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Item 2. Management’s Discussion and Analysis

2022-05-06 compared with 2021-11-05 · 146 added, 150 removed, 409 unchanged (42% of the section changed)

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Information contained in or linked from our websites is not incorporated into and does not constitute a part of this report.

Critical Accounting Policies and Estimates

The following discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements and the notes thereto, which have been prepared in accordance with GAAP and accounting practices in the banking industry.

Certain of those accounting policies are considered critical accounting policies, because they require us to make estimates and assumptions regarding circumstances or trends that could materially affect the value of those assets, such as economic conditions or trends that could impact our ability to fully collect our loans or ultimately realize the carrying value of certain of our other assets.

Those estimates and assumptions are made based on current information available to us regarding those economic conditions or trends or other circumstances.

If changes were to occur in the events, trends or other circumstances on which our estimates or assumptions were based, these changes could have a material adverse effect on the carrying value of assets and liabilities and on our results of operations.

We have identified two policies and estimates as being critical because they require management to make particularly difficult, subjective, and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions.

These policies relate to the allowance for credit losses and the valuation of single family mortgage servicing rights.

These policies and estimates are described in further detail in Part II, Item 7- Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 1, Summary of Significant Accounting Policies, within our 2020 Annual Report on Form 10-K.

Critical Accounting Estimates

We have identified two estimates as being critical because they require management to make particularly difficult, subjective, and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions.

These policies relate to the allowance for credit losses (“ACL”) and the valuation of single family mortgage servicing rights (“MSRs").

The ACL is calculated based on quantitative and qualitative factors to estimate credit losses over the life of the loan.

The inputs used to determine quantitative factors include estimates based on historical experience of probability of default and losses given default.

Inputs used to determine qualitative factors include changes in current portfolio characteristics and operating environments such as current and forecasted unemployment rates, capitalization rates used to value properties securing loans, rental rates and single family pricing indexes.

Qualitative factors may also include adjustments to address matters not contemplated by the model and to assumptions used to determine qualitative factors.

Although we believe that our methodology for determining an appropriate level for the ACL adequately addresses the various components that could potentially result in credit losses, the processes and their elements include features that may be susceptible to significant change.

Any unfavorable

differences between the actual outcome of credit-related events and our estimates could require an additional provision for credit losses.

For example, if the projected unemployment rate was downgraded one grade, the amount of the ACL on March 31, 2022 would increase by approximately $6 million.

This sensitivity analysis is hypothetical and has been provided only to indicate the potential impact that changes in assumptions may have on the ACL estimate.

The valuation of MSRs is based on various assumptions which are set forth in Note 7– Mortgage Banking Operations of the financial statements.

Note 7 also provides sensitivity analysis based on the assumptions used.

The sensitivity analyses are hypothetical and have been provided to indicate the potential impact that changes in assumptions may have on the estimate of the value of MSRs.

Summary Financial Data

Quarter Ended Nine Months Ended September 30,

(in thousands, except per share data and FTE data) September 30, 2021 June 30, 2021 2021 2020

Quarter Ended

(in thousands, except per share data and FTE data) March 31, 2022 December 31, 2021 March 31, 2021

Select Income Statement data:

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For a reconciliation of return on average tangible equity to the nearest comparable GAAP financial measure, see “Non-GAAP Financial Measures” elsewhere in this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

(in thousands, except share and per share data) September 30, 2021 December 31, 2020

(in thousands, except share and per share data) March 31, 2022 December 31, 2021

Selected Balance Sheet Data

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Deposits 6,270,535 6,146,509

273,000 41,000

Long-term debt 224,137 126,026

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For a reconciliation to the nearest comparable GAAP financial measure, see “Non-GAAP Financial Measures” elsewhere in this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

(2) This ratio excludes balances insured by the FHA or guaranteed by the VA or SBA, including PPP loans.

(2) This ratio excludes balances insured by the FHA or guaranteed by the VA or SBA.

Current Developments

COVID-19 Pandemic Update

We continue to monitor the spread of COVID-19 in our communities and adapt to changes in guidance from local healthcare officials.

We have taken measures to mitigate opportunities for spread and to help provide a safe environment for our team members.

Our initial response included a business continuity plan with a remote working strategy, social distancing and sanitation plan.

We continue to monitor this plan to adapt to recent developments.

We continue to take significant measures to protect our employees, such as having most work remotely and where remote work is not viable, implementing a social distancing and sanitation plan.

As a federal contractor, we believe we are subject to the Safer Federal Workforce COVID-19 Workplace Safety:

Guidance for Federal Contractors and Subcontractors which will require vaccinations for most if not all of our employees beginning in December 2021.

If we are not subject to the vaccine requirements for federal contractors, as a company with more than 100 employees we will be subject instead to the Department of Labor’s Occupational Safety and Health Administration ("OSHA") to Emergency Temporary Standard issued on November 4, 2021 which required that all employers with at least 100 employees ensure that their employees are fully vaccinated for COVID-19 or require employees to obtain a negative COVID-19 test at least once a week.

Employers must comply with most requirements under the Emergency Temporary Standard by December 4, 2021 and with testing requirements by January 4, 2022.

Any requirement to mandate COVID-19 vaccination of our workforce or require our unvaccinated employees to be tested weekly could result in employee attrition and difficulty securing future labor needs, and may have an adverse effect on our future revenues, costs, and results of operations.

At September 30, 2021, all of our retail deposit branches were open to serve our customers and communities.

We participated in the Small Business Administration’s ("SBA") Paycheck Protection Program (“PPP”), and during 2021 we funded 1,384 loans with balances of $159 million under the PPP.

As of September 30, 2021, PPP outstanding loan balances were $77 million.

The loans funded through the PPP program are fully guaranteed by the U.S.

Through September 30, 2021, cumulative PPP loans forgiven totaled $368 million.

As part of our capital management strategy, during the first nine months of 2021, we repurchased a total of 1,498,974 shares of our common stock at an average price of $43.36 per share.

On October 28, 2021, the Board of Directors approved an expansion of the Company's share repurchase program for up to $20 million of its common stock.

Management's Overview of the Third Quarter 2021 Financial Performance

Third Quarter of 2021 Compared to the Second Quarter of 2021

Our net income and income before taxes were $27.2 million and $34.8 million, respectively, in the third quarter of 2021, as compared to $29.2 million and $37.4 million, respectively, in the second quarter of 2021.

The $2.5 million decrease in income before taxes was due to lower net interest income and lower noninterest income, which was partially offset by a higher recovery of our allowance for credit losses and lower noninterest expenses.

On January 19, 2022, we completed a $100 million subordinated notes offering due in 2032 (the “Notes”).

Interest on the Notes initially will accrue at a rate equal to 3.5% per annum from and including the date of original issuance to, but excluding, January 30, 2027, payable semiannually in arrears.

From and including January 30, 2027, to, but excluding, the maturity date

or the date of earlier redemption, the Notes will bear interest equal to the three-month term SOFR plus 215 basis points, payable quarterly in arrears.

Net proceeds were $98 million, after deducting underwriting discounts and offering expenses.

We used a significant portion of the net proceeds from the Notes offering to repurchase shares of our common stock through open market purchases and we plan to use the remainder of the net proceeds for working capital and other general corporate purposes, including support for growth of our assets.

As part of our capital management strategy, during the first three months of 2022, we repurchased a total of 1,471,485 shares of our common stock at an average price of $50.97 per share.

As part of our business strategy, we are focusing on growing our loan portfolio and leveraging our existing operating expense infrastructure.

Increases in our loan portfolio will have the effect of increasing our level of net interest income in future periods, a more stable source of revenues as compared to gain on loan origination and sale activities.

As part of this strategy, we did not sell any multifamily portfolio loans in the first quarter of 2022.

Management's Overview of the First Quarter 2022 Financial Performance

First Quarter of 2022 Compared to the Fourth Quarter of 2021

Our net income and income before taxes were $20.0 million and $24.6 million, respectively, in the first quarter of 2022, as compared to $29.4 million and $37.7 million, respectively, in the fourth quarter of 2021.

The $13.1 million decrease in income before taxes was due to lower net interest income, lower noninterest income and higher noninterest expenses, partially offset by a higher recovery of our allowance for credit losses.

Income Taxes:

Our effective tax rate was 22.0% in both the second and third quarter of 2021 as compared to a statutory rate of 23.5%.

Our effective tax rate was 19.0% in the first quarter of 2022 as compared to 22.0% in fourth quarter of 2021 and a statutory rate of 23.4%.

Our effective tax rate was lower than our statutory rate due to the benefits of tax advantaged investments.

Additionally, our effective tax rate in the first quarter of 2022 was lower than the fourth quarter of 2021 due to reductions in taxes on income related to excess tax benefits resulting from the vesting of stock awards during the first quarter.

Net Interest Income:

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Quarter Ended

September 30, 2021 June 30, 2021

March 31, 2022 December 31, 2021

(in thousands) Average

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Liabilities and shareholders' equity:

Interest-bearing deposits:

Demand deposits

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886,416 1,020 0.47 % 932,559 1,187 0.51 %

Total deposits

4,525,730 2,507 0.22 % 4,577,504 2,773 0.24 %

Total 4,513,631 2,284 0.21 % 4,591,239 2,481 0.21 %

64,557 91 0.56 % 25,711 48 0.73 %

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Net interest margin 3.27 % 3.34 %

(1) Includes taxable-equivalent adjustments primarily related to tax-exempt income on certain loans and securities of $0.9 million for both the quarters ended September 30, 2021 and June 30, 2021.

(1) Includes taxable-equivalent adjustments primarily related to tax-exempt income on certain loans and securities of $0.9 million for tboth quarters ended March 31, 2022 and December 31, 2021.

The estimated federal statutory tax rate was 21% for the periods presented.

(2) Cost of all deposits, including noninterest-bearing demand deposits was 0.16% and 0.18% for the quarter ended September 30, 2021 and June 30, 2021, respectively.

Net interest income was lower in the third quarter of 2021 as compared to the second quarter of 2021 primarily due to a $1.7 million decrease in interest income derived from Paycheck Protection Program (“PPP”) loans.

This was partially offset by higher levels of non-PPP loans.

Excluding the impact of PPP loans, our net interest margin in the third quarter of 2021 was consistent with our net interest margin in the second quarter of 2021.

(2) Cost of all deposits, including noninterest-bearing demand deposits was 0.15% and 0.16% for the quarter ended March 31, 2022 and December 31, 2021, respectively.

Net interest income was $2.5 million lower in the first quarter of 2022 as compared to the fourth quarter of 2021 primarily due to lower average loan balances, a $0.7 million increase in interest expense related to the $100 million subordinated notes offering completed in January 2022 and a $0.6 million decrease in income from Paycheck Protection Program loans.

The lower average loan balances were primarily due to the sale of $244 million of multifamily loans in November of 2021 which was partially offset by the increase in loan balances during the first quarter.

Provision for Credit Losses:

As a result of the continued favorable performance of our loan portfolio, a stable low level of nonperforming assets and an improved outlook of the estimated impact of COVID-19 on our loan portfolio, we recorded a $5 million recovery of our allowance for credit losses in the third quarter of 2021, as compared to a $4 million recovery of our allowance for credit losses in the second quarter of 2021.

Noninterest Income consisted of the following for the periods indicated:

As a result of the continued favorable performance of our loan portfolio, a stable low level of nonperforming assets and an improved outlook of the estimated impact of COVID-19 on our loan portfolio, we recorded a $9 million recovery of our allowance for credit losses in the first quarter of 2022, as compared to a $6 million recovery of our allowance for credit losses in the fourth quarter of 2021.

Noninterest Income consisted of the following:

Quarter Ended

(in thousands) September 30, 2021 June 30, 2021

(in thousands) March 31, 2022 December 31, 2021

Noninterest income

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$ 6,169 $ 10,578

Commercial real estate, multifamily and SBA 3,260 5,435

CRE, multifamily and SBA 2,105 9,501

Loan servicing income 3,304 2,540

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(1) May include loans originated as held for investment.

Loan servicing income, a component of noninterest income, consisted of the following for the periods indicated:

Loan servicing income, a component of noninterest income, consisted of the following:

Quarter Ended

(in thousands) September 30, 2021 June 30, 2021

(in thousands) March 31, 2022 December 31, 2021

Single family servicing income, net

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(3,425) (4,216)

(701) (1,206)

Risk management, single family MSRs:

Changes in fair value due to assumptions (2)

Net gain (loss) from derivatives hedging (293) 5,024

Net gain (loss) from economic hedging (10,183) (378)

Single Family servicing income (loss) 566 (531)

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(2) Principally reflects changes in model assumptions, including prepayment speed assumptions, which are primarily affected by changes in mortgage interest rates.

The decrease in noninterest income in the third quarter of 2021 as compared to the second quarter of 2021 was due to a $3.8 million decrease in gain on loan origination and sale activities.

The decrease in gain on loan origination and sale activities was primarily due to a lower volume of single family rate locks and lower levels of CRE loans sold in the third quarter of 2021 as compared to the second quarter of 2021.

Noninterest Expense consisted of the following for the periods indicated:

The decrease in noninterest income in the first quarter of 2022 as compared to the fourth quarter of 2021 was due to a $11.8 million decrease in gain on loan origination and sale activities and a $1.9 million decrease in other income which were partially offset by a $0.8 million increase in loan servicing income.

The decrease in gain on loan origination and sale activities was due to a $4.4 million decrease in single family gain on loan origination and sale activities and a $7.4 million decrease in commercial real estate (“CRE”) and commercial gain on loan origination and sale activities.

The decrease in single family gain on loan origination and sale activities was due to a decrease in rate lock volume and margins as a result of the effects of increasing interest rates.

The decrease in CRE and commercial gain on loan origination and sale activities was primarily due to an 84% decrease in the volume of loans sold.

The decrease in other income was due to a $1.0 million decrease in revenues from investments in community development entities and $0.6 million gain on sale of other real estate owned realized in the fourth quarter.

Noninterest Expense consisted of the following:

Quarter Ended

(in thousands) September 30, 2021 June 30, 2021

(in thousands) March 31, 2022 December 31, 2021

Noninterest expense

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Total noninterest expense $ 54,473 $ 53,971

The $0.9 million decrease in noninterest expense in the third quarter of 2021 as compared to the second quarter of 2021 was primarily due to lower compensation and benefits costs partially offset by higher general, administrative and other costs.

The reduction in compensation and benefit costs was due to reductions in commission expense related to lower levels of loans closed for our single family mortgage operations and lower benefit costs due to third quarter seasonality.

General, administrative and other costs increased due to a $1.9 million reimbursement of legal costs received from our insurance carrier in the second quarter of 2021 and higher marketing costs.

Nine Months Ended September 30, 2021 Compared to Nine Months Ended September 30, 2020

Our net income and income before taxes were $86.0 million and $109.0 million, respectively, in the nine months ended September 30, 2021, as compared to $52.4 million and $66.6 million, respectively, in the nine months ended September 30, 2020.

The $42.3 million increase in income before taxes was due to higher net interest income, lower provision for credit losses and lower noninterest expense, partially offset by lower noninterest income.

The $0.5 million increase in noninterest expense in the first quarter of 2022 as compared to the fourth quarter of 2021 was primarily due to higher compensation and benefits and occupancy costs, partially offset by lower general, administrative and other costs.

The higher level of compensation and benefit costs reflect a $1.0 million reversal of previously accrued medical benefits related to the positive experience in our self-insured medical program in the fourth quarter.

Occupancy costs increased due to common area maintenance rent increases and accelerated depreciation in the first quarter of 2022.

Legal costs, which are included in general, administrative and other costs, were $1.4 million lower in the first quarter of 2022 as compared to the fourth quarter of 2021 due to higher nonrecurring costs expended on litigation activities and legal matters in the fourth quarter.

First Quarter of 2022 Compared to First Quarter of 2021

Our net income and income before taxes were $20.0 million and $24.6 million, respectively, in the first quarter of 2022, as compared to $29.7 million and $36.7 million, respectively, in the first quarter of 2021.

The $12.1 million decrease in income before taxes was due to lower noninterest income, partially offset by a recovery of our allowance for credit losses in 2022 and lower noninterest expense.

Income Taxes:

Our effective tax rate during the nine months ended September 30, 2021 was 21.1% as compared to 21.4% in the nine months ended September 30, 2020 and a statutory rate of 23.5%.

Our effective tax rate was lower than our statutory rate due primarily to the benefits of tax advantaged investments.

Our effective tax rate during first quarter of 2022 was 19.0% as compared to 19.3% in the first quarter of 2021 and a statutory rate of 23.4%.

Our effective tax rate for both periods was lower than our statutory rate due to the benefits of tax advantaged investments and reductions in taxes on income related to excess tax benefits resulting from the exercise and vesting of stock awards during the quarter.

Net Interest Income:

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and (v) net yield on interest-earning assets:

Nine Months Ended September 30,

Quarter Ended March 31,

(in thousands) Average

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Interest-bearing liabilities:

Interest-bearing deposits:

Demand deposits

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886,416 1,020 0.47 % 1,180,290 2,253 0.77 %

Total deposits

4,563,927 8,930 0.26 % 4,293,745 29,118 0.90 %

Total 4,513,631 2,284 0.21 % 4,589,126 3,650 0.32 %

64,557 91 0.56 % 203,621 161 0.32 %

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Net interest margin 3.27 % 3.29 %

(1) Includes taxable-equivalent adjustments primarily related to tax-exempt income on certain loans and securities of $2.6 million for both the nine months ended September 30, 2021 and 2020.

(1) Includes taxable-equivalent adjustments primarily related to tax-exempt income on certain loans and securities of $0.9 million and $0.8 million for the quarters ended March 31, 2022 and 2021, respectively.

The estimated federal statutory tax rate was 21% for the periods presented.

(2) Cost of deposits including noninterest-bearing deposits, was 0.20% and 0.70% for the nine months ended September 30, 2021 and 2020, respectively.

Net interest income was higher in the nine months ended September 30, 2021 as compared to the nine months ended September 30, 2020 due to a $114 million increase in interest earning assets and an increase in our net interest margin from 3.09% in the nine months ended September 30, 2020 to 3.39% in the nine months ended September 30, 2021.

The increase in interest earning assets was due to an increase in total loans.

The increase in our net interest margin was due to a 42 basis point increase in our net interest rate spread as decreases in the rates paid on interest bearing liabilities were greater than the decreases in yields on our interest earning assets.

The 17 basis point decrease in yield on interest earning assets was due to the origination of loans and purchases of securities at current market rates which were below our portfolio rates, the repricing down of variable rate loans and the prepayment and paydown of higher yielding loans and investments in our portfolios.

Our cost of interest-bearing

liabilities decreased from 0.96% in the nine months ended September 30, 2020 to 0.37% in the nine months ended September 30, 2021 due to a decrease in market interest rates which allowed us to reprice our deposits and borrowings at lower rates.

(2) Cost of deposits including noninterest-bearing deposits, was 0.15% and 0.25% for the quarters ended March 31, 2022 and 2021, respectively.

Net interest income was stable in the first quarter of 2022 as compared to the first quarter of 2021 as increases in the average balance of loans was offset by a decrease in the net interest margin.

Our net interest margin decreased slightly from 3.29% in the first quarter of 2021 compared to 3.27% in the first quarter of 2022 as a six basis point decrease in our yield on interest earning assets was offset by a four basis point decrease in the rate on interest-bearing liabilities.

The decrease in yield on interest earning assets was primarily due to the prepayment and paydown of higher yielding loans and investments in our portfolios during 2021.

Our cost of interest-bearing liabilities decreased due to decreases in market interest rates during 2021 which was partially offset by the impact of the $100 million subordinated notes offering completed in January 2022.

The increase in the average balance of loans reflects the increases in our loans held for investment that occurred in 2021 and in the first quarter of 2022.

Provision for Credit Losses:

As a result of the favorable performance of our loan portfolio, a stable low level of nonperforming assets and an improved outlook of the estimated impact of COVID-19 on our loan portfolio, we recorded a $9 million recovery of our allowance for credit losses in the nine months ended September 30, 2021.

Due to adverse economic conditions related to the COVID-19 pandemic, in the nine months ended September 30, 2020 we recorded a $20.5 million provision for credit losses as an estimate of the potential adverse impact of those conditions on our loan portfolio.

Noninterest Income consisted of the following for the periods indicated:

Nine Months Ended September 30,

We recorded no provision for credit losses in the first quarter of 2021.

Noninterest Income consisted of the following:

Quarter Ended March 31,

(in thousands) 2022 2021

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$ 6,169 $ 26,187

15,967 11,947

Loan servicing income 3,304 748

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(1) May include loans originated as held for investment.

Loan servicing income, a component of noninterest income, consisted of the following for the periods indicated:

Nine Months Ended September 30,

Loan servicing income, a component of noninterest income, consisted of the following:

Quarter Ended March 31,

(in thousands) 2022 2021

4 unchanged sentences

(3,425) (5,693)

(3,665) 1,111

Risk management, single family MSRs:

1 unchanged sentence

10,303 11,463

Net loss from derivatives hedging (7,860) 22,148

Net gain (loss) from economic hedging (10,183) (12,591)

Single Family servicing income (loss) 566 (2,886)

5 unchanged sentences

(2) Principally reflects changes in model assumptions, including prepayment speed assumptions, which are primarily affected by changes in mortgage interest rates.

The decrease in noninterest income for the nine months ended September 30, 2021 as compared to the nine months ended September 30, 2020 was due to a decrease in gain on loan origination and sale activities and loan servicing income.

The $13.5 million decrease in gain on loan origination and sale activities was due to a $17.5 million decrease in single family gain on loan origination and sale activities which was partially offset by a $4.0 million increase in commercial real estate (“CRE”) and commercial gain on loan origination and sale activities.

The decrease in single family gain on loan origination and sale activities was due primarily to a 22% decrease in rate locks.

The increase in CRE and commercial gain on loan origination and sale activities was due to a 44% increase in the realized gain on sale which was partially offset by a 7% decrease in the volume of loans sold.

The $2.2 million decrease in loan servicing income was due to a $5.6 million decrease in single family servicing income which was partially offset by a $3.4 million increase in commercial loan servicing income.

The decrease in single family servicing income was due primarily to increased amortization of single family MSRs due to higher levels of prepayments and a $0.9 million decrease in risk management results.

The increase in commercial loan servicing income was primarily due to higher levels of prepayment fees.

Noninterest Expense consisted of the following for the periods indicated:

Nine Months Ended September 30,

The decrease in noninterest income for the first quarter of 2022 as compared to the first quarter of 2021 was due to decreases in gain on loan origination and sale activities, which was partially offset by higher loan servicing income.

The $25.2 million decrease in gain on loan origination and sale activities was due to a $20.0 million decrease in single family gain on loan origination and sale activities and a $5.2 million decrease in CRE and commercial gain on loan origination and sale activities.

The decrease in single family gain on loan origination and sale activities was due to a decrease in rate lock volume and margins as a result of the effects of increasing interest rates.

The decrease in CRE and commercial gain on loan origination and sale activities was primarily due to a 81% decrease in the volume of loans sold.

The $2.6 million increase in loan servicing income was primarily due to lower levels of prepayments and improved risk management results.

Noninterest Expense consisted of the following:

Quarter Ended March 31,

(in thousands) 2022 2021

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Total noninterest expense $ 54,473 $ 56,608

The $9.5 million decrease in noninterest expense in the nine months ended September 30, 2021 as compared to the nine months ended September 30, 2020 was due to lower information services expense, occupancy expense and general, administrative and other expenses.

The $1.7 million decrease in information services costs was primarily due to lower core processing costs related to a renegotiation of our contract.

The $4.9 million decrease in occupancy expenses was primarily due to $4.4 million of impairments related to ongoing restructuring of our facilities recognized in the nine months ended September 30, 2020, with no similar charges in 2021.

The $2.9 million decrease in general, administrative and other costs was due to a $1.9 million reimbursement of legal costs received from our insurance carrier in the second quarter of 2021 and $1.0 million of charges incurred in 2020 related to our efficiency improvement initiatives, which were partially offset by a $0.6 million increase in marketing costs.

The $2.1 million decrease in noninterest expense in the first quarter of 2022 as compared to the first quarter of 2021 was due to lower compensation and benefit costs, partially offset by an increase in general, administrative and other expenses.

The $3.8 million decrease in compensation and benefits expense is primarily due to reduced commission expense on lower loan origination volumes in our single family mortgage operations.

The increase in general, administrative and other costs was due to charges related to nonrecurring costs expended on litigation activities and legal matters in the first quarter of 2022.

Financial Condition

During the nine months ended September 30, 2021, total assets increased by $135 million due to a $120 million increase in loans held for investment and a $161 million increase in cash, partially offset by decreases in investments and other assets.

Loans held for investment increased due to $2.5 billion of originations, which were partially offset by prepayments and scheduled payments of $2.0 billion and transfer of loans to loans held for sale of $391 million.

Total liabilities increased primarily due to a $538 million increase in deposits, partially offset by a $323 million decrease in borrowings.

The decrease in borrowings reflect the reduced need of wholesale funding resulting from the increase in deposits.

The growth in deposits was due to new customers and increases in existing customer balances.

During the first quarter of 2022, total assets increased $307 million due primarily to a $331 million increase in loans held for investment and a $77 million increase in investment securities which were partially offset by a decrease of $117 million in loans held for sale.

Loans held for investment increased due to $747 million of originations, which were partially offset by prepayments and scheduled payments of $419 million.

Total liabilities increased $421 million due to increases in deposits, borrowings and long-term debt.

The $124 million increase in deposits was due to higher levels of business deposits and wholesale deposits.

The increase in borrowings was due to an increased need for wholesale borrowings to fund loan growth.

Long-term debt increased due to our $100 million subordinated debt offering in completed in January 2022.

Credit Risk Management

As of September 30, 2021, our ratio of nonperforming assets to total assets remained low at 0.26% while our ratio of total loans delinquent over 30 days to total loans was 0.54%.

The Company recorded a $9 million recovery of our allowance for credit losses for the nine months ended September 30, 2021.

As of March 31, 2022, our ratio of nonperforming assets to total assets remained low at 0.17% while our ratio of total loans delinquent over 30 days to total loans was 0.42%.

The Company recorded a $9 million recovery of our allowance for credit losses for the quarter ended March 31, 2022.

As a result of the COVID-19 pandemic, the Company has approved forbearances for some of its borrowers.

The status of these forbearances as of September 30, 2021 is as follows:

The status of these forbearances as of March 31, 2022 is as follows:

Forbearances Approved (2)(3)

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Each of these loans continued to make monthly payments under the existing or modified payment terms.

At September 30, 2021, two of these loans with $2 million in balances were still operating under the terms of their modification.

(3) There were no forbearances initiated in the third quarter of 2021.

At March 31, 2022, only one of these loans with a $1 million balance is still operating under the terms of their modification.

(3) There were no forbearances initiated in the first quarter of 2022.

The forbearances approved for commercial and industrial loans and CRE nonowner occupied loans were generally for a period of three months while the forbearances for single family, HELOCs and consumer loans were generally for a period of three to six months.

As of September 30, 2021, excluding the loans with forbearances still in place, 99% of the commercial and CRE loans approved for a forbearance have completed their forbearance period and have resumed payments.

The forbearance periods for the majority of single family and consumer loans granted forbearance that were not complete as of September 30, 2021 are scheduled to be completed in the fourth quarter of 2021.

As of March 31, 2022, excluding the loans with forbearances still in place, 99% of the commercial and CRE loans approved for a forbearance have completed their forbearance period and have resumed payments.

The forbearance periods for the majority of single family and consumer loans granted forbearance that were not complete as of March 31, 2022 are scheduled to be completed in the second quarter of 2022.

Management considers the current level of the ACL to be appropriate to cover estimated lifetime losses within our LHFI portfolio.

The following table presents the ACL by product type:

At September 30, 2021 At December 31, 2020

At March 31, 2022 At December 31, 2021

(in thousands) Amount Rate (1)

Amount Rate (1)

Commercial real estate loans

Non-owner occupied commercial real estate $ 9,636 1.28 % $ 8,845 1.07 %

Non-owner occupied CRE $ 2,294 0.33 % $ 7,509 1.06 %

Multifamily 8,427 0.31 % 5,854 0.24 %

2 unchanged sentences

456 1.24 % 507 1.34 %

Commercial real estate construction

351 1.96 % 1,670 6.12 %

CRE construction 184 1.02 % 150 1.06 %

Single family construction

4 unchanged sentences

Commercial and industrial loans

Owner occupied commercial real estate 5,285 1.18 % 4,994 1.08 %

Owner occupied CRE 3,536 0.76 % 5,006 1.10 %

Commercial business 6,910 1.83 % 12,273 3.39 %

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Total ACL $ 37,944 0.66 % $ 47,123 0.88 %

(1) The reserve rate is calculated excluding balances related to loans that are insured by the FHA or guaranteed by the VA or SBA, including PPP loans.

(1) The ACL rate is calculated excluding balances related to loans that are insured by the FHA or guaranteed by the VA or SBA.

Liquidity and Sources of Funds

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Interest payments and obligations related to leases and services are typically met by cash generated from our operations.

The Company does not have any obligation to repay long term debt within the next five years.

At September 30, 2021 and December 31, 2020, the Bank had available borrowing capacity of $1.1 billion and $550 million, respectively, from the FHLB, and $297 million and $406 million, respectively, from the Federal Reserve Bank of San Francisco and $1.0 billion and $1.2 billion under borrowing lines established with other financial institutions.

For the nine months ended September 30, 2021, cash and cash equivalents increased by $161 million compared to an increase of $21 million during the nine months ended September 30, 2020.

The Company has $64 million of Senior Notes which mature in 2026 which it expects to pay off from available cash or from the issuance of new debt.

At March 31, 2022 and December 31, 2021, the Bank had available borrowing capacity of $1.8 billion and $1.8 billion, respectively, from the FHLB, and $308 million and $274 million, respectively, from the FRBSF and $1.0 billion and $1.0 billion under borrowing lines established with other financial institutions.

For the quarter ended March 31, 2022, cash and cash equivalents increased by $9 million compared to an increase of $11 million during the quarter ended March 31, 2021.

As excess liquidity can reduce the Company’s earnings and returns, the Company manages its cash positions to minimize the level of excess liquidity and does not attempt to maximize the level of cash and cash equivalents.

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The Company's operating assets and liabilities are used to support our lending activities, including the origination and sale of mortgage loans.

For the nine months ended September 30, 2021, net cash of $182 million was provided by operating activities, primarily from cash proceeds from the sale of loans exceeding cash used to fund LHFS.

We believe that cash flows from operations, available cash balances and our ability to generate cash through short-term debt are sufficient to fund our operating liquidity needs.

For the nine months ended September 30, 2020, net cash of $40 million was used in operating activities, primarily from cash used to fund LHFS production exceeding cash proceeds from the sale of loans.

For the quarter ended March 31, 2022, net cash of $124 million was provided by operating activities, primarily from cash proceeds from the sale of loans exceeding cash used to fund LHFS.

For the quarter ended March 31, 2021, net cash of $2 million was used in operating activities, primarily from cash used to fund LHFS production exceeding cash proceeds from the sale of loans.

We believe that cash flows from operations, available cash balances and our ability to generate cash through short-term debt borrowings are sufficient to fund our operating liquidity needs.

We are currently not aware of any trends or demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in our liquidity increasing or decreasing in any material way that will impact our capital needs during or beyond the next 12 months.

Cash flows from investing activities

The Company's investing activities primarily include AFS securities and loans originated as held for investment.

For the nine months ended September 30, 2021, net cash of $155 million was used in investing activities primarily from the origination of LHFI net of principal repayments and the purchase of AFS securities, partially offset by the proceeds from the sale of loans originated as LHFI and AFS securities.

For the nine months ended September 30, 2020, net cash of $394 million was used by investing activities, primarily due to the purchase of investment securities and the origination of LHFI net of principal payments, partially offset by proceeds from the sale of loans originated as LHFI and investment securities and principal payments and maturities of investment securities.

The Company's investing activities primarily include AFS investment securities and loans originated as held for investment.

For the quarter ended March 31, 2022, net cash of $464 million was used in investing activities primarily from the origination of LHFI net of principal repayments and the purchase of AFS investment securities.

For the quarter ended March 31, 2021, net cash of $28 million was used in investing activities for the origination of LHFI and the purchase of AFS investment securities, which were partially offset by principal payments and the proceeds from the sale of loans originated as LHFI and AFS investment securities.

Cash flows from financing activities

The Company's financing activities are primarily related to deposits and net proceeds from borrowings.

For the nine months ended September 30, 2021, net cash of $134 million was provided by financing activities, primarily due to growth in deposits, partially offset by net repayment of short-term borrowings, repurchases of and dividends paid on our common stock.

For the nine months ended September 30, 2020, net cash of $455 million was provided by financing activities, primarily due to net proceeds from borrowings and increase in deposits, partially offset by common stock repurchases and dividends paid on our common stock.

For the quarter ended March 31, 2022, net cash of $349 million was provided by financing activities, primarily due to growth in deposits and an increase in short-term borrowings and proceeds from the issuance of the subordinated notes, partially offset by repurchases of and dividends paid on our common stock.

For the quarter ended March 31, 2021, net cash of $41 million was provided by financing activities, primarily due to growth in deposits, which was partially offset by net repayment of short-term borrowings, repurchases of and dividends paid on our common stock.

Off-Balance Sheet Arrangements

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These commitments include the following:

(in thousands) At September 30, 2021 At December 31, 2020

(in thousands) At March 31, 2022 At December 31, 2021

Unused consumer portfolio lines $ 433,656 $ 405,992

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(1) Within the commercial portfolio, undistributed construction loan proceeds, where the Company has an obligation to advance funds for construction

progress payments, were $564 million and $395 million at September 30, 2021 and December 31, 2020, respectively.

progress payments, were $554 million and $584 million at March 31, 2022 and December 31, 2021, respectively.

Capital Resources and Dividend Policy

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(on a consolidated basis) and HomeStreet Bank as compared to the respective regulatory requirements applicable to them:

At September 30, 2021

At March 31, 2022

Actual For Minimum Capital

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"Well Capitalized"

(in thousands) Amount Ratio Amount Ratio Amount Ratio

(dollars in thousands) Amount Ratio Amount Ratio Amount Ratio

HomeStreet, Inc.

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"Well Capitalized"

(in thousands) Amount Ratio Amount Ratio Amount Ratio

(dollars in thousands) Amount Ratio Amount Ratio Amount Ratio

HomeStreet, Inc.

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The required ratios for capital adequacy set forth in the above table do not include the Capital Rules’ additional capital conservation buffer, though each of the Company and Bank maintained capital ratios necessary to satisfy the capital conservation buffer requirements as of the dates indicated.

At September 30, 2021, capital conservation buffers for the Company and the Bank were 5.01% and 5.71%, respectively.

The Company paid a quarterly cash dividend of $0.25 per common share in each of the first, second and third quarters of 2021.

It is our current intention to continue to pay quarterly dividends, and on October 28, 2021 we declared another cash dividend of $0.25 per common share payable on November 23, 2021 to shareholders of record as of the close of business on November 9, 2021.

At March 31, 2022, capital conservation buffers for the Company and the Bank were 4.43% and 5.23%, respectively.

The Company paid a quarterly cash dividend of $0.35 per common share in the first quarter of 2022.

It is our current intention to continue to pay quarterly dividends, and on April 28, 2022 we declared another cash dividend of $0.35 per common share payable on May 24, 2022 to shareholders of record as of the close of business on May 10, 2022.

The amount and declaration of future cash dividends are subject to approval by our Board of Directors and certain regulatory restrictions.

We had no material commitments for capital expenditures as of September 30, 2021.

We had no material commitments for capital expenditures as of March 31, 2022.

However, we intend to take advantage of opportunities that may arise in the future to grow our businesses, which may include opening additional offices or acquiring complementary businesses that we believe will provide us with attractive risk-adjusted returns.

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To supplement our unaudited condensed consolidated financial statements presented in accordance with GAAP, we use certain non-GAAP measures of financial performance.

In this Quarterly Report on Form 10-Q, we use the following non-GAAP measures:

(i) tangible common equity and tangible assets as we believe this information is consistent with the treatment by bank regulatory agencies, which excluded intangible assets from the calculation of capital ratios;

and (ii) an efficiency ratio which is the ratio of noninterest expenses to the sum of net interest income and noninterest income, excluding certain items of income or expense and excluding taxes incurred and payable to the state of Washington as such taxes are not classified as income taxes and we believe including them in noninterest expenses impacts the comparability of our results to those companies whose operations are in states where assessed taxes on business are classified as income taxes.

These supplemental performance measures may vary from, and may not be comparable to, similarly titled measures provided by other companies in our industry.

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Generally, a non-GAAP financial measure is a numerical measure of a company’s performance that either excludes or includes amounts that are not normally excluded or included in the most directly comparable measure calculated and presented in accordance with GAAP.

A non-GAAP financial measure may also be a financial metric that is not required by GAAP or other applicable requirement.

A non-GAAP financial measure may also be a financial metric that is not required by GAAP or other applicable requirements.

We believe that these non-GAAP financial measures, when taken together with the corresponding GAAP financial measures, provide meaningful supplemental information regarding our performance by providing additional information used by management that is not otherwise required by GAAP or other applicable requirements.

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These non-GAAP financial measures also facilitate a comparison of our performance to prior periods.

We believe these measures are frequently used by securities analysts, investors and other interested parties in the evaluation of companies in our industry.

However, these non-GAAP financial measures should be considered in addition to, not as a substitute for or superior to, financial measures prepared in accordance with GAAP.

In the information below, we have provided a reconciliation of, where applicable, the most comparable GAAP financial measures to the non-GAAP measures used in this quarterly report on Form 10-Q, or a reconciliation of the non-GAAP calculation of the financial measure.

In this quarterly report on Form 10-Q, we use (i) tangible common equity and tangible assets and ratios calculated using these measures as we believe this information is consistent with the treatment by bank regulatory agencies, which exclude intangible assets from the calculation of capital ratios;

and (ii) an efficiency ratio which is the ratio of noninterest expense to the sum of net interest income and noninterest income, excluding certain items of income or expense and excluding taxes incurred and payable to the state of Washington as such taxes are not classified as income taxes and we believe including them in noninterest expense impacts the comparability of our results to those companies whose operations are in states where assessed taxes on business are classified as income taxes.

We believe these measures are frequently used by securities analysts, investors and other parties in the evaluation of companies in our industry.

Rather, these non-GAAP financial measures should be considered in addition to, not as a substitute for or superior to, financial measures prepared in accordance with GAAP.

In the information below, we have provided reconciliations of, where applicable, the most comparable GAAP financial measures to the non-GAAP measures used in this Quarterly Report on Form 10-Q, or a reconciliation of the non-GAAP calculation of the financial measure.

Reconciliations of non-GAAP results of operations to the nearest comparable GAAP measures:

As of or for the quarter ended As of or for the nine months ended September 30,

(in thousands) September 30, 2021 June 30, 2021 2021 2020

For the quarter ended

(in thousands) March 31, 2022 December 31, 2021 March 31, 2021

Return on average tangible equity (annualized)

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$ 54,473 $ 53,971 $ 56,608

Restructuring related charges — — — (5,725)

Legal fees recovery — 1,900 1,900 —

State of Washington taxes

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15,558 28,620 38,833

Contingent payout

Adjusted total

$ 81,782 $ 86,196 $ 261,328 $ 257,435

62.8 % 62.8 % 61.8 % 63.4 %

(in thousands, except share data) September 30, 2021 December 31, 2020

Total $ 70,104 $ 85,704 $ 93,350

Ratio 77.0 % 62.2 % 60.0 %

Effective tax rate used in computations above 22.0 % 22.0 % 19.3 %

(in thousands, except share data) March 31, 2022 December 31, 2021

Tangible book value per share

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$ 7,479,430 $ 7,172,382

Ratio 7.6 % 9.5 %

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis