Live Oak Bancshares, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following presents management’s discussion and analysis of the financial condition and results of operations of Live Oak Bancshares, Inc. (the “Company” or “LOB”). This discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes included elsewhere in this quarterly report on Form 10-Q and with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2020 (the "2020 Annual Report"). Results of operations for the periods included in this quarterly report on Form 10-Q are not necessarily indicative of results to be obtained during any future period. Important Note Regarding Forward-Looking Statements This quarterly report on Form 10-Q contains statements that management believes are forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. These statements generally relate to the financial condition, results of operations, plans, objectives, future performance or business of Live Oak Bancshares, Inc. (the "Company"). They usually can be identified by the use of forward-looking terminology, such as “believes,” “expects,” or “are expected to,” “plans,” “projects,” “goals,” “estimates,” “will,” “may,” “should,” “could,” “would,” “continues,” “intends to,” “outlook” or “anticipates,” or variations of these and similar words, or by discussions of strategies that involve risks and uncertainties. You should not place undue reliance on these statements, as they are subject to risks and uncertainties, including but not limited to, those described in this Report. When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements management may make. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information actually known to the Company at the time. Management undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Forward-looking statements contained in this Report are based on current expectations, estimates and projections about the Company’s business, management’s beliefs and assumptions made by management. These statements are not guarantees of the Company’s future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in the forward-looking statements. These risks, uncertainties and assumptions include, without limitation: • deterioration in the financial condition of borrowers resulting in significant increases in the Company’s loan and lease losses and provisions for those losses and other adverse impacts to results of operations and financial condition; • changes in Small Business Administration ("SBA") rules, regulations and loan products, including specifically the Section 7(a) program, changes in SBA standard operating procedures or changes to the status of Live Oak Banking Company (the "Bank") as an SBA Preferred Lender; • changes in rules, regulations or procedures for other government loan programs, including those of the United States Department of Agriculture (“USDA”); • changes in interest rates that affect the level and composition of deposits, loan demand and the values of loan collateral, securities, and interest sensitive assets and liabilities; • the failure of assumptions underlying the establishment of reserves for possible loan and lease losses; • changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions, or regulatory developments; • the potential impacts of the Coronavirus Disease 2019 (“COVID-19”) pandemic on trade (including supply chains and export levels), travel, employee productivity and other economic activities that may have a destabilizing and negative effect on financial markets, economic activity and customer behavior; • a reduction in or the termination of the Company’s ability to use the technology-based platform that is critical to the success of the Company’s business model or to develop a next-generation banking platform, including a failure in or a breach of the Company’s operational or security systems or those of its third party service providers; 33 • changes in financial market conditions, either internationally, nationally or locally in areas in which the Company conducts operations, including reductions in rates of business formation and growth, demand for the Company’s products and services, commercial and residential real estate development and prices, premiums paid in the secondary market for the sale of loans, and valuation of servicing rights; • changes in accounting principles, policies, and guidelines applicable to bank holding companies and banking; • fluctuations in markets for equity, fixed-income, commercial paper and other securities, which could affect availability, market liquidity levels, and pricing; • the effects of competition from other commercial banks, non-bank lenders, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and mutual funds, and other financial institutions operating in the Company’s market area and elsewhere, including institutions operating regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone and the Internet; • the Company's ability to attract and retain key personnel; • changes in governmental monetary and fiscal policies as well as other legislative and regulatory changes, including with respect to SBA or USDA lending programs and investment tax credits; • changes in political and economic conditions, including as a result of the 2020 federal elections; • the impact of heightened regulatory scrutiny of financial products and services, primarily led by the Consumer Financial Protection Bureau and various state agencies; • the Company's ability to comply with any requirements imposed on it by regulators, and the potential negative consequences that may result; • operational, compliance and other factors, including conditions in local areas in which the Company conducts business such as inclement weather or a reduction in the availability of services or products for which loan proceeds will be used, that could prevent or delay closing and funding loans before they can be sold in the secondary market; • the effect of any mergers, acquisitions or other transactions, to which the Company or the Bank may from time to time be a party, including management’s ability to successfully integrate any businesses acquired; • other risk factors listed from time to time in reports that the Company files with the SEC, including those described under “Risk Factors” in this Report; and • the Company’s success at managing the risks involved in the foregoing. Except as otherwise disclosed, forward-looking statements do not reflect: (i) the effect of any acquisitions, divestitures or similar transactions that have not been previously disclosed; (ii) any changes in laws, regulations or regulatory interpretations; or (iii) any change in current dividend or repurchase strategies, in each case after the date as of which such statements are made. All forward-looking statements speak only as of the date on which such statements are made, and the Company undertakes no obligation to update any statement, to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. Amounts in all tables in Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) have been presented in thousands, except percentage, time period, stock option, share and per share data or where otherwise indicated. 34 Nature of Operations LOB is a financial holding company and a bank holding company headquartered in Wilmington, North Carolina incorporated under the laws of the state of North Carolina in December 2008. The Company conducts business operations primarily through its commercial bank subsidiary, Live Oak Banking Company (the “Bank”). The Bank was incorporated in February 2008 as a North Carolina-chartered commercial bank. The Bank specializes in providing lending and deposit related services to small businesses nationwide. The Bank identifies and extends lending to credit-worthy borrowers within both specified industries, also called verticals, through expertise within those industries, and more broadly to select borrowers outside of those industries. A significant portion of the loans originated by the Bank are guaranteed by the SBA under the 7(a) Loan Program and the U.S. Department of Agriculture’s ("USDA") Rural Energy for America Program ("REAP"), Water and Environmental Program (“WEP”) and Business & Industry ("B&I") loan programs. The Company’s wholly owned subsidiaries are the Bank, Government Loan Solutions (“GLS”), Live Oak Grove, LLC (“Grove”), Live Oak Ventures, Inc. (“Live Oak Ventures”), and Canapi Advisors, LLC (“Canapi”). The Bank’s wholly owned subsidiaries are Live Oak Number One, Inc., Live Oak Clean Energy Financing LLC (“LOCEF”), and Live Oak Private Wealth, LLC. Live Oak Number One, Inc. holds properties foreclosed on by the Bank. LOCEF provides financing to entities for renewable energy applications and became a wholly owned subsidiary of the Bank during the first quarter of 2019. Live Oak Private Wealth, LLC and its wholly owned subsidiary, Jolley Asset Management, LLC (“JAM”), provide high-net-worth individuals and families with strategic wealth and investment management services. GLS is a management and technology consulting firm that advises and offers solutions and services to participants in the government guaranteed lending sector. GLS primarily provides services in connection with the settlement, accounting, and securitization processes for government guaranteed loans, including loans originated under the SBA 7(a) loan programs and USDA guaranteed loans. The Grove provides Company employees and business visitors an on-site restaurant location. Live Oak Ventures’ purpose is investing in businesses that align with the Company's strategic initiative to be a leader in financial technology. Canapi provides investment advisory services to a series of funds focused on providing venture capital to new and emerging financial technology companies. The Company generates revenue primarily from net interest income and secondarily through origination and sale of government guaranteed loans. Income from the retention of loans is comprised principally of interest income. The Company has historically elected to account for certain loans under the fair value option with interest reported in interest income and changes in fair value reported in the net gain (loss) on loans accounted for under the fair value option line item of the consolidated statements of income. During the first quarter of 2021, the Company chose not to elect fair value for all retained participating interests arising from new government guaranteed loan sales. Income from the sale of loans is comprised of loan servicing revenue and revaluation of related servicing assets along with net gains on sales of loans. Offsetting these revenues are the cost of funding sources, provision for loan and lease credit losses, any costs related to foreclosed assets and other operating costs such as salaries and employee benefits, travel, professional services, advertising and marketing and tax expense. The Company also has less routinely generated gains and losses arising from its financial technology investments in its fintech segment, as discussed more fully later in this section entitled “Results of Segment Operations”. Recent Developments Positive indications of recovery from the COVID-19 pandemic are beginning to appear in the United States; however, the fallout continues to have a complex and significant adverse impact on certain areas of the economy, the banking industry and the Company, all of which are subject to a high degree of uncertainty. This uncertainty is magnified with the risk of a resurgence of the virus or new variants. While it is not possible to know the full universe or extent of these impacts as of the date of this filing, we are disclosing potentially material items of which we are currently aware. 35 Financial position and results of operations Relating to our March 31, 2021 financial condition and results of operations, improving conditions around COVID-19 had a material impact on the allowance for credit losses (“ACL”) on loans and leases, loans carried at fair value, loan servicing asset revaluation, net gains on sales of loans and net interest income, largely due to improvement in economic forecasts and broader markets. With improving forecasts related to employment and default expectations, the ACL and resulting recovery for loan and lease credit losses, while the loan fair value calculation and net gain on loans accounted for under the fair value option were positively affected. With the ongoing monitoring of effects surfacing in certain pandemic-at-risk verticals combined with the risk that payment deferrals and those being made by the SBA for borrowers under its programs may be skewing actual indications of ability to repay, total credit related reserves continued to grow but at a slower pace due to the above mentioned continued improvement in economic forecasts during the first quarter. Refer to the discussion of the ACL and loans at fair value in Notes 5 and 9, respectively, of the Unaudited Condensed Consolidated Financial Statements as well as further discussion below in MD&A. Also impacted by improving market conditions was the Company’s valuation of the loan servicing asset as discussed in Note 7 of the notes to Unaudited Condensed Consolidated Financial Statements and net gains on sales of loans, both of which are further discussed below in MD&A. The secondary market continued to improve during the first quarter of 2021 which produced positive adjustments for loans carried at fair value and the loan servicing asset valuation. The net interest margin was positively impacted by Paycheck Protection Program (“PPP”) lending as discussed more fully below in MD&A. Should economic conditions worsen, the Company could experience significant levels of provision in the ACL and negative fair value marks and record additional credit or market related loss expense. It is also possible that the Company’s asset quality measures could worsen at future measurement periods if there is a significant resurgence of COVID-19 cases or variants. While there has been a recovery in secondary market pricing, the income from gain on sale of loans in future periods could be reduced due to COVID-19 and the termination of pandemic response programs. At this time, the Company is unable to project the materiality of such impacts but anticipates that the breadth of the economic impact could impact gains in future periods. Interest income could be further reduced due to COVID-19. In accordance with guidance from banking regulators, the Company has worked and continues to work with COVID-19 affected borrowers to help defer their payments, interest, and fees. In addition to regulatory relief on deferrals from banking regulators, payment relief has been available through the first quarter of 2021 from the SBA for certain loans guaranteed by that agency pursuant to the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) and subsequently by the below discussed Economic Aid Act. While interest will still accrue to interest income, through GAAP accounting, should eventual credit losses on these loans with deferred payments emerge, interest income accrued would need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. As of March 31, 2021, the Company carried $4.3 million in accrued interest on outstanding loans with deferrals made to COVID-19 affected borrowers. A t this time, the Company is unable to project the materiality of such an impact on future deferrals to COVID-19 borrowers, but recognizes the breadth of the economic impact may affect our borrowers’ ability to repay in future periods. Capital and liquidity As of March 31, 2021, all of the Company’s capital ratios, and the Bank’s capital ratios, were in excess of all minimum regulatory requirements. While the Company believes that capital is sufficient to withstand a double-dip economic recession brought about by a resurgence in COVID-19, reported and regulatory capital ratios could be adversely impacted by further credit losses. The Company relies on cash on hand as well as dividends from the Bank to service any debt at the Company. If our capital deteriorates such that the Bank is unable to pay dividends to the Company for an extended period of time, the Company may not be able to service its debt. The Company maintains access to multiple sources of liquidity. Wholesale funding markets have remained open to the Company, but rates for short-term funding can be volatile and the secondary market for guaranteed loans has shown reactionary and varying responses to the changing economic environment. If funding costs are elevated for an extended period of time, it could have an adverse effect on the Company’s net interest margin. If an extended recession causes large numbers of the Company’s deposit customers to withdraw their funds, the Company might become more reliant on volatile or more expensive sources of funding. 36 The Federal Reserve created the Paycheck Protection Program Liquidity Facility (“PPPLF”) to help provide financing for the origination of PPP loans. The PPPLF extends loans to banks that have loaned money to small businesses under the PPP, discussed in more detail below. Amounts borrowed are non-recourse and have a 100% advance rate equal to the principal amount of PPP loans pledged as security. In addition, loans financed under the PPPLF have a neutral impact on regulatory leverage capital ratios. The maturity date of a borrowing under the PPPLF is equal to the maturity date of the PPP loan pledged to secure the borrowing and would be accelerated (i) if the underlying PPP loan goes into default and is transferred to the SBA to realize on the SBA guarantee or (ii) to the extent that any loan forgiveness reimbursement is received from the SBA. Borrowings under the PPPLF bear interest at a rate of 0.35%, and there are no fees paid by the Company. As of March 31, 2021, the Company had outstanding borrowings of $1.41 billion from the PPPLF. Lending operations and accommodations to borrowers With the establishment of the PPP administered by the SBA, the Company has implemented new loan programs and systems using its technology platform while participating in assisting its customers and other small businesses in need of resources through the program. PPP loans earn interest at 1% and currently have a two-year or five-year contractual term depending on the origination date. For the earlier loans with a two-year term there is an option to extend to five years if agreed upon by the borrower and lender. The Company expects that some portion of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program. As of March 31, 2021, the Company carried 9,046 PPP loans on its balance sheet representing a book balance of $1.45 billion, which includes $33.7 million in net deferred fees, to be amortized and recognized in interest income over the remaining lives of the loans. The Company recognized $17.2 million of interest income in the first quarter of 2021 related to amortization of net PPP fees. As of May 4, 2021, the Company has secured funding from the SBA for 3,870 new PPP loans representing approximately $541.0 million in aggregate year to date 2021 originations. Loans funded through the PPP are fully guaranteed by the SBA, subject to the terms and conditions of the program. Should those circumstances change, the Company could be required to record additional credit loss expense through earnings. With the passage of the CARES Act on March 27, 2020 , the SBA was making six months of principal and interest payments on all fully disbursed SBA 7(a) and SBA Express loans in regular servicing status that closed by September 25, 2020. In addition, with regulatory guidance to work with borrowers during this unprecedented situation, the Company has also mobilized to provide a payment deferral program when needed by customers that are adversely affected by the pandemic. Depending on the demonstrated need of the client, the Company was deferring either the full loan payment or the principal component of the loan payment for 60 or 90 days. In accordance with interagency guidance issued in March 2020, these short-term deferrals were not considered troubled debt restructurings. After 60 or 90 days, borrowers may apply for an additional deferral. In the absence of other intervening factors, such short-term modifications made on a good faith basis are not categorized as a troubled debt restructuring, nor are loans granted payment deferrals related to COVID-19 placed on non-accrual (provided the loans were not past due or on non-accrual status prior to the deferral). At March 31, 2021 and December 30, 2020, the Company estimated that as a percentage of total loans and leases at amortized cost, excluding PPP loans, 44% and 20%, respectively, of its loans were receiving the six months of payments from the SBA and that 2% and 11%, respectively, of its loans had a payment deferral in place. The decrease in loans on payment deferral during the first quarter was largely a product of the Economic Aid Act introduced late in 2020, as discussed below. The Company estimated that 20.5% of its loans and leases at amortized cost, excluding PPP loans, were receiving payments from the SBA and that 0.6%, had a payment deferral in place as of May 4, 2021 . On October 2, 2020, the SBA began approving PPP forgiveness applications and remitting forgiveness payments to PPP lenders for PPP borrowers. As of May 4, 2021, the Company has received $905.6 million in PPP loan forgiveness from 7,000, or 63% of total PPP loans originated by count. On June 5, 2020, the Paycheck Protection Program Flexibility Act (the “new Act”) was signed into law and made significant changes to the PPP to provide additional relief for small businesses. The new Act increased flexibility for small businesses that have been unable to rehire employees due to lack of employee availability or have been unable to operate as normal due to COVID-19 related restrictions. It extended the period that businesses have to use PPP funds to qualify for loan forgiveness to 24 weeks, up from 8 weeks under the original rules. The new Act also relaxed the requirements that loan recipients must adhere to in order to qualify for loan forgiveness. In addition, the new Act extended the payment deferral period for PPP loans until the date when the amount of loan forgiveness is determined and remitted to the lender. For PPP recipients who do not apply for forgiveness, the loan deferral period is 10 months after the applicable forgiveness period ends. On December 27, 2020 the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (Economic Aid Act) was e nacted which allows the SBA to make payments of up to $9,000 per month for up to six months of principal and interest payments on certain fully disbursed SBA 7(a) and SBA 504 loans in regular servicing status based upon the origination date. In addition this legislation increased the 75% guarantee on many SBA 7(a) loans to 90%, among other things. 37 Credit While most industries have and will continue to experience adverse impacts as a result of COVID-19, the Company has $451.9 million in total unguaranteed exposure in six verticals considered by management to be “at-risk” of significant impact: hotels, wine and craft beverage, educational services, entertainment centers, fitness centers, and quick service restaurants, each comprising $130.9 million or 4.8%, $112.2 million or 4.1%, $98.8 million or 3.6%, $54.6 million or 2.0%, $32.3 million or 1.2%, and $23.1 million or 0.8% of total unguaranteed loans and leases (all at amortized cost, inclusive of loans carried at fair value) as of March 31, 2021, respectively. The Company continues to work with customers directly affected by COVID-19 and is prepared to offer short-term assistance in accordance with regulatory guidelines. As a result of the uncertain economic environment caused by COVID-19, the Company is engaging in more frequent communication with borrowers in an effort to better understand their situation and the challenges faced and circumstances evolve, which the Company anticipates will enable it to respond proactively as needs and issues arise. Results of Operations Performance Summary Three months ended March 31, 2021 compared with three months ended March 31, 2020 For the three months ended March 31, 2021, the Company reported net income of $39.4 million, or $0.88 per diluted share, compared to net loss of $7.6 million, or $0.19 per diluted share, for the first quarter of 2020. This increase in net income is largely due to the following items: • Increase in net interest income of $29.8 million, or 74.2%, predominately driven by significant growth in total loan and lease portfolios which was accentuated by the origination of $2.27 billion in PPP loans since the second quarter of 2020; • A decrease in the provision for loan and lease credit losses of $12.7 million, or 107.4%, resulting in a recovery for the quarter; • A net gain on the loan servicing asset revaluation of $1.5 million, increasing by $6.2 million, or 131.8%, compared to a net loss of $4.7 million for the first quarter of 2020; and • A net gain on loans accounted for under the fair value option of $4.2 million, increasing by $14.9 million, or 139.7%, compared to a net loss of $10.6 million for the first quarter of 2020. Other key factors partially offsetting the increase net income for the first quarter of 2021 were: • An increase in salaries and employee benefits of $3.3 million, or 11.8%; • $3.1 million in impairment charges related to a $3.9 million renewable energy tax credit investment ; and • Increased income tax expense of $12.0 million, or 153.8% primarily due to the above discussed increase in net income. Net Interest Income and Margin Net interest income represents the difference between the income that the Company earns on interest-earning assets and the cost of interest-bearing liabilities. The Company’s net interest income depends upon the volume of interest-earning assets and interest-bearing liabilities and the interest rates that the Company earns or pays on them, respectively. Net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as “volume changes.” It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as “rate changes.” As a bank without a branch network, the Bank gathers deposits over the Internet and in the community in which it is headquartered. Due to the nature of a branchless bank and the relatively low overhead required for deposit gathering, the rates that the Bank offers are generally above the industry average. 38 Three months ended March 31, 2021 compared with three months ended March 31, 2020 For the three months ended March 31, 2021, net interest income increased $29.8 million, or 74.2%, to $70.0 million compared to $40.2 million for the three months ended March 31, 2020. The increase was principally due to the significant growth in the held for investment loan and lease portfolios reflecting the Company's ongoing initiative to grow recurring revenue sources. This increase over the prior year was further enhanced by the aforementioned origination of $2.27 billion in PPP loans since the second quarter of 2020 with $20.7 million in interest income coming from amortization of net deferred fees combined with a 1% annualized interest rate. Accordingly, average interest earning assets increased by $2.91 billion, or 64.2%, to $7.44 billion for the three months ended March 31, 2021, compared to $4.53 billion for the three months ended March 31, 2020, while the yield on average interest earning assets decreased 81 basis points to 4.81%. The cost of funds on interest bearing liabilities for the three months ended March 31, 2021 decreased 112 basis points to 1.02%, and the average balance of interest bearing liabilities increased by $2.92 billion, or 66.8%, over the same period in 2020. The increase in average interest bearing liabilities was largely driven by funding for significant loan originations and growth from the prior year. As indicated in the rate/volume table below, increased interest earning asset volume more than offset lower yields, outpacing the higher volume and greater levels of cost declines of interest bearing liabilities, resulting in increases to interest income of $24.8 million and decreases to interest expense of $5.0 million for the three months ended March 31, 2021 compared to the three months ended March 31, 2020. For the three months ended March 31, 2020 compared to the three months ended March 31, 2021, net interest margin increased from 3.55% to 3.81%, respectively, due primarily to recognition of PPP related income, which is being accelerated with forgiveness efforts, in combination with significant loan portfolio growth, the maturity of longer term deposits which are repricing at lower rates and repricing of savings portfolio at lower rates. 39 Average Balances and Yields. The following table presents information regarding average balances for assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amount of interest expense on average interest-bearing liabilities, and the resulting average yields and costs. The yields and costs for the periods indicated are derived by dividing the income or expense by the average balances for assets or liabilities, respectively, for the periods presented and annualizing that result. Loan fees are included in interest income on loans. Three Months Ended March 31, 2021 2020 Average Balance Interest Average Yield/Rate Average Balance Interest Average Yield/Rate Interest earning assets: Interest earning balances in other banks $ 331,260 $ 297 0.36 % $ 157,136 $ 532 1.36 % Federal funds sold 28,202 6 0.09 72,750 218 1.20 Investment securities 736,158 2,929 1.61 536,206 3,762 2.81 Loans held for sale 1,158,844 15,077 5.28 1,016,542 15,865 6.26 Loans and leases held for investment (1) 5,186,963 69,916 5.47 2,750,268 43,096 6.29 Total interest earning assets 7,441,427 88,225 4.81 4,532,902 63,473 5.62 Less: Allowance for credit losses on loans and leases (52,317 ) (27,003 ) Non-interest earning assets 593,573 507,441 Total assets $ 7,982,683 $ 5,013,340 Interest bearing liabilities: Interest bearing checking $ 250,005 $ 356 0.58 % $ — $ — — % Savings 2,356,598 3,512 0.60 1,123,882 4,844 1.73 Money market accounts 105,753 83 0.32 77,622 100 0.52 Certificates of deposit 3,151,575 12,993 1.67 3,162,660 18,311 2.32 Total deposits 5,863,931 16,944 1.17 4,364,164 23,255 2.14 Borrowings 1,429,177 1,331 0.38 7,156 57 3.19 Total interest bearing liabilities 7,293,108 18,275 1.02 4,371,320 23,312 2.14 Non-interest bearing deposits 63,917 48,925 Non-interest bearing liabilities 39,155 53,494 Shareholders' equity 586,503 539,601 Total liabilities and shareholders' equity $ 7,982,683 $ 5,013,340 Net interest income and interest rate spread $ 69,950 3.79 % $ 40,161 3.48 % Net interest margin 3.81 % 3.55 % Ratio of average interest-earning assets to average interest-bearing liabilities 102.03 % 103.70 % (1) Average loan and lease balances include non-accruing loans and leases. 40 Rate/Volume Analysis. The following table sets forth the effects of changing rates and volumes on net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. For purposes of this table, increases or decreases attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume. Three Months Ended March 31, 2021 vs. 2020 Increase (Decrease) Due to Rate Volume Total Interest income: Interest earning balances in other banks $ (608 ) $ 373 $ (235 ) Federal funds sold (141 ) (71 ) (212 ) Investment securities (1,932 ) 1,099 (833 ) Loans held for sale (2,824 ) 2,036 (788 ) Loans and leases held for investment (8,694 ) 35,514 26,820 Total interest income (14,199 ) 38,951 24,752 Interest expense: Interest bearing checking — 356 356 Savings (4,907 ) 3,575 (1,332 ) Money market accounts (46 ) 29 (17 ) Certificates of deposit (5,263 ) (55 ) (5,318 ) Borrowings (5,052 ) 6,326 1,274 Total interest expense (15,268 ) 10,231 (5,037 ) Net interest income $ 1,069 $ 28,720 $ 29,789 Provision for Loan and Lease Credit Losses The provision for loan and lease credit losses represents the amount necessary to be charged against the current period’s earnings to maintain the allowance for credit losses (“ACL”) on loans and leases at a level that is appropriate in relation to the estimated losses inherent in the loan and lease portfolio. Losses inherent in loan relationships are mitigated if a portion of the loan is guaranteed by the SBA or USDA. A typical SBA 7(a) loan carries a 75% guarantee while USDA guarantees range from 50% to 90% depending on loan size, which serve to reduce the risk profile of these loans. The Company believes that its focus on compliance with regulations and guidance from the SBA and USDA are key factors to managing this risk. For the first quarter of 2021, there was a recovery of loan and lease credit losses of $873 thousand compared to a provision of $11.8 million for the same period in 2020, a decrease in provision of $12.7 million. The negative provision for the first quarter of 2021 was primarily the result of improved forecasts related to employment and default expectations as the economic outlook has improved significantly over that experienced in 2020, combined with the effects of a $1.7 million recovery from a previously charged-off hotel loan discussed below. Loans and leases held for investment at historical cost were $4.67 billion as of March 31, 2021, increasing by $2.68 billion, or 134.9%, compared to March 31, 2020. This growth was largely fueled by $2.27 billion in PPP loan originations since the second quarter of 2020. Excluding PPP loan originations and net unearned fees on those loans, the balance in loans and leases held for investment at historical cost was $3.22 billion at March 31, 2021, an increase of $1.23 billion, or 62.2%, over March 31, 2020. This growth, outside of PPP activity in the third quarter of 2020, was fueled by robust origination. Net recoveries for loans and leases carried at historical cost were $984 thousand, or 0.09% of average quarterly loans and leases held for investment, carried at historical cost, on an annualized basis, for the three months ended March 31, 2021, compared to net charge-offs of $2.8 million, or 0.58%, for the three months ended March 31, 2020. The decrease in charge-offs was primarily driven by a $1.7 million recovery of a previously charged-off hotel loan which paid off during the first quarter of 2021. Net charge-offs are a key element of historical experience in the Company's estimation of the allowance for credit losses on loans and leases. 41 In addition, nonperforming loans and leases not guaranteed by the SBA or USDA, excluding $ 5.8 million and $ 8.2 million accounted for under the fair value option at March 31, 2021 and 2020 , respectively, totaled $ 24.7 million, which was 0. 53 % of the held for investment loan and lease portfolio carried at historical cost at March 31, 2021 , compared to $ 9.6 million, or 0. 4 8 % of loans and leases held for investment at March 31, 2020 . Nonperforming loans and leases carried at historical cost which are not guaranteed by the SBA or USDA were 0. 77 % of the historical cost portion of the held for investment loan and lease portfolio, excluding PPP loans, at March 31, 2021 . Noninterest Income Noninterest income is principally comprised of net gains from the sale of SBA and USDA-guaranteed loans along with loan servicing revenue and related revaluation of the servicing asset. Revenue from the sale of loans depends upon the volume, maturity structure and rates of underlying loans as well as the pricing and availability of funds in the secondary markets prevailing in the period between completed loan funding and closing of sale. In addition, the loan servicing revaluation is significantly impacted by changes in market rates and other underlying assumptions such as prepayment speeds and default rates. Net gain (loss) on loans accounted for under the fair value option is also significantly impacted by changes in market rates, prepayment speeds and inherent credit risk. Other less common elements of noninterest income include less routine gains and losses on investments. The following table shows the components of noninterest income and the dollar and percentage changes for the periods presented. Three Months Ended March 31, 2021/2020 Increase (Decrease) 2021 2020 Amount Percent Noninterest income Loan servicing revenue $ 6,434 $ 6,422 $ 12 0.19 % Loan servicing asset revaluation 1,493 (4,692 ) 6,185 131.82 Net gains on sales of loans 11,929 11,112 817 7.35 Net gain (loss) on loans accounted for under the fair value option 4,218 (10,638 ) 14,856 139.65 Equity method investments income (loss) (1,157 ) (2,478 ) 1,321 53.31 Equity security investments gains (losses), net 105 (64 ) 169 264.06 Loss on sale of investment securities available-for-sale, net — (79 ) 79 100.00 Lease income 2,599 2,624 (25 ) (0.95 ) Management fee income 1,934 1,644 290 17.64 Other noninterest income 3,502 1,891 1,611 85.19 Total noninterest income $ 31,057 $ 5,742 $ 25,315 440.87 % For the three months ended March 31, 2021, noninterest income increased by $25.3 million, or 440.9%, compared to the three months ended March 31, 2020. The increase from the prior year is primarily the result of the aforementioned increase in net gains on loan servicing asset revaluation of $6.2 million combined with a net gain on loans accounted for under the fair value option of $14.9 million, both a product of improved market conditions compared to the impacts of COVID-19 in 2020. The following table reflects loan and lease production, sales of guaranteed loans and the aggregate balance in guaranteed loans sold. These components are key drivers of the Company's noninterest income. Three Months Ended March 31, For years ended December 31, 2021 2020 2020 2019 2018 2017 Amount of loans and leases originated $ 1,180,219 $ 500,634 $ 4,450,198 $ 2,001,886 $ 1,765,680 $ 1,934,238 Guaranteed portions of loans sold 136,747 162,297 542,596 340,374 945,178 787,926 Outstanding balance of guaranteed loans sold (1) 2,843,963 2,761,015 2,819,625 2,746,840 3,045,460 2,680,641 (1) This represents the outstanding principal balance of guaranteed loans serviced, as of the last day of the applicable period, which have been sold into the secondary market. 42 Changes in various components of noninterest income are discussed in more detail below. Loan Servicing Revaluation: The Company revalues its serviced loan portfolio at least quarterly. The revaluation considers the amortization of the portfolio, current market conditions for loan sale premiums, and current prepayment speeds. For the three months ended March 31, 2021, there was a net positive loan servicing revaluation adjustment of $1.5 million compared to a net negative adjustment of $4.7 million for the three months ended March 31, 2020. The net positive revaluation amount for the first quarter compared to the corresponding period of 2020 was primarily a result of improving market conditions and pricing for government guaranteed loans. Net Gains on Sale of Loans: For the three months ended March 31, 2021, net gains on sales of loans increased $817 thousand, or 7.4%, compared to the three months ended March 31, 2020. For the three months ended March 31, 2021, the volume of guaranteed loans sold decreased $25.6 million, or 18.7%, to $136.7 million from $162.3 million for the three months ended March 31, 2020. The average net gain on guaranteed loan sales increased from $63.7 thousand to $83.9 thousand, per million sold, in the first quarters of 2020 and 2021, respectively. With lower loan sale volume and higher premium levels in the secondary market in the first quarter of 2021 compared to the first quarter of 2020, the average net gain on guaranteed loan sales increased, largely as a result of the level of market improvement in premium levels. The magnitude of the increase in net gains on sale of loans was muted somewhat due the Company’s choice to not elect fair value for all retained participating interests arising from new government guaranteed loan sales beginning in the first quarter of 2021. Not electing fair value generally results in a larger discount, which will reduce the amount of gain recognized at the date of sale. This larger discount is subsequently accreted into interest income over the underlying loan’s remaining term using the effective interest method. Management made this change of election in alignment with its ongoing effort to reduce volatility and drive more predictable revenue. In accordance with accounting standards, any loans for which fair value was previously elected will continue to be measured as such. Net Gain (Loss) on Loans Accounted for Under the Fair Value Option : For the three months ended March 31, 2021, the net gain on loans accounted for under the fair value option increased $14.9 million, or 139.78%, compared to the three months ended March 31, 2020. The carrying amount of loans accounted for under the fair value option at March 31, 2021 and 2020 was $826.7 million ($35.9 million classified as held for sale and $790.8 million classified as held for investment) and $850.6 million ($19.2 million classified as held for sale and $831.4 million classified as held for investment), respectively, a decrease of $23.8 million, or 2.8%. The first quarter of 2020 net gain on loans accounted for under the fair value option was largely due to improving market conditions compared to COVID-19 pandemic economic impacts in the prior year. Noninterest Expense Noninterest expense comprises all operating costs of the Company, such as employee related costs, travel, professional services, advertising and marketing expenses, exclusive of interest and income tax expense. The following table shows the components of noninterest expense and the related dollar and percentage changes for the periods presented. Three Months Ended March 31, 2021/2020 Increase (Decrease) 2021 2020 Amount Percent Noninterest expense Salaries and employee benefits $ 31,366 $ 28,063 $ 3,303 11.77 % Non-staff expenses: Travel expense 659 1,781 (1,122 ) (63.00 ) Professional services expense 3,831 1,937 1,894 97.78 Advertising and marketing expense 652 1,361 (709 ) (52.09 ) Occupancy expense 2,112 2,421 (309 ) (12.76 ) Data processing expense 3,894 3,157 737 23.34 Equipment expense 4,354 4,635 (281 ) (6.06 ) Other loan origination and maintenance expense 3,327 2,456 871 35.46 Renewable energy tax credit investment impairment 3,127 — 3,127 100.00 FDIC insurance 1,765 1,510 255 16.89 Other expense 3,185 2,170 1,015 46.77 Total non-staff expenses 26,906 21,428 5,478 25.56 Total noninterest expense $ 58,272 $ 49,491 $ 8,781 17.74 % 43 Total noninterest expense for the three months ended March 31, 2021 increased $8.8 million, or 17.7%, compared to the same period in 2020. The increase in noninterest expense for the comparable three month period was largely driven by salaries and employee benefits and renewable energy tax credit investment impairment. Changes in various components of noninterest expense are discussed below. Salaries and employee benefits : Total personnel expense for the three months ended March 31, 2021 increased by $3.3 million, or 11.8%, compared to the same period in 2020. The quarter over quarter increase is principally due to the vesting of approximately 398 thousand restricted stock unit awards with market price conditions in the first quarter of 2021 that impacted both compensation expense and payroll tax expense by a combined $2.6 million. The first quarter of 2021 also included a severance payment of $750 thousand. In addition, the salary base grew from prior periods as the Company continued to expand its employee base consistent with strategic and growth initiatives. Total full-time equivalent employees increased from 622 at March 31, 2020 to 651 at March 31, 2021. Salaries and employee benefits expense included $5.0 million and $2.9 million of stock-based compensation for the three months ended March 31, 2021 and 2020, respectively. Expenses related to the employee stock purchase program, stock grants, stock option compensation and restricted stock expense are all considered stock-based compensation. Professional services expense: Total professional services expense increased $1.9 million, or 97.8%, compared to the same period in 2020. This increase was primarily driven by an increase in legal fees related to the previously disclosed letter the Company received in December 2020 and the resulting putative class action filed against the Company and other parties in March 2021 as described in Note 10. Commitments and Contingencies. Renewable tax credit investment impairment: The Company recognized $3.1 million in impairment charges related to a $3.9 million renewable energy tax credit investment that was fully funded during the quarter. Investments of this type generate a return primarily through the realization of income tax credits and other benefits; accordingly, impairment of the investment amount is recognized in conjunction with the realization of related tax benefits. This investment generated a federal investment tax credit of $3.4 million which is included in the Company’s estimated annual effective tax rate. Results of Segment Operations Three months ended March 31, 2021 compared with three months ended March 31, 2020 The Company’s operations are managed along two primary operating segments Banking and Fintech. A description of each business and the methodologies used to measure financial performance is described in Note 12. Segments in the accompanying notes to the Unaudited Condensed Consolidated Financial Statements. Net income (loss) by operating segment is presented below: Three Months Ended March 31, 2021 2020 Banking $ 41,056 $ (8,152 ) Fintech (907 ) (2,126 ) Other (722 ) 2,676 Consolidated net income (loss) $ 39,427 $ (7,602 ) Banking Net income increased $49.2 million, compared to the first quarter of 2020. The increase was primarily the result of increased net interest income and a negative provision for loan and lease credit losses. Net interest income increased $29.7 million, or 74.0%, compared to the first quarter of 2020. See the analysis of net interest income included in the above section captioned “Net Interest Income and Margin” as it is predominantly related to the Banking segment. See the analysis of provision for loan and lease credit losses included in the above section captioned “ Provision for Loan and Lease Credit Losses ” as it is entirely related to the Banking segment. Noninterest income increased $24.6 million, compared to the first quarter of 2020. This increase was largely comprised of a net positive increase in the loan servicing asset revaluation of $6.2 million, or 131.8% combined with an increase in the net gain on loans accounted for under the fair value option of $14.9 million, or 139.7%. See the analysis of these categories of noninterest income included in the above section captioned “Noninterest Income” for additional discussion. 44 Noninterest expense increased $ 8.9 million, or 19. 1 % compared to the first quarter of 2020 . See the analysis of these categories of noninterest expense included in the above section captioned “Noninterest Expense” for additional discussion. Income tax expense increased $8.8 million, or 211.5%, compared to the first quarter of 2020. See the below section captioned “Income Tax Expense.” Fintech Net loss decreased by $1.2 million, or 57.3%, compared to the first quarter of 2020. The decrease was primarily the result of increased non-interest income. Noninterest income increased $876 thousand compared to the first quarter of 2020, or 99.5%. This increase was largely due to with an increase of $899 thousand in the Company’s pro rata portion of increased profitability in its Canapi Ventures Fund investments. Noninterest expense decreased $470 thousand, or 31.5% compared to the first quarter of 2020. This decrease was largely due to a reduction in expenses incurred by Canapi Advisors compared to the first quarter of 2020. Income tax benefit decreased $249 thousand, or 102.0%, compared to the first quarter of 2020, consistent with the segment’s decrease in net loss before taxes. Income Tax Expense For the three months ended March 31, 2021, income tax expense increased by $12.0 million compared to the same period in 2020, and the Company’s effective tax rates were 9.6% and 50.6%, respectively. The effective rate for the first quarter of 2021 is principally due to earlier discussed items related to renewable energy tax credit investments and an income tax benefit of $4.3 million arising from the vesting of approximately 398 thousand restricted stock unit awards with market price conditions, as the fair value of these awards exceeded the total compensation cost recognized by the Company for book purposes. The negative effective rate during the first quarter of 2020 was partially a result of a discrete, estimated income tax benefit of $3.7 million related to the enactment of the CARES Act on March 27, 2020. The CARES Act allows taxpayers to carryback certain net operating losses to each of the five taxable years preceding the taxable year of such losses. As a result, the Company was allowed to carryback its 2018 net operating loss which had been utilized and measured under the prior law using a 21% corporate income tax rate to pre-2018 taxable years during which the corporate income tax rate was 35%. The remaining income tax benefit in the first quarter of 2020 was predominantly driven by the Company’s overall net pretax loss. The increase from an income tax benefit in the first quarter of 2020 to income tax expense for the first quarter of 2021 is primarily due to a significant increase in income before taxes. Discussion and Analysis of Financial Condition March 31, 2021 vs. December 31, 2020 Total assets at March 31, 2021 were $8.42 billion, an increase of $545.6 million, or 6.82%, compared to total assets of $7.87 billion at December 31, 2020. The growth in total assets was principally driven by the following: • Cash and cash equivalents, comprised of cash and due from banks and federal funds sold, was $635.5 million at March 31, 2021, an increase of $317.2 million, or 99.7%, compared to $318.3 million at December 31, 2020. This increase reflects liquidity planning through increased levels of deposits for funding current and future originations; and • Growth in total loans and leases held for investment and held for sale of $213.1 million resulting from strong origination activity in the first quarter of 2021. Total first quarter originations were $1.18 billion, comprised of $672.4 million in loans and leases exclusive of PPP and an additional $507.8 million in PPP loans. Total investment securities increased $25.1 million during the first three months of 2021, from $750.1 million at December 31, 2020, to $775.2 million at March 31, 2021, an increase of 3.3%. The Company increased its investment securities position during the first three months of 2021 largely as a part of its annual investment asset-liability planning. At March 31, 2021, the investment portfolio was comprised of U.S. government agency, U.S. government-sponsored entity mortgage-backed securities and municipal bonds. 45 Loans and leases held for sale decreased $98.7 million, or 8.4%, during the first three months of 2020, from $1.18 billion at December 31, 2020, to $1.08 billion at March 31, 2021. The decrease was primarily the result of strong loan sales in the first quarter of 2021. Loans and leases held for investment increased $311.8 million, or 6.1%, during the first three months of 2021, from $5.14 billion at December 31, 2020, to $5.46 billion at March 31, 2021. The increase was primarily the result of the above mentioned loan originations in 2021. All PPP loans are classified as held for investment. Total deposits were $6.32 billion at March 31, 2021, an increase of $603.2 million, or 10.6%, from $5.71 billion at December 31, 2020. The increase in deposits was largely driven by PPP and other significant loan origination efforts during the first quarter of 2020. Borrowings decreased to $1.47 billion at March 31, 2021 from $1.54 billion at December 31, 2020. This decrease was related principally to net curtailments of borrowings through the PPPLF in the first quarter of 2021 as PPP loan forgiveness outpaced new PPPLF advances. These PPPLF borrowings are used to help fund PPP loans. Shareholders’ equity at March 31, 2021 was $590.4 million as compared to $567.9 million at December 31, 2020. The book value per share was $13.74 at March 31, 2021 compared to $13.38 at December 31, 2020. Average equity to average assets was 7.4% for the three months ended March 31, 2021 compared to 8.1% for the year ended December 31, 2020. The increase in shareholders’ equity for the first three months of 2021 was principally the result of net income of $39.4 million and stock-based compensation expense of $5.0 million, partially offset by other comprehensive income of $12.4 million and $11.3 million in cash paid in lieu of stock for employee tax obligations in settlement of vested stock grants, principally related to the approximately 398 thousand awards with market price conditions vesting the first quarter discussed earlier. During the first three months of 2021, 415,504 shares of Class B common stock (non-voting) were converted to Class A common stock (voting) under a private sale. The conversion decreased the value of Class B common stock (non-voting) and increased the value of Class A common stock (voting) by $4.4 million. Asset Quality Management considers asset quality to be of primary importance. A formal loan review function, independent of loan origination, is used to identify and monitor problem loans. This function reports directly to the Audit & Risk Committee of the Board of Directors. Nonperforming Assets The Bank places loans and leases on nonaccrual status when they become 90 days past due as to principal or interest payments, or prior to that if management has determined based upon current information available to them that the timely collection of principal or interest is not probable. When a loan or lease is placed on nonaccrual status, any interest previously accrued as income but not actually collected is reversed and recorded as a reduction of loan or lease interest and fee income. Typically, collections of interest and principal received on a nonaccrual loan or lease are applied to the outstanding principal as determined at the time of collection of the loan or lease. Troubled debt restructurings (“TDRs”) occur when, because of economic or legal reasons pertaining to the debtor’s financial difficulties, debtors are granted concessions that would not otherwise be considered. Such concessions would include, but are not limited to, the transfer of assets or the issuance of equity interests by the debtor to satisfy all or part of the debt, modification of the terms of debt or the substitution or addition of debtor(s). Nonperforming assets and TDRs, excluding loans measured at fair value, at March 31, 2021 were $97.2 million, which represented a $14.7 million, or 17.9%, increase from December 31, 2020. These nonperforming assets, at March 31, 2021 were comprised of $57.4 million in nonaccrual loans and leases and $4.2 million in foreclosed assets. Of the $97.2 million of nonperforming assets and TDRs, $51.8 million carried an SBA guarantee, leaving an unguaranteed exposure of $45.4 million in total nonperforming assets and TDRs at March 31, 2021. This represents an increase of $6.1 million, or 15.4%, from an unguaranteed exposure of $39.3 million at December 31, 2020. 46 The following table provides information with respect to nonperforming assets and troubled debt restructurings , excluding loans measured at fair value, at the dates indicated. March 31, 2021 (1) December 31, 2020 (1) Nonaccrual loans and leases: Total nonperforming loans and leases (all on nonaccrual) (2) $ 57,371 $ 46,110 Total accruing loans and leases past due 90 days or more — — Foreclosed assets 4,185 4,155 Total troubled debt restructurings (3) 48,514 39,803 Less nonaccrual troubled debt restructurings (12,853 ) (7,592 ) Total performing troubled debt restructurings (3) 35,661 32,211 Total nonperforming assets and troubled debt restructurings (2)(3) $ 97,217 $ 82,476 Allowance for credit losses on loans and leases $ 52,417 $ 52,306 Total nonperforming loans and leases to total loans and leases held for investment (2) 1.23 % 1.06 % Total nonperforming loans and leases to total assets (2) 0.76 % 0.66 % Total nonperforming assets and troubled debt restructurings to total assets (2) (3) 1.28 % 1.17 % Allowance for credit losses on loans and leases to loans and leases held for investment 1.12 % 1.21 % Allowance for credit losses on loans and leases to total nonperforming loans and leases (2) 91.36 % 113.44 % (1) Excludes loans measured at fair value. (2) The period ended December 31, 2020 excludes one $6.1 million hotel loan classified as held for sale. (3) The period ended March 31, 2021 and December 31, 2020 excludes one $5.1 million hotel loan classified as held for sale. March 31, 2021 (1) December 31, 2020 (1) Nonaccrual loans and leases guaranteed by U.S. government: Total nonperforming loans and leases guaranteed by the U.S government (all on nonaccrual) $ 32,633 $ 26,032 Total accruing loans and leases past due 90 days or more guaranteed by the U.S government — — Foreclosed assets guaranteed by the U.S. government 3,244 3,220 Total troubled debt restructurings guaranteed by the U.S. government 23,110 18,160 Less nonaccrual troubled debt restructurings guaranteed by the U.S. government (7,162 ) (4,271 ) Total performing troubled debt restructurings guaranteed by U.S. government 15,948 13,889 Total nonperforming assets and troubled debt restructurings guaranteed by the U.S. government $ 51,825 $ 43,141 Allowance for credit losses on loans and leases $ 52,417 $ 52,306 Total nonperforming loans and leases not guaranteed by the U.S. government to total held for investment loans and leases 0.53 % 0.46 % Total nonperforming loans and leases not guaranteed by the U.S. government to total assets 0.33 % 0.29 % Total nonperforming assets and troubled debt restructurings not guaranteed by the U.S. government to total assets 0.60 % 0.56 % Allowance for credit losses on loans and leases to total nonperforming loans and leases not guaranteed by the U.S government 211.89 % 260.51 % (1) Excludes loans measured at fair value. 47 Total nonperforming assets and TDRs, including loans measured at fair value, at March 31, 2021 were $173.3 million, which represented a $20.1 million, or 13.1%, increase from December 31, 2020. These nonperforming assets, at March 31, 2021 were comprised of $101.3 million in nonaccrual loans and leases and $4.2 million in foreclosed assets. Of the $173.3 million of nonperforming assets and TDRs, $111.0 million carried an SBA guarantee, leaving an unguaranteed exposure of $62.3 million in total nonperforming assets and TDRs at March 31, 2021. This represents an increase of $6.7 million, or 12.2%, from an unguaranteed exposure of $55.5 million at December 31, 2020. See the below discussion related to the change in potential problem and impaired loans and leases for management’s overall observations regarding growth in total nonperforming loans and leases. As a percentage of the Bank’s total capital, nonperforming loans and leases, excluding loans measured at fair value, represented 10.3% at March 31, 2021, compared to 8.8% at December 31, 2020. Adjusting the ratio to include only the unguaranteed portion of nonperforming loans and leases at historical cost to reflect management’s belief that the greater magnitude of risk resides in this portion, the ratios at March 31, 2021 and December 31, 2020 were 4.4% and 3.8%, respectively. As of March 31, 2021, and December 31, 2020, potential problem (also referred to as criticized) and classified loans and leases, excluding loans measured at fair value, totaled $341.2 million and $311.4 million, respectively. The following is a discussion of these loans and leases. Risk Grades 5 through 8 represent the spectrum of criticized and classified loans and leases. For a complete description of the risk grading system, see Note 5. Loans and Leases Held for Investment and Credit Quality in the Company’s 2020 Form 10-K. At March 31, 2021, the portion of criticized and classified loans and leases guaranteed by the SBA or USDA totaled $188.7 million resulting in unguaranteed exposure risk of $152.5 million, or 7.9% of total held for investment unguaranteed exposure carried at historical cost. This compares to the December 31, 2020 portion of criticized and classified loans and leases guaranteed by the SBA or USDA which totaled $168.9 million resulting in unguaranteed exposure risk of $142.5 million, or 8.2% of total held for investment unguaranteed exposure carried at historical cost. As of March 31, 2021, loans and leases carried at historical cost within the following verticals comprise the largest portion of the total potential problem and classified loans and leases: Educational Services at 17.3%, Wine and Craft Beverage at 16.3%, Entertainment Centers at 13.6%, Hotels at 10.2%, Healthcare at 9.5%, Self Storage at 7.8%, Fitness Centers at 6.9%, and Veterinary at 4.3%. As of December 31, 2020, loans and leases carried at historical cost within the following verticals comprise the largest portion of the total potential problem and classified loans and leases: Educational Services at 15.3%, Wine and Craft Beverage at 14.3%, Hotels at 13.6%, Entertainment Centers at 12.5%, Healthcare at 10.3%, Fitness Centers at 7.2%, Self Storage at 6.4% and Veterinary at 4.5%. Other than Hotels which are a part of the Company’s Specialty Lending division, all of the above listed verticals are within the Company’s Small Business Banking division. During the first quarter of 2021 the amount of potential problem loans in the Hotel vertical decreased by $7.3 million principally as a result of one large hotel loan payoff. The majority of the $29.8 million first quarter increase in potential problem and classified loans and leases was comprised of borrowers largely concentrated in the Company’s more mature verticals. Furthermore, the Company believes that its underwriting and credit quality standards have continued to tighten with emphasis on new production in pandemic resilient verticals and increased monitoring of existing loans in pandemic susceptible verticals as the impacts and uncertainties COVID-19 continue to evolve. With this emphasis, systemic issues continued to appear within the Hotel, Wine and Craft Beverage, Fitness Centers, Educational Services, Entertainment Center and Quick Service Restaurants verticals due to stress related to the COVID-19 pandemic and have contributed to the increase in criticized and classified loans and leases. Loans and leases that experience insignificant payment delays and payment shortfalls are generally not individually evaluated for the purpose of estimating the allowance for credit losses. The Bank generally considers an “insignificant period of time” from payment delays to be a period of 90 days or less, unless the borrower was not past due at the time of a modification as a part of a COVID-19 assistance program. The Bank would consider a modification for a customer experiencing what is expected to be a short-term event that has temporarily impacted cash flow. This could be due, among other reasons, to illness, weather, impact from a one-time expense, slower than expected start-up, construction issues or other short-term issues. In all cases, credit personnel will review the request to determine if the customer is stressed and how the event has impacted the ability of the customer to repay the loan or lease long term. At March 31, 2021, the Company had $62.3 million in modified unguaranteed loans and leases for borrowers impacted by the COVID-19 pandemic. These modifications were primarily short-term payment deferrals generally no more than six-months in duration and accordingly are not considered troubled debt restructurings. As of May 4, 2021, the Company’s modified unguaranteed loans and leases for borrowers impacted by the COVID-19 pandemic was approximately $13.9 million, a decrease from March 31, 2021 due to borrowers beginning to emerge from deferral needs. 48 Management endeavors to be proactive in its approach to identify and resolve problem loans and leases and is focused on working with the borrowers and guarantors of these loans and leases to provide loan and lease modifications when warranted. Management implements a proactive approach to identifying and classifying loans and leases as special mention (also referred to as criticized), Risk Grade 5. At March 31, 2021, and December 31, 2020, Risk Grade 5 loans and leases, excluding loans measured at fair value, totaled $254.7 million and $237.5 million, respectively. The increase in Risk Grade 5 loans and leases, exclusive of loans measured at fair value, during the first quarter of 2021 was principally confined to three verticals: Educational Services ($11.3 million or 65.9%), Wine and Craft Beverage ($11.0 million or 64.0%) and Entertainment Centers ($7.6 million or 43.9%). Partially offsetting the above increases were declines in Risk Grade 5 loans principally concentrated in three verticals: Hotels ($6.9 million or 40.1%), Senior Care ($5.0 million or 29.1%) and Self Storage ($2.2 million or 12.7%). Other than Hotels, which are a part of the Company’s Specialty Lending division, all of the above listed verticals are within the Company’s Small Business Banking division. Lower levels of Risk Grade 5 loans in the Hotels are discussed above while the lower levels of loans in Senior Care and Self Storage were principally due to principally due to two previous Risk Grade 5 relationships continuing to experience stress and being downgraded to Risk Grade 6 during the first quarter. At March 31, 2021, approximately 100.0% of loans and leases classified as Risk Grade 5 are performing with only one relationship having payments past due more than 30 days. While the level of nonperforming assets fluctuates in response to changing economic and market conditions, in light of the relative size and composition of the loan and lease portfolio and management’s degree of success in resolving problem assets, management believes that a proactive approach to early identification and intervention is critical to successfully managing a small business loan portfolio. In conjunction with this, management believes that volumes of delinquencies may not be an accurate depiction of the borrower’s repayment abilities under the current pandemic induced circumstances due to payments being made by the SBA on behalf of borrower with loans under its programs. As government payment assistance began to expire toward the end of 2020, borrowers with continuing difficulties arising from the pandemic were provided additional relief through payment deferrals. Management monitors these borrowers closely and has observed financial conditions continuing to improve. Management has also noted that most loans with expired government assistance have been able to resume making regular payments in early 2021. Allowance for Credit Losses on Loans and Leases See Note 1. Organization and Summary of Significant Accounting Policies of the Notes to the Consolidated Financial Statements in the Company’s 2020 Form 10-K for a description of the methodologies used to estimate the allowance for credit losses. The ACL of $52.3 million at December 31, 2020 increased by $111 thousand, or 0.2%, to $52.4 million at March 31, 2021. The ACL, as a percentage of loans and leases held for investment at historical cost amounted to 1.1% at March 31, 2021 and 1.2% at December 31, 2020. Excluding PPP loans and related reserves, the ACL, as a percentage of loans and leases held for investment at historical cost amounted to 1.6% and 1.8% at March 31, 2021 and December 31, 2020, respectively. The slight increase in the ACL during the first quarter was primarily due to impact of growth in loan and lease originations being largely mitigated by the effects of improved forecasts related to employment and default expectations as the economic outlook has continued to improve, combined with the effects of a $1.7 million recovery from a previously charged-off hotel loan , as addressed more fully in the Provision for Loan and Lease Credit Losses section of Results of Operations. Actual past due held for investment loans and leases, inclusive of loans measured at fair value, have decreased by $12.1 million since December 31, 2020. Total loans and leases 90 or more days past due increased $2.5 million, or 4.0%, compared to December 31, 2020. The increase was comprised of a $3.9 million decrease in unguaranteed offset by a $6.4 million increase in the guaranteed portions of past due loans compared to December 31, 2020. At March 31, 2021 and December 31, 2020, total held for investment unguaranteed loans and leases past due as a percentage of total held for investment unguaranteed loans and leases, inclusive of loans measured at fair value, was 0.9% and 1.1%, respectively. Total unguaranteed loans and leases past due were comprised of $18.9 million carried at historical cost, an decrease of $4.2 million, and $5.8 million measured at fair value, a decrease of $462 thousand as of March 31, 2021 compared to December 31, 2020. Management continues to actively monitor and work to improve asset quality. Management believes the ACL of $52.4 million at March 31, 2021 is appropriate in light of the risk inherent in the loan and lease portfolio. Management’s judgments are based on numerous assumptions about current and expected events that it believes to be reasonable, but which may or may not be valid, including but not limited to factors related to the above mentioned SBA delinquency effect and pandemic-susceptible verticals. Accordingly, no assurance can be given that management’s ongoing evaluation of the loan and lease portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the ACL, thus adversely affecting the Company’s operating results. Additional information on the ACL is presented in Note 5. Loans and Leases Held for Investment and Credit Quality of the Notes to the Unaudited Condensed Consolidated Financial Statements in this report. 49 Liquidity Management Liquidity management refers to the ability to meet day-to-day cash flow requirements based primarily on activity in loan and deposit accounts of the Company’s customers. Liquidity is immediately available from four major sources: (a) cash on hand and on deposit at other banks; (b) the outstanding balance of federal funds sold; (c) the market value of unpledged investment securities; and (d) availability under lines of credit. At March 31, 2021, the total amount of these four items was $3.38 billion, or 40.1% of total assets, an increase of $322.5 million from $3.06 billion, or 38.8% of total assets, at December 31, 2020. Loans and other assets are funded by loan sales, wholesale deposits, core deposits and PPPLF borrowings. To date, an increasing retail deposit base and an increased long term wholesale deposit base along with PPPLF borrowings have been adequate to meet loan obligations, while maintaining the desired level of immediate liquidity. Additionally, the investment securities portfolio is available for both immediate and secondary liquidity purposes. At March 31, 2021, none of the investment securities portfolio was pledged to secure public deposits or pledged to retail repurchase agreements, leaving $775.2 million available as lendable collateral. Contractual Obligations The following table presents the Company’s significant fixed and determinable contractual obligations by payment date as of March 31, 2021. The payment amounts represent those amounts contractually due to the recipient. The table excludes liabilities recorded where management cannot reasonably estimate the timing of any payments that may be required in connection with these liabilities. Payments Due by Period Total Less than One Year One to Three Years Three to Five Years More than Five Years Contractual Obligations Deposits without stated maturity $ 3,178,069 $ 3,178,069 $ — $ — $ — Time deposits 3,137,935 2,011,064 569,062 301,987 255,822 Borrowings 1,465,961 9,303 1,430,319 20,846 5,493 Operating lease obligations 3,295 744 1,102 257 1,192 Total $ 7,785,260 $ 5,199,180 $ 2,000,483 $ 323,090 $ 262,507 As of March 31, 2021, and December 31, 2020, the Company had unfunded commitments to provide capital contributions for on-balance sheet investments in the amount of $12.4 million and $15.8 million, respectively. Asset/Liability Management and Interest Rate Sensitivity One of the primary objectives of asset/liability management is to maximize the net interest margin while minimizing the earnings risk associated with changes in interest rates. One method used to manage interest rate sensitivity is to measure, over various time periods, the interest rate sensitivity positions, or gaps. As of March 31, 2021, the balance sheet’s total cumulative gap position was asset-sensitive at 2.7%. The interest rate gap method, however, addresses only the magnitude of asset and liability repricing timing differences as of the report date and does not address earnings, market value, changes in account behaviors based on the interest rate environment, nor growth. Therefore, management uses an earnings simulation model to prepare, on a regular basis, earnings projections based on a range of interest rate scenarios to measure interest rate risk more accurately. As of March 31, 2021, the Company’s interest rate risk profile under the earnings simulation model method remains asset-sensitive. An asset-sensitive position means that net interest income will generally move in the same direction as interest rates. For instance, if interest rates increase, net interest income can be expected to increase, and if interest rates decrease, net interest income can be expected to decrease. The Company attempts to mitigate interest rate risk by match funding assets and liabilities with similar rate instruments. The quarterly revaluation adjustment to the servicing asset, however, adjusts in an opposite direction to interest rate changes. Asset/liability sensitivity is primarily derived from the prime-based loans that adjust as the prime interest rate changes, rates on cash accounts that adjusts as the federal funds rate changes and the longer duration of indeterminate term deposits. 50 Capital The maintenance of appropriate levels of capital is a management priority and is monitored on a regular basis. The Company’s principal goals related to the maintenance of capital are to provide adequate capital to support the Company’s risk profile consistent with the risk appetite approved by the Board of Directors; provide financial flexibility to support future growth and client needs; comply with relevant laws, regulations, and supervisory guidance; achieve optimal credit ratings for the Company and its subsidiaries; and provide a competitive return to shareholders. Management regularly monitors the capital position of the Company on both a consolidated and bank level basis. In this regard, management’s goal is to maintain capital at levels that are in excess of the regulatory “well capitalized” levels. Risk-based capital ratios, which include Tier 1 Capital, Total Capital and Common Equity Tier 1 Capital, are calculated based on regulatory guidance related to the measurement of capital and risk-weighted assets. Capital amounts and ratios as of March 31, 2021 and December 31, 2020, are presented in the table below. Actual Minimum Capital Requirement Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions (1) Amount Ratio Amount Ratio Amount Ratio Consolidated - March 31, 2021 Common Equity Tier 1 (to Risk-Weighted Assets) $ 554,527 12.16 % $ 205,237 4.50 % N/A N/A Total Capital (to Risk-Weighted Assets) 607,362 13.32 364,866 8.00 N/A N/A Tier 1 Capital (to Risk-Weighted Assets) 554,527 12.16 273,649 6.00 N/A N/A Tier 1 Capital (to Average Assets) 554,527 8.50 260,985 4.00 N/A N/A Bank - March 31, 2021 Common Equity Tier 1 (to Risk-Weighted Assets) $ 503,391 11.39 % $ 198,865 4.50 % $ 287,250 6.50 % Total Capital (to Risk-Weighted Assets) 556,227 12.59 353,538 8.00 441,923 10.00 Tier 1 Capital (to Risk-Weighted Assets) 503,391 11.39 264,154 6.00 353,538 8.00 Tier 1 Capital (to Average Assets) 503,391 7.76 259,401 4.00 324,251 5.00 Consolidated - December 31, 2020 Common Equity Tier 1 (to Risk-Weighted Assets) $ 521,568 12.15 % $ 193,172 4.50 % N/A N/A Total Capital (to Risk-Weighted Assets) 574,621 13.39 343,417 8.00 N/A N/A Tier 1 Capital (to Risk-Weighted Assets) 521,568 12.15 257,563 6.00 N/A N/A Tier 1 Capital (to Average Assets) 521,568 8.40 248,417 4.00 N/A N/A Bank - December 31, 2020 Common Equity Tier 1 (to Risk-Weighted Assets) $ 470,069 11.25 % $ 188,012 4.50 % $ 271,573 6.50 % Total Capital (to Risk-Weighted Assets) 522,305 12.50 334,243 8.00 417,804 10.00 Tier 1 Capital (to Risk-Weighted Assets) 470,069 11.25 250,683 6.00 334,243 8.00 Tier 1 Capital (to Average Assets) 470,069 7.60 247,288 4.00 309,110 5.00 (1) Prompt corrective action provisions are not applicable at the bank holding company level. Critical Accounting Policies and Estimates The preparation of consolidated financial statements in accordance with GAAP requires the Company to make estimates and judgments that affect reported amounts of assets, liabilities, income and expenses and related disclosure of contingent assets and liabilities. The Company bases estimates on historical experience and on various other assumptions that are believed to be reasonable under current circumstances, results of which form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. Estimates are evaluated on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions. 51 Accounting policies, as described in detail in the Notes to the Company’s Unaudited Condensed Consolidated Financial Statements in this report and in the Company’s Annual Report on Form 10-K for the year ended December 31, 20 20 , are an integral part of the Company’s consolidated financial statements. A thorough understanding of these accounting policies is essential when reviewing the Company’s reported results of operations and financial position. Management believes that the critical accounting policies and estimates listed below require the Company to make difficult, subjective or complex judgments about matters that are inherently uncertain. • Determination of the allowance for credit losses on loans and leases; • Valuation of loans accounted for under the fair value option; • Valuation of servicing assets; • Valuation of equity security investments where no readily available market price exists; • Consideration of significant influence for certain relationships where we have equity interests; • Income taxes; • Restricted stock unit awards with market price conditions; • Valuation of foreclosed assets; and • Business combination and goodwill. Changes in these estimates, that are likely to occur from period to period, or the use of different estimates that the Company could have reasonably used in the current period, would have a material impact on the Company’s financial position, results of operations or liquidity.