¨

Diluted earnings per share were  $0.26 for the third  quarter of 2019, compared to $0.28 for the third quarter of 2018, and $0.26 for the second quarter of 2019.    Diluted earnings per share were  $0.80 for the first nine months of 2019, compared to $0.53 for the first nine months of 2018.  

·

Earnings for the third quarter of 2019, second quarter of 2019, and first nine months of 2019 were reduced by merger-related costs for the merger with Presidio, and earnings for the third quarter of 2018, and first nine months of 2018 were reduced by merger-related costs for the acquisitions of Tri-Valley and United American, as follows:

For the Quarter Ended

For the Nine Months Ended

MERGER-RELATED COSTS

September 30, 

June 30, 

September 30, 

September 30, 

September 30, 

(in $000’s, unaudited)

2019

2019

2018

2019

2018

Salaries and employee benefits

$

 —

$

 —

$

183

$

 —

$

3,576

Other

661

540

16

1,201

5,452

Total merger-related costs

$

661

$

540

$

199

$

1,201

$

9,028

¨

The following table indicates the ratios for the return on average tangible assets and the return on average tangible equity for the periods indicated:

For the Quarter Ended

For the Nine Months Ended

September 30, 

June 30, 

September 30, 

September 30, 

September 30, 

2019

2019

2018

2019

2018

Return on average tangible assets

Return on average tangible equity

¨

Net interest income, before provision for loan losses, decreased 6% to $30.6 million for the third quarter of 2019, compared to $32.5 million for the third  quarter of 2018, and decreased 1%  from $30.9 million for the second quarter of 2019.  Net interest income increased 4% to $92.6 million for the first nine months of 2019, compared to $89.0 million for the first nine months of 2018. 

·

The fully tax equivalent (“FTE”) net interest margin contracted 12 basis points to 4.24%  for the third quarter of 2019, from 4.36% for the third quarter of 2018,  primarily due to a decline in the average balance of loans and a higher cost of deposits.  The net interest margin contracted 14 basis points for the third quarter of 2019 from 4.38% for the second quarter of 2019, primarily due to a decrease in the average yield on loans, securities and overnight funds, partially offset by a higher average balance of loans.

·

For the first nine months of 2019, the net interest margin expanded 6 basis points to 4.33%, compared to 4.27% for the first nine months of 2018, primarily due to a higher average balance of loans and securities, the impact of increases in the yields on loans, investment securities, and overnight funds, and an increase in the accretion of the loan purchase discount into loan interest income from the acquisitions, partially offset by an increase in the cost of deposits, and a decrease in the average balance of Bay View Funding’s factored receivables.

¨

The following tables present the average balance of loans outstanding, interest income, and the average yield for the periods indicated:

For the Quarter Ended

For the Quarter Ended

September 30, 2019

September 30, 2018

Average

Interest

Average

Average

Interest

Average

(in $000’s, unaudited)

Balance

Income

Yield

Balance

Income

Yield

Loans, core bank and asset-based lending

$

1,748,379

$

23,401

5.31

%  

$

1,780,025

$

23,374

5.21

%

Bay View Funding factored receivables

47,614

2,879

23.99

%  

69,740

4,185

23.81

%

Residential mortgages

34,639

229

2.62

%  

40,277

272

2.68

%

Purchased commercial real estate ("CRE") loans

30,567

284

3.69

%  

36,167

295

3.24

%  

Loan credit mark / accretion

(5,359)

471

0.11

%  

(7,418)

506

0.11

%

Total loans

$

1,855,840

$

27,264

5.83

%  

$

1,918,791

$

28,632

5.92

%

·

The average yield on the total loan portfolio decreased to 5.83% for the third quarter of 2019, compared to 5.92% for the third quarter of 2018, primarily due to a decrease in the average balance of Bay View Funding’s factored receivables.

For the Quarter Ended

For the Quarter Ended

September 30, 2019

June 30, 2019

Average

Interest

Average

Average

Interest

Average

(in $000’s, unaudited)

Balance

Income

Yield

Balance

Income

Yield

Loans, core bank and asset-based lending

$

1,748,379

$

23,401

5.31

%  

$

1,727,988

$

23,342

5.42

%

Bay View Funding factored receivables

47,614

2,879

23.99

%  

45,708

2,967

26.04

%

Residential mortgages

34,639

229

2.62

%  

36,136

234

2.60

%

Purchased CRE loans

30,567

284

3.69

%  

31,484

290

3.69

%

Loan credit mark / accretion

(5,359)

471

0.11

%  

(5,842)

418

0.10

%

Total loans

$

1,855,840

$

27,264

5.83

%  

$

1,835,474

$

27,251

5.96

%

·

The average yield on the total loan portfolio decreased to 5.83% for the third quarter of 2019, compared to 5.96% for the second quarter of 2019, primarily due to decreases in the prime rate on loans.

For the Nine Months Ended

For the Nine Months Ended

September 30, 2019

September 30, 2018

Average

Interest

Average

Average

Interest

Average

(in $000’s, unaudited)

Balance

Income

Yield

Balance

Income

Yield

Loans, core bank and asset-based lending

$

1,733,784

$

69,594

5.37

%  

$

1,645,615

$

63,556

5.16

%

Bay View Funding factored receivables

47,271

8,800

24.89

%  

57,096

10,687

25.03

%

Residential mortgages

35,840

714

2.66

%  

41,959

850

2.71

%

Purchased CRE loans

31,788

869

3.65

%  

36,740

947

3.45

%  

Loan credit mark / accretion

(5,813)

1,344

0.10

%  

(4,864)

1,232

0.10

%

Total loans

$

1,842,870

$

81,321

5.90

%  

$

1,776,546

$

77,272

5.82

%

·

The average yield on the total loan portfolio increased to 5.90% for the nine months ended September 30, 2019, compared to 5.82% for the nine months ended September 30, 2018,  primarily due to increases in the prime rate, and an increase in the accretion of the loan purchase discount into loan interest income from the acquisitions.

·

The total purchase discount on loans from Focus Business Bank (“Focus”) loan portfolio was $5.4 million on the acquisition date of August 20, 2015, of which $437,000 remains outstanding as of September 30, 2019.  The total purchase discount on loans from Tri-Valley loan portfolio was $2.6 million on the acquisition date of April 6, 2018, of which $1.8 million remains outstanding as of September 30, 2019.    The total purchase discount on loans from United American loan portfolio was $4.7 million on the acquisition date of May 4, 2018, of which $2.9 million remains outstanding as of September 30, 2019.

¨

The cost of total deposits was 0.31% for the third quarter of 2019, compared to 0.23% for the third quarter of 2018 and 0.31% for the second quarter of 2019.  The cost of total deposits was 0.30% for the nine months ended September 30, 2019,  compared to 0.19% for the nine months ended September 30, 2018.  

¨

There was a $576,000 credit to the provision for loan losses for the third quarter of 2019, compared to a $425,000 credit to the provision for loan losses for the third quarter of 2018, and a $740,000 credit to the provision for loan losses for the second quarter of 2019.  There was a $2.4  million credit to the provision for loan losses for the nine months ended September 30, 2019, compared to a $7.3 million provision for loan losses for the nine months ended September 30, 2018.  The higher provision for loan losses for the nine months ended September 30, 2018 included a $7.0 million specific reserve for a lending relationship that was placed on nonaccrual during the second quarter of 2018.

¨

Total noninterest income increased to  $2.6 million for the third quarter of 2019, compared to $2.2 million the third quarter of 2018, primarily due to a $330,000 gain on sales of securities for the third quarter of 2019.  Noninterest income declined to $2.6 million for the third quarter of 2019 from $2.8 million for the second quarter of 2019, primarily due to a higher gain on the sales of securities for the second quarter of 2019. 

·

For the nine months ended September 30, 2019, noninterest income increased to $7.9 million, compared to $7.2 million for the  nine months ended September 30, 2018. The increase in noninterest income for the first nine months of 2019, was primarily due to higher service charges and fees on deposit accounts, and a higher gain on sales of securities for the first nine months of 2019, partially offset by lower gain on sales of Small Business Administration (“SBA”) loans for the first nine months of 2019, and proceeds from a legal settlement in the first nine months of 2018. 

·

The Company received $1.3 million in proceeds from a legal settlement during the second quarter of 2018, of which $377,000 was recorded in other noninterest income, and $922,000 was credited to professional fees for recaptured legal fees previously paid by the Company.

¨

Total noninterest expense for the third quarter of 2019 increased to  $17.9 million, compared to $17.7 million for the  third  quarter of 2018, primarily due to higher merger-related costs for the third quarter of 2019.  Noninterest expense for the third quarter of 2019 included total merger-related costs of $661,000 for the Presidio acquisition (all included in other noninterest expense), compared to total merger-related costs of $199,000 for the third quarter of 2018 for the Tri-Valley and United American acquisitions.  The merger-related costs of $199,000 for the third quarter of 2018 consisted of $183,000 included in salaries and employee benefits expense and $16,000 included in other noninterest expense.  Total noninterest expense for the third quarter of 2019 decreased to $17.9 million, compared to $18.4 million for the second quarter of 2019, primarily due to lower salaries and employee benefits and lower other noninterest expense. 

·

Total noninterest expense for the nine months ended September 30, 2019 decreased to $54.3 million, compared to $58.6 million for the nine months ended September 30, 2018, primarily due to lower merger-related costs, partially offset by higher professional fees.  Noninterest expense for the nine months ended September 30, 2019 included total merger-related costs of

$1.2 million for the Presidio acquisition (all included in other noninterest expense), compared to total merger-related costs of $9.0 million for the nine months ended September 30, 2018 for the Tri-Valley and United American acquisitions.  The merger-related costs of $9.0 million for the nine months ended September 30, 2018 consisted of $3.6 million included in salaries and employee benefits and $5.4 million in other noninterest expense. Professional fees for the nine months ended September 30, 2018 included a recovery of $922,000 from a legal settlement. 

·

Full time equivalent employees were 308 at September 30, 2019,  296 at September 30, 2018, and 309 at June 30, 2019.

¨

The efficiency ratio was 53.87% for the third quarter of 2019, compared to 51.15% for the third  quarter of 2018, and 54.76% for the second quarter of 2019.  The efficiency ratio for the nine months ended September 30, 2019 was 54.04%, compared to 60.93% for the nine months ended September 30, 2018.   

¨

Income tax expense was $4.6 million for the third quarter of 2019, compared to $5.0 million for the third quarter of 2018, and $4.6 million for the second quarter of 2019.  Income tax expense for the nine months ended September 30, 2019 was $13.8 million, compared to $8.2 million for the nine months ended September 30, 2018.  The effective tax rate for the third quarter of 2019 was 29.1%, compared to 28.7% for the third quarter of 2018, and 28.9% for the second quarter of 2019.    The effective tax rate for the  nine months ended September 30, 2019 was 28.4%, compared to 27.0% for the  nine months ended September 30, 2018.    

·

The difference in the effective tax rate for the periods reported compared to the combined Federal and state statutory tax rate of 29.6% is primarily the result of the Company’s investment in life insurance policies whose earnings are not subject to taxes, tax credits related to investments in low income housing limited partnerships (net of low income housing investment losses), and tax-exempt interest income earned on municipal bonds.

¨

Total assets remained relatively flat at $3.18 billion at September 30, 2019, compared to $3.19 billion at September 30, 2018 and increased 2% from $3.11 billion at June 30, 2019. 

¨

Securities available-for-sale, at fair value, totaled $333.1 million at September 30, 2019, compared to $319.1 million at September 30, 2018, and $383.1 million at June 30, 2019.  At September 30, 2019, the Company’s securities available-for-sale portfolio comprised $212.7 million of agency mortgage-backed securities (all issued by U.S. Government sponsored entities),  and $120.4 million of U.S. Treasury. The pre-tax unrealized gain on securities available-for-sale at September 30, 2019 was $1.7 million, compared to a pre-tax unrealized loss on securities available-for-sale of ($12.7) million at September 30, 2018, and a pre-tax unrealized gain on securities available-for-sale of $915,000 at June 30, 2019.  All other factors remaining the same, when market interest rates are rising, the Company will experience a lower unrealized gain (or a higher unrealized loss) on the securities portfolio.

·

During the third quarter of 2019, the Company sold $38.9 million of securities available-for-sale for a net gain of $330,000.  The securities sold consisted of $18.6 million of agency mortgage-backed securities and  $20.3 million of U.S. Treasury  securities.

¨

At September 30, 2019, securities held-to-maturity, at amortized cost, totaled $342.0 million, compared to $375.7 million at September 30, 2018, and $351.4 million at June 30, 2019.  At September 30, 2019, the Company’s securities held-to-maturity portfolio was comprised of $259.3 million of agency mortgage-backed securities, and $82.7 million of tax-exempt municipal bonds.

¨

¨

The loan portfolio remains well-diversified as reflected in the following table which summarizes the distribution of loans, excluding loans held-for-sale, and the percentage of distribution in each category for the periods indicated:

LOANS

September 30, 2019

June 30, 2019

September 30, 2018

(in $000’s, unaudited)

Balance

% to Total

Balance

% to Total

Balance

% to Total

Commercial

$

528,060

28

%    

$

567,529

30

%    

$

600,594

32

%    

Real estate:

CRE

1,080,235

58

%    

1,037,885

55

%    

988,491

52

%    

Land and construction

96,610

 5

%    

97,297

 5

%    

131,548

 7

%    

Home equity

111,610

 6

%    

116,057

 6

%    

116,657

 6

%    

Residential mortgages

47,276

 2

%    

48,944

 3

%    

52,441

 2

%    

Consumer

11,701

 1

%    

10,279

 1

%    

9,932

 1

%    

Total Loans

1,875,492

100

%    

1,877,991

100

%    

1,899,663

100

%    

Deferred loan fees, net

(105)

 -

(224)

 —

(276)

 —

Loans, net of deferred fees 

$

1,875,387

100

%    

$

1,877,767

100

%    

$

1,899,387

100

%    

·

Loans, excluding loans held-for-sale, decreased $24.0 million or (1%), to $1.88 billion at September 30, 2019, compared to $1.90 billion at September 30, 2018, primarily due to a decline of $72.5 million in commercial loans (“C&I”),  $34.9 million in land and construction loans,  $5.0 million in home equity loans, $4.8 million in purchased residential mortgages, and $3.8 million in purchased CRE loans, partially offset by an increase of $95.5 million in CRE loans. Loans, excluding loans held-for-sale, remained flat at $1.88 billion at September 30, 2019, compared to $1.88 billion June 30, 2019.    

·

C&I line usage was 35% at September 30, 2019, compared to 40% at June 30, 2019, and 36% at September 30, 2018.

·

At September 30, 2019,  38% of the CRE loan portfolio was secured by owner-occupied real estate.

¨

The following table summarizes the allowance for loan losses (“ALLL”) for the periods indicated:

For the Quarter Ended

For the Nine Months Ended

ALLOWANCE FOR LOAN LOSSES

September 30, 

June 30, 

September 30, 

September 30, 

September 30, 

(in $000’s, unaudited)

2019

2019

2018

2019

2018

Balance at beginning of period

$

26,631

$

27,318

$

26,664

$

27,848

$

19,658

Charge-offs during the period

(318)

(76)

(744)

(620)

(1,860)

Recoveries during the period

158

129

1,931

1,044

2,349

Net recoveries (charge-offs) during the period

(160)

53

1,187

424

489

Provision (credit) for loan losses during the period

(576)

(740)

(425)

(2,377)

7,279

Balance at end of period

$

25,895

$

26,631

$

27,426

$

25,895

$

27,426

Total loans, net of deferred fees

$

1,875,387

$

1,877,767

$

1,899,387

$

1,875,387

$

1,899,387

Total nonperforming loans

$

14,247

$

17,018

$

24,715

$

14,247

$

24,715

Allowance for loan losses to total loans

1.38

%  

1.42

%  

1.44

%

1.38

%  

1.44

%

Allowance for loan losses to total nonperforming loans

181.76

%  

156.49

%  

110.97

%

181.76

%  

110.97

%

·

The ALLL was 1.38% of total loans at September 30, 2019, compared to 1.44% at September 30, 2018, and 1.42% at June 30, 2019.  The ALLL to total nonperforming loans was 181.76% at September 30, 2019, compared to 110.97% at September 30, 2018, and  156.49% at June 30, 2019.

·

Net charge-offs totaled $160,000 for the third quarter of 2019, compared to net recoveries of $1.2 million for the third quarter of 2018, and net recoveries of $53,000 for the second quarter of 2019.   

¨

The following is a breakout of nonperforming assets (“NPAs”) at the periods indicated:

End of Period:

NONPERFORMING ASSETS

September 30, 2019

June 30, 2019

September 30, 2018

(in $000’s, unaudited)

Balance

% of Total

Balance

% of Total

Balance

% of Total

Commercial loans

$

7,390

52

%  

$

6,583

39

%  

$

17,134

69

%

CRE loans

5,094

36

%  

8,442

49

%  

5,639

23

%

SBA loans

1,007

 7

%  

513

 3

%  

227

 1

%

Restructured and loans over 90 days past due and still accruing

609

 4

%  

1,323

 8

%  

1,373

 6

%

Home equity and consumer loans

147

 1

%  

157

 1

%  

342

 1

%

Total nonperforming assets

$

14,247

100

%  

$

17,018

100

%  

$

24,715

100

%

·

NPAs totaled  $14.2 million, or 0.45% of total assets, at September 30, 2019, compared to $24.7 million, or 0.77% of total assets, at September 30, 2018, and $17.0 million, or 0.55% of total assets, at June 30, 2019.  

·

A large lending relationship was placed on nonaccrual during the second quarter of 2018.  At September 30, 2019, the recorded investment of this lending relationship was $10.8 million, and the Company had a $6.0 million specific loan loss reserve allocated for this lending relationship, compared to a recorded investment of $21.8 million, and a $7.0 million specific loan loss reserve allocated for this lending relationship at September 30, 2018, and a recorded investment of $10.8 million, and a $5.9 million specific loan loss reserve allocated for this lending relationship at June 30, 2019.

·

The decrease in nonperforming assets at September 30, 2019 from June 30, 2019 was primarily due to the payoff of  two secured CRE loans to entities affiliated with DC Solar Solutions, Inc. (“DC Solar”), which were placed on nonaccrual during the first quarter of 2019.

·

There were no foreclosed assets at September 30, 2019,  September 30, 2018, or June 30, 2019. 

·

Classified assets decreased to  $20.2 million, or 0.64% of total assets, at September 30, 2019, compared to $30.5 million, or 0.95% of total assets, at September 30, 2018, and $31.2 million, or 1.00% of total assets, at June 30, 2019, primarily due to the payoff of classified loans. 

¨

On January 1, 2019, the Company adopted Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842).  Under the new guidance, the Company recognizes the following for all leases, at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use (“ROU”) asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. While the new standard impacts lessors, the Company is impacted as a lessee of the offices and real estate used for operations.  The Company's lease agreements include options to renew at the Company's discretion. The extensions are not reasonably certain to be exercised, therefore they are not considered in the calculation of the ROU asset and lease liability. Total assets and total liabilities were  $7.1 million on its consolidated statement of financial condition at September 30, 2019, as a result of recognizing right-of-use assets, included in other assets, and lease liabilities, included in other liabilities, related to non-cancelable operating lease agreements for office space. 

¨

The following table summarizes the distribution of deposits and the percentage of distribution in each category for the periods indicated:

DEPOSITS

September 30, 2019

June 30, 2019

September 30, 2018

(in $000’s, unaudited)

Balance

% to Total

Balance

% to Total

Balance

% to Total

Demand, noninterest-bearing

$

1,094,953

41

%  

$

994,082

38

%  

$

1,081,846

39

%

Demand, interest-bearing

666,054

25

%  

682,114

26

%  

670,624

24

%

Savings and money market

761,471

28

%  

788,832

30

%  

828,297

30

%

Time deposits — under $250

53,560

 2

%  

53,351

 2

%  

68,194

 3

%

Time deposits — $250 and over

95,543

 3

%  

88,519

 3

%  

84,763

 3

%

CDARS — interest-bearing demand,

  money market and time deposits

17,409

 1

%  

15,575

 1

%  

11,575

 1

%  

Total deposits

$

2,688,990

100

%  

$

2,622,473

100

%  

$

2,745,299

100

%

·

Total deposits decreased $56.3 million, or (2)%, to $2.69 billion at September 30, 2019, compared to $2.75 billion at September 30, 2018, and increased $66.5 million or 3% from $2.62 billion at June 30, 2019.    

·

Deposits, excluding all time deposits and CDARS deposits, decreased $58.3 million, or (2%), to $2.52 billion at September 30, 2019, compared to $2.58 billion at September 30, 2018,  and increased $57.5 million or 2% at June 30, 2019, compared to $2.47 billion at June 30, 2019.

¨

¨

The Company’s consolidated capital ratios exceeded regulatory guidelines and the Bank’s capital ratios exceeded the regulatory guidelines under the Basel III prompt corrective action (“PCA”) regulatory guidelines for a well-capitalized financial institution, and the Basel III minimum regulatory requirements at September 30, 2019, as reflected in the following table:

Well-capitalized

Financial

Institution

Basel III

Heritage

Heritage

Basel III PCA

Minimum

Commerce

Bank of

Regulatory

Regulatory

CAPITAL RATIOS

Corp

Commerce

Guidelines

Requirement (1)

Total Risk-Based

16.2

%  

15.2

%  

10.0

%  

10.5

%

Tier 1 Risk-Based

13.3

%  

14.1

%  

8.0

%  

8.5

%

Common Equity Tier 1 Risk-Based

13.3

%  

14.1

%  

6.5

%  

7.0

%

Leverage

10.0

%  

10.6

%  

5.0

%  

4.0

%

(1)

Basel III minimum regulatory requirements for both the Company and the Bank include a 2.5% capital conservation buffer, except the leverage ratio.

¨

The following table reflects the components of accumulated other comprehensive loss, net of taxes, for the periods indicated:

ACCUMULATED OTHER COMPREHENSIVE LOSS

September 30, 

June 30, 

September 30, 

(in $000’s, unaudited)

2019

2019

2018

Unrealized gain (loss) on securities available-for-sale

$

1,202

$

675

$

(8,980)

Remaining unamortized unrealized gain on securities

     available-for-sale transferred to held-to-maturity

306

316

350

Split dollar insurance contracts liability

(3,794)

(3,770)

(3,740)

Supplemental executive retirement plan liability

(3,898)

(3,931)

(5,417)

Unrealized gain on interest-only strip from SBA loans

386

408

614

     Total accumulated other comprehensive loss

$

(5,798)

$

(6,302)

$

(17,173)

¨

Tangible equity increased to $301.2 million at September 30, 2019, compared to $257.2 million at September 30, 2018, and $293.5 million at June 30, 2019.  Tangible book value per share was $6.92 at September 30, 2019, compared to $5.94 at September 30, 2018, and $6.75 at June 30, 2019.  

For the Quarter Ended:

Percent Change From:

For the Nine Months Ended:

CONSOLIDATED INCOME STATEMENTS

September 30, 

June 30, 

September 30, 

June 30, 

September 30, 

September 30, 

September 30, 

Percent

(in $000’s, unaudited)

2019

2019

2018

2019

2018

2019

2018

Change

Interest income

$

33,250

$

33,489

$

34,610

%  

%

$

100,188

$

94,467

%

Interest expense

2,625

2,573

2,159

%  

%

7,605

5,504

%

       Net interest income before provision

   for loan losses

30,625

30,916

32,451

%  

%

92,583

88,963

%

Provision (credit) for loan losses

(576)

(740)

(425)

%  

%

(2,377)

7,279

%

Net interest income after provision

   for loan losses

31,201

31,656

32,876

%  

%

94,960

81,684

%

Noninterest income:

Service charges and fees on deposit accounts

1,032

1,177

1,107

%  

%

3,370

2,981

%

Increase in cash surrender value of

  life insurance

336

333

216

%  

%

999

816

%

Gain on sales of securities

330

548

 —

%  

N/A

878

266

%

Gain on sales of SBA loans

156

36

236

%  

%

331

551

%

Servicing income

139

150

163

%  

%

480

533

%

Other

625

521

484

%  

%

1,793

2,034

%

Total noninterest income

2,618

2,765

2,206

%  

%

7,851

7,181

%

Noninterest expense:

Salaries and employee benefits

10,467

10,698

10,719

%  

%

31,935

35,302

%

Occupancy and equipment

1,550

1,578

1,559

%  

%

4,634

3,927

%

Professional fees

789