FIVE STAR BANCORP 10-Q

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion presents management’s perspective on our results of operations and financial condition on a consolidated basis. However, because we conduct all of our material business operations through our bank subsidiary, Five Star Bank (the “Bank”), the discussion and analysis relates to activities primarily conducted by the Bank. Management’s discussion of the financial condition and results of operations, which is unaudited, should be read in conjunction with the related unaudited consolidated financial statements and accompanying notes in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and accompanying notes included in the 2022 Annual Report on Form 10-K, which was filed with the SEC on February 24, 2023. Average balances, including balances used in calculating certain financial ratios, are generally comprised of average daily balances. Unless otherwise indicated, references in this report to “we,” “our,” “us,” “the Company,” or “Bancorp” refer to Five Star Bancorp and our consolidated subsidiary. All references to “the Bank” refer to Five Star Bank, our wholly owned subsidiary. Cautionary Note Regarding Forward-Looking Statements This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements represent plans, estimates, objectives, goals, guidelines, expectations, intentions, projections, and statements of our beliefs concerning future events, business plans, objectives, expected operating results, and the assumptions upon which those statements are based. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate, or imply future results, performance, or achievements, and are typically identified with words such as “may,” “could,” “should,” “will,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “aim,” “intend,” “plan,” or words or phases of similar meaning. To the extent that this discussion describes prior performance, the descriptions relate only to the periods listed, which may not be indicative of our future financial outcomes. We caution that the forward-looking statements are based largely on our expectations and are subject to a number of known and unknown risks and uncertainties that are subject to change based on factors which are, in many instances, beyond our control. Such forward-looking statements are based on various assumptions (some of which may be beyond our control) and are subject to risks and uncertainties, which change over time, and other factors which could cause actual results to differ materially from those currently anticipated. Such risks and uncertainties include, but are not limited to: • risks related to the concentration of our business in California, and specifically within Northern California, including risks associated with any downturn in the real estate sector; • changes in market interest rates that affect the pricing of our loans and deposits, our net interest income, and our borrowers’ ability to repay loans; • changes in the U.S. economy, including an economic slowdown, inflation, deflation, housing prices, employment levels, rate of growth, and general business conditions, including uncertainty regarding the federal government's debt limit or a prolonged shutdown of the federal government; • uncertain market conditions and economic trends nationally, regionally, and particularly in Northern California and California; • the impacts related to or resulting from recent bank failures and other economic and industry volatility, including potential increased regulatory requirements and costs and potential impacts to macroeconomic conditions; • the impact of recent and future legislative and regulatory changes, including changes in banking, securities, and tax laws and regulations and their application by our regulators, and economic stimulus programs; • the effects of increased competition from a wide variety of local, regional, national, and other providers of financial and investment services; • the risks associated with our loan portfolios, and specifically with our commercial real estate loans; • our ability to maintain adequate liquidity and to maintain capital necessary to fund our growth strategy and operations and to satisfy minimum regulatory capital levels; • risks related to our strategic focus on lending to small to medium-sized businesses; • the sufficiency of the assumptions and estimates we make in establishing reserves for potential loan losses and the value of loan collateral and securities; • our level of nonperforming assets and the costs associated with resolving problem loans, if any, and complying with government-imposed foreclosure moratoriums; 28 • our ability to comply with various governmental and regulatory requirements applicable to financial institutions, including supervisory actions by federal and state banking agencies; • governmental monetary and fiscal policies, including the policies of the Federal Reserve; • risks associated with unauthorized access, cyber-crime, and other threats to data security; • our ability to implement, maintain, and improve effective internal controls; • our ability to attract and retain executive officers and key employees and their customer and community relationships; • the occurrence or impact of climate change or natural or man-made disasters or calamities, such as wildfires, droughts, and earthquakes; and • other factors that are discussed in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The foregoing factors could cause results or performance to materially differ from those expressed in our forward-looking statements, should not be considered exhaustive, and should be read together with other cautionary statements that are included in this report and those discussed in the section entitled “Risk Factors” of our 2022 Annual Report on Form 10-K, and other filings we may make with the SEC, copies of which are available from us at no charge. New risks and uncertainties may emerge from time to time, and it is not possible for us to predict their occurrence or how they will affect us. If one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance, or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements contained in this Quarterly Report on Form 10-Q. Therefore, we caution you not to place undue reliance on our forward-looking information and statements. We disclaim any duty to revise or update the forward-looking statements, whether written or oral, to reflect actual results or changes in the factors affecting the forward-looking statements, except as specifically required by law. Company Overview Headquartered in the greater Sacramento metropolitan area of California, Five Star Bancorp is a bank holding company that operates through its wholly owned subsidiary, Five Star Bank, a California state-chartered non-member bank. We provide a broad range of banking products and services to small and medium-sized businesses, professionals, and individuals primarily in Northern California through seven branch offices and one loan production office. Our mission is to strive to become the top business bank in all markets we serve through exceptional service, deep connectivity, and customer empathy. We are dedicated to serving real estate, agricultural, faith-based, and small to medium-sized enterprises. We aim to consistently deliver value that meets or exceeds the expectations of our shareholders, customers, employees, business partners, and community. We refer to our mission as “purpose-driven and integrity-centered banking.” At March 31, 2023, we had total assets of $3.4 billion, total loans held for investment, net of allowance for credit losses, of $2.8 billion, and total deposits of $2.9 billion. Critical Accounting Estimates The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Quarterly Reports on Form 10-Q and, therefore, do not include all footnotes as would be necessary for a fair presentation of financial position, results of operations and comprehensive income, changes in shareholders’ equity, and cash flows in conformity with GAAP as contained within the FASB's ASC and the rules and regulations of the SEC, including the instructions to Regulation S-X. However, these interim unaudited consolidated financial statements reflect all adjustments (consisting solely of normal recurring adjustments and accruals) which, in the opinion of management, are necessary for a fair presentation of financial position, results of operations and comprehensive income, changes in shareholders’ equity, and cash flows for the interim periods presented. These unaudited consolidated financial statements have been prepared on a basis consistent with, and should be read in conjunction with, the audited consolidated financial statements as filed in our 2022 Annual Report on Form 10-K and the notes thereto. Our most significant accounting policies and our critical accounting estimates are described in greater detail in Note 1, Basis of Presentation, in our audited consolidated financial statements and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates included in the 2022 Annual Report on Form 10-K. We have identified accounting policies and estimates that, due to the difficult, subjective, or complex judgments and assumptions inherent in those policies and estimates and the potential sensitivity of our unaudited consolidated financial statements to those judgments and assumptions, are critical to an understanding of our consolidated financial condition and results of operations. We believe that the judgments, estimates, and assumptions used in the 29 preparation of our financial statements are reasonable and appropriate, based on the information available at the time they were made. However, actual results may differ from those estimates, and these differences may be material. There have been no significant changes concerning our critical accounting estimates as described in our 2022 Annual Report on Form 10-K. Pursuant to the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), as an emerging growth company, we can elect to opt out of the extended transition period for adopting any new or revised accounting standards. We have elected not to opt out of the extended transition period, which means that when a standard is issued or revised and it has different application dates for public and private companies, we may adopt the standard on the application date for private companies. We have elected to take advantage of the scaled disclosures and other relief under the JOBS Act, and we may take advantage of some or all of the reduced regulatory and reporting requirements that will be available to us under the JOBS Act, so long as we qualify as an emerging growth company. 30 Executive Summary Net income for the three months ended March 31, 2023 totaled $13.2 million, compared to net income of $9.9 million for the three months ended March 31, 2022. The following are highlights of our operating and financial performance for the periods presented: • Deposits. Total deposits increased by $138.4 million from $2.8 billion at December 31, 2022 to $2.9 billion at March 31, 2023. Deposit increases were primarily attributable to an increase in the number of new deposit relationships, as well as normal fluctuations in some of our large existing accounts. Non-interest-bearing deposits decreased by $134.6 million in the first three months of 2023 to $836.7 million, and represented 28.65% of total deposits at March 31, 2023, compared to 34.91% of total deposits at December 31, 2022. Our loan to deposit ratio was 98.66% at March 31, 2023, compared to 100.67% at December 31, 2022. • Assets. Total assets were $3.4 billion at March 31, 2023, representing a $170.1 million, or 5.27%, increase compared to $3.2 billion at December 31, 2022. • Loans. Total loans held for investment were $2.9 billion at March 31, 2023, compared to $2.8 billion at December 31, 2022, an increase of $78.5 million, or 2.81%. The increase was primarily attributable to a $47.8 million increase in commercial real estate loans, a $9.7 million increase in commercial construction loans, an $8.3 million increase in commercial secured loans, and an $8.0 million increase in commercial land and development loans. • Non-accrual Loans. Credit quality remains strong, with non-accrual loans representing $0.4 million, or 0.01% of total loans held for investment, at March 31, 2023, compared to $0.4 million, or 0.01% of total loans held for investment, at December 31, 2022. The ratio of allowance for credit losses to total loans held for investment, or total loans at period end, was 1.19% at March 31, 2023 and 1.02% at December 31, 2022. • ROAA and ROAE. ROAA and ROAE were 1.65% and 20.94%, respectively, for the three months ended March 31, 2023, as compared to ROAA of 1.53% and ROAE of 17.07% for the three months ended March 31, 2022. • Net Interest Margin. Net interest margin was 3.75% for the three months ended March 31, 2023, and 3.60% for the three months ended March 31, 2022. The increase in net interest margin for the three months ended March 31, 2023 compared to the three months ended March 31, 2022 was primarily attributable to interest income resulting from yields earned and loan growth quarter over quarter, which more than offset increases to interest expense from rates paid and deposit growth. • Efficiency Ratio. Efficiency ratio was 36.43% for the three months ended March 31, 2023, down from 39.82% for the corresponding period of 2022. The decrease was primarily attributable to the change in net interest income more than offsetting the change in non-interest expense period-over-period. • Capital Ratios . All capital ratios were above well-capitalized regulatory thresholds as of March 31, 2023. The total risk-based capital ratio for the Company was 12.50% at March 31, 2023, compared to 12.46% at December 31, 2022. The Tier 1 leverage ratio was 8.53% at March 31, 2023, compared to 8.60% at December 31, 2022. For additional information about the regulatory capital requirements applicable to the Company and the Bank, see the section entitled “—Financial Condition Summary—Capital Adequacy” below. • Dividends. The board of directors declared a cash dividend of $0.15 per share on January 19, 2023. 31 Highlights of the financial results are presented in the following tables: (dollars in thousands) March 31, 2023 December 31, 2022 Selected financial condition data: Total assets $ 3,397,308 $ 3,227,159 Total loans held for investment 2,869,848 2,791,326 Total deposits 2,920,406 2,782,004 Total subordinated notes, net 73,640 73,606 Total shareholders’ equity 260,656 252,825 Asset quality ratios: Allowance for credit losses to total loans held for investment 1.19 % 1.02 % Allowance for credit losses to nonperforming loans 8,167.68 % 7,026.98 % Nonperforming loans to total loans held for investment 0.01 % 0.01 % Capital ratios: Total capital (to risk-weighted assets) 12.50 % 12.46 % Tier 1 capital (to risk-weighted assets) 9.02 % 8.99 % Common equity Tier 1 capital (to risk-weighted assets) 9.02 % 8.99 % Tier 1 leverage 8.53 % 8.60 % Total shareholders’ equity to total assets 7.67 % 7.83 % Tangible shareholders’ equity to tangible assets 1 7.67 % 7.83 % For the three months ended (dollars in thousands, except per share data) March 31, 2023 March 31, 2022 Selected operating data: Net interest income $ 29,148 $ 21,883 Provision for credit losses 900 950 Non-interest income 1,371 2,164 Non-interest expense 11,118 9,575 Net income 13,161 9,862 Earnings per common share: Basic $ 0.77 $ 0.58 Diluted $ 0.77 $ 0.58 Performance and other financial ratios: ROAA 1.65 % 1.53 % ROAE 20.94 % 17.07 % Net interest margin 3.75 % 3.60 % Cost of funds 1.53 % 0.17 % Efficiency ratio 36.43 % 39.82 % Cash dividend payout ratio on common stock 2 19.48 % 25.86 % 1 Tangible shareholders’ equity to tangible assets is considered a non-GAAP financial measure. See the section entitled “Non-GAAP Financial Measures” for a reconciliation of our non-GAAP financial measures to the most directly comparable GAAP financial measure. Tangible shareholders’ equity to tangible assets is defined as total equity less goodwill and other intangible assets, divided by total assets less goodwill and other intangible assets. The most directly comparable GAAP financial measure is total shareholders’ equity to total assets. We had no goodwill or other intangible assets as of any of the dates indicated. As a result, tangible shareholders’ equity to tangible assets is the same as total shareholders’ equity to total assets at the end of each of the periods indicated. 2 Cash dividend payout ratio on common stock is calculated as dividends on common shares divided by basic earnings per common share. 32 RESULTS OF OPERATIONS The following discussion of our results of operations compares the three months ended March 31, 2023 to the three months ended March 31, 2022. The results of operations for the three months ended March 31, 2023 are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 2023. Net Interest Income Net interest income is the most significant contributor to our net income. Net interest income represents interest income from interest-earning assets, such as loans and investments, less interest expense on interest-bearing liabilities, such as deposits, FHLB advances, subordinated notes, and other borrowings, which are used to fund those assets. In evaluating our net interest income, we measure and monitor yields on our interest-earning assets and interest-bearing liabilities as well as trends in our net interest margin. Net interest margin is a ratio calculated as net interest income divided by total interest-earning assets for the same period. We manage our earning assets and funding sources in order to maximize this margin while limiting credit risk and interest rate sensitivity to our established risk appetite levels. Changes in market interest rates and competition in our market typically have the largest impact on periodic changes in our net interest margin. Our net interest margin of 3.75% for the three months ended March 31, 2023 increased from 3.60% for the three months ended March 31, 2022. The increase was primarily due to a 142 basis point increase in the average yield on interest-earning assets, which increased from 3.76% for the three months ended March 31, 2022 to 5.18% for the three months ended March 31, 2023, partially offset by a 193 basis point increase in average rates paid on interest-bearing liabilities, which increased from 0.28% for the three months ended March 31, 2022 to 2.21% for the three months ended March 31, 2023. Average balance sheet, interest, and yield/rate analysis. The following table presents average balance sheet information, interest income, interest expense, and the corresponding average yield earned or rates paid for each period reported. The average balances are daily averages and include both performing and nonperforming loans. For the three months ended March 31, 2023 For the three months ended March 31, 2022 (dollars in thousands) Average Balance Interest Income/ Expense Average Yield/ Rate Average Balance Interest Income/ Expense Average Yield/ Rate Assets Interest-earning deposits with banks 1 $ 200,541 $ 2,167 4.38 % $ 339,737 $ 192 0.23 % Investment securities 2 119,489 650 2.21 % 148,736 567 1.54 % Loans held for investment and sale 1,3 2,836,070 37,494 5.36 % 1,977,509 22,112 4.53 % Total interest-earning assets 1 3,156,100 40,311 5.18 % 2,465,982 22,871 3.76 % Interest receivable and other assets, net 69,253 150,116 Total assets $ 3,225,353 $ 2,616,098 Liabilities and shareholders’ equity Interest-bearing transaction accounts $ 379,593 $ 433 0.46 % $ 276,690 $ 70 0.10 % Savings accounts 155,233 545 1.42 % 90,815 25 0.11 % Money market accounts 1,087,122 5,436 2.03 % 920,767 367 0.16 % Time accounts 300,952 2,964 3.99 % 128,183 83 0.26 % Subordinated debt and other borrowings 1 125,691 1,785 5.76 % 28,393 443 6.33 % Total interest-bearing liabilities 2,048,591 11,163 2.21 % 1,444,848 988 0.28 % Demand accounts 901,491 922,128 Interest payable and other liabilities 20,344 14,800 Shareholders’ equity 254,927 234,322 Total liabilities and shareholders’ equity $ 3,225,353 $ 2,616,098 Net interest spread 4 2.97 % 3.48 % Net interest income/margin 5 $ 29,148 3.75 % $ 21,883 3.60 % 33 1 Interest income/expense is divided by the actual number of days in the period multiplied by the actual number of days in the year to correspond to stated interest rate terms, where applicable. 2 Yields on available-for-sale securities are calculated based on fair value. Investment security interest is earned on 30/360 day basis monthly. Yields are not calculated on a tax-equivalent basis. 3 Average loan balance includes both loans held for investment and loans held for sale. Non-accrual loans are included in total loan balances. No adjustment has been made for these loans in the yield calculations. Interest income on loans includes amortization of deferred loan fees, net of deferred loan costs. 4 Net interest spread represents the average yield earned on interest-earning assets minus the average rate paid on interest-bearing liabilities. 5 Net interest margin is computed by calculating the difference between interest income and interest expense, divided by the average balance of interest-earning assets, then annualized based on the number of days in the given period. Analysis of changes in interest income and expenses. Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average yields/rates. The following table shows the effect that these factors had on the interest earned from our interest-earning assets and interest incurred on our interest-bearing liabilities. The effect of changes in volume is determined by multiplying the change in volume by the current period’s average yield/rate. The effect of rate changes is calculated by multiplying the change in average yield/rate by the previous period’s volume. Changes not solely attributable to volume or yields/rates have been allocated in proportion to the respective volume and yield/rate components. For the three months ended March 31, 2023 compared to the three months ended March 31, 2022 (dollars in thousands) Volume Yield/Rate Total Interest-earning deposits with banks $ (1,504) $ 3,479 $ 1,975 Investment securities (160) 243 83 Loans held for investment and sale 11,122 4,260 15,382 Total interest-earning assets 9,458 7,982 17,440 Interest-bearing transaction accounts 117 246 363 Savings accounts 226 294 520 Money market accounts 832 4,237 5,069 Time accounts 1,702 1,179 2,881 Subordinated debt and other borrowings 1,382 (40) 1,342 Total interest-bearing liabilities 4,259 5,916 10,175 Changes in net interest income/margin $ 5,199 $ 2,066 $ 7,265 Factors affecting interest income and yields Interest income increased by $17.4 million, or 76.25%, to $40.3 million for the three months ended March 31, 2023 from $22.9 million for the corresponding period of 2022 due to the following: • Rates. The average yields on interest-earning assets were 5.18% and 3.76% for the three months ended March 31, 2023 and March 31, 2022, respectively. The increase in yields period-over-period was primarily due to increased rates earned on loans held for investment and sale originated in the current environment of rising rates, and increases in yields earned on interest-earning deposits with banks. • Volume. Average interest-earning assets increased by approximately $690.1 million period-over-period, driven by new loan originations which drove increases in the average daily balances of loans for the three months ended March 31, 2023. 34 Factors affecting interest expense and rates Interest expense increased by $10.2 million, or 1,029.86%, to $11.2 million for the three months ended March 31, 2023 from $1.0 million for the same period of 2022 due to the following: • Rates. The average costs of interest-bearing liabilities were 2.21% and 0.28% for the three months ended March 31, 2023 and March 31, 2022, respectively. The increase in cost period-over-period was due to increases in the rates paid on interest-bearing deposit accounts, with the most significant increases in time and money market accounts. The average cost of subordinated debt and other borrowings decreased from 6.33% to 5.76% for the three months ended March 31, 2022 and March 31, 2023, respectively, due to a reduction of interest expenses as a percentage of the average balance during the three months ended March 31, 2023. Additionally, the cost of funds increased from 0.17% for the quarter ended March 31, 2022 to 1.53% for the quarter ended March 31, 2023. • Volume. Average interest-bearing liabilities increased by $603.7 million period-over-period, primarily driven by increases in average balances for interest-bearing deposit accounts, with the most substantial average balance increases in time accounts. Average subordinated debt and other borrowings increased by $97.3 million period-over-period, consisting of FHLB advances which did not occur during the three months ended March 31, 2022, combined with an increase in the average balance of subordinated debt. Provision for Credit Losses The provision for credit losses is based on management’s assessment of the adequacy of our allowance for credit losses. Factors impacting the provision include inherent risk characteristics in our loan portfolio, the level of nonperforming loans and net charge-offs, both current and historic, local economic and credit conditions, the direction of the change in collateral values, and the funding probability on unfunded lending commitments. The provision for credit losses is charged against earnings in order to maintain our allowance for credit losses, which reflects management’s best estimate of forecasted life of loan losses in our loan portfolio at the balance sheet date. We recorded a $0.9 million provision for credit losses in the first quarter of 2023, compared to a $1.0 million provision for credit losses recorded for the same period of 2022. The decrease of $0.1 million was primarily due to a decline in loan growth during the first quarter of 2023. This decline was partially offset by provisions required for loans designated as watch and substandard, which increased from $17.0 million as of March 31, 2022 to $24.6 million as of March 31, 2023. Beginning January 1, 2023, we adopted ASC 326, which replaced the former "incurred loss" model for recognizing credit losses with an "expected loss" model referred to as the CECL model. The CECL allowance model calculates reserves over the life of the loan and is largely driven by portfolio characteristics, economic outlook, and other key methodology assumptions. Under the CECL model, the calculated allowance for credit losses was $5.3 million higher on January 1, 2023 than the allowance under the incurred loss model. Utilizing CECL may have an impact on our allowance for credit losses going forward and resulted in a lack of comparability between the 2022 and 2023 quarterly periods. Non-interest Income Non-interest income is a secondary contributor to our net income. Non-interest income consists of service charges on deposit accounts, net gain on sale of securities, gain on sale of loans, loan-related fees, FHLB stock dividends, earnings on BOLI, and other income. 35 The following table details the components of non-interest income for the periods indicated for the three months ended March 31, 2023 compared to three months ended March 31, 2022. For the three months ended (dollars in thousands) March 31, 2023 March 31, 2022 $ Change % Change Service charges on deposit accounts $ 117 $ 108 $ 9 8.33 % Net gain on sale of securities — 5 (5) (100.00) % Gain on sale of loans 598 918 (320) (34.86) % Loan-related fees 308 596 (288) (48.32) % FHLB stock dividends 193 102 91 89.22 % Earnings on BOLI 102 90 12 13.33 % Other income 53 345 (292) (84.64) % Total non-interest income $ 1,371 $ 2,164 $ (793) (36.65) % Gain on sale of loans. The decrease in gain on sale of loans related primarily to an overall decline in the effective yields on loans sold during the three months ended March 31, 2023 compared to the three months ended March 31, 2022. During the three months ended March 31, 2023, approximately $12.7 million of loans were sold with an effective yield of 4.72%, as compared to approximately $11.7 million of loans sold with an effective yield of 7.84% during the three months ended March 31, 2022. Loan-related fees. The decrease in loan-related fees was primarily a result of $0.3 million of swap referral fees recognized during the three months ended March 31, 2022 which did not recur in the three months ended March 31, 2023. Other income. The decrease in other income resulted primarily from a $0.3 million gain recorded on a distribution received on an investment in a venture-backed fund during the three months ended March 31, 2022 which did not recur during the three months ended March 31, 2023. Non-interest Expense Non-interest expense includes salaries and employee benefits, occupancy and equipment, data processing and software, FDIC insurance, professional services, advertising and promotional, loan-related expenses, and other operating expenses. In evaluating our level of non-interest expense, we closely monitor the Company’s efficiency ratio, which is calculated as non-interest expense divided by the sum of net interest income and non-interest income. We constantly seek to identify ways to streamline our business and operate more efficiently, to reduce our non-interest expense over time as a percentage of our revenue, while continuing to achieve growth in total loans and assets. Over the past several years, we have invested significant resources in personnel, technology, and infrastructure. As we execute initiatives based on growth, we expect non-interest expense to grow. Non-interest expense has increased throughout the periods presented below; however, we expect our efficiency ratio will improve going forward due, in part, to our past investment in infrastructure. 36 The following table details the components of non-interest expense for three months ended March 31, 2023 compared to three months ended March 31, 2022. For the three months ended (dollars in thousands) March 31, 2023 March 31, 2022 $ Change % Change Salaries and employee benefits $ 6,618 $ 5,675 $ 943 16.62 % Occupancy and equipment 523 520 3 0.58 % Data processing and software 872 716 156 21.79 % FDIC insurance 402 165 237 143.64 % Professional services 631 554 77 13.90 % Advertising and promotional 418 344 74 21.51 % Loan-related expenses 255 278 (23) (8.27) % Other operating expenses 1,399 1,323 76 5.74 % Total non-interest expense $ 11,118 $ 9,575 $ 1,543 16.11 % Salaries and employee benefits. The increase in salaries and employee benefits was primarily a result of: (i) a $0.7 million increase in salaries, insurance, and benefits as a result of a 7.10% increase in headcount and recognition of employer taxes and 401(k) contributions recorded for bonuses and commissions paid during the three months ended March 31, 2023, as compared to the three months ended March 31, 2022; (ii) a $0.7 million decrease in loan origination costs due to lower loan production; and (iii) a $0.3 million increase in estimated bonus expense based on increased headcount and salaries. These increases were partially offset by $0.7 million of lower commission expenses due to lower loan production during the three months ended March 31, 2023, as compared to the three months ended March 31, 2022. Data processing and software. Data processing and software expenses increased, primarily due to: (i) increased usage of our digital banking platform; (ii) higher transaction volumes related to the increased number of loan and deposit accounts; and (iii) increased number of licenses required for new users on our loan origination and documentation system. FDIC insurance. The increase in FDIC insurance related primarily to a final rule adopted by the FDIC to increase initial base deposit insurance assessment rates for insured depository institutions by two basis points, beginning with the first quarterly assessment period in 2023. FDIC insurance also increased for the three months ended March 31, 2023 compared to the three months ended March 31, 2022 due to a $539.7 million increase in the assessment base period-over-period. Provision for Income Taxes The provision for income tax was $5.3 million for the three months ended March 31, 2023, compared to $3.7 million for the three months ended March 31, 2022. Additionally, the provision for income taxes for the three months ended March 31, 2022 included a provision to tax return true-up of approximately $0.3 million relating to the 2021 tax return filed in 2022, which did not recur during the three months ended March 31, 2023. Effective income tax rates for the three months ended March 31, 2023 and 2022 were 28.86% and 27.07%, respectively. Differences between the Company’s effective tax rate and federal and state blended statutory rates are due to certain items, such as tax-exempt income from municipal securities, earnings on BOLI, non-deductible expenses, vesting of stock awards, and benefits from tax credits as compared to pre-tax income. 37 FINANCIAL CONDITION SUMMARY The following discussion compares our financial condition as of March 31, 2023 to our financial condition as of December 31, 2022. The following table summarizes selected components of our unaudited consolidated balance sheets as of March 31, 2023 and December 31, 2022. (in thousands) March 31, 2023 December 31, 2022 Total assets $ 3,397,308 $ 3,227,159 Cash and cash equivalents 347,939 259,991 Total investments 118,654 119,744 Loans held for investment 2,869,848 2,791,326 Total deposits 2,920,406 2,782,004 Subordinated notes, net 73,640 73,606 Total shareholders’ equity 260,656 252,825 Total Assets At March 31, 2023, total assets were $3.4 billion, an increase of $170.1 million from $3.2 billion at December 31, 2022, primarily due to an increase in cash and cash equivalents of $87.9 million and in loans held for investment of $78.5 million. Cash and Cash Equivalents Total cash and cash equivalents were $347.9 million at March 31, 2023, an increase of $87.9 million from $260.0 million at December 31, 2022. The increase in cash and cash equivalents was primarily due to an increase in deposits of $138.4 million and an increase in FHLB advances of $20.0 million, partially offset by loan originations, net of repayments, of $69.5 million. Investment Portfolio Our investment portfolio is primarily comprised of U.S. government agency securities, mortgage-backed securities, and obligations of states and political subdivisions, which are high-quality liquid investments. We manage our investment portfolio according to written investment policies approved by our board of directors. Our investment strategy aims to maximize earnings while maintaining liquidity in securities with minimal credit risk and interest rate risk that is reflective of the yields obtained on those securities. Most of our securities are classified as available-for-sale, although we have one long-term, fixed rate municipal security classified as held-to-maturity. Our total securities available-for-sale and held-to-maturity amounted to $118.7 million at March 31, 2023 and $119.7 million at December 31, 2022, representing a decrease of $1.0 million period-over-period. The decrease to available-for-sale securities was primarily due to maturities, prepayments, and calls of $2.9 million, partially offset by an unrealized gain on securitie s of $2.1 million, with the remainder of the change due to amortization on premiums . For the quarter, other comprehensive income increased by $1.5 million, primarily from our mortgage-backed and municipal securities portfolios, resulting in tax-effected increases from each of those portfolios of $0.7 million and $0.8 million, respectively. This unrealized gain was attributable to interest rate changes that occurred during the period. 38 The following table presents the carrying value of our investment portfolio as of the dates indicated: As of March 31, 2023 December 31, 2022 (dollars in thousands) Carrying Value % of Total Carrying Value % of Total Available-for-sale (at fair value): U.S. government agencies $ 13,147 11.09 % $ 14,173 11.84 % Mortgage-backed securities 60,969 51.38 % 61,271 51.17 % Obligations of states and political subdivisions 38,871 32.76 % 38,426 32.09 % Collateralized mortgage obligations 384 0.32 % 395 0.33 % Corporate bonds 1,769 1.49 % 1,723 1.44 % Total available-for-sale 115,140 97.04 % 115,988 96.87 % Held-to-maturity (at amortized cost): Obligations of states and political subdivisions 3,514 2.96 % 3,756 3.13 % Total $ 118,654 100.00 % $ 119,744 100.00 % 39 The following table presents the carrying value of our securities by their stated maturities, as well as the weighted average yields for each maturity range, as of March 31, 2023: Due in one year or less Due after one year through five years Due after five years through ten years Due after ten years Total (dollars in thousands) Carrying Value Weighted Average Yield Carrying Value Weighted Average Yield Carrying Value Weighted Average Yield Carrying Value Weighted Average Yield Carrying Value Weighted Average Yield Available-for-sale: U.S. government agencies $ — — % $ 1,004 3.09 % $ 2,094 4.84 % $ 10,049 4.48 % $ 13,147 4.43 % Mortgage-backed securities — — % — — % 2 6.94 % 60,967 1.68 % 60,969 1.68 % Obligations of states and political subdivisions — — % — — % 5,307 1.62 % 33,564 1.76 % 38,871 1.74 % Collateralized mortgage obligations — — % — — % 384 1.76 % — — % 384 1.76 % Corporate bonds — — % 1,769 1.25 % — — % — — % 1,769 1.25 % Total available-for-sale — — % 2,773 1.91 % 7,787 2.49 % 104,580 1.98 % 115,140 2.01 % Held-to-maturity: Obligations of states and political subdivisions 354 6.00 % 950 6.00 % 1,375 6.00 % 835 6.00 % 3,514 6.00 % Total $ 354 6.00 % $ 3,723 2.96 % $ 9,162 3.02 % $ 105,415 2.01 % $ 118,654 2.13 % 40 The following table presents the carrying value of our securities by their stated maturities, as well as the weighted average yields for each maturity range, as of December 31, 2022: Due in one year or less Due after one year through five years Due after five years through ten years Due after ten years Total (dollars in thousands) Carrying Value Weighted Average Yield Carrying Value Weighted Average Yield Carrying Value Weighted Average Yield Carrying Value Weighted Average Yield Carrying Value Weighted Average Yield Available-for-sale: U.S. government agencies $ — — % $ 849 1.98 % $ 2,625 3.61 % $ 10,699 2.90 % $ 14,173 2.98 % Mortgage-backed securities — — % — — % 2 6.94 % 61,269 1.67 % 61,271 1.67 % Obligations of states and political subdivisions 501 2.80 % — — % 4,761 1.63 % 33,164 1.76 % 38,426 1.76 % Collateralized mortgage obligations — — % — — % — — % 395 1.76 % 395 1.76 % Corporate bonds — — % 1,723 1.25 % — — % — — % 1,723 1.25 % Total available-for-sale 501 2.80 % 2,572 1.49 % 7,388 2.33 % 105,527 1.82 % 115,988 1.85 % Held-to-maturity: Obligations of states and political subdivisions 417 6.00 % 1,015 6.00 % 1,470 6.00 % 854 6.00 % 3,756 6.00 % Total $ 918 4.25 % $ 3,587 2.77 % $ 8,858 2.94 % $ 106,381 1.86 % $ 119,744 1.98 % Weighted average yield for securities available-for-sale is the projected yield to maturity given current cash flow projections for U.S. government agency securities, mortgage-backed securities, and collateralized mortgage obligations. For callable municipal securities and corporate bonds, weighted average yield is a yield to worst. Weighted average yield for securities held-to-maturity is the stated coupon of the bond. 41 Loan Portfolio Our loan portfolio is our largest class of interest-earning assets and typically provides higher yields than other types of interest-earning assets. Associated with the higher yields is an inherent amount of credit risk, which we attempt to mitigate with strong underwriting. As of March 31, 2023 and December 31, 2022, our total loans amounted to $2.9 billion and $2.8 billion, respectively. The following table presents the balance and associated percentage of each major product type within our portfolio as of the dates indicated. As of March 31, 2023 December 31, 2022 (dollars in thousands) Amount % of Loans Amount % of Loans Loans held for investment: Real estate: Commercial $ 2,442,520 84.71 % $ 2,394,674 85.44 % Commercial land and development 15,475 0.54 % 7,477 0.27 % Commercial construction 98,415 3.41 % 88,669 3.16 % Residential construction 9,410 0.33 % 6,693 0.24 % Residential 23,862 0.83 % 24,230 0.86 % Farmland 51,616 1.79 % 52,478 1.87 % Commercial: Secured 173,500 6.02 % 165,186 5.89 % Unsecured 24,776 0.86 % 25,431 0.91 % Consumer and other 32,378 1.12 % 28,628 1.02 % Loans held for investment, gross 2,871,952 99.61 % 2,793,466 99.66 % Loans held for sale: Commercial 11,315 0.39 % 9,416 0.34 % Total loans, gross 2,883,267 100.00 % 2,802,882 100.00 % Net deferred loan fees (2,104) (2,140) Total loans $ 2,881,163 $ 2,800,742 Commercial real estate loans consist of term loans secured by a mortgage lien on the real property, such as office and industrial buildings, manufactured home communities, self-storage facilities, hospitality properties, faith-based properties, retail shopping centers, and apartment buildings, as well as commercial real estate construction loans that are offered to builders and developers. Commercial land and development and commercial construction loans consist of loans made to fund commercial land acquisition and development and commercial construction, respectively. The real estate purchased with these loans is generally located in or near our market. Commercial loans consist of financing for commercial purposes in various lines of business, including manufacturing, service industry, and professional service areas. Commercial loans can be secured or unsecured but are generally secured with the assets of the company and/or the personal guaranty of the business owner(s). Residential real estate and construction real estate loans consist of loans secured by single-family and multifamily residential properties, which are both owner-occupied and investor-owned. 42 The following tables present the commercial real estate loan balance, associated percentage of commercial real estate concentrations, estimated real estate collateral values, and related loan-to-value (“LTV”) ranges by collateral type as of the dates indicated. Revolving lines of credit with zero balance and 0.00% LTV are excluded from this table. Collateral values are determined at origination using third-party real estate appraisals or evaluations. Updated appraisals, which are included in the table below, are obtained for loans that are downgraded to watch or substandard. Loans over $1.0 million are reviewed annually, at which time an internal assessment of collateral values is completed. (dollars in thousands) Loan Balance % of Commercial Real Estate Collateral Value Minimum LTV Maximum LTV March 31, 2023 Manufactured home community $ 709,015 29.03 % $ 1,230,431 17.03 % 77.99 % RV Park 304,840 12.48 % 524,891 18.56 % 80.67 % Retail 266,740 10.92 % 494,906 14.55 % 82.95 % Multifamily 201,562 8.25 % 402,384 13.93 % 75.00 % Industrial 171,456 7.02 % 410,282 9.67 % 75.00 % Mini storage 157,339 6.44 % 305,885 19.15 % 70.00 % Faith-based 151,632 6.21 % 404,559 2.43 % 73.12 % Office 141,501 5.79 % 305,301 4.88 % 74.23 % All other types 1 338,435 13.86 % 699,599 4.00 % 152.76 % Total $ 2,442,520 100.00 % $ 4,778,238 2.43 % 152.76 % December 31, 2022 Manufactured home community $ 673,891 28.14 % $ 1,174,642 17.10 % 78.19 % RV Park 292,886 12.23 % 506,041 18.64 % 77.89 % Retail 264,599 11.05 % 490,291 16.48 % 73.93 % Multifamily 202,203 8.44 % 459,695 14.19 % 75.00 % Industrial 166,403 6.95 % 366,291 10.77 % 75.00 % Mini storage 158,650 6.63 % 289,820 20.20 % 70.04 % Faith-based 146,740 6.13 % 383,321 3.19 % 73.55 % Office 145,899 6.09 % 310,248 6.66 % 74.68 % All other types 1 343,403 14.34 % 704,984 — % 152.96 % Total $ 2,394,674 100.00 % $ 4,685,333 — % 152.96 % 1 Types of collateral in the “all other types” category are those that individually make up less than 5.00% commercial real estate concentration and include hospitality properties, auto dealerships, car washes, assisted living communities, country clubs, gas stations/convenience stores, medical offices, special purpose properties, mortuaries, restaurants, and schools. Over the past several years, we have experienced significant growth in our loan portfolio, although the relative composition of the portfolio has not changed significantly. Our primary focus remains commercial real estate lending (including commercial, commercial land and development, and commercial construction), which constitutes 89.08% of loans held for investment at March 31, 2023. Commercial secured lending represents 6.05% of loans held for investment at March 31, 2023. We sell the guaranteed portion of all SBA 7(a) loans in the secondary market and will continue to do so as long as market conditions continue to be favorable. We recognize that our commercial real estate loan concentration is significant within our balance sheet. Commercial real estate loan balances as a percentage of risk-based capital were 673.90% and 680.34% as of March 31, 2023 and December 31, 2022, respectively. We have established internal concentration limits in the loan portfolio for commercial real estate loans by sector (e.g., manufactured home communities, self-storage, hospitality, etc.). All loan sectors were within our established limits as of March 31, 2023. Additionally, our loans are geographically concentrated with borrowers and collateral properties primarily in California. 43 We believe that our past success is attributable to focusing on products and markets where we have significant expertise. Given our concentrations, we have established strong risk management practices, including risk-based lending standards, self-established product and geographical limits, annual evaluations of income property loans, and semi-annual top-down and bottom-up stress testing. We expect to continue growing our loan portfolio. We do not expect our product or geographic concentrations to materially change. The following table sets forth the contractual maturities of our loan portfolio as of March 31, 2023: (in thousands) Due in 1 year or less Due after 1 year through 5 years Due after 5 years through 15 years Due after 15 years Total Real estate: Commercial $ 18,853 $ 233,844 $ 2,126,171 $ 63,652 $ 2,442,520 Commercial land and development 1,536 13,132 807 — 15,475 Commercial construction 2,978 41,325 54,112 — 98,415 Residential construction 1,443 6,267 1,700 — 9,410 Residential 37 6,611 16,225 989 23,862 Farmland 1,431 4,490 45,695 — 51,616 Commercial: Secured 39,609 44,504 97,487 3,215 184,815 Unsecured 696 10,644 13,436 — 24,776 Consumer and other 1,338 7,742 23,298 — 32,378 Total $ 67,921 $ 368,559 $ 2,378,931 $ 67,856 $ 2,883,267 The following table sets forth the contractual maturities of our loan portfolio as of December 31, 2022: (in thousands) Due in 1 year or less Due after 1 year through 5 years Due after 5 years through 15 years Due after 15 years Total Real estate: Commercial $ 19,406 $ 227,519 $ 2,083,818 $ 63,931 $ 2,394,674 Commercial land and development 1,611 5,053 813 — 7,477 Commercial construction 1,957 37,510 49,202 — 88,669 Residential construction 594 4,783 1,316 — 6,693 Residential 348 6,635 16,248 999 24,230 Farmland 992 5,685 45,801 — 52,478 Commercial: Secured 36,154 46,814 88,418 3,216 174,602 Unsecured 55 10,347 15,029 — 25,431 Consumer and other 1,321 8,234 19,067 6 28,628 Total $ 62,438 $ 352,580 $ 2,319,712 $ 68,152 $ 2,802,882 44 The following table sets forth the sensitivity to interest rate changes of our loan portfolio as of March 31, 2023: (in thousands) Fixed Interest Rates Floating or Adjustable Rates Total Real estate: Commercial $ 558,746 $ 1,883,774 $ 2,442,520 Commercial land and development 1,502 13,973 15,475 Commercial construction 1,405 97,010 98,415 Residential construction 3,593 5,817 9,410 Residential 1,363 22,499 23,862 Farmland 5,802 45,814 51,616 Commercial: Secured 40,740 144,075 184,815 Unsecured 19,829 4,947 24,776 Consumer and other 32,378 — 32,378 Total $ 665,358 $ 2,217,909 $ 2,883,267 The following table sets forth the sensitivity to interest rate changes of our loan portfolio as of December 31, 2022: (in thousands) Fixed Interest Rates Floating or Adjustable Rates Total Real estate: Commercial $ 552,206 $ 1,842,468 $ 2,394,674 Commercial land and development 1,514 5,963 7,477 Commercial construction 1,405 87,264 88,669 Residential construction 3,366 3,327 6,693 Residential 1,531 22,699 24,230 Farmland 6,261 46,217 52,478 Commercial: Secured 37,517 137,085 174,602 Unsecured 20,607 4,824 25,431 Consumer and other 28,628 — 28,628 Total $ 653,035 $ 2,149,847 $ 2,802,882 Asset Quality We manage the quality of our loans based upon trends at the overall loan portfolio level as well as within each product type. We measure and monitor key factors that include the level and trend of classified, delinquent, non-accrual, and nonperforming assets, collateral coverage, credit scores, and debt service coverage, where applicable. These metrics directly impact our evaluation of the adequacy of our allowance for credit losses. Our primary objective is to maintain a high level of asset quality in our loan portfolio. We believe our underwriting practices and policies, established by experienced professionals, appropriately govern the risk profile for our loan portfolio. These policies are continually evaluated and updated as necessary. All loans are assessed and assigned a risk classification at origination based on underlying characteristics of the transaction, such as collateral cash flow, collateral coverage, and borrower strength. We believe that we have a comprehensive methodology to proactively monitor our credit quality after the origination process. Particular emphasis is placed on our commercial portfolio, where risk assessments are reevaluated as a result of reviewing commercial property operating statements and borrower financials. On an ongoing basis, we also monitor payment performance, delinquencies, and tax and property insurance compliance. We design our practices to facilitate the early detection and remediation of problems within our loan portfolio. Assigned risk classifications are an integral part of management’s assessment of the adequacy of our allowance for credit losses. We periodically employ the 45 use of an independent consulting firm to evaluate our underwriting and risk assessment process. Like other financial institutions, we are subject to the risk that our loan portfolio will be exposed to increasing pressures from deteriorating borrower credit due to general economic conditions and rising interest rates. Nonperforming Assets Our nonperforming assets consist of nonperforming loans and foreclosed real estate, if any. Nonperforming loans consist of non-accrual loans and loans contractually past due by 90 days or more and still accruing. Loans on which the accrual of interest has been discontinued are designated as non-accrual loans. Accrual of interest on loans is discontinued either when reasonable doubt exists as to the full and timely collection of interest or principal or when a loan becomes contractually past due by 90 days or more with respect to interest or principal. When a loan is placed on non-accrual status, all interest previously accrued, but not collected, is reversed against current period interest income. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest. SBA Loans During the three months ended March 31, 2023, the Company sold 55 SBA 7(a) loans with government guaranteed portions totaling $12.7 million. The Company received gross proceeds of $13.3 million on the loans sold during the three months ended March 31, 2023, resulting in the recognition of net gains on sale of $0.6 million during the same period. Non-accrual Loans The following table provides details of our nonperforming and restructured assets and certain other related information as of the dates presented: As of (dollars in thousands) March 31, 2023 December 31, 2022 Non-accrual loans: Real estate: Commercial $ 102 $ 106 Residential 175 175 Commercial: Secured 118 123 Consumer and other 23 — Total non-accrual loans 418 404 Loans past due 90 days or more and still accruing: Total loans past due and still accruing — — Total nonperforming loans 418 404 Real estate owned — — Total nonperforming assets $ 418 $ 404 Performing LMs (not included above) $ — $ — Allowance for credit losses to period end nonperforming loans 8,167.68 % 7,026.98 % Nonperforming loans to loans held for investment 1 0.01 % 0.01 % Nonperforming assets to total assets 0.01 % 0.01 % Nonperforming loans plus performing LMs to loans held for investment 1 0.01 % 0.01 % 1 Loans held for investment are equivalent to total loans outstanding at period end. 46 The ratio of nonperforming loans to loans held for investment remained consistent at 0.01% as of December 31, 2022 and March 31, 2023. Potential Problem Loans We utilize a risk grading system for our loans to aid us in evaluating the overall credit quality of our real estate loan portfolio and assessing the adequacy of our allowance for credit losses. All loans are grouped into a risk category at the time of origination. Commercial real estate loans over $1.0 million are reevaluated at least annually for proper classification in conjunction with our review of property and borrower financial information. All loans are reevaluated for proper risk grading as new information such as payment patterns, collateral condition, and other relevant information comes to our attention. The banking industry defines loans graded substandard or doubtful as “classified” loans. The following table shows our levels of classified loans as of the periods indicated: (in thousands) Pass Watch Substandard Doubtful Total March 31, 2023 Real estate: Commercial $ 2,425,747 $ 16,671 $ 102 $ — $ 2,442,520 Commercial land and development 15,475 — — — 15,475 Commercial construction 92,515 5,900 — — 98,415 Residential construction 9,410 — — — 9,410 Residential 23,687 — 175 — 23,862 Farmland 51,616 — — — 51,616 Commercial: Secured 171,807 1,575 118 — 173,500 Unsecured 24,776 — — — 24,776 Consumer 32,355 — 23 — 32,378 Total $ 2,847,388 $ 24,146 $ 418 $ — $ 2,871,952 December 31, 2022 Real estate: Commercial $ 2,379,766 $ 14,802 $ 106 $ — $ 2,394,674 Commercial land and development 7,477 — — — 7,477 Commercial construction 82,769 5,900 — — 88,669 Residential construction 6,693 — — — 6,693 Residential 24,055 — 175 — 24,230 Farmland 52,478 — — — 52,478 Commercial: Secured 163,879 1,184 123 — 165,186 Unsecured 25,431 — — — 25,431 Consumer 28,602 — 26 — 28,628 Total $ 2,771,150 $ 21,886 $ 430 $ — $ 2,793,466 Loans designated as watch and substandard, which are not considered adversely classified, increased to $24.6 million at March 31, 2023 from $22.3 million at December 31, 2022. Loans designated as watch increased while loans designated substandard decreased period-over-period due to additional commercial real estate loans designated as watch at March 31, 2023, partly offset by an improvement in the risk grade of some commercial real estate loans designated as watch at December 31, 2022. This resulted in an increase in the reserve overall. There were no loans with doubtful risk grades at March 31, 2023 or December 31, 2022. 47 Allowance for Credit Losses The allowance for credit losses is established through a provision for credit losses charged to operations. Loans are charged against the allowance for credit losses when management believes that the collectability of the principal is unlikely. Subsequent recoveries of previously charged-off amounts, if any, are credited to the allowance for credit losses. The allowance for credit losses is evaluated on a regular basis by management and is based on management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. At March 31, 2023, the Company’s allowance for credit losses was $34.2 million, as compared to $28.4 million at December 31, 2022. The $5.8 million increase in the allowance is due to a $5.3 million adjustment recorded in connection with the adoption of ASC 326 and a $0.9 million provision for credit losses recorded during the three months ended March 31, 2023, partially offset by net charge-offs of $0.4 million during the same period. While the entire allowance for credit losses is available to absorb losses from any and all loans, the following table represents management’s allocation of our allowance for credit losses by loan category, and the percentage of the allowance for credit losses in each category, for the periods indicated. March 31, 2023 December 31, 2022 (in thousands) Amount % of Total Amount % of Total Real estate: Commercial $ 26,846 78.56 % $ 19,216 67.69 % Commercial land and development 224 0.66 % 54 0.19 % Commercial construction 1,423 4.16 % 645 2.27 % Residential construction 173 0.51 % 49 0.17 % Residential 179 0.52 % 175 0.62 % Farmland 217 0.64 % 644 2.27 % Commercial: Secured 4,215 12.33 % 7,098 25.00 % Unsecured 150 0.44 % 116 0.41 % Consumer and other 400 1.17 % 347 1.22 % Unallocated 345 1.01 % 45 0.16 % Total allowance for credit losses $ 34,172 100.00 % $ 28,389 100.00 % The ratio of allowance for credit losses to total loans held for investment was 1.19% at March 31, 2023, compared to 1.02% at December 31, 2022. Nonperforming loans totaled $0.4 million, or 0.01% of total loans held for investment, at both March 31, 2023 and December 31, 2022. 48 The following table provides information on the activity within the allowance for credit losses as of and for the periods indicated: As of and for the three months ended March 31, 2023 March 31, 2022 (dollars in thousands) Activity % of Average Loans Held for Investment Activity % of Average Loans Held for Investment Average loans held for investment $ 2,826,035 $ 1,970,311 Allowance for credit losses (beginning of period) $ 28,389 $ 23,243 Effect of adoption of ASC 326 5,262 — Net (charge-offs) recoveries: Commercial: Secured (396) (0.01) % (263) (0.01) % Consumer and other 17 — % (26) — % Net charge-offs (379) (0.01) % (289) (0.01) % Provision for credit losses 900 950 Allowance for credit losses (end of period) $ 34,172 $ 23,904 Loans held for investment $ 2,869,848 $ 2,080,158 Allowance for credit losses to loans held for investment 1.19 % 1.15 % Liabilities During the first three months of 2023, total liabilities increased by $162.3 million from $3.0 billion as of December 31, 2022 to $3.1 billion as of March 31, 2023. This increase was primarily due to an increase in total deposits of $138.4 million, comprised of an increase of $273.0 million in interest-bearing deposits, partially offset by a decrease of $134.6 million in non-interest-bearing deposits, as well as increases in FHLB advances of $20.0 million. Deposits Representing 93.11% of our total liabilities as of March 31, 2023, deposits are our primary source of funding for our business operations. Total deposits increased by $138.4 million, or 4.97%, to $2.9 billion at March 31, 2023 from $2.8 billion at December 31, 2022. Deposit increases were primarily attributable to an increase in the number of new relationships, as well as normal fluctuations in some of our larger accounts. Non-interest-bearing deposits decreased by $134.6 million from December 31, 2022 to $836.7 million and represented 28.65% of total deposits at March 31, 2023, compared to 34.91% of total deposits at December 31, 2022. Our loan to deposit ratio was 98.66% at March 31, 2023, as compared to 100.67% at December 31, 2022. We intend to continue to operate our business with a loan to deposit ratio within the range of these levels. 49 The following tables summarize our deposit composition by average deposits and average rates paid for the periods indicated: For the three months ended March 31, 2023 March 31, 2022 (dollars in thousands) Average Amount Average Rate Paid % of Total Deposits Average Amount Average Rate Paid % of Total Deposits Interest-bearing transaction accounts $ 379,593 0.46 % 13.44 % $ 276,690 0.10 % 11.83 % Money market and savings accounts 1,242,355 1.95 % 43.98 % 1,011,582 0.16 % 43.26 % Time accounts 300,952 3.99 % 10.66 % 128,183 0.26 % 5.48 % Demand accounts 901,491 — % 31.92 % 922,128 — % 39.43 % Total deposits $ 2,824,391 1.35 % 100.00 % $ 2,338,583 0.10 % 100.00 % Uninsured and uncollateralized deposits totaled $1.0 billion and $1.2 billion at March 31, 2023 and December 31, 2022, respectively. As of March 31, 2023, our 40 largest deposit relationships, each accounting for more than $10.0 million, totaled $1.6 billion, or 54.40% of our total deposits. The average age on deposit relationships of more than $10.0 million was 10.6 years. As of December 31, 2022, our 40 largest deposit relationships, each accounting for more than $10.0 million, totaled $1.5 billion, or 52.15% of our total deposits. Overall, our large deposit relationships have been relatively consistent over time and have helped to continue to grow our deposit base. Our large deposit relationships are comprised of the following entity types as of the periods indicated: (in thousands) March 31, 2023 December 31, 2022 Municipalities $ 641,795 $ 601,968 Non-profits 232,065 195,996 Businesses 589,138 527,921 Brokered deposits 125,617 124,993 Total $ 1,588,615 $ 1,450,878 Our largest single deposit relationship at March 31, 2023 related to a non-profit association that supports hospitals and health systems. The balances for this customer were $220.9 million, or approximately 7.56% of total deposits, as of that date. At December 31, 2022, our largest single deposit relationship related to a government agency and had balances of $180.0 million, or 6.47% of total deposits as of that date. The following table sets forth the maturity of time deposits as of March 31, 2023: (in thousands) $250,000 or Greater Less than $250,000 Total Uninsured Portion Remaining maturity: Three months or less $ 134,161 $ 139,154 $ 273,315 $ 131,161 Over three through six months 55,434 699 56,133 52,434 Over six through twelve months 5,142 2,863 8,005 3,392 Over twelve months 34,303 814 35,117 32,303 Total $ 229,040 $ 143,530 $ 372,570 $ 219,290 50 FHLB Advances and Other Borrowings From time to time, we utilize short-term collateralized FHLB borrowings to maintain adequate liquidity. There were borrowings of $120.0 million outstanding as of March 31, 2023 and borrowings of $100.0 million outstanding as of December 31, 2022. In 2022, we issued subordinated notes of $75.0 million. This debt was issued to investors in private placement transactions. See Note 6, Long Term Debt and Other Borrowings, in the notes to our unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q for additional information regarding these subordinated notes. The proceeds of the notes qualify as Tier 2 capital for the Company under the regulatory capital rules of the federal banking agencies. The following table is a summary of our outstanding subordinated notes as of March 31, 2023: (in thousands) Issuance Date Amount of Notes Prepayment Right Maturity Date Subordinated notes August 2022 $ 75,000 August 17, 2027 September 1, 2032 Fixed at 6.00% through September 1, 2027, then three-month Term SOFR plus 329.0 basis points (8.18% as of March 31, 2023) through maturity Shareholders’ Equity Shareholders’ equity totaled $260.7 million at March 31, 2023 and $252.8 million at December 31, 2022. The increase in shareholders’ equity was primarily attributable to net income recognized of $13.2 million and $1.5 million in other comprehensive income, partially offset by a decrease of $4.5 million to retained earnings, net of tax effect, relating to the adoption of ASC 326 on January 1, 2023 and $2.6 million in cash distributions paid during the three months ended March 31, 2023. Liquidity and Capital Resources Liquidity Management We manage liquidity based upon factors that include the level of diversification of our funding sources, the composition of our deposit types, the availability of unused funding sources, our off-balance sheet obligations, the amount of cash and liquid securities we hold, and the availability of assets to be readily converted into cash without undue loss. As the primary federal regulator of the Bank, the FDIC evaluates our liquidity on a stand-alone basis pursuant to applicable guidance and policies. Liquidity refers to our capacity to meet our cash obligations at a reasonable cost. Our cash obligations require us to have cash flow that is adequate to fund loan growth and maintain on-balance sheet liquidity while meeting present and future obligations of deposit withdrawals, borrowing maturities, and other contractual cash obligations. In managing our cash flows, management regularly confronts situations that can give rise to increased liquidity risk. These include funding mismatches, market constraints in accessing sources of funds, and the ability to convert assets into cash. Changes in economic conditions or exposure to borrower credit quality, capital markets, and operational, legal, or reputational risks could also affect the Bank’s liquidity risk profile and are considered in the assessment of liquidity management. The Company is a corporation separate and apart from the Bank and, therefore, must provide for its own liquidity, including liquidity required to meet its debt service requirements on its subordinated debt. The Company’s main source of cash flow is dividends declared and paid to it by the Bank. There are statutory and regulatory limitations that affect the ability of the Bank to pay dividends to the Company, including various legal and regulatory provisions that limit the amount of dividends the Bank can pay to the Company without regulatory approval. Under the California Financial Code, payment of a dividend from the Bank to the Company without advance regulatory approval is restricted to the lesser of the Bank’s retained earnings or the amount of the Bank’s net income from the previous three fiscal years less the amount of dividends paid during that period. We believe that these limitations will not impact our ability to meet our ongoing short-term cash obligations. For contingency purposes, the Company maintains a minimum level of cash to fund one year’s projected operating cash flow needs plus two years’ subordinated notes debt service. We continually monitor our liquidity position in order to meet all reasonably foreseeable short-term, long-term, and strategic liquidity demands. Management has established a comprehensive process for identifying, measuring, monitoring, and controlling liquidity risk. Because of its critical importance to the viability of the Bank, liquidity risk management is fully integrated into our risk management 51 processes. Critical elements of our liquidity risk management include effective corporate governance, consisting of oversight by the board of directors and active involvement by management; appropriate strategies, policies, procedures, and limits used to manage and mitigate liquidity risk; comprehensive liquidity risk measurement and monitoring systems, including stress tests, that are commensurate with the complexity of our business activities; active management of intraday liquidity and collateral; an appropriately diverse mix of existing and potential future funding sources; adequate levels of highly liquid marketable securities free of legal, regulatory, or operational impediments that can be used to meet liquidity needs in stress situations; comprehensive contingency funding plans that sufficiently address potential adverse liquidity events and emergency cash flow requirements; and internal controls and internal audit processes sufficient to determine the adequacy of the Bank’s liquidity risk management process. Our liquidity position is supported by management of our liquid assets and liabilities and access to alternative sources of funds. Our liquidity requirements are met primarily through our deposits, FHLB advances, and the principal and interest payments we receive on loans and investment securities. Cash on hand, cash at third-party banks, investments available-for-sale, and maturing or prepaying balances in our investment and loan portfolios are our most liquid assets. Other sources of liquidity that are routinely available to us include funds from retail and wholesale deposits, advances from the FHLB, and proceeds from the sale of loans. Less commonly used sources of funding include borrowings from the Federal Reserve Discount Window, draws on established federal funds lines from unaffiliated commercial banks, and the issuance of debt or equity securities. We believe we have ample liquidity resources to fund future growth and meet other cash needs as necessary. In addition, we have a shelf registration statement on file with the SEC registering $250.0 million for any combination of equity or debt securities, depository shares, warrants, purchase contracts, purchase units, subscription rights, and units in one or more offerings. Specific information on the terms of and the securities being offered will be provided at the time of the offering. Proceeds from any future offerings are expected to be used for corporate purposes or other purposes to be disclosed at the time of the offering. Sources and Uses of Cash Our executive officers and board of directors review our sources and potential uses of cash in connection with our annual budgeting process. Generally speaking, our principal funding source is cash from deposits, and our principal uses of cash include funding of loans, operating expenses, income taxes, and dividend payments, as described below. As of March 31, 2023, management believes the above-mentioned sources will provide adequate liquidity during the next twelve months for the Bank to meet its operating needs. Loans Loans are a significant use of cash in daily operations, and a source of cash as customers make payments on their loans or as loans are sold to other financial institutions. Cash flows from loans are affected by the timing and amount of customer payments and prepayments, changes in interest rates, the general economic environment, competition, and the political environment. During the three months ended March 31, 2023, we had cash outflows of $69.5 million in loan originations and advances, net of principal collected, and $24.0 million in loans originated for sale. Additionally, we enter into commitments to extend credit in the ordinary course of business, such as commitments to fund new loans and undisbursed construction funds. While these commitments represent contractual cash requirements, a portion of these commitments to extend credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. At March 31, 2023, total off-balance sheet commitments totaled $335.1 million. We expect to fund these commitments to the extent utilized primarily through the repayment of existing loans, deposit growth, and liquid assets. Deposits Deposits are our primary source of funding for our business operations, and the cost of deposits has a significant impact on our net interest income and net interest margin. Our deposits are primarily made up of money market, interest checking, time deposits, and non-interest-bearing demand deposits. Aside from commercial and business clients, a significant portion of our deposits are from municipalities and 52 non-profit organizations. Cash flows from deposits are impacted by the timing and amount of customer deposits, changes in market rates, and collateral availability. During the three months ended March 31, 2023, we had significant cash inflows related to an increase in deposits of $138.4 million, primarily as a result of an increase in the number of new relationships and fluctuations in existing accounts. Over the next twelve months, approximately $337.5 million of time deposits are expected to mature. These deposits may not renew due to general competition. However, based on our historical runoff experience, we expect the outflow will not be significant and can be replenished through our organic growth in deposits. We believe our emphasis on local deposits, combined with our liquid investment portfolio, provides a stable funding base. At March 31, 2023, cash and cash equivalents represented 11.91% of total deposits. Investment Securities Our investment securities totaled $118.7 million at March 31, 2023. Mortgage-backed securities and obligations of states and political subdivisions comprised 51.38% and 32.76% of our investment portfolio, respectively. Cash proceeds from mortgage-backed securities result from payments of principal and interest by borrowers. Cash proceeds from obligations of states and political subdivisions occur when these securities are called or mature. Assuming the current prepayment speed and interest rate environment, we expect to receive approximately $8.2 million from our securities over the next 12 months. In future periods, we expect to maintain approximately the same level of cash flows from our securities. Depending on market yield and our liquidity, we may purchase securities as a use of cash in our interest-earning asset portfolio. During the three months ended March 31, 2023, we had cash proceeds from sales, maturities, calls, and prepayments of securities of $2.9 million. Additionally, at March 31, 2023, securities available-for-sale totaled $115.1 million, of which $93.9 million have been pledged as collateral for borrowings and other commitments. FHLB Financing The Bank is a shareholder of the FHLB, which enables the Bank to have access to lower-cost FHLB financing when necessary. At March 31, 2023, the Bank had outstanding borrowings of $120.0 million and a total financing availability of $278.1 million, net of letters of credit issued of $666.5 million. Federal Reserve Discount Window and Correspondent Bank Lines of Credit At March 31, 2023, unused and available amounts for borrowing from the Federal Reserve discount window and correspondent bank lines of credit were $76.7 million and $190.0 million, respectively. Total Liquidity Total liquidity (consisting of cash and cash equivalents and unused and available borrowing capacity as set forth below) was approximately $892.7 million as of March 31, 2023 . March 31, 2023 Available (in thousands) Line of Credit Borrowings FHLB advances $ 398,145 $ 120,000 $ 278,145 Federal Reserve discount window 76,665 — 76,665 Correspondent bank lines of credit 190,000 — 190,000 Cash and cash equivalents — — 347,939 Total $ 664,810 $ 120,000 $ 892,749 Future Contractual Obligations Our estimated future contractual obligations as of March 31, 2023 include both current and long-term obligations. Under our operating leases, we have an operating lease liability of $5.4 million. We also have a current obligation of $331.8 million and a long-term obligation of $40.8 million related to time deposits, as discussed in Note 5, Interest-Bearing 53 Deposits. We have net subordinated notes of $73.6 million, all of which are long-term obligations. We also had contractual obligations on unfunded loan commitments and standby letters of credit totaling $335.1 million. Dividends The Company paid dividends to its shareholders totaling $2.6 million during the three months ended March 31, 2023. We expect to continue our current practice of paying quarterly cash dividends with respect to our common stock, subject to our board of directors’ discretion to modify or terminate this practice at any time and for any reason without prior notice. We believe our quarterly dividend rate per share, as approved by our board of directors, enables us to balance our multiple objectives of managing our business and returning a portion of our earnings to our shareholders. Assuming continued payment during the rest of 2023 at a rate of $0.20 per share, our average total dividend paid each quarter would be approximately $3.5 million based on the number of currently outstanding shares if there are no increases or decreases in the number of shares, and given that unvested RSAs share equally in dividends with outstanding common stock. Impact of Inflation Our unaudited consolidated financial statements and related notes have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars, without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of operations. Unlike most industrial companies, nearly all of our assets and liabilities are monetary in nature. As a result, interest rates have a greater impact on our performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods or services. Historical Information The following table summarizes our consolidated cash flow activities: Three months ended March 31, (in thousands) 2023 2022 $ Change Net cash provided by operating activities $ 694 $ 3,486 $ (2,792) Net cash used in investing activities (68,559) (133,513) 64,954 Net cash provided by financing activities 155,813 209,662 (53,849) Operating Activities Net cash provided by operating activities decreased by $2.8 million for the three months ended March 31, 2023 as compared to the three months ended March 31, 2022. Cash provided by operating activities is subject to variability period-over-period as a result of timing differences, including with respect to the collection of receivables and payments of interest expense, accounts payable, and bonuses. Investing Activities Net cash used in investing activities decreased by $65.0 million for the three months ended March 31, 2023 as compared to the three months ended March 31, 2022, primarily due to decreased loan origination growth. Financing Activities Net cash provided by financing activities decreased by $53.8 million for the three months ended March 31, 2023 as compared to the three months ended March 31, 2022, primarily due to decreased deposit growth. Capital Adequacy We manage our capital by tracking our level and quality of capital with consideration given to our overall financial condition, our asset quality, our level of allowance for credit losses, our geographic and industry concentrations, and other risk factors on our balance sheet, including interest rate sensitivity. 54 Bancorp and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements as set forth in the following tables can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on our unaudited consolidated financial statements. Historically, as a bank holding company with less than $3.0 billion in total consolidated assets and that met certain other criteria, we had been operating under the Small Bank Holding Company Policy Statement, which provides an exemption from the Federal Reserve’s generally applicable risk-based capital ratio and leverage ratio requirements. Having passed this threshold as of September 30, 2022, we are no longer subject to this policy statement and our capital adequacy is evaluated relative to the Federal Reserve's generally applicable capital requirements. Bancorp's total consolidated assets were not in excess of $3.0 billion as of June 30, 2022, and so it has prepared and filed financial reports with the Federal Reserve as a small bank holding company. If the Company’s total consolidated assets remain in excess of $3.0 billion as of June 30, 2023, then starting in March 2024, the Company will cease filing financial reports with the Federal Reserve as though it were a small holding company. Under federal regulations implementing the Basel III framework, the Bank is subject to minimum risk-based and leverage capital requirements. The Bank also is subject to regulatory thresholds that must be met for an insured depository institution to be classified as “well-capitalized” under the prompt corrective action framework. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance sheet items, as calculated under regulatory accounting practices. Capital amounts for Bancorp and the Bank, and the Bank’s prompt corrective action classification, are also subject to qualitative judgments by the regulators about components of capital, risk weightings, and other factors. As of March 31, 2023, both Bancorp and the Bank were in compliance with all applicable regulatory capital requirements, and the Bank qualified as “well-capitalized” under the prompt corrective action framework. Management reviews capital ratios on a regular basis to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet our anticipated future needs. For all periods presented, the Bank’s ratios exceed the regulatory definition of “well-capitalized” under the regulatory framework for prompt corrective action, and Bancorp’s ratios exceed the minimum ratios that would be required for it to be considered a well-capitalized bank holding company. The capital adequacy ratios as of March 31, 2023 and December 31, 2022 for Bancorp and the Bank are presented in the following tables. As of March 31, 2023 and December 31, 2022, Bancorp’s Tier 2 capital included subordinated debt, which was not included at the Bank level. Eligible amounts of subordinated debt included in Tier 2 capital will be phased out by 20% per year beginning five years before the maturity date of the notes. Capital Ratios for Bancorp Actual Ratio Required for Capital Adequacy Purposes 1 Ratio to be Well-Capitalized under Prompt Corrective Action Provisions (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio March 31, 2023 Total capital (to risk-weighted assets) $ 379,344 12.50 % $ 242,780 8.00 % N/A N/A Tier 1 capital (to risk-weighted assets) $ 273,662 9.02 % $ 182,037 6.00 % N/A N/A Common equity tier 1 capital (to risk-weighted assets) $ 273,662 9.02 % $ 136,528 4.50 % N/A N/A Tier 1 leverage $ 273,662 8.53 % $ 128,329 4.00 % N/A N/A December 31, 2022 Total capital (to risk-weighted assets) $ 366,113 12.46 % $ 235,065 8.00 % N/A N/A Tier 1 capital (to risk-weighted assets) $ 263,993 8.99 % $ 176,191 6.00 % N/A N/A Common equity tier 1 capital (to risk-weighted assets) $ 263,993 8.99 % $ 132,144 4.50 % N/A N/A Tier 1 leverage $ 263,993 8.60 % $ 122,788 4.00 % N/A N/A 55 Capital Ratios for the Bank Actual Ratio Required for Capital Adequacy Purposes Ratio to be Well-Capitalized under Prompt Corrective Action Provisions (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio March 31, 2023 Total capital (to risk-weighted assets) $ 370,001 12.21 % $ 242,425 8.00 % $ 303,031 10.00 % Tier 1 capital (to risk-weighted assets) $ 337,959 11.15 % $ 181,861 6.00 % $ 242,482 8.00 % Common equity tier 1 capital (to risk-weighted assets) $ 337,959 11.15 % $ 136,396 4.50 % $ 197,016 6.50 % Tier 1 leverage $ 337,959 10.54 % $ 128,258 4.00 % $ 160,322 5.00 % December 31, 2022 Total capital (to risk-weighted assets) $ 356,301 12.14 % $ 234,795 8.00 % $ 293,494 10.00 % Tier 1 capital (to risk-weighted assets) $ 327,788 11.17 % $ 176,072 6.00 % $ 234,763 8.00 % Common equity tier 1 capital (to risk-weighted assets) $ 327,788 11.17 % $ 132,054 4.50 % $ 190,745 6.50 % Tier 1 leverage $ 327,788 10.69 % $ 122,652 4.00 % $ 153,315 5.00 % 1 The listed capital adequacy ratios exclude capital conservation buffers. Non-GAAP Financial Measures Some of the financial measures discussed herein are non-GAAP financial measures. In accordance with SEC rules, we classify a financial measure as being a non-GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, that are included or excluded, as the case may be, in the most directly comparable measure calculated and presented in accordance with GAAP in our consolidated statements of income, balance sheets, statements of shareholders’ equity, or statements of cash flows. Tangible shareholders’ equity to tangible assets is defined as total equity less goodwill and other intangible assets, divided by total assets less goodwill and other intangible assets. The most directly comparable GAAP financial measure is total shareholders’ equity to total assets. We had no goodwill or other intangible assets at the end of any period indicated. As a result, tangible shareholders’ equity to tangible assets is the same as total shareholders’ equity to total assets at the end of each of the periods indicated. We believe that these non-GAAP financial measures provide useful information to management and investors that is supplementary to our financial condition, results of operations, and cash flows computed in accordance with GAAP. However, we acknowledge that our non-GAAP financial measures have a number of limitations. As such, you should not view these disclosures as a substitute for results determined in accordance with GAAP, and they are not necessarily comparable to non-GAAP financial measures that other banking companies use. Other banking companies may use names similar to those we use for the non-GAAP financial measures we disclose, but may calculate them differently. You should understand how we and other companies each calculate our non-GAAP financial measures when making comparisons. Recent Legislative and Regulatory Developments Potential Regulatory Reform in Response to Recent Bank Failures The recent failures of Silicon Valley Bank (Santa Clara, California), Signature Bank (New York, New York), and First Republic Bank (San Francisco, California) in March and April of this year may lead to regulatory changes and initiatives that could impact the Company. For example, the FDIC has stated that it plans to impose a special deposit insurance assessment on banks in order to recover losses that the FDIC's Deposit Insurance Fund incurred to support uninsured depositors of these institutions. In addition, President Biden has encouraged the federal banking agencies to adopt various reforms, including the completion of an incentive compensation rule for bank executives pursuant to Section 956 of the Dodd-Frank Act, in response to these failures. On April 28, 2023, the Federal Reserve and the FDIC issued reports on the potential causes of failures of Silicon Valley Bank and Signature Bank, respectively. Among the changes discussed, the Federal Reserve and the FDIC highlighted potential changes needed to supervisory approaches for banks of all sizes as well 56 as to regulatory requirements. Currently, it is unclear what actions federal regulatory agencies will take as a result of these failures. Bank Term Funding Program The Federal Reserve created the Bank Term Funding Program (the “BTFP”) in response to recent concerns over liquidity in the banking sector. This program provides funding to eligible depository institutions to help ensure that banks can meet the needs of all depositors. The BTFP offers one-year loans to banks pledging any collateral eligible for purchase by the Federal Reserve Banks in open market operations, such as U.S. Treasury securities, U.S. agency securities, and U.S. agency mortgage-backed securities. At March 31, 2023, the Company had not participated in the BTFP. Small Business Lending Data Collection Rule On March 30, 2023, the Consumer Financial Protection Bureau finalized a rule under Section 1071 of the Dodd-Frank Act requiring lenders to collect and report data regarding small business lending activity. The Company is evaluating the impact of the new rule. 57 Glossary of Acronyms, Abbreviations, and Terms The terms identified below are used in various sections of this Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 and the unaudited Consolidated Financial Statements and Notes to the Financial Statements in Item 1 of this Form 10-Q. 2022 Annual Report on Form 10-K Company’s Annual Report on Form 10-K for the year ended December 31, 2022 Federal Reserve Board of Governors of the Federal Reserve System ACL Allowance for Credit Losses FRB Federal Reserve Bank of San Francisco ASC Accounting Standards Codification GAAP Generally Accepted Accounting Principles in the U.S. ASU Accounting Standards Update GNMA Government National Mortgage Association AFS Available-for-Sale GSE Government sponsored entity Bancorp Five Star Bancorp and its subsidiary HTM Held-to-Maturity Bank Five Star Bank ICS Insured Cash Sweep® Basel III A capital framework and rules for U.S. banking organizations IPO Initial Public Offering BOLI Bank-Owned Life Insurance LM Modifications to loans to borrowers experiencing financial difficulty CDARS Certificate of Deposit Account Registry Service® NI Net income CECL Current expected credit loss model for recognition of credit losses under ASC 326 NIM Net Interest Margin C&I Commercial & Industrial OCI Other comprehensive income CRE Commercial Real Estate ROAA Return on Average Assets, annualized EPS Earnings per Share ROAE Return on Average Equity, annualized FASB Financial Accounting Standards Board ROUA Right-of-Use Asset FDIC Federal Deposit Insurance Corporation SBA U.S. Small Business Administration FHLB Federal Home Loan Bank of San Francisco SEC Securities and Exchange Commission FHLMC Federal Home Loan Mortgage Corporation SOFR Secured Overnight Financing Rate FNMA Federal National Mortgage Association TDR Troubled Debt Restructuring 58 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk Not applicable for a smaller reporting company.