Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain matters discussed in this Form 10-Q may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate, projections of future performance or financial items, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management expectations and may, therefore, involve risks and uncertainties. Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward- looking statements as a result of a wide variety or range of factors including, but not limited to:
● potential adverse impacts to economic conditions in general and in California, Colorado, New Mexico and Washington specifically, other markets where the Company has lending relationships, or other aspects of the Company’s business operations or financial markets, including, without limitation, as a result of employment levels, labor shortages and the effects of inflation, a potential recession, or slowed economic growth caused by increasing political instability from acts of war, as well as supply chain disruptions;
● changes in the interest rate environment, including the recent increases in the Board of Governors of the Federal Reserve System (“Federal Reserve”) benchmark rate and duration at which such increased interest rate levels are maintained, which could adversely affect our revenues and expenses, the values of our assets and obligations, and the availability and cost of capital and liquidity;
● the impact of continuing high inflation and the current and future monetary policies of the Federal Reserve in response thereto;
● the effects of any federal government shutdown;
● expected revenues, cost savings, synergies and other benefits from our recent acquisition of Pacific Enterprise Bancorp (“PEB”) might not be realized within the expected time frames or at all and costs or difficulties relating to integration matters, including but not limited to client and employee retention, might be greater than expected;
● the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for credit losses and provision for credit losses;
● changes in the levels of general interest rates and the relative differences between short and long-term interest rates and loan and deposit interest rates;
● the possibility that unexpected outflows of uninsured deposits may require us to sell investment securities at a loss;
● our net interest margin and funding sources;
● fluctuations in the demand for loans and the number of unsold homes, land and other properties;
● fluctuations in real estate values in our market areas;
● secondary market conditions for loans and our ability to sell loans in the secondary market;
● results of examinations of us by regulatory authorities and the possibility that any such regulatory authority may, among other things, limit our business activities, require us to change our business mix, increase our allowance for credit losses, write-down asset values or increase our capital levels, affect our ability to borrow funds or maintain or increase deposits;
● risks related to our acquisition strategy, including our ability to identify future suitable acquisition candidates, exposure to potential asset and credit quality risks and unknown or contingent liabilities, the need for capital to finance such transactions, our ability to obtain required regulatory approvals and possible failures in realizing the anticipated benefits from acquisitions;
● challenges arising from attempts to expand into new geographic markets, products, or services;
● future goodwill impairment due to changes in our business, market conditions, or other factors;
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● the impact of bank failures or adverse developments at other banks and related negative press about the banking industry in general on investor and depositor sentiment;
● review of the Company’s accounting, accounting policies and internal control over financial reporting;
● risks and uncertainties related to the recent restatement of certain of our historical consolidated financial statements;
● the subsequent discovery of additional adjustments to the Company’s previously issued financial statements;
● legislative or regulatory changes that adversely affect our business, including changes in banking, securities and tax laws, in regulatory policies and principles, or the interpretation of regulatory capital or other rules, and other governmental initiatives affecting the financial services industry;
● our ability to attract and retain deposits;
● our ability to control operating costs and expenses;
● the use of estimates in determining the fair value of certain of our assets and liabilities, which estimates may prove to be incorrect and result in significant changes in valuation;
● difficulties in reducing risk associated with the loans and securities on our balance sheet;
● staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;
● the effectiveness of our risk management framework;
● disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions, which could expose us to litigation or reputational harm;
● an inability to keep pace with the rate of technological advances;
● risks associated with dependence on our Chief Executive Officer and other members of our senior management team and our ability to attract, motivate and retain qualified personnel;
● costs and effects of litigation, including settlements and judgments;
● our ability to implement our business strategies and manage our growth;
● liquidity issues, including our ability to borrow funds or raise additional capital, if necessary or desired;
● the loss of our large loan and deposit relationships;
● increased competitive pressures among financial services companies;
● changes in consumer spending, borrowing and savings habits;
● the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;
● our ability to pay dividends on our common stock;
● the quality and composition of our securities portfolio and the impact of any adverse changes in the securities markets;
● the inability of key third-party providers to perform their obligations to us;
● changes in accounting principles, policies or guidelines and practices, as may be adopted by the financial institution regulatory agencies, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board;
● the effects of climate change, severe weather events, natural disasters, pandemics, epidemics and other public health crises, acts of war or terrorism, and other external events on our business;
● other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services; and
● risks described in other reports filed with or furnished to the Securities and Exchange Commission (“SEC”), including our Annual Report on Form 10-K/A for the year ended December 31, 2022 (“2022 Annual Report”) and this Form 10-Q.
In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this report might not occur, and you should not put undue reliance on any forward-looking statements. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to us. We do not undertake and specifically disclaim any obligation to revise any forward-looking statements included in this report or the reasons why actual results could differ from those contained in such statements, whether as a result of new information or to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such
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statements. These risks could cause our actual results for the remainder of 2023 and beyond to differ materially from those expressed in any forward-looking statements by, or on behalf of us and could negatively affect our consolidated financial condition and consolidated results of operations as well as our stock price performance.
Executive Overview
General. BayCom is a bank holding company headquartered in Walnut Creek, California. BayCom’s wholly owned banking subsidiary, United Business Bank, provides a broad range of financial services to businesses and business owners as well as individuals through its network of 35 full-service branches, with 17 locations in California, two in Washington, five in New Mexico and 11 in Colorado. The Company’s business activities generally are limited to passive investment activities and oversight of its investment in the Bank. Accordingly, the information set forth in this report, including the consolidated financial statements and related data, relate primarily to the Bank.
Our principal objective is to continue to increase shareholder value and generate consistent earnings growth by expanding our commercial banking franchise through both strategic acquisitions and organic growth. Since 2010, we have expanded our geographic footprint through 10 strategic acquisitions. We believe our strategy of selectively acquiring and integrating community banks has provided us with economies of scale and improved our overall franchise efficiency. Looking forward, we expect to continue to pursue strategic acquisitions and believe our targeted market areas present us with many and varied acquisition opportunities. We are also focused on continuing to grow organically and believe the metropolitan and community markets in which we operate currently provide meaningful opportunities to expand our commercial client base and increase both interest-earning assets and market share. We believe our geographic footprint, which now includes the San Francisco Bay area, the metropolitan markets of Los Angeles, California, Seattle, Washington, and Denver, Colorado, and community markets including Albuquerque, New Mexico, and Custer, Delta, and Grand counties, Colorado, provides us with access to low cost, stable core deposits that we can use to fund commercial loan growth. We strive to provide an enhanced banking experience for our clients by providing them with a comprehensive suite of sophisticated banking products and services tailored to meet their needs, while delivering the high-quality, relationship-based client service of a community bank. At September 30, 2023, on a consolidated basis, the Company had approximately $2.6 billion in total assets, $2.0 billion in total loans, $2.2 billion in total deposits and $307.3 million in shareholders’ equity.
We continue to focus on growing our commercial loan portfolios through acquisitions as well as organic growth. At September 30, 2023, our $2.0 billion total loan portfolio included $426.6 million, or 21.7 %, of acquired loans (all of which were recorded to their estimated fair values at the time of acquisition), and the remaining $1.5 billion, or 78.3%, consisted of loans we originated.
The profitability of our operations depends primarily on our net interest income after provision for credit losses, which is the difference between interest earned on interest earning assets and interest paid on interest bearing liabilities less provision for credit losses. Our net income is also affected by other factors, including the provision for credit losses on loans, noninterest income and noninterest expense.
On February 1, 2022, the Company completed its acquisition of PEB, which was headquartered in Irvine, California. Under the terms of the merger agreement, PEB merged with and into BayCom (the “Merger”), with BayCom as the surviving corporation in the Merger. Immediately following the Merger, Pacific Enterprise Bank, a wholly-owned subsidiary of PEB, merged with and into United Business Bank, a wholly-owned subsidiary of BayCom (the “Bank Merger”), with the Bank as the surviving bank in the Bank Merger. For additional information, see “Note 3 – Acquisitions” contained in the Notes to Condensed Consolidated Financial Statements included in “Item 1. Financial Information” of Part I of this report.
Set forth below is a discussion of the primary factors affecting our results of operations:
Net interest income. Net interest income represents interest income less interest expense. We generate interest income from interest and fees received on interest earning assets, including loans and investment securities and dividends on Federal Home Loan Bank of San Francisco (“FHLB”) and Federal Reserve Bank of San Francisco (“FRB”) stock we own. We incur interest expense from interest paid on interest bearing liabilities, including interest bearing deposits and
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borrowings. To evaluate net interest income, we measure and monitor: (i) yields on our loans and other interest earning assets; (ii) the costs of our deposits and other funding sources; (iii) our net interest margin; and (iv) the regulatory risk weighting associated with our assets. Net interest margin is calculated as the annualized net interest income divided by average interest earning assets. Because noninterest bearing sources of funds, such as noninterest bearing deposits and shareholders’ equity, also fund interest earning assets, net interest margin reflects the benefit of these noninterest bearing sources.
Changes in market interest rates, the slope of the yield curve, and interest we earn on interest earning assets or pay on interest bearing liabilities, as well as the volume and types of interest earning assets, interest bearing and noninterest bearing liabilities and shareholders’ equity, usually have the largest impact on changes in our net interest spread, net interest margin and net interest income during a reporting period. Since March 2022 through the quarter ended September 30, 2023, in response to inflation, the Federal Open Market Committee (“FOMC”) of the Board of Governors of the Federal Reserve System (“Federal Reserve”) has increased the target range for the federal funds rate by 525 basis points, including 100 basis points during the first nine months of 2023, to a range of 5.25% to 5.50%. The increase in the average yield on interest-earning assets during the three and nine months ended September 30, 2023 reflects the lagging benefit of variable rate interest-earning assets beginning to reprice higher. We believe our balance sheet is structured to enhance our net interest margin if the FOMC continues to raise the targeted federal funds rate.
Noninterest income. Noninterest income consists of, among other things: (i) service charges on loans and deposits; (ii) gain on sale of loans; and (iii) gain (loss) on equity securities; and (iv) other noninterest income. Gain on sale of loans includes income (or losses) from the sale of the guaranteed portion of Small Business Administration (“SBA”) loans, capitalized loan servicing rights and other related income.
Provision for credit losses. We established an allowance for credit losses by charging amounts to provision for credit losses at a level required to reflect estimated credit losses in the loan and available-for sale investment securities portfolios. For loans, management considers many factors including historical experience, types and amounts of the portfolio and adverse situations that may affect borrowers’ ability to repay, among other factors. See “Critical Accounting Policies and Estimates - Allowance for Credit Losses” for a description of the manner in which the provision for credit losses is established.
For investments, the Company evaluates investment available-for-sale debt securities in an unrealized loss position to determine whether the decline in the fair value below the amortized cost basis is due to credit-related factors or noncredit-related factors. Such situations may result from either a decline in the financial condition of the issuing entity or in the case of fixed interest rate investments, from rising interest rates. In making this assessment, management considers the length of time and the extent to which fair value is less than amortized cost, the nature of the security, the underlying collateral, and the financial condition and prospects of the issuer, among other factors. This assessment also includes a determination of whether the Company intends to sell the security, or if it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis less any current-period credit losses. If this assessment indicates a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses for available-for-sale securities is recorded for the credit loss, limited by the amount that the fair value is less than the amortized costs basis. Any impairment that has not been recorded through an allowance for credit losses for available-for-sale securities is recognized in other comprehensive income. Changes in the allowance for credit losses for available-for-sale securities are recorded as provision for (or reversal of) credit loss. Losses are charged against the allowance for credit losses for available-for-sale securities, with a corresponding adjustment to the security's amortized cost basis, when management believes the uncollectibility of an available-for-sale security is confirmed or when either criteria regarding intent or requirement to sell is met.
Noninterest expense. Noninterest expense includes, among other things: (i) salaries and related benefits; (ii) occupancy and equipment expense; (iii) data processing; (iv) Federal Deposit Insurance Corporation (“FDIC”) and state assessments; (v) outside and professional services; and (vi) other general and administrative expenses, including amortization of intangible assets. Salaries and related benefits include compensation, employee benefits and employment tax expenses for our personnel. Occupancy and equipment expense includes depreciation expense on our owned properties and equipment, lease expense on our leased properties and other occupancy-related expenses. Data processing expense
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includes fees paid to our third-party data processing system provider and other data service providers. FDIC and state assessments expense represents the assessments that we pay to the FDIC for deposit insurance and other regulatory costs to various states. Outside and professional fees include legal, accounting, consulting and other outsourcing arrangements. Amortization of intangibles represents the amortization of our core deposit intangible from various acquisitions. Other general and administrative expenses include expenses associated with travel, meals, training, supplies and postage. Noninterest expenses generally increase as we grow our business. Noninterest expenses have increased significantly over the past few years as we have grown through acquisitions and organically, and as we have built out our operational infrastructure.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with GAAP. In doing so, we have to make estimates and assumptions. Our critical accounting estimates are those estimates that involve a significant level of uncertainty at the time the estimate was made, and changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have used in the current period, that would have a material impact on our financial condition or results of operations. Accordingly, actual results could differ materially from our estimates. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We have reviewed our critical accounting estimates with the audit committee of our Board of Directors. Our critical accounting estimates are described in detail in the Critical Accounting Estimates section of our 2022 Annual Report. There have been no significant changes to our critical accounting estimates since December 31, 2022, except for the following:
On January 1, 2023, the Company adopted ASU 2016-03 Financial Instruments — Credit Losses (ASC 326): Measurement of Credit Losses on Financial Instruments , which replaces the incurred loss methodology with the current expected credit loss (“CECL”) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized costs, including loan receivables. It also applies to off-balance sheet credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar instruments) and net investments in certain leases. In addition, ASC 326 made changes to the accounting for available-for-sale debt securities. One such change is to require increases or decreases in credit losses be presented as an allowance rather than as a write-down on available for sale debt securities, based on management's intent to sell the security or likelihood the Company will be required to sell the security, before recovery of the amortized cost basis.
Allowance for credit loan losses for investment securities available-for-sale. The Company evaluates investment securities available-for-sale in an unrealized loss position to determine whether the decline in the fair value below the amortized cost basis (impairment) is due to credit-related factors or noncredit-related factors. Impairment may result from either a decline in the financial condition of the issuing entity or in the case of fixed interest rate investments, from rising interest rates. In making this assessment, management considers the length of time and the extent to which fair value is less than amortized cost, the nature of the security, the underlying collateral, and the financial condition and prospects of the issuer, among other factors. This assessment also includes a determination of whether the Company intends to sell the security, or it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis less any current-period credit losses.
Any impairment that is not credit related is recognized in other comprehensive income, net of applicable taxes. Credit-related impairment is recognized as an allowance for credit losses on the balance sheet, limited to the amount by which the amortized cost basis exceeds the fair value, with a corresponding adjustment to earnings. Changes in the allowance for available-for-sale securities are recorded as provision for (or reversal of) credit loss. However, if the uncollectibility of an available-for-sale security is confirmed or if the Company intends to sell an impaired available-for-sale debt security or more likely than not will be required to sell such a security before recovering its amortized cost basis, the entire impairment amount is recognized in earnings with a corresponding adjustment to the security's amortized cost basis.
Allowance for credit losses for loans . The allowance for credit losses (“ACL”) for loans is the combination of the allowance for credit losses for loans and the reserve for unfunded loan commitments. The allowance for credit losses for loans is reported as a reduction of the amortized cost basis of loans, while the reserve for unfunded loan commitments is included within "Interest payable and other liabilities" on the consolidated balance sheets. The
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amortized cost basis of loans does not include accrued interest receivable, which is included in "Interest receivable and other assets" on the consolidated balance sheets. The "Provision for credit losses" on the consolidated statements of income (loss) is a combination of the provision for credit losses for loans, the provision for unfunded loan commitments, and the provision for investment securities available-for-sale.
Under the CECL methodology, expected credit losses reflect expected losses over the remaining contractual life of an asset, considering the effect of prepayments and available information about the collectability of cash flows, including information about relevant historical experience, current conditions, and reasonable and supportable forecasts of future events and circumstances. Thus, the CECL methodology incorporates a broad range of information in developing credit loss estimates. The CECL methodology could result in significant changes to both the timing and amounts of provision for credit losses and the allowance as compared to historical periods. Loans that are deemed to be uncollectable are charged off and deducted from the allowance. The provision for credit losses and recoveries on loans previously charged off are added to the allowance. Regardless of the determination that a charge-off is appropriate for financial accounting purposes, the Company manages its loan portfolio by continually monitoring, where possible, a borrower's ability to pay through the collection of financial information, delinquency status, borrower discussion and the encouragement to repay in accordance with the original contract or modified terms, if appropriate.
The allowance for credit losses for loans is comprised of an individually evaluated component for loans that no longer share similar risk characteristics with other loans and a pooled loans component for loans that share similar risk characteristics.
A loan with an outstanding balance greater than $100,000 is individually evaluated for expected credit loss when it is probable that we will be unable to collect all amounts due according to the original contractual terms of the loan agreement. We select loans for individual assessment on an ongoing basis using certain criteria such as payment performance, borrower reported and forecasted financial results, and other external factors when appropriate. Loans that do not share the same risk characteristics as pooled loans are evaluated individually for credit loss and generally include all nonaccrual loans, collateral dependent loans, and certain troubled debt restructured loans. We measure the current expected credit loss of an individually evaluated loan based upon the fair value of the underlying collateral, adjusted for costs to sell when applicable, or if the loan is not collateral-dependent we utilize the present value of expected future cash flows, discounted at the effective interest rate. A loan for which the terms have been modified resulting in a concession, and where the borrower is experiencing financial difficulties, is considered a modified loan to a borrower experiencing financial difficulty. The ACL on modified loans to borrowers experiencing financial difficulty is measured using the same method as individually evaluated loans. When the value of a concession is measured using the discounted cash flow method, the ACL is determined by discounting the expected future cash flows at the original interest rate of the loan. To the extent a loan balance exceeds the estimated collectable value, a reserve or charge-off is recorded depending upon either the certainty of the estimate of loss or the fair value of the loan’s collateral if the loan is collateral-dependent.
Our CECL methodology for the pooled loans component includes both quantitative and qualitative loss factors which are applied to our population of loans and assessed at a pool level. The quantitative CECL model estimates credit losses by applying pool-specific probability of default ("PD") and loss given default ("LGD") rates to the expected exposure at default ("EAD") over the contractual life of loans. The qualitative component considers internal and external risk factors that may not be adequately assessed in the quantitative model. Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments and curtailments, when appropriate. The pooled loans' contractual loan terms exclude extensions, renewals, and modifications. To estimate future prepayments by loan pool, we use our actual historical loan prepayment experience over a trailing time period, adjusted for forecasted economic conditions, to estimate future prepayments by loan pool. To estimate curtailment by loan pool we use our actual historical loan curtailment experience over a trailing time period, adjusted for forecasted economic conditions. Where observations in either case may be insufficient, the global rate, which is simply the aggregate performance of all loan segments of the Bank, is used.
The ACL model utilizes a discounted cash flow ("DCF") method to measure the expected credit losses on loans collectively evaluated that are sub-segmented by loan pools with similar credit risk characteristics, which generally
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correspond to federal regulatory reporting codes (i.e, Call codes), with PCD assets pooled separately by similar loan pools to evaluate and measure the allowance for credit loss:
● Loans secured by real estate:
o 1-4 family residential construction loans and other construction loans and all land development and other land loans
o Secured by farmland and finance agricultural production and other loans to farmers
o Revolving, open-end loans secured by 1-4 family residential properties extended under lines of credit and closed-end loans secured by 1-4 family residential properties, secured by junior liens
o Closed-end loans secured by 1-4 family residential properties, secured by first liens
o Commercial real estate loans secured by owner-occupied non-farm nonresidential properties
o Commercial real estate loans secured by other non-farm nonresidential properties and
o Secured by multifamily (5 or more units) residential properties
● Commercial and industrial loans
● Loans to individuals for household, family and other personal expenditures (i.e., consumer loans)
● Paycheck Protection Program loans (which are fully government guaranteed)
In determining the PD for each pooled segment, the Bank utilized regression analyses to identify certain economic drivers that were considered highly correlated to historical Bank or peer loan default experience. The regression models developed correlate macroeconomic variables to historical credit performance based on call report data over a 64 quarter (16-year) period which captures a full economic cycle from 2004 to 2019. We elected to exclude historical data from 2020 - 2021 to assess the quantitative expected credit losses because we believe that period is an outlier and did not represent normal economic behavior considering the Covid-19 pandemic lockdown with changes in macroeconomic variables and the significant levels of government relief programs in place during that period. For all segments, the Company's actual loss history was not statistically relevant, thus the loss history of peers, defined as commercial financial institutions with asset size of one to five billion, domiciled in California, with similar concentrations of lending were utilized to determine loss rates. The peers utilized in the ACL are segment specific. Additionally, management chose the national unemployment rate and U.S. gross domestic product as the primary economic forecast drivers for all segments. A third party provides LGD estimates for each segment based on a banking industry Frye-Jacobs Risk Index approach.
In its loss forecasting framework, the Company incorporates forward-looking information through the use of macroeconomic scenarios applied over the forecasted life of the assets. The quantitative CECL model applies the projected rates based on the economic forecasts for the four quarter (one-year) reasonable and supportable forecast horizon to EAD to estimate defaulted loans. The economic data is updated quarterly, which is based on Federal Reserve Economic Data (“FRED”) forecasts. Historical LGD rates are applied to estimated defaulted loans to determine estimated credit losses. For periods beyond the forecast horizon, the economic factors revert to historical averages on a straight-line basis over an eight-quarter (two-year) period. Subsequent to the reversion period for the remaining contractual life of loans and leases, the PD, LGD, and prepayment rates are based on historical experience during a full economic cycle.
Management considers whether adjustments to the quantitative portion of the ACL are needed for differences in segment-specific risk characteristics or to reflect the extent to which it expects current conditions and reasonable and supportable forecasts of economic conditions to differ from the conditions that existed during the historical period included in the development of PD and LGD. Qualitative internal and external risk factors include, but are not limited to, the following:
● Changes in the nature and volume of the loan portfolio
● Changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans
● Changes in lending policies and procedures, including changes in underwriting standards and collection
● Changes in economic and business conditions, and developments that affect the collectability of the portfolio
● Changes in the experience, ability, and depth of credit management and lending staff
● Changes in the quality of our systematic loan review processes
● Changes in the value of underlying collateral, where applicable
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● Changes in concentration of credit
● The effect of other external factors such as legal and regulatory requirements on the level of estimated credit losses in the portfolio
PCD assets are assets acquired at a discount that is due, in part, to credit quality deterioration since origination which may be determined through observation of missed payments, downgrade in risk rating, deterioration of a borrower's financial trends or other observable factors including subjectivity utilized by management. PCD assets are initially recorded at fair value, by taking the sum of the present value of expected future cash flows and an allowance for credit losses, at acquisition. The allowance for credit losses for PCD assets is recorded through a gross-up of reserves on the consolidated balance sheets, while the allowance for acquired non-PCD assets, such as loans, is recorded through the provision for credit losses on the consolidated statements of income, consistent with originated loans. Subsequent to acquisition, the allowance for credit losses for PCD loans will generally follow the same forward-looking estimation, provision, and charge-off process as non-PCD acquired and originated loans.
The estimated credit losses associated with unfunded lending commitments are calculated using the same models and methodologies noted above and incorporate utilization assumptions at the estimated time of default. While the provision for credit losses associated with unfunded commitments is included in "provision for credit losses" on the consolidated statement of income, the reserve for unfunded commitments is maintained on the consolidated balance sheet in "Interest payable and other liabilities".
Comparison of Financial Condition at September 30, 2023 and December 31, 2022
Total assets. Total assets increased $61.1 million, or 2.4%, to $2.6 billion at September 30, 2023, from December 31, 2022. The increase primarily was due to cash and cash equivalents increasing $125.1 million, or 70.8%, partially offset by decreases in loans receivable, net, of $53.2 million or 2.7% and investment securities available-for-sale of $8.2 million or 5.3%. In addition, interest receivable and other assets increased $2.0 million or 4.5%, equity securities decreased $2.1 million or 15.4%, and loans held for sale decreased $1.1 million or 46.5%.
Cash and cash equivalents. Cash and cash equivalents increased $125.1 million, or 70.8%, to $301.9 million, at September 30, 2023, from $176.8 million at December 31, 2022. The increase primarily was due to a $121.7 million increase in federal funds sold and interest bearing balances in banks during the nine months ended September 30, 2023, consistent with management’s strategy to increase liquidity following the recent turmoil in the banking industry resulting from several recent high profile bank failures.
Investment securities available-for-sale. Investment securities available-for-sale decreased $8.2 million, or 5.3%, to $145.8 million at September 30, 2023 from $154.0 million at December 31, 2022. The decrease primarily was due to unrealized losses on investment securities available-for-sale of $8.0 million as a result of fair value adjustments and the routine amortization and repayment of investment principal balances, and securities called and matured of $6.3 million, partially offset by the purchase of $6.4 million of investment securities during the nine months ended September 30, 2023.
Equity securities. Equity securities decreased $2.1 million, or 15.4%, to $11.6 million at September 30, 2023 from $13.8 million at December 31, 2022, primarily due to a $2.1 million mark-to-market downward adjustment recorded during the nine months ended September 30, 2023.
Loans receivable, net. We originate a wide variety of loans with a focus on commercial real estate (“CRE”) loans and commercial and industrial loans. Loans receivable, net decreased $53.2 million, or 2.7%, to $1.9 billion at September 30, 2023 from December 31, 2022. The decrease was due to $180.0 million of loan repayments, including $6.7 million in Paycheck Protection Program (“PPP”) loans, and $7.2 million in loan sales, partially offset by $135.0 million of new loan originations.
The following table provides information about our loan portfolio by type of loan, with purchase credit deteriorated (“PCD”) loans presented as a separate balance, at the dates presented .
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September 30,
December 31,
2023
2022
% Change
(Dollars in thousands)
Commercial and industrial (1)
$
170,738
$
184,521
(7.5)
%
Real estate:
Residential
87,103
109,927
(20.8)
Multifamily residential
250,649
234,868
6.7
Owner occupied CRE
514,546
641,815
(19.8)
Non-owner occupied CRE
909,884
807,996
12.6
Construction and land
8,404
9,109
(7.7)
Total real estate
1,770,586
1,803,715
(1.8)
Consumer
639
4,183
(84.7)
PCD loans
26,767
28,787
(7.0)
Total Loans
1,968,730
2,021,206
(2.6)
Net deferred loan fees
74
(82)
(190.7)
Allowance for credit losses (2)
(19,800)
(18,900)
4.8
Loans, net
$
1,949,004
$
2,002,224
(2.7)
%
(1) Includes $4.3 million and $11.1 million of PPP loans as of September 30, 2023 and December 31, 2022, respectively.
(2) Allowance for credit losses at September 30, 2023 is estimated under CECL whereas at December 31, 2022, the allowance for loan losses is estimated under the incurred loss methodology.
The following table shows as of September 30, 2023, the geographic distribution of our loan portfolio by type of loan in dollar amounts and percentages:
San Francisco Bay
Total in State of
Area (1)
Other California (2)
California
All Other States (3)
Total
% of
% of
% of
% of
% of
Total in
Total in
Total in
Total in
Total in
Amount
Category
Amount
Category
Amount
Category
Amount
Category
Amount
Category
(Dollars in thousands)
September 30, 2023
Commercial and industrial
$
36,516
8.5
%
$
81,042
9.4
%
$
117,558
9.1
%
$
53,385
7.9
%
$
170,943
8.7
%
Real estate:
Residential
14,416
3.3
43,130
5.0
57,546
4.4
30,053
4.5
87,599
4.4
Multifamily residential
48,751
11.3
109,778
12.7
158,529
12.2
94,843
14.1
253,372
12.9
Owner occupied CRE
168,796
39.2
308,752
35.7
477,548
36.9
48,930
7.3
526,478
26.7
Non-owner occupied CRE
162,524
37.7
314,151
36.4
476,675
36.8
444,620
66.0
921,295
46.8
Construction and land
—
—
6,839
0.8
6,839
0.5
1,565
0.2
8,404
0.4
Total real estate
394,487
782,650
1,177,137
620,011
1,797,148
Consumer
4
0.0
%
1
—
%
5
—
%
634
0.1
%
639
0.0
%
Total loans
$
431,007
$
863,693
$
1,294,700
$
674,030
$
1,968,730
December 31, 2022
Commercial and industrial
$
54,056
7.8
%
$
92,546
10.1
%
$
146,602
9.1
%
$
41,936
10.2
%
$
188,538
9.3
%
Real estate:
Residential
17,112
2.5
52,081
5.7
$
69,193
4.3
41,413
10.1
110,606
5.5
Multifamily residential
58,533
8.4
108,198
11.8
166,731
10.4
70,974
17.3
237,705
11.8
Owner occupied CRE
242,755
35.0
363,210
39.7
605,965
37.6
52,191
12.7
658,156
32.6
Non-owner occupied CRE
321,523
46.3
289,528
31.6
611,051
37.9
197,804
48.1
808,855
40.0
Construction and land
—
—
8,678
0.9
8,678
0.5
4,485
1.1
13,163
0.7
Total real estate
639,923
821,695
1,461,618
366,867
1,828,485
Consumer
391
0.1
%
1,672
0.2
%
2,063
0.1
%
2,120
0.5
%
4,183
0.2
%
Total loans
$
694,370
$
915,913
$
1,610,283
$
410,923
$
2,021,206
(1) Includes Alameda, Contra Costa, Solano, Sonoma, Marin, San Francisco, San Mateo and Santa Clara counties.
(2) Includes loans located in Sacramento and Northern California counties totaling $98.0 million at September 30, 2023, and loans located in Los Angeles and Orange counties totaling $524.5 million at September 30, 2023. At December 31, 2022, loans in Sacramento and Northern California counties and loans in Los Angeles and Orange counties totaled $102.1 million and $539.6 million, respectively.
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(3) Includes loans located primarily in the states of Colorado, New Mexico and Washington. At September 30, 2023, loans in Colorado, New Mexico and Washington totaled $87.9 million, $45.3 million and $104.1 million, respectively. At December 31, 2022, loans in Colorado, New Mexico and Washington totaled $97.2 million, $51.3 million and $87.4 million, respectively.
Nonperforming assets and loans. Nonperforming assets generally consists of nonaccrual loans, accruing loans that are 90 days or more past due and other real estate owned (“OREO”). Nonperforming loans generally consist of nonaccrual loans and accruing loans that are 90 days or more past due. Nonperforming assets decreased $923,000, or 6.1%, to $14.3 million, or 0.56% of total assets at September 30, 2023 from $15.2 million, or 0.61% of total assets at December 31, 2022. The decrease in nonperforming assets was primarily due to the renewal of one accruing loan 90 days or more past due and in the process of collection totaling $934,000 at December 31, 2022, the charge-off of six nonaccrual loans totaling $356,000 during the nine months ended September 30, 2023, and the payoff during the current quarter of one $774,000 performing (accruing) modified loan to a borrower experiencing financial difficulty, partially offset by three new nonaccrual real estate loans totaling $500,000 and one new commercial nonaccrual loan totaling $1.0 million during the current quarter of 2023. There were no accruing loans 90 days or more past due or OREO at September 30, 2023, compared to $934,000 of accruing loans 90 days or more past due and $21,000 of OREO at December 31, 2022.
Nonperforming loans totaled $14.3 million, or 0.73% of total loans, at September 30, 2023, of which $801,000 were guaranteed by governmental agencies, compared to $15.2 million, or 0.75% of total loans, at December 31, 2022, of which $839,000 were guaranteed by governmental agencies. At September 30, 2023, there were no performing (accruing) modified loans to borrowers experiencing financial difficulty. Not included in nonperforming loans at December 31, 2022, was $759,000 of performing (accruing) modified loans to borrowers experiencing financial difficulty.
At September 30, 2023 and December 31, 2022, nonaccrual loans included $2.3 million and $2.5 million of loans 30-89 days past due, and $2.6 million and $4.0 million of loans less than 30 days past due, respectively. At September 30, 2023, the $2.6 million of nonaccrual loans less than 30 days past due was comprised of 15 loans, all of which were placed on nonaccrual due to concerns over the financial condition of the borrowers.
During the quarter ended September 30, 2023, the Company determined that a certificate of deposit-secured line of credit loan made to a revocable living trust (the “Trust” or the “Borrower”) with an outstanding balance of approximately $1.0 million as of September 30, 2023 was impaired and placed on nonaccrual as a result of the sole trustee and beneficiary of the Trust filing for personal bankruptcy in July 2023. At June 30, 2023, the loan had an outstanding balance of $5.0 million and was secured by a $4.0 million certificate of deposit held at the Bank. An additional $1.0 million in cash collateral securing the loan had previously been released by the Bank into a third-party escrow account at the request of the Borrower to be used as a refundable retainer in connection with a separate transaction by the Borrower. The loan matured on July 16, 2023, and the Bank received notification that the sole trustee and beneficiary of the Trust filed for personal bankruptcy on July 18, 2023. After receiving this notification, the Bank used the $4.0 million certificate of deposit held at the Bank to offset amounts owed on the loan and contacted the third-party escrow agent for the return of the additional $1.0 million of collateral. The Bank was advised by the escrow agent that the previously escrowed funds had been released by the escrow agent, which was done without the Bank’s consent and contrary to the written escrow instructions. The Bank has initiated legal action against the Borrower, the Borrower’s related parties and the escrow agent to recover the previously escrowed collateral. The results of the legal action and the Bank’s ability to recover the previously escrowed collateral are currently uncertain. The loan was fully reserved for at September 30, 2023.
In general, loans are placed on nonaccrual status after being contractually delinquent for more than 90 days, or earlier, if management believes full collection of future principal and interest on a timely basis is unlikely. When a loan is placed on nonaccrual status, all interest accrued but not received is charged against interest income. When the ability to fully collect nonaccrual loan principal is in doubt, cash payments received are applied against the principal balance of the loan until such time as full collection of the remaining recorded balance is expected. Interest received on such loans is recognized as interest income when received. A nonaccrual loan is restored to an accrual basis when principal and interest payments are paid current, and full payment of principal and interest is probable. Loans that are well secured and in the process of collection will remain on accrual status .
Loans may be acquired at a premium or discount to par value, in which case the premium is amortized (subtracted from) or accreted (added to) interest income over the remaining life of the loan. Generally, as time goes on, the effects of
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loan discount accretion and loan premium amortization decrease as the purchased loans mature or pay off early. Upon the early pay off of a loan, any remaining (unaccreted) discount or (unamortized) premium is immediately taken into interest income; as loan payoffs may vary significantly from quarter to quarter, so may the impact of discount accretion and premium amortization on interest income.
Troubled Loan Modifications. Occasionally, the Company offers modifications of loans to borrowers experiencing financial difficulty by providing principal forgiveness, interest rate reductions, other-than-insignificant payment delays, term extensions or any combination of these. When principal forgiveness is provided, the amount of the forgiveness is charged-off against the allowance for credit losses for loans. Upon the Company’s determination that a modified loan (or portion of a loan) has subsequently been deemed uncollectible, the loan (or a portion of the loan) is charged off. Therefore, the amortized cost basis of the loan is reduced by the uncollectible amount and the allowance for credit losses for loans is adjusted by the same amount.
Loan modifications to borrowers experiencing financial difficulty as of September 30, 2023 totaled $5.2 million, of which none were accruing and performing according to their modified terms, compared to $6.3 million, of which $759,000 were accruing and performing according to their modified terms, at December 31, 2022. Modified loans that are accruing and performing according to their modified terms are not considered nonperforming loans as they continue to accrue interest despite their modified status. The related allowance for credit losses on individually evaluated modified loans totaled $342,000 and $393,000 at September 30, 2023 and December 31, 2022, respectively.
The following table provides information regarding nonperforming loans, nonperforming assets and modified loans as of the dates indicated:
September 30,
December 31,
2023
2022
(Dollars in thousands)
Loans accounted for on a nonaccrual basis:
Commercial and industrial
$
1,944
$
869
Real estate:
Residential
1,554
2,213
Multifamily residential
5,315
5,351
Owner occupied CRE
5,023
5,491
Non-owner occupied CRE
119
365
Construction and land
366
—
Total real estate
12,377
13,420
Consumer
—
—
Total nonaccrual loans
14,321
14,289
Accruing loans 90 days or more past due
—
934
Total nonperforming loans
14,321
15,223
Real estate owned
—
21
Total nonperforming assets (1)
$
14,321
$
15,244
Modified loans to borrowers experiencing financial difficulty – performing
—
759
PCD loans
$
26,767
$
28,787
Nonperforming assets to total assets (1)
0.56
%
0.61
%
Nonperforming loans to total loans (1)
0.73
%
0.75
%
(1)
Performing modified loans to borrowers experiencing financial difficulty are neither included in nonperforming loans above nor are they included in the numerators used to calculate these ratios.
Interest foregone on nonaccrual loans was approximately $173,000 and $593,000 for the three and nine months ended September 30, 2023, and $230,000 and $388,000 for the three and nine month ended September 30, 2022, respectively, none of which was included in interest income.
Allowance for credit losses for loans and unfunded commitments. The allowance for credit losses for loans is maintained to cover losses that are estimated in accordance with GAAP. It is our estimate of credit losses inherent in our
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loan portfolio at each balance sheet date. Our methodology for analyzing the allowance for credit losses for loans consists of general and specific components. For the general component, we stratify the loan portfolio into homogeneous groups of loans that possess similar loss potential characteristics and apply a loss ratio to these groups of loans to estimate the credit losses in the loan portfolio. We use both historical loss ratios and qualitative loss factors assigned to major loan collateral types to establish general component loss allocations. Qualitative loss factors are based on management’s judgment of company, market, industry or business specific data and external economic indicators, which may not yet be reflected in the historical loss ratios, and that could impact our loan portfolio. Management and the Board of Directors set and adjust qualitative loss factors by regularly reviewing changes in underlying loan composition and the seasonality of specific portfolios. Management and the Board of Directors also consider credit quality and trends relating to delinquency, nonperforming and classified loans within our loan portfolio when evaluating qualitative loss factors. Additionally, management and the Board of Directors adjust qualitative factors to account for the potential impact of external economic factors, including the unemployment rate, vacancy rates, capitalization rates, commodity prices and other pertinent economic data specific to our primary market area and lending portfolios.
For the specific component, the allowance for credit losses for loans is established for individually evaluated loans. Management evaluates current information and events regarding a borrower’s ability to repay its obligations and considers a loan to be impaired when the ultimate collectability of amounts due, according to the contractual terms of the loan agreement, is in doubt. If an individually evaluated loan is collateral-dependent, the fair value of the collateral, less the estimated cost to sell, is used to determine the amount of impairment. If an individually evaluated loan is not collateral-dependent, the impairment amount is determined using the negative difference, if any, between the estimated discounted cash flows and the loan amount due. For individually evaluated loans, the amount of the impairment can be adjusted, based on current data, until such time as the actual basis is established by acquisition of the collateral or until the basis is collected. Impairment losses are reflected in the allowance for credit losses for loans through a charge to the provision for credit losses. Subsequent recoveries are credited to the allowance for credit losses for loans. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement. Cash receipts on nonaccrual loans for which the accrual of interest has been discontinued are applied first to principal.
Estimated credit losses for unfunded loan commitments are calculated using the same models and methodologies noted above and incorporate utilization assumptions at the estimated time of default. While the provision for credit losses for unfunded loan commitments is included in "provision for (reversal of) credit losses" on the consolidated statement of income, the reserve for unfunded loan commitments is maintained on the consolidated balance sheet in interest payable and other liabilities.
The Company adopted the CECL standard as of December 15, 2022, which resulted in a one-time adjustment to the allowance for credit losses for loans of $1.5 million (which included the reclassification of the net credit discount on acquired PCD loans totaling $845,000) and an allowance for unfunded credit commitments of $45,000, as well as an after-tax decrease to opening retained earnings of $491,000 on January 1, 2023.
At September 30, 2023, the Company’s allowance for credit losses for loans was $19.8 million under the CECL framework, or 1.01% of total loans, compared to an allowance for loan losses of $18.9 million under the allowance for loan losses incurred loss framework, or 0.94% of total loans, at December 31, 2022. In addition to the CECL adjustment on January 1, 2023, a $201,000 reversal of the allowance for credit losses for loans was recorded for the nine months ended September 30, 2023, compared to $7,000 provision for loan losses for the nine months ended September 30, 2022. The reversal of the allowance for credit losses for loans primarily resulted from $399,000 in net charge-offs for the nine months ended September 30, 2023, coupled with improvements in forecasted economic conditions, specifically, national gross domestic product and national unemployment, indicators utilized to estimate credit losses and, to a lesser extent, a decrease in outstanding loan balances, partially offset by an overall increase in reserves for individually evaluated loans, and increase in qualitative reserves.
We recorded net charge-offs of $24,000 and $399,000 for the three and nine months ended September 30, 2023, and $944,000 and $3.5 million for the three and nine months ended September 30, 2022, respectively. The calculation of the allowance for credit losses for loans at September 30, 2023 and the allowance for loan losses at December 31, 2022, excludes the balance of PPP loans held in portfolio as of those dates as PPP loans are fully guaranteed by the SBA.
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In accordance with acquisition accounting, loans acquired from acquisitions were recorded at their estimated fair value, which resulted in a net discount to the loans’ contractual amounts. Credit discounts are included in the determination of fair value and as a result, no allowance for credit losses for loans is recorded for acquired loans at the acquisition date. However, the allowance for credit loss includes an estimate for credit deterioration of acquired loans that occurs after the date of acquisition, which is included in the credit loss provision in the period that the deterioration occurred. The discount recorded on the acquired loans is not reflected in the allowance for credit losses for loans or related allowance coverage ratios. As of September 30, 2023 , acquired loans net of their discount totaled $224.4 million and the remaining net discount on these acquired loans was $419,000, compared to $257.4 million of acquired loans and $522,000 of net discounts at December 31 , 2022 . The net discount includes a credit discount based on estimated losses in the acquired loans partially offset by a premium, if any, based on market interest rates on the date of acquisition.
The following table presents certain credit ratios at the dates and for the periods indicated and each component of the ratio’s calculations:
At and for the nine months ended September 30,
2023
2022
(Dollars in thousands)
Allowance for credit losses on loans as a percentage of total loans outstanding at period end
1.01
%
0.90
%
Allowance for credit losses on loans
$
19,800
$
18,050
Total loans outstanding
1,968,804
1,994,966
Nonaccrual loans as a percentage of total loans outstanding at period end
0.73
%
0.82
%
Total nonaccrual loans
$
14,321
$
16,369
Total loans outstanding
1,968,804
1,994,966
Allowance for credit losses on loans as a percentage of nonaccrual loans at period end
138.26
%
110.27
%
Allowance for credit losses on loans
$
19,800
$
18,050
Total nonaccrual loans
14,321
16,369
Net charge-offs/(recoveries) during period to average loans outstanding:
Commercial and industrial:
0.12
%
1.21
%
Net charge-offs
$
229
$
3,461
Average loans outstanding
190,582
285,935
Construction and land:
—
%
—
%
Net charge-offs
$
—
$
—
Average loans outstanding
12,491
18,206
Commercial estate:
—
%
—
%
Net (recoveries)/charge-offs
$
(2)
$
1
Average loans outstanding
1,719,547
1,577,751
Residential:
0.19
%
0.01
%
Net charge-offs
$
174
$
6
Average loans outstanding
93,087
89,228
Consumer:
(0.06)
%
0.29
%
Net (recoveries)/charge-offs
$
(1)
$
6
Average loans outstanding
1,729
2,085
Total loans:
0.02
%
0.18
%
Total net charge-offs
$
400
$
3,474
Total average loans outstanding
2,017,436
1,973,205
As of September 30, 2023, the Company individually evaluated $14.3 million in loans, inclusive of $9.6 million of nonperforming loans. Of these individually evaluated loans, $4.8 million had a specific allowance of $1.9 million as of September 30, 2023. As of December 31, 2022, the Company individually evaluated $15.0 million in loans, inclusive of $14.3 million of nonperforming loans and $759,000 of performing (accruing) modified loans to borrowers experiencing financial difficulty . Of these individually evaluated loans, $1.4 million had a specific allowance of $1.2 million as of December 31, 2022.
Management considers the allowance for credit losses for loans at September 30, 2023 to be adequate to cover losses inherent in the loan portfolio based on the assessment of the above-mentioned factors affecting the loan portfolio.
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While management believes the estimates and assumptions used in its determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future losses will not exceed the amount of the established allowance for credit losses for loans or that any increased allowance for credit losses for loans that may be required will not adversely impact our financial condition and results of operations. A further decline in national and local economic conditions as a result of unemployment levels, labor shortages and the effects of inflation, a potential recession, or slowed economic growth caused by increasing political instability from acts of war, as well as supply chain disruptions, among other factors, could result in a material increase in the allowance for credit losses for loans and may adversely affect the Company’s financial condition and results of operations. In addition, the determination of the amount of our allowance for credit losses for loans is subject to review by bank regulators, as part of the routine examination process, which may result in additions to our provision for credit losses based upon their judgment of information available to them at the time of their examination.
Deposits. Deposits are our primary source of funding and consist of core deposits from the communities served by our branch and office locations. We offer a variety of deposit accounts with a competitive range of interest rates and terms to both consumers and businesses. Deposits include interest bearing and noninterest bearing demand accounts, savings, money market, certificates of deposit and individual retirement accounts. These accounts earn interest at rates established by management based on competitive market factors, management’s desire to increase certain product types or maturities, and in keeping with our asset/liability, liquidity and profitability objectives. Competitive products, competitive pricing and high touch client service are important to attracting and retaining these deposits.
Total deposits increased $74.0 million, or 3.5%, to $2.2 billion at September 30, 2023 from December 31, 2022. At September 30, 2023, noninterest bearing demand deposits totaled $667.3 million, or 30.9% of total deposits, compared to $773.3 million, or 37.1% of total deposits, at December 31, 2022 . At September 30, 2023, uninsured deposits totaled $991.6 million, compared to $1.1 billion at December 31, 2022. The uninsured amounts are estimates based on the methodologies and assumptions used for United Business Bank’s regulatory reporting requirements. We consider our deposit base to be seasoned, stable and well-diversified, and we do not have any significant industry concentrations among our non-insured deposits. We also offer an insured cash sweep product (ICS) that allows customers to insure deposits above FDIC insurance limits. At September 30, 2023, our average deposit account size (excluding public funds), calculated by dividing period-end deposits by the population of accounts with balances, was approximately $59,000. See Note 18 of the Notes to Condensed Consolidated Financial Statements in this Form 10-Q for information regarding our top ten depositors.
The following table sets forth the dollar amount of deposits in the various types of deposit programs offered at the dates indicated.
September 30,
December 31,
2023
2022
% Change
(Dollars in thousands)
Noninterest bearing demand deposits
$
667,336
$
773,274
(13.7)
%
NOW accounts and savings
394,898
441,064
(10.5)
Money market
665,866
577,792
15.2
Time deposits
431,344
293,349
47.0
Total
$
2,159,444
$
2,085,479
3.5
%
Borrowings. Although deposits are our primary source of funds, we may from time to time utilize borrowings as a cost-effective source of funds when they can be invested at a positive interest rate spread, for additional capacity to fund loan demand, or to meet our asset/liability management goals. We are a member of and may obtain advances from the FHLB of San Francisco, which is part of the Federal Home Loan Bank System. The eleven regional Federal Home Loan Banks provide a central credit facility for their member institutions. These advances are provided upon the security of certain of our mortgage loans and mortgage-backed securities. These advances may be made pursuant to several different credit programs, each of which has its own interest rate, range of maturities and call features.
At September 30, 2023 and December 31, 2022, we had the ability to borrow up to $597.6 million and $473.6 million, respectively, from the FHLB of San Francisco. At both September 30, 2023 and December 31, 2022, there were no FHLB advances outstanding.
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We may also utilize Fed Funds purchased from correspondent banks as a source of short-term funding. At both September 30, 2023 and December 31, 2022, we had a total of $65.0 million in federal funds line available from third-party financial institutions and no balances outstanding at these dates.
At both September 30, 2023 and December 31, 2022, the Company had outstanding junior subordinated deferrable interest debentures, net of fair value adjustments, assumed in connection with its previous acquisitions totaling $8.5 million.
At September 30, 2023, the Company had outstanding subordinated debt, net of costs to issue, totaling $63.8 million compared to $63.7 million at December 31, 2022.
We are required to provide collateral for certain local agency deposits. At September 30, 2023 and December 31, 2022, the FHLB of San Francisco had issued a letters of credit on behalf of the Bank totaling $42.6 million and $40.6 million, respectively, as collateral for local agency deposits.
Shareholders’ equity. Shareholders’ equity decreased $9.9, to $307.3 million at September 30, 2023 from $317.1 million at December 31, 2022. The decrease in shareholders’ equity primarily was due to the repurchase of $21.7 million of Company common stock, cash dividends paid or accrued payable totaling $3.6 million, and a $5.7 million increase in accumulated other comprehensive loss, net of taxes, partially offset by $21.0 million of net income earned during the first nine months of 2023. In addition, shareholder’s equity was negatively impacted by the adoption of CECL in the first quarter of 2023, which as of January 1, 2023, resulted in an after-tax decrease to opening retained earnings of $491,000. During the three months ended September 30, 2023, the Company repurchased a total of 239,649 shares of its common stock at a total cost of $4.5 million, or $18.86 per share. During the nine months ended September 30, 2023, the Company repurchased a total of 1,206,481 shares of its common stock at a total cost of $21.7 million, or $17.96 per share. For additional information see Part II, Item 2, “Unregistered Sales of Equity Securities, Use of Proceeds, and Issuer Purchases of Equity Securities.”
Comparison of Results of Operations for the Three and Nine Months Ended September 30, 2023 and 2022
Earnings summary. Net income was $6.6 million for the three months ended September 30, 2023, compared to $7.0 million for the three months ended September 30, 2022, a decrease of $340,000 or 4.9%. The decrease was the result of a $728,000 decrease in noninterest income and a $423,000 increase in noninterest expense, partially offset by a $520,000 decrease in provision for credit losses, a $84,000 increase in net interest income and a $207,000 decrease in provision for income taxes. Diluted earnings per share were $0.56 for the three months ended September 30, 2023, compared to $0.52 for the three months ended September 30, 2022.
Net income was $21.0 million for the nine months ended September 30, 2023, compared to $16.1 million for the nine months ended September 30, 2022, an increase of $4.9 million or 30.6%. The increase was primarily the result of a $4.1 million increase in net interest income, a $4.1 million decrease in provision for credit losses, reflecting a $311,000 reversal of the allowance for credit losses for the nine months ended September 30, 2023, compared to a $3.8 million provision for credit losses for the same period in 2022, partially offset by a $891,000 decrease in noninterest income and a $2.4 million increase in provision for income taxes.
Our efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income before provision for credit losses and noninterest income, was 62.42% and 63.07% for the three and nine months ended September 30, 2023, compared to 59.38% and 65.78% for the three and nine months ended September 30, 2022, respectively. The higher efficiency ratio during the three months ended September 30, 2023 compared to the same period in 2022 was due to lower noninterest income and higher noninterest expenses. The improvement in the efficiency ratio during the nine months ended September 30, 2023 compared to the same period in 2022 was due to higher revenues, while total noninterest expenses remained relatively unchanged.
Interest income. Interest income for the three months ended September 30, 2023 was $32.8 million, compared to $27.1 million for the three months ended September 30, 2022, an increase of $5.7 million or 21.0%. The increase in
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interest income between periods reflects increases in interest income in all interest-earning asset categories, with the largest increases from loans, and fed funds sold and interest bearing balances in banks. Increased yields earned on interest-earning assets, along with an increase in the average balance of fed funds sold and interest bearing balances in banks, were the primary drivers for the increase in interest income.
Interest income on loans, including fees, increased $3.2 million, or 13.4%, to $27.2 million for the three months ended September 30, 2023, compared to $24.0 million for the three months ended September 30, 2022, due to a 69 basis point increase in the average loan yield, partially offset by a $24.2 million decrease in the average balance of loans. The average yield on loans, including the accretion of the net discount and deferred PPP loan fees recognized for the three months ended September 30, 2023, was 5.42%, compared to 4.73% for the three months ended September 30, 2022. Interest income on loans for three months ended September 30, 2023 and 2022 included $372,000 and $63,000, respectively, in accretion of the net discount on acquired loans and revenue from PCD loans in excess of discounts. The remaining net discount on acquired loans was $419,000 and $480,000 at September 30, 2023 and September 30, 2022, respectively. Interest income on loans for three months ended September 30, 2023, included minimal fees earned related to PPP loans, compared to $161,000 in fees earned related to PPP loans during the three months ended September 30, 2022. As of September 30, 2023, there was a minimal amount of unrecognized PPP deferred fees and costs. Interest income on loans for the three months ended September 30, 2023 and 2022, included $142,000 and $195,000, respectively, in fees related to prepayment penalties.
Interest income on investment securities increased $149,000, or 9.6%, to $1.7 million for the three months ended September 30, 2023, compared to $1.6 million for the three months ended September 30, 2022, due to a 74 basis point increase in the average yield earned on investment securities, partially offset by a $20.1 million decrease in the average balance of investment securities. The average yield on investment securities was 4.01% for the three months ended September 30, 2023 compared to 3.27% for the three months ended September 30, 2022.
Interest income on federal funds sold and interest-bearing balances in banks increased $2.2 million, or 173.8%, to $3.5 million for the three months ended September 30, 2023, compared to $1.3 million for the three months ended September 30, 2022. The increase was due to a 320 basis point increase in the average yield earned on federal funds sold and, to a lesser extent, a $25.0 million increase in the average balance of federal funds sold and interest-bearing balances in banks. The average yield on federal funds sold and interest-bearing balances in banks was 5.38% for the three months ended September 30, 2023 compared to 2.18% for the three months ended September 30, 2022. In addition, during the third quarter of 2023, we received $376,000 in cash dividends on our FRB and FHLB stock, up 31.9% from $285,000 in the third quarter of 2022.
Interest income for the nine months ended September 30, 2023 was $94.1 million, compared to $77.6 million for the nine months ended September 30, 2022, an increase of $10.2 million or 14.6%. The increase in interest income between periods reflects increases in interest income in all interest-earning asset categories, with the largest increases from loans, and federal funds sold and interest bearing balances in banks. Increased yields earned on interest-earning assets, along with an increase in the average balance of loans, were the primary drivers for the increase in interest income.
Interest income on loans, including fees, increased $10.2 million, or 14.6%, to $80.2 million for the nine months ended September 30, 2023, compared to $69.9 million for the nine months ended September 30, 2022. The increase was primarily due to a 57 basis point increase in the average loan yield and, to a lesser extent, a $46.2 million increase in the average balance of loans. The average yield on loans, including the accretion of the net discount and deferred PPP loan fees recognized for the nine months ended September 30, 2023, was 5.31%, compared to 4.74% for the same period in 2022. Interest income on loans for nine months ended September 30, 2023 and 2022 included $474,000 and $1.5 million, respectively, in accretion of the net discount on acquired loans and revenue from PCD loans in excess of discounts. Interest income on loans for nine months ended September 30, 2023 and 2022 included $92,000 and $1.7 million in fees earned related to PPP loans, respectively. Interest income on loans for the nine months ended September 30, 2023 and 2022, included $458,000 and $916,000, respectively, in fees related to prepayment penalties.
Interest income on investment securities increased $554,000, or 12.4%, to $5.0 million for the nine months ended September 30, 2023, compared to $4.5 million for the nine months ended September 30, 2022, due to a 76 basis point increase in the average yield earned on investment securities, partially offset by a $17.0 million decrease in the average
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balance of investment securities. The average yield on investment securities available-for-sale was 3.97% for the nine months ended September 30, 2023 compared to 3.21% for the nine months ended September 30, 2022.
Interest income on federal funds sold and interest-bearing balances in banks increased $5.6 million, or 243.5%, to $7.9 million for the nine months ended September 30, 2023, compared to $2.3 million for the nine months ended September 30, 2022, due to a 418 basis point increase in the average yield earned on federal funds sold and interest-bearing balances in banks, partially offset by a $129.8 million decrease in the average balance of federal funds sold and interest-bearing balances in banks. The average yield on federal funds sold and interest-bearing balances in banks was 5.09% for the nine months ended September 30, 2023 compared to 0.91% for the nine months ended September 30, 2022.
Interest expense. Interest expense increased $5.6 million, or 232.5%, to $8.0 million for the three months ended September 30, 2023, compared to $2.4 million for the three months ended September 30, 2022, reflecting higher funding costs primarily related to increased market rates of interest payable on our deposits. The average rate paid on interest-bearing liabilities for three months ended September 30, 2023 was 2.04% compared to 0.66% for three months ended September 30, 2022. Total average interest-bearing liabilities increased $116.0 million, or 8.05%, to $1.6 billion for the three months ended September 30, 2023, compared to $1.4 billion for the three months ended September 30, 2022.
Interest expense on deposits increased $5.5 million, or 398.1%, to $6.9 million for the three months ended September 30, 2023 compared to $1.4 million for the three months ended September 30, 2022. The increase primarily was due to an increase in the average cost of deposits, specifically, money market accounts and time deposits. The average rate paid on interest bearing deposits increased by 145 basis points to 1.85% for the three months ended September 30, 2023, compared to 0.40% for the three months ended September 30, 2022. The overall average cost of deposits for the three months ended September 30, 2023 and 2022 was 1.27% and 0.25%, respectively. The average balance of interest-bearing deposits totaled $1.5 billion for the three months ended September 30, 2023, compared to $1.4 billion for the three months ended September 30, 2022. The increase primarily was due to an increase in the average balance of time deposits, partially offset by slight decreases in the average balances of savings, NOW and money market accounts. The average balance of noninterest bearing deposits decreased $127.1 million, or 15.8%, to $674.8 million for the three months ended September 30, 2023 compared to $801.9 million for the same period in 2022.
Interest expense on borrowings increased $88,000, or 8.44%, to $1.1 million for the three months ended September 30, 2023, compared to $1.0 million for the three months ended September 30, 2022, due to a 401 basis point increase in the average rate paid on junior subordinated debentures. The average cost of total borrowings increased to 6.09% for the three months ended September 30, 2023, compared to 5.64% for the three months ended September 30, 2022. The average balance of borrowings increased $341,000 to $72.4 million during the three months ended September 30, 2023, compared to $72.1 million during the three months ended September 30, 2022.
Interest expense increased $12.5 million, or 170.6%, to $19.8 million for the nine months ended September 30, 2023 compared to $7.3 million for the nine months ended September 30, 2022, reflecting higher funding costs related to increased rates of interest payable on our deposits and junior subordinated debentures. The average rate paid on interest bearing liabilities for nine months ended September 30, 2023 was 1.75% compared to 0.64% for nine months ended September 30, 2022. Total average interest-bearing liabilities decreased $14.6 million, or 0.96%, to $1.5 billion for the nine months ended September 30, 2023, compared to $1.5 billion for the nine months ended September 30, 2022.
Interest expense on deposits increased $12.2 million, or 282.6%, to $16.5 million for the nine months ended September 30, 2023 compared to $4.3 million for the nine months ended September 30, 2022. The increase primarily was due to an increase in the average cost of deposits, specifically money market accounts and time deposits. The average rate paid on interest bearing deposits increased by 113 basis points to 1.53% for the nine months ended September 30, 2023, compared to 0.40% for the nine months ended September 30, 2022. The overall average cost of deposits for the nine months ended September 30, 2023 and 2022 was 1.03% and 0.26%, respectively. The average balance of interest-bearing deposits totaled $1.4 billion for the nine months ended September 30, 2023, relatively unchanged compared to the same period in 2022, with decreases in the average balances of savings, NOW and money market accounts being offset by an increase in the average balance of time deposits. The average balance of noninterest bearing deposits decreased $85.4 million, or 10.9%, to $697.9 million for the nine months ended September 30, 2023 compared to $783.3 million for the same period in 2022.
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Interest expense on borrowings increased $303,000, or 95.3%, to $3.3 million for the nine months ended September 30, 2023, compared to $3.0 million for the nine months ended September 30, 2022, due to a 472 basis point increase in the average rate paid on junior subordinated debentures. The average cost of total borrowings increased to 6.10% for the nine months ended September 30, 2023, compared to 5.58% for the nine months ended September 30, 2022. The average balance of borrowings increased $518,000 to $72.6 million during the nine months ended September 30, 2023, compared to $72.0 million during the nine months ended September 30, 2022.
Net interest income and net interest margin. Net interest income increased $84,000, or 0.3%, to $24.8 million for the three months ended September 30, 2023, compared to $24.7 million for the three months ended September 30, 2022. The increase in net interest income primarily was due to increases in interest income on loans, federal funds sold and interest-bearing balances in banks and, to a lesser extent, investment securities, including dividends on Federal Reserve Bank (“FRB”) and Federal Home Loan Bank (“FHLB”) stock, partially offset by higher funding costs related to our deposits and junior subordinated debentures due to higher market rates.
The average yield (annualized) on interest earning assets for the three months ended September 30, 2023 increased to 5.34%, a 96 basis point increase from 4.38% for the three months ended September 30, 2022, while the average cost of interest bearing liabilities was 2.04% and 0.66% for the three months ended September 30, 2023 and 2022, respectively. The average yield (annualized) on interest earning assets for the nine months ended September 30, 2023 increased 109 basis points to 5.21%, from 4.12% for the nine months ended September 30, 2022, while the average cost of interest bearing liabilities for the nine months ended September 30, 2023 increased to 1.75%, or 111 basis points, from 0.64% for the nine months ended September 30, 2022. The increases in average yields on interest-earning assets and average rates paid on interest-bearing liabilities during the three and nine months ended September 30, 2023, compare to the same periods in 2022, were due to increases in the target range for federal funds since March 2022, including a 100 basis point increase during the first nine months of 2023, to a range of 5.25% to 5.50%.
The annualized net interest margin for the three and nine months ended September 30, 2023 was 4.03% and 4.12%, compared to 3.99% and 3.73% for the three and nine months ended September 30, 2022, respectively. The increase in net interest margin reflects the increased net interest income resulting from an improved mix of interest-earning assets, including increased balances of higher yielding loans and investment securities available for sale, and a lower average balance of interest earning assets. The average yield on PPP loans for the three and nine months ended September 30, 2023 was 1.00% and 3.11%, including the recognition of deferred fees, resulting in a negative impact of eight basis points and five basis points to the net interest margin during the three and nine months ended September 30 2023, respectively, compared to an average yield of 2.28% and 3.93%, including the recognition of deferred fees, resulting in a positive impact of three basis points and 10 basis points during three and nine months ended September 30, 2022, respectively. The impact of PPP loans on net interest margin will change during any period based on the volume of prepayments or amounts forgiven by the SBA as certain criteria are met but will cease completely after the maturity of the loans. Accretion of acquisition accounting discounts on loans and the recognition of revenue from acquired loans in excess of discounts increased net interest margin eight basis points during the three months ended September 30, 2023 and increased net interest margin by four basis points during the nine months ended September 30, 2023 compared to one and eight basis points during the three and nine months ended September 30, 2022, respectively.
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Average Balances, Interest and Average Yields/Cost. The following table presents, for the periods indicated, information about (i) average balances, the total dollar amount of interest income from interest earning assets and the resultant average yields; (ii) average balances, the total dollar amount of interest expense on interest bearing liabilities and the resultant average costs; (iii) net interest income; (iv) the interest rate spread; and (v) the net interest margin. Nonaccrual loans have been included in the table as loans carrying a zero yield. Yields have been calculated on a pre-tax basis. Loan yields include the effect of amortization or accretion of deferred loan fees/costs and purchase accounting premiums/discounts to interest and fees on loans.
Three months ended September 30,
2023
2022
Annualized
Annualized
Average
Average
Average
Average
Balance(1)
Interest
Yield/Cost
Balance(1)
Interest
Yield/Cost
(Dollars in thousands)
Interest earning assets
Fed Funds sold and interest bearing balances in banks
$
259,595
$
3,521
5.38
%
$
234,627
$
1,287
2.18
%
Investments securities
168,636
1,704
4.01
%
188,739
1,555
3.27
%
FHLB Stock
11,446
232
8.05
%
10,679
160
5.93
%
FRB Stock
9,625
144
5.94
%
9,592
125
5.19
%
Total loans
1,991,553
27,229
5.42
%
2,015,790
24,010
4.73
%
Total interest earning assets
2,440,855
32,830
5.34
%
2,459,427
27,137
4.38
%
Noninterest earning assets
141,999
135,399
Total average assets
$
2,582,854
$
2,594,826
Interest bearing liabilities
Savings
$
108,157
36
0.13
%
$
126,923
44
0.14
%
NOW accounts
295,383
68
0.09
%
335,037
80
0.10
%
Money market
622,992
2,818
1.79
%
645,340
750
0.46
%
Time deposits
458,643
3,986
3.45
%
262,234
513
0.78
%
Total interest bearing deposit accounts
1,485,175
6,908
1.85
%
1,369,534
1,387
0.40
%
Subordinated debt, net
63,812
896
5.56
%
63,644
896
5.58
%
Junior subordinated debentures, net
8,533
217
10.09
%
8,452
129
6.08
%
Other borrowings
91
—
—
—
—
—
Total interest bearing liabilities
1,557,611
8,021
2.04
%
1,441,630
2,412
0.66
%
Noninterest bearing deposits
674,776
801,871
Other noninterest bearing liabilities
40,319
28,941
Noninterest bearing liabilities
715,095
830,812
Total average liabilities
2,272,706
2,272,442
Average equity
310,147
322,384
Total average liabilities and equity
$
2,582,853
$
2,594,826
Net interest income
$
24,809
$
24,725
Interest rate spread (2)
3.30
%
3.72
%
Net interest margin (3)
4.03
%
3.99
%
Ratio of average interest earning assets to average interest bearing liabilities
156.70
%
170.60
%
(1) Average balances are computed using average daily balances.
(2) Interest rate spread is calculated as the average rate earned on interest earning assets minus the average rate paid on interest bearing liabilities.
(3) Net interest margin is calculated as net interest income divided by total average interest earning assets.
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Nine months ended September 30,
2023
2022
(Dollars in thousands)
Annualized
Annualized
Average
Average
Average
Average
Balance (1)
Interest
Yield/Cost
Balance(1)
Interest
Yield/Cost
(Dollars in thousands)
Interest earning assets
Fed Funds sold and interest-bearing balances in banks
$
207,788
$
7,910
5.09
%
$
337,565
$
2,303
0.91
%
Investments securities
169,804
5,037
3.97
%
186,799
4,483
3.21
%
FHLB Stock
11,060
616
7.45
%
10,418
467
5.99
%
FRB Stock
9,613
432
6.01
%
8,998
387
5.75
%
Total loans
2,017,017
80,151
5.31
%
1,970,850
69,921
4.74
%
Total interest earning assets
2,415,282
94,146
5.21
%
2,514,630
77,561
4.12
%
Noninterest earning assets
143,883
140,575
Total average assets
$
2,559,165
$
2,655,205
Interest bearing liabilities
Savings
$
113,336
113
0.13
%
$
125,829
130
0.14
%
NOW accounts
303,266
210
0.09
%
346,230
246
0.09
%
Money market
614,471
6,934
1.51
%
694,599
2,321
0.45
%
Time deposits
406,933
9,232
3.03
%
286,500
1,613
0.75
%
Total interest bearing deposit accounts
1,438,006
16,489
1.53
%
1,453,158
4,310
0.40
%
Subordinated debt, net
63,770
2,687
5.63
%
63,601
2,687
5.65
%
Junior subordinated debentures, net
8,512
623
9.78
%
8,431
319
5.06
%
Other borrowings
269
—
—
%
—
—
—
%
Total interest bearing liabilities
1,510,557
19,799
1.75
%
1,525,190
7,316
0.64
%
Noninterest bearing deposits
697,858
783,293
Other noninterest bearing liabilities
36,840
29,158
Noninterest bearing liabilities
734,698
812,451
Total average liabilities
2,245,255
2,337,641
Average equity
313,912
317,564
Total average liabilities and equity
$
2,559,167
$
2,655,205
Net interest income
$
74,347
$
70,245
Interest rate spread (2)
3.46
%
3.48
%
Net interest margin (3)
4.12
%
3.73
%
Ratio of average interest earning assets to average interest bearing liabilities
159.89
%
164.87
%
(1) Average balances are computed using average daily balances.
(2) Interest rate spread is calculated as the average rate earned on interest earning assets minus the average rate paid on interest bearing liabilities.
(3) Net interest margin is calculated as net interest income divided by total average interest earning assets.
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Rate/Volume Analysis. Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest earning assets and interest bearing liabilities, as well as changes in weighted average interest rates. The following table sets forth the effects of changing rates and volumes on our net interest income during the periods shown. Information is provided with respect to (i) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate) and (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume). Changes applicable to both volume and rate have been allocated to volume.
Three months ended September 30,
Nine months ended September 30,
2023 compared to 2022
2023 compared to 2022
Increase/(Decrease)
Increase/(Decrease)
Attributable to
Attributable to
Rate
Volume
Total
Rate
Volume
Total
(Dollars in thousands)
(Dollars in thousands)
Interest earning assets
Fed funds sold and interest bearing balances in banks
$
2,097
$
137
$
2,234
$
6,492
$
(885)
$
5,607
Investments securities
315
(166)
149
962
(408)
554
FHLB stock and FRB stock
80
11
91
139
55
194
Total loans
3,508
(289)
3,219
8,592
1,638
10,230
Total interest income
6,000
(307)
5,693
16,185
400
16,585
Interest bearing liabilities
Savings
(1)
(7)
(8)
(4)
(13)
(17)
NOW accounts
(3)
(9)
(12)
(5)
(31)
(36)
Money market accounts
2,094
(26)
2,068
4,881
(268)
4,613
Time deposits
3,089
384
3,473
6,941
678
7,619
Total deposit accounts
5,179
342
5,521
11,813
366
12,179
Subordinated debt, net
—
—
—
—
—
—
Junior subordinated debentures, net
87
1
88
301
3
304
Other borrowings
—
—
—
—
—
—
Total interest expense
5,266
343
5,609
12,114
369
12,483
Net interest income
$
734
$
(650)
$
84
$
4,071
$
31
$
4,102
Provision for credit losses. We recorded a $674,000 provision for credit losses and a $311,000 reversal of the allowance for credit losses for the three and nine months ended September 30, 2023, compared to a $1.2 million and a $3.8 million provision for loan losses for the three and nine months ended September 30, 2022, respectively. The provision for credit losses for loans in the third quarter of 2023 was primarily due to $1.2 million increase in reserves for individually evaluated loans, which included the loan to the Trust discussed above which was placed on nonaccrual during the quarter, and an increase in qualitative reserves, partially offset by improvements in forecasted economic conditions, specifically, national gross domestic product and national unemployment, indicators utilized to estimate credit losses and, to a lesser extent, a decrease in outstanding loan balances and $24,000 in net charge-offs during the third quarter of 2023. The reversal of the allowance for credit losses primarily resulted from $399,000 in net charge-offs for the nine months ended September 30, 2023, coupled with improvements in forecasted economic conditions, specifically, national gross domestic product and national unemployment, indicators utilized to estimate credit losses and, to a lesser extent, a decrease in outstanding loan balances, partially offset by an overall increase in reserves for individually evaluated loans, and increase in qualitative reserves.
Noninterest income. Noninterest income decreased $728,000, or 30.6%, to $1.7 million for the three months ended September 30, 2023 compared to $2.4 million for the three months ended September 30, 2022. The decrease was primarily due to a $1.3 million decrease in gain on sale of loans due to a decrease in the volume of and premiums observed on SBA loans (guaranteed portion) sold and a $57,000 decrease in loan servicing fees and other fees, partially offset by a $288,000 increase in income from our investment in a Small Business Investment Company (“SBIC”) fund, a $156,000 increase in service charges and other fees, a $88,000 decrease in loss on equity securities and a $47,000 increase in other income and fees.
Noninterest income decreased $891,000, or 17.2%, to $4.3 million for the nine months ended September 30, 2023 compared to $5.2 million for the nine months ended September 30, 2022. The decrease was primarily due to a $1.7 million
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bargain purchase gain in 2022 with no similar activity in 2023, a $2.2 million decrease in gain on sale of loans due to a decrease in the volume of premiums observed on SBA loans (guaranteed portion) sold and a $236,000 decrease in loan servicing fees and other fees, partially offset by a $1.9 million improvement in fair value adjustments on equity securities, a $784,000 increase in income on investment in a Small Business Investment Company (“SBIC”) fund and a $575,000 increase in service charges and other fees.
The following table presents the key components of noninterest income for the periods indicated:
Three months ended September 30,
2023
2022 (As Restated)
$ Change
% Change
(Dollars in thousands)
Gain on sale of loans
$
28
$
1,278
$
(1,250)
(97.8)
%
Loss on equity securities
(274)
(362)
88
(24.3)
%
Service charges and other fees
973
817
156
19.1
%
Loan servicing and other loan fees
431
488
(57)
(11.7)
%
Income on investment in SBIC fund
225
(63)
288
457.1
%
Other income and fees
271
224
47
21.0
%
Total noninterest income
$
1,654
$
2,382
$
(728)
(30.6)
%
Nine months ended September 30,
2023
2022 (As Restated)
$ Change
% Change
(Dollars in thousands)
Gain on sale of loans
$
508
$
2,714
$
(2,206)
(81.3)
%
Loss on equity securities
(2,087)
(3,971)
1,884
(47.4)
%
Service charges and other fees
2,740
2,165
575
26.6
%
Loan servicing and other loan fees
1,434
1,670
(236)
(14.1)
%
Income on investment in SBIC fund
939
155
784
505.8
%
Bargain purchase gain
—
1,665
(1,665)
N/M
%
Other income and fees
769
796
(27)
(3.4)
%
Total noninterest income
$
4,303
$
5,194
$
(891)
(17.2)
%
N/M - Not meaningful
Noninterest expense. Noninterest expense increased $423,000, or 2.6%, to $16.5 million for the three months ended September 30, 2023 compared to $16.1 million for the three months ended September 30, 2022. The increase primarily was due to a $212,000 increase in data processing expense due to annual price increases that became effective in the third quarter of 2023 and increased data project expense, a $120,000 increase in salaries and employee benefits expense due to wage increases and an increase in full-time equivalent employees, and a $90,000 increase in occupancy and equipment expense due to higher depreciation and property maintenance expense.
Noninterest expense was $49.6 million for both the nine months ended September 30, 2023 and the nine months ended September 30, 2022. The changes in noninterest expense included a $1.4 million decrease in other noninterest expenses due primarily to $3.1 million in total PEB acquisition-related expenses in 2022 with no similar expenses in 2023, a $647,000 decrease in data processing expense due to $1.1 million in PEB acquisition-related expenses incurred in 2022 with none in 2023 and vendor data processing invoice credits in 2023, partially offset by increased data processing volume and prices, and data processing project expense in 2023 and a $254,000 decrease in occupancy and equipment expense due to $375,000 of PEB acquisition-related expenses incurred in 2022 partially offset by increased depreciation and property maintenance expense, offset by a $2.3 million increase in salaries and employee benefits expense due to wage increase and an increase in full-time equivalent employees.
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The following table details the components of noninterest expense for the periods indicated:
Three months ended September 30,
2023
2022
$ Change
% Change
(Dollars in thousands)
Salaries and related benefits
$
10,284
$
10,164
$
120
1.2
%
Occupancy and equipment
2,133
2,043
90
4.4
%
Data processing
1,774
1,562
212
13.6
%
Other
2,328
2,327
1
0.0
%
Total noninterest expense
$
16,519
$
16,096
$
423
2.6
%
Nine months ended September 30,
2023
2022
$ Change
% Change
(Dollars in thousands)
Salaries and employee benefits
$
32,065
$
29,751
$
2,314
7.8
%
Occupancy and equipment
6,134
6,388
(254)
(4.0)
%
Data processing
4,855
5,502
(647)
(11.8)
%
Other
6,551
7,986
(1,435)
(18.0)
%
Total noninterest expense
$
49,605
$
49,627
$
(22)
(0.0)
%
Income taxes. The provision for income taxes decreased $207,000, or 7.3%, to $2.6 million the three months ended September 30, 2023 compared to $2.8 million for the three months ended September 30, 2022 due to lower taxable income. For the nine months ended September 30, 2022, the provision for income taxes increased $2.4 million, or 41.6%, to $8.3 million, compared to $5.9 million for the nine months ended September 30, 2022 due to higher taxable income. The Company’s effective tax rate was 28.5% and 28.4% for three and nine months ended September 30, 2023 compared to 29.0% and 28.3% for the three and nine months ended September 30, 2022. The effective tax rate was lower for the three months ended September 30, 2023, compared to the same period in 2022, due to slightly lower permanent tax differences. The effective tax rate during the nine months ended September 30, 2022, was positively impacted by the non-taxable bargain purchase gain in the first quarter of 2022.
Liquidity and Capital Resources
Planning for our normal business liquidity needs, both expected and unexpected, is done on a daily and short-term basis through the cash management function. On a longer-term basis, it is accomplished through the budget and strategic planning functions, with support from internal asset/liability management software model projections.
Management maintains a liquidity position that it believes will adequately provide funding for loan demand and deposit run off that may occur in the normal course of business. We rely on a number of different sources in order to meet our potential liquidity demands. Our primary sources of funds are deposits, escrow and custodial deposits, principal and interest payments on loans and proceeds from sale of loans. During the three months ended September 30, 2023, the Bank sold $300,000 in loans and loan participation interests and received $58.6 million in principal loan repayments. While maturities and scheduled amortization of loans are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by market interest rates, economic conditions, and competition.
Deposits increased $61.1 million to $2.2 billion and liquid assets, in the form of cash and cash equivalents, time deposit in banks and investment securities, increased $116.5 million to $449.5 million at September 30, 2023 from December 31, 2022. Management believes that our securities portfolio is of high quality and the securities would therefore be marketable. Securities purchased during the three and nine months ended September 30, 2023, totaled $3.9 million and $6.4 million, respectively, and securities repayments, maturities and sales in those periods were $3.4 million and $6.3 million, respectively. Certificates of deposit scheduled to mature in one year or less at September 30, 2023, totaled $349.9 million. It is management’s policy to manage deposit rates that are competitive with other local financial institutions. Based on this management strategy, we believe that most of our maturing certificates of deposit will remain with us.
In addition to these primary sources of funds, management has several secondary sources available to meet potential funding requirements. As of September 30, 2023, the Bank had an available borrowing capacity of $597.6 million with the FHLB of San Francisco, with no borrowings outstanding at that date or at December 31, 2022. The Bank also
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had, as of that date, federal funds lines with available commitments totaling $65.0 million with four correspondent banks. There were no amounts outstanding under these facilities at September 30, 2023 and December 31, 2022. Subject to market conditions, we expect to utilize these borrowing facilities from time to time in the future to fund loan originations and deposit withdrawals, to satisfy other financial commitments, repay maturing debt and to take advantage of investment opportunities to the extent feasible.
Liquidity management is both a daily and long-term function of the Company’s management. Excess liquidity is generally invested in short-term investments, such as overnight deposits and federal funds. On a longer-term basis, a strategy is maintained of investing in various lending products and investment securities, including U.S. Government obligations and U.S. agency securities. We use our sources of funds primarily to meet our ongoing commitments, pay maturing deposits and fund withdrawals, and to fund loan commitments. Loan commitments and letters of credit were $79.6 million, including $1.5 million of undisbursed construction and development loan commitments, at September 30, 2023. For information regarding our commitments, see “Note 18 – Commitments and Contingencies” of the Notes to Condensed Consolidated Financial Statements included in “Item 1. Financial Information” of Part I of this report.
Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash provided by operating activities for the nine months ended September 30, 2023 was $22.4 million, compared to $23.8 million provided by operating activities for the nine months ended September 30, 2022. During the nine months ended September 30, 2023, net cash provided by investing activities was $52.9 million, which consisted primarily of net change in loans receivable, compared to $82.6 million of cash provided by investing activities for the nine months ended September 30, 2022. Net cash provided by financing activities for the nine months ended September 30, 2023 was $49.8 million, which was comprised primarily of net change in deposits, compared to $261.4 million used in financing activities during the nine months ended September 30, 2022. Management believes our capital sources are adequate to meet all reasonably foreseeable short-term and long-term cash requirements. There has not been a material change in our liquidity and capital resources since the information disclosed in our 2022 Annual Report other than set forth above. We are not aware of any reasonably likely material changes in the mix and relative cost of such resources.
BayCom Corp is a separate legal entity from the Bank and must provide for its own liquidity. At September 30, 2023, BayCom Corp had liquid assets of $13.9 million. In addition to its operating expenses, BayCom Corp is responsible for paying to its shareholders any dividends that have been declared, funding stock repurchases, and making payments on its junior subordinated debentures and subordinated notes. BayCom Corp can receive dividends and other capital distributions from the Bank, although there are regulatory restrictions on the ability of the Bank to pay dividends and make other capital distributions.
On August 18, 2023, the Company announced that its Board of Directors declared a quarterly cash dividend of $0.10 per share on the Company’s outstanding common stock, payable on October 13, 2023 to shareholders of record as of the close of business on September 15, 2023. The Company expects to continue to pay quarterly cash dividends on its common stock, subject to the Board of Directors’ discretion to modify or terminate this practice at any time and for any reason without prior notice. Assuming continued payment of the cash dividend at this rate of $0.10 per share, our average total dividend paid each quarter would be approximately $1.2 million based on the number of our outstanding shares at September 30, 2023. The dividends we pay if any, may be limited as more fully discussed under “Business – Supervision and Regulation – BayCom Corp – Dividends” and “– Regulatory Capital Requirements” contained in “Part I. Item 1. Business” of the 2022 Annual Report.
From time to time, our Board of Directors has authorized stock repurchase programs. In general, stock repurchases allow us to proactively manage our capital position and return excess capital to shareholders. Stock repurchases also provide us with shares of common stock necessary to satisfy obligations related to stock compensation awards. In August 2023, our Board of Directors announced a new stock repurchase program, to commence following completion of the existing stock repurchase program (which was completed during the quarter ended September 30, 2023), for the repurchase of up to 588,000 shares, or approximately 5.0% of the Company’s outstanding common stock, over a one year period. Purchases under the Company’s stock repurchase programs may be made through open market purchases, privately negotiated transactions, or otherwise in compliance with Rule 10b-18 under the Securities Exchange Act of 1934. The repurchase programs may be suspended, terminated, or modified at any time for any reason, including market conditions, the cost of repurchasing shares, the availability of alternative investment opportunities, liquidity, and other
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factors deemed appropriate. The Company’s stock repurchase programs do not obligate the Company to purchase any particular number of shares. As of September 30, 2023, there remained 482,311 shares available for repurchase under the Company’s existing stock repurchase program. For additional information on the Company’s stock repurchases, see “Item 2. Unregistered Sales of Equity Securities, Use of Proceeds, and Issuer Purchases of Equity Securities” contained in Part II of this report.
Regulatory Capital
The Bank, as a state-chartered, federally insured commercial bank, and member of the Board of Governors of the Federal Reserve System, is subject to capital requirements established by the Federal Reserve. The Federal Reserve requires the Bank to maintain levels of capital adequacy that generally parallel the FDIC requirements. The capital adequacy requirements are quantitative measures established by regulation that require the Bank to maintain minimum amounts and ratios of capital. The FDIC requires the Bank to maintain minimum ratios of Total Capital, Tier 1 Capital, and Common Equity Tier 1 Capital to risk-weighted assets as well as Tier 1 Leverage Capital to average assets. Consistent with our goal to operate a sound and profitable organization, our policy is for the Bank to maintain “Well Capitalized” status under the Federal Reserve regulations. Based on capital levels at September 30, 2023 and December 31, 2022, the Bank was considered Well Capitalized at both of those dates.
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The table below shows the capital ratios under the Basel III capital framework as of the dates indicated:
At September 30, 2023
At December 31, 2022
Amount
Ratio
Amount
Ratio
(As Restated)
(As Restated)
(Dollars in thousands)
Leverage Ratio
BayCom Corp
$
279,103
11.30
%
$
283,431
11.79
%
Minimum requirement for “Well Capitalized”
123,478
5.00
%
120,193
5.00
%
Minimum regulatory requirement
98,782
4.00
%
96,154
4.00
%
United Business Bank
336,437
13.26
%
336,667
13.64
%
Minimum requirement for “Well Capitalized”
126,900
5.00
%
123,402
5.00
%
Minimum regulatory requirement
101,520
4.00
%
98,722
4.00
%
Common Equity Tier 1 Ratio
BayCom Corp
279,103
14.12
%
283,431
13.68
%
Minimum requirement for “Well Capitalized”
128,512
6.50
%
134,648
6.50
%
Minimum regulatory requirement
88,970
4.50
%
93,218
4.50
%
United Business Bank
336,437
17.20
%
336,667
16.42
%
Minimum requirement for “Well Capitalized”
127,118
6.50
%
133,242
6.50
%
Minimum regulatory requirement
88,005
4.50
%
92,245
4.50
%
Tier 1 Risk-Based Capital Ratio
BayCom Corp
288,588
14.60
%
292,916
14.14
%
Minimum requirement for “Well Capitalized”
158,169
8.00
%
165,721
8.00
%
Minimum regulatory requirement
118,627
6.00
%
124,291
6.00
%
United Business Bank
336,437
17.20
%
336,667
16.42
%
Minimum requirement for “Well Capitalized”
156,453
8.00
%
163,991
8.00
%
Minimum regulatory requirement
117,340
6.00
%
122,993
6.00
%
Total Risk-Based Capital Ratio
BayCom Corp
373,638
18.90
%
377,131
18.21
%
Minimum requirement for “Well Capitalized”
197,711
10.00
%
207,151
10.00
%
Minimum regulatory requirement
158,169
8.00
%
165,721
8.00
%
United Business Bank
356,487
18.23
%
355,882
17.36
%
Minimum requirement for “Well Capitalized”
195,567
10.00
%
204,988
10.00
%
Minimum regulatory requirement
156,453
8.00
%
163,991
8.00
%
In addition to the minimum capital ratios, the Bank must maintain a capital conservation buffer consisting of additional Common Equity Tier 1 capital greater than 2.5% above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of eligible retained income that could be utilized for such actions. At September 30, 2023, the Bank’s Common Equity Tier 1 capital exceeded the required capital conservation buffer.
For a bank holding company with less than $3.0 billion in assets, the capital guidelines apply on a bank only basis and the Federal Reserve expects the holding company’s subsidiary bank(s) to be Well Capitalized under the prompt corrective action regulations. If the Company were subject to regulatory guidelines for bank holding companies with $3.0 billion or more in assets, at September 30, 2023, the Company would have exceeded all regulatory capital requirements.
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For additional information, see “Item 1. Business — Supervision and Regulation — United Business Bank — Capital Requirements” and Note 19, “Regulatory Matters” in the Notes to the Consolidated Financial Statements, included in “Item 8. Financial Statements and Supplementary Data” in the 2022 Annual Report.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.