pmbc-20200630

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)


☒			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2020


☐			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 0-30777

PACIFIC MERCANTILE BANCORP

(Exact name of Registrant as specified in its charter)


California						33-0898238
(State or other jurisdiction of incorporation or organization)						(I.R.S. Employer Identification No.)

949 South Coast Drive, Suite 300, Costa Mesa, California 92626

(Address of principal executive offices) (Zip Code)

(714) 438-2500

(Registrant’s telephone number, including area code)

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


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, without par value	"PMBC"	Nasdaq Global Select Market

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 x 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 x No ¨

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

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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 Securities Exchange Act Rule 12b-2). Yes ☐ No x

As of August 6, 2020, there were 22,157,649 shares of Common Stock and 1,467,155 shares of Non-Voting Common Stock outstanding.

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PACIFIC MERCANTILE BANCORP

QUARTERLY REPORT ON FORM 10Q

FOR THE QUARTER ENDED JUNE 30, 2020

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		Page No.
Part I. Financial Information

Item 1.	Financial Statements (unaudited)	4

	Consolidated Statements of Financial Condition at June 3 0 , 2020 and December 31, 2019	4

	Consolidated Statements of Operations for the Three and Six Months Ended June 30 , 2020 and 2019	5

	Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2020 and 2019	6

	Consolidated Statement of Shareholders' Equity for the Three and Six Months Ended June 30 , 2020 and 2019	7

	Consolidated Statements of Cash Flows for the Six Months Ended June 30 , 2020 and 2019	8

	Notes to Interim Consolidated Financial Statements	9

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	39

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	64

Item 4.	Controls and Procedures	64

Part II. Other Information

Item 1.	Legal Proceedings	65

Item 1A.	Risk Factors	65

Item 6.	Exhibits	66

Signatures			67

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PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollars in thousands)

(Unaudited)


	June 30, 2020		December 31, 2019
ASSETS
Cash and due from banks	$	17,170	$	17,409
Interest bearing deposits with financial institutions	241,859		202,729
Cash and cash equivalents	259,029		220,138
Interest-bearing time deposits with financial institutions	2,345		2,420
Federal Reserve Bank of San Francisco and Federal Home Loan Bank Stock, at cost	7,910		7,910
Securities available for sale, at fair value	26,213		28,344

Loans (net of allowances of $18,166 and $13,611, respectively)	1,350,800		1,117,511

Accrued interest receivable	5,429		4,095
Premises and equipment, net	1,110		1,117
Net deferred tax assets	9,816		8,434
Intangible assets	239		266
Other assets	25,301		25,919
Total assets	$	1,688,192	$	1,416,154
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Noninterest-bearing	$	596,052	$	397,000
Interest-bearing	832,474		802,570
Total deposits	1,428,526		1,199,570
Borrowings	73,962		30,000
Accrued interest payable	288		398
Other liabilities	18,132		19,611
Junior subordinated debentures	17,527		17,527

Total liabilities	1,538,435		1,267,106
Commitments and contingencies (Note 11 and Note 14)
Shareholders’ equity:




Common stock, no par value, 85,000,000 shares of voting common stock and 2,000,000 shares of non-voting common stock authorized; 22,159,885 and 22,106,374 voting shares issued and outstanding at June 30, 2020 and December 31, 2019, respectively; 1,467,155 non-voting shares issued and outstanding at June 30, 2020 and December 31, 2019	154,046		153,570
Accumulated deficit	(4,410)		(3,955)
Accumulated other comprehensive income (loss)	121		(567)
Total shareholders’ equity	149,757		149,048
Total liabilities and shareholders’ equity	$	1,688,192	$	1,416,154

The accompanying notes are an integral part of these consolidated financial statements.

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PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except for per share data)

(Unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2020		2019		2020		2019
Interest income:
Loans, including fees	$	15,291	$	14,586	$	29,078	$	29,106
Securities available for sale and stock	210		260		471		551
Interest-bearing deposits with financial institutions	79		1,620		800		2,975
Total interest income	15,580		16,466		30,349		32,632
Interest expense:
Deposits	1,963		3,753		4,928		7,377
Borrowings	299		494		630		985
Total interest expense	2,262		4,247		5,558		8,362
Net interest income	13,318		12,219		24,791		24,270
Provision for loan and lease losses	2,850		—		9,050		3,300
Net interest income after provision for loan and lease losses	10,468		12,219		15,741		20,970
Noninterest income



Service fees on deposits and other banking services	625		443		1,147		840

Net gain on sale of Small Business Administration loans	—		300		—		600
Net loss on sale of other assets	(53)		(11)		(47)		(36)
Other noninterest income	599		654		1,165		1,472
Total noninterest income	1,171		1,386		2,265		2,876
Noninterest expense
Salaries and employee benefits	5,462		5,737		11,531		11,177
Occupancy	668		647		1,339		1,274
Equipment and depreciation	508		480		959		941
Data processing	592		526		1,236		1,044
FDIC expense	210		193		403		357

Other real estate owned expense, net	—		1		—		69
Professional fees	702		1,190		1,563		1,986

Business development	137		241		309		437

Loan related expense	152		122		277		307
Insurance	63		61		126		123
Other operating expense	440		509		908		976
Total noninterest expense	8,934		9,707		18,651		18,691
Income (loss) before income taxes	2,705		3,898		(645)		5,155
Income tax provision (benefit)	800		1,170		(190)		1,545










Net income (loss) allocable to common shareholders	$	1,905	$	2,728	$	(455)	$	3,610
Basic income (loss) per common share:

Net income (loss) allocable to common shareholders	$	0.08	$	0.12	$	(0.02)	$	0.15
Diluted income (loss) per common share:

Net income (loss) allocable to common shareholders	$	0.08	$	0.12	$	(0.02)	$	0.15
Weighted average number of common shares outstanding:
Basic	23,502,400		22,619,993		23,488,721		22,224,376
Diluted	23,713,486		23,615,958		23,488,721		23,581,106

The accompanying notes are an integral part of these consolidated financial statements.

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PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands)

(Unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2020		2019		2020		2019
Net income (loss)	$	1,905	$	2,728	$	(455)	$	3,610
Other comprehensive income, net of tax:
Change in unrealized holding gain on securities available for sale	141		273		688		640




Total comprehensive income	$	2,046	$	3,001	$	233	$	4,250

The accompanying notes are an integral part of these consolidated financial statements.

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PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Shares and dollars in thousands)

(Unaudited)

For the Three and Six Months Ended June 30, 2020 and 2019


	Common stock							Accumulated deficit		Accumulated other comprehensive income (loss)		Total
		Number of shares			Amount
Balance at December 31, 2019	23,574		$	153,570		$	(3,955)	$	(567)	$	149,048





Issuance of restricted stock, net	19		—			—		—		—


Common stock based compensation expense	—		214			—		—		214
Common stock options exercised	11		50			—		—		50
Net loss	—		—			(2,360)		—		(2,360)
Other comprehensive income	—		—			—		547		547
Balance at March 31, 2020	23,604		$	153,834		$	(6,315)	$	(20)	$	147,499
Issuance of restricted stock, net	23		—			—		—		—
Common stock based compensation expense	—		212			—		—		212

Net income	—		—			1,905		—		1,905
Other comprehensive income	—		—			—		141		141
Balance at June 30, 2020	23,627		$	154,046		$	(4,410)	$	121	$	149,757


	Series A Non-Voting Preferred stock								Common stock							Accumulated deficit		Accumulated other comprehensive income (loss)	Total
		Number of shares			Amount			Number of shares			Amount
Balance at December 31, 2018	1,467		$	8,480		21,916			$	143,466		$	(9,428)	$	(1,144)	$	141,374


Implementation of ASU 2016-02	—		—			—			—			(207)		—		(207)
Issuance of restricted stock, net	—		—			102			—			—		—		—
Common stock based compensation expense	—		—			—			200			—		—		200

Net income	—		—			—			—			882		—		882
Other comprehensive income	—		—			—			—			—		367		367
Balance at March 31, 2019	1,467		$	8,480		22,018			$	143,666		$	(8,753)	$	(777)	$	142,616

Issuance of restricted stock, net	—		—			15			—			—		—		—
Exchange Series A Non-Voting Preferred Stock to Non-Voting Common Stock	(1,467)		(8,480)			1,467			8,480			—		—		—
Common stock based compensation expense	—		—			—			219			—		—		219
Common stock options exercised	—		—			15			80			—		—		80
Net income	—		—			—			—			2,728		—		2,728
Other comprehensive income	—		—			—			—			—		273		273
Balance at June 30, 2019	—		$	—		$	23,515		$	152,445		$	(6,025)	$	(504)	$	145,916

The accompanying notes are an integral part of these consolidated financial statements.

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PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)


	Six Months Ended June 30,
	2020		2019
Cash Flows From Operating Activities:
Net income (loss)	$	(455)	$	3,610
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	198		213
Provision for loan and lease losses	9,050		3,300
Amortization of premium on securities	64		77


Net amortization (accretion) of deferred fees and unearned income on loans	(1,544)		320
Net loss on sales of other real estate owned	—		66

Net loss on sale of other assets	47		36
Net gain on sale of Small Business Administration loans	—		(600)
Small Business Administration loan originations	—		(7,139)
Proceeds from sale of Small Business Administration loans	—		7,800

Stock-based compensation expense	426		419


Changes in operating assets and liabilities:
Net increase in accrued interest receivable	(1,334)		(362)
Net decrease in other assets	147		5,675
Net (increase) decrease in deferred taxes	(1,671)		1,872
Net decrease (increase) in income taxes receivable	(233)		390
Net increase (decrease) in accrued interest payable	(110)		136
Net decrease in other liabilities	(1,479)		(8,653)

Net cash provided by operating activities	3,106		7,160
Cash Flows From Investing Activities:
Net decrease in interest-bearing time deposits with financial institutions	75		—
Maturities of and principal payments received on securities available for sale and other stock	3,044		3,669

Proceeds from sale of securities available for sale and other stock	—		912
Purchase of other investments	—		(877)

Proceeds from sale of other real estate owned	—		1,107

Net (increase) decrease in loans	(240,156)		1,885

Purchases of premises and equipment	(239)		(96)
Proceeds from sale of other assets	93		55

Net cash provided by (used in) investing activities	(237,183)		6,655
Cash Flows From Financing Activities:




Net increase in deposits	228,956		63,628
Proceeds from borrowings	113,962		40,000
Payments of borrowings	(70,000)		(40,000)
Proceeds from exercise of common stock options	50		80

Net cash provided by financing activities	272,968		63,708
Net increase in cash and cash equivalents	38,891		77,523
Cash and Cash Equivalents, beginning of period	220,138		187,718
Cash and Cash Equivalents, end of period	$	259,029	$	265,241
Supplementary Cash Flow Information:
Cash paid for interest on deposits and other borrowings	$	5,668	$	8,226
Cash paid for income taxes	$	1,248	$	62

Noncash Investing Activities:
Transfer of loans into other assets	$	639	$	82



Right-of-use assets obtained in exchange for new operating lease liabilities	$	—	$	9,919

The accompanying notes are an integral part of these consolidated financial statements.

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1. Nature of Business

Organization

Pacific Mercantile Bancorp (“PMBC”) is a bank holding company which, through its wholly owned subsidiary, Pacific Mercantile Bank (the “Bank”), is engaged in the commercial banking business in Southern California. PMBC is registered as a one bank holding company under the United States Bank Holding Company Act of 1956, as amended, and, as such, is regulated by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) and the Federal Reserve Bank of San Francisco (“FRBSF”) under delegated authority from the Federal Reserve Board. Substantially all of our operations are conducted and substantially all of our assets are owned by the Bank, which accounts for substantially all of our consolidated revenues, expenses, and income. The Bank provides a full range of banking services to middle-market businesses and professionals primarily in Orange, Los Angeles, San Bernardino and San Diego counties in Southern California and is subject to competition from, among other things, other banks and financial institutions and from financial services organizations conducting operations in those same markets. The Bank is chartered by the California Department of Business Oversight under the Division of Financial Institutions and is a member of the FRBSF. In addition, the deposit accounts of the Bank’s customers are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to the maximum amount allowed by law.

PMBC and the Bank are sometimes referred to, together, on a consolidated basis, in this report as the “Company” or as “we”, “us” or “our”.

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2. Significant Accounting Policies

Except as discussed below, our accounting policies are described in Note 2, Significant Accounting Policies of our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2019 (“Form 10-K”).

Interim Consolidated Financial Statements Basis of Presentation

Our interim consolidated financial statements are prepared in accordance with generally accepted accounting principles in effect in the United States (“GAAP”) for interim financial information pursuant to rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”), including instructions to Form 10-Q and Article 10 of Regulation S-X, on a basis consistent with prior periods. Our financial statements reflect all adjustments that are, in the opinion of management, necessary to present a fair statement of the results for the interim periods presented. The interim results are not necessarily indicative of operating results for the full year. The interim information should be read in conjunction with our audited consolidated financial statements in our Form 10-K.

Use of Estimates

The preparation of the financial statements in conformity with GAAP requires us to make certain estimates and assumptions that could affect the reported amounts of certain of our assets, liabilities, and contingencies at the date of the financial statements and the reported amounts of our revenues and expenses during the reporting periods. For the fiscal periods covered by this report, those estimates related primarily to our determinations of the allowance for loan and lease losses (“ALLL”), the fair values of securities available for sale, and the determination of the valuation allowance pertaining to deferred tax assets. If circumstances or financial trends on which those estimates were based were to change in the future or there were to occur any currently unanticipated events affecting the amounts of those estimates, our future financial position or results of operations could differ, possibly materially, from those expected at the current time.

Principles of Consolidation

Our consolidated financial statements for the three and six months ended June 30, 2020 and 2019 include the accounts of PMBC and the Bank. All significant intercompany balances and transactions were eliminated in consolidation.

Recent Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which 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 will now use forward-looking information to better inform their credit loss estimates. Additionally, the ASU amends the accounting guidance for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. On November 15, 2019, the FASB issued ASU 2019-10, "Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates" which finalizes various effective date delays for private companies, not-for-profit organizations, and smaller reporting companies applying the credit losses (CECL), leases, and hedging standards. The effective date for smaller reporting companies has been delayed from the interim and annual periods beginning after December 15, 2020 to the interim and annual periods beginning after December 15, 2022. Early adoption is permitted for interim and annual periods beginning after December 15, 2018. We plan to adopt this guidance on January 1, 2023 and expect that it will have a material impact on the determination of our ALLL. We are unable to estimate the expected impact to the ALLL upon adoption due to various factors, primarily the fine tuning of our qualitative assumptions used within our preliminary model, uncertainty regarding economic conditions and the size and mix of our loan portfolio at the time of adoption, which could impact our historical loss factors. We are currently working with our existing ALLL software provider on further developing the model to perform the ALLL calculations upon adoption and we believe that we currently have in place the internal team capable of handling this implementation.

In December 2019, the FASB issued ASU 2019-12, "Income Taxes (Topic 740), Simplifying the Accounting for Income Taxes," which eliminates certain exceptions to the guidance in ASC 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. This guidance is effective for public business entities for fiscal years beginning after December 15, 2020 and interim periods within those fiscal years. Early adoption is permitted. Entities that elect to early adopt the amendments in an interim period should reflect any adjustments as of the beginning of the annual period that includes that

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interim period. Additionally, entities that elect early adoption must adopt all the amendments in the same period. We are currently evaluating this guidance to determine the date of adoption and the impact on the Company.

In March 2020, the FASB issued ASU 2020-04, "Reference Rate Reform (Topic 848), Facilitation of the Effects of Reference Rate Reform on Financial Reporting," which provides temporary optional expedients to ease the financial reporting burdens of the expected market transition from London Interbank Offered Rate (LIBOR) to an alternative reference rate such as Secured Overnight Financing Rate (SOFR). The guidance was effective upon issuance and generally can be applied through December 31, 2022. We are currently evaluating this guidance to determine the date of adoption and the impact on the Company.

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3. Fair Value Measurements

Under FASB Accounting Standards Codification (“ASC”) 820-10, we group assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:


Level 1			Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2			Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3			Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

Risks with Fair Value Measurements

Fair value estimates are made at a discrete point in time based on relevant market information and other information about the financial instruments. Because no active market exists for a significant portion of our financial instruments, fair value estimates are based in large part on judgments we make primarily regarding current economic conditions, risk characteristics of various financial instruments, prepayment rates, and future expected loss experience. These estimates are subjective in nature and invariably involve some inherent uncertainties. Additionally, the occurrence of unexpected events or changes in circumstances can occur that could require us to make changes to our assumptions and which, in turn, could significantly affect and require us to make changes to our previous estimates of fair value.

In addition, the fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of existing and anticipated future customer relationships and the value of assets and liabilities that are not considered financial instruments, such as premises and equipment and other real estate owned (“OREO”).

Measurement Methodology

Cash and Cash Equivalents. The fair value of cash and cash equivalents approximates its carrying value.

Interest-Bearing Deposits with Financial Institutions. The fair values of interest-bearing deposits maturing within one year approximate their carrying values.

FHLB and FRBSF Stock. The Bank is a member of the Federal Home Loan Bank of San Francisco (“FHLB”) and the FRBSF. As members, we are required to own stock of the FHLB and the FRBSF, the amount of which is based primarily on the level of our borrowings from those institutions. We also have the right to acquire additional shares of stock in either or both of the FHLB and the FRBSF. During the three and six months ended June 30, 2020, we purchased no FHLB or FRBSF stock. No shares of FHLB stock or FRBSF stock were called during the three and six months ended June 30, 2020. The fair values of the FHLB and FRBSF stock are equal to their respective carrying amounts, are classified as restricted securities and are periodically evaluated for impairment based on our assessment of the ultimate recoverability of our investments in that stock. Any cash or stock dividends paid to us on such stock are reported as income.

Investment Securities Available for Sale. Fair value measurement for our investment securities available for sale is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 investment securities include those traded on an active exchange, such as the New York Stock Exchange, and U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets. Level 2 investment securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Equity Investments Without Readily Determinable Fair Value. Equity investments without readily determinable fair value are accounted for under the measurement alternative method of accounting. These investments are measured at cost, less any impairment, plus or minus any changes resulting from observable price changes in orderly transactions for an identical or similar investment of the same issuer. Any cash or stock dividends paid to us on such investments are reported as noninterest income.

Impaired Loans. Loans measured for impairment are measured at an observable market price (if available), or the fair value of the loan’s collateral (if the loan is collateral dependent). The fair value of an impaired loan may be estimated using one of several methods, including collateral value, market value of similar debt, liquidation value and discounted cash flows. Those

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impaired loans not requiring a specific loan loss reserve represent loans for which the fair value of the expected repayments or collateral exceeds the recorded investments in such loans. When the fair value of the collateral is based on an observable market price or a current appraised value, we record the impaired loan at Level 2. When an appraised value is not available or we determine that the fair value of the collateral is further impaired below the appraised value and there is no observable market price, we record the impaired loan at Level 3.

Loans. The fair value for loans with variable interest rates less a credit discount is the carrying amount. The fair value of fixed rate loans is derived by calculating the present value of expected future cash flows discounted at the loan’s original interest rate by the various homogeneous categories of loans. All loans have been adjusted to reflect changes in credit risk and represent the exit price of the loans. Changes are not recorded directly as an adjustment to current earnings or comprehensive income, but rather as an adjustment component in determining the overall adequacy of the loan loss reserve.

Other Real Estate Owned. OREO is reported at its net realizable value (fair value less estimated costs to sell) at the time any real estate collateral is acquired by the Bank in satisfaction of a loan. Subsequently, OREO is carried at the lower of carrying value or fair value less estimated costs to sell. Fair value is determined based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, we record the foreclosed asset at Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, we record the foreclosed asset at Level 3.

Other Foreclosed Assets. Other foreclosed assets are reported at their net realizable value (fair value less estimated costs to sell) at the time any collateral other than real estate is acquired by the Bank in satisfaction of a loan. Subsequently, other foreclosed assets are carried at the lower of carrying value or fair value less estimated costs to sell. Fair value is determined based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, we record the foreclosed asset at Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, we record the foreclosed asset at Level 3.

Deposits. Deposits are carried at historical cost. The carrying amounts of deposits from savings and money market accounts are deemed to approximate fair value as they either have no stated maturities or short-term maturities. Certificates of deposit are estimated utilizing discounted cash flow techniques. The interest rates applied are rates currently being offered for similar certificates of deposit.

Borrowings. The fair value of borrowings is the carrying amount for those borrowings that mature on a daily basis. The fair value of term borrowings is derived by calculating the discounted value of future cash flows expected to be paid out by the Company. We classify our borrowings in Level 2 of the fair value hierarchy.

Junior Subordinated Debentures. The fair value of the junior subordinated debentures is based on quoted market prices of the underlying securities. These securities are variable rate in nature and repriced quarterly. We classify our junior subordinated debentures in Level 2 of the fair value hierarchy.

Commitments to Extend Credit and Standby Letters of Credit. The fair value of commitments to extend credit and standby letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.

Interest Receivable and Interest Payable. The carrying amounts of our accrued interest receivable and accrued interest payable are deemed to approximate fair value.

Assets Recorded at Fair Value on a Recurring Basis

The following tables show the recorded amounts of assets and liabilities measured at fair value on a recurring basis at June 30, 2020 and December 31, 2019:

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	At June 30, 2020
(Dollars in thousands)	Total		Level 1		Level 2		Level 3
Assets at Fair Value:
Debt securities available for sale

Commercial mortgage backed securities issued by U.S. Agencies	$	8,953	$	—	$	8,953	$	—
Residential mortgage backed securities issued by U.S. agencies	17,260		—		17,260		—



Total debt securities available for sale at fair value	$	26,213	$	—	$	26,213	$	—


	At December 31, 2019
(Dollars in thousands)	Total		Level 1		Level 2		Level 3
Assets at Fair Value:
Debt securities available for sale

Commercial mortgage backed securities issued by U.S. Agencies	$	9,229	$	—	$	9,229	$	—
Residential mortgage backed securities issued by U.S. agencies	19,115		—		19,115		—


Total debt securities available for sale	$	28,344	$	—	$	28,344	$	—

Assets Recorded at Fair Value on a Nonrecurring Basis

We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These nonrecurring fair value adjustments typically involve application of the lower of cost or market accounting or write-downs of individual assets. Information regarding assets measured at fair value on a nonrecurring basis is set forth in the table below.


	At June 30, 2020														At December 31, 2019
(Dollars in thousands)	Total		Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3
Assets at Fair Value:
Impaired loans	$	24,681	$	—	$	—	$	24,681	$	15,682	$	—	$	—	$	15,682

Other foreclosed assets	663		—		663		—		164		—		164		—

Total	$	25,344	$	—	$	663	$	24,681	$	15,846	$	—	$	164	$	15,682

Significant Unobservable Inputs and Valuation Techniques of Level 3 Fair Value Measurements

For our fair value measurements classified in Level 3 of the fair value hierarchy as of June 30, 2020, a summary of the significant unobservable inputs and valuation techniques is as follows:

Fair Value Measurement as of June 30, 2020

Valuation Techniques⁽²⁾

Unobservable Inputs⁽²⁾

Range

Weighted Average

(Dollars in thousands)

Assets

Impaired loans

24,681

Third-Party Pricing

Discounted cash flow

N/A ⁽¹⁾

(1)As part of our process, we obtain appraisals for our various properties included within impaired loans which primarily rely upon market comparisons. These market comparisons support our assumption that the carrying value of the respective loans either requires or does not require additional impairment.

(2)As of June 30, 2020, there has been no change to our valuation techniques or the types of unobservable inputs used in the calculation of fair value from December 31, 2019.

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Fair Value Measurements for Other Financial Instruments

The table below provides estimated fair values and related carrying amounts of our financial instruments as of June 30, 2020 and December 31, 2019, excluding financial assets and liabilities which are recorded at fair value on a recurring basis.


	Estimated Fair Value
			At June 30, 2020																								At December 31, 2019
			Carrying Value			Total			Level 1			Level 2			Level 3			Carrying Value			Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Financial assets:
Cash and cash equivalents	$	259,029		$	259,029		$	259,029		$	—		$	—		$	220,138		$	220,138		220,138		—		—
Interest-bearing deposits with financial institutions	2,345			2,345			2,345			—			—			2,420			2,420			2,420		—		—
Federal Reserve Bank of San Francisco and Federal Home Loan Bank stock	7,910			7,910			7,910			—			—			7,910			7,910			7,910		—		—
Loans, net	1,350,800			1,355,702			—			—			1,355,702			1,117,511			1,120,096			—		—		1,120,096
Accrued interest receivable	5,429			5,429			5,429			—			—			4,095			4,095			4,095		—		—
Financial liabilities:
Noninterest bearing deposits	596,052			596,052			596,052			—			—			397,000			397,000			397,000		—		—
Interest-bearing deposits	832,474			835,150			—			835,150			—			802,570			803,549			—		803,549		—
Borrowings	73,962			74,088			—			74,088			—			30,000			29,974			—		29,974		—
Junior subordinated debentures	17,527			17,527			—			17,527			—			17,527			17,527			—		17,527		—
Accrued interest payable	288			288			288			—			—			398			398			398		—		—

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4. Investments

Securities Available For Sale, at Fair Value

The following table sets forth the major components of securities available for sale and compares the amortized costs and estimated fair market values of, and the gross unrealized gains and losses on, these securities at June 30, 2020 and December 31, 2019:


(Dollars in thousands)	June 30, 2020																					December 31, 2019
			Amortized Cost			Gross Unrealized									Estimated Fair Value			Amortized Cost			Gross Unrealized				Estimated Fair Value
									Gain			Loss												Gain		Loss
Securities Available for Sale

Commercial mortgage backed securities issued by U.S. Agencies⁽¹⁾	$	8,537		$	416		$	—		$	8,953		$	9,147		$	128		$	(46)		$	9,229
Residential mortgage backed securities issued by U.S. Agencies⁽²⁾	16,883			380			(3)			17,260			19,380			12			(277)			19,115




Total	$	25,420		$	796		$	(3)		$	26,213		$	28,527		$	140		$	(323)		$	28,344

(1)Secured by first liens on commercial apartment building mortgages.

(2)Secured by closed-end first liens on 1-4 family residential mortgages.

At June 30, 2020 and December 31, 2019, U.S. agency residential mortgage backed securities with an aggregate fair market value of $8.3 million and $9.2 million, respectively, were pledged to secure repurchase agreements, local agency deposits and treasury, tax and loan accounts.

The amortized cost and estimated fair values of securities available for sale at June 30, 2020 and December 31, 2019 are shown in the tables below by contractual maturities taking into consideration historical prepayments based on the prior twelve months of principal payments. Expected maturities will differ from contractual maturities and historical prepayments, particularly with respect to collateralized mortgage obligations, primarily because prepayment rates are affected by changes in conditions in the interest rate market and, therefore, future prepayment rates may differ from historical prepayment rates.


	At June 30, 2020 Maturing in
(Dollars in thousands)	One year or less			Over one year through five years			Over five years through ten years			Over ten Years			Total
Securities available for sale, amortized cost	$	5,379		$	12,570		$	7,471		$	—		$	25,420
Securities available for sale, estimated fair value	5,465			12,880			7,868			—			26,213
Weighted average yield	1.42		%	1.51		%	1.92		%	—		%	1.61		%


	At December 31, 2019 Maturing in
(Dollars in thousands)	One year or less			Over one year through five years			Over five years through ten years			Over ten Years			Total
Securities available for sale, amortized cost	$	5,286		$	13,032		$	6,842		$	3,367		$	28,527
Securities available for sale, estimated fair value	5,230			12,887			6,849			3,378			28,344
Weighted average yield	1.58		%	1.66		%	2.22		%	2.53		%	1.88		%

We purchased no securities available for sale during the three and six months ended June 30, 2020 or during the three and six months ended June 30, 2019. We had no sales of securities available for sale during the three and six months ended June 30, 2019 or the three and six months ended June 30, 2020.

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The tables below indicate, as of June 30, 2020 and December 31, 2019, the gross unrealized losses and fair values of our investments, aggregated by investment category, and length of time that the individual securities have been in a continuous unrealized loss position.


	Securities with Unrealized Loss at June 30, 2020
	Less than 12 months						12 months or more						Total
(Dollars in thousands)	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss

Commercial mortgage backed securities issued by U.S. Agencies	$	43	$	—	$	164	$	(3)	$	207	$	(3)




Total	$	43	$	—	$	164	$	(3)	$	207	$	(3)


	Securities with Unrealized Loss at December 31, 2019
	Less than 12 months						12 months or more						Total
(Dollars in thousands)	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss

Commercial mortgage backed securities issued by U.S. Agencies	4,472		(46)		—		—		4,472		(46)
Residential mortgage backed securities issued by U.S. Agencies	76		(1)		15,965		(276)		16,041		(277)



Total	$	4,548	$	(47)	$	15,965	$	(276)	$	20,513	$	(323)

We regularly monitor investments for significant declines in fair value. We have determined that declines in the fair values of these investments below their respective amortized costs, as set forth in the tables above, are temporary because (i) those declines were due to interest rate changes and not to a deterioration in the creditworthiness of the issuers of those investment securities, and (ii) we have the ability to hold those securities until there is a recovery in their values or until their maturity.

We recognize other-than-temporary impairments (“OTTI”) to our available-for-sale debt securities in accordance with FASB ASC 320-10. When there are credit losses associated with, but we have no intention to sell, an impaired debt security, and it is more likely than not that we will not have to sell the security before recovery of its cost basis, we will separate the amount of impairment, or OTTI, between the amount that is credit-related and the amount that is related to non-credit factors. Credit-related impairments are recognized in our consolidated statements of operations. Any non-credit-related impairments are recognized and reflected in other comprehensive income in our consolidated statements of financial condition.

Through the impairment assessment process, we determined that there were no available-for-sale debt securities that were other-than-temporarily impaired at June 30, 2020. We recorded no impairment credit losses on available-for-sale debt securities in our consolidated statements of operations for the three and six months ended June 30, 2020 and 2019.

We have made a determination that the remainder of our securities with respect to which there were unrealized losses as of June 30, 2020 are not other-than-temporarily impaired, because we have concluded that we have the ability to continue to hold those securities until their respective fair market values increase above their respective amortized costs or, if necessary, until their respective maturities. In reaching that conclusion we considered a number of factors and other information, which included: (i) the significance of each such security, (ii) the amount of the unrealized losses attributable to each such security, (iii) our liquidity position, (iv) the impact that retention of those securities could have on our capital position and (v) our evaluation of the expected future performance of these securities (based on the criteria discussed above).

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Equity Investments Without Readily Determinable Fair Value

As of June 30, 2020, we had three investments in private companies and limited partnerships without a readily determinable fair value. As of June 30, 2020, we owned less than 3% of the total investment in each such company or partnership. Under ASU 2016-01, we elected to measure these equity investments using the measurement alternative, which requires that these investments are measured at cost, less any impairment, plus or minus any changes resulting from observable price changes in orderly transactions for an identical or similar investment of the same issuer. During the three and six months ended June 30, 2020, these investments were not impaired and there were no observable price changes. As a result, the balance shown below as of June 30, 2020 represents the cost of the investments and is included within other assets on the consolidated statements of financial condition. During the three and six months ended June 30, 2020, we had $199 thousand of capital contributions to these investments. We had $283 thousand and $877 thousand, respectively, of capital contributions to these investments during the three and six months ended June 30, 2019. As of June 30, 2020 and December 31, 2019, our equity investments without readily determinable fair value were as follows:


	June 30, 2020		December 31, 2019
	(Dollars in thousands)
Equity investments without readily determinable fair value	$	2,316	$	2,117

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5. Loans and Allowance for Loan and Lease Losses

The loan portfolio consisted of the following at:


	June 30, 2020						December 31, 2019
(Dollars in thousands)	Amount		Percent		Amount		Percent
Commercial loans	$	698,280	51.0	%	$	409,420	36.2	%
Commercial real estate loans – owner occupied	195,379		14.3	%	219,483		19.5	%
Commercial real estate loans – all other	203,330		14.8	%	208,283		18.5	%
Residential mortgage loans – multi-family	164,575		12.0	%	176,523		15.7	%
Residential mortgage loans – single family	15,522		1.1	%	18,782		1.7	%
Construction and land development loans	7,247		0.5	%	2,981		0.3	%
Consumer loans	85,414		6.3	%	90,867		8.1	%
Gross loans	1,369,747		100.0	%	1,126,339		100.0	%
Deferred fee (income) costs, net	(781)				4,783
Allowance for loan and lease losses	(18,166)				(13,611)
Loans, net	$	1,350,800			$	1,117,511

At June 30, 2020, commercial loans included $280.3 million of loans originated through the Paycheck Protection Program ("PPP"), which is administered by the Small Business Administration ("SBA") and was established by the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"), and subsequently modified by the Paycheck Protection Program Flexibility Act ("PPPFA"). The PPP loans are 100% guaranteed by the SBA and the principal and interest may be forgiven by the SBA if the borrower demonstrates that the loan proceeds were used as prescribed by the governing legislation and regulations during either an 8-week or 24-week period following funding (the "Covered Period"). Borrowers may begin submitting applications for forgiveness in the third quarter of 2020 and have until 10 months following the end of their Covered Period to apply.

At June 30, 2020 and December 31, 2019, real estate loans of approximately $470 million and $278 million, respectively, were pledged to secure borrowings obtained from the FHLB and to support our unfunded borrowing capacity. At June 30, 2020 and December 31, 2019, commercial and consumer loans of $202 million and $210 million, respectively, were pledged to secure borrowings from the FRB to support our unfunded borrowing capacity. No loans were sold during the three and six months ended June 30, 2020. During the three and six months ended June 30, 2019, we sold $2.4 million and $7.1 million, respectively, of SBA loans for a gain of $289 thousand and $564 thousand, respectively. During the three and six months ended June 30, 2020, we purchased no loans. During the three and six months ended June 30, 2019, we purchased loans totaling $46.4 million, of which $39.9 million were consumer loans.

Allowance for Loan and Lease Losses

The ALLL represents our estimate of credit losses in our loan and lease portfolio that are probable and estimable at the balance sheet date. We employ economic models that are based on bank regulatory guidelines, industry standards and our own historical loan loss experience, as well as a number of more subjective qualitative factors, to determine both the sufficiency of the ALLL and the amount of the provisions that are required to increase or replenish the ALLL.

The ALLL is first determined by (i) analyzing all classified loans (graded as “Substandard” or “Doubtful” under our internal asset quality grading parameters) on nonaccrual status for loss exposure and (ii) establishing specific reserves as needed. ASC 310-10 defines loan impairment as the existence of uncertainty concerning collection of all principal and interest in accordance with the contractual terms of a loan. For collateral dependent loans, impairment is typically measured by comparing the loan amount to the fair value of collateral, less estimated costs to sell, with any “shortfall” amount charged off. Other methods can be used in estimating impairment, including market price and the present value of expected future cash flows discounted at the loan’s original interest rate. We are an active lender with the U.S. Small Business Administration and collection of a percentage of the loan balance of many of the loans originated is guaranteed. The ALLL reserves are calculated against the non-guaranteed loan balances.

On a quarterly basis, we utilize a classification based loan loss migration model as well as review individual loans in determining the adequacy of the ALLL for homogenous pools of loans that are not subject to specific reserve allocations. Our loss migration analysis utilizes a series of nineteen staggered 16-quarter migration periods of loan loss history and industry loss factors to determine historical losses by classification category for each loan type, except certain consumer loans (automobile, mortgage and credit cards). We then apply these calculated loss factors, together with qualitative factors based on external economic conditions and trends and internal assessments, to the outstanding loan balances in each homogenous group of loans,

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and then, using our internal asset quality grading parameters, we grade the loans as “Pass,” “Special Mention,” “Substandard” or “Doubtful”. We analyze impaired loans individually. This grading is based on the credit classifications of assets as prescribed by government regulations and industry standards and is separated into the following groups:

•Pass: Loans classified as pass include current loans performing in accordance with contractual terms, installment/consumer loans that are not individually risk rated, and loans which exhibit certain risk factors that require greater than usual monitoring by management.

•Special Mention: Loans classified as special mention, while generally not delinquent, have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the Bank’s credit position at some future date.

•Substandard: Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

•Doubtful: Loans classified as doubtful have all the weaknesses inherent in a substandard loan, and may also be at delinquency status and have defined weaknesses based on currently existing facts, conditions and values making collection or liquidation in full highly questionable and improbable.

Set forth below is a summary of the activity in the ALLL, by portfolio type, during the three and six months ended June 30, 2020 and 2019:


(Dollars in thousands)	Commercial		Real Estate		Construction and Land Development		Consumer and Single Family Mortgages		Unallocated		Total
ALLL in the three months ended June 30, 2020:
Balance at beginning of period	$	11,218	$	4,368	$	55	$	1,879	$	—	$	17,520
Charge offs	(2,229)		—		—		(20)		—		(2,249)
Recoveries	42		—		—		3		—		45
Provision	2,456		365		22		7		—		2,850
Balance at end of period	$	11,487	$	4,733	$	77	$	1,869	$	—	$	18,166
ALLL in the six months ended June 30, 2020:
Balance at beginning of period	$	8,883	$	2,897	$	34	$	1,797	$	—	$	13,611
Charge offs	(4,478)		—		—		(84)		—		(4,562)
Recoveries	60		—		—		7		—		67
Provision	7,022		1,836		43		149		—		9,050
Balance at end of period	$	11,487	$	4,733	$	77	$	1,869	$	—	$	18,166
ALLL in the three months ended June 30, 2019:
Balance at beginning of period	$	6,895	$	2,709	$	295	$	1,486	$	129	$	11,514
Charge offs	(103)		—		—		(24)		—		(127)
Recoveries	82		—		—		5		—		87
Provision	(65)		81		(176)		289		(129)		—
Balance at end of period	$	6,809	$	2,790	$	119	$	1,756	$	—	$	11,474
ALLL in the six months ended June 30, 2019:
Balance at beginning of period	$	8,071	$	3,643	$	426	$	1,290	$	76	$	13,506
Charge offs	(5,772)		—		—		(53)		—		(5,825)
Recoveries	483		—		—		10		—		493
Provision	4,027		(853)		(307)		509		(76)		3,300
Balance at end of period	$	6,809	$	2,790	$	119	$	1,756	$	—	$	11,474

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Set forth below is information regarding loan balances and the related ALLL, by portfolio type, as of June 30, 2020 and December 31, 2019.


(Dollars in thousands)	Commercial		Real Estate		Construction and Land Development		Consumer and Single Family Mortgages		Unallocated		Total
ALLL balance at June 30, 2020 related to:
Loans individually evaluated for impairment	$	911	$	—	$	—	$	—	$	—	$	911
Loans collectively evaluated for impairment	10,576		4,733		77		1,869		—		17,255
Total	$	11,487	$	4,733	$	77	$	1,869	$	—	$	18,166
Loan balance at June 30, 2020 related to:
Loans individually evaluated for impairment	$	17,968	$	5,875	$	—	$	—	$	—	$	23,843
Loans collectively evaluated for impairment	680,312		557,410		7,247		100,935		—		1,345,904
Total	$	698,280	$	563,285	$	7,247	$	100,935	$	—	$	1,369,747
ALLL balance at December 31, 2019 related to:
Loans individually evaluated for impairment	$	561	$	—	$	—	$	—	$	—	$	561
Loans collectively evaluated for impairment	8,322		2,897		34		1,797		—		13,050
Total	$	8,883	$	2,897	$	34	$	1,797	$	—	$	13,611
Loan balance at December 31, 2019 related to:
Loans individually evaluated for impairment	$	9,056	$	6,507	$	—	$	—	$	—	$	15,563
Loans collectively evaluated for impairment	400,364		597,782		2,981		109,649		—		1,110,776
Total	$	409,420	$	604,289	$	2,981	$	109,649	$	—	$	1,126,339

Credit Quality

The amounts of nonperforming assets and delinquencies that occur within our loan portfolio factor into our evaluation of the adequacy of the ALLL.

The following table provides a summary of the delinquency status of loans by portfolio type at June 30, 2020 and December 31, 2019:

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(Dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days and Greater		Total Past Due		Current		Total Loans Outstanding		Loans >90 Days and Accruing
At June 30, 2020
Commercial loans	$	4,070	$	1,842	$	11,857	$	17,769	$	680,511	$	698,280	$	670
Commercial real estate loans – owner-occupied	—		1,063		—		1,063		194,316		195,379		—
Commercial real estate loans – all other	—		—		—		—		203,330		203,330		—
Residential mortgage loans – multi-family	—		—		375		375		164,200		164,575		375
Residential mortgage loans – single family	—		—		—		—		15,522		15,522		—
Construction and land development loans	—		—		—		—		7,247		7,247		—
Consumer loans	200		—		180		380		85,034		85,414		—
Total	$	4,270	$	2,905	$	12,412	$	19,587	$	1,350,160	$	1,369,747	$	1,045
At December 31, 2019
Commercial loans	$	354	$	1,361	$	533	$	2,248	$	407,172	$	409,420	$	—
Commercial real estate loans – owner-occupied	749		—		—		749		218,734		219,483		—
Commercial real estate loans – all other	—		—		—		—		208,283		208,283		—
Residential mortgage loans – multi-family	—		—		—		—		176,523		176,523		—
Residential mortgage loans – single family	—		—		—		—		18,782		18,782		—
Construction and land development loans	—		—		—		—		2,981		2,981		—
Consumer loans	312		3		—		315		90,552		90,867		—
Total	$	1,415	$	1,364	$	533	$	3,312	$	1,123,027	$	1,126,339	$	—

Generally, the accrual of interest on a loan is discontinued when principal or interest payments become more than 90 days past due, unless we believe that the loan is adequately collateralized and it is in the process of collection. There were three loans, or $1.0 million, 90 days or more past due and still accruing interest at June 30, 2020. There were no loans 90 days or more past due and still accruing interest at December 31, 2019. In certain instances, when a loan is placed on nonaccrual status, previously accrued but unpaid interest is reversed against current income. Subsequent collections of cash are applied as principal reductions when received (referred to as full nonaccrual basis of accounting), except when the ultimate collectability of principal is probable, in which case such payments are applied to accrued and unpaid interest, which is credited to income (referred to as nonaccrual cash basis of accounting). Nonaccrual loans may be restored to accrual status when principal and interest become current and full repayment becomes expected.

The following table provides information with respect to loans on nonaccrual status, by portfolio type, as of June 30, 2020 and December 31, 2019:


	June 30, 2020		December 31, 2019
	(Dollars in thousands)
Nonaccrual loans:
Commercial loans	$	18,200	$	9,101
Commercial real estate loans – owner occupied	6,225		6,507




Consumer	256		74
Total⁽¹⁾	$	24,681	$	15,682

(1) Nonaccrual loans may include loans that are currently considered performing loans.

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We classify our loan portfolio using internal asset quality ratings. The following table provides a summary of loans by portfolio type and our internal asset quality ratings as of June 30, 2020 and December 31, 2019:


	June 30, 2020		December 31, 2019
	(Dollars in thousands)
Pass:
Commercial loans	$	623,600	$	357,079
Commercial real estate loans – owner occupied	163,675		206,589
Commercial real estate loans – all other	203,330		208,283
Residential mortgage loans – multi family	164,201		176,523
Residential mortgage loans – single family	15,522		18,782
Construction and land development loans	7,247		2,981
Consumer loans	84,796		90,793
Total pass loans	$	1,262,371	$	1,061,030
Special Mention:
Commercial loans	$	20,321	$	21,894
Commercial real estate loans – owner occupied	4,239		6,387

Residential mortgage loans – multi family	375		—



Total special mention loans	$	24,935	$	28,281
Substandard:
Commercial loans	$	50,532	$	30,447
Commercial real estate loans – owner occupied	27,465		6,507




Consumer loans	618		74
Total substandard loans	$	78,615	$	37,028
Doubtful:
Commercial loans	$	3,826	$	—






Total doubtful loans	$	3,826	$	—
Total Loans:	$	1,369,747	$	1,126,339

Impaired Loans

A loan generally is classified as impaired when, in our opinion, principal or interest is not likely to be collected in accordance with the contractual terms of the loan agreement. We measure for impairments on a loan-by-loan basis, using either the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if the loan is collateral dependent.

The following table sets forth information regarding impaired loans, at June 30, 2020 and December 31, 2019:


	June 30, 2020		December 31, 2019
	(Dollars in thousands)
Impaired loans:
Nonaccruing loans	$	24,681	$	15,682
Nonaccruing restructured loans⁽¹⁾	—		—
Accruing restructured loans⁽¹⁾⁽²⁾	—		—

Total impaired loans	$	24,681	$	15,682
Impaired loans less than 90 days delinquent and included in total impaired loans	$	13,314	$	15,149

(1)As of June 30, 2020 and December 31, 2019, we had no restructured loans.

(2)See “Troubled Debt Restructurings” below for a description of accruing restructured loans at June 30, 2020 and December 31, 2019.

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The table below contains additional information with respect to impaired loans, by portfolio type, as of June 30, 2020 and December 31, 2019:


	June 30, 2020										December 31, 2019
	Recorded Investment		Unpaid Principal Balance		Related Allowance (1)		Recorded Investment		Unpaid Principal Balance		Related Allowance (1)
	(Dollars in thousands)
No allowance recorded:
Commercial loans	$	15,208	$	22,832	$	—	$	7,996	$	12,090	$	—
Commercial real estate loans – owner occupied	6,225		6,750		—		6,507		6,784		—




Consumer loans	256		297		—		74		101		—
Total	$	21,689	$	29,879	$	—	$	14,577	$	18,975	$	—
With allowance recorded:
Commercial loans	$	2,992	$	3,062	$	911	$	1,105	$	1,122	$	561






Total	$	2,992	$	3,062	$	911	$	1,105	$	1,122	$	561
All impaired loans
Commercial loans	$	18,200	$	25,894	$	911	$	9,101	$	13,212	$	561
Commercial real estate loans – owner occupied	6,225		6,750		—		6,507		6,784		—




Consumer loans	256		297		—		74		101		—
Total	$	24,681	$	32,941	$	911	$	15,682	$	20,097	$	561

(1)When the discounted cash flows, collateral value or market price equals or exceeds the recorded investment in the loan, then specific reserves are not required to be set aside for the loan within the ALLL. This typically occurs when the impaired loans have been partially charged-off and/or there have been interest payments received and applied to the balance of the principal outstanding.

At June 30, 2020 and December 31, 2019, there were $21.7 million and $14.6 million, respectively, of impaired loans for which no specific reserves had been allocated because these loans, in our judgment, were sufficiently collateralized. Of the impaired loans at June 30, 2020 for which no specific reserves were allocated, $12.3 million had been deemed impaired in the prior year.

Average balances and interest income recognized on impaired loans, by portfolio type, for the three and six months ended June 30, 2020 and 2019 were as follows:


	Three Months Ended June 30,														Six Months Ended June 30,
	2020						2019						2020				2019
	Average Balance		Interest Income Recognized		Average Balance		Interest Income Recognized		Average Balance		Interest Income Recognized		Average Balance		Interest Income Recognized
	(Dollars in thousands)
No allowance recorded:
Commercial loans	$	13,784	$	19	$	471	$	—	$	11,855	$	115	$	1,432	$	—
Commercial real estate loans – owner occupied	6,297		—		794		—		6,367		—		806		—
Commercial real estate loans – all other	—		—		—		—		—		—		—		—

Residential mortgage loans – single family	—		—		—		—		—		—		—		—

Consumer loans	221		—		67		—		172		—		59		—
Total	20,302		19		1,332		—		18,394		115		2,297		—
With allowance recorded:
Commercial loans	2,048		—		—		—		1,734		—		—		—






Total	2,048		—		—		—		1,734		—		—		—
Total
Commercial loans	15,832		19		471		—		13,589		115		1,432		—
Commercial real estate loans – owner occupied	6,297		—		794		—		6,367		—		806		—
Commercial real estate loans – all other	—		—		—		—		—		—		—		—

Residential mortgage loans – single family	—		—		—		—		—		—		—		—

Consumer loans	221		—		67		—		172		—		59		—
Total	$	22,350	$	19	$	1,332	$	—	$	20,128	$	115	$	2,297	$	—

The interest that would have been earned had the impaired loans remained current in accordance with their original terms was $596 thousand and $26 thousand during the three months ended June 30, 2020 and 2019, respectively, and $1.2 million and $45 thousand during the six months ended June 30, 2020 and 2019, respectively.

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Troubled Debt Restructurings (“TDRs”)

Pursuant to the FASB's ASU No. 2011-2, A Creditor’s Determination of whether a Restructuring is a Troubled Debt Restructuring, the Bank's TDRs totaled $0 at both June 30, 2020 and December 31, 2019. TDRs consist of loans to which modifications have been made for the purpose of alleviating temporary impairments of the borrower's financial condition and cash flows. Those modifications have come in the form of changes in amortization terms, reductions in interest rates, interest only payments and, in limited cases, concessions to outstanding loan balances. The modifications are made as part of workout plans we enter into with the borrower that are designed to provide a bridge for the borrower’s cash flow shortfalls in the near term. If a borrower works through the near term issues, then in most cases, the original contractual terms of the borrower’s loan will be reinstated. TDRs do not include short term loan modifications made on a good faith basis in response to COVID-19.

There were no loans restructured as TDRs during the three or six months ended June 30, 2020 or 2019.

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6. Leases

We have historically entered into a number of lease arrangements under which we are the lessee. Specifically, all of our physical locations are subject to operating leases. In addition, we have elected the short-term lease practical expedient related to operating leases.

Two of our office leases, including our corporate headquarters, include multiple optional renewal periods. To the extent we conclude that it is reasonably certain that a renewal option will be exercised, that renewal period is then included in the lease term, and the related payments are reflected in the ROU asset and lease liability. Generally, we consider any additional renewal periods to be reasonably certain of being exercised.

All of our leases include fixed rental payments. We commonly enter into leases under which the lease payments increase at pre-determined dates. While the majority of our leases are gross leases, we also have a number of leases in which we make separate payments to the lessor based on the lessor’s property and casualty insurance costs and the property taxes assessed on the property, as well as a portion of the common area maintenance associated with the property.

During the three months ended June 30, 2020 and 2019, we recognized rent expense associated with our leases as follows:


	Three Months Ended June 30,						Six Months Ended June 30,
	2020		2019		2020		2019
Lease cost	(Dollars in thousands)
Finance lease cost:


Operating lease cost	$	609	$	568	$	1,218	$	1,113
Short-term lease cost⁽¹⁾	39		29		74		81

Total lease cost	$	648	$	597	$	1,292	$	1,194



Weighted-average remaining lease term—operating leases (in years)	4.87		5.57		4.87		5.57

(1) Includes leases that are less than 12 months and equipment leases that are accounted for on a cash basis.

Because we generally do not have access to the rate implicit in the lease, we utilize our borrowing rate with the FHLB as the discount rate. The weighted average discount rate associated with operating leases as of June 30, 2020 and 2019 is 2.31% and 1.69%, respectively.

Supplemental balance sheet information related to leases was as follows:


	Financial Statement Classification	June 30, 2020		December 31, 2019
		(Dollars in thousands)
Operating right-of-use assets	Other assets	$	11,084	$	12,159
Operating lease liabilities	Other liabilities	$	12,023	$	13,020

During the six months ended June 30, 2020 and 2019, we had the following cash and noncash activities associated with our leases:


	Six Months Ended June 30,		Six Months Ended June 30,
	2020		2019
	(Dollars in thousands)
Cash paid for amounts included in the measurement of lease liabilities

Operating cash flows from operating leases (fixed payments)	$	1,141	$	1,113



Noncash activities:
Right-of-use assets obtained in exchange for new operating lease liabilities	$	—	$	9,919

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Maturities of operating lease liabilities as of June 30, 2020 are as follows:


(Dollars in thousands)
For the years ending December 31,
Remainder of 2020	$	1,223
2021	2,490
2022	2,575
2023	2,662
2024	2,750
2025 and beyond	1,020
Total	12,720
Less: Imputed interest	(697)
Total Lease liabilities	$	12,023

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7. Income Taxes

The CARES Act, passed by Congress during the first quarter of 2020 in response to the outbreak of COVID-19, provides for assistance in the form of income tax related relief measures, including temporary changes to income tax laws such as the ability to carryback NOLs for a period of five years, which does not apply to our Company. Management performed an evaluation of the tax relief measures available, and determined there was no significant impact to our Company, and therefore, no tax relief provisions were applied.

For the three months ended June 30, 2020, we had income tax expense of $800 thousand as a result of our operating income, and for the six months ended June 30, 2020, we had income tax benefit of $190 thousand as a result of our year-to-date operating loss. Accounting rules specify that management must evaluate the deferred tax asset on a recurring basis to determine whether enough positive evidence exists to determine whether it is more-likely-than-not that the deferred tax asset will be available to offset or reduce future taxes. The tax code allows net operating losses incurred prior to December 31, 2017 to be carried forward for 20 years from the date of the loss, and based on its evaluation, management believes that the Company will be able to realize the deferred tax asset within the period that our net operating losses may be carried forward. Due to the hierarchy of evidence that the accounting rules specify, management determined that there continued to be enough positive evidence to support no valuation allowance on our deferred tax asset at June 30, 2020. Significant positive evidence included our three-year cumulative income position, the expectation that we will have positive earnings for the year based on positive income in eleven of the last twelve trailing quarters, and forecasted net income for the year. Negative evidence included our accumulated deficit, net loss for the first quarter of 2020, and deterioration in asset quality.

For the three and six months ended June 30, 2019, we had an income tax expense of $1.2 million and $1.5 million, respectively, as a result of our operating income. During the three and six months ended June 30, 2019, management determined that there continued to be enough positive evidence to support no valuation allowance on our deferred tax asset. Based on this evaluation, management believed that the Company would be able to realize the deferred tax asset within the period that our operating losses may be carried forward. Significant positive evidence included our three-year cumulative income position, continued improvement in asset quality, and the expectation that we will continue to have positive earnings based on ten trailing quarters of positive income and our forecast. Negative evidence at June 30, 2019 included our accumulated deficit.

We file income tax returns with the U.S. federal government and the State of California. As of June 30, 2020, we were subject to examination by the Internal Revenue Service with respect to our U.S. federal tax returns for the 2016 to 2019 (when filed) tax years and the Franchise Tax Board for California state income tax returns for the 2015 to 2019 (when filed) tax years. Net operating losses on our U.S. federal and California state income tax returns may be carried forward up to 20 years. In June 2020, the State of California suspended the use of net operating losses for the years 2020, 2021, and 2022, and extended the carryover periods for these years. As of June 30, 2020, we do not have any unrecognized tax benefits.

Our policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of tax expense. We did not have any accrued interest or penalties associated with any unrecognized tax benefits, and no interest expense was recognized during the three months ended June 30, 2020 and 2019.

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8. Stock-Based Employee Compensation Plans

In May 2010, our shareholders approved the adoption of our 2010 Equity Incentive Plan, which was amended at the Annual Shareholders meeting held in May 2013 (the “2010 Incentive Plan”), and which superseded our shareholder-approved 2008 and 2004 Equity Incentive Plans (the “Previously Approved Plans”). As of June 30, 2020, there were no options to purchase shares of our common stock granted under the Previously Approved Plans. As of June 30, 2020, there were options to purchase a total of 349,730 shares of our common stock and 58,849 shares of our unvested restricted stock grants under the 2010 Incentive Plan.

In May 2019, our shareholders approved the adoption of our 2019 Equity Incentive Plan (the “2019 Incentive Plan”), which authorized and set aside a total of 2,000,000 shares of our common stock for issuance on the exercise of stock options or the grant of restricted stock or other equity incentives to our officers, and other key employees and directors. There were 250,000 options to purchase shares of our common stock granted during 2019 under the 2019 Incentive Plan and outstanding at June 30, 2020. Since approval of the 2019 Incentive Plan, no additional awards will be issued under the 2010 Incentive Plan, although awards outstanding under the 2010 Incentive Plan will remain outstanding and will continue to be governed by the terms of the 2010 Incentive Plan and any applicable award agreements. Under the terms of the 2019 Incentive Plan, any forfeited options or unvested restricted stock grants that had been issued under the Previously Approved Plans or the 2010 Incentive Plan will not be available for future equity incentive grants. Each restricted stock option or restricted stock unit issued under the terms of the 2019 Incentive Plan will be counted against the share limit as 2.5 shares, while each stock option or SAR issued will be counted as one share against the share limit. As of June 30, 2020, there were outstanding options to purchase a total of 250,000 shares of our common stock, 100,000 shares of our unvested restricted stock units, and 62,487 shares of our unvested restricted stock grants under the 2019 Incentive Plan. As of June 30, 2020, there remain 1,343,783 shares available for future grants under the 2019 Incentive Plan.

A stock option entitles the recipient to purchase shares of our common stock at a price per share that may not be less than 100% of the fair market value of the Company’s shares on the date the option is granted. Restricted shares may be granted at such purchase prices and on such other terms, including restrictions and Company repurchase or reacquisition rights, as are fixed by the Compensation Committee at the time rights to purchase such restricted shares are granted. Stock Appreciation Rights (“SARs”) entitle the recipient to receive a cash payment in an amount equal to the difference between the fair market value of the Company’s shares on the date of vesting and a “base price” (which, in most cases, will be equal to the fair market value of the Company’s shares on the date the SAR is granted), subject to the right of the Company to make such payment in shares of its common stock at their then fair market value. Stock units may be payable in cash or shares of common stock, or a combination of the two. A stock unit is a bookkeeping entry representing the equivalent of one common share. Options, restricted shares, SARs and stock units may vest immediately or in installments over various periods generally ranging up to five years, subject to the recipient’s continued employment or service or the achievement of specified performance goals, as determined by the Compensation Committee at the time it grants or awards the options, the restricted shares, the SARs or the stock units. Stock options, SARs and stock units may be granted for terms of up to 10 years after the date of grant, but will terminate sooner upon or shortly after a termination of service occurring prior to the expiration of the term of the option, SAR or stock unit. The Company will become entitled to repurchase any unvested restricted shares, at the same price that was paid for the shares by the recipient, or to cancel those shares in the event of a termination of employment or service of the holder of such shares or if any performance goals specified in the award are not satisfied. To date, the Company has not granted any SARs.

Under FASB ASC 718-10, we are required to recognize, in our financial statements, the fair value of the options, restricted shares, SARs and stock units that we grant as compensation cost over their respective service periods. The fair values of the options that were outstanding at June 30, 2020 under the 2010 Incentive Plan and the 2019 Incentive Plan were estimated as of their respective dates of grant using the Black-Scholes option-pricing model. The Company, under the 2010 Incentive Plan and the 2019 Incentive Plan, has also granted restricted stock and stock units for the benefit of its employees and directors. These restricted shares vest over a period ranging from three to five years for employees and one year for directors while the stock units vest over a period of one to five years. The recipients of restricted shares have the right to vote all shares subject to such grant and receive all dividends with respect to such shares whether or not the shares have vested. The recipients of stock units have no rights of a stockholder. The recipients do not pay any cash consideration for the shares or stock units.

Stock Options

There were no stock options granted during the three and six months ended June 30, 2020 or 2019. The following table summarizes the stock option activity under the Company’s equity incentive plans during the six months ended June 30, 2020 and 2019, respectively.

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	Number of Shares	Weighted- Average Exercise Price Per Share		Number of Shares	Weighted- Average Exercise Price Per Share
	2020				2019
Outstanding – January 1,	1,009,466	$	6.98	864,330	$	6.86
Granted	—	—		—	—
Exercised	(10,728)	4.66		(15,000)	5.30
Forfeited/Canceled	(399,008)	6.98		(6,884)	8.13
Outstanding – June 30,	599,730	7.02		842,446	6.88
Options Exercisable – June 30,	314,112	$	6.66	721,420	$	6.68
Options Vested – June 30,	314,112	$	6.66	721,420	$	6.68

Options to purchase zero and 15,000 shares of our common stock were exercised during the three months ended June 30, 2020 and 2019, respectively, and 10,728 and 15,000 during the six months ended June 30, 2020 and 2019, respectively. The aggregate intrinsic value of options exercised during the three months ended June 30, 2020 and 2019 was $0 and $39 thousand, respectively, and $29 thousand and $39 thousand during the six months ended June 30, 2020 and 2019, respectively. The fair value of options that vested during the three months ended June 30, 2020 and 2019 was $14 thousand and $74 thousand, respectively, and $97 thousand and $412 thousand during the six months ended June 30, 2020 and 2019, respectively.

The following table provides additional information regarding the vested and unvested options that were outstanding at June 30, 2020.


Options Outstanding as of June 30, 2020									Options Exercisable as of June 30, 2020⁽¹⁾
Exercise Price	Vested	Unvested	Weighted Average Exercise Price Per Share		Weighted Average Remaining Contractual Life (Years)	Shares	Weighted Average Exercise Price Per Share
$2.97 – $3.99	12,000	—	$	3.74	1.57	12,000	$	3.74
$4.00 – $5.99	16,000	—	4.34		0.80	16,000	4.34
$6.00 – $6.99	207,739	6,400	6.61		4.63	207,739	6.60
$7.00 – $7.99	34,157	250,000	7.30		8.63	34,157	7.10
$8.00 – $8.40	44,216	29,218	8.22		7.65	44,216	8.20
	314,112	285,618	$	7.02	6.73	314,112	$	6.66

(1)The weighted average remaining contractual life of the options that were exercisable as of June 30, 2020 was 4.72 years.

The aggregate intrinsic value of options that were outstanding and exercisable at June 30, 2020 and December 31, 2019 was $0 and $952 thousand, respectively.

A summary of the status of the unvested options outstanding as of June 30, 2020 and 2019, and changes in the weighted average grant date fair values of the unvested options during the six months ended June 30, 2020 and 2019, are set forth in the following table.


	For the six months ended June 30,
	2020				2019
	Number of Shares Subject to Options	Weighted Average Grant Date Fair Value Per Share		Number of Shares Subject to Options	Weighted Average Grant Date Fair Value Per Share
Unvested at the beginning of the period	334,322	$	2.19	275,457	$	2.79
Granted	—	—		—	—
Vested	(34,809)	2.78		(147,687)	2.79
Forfeited/Canceled	(13,895)	2.81		(6,744)	2.83
Unvested at the end of the period	285,618	2.09		121,026	2.79

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At June 30, 2020, the weighted average period over which nonvested awards were expected to be recognized was 3.76 years.

Restricted Stock

The following table summarizes the activity related to restricted stock granted, vested and forfeited under our equity incentive plans during the six months ended June 30, 2020 and 2019.


	For the six months ended June 30,
	2020				2019
	Number of Shares	Average Grant Date Fair Value Per Share		Number of Shares	Average Grant Date Fair Value Per Share
Outstanding at the beginning of the period	124,202	$	8.44	115,031	$	8.04
Granted	63,256	5.57		123,896	8.59
Vested	(45,649)	8.46		(61,337)	7.78
Forfeited	(20,473)	8.21		(7,376)	8.77
Outstanding at the end of the period	121,336	$	6.98	170,214	$	8.50

Stock Units

There was no activity related to stock units granted, vested and forfeited under our equity incentive plans during the six months ended June 30, 2020 and 2019.

Compensation Expense

We expect that the compensation expense that will be recognized during the periods presented below in respect of stock options, restricted stock, and stock units outstanding at June 30, 2020, will be as follows:


	Estimated Stock Based Compensation Expense Stock Options		Estimated Stock Based Compensation Expense Restricted Stock		Estimated Stock Based Compensation Expense Stock Units		Estimated Stock Based Compensation Expense Total
(Dollars in thousands)
For the years ending December 31,
Remainder of 2020	$	89	$	230	$	123	$	442
2021	125		261		244		630
2022	110		123		164		397
2023	101		50		—		151
2024 and beyond	67		10		—		77
	$	492	$	674	$	531	$	1,697

The aggregate amounts of stock based compensation expense recognized in our consolidated statements of operations for the three months ended June 30, 2020 and 2019 were $150 thousand and $154 thousand, respectively, in each case net of taxes, and $301 thousand and $295 thousand for the six months ended June 30, 2020 and 2019, respectively, in each case net of taxes.

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9. Earnings Per Share (“EPS”)

Basic EPS excludes dilution and is computed by dividing net income or loss allocable to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if stock options or other contracts to issue common stock were exercised or converted into common stock that would then share in our earnings.

The following table shows how we computed basic and diluted EPS for the three and six months ended June 30, 2020 and 2019.


(In thousands, except per share data)	For the Three Months Ended June 30,									For the Six Months Ended June 30,
			2020			2019			2020			2019
Basic EPS:
Net income (loss)	$	1,905		$	2,728		$	(455)		$	3,610



Net income allocable to common shareholders	$	1,905		$	2,728		$	(455)		$	3,610
Less earnings allocated to participating securities	17			102			—			191
Earnings allocated to common shareholders	$	1,888		$	2,626		$	(455)		$	3,419
Weighted average common shares outstanding	23,502			22,620			23,489			22,224
Basic earnings per common share	$	0.08		$	0.12		$	(0.02)		$	0.15
Diluted EPS:
Earnings allocated to common shareholders	$	1,905		$	2,728		$	(455)		$	3,610
Weighted average common shares outstanding	23,502			22,620			23,489			22,224
Add dilutive effects of restricted stock grants	111			170			—			154
Add dilutive effects of restricted stock units	100			—			—			—
Add dilutive effects for assumed conversion of Series A preferred stock	—			710			—			1,086
Add dilutive effect for stock options	—			116			—			117
Weighted average diluted common shares outstanding	23,713			23,616			23,489			23,581
Diluted earnings per common share	$	0.08		$	0.12		$	(0.02)		$	0.15

(1)The basic and diluted earnings per share amounts for the three and six months ended June 30, 2020 and 2019 are the same under both the Treasury Stock Method and the Two-Class Method as prescribed in FASB ASC 260-10, Earnings Per Share.

The weighted average shares that have an antidilutive effect in the calculation of diluted net income per share and have been excluded from the computations above were as follows:


	For the Three Months Ended June 30,			For the Six Months Ended June 30,
	2020	2019	2020	2019
Stock options⁽¹⁾⁽²⁾	631,995	183,724	782,909	184,275

(1)Stock options that were excluded from the computation of diluted earnings per common share for the three and six months ended June 30, 2020 and 2019 as a result of the reported net loss available to common shareholders.

(2)Represents stock options that were excluded from the computation of diluted earnings per common share for the three and six months ended June 30, 2020 and 2019 as a result of the shares being “out-of-the-money.”

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10. Shareholders’ Equity

Accumulated Other Comprehensive Income (Loss), net

Accumulated other comprehensive income (loss), net as of June 30, 2020 and December 31, 2019 was as follows:


	Unrealized Gain (Loss) on Securities Available-for-Sale, net of tax		Accumulated Other Comprehensive Income (Loss), Net
	(Dollars in thousands)
Ending balance as of December 31, 2018	$	(1,144)	$	(1,144)
Other comprehensive income before reclassifications, net of tax of $242 thousand	577		577

Other comprehensive loss, net of tax of $242 thousand	577		577
Ending balance as of December 31, 2019	$	(567)	$	(567)
Other comprehensive income before reclassifications, net of tax of $289 thousand	688		688

Other comprehensive income, net of tax of $289 thousand	688		688
Ending balance as of June 30, 2020	$	121	$	121

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11. Commitments and Contingencies

Commitments

To meet the financing needs of our customers in the normal course of business, we are a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements. At June 30, 2020 and December 31, 2019, we were committed to fund certain loans including letters of credit amounting to approximately $286 million and $316 million, respectively. The contractual amounts of a credit-related financial instrument, such as a commitment to extend credit, a credit-card arrangement or a letter of credit, represent the amount of potential accounting loss should the commitment be fully drawn upon, the customer were to default, and the value of any existing collateral securing the customer’s payment obligation becomes worthless. The loss reserve for unfunded loan commitments was $350 thousand at both June 30, 2020 and December 31, 2019.

As a result, we use the same credit policies in making commitments to extend credit and conditional obligations as we do for on-balance sheet instruments. Commitments generally have fixed expiration dates; however, since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis, using the same credit underwriting standards that are employed in making commercial loans. The amount of collateral obtained, if any, upon an extension of credit is based on our evaluation of the creditworthiness of the customer. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, residential real estate and income-producing commercial properties.

Borrowings

At June 30, 2020 and December 31, 2019, our borrowings and contractual obligations consisted of the following:


(Dollars in thousands)	June 30, 2020		December 31, 2019
FHLB advances—short-term	$	70,000	$	30,000
Other borrowings—short-term⁽¹⁾	3,962		—



Total	$	73,962	$	30,000

(1) Other borrowings are from the Federal Reserve's Paycheck Protection Program Liquidity Facility ("PPPLF") that extends credit to eligible financial institutions that originate PPP loans.

The table below sets forth the amounts of, the interest rates we pay on, and the maturity dates of these FHLB borrowings. These borrowings had a weighted-average annualized interest rate of 0.63% for the six months ended June 30, 2020.


Principal Amounts	Interest Rate		Maturity Dates
(Dollars in thousands)
50,000	0.22	%	September 30, 2020
10,000	1.71	%	December 30, 2020
10,000	1.62	%	January 25, 2021

At June 30, 2020, $470 million of loans were pledged to support our FHLB borrowings and our unfunded borrowing capacity. As of June 30, 2020, we had unused borrowing capacity of $239 million with the FHLB. The highest amount of borrowings outstanding at any month-end during the three months ended June 30, 2020 was $124 million. At June 30, 2020 and December 31, 2019, commercial and consumer loans of $187 million and $210 million, respectively, were pledged to secure borrowings from the FRB to support our unfunded borrowing capacity of $126 million and $146 million, respectively.

As of December 31, 2019, we had $30.0 million of outstanding short-term borrowings and no outstanding long-term borrowings that we had obtained from the FHLB. These borrowings had a weighted-average annualized interest rate of 1.82% for the year ended December 31, 2019. As of December 31, 2019, we had unused borrowing capacity of $172 million with the FHLB. The highest amount of borrowings outstanding at any month-end during the year ended December 31, 2019 was $55 million.

Litigation, Claims and Assessments

We are a defendant in or a party to a number of legal actions or proceedings that arise in the ordinary course of business. In some of these actions and proceedings, claims for monetary damages are asserted against us.

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In accordance with applicable accounting guidance, we establish an accrued liability for lawsuits or other legal proceedings when they present loss contingencies that are both probable and estimable. We estimate any potential loss based upon currently available information and significant judgments and a variety of assumptions, and known and unknown uncertainties. Moreover, the facts and circumstances on which such estimates are based will change over time. Therefore, the amount of any losses we might incur in any lawsuits or other legal proceedings may exceed amounts which we had accrued based on our estimates and those estimates do not represent the maximum loss exposure that we may have in connection with any lawsuits or other legal proceedings.

Based on our evaluation of lawsuits and other proceedings that were pending against us as of June 30, 2020, the outcomes in those suits or other proceedings are not expected to have, either individually or in the aggregate, a material adverse effect on our consolidated financial position, results of operations or cash flows. However, in light of the inherent uncertainties involved, some of which are beyond our control, and the very large or indeterminate damages often sought in such legal actions or proceedings, an adverse outcome in one or more of these suits or proceedings could be material to our results of operations or cash flows for any particular reporting period.

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12. Business Segment Information

We have one reportable business segment, commercial banking. The commercial banking segment provides middle-market businesses, professional firms and individuals with a diversified range of products and services such as various types of deposit accounts, various types of commercial and consumer loans, cash management services, and online banking services.

Since our operating segment derives all of its revenues from interest and noninterest income and interest expense constitutes its most significant expense, this segment is reported below using net interest income (interest income less interest expense) and noninterest income (primarily net gains on sales of Small Business Administration loans and fee income). We do not allocate general and administrative expenses or income taxes to our operating segment.

The following table sets forth information regarding the net interest income and noninterest income for our commercial banking segment for the three and six months ended June 30, 2020 and 2019.


(Dollars in thousands)	Commercial		Other⁽¹⁾		Total
Net interest income for the three months ended June 30,
2020	$	13,486	$	(168)	$	13,318
2019	$	12,449	$	(230)	$	12,219
Noninterest income for the three months ended June 30,
2020	$	1,159	$	12	$	1,171
2019	$	1,379	$	7	$	1,386
Net interest income for the six months ended June 30,
2020	$	25,155	$	(364)	$	24,791
2019	$	24,733	$	(463)	$	24,270
Noninterest income for the six months ended June 30,
2020	$	2,248	$	17	$	2,265
2019	$	2,862	$	14	$	2,876
Segment Assets at:
June 30, 2020	$	1,685,412	$	2,780	$	1,688,192
December 31, 2019	$	1,414,996	$	1,158	$	1,416,154

(1)Represents net interest income and noninterest income for PMBC.

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13. Regulatory Capital

Under federal banking regulations that apply to all United States-based bank holding companies over $3 billion in total assets and all federally insured banks, the Bank (on a stand-alone basis) must meet specific capital adequacy requirements that, for the most part, involve quantitative measures, primarily in terms of the ratios of their capital to their assets, liabilities, and certain off-balance sheet items, calculated under regulatory accounting practices. The Company (on a consolidated basis) is below the reporting threshold of $3 billion in total assets and therefore is not subject to the same capital adequacy requirements. Under those regulations, each federally insured bank is determined by its primary federal bank regulatory agency to come within one of the following capital adequacy categories on the basis of its capital ratios:

•well-capitalized

•adequately capitalized

•undercapitalized

•significantly undercapitalized; or

•critically undercapitalized

Certain qualitative assessments also are made by a banking institution’s primary federal regulatory agency that could lead the agency to determine that the banking institution should be assigned to a lower capital category than the one indicated by the quantitative measures used to assess the institution’s capital adequacy. At each successive lower capital category, a banking institution is subject to greater operating restrictions and increased regulatory supervision by its federal bank regulatory agency.

The following table sets forth the capital and capital ratios of the Bank (on a stand-alone basis) at June 30, 2020, as compared to the regulatory requirements applicable to it.


				Applicable Federal Regulatory Requirement
					For Capital Adequacy Purposes				To be Categorized As Well-Capitalized
	Amount	Ratio		Amount	Ratio	Amount		Ratio
	(Dollars in thousands)


Total Capital to Risk Weighted Assets	173,270	14.5	%	123,451	At least 8.625	$	123,938	At least 10.0


Common Equity Tier 1 Capital to Risk Weighted Assets	158,302	13.3	%	63,518	At least 5.125	$	80,560	At least 6.5


Tier 1 Capital to Risk Weighted Assets	158,302	13.3	%	82,109	At least 6.625	$	99,151	At least 8.0


Tier 1 Capital to Average Assets	158,302	9.2	%	57,253	At least 4.0	$	71,566	At least 5.0

In early July 2013, the Federal Reserve Board and the FDIC issued final rules implementing the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform and Consumer Protection Act changes. The rules revise minimum capital requirements and adjust prompt correct action thresholds. The final rules revise the regulatory capital elements, add a new common equity Tier 1 capital ratio, increase the minimum Tier 1 capital ratio requirement, and implement a new capital conservation buffer. The rules also permit certain banking organizations to retain, through a one-time election, the existing treatment for accumulated other comprehensive income. The final rules took effect for community banks on January 1, 2015, subject to a transition period for certain parts of the rules. At June 30, 2020, the Bank (on a stand-alone basis) continued to qualify as a well-capitalized institution under the capital adequacy guidelines described above.

On September 17, 2019, the FDIC finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio (CBLR) framework), as required by the Economic Growth, Regulatory Relief and Consumer Protection Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework. In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 9.0%, 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 regulations and will not be required to report or calculate risk-based capital. The Company has determined it will not opt into the CBLR framework for the Bank.

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14. Risks and Uncertainties

The outbreak of the novel coronavirus (“COVID-19”) and the Federal Reserve's response to the economic challenges during the first two quarters of 2020 has resulted in an uncertain and rapidly evolving economy. Governmental response to combat this pandemic have resulted in approximately 40% of our staff to shift to work remotely. Our business continuity plans have been activated by COVID-19 and we have been able to fully support our remote workforce and have the ability to support all employees in a remote work environment. These remote work arrangements have not adversely impacted our ability to serve our clients, and have not had an impact on our financial reporting systems or the internal controls we have over financial reporting, disclosures and related procedures.

The most significant impact of COVID-19 on our business has been to the quality of our loan portfolio and to net interest income as short-term interest rates sharply declined. We have increased the qualitative factors used in the determination of the adequacy of our allowance for loan and lease loss in anticipation of the impact that COVID-19 will have on our clients and their ability to fulfill their obligations. We have no certainty that the provisions we made during the first two quarters of 2020 will be sufficient to absorb the losses that stem from the impact of COVID-19 on our clients. As the longer term effects on our clients from the COVID-19 pandemic become more apparent, we may need to charge-off some or all of the balance on certain loans and make further provisions to increase our allowance for loan and lease losses. These potential additional provisions for loan and lease losses will have a direct impact upon our capital, including the potential need to reevaluate the need for a valuation allowance on our deferred tax asset. At this time, we don't expect that there would be any material impairment to the valuation of other long-lived assets, right of use assets, or our investment securities.

The Bank is currently Well Capitalized under federal banking regulations that apply to all United States-based banks, with approximately $49 million of capital in excess of what is required for the Bank to be Well Capitalized using the ratio of Total Capital to Risk Weighted Assets. The Company has approximately $10 million of capital that it could contribute to the Bank should it be needed. In the event that future loan and leases loss and/or tax provisions reduce our capital surplus, we would be required to undertake measures to return the Bank's capital ratios to Well Capitalized levels, which could include but not be limited to raising additional capital or reducing the Bank's asset size. We believe that we would have access to equity and debt markets to secure additional capital for the Bank should the need arise, but we have no certainty regarding the extent of the availability of these markets at the time such need would arise.

Increased demand for liquidity by our clients is another impact that we anticipate could occur should the COVID-19 effects be prolonged. As of June 30, 2020 the Company and the Bank's on-balance sheet liquidity was very strong and combined with our contingent liquidity resources, we believe that the Bank has sufficient resources to meet the liquidity needs of our clients. In response to COVID-19, the Federal Reserve has made other provisions that could assist the Bank in satisfying its liquidity needs, such as reducing our reserve requirement to zero, expanding access to the discount window through collateral pledging and extension of term borrowings.

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

Forward Looking Statements

Statements contained in this Quarterly Report on Form 10-Q (this “Report”) that are not historical facts or that discuss our expectations, beliefs or views regarding our future operations or future financial performance, or financial or other trends in our business or in the markets in which we operate, and our future plans, including the credit exposure of certain loan products and other components of our business that could be impacted by the COVID-19 pandemic, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Often, they include words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” “project,” “forecast,” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could,” or “may.” The information contained in such forward-looking statements is based on current information available to us and on assumptions that we make about future economic and market conditions and other events over which we do not have control. In addition, our business and the markets in which we operate are subject to a number of risks and uncertainties. Such risks and uncertainties, and the occurrence of events in the future or changes in circumstances that had not been anticipated, could cause our financial condition or actual operating results in the future to differ materially from our expected financial condition or operating results that are set forth in the forward-looking statements contained in this Report and could, therefore, also affect the price performance of our shares.

In addition to the risk of incurring loan losses and provision for loan losses, which is an inherent risk of the banking business, these risks and uncertainties include, but are not limited to, the following: deteriorating economic conditions and macroeconomic factors such as unemployment rates and the volume of bankruptcies, as well as changes in monetary, fiscal or tax policy to address the impact of COVID-19, any of which could cause us to incur additional loan losses and adversely affect our results of operations in the future; the risk that the credit quality of our borrowers declines; potential declines in the value of the collateral for secured loans; the risk that steps we have taken to strengthen our overall credit administration are not effective; the risk of a recession in the United States economy, and domestic or international economic conditions, which could cause us to incur additional loan losses and adversely affect our results of operations in the future; the risk that our interest margins and, therefore, our net interest income will be adversely affected by changes in prevailing interest rates; the risk that we will not succeed in further reducing our remaining nonperforming assets, in which event we would face the prospect of further loan charge-offs and write-downs of other real estate owned and would continue to incur expenses associated with the management and disposition of those assets; the risk that we will not be able to manage our interest rate risks effectively, in which event our operating results could be harmed; the prospect of changes in government regulation of banking and other financial services organizations, which could impact our costs of doing business and restrict our ability to take advantage of business and growth opportunities; the risk that our efforts to develop a robust commercial banking platform may not succeed; and the risk that we may be unable to realize our expected level of increasing deposit inflows. Many of the foregoing risks and uncertainties are, and will be, exacerbated by the COVID-19 pandemic and any worsening of the global business and economic environment as a result. Readers of this Report are encouraged to review the additional information regarding these and other risks and uncertainties to which our business is subject that is contained in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K”) that we filed with the Securities and Exchange Commission (“SEC”) on March 9, 2020, as such information may be updated from time to time in subsequent Quarterly Reports on Form 10-Q that we file with the SEC. We urge you to read those risk factors in conjunction with your review of the following discussion and analysis of our results of operations for the three and six months ended, and our financial condition at, June 30, 2020.

Due to the risks and uncertainties we face, readers are cautioned not to place undue reliance on the forward-looking statements contained in this Report, which speak only as of the date of this Report, or to make predictions about future performance based solely on historical financial performance. We also disclaim any obligation to update forward-looking statements contained in this Report as a result of new information, future events or otherwise, except as may otherwise be required by law.

Overview

The following discussion presents information about our consolidated results of operations, financial condition, liquidity and capital resources and should be read in conjunction with our consolidated financial statements and the notes thereto included in Item 1 above of this Report.

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Our principal operating subsidiary is Pacific Mercantile Bank (the “Bank”), which is a California state chartered bank. The Bank accounts for substantially all of our consolidated revenues, expenses and income and our consolidated assets and liabilities. Accordingly, the following discussion focuses primarily on the Bank’s results of operations and financial condition.

As of June 30, 2020, our total assets, net loans and total deposits were $1.7 billion, $1.4 billion and $1.4 billion, respectively.

The Bank, which is headquartered in Orange County, California, approximately 40 miles south of Los Angeles, conducts a commercial banking business in Orange, Los Angeles, San Bernardino and San Diego counties in Southern California. The Bank is also a member of the Federal Reserve System and its deposits are insured, to the maximum extent permitted by law, by the Federal Deposit Insurance Corporation (the “FDIC”). For the six months ended June 30, 2020 and 2019, we operated as one reportable segment, Commercial Banking.

Unless the context otherwise requires, the “Company,” “we,” “our,” “ours,” and “us” refer to Pacific Mercantile Bancorp and its consolidated subsidiaries.

COVID-19 Impact

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Results of Operations

Operating Results for the Three and Six Months Ended June 30, 2020 and 2019

Our operating results for the three and six months ended June 30, 2020, compared to the same period in June 30, 2019, were as follows:


	Three Months Ended June 30,						2020 vs. 2019 % Change			Six Months Ended June 30,					2020 vs. 2019 % Change
	2020		2019						2020			2019
	(Dollars in thousands)
Interest income	$	15,580	$	16,466	(5.4)	%	$	30,349		$	32,632		(7.0)	%
Interest expense	2,262		4,247		(46.7)	%	5,558			8,362			(33.5)	%
Provision for loan and lease losses	2,850		—		N/A		9,050			3,300			174.2	%
Noninterest income	1,171		1,386		(15.5)	%	2,265			2,876			(21.2)	%
Noninterest expense	8,934		9,707		(8.0)	%	18,651			18,691			(0.2)	%
Income tax expense	800		1,170		(31.6)	%	(190)			1,545			(112.3)	%


Net income (loss)	1,905		2,728		(30.2)	%	(455)			3,610			(112.6)	%

Interest Income

Three Months Ended June 30, 2020 and 2019

Total interest income decreased 5.4% to $15.6 million for the three months ended June 30, 2020 from $16.5 million for the three months ended June 30, 2019. This was primarily due to a decrease in interest earned on short-term investments as a result of a decrease in the average yield during the three months ended June 30, 2020 as compared to the same prior year period. During the three months ended June 30, 2020 and 2019, interest income on loans was $15.3 million and $14.6 million, respectively, yielding 4.62% and 5.51% on average loan balances of $1.33 billion and $1.06 billion, respectively. The increase to interest income on loans is due to an increase in the average loan balance primarily attributable to the execution of PPP during the three months ended June 30, 2020. The decrease in average loan yields is primarily attributable to the Board of Governors of the Federal Reserve System ("Federal Reserve Board") cutting short-term interest rates by 225 basis points throughout the course of the year from June 30, 2019 through June 30, 2020, of which 150 of the basis point reduction occurred in the first quarter of 2020 in response to the economic conditions caused by the outbreak of COVID.

During the three months ended June 30, 2020 and 2019, interest income from our securities available-for-sale and stock was $210 thousand and $260 thousand, respectively, yielding 2.41% and 2.83% on average balances of $35.0 million and $36.9 million, respectively. The average securities balances decreased as a result of the maturities of, and payments on, securities available-for-sale during 2019. Interest income from our short-term investments, including our Federal Funds sold and interest-bearing deposits, was $79 thousand and $1.6 million for the three months ended June 30, 2020 and 2019, respectively, yielding 0.10% and 2.41% on average balances of $322.0 million and $270.0 million, respectively. The decrease in interest income from our short-term investments was primarily attributable to the Federal Reserve Board cutting short-term interest rates by 225 basis points throughout the course of the year from June 30, 2019 through June 30, 2020, of which 150 of the basis point reduction occurred in the first quarter of 2020 in response to the economic conditions caused by the outbreak of COVID. As a result, total interest income on investments decreased for the three months ended June 30, 2020 as compared to the three months ended June 30, 2019.

Six Months Ended June 30, 2020 and 2019

Total interest income decreased 7.0% to $30.3 million for the six months ended June 30, 2020 from $32.6 million for the six months ended June 30, 2019. This was primarily due to a decrease in interest income on short-term investments during the six months ended June 30, 2020 as compared to the same prior year period. During the six months ended June 30, 2020 and 2019, interest income on loans was $29.1 million and $29.1 million, respectively, yielding 4.78% and 5.48% on average loan balances of $1.22 billion and $1.07 billion, respectively. The increase in the average loan balances is primarily attributable to the execution of PPP during the three months ended June 30, 2020. Loan interest income remained consistent at $29.1 million despite the decrease in yield as a result of fee income from PPP loans included in interest income. The decrease in average loan yield is primarily attributable to the Federal Reserve Board cutting short-term interest rates by 225 basis points throughout the course of the year from June 30, 2019 through June 30, 2020, of which 150 of the basis point reduction occurred in the first quarter of 2020 in response to the economic conditions caused by the outbreak of COVID.

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During the six months ended June 30, 2020 and 2019, interest income from our securities available-for-sale and stock was $471 thousand and $551 thousand, respectively, yielding 2.67% and 2.92% on average balances of $35.4 million and $38.0 million, respectively. The average securities balances decreased as a result of the maturities of, and payments on, securities available-for-sale during 2019. Interest income from our short-term investments, including our Federal Funds sold and interest-bearing deposits, was $800 thousand and $3.0 million for the six months ended June 30, 2020 and 2019, respectively, yielding 0.59% and 2.42% on average balances of $271.3 million and $247.9 million, respectively. The decrease in interest income from our short-term investments was primarily attributable to an decrease in the average yield during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019 as a result of the Federal Reserve Board cutting short-term interest rates by 225 basis points throughout the course of the year from June 30, 2019 through June 30, 2020, of which 150 of the basis point reduction occurred in the first quarter of 2020 in response to the economic conditions caused by the outbreak of COVID. As a result, total interest income on investments decreased for the six months ended June 30, 2020 as compared to the six months ended June 30, 2019.

Interest Expense

Three Months Ended June 30, 2020 and 2019

Total interest expense decreased 46.7% to $2.3 million for the three months ended June 30, 2020 from $4.2 million for the three months ended June 30, 2019. The decrease was primarily due to a decrease in our cost of funds from 1.92% at June 30, 2019 to 0.95% at June 30, 2020, partially offset by an increase in the average balance of interest-bearing liabilities from $888.9 million at June 30, 2019 to $957.9 million at June 30, 2020, which consisted of deposits, borrowings and junior subordinated debentures. Our cost of funds decreased as a result of the actions of the Federal Reserve Board to cut short-term interest rates by 75 basis points throughout the year 2019 and 150 basis points during the first quarter of 2020 in response to the outbreak of COVID. The increase in our average balance of interest-bearing liabilities is primarily the result of an increase in our FHLB borrowings. Interest expense on our certificates of deposit for the three months ended June 30, 2020 and 2019 was $1.4 million and $1.5 million, respectively, with a cost of funds of 2.12% and 2.25% on average balances of $260.4 million and $261.7 million, respectively.

Six Months Ended June 30, 2020 and 2019

Total interest expense decreased 33.5% to $5.6 million for the six months ended June 30, 2020 from $8.4 million the six months ended June 30, 2019. The decrease was primarily due to a decrease in our cost of funds from 1.90% at June 30, 2019 to 1.24% at June 30, 2020, partially offset by an increase in the average balance of interest-bearing liabilities of $886.1 million at June 30, 2019 to $902.0 million at June 30, 2020, which consisted of deposits, borrowings and junior subordinated debentures. Our cost of funds decreased as a result of the actions of the Federal Reserve Board to cut short-term interest rates by 75 basis points throughout the year 2019 and 150 basis points during the first quarter of 2020 in response to the outbreak of COVID. The increase in our average balance of interest-bearing liabilities is primarily the result of an increase in our Federal Home Loan Bank (“FHLB”) borrowings. Interest expense on our certificates of deposit for the six months ended June 30, 2020 and 2019 was $3.0 million and $2.8 million, respectively, with a cost of funds of 2.21% and 2.13% on average balances of $268.2 million and $267.0 million, respectively.

Net Interest Margin

One of the principal determinants of a bank’s income is its net interest income, which is the difference between (i) the interest that a bank earns on loans, investment securities and other interest earning assets, on the one hand, and (ii) its interest expense, which consists primarily of the interest it must pay to attract and retain deposits and the interest that it pays on borrowings and other interest-bearing liabilities, on the other hand. As a general rule, all other things being equal, the greater the difference or “spread” between the amount of our interest income and the amount of our interest expense, the greater will be our net income; whereas, a decline in that difference or “spread” will generally result in a decline in our net income.

A bank’s interest income and interest expense are affected by a number of factors, some of which are outside of its control, including national and local economic conditions and the monetary policies of the Federal Reserve Board which affect interest rates, competition in the market place for loans and deposits, the demand for loans and the ability of borrowers to meet their loan payment obligations. Net interest income, when expressed as a percentage of total average interest earning assets, is a banking organization’s “net interest margin.”

The following tables set forth information regarding our average balances, yields on interest earning assets, interest expense on interest-bearing liabilities, the interest rate spread and the interest rate margin for the three and six months ended June 30, 2020 and 2019. Average balances are calculated based on average daily balances.

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	Three Months Ended June 30,
	2020										2019
	Average Balance		Interest Earned/ Paid		Average Yield/ Rate		Average Balance		Interest Earned/ Paid		Average Yield/ Rate
	(Dollars in thousands)
Interest-earning assets
Short-term investments⁽¹⁾	$	322,023	$	79	0.10	%	$	269,980	$	1,620	2.41	%
Securities available for sale and stock⁽²⁾	35,000		210		2.41	%	36,880		260		2.83	%
Loans⁽³⁾	1,331,270		15,291		4.62	%	1,062,228		14,586		5.51	%
Total interest-earning assets	1,688,293		15,580		3.71	%	1,369,088		16,466		4.82	%
Noninterest-earning assets
Cash and due from banks	16,622						15,573
All other assets	28,048						26,052
Total assets	$	1,732,963					$	1,410,713
Interest-bearing liabilities:
Interest-bearing checking accounts	$	103,164	$	25	0.10	%	$	108,530	$	181	0.67	%
Money market and savings accounts	454,877		567		0.50	%	460,935		2,106		1.83	%
Certificates of deposit	260,354		1,371		2.12	%	261,721		1,466		2.25	%
Other borrowings	122,015		130		0.43	%	40,220		262		2.61	%
Junior subordinated debentures	17,527		169		3.88	%	17,527		232		5.31	%
Total interest bearing liabilities	957,937		2,262		0.95	%	888,933		4,247		1.92	%
Noninterest bearing liabilities
Demand deposits	606,481						360,597
Accrued expenses and other liabilities	18,649						16,544
Shareholders’ equity	149,896						144,639
Total liabilities and shareholders’ equity	$	1,732,963					$	1,410,713
Net interest income			$	13,318					$	12,219
Net interest income/spread					2.76	%					2.90	%
Net interest margin					3.17	%					3.58	%

(1)Short-term investments consist of Federal Funds sold and interest bearing deposits that we maintain at other financial institutions.

(2)Stock consists of FHLB stock and FRBSF stock.

(3)Loans include the average balance of nonaccrual loans.

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	Six Months Ended June 30,
	2020										2019
	Average Balance		Interest Earned/ Paid		Average Yield/ Rate		Average Balance		Interest Earned/ Paid		Average Yield/ Rate
	(Dollars in thousands)
Interest-earning assets
Short-term investments⁽¹⁾	$	271,310	$	800	0.59	%	$	247,893	$	2,975	2.42	%
Securities available for sale and stock⁽²⁾	35,422		471		2.67	%	38,035		551		2.92	%
Loans⁽³⁾	1,224,134		29,078		4.78	%	1,071,449		29,106		5.48	%
Total interest-earning assets	1,530,866		30,349		3.99	%	1,357,377		32,632		4.85	%
Noninterest-earning assets
Cash and due from banks	16,698						15,330
All other assets	26,601						27,632
Total assets	$	1,574,165					$	1,400,339
Interest-bearing liabilities:
Interest-bearing checking accounts	$	103,260	$	113	0.22	%	$	102,038	$	342	0.68	%
Money market and savings accounts	435,205		1,864		0.86	%	459,463		4,220		1.85	%
Certificates of deposit	268,200		2,951		2.21	%	266,959		2,815		2.13	%
Other borrowings	77,821		263		0.68	%	40,110		520		2.61	%
Junior subordinated debentures	17,527		367		4.21	%	17,527		465		5.35	%
Total interest bearing liabilities	902,013		5,558		1.24	%	886,097		8,362		1.90	%
Noninterest bearing liabilities
Demand deposits	502,514						350,919
Accrued expenses and other liabilities	19,175						19,397
Shareholders’ equity	150,463						143,926
Total liabilities and shareholders’ equity	$	1,574,165					$	1,400,339
Net interest income			$	24,791					$	24,270
Net interest income/spread					2.75	%					2.95	%
Net interest margin					3.26	%					3.61	%

(1)Short-term investments consist of Federal Funds sold and interest bearing deposits that we maintain at other financial institutions.

(2)Stock consists of FHLB stock and FRBSF stock.

(3)Loans include the average balance of nonaccrual loans.

The following table sets forth changes in interest income, including loan fees, and interest paid in the three and six months ended June 30, 2020 and 2019 and the extent to which those changes were attributable to changes in (i) the volumes of or the rates of interest earned on interest-earning assets and (ii) the volumes of or the rates of interest paid on our interest-bearing liabilities.

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	Three Months Ended June 30, 2020 Compared to Three Months Ended June 30, 2019 Increase (Decrease) due to Changes in										Six Months Ended June 30, 2020 Compared to Six Months Ended June 30, 2019 Increase (Decrease) due to Changes in
	Volume		Rates		Total Increase (Decrease)		Volume		Rates		Total Increase (Decrease)
	(Dollars in thousands)
Interest income
Short-term investments⁽¹⁾	$	261	$	(1,802)	$	(1,541)	$	259	$	(2,434)	$	(2,175)
Securities available for sale and stock⁽²⁾	(13)		(37)		(50)		(36)		(44)		(80)
Loans	3,297		(2,592)		705		3,921		(3,949)		(28)
Total earning assets	3,545		(4,431)		(886)		4,144		(6,427)		(2,283)
Interest expense
Interest-bearing checking accounts	(9)		(147)		(156)		4		(233)		(229)
Money market and savings accounts	(27)		(1,512)		(1,539)		(212)		(2,144)		(2,356)
Certificates of deposit	(8)		(87)		(95)		14		122		136
Borrowings	216		(348)		(132)		288		(545)		(257)
Junior subordinated debentures	—		(63)		(63)		—		(98)		(98)
Total interest-bearing liabilities	172		(2,157)		(1,985)		94		(2,898)		(2,804)
Net interest income	$	3,373	$	(2,274)	$	1,099	$	4,050	$	(3,529)	$	521

(1)Short-term investments consist of Federal Funds sold and interest bearing deposits that we maintain at other financial institutions.

(2)Stock consists of FHLB stock and FRBSF stock.

Provision for Loan and Lease Losses

We maintain reserves to provide for loan losses that occur in the ordinary course of the banking business. When it is determined that the payment in full of a loan has become unlikely, the carrying value of the loan is reduced (“written down”) to what management believes is its realizable value or, if it is determined that a loan no longer has any realizable value, the carrying value of the loan is written off in its entirety (a loan “charge-off”). Loan charge-offs and write-downs are charged against our allowance for loan and lease losses (“ALLL”). The amount of the ALLL is increased periodically to replenish the ALLL after it has been reduced due to loan write-downs or charge-offs. The ALLL also is increased or decreased periodically to reflect increases or decreases in the volume of outstanding loans and to take account of changes in the risk of probable loan losses due to financial performance of borrowers, the value of collateral securing nonperforming loans or changing economic conditions. Increases in the ALLL are made through a “provision for loan and lease losses” that is recorded as an expense in the statement of operations. Increases in the ALLL are also recognized through the recovery of charged-off loans which are added back to the ALLL. As such, recoveries are a direct offset for a provision for loan and lease losses that would otherwise be needed to replenish or increase the ALLL.

We employ economic models and data that conform to bank regulatory guidelines and reflect sound industry practices as well as our own historical loan loss experience to determine the sufficiency of the ALLL and any provisions needed to increase or replenish the ALLL. Those determinations involve judgments and assumptions about current economic conditions and external events that can impact the ability of borrowers to meet their loan obligations. However, the duration and impact of these factors cannot be determined with any certainty. As such, unanticipated changes in economic or market conditions, bank regulatory guidelines or the sound practices that are used to determine the sufficiency of the ALLL, could require us to record additional, and possibly significant, provisions to increase the ALLL. This would have the effect of reducing reportable income or, in the most extreme circumstance, creating a reportable loss. In addition, the Federal Reserve Bank and the California Department of Business Oversight (“CDBO”), as an integral part of their regulatory oversight, periodically review the adequacy of our ALLL. These agencies may require us to make additional provisions for perceived potential loan losses, over and above the provisions that we have already made, the effect of which would be to reduce our income or increase any losses we might incur.

We recorded a provision for loan and lease losses of $2.9 million and $9.1 million, respectively, during the three and six months ended June 30, 2020 as a result of total charge-offs of $2.2 million and $4.5 million, respectively, increases in classified and nonperforming loans, and qualitative factor increases related to COVID. For the three and six months ended June 30, 2020, we made adjustments to our qualitative risk factor to incorporate the current economic conditions caused by the COVID pandemic. We recorded a provision for loan and lease losses of zero and $3.3 million, respectively, during the three and six months ended June 30, 2019 as a result of total charge-offs of $5.8 million, which primarily related to one large credit, partially offset by a decline in the level of classified assets.

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See “—Financial Condition—Nonperforming Assets and Allowance for Loan and Lease Losses” below in this Item 2 for additional information regarding the ALLL.

Noninterest Income

The following table identifies the components of and the percentage changes in noninterest income during the three and six months ended June 30, 2020 and 2019:


	Three Months Ended June 30,										Six Months Ended June 30,
	Amount		Amount		Percentage Change		Amount		Amount		Percentage Change
	2020		2019		2020 vs. 2019		2020		2019		2020 vs. 2019
	(Dollars in thousands)



Service fees on deposits and other banking services	$	625	$	443	41.1	%	$	1,147	$	840	36.5	%


Net loss on sale of other assets	(53)		(11)		381.8	%	(47)		(36)		30.6	%
Net gain on sale of Small Business Administration loans	—		300		100.0	%	—		600		100.0	%
Other noninterest income	599		654		(8.4)	%	1,165		1,472		(20.9)	%
Total noninterest income	$	1,171	$	1,386	(15.5)	%	$	2,265	$	2,876	(21.2)	%

Three Months Ended June 30, 2020 and 2019

Noninterest income decreased by $215 thousand, or 15.5%, for the three months ended June 30, 2020 as compared to the three months ended June 30, 2019, primarily as a result of:

•A net gain on sale of SBA loans of $300 thousand during the three months ended June 30, 2019 that did not occur in the same period in 2020; and

•A decrease of $55 thousand in other noninterest income during the second quarter of 2020 as compared to the same quarter of 2019 which included nonrecurring early closure and annual loan fees, partially offset by

•An increase of $182 thousand in service fees on loans and deposits and other banking services during the second quarter of 2020.

Six Months Ended June 30, 2020 and 2019

Noninterest income decreased $611 thousand, or 21.2%, for the six months ended June 30, 2020 as compared to the six months ended June 30, 2019, primarily as a result of:

•A net gain on sale of SBA loans of $600 thousand during the six months ended June 30, 2019 that did not occur in the same period in 2020; and

•A decrease of $307 thousand in other noninterest income which included nonrecurring early closure and annual loan fees in 2019; partially offset by

•An increase in service fees on loans and deposits and other banking services during the six months ended June 30, 2020 as compared to the same period in 2019.

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Noninterest Expense

The following table sets forth the principal components and the amounts of, and the percentage changes in, noninterest expense during the three and six months ended June 30, 2020 and 2019.


	Three Months Ended June 30,										Six Months Ended June 30,
	2020		2019		2020 vs. 2019		2020		2019		2020 vs. 2019
	Amount		Amount		Percent Change		Amount		Amount		Percent Change
	(Dollars in thousands)
Salaries and employee benefits	$	5,462	$	5,737	(4.8)	%	$	11,531	$	11,177	3.2	%
Occupancy	668		647		3.2	%	1,339		1,274		5.1	%
Equipment and depreciation	508		480		5.8	%	959		941		1.9	%
Data processing	592		526		12.5	%	1,236		1,044		18.4	%
FDIC expense	210		193		8.8	%	403		357		12.9	%

Other real estate owned expense, net	—		1		100.0	%	—		69		(100.0)	%
Professional fees	702		1,190		(41.0)	%	1,563		1,986		(21.3)	%

Business development	137		241		(43.2)	%	309		437		(29.3)	%

Loan related expense	152		122		24.6	%	277		307		(9.8)	%
Insurance	63		61		3.3	%	126		123		2.4	%
Other operating expenses ⁽¹⁾	440		509		(13.6)	%	908		976		(7.0)	%
Total noninterest expense	$	8,934	$	9,707	(8.0)	%	$	18,651	$	18,691	(0.2)	%

(1)Other operating expenses primarily consist of telephone, investor relations, promotional, regulatory expenses, and correspondent bank fees.

Three Months Ended June 30, 2020 and 2019

Noninterest expense decreased $773 thousand, or 8.0%, for the three months ended June 30, 2020 as compared to the three months ended June 30, 2019, primarily as a result of:

•A decrease of $275 thousand in salaries and employee benefits primarily related to a reorganization of the Bank during the second quarter of 2020; and

•A decrease of $488 thousand in our professional fees primarily related to lower legal fees during the second quarter of 2020 compared to legal fees in the second quarter of 2019; and

•A decrease of $104 thousand in our business development costs related to the implementation of cost savings initiatives; partially offset by

•An increase of $66 thousand in our data processing fees primarily related to a higher credit card and deposit transaction volume in the second quarter of 2020; and

•An increase in various expense accounts related to the normal course of operating, including expenses related to loan production and servicing during the three months ended June 30, 2020 as compared to the three months ended June 30, 2019.

Six Months Ended June 30, 2020 and 2019

Noninterest expense decreased $40 thousand, or 0.2%, for the six months ended June 30, 2020 as compared to the six months ended June 30, 2019, primarily as a result of:

•A decrease of $423 thousand in our professional fees primarily related to higher legal fees in 2019; and

•A decrease of $128 thousand in our business development costs related to the implementation of cost savings initiatives; partially offset by

•An increase of $354 thousand in salaries and employee benefits primarily related to an increase in employee compensation expense and hiring related fees; and

•An increase of $192 thousand in our data processing fees primarily related to a higher credit card and deposit transaction volume in the current year.

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Provision for Income Tax

For the three months ended June 30, 2020, we had income tax expense of $800 thousand as a result of our operating income, and for the six months ended June 30, 2020, we had income tax benefit of $190 thousand as a result of our year-to-date operating loss. Accounting rules specify that management must evaluate the deferred tax asset on a recurring basis to determine whether enough positive evidence exists to determine whether it is more-likely-than-not that the deferred tax asset will be available to offset or reduce future taxes. The tax code allows net operating losses incurred prior to December 31, 2017 to be carried forward for 20 years from the date of the loss, and based on its evaluation, management believes that the Company will be able to realize the deferred tax asset within the period that our net operating losses may be carried forward. Due to the hierarchy of evidence that the accounting rules specify, management determined that there continued to be enough positive evidence to support no valuation allowance on our deferred tax asset at June 30, 2020. Significant positive evidence included our three-year cumulative income position, the expectation that we will have positive earnings for the year based on positive income in eleven of the last twelve trailing quarters, and our forecasted net income for the year. Negative evidence included our accumulated deficit, net loss for the first quarter of 2020, and deterioration in asset quality.

For the three months and six months ended June 30, 2019, we had income tax expense of $1.2 million and $1.5 million, respectively, as a result of our operating income. During the three months ended June 30, 2019, management determined that there continued to be enough positive evidence to support no valuation allowance on our deferred tax asset. Based on this evaluation, management believed that the Company would be able to realize the deferred tax asset within the period that our operating losses may be carried forward. Significant positive evidence included our three-year cumulative income position, continued improvement in asset quality, and the expectation that we will continue to have positive earnings based on ten trailing quarters of positive income and our forecast. Negative evidence at June 30, 2019 included our accumulated deficit.

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Financial Condition

Assets

Our total assets increased by $272 million at June 30, 2020 compared to December 31, 2019. The following table sets forth the composition of our interest earning assets at:


	June 30, 2020		December 31, 2019
	(Dollars in thousands)
Interest-bearing deposits with financial institutions ⁽¹⁾	$	241,859	$	202,729
Interest-bearing time deposits with financial institutions	2,345		2,420
Federal Reserve Bank of San Francisco and Federal Home Loan Bank Stock, at cost	7,910		7,910
Securities available for sale, at fair value	26,213		28,344

Loans (net of allowances of $18,166 and $13,611, respectively)	1,350,800		1,117,511

(1)Includes interest-earning balances maintained at the FRBSF.

Investment Portfolio

Securities Available for Sale. Securities that we intend to hold for an indefinite period of time, but which may be sold in response to changes in liquidity needs, in interest rates, or in prepayment risks or other similar factors, are classified as “securities available for sale”. Such securities are recorded on our balance sheet at their respective fair values and increases or decreases in those values are recorded as unrealized gains or losses, respectively, and are reported as other comprehensive income (loss) on our accompanying consolidated statements of financial condition, rather than included in or deducted from our earnings.

The following is a summary of the major components of securities available for sale and a comparison of the amortized cost, estimated fair values and the gross unrealized gains and losses attributable to those securities, as of June 30, 2020 and December 31, 2019:


(Dollars in thousands)	Amortized Cost		Gross Unrealized Gain		Gross Unrealized Loss		Estimated Fair Value
Securities available for sale at June 30, 2020:

Commercial mortgage backed securities issued by U.S. Agencies	$	8,537	$	416	$	—	$	8,953
Residential mortgage backed securities issued by U.S. Agencies	16,883		380		(3)		17,260




Total securities available for sale	$	25,420	$	796	$	(3)	$	26,213
Securities available for sale at December 31, 2019:

Commercial mortgage backed securities issued by U.S. Agencies	$	9,147	$	128	$	(46)	$	9,229
Residential mortgage backed securities issued by U.S. Agencies	19,380		12		(277)		19,115




Total securities available for sale	$	28,527	$	140	$	(323)	$	28,344

The amortized cost of securities available for sale at June 30, 2020 is shown in the table below by contractual maturities taking into consideration historical prepayments based on the prior twelve months of principal payments. Expected maturities will differ from contractual maturities and historical prepayments, particularly with respect to collateralized mortgage obligations, if any, primarily because prepayment rates are affected by changes in conditions in the interest rate market and, therefore, future prepayment rates may differ from historical prepayment rates.

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	June 30, 2020 Maturing in
	One year or less						Over one year through five years						Over five years through ten years						Over ten years		Total
(Dollars in thousands)	Amortized Cost		Weighted Average Yield		Amortized Cost		Weighted Average Yield		Amortized Cost		Weighted Average Yield		Amortized Cost		Weighted Average Yield		Amortized Cost		Weighted Average Yield
Securities available for sale:

Commercial mortgage backed securities issued by U.S. Agencies	726		0.66	%	2,773		1.61	%	5,038		2.09	%	—		—	%	8,537		1.81	%
Residential mortgage-backed securities issued by U.S. Agencies	4,653		1.54	%	9,797		1.48	%	2,433		1.58	%	—		—	%	16,883		1.51	%



Total securities available for sale	$	5,379	1.42	%	$	12,570	1.51	%	$	7,471	1.92	%	$	—	—	%	$	25,420	1.61	%

Loans

The outbreak of COVID-19 will continue to have an impact on our loan portfolio as we experience a prolonged period of economic uncertainty that affects a broad range of industries in which our customers operate. Disruptions to our customers could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans. As a result of these risks, we have provided for additional losses in our provision for loan and lease losses with increased qualitative factors to reflect the current economic environment. Our participation in the PPP has allowed us to assist hundreds of our customers in securing funding from the SBA. The Bank was able to begin processing applications for PPP loans on April 3, 2020, the very first day the SBA began accepting applications, due to the preparations made by the Bank at the end of the first quarter. During the second quarter, the Bank was able to process 693 loan applications for approximately $280 million, which was largely for the benefit of the Bank's existing clients who have been impacted by COVID-19. Our loan growth in the second quarter of 2020 was primarily due to these loans funded under the PPP.

The following table sets forth the composition, by loan category, of our loan portfolio at June 30, 2020 and December 31, 2019:


	June 30, 2020						December 31, 2019
	Amount		Percent		Amount		Percent
	(Dollars in thousands)
Commercial loans	$	698,280	51.0	%	$	409,420	36.2	%
Commercial real estate loans – owner occupied	195,379		14.3	%	219,483		19.5	%
Commercial real estate loans – all other	203,330		14.8	%	208,283		18.5	%
Residential mortgage loans – multi-family	164,575		12.0	%	176,523		15.7	%
Residential mortgage loans – single family	15,522		1.1	%	18,782		1.7	%

Construction and land development loans	7,247		0.5	%	2,981		0.3	%
Consumer loans	85,414		6.3	%	90,867		8.1	%
Total loans	1,369,747		100.0	%	1,126,339		100.0	%
Deferred loan origination costs, net	(781)				4,783
Allowance for loan and lease losses	(18,166)				(13,611)
Loans, net	$	1,350,800			$	1,117,511

Commercial loans are loans to businesses to finance capital purchases or improvements, or to provide cash flow for operations. Commercial real estate and residential mortgage loans are loans secured by trust deeds on real properties, including commercial properties and single family and multi-family residences. Construction loans are interim loans to finance specific construction projects. Land development loans are loans secured by non-arable bare land. Consumer loans include installment loans to consumers.

The following table sets forth the maturity distribution of our loan portfolio (excluding single and multi-family residential mortgage loans and consumer loans) at June 30, 2020:

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	June 30, 2020
	One Year or Less		Over One Year Through Five Years		Over Five Years		Total
	(Dollars in thousands)
Real estate loans⁽¹⁾
Floating rate	$	9,448	$	27,873	$	101,300	$	138,621
Fixed rate	15,982		65,017		186,336		267,335
Commercial loans
Floating rate	74,893		86,264		22,329		183,486
Fixed rate	114,187		366,368		34,239		514,794
Total	$	214,510	$	545,522	$	344,204	$	1,104,236

(1)Does not include mortgage loans on single or multi-family residences or consumer loans, which totaled $180.1 million and $85.4 million, respectively, at June 30, 2020.

Nonperforming Assets and Allowance for Loan and Lease Losses

Nonperforming Assets. Nonperforming loans consist of (i) loans on nonaccrual status which are loans on which the accrual of interest has been discontinued and include restructured loans when there has not been a history of past performance on debt service in accordance with the contractual terms of the restructured loans, and (ii) loans 90 days or more past due and still accruing interest. Nonperforming assets are comprised of nonperforming loans and other real estate owned (“OREO”), which consists of real properties that we have acquired by or in lieu of foreclosure and which we intend to offer for sale.

Loans are placed on nonaccrual status when, in our opinion, the full timely collection of principal or interest is in doubt. Generally, the accrual of interest is discontinued when principal or interest payments become more than 90 days past due, unless we believe the loan is adequately collateralized and the loan is in the process of collection. However, in certain instances, we may place a particular loan on nonaccrual status earlier, depending upon the individual circumstances involved in that loan’s delinquency. When a loan is placed on nonaccrual status, previously accrued but unpaid interest is reversed against current income. Subsequent collections of unpaid amounts on such a loan are applied to reduce principal when received, except when the ultimate collectability of principal is probable, in which case such payments are applied to interest and are credited to income. Nonaccrual loans may be restored to accrual status if and when principal and interest become current and full repayment is expected. Interest income is recognized on the accrual basis for impaired loans which, based on our nonaccrual policy, do not require nonaccrual treatment.

The following table sets forth information regarding our nonperforming assets, as well as information regarding restructured loans, at June 30, 2020 and December 31, 2019:


	At June 30, 2020		At December 31, 2019
	(Dollars in thousands)
Nonaccrual loans:
Commercial loans	$	18,200	$	9,101
Commercial real estate	6,225		6,507


Consumer	256		74
Total nonaccrual loans	$	24,681	$	15,682
Other real estate owned (OREO)⁽¹⁾:




Total other real estate owned	$	—	$	—
Loans past due 90 days and still accruing interest:
Commercial loans	$	670	$	—
Residential mortgage	375
Total loans past due 90 days and still accruing interest	$	1,045	$	—
Other nonperforming assets:
Other foreclosed assets	663		164


Total nonperforming assets	$	26,389	$	15,846
Restructured loans⁽¹⁾:
Accruing loans	$	—	$	—
Nonaccruing loans (included in nonaccrual loans above)	—		—
Total restructured loans	$	—	$	—

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(1)As of June 30, 2020 and December 31, 2019, we had no other real estate owned and no restructured loans.

As the table above indicates, total nonperforming assets increased by approximately $10.5 million, or 67%, to $26.4 million as of June 30, 2020 from $15.8 million as of December 31, 2019. The increase in our nonaccrual loans resulted primarily from $16.9 million of additions, partially offset by $4.6 million of charge-offs, $1.2 million of payoffs or pay downs on our nonaccrual loans, and the transfer to other assets of $558 thousand during the six months ended June 30, 2020.

Information Regarding Impaired Loans. At June 30, 2020, loans deemed impaired totaled $24.7 million as compared to $15.7 million at December 31, 2019. We had an average investment in impaired loans of $20.1 million for the six months ended June 30, 2020, as compared to $2.3 million for the six months ended June 30, 2019. The interest that would have been earned during the six months ended June 30, 2020 had the nonaccruing impaired loans remained current in accordance with their original terms was approximately $1.2 million.

The following table sets forth the amount of impaired loans to which a portion of the ALLL has been specifically allocated, and the aggregate amount so allocated, in accordance with Accounting Standards Codification 310-10, and the amount of the ALLL and the amount of impaired loans for which no such allocations were made, in each case at June 30, 2020 and December 31, 2019:


	June 30, 2020										December 31, 2019
	Loans		Reserves for Loan Losses		% of Reserves to Loans		Loans		Reserves for Loan Losses		% of Reserves to Loans
	(Dollars in thousands)
Impaired loans with specific reserves	$	2,992	$	911	30.4	%	$	1,105	$	561	50.8	%
Impaired loans without specific reserves	21,689		—		—		14,577		—		—
Total impaired loans	$	24,681	$	911	3.7	%	$	15,682	$	561	3.6	%

The $9.0 million increase in impaired loans to $24.7 million at June 30, 2020 from $15.7 million at December 31, 2019 was primarily attributable to $15.3 million in additions to impaired loans during the period, partially offset by $1.2 million in principal payments, $558 thousand transferred to other assets, and $4.6 million charged-off during the six months ended June 30, 2020. Based on an internal analysis, using the current estimated fair values of the collateral or the discounted present values of the future estimated cash flows of the impaired loans, we concluded that, at June 30, 2020, $911 thousand specific reserves were required on our impaired loans and that all impaired loans were otherwise well secured and adequately collateralized.

Allowance for Loan and Lease Losses. The ALLL totaled $18.2 million, representing 1.33% of total loans outstanding at June 30, 2020, as compared to $13.6 million, or 1.21% of loans outstanding, at December 31, 2019. Total loans at June 30, 2020 included $280.3 million of PPP loans that are 100% government guaranteed, and the ALLL to total loans excluding the PPP loans at this date was 1.67%.

The adequacy of the ALLL is determined through periodic evaluations of the loan portfolio and other factors that can reasonably be expected to affect the ability of borrowers to meet their loan obligations. Those factors are inherently subjective as the process for determining the adequacy of the ALLL involves some significant estimates and assumptions about such matters such as (i) economic conditions and trends and the amounts and timing of expected future cash flows of borrowers which can affect their ability to meet their loan obligations to us, (ii) the fair value of the collateral securing nonperforming loans, (iii) estimates of losses that we may incur on nonperforming loans, which are determined on the basis of historical loss experience and industry loss factors and bank regulatory guidelines, which are subject to change, and (iv) various qualitative factors. Since those factors are subject to changes in economic and other conditions and changes in regulatory guidelines or other circumstances over which we have no control, the amount of the ALLL may prove to be insufficient to cover all of the loan losses we might incur in the future. In such an event, it may become necessary for us to increase the ALLL from time to time to maintain its adequacy. Such increases are effectuated by means of a charge to income, referred to as the “provision for loan and lease losses”, in our statements of our operations. See “—Results of Operations— Provision for Loan and Lease Losses, above in this Item 2.

The amount of the ALLL is first determined by assigning reserve ratios for all loans. All nonaccrual loans and other loans classified as “Special Mention,” “Substandard” or “Doubtful” (“classified loans” or “classification categories”) and not fully collateralized are then assigned specific reserves within the ALLL, with greater reserve allocations made to loans deemed to be of a higher risk. These ratios are determined based on prior loss history and industry guidelines and loss factors, by type of loan, adjusted for current economic factors and current economic trends. Refer to Note 5, Loans and Allowance for Loan and Lease Losses, in Item 1 for definitions related to our internal asset quality indicators stated above.

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On a quarterly basis, we utilize a classification based loan loss migration model as well as review individual loans in determining the adequacy of the ALLL. Our loss migration analysis tracks a certain number of quarters of loan loss history and industry loss factors to determine historical losses by classification category for each loan type, except certain consumer loans (automobile, mortgage and credit cards), which are analyzed as homogeneous loan pools. These calculated loss factors are then applied to outstanding loan balances. We analyze impaired loans individually.

In determining whether and the extent to which we will make adjustments to our loan loss migration model for purposes of determining the ALLL, we also consider a number of qualitative factors that can affect the performance and the collectability of the loans in our loan portfolio. Such qualitative factors include:

•The effects of changes that we may make in our loan policies or underwriting standards on the quality of the loans and the risks in our loan portfolios;

•Trends and changes in local, regional and national economic conditions, as well as changes in industry specific conditions, and any other reasonably foreseeable events that could affect the performance or the collectability of the loans in our loan portfolios;

•Material changes that may occur in the mix or in the volume of the loans in our loan portfolios that could alter, whether positively or negatively, the risk profile of those portfolios;

•Changes in management or loan personnel or other circumstances that could, either positively or negatively, impact the application of our loan underwriting standards, the monitoring of nonperforming loans or our loan collection efforts; and

•External factors that, in addition to economic conditions, can affect the ability of borrowers to meet their loan obligations, such as fires, earthquakes and terrorist attacks.

Determining the effects that these qualitative factors may have on the performance of each category of loans in our loan portfolio requires numerous judgments, assumptions and estimates about conditions, trends and events which may subsequently prove to have been incorrect due to circumstances outside of our control. Moreover, the effects of qualitative factors such as these on the performance of our loan portfolios are often difficult to quantify. As a result, we may sustain loan losses in any particular period that are sizable in relation to the ALLL or that may even exceed the ALLL.

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Set forth below is information regarding loan balances and the related ALLL, by portfolio type, for the six months ended June 30, 2020 and 2019.


(Dollars in thousands)	Commercial		Real Estate		Construction and land Development		Consumer and Single Family Mortgages		Unallocated		Total
ALLL for the six months ended June 30, 2020:
Balance at beginning of year	$	8,883	$	2,897	$	34	$	1,797	$	—	$	13,611
Charge-offs	(4,478)		—		—		(84)		—		(4,562)
Recoveries	60		—		—		7		—		67
Provision	7,022		1,836		43		149		—		9,050
Balance at June 30, 2020	$	11,487	$	4,733	$	77	$	1,869	$	—	$	18,166
Allowance for loan and lease losses as a percentage of average total loans											1.48		%
Allowance for loan and lease losses as a percentage of total outstanding loans											1.33		%
Ratio of net charge-offs to average loans outstanding (annualized)											0.74		%
ALLL for the six months ended June 30, 2019:
Balance at beginning of year	$	8,071	$	3,643	$	426	$	1,290	$	76	$	13,506
Charge-offs	(5,772)		—		—		(53)		—		(5,825)
Recoveries	483		—		—		10		—		493
Provision	4,027		(853)		(307)		509		(76)		3,300
Balance at June 30, 2019	$	6,809	$	2,790	$	119	$	1,756	$	—	$	11,474
Allowance for loan and lease losses as a percentage of average total loans											1.07		%
Allowance for loan and lease losses as a percentage of total outstanding loans											1.06		%
Ratio of net charge-offs to average loans outstanding (annualized)											1.00		%

The ALLL increased by $6.7 million from June 30, 2019 to June 30, 2020 primarily as a result of charge-offs exceeding recoveries, an increase in classified and nonperforming loans, and qualitative factor increases related to COVID during the six months ended June 30, 2020. The reserve for loan losses may include an unallocated amount based upon our judgment as to possible credit losses inherent in the loan portfolio that may not have been captured by historical loss experience, qualitative factors, or specific evaluations of impaired loans. Unallocated reserves may be adjusted for factors including, but not limited to, unexpected or unusual events, volatile market and economic conditions, effects of changes or seasoning in methodologies, regulatory guidance and recommendations, or other factors that may impact borrower operating conditions and loss expectations. Management’s judgment as to unallocated reserves is determined in the context of, but separate from, the historical loss trends and qualitative factors described above. The unallocated reserve for loan losses was zero at June 30, 2020 and December 31, 2019.

We classify our loan portfolios using asset quality ratings. The credit quality table in Note 5, Loans and Allowance for Loan and Lease Losses above in Item 1, provides a summary of loans by portfolio type and asset quality ratings as of June 30, 2020 and December 31, 2019. Loans totaled approximately $1.37 billion at June 30, 2020, an increase of $243.4 million from $1.13 billion at December 31, 2019. The disaggregation of the loan portfolio by risk rating in the credit quality table located in Note 5 reflects the following changes that occurred between December 31, 2019 and June 30, 2020:

•Loans rated “Pass” totaled $1.26 billion, an increase of $201.3 million from $1.06 billion at December 31, 2019. The increase was primarily attributable to the $280 million of PPP loans funded during the quarter in addition to upgrades from "Special Mention" of $7.6 million, partially offset by downgrades to “Special Mention” and “Substandard” of $30.8 million and $34.8 million, respectively, and pay downs of principal payments.

•Loans rated “Special Mention” totaled $24.9 million, a decrease of $3.3 million from $28.3 million at December 31, 2019. The decrease was primarily the result of upgrades to "Pass" of $7.6 million,

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downgrades to "Substandard" of $20.8 million, and $5.8 million of payoffs and principal payments, partially offset by $30.8 million downgraded from “Pass".

•Loans rated “Substandard” totaled $78.6 million, an increase of $41.6 million from $37.0 million at December 31, 2019. This increase was primarily the result of $34.8 million downgraded from “Pass”, $20.5 million downgraded from "Special Mention", and $1.3 million advanced on lines of credit, partially offset by $3.8 million downgraded to "Doubtful", $2.0 million of upgraded notes, charge-offs of $4.5 million, $4.0 million in principal payments, and $639 thousand transfer to other assets. The loans downgraded from the "Pass" rating had been rated "Watch", a rating within our "Pass" rating that receives more oversight and attention by management.

•Loans rated "Doubtful" totaled $3.8 million at June 30, 2020, an increase from zero at December 31, 2019. This increase was the result of loans downgraded from "Substandard".

Our loss migration analysis currently utilizes a series of nineteen staggered 16-quarter migration periods. As a result, for purposes of determining applicable loss factors at June 30, 2020, our migration analysis covered the period from June 30, 2016 to June 30, 2020. We believe this was consistent with and reasonably reflects current economic conditions, portfolio trends and the risks that were inherent in our loan portfolio at June 30, 2020.

The table below sets forth loan delinquencies, by quarter, for the five preceding quarters ended June 30, 2020.


	June 30, 2020		March 31, 2020		December 31, 2019		September 30, 2019		June 30, 2019
Loans Delinquent:	(Dollars in thousands)
90 days or more:
Commercial loans	$	11,857	$	3,671	$	533	$	82	$	—



Consumer loans	—		—		—		—		—
	12,412		3,765		533		82		—
30-89 days:
Commercial loans	5,912		20,903		1,715		3,490		5,334
Commercial real estate	1,063		955		749		—		—

Land development loans	—		—		—		4,267		—

Consumer loans	200		579		315		70		—
	7,175		22,437		2,779		7,827		5,334
Total Past Due⁽¹⁾⁽²⁾:	$	19,587	$	26,202	$	3,312	$	7,909	$	5,334

(1)Past due balances include nonaccrual loans.

(2)No loans 90 days or more past due at June 30, 2019.

As the above table indicates, total past due loans increased by $16.3 million, to $19.6 million at June 30, 2020 from $3.3 million at December 31, 2019. Loans past due 90 days or more increased by $11.9 million, to $12.4 million at June 30, 2020, from $533 thousand at December 31, 2019.

Loans 30-89 days past due increased by $4.4 million to $7.2 million at June 30, 2020 from $2.8 million at December 31, 2019 primarily attributable to $27.9 million of additions, partially offset by $18.2 million paid current, $859 thousand of charge-offs, $3.6 million aged to over 90 days past due, transfer to other assets of $508 thousand, and principal payments of $335 thousand.

Deposits

Average Balances of and Average Interest Rates Paid on Deposits

Set forth below are the average amounts of, and the average rates paid on, deposits for the six months ended June 30, 2020 and year ended December 31, 2019:

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	Six Months Ended June 30, 2020						Year Ended December 31, 2019
	Average Balance		Average Rate		Average Balance		Average Rate
	(Dollars in thousands)
Noninterest bearing demand deposits	$	502,514	—		$	382,198	—
Interest-bearing checking accounts	103,260		0.22	%	109,234		0.59	%
Money market and savings deposits	435,205		0.86	%	438,814		1.74	%
Time deposits⁽¹⁾	268,200		2.21	%	265,859		2.26	%
Total deposits	$	1,309,179	0.76	%	$	1,196,105	1.19	%

(1)Comprised of time certificates of deposit in denominations of less than and more than $100,000.

Deposit Totals

Deposits totaled $1.4 billion at June 30, 2020 as compared to $1.2 billion at December 31, 2019. Deposit growth in the second quarter of 2020 was primarily concentrated in noninterest bearing demand deposits as a result of PPP loan funding. The following table provides information regarding the mix of our deposits at June 30, 2020 and December 31, 2019:


	At June 30, 2020						At December 31, 2019
	Amounts		% of Total Deposits		Amounts		% of Total Deposits
	(Dollars in thousands)
Deposits
Noninterest bearing demand deposits	$	596,052	41.8	%	$	397,000	33.1	%
Savings and other interest-bearing transaction deposits	582,953		40.8	%	525,692		43.8	%
Time deposits⁽¹⁾	249,521		17.5	%	276,878		23.1	%
Total deposits	$	1,428,526	100.0	%	$	1,199,570	100.0	%

(1)Comprised of time certificates of deposit in denominations of less than and more than $100,000.

Certificates of deposit in denominations of $100,000 or more, on which we pay higher rates of interest than on other deposits, aggregated $228.1 million, or 16.0%, of total deposits at June 30, 2020, as compared to $252.9 million, or 21.1%, of total deposits at December 31, 2019.

Set forth below is a maturity schedule of domestic time certificates of deposit outstanding at June 30, 2020 and December 31, 2019:


	June 30, 2020						December 31, 2019
Maturities	Certificates of Deposit Under $ 100,000		Certificates of Deposit $100,000 or more		Certificates of Deposit Under $100,000		Certificates of Deposit $100,000 or more
	(Dollars in thousands)
Three months or less	$	4,294	$	59,612	$	6,532	$	46,621
Over three and through six months	4,303		50,538		4,376		45,882
Over six and through twelve months	8,317		71,079		8,186		93,316
Over twelve months	4,539		46,839		4,926		67,039
Total	$	21,453	$	228,068	$	24,020	$	252,858

Other Assets and Other Liabilities

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” which requires lessees to recognize the following for all leases (with the exception of short-term leases) at the commencement date: a lease liability measured on a discounted basis and a right-of-use asset a specified asset for the lease term. The new standard establishes a right-of-use model (ROU) that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer

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than 12 months. The new standard had a material effect on our financial statements related to the recognition of new ROU assets and lease liabilities on our balance sheet for our office operating leases.

During the six months ended June 30, 2020, we did not recognize additional operating liabilities or corresponding ROU assets based on the present value of the remaining minimum rental payments under current leasing standards for existing operating leases. Refer to the Note 1, Significant Accounting Policies and Note 6, Leases above in Item 1 for further detail.

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Liquidity

We actively manage our liquidity needs to ensure that sufficient funds are available to meet our needs for cash, including to fund new loans and deposit withdrawals by our customers. We project the future sources and uses of funds and maintain liquid funds for unanticipated events such as the COVID-19 pandemic. Our primary sources of cash include cash we have on deposit at other financial institutions, payments from borrowers on their loans, proceeds from sales or maturities of securities held for sale, sales of residential mortgage loans, increases in deposits and increases in borrowings principally from the FHLB. The primary uses of cash include funding new loans and making advances on existing lines of credit, purchasing investments, including securities available for sale, funding new residential mortgage loans, funding deposit withdrawals and paying operating expenses. We maintain funds in overnight Federal Funds sold and other short-term investments to provide for short-term liquidity needs. We also have obtained credit lines from the FHLB and other financial institutions to meet any additional liquidity requirements we might have. See “—Contractual Obligations—Borrowings” below for additional information related to our borrowings from the FHLB.

Our liquid assets, which included cash and due from banks, Federal Funds sold, interest earning deposits that we maintain with financial institutions and unpledged securities available for sale (excluding FRBSF and FHLB stock) totaled $265.3 million, which represented 16% of total assets, at June 30, 2020. We believe that our cash and cash equivalent resources, together with available borrowings under our credit facilities, will be sufficient to meet normal operating requirements for at least the next twelve months, including to enable us to meet any increase in deposit withdrawals that might occur in the foreseeable future. We believe that during this period of uncertain economic conditions related to COVID, our liquidity position is strong, and will be closely monitored as conditions change.

Cash Flow Provided by Operating Activities. During the six months ended June 30, 2020, operating activities provided net cash of $3.1 million, primarily attributable to a $9.1 million noncash adjustment related to our provision for loan and lease losses, partially offset by a $1.7 million increase in deferred taxes, net accretion of deferred loan fees of $1.5 million, and a $1.5 million decrease in other liabilities. During the six months ended June 30, 2019, operating activities provided net cash of $7.2 million, primarily attributable to our net income of $3.6 million and a $3.3 million noncash adjustment related to our provision for loan and lease losses.

Cash Flow Provided by (Used In) Investing Activities. During the six months ended June 30, 2020, investing activities used net cash of $237.2 million, primarily attributable to a $240.2 million increase in loans, offset by $3.0 million of cash provided from maturities of and principal payments on securities available for sale and other stock. During the six months ended June 30, 2019, investing activities provided net cash of $6.7 million, primarily attributable to a $1.9 million decrease in loans, $3.7 million of cash provided from maturities of and principal payments on securities available for sale and other stock and $1.1 million of cash provided from the sale of other real estate owned, partially offset by the purchase of $877 thousand of equity securities without readily determinable fair values.

Cash Flow Provided by Financing Activities. During the six months ended June 30, 2020, financing activities provided net cash of $273.0 million, consisting of a $229.0 million increase in our deposits, which was primarily the result of PPP loans funded by the SBA, and net proceeds of $44.0 million in borrowings. During the six months ended June 30, 2019, financing activities used net cash of $63.7 million which consisted of a $63.6 million increase in our deposits, which was primarily the result of new client acquisition.

Ratio of Loans to Deposits. The relationship between gross loans and total deposits can provide a useful measure of a bank’s liquidity. Since repayment of loans tends to be less predictable than the maturity of investments and other liquid resources, the higher the loan-to-deposit ratio the less liquid are our assets. On the other hand, since we realize greater yields on loans than we do on investments, a lower loan-to-deposit ratio can adversely affect interest income and earnings. As a result, our goal is to achieve a loan-to-deposit ratio that appropriately balances the requirements of liquidity and the need to generate a fair return on our assets. At June 30, 2020 and December 31, 2019, the loan-to-deposit ratio was 96% and 94%, respectively.

Capital Resources

Regulatory Capital Requirements Applicable to Banking Institutions

•well-capitalized

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•adequately capitalized

•undercapitalized

•significantly undercapitalized; or

•critically undercapitalized

The following table sets forth the capital and capital ratios of the Bank (on a stand-alone basis) at June 30, 2020, as compared to the regulatory requirements applicable to it.


				Applicable Federal Regulatory Requirement
					For Capital Adequacy Purposes				To be Categorized As Well-Capitalized
	Amount	Ratio		Amount	Ratio	Amount		Ratio
	(Dollars in thousands)


Total Capital to Risk Weighted Assets	173,270	14.5	%	123,451	At least 8.625	$	123,938	At least 10.0


Common Equity Tier 1 Capital to Risk Weighted Assets	158,302	13.3	%	63,518	At least 5.125	$	80,560	At least 6.5


Tier 1 Capital to Risk Weighted Assets	158,302	13.3	%	82,109	At least 6.625	$	99,151	At least 8.0


Tier 1 Capital to Average Assets	158,302	9.2	%	57,253	At least 4.0	$	71,566	At least 5.0

As the above table indicates, at June 30, 2020, the Bank (on a stand-alone basis) qualified as a “well-capitalized” institution under federally mandated capital standards and federally established prompt corrective action regulations. Since June 30, 2020, there have been no events or circumstances known to us which have changed or which are expected to result in a change in the Bank’s classifications as a well-capitalized institution.

In early July 2013, the Federal Reserve Board and the FDIC issued final rules implementing the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform and Consumer Protection Act changes. The rules revise minimum capital requirements and adjust prompt corrective action thresholds. The final rules revise the regulatory capital elements, add a new common equity Tier 1 capital ratio, increase the minimum Tier 1 capital ratio requirement, and implement a new capital conservation buffer. The rules also permit certain banking organizations to retain, through a one-time election, the existing treatment for accumulated other comprehensive income. The final rules took effect for community banks on January 1, 2015, subject to a transition period for certain parts of the rules. At June 30, 2020, the Bank (on a stand-alone basis) continued to qualify as a well-capitalized institution under the capital adequacy guidelines described above.

Dividend Policy and Share Repurchase Programs

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It is, and since the beginning of 2009 it has been, the policy of the Boards of Directors of the Company and the Bank to preserve cash to enhance our capital positions and the Bank’s liquidity. In addition, we have agreed that the Bank will not, without the FRB and the CDBO’s prior written approval, pay any dividends to Bancorp. Accordingly, we do not expect to pay dividends or make share repurchases for the foreseeable future.

The principal source of cash available to a bank holding company consists of cash dividends from its bank subsidiaries. There are currently several restrictions on the Bank’s ability to pay us cash dividends. Government regulations, including the laws of the State of California, as they pertain to the payment of cash dividends by California state-chartered banks, limits the amount of funds that the Bank is permitted to dividend to us. Further, Section 23(a) of the Federal Reserve Act limits the amounts that a bank may loan to its bank holding company to an aggregate of no more than 10% of the bank subsidiary’s capital surplus and retained earnings and requires that such loans be secured by specified assets of the bank holding company. We have committed to obtaining approval from the FRB and the CDBO prior to Bancorp paying any dividends, or making any distributions representing interest, principal or other sums on subordinated debentures or trust preferred securities. There can be no assurance that our regulators will approve such payments or dividends in the future. Refer to “Supervision and Regulation” in Item 1 of our 2019 Form 10-K and Note 14, Shareholders’ Equity in the notes to our consolidated financial statements on our 2019 Form 10-K for more detail regarding the regulatory restrictions on our and the Bank’s ability to pay dividends. In addition, we currently have sufficient cash on hand to meet our cash obligations. As a result, we do not expect that these restrictions will impact our ability to meet our cash obligations.

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Off-Balance Sheet Arrangements

Loan Commitments and Standby Letters of Credit. To meet the financing needs of our customers in the normal course of business, we are a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. At June 30, 2020 and December 31, 2019, we were committed to fund certain loans including letters of credit amounting to approximately $286 million and $316 million, respectively.

Commitments to extend credit and standby letters of credit generally have fixed expiration dates or other termination clauses and the customer may be required to pay a fee and meet other conditions in order to draw on those commitments or standby letters of credit. We expect, based on historical experience, that many of the commitments will expire without being drawn upon and, therefore, the total commitment amounts do not necessarily represent future cash requirements.

To varying degrees, commitments to extend credit involve elements of credit and interest rate risk for us that are in excess of the amounts recognized in our balance sheets. Our maximum exposure to credit loss in the event of nonperformance by the customers to whom such commitments are made could potentially be equal to the amount of those commitments. As a result, before making such a commitment to a customer, we evaluate the customer’s creditworthiness using the same underwriting standards that we would apply if we were approving loans to the customer. In addition, we often require the customer to secure its payment obligations for amounts drawn on such commitments with collateral such as accounts receivable, inventory, property, plant and equipment, income-producing commercial properties, residential properties and properties under construction. As a consequence, our exposure to credit and interest rate risk on such commitments is not different in character or amount than risks inherent in the outstanding loans in our loan portfolio.

Standby letters of credit are conditional commitments issued by the Bank to guarantee a payment obligation of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.

Contractual Obligations

Borrowings. At June 30, 2020 and December 31, 2019, our borrowings consisted of the following:


(Dollars in thousands)	June 30, 2020		December 31, 2019
FHLB advances—short-term	$	70,000	$	30,000
Other borrowings—short-term⁽¹⁾	3,962		—



Total	$	73,962	$	30,000

_______________

(1) Other borrowings are from the Federal Reserve's Paycheck Protection Program Liquidity Facility ("PPPLF") that extends credit to eligible financial institutions that originate PPP loans.


Principal Amounts	Interest Rate		Maturity Dates
(Dollars in thousands)
50,000	0.22	%	September 30, 2020
10,000	1.71	%	December 30, 2020
10,000	1.62	%	January 25, 2021

At June 30, 2020, $470 million of loans were pledged to support our unfunded borrowing capacity. At June 30, 2020, we had unused borrowing capacity of $239 million with the FHLB. The highest amount of borrowings outstanding at any month-end during the three months ended June 30, 2020 was $124.0 million from the FHLB. The highest amount of borrowings outstanding at any month end in 2019 consisted of $55.0 million of borrowings from the FHLB. At June 30, 2020 and December 31, 2019, commercial and consumer loans of $187 million and $210 million, respectively, were pledged to secure borrowings from the FRB to support our unfunded borrowing capacity of $126 million and $146 million, respectively.

Junior Subordinated Debentures. Pursuant to rulings of the Federal Reserve Board, bank holding companies were permitted to issue long term subordinated debt instruments that, subject to certain conditions, would qualify as and, therefore, augment capital for regulatory purposes. At June 30, 2020, we had outstanding approximately $17.5 million principal amount of Debentures, of which $17.0 million would qualify as additional Tier 1 capital for regulatory purposes as of June 30, 2020 if we were to surpass the reporting threshold of $3 billion in total assets.

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Set forth below is certain information regarding the Debentures:

Original Issue Dates

Principal Amount

Interest Rates

Maturity Dates⁽¹⁾

September 2002

7,217

LIBOR plus 3.40%

September 2032

October 2004

10,310

LIBOR plus 2.00%

October 2034

Total

17,527

(1)Subject to the receipt of prior regulatory approval, we may redeem the Debentures, in whole or in part, without premium or penalty, at any time prior to maturity.

These Debentures require quarterly interest payments, which are used to make quarterly distributions required to be paid on the corresponding trust preferred securities. Subject to certain conditions, we have the right, at our discretion, to defer those interest payments, and the corresponding distributions on the trust preferred securities, for up to five years. Exercise of this deferral right does not constitute a default of our obligations to pay the interest on the Debentures or the corresponding distributions that are payable on the trust preferred securities. We have committed to obtaining approval from the FRB and the CDBO prior to making any distributions representing interest, principal or other sums on subordinated debentures or trust preferred securities. Refer to “Supervision and Regulation” in Item 1 of our 2019 Form 10-K for further detail. As of June 30, 2020, we were current on all interest payments. There can be no assurance that our regulators will approve such payments in the future.

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Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) and general practices in the banking industry. Certain of those accounting policies are considered critical accounting policies, because they require us to make assumptions and judgments regarding circumstances or trends that could affect the carrying value of our material assets, such as, for example, assumptions regarding economic conditions or trends that could impact our ability to fully collect our loans or ultimately realize the carrying value of certain of our other assets, such as securities available for sale and our deferred tax asset. Those assumptions and judgments are based on current information available to us regarding those economic conditions or trends or other circumstances. If adverse changes were to occur in the conditions, trends or other events on which our assumptions or judgments had been based, then under GAAP it could become necessary for us to reduce the carrying values of any affected assets on our balance sheet. In addition, because reductions in the carrying value of assets are sometimes effectuated by or require charges to income, such reductions also may have the effect of reducing our income.

There have been no significant changes during the six months ended June 30, 2020 to the items that we disclosed as our critical accounting policies and estimates in Critical Accounting Policies within Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 2019 Form 10-K.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As an accelerated filer subject to the smaller reporting company disclosure requirements we are not required to provide the information required by this item.

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognized that any system of controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by SEC rules, an evaluation was performed under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer of the effectiveness, as of June 30, 2020, of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2020, the Company’s disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the three months ended June 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are subject to legal actions that arise from time to time in the ordinary course of our business. Currently, neither we nor any of our subsidiaries is a party to, and none of our or our subsidiaries’ property is the subject of, any material legal proceeding.

ITEM 1A. RISK FACTORS

The following risk factors supplement, and should be read in conjunction with, the risk factors described in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

The outbreak of the novel coronavirus (“COVID-19”) has adversely impacted certain industries in which our customers operate and impaired their ability to fulfill their obligations to us. Further, the spread of the outbreak has caused and may continue to cause severe disruptions in the U.S. economy, disrupting banking and other financial activity in the areas in which we operate, and could potentially create widespread business continuity issues for us.

Our business is dependent upon the willingness and ability of our employees and customers to conduct banking and other financial transactions. The spread of COVID-19 has caused and may continue to cause severe disruptions in the U.S. economy at large, and for small businesses in particular, and has resulted and may continue to result in disruptions to our customers’ businesses, and a decrease in consumer confidence and business generally. Disruptions to our customers may continue to result in increased risk of delinquencies, defaults, foreclosures and losses on our loans, declines in revenues, negatively impact regional economic conditions, result in declines in local loan demand, liquidity of loan guarantors, loan collateral (particularly in real estate), loan originations and deposit availability and negatively impact the implementation of our growth strategy.

We rely upon our third-party vendors to conduct business and to process, record, and monitor transactions. If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our customers. Furthermore, the outbreak could negatively impact the ability of our employees and customers to engage in banking and other financial transactions in the geographic areas in which we operate and could create widespread business continuity issues for us. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of a COVID-19 outbreak in our market areas. Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective.

The extent of impacts resulting from the COVID-19 pandemic and other events beyond our control will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the COVID-19 pandemic and actions taken to contain the COVID-19 or its impact, among others.

Our participation in the Paycheck Protection Program (the “PPP”) exposes us to risks related to noncompliance with the PPP, as well as litigation risk related to our administration of the PPP loan program, which could have a material adverse impact on our business, financial condition and results of operations.

We are a participating lender in the PPP, a loan program administered through the SBA, that was created to help eligible businesses, organizations and self-employed persons fund their operational costs during the COVID-19 pandemic. Under this program, the SBA guarantees 100% of the amounts loaned under the PPP. The PPP opened on April 3, 2020; however, because of the short window between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the PPP, which exposes us to risks relating to noncompliance with the PPP. For instance, other financial institutions have experienced litigation related to their process and procedures used in processing applications for the PPP. Any financial liability, litigation costs or reputational damage caused by PPP related litigation could have a material adverse impact on our business, financial condition and results of operations. In addition, we may be exposed to credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced. If a deficiency is identified, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from us.

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ITEM 6. EXHIBITS


Exhibit No.						Description of Exhibit


10.1						Form of Indemnification Agreement by and between Pacific Mercantile Bancorp and its directors and executive officers (Incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K dated May 21, 2020 and filed with the Commission on May 21, 2020.)

10.2						Form of Indemnification Agreement by and between Pacific Mercantile Bank and its directors and executive officers (Incorporated by reference to Exhibit 10.2 to the Current Report on Form 8-K dated May 21, 2020 and filed with the Commission on May 21, 2020.)

31.1						Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2						Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1**						Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2**						Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit 101.INS						XBRL Instance Document

Exhibit 101.SCH						XBRL Taxonomy Extension Schema Document

Exhibit 101.CAL						XBRL Taxonomy Extension Calculation Linkbase Document

Exhibit 101.DEF						XBRL Taxonomy Extension Definition Linkbase Document

Exhibit 101.LAB						XBRL Taxonomy Extension Labels Linkbase Document

Exhibit 101.PRE						XBRL Taxonomy Extension Presentation Linkbase Document

** Furnished herewith.

Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on August 7, 2020.

PACIFIC MERCANTILE BANCORP

By:

/s/ BRADFORD R. DINSMORE

Bradford R. Dinsmore

President and Chief Executive Officer

(Principal Executive Officer)

PACIFIC MERCANTILE BANCORP

By:

/s/ CURT A. CHRISTIANSSEN

Curt A. Christianssen

Chief Financial Officer

(Principal Financial Officer)