CVB FINANCIAL CORP 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion provides information about the results of operations, financial condition, liquidity and capital resources of CVB Financial Corp. (referred to herein on an unconsolidated basis as “CVB” and on a consolidated basis as “we,” “our” or the “Company”) and its wholly owned bank subsidiary, Citizens Business Bank (the “Bank” or “CBB”). This information is intended to facilitate the understanding and assessment of significant changes and trends related to our financial condition and the results of our operations. This discussion and analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2019, and the unaudited condensed consolidated financial statements and accompanying notes presented elsewhere in this report. IMPACT OF COVID-19 The spread of COVID-19 has created a global public health crisis that has resulted in unprecedented volatility and disruption in financial markets and deterioration in economic activity and market conditions in the markets we serve. The pandemic has already affected our customers and the communities we serve and depending on the duration of the crisis, the adverse impact on our financial position and results of operations could be significant. In response to the anticipated effects of the pandemic on the U.S. economy, the Board of Governors of the Federal Reserve System (“FRB”) has taken significant actions, including a reduction in the target range of the federal funds rate to 0.0% to 0.25% and an indeterminate amount of purchases of Treasury and mortgage-backed securities. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into law. It contains substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The CARES Act includes the Paycheck Protection Program (“PPP”), a $349 billion program designed to aid small- and medium-sized businesses through 100% SBA guaranteed loans distributed through banks. These loans were intended to guarantee 24 weeks of payroll and other costs to help those businesses remain viable and keep their workers employed. The SBA exhausted the initial funding for this program on April 15, 2020, but legislation passed on April 24, 2020 to provide additional PPP funds of $310 billion. We originated and funded about 4,100 loans, totaling approximately $1.10 billion, as of September 30, 2020. In response to the COVID-19 pandemic, we have also implemented a short-term loan modification program to provide temporary payment relief to certain of our borrowers who meet the program’s qualifications. This program allows for a deferral of payments for 90 days. The deferred payments along with interest accrued during the deferral period are due and payable on the maturity date of the existing loan. As of October 9, 2020, we have remaining temporary payment deferments of principal, interest or of principal and interest in response to the CARES Act for 33 loans totaling $68.6 million. These deferments were primarily for 90 days, with 89% of these loans being pass rated. Of these loans, 27 have received a second deferment and the remaining six loans are first deferments. The third quarter of 2020 did not include a provision for credit losses, as the economic outlook is generally consistent with the forecast from the prior quarter end. In comparison, the Company recorded a provision for credit losses of $23.5 million in the first half of 2020, including $11.5 million in the second quarter. We continue to monitor the impact of COVID-19 closely, as well as any effects that may result from the CARES Act. The extent to which the COVID-19 pandemic will impact our operations and financial results during the fourth quarter of 2020 is highly uncertain, but we may experience increased provision for credit losses if this pandemic results in economic stress greater than forecasted on our borrowers and loan portfolios and lower interest income if the current low interest rate environment continues. 37 Table of Contents CRITICAL ACCOUNTING POLICIES The discussion and analysis of the Company’s unaudited condensed consolidated financial statements are based upon the Company’s unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these unaudited condensed consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and are essential to understanding Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following is a summary of the more judgmental and complex accounting estimates and principles. In each area, we have identified the variables we believe are most important in our estimation process. We utilize information available to us to make the necessary estimates to value the related assets and liabilities. Actual performance that differs from our estimates and future changes in the key variables and information could change future valuations and impact the results of operations. · Allowance for Credit Losses (“ACL”) · Business Combinations · Valuation and Recoverability of Goodwill · Income Taxes Our significant accounting policies are described in greater detail in our 2019 Annual Report on Form 10-K in the “Critical Accounting Policies” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Note 3 – Summary of Significant Accounting Policies , included in our Annual Report on Form 10-K for the year ended December 31, 2019, which are essential to understanding Management’s Discussion and Analysis of Financial Condition and Results of Operations. Adoption of Allowance for Credit Losses We adopted ASU 2016-13, commonly referred to as Current Expected Credit Losses (“CECL”), which replaces the “incurred loss” approach with an “expected loss” model over the life of the loan, effective on January 1, 2020. We adopted the guidance using a modified retrospective approach, as required, and have not adjusted prior period comparative information and will continue to disclose prior period financial information in accordance with the previous accounting guidance. The adoption of ASU 2016-13, resulted in a reduction to our opening retained earnings of approximately $1.3 million. The ACL policy is described more fully in Note 3 – Summary of Significant Accounting Policies of the notes to the unaudited condensed consolidated financial statements. 38 Table of Contents Recently Issued Accounting Pronouncements but Not Adopted as of September 30, 2020 Standard Description Adoption Timing Impact on Financial Statements ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting Issued March 2020 The FASB issued ASU 2020-04, Reference Rate Reform: Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The amendments in this update provide temporary, optional guidance to ease the potential burden in accounting for transitioning away from reference rates such as LIBOR. The amendments provide optional expedients and exceptions for applying GAAP to transactions affected by reference rate reform if certain criteria are met. The amendments primarily include relief related to contract modifications and hedging relationships, as well as providing a one-time election for the sale or transfer of debt securities classified as held-to-maturity. This guidance is effective immediately and the amendments may be applied prospectively through December 31, 2022. 1st Quarter 2020 through the 4th Quarter 2022 Although the Company is assessing the impacts of this transition and exploring alternatives to use in place of LIBOR for various financial instruments, primarily related to our variable-rate loans, our subordinated debentures, and interest rate swap derivatives that are indexed to LIBOR, we do not expect this ASU to have a material impact on the Company’s consolidated financial statements. ASU 2020-01, Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) Issued January 2020 The FASB issued ASU 2020-01, Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815). This ASU clarifies the interactions between ASC 321, ASC 323 and ASC 815 and addresses accounting for the transition into and out of the equity method and also provides guidance on whether equity method accounting would be applied to certain purchased options and forward contracts upon settlement. 1st Quarter 2021 The adoption of this ASU will not have an impact on our consolidated financial statements. ASU 2020-06, Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity Issued August 2020 The FASB issued ASU 2020-06, Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. This ASU reduces the number of accounting models for convertible instruments and allows more contracts to qualify for equity classification. 1st Quarter 2022 The adoption of this ASU is not expected to have a material impact on our consolidated financial statements. 39 Table of Contents OVERVIEW For the third quarter of 2020, we reported net earnings of $47.5 million, compared with $41.6 million for the second quarter of 2020 and $50.4 million for the third quarter of 2019. Diluted earnings per share were $0.35 for the third quarter, compared to $0.31 for the prior quarter and $0.36 for the same period last year. No provision for credit losses was recorded for the third quarter of 2020. The Company’s economic forecast of macro-economic variables was generally consistent with the forecast at the end of the second quarter. A $23.5 million provision for credit losses was recorded in the first half of 2020, due to the economic disruption and forecasted impact resulting from COVID-19. In comparison to the prior year, a $1.5 million loan loss provision was incurred for the third quarter of 2019. During the third quarter of 2020, we experienced minimal credit charge-offs of $231,000 and total recoveries of $117,000, resulting in net charge-offs of $114,000. During the second quarter of 2020, the Company originated, under the SBA Paycheck Protection Program, approximately 4,100 loans, of which $1.10 billion was outstanding at September 30, 2020. Interest and fee income from PPP loans increased from approximately $8.5 million in the second quarter of 2020, to $9.5 million in the third quarter of 2020. At September 30, 2020, total assets of $13.82 billion increased $2.54 billion, or 22.48%, from total assets of $11.28 billion at December 31, 2019. Interest-earning assets of $12.59 billion at September 30, 2020 increased $2.57 billion, or 25.59%, when compared with $10.03 billion at December 31, 2019. The increase in interest-earning assets was primarily due to a $1.31 billion increase in interest-earning balances due from the Federal Reserve, an $843.3 million increase in total loans, and a $368.6 million increase in investment securities. Excluding PPP loans, total loans declined by $257.8 million from December 31, 2019. Total investment securities were $2.78 billion at September 30, 2020, an increase of $368.6 million, or 15.27%, from $2.41 billion at December 31, 2019. At September 30, 2020, investment securities held-to-maturity (“HTM”) totaled $577.7 million. At September 30, 2020, investment securities available-for-sale (“AFS”) totaled $2.21 billion, inclusive of a net pre-tax unrealized gain of $55.3 million, an increase of $33.4 million from December 31, 2019. HTM securities declined by $96.8 million, or 14.35%, and AFS securities increased by $465.4 million, or 26.74%, from December 31, 2019. Our tax equivalent yield on investments was 1.99% for the quarter ended September 30, 2020, compared to 2.22% for the second quarter of 2020 and 2.47% for the third quarter of 2019. Total loans and leases, net of deferred fees and discounts, of $8.41 billion at September 30, 2020 increased by $843.3 million, or 11.15%, from December 31, 2019. The increase in total loans included $1.10 billion in PPP loans and a $130.9 million decline in dairy & livestock and agribusiness loans primarily due to seasonal pay downs, which historically occur in the first quarter of each calendar year. Excluding PPP loans and dairy & livestock and agribusiness loans, total loans declined by $126.9 million, or 1.77%. The $126.9 million decrease in loans included decreases of $118.1 million in commercial and industrial loans, $27.3 million in consumer and other loans, $15.1 million in municipal lease financings, $15.0 million in construction loans, and $8.7 million in SFR mortgage loans. Partially offsetting these declines was an increase in commercial real estate loans of $53.6 million. Our yield on loans was 4.47% for the quarter ended September 30, 2020, compared to 4.77% for the second quarter of 2020 and 5.23% for the third quarter of 2019. This decline was primarily due to the impact of the Federal Reserve’s rate decreases and the decline in discount accretion income for acquired loans. Interest income for yield adjustments related to discount accretion on acquired loans was $4.2 million for the quarter ended September 30, 2020, compared to $4.1 million for the second quarter of 2020 and $7.2 million for the third quarter of 2019. Noninterest-bearing deposits were $6.92 billion at September 30, 2020, an increase of $1.67 billion, or 31.91%, when compared to December 31, 2019. The significant deposit growth in the first nine months of 2020 was primarily due to our customers maintaining greater liquidity. At September 30, 2020, noninterest-bearing deposits were 61.95% of total deposits, compared to 60.26% at December 31, 2019. Our average cost of total deposits was 0.11% for the quarter ended September 30, 2020, compared to 0.12% for the second quarter of 2020 and 0.21% for the third quarter of 2019. Customer repurchase agreements totaled $483.4 million at September 30, 2020, compared to $428.7 million at December 31, 2019. Our average cost of total deposits including customer repurchase agreements was 0.11% for the quarter ended September 30, 2020, compared to 0.12% for the second quarter of 2020 and 0.22% for the third quarter of 2019. At September 30, 2020, we had $10.0 million in short-term borrowings with 0% cost, compared to no borrowings at December 31, 2019 and September 30, 2019. At September 30, 2020, we had $25.8 million of junior subordinated debentures, unchanged from December 31, 2019. Our average cost of funds was 0.11% for the quarter ended September 30, 2020, 0.13% for the second quarter of 2020, and 0.23% for the third quarter of 2019. 40 Table of Contents The allowance for credit losses totaled $93.9 million at September 30, 2020, compared to $68.7 million at December 31, 2019. Due to the adoption of CECL, effective on January 1, 2020, a transition adjustment of $1.8 million was added to the beginning balance of the allowance and was increased by $23.5 million in provision for credit losses in the first nine months of 2020 due to the severe economic disruption forecasted to result from the COVID-19 pandemic. At September 30, 2020, ACL as a percentage of total loans and leases outstanding was 1.12%, or 1.28% when PPP loans are excluded. This compares to 0.91% at December 31, 2019. As of September 30, 2020, total discounts on acquired loans were $35.2 million. The Company’s total equity was $1.98 billion at September 30, 2020. This represented a decrease of $12.1 million, or 0.61%, from total equity of $1.99 billion at December 31, 2019. This decrease was primarily due to repurchase of common stock of $91.7 million under our 10b5-1 stock repurchase program, and $73.3 million in cash dividends, offset by net earnings of $127.1 million and a $23.5 million increase in other comprehensive income resulting from the tax effected impact of the increase in market value of our available-for-sale investment securities portfolio. Our tangible common equity ratio was 9.8% at September 30, 2020. Our capital ratios under the revised capital framework referred to as Basel III remain well-above regulatory requirements. As of September 30, 2020, the Company’s Tier 1 leverage capital ratio totaled 9.88%, our common equity Tier 1 ratio totaled 14.60%, our Tier 1 risk-based capital ratio totaled 14.89%, and our total risk-based capital ratio totaled 16.08%. We did not elect to phase in the impact of CECL on regulatory capital, as allowed under the interim final rule of the FDIC and other U.S. banking agencies. Refer to our Analysis of Financial Condition – Capital Resources . 41 Table of Contents ANALYSIS OF THE RESULTS OF OPERATIONS Financial Performance Three Months Ended Variance September 30, June 30, 2020 2020 $ % (Dollars in thousands, except per share amounts) Net interest income $ 103,325 $ 104,569 $ (1,244) -1.19 % Provision for credit losses - (11,500 ) 11,500 100.00 % Noninterest income 13,153 12,152 1,001 8.24 % Noninterest expense (49,588 ) (46,398 ) (3,190) -6.88 % Income taxes (19,398 ) (17,192 ) (2,206) -12.83 % Net earnings $ 47,492 $ 41,631 $ 5,861 14.08 % Earnings per common share: Basic $ 0.35 $ 0.31 $ 0.04 Diluted $ 0.35 $ 0.31 $ 0.04 Return on average assets 1.38 % 1.33 % 0.05% Return on average shareholders’ equity 9.51 % 8.51 % 1.00% Efficiency ratio 42.57 % 39.75 % 2.82% Noninterest expense to average assets 1.44 % 1.48 % -0.04% Three Months Ended Nine Months Ended September 30, Variance September 30, Variance 2020 2019 $ % 2020 2019 $ % (Dollars in thousands, except per share amounts) Net interest income $ 103,325 $ 108,159 $ (4,834) -4.47% $ 310,200 $ 328,752 $ (18,552) -5.64% Provision for credit losses - (1,500) 1,500 100.00% (23,500) (5,000) (18,500) -370.00% Noninterest income 13,153 11,894 1,259 10.59% 36,945 46,402 (9,457) -20.38% Noninterest expense (49,588) (47,535) (2,053) -4.32% (144,627) (149,667) 5,040 3.37% Income taxes (19,398) (20,595) 1,197 5.81% (51,915) (63,941) 12,026 18.81% Net earnings $ 47,492 $ 50,423 $ (2,931 ) -5.81% $ 127,103 $ 156,546 $ (29,443 ) -18.81% Earnings per common share: Basic $ 0.35 $ 0.36 $ (0.01) $ 0.93 $ 1.12 $ (0.19) Diluted $ 0.35 $ 0.36 $ (0.01) $ 0.93 $ 1.12 $ (0.19) Return on average assets 1.38 % 1.78% -0.40% 1.35% 1.86% -0.51% Return on average shareholders’ equity 9.51 % 10.18% -0.67% 8.55% 10.89% -2.34% Efficiency ratio 42.57 % 39.60% 2.97% 41.66% 39.89% 1.77% Noninterest expense to average assets 1.44 % 1.68% -0.24% 1.54% 1.77% -0.23% 42 Table of Contents Return on Average Tangible Common Equity Reconciliation (Non-GAAP) The return on average tangible common equity is a non-GAAP disclosure. The Company uses certain non-GAAP financial measures to provide supplemental information regarding the Company’s performance. The following is a reconciliation of net income, adjusted for tax-effected amortization of intangibles, to net income computed in accordance with GAAP; a reconciliation of average tangible common equity to the Company’s average stockholders’ equity computed in accordance with GAAP; as well as a calculation of return on average tangible common equity. Three Months Ended Nine Months Ended September 30, June 30, September 30, September 30, September 30, 2020 2020 2019 2020 2019 (Dollars in thousands) Net Income $ 47,492 $ 41,631 $ 50,423 $ 127,103 $ 156,546 Add: Amortization of intangible assets 2,292 2,445 2,648 7,182 8,338 Less: Tax effect of amortization of intangible assets (1) (678) (723) (783) (2,123) (2,465) Tangible net income $ 49,106 $ 43,353 $ 52,288 $ 132,162 $ 162,419 Average stockholders’ equity $ 1,985,842 $ 1,966,600 $ 1,965,427 $ 1,986,300 $ 1,921,981 Less: Average goodwill (663,707) (663,707) (663,707) (663,707) (665,470) Less: Average intangible assets (37,133) (39,287) (46,720) (39,376) (49,682) Average tangible common equity $ 1,285,002 $ 1,263,606 $ 1,255,000 $ 1,283,217 $ 1,206,829 Return on average equity, annualized 9.51 % 8.51 % 10.18 % 8.55 % 10.89 % Return on average tangible common equity, annualized 15.20 % 13.80 % 16.53 % 13.76 % 17.99 % (1) Tax effected at respective statutory rates. Net Interest Income The principal component of our earnings is net interest income, which is the difference between the interest and fees earned on loans and investments (interest-earning assets) and the interest paid on deposits and borrowed funds (interest-bearing liabilities). Net interest margin is net interest income as a percentage of average interest-earning assets for the period. The level of interest rates and the volume and mix of interest-earning assets and interest-bearing liabilities impact net interest income and net interest margin. The net interest spread is the yield on average interest-earning assets minus the cost of average interest-bearing liabilities. Net interest margin and net interest spread are included on a tax equivalent (TE) basis by adjusting interest income utilizing the federal statutory tax rates of 21% in effect for the three and nine months ended September 30, 2020 and 2019. Our net interest income, interest spread, and net interest margin are sensitive to general business and economic conditions. These conditions include short-term and long-term interest rates, inflation, monetary supply, and the strength of the international, national and state economies, in general, and more specifically, the local economies in which we conduct business. Our ability to manage net interest income during changing interest rate environments will have a significant impact on our overall performance. We manage net interest income through affecting changes in the mix of interest-earning assets as well as the mix of interest-bearing liabilities, changes in the level of interest-bearing liabilities in proportion to interest-earning assets, and in the growth and maturity of earning assets. See Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset/Liability and Market Risk Management – Interest Rate Sensitivity Management included herein. 43 Table of Contents The table below presents the interest rate spread, net interest margin and the composition of average interest-earning assets and average interest-bearing liabilities by category for the periods indicated, including the changes in average balance, composition, and average yield/rate between these respective periods. Three Months Ended September 30, 2020 2019 Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate (Dollars in thousands) INTEREST-EARNING ASSETS Investment securities (1) Available-for-sale securities: Taxable $ 1,970,636 $ 8,244 1.82% $ 1,505,087 $ 8,949 2.38% Tax-advantaged 36,193 203 3.26% 40,189 273 3.75% Held-to-maturity securities: Taxable 429,897 2,265 2.11% 506,203 2,883 2.28% Tax-advantaged 164,854 1,110 3.26% 205,996 1,415 3.32% Investment in FHLB stock 17,688 215 4.84% 17,688 301 6.75% Interest-earning deposits with other institutions 1,494,149 389 0.10% 174,119 946 2.16% Loans (2) 8,382,257 94,200 4.47% 7,495,289 98,796 5.23% Total interest-earning assets 12,495,674 106,626 3.45% 9,944,571 113,563 4.55% Total noninterest-earning assets 1,231,502 1,269,845 Total assets $ 13,727,176 $ 11,214,416 INTEREST-BEARING LIABILITIES Savings deposits (3) $ 3,735,204 2,010 0.21% $ 2,991,330 3,501 0.46% Time deposits 449,484 948 0.84% 473,347 1,088 0.91% Total interest-bearing deposits 4,184,688 2,958 0.28% 3,464,677 4,589 0.53% FHLB advances, other borrowings, and customer repurchase agreements 539,833 343 0.25% 446,087 815 0.72% Interest-bearing liabilities 4,724,521 3,301 0.28% 3,910,764 5,404 0.55% Noninterest-bearing deposits 6,731,711 5,227,595 Other liabilities 285,102 110,630 Stockholders’ equity 1,985,842 1,965,427 Total liabilities and stockholders’ equity $ 13,727,176 $ 11,214,416 Net interest income $ 103,325 $ 108,159 Net interest spread - tax equivalent 3.17% 4.00% Net interest margin 3.33% 4.32% Net interest margin - tax equivalent 3.34% 4.34% (1) Includes tax equivalent (TE) adjustments utilizing federal statutory rates of 21% in effect for the three months ended September 30, 2020 and 2019. The non TE rates were 1.93% and 2.40% for the three months ended September 30, 2020 and 2019, respectively. (2) Includes loan fees of $7.4 million and $782,000 for the three months ended September 30, 2020 and 2019, respectively. Prepayment penalty fees of $1.8 million and $1.0 million are included in interest income for the three months ended September 30, 2020 and 2019, respectively. (3) Includes interest-bearing demand and money market accounts. 44 Table of Contents Nine Months Ended September 30, 2020 2019 Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate (Dollars in thousands) INTEREST-EARNING ASSETS Investment securities (1) Available-for-sale securities: Taxable $ 1,737,723 $ 26,313 2.08% $ 1,582,902 $ 29,079 2.45% Tax-advantaged 36,897 632 3.30% 42,746 906 3.87% Held-to-maturity securities: Taxable 449,230 7,410 2.20% 509,247 8,725 2.29% Tax-advantaged 177,364 3,623 3.29% 216,343 4,524 3.37% Investment in FHLB stock 17,688 761 5.75% 17,688 931 7.04% Interest-earning deposits with other institutions 947,211 1,285 0.18% 70,848 1,140 2.15% Loans (2) 7,972,208 281,669 4.72% 7,571,502 300,326 5.30% Total interest-earning assets 11,338,321 321,693 3.82% 10,011,276 345,631 4.63% Total noninterest-earning assets 1,237,241 1,269,160 Total assets $ 12,575,562 $ 11,280,436 INTEREST-BEARING LIABILITIES Savings deposits (3) $ 3,396,259 7,131 0.28% $ 3,047,444 9,159 0.40% Time deposits 448,615 2,946 0.88% 497,370 3,394 0.91% Total interest-bearing deposits 3,844,874 10,077 0.35% 3,544,814 12,553 0.47% FHLB advances, other borrowings, and customer repurchase agreements 505,710 1,416 0.37% 573,633 4,326 1.00% Interest-bearing liabilities 4,350,584 11,493 0.35% 4,118,447 16,879 0.55% Noninterest-bearing deposits 6,063,469 5,136,233 Other liabilities 175,209 103,775 Stockholders’ equity 1,986,300 1,921,981 Total liabilities and stockholders’ equity $ 12,575,562 $ 11,280,436 Net interest income $ 310,200 $ 328,752 Net interest spread - tax equivalent 3.47% 4.08% Net interest margin 3.67% 4.39% Net interest margin - tax equivalent 3.68% 4.41% (1) Includes tax equivalent (TE) adjustments utilizing federal statutory rates of 21% in effect for the nine months ended September 30, 2020 and 2019. The non TE rates were 2.16% and 2.45% for the nine months ended September 30, 2020 and 2019, respectively. (2) Includes loan fees of $15.3 million and $2.3 million for the nine months ended September 30, 2020 and 2019, respectively. Prepayment penalty fees of $5.4 million and $3.4 million are included in interest income for the nine months ended September 30, 2020 and 2019, respectively. (3) Includes interest-bearing demand and money market accounts. 45 Table of Contents The following table presents a comparison of interest income and interest expense resulting from changes in the volumes and rates on average interest-earning assets and average interest-bearing liabilities for the periods indicated. Changes in interest income or expense attributable to volume changes are calculated by multiplying the change in volume by the initial average interest rate. The change in interest income or expense attributable to changes in interest rates is calculated by multiplying the change in interest rate by the initial volume. The changes attributable to interest rate and volume changes are calculated by multiplying the change in rate times the change in volume. Rate and Volume Analysis for Changes in Interest Income, Interest Expense and Net Interest Income Comparison of Three Months Ended September 30, 2020 Compared to 2019 Increase (Decrease) Due to Volume Rate Rate/ Volume Total (Dollars in thousands) Interest income: Available-for-sale securities: Taxable investment securities $ 1,835 $ (2,108 ) $ (432 ) $ (705 ) Tax-advantaged investment securities (24 ) (42 ) (4 ) (70 ) Held-to-maturity securities: Taxable investment securities (395 ) (194 ) (29 ) (618 ) Tax-advantaged investment securities (273 ) (27 ) (5 ) (305 ) Investment in FHLB stock - (86 ) - (86 ) Interest-earning deposits with other institutions 7,184 (902 ) (6,839 ) (557 ) Loans 12,369 (15,170 ) (1,795 ) (4,596 ) Total interest income 20,696 (18,529 ) (9,104 ) (6,937 ) Interest expense: Savings deposits 874 (1,894 ) (471 ) (1,491 ) Time deposits (53 ) (83 ) (4 ) (140 ) FHLB advances, other borrowings, and customer repurchase agreements 172 (532 ) (112 ) (472 ) Total interest expense 993 (2,509 ) (587 ) (2,103 ) Net interest income $ 19,703 $ (16,020 ) $ (8,517 ) $ (4,834 ) Comparision of Nine Months Ended September 30, 2020 Compared to 2019 Increase (Decrease) Due to Volume Rate Rate/ Volume Total (Dollars in thousands) Interest income: Available-for-sale securities: Taxable investment securities $ 1,861 $ (4,349 ) $ (278 ) $ (2,766 ) Tax-advantaged investment securities (124 ) (174 ) 24 (274 ) Held-to-maturity securities: Taxable investment securities (1,015 ) (339 ) 39 (1,315 ) Tax-advantaged investment securities (815 ) (105 ) 19 (901 ) Investment in FHLB stock - (170 ) - (170 ) Interest-earning deposits with other institutions 14,238 (1,054 ) (13,039 ) 145 Loans 15,682 (32,613 ) (1,726 ) (18,657 ) Total interest income 29,827 (38,804 ) (14,961 ) (23,938 ) Interest expense: Savings deposits 1,045 (2,758 ) (315 ) (2,028 ) Time deposits (331 ) (130 ) 13 (448 ) FHLB advances, other borrowings, and customer repurchase agreements (513 ) (2,719 ) 322 (2,910 ) Total interest expense 201 (5,607 ) 20 (5,386 ) Net interest income $ 29,626 $ (33,197 ) $ (14,981 ) $ (18,552 ) 46 Table of Contents Third Quarter of 2020 Compared to the Third Quarter of 2019 Net interest income, before provision for credit losses, of $103.3 million for the third quarter of 2020 decreased $4.8 million, or 4.47%, compared to $108.2 million for the third quarter of 2019. Interest-earning assets increased on average by $2.55 billion, or 25.65%, from $9.94 billion for the third quarter of 2019 to $12.50 billion for the third quarter of 2020. Our net interest margin (TE) was 3.34% for the third quarter of 2020, compared to 4.34% for the third quarter of 2019. Interest income for the third quarter of 2020 was $106.6 million, which represented a $6.9 million, or 6.11%, decrease when compared to the same period of 2019. Average interest-earning assets increased to $12.50 billion and the average interest-earning asset yield of 3.45%, compared to 4.55% for the third quarter of 2019. The 110 basis point decrease in the interest-earning asset yield over the third quarter of 2019 was primarily due to a combination of a 76 basis point decrease in loan yields, a 48 basis point decrease in investment yields and a change in mix of earning assets with average balances at the Federal Reserve growing to 11.62% of earning assets for the third quarter of 2020, compared to 1.69% for the third quarter of 2019. The increase in balances at the Federal Reserve resulted from $2.22 billion in average deposit growth during the third quarter of 2020. Interest income and fees on loans for the third quarter of 2020 of $94.2 million decreased $4.6 million, or 4.65%, when compared to the third quarter of 2019. Average loans increased $887.0 million for the third quarter of 2020 when compared with the same period of 2019, primarily due to $1.10 billion in average PPP loans originated in the second quarter of 2020. The PPP loans we originated resulted in the recognition of approximately $9.5 million in loan interest and fee income in the third quarter of 2020. Discount accretion on acquired loans decreased by $2.9 million compared to the third quarter of 2019. The Federal Reserve lowered short-term interest rates by 175 basis points when compared to the end of the third quarter of 2019. The significant decline in interest rates over the past four quarters had a negative impact on loan yields, which after excluding discount accretion, nonaccrual interest income, and the impact from PPP loans, declined by 44 basis points from the third quarter of 2019. Interest income from investment securities was $11.8 million for the third quarter of 2020, a $1.7 million, or 12.56%, decrease from $13.5 million for the third quarter of 2019. This decrease was primarily the result of a 47 basis point decline in the non tax-equivalent yield on investments as the decline in interest rates over the past four quarters decreased yields on investment securities. Partially offsetting the decline from lower rates was a $344.1 million increase in average investment securities for the third quarter of 2020, compared to the same period of 2019. Interest expense of $3.3 million for the third quarter of 2020, decreased $2.1 million, or 38.92%, compared to the third quarter of 2019. The average rate paid on interest-bearing liabilities declined to 0.28% for the third quarter of 2020 from 0.55% for the third quarter of 2019. On average, noninterest-bearing deposits were 61.67% of our total deposits for the third quarter of 2020, compared to 60.14% for the third quarter of 2019. In comparison to the third quarter of 2019, our overall cost of funds decreased by 12 basis points, as average noninterest-bearing deposits grew by $1.50 billion. Average interest-bearing deposits increased by $720.0 million compared to the third quarter of 2019, while the cost of interest-bearing deposits decreased by 25 basis points. Nine Months of 2020 Compared to the Nine Months of 2019 Net interest income, before provision for credit losses, was $310.2 million for the nine months ended September 30, 2020, a decrease of $18.6 million, or 5.64%, compared to $328.8 million for the same period of 2019. Interest-earning assets increased on average by $1.33 billion, or 13.26%, from $10.01 billion for the nine months ended September 30, 2019 to $11.34 billion for the current year. Our net interest margin (TE) was 3.68% during the first nine months of 2020, compared to 4.41% for the same period of 2019. Interest income for the nine months ended September 30, 2020 was $321.7 million, which represented a $23.9 million, or 6.93%, decrease when compared to the same period of 2019. Compared to the first nine months of 2019, average interest-earning assets increased by $1.33 billion primarily due to PPP loans, and the yield on interest-earning assets decreased by 81 basis points. The 81 basis point decrease in the earning asset yield over the first nine months of 2020, resulted from a 58 basis point decrease in loan yields from 5.30% for first nine months of 2019 to 4.72% for the same period of 2020, and a 31 basis point decline in investment yields, as well as a change in the mix of earning assets resulting from an $852.6 million increase in average balances at the Federal Reserve. Average loans as a percentage of earning assets declined from 75.63% for the first nine months of 2019 to 70.31% for the first nine months of 2020. Conversely, average balances at the Federal Reserve grew as a percentage of earning assets from 0.64% in the prior year to 8.09% for the first nine months of 2020. 47 Table of Contents Interest income and fees on loans for the first nine months of 2020 of $281.7 million decreased $18.7 million, or 6.21%, when compared to the same period of 2019. Average loans increased $400.7 million for the first nine months of 2020 when compared with the same period of 2019, primarily due to $591.4 million in average PPP loans. The PPP loans we originated resulted in approximately $13.5 million in fee income and $4.5 million in loan interest during the first nine months of 2020. The first nine months of 2020 reflected a $9.3 million decrease in discount accretion on acquired loans and nonaccrual interest income when compared to the same period of 2019. Loan yields decreased by 58 basis points from the prior nine month period. Excluding the impact of PPP loans, interest income related to purchase discount accretion and nonaccrual interest income, loan yields were 33 basis points lower than the first nine months of 2019. This decline in loan yields was primarily due to lower rates on loans indexed to variable interest rates such as the Bank’s prime rate. Interest income from investment securities was $38.0 million for the nine months ended September 30, 2020, a $5.3 million decrease from $43.2 million for the first nine months of 2019. This decrease was the net result of a 29 basis point decline in the non tax-equivalent yield on securities, compared to the first nine months of 2019, partially offset by a $50.0 million increase in the average investment securities for the first nine months of 2020. Interest expense of $11.5 million for the nine months ended September 30, 2020, decreased by $5.4 million from the same period of 2019. The average rate paid on interest-bearing liabilities decreased by 20 basis points, to 0.35% for the first nine months of 2020, from 0.55% for the same period of 2019. The rate on interest-bearing deposits for the first nine months of 2020 decreased by 12 basis points from the same period in 2019. Average interest-bearing liabilities were $232.1 million higher for the first nine months of 2020 when compared with the same period of 2019. Average interest-bearing deposits grew by $300.1 million when compared to the first nine months of 2019. Average noninterest-bearing deposits represented 61.20% of our total deposits for the nine months ended September 30, 2020, compared to 59.17% for the same period of 2019. Total cost of funds for the first nine months of 2020 was 0.15%, compared with 0.24% for the same period of 2019. Provision for Credit Losses The provision for credit losses is a charge to earnings to maintain the allowance for credit losses at a level consistent with management’s assessment of expected lifetime losses in the loan portfolio at the balance sheet date. On January 1, 2020, we adopted ASU 2016-13, commonly referred to as CECL, which replaces the “incurred loss” approach with an “expected loss” model over the life of the loan. The allowance for credit losses on loans totaled $93.9 million at September 30, 2020, compared to $68.7 million at December 31, 2019 and $68.7 million as of September 30, 2019. Upon adoption of CECL, a transition adjustment of $1.8 million was added to the beginning balance of the allowance, with no impact on the consolidated statement of earnings, and was increased by $23.5 million in provision for credit losses in the first nine months of 2020 due to the severe economic disruption forecasted as a result of the COVID-19 pandemic. For the nine months ended September 30, 2020, we experienced minimal credit charge-offs of $484,000 and total recoveries of $353,000, resulting in net charge-offs of $131,000. This compares to a $5.0 million loan loss provision and net recoveries of $59,000 for the same period of 2019. The ratio of the allowance for credit losses to total loans and leases outstanding, net of deferred fees and discount, as of September 30, 2020, was 1.12%, or 1.28% when PPP loans are excluded. This compares to 0.91% and 0.92%, as of December 31, 2019 and September 30, 2019, respectively. As of September 30, 2020, remaining discounts on acquired loans were $35.2 million. Refer to the discussion of “Allowance for Credit Losses” in Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations contained herein for discussion concerning observed changes in the credit quality of various components of our loan portfolio as well as changes and refinements to our methodology. No assurance can be given that economic conditions which adversely affect the Company’s service areas or other circumstances will or will not be reflected in increased provisions for credit losses in the future, as the nature of this process requires considerable judgment. We may experience increases in the provision for credit losses, in future periods, due to further deterioration in economic conditions from the COVID-19 pandemic. See “Allowance for Credit Losses” under Analysis of Financial Condition herein. 48 Table of Contents Noninterest Income Noninterest income includes income derived from financial services offered, such as CitizensTrust, BankCard services, international banking, and other business services. Also included in noninterest income are service charges and fees, primarily from deposit accounts, gains (net of losses) from the disposition of investment securities, loans, other real estate owned, and fixed assets, and other revenues not included as interest on earning assets. The following table sets forth the various components of noninterest income for the periods presented. Three Months Ended September 30, Variance Nine Months Ended September 30, Variance 2020 2019 $ % 2020 2019 $ % (Dollars in thousands) Noninterest income: Service charges on deposit accounts $ 3,970 $ 4,833 $ (863) -17.86% $ 12,555 $ 15,039 $ (2,484) -16.52% Trust and investment services 2,405 2,330 75 3.22% 7,302 6,964 338 4.85% Bankcard services 456 637 (181) -28.41% 1,438 2,614 (1,176) -44.99% BOLI income 1,469 1,797 (328) -18.25% 5,211 4,482 729 16.27% Swap fee income 1,591 378 1,213 320.90% 4,149 1,135 3,014 265.55% Gain on OREO, net 13 - 13 - 23 129 (106) -82.17% Gain on sale of building, net 1,680 - 1,680 - 1,680 4,545 (2,865) -63.04% Gain on eminent domain condemnation, net - - - - - 5,685 (5,685) -100.00% Other 1,569 1,919 (350) -18.24% 4,587 5,809 (1,222) -21.04% Total noninterest income $ 13,153 $ 11,894 $ 1,259 10.59% $ 36,945 $ 46,402 $ (9,457) -20.38% Third Quarter of 2020 Compared to the Third Quarter of 2019 The $1.3 million increase in noninterest income was primarily due to a $1.7 million net gain on the sale of one of our bank owned buildings, related to a banking center that was closed in September in the third quarter of 2020. The Bank enters into interest rate swap agreements with our customers to manage our interest rate risk and enters into identical offsetting swaps with a counterparty. The changes in the fair value of the swaps primarily offset each other resulting in swap fee income (refer to Note 8 – Derivative Financial Instruments of the notes to the unaudited condensed consolidated financial statements of this report for additional information). The third quarter of 2020 included higher swap fee income of $1.2 million compared to the third quarter of 2019, due to higher volume of swap transactions. We executed on swap agreements related to new loan originations with a notional amount totaling $73.2 million for the third quarter of 2020, compared to $19.0 million for the third quarter of 2019. Service charges on deposit accounts decreased by $863,000 from the third quarter of 2019. This decrease was primarily due to the increase in noninterest-bearing deposits held at the Bank by our customers, which earn credits toward the fees associated with the products and services utilized by our business customers. CitizensTrust consists of Wealth Management and Investment Services income. The Wealth Management group provides a variety of services, which include asset management, financial planning, estate planning, retirement planning, private and corporate trustee services, and probate services. Investment Services provides self-directed brokerage, 401(k) plans, mutual funds, insurance and other non-insured investment products. At September 30, 2020, CitizensTrust had approximately $2.91 billion in assets under management and administration, including $2.08 billion in assets under management. CitizensTrust generated fees of $2.4 million for the third quarter of 2020, compared to $2.3 million for the third quarter of 2019. The Bank’s investment in BOLI includes life insurance policies acquired through acquisitions and the purchase of life insurance by the Bank on a select group of employees. The Bank is the owner and beneficiary of these policies. BOLI is recorded as an asset at its cash surrender value. Increases in the cash value of these policies, as well as insurance proceeds received, are recorded in noninterest income and are not subject to income tax, as long as they are held for the life of the covered parties. Income from BOLI declined by $328,000 compared to the third quarter of 2019. 49 Table of Contents Nine Months of 2020 Compared to the Nine Months of 2019 The $9.5 million decrease in noninterest income for the nine months ended September 30, 2020, was primarily due to a $5.7 million net gain from the legal settlement of an eminent condemnation of one of our business financial center buildings in Bakersfield during the first nine month of 2019. In addition, there was a $2.9 million decrease in net gains on sale of bank owned buildings between the first nine months of 2020 and the first nine months of 2019. Service charges on deposit accounts decreased by $2.5 million from the first nine months of 2019. This decrease was primarily due to the higher earnings credits generated by the significant increase in our customer’s noninterest-bearing deposits held at the Bank. In addition, bankcard services decreased by approximately $1.2 million when compared to 2019, primarily due to the Durbin Amendment’s cap on debit card interchange fees. Swap fee income increased $3.0 million compared to the third quarter of 2019, due to higher volume of swap transactions. The $729,000 increase in BOLI income included $1.2 million of death benefits included in our BOLI policies for the first nine months of 2020. The $1.2 million decrease in other income in the first nine months of 2020 included decreases in dividend income from various equity investments, other banking fee income and SBA servicing income when compared to the same period of 2019. Noninterest Expense The following table summarizes the various components of noninterest expense for the periods presented. Three Months Ended Nine Months Ended September 30, Variance September 30, Variance 2020 2019 $ % 2020 2019 $ % (Dollars in thousands) Noninterest expense: Salaries and employee benefits $ 31,034 $ 30,122 $ 912 3.03% $ 90,617 $ 88,286 $ 2,331 2.64% Occupancy 4,290 3,976 314 7.90% 12,171 12,771 (600) -4.70% Equipment 985 903 82 9.08% 2,972 2,959 13 0.44% Professional services 2,019 1,688 331 19.61% 6,643 5,653 990 17.51% Computer software expense 2,837 2,663 174 6.53% 8,407 8,032 375 4.67% Marketing and promotion 728 1,517 (789) -52.01% 3,538 4,149 (611) -14.73% Amortization of intangible assets 2,292 2,648 (356) -13.44% 7,182 8,338 (1,156) -13.86% Telecommunications expense 643 656 (13) -1.98% 1,929 2,126 (197) -9.27% Regulatory assessments 998 147 851 578.91% 1,313 1,805 (492) -27.26% Insurance 400 430 (30) -6.98% 1,192 1,368 (176) -12.87% Loan expense 207 308 (101) -32.79% 833 1,115 (282) -25.29% OREO expense 830 - 830 - 1,200 37 1,163 3143.24% Directors’ expenses 358 350 8 2.29% 1,067 1,029 38 3.69% Stationery and supplies 227 259 (32) -12.36% 894 867 27 3.11% Acquisition related expenses - 244 (244) -100.00% - 6,005 (6,005) -100.00% Other 1,740 1,624 116 7.14% 4,669 5,127 (458) -8.93% Total noninterest expense $ 49,588 $ 47,535 $ 2,053 4.32% $ 144,627 $ 149,667 $ (5,040) -3.37% Noninterest expense to average assets 1.44% 1.68% 1.54% 1.77% Efficiency ratio (1) 42.57% 39.60% 41.66% 39.89% (1) Noninterest expense divided by net interest income before provision for credit losses plus noninterest income. Third Quarter of 2020 Compared to the Third Quarter of 2019 Our ability to control noninterest expenses in relation to asset growth can be measured in terms of total noninterest expenses as a percentage of average assets. Noninterest expense as a percentage of average assets was 1.44% for the third quarter of 2020, compared to 1.68% for the third quarter of 2019. This decline mostly reflects the $2.51 billion growth in average assets that resulted primarily from $2.22 billion in average deposit growth. Our ability to control noninterest expenses in relation to the level of total revenue (net interest income before provision for credit losses plus noninterest income) can be measured by the efficiency ratio and indicates the percentage of net revenue that is used to cover expenses. The efficiency ratio was 42.57% for the third quarter of 2020, compared to 39.60% for the third quarter of 2019. 50 Table of Contents Noninterest expense of $49.6 million for the third quarter of 2020 was $2.1 million, or 4.32%, higher than the third quarter of 2019. There were no merger related expenses related to the Community Bank (“CB”) acquisition for the third quarter of 2020, compared to $244,000 for the third quarter of 2019. The $912,000 increase in salary expense from the prior year was primarily due to $1.1 million in additional bonus expense for “Thank You Awards” paid to all Bank employees during the third quarter of 2020. The third quarter of 2020 also reflected an $833,000 increase in regulatory assessments resulting from final application of assessment credits provided by the FDIC at the end of the second quarter of 2020 and a $700,000 write-down of one OREO property. These increases were partially offset by a $789,000 decrease in marketing and promotion expense. Nine Months of 2020 Compared to the Nine Months of 2019 Noninterest expense of $144.6 million for the first nine months of 2020 was $5.0 million lower than the prior year period. The decrease was primarily due to $6.0 million in merger related expenses for the nine months ended September 30, 2019, compared to no merger related expense for the same period of 2020. The year-over-year decrease also included a $1.2 million decrease in amortization of CDI. These decreases were partially offset by a $2.3 million increase in salaries and benefit costs. Salary and benefit expense would have increased by $3.9 million, or approximately 4%, when a $1.6 million increase in net deferred loan costs, primarily related to the origination of PPP loans, is excluded for the nine months ended September 30, 2020. This $3.9 million increase was primarily due to $3.0 million, or 3.93%, in higher salaries, payroll taxes and benefits when compared to the prior year period. As a percentage of average assets, noninterest expense was 1.54% for the nine months ended September 30, 2020, compared to 1.77% for the same period of 2019. For the nine months ended September 30, 2020, the efficiency ratio was 41.66%, compared to 39.89% for the same period of 2019. Income Taxes The Company’s effective tax rate for the three and nine months ended September 30, 2020 was 29.00%, compared to 29.00% for the same periods of 2019. Our estimated annual effective tax rate varies depending upon the level of tax-advantaged income as well as available tax credits. The Company’s effective tax rates are below the nominal combined Federal and State tax rate primarily as a result of tax-advantaged income from certain municipal security investments, municipal loans and leases and BOLI, as well as available tax credits for each period. 51 Table of Contents ANALYSIS OF FINANCIAL CONDITION Total assets of $13.82 billion at September 30, 2020 increased $2.54 billion, or 22.48%, from total assets of $11.28 billion at December 31, 2019. Interest-earning assets totaled $12.59 billion at September 30, 2020, an increase of $2.57 billion, or 25.59%, when compared with $10.03 billion at December 31, 2019. The increase in interest-earning assets was primarily due to a $1.31 billion increase in interest-earning balances due from the Federal Reserve, an $843.3 million increase in total loans, and a $368.6 million increase in investment securities. The increase in total loans was due to the origination of approximately 4,100 PPP loans, totaling $1.10 billion at September 30, 2020. Excluding PPP loans, total loans declined by $257.8 million from December 31, 2019. Total liabilities were $11.84 billion at September 30, 2020, an increase of $2.55 billion, or 27.44%, from total liabilities of $9.29 billion at December 31, 2019. Total deposits grew by $2.46 billion, or 28.30%. This significant deposit growth in the first nine months of 2020 was primarily due to our customers maintaining greater liquidity. Total equity decreased $12.1 million, or 0.61%, to $1.98 billion at September 30, 2020, compared to total equity of $1.99 billion at December 31, 2019. The $12.1 million decrease in equity was primarily due to the repurchase of 4.9 million shares of common stock for $91.7 million under our 10b5-1 stock repurchase program. We previously announced that we suspended this 10b5-1 stock repurchase program due to the Company’s outlook due to the uncertainty of the COVID-19 pandemic. We had $127.1 million in net earnings during the first nine months of 2020, offset by $73.3 million in cash dividends declared and a cumulative effect adjustment to beginning retained earnings of $1.3 million, net of tax, due to the adoption of CECL on January 1, 2020. Our equity also increased by $23.5 million as a result of an increase in other comprehensive income from the increase in our tax adjusted market value of our available-for-sale investment securities. Investment Securities The Company maintains a portfolio of investment securities to provide interest income and to serve as a source of liquidity for its ongoing operations. At September 30, 2020, total investment securities were $2.78 billion. This represented an increase of $368.6 million, or 15.27%, from total investment securities of $2.41 billion at December 31, 2019. The increase in investment securities was primarily due to new securities purchased exceeding cash outflow from the portfolio in the first nine months of 2020. At September 30, 2020, investment securities HTM totaled $577.7 million. At September 30, 2020, our AFS investment securities totaled $2.21 billion, inclusive of a pre-tax net unrealized gain of $55.3 million. The after-tax unrealized gain reported in AOCI on AFS investment securities was $38.9 million. The changes in the net unrealized holding gain resulted primarily from fluctuations in market interest rates. For the nine months ended September 30, 2020 and 2019, repayments/maturities of investment securities totaled $536.7 million and $355.8 million, respectively. The Company purchased additional investment securities totaling $882.1 million and $268.3 million for the nine months ended September 30, 2020 and 2019, respectively. There were no investment securities sold during the first nine months of 2020. During the first nine months of 2019, we sold 14 investment securities at book value of approximately $152.6 million. The average duration of our investment securities portfolio was approximately 2.7 years at September 30, 2020. 52 Table of Contents The tables below set forth our investment securities AFS and HTM portfolio by type for the dates presented. September 30, 2020 Amortized Cost Gross Unrealized Holding Gain Gross Unrealized Holding Loss Fair Value Total Percent (Dollars in thousands) Investment securities available-for-sale: Mortgage-backed securities $ 1,710,160 $ 46,713 $ (2) $ 1,756,871 79.65% CMO/REMIC 404,380 7,326 (212) 411,494 18.66% Municipal bonds 35,011 1,457 - 36,468 1.65% Other securities 813 - - 813 0.04% Total available-for-sale securities $ 2,150,364 $ 55,496 $ (214) $ 2,205,646 100.00% Investment securities held-to-maturity: Government agency/GSE $ 103,317 $ 6,627 $ - $ 109,944 17.88% Mortgage-backed securities 152,285 7,837 - 160,122 26.36% CMO/REMIC 159,676 5,315 - 164,991 27.64% Municipal bonds 162,416 6,387 (338) 168,465 28.12% Total held-to-maturity securities $ 577,694 $ 26,166 $ (338) $ 603,522 100.00% December 31, 2019 Amortized Cost Gross Unrealized Holding Gain Gross Unrealized Holding Loss Fair Value Total Percent (Dollars in thousands) Investment securities available-for-sale: Mortgage-backed securities $ 1,185,757 $ 21,306 $ (750) $ 1,206,313 69.32% CMO/REMIC 493,214 1,392 (896) 493,710 28.37% Municipal bonds 38,506 850 (2) 39,354 2.26% Other securities 880 - - 880 0.05% Total available-for-sale securities $ 1,718,357 $ 23,548 $ (1,648) $ 1,740,257 100.00% Investment securities held-to-maturity: Government agency/GSE $ 117,366 $ 2,280 $ (657) $ 118,989 17.40% Mortgage-backed securities 168,479 2,083 (54) 170,508 24.98% CMO/REMIC 192,548 - (2,458) 190,090 28.55% Municipal bonds 196,059 3,867 (565) 199,361 29.07% Total held-to-maturity securities $ 674,452 $ 8,230 $ (3,734) $ 678,948 100.00% As of September 30, 2020, approximately $66.7 million in U.S. government agency bonds are callable. The Agency CMO/REMIC securities are backed by agency-pooled collateral. Municipal bonds, which represented approximately 7% of the total investment portfolio, are predominately AA or higher rated securities. We adopted ASU 2016-13 on January 1, 2020, on a prospective basis. Under the new guidance, once it is determined that a credit loss has occurred, an allowance for credit losses is established on our available-for-sale and held-to-maturity securities. Prior to adoption of this standard, when a decline in fair value of a debt security was determined to be other than temporary, an impairment charge for the credit component was recorded, and a new cost basis in the investment was established. During the third quarter of 2020, management determined that credit losses did not exist for securities in an unrealized loss position. 53 Table of Contents The following table presents the Company’s available-for-sale investment securities, by investment category, in an unrealized loss position for which an allowance for credit losses has not been recorded as of September 30, 2020. September 30, 2020 Less Than 12 Months 12 Months or Longer Total Fair Value Gross Unrealized Holding Losses Fair Value Gross Unrealized Holding Losses Fair Value Gross Unrealized Holding Losses (Dollars in thousands) Investment securities available-for-sale: Mortgage-backed securities $ 30,851 $ (2) $ - $ - $ 30,851 $ (2) CMO/REMIC 71,781 (212) - - 71,781 (212) Municipal bonds - - - - - - Total available-for-sale securities $ 102,632 $ (214) $ - $ - $ 102,632 $ (214) The table below presents the Company’s investment securities’ gross unrealized losses and fair value by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2019, prior to adoption of ASU 2016-13. Management previously reviewed individual securities to determine whether a decline in fair value below the amortized cost basis is other-than-temporary. The unrealized losses on these securities were primarily attributed to changes in interest rates. The issuers of these securities have not, to our knowledge, evidenced any cause for default on these securities. These securities have fluctuated in value since their purchase dates as market interest rates have fluctuated. However, we have the ability and the intention to hold these securities until their fair values recover to cost or maturity. As such, management does not deem these securities to be other-than-temporarily-impaired. December 31, 2019 Less Than 12 Months 12 Months or Longer Total Fair Value Gross Unrealized Holding Losses Fair Value Gross Unrealized Holding Losses Fair Value Gross Unrealized Holding Losses (Dollars in thousands) Investment securities available-for-sale: Mortgage-backed securities $ 20,289 $ (6) $ 97,964 $ (744) $ 118,253 $ (750) CMO/REMIC 177,517 (705) 34,565 (191) 212,082 (896) Municipal bonds - - 563 (2) 563 (2) Total available-for-sale securities $ 197,806 $ (711) $ 133,092 $ (937) $ 330,898 $ (1,648) Investment securities held-to-maturity: Government agency/GSE $ 28,359 $ (252) $ 19,405 $ (405) $ 47,764 $ (657) Mortgage-backed securities 10,411 (54) - - 10,411 (54) CMO/REMIC 23,897 (104) 166,193 (2,354) 190,090 (2,458) Municipal bonds 7,583 (32) 29,981 (533) 37,564 (565) Total held-to-maturity securities $ 70,250 $ (442) $ 215,579 $ (3,292) $ 285,829 $ (3,734) Refer to Note 4 – Investment Securities of the notes to the unaudited condensed consolidated financial statements of this report for additional information on our investment securities portfolio. 54 Table of Contents Loans Total loans and leases, net of deferred fees and discounts, of $8.41 billion at September 30, 2020 increased by $843.3 million, or 11.15%, from $7.56 billion at December 31, 2019. The increase in total loans included $1.10 billion in PPP loans and a $130.9 million decline in dairy & livestock and agribusiness loans primarily due to seasonal pay downs, which historically occur in the first quarter of each calendar year. Excluding PPP loans and dairy & livestock and agribusiness loans, total loans declined by $126.9 million, or 1.77%. The $126.9 million decrease in loans included decreases of $118.1 million in commercial and industrial loans, $27.3 million in consumer and other loans, $15.1 million in municipal lease financings, $15.0 million in construction loans, and $8.7 million in SFR mortgage loans. Partially offsetting these declines was an increase in commercial real estate loans of $53.6 million. The following table presents our loan portfolio by type as of the dates presented. Distribution of Loan Portfolio by Type September 30, 2020 December 31, 2019 (Dollars in thousands) Commercial and industrial $ 817,056 $ 935,127 SBA 304,987 305,008 SBA - Paycheck Protection Program (PPP) 1,101,142 - Real estate: Commercial real estate 5,428,223 5,374,617 Construction 101,903 116,925 SFR mortgage 274,731 283,468 Dairy & livestock and agribusiness 252,802 383,709 Municipal lease finance receivables 38,040 53,146 Consumer and other loans 88,988 116,319 Total loans 8,407,872 7,568,319 Less: Deferred loan fees, net (1) - (3,742) Total loans, net of deferred loan fees 8,407,872 7,564,577 Less: Allowance for credit losses (93,869) (68,660) Total loans and lease finance receivables, net $ 8,314,003 $ 7,495,917 (1) Beginning with March 31, 2020, total loans are presented net of deferred loan fees by respective class of financing receivables. As of September 30, 2020, 69.04% of the Company’s total gross loan portfolio consisted of real estate loans, with commercial real estate loans representing 64.56% of total loans. As of September 30, 2020, $271.2 million, or 5.00% of the total commercial real estate loans included loans secured by farmland, compared to $241.8 million, or 4.50%, at December 31, 2019. The loans secured by farmland included $121.1 million for loans secured by dairy & livestock land and $150.2 million for loans secured by agricultural land at September 30, 2020, compared to $125.9 million for loans secured by dairy & livestock land and $115.9 million for loans secured by agricultural land at December 31, 2019. As of September 30, 2020, dairy & livestock and agribusiness loans of $252.8 million were comprised of $210.4 million for dairy & livestock loans and $42.4 million for agribusiness loans, compared to $323.5 million for dairy & livestock loans and $60.2 million for agribusiness loans at December 31, 2019. Real estate loans are loans secured by conforming trust deeds on real property, including property under construction, land development, commercial property and single-family and multi-family residences. Our real estate loans are comprised of industrial, office, retail, medical, single-family residences, multi-family residences, and farmland. Consumer loans include installment loans to consumers as well as home equity loans, auto and equipment leases and other loans secured by junior liens on real property. Municipal lease finance receivables are leases to municipalities. Dairy & livestock and agribusiness loans are loans to finance the operating needs of wholesale dairy farm operations, cattle feeders, livestock raisers and farmers. As of September 30, 2020, the Company had $185.5 million of total SBA 504 loans. SBA 504 loans include term loans to finance capital expenditures and for the purchase of commercial real estate. Initially the Bank provides two separate loans to the borrower representing a first and second lien on the collateral. The loan with the first lien is typically at a 50% advance to the acquisition costs and the second lien loan provides the financing for 40% of the acquisition costs with the borrower’s down payment of 10% of the acquisition costs. The Bank retains the first lien loan for its term and sells the second lien loan to the SBA subordinated debenture program. A majority of the Bank’s 504 loans are granted for the purpose of commercial real estate acquisition. As of September 30, 2020, the Company had $119.5 million of total SBA 7(a) loans that include a guarantee of payment from the SBA (typically 75% of the loan amount, but up to 90% in certain cases) in the event of default. The SBA 7(a) loans include revolving lines of credit (SBA Express) and term loans of up to ten (10) years to finance long-term working capital requirements, capital expenditures, and/or for the purchase or refinance of commercial real estate. 55 Table of Contents As an active participant in the SBA’s Paycheck Protection Program, we have originated approximately 4,100 PPP loans, totaling $1.10 billion as of September 30, 2020. As of September 30, 2020, the Company had $101.9 million in construction loans. This represents 1.21% of total loans held-for-investment. Although our construction loans are located throughout our market footprint, the majority of construction loans consist of commercial land development and construction projects in Los Angeles County, Orange County, and the Inland Empire region of Southern California. There were no nonperforming construction loans at September 30, 2020. Our loan portfolio is geographically disbursed throughout our marketplace. The following is the breakdown of our total held-for-investment commercial real estate loans, by region as of September 30, 2020. September 30, 2020 Total Loans Commercial Real Estate Loans (Dollars in thousands) Los Angeles County $ 3,609,538 42.9 % $ 2,219,742 40.9 % Central Valley 1,316,422 15.7 % 941,699 17.3 % Orange County 1,119,311 13.3 % 666,886 12.3 % Inland Empire 1,183,026 14.1 % 829,791 15.3 % Central Coast 523,297 6.2 % 368,346 6.8 % San Diego 234,903 2.8 % 144,973 2.7 % Other California 127,669 1.5 % 83,544 1.5 % Out of State 293,706 3.5 % 173,242 3.2 % $ 8,407,872 100.0 % $ 5,428,223 100.0 % The table below breaks down our commercial real estate portfolio. September 30, 2020 Loan Balance Percent Percent Owner- Occupied (1) Average Loan Balance (Dollars in thousands) Commercial real estate: Industrial $ 1,842,412 33.9% 54.4% $ 1,390 Office 992,216 18.3% 25.1% 1,603 Retail 771,125 14.2% 13.3% 1,673 Multi-family 608,374 11.2% 2.1% 1,662 Medical 300,867 5.6% 47.7% 1,791 Secured by farmland (2) 271,242 5.0% 97.4% 1,858 Other (3) 641,987 11.8% 54.7% 1,417 Total commercial real estate $ 5,428,223 100.0% 39.2% $ 1,534 (1) Represents percentage of reported owner-occupied at origination in each real estate loan category. (2) The loans secured by farmland included $121.1 million for loans secured by dairy & livestock land and $150.2 million for loans secured by agricultural land at September 30, 2020. (3) Other loans consist of a variety of loan types, none of which exceeds 2.0% of total commercial real estate loans at September 30, 2020. 56 Table of Contents The pandemic has had a greater impact on certain industries, such a retail, hospitality, and entertainment. At September 30, 2020, commercial real estate loans on retail properties comprised $771.1 million and approximately 9% of total loans; 1% of these loans are on deferment and $7 million of these loans are classified. At origination, these loans on retail properties were underwritten with loan-to-values averaging approximately 53%. Approximately 53% of these loans were originated prior to 2017. We also have $66.6 million of commercial real estate loans for hospitality properties, which is less than 1% of total loans; none of these loans are classified, but 16% of these loans are on deferment. At September 30, 2020, commercial and industrial and SBA loans to customers in the hotel, restaurant, entertainment, retail trade, or recreation industries represented approximately $96 million in loans, or approximately 1% of total loans; $1.6 million of these loans are classified and $1.4 million are on deferment. Nonperforming Assets The following table provides information on nonperforming assets as of the dates presented. September 30, 2020 December 31, 2019 (Dollars in thousands) Nonaccrual loans $ 11,775 $ 5,033 Loans past due 90 days or more and still accruing interest - - Nonperforming troubled debt restructured loans (TDRs) - 244 Total nonperforming loans 11,775 5,277 OREO, net 4,189 4,889 Total nonperforming assets $ 15,964 $ 10,166 Performing TDRs $ 2,217 $ 3,112 Total nonperforming loans and performing TDRs $ 13,992 $ 8,389 Percentage of nonperforming loans and performing TDRs to total loans, net of deferred fees 0.17% 0.11% Percentage of nonperforming assets to total loans, net of deferred fees, and OREO 0.19% 0.13% Percentage of nonperforming assets to total assets 0.12% 0.09% Troubled Debt Restructurings (“TDRs”) Total TDRs were $2.2 million at September 30, 2020, compared to $3.4 million at December 31, 2019. At September 30, 2020, all of our TDRs were performing and accruing interest as restructured loans. Our performing TDRs were generally provided a modification of loan repayment terms in response to borrower financial difficulties. The performing restructured loans represent the only loans accruing interest at each respective reporting date. A performing restructured loan is categorized as such if we believe that it is reasonably assured of repayment and is performing in accordance with the modified terms. In accordance with regulatory guidance, if borrowers are less than 30 days past due on their loans and enter into loan modifications offered as a result of COVID-19, their loans generally continue to be considered performing loans and continue to accrue interest during the period of the loan modification. For borrowers who are 30 days or more past due when entering into loan modifications offered as a result of COVID-19, we evaluate the loan modifications under our existing troubled debt restructuring framework, and where such a loan modification would result in a concession to a borrower experiencing financial difficulty, the loan will be accounted for as a TDR and will generally not accrue interest. For all borrowers who enroll in these loan modification programs offered as a result of COVID-19, the delinquency status of the borrowers is frozen, resulting in a static delinquency metric during the deferral period. Upon exiting the deferral program, the measurement of loan delinquency will resume where it had left off upon entry into the program. As of October 9, 2020, we have temporary payment deferments of principal, interest or of principal and interest on 33 loans in the amount of $68.6 million, or less than 1% of our total loan portfolio, at September 30, 2020. These deferments were primarily for 90 days, with 89% of these loans being pass rated; 27 of these loans have received a second deferment and the remaining six loans are first deferments. The majority of the loans with payment deferments were commercial real estate loans, which represented approximately $65.9 million of the $68.6 million. 57 Table of Contents The following table provides a summary of TDRs as of the dates presented. September 30, 2020 December 31, 2019 Balance Number of Loans Balance Number of Loans (Dollars in thousands) Performing TDRs: Commercial and industrial $ 47 1 $ 78 2 SBA - - 536 1 Real Estate: Commercial real estate 354 1 397 1 Construction - - - - SFR mortgage 1,816 7 2,101 8 Dairy & livestock and agribusiness - - - - Consumer and other - - - - Total performing TDRs $ 2,217 9 $ 3,112 12 Nonperforming TDRs: Commercial and industrial $ - - $ - - SBA - - - - Real Estate: Commercial real estate - - - - Construction - - - - SFR mortgage - - - - Dairy & livestock and agribusiness - - - - Consumer and other - - 244 1 Total nonperforming TDRs $ - - $ 244 1 Total TDRs $ 2,217 9 $ 3,356 13 At September 30, 2020, there was no ACL allocated to TDRs. At December 31, 2019, there was no allowance for loan losses specifically allocated to TDRs. Impairment amounts identified are typically charged off against the allowance at the time a probable loss is determined. There were no charge-offs on TDRs for the nine months ended September 30, 2020, compared to $78,000 for the nine months ended September 30, 2019. 58 Table of Contents Nonperforming Assets and Delinquencies The table below provides trends in our nonperforming assets and delinquencies as of the dates presented. September 30, 2020 June 30, 2020 March 31, 2020 December 31, 2019 September 30, 2019 (Dollars in thousands) Nonperforming loans (1): Commercial and industrial $ 1,822 $ 1,222 $ 1,703 $ 1,266 $ 1,550 SBA 1,724 1,598 2,748 2,032 2,706 Real estate: Commercial real estate 6,481 2,628 947 724 1,083 Construction - - - - - SFR mortgage 675 1,080 864 878 888 Dairy & livestock and agribusiness 849 - - - - Consumer and other loans 224 289 166 377 385 Total $ 11,775 $ 6,817 $ 6,428 $ 5,277 $ 6,612 % of Total loans 0.14% 0.08% 0.09% 0.07% 0.09% Past due 30-89 days: Commercial and industrial $ 3,627 $ 630 $ 665 $ 2 $ 756 SBA 66 214 3,086 1,402 303 Real estate: Commercial real estate - 4 210 - 368 Construction - - - - - SFR mortgage - 446 233 249 - Dairy & livestock and agribusiness - 882 166 - - Consumer and other loans 67 413 - - - Total $ 3,760 $ 2,589 $ 4,360 $ 1,653 $ 1,427 % of Total loans 0.04% 0.03% 0.06% 0.02% 0.02% OREO: SBA $ 797 $ 797 $ 797 $ 797 $ 444 Real estate: Commercial real estate 1,575 2,275 2,275 2,275 2,275 SFR mortgage 1,817 1,817 1,817 1,817 6,731 Total $ 4,189 $ 4,889 $ 4,889 $ 4,889 $ 9,450 Total nonperforming, past due, and OREO $ 19,724 $ 14,295 $ 15,677 $ 11,819 $ 17,489 % of Total loans 0.23% 0.17% 0.21% 0.16% 0.23% (1) As of June 30, 2020, nonperforming loans included $25,000 of commercial and industrial loans past due 90 days or more and still accruing interest. Nonperforming loans, defined as nonaccrual loans, nonperforming TDR loans and loans past due 90 days or more and still accruing interest, were $11.8 million at September 30, 2020, or 0.14% of total loans. Total nonperforming loans at September 30, 2020 included $9.3 million of nonperforming loans acquired from CB in the third quarter of 2018. This compares to nonperforming loans of $5.3 million, or 0.07% of total loans, at December 31, 2019 and $6.6 million, or 0.09% of total loans, at September 30, 2019. The $5.0 million quarter-over-quarter increase in nonperforming loans was primarily due to increases of $3.9 million in nonperforming commercial real estate loans, $849,000 in nonperforming dairy & livestock and agribusiness loans, $600,000 in nonperforming commercial and industrial loans, and $126,000 in nonperforming SBA loans. This was partially offset by a $405,000 decrease in nonperforming SFR mortgage loans and a $65,000 decrease in nonperforming consumer and other loans. In response to the COVID-19 pandemic, we have implemented a short-term loan modification program to provide temporary payment relief to certain of our borrowers who meet the program’s qualifications. This program allows for a deferral of payments for 90 days, which we may extend for an additional 90 days, for a maximum of 180 days on a cumulative basis. The deferred payments along with interest accrued during the deferral period are due and payable on the maturity date of the existing loan. 59 Table of Contents At September 30, 2020, we had four OREO properties with a carrying value of $4.2 million, compared to four OREO properties with a carrying value of $4.9 million at December 31, 2019 and three OREO properties with a carrying value of $9.5 million at September 30, 2019. We reflected a $700,000 write-down of one OREO property in the third quarter of 2020. There were no additions to or sales of OREO properties for the nine months ended September 30, 2020. Changes in economic and business conditions have had an impact on our market area and on our loan portfolio. We continually monitor these conditions in determining our estimates of needed reserves. However, we cannot predict the extent to which the deterioration in general economic conditions, real estate values, changes in general rates of interest and changes in the financial conditions or business of a borrower may adversely affect a specific borrower’s ability to pay or the value of our collateral. See “ Risk Management – Credit Risk Management ” contained in our Annual Report on Form 10-K for the year ended December 31, 2019. Allowance for Credit Losses We adopted CECL on January 1, 2020, which replaces the “incurred loss” approach with an “expected loss” model over the life of the loan, as further described in Note 3 – Summary of Significant Accounting Policies of the notes to the unaudited condensed consolidated financial statements. The allowance for credit losses totaled $93.9 million as of September 30, 2020, compared to $68.7 million as of December 31, 2019 and $68.7 million as of September 30, 2019. Our allowance for credit losses at September 30, 2020 was 1.12%, or 1.28% of total loans when excluding the $1.10 billion in PPP loans. Upon implementation of CECL, a transition adjustment of $1.8 million was added to the beginning balance of the allowance and was increased by a $23.5 million credit loss provision in the first nine months of 2020 due to the severe economic disruption resulting from the COVID-19 pandemic. Net charge-offs were $131,000 for the nine months ended September 30, 2020. This compares to a $5.0 million loan loss provision and $59,000 in net recoveries for the same period of 2019. Our modeling processes incorporate a lifetime historical loss rate methodology by different asset classes. These models use key loan attributes by asset class and macroeconomic variables. Macroeconomic variables include GDP, and unemployment rate, among others. Our economic forecast incorporates a weighting of multiple forecasts. The forecast includes a reasonable and supportable forecast period of two to three years for the macroeconomic variables, which revert to a historical mean based on an input reversion approach. We consider publicly published economic forecasts from multiple sources, including Moody’s. Our economic forecast continues to be a blend of multiple forecasts produced by Moody’s. Moody’s baseline forecast continues to represent more than a 50% weighting in our multi-weighted forecast scenario. This U.S. baseline forecast assumes GDP will increase by 27% in the third quarter, 2.9% in the fourth quarter and then grow by 3.5% in 2021 and 5% in 2022. The unemployment rate in this baseline forecast is forecasted to be 8.9% in the third quarter of 2021, stay at an elevated level over 8% through 2021, before declining to 6.4% percent in 2022. With California slowly re-opening its economy and currently having an unemployment rate greater than 11% percent, our forecast includes a partial weighting of downside economic forecast scenarios from Moody’s. If the economic forecast deteriorates further due to the COVID-19 pandemic, or the economic impact on our borrowers is more severe than we have forecasted, we may experience increases in the allowance for credit losses in future periods. 60 Table of Contents The table below presents a summary of charge-offs and recoveries by type, the provision for credit losses on loans, and the resulting allowance for credit losses for the periods presented. As of and For the Nine Months Ended September 30, 2020 2019 (Dollars in thousands) Allowance for credit losses at beginning of period $ 68,660 $ 63,613 Impact of adopting ASU 2016-13 1,840 - Charge-offs: Commercial and industrial (172) (48) SBA (203) (295) Commercial real estate - - Construction - - SFR mortgage - - Dairy & livestock and agribusiness - (78) Consumer and other loans (109) (7) Total charge-offs (484) (428) Recoveries: Commercial and industrial 7 253 SBA 72 9 Commercial real estate - - Construction 9 9 SFR mortgage 206 191 Dairy & livestock and agribusiness - 19 Consumer and other loans 59 6 Total recoveries 353 487 Net (charge-offs) recoveries (131) 59 Provision for credit losses 23,500 5,000 Allowance for credit losses at end of period $ 93,869 $ 68,672 Summary of reserve for unfunded loan commitments: Reserve for unfunded loan commitments at beginning of period $ 8,959 $ 8,959 Impact of adopting ASU 2016-13 41 - Provision for unfunded loan commitments - - Reserve for unfunded loan commitments at end of period $ 9,000 $ 8,959 Reserve for unfunded loan commitments to total unfunded loan commitments 0.50% 0.55% Amount of total loans at end of period (1) $ 8,407,872 $ 7,494,451 Average total loans outstanding (1) $ 7,972,208 $ 7,571,502 Net recoveries to average total loans -0.002% 0.001% Net recoveries to total loans at end of period -0.002% 0.001% Allowance for credit losses to average total loans 1.18% 0.91% Allowance for credit losses to total loans at end of period 1.12% 0.92% Net (charge-offs) recoveries to allowance for credit losses -0.14% 0.09% Net (charge-offs) recoveries to provision for credit losses -0.56% 1.18% (1) Net of deferred loan origination fees, costs and discounts. 61 Table of Contents The ACL/Total Loan Coverage Ratio as of September 30, 2020 increased to 1.12%, compared to 0.93% as of January 1, 2020 due to the forecasted impact on the economy from the COVID-19 crisis. At implementation of CECL on January 1, 2020, the reserve for unfunded loan commitments included a transition adjustment of $41,000 for our off-balance sheet credit exposures. The Bank’s ACL methodology also produced an allowance of $9.0 million for our off-balance sheet credit exposures, which was unchanged from the allowance at January 1, 2020. While we believe that the allowance at September 30, 2020 was appropriate to absorb losses from known or inherent risks in the portfolio, no assurance can be given that economic conditions, interest rate fluctuations, conditions of our borrowers (including fraudulent activity), or natural disasters, which adversely affect our service areas or other circumstances or conditions, including those defined above, will not be reflected in increased provisions for credit losses in the future. Deposits The primary source of funds to support earning assets (loans and investments) is the generation of deposits. Total deposits were $11.17 billion at September 30, 2020. This represented an increase of $2.46 billion, or 28.30%, over total deposits of $8.70 billion at December 31, 2019. The composition of deposits is summarized as of the dates presented in the table below. September 30, 2020 December 31, 2019 Balance Percent Balance Percent (Dollars in thousands) Noninterest-bearing deposits $ 6,919,423 61.95 % $ 5,245,517 60.26 % Interest-bearing deposits Investment checking 447,910 4.01 % 454,565 5.22 % Money market 2,878,457 25.77 % 2,158,161 24.79 % Savings 477,896 4.28 % 400,377 4.60 % Time deposits 445,148 3.99 % 446,308 5.13 % Total deposits $ 11,168,834 100.00 % $ 8,704,928 100.00 % The amount of noninterest-bearing deposits in relation to total deposits is an integral element in our strategy of seeking to achieve a low cost of funds. Noninterest-bearing deposits totaled $6.92 billion at September 30, 2020, representing an increase of $1.67 billion, or 31.91%, from noninterest-bearing deposits of $5.25 billion at December 31, 2019. Noninterest-bearing deposits represented 61.95% of total deposits for September 30, 2020, compared to 60.26% of total deposits for December 31, 2019. Savings deposits, which include savings, interest-bearing demand, and money market accounts, totaled $3.80 billion at September 30, 2020, representing an increase of $791.2 million, or 26.26%, from savings deposits of $3.01 billion at December 31, 2019. Time deposits totaled $445.1 million at September 30, 2020, representing a decrease of $1.2 million, or 0.26%, from total time deposits of $446.3 million for December 31, 2019. 62 Table of Contents Borrowings We offer a repurchase agreement product to our customers. This product, known as Citizens Sweep Manager, sells our investment securities overnight to our customers under an agreement to repurchase them the next day at a price that reflects the market value of the use of funds by the Bank for the period concerned. These repurchase agreements are signed with customers who want to invest their excess deposits, above a pre-determined balance in a demand deposit account, in order to earn interest. As of September 30, 2020 and December 31, 2019, total funds borrowed under these agreements were $483.4 million and $428.7 million, respectively, with a weighted average interest rate of 0.14% and 0.44%, respectively. At September 30, 2020, we had $10.0 million in short-term borrowings that were interest-free advances from the FHLB. We had no short-term borrowings at December 31, 2019. At September 30, 2020, $6.00 billion of loans and $1.86 billion of investment securities, at carrying value, were pledged to secure public deposits, short and long-term borrowings, and for other purposes as required or permitted by law. Aggregate Contractual Obligations The following table summarizes the aggregate contractual obligations as of September 30, 2020. Maturity by Period Total Less Than One Year One Year Through Three Years Four Years Through Five Years Over Five Years (Dollars in thousands) Deposits (1) $ 11,168,834 $ 11,126,422 $ 32,422 $ 9,394 $ 596 Customer repurchase agreements (1) 483,420 483,420 - - - Junior subordinated debentures (1) 25,774 - - - 25,774 Deferred compensation 21,864 681 1,172 619 19,392 Operating leases 23,416 6,880 9,921 4,476 2,139 Affordable housing investment 3,159 2,285 814 47 13 Total $ 11,726,467 $ 11,619,688 $ 44,329 $ 14,536 $ 47,914 (1) Amounts exclude accrued interest. Deposits represent noninterest-bearing, money market, savings, NOW, certificates of deposits, brokered and all other deposits held by the Bank. Customer repurchase agreements represent excess amounts swept from customer demand deposit accounts, which mature the following business day and are collateralized by investment securities. These amounts are due to customers. At September 30, 2020, we had $10.0 million in FHLB short-term borrowings with a cost of 0.0%, compared to zero at December 31, 2019 and September 30, 2019. Junior subordinated debentures represent the amounts that are due from the Company to CVB Statutory Trust III. The debentures have the same maturity as the Trust Preferred Securities. These debentures bear interest at three-month LIBOR plus 1.38% and mature in 2036. Deferred compensation represents the amounts that are due to former employees based on salary continuation agreements as a result of acquisitions and amounts due to current employees under our deferred compensation plans. Operating leases represent the total minimum lease payments due under non-cancelable operating leases. Refer to Note 11 – Leases of the notes to the Company’s unaudited condensed consolidated financial statements for a more detailed discussion about leases. 63 Table of Contents Off-Balance Sheet Arrangements The following table summarizes the off-balance sheet items at September 30, 2020. Maturity by Period Total Less Than One Year One Year to Three Years Four Years to Five Years After Five Years (Dollars in thousands) Commitment to extend credit: Commercial and industrial $ 989,178 $ 672,740 $ 197,626 $ 5,295 $ 113,517 SBA 591 185 - - 406 SBA - PPP - - - - - Real estate: Commercial real estate 310,666 49,450 91,984 126,299 42,933 Construction 78,623 63,329 15,294 - - SFR Mortgage 1,706 - - - 1,706 Dairy & livestock and agribusiness (1) 232,870 188,380 43,873 130 487 Consumer and other loans 131,693 10,354 12,069 3,952 105,318 Total commitment to extend credit 1,745,327 984,438 360,846 135,676 264,367 Obligations under letters of credit 48,776 46,337 2,391 48 - Total $ 1,794,103 $ 1,030,775 $ 363,237 $ 135,724 $ 264,367 (1) Total commitments to extend credit to agribusiness were $17.2 million at September 30, 2020. As of September 30, 2020, we had commitments to extend credit of approximately $1.75 billion, and obligations under letters of credit of $48.8 million. Commitments to extend credit are agreements to lend to customers, provided there is no violation of any material condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Commitments are generally variable rate, and many of these commitments are expected to expire without being drawn upon. As such, the total commitment amounts do not necessarily represent future cash requirements. We use the same credit underwriting policies in granting or accepting such commitments or contingent obligations as we do for on-balance sheet instruments, which consist of evaluating customers’ creditworthiness individually. Due to the adoption of CECL on January 1, 2020, a transition adjustment of $41,000 was added to the beginning balance of the reserve for unfunded loan commitments. The Company recorded no provision or recapture of provision for unfunded loan commitments for the three and nine months ended September 30, 2020 and 2019. The Company had a reserve for unfunded loan commitments of $9.0 million as of September 30, 2020 and December 31, 2019 included in other liabilities. Standby letters of credit are conditional commitments issued by the Bank to guarantee the financial performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing or purchase arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. When deemed necessary, we hold appropriate collateral supporting those commitments. Capital Resources Our primary source of capital has been the retention of operating earnings and issuance of common stock in connection with periodic acquisitions. In order to ensure adequate levels of capital, we conduct an ongoing assessment of projected sources, needs and uses of capital in conjunction with projected increases in assets and the level of risk. As part of this ongoing assessment, the Board of Directors reviews the various components of our capital. Total equity decreased $12.1 million, or 0.61%, to $1.98 billion at September 30, 2020, compared to total equity of $1.99 billion at December 31, 2019. The $12.1 million decrease in equity was primarily due to the repurchase of 4.9 million shares of common stock for $91.7 million under our 10b5-1 stock repurchase program. We previously announced that we suspended this 10b5-1 stock repurchase program due to the uncertainty of the COVID-19 pandemic. We had $127.1 million in net earnings during the first nine months of 2020, offset by $73.3 million in cash dividends declared and a cumulative effect adjustment to beginning retained earnings of $1.3 million, net of tax, due to the adoption of CECL on January 1, 2020. Our equity also increased by $23.5 million as a result of an increase in other comprehensive income from the increase in our tax adjusted market value of our available-for-sale investment securities. Our tangible common equity ratio was 9.78% at September 30, 2020. 64 Table of Contents During the third quarter of 2020, the Board of Directors of CVB declared quarterly cash dividends totaling $0.18 per share. Dividends are payable at the discretion of the Board of Directors and there can be no assurance that the Board of Directors will continue to pay dividends at the same rate, or at all, in the future. CVB’s ability to pay cash dividends to its shareholders is subject to restrictions under federal and California law, including restrictions imposed by the Federal Reserve, and covenants set forth in various agreements we are a party to including covenants set forth in our junior subordinated debentures. On August 11, 2016, our Board of Directors approved a program to repurchase up to 10,000,000 shares of CVB common stock in the open market or in privately negotiated transactions, at times and at prices considered appropriate by us, depending upon prevailing market conditions and other corporate and legal considerations. There is no expiration date for this repurchase program. Up to 9,577,917 of such shares were available for repurchase under the Company’s current 10b5-1 plan originally adopted in November, 2018 and subsequently amended in July, 2019. On March 31, 2020, the Company announced that it suspended its 10b5-1 stock repurchase program due to the uncertainty of the COVID-19 pandemic. For the nine months ended September 30, 2020, the Company repurchased 4,944,290 shares of CVB common stock outstanding under this program. As of September 30, 2020, we have 4,585,145 shares of CVB common stock remaining that are eligible for repurchase under the common stock repurchase program. The Bank and the Company are required to meet risk-based capital standards under the revised capital framework referred to as Basel III set by their respective regulatory authorities. The risk-based capital standards require the achievement of a minimum total risk-based capital ratio of 8.0%, a Tier 1 risk-based capital ratio of 6.0% and a common equity Tier 1 (“CET1”) capital ratio of 4.5%. In addition, the regulatory authorities require the highest rated institutions to maintain a minimum leverage ratio of 4.0%. To be considered “well-capitalized” for bank regulatory purposes, the Bank and the Company are required to have a CET1 capital ratio equal to or greater than 6.5%, a Tier 1 risk-based capital ratio equal to or greater than 8.0%, a total risk-based capital ratio equal to or greater than 10.0% and a Tier 1 leverage ratio equal to or greater than 5.0%. At September 30, 2020, the Bank and the Company exceeded the minimum risk-based capital ratios and leverage ratios required to be considered “well-capitalized” for regulatory purposes. For further information about capital requirements and our capital ratios, see “Item 1. Business – Capital Adequacy Requirements ” as described in our Annual Report on Form 10-K for the year ended December 31, 2019. At September 30, 2020, the Bank and the Company exceeded the minimum risk-based capital ratios and leverage ratios, under the revised capital framework referred to as Basel III, required to be considered “well-capitalized” for regulatory purposes. We did not elect to phase in the impact of CECL on regulatory capital, as allowed under the interim final rule of the FDIC and other U.S. banking agencies. The table below presents the Company’s and the Bank’s risk-based and leverage capital ratios for the periods presented. September 30, 2020 December 31, 2019 Capital Ratios Adequately Capitalized Ratios Minimum Required Plus Capital Conservation Buffer Well Capitalized Ratios CVB Financial Corp. Consolidated Citizens Business Bank CVB Financial Corp. Consolidated Citizens Business Bank Tier 1 leverage capital ratio 4.00 % 4.00 % 5.00 % 9.88 % 9.71 % 12.33 % 12.19 % Common equity Tier 1 capital ratio 4.50 % 7.00 % 6.50 % 14.60 % 14.64 % 14.83 % 14.94 % Tier 1 risk-based capital ratio 6.00 % 8.50 % 8.00 % 14.89 % 14.64 % 15.11 % 14.94 % Total risk-based capital ratio 8.00 % 10.50 % 10.00 % 16.08 % 15.83 % 16.00 % 15.83 % 65 Table of Contents ASSET/LIABILITY AND MARKET RISK MANAGEMENT Liquidity and Cash Flow The objective of liquidity management is to ensure that funds are available in a timely manner to meet our financial obligations when they come due without incurring unnecessary cost or risk, or causing a disruption to our normal operating activities. This includes the ability to manage unplanned decreases or changes in funding sources, accommodating loan demand and growth, funding investments, repurchasing securities, paying creditors as necessary, and other operating or capital needs. We regularly assess the amount and likelihood of projected funding requirements through a review of factors such as historical deposit volatility and funding patterns, present and forecasted market and economic conditions, individual customer funding needs, as well as current and planned business activities. Management has an Asset/Liability Committee that meets monthly. This committee analyzes the cash flows from loans, investments, deposits and borrowings. In addition, the Company has a Balance Sheet Management Committee of the Board of Directors that meets monthly to review the Company’s balance sheet and liquidity position. This committee provides oversight to the balance sheet and liquidity management process and recommends policy guidelines for the approval of our Board of Directors, and courses of action to address our actual and projected liquidity needs. Our primary sources and uses of funds for the Company are deposits and loans. Our deposit levels and cost of deposits may fluctuate from period-to-period due to a variety of factors, including the stability of our deposit base, prevailing interest rates, and market conditions. Total deposits of $11.17 billion at September 30, 2020 increased $2.46 billion, or 28.30%, over total deposits of $8.70 billion at December 31, 2019. This significant deposit growth was primarily due to our customers maintaining greater liquidity. In general, our liquidity is managed daily by controlling the level of liquid assets as well as the use of funds provided by the cash flow from the investment portfolio, loan demand and deposit fluctuations. Our definition of liquid assets includes cash and cash equivalents in excess of minimum levels needed to fulfill normal business operations, short-term investment securities and other anticipated near term cash flows from investments. To meet unexpected demands, lines of credit are maintained with correspondent banks, the Federal Home Loan Bank and the Federal Reserve, although availability under these lines of credit are subject to certain conditions. The sale of investment securities can also serve as a contingent source of funds. We can obtain additional liquidity from deposit growth by offering competitive interest rates on deposits from both our local and national wholesale markets. At September 30, 2020, we had $25.8 million in subordinated debt and $10.0 million in FHLB short-term borrowings at 0% cost. The Bank has available lines of credit exceeding $4 billion, most of which is secured by pledged loans. Our balance sheet has significant liquidity and our assets are funded almost entirely with core deposits. Furthermore, we have significant off-balance sheet sources of liquidity. CVB is a holding company separate and apart from the Bank that must provide for its own liquidity and must service its own obligations. Substantially all of CVB’s revenues are obtained from dividends declared and paid by the Bank to CVB. There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to CVB. In addition, our regulators could limit the ability of the Bank or CVB to pay dividends or make other distributions. For the Bank, sources of funds include principal payments on loans and investments, growth in deposits, FHLB advances, and other borrowed funds. Uses of funds include withdrawal of deposits, interest paid on deposits, increased loan balances, purchases, and noninterest expenses. 66 Table of Contents Below is a summary of our average cash position and statement of cash flows for the nine months ended September 30, 2020 and 2019. For further details see our “ Condensed Consolidated Statements of Cash Flows (Unaudited)” under Part I, Item 1 of this report. Consolidated Summary of Cash Flows Nine Months Ended September 30, 2020 2019 (Dollars in thousands) Average cash and cash equivalents $ 1,071,392 $ 237,244 Percentage of total average assets 8.52% 2.10% Net cash provided by operating activities $ 138,019 $ 147,410 Net cash (used in) provided by investing activities (1,200,664) 538,256 Net cash provided by (used in) financing activities 2,362,080 (412,066) Net increase in cash and cash equivalents $ 1,299,435 $ 273,600 Average cash and cash equivalents increased by $834.1 million, or 351.60%, to $1.07 billion for the nine months ended September 30, 2020, compared to $237.2 million for the same period of 2019. At September 30, 2020, cash and cash equivalents totaled $1.48 billion. This represented an increase of $1.05 billion, or 239.38%, from $437.5 million at September 30, 2019. Interest Rate Sensitivity Management During periods of changing interest rates, the ability to re-price interest-earning assets and interest-bearing liabilities can influence net interest income, the net interest margin, and consequently, our earnings. Interest rate risk is managed by attempting to control the spread between rates earned on interest-earning assets and the rates paid on interest-bearing liabilities within the constraints imposed by market competition in our service area. The primary goal of interest rate risk management is to control exposure to interest rate risk, within policy limits approved by the Board of Directors. These limits and guidelines reflect our risk appetite for interest rate risk over both short-term and long-term horizons. We measure these risks and their impact by identifying and quantifying exposures through the use of sophisticated simulation and valuation models, which, as described in additional detail below, are employed by management to understand net interest income (NII) at risk and economic value of equity (EVE) at risk. Net interest income at risk sensitivity captures asset and liability re pricing mismatches and is considered a shorter term measure, while EVE sensitivity captures mismatches within the period end balance sheets through the financial instruments’ respective maturities or estimated durations and is considered a longer term measure. One of the primary methods that we use to quantify and manage interest rate risk is simulation analysis, which we use to model NII from the Company’s balance sheet under various interest rate scenarios. We use simulation analysis to project rate sensitive income under many scenarios. The analyses may include rapid and gradual ramping of interest rates, rate shocks, basis risk analysis, and yield curve scenarios. Specific balance sheet management strategies are also analyzed to determine their impact on NII and EVE. Key assumptions in the simulation analysis relate to the behavior of interest rates and pricing spreads, the changes in product balances, and the behavior of loan and deposit clients in different rate environments. This analysis incorporates several assumptions, the most material of which relate to the re-pricing characteristics and balance fluctuations of deposits with indeterminate or non-contractual maturities, and prepayment of loans and securities. Our interest rate risk policy measures the sensitivity of our net interest income over both a one-year and two-year cumulative time horizon. The simulation model estimates the impact of changing interest rates on interest income from all interest-earning assets and interest expense paid on all interest-bearing liabilities reflected on our balance sheet. This sensitivity analysis is compared to policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon assuming no balance sheet growth, given a 200 basis point upward and either a 100 or 200 basis point downward shift in interest rates depending on the level of current market rates. The simulation model uses a parallel yield curve shift that ramps rates up or down on a pro rata basis over the 12-month and 24-month time horizon. 67 Table of Contents The following depicts the Company’s net interest income sensitivity analysis as of the periods presented below. Estimated Net Interest Income Sensitivity (1) September 30, 2020 December 31, 2019 24-month Period 24-month Period Interest Rate Scenario 12-month Period (Cumulative) Interest Rate Scenario 12-month Period (Cumulative) + 200 basis points 9.30% 18.30% + 200 basis points 5.20% 10.00% - 100 basis points -0.60% -1.40% - 100 basis points -2.10% -4.60% (1) Percentage change from base scenario, but the current low interest rate environment limits the absolute decline in rates as the model does not assume rates go below zero. Based on our current simulation models, we believe that the interest rate risk profile of the balance sheet is asset sensitive over both a one-year and a two-year horizon. The estimated sensitivity does not necessarily represent a forecast and the results may not be indicative of actual changes to our net interest income. These estimates are based upon a number of assumptions including: the nature and timing of interest rate levels including yield curve shape, re-pricing characteristics and balance fluctuations of deposits with indeterminate or non-contractual maturities, prepayments on loans and securities, pricing strategies on loans and deposits, and replacement of asset and liability cash flows. While the assumptions used are based on current economic and local market conditions, there is no assurance as to the predictive nature of these conditions including how customer preferences or competitor influences might change. Our exposure in the rates down scenario is impacted by the current low interest rate environment and the model does not assume that rates go below 0.01%. We also perform valuation analysis, which incorporates all cash flows over the estimated remaining life of all material balance sheet and derivative positions. The valuation of the balance sheet, at a point in time, is defined as the discounted present value of all asset cash flows and derivative cash flows minus the discounted present value of all liability cash flows, the net of which is referred to as EVE. The sensitivity of EVE to changes in the level of interest rates is a measure of the longer-term re-pricing risk and options risk embedded in the balance sheet. EVE uses instantaneous changes in rates, as shown in the table below. Assumptions about the timing and variability of balance sheet cash flows are critical in the EVE analysis. Particularly important are the assumptions driving prepayments and the expected duration and pricing of the indeterminate deposit portfolios. EVE sensitivity is reported in both upward and downward rate shocks. At September 30, 2020 and December 31, 2019, the EVE profile indicates a decline in net balance sheet value due to instantaneous downward changes in rates, compared to an increase resulting from an increase in rates. Economic Value of Equity Sensitivity Instantaneous Rate Change September 30, 2020 December 31, 2019 100 bp decrease in interest rates -21.6% -17.5 % 100 bp increase in interest rates 15.2% 14.2 % 200 bp increase in interest rates 26.5% 25.5 % 300 bp increase in interest rates 30.7% 30.0 % 400 bp increase in interest rates 36.3% 36.2 % As EVE measures the discounted present value of cash flows over the estimated lives of instruments, the change in EVE does not directly correlate to the degree that earnings would be impacted over a shorter time horizon (i.e., the current year). Further, EVE does not take into account factors such as future balance sheet growth, changes in asset and liability mix, changes in yield curve relationships, and changing product spreads that could mitigate the adverse impact of changes in interest rates. 68 Table of Contents