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Bank of Commerce (BOCH)

Filed: 6 Mar 20, 3:42pm
 

 

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, 2019

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference to Part III of this Form 10-K or any amendment to this Form 10-K. ☒

 

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. (Check one).

 

Large accelerated filer ☐

Accelerated filer☒

Non-accelerated filer ☐

Smaller Reporting Company☒

Emerging growth company ☐

 

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

 

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

 

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 2019, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $183,709,927 based on the closing sale price of $10.69 as reported on the NASDAQ Global Market as of June 30, 2019.

 

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 25, 2020 was 17,756,658.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Proxy Statement of the registrant for its 2020 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
 
 

 

 
 

 

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;

Our failure to realize all of the anticipated benefits of our acquisition of Merchants Holding Company;

Our inability to successfully manage our growth or implement our growth strategy;

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;

Volatility in the capital or credit markets;

Changes in the financial performance and/or condition of our borrowers;

Our concentration in real estate lending;

Developments and changes in laws and 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 Business Oversight;

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;

The timely development of competitive new products and services and the acceptance of these products and services by new and existing customers;

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 raise additional capital;

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;

Consolidation in the financial services industry in the Company's markets resulting in the creation of larger financial institutions that may have greater resources could change the competitive landscape and the influx of fintech companies competing for business;

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;

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

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.

 

2

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

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

 

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

 

On January 31, 2019, we completed the acquisition of Merchants Holding Company (“Merchants”), to extend our presence in the Sacramento marketplace. Merchants, headquartered in Sacramento, California, was the parent company of The Merchants National Bank of Sacramento (“Merchants Bank”), a 97-year-old bank with approximately $211.7 million in assets as of January 31, 2019. See Note 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, depth and knowledge of our management team represent one of our greatest strengths and competitive advantages.

 

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

 

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

 

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

 

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

 

Principal Market

 

We operate under the name Merchants Bank of Commerce in northern California from Sacramento to Yreka along the Interstate 5 corridor.

 

Principal Products and Services

 

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

 

3

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

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.

 

Regulatory Capital

 

Our regulators measure our capital adequacy and compliance with minimum leverage ratio guidelines. As of December 31, 2019, the most recent notification from the FDIC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since the notification that management believes have changed the Bank’s risk category. See Item 7 - Management’s Discussion And Analysis Of Financial Condition And Results Of Operations and Note 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 banking firms, investment advisory firms, brokerage firms, investment companies and insurance entities which offer financial services, located both domestically and through alternative delivery channels such as the Internet. Many of these competitors enjoy fewer regulatory constraints and some may have lower cost structures. Our ability to compete is focused on various factors such as customer service, interest rates on loans and deposits, lending limits, customer convenience and technological advances.

 

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

 

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

 

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.

 

Employees

 

As of December 31, 2019, we employed 214 full-time equivalent employees. None of the employees are subject to a collective bargaining agreement and management believes its relations with employees to be good. Information regarding employment agreements with our executive officers is contained in Item 11 – Executive Compensation below, which is incorporated by reference to our proxy statement for the 2020 annual meeting of shareholders.

 

Government Supervision and Regulation

 

Supervision and Regulation

 

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

 

This section provides a general overview of the federal and state regulatory framework applicable to the Holding Company and the Bank. It is not intended to summarize all applicable laws and regulations. To the extent 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 Business Oversight (“CDBO”).

 

Bank Holding Company Regulation

 

General

 

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

 

4

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.

 

Federal and State Regulation of the Bank

 

General

 

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

 

Consumer Protection

 

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

 

Community Reinvestment

 

The Community Reinvestment Act of 1977 (the “CRA”) requires that, in connection with examinations of financial institutions within their 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.

 

5

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

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

 

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

 

State Law Restrictions

 

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

 

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

 

Interstate Banking and Branching

 

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

 

Cash Dividends

 

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

 

6

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Capital Adequacy and Prompt Corrective Action

 

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

 

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

 

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

 

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

 

The 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. To qualify for the framework, a community banking organization must have a tier 1 leverage ratio of greater than 9%, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization 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. The CBLR framework will be available for banks to use in their March 31, 2020 call reports.

 

Regulatory Oversight and Examination

 

Inspections

 

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

 

Examinations

 

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

 

Commercial Real Estate Ratios

 

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

 

Corporate Governance and Accounting

 

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

 

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BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

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

 

Anti-Money Laundering and Anti-Terrorism

 

The Bank Secrecy Act and the USA Patriot Act of 2001

 

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

 

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

 

Financial Services Modernization

 

Gramm-Leach-Bliley Act of 1999

 

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

 

Deposit Insurance

 

FDIC Insured Deposits

 

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

 

Safety and Soundness

 

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

 

Insurance of Deposit Accounts

 

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

 

Brokered Deposits

 

On December 12, 2019, the FDIC issued a proposed rule to modernize its brokered deposit regulations that apply to less than well capitalized insured depository institutions. This proposal would establish a new framework for analyzing whether deposits placed through deposit placement arrangements qualify as brokered deposits. Further, under FDIC deposit insurance rules, banks may be assessed higher premiums if they have a high level of brokered deposits. For calendar quarters prior to April 1, 2018, CDARS and ICS reciprocal deposits were considered to be brokered deposits by regulatory authorities and were reported as such on quarterly Call Reports. However, with the passage of the Crapo Bill, those CDARS and ICS reciprocal deposits are no longer classified as brokered deposits. At December 31, 2019, we had $64.0 million in deposits which are part of the CDARS and ICS programs.

 

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BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

The Dodd-Frank Act

 

General

 

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

 

Corporate Governance

 

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

 

Prohibition Against Charter Conversions of Troubled Institutions

 

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

 

Consumer Financial Protection Bureau

 

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

 

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 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 (either by filling an open seat or by adding a seat). One or two more women directors may be required, depending upon the size of the public company’s board by December 31, 2021. We had one female serving on our board as of December 31, 2019, and we will continue to advance equitable gender representation by adding females to our board in accordance with California’s Women on Boards bill.

 

Recent and Proposed Legislation

 

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

 

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

 

For example, 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 the FDIC issued its final rule relating to the CBLR framework on September 17, 2019. The Crapo Bill also included regulatory relief for community banks regarding regulatory examination cycles, call reports, the Volcker Rule (proprietary trading prohibitions), mortgage disclosures and risk weights for certain high-risk commercial real estate. However, it is difficult at this time to predict when or how the new standards under the Crapo Bill will ultimately be applied to us or what specific impact the Crapo Bill (and any further implementing rules and regulations) will have on community banks.

 

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BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Effects of Federal Government Monetary Policy

 

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.

 

Available Information

 

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

 

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

 

Annual Disclosure Statement

 

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

 

 

Item 1a - Risk Factors

 

Company

 

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

 

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

 

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

 

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

 

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

 

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.

 

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.

 

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BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

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

 

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

 

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

 

Purchased loans included in the loan portfolio totaled $93.6 million or 9% of gross portfolio loans as of December 31, 2019. The loans were purchased as a pool of loans, individual loans or as purchased participations from other institutions. The majority of the loans are located outside our principal market. The loans were purchased under several different contracts and, $61.0 million or 6% of our gross portfolio loans are serviced by two unrelated third party servicing companies. A disruption to the operations of either of the loan servicing companies could reduce the value of the assets that we own. In addition, if we were forced to service these loans ourselves, we would incur additional monitoring and servicing costs due to the geographic disbursement of the portfolio, which would adversely affect our noninterest expense.

 

We have a concentration risk in real estate related loans.

 

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

 

69% was commercial real estate (non-owner occupied and owner-occupied),

6% was residential 1-4 family mortgage,

3% was residential ITIN,

2% was residential equity lines and

3% was 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 risks than residential first mortgage loans. These loans are primarily made based on and repaid from the cash flow of the borrower (which may be unpredictable) and secondarily on the underlying collateral provided by the borrower. Any decline in the economy in general, material increases in interest rates, changes in tax policies, tightening credit or refinancing markets, or a decline in real estate values in our principal market areas in particular, could have an adverse impact on the repayment of these loans. Further, our ability to recover on these loans by selling or disposing of the underlying real estate collateral would be adversely impacted by any decline in real estate values, which increases the likelihood that we would suffer losses on defaulted loans secured by real estate beyond the amounts provided for in the ALLL. Any increase in net charge-offs and in the ALLL could also have a material adverse effect on our business, financial condition, and results of operations and prospects.

 

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

 

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

 

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

 

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

 

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

 

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

 

Additionally, the changes in accounting standards described immediately below will change the current historical method of providing allowances for credit losses that are probable, and may require us to increase the amount of the allowance for loan and lease losses.

 

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

 

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

 

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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, to estimate expected credit losses, we have incurred one-time and recurring costs, some of which are related to system changes and data collection.

 

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

 

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

 

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

 

Defaults may negatively impact us.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

12

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

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

 

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

 

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

 

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

 

The condition of other financial institutions could negatively affect us.

 

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

 

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

 

Competition in our market areas may limit future success.

 

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

 

Derivative financial instruments subject the Company to credit and market risk

 

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

 

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

 

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

 

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

 

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

 

Internal control systems could fail to detect certain events.

 

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

 

13

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

We are susceptible to the risks of natural disasters such as earthquakes, volcanic eruptions, tsunami, wildfires, droughts, floods, mudslides, hurricanes, tornados and other geologic processes. 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.

 

14

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

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

.

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

 

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

 

We believe that our Subordinated Notes meet the requirements of Tier 2 Capital in accordance with the Final Rules and current statutory guidance provided by the Federal Reserve Board. The Federal Reserve Board does not provide prior approval for the Subordinated Notes to be classified as Tier 2 Capital however, we did not receive any indication that the Subordinated Notes did not qualify as tier 2 capital during our most recent examination process with the Federal Reserve Bank of San 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.

 

Our deposits are subject to volatility

 

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

 

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

 

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

 

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

 

Shareholders

 

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

 

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

 

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

 

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

 

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

 

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;

 

15

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

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 as evidenced by the recent volatility and disruption of capital and credit markets.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

At December 31, 2019, 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 dividend payments on our trust preferred securities before any dividends can be paid on our common stock; moreover, in the event of our bankruptcy, dissolution, or liquidation, all obligations outstanding with respect to our trust preferred securities must be satisfied before any distributions can be made to our shareholders. While we have the right to defer dividends on the trust preferred securities for a period of up to five years, no dividends may be paid to our common shareholders during that time if any such election has been made.

 

Our 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 pursuant to a private placement with certain institutional investors. 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 agreement.

 

16

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 lease agreement expires in 2024.

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 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.

 

 

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 2,368 shareholders of the Holding Company’s common stock as of December 31, 2019, including those held in street name, and the market price on that date was $11.57 per share.

 

Cash Dividends

 

We declared cash dividends of $0.19 and $0.15 during the years ended December 31, 2019 and 2018, respectively. Our ability to pay dividends is subject to certain regulatory requirements. The Federal Reserve Board generally prohibits a bank holding company from declaring or paying a cash dividend which would impose undue pressure on the capital of subsidiary banks or would be funded only through borrowing or other arrangements that might adversely affect a financial services holding company’s financial position. The Board of Governors of the Federal Reserve System policy is that a bank holding company should not continue its existing rate of cash dividends on its common stock unless its net income is sufficient to fully fund each dividend and its prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition. The power of the board of directors of an insured depository institution to declare a cash dividend or other distribution with respect to capital is subject to statutory and regulatory restrictions which limit the amount available for such distribution depending upon the earnings, financial condition and cash needs of the institution, as well as general business conditions.

 

Our ability to pay dividends is subject to certain contractual requirements. Our trust preferred securities 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

 

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

 

  

Total Number Of

  

Average Price

  

Total Number of Shares

  

Maximum Number Of

 
  

Common Shares

  

Paid Per

  

Purchased As Part Of

  

Shares That May Yet Be

 

Period

 

Purchased

  

Common Share 1

  

Publicly Announced Plan

  

Purchased Under The Plan

 

10/1/19-10/31/19

  71,499  $11.13   71,499   1,428,501 

11/1/19-11/30/19

  13,493  $11.26   13,493   1,415,008 

12/1/19-12/31/19

  5,509  $11.28   5,509   1,409,499 

Total

  90,501  $11.16   90,501     

 

1 - Average price paid per common share includes commissions.

 

17

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, 2019, have been derived from the Company’s audited Consolidated Financial Statements and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s audited Consolidated Financial Statements and notes thereto, included elsewhere in this report.

 

Amounts in thousands (except ratios and per share data)

 

2019

  

2018

  

2017

  

2016

  

2015

 

Statements of income

                    

Interest income

 $59,563  $52,701  $45,949  $41,009  $38,753 

Net interest income

 $53,535  $47,546  $41,362  $36,231  $33,770 

Provision for loan and lease losses

 $  $  $950  $  $ 

Noninterest income

 $4,184  $4,019  $4,824  $3,486  $3,183 

Noninterest expense

 $37,255  $32,206  $30,964  $32,500  $24,905 

Net income available to common shareholders

 $14,961  $15,730  $7,344  $5,259  $8,295 
                     

Balance sheets

                    

Total assets

 $1,479,616  $1,307,104  $1,269,421  $1,140,992  $1,015,441 

Average total assets

 $1,458,112  $1,288,841  $1,198,251  $1,079,750  $992,731 

Total gross loans

 $1,032,903  $946,251  $879,835  $804,211  $716,639 

Allowance for loan and lease losses

 $12,231  $12,292  $11,925  $11,544  $11,180 

Total deposits

 $1,267,171  $1,131,716  $1,102,732  $1,004,666  $803,735 

Total shareholders’ equity

 $174,478  $138,321  $127,264  $94,106  $90,522 
                     

Ratios 1

                    

Return on average assets 2

  1.03

%

  1.22

%

  0.61

%

  0.49

%

  0.86

%

Return on average shareholders’ equity 3

  9.09

%

  12.08

%

  6.34

%

  5.68

%

  8.10

%

Average equity to average assets

  11.29

%

  10.10

%

  9.67

%

  8.57

%

  10.68

%

Common equity tier 1 capital ratio 4

  13.19

%

  12.79

%

  12.26

%

  9.43

%

  10.06

%

Tier 1 capital ratio 4

  14.04

%

  13.71

%

  13.23

%

  10.42

%

  11.16

%

Total capital ratio 4

  15.97

%

  15.82

%

  15.44

%

  12.68

%

  13.52

%

Tier 1 leverage ratio 4

  11.30

%

  11.21

%

  10.86

%

  9.13

%

  10.03

%

Net interest margin 5

  3.94

%

  3.90

%

  3.68

%

  3.60

%

  3.64

%

Average earning assets to total average assets

  93.29

%

  94.67

%

  93.85

%

  93.34

%

  93.43

%

Nonperforming assets to total assets 6

  0.38

%

  0.32

%

  0.46

%

  1.06

%

  1.53

%

Net charge-offs (recoveries) to average loans

  0.01

%

  (0.04

)%

  0.07

%

  (0.05

)%

  (0.05

)%

Allowance for loan and lease losses to gross loans

  1.18

%

  1.30

%

  1.36

%

  1.44

%

  1.56

%

Nonperforming loans to allowance for loan and lease losses

  45.92

%

  33.73

%

  48.63

%

  98.64

%

  126.09

%

Efficiency ratio 7

  64.5

%

  62.5

%

  67.0

%

  81.8

%

  67.4

%

                     

Share data

                    

Average common shares outstanding – basic

  17,956   16,248   15,207   13,367   13,331 

Average common shares outstanding – diluted

  18,024   16,332   15,310   13,425   13,365 

Book value per common share

 $9.62  $8.47  $7.82  $7.00  $6.76 

Book value per common share - tangible 8

 $8.71  $8.36  $7.70  $6.83  $6.76 

Basic earnings per share

 $0.83  $0.97  $0.48  $0.39  $0.62 

Diluted earnings per share

 $0.83  $0.96  $0.48  $0.39  $0.62 

Cash dividends per common share

 $0.19  $0.15  $0.12  $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 (which included preferred stock costs in 2015) divided by average total assets.

3 - Return on average shareholders' equity is net income (which included preferred stock costs in 2015) 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 - Net interest margin is net interest income expressed as a percentage of average interest-earning assets.

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

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

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

 

 

18

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

 

EXECUTIVE OVERVIEW

 

Net income for the years ended December 31, 2019 and 2018 was $15.0 million or $0.83 per share diluted and $15.7 million or $0.96 per share-diluted, respectively. 

 

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

 

Financial performance for 2018 and 2017 includes “selected tax items” which complicates reporting period comparisons. The 2018 results include a $1.5 million decrease in our income tax provision composed of a $988 thousand reversal of our reserve for uncertain tax position and a $484 thousand benefit as a result of our cost segregation study and tangible property review. The 2017 results include a $2.5 million increase in our income tax provision as a result of the Tax Cuts and Jobs Act of 2017.

 

Non-GAAP Financial Measures

 

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

 

SELECTED NON-GAAP FINANCIAL INFORMATION - UNAUDITED

 

(amounts in thousands except per share data)

 
  

For The Twelve Months Ended

 

Reconciliation of Net Income (GAAP) to Net Income

 

December 31,

 

Excluding Selected Tax Items (non-GAAP):

 

2019

  

2018

  

2017

 

Net income (GAAP)

 $14,961  $15,730  $7,344 

Selected tax items:

            

Reversal of uncertain tax position (GAAP)

     (988)   

Benefit from cost segregation study and tangible property review (GAAP)

     (484)   

Deferred tax asset write-down (GAAP)

        2,490 

Total selected tax items

     (1,472)  2,490 

Net income excluding selected tax items (non-GAAP)

 $14,961  $14,258  $9,834 
             

Earnings per share - diluted (GAAP)

 $0.83  $0.96  $0.48 

Effect of selected tax items

     (0.09)  0.16 

Earnings per share - diluted excluding selected tax items (non-GAAP)

 $0.83  $0.87  $0.64 
             

GAAP Information:

            

Return on average assets

  1.03

%

  1.22

%

  0.61

%

Return on average equity

  9.09

%

  12.08

%

  6.34

%

Effective tax rate

  26.9

%

  18.7

%

  48.5

%

             

Non-GAAP Information:

            

Return on average assets excluding selected tax items

  1.03

%

  1.11

%

  0.82

%

Return on average equity excluding selected tax items

  9.09

%

  10.95

%

  8.48

%

Effective tax rate excluding selected tax items

  26.9

%

  26.3

%

  31.1

%

 

19

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Financial Highlights for the year ended December 31, 2019 were as follows:

 

Performance

Net income of $15.0 million was a decrease of $769 thousand (5%) from $15.7 million earned during the same period in the prior year. Earnings of $0.83 per share – diluted was an decrease of $0.13 (14%) from $0.96 per share – diluted earned during the same period in the prior year and reflects the impact of the following:

 

o

1,834,142 shares of common stock issued during the first quarter of 2019 as part of our acquisition of Merchants and

 

o

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

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

Net interest margin improved to 3.94% compared to 3.90% for the same period in the prior year.

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

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

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

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

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

 

o

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

 

o

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

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

 

o

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

 

o

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

 

Capital

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

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

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

The Bank maintained capital levels in excess of the “well-capitalized” standards at December 31, 2019 under the regulatory framework for prompt corrective action.

 

Credit Quality

Nonperforming assets at December 31, 2019 totaled $5.7 million or 0.38% of total assets, an increase of $1.5 million since December 31, 2018. The increase was primarily caused by loans to one commercial real estate borrower that were in nonaccrual status and had zero calculated impairment at December 31, 2019.

There was no provision for loan and lease losses during the current year, net loan loss charge-offs totaled $61 thousand for the year.

 

Vision and Objectives

 

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

 

Our vision is to remain independent, expanding our presence with organic growth and the addition of new strategically important locations. We will pursue attractive opportunities to enter related lines of business and to acquire financial institutions with complementary lines of business when it is beneficial to do so. During 2019, with the purchase of Merchants, our growth in average assets totaled $169.3 million or 13%.

 

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

 

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

 

20

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

RESULTS OF OPERATIONS

 

The following discussion and analysis provides a comparison of the results of operations for the two years ended December 31, 2019. This discussion should be read in conjunction with the Consolidated Financial Statements and related notes.

 

Overview

 

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

 

The Year Ended December 31, 2019 Compared to the Year Ended December 31, 2018

 

Net income was $15.0 million for the year ended December 31, 2019, compared to $15.7 million for the year ended December 31, 2018. For 2019, increases in net interest income and noninterest income were offset by increased noninterest expenses and provision for income taxes.

 

Diluted earnings per share were $0.83 for the year ended December 31, 2019 compared with $0.96 for the same period a year previous.

 

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

 

Return on Average Assets and Return on Average Equity

 

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

 

  

2019

  

2018

  

2017

 

Return on average assets

  1.03

%

  1.22

%

  0.61

%

Return on average equity

  9.09

%

  12.08

%

  6.34

%

 

Net Interest Income and Net Interest Margin

 

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

 

Interest income for the year ended December 31, 2019 was $59.6 million, an increase of $6.9 million or 13% compared to a year previous. The increase in interest income was derived from our loan portfolio ($5.6 million), our investment securities portfolio ($1.1 million) and our interest bearing cash balances ($160 thousand). All of our earning assets benefited from increases in both volume and yield.

 

Interest expense for the year ended December 31, 2019 was $6.0 million, an increase of $873 thousand or 17% compared to a year previous.

 

 

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

 

Interest on senior and subordinated term debt decreased $271 thousand during 2019. During the second quarter of 2019, we completed the early repayment of our variable senior debt.

 

Interest on FHLB term debt decreased $188 thousand during 2019. FHLB term debt averaged $9.6 million in 2019 and $22.5 million in 2018. In addition, the cost of FHLB term debt was 2.56% in 2019 compared with 1.94% in 2018.

 

Interest on junior subordinated debentures increased $41 thousand during 2019.

 

The net interest margin for the year ended December 31, 2019 was 3.94% an increase of four basis points as compared to 2018.

 

Maintaining our net interest margin in the future will be challenging as current market pressures are anticipated to cause our yield on average interest-earning assets to decline.

 

21

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

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

 

  

Years Ended December 31,

 
  

2019

  

2018

  

2017

 
  

Average

      

Yield/

  

Average

      

Yield/

  

Average

      

Yield/

 

(Amounts in thousands)

 

Balance

  

Interest(1)

  

Rate(5)

  

Balance

  

Interest(1)

  

Rate(5)

  

Balance

  

Interest(1)

  

Rate(5)

 

Interest-earning assets:

                                    

Net loans (2)

 $1,020,801  $50,534   4.95

%

 $915,360  $44,955   4.91

%

 $818,119  $39,112   4.78

%

Taxable securities

  246,723   6,673   2.70

%

  207,407   5,165   2.49

%

  165,333   3,921   2.37

%

Tax-exempt securities (3)

  38,706   1,244   3.21

%

  50,330   1,629   3.24

%

  74,231   2,144   2.89

%

Interest-bearing deposits in other banks

  54,095   1,112   2.06

%

  47,038   952   2.02

%

  66,872   772   1.15

%

Average interest-earning assets

  1,360,325   59,563   4.38

%

  1,220,135   52,701   4.32

%

  1,124,555   45,949   4.09

%

Cash and due from banks

  22,806           20,468           18,301         

Premises and equipment, net

  15,598           13,952           15,567         

Goodwill and other intangible assets, net

  15,565           1,917           2,136         

Other assets

  43,818           32,369           37,692         

Average total assets

 $1,458,112          $1,288,841          $1,198,251         
                                     

Interest-bearing liabilities:

                                    

Demand - interest-bearing

 $242,516   480   0.20

%

 $238,328   414   0.17

%

 $209,792   274   0.13

%

Money market

  304,340   1,599   0.53

%

  250,685   646   0.26

%

  224,913   470   0.21

%

Savings

  136,733   493   0.36

%

  109,025   288   0.26

%

  111,376   200   0.18

%

Certificates of deposit

  160,550   1,977   1.23

%

  168,183   1,910   1.14

%

  205,648   2,188   1.06

%

Federal Home Loan Bank of San Francisco borrowings

  9,644   247   2.56

%

  22,466   435   1.94

%

  302   3   0.99

%

Other borrowings

  10,895   806   7.40

%

  15,143   1,077   7.11

%

  17,981   1,165   6.48

%

Junior subordinated debentures

  10,310   426   4.13

%

  10,310   385   3.73

%

  10,310   287   2.78

%

Average interest-bearing liabilities

  874,988   6,028   0.69

%

  814,140   5,155   0.63

%

  780,322   4,587   0.59

%

Noninterest-bearing demand

  400,588           332,197           289,735         

Other liabilities

  17,894           12,286           12,293         

Shareholders’ equity

  164,642           130,218           115,901         

Average liabilities and shareholders’ equity

 $1,458,112          $1,288,841          $1,198,251         

Net interest income and net interest margin(4)

     $53,535   3.94

%

     $47,546   3.90

%

     $41,362   3.68

%

 

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

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

(3) Interest income and yields on tax-exempt securities are not presented on a taxable equivalent basis.

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

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

 

22

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

The following table sets forth a summary of the changes in net interest income due to changes in average asset and liability balances (volume variance) and changes in average rates (rate variance) for 2019 compared to 2018 and 2018 compared to 2017. 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 not presented on a taxable equivalent basis.

 

Analysis of Changes in Net Interest Income

 

  

Years Ended December 31,

 
  

2019 over 2018

  

2018 over 2017

 

(Amounts in thousands)

 

Volume

  

Rate

  

Net Change

  

Volume

  

Rate

  

Net Change

 

Increase (decrease) in interest income:

                        

Net loans

 $5,217  $362  $5,579  $4,752  $1,091  $5,843 

Taxable securities

  1,037   471   1,508   1,040   204   1,244 

Tax-exempt securities (1)

  (374)  (11)  (385)  (823)  308   (515)

Interest-bearing deposits in other banks

  145   15   160   (117)  297   180 

Total increase (decrease)

  6,025   837   6,862   4,852   1,900   6,752 
                         

Increase (decrease) in interest expense:

                        

Interest-bearing demand and money market

  7   59   66   41   99   140 

Money market

  163   790   953   58   118   176 

Savings

  84   121   205   (4)  92   88 

Certificates of deposit

  (78)  145   67   (441)  163   (278)

Federal Home Loan Bank of San Francisco borrowings

  (433)  245   (188)  426   6   432 

Other borrowings

  (316)  45   (271)  (231)  143   (88)

Junior subordinated debentures

     41   41      98   98 

Total increase

  (573)  1,446   873   (151)  719   568 

Net increase (decrease)

 $6,598  $(609) $5,989  $5,003  $1,181  $6,184 

 

(1) Interest income on tax-exempt securities are not presented on a taxable equivalent basis.

 

Noninterest Income

 

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

 

  

Years Ended December 31,

 
  

2019 Compared to 2018

  

2018 Compared to 2017

 
          

Change

  

Change

          

Change

  

Change

 

(Amounts in thousands)

 

2019

  

2018

  

Amount

  

Percent

  

2018

  

2017

  

Amount

  

Percent

 

Noninterest income:

                                

Service charges on deposit accounts

 $730  $682  $48   7

%

 $682  $542  $140   26

%

ATM and point of sale fees

  1,158   1,131   27   2

%

  1,131   1,093   38   3

%

Payroll and benefit processing fees

  669   652   17   3

%

  652   658   (6)  (1

)%

Life insurance

  536   512   24   5

%

  512   1,050   (538)  (51

)%

Gains on sales of investment securities, net

  186   44   142   323

%

  44   137   (93)  (68

)%

Federal Home Loan Bank of San Francisco dividends

  507   480   27   6

%

  480   318   162   51

%

Gain (loss) on sale of OREO

  62   73   (11)  (15

)%

  73   368   (295)  (80

)%

Insured cash sweep fees

           

%

     197   (197)  (100

)%

Other

  336   445   (109)  (24

)%

  445   461   (16)  (3

)%

Total noninterest income

 $4,184  $4,019  $165   4

%

 $4,019  $4,824  $(805)  (17

)%

 

Noninterest income in 2019 was $4.2 million, an increase of $165 thousand or 4% compared to 2018. During 2018, we recognized a $96 thousand special dividend on Federal Home Loan Bank of San Francisco stock that did not recur in 2019.

 

23

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Noninterest Expense

 

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

 

  

Years Ended December 31,

 
  

2019 Compared to 2018

  

2018 Compared to 2017

 
          

Change

  

Change

          

Change

  

Change

 

(Amounts in thousands)

 

2019

  

2018

  

Amount

  

Percent

  

2018

  

2017

  

Amount

  

Percent

 

Noninterest expense:

                                

Salaries & related benefits

 $20,804  $18,709  $2,095   11

%

 $18,709  $17,819  $890   5

%

Premises & equipment

  3,752   3,983   (231)  (6

)%

  3,983   4,178   (195)  (5

)%

Federal Deposit Insurance Corporation insurance premium

  91   376   (285)  (76

)%

  376   318   58   18

%

Data processing

  2,535   1,997   538   27

%

  1,997   1,813   184   10

%

Professional services

  1,539   1,431   108   8

%

  1,431   1,398   33   2

%

Telecommunications

  737   594   143   24

%

  594   879   (285)  (32

)%

Acquisition and merger

  2,193   844   1,349   160

%

  844      844   100

%

Other

  5,604   4,272   1,332   31

%

  4,272   4,559   (287)  (6

)%

Total noninterest expense

 $37,255  $32,206  $5,049   16

%

 $32,206  $30,964  $1,242   4

%

 

Noninterest expense for the year ended December 31, 2019 was $37.3 million, an increase of $5.0 million or 16% compared to 2018.

 

For the year ended December 31, 2019 compared to the prior year:

 

Salaries and related benefit costs increased $2.1 million thousand primarily as a result of additional employees from the Merchants acquisition.

Federal Deposit Insurance Corporation insurance premium decreased $285 thousand due to Small Bank Assessment Credits from the FDIC in 2019.

Costs related to the name change totaled $503 thousand in 2019.

Amortization of the core deposit intangible for the deposits acquired from Merchants totaled $499 thousand in 2019.

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

 

Income Taxes

 

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

 

  

Years Ended December 31,

 

(Amounts in thousands)

 

2019

  

2018

  

2017

 

Income before provision for income taxes

 $20,464  $19,359  $14,272 

Provision for income taxes

 $5,503  $3,629  $6,928 

Effective tax rate

  26.9

%

  18.7

%

  48.5

%

 

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

 

  

2019

  

2018

  

2017

 

Income tax at the federal statutory rate

  21.0

%

  21.0

%

  34.0

%

State franchise tax, net of federal tax benefit

  8.6

%

  8.3

%

  6.5

%

Amortization of affordable housing credit partnerships

  2.4

%

  2.7

%

  4.8

%

Officer life insurance

  (0.5

)%

  (0.6

)%

  (2.5

)%

Tax-exempt interest

  (1.3

)%

  (1.8

)%

  (5.2

)%

Affordable housing credits and benefits

  (3.5

)%

  (3.8

)%

  (5.7

)%

Accelerated depreciation - cost segregation study

  

%

  (2.5

)%

  

%

Reversal of uncertain tax position

  

%

  (5.1

)%

  

%

Deferred tax asset write-down

  

%

  

%

  17.5

%

Other

  0.2

%

  0.5

%

  (0.8

)%

Effective Tax Rate

  26.9

%

  18.7

%

  48.5

%

 

Cost Segregation Study and Tangible Property Review

 

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

 

24

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Amended Tax Returns

 

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

 

25

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

FINANCIAL CONDITION

 

Consolidated Balance Sheets

 

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

 

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

 

Available-for-sale investment securities totaled $287.0 million at December 31, 2019, compared with $257.0 million at December 31, 2018. Our available-for-sale investment portfolio provides a secondary source of liquidity to fund other higher yielding asset opportunities, such as loan originations. During 2019, we purchased securities with a par value of $96.8 million and the Merchants acquisition added securities with a par value of $107.4 million. During 2019, we sold securities with a par value of $118.0 million resulting in $186 thousand in net realized gains. During 2019, we also received $64.2 million in proceeds from principal payments, calls and maturities within the available-for-sale securities portfolio.

 

At December 31, 2019, our net unrealized gains on available-for-sale securities were $3.7 million compared with $4.3 million net unrealized losses at December 31, 2018. The changes in the net unrealized losses to net unrealized gains was primarily driven by significant changes in market interest rates.

 

We recorded gross loan balances of $1.033 billion at December 31, 2019, compared with $946.3 million at December 31, 2018, an increase of $87 million. The increase in gross loans included $80.1 million in loans received from the acquisition of Merchants.

 

The ALLL at December 31, 2019 decreased $61 thousand to $12.2 million compared to $12.3 million at December 31, 2018. At December 31, 2019, relying on our ALLL methodology, which uses criteria such as risk factors and historical loss rates, and given the ongoing improvements in asset quality, we believe the ALLL is adequate. There is, however, no assurance that future loan and lease losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses.

 

Nonperforming loans, which include nonaccrual loans and accruing loans past due over 90 days, increased by $1.5 million to $5.6 million, or 0.54% of gross loans, as of December 31, 2019, compared to $4.1 million, or 0.44% of gross loans as of December 31, 2018. The increase in nonperforming loans was primarily caused by loans to one commercial real estate borrower that were placed on nonaccrual and had zero calculated impairment at December 31, 2019.

 

Past due loans as of December 31, 2019 decreased to $4.9 million, compared to $13.9 million as of December 31, 2018. The decrease in past due loans was primarily due to the sale of a $9.9 million nonaccrual commercial real estate loan. We believe that risk grading for past due and nonperforming loans appropriately reflects the risk associated with the past due loans. See Note 5 Loans in the Notes to Consolidated Financial Statements in this document for further detail on the ALLL and the loan portfolio.

 

Premises and equipment totaled $15.9 million at December 31, 2019, an increase of $2.8 million compared to $13.1 million at December 31, 2018. The increase included $2.2 million in premises and equipment acquired from Merchants.

 

Our OREO balance at December 31, 2019 was $35 thousand compared to $31 thousand at December 31, 2018. For the year ended December 31, 2019, we transferred three foreclosed properties in the amount of $74 thousand to OREO. During 2019, we sold three properties with balances of $70 thousand for a net gain of $62 thousand.

 

Bank-owned life insurance increased $1.3 million during the year ended December 31, 2019 to $23.7 million compared to $22.4 million at December 31, 2018. The increase included $755 thousand in bank-owned life insurance acquired from Merchants.

 

Our net deferred tax assets were $4.6 million at December 31, 2019 compared to $7.0 million at December 31, 2018. The decrease was primarily due to unrealized gains in the investment portfolio and core deposit intangibles related to the acquisition of Merchants.

 

Goodwill and other intangible assets, net increased $14.7 million during the year ended December 31, 2019 to $16.5 million compared to $1.8 million at December 31, 2018. The increase was due to $11.0 million of goodwill and $4.1 million in net core deposit intangibles related to the acquisition of Merchants.

 

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

 

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

 

 

Total non-maturing deposits increased $136.1 million compared to December 31, 2018.

 

o

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

 

Certificates of deposit decreased $596 thousand compared to December 31, 2018.

 

o

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

 

o

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

 

Other liabilities which include the Bank’s supplemental executive retirement plan, operating leases and funding obligation for investments in qualified affordable housing partnerships increased $4.3 million to $17.7 million as of December 31, 2019 compared to $13.4 million at December 31, 2018. The increase included the $4.4 million operating lease liability recorded upon the adoption of ASU No. 2016-02.

 

26

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Investment Securities

 

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

 

The investment securities portfolio also:

 

 

Partially mitigates interest rate risk;

 

Diversifies the credit risk inherent in the loan portfolio;

 

Provides a vehicle for the investment of excess liquidity;

 

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

 

Is used as collateral for certain public funds.

 

Our available-for-sale investment securities totaled $287.0 million at December 31, 2019, compared to $257.0 million at December 31, 2018. The Merchants acquisition added 231 securities with a par value of $107.4 million to our investment securities portfolio. During the first quarter of 2019, we sold a portion of our investment securities portfolio to provide liquidity for our seasonal decline in deposit balances and our planned reduction of wholesale certificates of deposit.

 

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

 

(Amounts in thousands)

 

2019

  

2018

  

2017

 

Available-for-sale securities:

            

U.S. government & agencies

 $38,733  $40,087  $40,369 

Obligations of state and political subdivisions

  42,098   50,530   78,844 

Residential mortgage-backed securities and collateralized mortgage obligations

  180,835   138,503   114,592 

Corporate securities

  2,966   2,922   4,992 

Commercial mortgage-backed securities

  19,307   24,762   26,641 

Other asset-backed securities

  3,011   124   1,505 

Total

 $286,950  $256,928  $266,943 

 

The following table presents information regarding the amortized cost, and maturity structure of the investment portfolio at December 31, 2019.

 

          

Maturities

  

Maturities

                 
  

Maturities

  

Over One Through

  

Over Five Through

  

Maturities

         
  

Within One Year

  

Five Years

  

Ten Years

  

Over Ten Years

  

Total

 

(Amounts in thousands)

 

Amount

  

Yield

  

Amount

  

Yield

  

Amount

  

Yield

  

Amount

  

Yield

  

Amount

  

Yield

 

Available-for-sale securities: (1)

                                        

U.S. government & agencies

 $1,250   3.01

%

 $51   3.01

%

 $18,143   3.33

%

 $18,847   2.97

%

 $38,291   3.14

%

Obligations of state and political subdivisions

  902   3.31

%

  11,011   3.55

%

  14,107   3.02

%

  14,682   3.25

%

  40,702   3.25

%

Residential mortgage-backed securities and collateralized mortgage obligations

  2,385   2.23

%

  126,361   2.77

%

  34,995   2.96

%

  15,373   2.84

%

  179,114   2.80

%

Corporate securities

  2,005   3.01

%

  1,000   2.00

%

     

%

     

%

  3,005   2.67

%

Commercial mortgage-backed securities

     

%

  1,019   2.43

%

  7,406   2.42

%

  10,701   2.78

%

  19,126   2.62

%

Other asset-backed securities

     

%

     

%

     

%

  3,019   2.82

%

  3,019   2.82

%

Total

 $6,542   2.77

%

 $139,442   2.82

%

 $74,651   3.01

%

 $62,622   2.96

%

 $283,257   2.90

%

 

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

 

Loan Portfolio

 

Loan Concentrations

 

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

 

27

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.

 

(Amounts in thousands)

 

As of December 31,

 

Loan Portfolio

 

2019

  

%

  

2018

  

%

  

2017

  

%

  

2016

  

%

  

2015

  

%

 

Commercial

 $141,197   14

%

 $135,543   14

%

 $142,405   16

%

 $146,881   18

%

 $125,394   17

%

Commercial real estate:

                                        

Real estate – construction and land development

  26,830   3

%

  22,563   2

%

  15,902   2

%

  36,792   5

%

  28,319   4

%

Real estate – commercial non-owner occupied

  493,920   48

%

  433,708   46

%

  377,668   43

%

  292,615   36

%

  228,174   32

%

Real estate – commercial owner occupied

  218,833   21

%

  204,622   22

%

  192,023   22

%

  174,298   22

%

  178,910   25

%

Residential real estate:

                                        

Real estate – residential - ITIN

  33,039   3

%

  37,446   4

%

  41,188   5

%

  45,566   6

%

  49,106   7

%

Real estate – residential - 1-4 family mortgage

  63,661   6

%

  34,366   4

%

  30,377   3

%

  20,425   3

%

  17,268   2

%

Real estate – residential - equity lines

  22,099   2

%

  26,958   3

%

  30,347   3

%

  35,953   4

%

  39,595   6

%

Consumer and other

  33,324   3

%

  51,045   5

%

  49,925   6

%

  51,681   6

%

  49,873   7

%

Gross loans

  1,032,903   100

%

  946,251   100

%

  879,835   100

%

  804,211   100

%

  716,639   100

%

Deferred fees and costs

  2,162       1,927       1,710       1,324       870     

Loans, net of deferred fees and costs

  1,035,065       948,178       881,545       805,535       717,509     

Allowance for loan and lease losses

  (12,231)      (12,292)      (11,925)      (11,544)      (11,180)    

Net loans

 $1,022,834      $935,886      $869,620      $793,991      $706,329     

 

The following table sets forth the maturity and distribution of our loan portfolio as of December 31, 2019.

 

      

After One

         
  

Within One

  

Through

  

After Five

     

(Amounts in thousands)

 

Year

  

Five Years

  

Years

  

Total

 

Commercial

 $66,951  $65,288  $9,792  $142,031 

Commercial real estate:

                

Real estate - construction and land development

  4,374   11,089   11,273   26,736 

Real estate - commercial non-owner occupied

  37,145   204,633   251,714   493,492 

Real estate - commercial owner occupied

  25,638   85,196   109,423   220,257 

Residential real estate:

                

Real estate - residential - ITIN

  3,401   13,411   16,227   33,039 

Real estate - residential - 1-4 family mortgage

  6,301   20,544   36,918   63,763 

Real estate - residential - equity lines

  718   2,002   19,678   22,398 

Consumer and other

  1,296   2,348   29,705   33,349 

Loans, net of deferred fees and costs

 $145,824  $404,511  $484,730  $1,035,065 

Loans with:

                

Fixed rates

  49,959  $190,871   199,155   439,985 

Variable rates

  95,865   213,640   285,575   595,080 

Total

  145,824  $404,511  $484,730  $1,035,065 

 

Loans with unique credit characteristics

 

ITIN Loans

 

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

 

SFC Loans

 

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

 

28

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Purchased Loans

 

In addition to loans we have originated or acquired through our acquisition of Merchants, the loan portfolio includes purchased loan pools and purchased participations. Purchased loans are recorded at their fair value at the acquisition date.

 

The following table presents the recorded investment in purchased loan pools and purchased participations at December 31, 2019 and 2018.

 

  

For The Years Ended December 31,

 
  

2019

  

2018

 

(Amounts in thousands)
Loan Type

 

Balance

  

% of Gross Loan

Portfolio

  

Balance

  

% of Gross Loan

Portfolio

 

Commercial

 $   

%

 $66   

%

Commercial real estate

  19,506   2

%

  29,096   3

%

Residential real estate

  45,494   4

%

  51,164   5

%

Consumer and other

  28,579   3

%

  46,049   5

%

Total purchased loans

 $93,579   9

%

 $126,375   13

%

 

Asset Quality

 

Nonperforming Assets

 

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

 

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

 

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

 

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.

 

29

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

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

 

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

 

(Amounts in thousands)

 

As of December 31,

 

Nonperforming Assets

 

2019

  

2018

  

2017

  

2016

  

2015

 

Commercial

 $61  $959  $1,603  $2,749  $1,994 

Commercial real estate:

                    

Real estate - commercial non-owner occupied

     548      1,196   5,488 

Real estate - commercial owner occupied

  3,103      600   784   1,071 

Total commercial real estate

  3,103   548   600   1,980   6,559 

Residential real estate:

                    

Real estate - residential - ITIN

  2,221   2,388   2,909   3,576   3,649 

Real estate - residential - 1-4 family mortgage

  191   185   606   1,914   1,775 

Real estate - residential - equity lines

     43   45   917    

Total residential real estate

  2,412   2,616   3,560   6,407   5,424 

Consumer and other

  40   23   36   250   32 

Total nonaccrual loans

  5,616   4,146   5,799   11,386   14,009 

90 days past due and still accruing

              88 

Total nonperforming loans

  5,616   4,146   5,799   11,386   14,097 

Other real estate owned

  35   31   35   759   1,423 

Total nonperforming assets

 $5,651  $4,177  $5,834  $12,145  $15,520 

Nonperforming loans to gross loans

  0.54

%

  0.44

%

  0.66

%

  1.42

%

  1.97

%

Nonperforming assets to total assets

  0.38

%

  0.32

%

  0.46

%

  1.06

%

  1.53

%

 

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

 

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

 

As of December 31, 2019, we had $6.5 million in troubled debt restructurings compared to $9.6 million as of December 31, 2018. As of December 31, 2019, we had 98 restructured loans that qualified as troubled debt restructurings, of which 94 loans were performing according to their restructured terms. Troubled debt restructurings represented 0.63% of gross loans as of December 31, 2019, compared with 1.01% at December 31, 2018.

 

Impaired loans of $4.8 million and $6.9 million were classified as accruing troubled debt restructurings at December 31, 2019 and December 31, 2018, respectively. For a restructured loan to be on accrual status, the loan’s collateral coverage must generally be greater than or equal to 100% of the loan balance, the loan payments must be current, and the borrower must demonstrate the ability to make payments from a verified source of cash flow. As of December 31, 2019, we had no obligations to lend additional funds on any restructured loans. As of December 31, 2018, we had one restructured commercial line of credit in nonaccrual status that had $313 thousand in available credit.

 

30

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.

 

(Amounts in thousands)

 

As of December 31,

 

Troubled Debt Restructurings

 

2019

  

2018

  

2017

  

2016

  

2015

 

Accruing troubled debt restructurings

                    

Commercial

 $595  $1,224  $1,551  $776  $49 

Commercial real estate:

                    

Real estate - commercial non-owner occupied

     795   803   808   824 

Residential real estate:

                    

Real estate - residential - ITIN

  3,957   4,484   4,614   5,033   5,458 

Real estate - residential - equity lines

  231   363   380   454   558 

Total accruing troubled debt restructurings

  4,783   6,866   7,348   7,071   6,889 
                     

Nonaccruing troubled debt restructurings

                    

Commercial

  47   877   863   1,940   863 

Commercial real estate:

                    

Real estate - commercial non-owner occupied

              4,292 

Real estate - commercial owner occupied

              1,071 

Residential real estate:

                    

Real estate - residential - ITIN

  1,593   1,793   2,396   2,691   2,538 

Real estate - residential - 1-4 family mortgage

        296   335   219 

Consumer and other

  40   23   26   29   32 

Total nonaccruing troubled debt restructurings

  1,680   2,693   3,581   4,995   9,015 
                     

Total troubled debt restructurings

                    

Commercial

  642   2,101   2,414   2,716   912 

Commercial real estate:

                    

Real estate - commercial non-owner occupied

     795   803   808   5,116 

Real estate - commercial owner occupied

              1,071 

Residential real estate:

                    

Real estate - residential - ITIN

  5,550   6,277   7,010   7,724   7,996 

Real estate - residential - 1-4 family mortgage

        296   335   219 

Real estate - residential - equity lines

  231   363   380   454   558 

Consumer and other

  40   23   26   29   32 

Total troubled debt restructurings

 $6,463  $9,559  $10,929  $12,066  $15,904 
                     

Total troubled debt restructuring to gross loans outstanding at period end

  0.63

%

  1.01

%

  1.24

%

  1.50

%

  2.22

%

 

Allowance for Loan and Lease Losses and Reserve for Unfunded Commitments

 

The ALLL at December 31, 2019 decreased $61 thousand to $12.2 million compared to $12.3 million at December 31, 2018. As a result of continued improved asset quality, no provision for loan and lease losses was necessary during the year ended December 31, 2019 and 2018.

 

The loans acquired from Merchants were recorded at fair value, which included a discount for credit risk adjustments, which is not a part of the ALLL. No ALLL is required for these acquired loans on the date of acquisition. As a result, our ALLL as a percentage of gross loans declined to 1.18% as of December 31, 2019 compared to 1.30% as of December 31, 2018.

 

31

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,

 

(Amounts in thousands)

 

2019

  

2018

  

2017

  

2016

  

2015

 

Beginning balance ALLL

 $12,292  $11,925  $11,544  $11,180  $10,820 

Provision for loan and lease loss charged to expense

        950       

Loans charged off

  (1,500)  (1,248)  (1,502)  (2,784)  (2,376)

Loan and lease loss recoveries

  1,439   1,615   933   3,148   2,736 

Ending balance ALLL

  12,231   12,292   11,925   11,544   11,180 

 

  

At December 31,

 
  

2019

  

2018

  

2017

  

2016

  

2015

 

Nonaccrual loans:

                    

Commercial

  61   959   1,603   2,749   1,994 

Real estate - commercial non-owner occupied

     548      1,196   5,488 

Real estate - commercial owner occupied

  3,103      600   784   1,071 

Real estate - residential - ITIN

  2,221   2,388   2,909   3,576   3,649 

Real estate - residential - 1-4 family mortgage

  191   185   606   1,914   1,775 

Real estate - residential - equity lines

     43   45   917    

Consumer and other

  40   23   36   250   32 

Total nonaccrual loans

  5,616   4,146   5,799   11,386   14,009 

Accruing troubled-debt restructured loans:

                    

Commercial

  595   1,224   1,551   776   49 

Real estate - commercial non-owner occupied

     795   803   808   824 

Real estate - residential - ITIN

  3,957   4,484   4,614   5,033   5,458 

Real estate - residential - equity lines

  231   363   380   454   558 

Total accruing restructured loans

  4,783   6,866   7,348   7,071   6,889 
                     

All other accruing impaired loans

           337   492 

Total impaired loans

  10,399   11,012   13,147   18,794   21,390 
                     

Gross loans outstanding

 $1,032,903  $946,251  $879,835  $804,211  $716,639 
                     

Ratio of ALLL to gross loans outstanding

  1.18

%

  1.30

%

  1.36

%

  1.44

%

  1.56

%

Nonaccrual loans to gross loans outstanding

  0.54

%

  0.44

%

  0.66

%

  1.42

%

  1.95

%

 

As of December 31, 2019, impaired loans totaled $10.4 million, of which $5.6 million were in nonaccrual status. Of the total impaired loans, $6.2 million or 100 were ITIN loans with an average balance of approximately $62 thousand per loan. The remaining impaired loans consist of four commercial loans, two commercial real estate loans, two residential mortgages, two consumer loans and five home equity loans.

 

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

 

32

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.

 

(Amounts in thousands)

 

At December 31,

 

ALLL

 

2019

  

%

  

2018

  

%

  

2017

  

%

  

2016

  

%

  

2015

  

%

 

Commercial

 $1,822   15

%

 $2,205   18

%

 $2,397   20

%

 $2,748   24

%

 $2,373   21

%

Commercial real estate:

                                        

Real estate - construction and land development

  131   1

%

  107   1

%

  82   1

%

  177   2

%

  246   2

%

Real estate - commercial non-owner occupied

  5,907   47

%

  5,169   42

%

  4,698   40

%

  3,637   32

%

  3,014   27

%

Real estate - commercial owner occupied

  2,058   17

%

  1,840   15

%

  1,734   15

%

  1,865   16

%

  2,643   24

%

Residential real estate:

                                        

Real estate - residential - ITIN

  569   5

%

  660   5

%

  602   5

%

  973   8

%

  998   9

%

Real estate - residential - 1-4 family mortgage

  185   2

%

  162   1

%

  151   1

%

  106   1

%

  111   1

%

Real estate - residential - equity lines

  278   2

%

  351   3

%

  416   3

%

  637   5

%

  469   4

%

Consumer and other

  933   8

%

  1,356   11

%

  1,435   12

%

  955   8

%

  770   7

%

Unallocated

  348   3

%

  442   4

%

  410   3

%

  446   4

%

  556   5

%

Total ALLL

 $12,231   100

%

 $12,292   100

%

 $11,925   100

%

 $11,544   100

%

 $11,180   100

%

 

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

 

Reserve for Unfunded Commitments

 

The reserve for unfunded commitments, which is included in Other Liabilities on the Consolidated Balance Sheets, was $695 thousand at December 31, 2019 and 2018. The adequacy of the reserve for unfunded commitments is reviewed on a quarterly basis, based upon changes in the amount of commitments, loss experience, and economic conditions. Any provision adjustment is recorded in Other Expenses in the Consolidated Statements of Income.

 

Deposits

 

Total deposits as of December 31, 2019 were $1.267 billion compared to $1.132 billion at December 31, 2018, an increase of $135 million or 12%. The following table presents deposit balances by major category as of December 31 for the last two years.

 

(Amounts in thousands)

 

At December 31,

 

Deposits

 

2019

  

%

  

2018

  

%

 

Noninterest-bearing demand

 $432,680   34

%

 $347,199   31

%

Interest-bearing demand

  239,258   19

%

  252,202   22

%

Money market

  307,559   24

%

  265,093   23

%

Savings

  135,888   11

%

  114,840   10

%

Certificates of deposit, $100,000 or greater

  120,282   10

%

  119,376   11

%

Certificates of deposit, less than $100,000

  31,504   2

%

  33,006   3

%

Total

 $1,267,171   100

%

 $1,131,716   100

%

 

The following table sets forth the distribution of average deposits and their respective average rates for the periods indicated.

 

  

Years Ended December 31,

 
  

2019

  

2018

  

2017

 

(Amounts in thousands)

 

Average Balance

  

Average Rate

  

Average Balance

  

Average Rate

  

Average Balance

  

Average Rate

 

Interest-bearing demand

 $242,516   0.20

%

 $238,328   0.17

%

 $209,792   0.13

%

Money market

  304,340   0.53

%

  250,685   0.26

%

  224,913   0.21

%

Savings

  136,733   0.36

%

  109,025   0.26

%

  111,376   0.18

%

Certificates of deposit

  160,550   1.23

%

  168,183   1.14

%

  205,648   1.06

%

Interest-bearing deposits

  844,139   0.54

%

  766,221   0.43

%

  751,729   0.42

%

Noninterest-bearing demand

  400,588       332,197       289,735     

Total deposits

 $1,244,727   0.37

%

 $1,098,418   0.30

%

 $1,041,464   0.30

%

 

33

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Deposit Maturity Schedule

 

The following table sets forth the maturities of certificates of deposit in the amounts of $100,000 or more as of December 31, 2019.

 

(Amounts in thousands)

    

Maturing in:

 

2019

 

Three months or less

 $20,991 

Three through six months

  22,871 

Six through twelve months

  28,714 

Over twelve months

  47,706 

Total

 $120,282 

 

We have an agreement with Promontory Interfinancial Network LLC (“Promontory”) which facilitates provision of FDIC deposit insurance to balances in excess of current FDIC deposit insurance limits. Promontory’s Certificate of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep (“ICS”) products use a deposit-matching program to exchange Bank deposits in excess of the current deposit insurance limits for excess balances at other participating banks, on a dollar-for-dollar basis (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.

 

Borrowings

 

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

 

 

  

Years Ended December 31,

 
  

2019

  

2018

  

2017

 
  

Average Balance

  

Average Rate

  

Average Balance

  

Average Rate

  

Average Balance

  

Average Rate

 

Federal Home Loan Bank of San Francisco borrowings

 $9,644   2.56

%

 $22,466   1.94

%

 $302   0.99

%

Other borrowings, net

  10,895   7.40

%

  15,143   7.11

%

  17,981   6.48

%

Junior subordinated debentures

  10,310   4.13

%

  10,310   3.73

%

  10,310   2.78

%

Total borrowings

 $30,849   4.80

%

 $47,919   3.96

%

 $28,593   5.09

%

 

Term Debt

 

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

 

Federal Home Loan Bank of San Francisco Borrowings

 

As of December 31, 2019 and 2018, the Bank had no Federal Home Loan Bank of San Francisco advances outstanding. The average balances outstanding on Federal Home Loan Bank of San Francisco term advances during 2019 and 2018 were $9.6 million and $22.5 million, respectively. See Note 10 Term Debt in the Notes to Consolidated Financial Statements for information on our Federal Home Loan Bank of San Francisco borrowings.

 

Senior Debt

 

In December of 2015, we entered into a senior debt loan agreement to borrow $10.0 million. During the second quarter of 2019, we completed the early repayment and termination of this variable-rate debt agreement.

 

Subordinated Debt

 

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

 

Junior Subordinated Debentures

 

Bank of Commerce Holdings Trust II

 

During July of 2005, we participated in a $10.0 million private placement of fixed rate trust-preferred securities (the "Trust-Preferred Securities") through a wholly owned Delaware trust affiliate, Bank of Commerce Holdings Trust II (the "Trust II"). Trust II simultaneously issued $310 thousand common securities to the Holding Company. Rates paid on the Trust-Preferred Securities have transitioned from fixed to floating and are now paid on a quarterly basis at a rate equal to three month LIBOR plus 158 basis point 3.47% at December 31, 2019. The Trust-Preferred Securities mature on September 15, 2035, and the covenants allow for redemption of the securities at our option during any quarter prior to maturity.

 

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

 

34

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

SOURCES OF INCOME

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

                      

Years 6

         
                      

Through

  

Beyond

     

(Amounts in thousands)

 

Year 1

  

Year 2

  

Year 3

  

Year 4

  

Year 5

  

Year 10

  

Year 10

  

Total

 

Rate Index:

                                

Fixed

 $49,959  $52,191  $33,501  $72,871  $32,308  $166,641  $32,514  $439,985 

Variable:

                                

Prime

  92,508   5,534   9,682   4,616   6,759   4,752      123,851 

5 Year Treasury

  24,733   66,548   83,684   66,329   77,812   54,490      373,596 

7 Year Treasury

  858   7,024   9,292   480   5,597   13,828      37,079 

1 Year LIBOR

  20,988                     20,988 

Other Indexes

  4,146   2,946   2,062   1,733   5,716   16,730   617   33,950 

Nonaccrual

  625   551   529   513   492   1,988   918   5,616 

Total

 $193,817  $134,794  $138,750  $146,542  $128,684  $258,429  $34,049  $1,035,065 

 

Non Interest Income

 

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

 

LIQUIDITY AND CASH FLOW

 

Merchants Bank of Commerce

 

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

 

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

 

We monitor the sources and uses of funds on a daily basis to maintain an acceptable liquidity position. One source of funds includes public deposits. We may be required to collateralize a portion of public deposits that exceed FDIC insurance limitations based on the state of California’s risk assessment of the Bank. Public deposits represent 2% of total deposits at December 31, 2019 and December 31, 2018.

 

35

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

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

 

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

 

 

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

 

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

 

We have entered into nonbinding federal funds line of credit agreements with three financial institutions. The available credit on these lines totaled $35.0 million at December 31, 2019 and had interest rates ranging from 1.80% to 2.58%. Advances under the lines are subject to funds availability, continued borrower eligibility, and may have consecutive day usage restrictions.

 

Bank of Commerce Holdings

 

The Holding Company is a separate entity from the Bank and must provide for its own liquidity. At December 31, 2019, the Holding Company had cash balances of $6.8 million. Our principal source of cash is dividends received from the Bank. During 2019, the Bank paid a dividend of $12.5 million to the Holding Company. There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to the Holding Company in the future.

 

Consolidated Statement of Cash Flows

 

Net cash of $16.6 million was provided by operating activities for the year ended December 31, 2019. As disclosed in the Consolidated Statements of Cash Flows The primary difference between net income and cash provided by operating activities, was non-cash items including:

 

 

$2.1 million in depreciation, accretion and amortization

 

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

 

 

$117.3 million in proceeds from sale of investment securities.

 

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

 

These sources of cash were partially offset by:

 

 

$97.7 million in purchases of investment securities.

 

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

 

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

 

 

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

 

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

 

$3.5 million decrease in net term debt.

 

$3.2 million dividends paid on common stock

 

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. 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.

 

For certain qualifying institutions, the FDIC has substituted a Community Bank Leverage Ratio in lieu of the Basel III capital requirements. The FDIC has set the Community Bank Leverage Ratio at 9%. The ratio will be defined as the ratio of Tier 1 capital to average total consolidated assets. Banks that meet the following criteria will only be required to report one ratio effective January 1, 2020:

 

 

Community Bank Leverage Ratio above 9%,

 

Consolidated assets less than $10 billion,

 

Off-balance-sheet exposures of 25% or less of consolidated assets and

 

Total trading assets and liabilities of 5% or less of assets.

 

36

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Any qualifying depository institution or its holding company that exceeds the Community Bank Leverage Ratio will be considered to have met generally applicable leverage and risk-based regulatory capital requirements and considered to be “well capitalized” under the prompt corrective action rules. Based on management’s review and analysis of Basel III and the Crapo Bill, management believes that the Holding Company and the Bank will exceed the standards under these rules.

 

CAPITAL ADEQUACY

 

Overall capital adequacy is monitored on a day-to-day basis by management and reported to our Board of Directors on a monthly basis.

 

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

 

 

  

December 31, 2019

 
                  

Applicable

  

Minimum

 
          

Well

  

Minimum

  

2019 Capital

  

Capital Requirement

 
      

Actual

  

Capitalized

  

Capital

  

Conservation

  

Plus Capital

 

(Amounts in thousands)

 

Capital

  

Ratio

  

Requirement

  

Requirement

  

Buffer

  

Conservation Buffer

 

Holding Company:

                        

Common equity tier 1 capital ratio

 $156,587   13.19

%

  n/a   4.50

%

  2.50

%

  7.00

%

Tier 1 capital ratio

 $166,587   14.04

%

  n/a   6.00

%

  2.50

%

  8.50

%

Total capital ratio

 $189,513   15.97

%

  n/a   8.00

%

  2.50

%

  10.50

%

Tier 1 leverage ratio

 $166,587   11.30

%

  n/a   4.00

%

  n/a   4.00

%

                         

Bank:

                        

Common equity tier 1 capital ratio

 $170,568   14.39

%

  6.50

%

  4.50

%

  2.50

%

  7.00

%

Tier 1 capital ratio

 $170,568   14.39

%

  8.00

%

  6.00

%

  2.50

%

  8.50

%

Total capital ratio

 $183,494   15.48

%

  10.00

%

  8.00

%

  2.50

%

  10.50

%

Tier 1 leverage ratio

 $170,568   11.58

%

  5.00

%

  4.00

%

  n/a   4.00

%

 

On December 10, 2015, the Holding Company issued $10.0 million in aggregate principal amount of Subordinated Notes to certain institutional investors. The Subordinated Notes qualify as Tier 2 Capital under the Final Rules. See Item 1a - Risk Factors, in our Annual Report on Form 10-K for the year ended December 31, 2019 for further detail on potential risks relating to the Subordinated Notes.

 

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

 

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

 

Goodwill and other intangible assets, net totaled $16.5 million at December 31. 2019 and primarily consisted of goodwill and core deposit intangibles recorded as part of previous acquisitions. See Note 7, Goodwill and Other 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. Under the Basel III risk based capital rules, the deduction for core deposit intangibles was initially subject to a phase in period which has now expired.

 

Goodwill and other intangible assets, net are deducted from tangible equity as part of the calculation of tangible book value per share.

 

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

 

  

2019

  

2018

  

2017

 

Dividends declared per common share for the quarter ended March 31,

 $0.04  $0.03  $0.03 

Dividends declared per common share for the quarter ended June 30,

  0.05   0.04   0.03 

Dividends declared per common share for the quarter ended September 30,

  0.05   0.04   0.03 

Dividends declared per common share for the quarter ended December 31,

  0.05   0.04   0.03 

Total

 $0.19  $0.15  $0.12 
             

Dividend payout ratio

  23

%

  15

%

  25

%

 

37

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

TANGIBLE BOOK VALUE PER SHARE

 

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

 

OFF-BALANCE SHEET ARRANGEMENTS

 

Information regarding Off-Balance Sheet Arrangements is included in Note 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 two years ended December 31, 2019 has not been material.

 

RISK MANAGEMENT

 

Overview

 

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

 

Board Committees

 

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

 

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

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

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

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

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

 

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

 

Management Committees

 

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

 

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.

 

38

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

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.

 

Liquidity Risk Management

 

Liquidity Risk

 

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

 

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

 

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

 

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 2020.

 

Term Debt

 

Federal Home Loan Bank of San Francisco borrowings

 

We periodically utilize Federal Home Loan Bank of San Francisco advances as a source of wholesale funding to provide temporary liquidity. As of December 31, 2019 and 2018, the Bank had no Federal Home Loan Bank of San Francisco advances outstanding. See Note 10 Term Debt in the Notes to Consolidated Financial Statements for information on our Federal Home Loan Bank of San Francisco borrowings and our remaining line of credit.

 

Senior Debt

 

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

 

Subordinated Debt

 

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

 

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

 

 

(Amounts in thousands)

 

2019

  

2018

  

2017

 

Senior debt

 $  $3,496  $7,096 

Less unamortized debt issuance cost

     (2)  (6)

Subordinated debt

  10,000   10,000   10,000 

Less unamortized debt issuance cost

  (43)  (89)  (132)

Total term debt at December 31,

 $9,957  $13,405  $16,958 

 

39

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

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

 

 

  

2019

  

2018

  

2017

 

Federal Home Loan Bank of San Francisco borrowings

  2.57

%

  1.94

%

  0.88

%

Senior debt

  6.73

%

  6.18

%

  5.21

%

Subordinated debt

  6.88

%

  6.88

%

  6.88

%

 

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

 

 

(Amounts in thousands)

 

2019

  

2018

  

2017

 

Federal Home Loan Bank of San Francisco borrowings:

            

Maximum outstanding at any month end

 $40,000  $70,000  $10,000 

Average balance during the year

 $9,644  $22,466  $302 

Effective weighted average interest rate during year

  2.56

%

  1.94

%

  0.99

%

Senior debt net of unamortized debt issuance costs:

            

Maximum outstanding at any month end

 $3,195  $6,890  $8,822 

Average balance during the year

 $960  $5,239  $8,132 

Effective weighted average interest rate during year

  7.22

%

  6.51

%

  5.34

%

Subordinated debt net of unamortized debt issuance costs:

            

Maximum outstanding at any month end

 $9,957  $9,911  $9,868 

Average balance during the year

 $9,934  $9,890  $9,849 

Effective weighted average interest rate during year

  7.38

%

  7.38

%

  7.38

%

 

Credit Risk Management

 

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

 

Concentrations of credit risk

 

We grant real estate construction, commercial, and installment loans to customers throughout northern California. In our judgment, a concentration exists in real estate related loans, which represented approximately 83% and 81% of our gross loan portfolio at December 31, 2019 and December 31, 2018.

 

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

 

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

 

Loan portfolio

 

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

 

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

 

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.

 

40

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Allowance for loan and lease losses

 

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

 

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

 

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

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Securities Portfolio

 

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

 

Deposits With Other Institutions

 

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

 

Market Risk Management

 

General

 

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

 

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.

 

41

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

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

 

Securities Portfolio

 

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

 

Operational Risk Management

 

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

 

SUMMARY OF CRITICAL ACCOUNTING POLICIES

 

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

 

Valuation of Investments and Impairment of Securities

 

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

 

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

 

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

 

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

 

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

 

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

 

Allowance for Loan and Lease Losses

 

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

 

42

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.

 

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.

 

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

 

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.

 

43

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

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.

 

On March 3, 2020, the Federal Reserve lowered the target range to between 100 and 125 basis points in response to risks posed by the coronavirus disease 2019. We are focused primarily on the effects of small changes in interest rates, either up or down. The most recent model results as of December 31, 2019, indicate the estimated annualized decrease in net interest income attributable to a 100 or 200 basis point increase in the federal funds rate was $441 thousand and $2.2 million, respectively. The model also shows an annualized decrease in net interest income attributable to a 300 or 400 basis point increase in the fed funds rate of $4.7 million and $6.5 million, respectively. In a declining rate environment, the most recent model results as of December 31, 2019, indicate the estimated annualized reduction in net interest income attributable to a 100 or 200 basis point decline in the federal funds rate was $66 thousand and $530 thousand, respectively. Given that the model assumes a static balance sheet, relies on historic betas and assumes immediate parallel rate changes, no assurance can be given that future performance will mirror the model.

 

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

 

Our approach to managing interest rate risk may include the use of derivatives, including interest rate swaps, caps and floors. This helps to minimize significant, unplanned fluctuations in earnings, fair values of assets and liabilities and cash flows caused by interest rate volatility. This approach involves a financial instrument with the same characteristics of certain assets and liabilities so that changes in interest rates do not have a significant adverse effect on the net interest margin and cash flows.

 

The following table sets forth as of December 31, 2019 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

     

(Amounts in thousands)

 

Months

  

One Year

  

Five Years

  

Years

  

Total

 

Interest-earning assets

                    

AFS securities

 $51,424  $41,679  $116,161  $77,686  $286,950 

Other investments

  49,266            49,266 

Loans, net of deferred fees and costs

  83,955   109,862   548,770   292,478   1,035,065 

Total earning assets

  184,645   151,541   664,931   370,164  $1,371,281 
                     

Interest-bearing liabilities

                    

Demand - interest-bearing

  239,258           $239,258 

Money market

  307,559            307,559 

Savings

  135,888            135,888 

Certificates of deposit

  27,926   63,975   59,847   38   151,786 

Term debt and junior subordinated debentures, net

  10,298   9,969         20,267 

Total interest-bearing deposits and borrowings

 $720,929  $73,944  $59,847  $38  $854,758 
                     

Re-pricing GAP

 $(536,284) $77,597  $605,084  $370,126  $516,523 

Cumulative re-pricing GAP

 $(536,284) $(458,687) $146,397  $516,523     
                     

Gap ratio

  0.26   2.05   11.11   9,741.16   1.60 

Cumulative gap ratio

  0.26   0.42   1.17   1.60     
                     

Gap as % of earning assets

  (39

)%

  6

%

  44

%

  27

%

  38

%

Cumulative GAP as % of earning assets

  (39

)%

  (33

)%

  11

%

  38

%

    

 

 

44

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Item 8 - Financial Statements and Supplementary Data

 

Index to Consolidated Financial Statements

 

 

 

 

Page

Report of Independent Registered Public Accounting Firm

46

Management’s Report on Internal Control Over Financial Reporting

47

Consolidated Balance Sheets as of December 31, 2019 and 2018

48

Consolidated Statements of Income for the years ended December 31, 2019 and 2018

49

Consolidated Statements of Comprehensive Income for the years ended December 31, 2019 and 2018

50

Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2019 and 2018

51

Consolidated Statements of Cash Flows for the years ended December 31, 2019 and 2018

52

Notes to Consolidated Financial Statements

54

 

 

45

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Report of Independent Registered Public Accounting Firm 

 

To the Board of Directors and Shareholders

Bank of Commerce Holdings

 

Opinions on the Financial Statements and Internal Control over Financial Reporting

 

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

 

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

 

Basis for Opinions

 

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

 

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

 

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

 

Definition and Limitations of Internal Control Over Financial Reporting

 

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

 

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

 

 

/s/ Moss Adams LLP

 

Sacramento, California

March 6, 2020

 

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

 

46

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

 

The Company’s independent registered public accounting firm has audited the Company’s consolidated financial statements that are included in this annual report and the effectiveness of our internal control over financial reporting as of December 31, 2019 and issued their Report of Independent Registered Public Accounting Firm, which appears on the previous page. The audit report expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019.

 

 

/s/ Randall S. Eslick

Randall S. Eslick, President and Chief Executive Officer

 

/s/ James A. Sundquist

James A. Sundquist, EVP and Chief Financial Officer

 

47

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Consolidated Balance Sheets

December 31, 2019 and 2018

 

 

(Amounts in thousands, except share information)

 

2019

  

2018

 

Assets:

        

Cash and due from banks

 $21,338  $23,692 

Interest-bearing deposits in other banks

  59,266   23,673 

Total cash and cash equivalents

  80,604   47,365 
         

Securities available-for-sale, at fair value

  286,950   256,928 
         

Loans, net of deferred fees and costs

  1,035,065   948,178 

Allowance for loan and lease losses

  (12,231)  (12,292)

Net loans

  1,022,834   935,886 
         

Premises and equipment, net

  15,906   13,119 

Other real estate owned

  35   31 

Life insurance

  23,701   22,410 

Deferred tax asset, net

  4,553   7,039 

Goodwill

  11,671   665 

Other intangible assets, net

  4,809   1,176 

Other assets

  28,553   22,485 

Total assets

 $1,479,616  $1,307,104 
         

Liabilities and shareholders' equity:

        

Liabilities:

        

Demand - noninterest-bearing

 $432,680  $347,199 

Demand - interest-bearing

  239,258   252,202 

Money market

  307,559   265,093 

Savings

  135,888   114,840 

Certificates of deposit

  151,786   152,382 

Total deposits

  1,267,171   1,131,716 
         

Term debt:

        

Other borrowings

  10,000   13,496 

Less unamortized debt issuance costs

  (43)  (91)

Net term debt

  9,957   13,405 
         

Junior subordinated debentures

  10,310   10,310 

Other liabilities

  17,700   13,352 

Total liabilities

  1,305,138   1,168,783 
         

Commitments and contingencies (Note 14)

        

Shareholders’ equity:

        

Common stock, no par value, 50,000,000 shares authorized; issued and outstanding - 18,137,167 as of December 31, 2019 and 16,333,502 as of December 31, 2018

  71,311   52,284 

Retained earnings

  100,566   89,045 

Accumulated other comprehensive income (loss), net of tax

  2,601   (3,008)

Total shareholders’ equity

  174,478   138,321 

Total liabilities and shareholders’ equity

 $1,479,616  $1,307,104 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

48

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Consolidated Statements of Income

For the years ended December 31, 2019 and 2018

 

(Amounts in thousands, except per share information)

 

2019

  

2018

 

Interest income:

        

Interest and fees on loans

 $50,534  $44,955 

Interest on taxable securities

  6,673   5,165 

Interest on tax-exempt securities

  1,244   1,629 

Interest on interest-bearing deposits in other banks

  1,112   952 

Total interest income

  59,563   52,701 

Interest expense:

        

Interest on demand - interest-bearing

  480   414 

Interest on money market

  1,599   646 

Interest on savings

  493   288 

Interest on certificates of deposit

  1,977   1,910 

Interest on Federal Home Loan Bank of San Francisco borrowings

  247   435 

Interest on other borrowings

  806   1,077 

Interest on junior subordinated debentures

  426   385 

Total interest expense

  6,028   5,155 

Net interest income

  53,535   47,546 

Provision for loan and lease losses

      

Net interest income after provision for loan and lease losses

  53,535   47,546 

Noninterest income:

        

Service charges on deposit accounts

  730   682 

ATM and point of sale fees

  1,158   1,131 

Payroll and benefit processing fees

  669   652 

Life insurance

  536   512 

Gain on sale of investment securities, net

  186   44 

Federal Home Loan Bank of San Francisco dividends

  507   480 

Gain on sale of OREO

  62   73 

Other income

  336   445 

Total noninterest income

  4,184   4,019 

Noninterest expense:

        

Salaries and related benefits

  20,804   18,709 

Premises and equipment

  3,752   3,983 

Federal Deposit Insurance Corporation insurance premium

  91   376 

Data processing

  2,535   1,997 

Professional services

  1,539   1,431 

Telecommunications

  737   594 

Acquisition and merger

  2,193   844 

Other expenses

  5,604   4,272 

Total noninterest expense

  37,255   32,206 

Income before provision for income taxes

  20,464   19,359 

Provision for income taxes

  5,503   3,629 

Net income

 $14,961  $15,730 
         

Earnings per share - basic

 $0.83  $0.97 

Weighted average shares - basic

  17,956   16,248 

Earnings per share - diluted

 $0.83  $0.96 

Weighted average shares - diluted

  18,024   16,332 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

49

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Consolidated Statements of Comprehensive Income

For the years ended December 31, 2019 and 2018

 

 

(Amounts in thousands)

 

2019

  

2018

 

Net income

 $14,961  $15,730 
         

Available-for-sale securities:

        

Changes in unrealized gain (loss) arising during the period

  8,149   (3,774)

Income taxes

  (2,409)  1,115 

Change in unrealized gain (loss), net of tax

  5,740   (2,659)
         

Reclassification adjustment for realized gains included in net income

  (186)  (44)

Income taxes

  55   13 

Realized gains, net of tax

  (131)  (31)

Net change in unrealized gain (loss) on available-for-sale securities

  5,609   (2,690)
         

Other comprehensive income (loss)

  5,609   (2,690)

Comprehensive income – Bank of Commerce Holdings

 $20,570  $13,040 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

50

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Consolidated Statements of Shareholders’ Equity

For the years ended December 31, 2018 and 20192019

 

              

Accumulated Other

     
      

Common

      

Comprehensive

     
  

Common

  

Stock

  

Retained

  

Income (Loss)

     

(Amounts in thousands except per share information)

 

Shares

  

Amount

  

Earnings

  

Net of Tax

  

Total

 

Balance at December 31, 2017

  16,272  $51,830  $75,700  $(266) $127,264 
                     

2018

                    

Net income

        15,730      15,730 

Reclassification of accumulated other comprehensive income due to tax rate change

        52   (52)   

Other comprehensive loss, net of tax

           (2,690)  (2,690)

Comprehensive income

              13,040 

Dividends declared on common stock ($0.15 per share)

        (2,437)     (2,437)

Stock compensation grants

  5   45         45 

Restricted stock granted, net

  20             

Stock options exercised

  37   216         216 

Compensation expense associated with stock options

     8         8 

Compensation expense associated with restricted stock, net of cash paid for shares surrendered for tax-withholding purposes

     185         185 

Balance at December 31, 2018

  16,334  $52,284  $89,045  $(3,008)  138,321 
                     

2019

                    

Net income

        14,961      14,961 

Other comprehensive income, net of tax

           5,609   5,609 

Comprehensive income

              20,570 

Dividends declared on common stock ($0.19 per share)

        (3,440)     (3,440)

Stock issued for Merchants acquisition

  1,834   19,607         19,607 

Repurchase of common stock

  (91)  (1,010)        (1,010)

Stock compensation grants

  6   58         58 

Restricted stock granted, net

  43             

Stock options exercised

  11   52         52 

Compensation expense associated with restricted stock, net of cash paid for shares surrendered for tax-withholding purposes

     320         320 

Balance at December 31, 2019

  18,137  $71,311  $100,566  $2,601  $174,478 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

51

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Consolidated Statements of Cash Flows

For the years ended December 31, 2019 and 2018

 

(Amounts in thousands)

 

2019

  

2018

 

Cash flows from operating activities:

        

Net income

 $14,961  $15,730 

Adjustments to reconcile net income to net cash provided by operating activities:

        

Provision for depreciation and amortization

  1,367   1,738 

Amortization of core deposit intangibles

  720   221 

Amortization of debt issuance costs

  48   48 

Compensation expense associated with stock options

     8 

Compensation expense associated with restricted stock

  414   288 

Tax benefits from vesting of restricted stock

  (9)  (46)

Net gain on sale or call of securities

  (186)  (44)

Amortization of premiums and accretion of discounts on investment securities, net

  1,477   1,845 

Amortization of premiums and accretion of discounts on acquired loans, net

  (1,598)  (355)

Gain on sale of OREO

  (62)  (73)

Increase in cash surrender value of life insurance

  (536)  (512)

Deferred compensation and salary continuation plan payments

  (1,507)  (905)

Increase in deferred compensation and salary continuation plans

  1,853   972 

Increase in deferred loan fees and costs

  (235)  (217)

Decrease in deferred income taxes

  154   595 

Decrease in other assets

  1,079   345 

(Decrease) increase in other liabilities

  (1,292)  1,094 

Net cash provided by operating activities

  16,648   20,732 
         

Cash flows from investing activities:

        

Proceeds from maturities and payments of available-for-sale securities

  64,183   31,538 

Proceeds from sale of available-for-sale securities

  117,299   30,235 

Purchases of available-for-sale securities

  (97,741)  (57,616)

Investment in qualified affordable housing partnerships

  (6)  (38)

Net purchase of Federal Home Loan Bank of San Francisco stock

  (34)  (1,355)

Loan originations, net of principal repayments

  (32,707)  (57,690)

Net repayment on (purchase of) purchased loans

  32,796   (8,499)

Purchase of premises and equipment

  (1,958)  (351)

Proceeds from the sale of OREO

  132   217 

Acquisition of Merchants Holding Company, net of cash paid

  (2,875)   

Net cash provided (used) by investing activities

  79,089   (63,559)
         

Cash flows from financing activities:

        

Net (decrease) increase in demand deposits, money market and savings

 $(16,162) $65,857 

Net decrease in certificates of deposit

  (38,599)  (36,873)

Advances on term debt

  180,160   230,160 

Repayment of term debt

  (183,656)  (233,761)

Proceeds from stock options exercised

  52   216 

Repurchase of common stock

  (1,010)   

Cash paid for common stock surrendered for tax-withholding purposes

  (94)  (103)

Cash dividends paid on common stock

  (3,189)  (2,274)

Net cash (used in) provided by financing activities

  (62,498)  23,222 

Net increase (decrease) cash and cash equivalents

  33,239   (19,605)

Cash and cash equivalents at the beginning of year

  47,365   66,970 

Cash and cash equivalents at the end of year

 $80,604  $47,365 

 

See accompanying Notes to Consolidated Financial Statements.

 

52

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

 

Consolidated Statements of Cash Flows (Continued)

 

 

(Amounts in thousands)

        

Supplemental disclosures of cash flow activity:

 

2019

  

2018

 

Cash paid during the period for:

        

Income taxes

 $6,007  $2,727 

Interest

 $6,029  $5,171 

Operating leases

 $897  $809 

Supplemental disclosures of non cash investing activities:

        

Transfer of loans to other real estate owned

 $74  $140 
         

Unrealized gain (loss) on investment securities available-for-sale, net of gains included in net income

 $7,963  $(3,818)

Changes in net deferred tax asset related to changes in unrealized (gain) loss on investment securities available-for-sale

  (2,354)  1,128 

Changes in accumulated other comprehensive income (loss) due to changes in unrealized (loss) gain on investment securities available-for-sale

 $5,609  $(2,690)
         

Reclassification of accumulated other comprehensive income due to tax rate change

 $  $52 

Supplemental disclosures of non cash financing activities:

        

Stock issued under employee plans

 $58  $45 

Cash dividend declared on common stock and payable after period-end

 $902  $651 

Right-of-use lease asset recorded on new leases

 $267  $ 

Right-of-use lease asset recorded on adoption of ASU No. 2016-03

 $3,905  $ 

Lease liability recorded on adoption of ASU No. 2016-02

 $4,363  $ 

Transactions Related to Acquisition:

        

Assets acquired - fair value

 $215,055  $ 

Goodwill

 $11,006  $ 

Liabilities assumed - fair value

 $191,154  $ 

 

See accompanying Notes to Consolidated Financial Statements.

 

 
53

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 Business Oversight (“CDBO”) and the Federal Deposit Insurance Corporation (“FDIC”). Substantially all of the Company’s activities are carried out through the Bank. The Bank was incorporated as a California banking corporation on November 25, 1981 and opened for business on October 22, 1982.

 

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

 

On January 31, 2019, we completed the acquisition of Merchants Holding Company (“Merchants”), to extend our presence in the Sacramento marketplace. Merchants, headquartered in Sacramento, California, was the parent company of The Merchants National Bank of Sacramento (“Merchants Bank”), a 97-year-old bank with approximately $211.7 million in assets as of January 31, 2019. Merchants Bank operated one full service branch and one limited service branch in the Sacramento metropolitan area. See Note 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. 2016-02

 

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

 

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

 

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

 

We determine if an arrangement is a lease at inception. Operating leases are included in Other 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 the borrowing rates for terms similar to the lease terms available under our existing line of credit with the Federal Home Loan Bank of San Francisco as our incremental borrowing rate in determining the present value of future payments. Our lease terms may include options to extend or terminate the lease which we recognize when it is reasonably certain that we will exercise that option. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.

 

Recent Accounting Pronouncement

 

ASU No. 2016-13

 

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

 

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

 

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

 

54

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
 
Notes to Consolidated Financial Statements

 

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

 

Basis of Financial Statement Presentation

 

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

 

Principles of Consolidation

 

The accompanying Consolidated Financial Statements include the accounts of the Holding Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. As of December 31, 2019 and 2018, the Company had one wholly-owned trust formed in 2005 to issue trust preferred securities and related common securities. We have not consolidated the accounts of the Trust in our Consolidated Financial Statements in accordance with Financial Accounting Standards Board Accounting Standards Codification (“FASB”) ASC 810, Consolidation (“ASC 810”). We are not considered the primary beneficiary of the Trust (variable interest entity). As a result, the junior subordinated debentures issued by the Holding Company to the Trust are reflected on the Company’s Consolidated Balance Sheets.

 

Subsequent Events

 

We have evaluated events and transactions subsequent to December 31, 2019 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.

 

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.

 

55

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
 
Notes to Consolidated Financial Statements

 

Loans

 

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

 

A loan is impaired when, based on current information and events, management believes it is probable that we will not be able to collect all amounts due according to the 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 CCO reviews and approves loans recommended for impaired status or their removal from impaired status.

 

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.

 

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 (CCO) is responsible for regularly reviewing the ALLL methodology, including loss factors, and ensuring that it is designed and applied in accordance with generally accepted accounting principles. The Board of Directors reviews and approves the adequacy of the ALLL quarterly.

 

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

 

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

 

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

 

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

 

We believe that the ALLL was adequate as of December 31, 2019. There is, however, no assurance that future loan and lease losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses. In addition, bank regulatory authorities, as part of their periodic examination of the Company, may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review. Approximately 83% of our loan portfolio is secured by real estate, and a significant decline in real estate market values may require an increase in the ALLL.

 

56

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
 
Notes to Consolidated Financial Statements

 

Reserve for Unfunded Commitments

 

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

 

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

 

Premises and Equipment

 

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

 

Goodwill and Other Intangibles

 

Intangible assets are comprised of goodwill and other intangibles acquired in business combinations. Goodwill and intangible assets with indefinite useful lives are not amortized. Intangible assets with definite useful lives are amortized to their estimated residual values over their respective estimated useful lives, and also reviewed for impairment. Amortization of intangible assets is included in non-interest expense in the Consolidated Statements of Income. We perform 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.

 

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.

 

57

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
 
Notes to Consolidated Financial Statements

 

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

 

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

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

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

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

 

Share Based Payments

 

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.

 

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, 2019 and 2018, advertising costs were $160 thousand and $47 thousand, respectively. Advertising costs are expensed as incurred.

 

Earnings per Share

 

Earnings per share is an important measure of our performance for investors and other users of financial statements. Certain of our securities, such as stock options or restricted stock, permit the holders to become common shareholders or add to the 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.

 

58

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, 2019, 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 2019 and 2018.

 

The Bank is required by federal regulations to set aside specified amounts of cash as reserves against transaction and time deposits. The cash reserve required as of December 31, 2019 and December 31, 2018 was $1.8 million and $1.4 million, respectively which was satisfied by vault cash balances.

 

 

 

NOTE 4. SECURITIES

 

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

 

  

As of December 31, 2019

 
      

Gross

  

Gross

     
  

Amortized

  

Unrealized

  

Unrealized

  

Estimated

 

(Amounts in thousands)

 

Costs

  

Gains

  

Losses

  

Fair Value

 

Available-for-sale securities:

                

U.S. government & agencies

 $38,291  $469  $(27) $38,733 

Obligations of state and political subdivisions

  40,702   1,422   (26)  42,098 

Residential mortgage-backed securities and collateralized mortgage obligations

  179,114   2,163   (442)  180,835 

Corporate securities

  3,005   6   (45)  2,966 

Commercial mortgage-backed securities

  19,126   221   (40)  19,307 

Other asset-backed securities

  3,019      (8)  3,011 

Total

 $283,257  $4,281  $(588) $286,950 

 

 

  

As of December 31, 2018

 
      

Gross

  

Gross

     
  

Amortized

  

Unrealized

  

Unrealized

  

Estimated

 

(Amounts in thousands)

 

Costs

  

Gains

  

Losses

  

Fair Value

 

Available-for-sale securities:

                

U.S. government & agencies

 $40,215  $202  $(330) $40,087 

Obligations of state and political subdivisions

  50,037   1,082   (589)  50,530 

Residential mortgage-backed securities and collateralized mortgage obligations

  142,355   129   (3,981)  138,503 

Corporate securities

  3,022      (100)  2,922 

Commercial mortgage-backed securities

  25,446   17   (701)  24,762 

Other asset-backed securities

  123   1      124 

Total

 $261,198  $1,431  $(5,701) $256,928 

 

59

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
 
Notes to Consolidated Financial Statements

 

The following table presents the expected maturities of investment securities at December 31, 2019.

 

  

Available-For-Sale

 

(Amounts in thousands)

 

Amortized Cost

  

Fair Value

 

Amounts maturing in:

        

One year or less

 $6,542  $6,567 

One year through five years

  139,442   141,580 

Five years through ten years

  74,651   75,295 

After ten years

  62,622   63,508 

Total

 $283,257  $286,950 

 

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

 

At December 31, 2019 and 2018, securities with a fair value of $81.4 million and $68.8 million, respectively, were pledged as collateral to secure public fund deposits, Federal Home Loan Bank of San Francisco borrowings and for other purposes as required by law.

 

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, 2019 and 2018.

 

  

For Years Ended December 31,

 

(Amounts in thousands)

 

2019

  

2018

 

Proceeds from sales of investment securities

 $117,299  $30,235 
         

Gross realized gains on sales of investments securities:

        

U.S. government & agencies

 $49  $ 

Obligations of state and political subdivisions

  482   262 

Residential mortgage-backed securities and collateralized mortgage obligations

  108    

Corporate securities

     1 

Commercial mortgage-backed securities

  34    

Total gross realized gains on sales of investment securities

  673   263 
         

Gross realized losses on sales of investment securities

        

U.S. government & agencies

  (16)  (43)

Obligations of state and political subdivisions

  (95)  (71)

Residential mortgage-backed securities and collateralized mortgage obligations

  (321)  (40)

Commercial mortgage-backed securities

  (54)  (19)

Other asset-backed securities

  (1)  (46)

Total gross realized losses on sales of investment securities

  (487)  (219)

Gains on sales of investment securities, net

 $186  $44 

 

Investment securities that were in an unrealized loss position as of December 31, 2019 and December 31, 2018 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, 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) $6,853  $(27)

Obligations of states and political subdivisions

  2,249   (26)        2,249   (26)

Residential mortgage-backed securities and collateralized mortgage obligations

  31,817   (207)  22,166   (235)  53,983   (442)

Corporate securities

        955   (45)  955   (45)

Commercial mortgage-backed securities

  1,464   (1)  4,549   (39)  6,013   (40)

Other asset-backed securities

  3,011   (8)        3,011   (8)

Total temporarily impaired securities

 $45,014  $(267) $28,050  $(321) $73,064  $(588)

 

60

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
 
Notes to Consolidated Financial Statements

 

  

As of December 31, 2018

 
  

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

 $7,223  $(39) $12,274  $(291) $19,497  $(330)

Obligations of states and political subdivisions

  5,545   (40)  16,320   (549)  21,865   (589)

Residential mortgage-backed securities and collateralized mortgage obligations

  21,791   (183)  93,038   (3,798)  114,829   (3,981)

Corporate securities

        2,922   (100)  2,922   (100)

Commercial mortgage-backed securities

  1,548   (7)  20,176   (694)  21,724   (701)

Total temporarily impaired securities

 $36,107  $(269) $144,730  $(5,432) $180,837  $(5,701)

 

At December 31, 2019 and December 31, 2018, the number of securities in an unrealized loss position was 63 and 163, respectively. In the opinion of management, these securities are considered only temporarily impaired due to changes in market interest rates or widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral. Our Investment Policy requires securities at the time of purchase to be rated A3/A- or higher by Moody’s, S&P and Fitch rating agencies. Management monitors the published credit ratings of our investment portfolio for material rating or outlook changes. For all private-label securities collateralized by mortgages, management also monitors the credit characteristics of the underlying mortgages to identify potential credit losses, if any, in the portfolio. Because the decline in fair value is not due to credit quality concerns, and because we have no plans to sell the securities before the recovery of their amortized cost, and we believe the bank has the ability to hold the securities to maturity these investments are not considered other-than-temporarily impaired.

 

The following table presents the characteristics of our securities that are in unrealized loss positions at December 31, 2019 and December 31, 2018.

 

  

Characteristics of securities in unrealized loss positions at

Available-for-sale securities:

 

December 31, 2019 and December 31, 2018

U.S. government & agencies

 

Direct obligations of the U.S. Government or obligations guaranteed by U.S. Government agencies.

Obligations of states and political subdivisions

 

General obligation issuances or revenue securities secured by revenues from specific sources issued by municipalities and political subdivisions located within the U.S.

Residential mortgage-backed securities and collateralized mortgage obligations

 

Obligations of U.S. government sponsored entities or non-governmental entities collateralized by high quality mortgages on residential properties. Issuances by non-governmental entities usually include good credit enhancements. Of the residential mortgage-backed securities and collateralized mortgage obligations that we owned at December 31, 2019 and December 31, 2018, 79% and 66% were issued or guaranteed by U.S. government sponsored entities, respectively.

Corporate securities

 

Debt obligations generally issued or guaranteed by large U.S. corporate institutions.

Commercial mortgage-backed securities

 

Obligations of U.S. government sponsored entities or non-governmental entities collateralized by high quality mortgages on commercial properties. Issuances by non-governmental entities usually include good credit enhancements. Of the commercial mortgage-backed securities that we owned at December 31, 2019 and December 31, 2018, 100% and 90% were issued or guaranteed by U.S. government sponsored entities, respectively.

Other asset-backed securities

 

Obligations secured by high quality loans with good credit enhancements issued by non-governmental issuers.

 

61

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
 
Notes to Consolidated Financial Statements
 

 

 

NOTE 5. LOANS

 

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

 

(Amounts in thousands)

 

As of December 31

 

Loan Portfolio

 

2019

  

2018

 

Commercial

 $141,197  $135,543 

Commercial real estate:

        

Real estate – construction and land development

  26,830   22,563 

Real estate – commercial non-owner occupied

  493,920   433,708 

Real estate – commercial owner occupied

  218,833   204,622 

Residential real estate:

        

Real estate – residential - Individual Tax Identification Number ("ITIN")

  33,039   37,446 

Real estate – residential - 1-4 family mortgage

  63,661   34,366 

Real estate – residential - equity lines

  22,099   26,958 

Consumer and other

  33,324   51,045 

Gross loans

  1,032,903   946,251 

Deferred fees and costs

  2,162   1,927 

Loans, net of deferred fees and costs

  1,035,065   948,178 

Allowance for loan and lease losses

  (12,231)  (12,292)

Net loans

 $1,022,834  $935,886 

 

Certain loans are pledged as collateral with the Federal Home Loan Bank of San Francisco and the Federal Reserve Bank. Pledged loans totaled $542.1 million and $490.2 million at December 31, 2019 and December 31, 2018, respectively.

 

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

 

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

 

Past Due Loans

 

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

 

                          

Recorded

 

(Amounts in thousands)

 30-59  60-89  

90 or Greater

              

Investment >

 

Past Due Loans at

 

Days Past

  

Days Past

  

Days Past

  

Total Past

          

90 Days and

 

December 31, 2019

 

Due

  

Due

  

Due

  

Due

  

Current

  

Total

  

Accruing

 

Commercial

 $71  $  $  $71  $141,126  $141,197  $ 

Commercial real estate:

                            

Real estate - construction and land development

              26,830   26,830    

Real estate - commercial non-owner occupied

              493,920   493,920    

Real estate - commercial owner occupied

  655      3,103   3,758   215,075   218,833    

Residential real estate:

                            

Real estate - residential - ITIN

  371   323   43   737   32,302   33,039    

Real estate - residential - 1-4 family mortgage

              63,661   63,661    

Real estate - residential - equity lines

  100         100   21,999   22,099    

Consumer and other

  200   50       250   33,074   33,324    

Total

 $1,397  $373  $3,146  $4,916  $1,027,987  $1,032,903  $ 

 

62

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
 
Notes to Consolidated Financial Statements

 

                          

Recorded

 

(Amounts in thousands)

 30-59  60-89  

90 or Greater

              

Investment >

 

Past Due Loans at

 

Days Past

  

Days Past

  

Days Past

  

Total Past

          

90 Days and

 

December 31, 2018

 

Due

  

Due

  

Due

  

Due

  

Current

  

Total

  

Accruing

 

Commercial

 $  $  $  $  $135,543  $135,543  $ 

Commercial real estate:

                            

Real estate - construction and land development

              22,563   22,563    

Real estate - commercial non-owner occupied

  10,878      548   11,426   422,282   433,708    

Real estate - commercial owner occupied

  688         688   203,934   204,622    

Residential real estate:

                            

Real estate - residential - ITIN

  184   279   259   722   36,724   37,446    

Real estate - residential - 1-4 family mortgage

        185   185   34,181   34,366    

Real estate - residential - equity lines

  90         90   26,868   26,958    

Consumer and other

  534   263      797   50,248   51,045    

Total

 $12,374  $542  $992  $13,908  $932,343  $946,251  $ 

 

Nonaccrual Loans

 

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

 

 

(Amounts in thousands)

 

As of December 31

 

Nonaccrual Loans

 

2019

  

2018

 

Commercial

 $61  $959 

Commercial real estate:

        

Real estate - commercial non-owner occupied

     548 

Real estate - commercial owner occupied

  3,103    

Residential real estate:

        

Real estate - residential - ITIN

  2,221   2,388 

Real estate - residential - 1-4 family mortgage

  191   185 

Real estate - residential - equity lines

     43 

Consumer and other

  40   23 

Total

 $5,616  $4,146 

 

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

 

63

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, 2019, and December 31, 2018.

 

  

As of December 31, 2019

 
      

Unpaid

     

(Amounts in thousands)

 

Recorded

  

Principal

  

Related

 

Impaired Loans

 

Investment

  

Balance

  

Allowance

 

With no related allowance recorded:

            

Commercial

 $94  $251  $ 

Commercial real estate:

            

Real estate - commercial owner-occupied

  3,103   3,103    

Residential real estate:

            

Real estate - residential - ITIN

  5,723   7,386    

Real estate - residential - 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:

            

Real estate - residential - ITIN

  455   455   38 

Real estate - residential - equity line