HANMI FINANCIAL CORP 10-Q

Item 2. Management’s Discussion and Analysis o f Financial Condition and Results of Operations The following is management’s discussion and analysis of our results of operations and financial condition as of and for the three months ended March 31, 2024. This analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2023 (the “2023 Annual Report on Form 10-K”) and with the unaudited consolidated financial statements and notes thereto set forth in this Quarterly Report on Form 10-Q for the period ended March 31, 2024 (this “Report”). Forward-Looking Statements Some of the statements contained in this Report are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements in this Report other than statements of historical fact are “forward–looking statements” for purposes of federal and state securities laws, including, but not limited to, statements about anticipated future operating and financial performance, financial condition and liquidity, business strategies, regulatory and competitive outlook, investment and expenditure plans, capital and financing needs and availability, plans and objectives of management for future operations, developments regarding our capital and strategic plans and other similar forecasts and statements of expectation and statements of assumptions underlying any of the foregoing. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue,” or the negative of such terms and other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, financial condition, levels of activity, performance or achievements to differ from those expressed or implied by the forward-looking statements. These factors include the following: • a failure to maintain adequate levels of capital and liquidity to support our operations; • general economic and business conditions internationally, nationally and in those areas in which we operate, including any potential recessionary conditions; • volatility and deterioration in the credit and equity markets; • changes in consumer spending, borrowing and savings habits; • availability of capital from private and government sources; • demographic changes; • competition for loans and deposits and failure to attract or retain loans and deposits; • inflation and fluctuations in interest rates that reduce our margins and yields, the fair value of financial instruments, the level of loan originations or prepayments on loans we have made and make, the level of loan sales and the cost we pay to retain and attract deposits and secure other types of funding; • our ability to enter new markets successfully and capitalize on growth opportunities; • the current or anticipated impact of military conflict, terrorism or other geopolitical events; • the effect of potential future supervisory action against us or Hanmi Bank and our ability to address any issues raised in our regulatory exams; • risks of natural disasters; • legal proceedings and litigation brought against us; • a failure in or breach of our operational or security systems or infrastructure, including cyberattacks; • the failure to maintain current technologies; • risks associated with Small Business Administration loans; • failure to attract or retain key employees; • our ability to access cost-effective funding; • changes in liquidity, including the size and composition of our deposit portfolio, including the percentage of uninsured deposits in the portfolio; • fluctuations in real estate values; • changes in accounting policies and practices; • changes in governmental regulation, including, but not limited to, any increase in FDIC insurance premiums and changes in the monetary policies of the U.S. Treasury and the Board of Governors of the Federal Reserve System; • the ability of Hanmi Bank to make distributions to Hanmi Financial Corporation, which is restricted by certain factors, including Hanmi Bank’s retained earnings, net income, prior distributions made, and certain other financial tests; • strategic transactions we may enter into; • the adequacy of and changes in the methodology for computing our allowance for credit losses; • our credit quality and the effect of credit quality on our credit losses expense and allowance for credit losses; 39 • changes in the financial performance and/or condition of our borrowers and the ability of our borrowers to perform under the terms of their loans and other terms of credit agreements; • our ability to control expenses; and • cyber security and fraud risks against our information technology and those of our third-party providers and vendors. For additional information concerning risks we face, see “Part II, Item 1A. Risk Factors” in this Report and “Item 1A. Risk Factors” in Part I of the 2023 Annual Report on Form 10-K. We undertake no obligation to update these forward-looking statements to reflect events or circumstances that occur after the date on which such statements were made, except as required by law. Critical Accounting Policies We have established various accounting policies that govern the application of GAAP in the preparation of our financial statements. Our significant accounting policies are described in the Notes to the consolidated financial statements in our 2023 Annual Report on Form 10-K. We had no significant changes in our accounting policies since the filing of our 2023 Annual Report on Form 10-K. Certain accounting policies require us to make significant estimates and assumptions that have a material impact on the carrying value of certain assets and liabilities, and we consider these critical accounting policies. For a description of these critical accounting policies, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies” in our 2023 Annual Report on Form 10-K. Actual results could differ significantly from these estimates and assumptions, which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and our results of operations for the reporting periods. Management has discussed the development and selection of these critical accounting policies with the Audit Committee of the Company’s Board of Directors. Executive Overview Financial results include the following: As of or for the Three Months Ended March 31, 2024 2023 (dollars in thousands, except per share data) Net income $ 15,164 $ 21,991 Earnings per diluted share $ 0.50 $ 0.72 Dividends per share $ 0.25 $ 0.25 Return on average assets 0.81 % 1.21 % Return on average stockholders’ equity 7.90 % 12.19 % Net income was $15.2 million, or $0.50 per diluted share, for the three months ended March 31, 2024 compared to $22.0 million, or $0.72 per diluted share, for the same period a year ago. The decrease in net income was driven by decreases in net interest income and noninterest income of $7.2 million and $0.6 million, respectively, and a $3.7 million increase in noninterest expense, offset by decreases in credit loss expense of $1.9 million and $2.7 million in income tax expense. Credit loss expense for the first quarter of 2024 was $0.2 million compared to $2.1 million for the first quarter of 2023. Credit loss expense for the first quarter of 2024 included a $0.4 million provision for loan losses, offset by a $0.2 million recovery for off-balance sheet items. Credit loss expense for the first quarter of 2023 included a $2.2 million provision for loan losses, offset by a $0.1 million recovery for off-balance sheet items. Other financial highlights include the following: March 31, December 31, 2024 2023 (in thousands) Loans receivable, gross $ 6,177,840 $ 6,182,434 Securities available for sale, at fair value 872,190 865,739 Total assets 7,512,046 7,570,341 Deposits 6,376,060 6,280,574 Borrowings 172,500 325,000 Total stockholders’ equity 703,100 701,891 40 Results of Operations Net Interest Income Our primary source of revenue is net interest income, which is the difference between interest derived from earning assets, and interest paid on liabilities obtained to fund those assets. Our net interest income is affected by changes in the level and mix of interest-earning assets and interest-bearing liabilities, referred to as volume changes. Net interest income is also affected by changes in the yields earned on assets and rates paid on liabilities, referred to as rate changes. Interest rates charged on loans receivable are affected principally by changes to market interest rates, the demand for loans receivable, the supply of money available for lending purposes, and other competitive factors. Those factors are, in turn, affected by general economic conditions and other factors beyond our control, such as federal economic policies, the general supply of money in the economy, legislative tax policies, governmental budgetary matters, and the actions of the Federal Reserve. 41 The following table shows the average balance of assets, liabilities and stockholders’ equity; the amount of interest income, on a tax-equivalent basis, and interest expense; the average yield or rate for each category of interest-earning assets and interest-bearing liabilities; and the net interest spread and the net interest margin for the periods indicated. All average balances are daily average balances. Three Months Ended March 31, 2024 March 31, 2023 Interest Average Interest Average Average Income / Yield / Average Income / Yield / Balance Expense Rate Balance Expense Rate Assets (dollars in thousands) Interest-earning assets: Loans receivable (1) $ 6,137,888 $ 91,674 6.00 % $ 5,944,399 $ 80,923 5.51 % Securities (2) 969,520 4,955 2.07 % 980,712 4,025 1.67 % FHLB stock 16,385 361 8.87 % 16,385 289 7.16 % Interest-bearing deposits in other banks 201,724 2,604 5.19 % 192,902 2,066 4.34 % Total interest-earning assets 7,325,517 99,594 5.47 % 7,134,398 87,303 4.96 % Noninterest-earning assets: Cash and due from banks 58,382 65,088 Allowance for credit losses (69,106 ) (71,452 ) Other assets 244,700 239,121 Total assets $ 7,559,493 $ 7,367,155 Liabilities and Stockholders’ Equity Interest-bearing liabilities: Deposits: Demand: interest-bearing $ 86,401 $ 30 0.14 % $ 109,391 $ 29 0.11 % Money market and savings 1,815,085 16,553 3.67 % 1,453,569 7,315 2.04 % Time deposits 2,507,830 29,055 4.66 % 2,223,615 18,154 3.31 % Total interest-bearing deposits 4,409,316 45,638 4.16 % 3,786,575 25,498 2.73 % Borrowings 162,418 1,655 4.10 % 268,056 2,369 3.58 % Subordinated debentures 130,088 1,646 5.06 % 129,483 1,583 4.89 % Total interest-bearing liabilities 4,701,822 48,939 4.19 % 4,184,114 29,450 2.85 % Noninterest-bearing liabilities and equity: Demand deposits: noninterest-bearing 1,921,189 2,324,413 Other liabilities 164,524 127,112 Stockholders’ equity 771,958 731,516 Total liabilities and stockholders’ equity $ 7,559,493 $ 7,367,155 Net interest income $ 50,655 $ 57,853 Cost of deposits (3) 2.90 % 1.69 % Net interest spread (taxable equivalent basis) (4) 1.28 % 2.10 % Net interest margin (taxable equivalent basis) (5) 2.78 % 3.28 % (1) Loans receivable include loans held for sale and exclude the allowance for credit losses. Nonaccrual loans receivable are included in the average loans receivable balance. (2) Securities average yield is calculated on a fully taxable equivalent basis using the current statutory federal tax rate of 21%. (3) Represents interest expense on deposits as a percentage of all interest-bearing and noninterest-bearing deposits. 42 (4) Represents the average yield earned on interest-earning assets less the average rate paid on interest-bearing liabilities. (5) Represents net interest income as a percentage of average interest-earning assets. The table below shows changes in interest income and interest expense and the amounts attributable to variations in interest rates and volumes for the periods indicated. The variances attributable to simultaneous volume and rate changes have been allocated to the change due to volume and the change due to rate categories in proportion to the relationship of the absolute dollar amount attributable solely to the change in volume and to the change in rate. Three Months Ended March 31, 2024 vs March 31, 2023 Increases (Decreases) Due to Change In Volume Rate Total (in thousands) Interest and dividend income: Loans receivable (1) $ 3,316 $ 7,435 $ 10,751 Securities (2) (46 ) 976 930 FHLB stock 2 70 72 Interest-bearing deposits in other banks 113 425 538 Total interest and dividend income 3,385 8,906 12,291 Interest expense: Demand: interest-bearing $ (6 ) $ 7 $ 1 Money market and savings 1,895 7,343 9,238 Time deposits 2,492 8,409 10,901 Borrowings (922 ) 208 (714 ) Subordinated debentures 7 56 63 Total interest expense 3,466 16,023 19,489 Change in net interest income $ (81 ) $ (7,117 ) $ (7,198 ) (1) Loans receivable include loans held for sale and exclude the allowance for credit losses. Nonaccrual loans receivable are included in the average loans receivable balance. (2) Securities average yield is calculated on a fully taxable equivalent basis using the current statutory federal tax rate of 21%. For the three months ended March 31, 2024 and 2023, net interest income was $50.7 million and $57.9 million, respectively. The net interest spread and net interest margin, on a taxable equivalent basis, for the quarter ended March 31, 2024, were 1.28% and 2.78%, respectively, compared to 2.10% and 3.28%, respectively, for the same period in 2023. Interest and dividend income increased $12.3 million, or 14.1%, to $99.6 million for the three months ended March 31, 2024 from $87.3 million for the same period in 2023, primarily due to higher average interest-earning asset yields and an increase in the average balance of loans. Interest expense increased $19.5 million, or 66.2%, to $48.9 million for the three months ended March 31, 2024 from $29.5 million for the same period in 2023 primarily due to increases in deposit rates and average deposit balances and, to a lesser extent, an increase in the cost of borrowings. The increases in average interest-earning asset yields and deposit and borrowing rates were due to the rising interest rate environment. The average balance of interest earning assets increased $191.1 million, or 2.7%, to $7.33 billion for the three months ended March 31, 2024, from $7.13 billion for the three months ended March 31, 2023. The average balance of loans increased $193.5 million, or 3.3%, to $6.14 billion for the three months ended March 31, 2024, from $5.94 billion for the three months ended March 31, 2023. The average balance of securities decreased $11.2 million, or 1.1%, to $969.5 million for the three months ended March 31, 2024, from $980.7 million for the three months ended March 31, 2023. The average balance of interest-bearing deposits at other banks increased $8.8 million, or 4.6%, to $201.7 million for the three months ended March 31, 2024, from $192.9 million for the three months ended March 31, 2023. The average yield on interest-earning assets, on a taxable equivalent basis, increased 51 basis points to 5.47% for the three months ended March 31, 2024, from 4.96% for the three months ended March 31, 2023. The average yield on loans increased to 6.00% for the three months ended March 31, 2024, from 5.51% for the three months ended March 31, 2023. The average yield on securities, on a taxable equivalent basis, increased to 2.07% for the three months ended March 31, 2024, from 1.67% for the three months ended March 31, 2023. The average yield on interest-bearing deposits in other banks increased 85 basis points to 5.19% for the three months ended March 31, 2024, from 4.34% for the three months ended March 31, 2023. The increased yields were primarily due to increases in market interest rates. 43 The average balance of interest-bearing liabilities increased $517.7 million, or 12.4%, to $4.70 billion for the three months ended March 31, 2024 compared with $4.18 billion for the three months ended March 31, 2023. The average balances of time deposits and money market and savings accounts increased $284.2 million and $361.5 million, respectively, offset partially by decreases in interest-bearing demand deposits and borrowings of $23.0 million and $105.6 million, respectively. The average cost of interest-bearing liabilities was 4.19% and 2.85% for the three months ended March 31, 2024 and 2023, respectively. The average cost of interest-bearing deposits increased 143 basis points to 4.16% for the three months ended March 31, 2024, compared with 2.73% for the three months ended March 31, 2023. The average cost of time deposits increased 135 basis points to 4.66% for the three months ended March 31, 2024 compared with 3.31% for the three months ended March 31, 2023. The average cost of money market and savings accounts increased 163 basis points to 3.67% for the three months ended March 31, 2023 compared with 2.04% for the three months ended March 31, 2023.The average cost of subordinated debentures increased 17 basis points to 5.06% for the three months ended March 31, 2024 compared with 4.89% for the three months ended March 31, 2023. The average cost of borrowings increased 52 basis points to 4.10% for the three months ended March 31, 2024 compared with 3.58% for the three months ended March 31, 2023. The increased costs were primarily due to increases in market interest rates. Credit Loss Expense For the first quarter of 2024, the Company recorded $0.2 million of credit loss expense, comprised of a $0.4 million provision for loan losses, offset by a $0.2 million recovery for off-balance sheet items. For the same period in 2023, the Company recorded $2.1 million of credit loss expense, comprised of a $2.2 million credit loss provision for loan losses, offset by a $0.1 million recovery for off-balance sheet items. The credit loss expense for the three months ended March 31, 2024 was mainly attributed to a $1.9 million specific allowance on a $3.9 million nonperforming commercial and industrial loan in the health-care industry, and $1.6 million in net charge-offs, offset by a $3.1 million decrease in the allowance for quantitative and qualitative considerations. The decrease in the allowance for quantitative and qualitative considerations was primarily attributable to a reduction of loss rates in the commercial real estate hospitality industry. The credit loss expense for the three months ended March 31, 2023 was mainly attributed to a specific reserve allocation of $2.5 million on a nonperforming commercial and industrial loan in the health-care industry, offset by loan recoveries of $5.0 million. See also “Allowance for Credit Losses and Allowance for Credit Losses Related to Off-Balance Sheet Items” for further details. Noninterest Income The following table sets forth the various components of noninterest income for the periods indicated: Three Months Ended March 31, Increase (Decrease) Increase (Decrease) 2024 2023 Amount Percent (in thousands) Service charges on deposit accounts $ 2,450 $ 2,579 $ (129 ) (5.00 )% Trade finance and other service charges and fees 1,414 1,258 156 12.40 Servicing income 712 742 (30 ) (4.04 ) Bank-owned life insurance income 304 270 34 12.59 All other operating income 928 1,618 (690 ) (42.65 ) Service charges, fees & other 5,808 6,467 (659 ) (10.19 ) Gain on sale of SBA loans 1,482 1,869 (387 ) (20.71 ) Gain on sale of mortgage loans 443 — 443 100.00 Total noninterest income $ 7,733 $ 8,336 $ (603 ) (7.23 )% For the three months ended March 31, 2024, noninterest income was $7.7 million, a decrease of $0.6 million, or 7.2%, compared to $8.3 million for the same period in 2023, due primarily to a decrease in all other operating income. The $0.7 million decrease in all other operating income was mainly attributed to a $0.6 million decrease in swap fee income. During the first quarter of 2024, the Company sold $29.7 million of residential loans and recognized a net gain of $0.4 million. The gain on sale of mortgage loans was partially offset by the reduction in gain on sale of SBA loans compared to the same period in 2023, due to lower sales volume of $4.1 million and a reduction in trade premiums of 62 basis points from 7.85% to 7.23%. 44 Noninterest Expense The following table sets forth the components of noninterest expense for the periods indicated: Three Months Ended March 31, Increase (Decrease) Increase (Decrease) 2024 2023 Amount Percent (in thousands) Salaries and employee benefits $ 21,585 $ 20,610 $ 975 4.73 % Occupancy and equipment 4,537 4,412 125 2.83 Data processing 3,551 3,253 298 9.16 Professional fees 1,893 1,335 558 41.80 Supplies and communications 601 676 (75 ) (11.09 ) Advertising and promotion 907 833 74 8.88 All other operating expenses 3,160 1,957 1,203 61.47 Subtotal 36,234 33,076 3,158 9.55 Other real estate owned expense 22 (201 ) 223 (110.95 ) Repossessed personal property expense (income) 189 (84 ) 273 (325.00 ) Total noninterest expense $ 36,445 $ 32,791 $ 3,654 11.14 % For the three months ended March 31, 2024, noninterest expense was $36.4 million, an increase of $3.7 million, or 11.1%, compared with $32.8 million for the same period in 2023. Salaries and employee benefits increased $1.0 million due to higher salaries, group insurance, share-based compensation expense and a decrease in capitalized loan origination costs from lower loan originations. Professional fees increased $0.6 million due to higher consulting, accounting and legal expenses. All other operating expenses increased $1.2 million mainly due to a higher FDIC assessment of $0.3 million and the reversal of a $0.4 million SBA impairment adjustment in the first quarter of 2023. The change in OREO expense was due to a $0.3 million reimbursement of expenses received during the three months ended March 31, 2023. The change in repossessed personal property expense was due to a $0.3 million loss on sale of lease assets. Income Tax Expense Income tax expense was $6.6 million and $9.3 million representing an effective income tax rate of 30.2% and 29.7% for the three months ended March 31, 2024 and 2023, respectively. Financial Condition Securities As of March 31, 2024, our securities portfolio consisted of U.S. government agency and sponsored agency mortgage-backed securities, collateralized mortgage obligations and debt securities, tax-exempt municipal bonds and U.S. Treasury securities. Most of these securities carry fixed interest rates. Other than holdings of U.S. government agency and sponsored agency obligations, there were no securities of any one issuer exceeding 10% of stockholders’ equity as of March 31, 2024 or December 31, 2023. Securities increased $6.5 million to $872.2 million at March 31, 2024 from $865.7 million at December 31, 2023, mainly attributed to $38.4 million in securities purchases, offset by $26.2 million in paydowns and maturities. 45 The following table summarizes the contractual maturity schedule for securities, at amortized cost, and their cost weighted average yield, which is calculated using amortized cost as the weight, as of March 31, 2024: After One Year But After Five Years But Within One Year Within Five Years Within Ten Years After Ten Years Total Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield (dollars in thousands) Securities available for sale: U.S. Treasury securities $ 41,132 3.95 % $ 47,275 3.94 % $ — 0.00 % $ — 0.00 % $ 88,407 3.94 % U.S. government agency and sponsored agency obligations: Mortgage-backed securities - residential 13 2.99 20 3.03 22,601 0.35 467,080 1.69 489,714 1.63 Mortgage-backed securities - commercial 4,107 3.72 4,384 0.84 — — 51,112 1.57 59,603 1.66 Collateralized mortgage obligations — — 166 1.27 353 2.63 131,237 3.55 131,756 3.54 Debt securities 30,705 2.08 101,531 1.14 — — — — 132,236 1.36 Total U.S. government agency and sponsored agency obligations 34,825 2.27 106,101 1.13 22,954 0.38 649,429 2.06 813,309 1.90 Municipal bonds-tax exempt — — — — 32,655 1.36 44,209 1.32 76,864 1.34 Total securities available for sale $ 75,957 3.18 % $ 153,376 1.99 % $ 55,609 2.22 % $ 693,638 2.01 % $ 978,580 2.11 % Loans Receivable As of March 31, 2024 and December 31, 2023, loans receivable (excluding loans held for sale), net of deferred loan fees and costs, discounts and allowance for credit losses, were $6.11 billion. For the three months ended March 31, 2024, there was $234.0 million in new loan production and $10.2 million in SBA loan purchases, offset partially by $141.6 million in loan sales and payoffs, and amortization and other reductions of $97.0 million. Loan production consisted of commercial real estate loans of $60.1 million, residential mortgages of $53.1 million, commercial and industrial loans of $50.8 million, equipment financing agreements of $39.2 million and SBA loans of $30.8 million. The table below shows the maturity distribution of outstanding loans, before the allowance for credit losses as of March 31, 2024. In addition, the table shows the distribution of such loans between those with floating or variable interest rates and those with fixed or predetermined interest rates. Within One Year After One Year but Within Three Years After Three Years but Within Five Years After Five Years but Within Fifteen Years After Fifteen Years Total (in thousands) Real estate loans: Commercial property Retail $ 150,284 $ 311,361 $ 360,865 $ 218,920 $ 49,629 $ 1,091,059 Hospitality 233,654 193,201 201,905 95,599 15,801 740,160 Office 54,535 342,603 150,388 21,239 7,082 575,847 Other 169,203 473,436 471,263 208,393 45,100 1,367,395 Total commercial property loans 607,676 1,320,601 1,184,421 544,151 117,612 3,774,461 Construction 63,437 38,788 1,991 — — 104,216 Residential 5,193 70 133 4,290 960,676 970,362 Total real estate loans 676,306 1,359,459 1,186,545 548,441 1,078,288 4,849,039 Commercial and industrial loans 309,891 241,011 98,652 125,297 — 774,851 Equipment financing agreements 32,340 203,635 300,864 17,111 — 553,950 Loans receivable $ 1,018,537 $ 1,804,105 $ 1,586,061 $ 690,849 $ 1,078,288 $ 6,177,840 Loans with predetermined interest rates 482,612 1,260,548 978,530 58,522 262,591 3,042,803 Loans with variable interest rates 535,925 543,557 607,531 632,327 815,697 3,135,037 46 The table below shows the maturity distribution of outstanding loans, before the allowance for credit losses, with fixed or predetermined interest rates, as of March 31, 2024. Within One Year After One Year but Within Three Years After Three Years but Within Five Years After Five Years but Within Fifteen Years After Fifteen Years Total (in thousands) Real estate loans: Commercial property Retail $ 119,432 $ 279,343 $ 198,809 $ 1,557 $ 235 $ 599,376 Hospitality 86,408 133,332 103,528 697 — 323,965 Office 25,608 264,095 91,734 — — 381,437 Other 105,980 378,570 270,490 28,954 5,218 789,212 Total commercial property loans 337,428 1,055,340 664,561 31,208 5,453 2,093,990 Construction 28,311 — — — — 28,311 Residential 1,569 70 — 2,523 257,138 261,300 Total real estate loans 367,308 1,055,410 664,561 33,731 262,591 2,383,601 Commercial and industrial loans 82,964 1,503 13,105 7,680 — 105,252 Equipment financing agreements 32,340 203,635 300,864 17,111 — 553,950 Loans receivable $ 482,612 $ 1,260,548 $ 978,530 $ 58,522 $ 262,591 $ 3,042,803 The table below shows the maturity distribution of outstanding loans, before the allowance for credit losses, with floating or variable interest rates (including hybrids), as of March 31, 2024. Within One Year After One Year but Within Three Years After Three Years but Within Five Years After Five Years but Within Fifteen Years After Fifteen Years Total (in thousands) Real estate loans: Commercial property Retail $ 30,852 $ 32,018 $ 162,057 $ 217,363 $ 49,395 $ 491,685 Hospitality 147,246 59,868 98,377 94,902 15,801 416,194 Office 28,927 78,508 58,653 21,239 7,082 194,409 Other 63,223 94,866 200,772 179,439 39,881 578,181 Total commercial property loans 270,248 265,260 519,859 512,943 112,159 1,680,469 Construction 35,126 38,788 1,991 — — 75,905 Residential 3,624 — 133 1,767 703,538 709,062 Total real estate loans 308,998 304,048 521,983 514,710 815,697 2,465,436 Commercial and industrial loans 226,927 239,509 85,548 117,617 — 669,601 Loans receivable $ 535,925 $ 543,557 $ 607,531 $ 632,327 $ 815,697 $ 3,135,037 Industry As of March 31, 2024, the loan portfolio included the following concentrations of loans to one type of industry that were greater than 10.0% of loans receivable outstanding: Percentage of Balance as of Loans Receivable March 31, 2024 Outstanding (in thousands) Lessor of nonresidential buildings $ 1,718,496 27.8 % Hospitality 744,054 12.0 % 47 Loan Quality Indicators Loans 30 to 89 days past due and still accruing were $15.8 million at March 31, 2024, compared with $10.3 million at December 31, 2023, attributable mainly to an increase of $2.7 million in past due residential loans and the addition of a $3.0 million commercial real estate industrial loan, offset by payoffs and other reductions of $0.2 million. At March 31, 2024 and December 31, 2023, there were no loans 90 days or more past due and still accruing interest. Activity in criticized loans was as follows for the periods indicated: Special Mention Classified (in thousands) March 31, 2024 Balance at January 1, 2024 $ 65,315 $ 31,367 Additions 671 3,631 Reductions (3,670 ) (11,329 ) Balance at March 31, 2024 $ 62,316 $ 23,669 March 31, 2023 Balance at January 1, 2023 $ 79,013 $ 46,192 Additions 766 13,808 Reductions (15,439 ) (12,713 ) Balance at March 31, 2023 $ 64,340 $ 47,287 Special mention loans were $62.3 million and $65.3 million at March 31, 2024 and December 31, 2023, respectively. The $3.0 million decrease included upgrades to pass loans of $1.5 million, downgrades to classified loans of $0.8 million, and paydowns and payoffs of $1.4 million, offset by downgrades from pass loans of $0.7 million. The upgrades to pass loans were primarily attributable to a $1.5 million retail loan and downgrades to classified consisted of two SBA commercial real estate retail loans for $0.8 million. The $14.7 million decrease in the first quarter of 2023 included downgrades to classified loans of $10.0 million, and payoffs of $4.6 million. Classified loans were $23.7 million and $31.4 million at March 31, 2024 and December 31, 2023, respectively. The $7.7 million decrease was primarily driven by paydowns and payoffs of $9.4 million, and charge-offs of $1.9 million, offset by new downgrades to classified loans of $3.6 million. The paydowns and payoffs during the three months ended March 31, 2024 were mainly attributed to payoffs of a $4.7 million commercial real estate industrial loan and a $1.2 million commercial real estate office loan, and a $0.9 million paydown on a previously mentioned nonperforming commercial and industrial loan in the health-care industry. The $1.1 million increase in the first quarter of 2023 was primarily driven by the downgrade of one loan in the amount of $10.0 million, offset by loan upgrades of $8.8 million. Nonperforming Assets Nonperforming loans consist of nonaccrual loans and loans 90 days or more past due and still accruing interest. Nonperforming assets consist of nonperforming loans and OREO. Loans are placed on nonaccrual status when, in the opinion of management, the full timely collection of principal or interest is in doubt. Generally, the accrual of interest is discontinued when principal or interest payments become more than 90 days past due, unless we believe the loan is adequately collateralized and in the process of collection. However, in certain instances, we may place a particular loan on nonaccrual status earlier, depending upon the individual circumstances surrounding the loan’s delinquency. When a loan is placed on nonaccrual status, previously accrued but unpaid interest is reversed against current income. Subsequent collections of cash are applied as principal reductions when received, except when the ultimate collectability of principal is probable, in which case interest payments are credited to income. Nonaccrual loans may be restored to accrual status when principal and interest become current and full repayment is expected, which generally occurs after sustained payment of six months. Interest income is recognized on the accrual basis for loans not meeting the criteria for nonaccrual. OREO consists of properties acquired by foreclosure or similar means. Except for nonaccrual loans, management is not aware of any other loans as of March 31, 2024 for which known credit problems of the borrower would cause serious doubts as to the ability of such borrowers to comply with their present loan repayment terms, or any known events that would result in a loan being designated as nonperforming at some future date. Nonaccrual loans were $14.0 million and $15.5 million as of March 31, 2024 and December 31, 2023, respectively, representing a decrease of $1.5 million, or 9.4%. The decrease in nonaccrual loans resulted from payoffs, paydowns, and upgrades 48 of $4.8 million, offset by additions to nonperforming loans of $3.3 million. The additions to nonperforming loans consisted of equipment financing agreements of $2.6 million and two SBA loans for $0.7 million. As of March 31, 2024 and December 31, 2023, 1.25% of equipment financing agreements were on nonaccrual status. As of March 31, 2024 and December 31, 2023, all loans 90 days or more past due were classified as nonaccrual. The $14.0 million of nonperforming loans as of March 31, 2024 had individually evaluated allowances of $5.3 million, compared to $15.5 million of nonperforming loans with individually evaluated allowances of $3.4 million as of December 31, 2023. Nonperforming assets were $14.1 million at March 31, 2024, or 0.19% of total assets, compared to $15.6 million, or 0.21%, at December 31, 2023. Additionally, not included in nonperforming assets were repossessed personal property assets associated with equipment finance agreements of $1.3 million at March 31, 2024 and December 31, 2023. Individually Evaluated Loans The Company reviews loans on an individual basis when the loan does not share similar risk characteristics with loan pools. Individually evaluated loans are measured for expected credit losses based on the present value of expected cash flows discounted at the effective interest rate, the observable market price, or the fair value of collateral. Individually evaluated loans were $14.0 million and $15.4 million as of March 31, 2024 and December 31, 2023, respectively, representing a decrease of $1.4 million, or 9.2%. Specific allowances associated with individually evaluated loans increased $1.9 million to $5.3 million as of March 31, 2024 compared with $3.4 million as of December 31, 2023, mainly attributed to a $1.9 million specific reserve allocation on a commercial and industrial loan in the health-care industry. No loans were modified to borrowers with financial difficulties during the three months ended March 31, 2024 or 2023. A borrower is experiencing financial difficulties when there is a probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. The Company may modify loans to borrowers experiencing financial difficulties by providing principal forgiveness, a term extension, an other-than-insignificant payment delay, or an interest rate reduction. Allowance for Credit Losses and Allowance for Credit Losses Related to Off-Balance Sheet Items The Company’s estimate of the allowance for credit losses at March 31, 2024 and December 31, 2023 reflected losses expected over the remaining contractual life of assets based on historical, current, and forward-looking information. The contractual term does not consider extensions, renewals or modifications. Management selected three loss methodologies for the collective allowance estimation. At March 31, 2024, the Company used the discounted cash flow (“DCF”) method to estimate allowances for credit losses for the commercial and industrial loan portfolio, the Probability of Default/Loss Given Default (“PD/LGD”) method for the commercial property, construction and residential property portfolios, and the Weighted Average Remaining Maturity (“WARM”) method to estimate expected credit losses for equipment financing agreements. Loans that do not share similar risk characteristics are individually evaluated for allowances. For all loans utilizing the DCF method, the Company determined that four quarters represented a reasonable and supportable forecast period and reverted to a historical loss rate over twelve quarters on a straight-line basis. For each of these loan segments, the Company applied an annualized historical PD/LGD using all available historical periods. Since reasonable and supportable forecasts of economic conditions are embedded directly into the DCF model, qualitative adjustments are considered but were minimal. For each of the loan segments identified above, the Company applied an annualized historical PD/LGD using all available historical periods. The PD/LGD method incorporates a forecast of economic conditions into loss estimates using a qualitative adjustment. For loan pools utilizing the PD/LGD method, the Company used historical periods that included an economic downturn to derive historical losses for better alignment in the estimation of expected losses under the PD/LGD method. The Company relied on Frye-Jacobs modeled LGD rates for loan segments with insufficient historical loss data. The Frye-Jacobs model provides a means of applying an LGD rate in the event that limited to no loss data is available. The PD/LGD method incorporates a forecast into loss estimates using a qualitative adjustment. The Company used the WARM method to estimate expected credit losses for the equipment financing agreements portfolio. The Company applied an expected loss ratio based on internal historical losses adjusted as appropriate for qualitative factors. 49 As of March 31, 2024 and December 31, 2023, the Company relied on the economic projections from Moody’s to inform its loss driver forecasts over the four-quarter forecast period. For all loan pools, the Company utilizes and forecasts the national unemployment rate as the primary loss driver. To adjust the historical and forecast periods to current conditions, the Company applies various qualitative factors derived from market, industry or business specific data, changes in the underlying portfolio composition, trends relating to credit quality, delinquent and nonperforming loans and adversely-rated equipment financing agreements, and reasonable and supportable forecasts of economic conditions. The following table reflects our allocation of the allowance for credit losses by loan category as well as the amount of loans in each loan category, including related percentages: March 31, 2024 December 31, 2023 Allowance Amount Percentage of Total Allowance Total Loans Percentage of Total Loans Allowance Amount Percentage of Total Allowance Total Loans Percentage of Total Loans (dollars in thousands) Real estate loans: Commercial property Retail $ 10,095 14.8 % $ 1,091,059 17.7 % $ 10,264 14.8 % $ 1,107,360 17.9 % Hospitality 11,668 17.1 740,160 12.0 15,534 22.4 740,519 12.0 Office 3,740 5.5 575,847 9.3 3,024 4.4 574,981 9.3 Other 8,270 12.1 1,367,395 22.1 8,663 12.4 1,366,534 22.1 Total commercial property loans 33,773 49.5 3,774,461 61.1 37,485 54.0 3,789,394 61.3 Construction 2,611 3.8 104,216 1.7 2,756 4.0 100,345 1.6 Residential 6,200 9.1 970,362 15.7 5,258 7.5 962,661 15.6 Total real estate loans 42,584 62.4 4,849,039 78.5 45,499 65.5 4,852,400 78.5 Commercial and industrial loans 11,836 17.3 774,851 12.5 10,257 14.8 747,819 12.1 Equipment financing agreements 13,850 20.3 553,950 9.0 13,706 19.7 582,215 9.4 Total $ 68,270 100.0 % $ 6,177,840 100.0 % $ 69,462 100.0 % $ 6,182,434 100.0 % The following table sets forth certain ratios related to our allowance for credit losses at the dates presented: As of March 31, 2024 December 31, 2023 (dollars in thousands) Ratios: Allowance for credit losses to loans receivable 1.11 % 1.12 % Nonaccrual loans to loans 0.23 % 0.25 % Allowance for credit losses to nonaccrual loans 486.81 % 448.89 % Balance: Nonaccrual loans at end of period $ 14,024 $ 15,474 Nonperforming loans at end of period $ 14,024 $ 15,474 The allowance for credit losses was $68.3 million and $69.5 million at March 31, 2024 and December 31, 2023, respectively. The allowance attributed to individually evaluated loans was $5.3 million and $3.4 million as of March 31, 2024 and December 31, 2023, respectively. The allowance attributed to collectively evaluated loans was $63.0 million and $66.1 million as of March 31, 2024 and December 31, 2023, respectively, and considered the impact of changes in macroeconomic assumptions, normalized interest rate forecasts for the subsequent four quarters, and a net reduction in specific qualitative factors allocated to criticized hospitality loans impacted by the pandemic. As of March 31, 2024 and December 31, 2023, the allowance for credit losses related to off-balance sheet items, primarily unfunded loan commitments, was $2.3 million and $2.5 million, respectively. The Bank closely monitors the borrower’s repayment capabilities, while funding existing commitments to ensure losses are minimized. Based on management’s evaluation and analysis of portfolio credit quality and prevailing economic conditions, we believe these allowances were adequate for current expected lifetime losses in the loan portfolio and off-balance sheet exposure as of March 31, 2024. 50 The following table presents a summary of gross charge-offs and recoveries for the loan portfolio: Three Months Ended March 31, 2024 2023 (in thousands) Gross charge-offs $ (2,123 ) $ (2,238 ) Gross recoveries 527 783 Net (charge-offs) recoveries $ (1,596 ) $ (1,455 ) For the three months ended March 31, 2024, gross charge-offs decreased $0.1 million from the same period in 2023. Gross recoveries, for the three months ended March 31, 2024 decreased $0.3 million from the same period in 2023. Gross charge-offs for the three months ended March 31, 2024 and 2023 primarily consisted of equipment financing agreements charge-offs of $2.0 million and $1.6 million, respectively. The following table presents a summary of net (charge-offs) recoveries for the loan portfolio: Three Months Ended Average Loans Net (Charge-Offs) Recoveries Net (Charge-Offs) Recoveries to Average Loans (1) (dollars in thousands) March 31, 2024 Commercial real estate loans $ 3,875,439 $ 46 0.00 % Residential loans 978,908 — — Commercial and industrial loans 710,440 (97 ) (0.05 ) Equipment financing agreements 573,101 (1,545 ) (1.08 ) Total $ 6,137,888 $ (1,596 ) (0.10 )% March 31, 2023 Commercial real estate loans $ 3,800,499 $ (412 ) (0.04 )% Residential loans 780,833 68 0.03 Commercial and industrial loans 760,835 25 0.01 Equipment financing agreements 602,232 (1,136 ) (0.75 ) Total $ 5,944,399 $ (1,455 ) (0.10 )% (1) Annualized Net loan charge-offs were $1.6 million, or 0.10% of average loans, and $1.5 million, or 0.10% of average loans, for the three months ended March 31, 2024 and 2023, respectively. Deposits The following table shows the composition of deposits by type as of the dates indicated: March 31, 2024 December 31, 2023 Balance Percent Balance Percent (dollars in thousands) Demand – noninterest-bearing $ 1,933,060 30.2 % $ 2,003,596 31.9 % Interest-bearing: Demand 87,374 1.4 87,452 1.4 Money market and savings 1,859,865 29.2 1,734,659 27.6 Uninsured amount of time deposits more than $250,000: Three months or less 105,953 1.7 186,321 3.0 Over three months through six months 125,310 2.0 201,085 3.2 Over six months through twelve months 402,935 6.3 222,683 3.6 Over twelve months 38,706 0.6 70,932 1.1 All other insured time deposits 1,822,857 28.6 1,773,846 28.2 Total deposits $ 6,376,060 100.0 % $ 6,280,574 100.0 % 51 Total deposits were $6.38 billion and $6.28 billion as of March 31, 2024 and December 31, 2023, respectively, representing an increase of $95.5 million, or 1.5%. The increase in deposits was primarily driven by a $125.2 million increase in money market and savings deposits and a $40.9 million increase in time deposits, partially offset by a $70.5 decline in noninterest-bearing demand deposits. The changes in deposit composition were primarily due to the increase in deposit rates. At March 31, 2024, the loan-to-deposit ratio was 96.9% compared to 98.4% at December 31, 2023. As of March 31, 2024, the aggregate amount of uninsured deposits (deposits in amounts greater than $250,000, which is the maximum amount for federal deposit insurance) was $2.56 billion. The aggregate amount of uninsured time deposits was $672.9 million. Other uninsured deposits, such as demand and money market and savings deposits were $1.89 billion. In addition, $1.15 billion of total uninsured deposits were in accounts with balances of $5.0 million or more at March 31, 2024. As of December 31, 2023, the aggregate amount of uninsured deposits was $2.52 billion. The aggregate amount of uninsured time deposits was $681.0 million. Other uninsured deposits, such as demand, money market and savings deposits were $1.84 billion. In addition, $1.09 billion of total uninsured deposits were in accounts with balances of $5.0 million or more at December 31, 2023. The Bank’s wholesale funds historically consisted of FHLB advances, brokered deposits as well as State of California time deposits. As of March 31, 2024 and December 31, 2023, the Bank had $172.5 million and $325.0 million of FHLB advances, and $43.3 million and $58.3 million of brokered deposits, respectively, and $120.0 million of State of California time deposits, as of March 31, 2024 and December 31, 2023. Borrowings and Subordinated Debentures Borrowings mostly take the form of FHLB advances. At March 31, 2024 and December 31, 2023, FHLB advances were $172.5 million and $325.0 million, respectively. FHLB open advances were $60.0 million and $212.5 million at March 31, 2024 and December 31, 2023, respectively. For the same periods, term advances were $112.5 million. Funds from deposit growth not used to fund loan production were used to pay off borrowings. The weighted-average interest rate of all FHLB advances at March 31, 2024 and December 31, 2023 was 4.53% and 4.69%, respectively. The FHLB maximum amount outstanding at any month end during each of the year-to-date periods ended March 31, 2024 and December 31, 2023 was $187.5 million and $450.0 million, respectively. The following is a summary of contractual maturities of FHLB advances greater than twelve months: March 31, 2024 December 31, 2023 FHLB of San Francisco Outstanding Balance Weighted Average Rate Outstanding Balance Weighted Average Rate (dollars in thousands) Advances due over 12 months through 24 months $ 25,000 4.44 % $ 12,500 1.90 % Advances due over 24 months through 36 months 37,500 4.32 62,500 4.37 Outstanding advances over 12 months $ 62,500 4.37 % $ 75,000 3.96 % 52 Subordinated debentures were $130.2 million and $130.0 million as of March 31, 2024 and December 31, 2023, respectively. Subordinated debentures are comprised of fixed-to-floating subordinated notes of $108.4 million and $108.3 million as of March 31, 2024 and December 31, 2023, respectively, and junior subordinated deferrable interest debentures of $21.8 million and $21.7 million as of March 31, 2024 and December 31, 2023, respectively. See “Note 8 – Borrowings and Subordinated Debentures” to the consolidated financial statements for more details. Stockholders' Equity Stockholders’ equity was $703.1 million and $701.9 million as of March 31, 2024 and December 31, 2023, respectively. First quarter net income, net of $7.7 million of dividends paid, added $7.5 million to stockholders' equity for the period, which was partially offset by a $3.4 million increase in unrealized after-tax losses on securities available for sale due to changes in interest rates, and a $1.6 million increase in unrealized after-tax losses on cash flow hedges. In addition, the Company repurchased 100,000 shares of common stock during the quarter at an average share price of $15.92 for a total cost of $1.6 million. At March 31, 2024, 309,972 shares remain under the Company's share repurchase program. Interest Rate Risk Management The spread between interest income on interest-earning assets and interest expense on interest-bearing liabilities is the principal component of net interest income, and interest rate changes substantially affect our financial performance. We emphasize capital protection through stable earnings. In order to achieve stable earnings, we prudently manage our assets and liabilities and closely monitor the percentage changes in net interest income and equity value in relation to limits established within our guidelines. The Company performs simulation modeling to estimate the potential effects of interest rate changes. The following table summarizes one of the stress simulations performed to forecast the impact of changing interest rates on net interest income and the value of interest-earning assets and interest-bearing liabilities reflected on our balance sheet (i.e., an instantaneous parallel shift in the yield curve of the magnitude indicated below) as of March 31, 2024. The Company compares this stress simulation to policy limits, which specify the maximum tolerance level for net interest income exposure over a 1- to 12-month and a 13- to 24- month horizon, given the basis point adjustment in interest rates reflected below. Net Interest Income Simulation 1- to 12-Month Horizon 13- to 24-Month Horizon Change in Interest Dollar Percentage Dollar Percentage Rates (Basis Points) Change Change Change Change (dollars in thousands) 300 $ 3,974 1.78 % $ 6,748 2.53 % 200 $ 2,191 0.98 % $ 3,114 1.17 % 100 $ 1,720 0.77 % $ 2,838 1.06 % -100 $ (3,009 ) (1.35 %) $ (5,793 ) (2.17 %) -200 $ (7,338 ) (3.28 %) $ (14,829 ) (5.56 %) -300 $ (12,621 ) (5.64 %) $ (26,885 ) (10.08 %) Economic Value of Equity (EVE) Change in Interest Dollar Percentage Rates (Basis Points) Change Change (dollars in thousands) 300 $ (13,191 ) (1.93 %) 200 $ (6,910 ) (1.01 %) 100 $ 3,948 0.58 % -100 $ (20,535 ) (3.01 %) -200 $ (61,535 ) (9.01 %) -300 $ (122,449 ) (17.93 %) The estimated sensitivity does not necessarily represent our 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 timing and magnitude of interest rate changes, prepayments on loans receivable and securities, pricing strategies on loans receivable and deposits, and replacement of asset and liability cash flows. 53 The key assumptions, based upon loans receivable, securities and deposits, are as follows: Conditional prepayment rates*: Loans receivable 15 % Securities 6 % Deposit rate betas*: NOW, savings, money market demand 48 % Time deposits, retail and wholesale 76 % * Balance-weighted average 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. Capital Resources and Liquidity Capital Resources Historically, our primary source of capital has been the retention of operating earnings. In order to ensure adequate capital levels, the Board regularly assesses projected sources and uses of capital, expected loan growth, anticipated strategic actions (such as stock repurchases and dividends), and projected capital thresholds under adverse and severely adverse economic conditions. In addition, the Board considers the Company’s access to capital from financial markets through the issuance of additional debt and securities, including common stock or notes, to meet its capital needs. The Company’s ability to pay dividends to shareholders depends in part upon dividends it receives from the Bank. California law restricts the amount available for cash dividends to the lesser of a bank’s retained earnings or net income for its last three fiscal years (less any distributions to shareholders made during such period). Where the above test is not met, cash dividends may still be paid, with the prior approval of the Department of Financial Protection and Innovation (“DFPI”), in an amount not exceeding the greater of: (1) retained earnings of the Bank; (2) net income of the Bank for its last fiscal year; or (3) the net income of the Bank for its current fiscal year. The Company paid dividends of $7.7 million ($0.25 per share) for the three months ended March 31, 2024 and $30.5 million ($1.00 per share) for the year 2023. As of April 1, 2024, the Bank has the ability to pay dividends of approximately $161.0 million, after giving effect to the $0.25 dividend declared on April 25, 2024, for the second quarter of 2024, without the prior approval of the Commissioner of the DFPI. At March 31, 2024, the Bank’s total risk-based capital ratio of 14.50%, Tier 1 risk-based capital ratio of 13.44%, common equity Tier 1 capital ratio of 13.44% and Tier 1 leverage capital ratio of 11.29% placed the Bank in the “well capitalized” category pursuant to capital rules, which is defined as institutions with total risk-based capital ratio equal to or greater than 10.00%, Tier 1 risk-based capital ratio equal to or greater than 8.00%, common equity Tier 1 capital ratios equal to or greater than 6.50%, and Tier 1 leverage capital ratio equal to or greater than 5.00%. At March 31, 2024, the Company's total risk-based capital ratio was 15.20%, Tier 1 risk-based capital ratio was 12.40%, common equity Tier 1 capital ratio was 12.05% and Tier 1 leverage capital ratio was 10.36%. For a discussion of implemented changes to the capital adequacy framework prompted by Basel III and the Dodd- Frank Wall Street Reform and Consumer Protection Act, see our 2023 Annual Report on Form 10-K. Liquidity For a discussion of liquidity for the Company, see Note 14 - Liquidity included in the notes to unaudited consolidated financial statements in this Report and Note 22 – Liquidity in our 2023 Annual Report on Form 10-K. Off-Balance Sheet Arrangements For a discussion of off-balance sheet arrangements, see Note 12 - Off-Balance Sheet Commitments included in the notes to unaudited consolidated financial statements in this Report and “Item 1. Business - Off-Balance Sheet Commitments” in our 2023 Annual Report on Form 10-K. Contractual Obligations There have been no material changes to the contractual obligations described in our 2023 Annual Report on Form 10-K. 54 Item 3. Quantitative and Qualitati ve Disclosures about Market Risk For quantitative and qualitative disclosures regarding market risks, see “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Interest Rate Risk Management” in this Report.