 3,767 | | | $ | 9,490 | |
New loan additions | | | 136 | | | | 3,513 | |
Advances on existing lines of credit | | | 1 | | | | 213 | |
Principal repayments | | | (1,308 | ) | | | (9,449 | ) |
Balance at end of year | | $ | 2,596 | �� | | $ | 3,767 | |
At December 31, 2020 and 2019, loan commitments to related parties totaled $9.1 million and $11.1 million, respectively. As of December 31, 2020 and 2019, 0 related party loans were past due or adversely classified. In our opinion, these transactions did not involve more than a normal risk of collectability or present other unfavorable terms. At December 31, 2020 and 2019, deposits of related parties amounted to $11.4 million and $12.0 million, respectively.
NOTE 24. PARENT COMPANY FINANCIAL STATEMENTS
Condensed Balance Sheets
Year ended December 31,
(Amounts in thousands) | | 2020 | | | 2019 | |
Assets: | | | | | | | | |
Cash | | $ | 3,859 | | | $ | 6,814 | |
Investment in: | | | | | | | | |
Merchants Bank of Commerce | | | 194,772 | | | | 188,459 | |
Bank of Commerce Mortgage | | | (64 | ) | | | (64 | ) |
Bank of Commerce Holdings Trust II | | | 310 | | | | 310 | |
Other assets | | | 380 | | | | 423 | |
Total Assets | | $ | 199,257 | | | $ | 195,942 | |
| | | | | | | | | |
Liabilities and shareholders' equity: | | | | | | | | |
Term debt: | | | | | | | | |
Subordinated debt, net | | $ | 10,000 | | | $ | 9,957 | |
Junior subordinated debentures | | | 10,310 | | | | 10,310 | |
Other liabilities | | | 1,245 | | | | 1,197 | |
Total liabilities | | | 21,555 | | | | 21,464 | |
Shareholders’ equity | | | 177,702 | | | | 174,478 | |
Total Liabilities and Shareholders’ Equity | | $ | 199,257 | | | $ | 195,942 | |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Condensed Statements of Income
Year Ended December 31,
(Amounts in thousands) | | 2020 | | | 2019 | |
Income: | | | | | | | | |
Other income | | $ | 8 | | | $ | 13 | |
Dividends from subsidiaries | | | 15,000 | | | | 12,500 | |
Total income | | | 15,008 | | | | 12,513 | |
Expenses: | | | | | | | | |
Management fees paid to subsidiaries | | | 297 | | | | 310 | |
Interest expense | | | 979 | | | | 1,233 | |
Noninterest expense | | | 663 | | | | 844 | |
Total expenses | | | 1,939 | | | | 2,387 | |
| | | | | | | | | |
Income before income taxes and equity in undistributed net income of subsidiaries | | | 13,069 | | | | 10,126 | |
Income tax expense (1) | | | 1 | | | | 1 | |
Income before equity in undistributed net income of subsidiaries | | | 13,068 | | | | 10,125 | |
Equity in undistributed net income of subsidiaries | | | 1,096 | | | | 4,836 | |
Net income | | $ | 14,164 | | | $ | 14,961 | |
(1) The Company has elected to record all income tax expense and benefit at the bank level. |
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Consolidated Financial Statements
Condensed Statements of Cash Flows
Year Ended December 31,
(Amounts in thousands) | | 2020 | | | 2019 | |
Cash flows from operating activities: | | | | | | | | |
Net income | | $ | 14,164 | | | $ | 14,961 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | |
Equity in undistributed net income of subsidiaries | | | (1,096 | ) | | | (4,836 | ) |
Amortization of debt issuance costs | | | 43 | | | | 48 | |
Provision for depreciation and amortization | | | 17 | | | | 18 | |
Decrease in other assets | | | 26 | | | | 13 | |
Decrease in other liabilities | | | (50 | ) | | | (164 | ) |
Net cash provided by operating activities | | | 13,104 | | | | 10,040 | |
| | | | | | | | | |
Cash flows from investing activities: | | | | | | | | |
Cash received from acquisition of Merchants Holding Company | | | 0 | | | | 292 | |
Cash paid for acquisition of Merchants Holding Company | | | 0 | | | | (15,300 | ) |
Net cash used in investing activities | | | 0 | | | | (15,008 | ) |
| | | | | | | | | |
Cash flows from financing activities: | | | | | | | | |
Repayment of term debt | | | 0 | | | | (3,496 | ) |
Repurchase of common stock | | | (12,653 | ) | | | (1,010 | ) |
Cash dividends paid on common stock | | | (3,406 | ) | | | (3,189 | ) |
Proceeds from stock options exercised | | | 0 | | | | 52 | |
Net cash used in financing activities | | | (16,059 | ) | | | (7,643 | ) |
Net decrease in cash and cash equivalents | | | (2,955 | ) | | | (12,611 | ) |
Cash and cash equivalents at the beginning of year | | | 6,814 | | | | 19,425 | |
Cash and cash equivalents at the end of year | | $ | 3,859 | | | $ | 6,814 | |
| | | | | | | | | |
Supplemental disclosures of non-cash financing activities: | | | | | | | | |
Stock compensation grants | | $ | 0 | | | $ | 58 | |
Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
There have been no changes in or disagreements with accountants or auditors on accounting and financial disclosure.
Item 9A - Controls and Procedures
Disclosure Controls and Procedures
As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including its President and Chief Executive Officer and its Chief Financial Officer, of the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based on that evaluation, the President and Chief Executive Officer and the Chief Financial Officer concluded that these disclosure controls and procedures were effective.
Disclosure controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving an entity’s disclosure objectives. The likelihood of achieving such objectives is affected by limitations inherent in disclosure controls and procedures. These include the fact that human judgment in decision-making can be faulty and that breakdowns in internal controls can occur because of human failures such as simple errors, mistakes or intentional circumvention of the established processes.
Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the Company’s Chief Executive Officer and the Chief Financial Officer and implemented by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America.
The Company’s internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
On a quarterly basis, we carry out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Principal Financial Officer (whom is also our Principal Accounting Officer) of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934. As of December 31, 2020, our management, including our Chief Executive Officer, and Principal Financial Officer, concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us that is required to be included in our periodic SEC filings.
Although we change and improve our internal controls over financial reporting on an ongoing basis, we do not believe that any such changes occurred in the fourth quarter of 2020 that materially affected or are reasonably likely to materially affect our internal control over financial reporting.
This annual report includes an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting.
Item 9B - Other Information
None to report.
Part III
Item 10 - Directors, Executive Officers and Corporate Governance
The response to this item is incorporated by reference to Bank of Commerce Holdings Proxy Statement for the 2021 Annual Meeting of shareholders (the “Proxy Statement”) under the captions “Information about the Director Nominees”, “Director Qualifications and Nominations for Directors”, “The Board and Governance Matters”, “Committees of the Board of Directors”, “Report of the Audit and Qualified Legal Compliance Committee”, “Director Independence, Certain Relationships and Related Transactions”, “Named Executive Officers of the Company”, “Delinquent Section 16(a) Reports”, “Voting Securities and Ownership of Certain Beneficial Holders”, and “Code of Conduct, Code of Ethics, and Corporate Governance Documents”.
Item 11 - Executive Compensation
The response to this item is incorporated by reference to the Proxy Statement, under the captions “Compensation Discussion and Analysis”, “Executive Compensation”, “Report of the Executive Compensation Committee on Executive Compensation”, and “Director Compensation”.
Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
The response to this item is incorporated by reference to the Proxy Statement, under the caption “Voting Securities and Ownership of Certain Beneficial Holders”.
Item 13 - Certain Relationships and Related Transactions and Director Independence
The response to this item is incorporated by reference to the Proxy Statement, under the caption “Certain Relationships and Related Transactions”.
Item 14 - Principal Accounting Fees and Services
The response to this item is incorporated by reference to the Proxy Statement, under the caption “Report of the Audit and Qualified Legal Compliance Committee.”
Part IV
Item 15 - Exhibits and Financial Statement Schedules
(a) The following documents are filed as a part of this Form 10-K:
(1) Financial Statements:
Reference is made to the Index to Consolidated Financial Statements under Item 8 in Part II of this Form 10-K.
(2) Financial Statement Schedules:
All schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
(3) Exhibits:
10.10* | Bank of Commerce Holdings 2019 Equity Incentive Plan | 8-K | 000-25135 | 10.1 | 5/23/2019 | |
10.11* | Form of Restricted Stock Agreement for 2019 Equity Incentive Plan | 10-K | 000-25135 | 10.11 | 3/6/2020 | |
10.12* | Amended and Restated Salary Continuation Agreement with Randall S. Eslick, dated November 19, 2013 | 10-K | 000-25135 | 10.10 | 3/11/2014 | |
10.13* | Salary Continuation Agreement with Robert H. Muttera, dated January 17, 2014 | 10-K | 000-25135 | 10.18 | 3/11/2014 | |
10.14* | Amendment to the Salary Continuation Agreements | 10-Q | 000-25135 | 10.1 | 4/28/2017 | |
10.15* | Amended and Restated Employment Agreement with Randall S. Eslick dated February 21, 2017. | 10-K | 000-25135 | 10.20 | 3/15/2017 | |
10.16* | Amended and Restated Employment Agreement with James A. Sundquist dated February 21, 2017. | 10-K | 000-25135 | 10-21 | 3/15/2017 | |
10.17* | Amended and Restated Employment Agreement with Robert H. Muttera dated February 21, 2017. | 10-K | 000-25135 | 10-23 | 3/15/2017 | |
10.18* | Amendment to Amended and Restated Employment Agreement with Randall S. Eslick dated May 3, 2018 | 10-Q | 000-2513 | 10.1 | 5/4/2018 | |
10.19* | Amendment to Amended and Restated Employment Agreement with James A. Sundquist dated May 3, 2018 | 10-Q | 000-2513 | 10.2 | 5/4/2018 | |
10.20* | Amendment to Amended and Restated Employment Agreement with Robert H. Muttera dated May 3, 2018 | 10-Q | 000-2513 | 10.4 | 5/4/2018 | |
10.21* | Second Amendment to Employment Agreement with Randall S. Eslick dated March 6, 2020 | 10-K | 000-25135 | 10.21 | 3/6/2020 | |
10.22* | Second Amendment to Employment Agreement with James A. Sundquist dated March 6, 2020 | 10-K | 000-25135 | 10.22 | 3/6/2020 | |
10.23* | Second Amendment to Employment Agreement with Robert H. Muttera dated March 6, 2020 | 10-K | 000-25135 | 10.23 | 3/6/2020 | |
10.24* | Severance and Release Agreement with Samuel D. Jimenez effective January 28, 2020 | 10-K | 000-25135 | 10.24 | 3/6/2020 | |
10.25* | Form of Indemnification Agreement | 8-K | 000-2513 | 10.1 | 12/20/2017 | |
10.26* | Employment Agreement amongst Bank of Commerce Holdings, Merchants Bank of Commerce, and Carl W. Rood, dated August 1, 2020 | 8-K | 000-25135 | 10.1 | 7/22/2020 | |
10.27 | Subordinated Note Purchase Agreement between Bank of Commerce Holdings and The Purchasers Named Herein, dated December 10, 2015 | 8-K | 000-2513 | 10.3 | 12/14/2015 | |
Item 16 – Form 10-K Summary
None.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 5, 2021.
| | BANK OF COMMERCE HOLDINGS |
| | | |
| | By | /s/ Randall S. Eslick |
| | | Randall S. Eslick |
| | | President and Chief Executive Officer |
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Randall S. Eslick and James A. Sundquist, and each of them, his true and lawful attorneys-in-fact, each with full power of substitution, for him in any and all capacities, to sign any amendments to this report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact or their substitute or substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.
| | | | | |
| | | | | |
Name | | Title | | Date |
| | | | | |
/s/ Randall S. Eslick | | President and Chief Executive Officer | | March 5, 2021 |
| | | | | |
/s/ James A. Sundquist | | Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer) | | March 5, 2021 |
| | | | | |
/s/ Lyle L. Tullis | | Chairman of the Board | | March 5, 2021 |
| | | | | |
/s/ Orin N. Bennett | | Director | | March 5, 2021 |
| | | | | |
/s/ Gary R. Burks | | Director | | March 5, 2021 |
| | | | | |
/s/ Joseph Q. Gibson | | Director | | March 5, 2021 |
| | | | | |
/s/ Jon W. Halfhide | | Director | | March 5, 2021 |
| | | | | |
/s/ David J. Inderkum | | Director | | March 5, 2021 |
| | | | | |
/s/ Linda J. Miles | | Director | | March 5, 2021 |
| | | | | |
/s/ Karl L. Silberstein | | Director | | March 5, 2021 |
| | | | | |
/s/ Terence J. Street | | Director | | March 5, 2021 |
