As filed with the Securities and Exchange Commission on March 3, 2020

File No.            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10

 

 

GENERAL FORM FOR REGISTRATION OF SECURITIES

PURSUANT TO SECTION 12(b) OR (g) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

 

CALIFORNIA BANCORP

(Exact name of registrant as specified in its charter)

 

 

 

California		82-1751097
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
1300 Clay Street, Suite 500 Oakland, California		94612 (Zip Code)
(Address of principal executive offices)

Registrant’s telephone number, including area code: (510) 457-3737

 

Copies to:
Steven E. Shelton President and Chief Executive Officer California BanCorp 1300 Clay Street, Suite 500 Oakland, California 94612 (510) 457-3737		Joshua A. Dean David J. Gershon Sheppard, Mullin, Richter & Hampton LLP 650 Town Center Drive, 4th Floor Costa Mesa, California 92626 (714) 424-8292

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

 

Title of each class to be so registered		Name of each exchange on which each class is to be registered
Common Stock, no par value per share		The Nasdaq Stock Market LLC

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

None

(Title of Class)

 

 

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

 

Large accelerated filer		☐		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.  ☐

 

 

 

TABLE OF CONTENTS

 

				Page
ITEM 1.		BUSINESS			3
ITEM 1A.		RISK FACTORS			23
ITEM 2.		FINANCIAL INFORMATION			38
ITEM 3.		PROPERTIES			70
ITEM 4.		SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT			71
ITEM 5.		DIRECTORS AND EXECUTIVE OFFICERS			72
ITEM 6.		EXECUTIVE COMPENSATION			80
ITEM 7.		CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE			85
ITEM 8.		LEGAL PROCEEDINGS			87
ITEM 9.		MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS			87
ITEM 10.		RECENT SALES OF UNREGISTERED SECURITIES			88
ITEM 11.		DESCRIPTION OF REGISTRANT’S SECURITIES TO BE REGISTERED			89
ITEM 12.		INDEMNIFICATION OF DIRECTORS AND OFFICERS			93
ITEM 13.		FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA			95
ITEM 14.		CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE			184
ITEM 15.		FINANCIAL STATEMENTS AND EXHIBITS			185

 

 

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Explanatory Note

California BanCorp is filing this General Form for Registration of Securities on Form 10 to register its common stock, no par value per share, pursuant to Section 12(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Once this registration statement is deemed effective, California BanCorp will be required to file annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, and to comply with all other obligations of the Exchange Act applicable to issuers filing registration statements pursuant to Section 12(b) of the Exchange Act.

We are an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”) and as defined in Section 2(a) of the Securities Act of 1933, as amended (the “Securities Act”). We are also a “smaller reporting company” as defined in Exchange Act Rule 12b-2. As such, we may elect to comply with certain reduced public company reporting requirements in future reports that we file with the Securities and Exchange Commission (the “SEC”).

Unless the context indicates otherwise, all references in this registration statement to “we,” “us,” and “our” refer to California BanCorp and our wholly-owned banking subsidiary, California Bank of Commerce, except that in the discussion of our capital stock and related matters, these terms refer solely to California BanCorp and not to California Bank of Commerce. All references to the “Company” refer to California BanCorp only, and all references to the “Bank” refer to California Bank of Commerce only.

Cautionary Note Regarding Forward-Looking Statements

Certain statements contained in this registration statement are forward-looking statements. These forward-looking statements include statements relating to our projected growth, anticipated future financial performance, financial condition, credit quality and management’s long-term performance goals, as well as statements relating to the anticipated effects on our business, financial condition and results of operations from expected developments or events, our business, growth and strategies. These statements, which are based on certain assumptions and estimates and describe our future plans, results, strategies and expectations, can generally be identified by the use of the words and phrases “may,” “will,” “should,” “could,” “would,” “goal,” “plan,” “potential,” “estimate,” “project,” “believe,” “intend,” “anticipate,” “expect,” “target,” “aim,” “predict,” “continue,” “seek,” “projection” and other variations of such words and phrases and similar expressions.

We have made the forward-looking statements in this registration statement based on assumptions and estimates that we believe to be reasonable in light of the information available to us at this time. However, these forward-looking statements are subject to significant risks and uncertainties, and could be affected by many factors. Factors that could have a material adverse effect on our business, financial condition, results of operations and future growth prospects can be found in the “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections of this registration statement and elsewhere in this registration statement. These factors include, but are not limited to, the following:

 

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business and economic conditions nationally, regionally and in our target markets, particularly in the greater San Francisco Bay Area and other areas in which we operate;

 

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concentration of our loan portfolio in commercial and industrial loans, which loans may be dependent on the borrower’s cash flows for repayment and, to some extent, the local and regional economy;

 

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concentration of our loan portfolio in real estate loans and changes in the prices, values and sales volumes of commercial and residential real estate;

 

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the concentration of our business activities within the geographic areas of Northern California;

 

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credit and lending risks associated with our commercial real estate, commercial and industrial, and construction and development portfolios;

 

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disruptions to the credit and financial markets, either nationally or globally;

 

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increased competition in the banking industry, nationally, regionally or locally;

 

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our ability to execute our business strategy to achieve profitable growth;

 

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the dependence of our operating model on our ability to attract and retain experienced and talented bankers in each of our markets;

 

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risks that our cost of funding could increase, in the event we are unable to continue to attract stable, low-cost deposits and/or reduce our cost of deposits;

 

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our ability to improve our operating efficiency;

 

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failure to keep pace with technological change or difficulties when implementing new technologies;

 

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our ability to attract and maintain business banking relationships with well-qualified businesses, real estate developers and investors with proven track records in our market areas;

 

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our ability to attract sufficient loans that meet prudent credit standards, including in our commercial and industrial and owner-occupied commercial real estate loan categories;

 

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failure to maintain adequate liquidity and regulatory capital and comply with evolving federal and state banking regulations;

 

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inability of our risk management framework to effectively mitigate credit risk, interest rate risk, liquidity risk, price risk, compliance risk, operational risk, strategic risk and reputational risk;

 

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our ability to develop new, and grow our existing, streams of noninterest income;

 

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our dependence on our management team and our ability to motivate and retain our management team;

 

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risks related to any future acquisitions, including failure to realize anticipated benefits from future acquisitions;

 

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system failures, data security breaches, including as a result of cyber-attacks, or failures to prevent breaches of our network security;

 

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data processing system failures and errors;

 

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our heavy reliance on communications and information systems to conduct business and reliance on third parties and affiliates to provide key components of business structure, any disruptions of which could interrupt operations or increase the costs of doing business;

 

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fraudulent and negligent acts by our customers, employees or vendors;

 

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our financial reporting controls and procedures’ ability to prevent or detect all errors or fraud;

 

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our ability to maintain expenses in line with current projections;

 

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fluctuations in the market value of the securities held in our securities portfolio;

 

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the adequacy of our reserves (including allowance for loan and lease losses and the appropriateness of our methodology for calculating such reserves;

 

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increased loan losses or impairment of goodwill and other intangibles;

 

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an inability to raise necessary capital to fund our growth strategy, operations, or to meet increased minimum regulatory capital levels;

 

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the sufficiency of our capital, including sources of such capital and the extent to which capital may be used or required;

 

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interest rate shifts and its impact on our financial condition and results of operation;

 

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the expenses that we will incur to operate as a public company and our inexperience complying with the requirements of being a public company;

 

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the institution and outcome of litigation and other legal proceeding to which we become subject;

 

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changes in our accounting standards;

 

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the impact of recent and future legislative and regulatory changes, including the adoption and implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”);

 

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examinations by our regulatory authorities, including the possibility that the regulatory authorities may, among other things, require us to increase our allowance for loan losses, or write-down assets, or otherwise impose restrictions or conditions on our operations, including, but not limited to, our ability to acquire or be acquired;

 

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governmental monetary and fiscal policies;

 

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changes in the scope and cost of Federal Deposit Insurance Corporation insurance and other coverage; and

 

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other factors and risks described under the “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections herein.

Because of these risks and other uncertainties, our actual results, performance or achievement, or industry results, may be materially different from the anticipated or estimated results discussed in the forward-looking statements in this registration statement. Our past results of operations are not necessarily indicative of our future results. You should not rely on any forward-looking statements, which represent our beliefs, assumptions and estimates only as of the dates on which they were made, as predictions of future events. We undertake no obligation to update these forward-looking statements, even though circumstances may change in the future, except as required under federal securities law. We qualify all of our forward-looking statements by these cautionary statements.

ITEM 1. BUSINESS

General Overview

California BanCorp was organized in 2017 to serve as the holding company for California Bank of Commerce (the “Bank”) and is headquartered in Oakland, California. California BanCorp commenced operation as a bank holding company on June 30, 2017 following a reorganization transaction in which it became the Bank’s holding company. This transaction was treated as an internal reorganization as all shareholders of the Bank became shareholders of the Company. As a bank holding company, the Company is subject to regulation and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Company has no operations other than ownership of the Bank.

The Bank is a California-chartered commercial bank founded in 2007. The Bank is headquartered in Lafayette, California, approximately 15 miles east of Oakland, California. The Bank is supervised and regulated by the California Department of Business Oversight (the “DBO”) and the Federal Deposit Insurance Corporation (the “FDIC”).

The Bank has three branch offices, including its headquarters, in Lafayette, Fremont and San Jose, California and it operates loan production offices in each of Oakland, Walnut Creek, San Jose and Sacramento. We primarily serve business and professional corporations with a variety of business focused financial services. Some of the products and services that we offer include commercial checking, savings and money market accounts, certificates of deposit, treasury and cash management services, foreign exchange services, commercial and industrial loans, asset-based loans, loans to dental and veterinary professionals, commercial real estate loans,

 

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residential and commercial construction and development loans, online banking, and mobile banking. In 2015, the Bank acquired Pan Pacific Bank, a business-focused community bank based on in Fremont, California with $131 million in assets. As of September 30, 2019, we had total consolidated assets of $1.1 billion, total loans of $933.3 million, total deposits of $923.9 million and total shareholders’ equity of $129.0 million.

Nasdaq Listing Application

Concurrently with filing this Registration Statement with the SEC we will apply for approval to list the shares of our common stock on the Nasdaq Global Market under our current symbol “CALB.” Our common stock is currently quoted on the OTCQX under the ticker symbol “CALB.”

Our Strategy

The Bank is a relationship-based commercial business bank focused on providing innovative products and services that are value-driven. We maintain a strong credit culture as a foundation of sound asset quality, and we embrace innovation and provide the solutions our customers need and expect. We focus on creating value for the communities and clients we serve to provide exceptional return for our shareholders, and also growing relationship deposits and lending those funds to invest in and support the communities we serve, with the ultimate goal of yielding superior growth in earnings per share.

Our strategic plan includes the following measures of long-term success: (i) earnings per share growth; (ii) return on assets; (iii) return on tangible common equity; (iv) total risk-based capital ratio; (v) core deposit growth; and (vi) non-performing assets to total assets ratio.

Our Market Area

We are headquartered in the San Francisco Bay Area in Oakland, California. The Bank maintains its headquarters in Lafayette, California, where it offers full banking services. We currently have one branch in Fremont, California and one branch in San Jose, California. We also operate loan production offices in Walnut Creek, Oakland, San Jose and Sacramento, California.

Our market areas cover primarily the greater San Francisco Bay Area and Sacramento. Our branches and loan production offices are located in three contiguous counties in the San Francisco Bay Area: Alameda, Contra Costa and Santa Clara; and Sacramento County. The economic base of this market area is heavily dependent on small and medium-sized businesses, providing us with a market rich in potential customers.

The four counties in which the Bank has offices have an estimated aggregate population of 5.8 million, based on 2010 U.S. Census data, and total deposits of approximately $287.5 billion as of June 30, 2019, according to the most recent data published by the FDIC.

The economies of the San Francisco Bay Area are primary driven by the technology, real estate, financial services, tourism, shipping and manufacturing industries and the area is home to the second highest concentration of Fortune 500 companies after the New York metropolitan area. Sacramento is the capitol of the State of California and government-related activities are a significant portion of the region’s economy. The Sacramento area also includes a number of higher education centers, including state universities and technical colleges.

Competition

The banking business is highly competitive, and we face competition in our market areas from many other local, regional, and national financial institutions. Competition among financial institutions is based on interest rates offered on deposit accounts, interest rates charged on loans, other credit and service charges relating to loans, the quality and scope of the services rendered, the convenience of banking facilities, and, in the case of

 

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loans to commercial borrowers, relative lending limits. We compete with commercial banks, credit unions, savings institutions, mortgage banking firms, finance companies, including “fintech” lenders, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as regional and national financial institutions that operate offices in our market areas and elsewhere. The competing major commercial banks have greater resources that may provide them a competitive advantage by enabling them to maintain numerous branch offices, mount extensive advertising campaigns and invest in new technologies, for example. The increasingly competitive environment is the result of changes in regulation, changes in technology and product delivery systems, additional financial service providers, and the accelerating pace of consolidation among financial services providers.

The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer most types of financial services, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems.

Some of our non-banking competitors, such as fintech lenders, have fewer regulatory constraints and may have lower cost structures. In addition, some of our competitors have assets, capital and lending limits greater than that of the Bank, have greater access to capital markets and offer a broader range of products and services than the Bank. These institutions may have the ability to finance wide-ranging advertising campaigns and may also be able to offer lower rates on loans and higher rates on deposits than we can offer. Some of these institutions offer services, such as international banking, which we do not directly offer, except for a limited suite of services such as international wires and currency exchange.

We compete with these institutions by focusing on our position as an independent, commercial business bank and rely upon local promotional activities, personal relationships established by our officers, directors, and employees with our customers, and specialized services tailored to meet the needs of the customers we serve. We strive to provide innovative products to our customers that are value-driven. We actively cultivate relationships with our customers that extend beyond a single loan to a full suite of products that serve the needs of our commercial customers. Our goal is to develop long-standing connections with our customers and the communities that we serve. While our position varies by market, our management believes that we can compete effectively as a result of local market knowledge, local decision making, and awareness of customer needs.

Our Business

General

We provide a range of commercial lending services, including commercial and industrial loans, commercial real estate loans, and residential and commercial construction and development loans. Our specialty commercial lending niches include dental and veterinary lending, commercial contractors, asset-based lending, commercial and residential construction and emerging businesses. Our customers are generally small to medium-sized businesses and professional firms that are located in or conduct a substantial portion of their business in our market areas. The majority of our customer-facing offices are loan production offices.

Credit Administration and Loan Review

Historically, we believe we have made sound, high quality loans while recognizing that lending money involves a degree of business risk. We have loan policies designed to assist us in managing this business risk. These policies provide a general framework for our loan origination, monitoring and funding activities, while recognizing that not all risks can be anticipated.

As part of our credit administration, we document the borrower’s business, purpose of the loan, our evaluation of the repayment source and the associated risks, our evaluation of collateral, covenants and

 

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monitoring requirements, and the risk rating rationale. Our strategy for approving or disapproving loans is to follow conservative loan policies and consistent underwriting practices which include:

 

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maintaining close relationships among our customers and their designated banker to ensure ongoing credit monitoring and loan servicing;

 

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granting credit on a sound basis with full knowledge of the purpose and source of repayment for such credit;

 

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confirming that primary and secondary sources of repayment are adequate in relation to the amount of the loan;

 

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developing and maintaining targeted levels of diversification for our loan portfolio as a whole and for loans within each category; and

 

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properly documenting each loan and confirming that any insurance coverage requirements are satisfied.

For loan approvals, a loan is first recommended by a line of business manager and then is directed to the appropriate officer within credit administration for approval, subject to specified limits. This process ensures that the loan is supported by both the line of business and credit administration and allows us to respond to customer credit requests in an expeditious manner. Proposed loans above the specified limit must be approved by the Bank’s board of directors.

Managing credit risk is a company-wide process. Our strategy for credit risk management includes centralized credit policies, uniform underwriting criteria and ongoing risk monitoring and review processes for all credit exposures. Our processes emphasize early-stage review of loans, regular credit evaluations and management reviews of loans, which supplement the ongoing and proactive credit monitoring and loan servicing provided by our bankers. Our Chief Credit Officer provides company-wide credit oversight and periodically reviews all credit risk portfolios to ensure that the risk identification processes are functioning properly and that our credit standards are followed. In addition, a third-party loan review is performed to assist in the identification of problem assets and to confirm our internal risk rating of loans. We attempt to identify potential problem loans early in an effort to seek aggressive resolution of these situations before the loans become a loss, record any necessary charge-offs promptly and maintain adequate allowance levels for probable loan losses inherent in the loan portfolio.

Our loan policies generally include other underwriting guidelines for loans collateralized by real estate. These underwriting standards are designed to determine the maximum loan amount that a borrower has the capacity to repay based upon the type of collateral securing the loan and the borrower’s income. Our loan policies include maximum amortization schedules and loan terms for each category of loans collateralized by liens on real estate.

In addition, our loan policies provide guidelines for: personal guarantees; environmental review; loans to employees, executive officers and directors; problem loan identification; maintenance of an adequate allowance for loan losses and other matters relating to lending practices. We do not make loans to any director, executive officer of the Bank, or the related interests of each, unless the loan is approved by the full board of directors of the Bank.

Lending Limits

Under California law, our ability to make aggregate secured and unsecured loans-to-one-borrower is limited to 25% and 15%, respectively, of unimpaired capital and surplus. At September 30, 2019, the Bank’s limit on aggregate secured loans-to-one-borrower was $33.7 million and unsecured loans-to-one borrower was $20.2 million. At September 30, 2019, the Bank’s highest aggregate balance of secured loans-to-one-borrower was $19.1 million and the highest aggregate balance of unsecured loans-to-one borrower was $5.2 million. The

 

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Bank’s legal lending limit will increase or decrease as the Bank’s level of capital increases or decreases. In addition, the Bank has established internal loan limits, which are lower than the legal lending limits for a California bank. Our board of directors will adjust the internal lending limit as deemed necessary to continue to mitigate risk and serve the Bank’s customers. We are also able to sell participations in our larger loans to other financial institutions, which allow us to manage the risk involved in these loans and to meet the lending needs of our customers requiring extensions of credit in excess of these limits.

Commercial and Industrial Loans

We have significant expertise in small to middle market commercial and industrial lending, with an emphasis on the dental and veterinary industries, contractors and emerging companies. Our success is the result of our product and market expertise, and our focus on delivering high-quality, customized and quick turnaround service for our customers due to our focus on maintaining an appropriate balance between prudent, disciplined underwriting, on the one hand, and flexibility in our decision making and responsiveness to our customers, on the other hand, which has allowed us to grow our commercial and industrial loan portfolio while maintaining asset quality. As of September 30, 2019, commercial and industrial loans made up approximately $402.3 million or 43% of our loan portfolio, of which dental loans were approximately $146.4 million, or approximately 16% of our loan portfolio.

We provide a mix of variable and fixed rate commercial and industrial loans. We extend commercial business loans for working capital, accounts receivable and inventory financing and other business purposes. Generally, short-term loans have maturities ranging from 12 months to 3 years, and “term loans” have maturities ranging from 5 to 10 years. Loans are generally intended to finance current transactions and typically provide for periodic principal payments, with interest payable monthly. Repayment of commercial loans depends substantially on the borrower’s underlying business, financial condition and cash flows, as well as the sufficiency of the collateral. Compared to real estate, the collateral may be more difficult to monitor, evaluate and sell. Where the borrower is a corporation, partnership or other entity, we typically require personal guarantees from significant equity holders. Our maximum loan-to-value ratio for commercial and industrial loans is dependent on the collateral.

Asset-Based Lending (ABL) Loans

A subset of our commercial and industrial loans are structured as asset based lending (“ABL”) loans, which are secured by the borrower’s accounts receivable or inventory. Our ABL loans are structured as callable and cancelable transactions. The ABL loans are originated through and managed by our Business Credit division. Repayment of ABL loans depends substantially on the ability of the borrower to monetize the assets in a defined borrowing base. Generally the borrowing base has a maximum advance rate of 80% against eligible receivables and may include a lower advance rate against inventory. Therefore, the quality and collectability of accounts receivable, concentrations among account debtors, financial strength of the account debtors, and quality and transferability of inventory can impact repayment. At September 30, 2019, ABL loans totaled approximately $43.3 million, or 5% of our loan portfolio.

Construction and Development Loans

We offer adjustable rate residential and commercial construction loan financing to builders and developers and to consumers who wish to build their own home. The term of construction and development loans generally is limited to 12 to 36 months. Most loans will mature and require payment in full upon the sale or refinance of the property. We believe that construction and development loans generally carry a higher degree of risk than long-term financing of stabilized, rented, and owner-occupied properties because repayment depends on the ultimate completion of the project and usually on the subsequent sale or refinance of the property. Specific risks include:

 

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cost overruns;

 

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mismanaged construction;

 

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inferior or improper construction techniques;

 

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economic changes or downturns during construction;

 

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a downturn in the real estate market;

 

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rising interest rates which may prevent sale of the property; and

 

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failure to sell or stabilize completed projects in a timely manner.

We attempt to reduce risk associated with construction and development loans by obtaining personal guarantees and by keeping the maximum loan-to-value ratio at or below 50%-75% depending on the project type with a maximum loan-to-cost ratio of 80%. Many of our loans will include interest reserves built into the loan commitment. Generally, for owner occupied commercial construction loans, we will require periodic cash payments for interest from the borrower’s cash flow. As of September 30, 2019, construction and development loans made up approximately $32.5 million or 3% of our loan portfolio.

Real Estate Loans

A significant component of our loan portfolio is loans secured by real estate. These loans include both commercial real estate loans and other loans secured by real estate. Real estate loans are subject to the same general risks as other loans and are particularly sensitive to fluctuations in the value of real estate. Fluctuations in the value of real estate and rising interest rates, as well as other factors arising after a loan has been made, could negatively affect a borrower’s cash flow, creditworthiness, and ability to repay the loan. We obtain a security interest in real estate where feasible, in addition to any other available collateral, in order to increase the likelihood of the ultimate repayment of the loan.

As of September 30, 2019, commercial real estate loans made up approximately $484.6 million, or 52%, of our loan portfolio. We do not originate residential mortgage loans and as of September 30, 2019, home equity loans made up approximately $1.7 million or less than one percent of our loan portfolio.

Our commercial real estate loans generally have terms of 10 years or less, although payments may be structured on a longer amortization basis. We evaluate each borrower on an individual basis and attempt to determine their business risks and credit profile. We attempt to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied industrial, office, and retail buildings where the loan-to-value ratio, established by independent appraisals, does not exceed 70% of cost or appraised value. We also generally require that a borrower’s cash flow exceed 130% of monthly debt service obligations. In order to ensure secondary sources of payment and liquidity to support a loan request, we typically review all of the personal financial statements of the principal owners and require their personal guarantees. Commercial real estate loans are generally viewed as having more risk of default than residential real estate loans. They are also typically larger than residential real estate loans and consumer loans and depend on cash flows from the owner’s business or the property to service the debt. Because our loan portfolio contains a number of commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in our levels of nonperforming assets.

Small Business Administration Loans

We offer U.S. Small Business Administration, or SBA, loans for qualifying businesses for loan amounts up to $5 million. The Bank primarily extends SBA loans known as SBA 7(a) loans and SBA 504 loans. SBA 7(a) loans are typically extended for working capital needs, purchase of inventory, purchase of machinery and equipment, debt refinance, business acquisitions, start-up financing or to purchase or construct owner-occupied commercial property. SBA 7(a) loans are typically term loans with maturities up to 10 years for loans not secured by real estate and up to 25 years for real estate secured loans. SBA loans are fully amortizing with monthly payments of principal and interest. SBA 7(a) loans are typically floating rate loans that are secured by business

 

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assets and/or real estate. Depending on the loan amount, each loan is typically guaranteed 75% to 85% by the SBA, with a maximum gross loan amount to any one small business borrower of $5 million and a maximum SBA guaranteed amount of $3.75 million.

We are generally able to sell the guaranteed portion of the SBA 7(a) loans in the secondary market at a premium, while earning servicing fee income on the sold portion over the remaining life of the loan. In addition to the interest yield earned on the unguaranteed portion of the SBA 7(a) loans that are not sold, we recognize income from gains on sales and from loan servicing on the SBA 7(a) loans that are sold.

SBA 504 loans are typically extended for the purpose of purchasing owner-occupied commercial real estate or long-term capital equipment. SBA 504 loans are typically extended for up to 20 years or the life of the asset being financed. SBA 504 loans are financed as a participation loan between the Bank and the SBA through a Certified Development Company (“CDC”). Generally, these loans are structured to give the Bank a 50% first deed of trust and the CDC a 40% second deed of trust, with the remaining 10% funded by the borrower. Interest rates for the first deed of trust loans are subject to normal bank commercial rates and terms and the second deed of trust CDC loans are fixed for the life of the loans based on certain indices.

Our SBA 7(a) loans are originated through our SBA Loan Department. The SBA Loan Department is staffed by loan officers who provide assistance to qualified businesses. The Bank is designated as an SBA Preferred Lender, whereby the SBA has delegated its authority to us to make, service and liquidate loans. This designation generally facilitates a more efficient marketing and approval process for SBA loans. We have attained SBA Preferred Lender status nationwide.

As of September 30, 2019, our SBA loan portfolio totaled approximately $11.5 million or approximately 1% of our loan portfolio.

Consumer Loans

We occasionally make loans to individuals for personal and household purposes, including secured and unsecured installment loans and revolving lines of credit. Consumer loans are underwritten based on the borrower’s income, current debt level, past credit history, and the availability and value of collateral. Consumer rates are both fixed and variable, with negotiable terms. Our installment loans typically amortize over periods up to 5 years. Although we typically require monthly payments of interest and a portion of the principal on our loan products, we will offer consumer loans with a single maturity date when a specific source of repayment is available. Consumer loans are generally considered to have greater risk than first or second mortgages on real estate because they may be unsecured, or, if they are secured, the value of the collateral may be difficult to assess and more likely to decrease in value than real estate. As of September 30, 2019, consumer loans made up less than $1 million of our loan portfolio.

Deposit Products

We offer a range of commercially focused deposit and treasury management services at our branch locations that are similar to those typically available in the commercial divisions of the larger regional and national banking institutions, including commercial analysis and other cash management accounts, ranging from money market accounts to long-term certificates of deposit. Transaction accounts and time deposits are tailored to and offered at rates competitive to those offered in our primary market areas. Our customers primarily include businesses, associations, organizations and governmental authorities. Our deposits are insured by the FDIC up to statutory limits.

 

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Securities

We manage our securities portfolio and cash to maintain adequate liquidity and to ensure the safety and preservation of invested principal, with a secondary focus on yield and returns. Specific goals of our investment portfolio are as follows:

 

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provide a ready source of balance sheet liquidity, ensuring adequate availability of funds to meet fluctuations in loan demand, deposit balances and other changes in balance sheet volumes and composition;

 

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serve as a means for diversification of our assets with respect to credit quality, maturity and other attributes;

 

•

serve as a tool for modifying our interest rate risk profile pursuant to our established policies; and

 

•

provide collateral to secure local governmental agency and business deposits.

Our investment portfolio is comprised primarily of U.S. government agency securities and mortgage-backed securities issued by government-sponsored entities, though we may hold other securities, such as corporate debt securities.

Our investment policy is reviewed annually by our board of directors. The Bank’s board of directors has delegated the responsibility of monitoring our investment activities to the Asset Liability Committee of the Bank’s board of directors. Day-to-day activities pertaining to the securities portfolio are conducted under the supervision of our Chief Financial Officer and Chief Executive Officer. We actively monitor our investments on an ongoing basis to identify any material changes in the securities. We also review our securities for potential other-than-temporary impairment at least quarterly.

Implications of Being an Emerging Growth Company

We qualify as an emerging growth company as that term is used in the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other burdens that are otherwise applicable generally to public companies. These provisions include:

 

•

a requirement to have only two years of audited financial statements and only two years of related management’s discussion and analysis of financial condition and results of operations;

 

•

exemption from the auditor attestation requirement in the assessment of the emerging growth company’s internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002;

 

•

reduced disclosure about the emerging growth company’s executive compensation arrangements; and

 

•

no non-binding advisory votes on executive compensation or golden parachute arrangements.

We could remain an emerging growth company for up to five years, or until the earliest of  (i) the last day of the first fiscal year in which our annual gross revenues exceed $1.07 billion, (ii) the date that we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, which would occur if the market value of our common stock that is held by non-affiliates exceeds $700 million as of the last business day of our most recently completed second fiscal quarter, or (iii) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three year period. We have elected to take advantage of the reduced disclosure requirements described above regarding our executive compensation arrangements for purposes of this registration statement. In addition, we expect to take advantage of certain of the reduced reporting and other requirements of the JOBS Act with respect to the periodic reports we will file with the SEC and proxy statements that we use to solicit proxies from our shareholders.

 

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In addition, Section 107 of the JOBS Act also provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. We plan to elect to use the extended period for compliance and, as a result, our financial statements may not be comparable to companies that comply with public company effective dates. See our discussion in “Risk Factors”.

Employees

As of September 30, 2019, we had 133.5 full-time equivalent employees (“FTE”). None of our employees are represented by any collective bargaining unit or is a party to a collective bargaining agreement. We consider our relationship with our employees to be good and have not experienced interruptions of operations due to labor disagreements.

General Corporate Information

Our principal executive offices are located at 1300 Clay Street, Suite 500, Oakland, California and our telephone number at that address is (510) 457-3615. Additional information can be found on our website: www.californiabankofcommerce.com. Information on our website or any other website is not incorporated by reference herein and does not constitute a part of this registration statement.

Public Information

After this registration statement becomes effective, we will file annual, quarterly and current reports, proxy statements and other documents with the SEC. Our SEC filings will be available to the public on the SEC’s Internet site at http://www.sec.gov. You may also obtain these documents, free of charge, from the investor relations section of our website at http://www.californiabankofcommerce.com.

Preliminary Estimated Unaudited Consolidated Financial Results for the Three Months and the Year Ended December 31, 2019

The following information sets forth summary consolidated financial data as of the dates and for the periods shown. Our actual results, as of and for the quarter and year ended December 31, 2019, remain subject to Management’s review as well as completion of the audit of our annual consolidated financial statements and related disclosures. Accordingly, you should not place undue reliance on these preliminary financial results, which may differ materially from actual results. See “Risk Factors”, “Cautionary Note Regarding Forward-Looking Statements”, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a discussion of certain factors that could result in differences between the preliminary estimated unaudited consolidated financial results reported below and the actual results. Our actual audited consolidated financial statements and related disclosures as of and for the year ended December 31, 2019 are not expected to be filed with the SEC until after this registration statement is completed.

 

11

The following table reflects unaudited income statement and per share data as well as selected performance measures for the three months and twelve months ended December 31, 2019 and 2018, respectively.

 

		Three months ended								Twelve months ended
		12/31/19				12/31/18				12/13/19				12/31/18
		(dollars in thousands, except per share data)
Income Statement Data:
Interest income		$	12,806			$	11,033			$	49,078			$	40,938
Interest expense			2,222				1,474				8,140				5,106
Net interest income			10,584				9,559				40,938				35,832
Provision for credit losses			1,000				591				2,326				1,435
Net interest income after provision for credit losses			9,584				8,968				38,612				34,397
Other income			1,146				862				4,248				3,716
Other expenses			9,825				7,091				33,223				26,371
Income before income taxes			905				2,739				9,637				11,742
Income taxes			327				632				2,636				3,029
Net Income		$	578			$	2,107			$	7,001			$	8,713
Per Share Data:
Basic earnings per share		$	0.07			$	0.26			$	0.87			$	1.22
Diluted earnings per share		$	0.07			$	0.26			$	0.86			$	1.19
Book value per share (at period-end)		$	16.09			$	15.15			$	16.09			$	15.15
Performance Measures:
Return on average assets			0.20	%			0.85	%			0.66	%			0.94	%
Return on average equity			1.76	%			6.96	%			5.52	%			8.65	%
Net interest margin			3.90	%			4.09	%			4.12	%			4.09	%
Efficiency ratio			83.76	%			68.05	%			73.52	%			66.68	%

Net interest income for the three months ended December 31, 2019 was 10.6 million, an increase of $1.0 million, or 10.72%, compared to the same period one year earlier. Net interest income for the twelve months ended December 31, 2019 was $40.9 million, an increase of $5.1 million, or 14.25%, compared to the twelve months ended December 31, 2018. The net interest margin was 3.90% for the fourth quarter of 2019 compared to 4.09% for the fourth quarter of 2018, representing a decrease of 19 basis points. The decrease was a direct result of strong average deposit growth combined with lower deposit leverage during the fourth quarter of 2019. The net interest margin for the years ended December 31, 2019 and 2018 was 4.12% and 4.09%, respectively, representing an increase of 3 basis points. The increase was primarily due to an increase in average loan balances combined with higher balance sheet leverage.

Non-interest income for the three months ended December 31, 2019 was $1.1 million, an increase of $284,000, or 32.95%, compared to the same period one year earlier. Non-interest income for the twelve months ended December 31, 2019 was $4.2 million, an increase of $532,000, or 14.32%, compared to the twelve months ended December 31, 2018. The improvement in non-interest income during both time periods of 2019 compared to 2018 was primarily due to increased fees and service charges resulting from growth in our loan and deposit portfolios.

Non-interest expense for the three months ended December 31, 2019 was $9.8 million, an increase of $2.7 million, or 38.56%, compared to the same period one year earlier. Non-interest income for the twelve months ended December 31, 2019 was $33.2 million, an increase of $6.9 million, or 25.98%, compared to the twelve months ended December 31, 2018. The increase in non-interest expense during both time periods of 2019 compared to 2018 reflects our investments in new initiatives and personnel to support future growth.

 

12

The following table reflects unaudited balance sheet and asset quality data as well as capital adequacy measures as of December 31, 2019, September 30, 2019, and December 31, 2018, respectively.

 

		12/31/19				09/30/19				12/31/18
		(dollars in thousands)
Balance Sheet Data:
Assets		$	1,152,034			$	1,094,609			$	1,005,677
Loans, net			941,132				925,257				836,131
Deposits			988,236				923,910				874,254
Shareholders’ equity			130,256				129,002				121,079
Asset Quality Data:
Allowance for loan losses / gross loans			1.17	%			1.12	%			1.28	%
Allowance for loan losses / nonperforming loans			402.29	%			222.74	%			241.99	%
Nonperforming assets / total assets			0.24	%			0.43	%			0.44	%
Nonperforming loans / gross loans			0.29	%			0.50	%			0.53	%
Capital Adequacy Measures:
Tier 1 leverage ratio			10.64	%			11.44	%			11.57	%
Tier 1 risk-based capital ratio			10.58	%			10.89	%			11.18	%
Total risk-based capital ratio			11.99	%			12.33	%			12.76	%
Total equity / total assets			11.31	%			11.79	%			12.04	%
Total tangible equity / total tangible assets			10.72	%			11.17	%			11.37	%

Total assets of $1.15 billion as of December 31, 2019 represented an increase of $57.4 million, or 5.25%, from September 30, 2019 and $146.4 million, or 14.55%, from December 31, 2018. Total net loans of $941.1 million represented an increase of $15.9 million, or 1.72%, from September 30, 2019 and 105.0 million, or 12.56%, from December 31, 2018. The largest categories of growth within the loan portfolio were in commercial real estate loans and commercial and industrial loans.

Total deposits of $988.2 million as of December 31, 2019 represented an increase of $64.3 million, or 6.96%, from September 30, 2019 and $114.0 million, or 13.04%, from December 31, 2018. The largest categories of growth within the deposit portfolio were in money market and savings accounts and non-interest bearing demand accounts.

The allowance for loan losses represented 1.17% of total gross loans as of December 31, 2019, compared to 1.12% and 1.28% as of September 30, 2019 and December 31, 2018, respectively. The changes in the coverage of the allowance for loan losses were primarily the result of charge-off activity during 2019, which partially offset provisions to accommodate loan growth. Nonperforming assets represented 0.24% of total assets at December 31, 2019 compared to 0.43% and 0.44% as of September 30, 2019 and December 31, 2018, respectively. Nonperforming assets decreased to $2.8 million compared to $4.7 million and $4.5 million as of September 30, 2019 and December 31, 2018, respectively.

Total shareholders’ equity of $130.3 as of December 31, 2019 represented an increase of $1.3 million, or 0.97%, from September 31, 2019 and $9.2 million, or 7.58%, from December 31, 2018.

Supervision and Regulation

As a financial institution, we are extensively regulated under both federal and state law. This supervisory framework could materially impact the conduct and profitability of our activities. These laws restrict permissible activities and investments and require compliance with various consumer protection provisions applicable to lending, deposit, brokerage, and fiduciary activities. They also impose capital adequacy requirements and conditions on our ability to pay dividends to our shareholders, to repurchase our stock and to receive dividends from our subsidiary banks.

 

13

As a bank holding company, the Company is subject to supervision and regulation by the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”). The Company is also a bank holding company within the meaning of the California Financial Code. As such, the Company and its subsidiaries are subject to examination by, and may be required to file reports with, the Federal Reserve and the DBO. As a California state-chartered commercial bank the Bank is subject to supervision, periodic examination and regulation by the DBO and the FDIC. The Company’s and the Bank’s regulators generally have broad discretion to impose restrictions and limitations on our operations. Banking regulation is intended to protect depositors and consumers and not shareholders.

The following discussion explains the major pieces of legislation and regulation affecting the banking industry and how that legislation and regulation affects our business. The following summary is qualified by reference to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on the business and prospects of the Company and the Bank, and legislative changes and the policies of various regulatory authorities may significantly affect our operations. We cannot predict the effect that fiscal or monetary policies, or new federal or state legislation or regulation may have on our future business and earnings.

Capital Adequacy

Bank holding companies and depository institutions are required to maintain minimum levels of capital and are subject to consolidated risk-based and leverage capital rules. The federal banking agencies have adopted minimum risk-based capital requirements (Tier 1 capital, common equity Tier 1 capital (“CET1”) and total capital) and leverage capital requirements, as well as guidelines that define components of the calculation of capital and the level of risk associated with various types of assets. Financial institutions are expected to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with the guidelines.

In addition to the minimum risk-based capital and leverage ratios, bank holding companies and depository institutions must maintain a “capital conservation buffer” consisting of CET1 in an amount equal to 2.5% of risk-weighted assets in order to avoid restrictions on their ability to make capital distributions and to pay certain discretionary bonus payments to executive officers. In order to avoid those restrictions, the capital conservation buffer effectively increases the minimum CET1 capital, Tier 1 capital, and total capital ratios for U.S. banking organizations to 7.0%, 8.5%, and 10.5%, respectively. Banking organizations with capital levels that fall within the buffer will be required to limit dividends, share repurchases or redemptions (unless replaced within the same calendar quarter by capital instruments of equal or higher quality), and discretionary bonus payments. The capital conservation buffer was phased in over four years beginning in 2015 and was fully phased in as of January 1, 2019.

The following table presents the risk-based and leverage capital requirements applicable to the Company and the Bank:

 

		Adequately Capitalized Requirement				Well-Capitalized Requirement				Well-Capitalized with Buffer (as fully phased in 2019)
Leverage			4.0	%			5.0	%			5.0	%
CET1			4.5	%			6.5	%			7.0	%
Tier 1			6.0	%			8.0	%			8.5	%
Total Capital			8.0	%			10.0	%			10.5	%

The capital rules require that goodwill and other intangible assets (other than mortgage servicing assets), net of associated deferred tax liabilities (“DTLs”), be deducted from CET1 capital. Additionally, deferred tax assets (“DTAs”) that arise from net operating loss and tax credit carryforwards, net of associated DTLs and valuation allowances, are fully deducted from CET1 capital. However, DTAs arising from temporary differences that could not be realized through net operating loss carrybacks, along with mortgage servicing assets and “significant”

 

14

(defined as greater than 10% of the issued and outstanding common stock of the unconsolidated financial institution) investments in the common stock of unconsolidated “financial institutions” are partially includible in CET1 capital, subject to deductions defined in the rules.

The FDIC also considers interest rate risk (arising when the interest rate sensitivity of a bank’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in the evaluation of the bank’s capital adequacy. Banks with excessive interest rate risk exposure are required to hold additional amounts of capital against their exposure to losses resulting from that risk. Through the risk-weighting of assets, the regulators also require banks to incorporate market risk components into their risk-based capital. Under these market risk requirements, capital is allocated to support the amount of market risk related to a bank’s lending and trading activities.

Enforcement Powers

If as a result of an examination of a bank holding company or a bank, its federal banking agency determines that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of its operations are unsatisfactory or that it or its management was in violation of any law or regulation, that agency would have the authority to take a number of different remedial actions as it deems appropriate under the circumstances. These actions include the power to enjoin any “unsafe or unsound” banking practices; to require that affirmative action be taken to correct any conditions resulting from any violation of law or unsafe or unsound practice; to issue an administrative order that can be judicially enforced; to require that it increase its capital; to restrict its growth; to assess civil monetary penalties against it or its officers or directors; to remove officers and directors of the bank; and if the federal banking agency concludes that such conditions at the bank holding company or the bank cannot be corrected or there is an imminent risk of loss to depositors, to terminate a bank’s deposit insurance, which in the case of a California state chartered bank would result in revocation of its charter and require it to cease its banking operations. Under California law the DBO has many of these same remedial powers with respect to the Bank.

Regulation of the Company

As a bank holding company, the Company is subject to supervision, regulation and examination by the Federal Reserve under the Bank Holding Company Act and the regulations of the Federal Reserve. The Company is required to file quarterly reports with the Federal Reserve and to provide additional information as the Federal Reserve may require. The Federal Reserve regularly examines the Company, may examine any of our subsidiaries and charges us for the cost of the examinations. The Federal Reserve also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices.

Acquisitions of Banks. The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before:

 

•

acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the bank’s voting shares;

 

•

acquiring all or substantially all of the assets of any bank; or

 

•

merging or consolidating with any other bank holding company.

Additionally, the Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly, substantially lessen competition, or otherwise

 

15

function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the communities to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks involved in the transaction. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy, which is discussed above.

Change in Bank Control. Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act of 1978, as amended, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control exists if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is generally presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities of the bank holding company, but the regulations set forth certain circumstances in which this presumption does not apply, and the regulations also provide a procedure for challenging rebuttable presumptions of control.

Permitted Activities. The Bank Holding Company Act generally prohibits a bank holding company from engaging in activities other than banking, managing or controlling banks or other permissible subsidiaries, and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those determined by the Federal Reserve to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. The Gramm-Leach-Bliley Act expanded the permissible activities of a bank holding company that qualifies as a financial holding company to engage in activities that are financial in nature or incidental or complementary to financial activities. Those activities include, among other activities, certain insurance, advisory and securities activities. The Company has not elected to be financial holding company and we have no plans to do so.

Imposition of Liability for Undercapitalized Subsidiaries: Source of Strength. Under the Federal Deposit Insurance Act (the “FDIA”) federal banking agencies are required to take “prompt corrective action” should an insured depository institution fail to meet certain capital adequacy standards. In the event an institution becomes “undercapitalized,” it must submit a capital restoration plan. The capital restoration plan will not be accepted by the regulators unless each company “having control of” the undercapitalized institution “guarantees” the subsidiary’s compliance with the capital restoration plan until it becomes “adequately capitalized.” For purposes of this statute, the Company has control of the Bank. The FDIA grants greater powers to bank regulators in situations where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior Federal Reserve approval of proposed distributions, or might be required to consent to a merger or to divest the troubled institution or other affiliates. See “Regulation of the Bank — Prompt Corrective Action” below.

Federal law and Federal Reserve policy require that the Company act as a source of financial and managerial strength to the Bank, committing resources to the Bank, including at times when it may not be in a financial position to provide it. As discussed above, the Company could be required to guarantee a capital plan of the Bank if it becomes undercapitalized for purposes of banking regulations. Any capital loans by a bank holding company to its subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. The Bank Holding Company Act provides that, in the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a bank subsidiary will be assumed by the bankruptcy trustee and entitled to priority of payment.

Restrictions on Dividends and Stock Repurchases. The Company’s ability to pay dividends to its shareholders is limited by both general corporate law considerations and the regulations and policies of the Federal Reserve applicable to bank holding companies. It is the Federal Reserve’s policy that a bank holding company should generally pay dividends on common stock only out of income available over the past year, and

 

16

only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition, and current Federal Reserve policy further calls for a bank holding company to consult with the Federal Reserve before repurchasing shares during a quarter in an amount that exceeds its earnings for the quarter. It is also the Federal Reserve’s policy that bank holding companies should not maintain dividend levels that undermine their ability to be a source of strength to its banking subsidiaries. The Federal Reserve has indicated that bank holding companies should carefully review their dividend policy and has discouraged payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong.

Bank holding companies must consult with the Federal Reserve before redeeming any equity or other capital instrument included in regulatory capital prior to stated maturity, if such redemption could have a material effect on the level or composition of the organization’s capital base. Bank holding companies experiencing financial weaknesses, or that are at significant risk of developing financial weaknesses, must consult with the Federal Reserve before redeeming or repurchasing common stock or other regulatory capital instruments.

As a California corporation, the Company is subject to the limitations of California law, which allows a California corporation to distribute cash or property to shareholders, including as a dividend or repurchase or redemption of shares, if the corporation meets either a retained earnings test or a “balance sheet” test. Under the retained earnings test, the Company may make a distribution from retained earnings to the extent that its retained earnings exceed the sum of (a) the amount of the distribution plus (b) the amount, if any, of dividends in arrears on shares with preferential dividend rights. The Company may also make a distribution if, immediately after the distribution, the value of its assets equals or exceeds the sum of (a) its total liabilities plus (b) the liquidation preference of any shares which have a preference upon dissolution over the rights of shareholders receiving the distribution. Indebtedness is not considered a liability if the terms of such indebtedness provide that payment of principal and interest thereon are to be made only if, and to the extent that, a distribution to shareholders could be made under the balance sheet test. In addition, the Company may not make distributions if it is, or as a result of the distribution would be, likely to be unable to meet its liabilities (except those whose payment is otherwise adequately provided for) as they mature.

The primary source of capital for the Company’s payment of any dividend or its repurchase of stock is expected to be the Bank, through the payment of dividends or management fees to the Company. The ability of the Bank to pay cash dividends or fees to the Company is limited by law and regulation, as described in “Regulation of the Bank — Dividend Restrictions Applicable to the Bank,” below.

Regulation of the Bank

The Bank is a California-chartered bank. The deposit accounts of the Bank are insured by the FDIC to the maximum extent provided under federal law. As a California-chartered bank, the Bank is subject to supervision and regulation by the DBO, the chartering authority for California banks, and as an FDIC-insured bank that is not a member of the Federal Reserve System, the FDIC. The FDIC and DBO regularly examine the Bank’s operations and have the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. The FDIC and the DBO also have the power to prohibit the continuance or development of unsafe or unsound banking practices or other violations of law. The Bank is also subject to numerous state and federal statutes and regulations that affect the Bank, its business, activities, and operations.

Prompt Corrective Action

The federal banking regulators are required to take “prompt corrective action” with respect to capital-deficient institutions. For this purpose, federal banking regulations define five capital categories: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” As of December 31, 2018 and September 30, 2019, the Bank’s capital levels exceeded the minimum levels required to be considered “well capitalized”, which means it had a common equity Tier 1 capital

 

17

ratio of 6.5% or higher; a Tier I risk-based capital ratio of 8.0% or higher; a total risk-based capital ratio of 10.0% or higher; and a leverage ratio of 5.0% or higher. The following table sets forth the minimum regulatory capital levels for each category:

 

Capital Category

Total Risk-Based Capital Ratio

Tier 1 Risk-Based Capital Ratio

Common Equity Tier 1 (CET1) Capital Ratio

Leverage Ratio

Tangible Equity to Assets

Supplemental Leverage Ratio

Well Capitalized

10% or greater

8% or greater

6.5% or greater

5% or greater

n/a

n/a

Adequately Capitalized

8% or greater

6% or greater

4.5% or greater

4% or greater

n/a

3% or greater

Undercapitalized

Less than 8%

Less than 6%

Less than 4.5%

Less than 4%

n/a

Less than 3%

Significantly Undercapitalized

Less than 6%

Less than 4%

Less than 3%

Less than 3%

n/a

n/a

Critically Undercapitalized

n/a

n/a

n/a

n/a

Less than 2%

n/a

An institution’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the institution’s overall financial condition or prospects for other purposes. An institution may be downgraded to a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. Failure to meet capital guidelines could subject a bank to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and certain other restrictions on its business.

Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories: undercapitalized, significantly undercapitalized, and critically undercapitalized. The severity of the action depends upon the capital category in which the institution is placed. As an institution’s capital decreases, the regulators’ enforcement powers become more severe.

In the event an institution becomes “undercapitalized,” it must submit a capital restoration plan. The federal banking regulators require that each company having control of the undercapitalized institution guarantees the subsidiary depository institution’s compliance with the capital restoration plan up to a certain specified amount. Any such guarantee from a depository institution’s holding company is entitled to a priority of payment in bankruptcy.

The bank regulators have greater power in situations where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan. In addition to requiring undercapitalized institutions to submit a capital restoration plan, bank regulations contain broad restrictions on certain activities of undercapitalized institutions including asset growth, acquisitions, branch establishment and expansion into new lines of business. With certain exceptions, an insured depository institution is prohibited from making capital distributions, including dividends, and is prohibited from paying management fees to control persons if the institution would be undercapitalized after any such distribution or payment.

A significantly undercapitalized institution is subject to mandated capital raising activities, restrictions on interest rates paid and transactions with affiliates, removal of management, and other restrictions. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized.

 

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Banks with risk-based capital and leverage ratios below the required minimums may also be subject to certain administrative actions, including the termination of deposit insurance upon notice and hearing, or a temporary suspension of insurance without a hearing in the event the institution has no tangible capital.

In addition to the federal regulatory capital requirements described above, the DBO has authority to take possession of the business and properties of a California-chartered bank in the event that the bank’s tangible shareholders’ equity is less than the greater of 4% of the bank’s total assets or $1.0 million.

Dividend Restrictions Applicable to the Bank

The primary source of funds for the Company is expected to be dividends from the Bank. California and federal laws and regulations limit the Bank’s payment of dividends to the Company.

Under the California Financial Code, the Bank is permitted to pay a dividend in the following circumstances: (i) without the consent of either the DBO or the Bank’s shareholders, in an amount not exceeding the lesser of (a) the retained earnings of the Bank; or (b) the net income of the Bank for its last three fiscal years, less the amount of any distributions made during the prior period; (ii) with the prior approval of the DBO, in an amount not exceeding the greatest of: (a) the retained earnings of the Bank; (b) the net income of the Bank for its last fiscal year; or (c) the net income for the Bank for its current fiscal year; and (iii) with the prior approval of the DBO and the Bank’s shareholders (i.e., the Company) in connection with a reduction of its contributed capital.

The Bank’s ability to pay dividends to the Company is further limited by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a depository institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. In addition, in order to pay a dividend, the Bank is generally required to maintain a capital conservation buffer of 2.5% in CET1. See “—Capital Adequacy Requirements” above.

Further, if, in the opinion of the FDIC, the Bank were engaged in or about to engage in an unsafe or unsound practice, the FDIC could require that the Bank stop or refrain from engaging in the practice. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice.

Branching

California law permits California banks, such as the Bank, to establish an additional banking office with notice to the DBO. Deposit-taking banking offices must be approved by the FDIC, which considers a number of factors, including a bank’s financial condition and management. The Dodd-Frank Act permits insured state banks to engage in interstate branching if the laws of the state where the new banking office is to be established would permit the establishment of the banking office if it were chartered by a bank in such state. A bank may also establish banking offices in other states by merging with banks or by purchasing banking offices of other banks in other states, subject to certain restrictions.

FDIC Insurance Assessments

The Bank’s deposits are insured by the Deposit Insurance Fund of the FDIC up to the maximum amount permitted by law.    As an FDIC insured financial institution, the Bank is subject to deposit insurance assessments as determined by the FDIC.

Under the FDIC’s risk-based deposit premium assessment system, the assessment rates for an insured depository institution are determined by an assessment rate calculator, which is based on a number of elements that measure the risk each institution poses to the Deposit Insurance Fund. As a result of the Dodd-Frank Act, the

 

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calculated assessment rate is applied to average consolidated assets less the average tangible equity of the insured depository institution during the assessment period to determine the dollar amount of the quarterly assessment. Premiums are assessed quarterly and could increase if, for example, criticized loans and leases and/or other higher risk assets increase or balance sheet liquidity decreases. In addition, the FDIC can impose special assessments in certain instances.

Concentrations in Commercial Real Estate Lending

The federal banking regulators have issued guidance to identify institutions that may be exposed to potential significant commercial real estate lending risks and may therefore warrant greater supervisory scrutiny. The guidance includes the following numerical tests:

 

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total reported loans for construction, land development and other land represent 100% or more of the institution’s total capital, or

 

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total commercial real estate loans represent 300% or more of the institution’s total capital, and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50% or more.

The guidance does not limit a bank’s levels of commercial real estate lending activities, but rather guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. Banking regulators expect banks with concentrations of commercial real estate loans to maintain appropriate underwriting discipline, risk-management and capital commensurate with the level and nature of their commercial real estate risks.

Community Reinvestment Act

The Community Reinvestment Act requires that the federal banking agencies evaluate the record of each financial institution in meeting the credit needs of its local community, including low- and moderate-income neighborhoods. Federal banking agencies must consider an institution’s Community Reinvestment Act compliance in approving mergers, acquisitions, and applications to open a branch. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank. Additionally, the Bank must publicly disclose the terms of various Community Reinvestment Act-related agreements.

Transactions with Affiliates and Insiders

We are subject to the provisions of Regulation W promulgated by the Federal Reserve, which implements Sections 23A and 23B of the Federal Reserve Act. Regulation W places limits and conditions on the amount and terms of the Bank’s loans or extensions of credit to, investments in, or certain other transactions with the Company or any other affiliated entity. Regulation W also prohibits, among other things, a depository institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies. Federal law also places restrictions on the Bank’s ability to extend credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated third parties; and must not involve more than the normal risk of repayment or present other unfavorable features.

The Bank Secrecy Act and the USA Patriot Act

The Bank is subject to the Bank Secrecy Act of 1970 as amended by the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Bank Secrecy Act”), which gives the federal government powers to address money laundering and terrorist threats through

 

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enhanced domestic security measures, expanded surveillance powers and mandatory transaction reporting obligations. For example, the Bank Secrecy Act and related regulations require that the Bank report currency transactions that exceed certain thresholds and transactions determined to be suspicious, establish due diligence requirements for accounts and take certain steps to verify customer identification when accounts are opened. The Bank Secrecy Act requires financial institutions to develop and maintain a program reasonably designed to ensure and monitor compliance with its requirements, to train employees to comply with and to test the effectiveness of the program. Any failure to meet the requirements of the Bank Secrecy Act can result in the imposition of substantial penalties and in adverse regulatory action against the offending bank.

Data Privacy and Cybersecurity

The Gramm-Leach-Bliley Act (the “GLBA”) and the implementing regulations issued by federal regulatory agencies require financial institutions (including banks, insurance agencies, and broker/dealers) to adopt policies and procedures regarding the disclosure of nonpublic personal information about their customers to non-affiliated third parties. In general, financial institutions are required to explain to customers their policies and procedures regarding the disclosure of such nonpublic personal information and, unless otherwise required or permitted by law, financial institutions are prohibited from disclosing such information except as provided in their policies and procedures. Specifically, the GLBA established certain information security guidelines that require each financial institution, under the supervision and ongoing oversight of its board of directors or an appropriate committee thereof, to develop, implement, and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against anticipated threats or hazards to the security or integrity of such information, and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.

Recent cyber-attacks against banks and other financial institutions that resulted in unauthorized access to confidential customer information have prompted the federal banking regulators to issue extensive guidance on cybersecurity. Among other things, financial institutions are expected to design multiple layers of security controls to establish lines of defense and ensure that their risk management processes address the risks posed by compromised customer credentials, including security measures to authenticate customers accessing internet-based services. A financial institution is expected to have a robust business continuity program to recover from a cyberattack and procedures for monitoring the security of third-party service providers that may have access to nonpublic data at the institution.

Consumer Laws and Regulations

The Bank is subject to consumer laws and regulations intended to protect consumers in transactions with depository institutions, as well as other laws or regulations affecting customers of financial institutions generally. These laws and regulations include, among others, the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement and Procedures Act, the Fair Credit Reporting Act and the Federal Trade Commission Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans.

The Dodd-Frank Act centralized responsibility for federal consumer financial protection including implementing, examining and enforcing compliance with federal consumer financial laws with the Consumer Financial Protection Bureau (the “CFPB”). Depository institutions with less than $10 billion in assets, such as the Bank, are subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The Dodd-Frank Act also gives state attorneys general the ability to enforce federal consumer protection laws.

 

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Future Legislation and Regulation

Regulators have increased their focus on the regulation of the financial services industry in recent years, leading in many cases to greater uncertainty and compliance costs for regulated entities. Proposals that could substantially intensify the regulation of the financial services industry have been and may be expected to continue to be introduced in the United States Congress, in state legislatures, and by applicable regulatory authorities. These proposals may change banking statutes and regulations and our operating environment in substantial and unpredictable ways. If enacted, these proposals could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. We cannot predict whether any of these proposals will be enacted and, if enacted, the effect that these proposals, or any implementing regulations, would have on our business, results of operations, or financial condition.

 

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ITEM 1A. RISK FACTORS

Our business is subject to certain risks, including those described below. If any of the events described in the following risk factors actually occurs then our business, results of operations and financial condition could be materially adversely affected. More detailed information concerning these risks is contained in other sections of this registration statement, including “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Risks related to our business

We may suffer losses in our loan portfolio.

Loan defaults and losses on the loans we make are an inherent risk of the banking business. As a lender, we are exposed to the risk that our borrowers will not repay their loans according to their terms, and that the collateral securing repayment of their loans, if any, may not be sufficient to ensure repayment. In addition, there are risks inherent in making any loan, including risks with respect to the period of time over which the loan may be repaid, risks relating to proper loan underwriting, risks resulting from changes in economic and industry conditions and risks inherent in dealing with individual borrowers. Although we believe that our underwriting criteria are, and historically have been, appropriate for the various kinds of loans we make, we have incurred losses on loans that have met these criteria, and may experience higher than expected losses depending on economic factors and our borrowers’ behavior. The risks of loan losses are exacerbated by adverse changes in economic, operating and other conditions, which are beyond our control, and may cause our actual loan losses to exceed our current allowance estimates.

We may be required to increase our allowance for loan losses, which would adversely affect our financial performance in the future.

We maintain an allowance for loan losses to provide a reserve for loan defaults and non-performance. There is no precise method of predicting loans losses. We regularly evaluate and conduct an analysis to determine the probable and estimable losses inherent in our loan portfolio and the adequacy of our allowance for loan losses. This evaluation requires us to make a number of estimates and judgments regarding the financial condition and creditworthiness of a significant number of our borrowers, the value and sufficiency of the collateral securing our loans, economic conditions and other factors, all of which are difficult to assess and may change over time.

If our estimates or judgments prove to be incorrect due to circumstances outside our control, the ineffectiveness of our credit administration or for other reasons or the Bank’s regulators come to a different conclusion regarding the adequacy of our allowance for loan losses, we could be require to increase the provisions we make for loan losses, which could reduce our income or could cause us to incur operating losses in the future. Moreover, additions to the allowance may be necessary based on changes in economic and real estate market conditions, new information regarding existing loans, identification of additional problem loans and other factors, or unanticipated loan losses results from other circumstances, both within and outside of our control. These additions may require increased provision expense, which could negatively impact our results of operations.

Our focus on lending to small to medium-sized businesses may increase our credit risk.

Most of our commercial business and commercial real estate loans are made to small to medium-sized businesses. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities, and may have a heightened vulnerability to economic conditions and greater customer concentration risk. If general economic conditions in the markets in which we operate negatively impact this customer segment, our results of operations and financial condition and the value of our common stock may be adversely affected. Moreover, a portion of these loans have been made by us in recent years and the borrowers

 

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may not have experienced a complete business or economic cycle. The deterioration of our borrowers’ businesses may hinder their ability to repay their loans with us, which could have a material adverse effect on our financial condition and results of operations.

Our business concentration in Northern California imposes risks resulting from any regional or local economic downturn affecting Northern California.

We conduct our banking operations primarily in the greater San Francisco Bay Area of Northern California and we recently expanded to Sacramento, California. As a result, a significant majority of the loans in our loan portfolios as of September 30, 2019 were secured by properties and collateral located in California. As of such date, approximately 80% of the loans in our loan portfolio were made to borrowers who primarily conduct business or live in Northern California. The balance of our other loans were made primarily to borrowers located in other areas of California and were secured by properties located in the state. This geographic concentration imposes risks from lack of geographic diversification, as adverse economic developments in Northern California, among other things, could affect the volume of loan originations, increase the level of nonperforming assets, increase the rate of foreclosure losses on loans and reduce the value of our loans and loan servicing portfolio. Any regional or local economic downturn that affects California or existing or prospective borrowers or property values in such areas may affect us and our profitability more significantly and more adversely than our competitors whose operations are less geographically concentrated.

Because a significant portion of our loan portfolio is comprised of real estate loans, negative changes in the economy affecting real estate values and liquidity could impair the value of collateral securing our real estate loans and result in loan and other losses.

As of September 30, 2019, approximately 57% of our loan portfolio was comprised of commercial real estate and other loans with real estate as a primary or secondary component of collateral. This includes collateral consisting of income producing and residential construction properties, which properties tend to be more sensitive to general economic conditions and downturns in real estate markets. As a result, adverse developments affecting real estate values in our market areas could increase the credit risk associated with our real estate loan portfolio. The market value of real estate can fluctuate significantly in a short period of time as a result of market conditions in the area in which the real estate is located. Adverse changes affecting real estate values and the liquidity of real estate in our markets could increase the credit risk associated with our loan portfolio, and could result in losses that would adversely affect credit quality, financial condition, and results of operation. Negative changes in the economy affecting real estate values and liquidity in our market areas could significantly impair the value of property pledged as collateral on loans and affect our ability to sell the collateral upon foreclosure without a loss or additional losses. Collateral may have to be sold for less than the outstanding balance of the loan, which could result in losses on such loans. Such declines and losses could have a material adverse impact on our business, results of operations and growth prospects. If real estate values decline, it is also more likely that we would be required to increase our allowance for loan losses, which could adversely affect our financial condition, results of operations and cash flows.

We are exposed to higher credit risk by commercial real estate, commercial and industrial and construction and development-based lending as well as relationship exposure with a number of large borrowers.

Commercial real estate, commercial and industrial and construction and development based lending usually involve higher credit risks than 1-4 family residential real estate lending. As of September 30, 2019, the following loan types accounted for the stated percentages of our loan portfolio: commercial real estate (both owner-occupied and non-owner occupied) -  52%; commercial and industrial -  43%; and construction and land -  3%. These types of loans also involve larger loan balances to a single borrower or groups of related borrowers. These higher credit risks are further heightened when the loans are concentrated in a small number of larger borrowers leading to relationship exposure. As of September 30, 2019, we had 17 relationships with over $10 million of outstanding borrowings with us. While we are not dependent on any of these relationships and while none of these large relationships have directly impacted our allowance for loan losses, a deterioration of any of these large credits could require us to increase our allowance for loan losses or result in significant losses to us.

 

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Non-owner occupied commercial real estate loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers’ ability to repay their loans depends on successful development of their properties, in addition to the factors affecting residential real estate borrowers. These loans also involve greater risk because they generally are not fully amortizing over the loan period, but have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or sell the underlying property in a timely manner.

Commercial and industrial loans and owner-occupied commercial real estate loans are typically based on the borrowers’ ability to repay the loans from the cash flow of their businesses. These loans may involve greater risk because the availability of funds to repay each loan depends substantially on the success of the business itself. In addition, the assets securing the loans have the following characteristics: (i) they depreciate over time, (ii) they are difficult to appraise and liquidate, and (iii) they fluctuate in value based on the success of the business.

A subset of our commercial and industrial loans are structured as Asset Based Lending (ABL) loans. Generally, our ABL loans are structured as callable and cancelable transactions. Generally the borrowing base has a maximum advance rate of 80% against eligible receivables and may include a lower advance rate against inventory. Repayment of ABL loans depends substantially on the ability of the borrower to monetize the assets in a defined borrowing base. Therefore, the quality and collectability of accounts receivable, concentrations among account debtors, financial strength of the account debtors, and quality and transferability of inventory can impact repayment. At September 30, 2019, ABL loans totaled approximately $43.3 million, or 5% of our loan portfolio

Risk of loss on a construction and development loan depends largely upon whether our initial estimate of the property’s value at completion of construction or development equals or exceeds the cost of the property construction or development (including interest), the availability of permanent take-out financing and the builder’s ability to ultimately sell the property. During the construction or development phase, a number of factors can result in delays and cost overruns. If estimates of value are inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan or by seizure of collateral.

Additionally, commercial real estate loans, commercial and industrial loans and construction and development loans are more susceptible to a risk of loss during a downturn in the business cycle. Our underwriting, review and monitoring cannot eliminate all of the risks related to these loans.

Banking regulators are giving commercial real estate lending greater scrutiny, and may require banks with higher levels of commercial real estate loans to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital levels as a result of commercial real estate lending growth and exposures. Therefore, we could be required to raise additional capital or restrict our future growth as a result of our higher level of commercial real estate loans.

A significant percentage of our loans are attributable to a relatively small number of borrowers.

Our 10 largest borrowing relationships accounted for approximately 13.5% of our loans at September 30, 2019. Our largest single borrowing relationship accounted for approximately 2.0% of our loans at September 30, 2019. The loss of any combination of these borrowers, or a significant decline in their borrowings due to fluctuations related to their business needs, could adversely affect our results of operations if we are unable to replace their borrowings with similarly priced new loans or investments. In addition, with this concentration of credit risk among a limited number of borrowers, we may face a greater risk of material credits losses if any one or several of these borrowers fail to perform in accordance with their loans, compared to a bank with a more diversified loan portfolio.

 

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We depend on our executive officers and other key individuals to continue the implementation of our long-term business strategy and could be harmed by the loss of their services and our inability to make up for such loss with qualified replacements.

We believe that our continued growth and future success will depend in large part on the skills of our management team and our ability to motivate and retain these individuals and other key individuals. The loss of any of their service could reduce our ability to successfully implement our long-term business strategy, our business could suffer and the value of our common stock could be materially adversely affected. Leadership changes will occur from time to time and we cannot predict whether significant resignations will occur or whether we will be able to recruit additional qualified personnel. We believe our management team possesses valuable knowledge about the banking industry and that their knowledge and relationships would be very difficult to replicate. Our success also depends on the experience of our bankers and lending officers and on their relationships with the customers and communities they serve. The loss of key personnel, or the inability to recruit and retain qualified and talented personnel in the future, could have an adverse effect on our business, financial condition or operating results.

We face strong competition from other companies that offer banking and financial services.

We conduct our banking operations primarily in Northern California. Many of our competitors offer the same, or a wider variety of, banking services within our market areas. These competitors include banks with nationwide operations, regional banks and community banks. In many instances these national and regional banks have greater resources than we do and some community banks may have stronger ties in local markets than we do, which may put us at a competitive disadvantage. We also face competition from many other types of financial institutions, including savings and loan institutions, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. In addition, a number of out-of-state financial institutions have opened production offices, or otherwise solicit deposits and loans, in our market areas. Increased competition in our markets may result in reduced loans and deposits, as well as reduced net interest margin and profitability. Ultimately, we may not be able to compete successfully against current and future competitors. If we are unable to attract and retain banking clients, we may be unable to continue to grow our loan and deposit portfolios, and our business, financial condition and results of operations may be adversely affected.

We follow a relationship-based operating model and our ability to maintain our reputation is critical to the success of our business and the failure to do so may materially adversely affect our performance.

We are a community bank, and our reputation is one of the most valuable components of our business. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining bankers and other associates who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates. Furthermore, maintaining our reputation also depends on our ability to protect our brand name and associated trademarks.

However, reputation risk, or the risk to our business, earnings and capital from negative public opinion surrounding our Company and the financial institutions industry generally, is inherent in our business. Negative public opinion can result from our actual or alleged conduct in any number of activities, including business and lending practices, corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect our ability to keep and attract customers and employees and can expose us to litigation and regulatory action. Although we take steps to minimize reputation risk in dealing with our customers and communities, this risk will always be present given the nature of our business.

If our reputation is negatively affected by the actions of our employees or otherwise, our business and operating results may be materially adversely affected.

 

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Interest rate shifts may reduce net interest income and otherwise negatively impact our financial condition and results of operations.

The majority of our banking assets are monetary in nature and subject to risk from changes in interest rates. Like most financial institutions, our earnings are significantly dependent on our net interest income, the principal component of our earnings, which is the difference between interest earned by us from our interest-earning assets, such as loans and investment securities, and interest paid by us on our interest-bearing liabilities, such as deposits and borrowings. We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, this “gap” will negatively impact our earnings. Many factors impact interest rates, including governmental monetary policies, inflation, recession, changes in unemployment, the money supply, and international disorder and instability in domestic and foreign financial markets.

Interest rate increases often result in larger payment requirements for our borrowers, which increase the potential for default. At the same time, the marketability of the property securing a loan may be adversely affected by any reduced demand resulting from higher interest rates. In a declining interest rate environment, there may be an increase in prepayments on loans as borrowers refinance their loans at lower rates.

Changes in interest rates also can affect the value of loans, securities and other assets. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans may lead to an increase in nonperforming assets and a reduction of income recognized, which could have a material adverse effect on our results of operations and cash flows.

If short-term interest rates remain at their historically low levels for a prolonged period, and assuming longer term interest rates fall further, we could experience net interest margin compression as our interest earning assets would continue to re-price downward while our interest-bearing liability rates could fail to decline in tandem. Such an occurrence would have a material adverse effect on our net interest income and our results of operations.

Although we believe that we have implemented effective asset and liability management strategies to mitigate the potential adverse effects of changes in interest rates on our results of operations, any substantial or unexpected change in, or prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations.

Our deposit portfolio includes significant concentrations and a large percentage of our deposits are attributable to a relatively small number of customers.

As a commercial bank, we provide services to a number of customers whose deposit levels vary considerably. Our 10 largest depositor relationships accounted for approximately 17.9% of our deposits at September 30, 2019. Our largest depositor relationship accounted for approximately 3.3% of our deposits at September 30, 2019. These deposits can and do fluctuate substantially. The loss of any combination of these depositors, or a significant decline in the deposit balances due to ordinary course fluctuations related to these customers’ businesses, could adversely affect our liquidity and require us to raise deposit rates to attract new deposits, purchase federal funds or borrow funds on a short-term basis to replace such deposits. Depending on the interest rate environment and competitive factors, low cost deposits may need to be replaced with higher cost funding, resulting in a decrease in net interest income and net income.

A lack of liquidity could adversely affect our operations and jeopardize our business, financial condition, and results of operations.

Liquidity is essential to our business. We rely on our ability to generate deposits and effectively manage the repayment and maturity schedules of our loans and investment securities, respectively, to ensure that we have

 

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adequate liquidity to fund our operations. An inability to raise funds through deposits, borrowings, the sale of our investment securities, Federal Home Loan Bank (‘FHLB”) advances, the sale of loans, and other sources could have a substantial negative effect on our liquidity. Our most important source of funds consists of deposits. Deposit balances can decrease when customers perceive alternative investments as providing a better risk/return tradeoff. If our customers move money out of bank deposits and into other investments, we would lose a relatively low-cost source of funds, increasing our funding costs and reducing our net interest income and net income.

Any decline in available liquidity could adversely impact our ability to originate loans, invest in securities, meet our expenses, pay dividends to our shareholders, or to fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, financial condition and results of operations.

We may need to raise additional capital in the future, and if we fail to maintain sufficient capital, whether due to losses, an inability to raise additional capital or otherwise, our financial condition, liquidity and results of operations, as well as our ability to maintain compliance with regulatory capital requirements, would be adversely affected.

We face significant capital and other regulatory requirements as a financial institution. In addition, the Company, on a consolidated basis, and the Bank, on a stand-alone basis, must meet certain regulatory capital requirements and maintain sufficient liquidity. We may need to raise additional capital in the future to provide us with sufficient capital resources and liquidity to meet our commitments and business needs. Our ability to raise additional capital depends on conditions in the capital markets, economic conditions and a number of other factors, including investor perceptions regarding the banking industry, market conditions and governmental activities, and on our financial condition and performance. Accordingly, we cannot assure you that we will be able to raise additional capital if needed or on terms acceptable to us. If we fail to maintain capital to meet regulatory requirements, our financial condition, liquidity and results of operations would be materially and adversely affected.

We may pursue acquisitions in the future, which would expose us to financial, execution and operational risks that could have a material adverse effect on our business, financial condition, results of operations and growth prospects.

We may pursue acquisitions of other financial institutions, bank branches and or financial services businesses in target markets. Such an acquisition strategy would involve significant risks, including our success in integrating the acquired operations, retaining key employees and customers, achieving anticipated synergies, meeting expectations and otherwise realizing the undertaking’s anticipated benefits; litigation resulting from circumstances occurring at the acquired entity prior to the date of acquisition; loan downgrades and credit loss provisions resulting from underwriting of certain acquired loans determined not to meet our credit standards; personnel changes that cause instability within a department; delays in implementing new policies or procedures or the failure to apply new policies or procedures; and other events relating to the performance of our business. Failure to successfully integrate the entities we acquire into our existing operations may increase our operating costs significantly and adversely affect our business and earnings.

System failure or breaches of our network security, including as a result of cyber-attacks or data security breaches, could subject us to increased operating costs as well as litigation and other liabilities.

The computer systems and network infrastructure we use may be vulnerable to physical theft, fire, power loss, telecommunications failure or a similar catastrophic event, as well as security breaches, denial of service attacks, viruses, worms and other disruptive problems caused by hackers. Any damage or failure that causes breakdowns or disruptions in our customer relationship management, general ledger, deposit, loan and other systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory

 

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scrutiny for failure to comply with required information security standards, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on us.

Computer break-ins, phishing and other disruptions could also jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure. Information security risks have generally increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties. Our operations rely on the secure processing, transmission and storage of confidential information in our computer systems and networks. In addition, to access our products and services, our customers may use devices that are beyond our control systems. Although we believe we have robust information security procedures and controls, our technologies, systems, networks, and our customers’ devices may become the target of cyber-attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of the Bank’s or our customers’ confidential, proprietary and other information, or otherwise disrupt the Bank’s or our customers’ or other third parties’ business operations. As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities.

The Bank is under continuous threat of loss due to hacking and cyber-attacks especially as we continue to expand customer capabilities to utilize internet and other remote channels to transact business. Two of the most significant cyber-attack risks that we face are e-fraud and loss of sensitive customer data. Loss from e-fraud occurs when cybercriminals breach and extract funds directly from customer or our accounts. Attempts to breach sensitive customer data, such as account numbers and social security numbers, are less frequent but would present significant reputational, legal and/or regulatory costs to us if successful. Our risk and exposure to these matters remains heightened because of the evolving nature and complexity of these threats from cybercriminals and hackers, our plans to continue to provide internet banking and mobile banking channels, and our plans to develop additional remote connectivity solutions to serve our customers. We cannot assure that we will not be the victim of successful hacking or cyberattacks in the future that could cause us to suffer material losses. The occurrence of any cyber-attack or information security breach could result in potential liability to customers, reputational damage and the disruption of our operations, and regulatory concerns, all of which could adversely affect our business, financial condition or results of operations.

We have a continuing need to stay current with technological changes to compete effectively and increase our efficiencies. We may not have the resources to implement new technology to stay current with these changes.

The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to provide secure electronic environments and create additional efficiencies in our operations as we continue to grow and expand our market area. In connection with implementing new technology enhancements or products in the future, we may experience certain operational challenges (e.g. human error, system error, incompatibility, etc.) which could result in us not fully realizing the anticipated benefits from such new technology or require us to incur significant costs to remedy any such challenges in a timely manner.

Many of our larger competitors have substantially greater resources to invest in technological improvements and have invested significantly more than us in technological improvements. As a result, they may be able to offer additional or more convenient products compared to those that we will be able to provide, which would put us at a competitive disadvantage. Accordingly, we may not be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to our customers, which could impair our growth and profitability.

 

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We rely on third parties to provide key components of our business infrastructure.

We rely on third parties to provide key components for our business operations, such as data processing and storage, recording and monitoring transactions, online banking interfaces and services, internet connections, and network access. While we select these third-party vendors carefully, we do not control their actions. Any problems caused by these third parties, including those resulting from breakdowns or other disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher volumes, cyber-attacks and security breaches at a vendor, failure of a vendor to provide services for any reason, or poor performance of services by a vendor, could adversely affect our ability to deliver products and services to our customers and otherwise conduct our business. Financial or operational difficulties of a third-party vendor could also hurt our operations if those difficulties interfere with the vendor’s ability to serve us. Replacing these third-party vendors could create significant delays and expense that adversely affect our business and performance.

We are subject to certain operational risks, including, but not limited to, customer or employee fraud and data processing system failures and errors.

Employee errors and employee and customer misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information. It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to financial claims for negligence.

We maintain a system of internal controls and insurance coverage to mitigate against operational risks, including data processing system failures and errors and customer or employee fraud. If our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could have a material adverse effect on our business, financial condition and results of operations.

In addition, we rely heavily upon information supplied by third parties, including the information contained in credit applications, property appraisals, title information, equipment pricing and valuation and employment and income documentation, in deciding which loans we will originate, as well as the terms of those loans. If any of the information upon which we rely is misrepresented, either fraudulently or inadvertently, and the misrepresentation is not detected prior to asset funding, the value of the asset may be significantly lower than expected, or we may fund a loan that we would not have funded or on terms we would not have extended. Whether a misrepresentation is made by the applicant or another third party, we generally bear the risk of loss associated with the misrepresentation. A loan subject to a material misrepresentation is typically unsellable or subject to repurchase if it is sold prior to detection of the misrepresentation. The sources of the misrepresentations are often difficult to locate, and it is often difficult to recover any of the monetary losses we may suffer.

We are exposed to risk of environmental liabilities with respect to properties to which we obtain title.

A significant portion of our loan portfolio is secured by real estate. In the course of our business, we may foreclose and take title to real estate and could be subject to environmental liabilities with respect to these properties. We may be held liable to a government entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation and remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. These costs and claims could adversely affect our business, results of operations and prospects.

 

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We may be adversely affected by the lack of soundness of other financial institutions or market utilities.

Our ability to engage in routine funding and other transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial institutions are interrelated as a result of trading, clearing, counterparty or other relationships. Defaults by, or even rumors or questions about, one or more financial institutions or market utilities, or the financial services industry generally, may lead to market-wide liquidity problems and losses of depositor, creditor and counterparty confidence and could lead to losses or defaults by us or by other institutions.

We face risks related to severe weather, natural disasters and other external events that could adversely affect our business.

Our operations and our customers are primarily located in the Northern California where natural and other disasters may occur. The region is vulnerable to natural disasters, such as earthquakes, fires, droughts and floods. These types of natural catastrophic may disrupt the local economies, our business and customers in these regions. These events could affect the stability of the Bank’s deposit base; impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans and cause significant property damage, any of which could materially adversely affect our business and operating results.

There are substantial risks and uncertainties associated with the introduction or expansion of lines of business or new products and services within existing lines of business.

From time to time, we may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, we may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove attainable. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on our business, results of operations, and financial condition.

The requirements of being a public company may strain our resources and divert management’s attention.

As a public company, we will be subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act, the Dodd-Frank Act, and other applicable securities rules and regulations. Compliance with these rules and regulations will increase our legal and financial compliance costs, make certain activities more difficult, time-consuming or costly and increase demand on our systems and resources. The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and operating results. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. In order to maintain and, if required, improve our disclosure controls and procedures and internal control over financial reporting to meet this standard, significant resources and management oversight may be required. As a result, management’s attention may be diverted from other business concerns, which could adversely affect our business and operating results.

In addition, changing laws, regulations and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time consuming. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities.

 

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Changes in accounting standards could materially impact our financial statements.

From time to time, the Financial Accounting Standards Board (“FASB”) or the SEC may change the financial accounting and reporting standards that govern the preparation of our financial statements. Such changes may result in us being subject to new or changing accounting and reporting standards. In addition, the bodies that interpret the accounting standards (such as banking regulators or outside auditors) may change their interpretations or positions on how these standards should be applied. These changes may be beyond our control, can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retrospectively, or apply an existing standard differently, also retrospectively, in each case resulting in our needing to revise or restate prior period financial statements.

Risks related to our common stock

Laws and regulations restrict our ability to pay dividends.

Both the Company and the Bank are subject to various regulatory restrictions relating to the payment of dividends. These restrictions are described in greater detail in “Business—Supervision and Regulation—Regulation of the Company” and “Business—Supervision and Regulation—Regulation of the Bank.

For the foreseeable future, the majority, if not all, of the Company’s revenue will be from any dividends paid to the Company by the Bank. Accordingly, our ability to pay dividends also depends on the ability of the Bank to pay dividends to the Company. Furthermore, our present and future dividend policy is subject to the discretion of our board of directors.

We cannot guarantee that the Company or the Bank will be permitted by financial condition or applicable regulatory restrictions to pay dividends or, that our board of directors will ever decide that we should pay dividends.

We have the ability to incur debt and pledge our assets, including our stock in the Bank, to secure that debt.

We have the ability to incur debt and pledge our assets to secure that debt. Absent special and unusual circumstances, a holder of indebtedness for borrowed money has rights that are superior to those of holders of common stock. For example, interest must be paid to the lender before dividends can be paid to the shareholders, and loans must be paid off before any assets can be distributed to shareholders if we were to liquidate. Furthermore, we would have to make principal and interest payments on our indebtedness, which could reduce our profitability or result in net losses on a consolidated basis even if the Bank were profitable.

Our stock price may be volatile, which could result in losses to our investors and litigation against us.

Many factors could cause our stock price to fluctuate substantially in the future. These factors include but are not limited to: actual or anticipated variations in earnings, changes in analysts’ recommendations or projections, our announcement of developments related to our businesses, operations and stock performance of other companies deemed to be peers, new technology used or services offered by traditional and non-traditional competitors, news reports of trends, irrational exuberance on the part of investors, new or expected changes to federal banking regulations, our limited number of shares and shareholders, and other issues related to the financial services industry. Our stock price may fluctuate significantly in the future, and these fluctuations may be unrelated to our performance. General market declines or market volatility in the future, especially in the financial institutions sector, could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices. Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. Moreover, in the past, securities class action lawsuits have been instituted against some companies following periods of volatility in the market price of its securities. We could in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert management’s attention and resources from our normal business.

 

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If equity research analysts do not publish research or reports about our business, or if they do publish such reports but issue unfavorable commentary or downgrade our common stock, the price and trading volume of our common stock could decline.

The trading market for our common stock could be affected by whether and to what extent equity research analysts publish research or reports about us and our business. We cannot predict at this time how many research analysts will cover us and our common stock or how many will publish research and reports on us. If one or more equity analysts cover us and publish research reports about our common stock, the price of our stock could decline if one or more securities analysts downgrade our stock or if those analysts issue other unfavorable commentary or cease publishing reports about us.

If any of the analysts who elect to cover us downgrade their recommendation with respect to our common stock, our stock price could decline rapidly. If any of these analysts ceases coverage of us, we could lose visibility in the market, which in turn could cause our common stock price or trading volume to decline and our common stock to be less liquid.

Our board of directors may issue shares of preferred stock that could adversely affect the rights of our common shareholders.

Our authorized capital stock includes 10,000,000 shares of preferred stock, none of which are issued and outstanding. Our board of directors, in its sole discretion, may designate and issue one or more series of preferred stock from the authorized and unissued shares of preferred stock. Subject to limitations imposed by law or our Articles of Incorporation, our board of directors is empowered to determine:

 

•

the designation of, and the number of, shares constituting each series of preferred stock;

 

•

the dividend rate for each series;

 

•

the terms and conditions of any voting, conversion and exchange rights for each series;

 

•

the amounts payable on each series on redemption or our liquidation, dissolution or winding-up;

 

•

the provisions of any sinking fund for the redemption or purchase of shares of any series; and

 

•

the preferences and the relative rights among the series of preferred stock.

We could issue preferred stock with voting and conversion rights that could adversely affect the voting power of the shares of our common stock and with preferences over the common stock with respect to dividends and in liquidation.

Our internal controls over financial reporting may not be effective and our management may not be able to certify as to their effectiveness, which could impair our ability to accurately report our financial results or prevent fraud, which could have a significant and adverse effect on our business, reputation and the market price of our common stock.

As a public company, our management will be responsible for establishing and maintaining adequate internal control over financial reporting and for evaluating and reporting on that system of internal control. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles (“GAAP”). We are currently in the process of enhancing our internal controls over financial reporting to enable us to comply with our obligations under the federal securities laws and other applicable legal requirements. We are not currently required to comply with SEC rules that implement Section 404 of the Sarbanes-Oxley Act; however, we are required to comply with certain FDIC rules that implement certain requirements under Section 404 of the Sarbanes-Oxley Act. When evaluating our internal controls over financial reporting, we may identify material weaknesses that we may not be able to remediate in

 

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time to meet the applicable deadline imposed upon us for compliance with the requirements of Section 404 of the Sarbanes-Oxley Act. In addition, if we fail to achieve and maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. We cannot be certain as to the timing of completion of our evaluation, testing and any remediation actions or the impact of the same on our operations. If we are not able to implement the requirements of Section 404 of the Sarbanes-Oxley Act in a timely manner or with adequate compliance, our independent registered public accounting firm may issue an adverse opinion due to ineffective internal controls over financial reporting, and we may be subject to sanctions or investigation by regulatory authorities, such as the SEC. As a result, there could be a negative reaction in the financial markets due to a loss of confidence in the reliability of our financial statements.

Furthermore, as we transition to a public company, we intend to continue to improve the effectiveness of our internal controls by hiring additional personnel, utilizing outside consultants and accountants to supplement our internal staff as needed, improving our IT systems, and implementing additional policies and procedures. We anticipate incurring costs in connection with these improvements to our internal control system. If we are unsuccessful in implementing these improvements, we may not be able to accurately and timely report our financial results, conclude on an ongoing basis that we have effective controls over financial reporting or prevent a material weakness in our internal controls over financial reporting, each of which could have a significant and adverse effect on our business, reputation and the market price of our common stock.

In connection with the audit of our 2018 financial statements, we identified material weaknesses in our internal controls over financial reporting.

In connection with the audit of our 2018 financial statements, control deficiencies were identified in our financial reporting process that, in aggregate, constituted a material weakness for the years ended December 31, 2018 and 2017. The identified weaknesses did not result in any restatements or adjustments to our financial statements. The material weaknesses related to:

 

•

Systems internal user access controls. The breadth and levels of employees with the ability to post or change entries to our general ledger created a risk of unauthorized posting or changes of entries. Our remediation efforts included hiring a third-party forensic accountant to review activity for multiple years including the years presented in this filing. We have identified no unauthorized postings or changes to our general ledgers or other financial records.

 

•

Inadequate evidence of manual controls over the general ledger. As a result of inadequate documentation of review of inputs to the general ledger and resulting outputs we were unable to evidence the effectiveness of design and operation of controls.

 

•

Precision of review. Documentation of controls, including management’s entity-level review of results, frequently did not evidence sufficient precision to demonstrate the effectiveness of the design and operation of such controls.

 

•

Completeness of controls related to deposit origination, file maintenance and call backs. Documentation and precision of controls related to deposit origination were insufficient to ensure that all callback of inputs and maintenance that should have occurred actually occurred. In addition, there were instances of a lack of segregation of duties in effecting controls.

 

•

Completeness of controls related to loan origination, file maintenance and call backs. Documentation and precision of controls related to loan origination were insufficient to ensure that all callback of inputs and maintenance that should have occurred actually occurred. In addition, there were instances of a lack of segregation of duties in effecting controls.

 

•

Precision of documentation of methodology in determining the allowance for loan losses and support of judgmental adjustments. Controls surrounding the determination of our allowance for

 

34

loan losses lacked sufficient precision in documentation to determine the effectiveness of review and support for judgmental adjustments. In addition, the processes used to ensure the completeness of reporting on loans identified for closer monitoring and identification of potential troubled debt restructuring were not sufficiently formalized.

During 2019, we committed substantial resources in our efforts to address the issues described above and we believe we have made significant progress toward remediation of the aggregate effect of these issues. We implemented new internal controls such as new internal reports, additional reviews and matching of transactions, segregation of duties and limitation of user access and change management controls that are intended to ensure that access to applications and data is adequately restricted to appropriate internal personnel. To date no additional material weaknesses have been identified, however, there can be no assurance that our remedial actions will be fully effective or will prevent weaknesses from re-occurring.

We are an emerging growth company and the reduced disclosure requirements applicable to emerging growth companies could make our common stock less attractive to investors.

We are an emerging growth company. Under the JOBS Act, emerging growth companies can take advantage of certain exemptions from various reporting requirements that are applicable to other public companies including, without limitation, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, exemptions from the requirements of holding a non-binding advisory shareholder vote on executive compensation and golden parachute payments, exemption from the requirement of auditor attestation in the assessment of our internal control over financial reporting and exemption from any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about our audit and the financial statements (auditor discussion and analysis). As a result of the foregoing, the information that we provide shareholders may be different than what is available with respect to other public companies.

In addition, Section 107 of the JOBS Act also provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. We plan to elect to use the extended period for compliance and, as a result, our financial statements may not be comparable to companies that comply with public company effective dates.

Our securities are not FDIC insured.

Our securities, including our common stock, are not savings or deposit accounts or other obligations of the Bank, are not insured by the Deposit Insurance Fund, the FDIC or any other governmental agency and are subject to investment risk, including the possible loss of your entire investment in our stock.

There is no guarantee that our common stock will be listed on The Nasdaq Stock Market.

We have applied to have our shares of common stock listed on The Nasdaq Stock Market. We believe that we will satisfy the listing requirements and expect that our common stock will be listed on The Nasdaq Stock Market concurrently with the effectiveness of this registration statement. Such listing, however, is not guaranteed. Even if such listing is approved, there can be no assurance any broker will be interested in trading our common stock. We cannot provide any assurance that an active and liquid trading market in our common stock will develop or, if developed, that the market will continue.

Risks related to the business environment and our industry

We are subject to extensive government regulation and supervision, which may interfere with our ability to conduct our business and may negatively impact our financial results.

The Company and the Bank are subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect consumers, depositors’ funds and the safety and soundness of the

 

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banking system as a whole, not our shareholders. These regulations affect the Bank’s lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Company and/or the Bank in substantial and unpredictable ways. Such changes could subject the Company and/or the Bank to additional costs, limit the types of financial services and products the Company and/or the Bank may offer, and/or limit the pricing the Company and/or the Bank may charge on certain banking services, among other things. Compliance personnel and resources may increase our costs of operations and adversely impact our earnings.

Our failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. See “Business—Supervision and Regulation”.

Bank regulatory agencies, including the Federal Reserve, FDIC and the DBO, periodically conduct examinations of our business, including for compliance with laws and regulations, and could subject us to regulatory enforcement actions or other negative consequences.

Bank regulatory agencies, including the Federal Reserve, the FDIC and the DBO, periodically conduct examinations of our business, including our compliance with laws and regulations. If, as a result of an examination, an agency were to determine that the financial, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of any of our operations had become unsatisfactory, or violates any law or regulation, such agency may take certain remedial or enforcement actions it deems appropriate to correct any deficiency. Remedial or enforcement actions include the power to enjoin “unsafe or unsound” practices, to require affirmative actions to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced against a bank, to direct an increase in the bank’s capital, to restrict the bank’s growth, to assess civil monetary penalties against a bank’s officers or directors, and to remove officers and directors. The CFPB also has authority to take enforcement actions, including cease-and desist orders or civil monetary penalties, if it finds that we offer consumer financial products and services in violation of federal consumer financial protection laws.

If a bank regulatory determines that we have violated a law or engaged in an unsafe or unsound practice, we could become subject to a variety of supervisory actions and orders, including cease and desist orders, prompt corrective actions, memoranda of understanding and other regulatory enforcement actions. Such supervisory actions could, among other things, impose greater restrictions on our business, as well as our ability to develop any new business. The Company could also be required to raise additional capital, or dispose of certain assets and liabilities within a prescribed time period, or both. Failure to implement remedial measures as required by financial regulatory agencies could result in additional orders or penalties from federal and state regulators, which could trigger one or more of the remedial actions described above. The terms of any supervisory action and associated consequences with any failure to comply with any supervisory action could have a material negative effect on our business, operating flexibility and overall financial condition.

Monetary policies and regulations of the Federal Reserve could adversely affect our business, financial condition and results of operations.

In addition to being affected by general economic conditions, our earnings and growth are affected by the policies of the Federal Reserve. An important function of the Federal Reserve is to regulate the money supply and credit conditions. Among the instruments used by the Federal Reserve to implement these objectives are open market operations in U.S. government securities, adjustments of the discount rate and changes in reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall

 

36

economic growth and the distribution of credit, bank loans, investments and deposits. Their use also affects interest rates charged on loans or paid on deposits. The monetary policies and regulations of the Federal Reserve have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. The effects of such policies upon our business, financial condition and results of operations cannot be predicted.

Our deposit insurance premiums could be substantially higher in the future, which could have a material adverse effect on our future earnings.

The FDIC insures deposits at FDIC-insured depository institutions, such as the Bank, up to applicable limits. The amount of a particular institution’s deposit insurance assessment is based on that institution’s risk classification under an FDIC risk-based assessment system. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to its regulators. Past market developments and bank failures significantly depleted the FDIC’s Deposit Insurance Fund and reduced the ratio of reserves to insured deposits. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures, we may be required to pay higher FDIC premiums. Any future additional assessments, increases or required prepayments in FDIC insurance premiums could reduce our profitability, may limit our ability to pursue certain business opportunities or otherwise negatively impact our operations.

We are subject to federal and state fair lending laws, and failure to comply with these laws could lead to material penalties.

Federal and state fair lending laws and regulations, such as the Equal Credit Opportunity Act and the Fair Housing Act, impose nondiscriminatory lending requirements on financial institutions. The Department of Justice, CFPB, the federal banking agencies and other federal and state agencies are responsible for enforcing these laws and regulations. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. A successful challenge to our performance under the fair lending laws and regulations could adversely impact our rating under the Community Reinvestment Act and result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on merger and acquisition activity and restrictions on expansion activity, which could negatively impact our reputation, business, financial condition and results of operations.

We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.

The Bank Secrecy Act of 1970, the USA PATRIOT Act and other laws and regulations require financial institutions, among other duties, to institute and maintain effective anti-money laundering programs and file suspicious activity and currency transaction reports as appropriate. If our policies, procedures and systems are deemed deficient we could be subject to liability, including fines, regulatory actions and regulatory restrictions on our ability to proceed with certain aspects of our business plan or expansionary activities, which would negatively impact our business, financial condition and results of operations. Failure to maintain and implement adequate programs to combat money laundering could also have serious reputational consequences for us. See “Business—Supervision and Regulation—Regulation of the Bank.”

 

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ITEM 2. FINANCIAL INFORMATION

Selected Financial Data

The following table sets forth summary historical consolidated financial data as of the dates and for the periods shown. On June 30, 2017, we completed a reorganization in which California BanCorp became the Bank’s holding company. The summary balance sheet data as of 2018 and 2017 and the summary income statement data for 2018 and 2017 have been derived from our audited consolidated financial statements included elsewhere in this registration statement. The summary consolidated financial data as of and for the nine months ended September 30, 2019 and 2018 is derived from our unaudited interim consolidated financial statements included elsewhere in this registration statement or derived from our internal financial statements and includes all normal and recurring adjustments that we consider necessary for a fair presentation. Operating results for the nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.

You should read the following financial data in conjunction with the other information contained in this registration statement, including under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in the financial statements and related notes thereto included elsewhere in this registration statement.

 

		(unaudited) As of and for the nine months ended September 30,								(audited) As of and for the year ended December 31,
		2019				2018				2018				2017
		(dollars in thousands, except per share data)
Income Statement Data:
Net interest income		$	30,354			$	26,274			$	35,833			$	31,533
Provision for loan losses			1,326				845				1,435				2,393
Non-interest income			3,100				2,854				3,716				3,091
Non-interest expense			23,397				19,281				26,372				20,945
Income (loss) before taxes			8,731				9,002				11,742				11,286
Provision for income taxes			2,309				2,397				3,029				5,659
Net (loss) Income		$	6,422			$	6,605			$	8,713			$	5,627
Per Share Data:
Average shares of common stock outstanding, basic			8,040,196				6,828,104				7,120,986				6,298,971
Average shares of common stock outstanding, diluted			8,120,376				7,056,597				7,317,612				6,642,508
Total shares of common stock outstanding			8,052,549				7,974,856				7,993,908				6,416,295
Basic income (loss) per share		$	0.80			$	0.97			$	1.22			$	0.89
Diluted income (loss) per share		$	0.79			$	0.94			$	1.19			$	0.85
Dividends declared per share		$	—			$	—			$	—			$	—
Dividend payout ratio			—	%			—	%			—	%			—	%
Book value (at period end)		$	16.02			$	14.82			$	15.15			$	13.21
Balance Sheet Data:
Gross Loans held for investment		$	933,278			$	782,978			$	844,728			$	729,937
Allowance for loan losses		$	10,413			$	10,200			$	10,800			$	9,300
Total Assets		$	1,094,609			$	954,608			$	1,005,677			$	866,470
Deposits		$	923,910			$	826,389			$	874,254			$	760,373
Shareholders’ Equity		$	129,002			$	118,227			$	121,079			$	84,743

 

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		(unaudited) As of and for the nine months ended September 30,								(audited) As of and for the year ended December 31,
		2019				2018				2018				2017
		(dollars in thousands, except per share data)
Performance Ratios:
Return on average assets			0.83	%			0.97	%			0.94	%			0.69	%
Return on average equity			6.87	%			9.38	%			8.65	%			6.84	%
Net interest rate spread(1)			3.63	%			3.66	%			3.64	%			3.85	%
Net interest margin(2)			4.20	%			4.08	%			4.09	%			4.15	%
Efficiency ratio(3)			69.94	%			66.19	%			66.68	%			60.49	%
Asset Quality Data (at Period End):
(Net charge-offs) recoveries to average loans held for investment (annualized)			(0.26	)%			0.01	%			0.01	%			(0.09	)%
Nonperforming assets to loans held for investment plus OREO			0.50	%			0.22	%			0.53	%			0.07	%
Allowance for loan losses to nonperforming loans			223	%			582	%			242	%			1,922	%
Allowance for loan losses to loans held for investment			1.12	%			1.30	%			1.28	%			1.27	%
Balance Sheet and Capital Ratios(4):
Loans held for investment to deposits			101.0	%			94.7	%			96.6	%			96.0	%
Tangible common equity to tangible assets			11.17	%			11.68	%			11.37	%			8.98	%
Leverage ratio			11.44	%			11.53	%			11.57	%			8.74	%
Tier 1 risk-based capital ratio			10.89	%			11.89	%			11.18	%			8.89	%
Total risk-based capital ratio			12.33	%			13.61	%			12.76	%			10.73	%

 

(1)	The interest rate spread represents the difference between the fully taxable equivalent weighted-average yield on interest-earning assets and the weighted-average cost of interest-bearing liabilities for the period.

(2)	The net interest margin represents fully taxable equivalent net interest income as a percent of average interest-earning assets for the period.

(3)	The efficiency ratio represents noninterest expense as a percentage of the sum of net interest income on a fully taxable equivalent basis and noninterest income.

(4)	Capital ratios for the nine months ended September 30, 2019 and 2018 and for the years ended December 31, 2018 and 2017 are for California BanCorp on a consolidated basis.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our consolidated financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes. Historical results of operations and the percentage relationships among any amounts included, and any trends that may appear, may not indicate trends in operations or results of operations for any future periods. We are a bank holding company and we conduct all of our material business operations through the Bank. As a result, the discussion and analysis below primarily relate to activities conducted at the Bank level.

Overview

California BanCorp is a California corporation that was organized to serve as the holding company for California Bank of Commerce. On June 30, 2017, we completed a reorganization in which California BanCorp became the Bank’s holding company. As a registered bank holding company under the Bank Holding Company Act, the Company is subject supervision and regulation by the Federal Reserve.

California Bank of Commerce, which was incorporated in 2007, is a California -chartered commercial bank headquartered in Lafayette, California. The Bank is regulated by the FDIC and the DBO and is not a member of the Federal Reserve. The Bank has seven offices, six of which are in the San Francisco Bay Area and all of which are in Northern California. These offices include three banking offices in Lafayette (the Bank’s headquarters), Fremont and San Jose, where the Bank offers loan, deposit and treasury management products. The Bank also has four loan production offices in Oakland, Walnut Creek, San Jose and Sacramento, California.

As with most community banks, the Bank derives a significant portion of its income from interest received on loans and investments. The Bank’s primary source of funding is deposits, both interest-bearing and noninterest-bearing. In order to maximize the Bank’s net interest income, or the difference between the income on interest-earning assets and the expense of interest-bearing liabilities, the Bank must not only manage the volume of these balance sheet items, but also the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities. To account for credit risk inherent in all loans, the Bank maintains an allowance for loan losses to absorb possible losses on existing loans that may become uncollectible. The Bank establishes and maintains this allowance by charging a provision for loan losses against operating earnings. Beyond its net interest income, the Bank further receives income through the net gain on sale of loans held for sale as well as servicing income which is retained on those sold loans. In order to maintain its operations and bank locations, the Bank incurs various operating expenses which are further described within the “Results of Operations” later in this section.

As of September 30, 2019, the Company had total consolidated assets of $1.1 billion, total net loans of $925.3 million, total deposits of $923.9 million and total shareholders’ equity of $129.0 million. The Company employs approximately 133.5 full-time equivalent employees and has an assets-to-FTE ratio of approximately $8.2 million.

Critical Accounting Policies and Estimates

Our accounting and reporting policies conform to accounting principles generally accepted in the United States of America (“GAAP”) and conform to general practices within the industry in which we operate. To prepare financial statements in conformity with GAAP, management makes estimates, assumptions and judgments based on available information. These estimates, assumptions and judgments affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements and, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the financial statement. In particular, management has identified several accounting policies that, due to the estimates, assumptions and judgments inherent in those policies, are critical in understanding our financial statements.

 

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The following is a discussion of the critical accounting policies and significant estimates that require us to make complex and subjective judgments. Additional information about these policies can be found in Note 1 of our consolidated financial statements as of December 31, 2018, included elsewhere in this registration statement.

Allowance for Loan Losses

The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

The allowance for loan losses is maintained at a level that management believes is appropriate to provide for known and inherent incurred loan losses as of the date of the consolidated balance sheet and we have established methodologies for the determination of its adequacy. The methodologies are set forth in a formal policy and take into consideration the need for an overall general valuation allowance as well as specific allowances that are determined on an individual loan basis.

The evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. While management uses available information to recognize losses on loans, changes in economic or other conditions may necessitate revision of the estimate in future periods.

As of and for the Year Ended December 31, 2018 Compared to the Year Ended December 31, 2017

Summary of Performance

We recognized net income of $8.7 million in 2018, compared to $5.6 million in 2017. The $3.1 million or 55% increase in net income in 2018 compared to 2017 was primarily the result of increases in net interest income and noninterest income, and decreases in provisions for loan losses and income taxes. Partially offsetting these improvements was an increase in noninterest expense. The following are some of the significant factors impacting our results of operations:

 

•

Net interest income increased by $4.3 million or 14% in 2018 compared to 2017. The increase in net interest income compared to 2017 was primarily the result of significant growth in average earning assets of $114.9 million, or 15% in 2018 compared to the prior year.

 

•

Noninterest income increased by $624 thousand or 20% in 2018 compared to 2017.    The increase in noninterest income in 2018 resulted primarily from increases in servicing income and gain-on-sale of investment securities in comparison to 2017 of $467 thousand and $159 thousand, respectively.

 

•

Our loan loss provision was $1.4 million in 2018, compared to $2.4 million in 2017. Our allowance for loan losses as a percentage of loans at December 31, 2018 was 1.28% compared to 1.27% at December 31, 2017.

 

•

Noninterest expense grew by $5.4 million or 26% in 2018 compared to 2017. The growth in operating expenses was mostly due to continued investment in resources to grow through customer acquisition and to service the growing number of customer relationships.

 

•

Income tax expense decreased by $2.6 million or 46% in 2018 compared to 2017.    In addition, our effective tax rate decreased significantly to 25.8% in 2018 from 50.1% in 2017.

As of December 31, 2018, we had total assets of $1.0 billion, compared to $866.5 million at December 31, 2017. The following are some of the significant factors impacting the changes in our financial condition:

 

•

Total assets increased by $139.2 million or 16% in 2018 compared to 2017.

 

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•

Gross loans grew by $114.2 million or 16% in 2018 compared to 2017.

 

•

Total deposits grew by $113.9 million or 15% in 2018 compared to 2017.    Interest bearing demand deposits grew by $76.0 million or 17% in 2018 compared to 2017.

 

•

Total shareholders’ equity increased by $36.3 million or 43% in 2018 compared to 2017.    In August 2018 the Company raised $25.0 million in gross proceeds from a private placement of common stock. As of December 31, 2018 the Company’s total risk-based capital ratio was 12.8% and its Tier 1 leverage ratio was 11.6%.

Results of Operations

Net Interest Income and Net Interest Margin

Net interest income, the difference between interest income and interest expense, is the largest component of our total revenue. Management closely monitors both total net interest income and the net interest margin (net interest income divided by average earning assets). We seek to maximize net interest income without exposing us to an excessive level of interest rate risk through our asset and liability management policies. Interest rate risk is managed by monitoring the pricing, maturity and repricing options of all classes of interest-bearing assets and liabilities. Our net interest margin is adversely impacted by the reversal of interest on nonaccrual loans and the reinvestment of loan payoffs into lower yielding investment securities and other short term investments.

Our net interest income was $35.8 million in 2018, compared to $31.5 million in 2017. The level of our net interest income depends on several factors in combination, including growth in earning assets, the mix of earning assets by loan type and by security type, the cost of interest-bearing liabilities and the mix of noninterest earning deposits to total deposits. The increase in 2018 of $4.3 million, or 14%, was primarily due to increases in interest income earned on our loan portfolio of $4.7 million, cash and equivalents of $1.2 million and investment securities of $360 thousand, partially offset by an increase in interest paid on deposits of $2.0 million.

 

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The following table shows, for each of 2018 and 2017, the annual average balance for each principal balance sheet category, and the amount of interest income or expense associated with that category. This table also shows the yields earned on each major component of our investment and loan portfolio, the average rates paid on each key segment of our interest bearing liabilities, and the net interest margin.

Distribution, Yield and Rate Analysis of Net Income

 

		Year Ended December 31,
		2018												2017
		Average Balance				Interest Income / Expense				Average Yield / Rate				Average Balance				Interest Income / Expense				Average Yield / Rate
Assets:
Loans, gross(1)		$	755,659,225			$	38,443,340				5.09	%		$	691,519,750			$	33,771,736				4.88	%
Securities			23,377,672				635,410				2.72	%			14,332,846				275,310				1.92	%
Interest bearing deposits and fed funds sold			97,250,623				1,859,592				1.91	%			54,289,869				645,603				1.19	%
Total interest earning assets(2)			876,287,520				40,938,342				4.67	%			760,142,465				34,692,649				4.56	%
Cash and due from banks			18,497,543												17,420,888
Premises and equipment, net			2,426,713												2,622,877
Goodwill and other intangible assets			7,768,128												7,824,263
Other assets			25,376,764												25,818,202
Total assets		$	930,356,668											$	813,828,695
Liabilities and shareholders’ equity:
Deposits:
Demand, noninterest-bearing		$	331,809,172											$	282,385,494
Demand, interest-bearing			26,199,672				21,697				0.08	%			22,230,626				17,349				0.08	%
Savings and money market			363,232,025				3,004,131				0.83	%			308,350,672				1,610,824				0.52	%
Time deposits—under $100,000			6,584,456				61,347				0.93	%			7,774,269				67,128				0.86	%
Time deposits—$100,000 and Over			85,839,772				1,374,270				1.60	%			84,248,746				745,604				0.89	%
Total interest-bearing deposits			481,855,925				4,461,445				0.93	%			422,604,313				2,440,905				0.58	%
Total deposits			813,665,097				4,461,445				0.55	%			704,989,807				2,440,905				0.35	%
Borrowings			11,908,315				644,221				5.41	%			24,134,410				718,411				2.98	%
Total interest-bearing liabilities			493,764,240				5,105,666				1.03	%			446,738,723				3,159,316				0.71	%
Other liabilities			4,072,444												2,403,170
Total liabilities			829,645,856												731,527,387
Shareholders’ equity			100,710,812												82,301,308
Total liabilities and shareholders’ equity			$930,356,668												$813,828,695
Net interest income / margin(2)											4.09	%											4.15	%
Net interest income						$	35,832,676											$	31,533,333

 

(1)	Loan fees have been included in the calculation of interest income. Loan fees were $1,246,548 and $1,237,288 for the years ended December 31, 2018 and 2017, respectively. Loans are net of deferred fees and related direct costs.

(2)	Net interest margin is net interest income divided by total interest earning assets.

 

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The following table sets forth the dollar difference in interest earned and paid for each major category of interest-earning assets and interest-bearing liabilities for the noted periods, and the amount of such change attributable to changes in average balances (volume) or changes in average interest rates. Volume variances are equal to the increase or decrease in average balance multiplied by current period rates, and rate variances are equal to the increase or decrease in rate times prior period average balances. Variances attributable to both rate and volume changes are calculated by multiplying the change in rate by the change in average balance, and are allocated to the volume variance.

Rate/Volume Analysis of Net Interest Income

 

		2018 vs. 2017
		Increase (Decrease) Due to Change in:
		Average Volume				Average Rate				Net Change
Income from the interest earning assets:
Loans, gross		$	3,434,105			$	1,237,499			$	4,671,604
Securities			257,669				102,431				360,100
Interest bearing deposits and fed funds sold			821,146				392,843				1,213,989
Total interest income on interest earning assets			4,512,920				1,732,773				6,245,693
Expense from the interest-bearing liabilities:
Demand, interest-bearing			3,287				1,061				4,348
Savings and money market			453,899				939,408				1,393,307
Time deposits-under $100,000			(11,085	)			5,304				(5,781	)
Time deposits—$100,000 and over			25,472				603,194				628,666
Total interest expense on interest-bearing deposits			471,573				1,548,967				2,020,540
Borrowings			61,839				(136,029	)			(74,190	)
Net interest income		$	3,979,508			$	319,835			$	4,299,343

Interest Income

Our interest income increased by $6.2 million in 2018 compared to 2017 primarily due to volume growth in average earning assets, and in particular an increase in loans. The increase in interest earned on our loan portfolio in 2018 of $4.7 million was comprised of $3.4 million attributable to an approximate $64.1 million increase in average loans outstanding and $1.2 million attributable to an increase in the yield earned on loans to 5.09% in 2018 from 4.88% in 2017.    

In addition to the increase in interest earned on loans, in 2018 interest income also increased by $1.6 million as a result of higher volume levels in interest-bearing due from banks and investment securities. In 2018 average interest-bearing due from banks increased $41.7 million and average investment securities increased approximately $9.0 million. Interest income also benefited from increased yields on interest-bearing deposits and investment securities. Yields on interest-bearing deposits were 1.91% in 2018 compared to 1.19% in 2017, resulting in an increase of $393 thousand in interest income. This increase in yield was directly related to increases in fed funds rates as a result of open market operations of the Federal Reserve in 2018. The yield earned on investment securities also increased to 2.72% in compared to 1.92% in 2017, largely the effect of generally higher medium and long term interest rates and slightly higher duration in the portfolio which resulted in an increase in interest income of $102 thousand.

 

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Interest Expense

Our interest expense increased by $1.9 million in 2018 primarily due to the effect of increased rates paid on interest-bearing deposits and the overall growth in the volume of average interest-bearing deposits to fund earning asset growth. The average rate paid on interest-bearing deposits in 2018 increased 35 basis points to 0.93% from 0.58% in 2017, which accounted for $1.5 million of the total increase in interest expense. An additional increase in interest expense of $472 thousand was attributable to an increase in average interest-bearing deposits of $59.3 million. Partially offsetting these increases was a reduction in interest cost related to borrowings of $74 thousand as the Company paid off $11 million of senior notes in August of 2018.

Our overall cost of deposits was 0.55% in 2018 compared to 0.35% in 2017 as growth in average noninterest bearing demand deposits offset, in part, the cost of average interest-bearing deposits. Average noninterest bearing demand deposits of $331.8 million in 2018 represented 41% of total deposits compared to $282.4 million and 40% in 2017. Our ability to manage the cost of our deposit funding is partially dependent on our ability to continue to attract noninterest-bearing demand deposits as part of a business banking relationship with our customers.

Provision for Loan Losses

The provision for loan losses was $1.4 million in 2018 compared to $2.4 million in 2017. The decrease in provision in 2018 was primarily due to lower net charge-off experience as well as a higher proportion of loan growth in lower risk-rated categories compared to 2017. In 2018, we recognized $64 thousand in net recoveries which compared to $618 thousand in net charge-offs recognized in 2017. Our allowance for loan loss as a percent of outstanding loans increased slightly to 1.28% at December 31, 2018 from 1.27% at the end of 2017. Our loan loss provisions have been sufficient to maintain an allowance for loan losses at a level that, in management’s judgment, is sufficient to absorb probable losses related to specifically identified impairment loans, as well as the probable incurred losses on the remaining loan portfolio. The process to establish an appropriate allowance for loan loss is discussed further below under “Allowance for Loan Losses.”

Noninterest Income

The following table sets forth the various components of our noninterest income for the periods indicated:

Noninterest Income

 

		Year Ended December 31,								Increase (Decrease) 2018 versus 2017
		2018				2017				Amount				Percent
Service charges and fees on deposit accounts		$	2,451,405			$	1,983,913			$	467,492				24	%
Gain on sales of loans			417,520				258,879				158,641				61	%
Earnings on BOLI			251,726				434,123				(182,397	)			-42	%
Gain on sales of investment securities			96,568				—				96,568				N/M
Other			498,693				414,511				84,182				20	%
Total		$	3,715,912			$	3,091,426			$	624,486				20	%

In 2018, noninterest income increased by $624 thousand or 20%, as service charges, gain-on-sale of loans, gain-on-sale of investment securities and other income increased by $467 thousand, $158 thousand, $97 thousand and $84 thousand, respectively. However, these increases were partially offset by a $182 thousand decline in net earnings on bank owned life insurance contracts.

 

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Noninterest Expense

The following table sets forth our noninterest expenses for the periods indicated:

Noninterest Expense

 

		Year Ended December 31,								Increase (Decrease) 2018 versus 2017
		2018				2017				Amount				Percent
Salaries and employee benefits		$	15,572,646			$	12,342,860			$	3,229,786				26	%
Occupancy and equipment			2,917,875				2,458,132				459,743				19	%
Professional fees			1,761,108				921,417				839,691				91	%
Data processing			1,539,842				1,455,791				84,051				6	%
Directors’ stock-based and other compensation			978,347				734,079				244,268				33	%
Advertising and marketing			781,370				612,616				168,754				28	%
Regulatory assessments and insurance			525,354				523,677				1,677				0	%
Loan Processing			523,726				515,136				8,590				2	%
Other			1,771,258				1,381,566				389,692				28	%
Total		$	26,371,526			$	20,945,274			$	5,426,252				26	%

Noninterest expense grew by $5.4 million, in 2018, compared to 2017. The largest component of noninterest expense is salaries and benefit expense, which increased by approximately $3.2 million or 26% in 2018. The increase in salary and benefits expense was primarily the result of hiring of key executive, lending and operational staff positions to support the Company’s continued growth. The number of full-time equivalent staff grew from 103 as of December 31, 2017 to 118 at the end of 2018. In addition, during 2018 we incurred $442 thousand in nonrecurring expenses related to transition of our former Chief Executive Officer. Occupancy and equipment cost increased by $459 thousand in 2018, the result of expansion to a new Walnut Creek, California location in the second half of 2017 and the addition of space to our Oakland, California office in early 2018. Professional fees increased by $839 thousand in 2018 the result of costs incurred related to various strategic initiatives, a private capital raise, and work to prepare for compliance with the internal controls framework applied to banks with assets greater than $1.0 billion set forth in the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”).

Provision for Income Taxes

Income tax expense was $3.0 million for the year ending December 31, 2018, a decrease of $2.6 million from the tax provision for 2017. For 2018 and 2017, our effective tax rates were 25.8% and 50.1%, respectively. The effective tax rate for 2018 compared to 2017 was reduced primarily as a result of lower corporate tax rates which were enacted by the Tax Cuts and Jobs Act.

Financial Condition

Summary

Assets grew by $139.2 million to $1.0 billion as of December 31, 2018, compared to $866.5 billion as of December 31, 2017. The increase in assets was primarily due to loan growth, which was $114.2 million or 16% in 2018 compared to 2017. In addition, investment securities and interest bearing deposits increased by $20.7 million in 2018.

Growth in assets was primarily funded by growth in deposits. Substantially all of our funding comes from deposits maintained by core business customer relationships. In 2018, deposits grew by $113.9 million or 15%,

 

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of which $37.9 million was noninterest-bearing demand accounts and $76.0 million was interest-bearing deposits. In addition, during 2018 we raised $23.6 million (net of issuance costs) through a private placement of common stock and used $11.0 million of the proceeds to retire senior notes that were outstanding as of December 31, 2017. Our capital also grew by $8.7 million through retention of earnings and $4.0 million related to share issuance/activity under stock compensation plans.

Loan Portfolio

Our loan portfolio consists primarily of loans to customers who have a full banking relationship with the Bank. Our business banking model emphasizes commercial and industrial loans and, in addition, substantial percentage of the commercial real estate loans are considered owner-occupied loans. Our loans are generated by our relationship managers and executives. Our senior management is actively involved in the lending, underwriting, and collateral valuation processes. Higher dollar loans or loan commitments are also approved through the Bank’s loan committee comprised of executives and outside board members.

The following tables set forth the composition of our loan portfolio as of the dates indicated:

Loan Portfolio Composition

 

		2018				2017
Loans:
Commercial & Industrial		$	336,234,467			$	329,030,432
Real estate—Construction & Land			42,294,500				41,264,748
Real estate—Other			451,850,943				344,817,073
Real estate—HELOC			2,064,056				3,618,113
Installment and other			12,284,106				11,206,703
Loans			844,728,072				729,937,069
Deferred loan origination costs, net			2,203,164				2,827,835
Allowance for loan losses			(10,800,000	)			(9,300,000	)
Loans, net		$	836,131,236			$	723,464,904

 

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Loan Maturities

The following table shows the maturity distribution for total loans outstanding as of December 31, 2018. The maturity distribution is grouped by remaining scheduled principal payments that are due within one year, after one but within five years, or after five years. The principal balance of loans are indicated by both fixed and floating rate categories.

Loan Maturities and Re-pricing Schedule

 

		Due in One Year Or Less				Over One Year But Less than Five Years				Over Five Years				Total				Loans with Fixed Rates(1)				Loans with Variable Rates
		(Dollars in thousands)
Commercial & Industrial		$	119,704,919			$	75,193,809			$	141,335,739			$	336,234,467			$	189,814,488			$	146,419,979
Real estate—Construction & Land			29,203,958				9,049,159				4,041,383				42,294,500				4,214,229				38,080,271
Real estate—Other			18,991,720				82,898,991				349,960,232				451,850,943				181,379,445				270,471,498
Real estate—HELOC			1,063,055				611,000				390,001				2,064,056				—				2,064,056
Installment and other			76,535				528,282				11,679,289				12,284,106				1,609,360				10,674,746
Loans		$	169,040,187			$	168,281,241			$	507,406,644			$	844,728,072			$	377,017,522			$	467,710,550

 

(1)	Excludes variable rate loans on floors.

Off-Balance Sheet Arrangements

In the normal course of our business, we make commitments to extend credit to our customers as long as there are no violations of any conditions established in contractual arrangements. Total unused commitments to extend credit were $325.5 million at December 31, 2018, compared to $275.0 million at December 31, 2017. Unused commitments represented 38% of gross loans outstanding at December 31, 2018 and 2017, respectively. We also had $7.5 million in standby letters of credit and commercial letters of credit at December 31, 2018 and $5.3 million in standby letters of credit at December 31, 2017. These commitments are obligations that represent a potential credit risk to us, and a $150 thousand reserve for unfunded commitments is reflected as a liability in our balance sheet at December 31, 2018.

The effect on our revenues, expenses, cash flows and liquidity from the unused portion of the commitments to provide credit cannot be reasonably predicted, because there is no certainty that lines of credit will ever be fully utilized. For more information regarding our off-balance sheet arrangements, see Note 12 to our audited financial statements at and or the years ended December 31, 2018 and 2017.

Contractual Obligations

At the end of 2018, we had contractual obligations for the following payments, by type and period due:

 

		2018				2017
Operating leases		$	7,283,754			$	7,477,068

Nonperforming Assets

Nonperforming assets are comprised of loans on non-accrual status, loans 90 days or more past due and still accruing interest, and other real estate owned. A loan is placed in non-accrual status if there is concern that principal and interest

 

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may not be fully collected or if the loan has been past due for a period of 90 days or more, unless the obligation is both well secured and in process of legal collection. When loans are placed on non-accrual status, all interest previously accrued but not collected is reversed against current period interest income. Income on non-accrual loans is subsequently recognized only to the extent that cash is received and the loan’s principal balance is deemed collectible. Loans are returned to accrual status when they are brought current with respect to principal and interest payments and future payments are reasonably assured. Other real estate owned is acquired in satisfaction of loans through foreclosure or other means and is carried on an individual asset basis at the lower of the recorded investment in the related loan or the estimated fair value of the property, less selling expenses. Loans in which the borrower is encountering financial difficulties and we have modified the terms of the original loan are evaluated for impairment and classified as troubled debt restructured loans (“TDR”).

Non-accrual loans at December 31, 2017 totaled $484,000 consisting of one commercial and industrial loan. At December 31, 2018, non-accrual loans totaled $4.46 million consisting of eight loans across four relationships, each of which was in in the commercial and industry segment. At December 31, 2018, the largest non-accrual relationship totaled $2.37 million consisting of three loans. The relationship was placed into a non-accrual status late in 2018 as a result of continued overdrafts and delayed loan payments. The second largest non-accrual relationship at December 31, 2018 totaled $1.24 million consisting of three loans. The relationship was placed into a non-accrual status in the summer of 2018 as a result of continued overdrafts, delayed loan payments, and inability to provide current financial information due to business losses incurred by the borrower. These two relationships account for 81% of the non-accrual balance as of December 31, 2018. We had no loans 90 days or more past due and still accruing interest as of December 31, 2018.

The following table presents information concerning our nonperforming and restructured loans as of the dates indicated:

Nonperforming and Restructured Loans

 

		December 31,
		2018				2017
Nonaccrual loans		$	4,463,232			$	483,885
Loans 90 days past due and still accruing			—				—
Total nonperforming loans			4,463,232				483,885
Foreclosed assets			—				—
Total nonperforming assets		$	4,463,232			$	483,885
Performing TDRs		$	930,123			$	1,877,681

Allowance for Loan Losses

We establish an allowance for loan losses, through a provision for loan losses, for both specific losses on impaired loans and the inherent risk of probable loss for non-impaired loans based on loan grades, loan characteristics, and economic trends. The allowance for loan losses consists of specific and general components. The allowance for loan losses is evaluated on a regular basis by management and the estimate is based upon management’s periodic review of the collectability of the loans that considers historical loss experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. The specific component relates to loans that are considered impaired for which an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

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Our allowance for loan losses was $10.8 million at December 31, 2018, compared to $9.3 million at December 31, 2017. The increase was the result of a provision for loan losses of $1.4 million and $64 thousand in recoveries during 2018. The allowance for loan loss as a percent of outstanding loans increased slightly to 1.28% at December 31, 2018 to 1.27% at the end of 2017. The $1.4 million provision for loan losses in 2018 was generally attributable to loan portfolio growth.

A loan is considered impaired when, based on current information and events, management concludes that it is probable that we will be unable to collect all amounts due (principal and interest) according to the original contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and probability of collecting scheduled principal and interest payments. Measurement of impairment is based on the present value of expected future cash flows of the impaired loan, which are discounted at the loan’s effective interest rate. For collateral-dependent loans, we use the fair value of the collateral for the impaired loan to measure impairment. An impairment allowance is established to record the difference between the carrying amount of the loan and the present value, or in the case of a collateral-dependent loan, the fair value of the collateral. As of December 31, 2018, we identified loans totaling $6.4 million as impaired, requiring reserves of $205 thousand, compared to $4.8 million, requiring reserves of $46 thousand at December 31, 2017.

The allowance for loan loss is maintained at a level that management believes is adequate to provide for loan losses based on currently available information. A comprehensive discussion concerning our allowance for loan loss is included in Note 5 of the accompanying Financial Statements for the year ended December 31, 2018.

The following table summarizes the activity in the allowance for loan losses for the periods indicated:

Allowance for Loan Losses

 

		2018				2017
Balance, beginning of year		$	9,300,000			$	7,525,000
Charge-offs:
Commercial & Industrial			—				(826,137	)
Real estate—Construction & Land			—				—
Real estate—Other			—				—
Real estate—HELOC			—				—
Installment and other			—				—
Total charge-offs			—				(826,137	)
Recoveries:
Commercial & Industrial			64,600				57,972
Real estate—Construction & Land			—				—
Real estate—Other			—				150,000
Real estate—HELOC			—				—
Installment and other			—				—
Total recoveries			64,600				207,972
Net recoveries (charge-offs)			64,600				(618,165	)
Provision (credit) for loan losses			1,435,400				2,393,165
Balance, end of year		$	10,800,000			$	9,300,000
Ratios:
Net recoveries (charge-offs) to average loans			0.01	%			(0.09	)%
Allowance for loan losses to total loans			1.28	%			1.27	%
Allowance for loan losses to nonperforming loans			242	%			1,922	%

 

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Allocation of Allowance for Loan Losses

Provided below is a summary of the allocation of the allowance for loan losses for specific loan categories at the dates indicated. The allocation presented should not be viewed as an indication that charges to the allowance will be incurred in these amounts or proportions, or that the portion of the allowance allocated to each loan category represents the total amounts available for charge-offs that may occur within these categories.

 

		December 31
		2018								2017
		Allowance				Percent of allowance to total loans in each category				Allowance				Percent of allowance to total loans in each category
Commercial & Industrial		$	5,577,564				1.66	%		$	5,529,735				1.68	%
Real estate—Construction & Land			1,493,045				3.53	%			769,719				1.87	%
Real estate—Other			3,703,298				0.82	%			2,929,445				0.85	%
Real estate—HELOC			15,762				0.76	%			42,077				1.16	%
Installment and other			10,331				0.08	%			29,024				0.26	%
Total		$	10,800,000				1.28	%		$	9,300,000				1.27	%

Investment Portfolio

Our investment portfolio is comprised of debt securities. We use two classifications for our investment portfolio: available-for-sale (AFS) and held-to-maturity (HTM). Securities that we have the positive intent and ability to hold to maturity are classified as “held-to-maturity securities” and reported at amortized cost. Securities not classified as held-to-maturity securities are classified as “investment securities available-for-sale” and reported at fair value. At December 31, 2018, our held-to-maturity investments totaled $6.0 million. We had no investment securities classified as held-to-maturity at December 31, 2017. Available-for sale securities had a total fair value of $37.4 million and $13.0 million at the end of 2018 and 2017, respectively. We also maintain surplus liquidity in interest earning accounts at banks and at the Federal Reserve Bank. As of December 31, 2018 and 2017, these assets totaled approximately $55.2 million and $65.0 million, respectively.

Our investments provide a source of liquidity because we can pledge them to support borrowed funds or can liquidate them to generate cash proceeds. Our investment portfolio is also a resource in managing interest rate risk, because the maturity and interest rate characteristics of this asset class can be readily changed to match changes in the loan and deposit portfolios. The majority of our available-for-sale investment portfolio is comprised of mortgage-backed securities (MBSs) that are either issued or guaranteed by U.S. government agencies or government-sponsored enterprises (GSEs). During 2018, we increased our investment portfolio to reduce asset sensitivity in response to changes in the interest rate environment. During 2018, we purchased $47.0 million in AFS securities and sold $18.9 million, realizing gains of $96 thousand on those sales.

As of December 31, 2018, the fair value of the available-for-sale portfolio was approximately equal to amortized cost. The HTM portfolio is comprised securities issued or guaranteed by U.S. government agencies or GSEs.

 

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