BANC OF CALIFORNIA, INC. (BANC) FY 2021 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Critical Accounting Estimates

We follow accounting and reporting policies and procedures that conform, in all material respects, to GAAP and to practices generally applicable to the financial services industry, the most significant of which are described in Note 1 — Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements included in Item 8. The preparation of Consolidated Financial Statements in conformity with GAAP requires management to make judgments and accounting estimates that affect the amounts reported for assets, liabilities, revenues and expenses on the Consolidated Financial Statements and accompanying notes, and amounts disclosed as contingent assets and liabilities. While we base estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.

Accounting estimates are necessary in the application of certain accounting policies and procedures that are particularly susceptible to significant change. Critical accounting policies are defined as those that require the most complex or subjective judgment and are reflective of significant uncertainties, and could potentially result in materially different results under different assumptions and conditions. Management has identified our most critical accounting policies and accounting estimates as: investment securities, allowance for credit losses, business combinations, valuation of acquired loans, goodwill and deferred income taxes. See Note 1 — Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements included in Item 8 for a description of these policies.

Investment Securities. Available-for-sale debt securities are carried at fair value. These securities are analyzed for credit losses under ASC 326, which requires the Company to determine whether impairment exists as of the reporting date and whether that impairment is due to credit losses. An allowance for credit losses would be established for losses on available-for-sale debt securities due to credit losses and would be reported as a component of provision for credit losses.

The valuation of investment securities considers observable data such as dealer quotes, market spreads, cash flows, yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and respective terms and conditions for debt instruments. We employ procedures to monitor the pricing service's assumptions and establish processes to challenge the pricing service's valuations that appear unusual or unexpected. Multiple quotes or prices may be obtained in this process and we determine which fair value is most appropriate based on market information and analysis. Quotes obtained through this process are generally non-binding. We follow established procedures to ensure that assets and liabilities are properly classified in the fair value hierarchy. All securities available-for-sale were classified as Level 2 at December 31, 2021 and 2020. When a market is illiquid or there is a lack of transparency around the inputs to valuation, including at least one unobservable input, the securities are classified as Level 3 and reliance is placed upon internally developed models and management's judgment and evaluation for valuation. We had no securities available-for-sale classified as Level 3 at December 31, 2021 and 2020.

The estimates used to determine the fair values of investment securities can be complex and require judgment. These critical estimates are difficult to predict and may result in credit losses in future periods if actual results materially differ from the estimated assumptions utilized in our valuation of these assets.

Allowance for Credit Losses (“ACL”). The ACL is estimated on a quarterly basis and represents management’s estimate of current expected credit losses in our loan portfolio. The ACL estimate is based on the accounting standard commonly known as CECL, which we adopted on January 1, 2020. Upon adoption, we recognized a Day 1 increase in the ACL of $6.4 million and a related after-tax decrease to retained earnings of $4.5 million. Our Day 1 ACL under the new CECL model totaled $68.1 million, or 1.14% of total loans, compared to $61.7 million, or 1.04% of total loans, under the incurred loss model at December 31, 2019. Under the CECL method, pools of loans with similar risk characteristics are collectively evaluated while loans that no longer share risk characteristics with loan pools are evaluated individually. Collective loss estimates are determined by applying loss factors, designed to estimate current expected credit losses, to amortized cost balances over the remaining life of the collectively evaluated portfolio. The allowance for loan losses includes qualitative adjustments to bring the allowance to the level management believes is appropriate based on factors that have not otherwise been fully accounted for, including those described in the federal banking agencies' joint interagency policy statement on ALL. These factors include, among others, inherent imprecision in forecasting economic variables, including determining the depth and duration of economic cycles and their impact to relevant economic variables; qualitative adjustments based on our evaluation of different forecast scenarios and known recent events impacting relevant economic variables; data factors that address the risk that certain model inputs may not reflect all available information including (i) risk factors that have not been fully addressed in internal risk ratings, (ii) changes in lending policies and procedures, (iii) changes in the level and quality of experience held by lending management, (iv) imprecision in the risk rating system and (v) limitations in data available for certain loan portfolios. The ACL process also includes challenging and calibrating the model and model results against observed information, trends and events within the loan portfolio, among others. The ACL and provision for credit losses include amounts and changes from both the allowance for loan losses and the reserve for unfunded commitments.

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Business Combinations. Business combinations are accounted for using the acquisition method of accounting under ASC Topic 805 - Business Combinations. Under the acquisition method, the Company measures the identifiable assets acquired, including identifiable intangible assets, and liabilities assumed in a business combination at fair value on acquisition date. Goodwill is generally determined as the excess of the fair value of the consideration transferred, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date.

The estimates used to determine the fair values of assets and liabilities acquired in a business combination can be complex and require judgment. For example, we generally value core deposit intangible assets using a discounted cash flow approach, which require a number of critical estimates that include, but are not limited to, future expected cash flows from depositor relationships, expected "decay" rates, and the determination of discount rates. These critical estimates are difficult to predict and may result in impairment charges in future periods if actual results materially differ from the estimated assumptions utilized in our initial valuation of net assets and liabilities acquired.

Goodwill. Goodwill represents the excess purchase price of businesses acquired over the fair value of the identifiable net assets acquired. Goodwill is not subject to amortization and is evaluated for impairment at least annually, normally during the fourth fiscal quarter, or more frequently in the interim if events occur or circumstances change indicating impairment may have occurred. The determination of whether impairment has occurred is based on an assessment of several factors, including, but not limited to, operating results, business plans, economic projections, anticipated future cash flows, and current market data. Any impairment identified as part of this testing is recognized through a charge to noninterest expense.

The assessment of impairment discussed above incorporate inherent uncertainties, including projected operating results and future market conditions, which are often difficult to predict and may result in impairment charges in future periods if actual results materially differ from the estimated assumptions utilized in our forecasts.

Acquired Loans. At acquisition date, loans are evaluated to determine whether they meet the criteria of a PCD loan. PCD loans are loans that in management's judgement have experienced more than insignificant deterioration in credit quality since origination. Factors that indicate a loan may have experienced more than insignificant credit deterioration include delinquency, downgrades in credit rating, non-accrual status, and other negative factors identified by management at the time of initial assessment. PCD loans are initially recorded at fair value, with the resulting non-credit discount or premium being amortized or accreted into interest income using the interest method. In addition to the fair value adjustment, at the date of acquisition, an ACL is established with a corresponding increase to the overall acquired loan balance. This initial ACL is determined using the Company's current expected credit losses methodology.

Acquired loans that are not considered PCD loans (“non-PCD loans”) are also recognized at fair value at the acquisition date, with the resulting credit and non-credit discount or premium being amortized or accreted into interest income using the interest method. In addition to the fair value adjustment, at the time of acquisition, the Company establishes an initial ACL for acquired non-PCD loans through a charge to the provision for credit losses. This initial ACL is determined using the Company's current expected credit losses methodology.

Subsequent to acquisition date, the ACL for both PCD and non-PCD loans is determined using the same methodology to determine current expected credit losses that is applied to all other loans.

The estimates used to determine the fair values of non-PCD and PCD acquired loans can be complex and require significant judgment regarding items such as default rates, timing and amount of future cash flows, prepayment rates and other factors. These critical estimates are difficult to predict and may result in provisions for credit losses in future periods if actual losses materially differ from the estimated assumptions utilized in our initial valuation of acquired loans.

Deferred Taxes. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Deferred tax assets are also recognized for operating loss and tax credit carryforwards. Accounting guidance requires that companies assess whether a valuation allowance should be established against the deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion, or all, of the deferred tax asset will not be realized. In assessing the realization of deferred tax assets, management will continue to evaluate both positive and negative evidence on a quarterly basis, including considering the four possible sources of future taxable income, such as future reversal of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and carryforwards, taxable income in prior carryback year(s), and future tax planning strategies.

Although we believe our assessments of the realizability of deferred income taxes are reasonable, no assurance can be given that their realizability will not be different from that which is reflected in our net deferred tax asset balance.

Tax positions that are uncertain but meet a more-likely-than-not recognition threshold are initially and subsequently measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement with a taxing

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authority that has full knowledge of all relevant information. The determination of whether or not a tax position meets the more likely than not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to management's judgment.

We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. Although we believe our reserves are reasonable, no assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in our historical income tax provisions and accruals. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made.

Recent Accounting Pronouncements

See Note 1 — Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements included in Item 8 for information on recent accounting pronouncements and their expected impact, if any, on our consolidated financial statements.

Non-GAAP Financial Measures

Under Item 10(e) of SEC Regulation S-K, public companies disclosing financial measures in filings with the SEC that are not calculated in accordance with GAAP must also disclose, along with each non-GAAP financial measure, certain additional information, including a presentation of the most directly comparable GAAP financial measure, a reconciliation of the non-GAAP financial measure to the most directly comparable GAAP financial measure, as well as a statement of the reasons why the company's management believes that presentation of the non-GAAP financial measure provides useful information to investors regarding the company's financial condition and results of operations and, to the extent material, a statement of the additional purposes, if any, for which the company's management uses the non-GAAP financial measure.

Tangible assets, tangible equity, tangible common equity, tangible equity to tangible assets, tangible common equity to tangible assets, tangible common equity per common share, return on average tangible common equity, adjusted noninterest income, adjusted noninterest expense, adjusted noninterest expense to average total assets, pre-tax pre-provision (PTPP) income (loss), adjusted PTPP income (loss), PTPP income (loss) ROAA, adjusted PTPP income (loss) ROAA, efficiency ratio, adjusted efficiency ratio, adjusted total revenue, adjusted net income, adjusted net income available to common stockholders, adjusted diluted earnings per share (EPS) and adjusted return on average assets (ROAA) constitute supplemental financial information determined by methods other than in accordance with GAAP. These non-GAAP measures are used by management in its analysis of the Company's performance.

Tangible assets and tangible equity are calculated by subtracting goodwill and other intangible assets from total assets and total equity. Tangible common equity is calculated by subtracting preferred stock from tangible equity. Return on average tangible common equity is computed by dividing net income (loss) available to common stockholders, after adjustment for amortization of intangible assets, by average tangible common equity. Banking regulators also exclude goodwill and other intangible assets from stockholders' equity when assessing the capital adequacy of a financial institution.

PTPP income is calculated by adding net interest income and noninterest income (total revenue) and subtracting noninterest expense. Adjusted PTPP income is calculated by adding net interest income and adjusted noninterest income (adjusted total revenue) and subtracting adjusted noninterest expense. PTPP income ROAA is computed by dividing annualized PTPP income by average assets. Adjusted PTPP income ROAA is computed by dividing annualized adjusted PTPP income by average assets. Efficiency ratio is computed by dividing noninterest expense by total revenue. Adjusted efficiency ratio is computed by dividing adjusted noninterest expense by adjusted total revenue.

Adjusted net income (loss) is calculated by adjusting net income (loss) for tax-effected noninterest income and expense adjustments and the tax impact from the exercise of stock appreciation rights. Adjusted ROAA is computed by dividing annualized adjusted net income by average assets. Adjusted net income (loss) available to common stockholders is computed by removing the impact of preferred stock redemptions from adjusted net income (loss).

Management believes the presentation of these non-GAAP financial measures provides useful supplemental information that is essential to a proper understanding of the financial results and operating performance of the Company. This disclosure should not be viewed as a substitute for results determined in accordance with GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies.

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The following tables provide reconciliations of the non-GAAP measures with financial measures defined by GAAP.

(1)Non-GAAP measure.

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(1)Non-GAAP measure.

(2)Adjustments shown net of a statutory Federal tax rate of 21%.

(1)Non-GAAP measure.

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(1)Non-GAAP measure.

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(1)Net income for the year ended December 31, 2021 includes an $11.3 million pre-tax charge for the expected lifetime credit losses for non-purchased credit deteriorated loans acquired in the PMB Acquisition; there is no similar charge in any of the other periods presented.

(2)Tax impact of adjustments shown at an effective tax rate of 25%.

(3)Non-GAAP measure.

(4)Represents adjusted net income available to common stockholders divided by average diluted common shares.

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Executive Overview

We are focused on providing core banking products and services, including customized and innovative banking and lending solutions, designed to cater to the unique needs of California's diverse businesses, entrepreneurs and communities through our 32 full service branches in Orange, Los Angeles, San Diego, and Santa Barbara Counties. Through our dedicated professionals, we are committed to servicing and building enduring relationships by providing a higher standard of banking. We offer a variety of financial products and services designed to serve the banking and financial needs of our target clients. We continue to grow average loans and earning assets, improve our deposit mix, reduce our cost of deposits, and maintain disciplined expense control. Strong loan production helped to offset runoff in certain legacy areas of our portfolio. Our loan pipeline is steadily building which is expected to support continued loan and earning asset growth through the year, assuming improving economic trends continue. In the fourth quarter of 2021, we completed our merger with Pacific Mercantile Bancorp. Through these efforts, we continue to transform our franchise into a relationship-focused business bank, maintaining our credit quality and serving businesses, entrepreneurs and individuals throughout California.

Financial Highlights

For the years ended December 31, 2021, 2020 and 2019, net income (loss) available to common stockholders was $50.6 million, $(1.1) million and $2.6 million. Diluted earnings (loss) per common share were $0.95, $(0.02), and $0.05 for the years ended December 31, 2021, 2020 and 2019. The increase in net income available to common stockholders for the year ended December 31, 2021 as compared to the year ended December 31, 2020 was mainly due to (i) higher net interest income due to higher average interest-earning assets, lower average interest-bearing liabilities and improved funding costs, partially offset by lower yields on average interest-earning assets, (ii) lower provision for credit losses due to improvement in the economy and its expected impact on lifetime credit losses, (iii) lower noninterest expense despite $15.9 million in merger costs due to the one-time charge of $26.8 million in 2020 related to the termination of our LAFC agreements, and (iv) the overall positive impact of the redemption of all of our Series D Depositary Shares in the first quarter of 2021.

Total assets were $9.39 billion at December 31, 2021, an increase of $1.52 billion, or 19.3%, from $7.88 billion at December 31, 2020.

Significant financial highlights include:

•Completed the PMB Acquisition on October 18, 2021, for total purchase consideration of $225.4 million, adding $1.54 billion in total assets, $962.9 million in loans and $1.28 billion in deposits at acquisition date

•Completed the system conversion for the PMB Acquisition in November 2021

•Return on average assets of 0.75% during 2021, compared to 0.16% during 2020

•Adjusted pre-tax pre-provision return on average assets of 1.24%, up from 0.93% in 2020

•Net interest margin of 3.26%, a 13 basis point increase from 2020

•Period-end total cost of deposits of 0.07%

•Average cost of total deposits of 0.19%, a 47 basis point decrease from 2020

•Noninterest-bearing deposit balances represented 37% of total deposits at December 31, 2021, up from 26% a year earlier

•Allowance for credit losses at 1.35% of total loans and 187% of non-performing loans at December 31, 2021

•Common Equity Tier 1 capital at 11.31% at December 31, 2021

Refer to the 2020 Form 10-K filed on February 26, 2021 for discussion related to 2020 activity compared to 2019 activity.

Merger with Pacific Mercantile Bancorp

On October 18, 2021, we completed the PMB Acquisition pursuant to which Pacific Mercantile Bancorp merged with and into the Company, with the Company as the surviving corporation. PMB was the bank holding company of the wholly-owned Pacific Mercantile Bank, a California state chartered commercial bank headquartered in Costa Mesa, California, and operated seven banking offices, including three full service branches, located throughout Southern California. PMB's size, business focus, and deposit profile aligned with our operations and is expected to accelerate our growth and operating scale in key markets.

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As a result of the PMB Acquisition, we issued approximately 11.9 million shares of common stock and paid $3.2 million in cash for total consideration of $225.4 million. We acquired $1.54 billion in total assets, including $962.9 million in loans and $57.2 million of goodwill, and assumed $1.28 billion in deposits and $17.5 million in trust preferred securities. The PMB Acquisition reduced our tangible book value per share by approximately $0.10. The system conversion was completed in November 2021.

COVID-19 Operational Update

The markets in which we operate are impacted by continuing uncertainty about the pace and strength of reopening and recovering from the COVID-19 pandemic. Despite the challenges created by the pandemic, we continue to execute on our strategic initiatives and the transformation of our balance sheet. We continue to operate 26 of our 32 branches as we temporarily closed some overlapping areas at the beginning of the pandemic to ensure an adequate balance between employee and client safety and business continuity to meet our clients' banking needs. We have adopted a hybrid workplace environment, allowing many of our employees outside of our branches the flexibility to continue to work remotely. We encourage our employees to get vaccinated and we continue to monitor all federal, state, and local laws to ensure we are in compliance with the latest health orders.

CARES Act Response Efforts

On March 27, 2020, the U.S. federal government signed the CARES Act into law, which provided emergency assistance and health care response for individuals, families, and businesses affected by the COVID-19 pandemic.

The CARES Act allocated nearly $660 billion for the PPP and was intended to assist small businesses negatively affected by the pandemic and economic downturn by providing funds for payroll and other qualifying expenses made through August 8, 2020. The loans are 100% guaranteed by the SBA and the full principal amount of the loans may qualify for loan forgiveness if certain conditions are met.

Paycheck Protection Program Flexibility Act of 2020

On October 7, 2020, the Paycheck Protection Program Flexibility Act of 2020 (“Flexibility Act”) extended the deferral period for borrower payments of principal, interest, and fees on all PPP loans to the date that the SBA remits the borrower’s loan forgiveness amount to the lender (or, if the borrower does not apply for loan forgiveness, 10 months after the end of the borrower’s loan forgiveness covered period). The extension of the deferral period under the Flexibility Act automatically applied to all PPP loans.

Economic Aid Act

On December 27, 2020, the Economic Aid Act extended the SBA's authority to make PPP loans through May 31, 2021. We elected to continue our participation in the PPP and resumed the origination of PPP loans effective January 11, 2021.

The PPP has provided an opportunity to differentiate ourselves by demonstrating how true client service can make a meaningful difference. We assisted numerous existing clients with our high touch business framework in addition to successfully attracting many new clients who are consistent with the type of commercial customers that we target in our traditional business development efforts.

As of December 31, 2021, we have helped businesses through the funding of $411 million in PPP loans and continue to support our clients as we work with them through the forgiveness process. Prior to acquisition, PMB originated $390 million in PPP loans. At December 31, 2021, outstanding PPP loans totaled $123.1 million, net of fees, of which $27.1 million related to round one and $96.0 million related to round two of the SBA program.

Borrower Payment Relief Efforts

We have been committed to supporting our customers during this period of economic uncertainty. We actively engaged with our borrowers seeking payment relief and waived certain fees for impacted clients. One method we deployed was to offer forbearance and deferments to qualified clients.  For single-family residential mortgage loans, the forbearance period was initially 90 days in length and was patterned after the HUD guidelines where applicable.  With respect to our non-SFR loan portfolio, the forbearance and deferment periods were also initially 90 days in length and were permitted to be extended. For those commercial borrowers that demonstrated a continuing need for a deferral, we generally obtained credit enhancements such as additional collateral, personal guarantees, and/or reserve requirements in order to grant an additional deferral period. At this time, we no longer offer COVID-related deferments or forbearances.

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Loans on deferment or forbearance status decreased $227.4 million during the year ended December 31, 2021. The Bank is in contact with borrowers to provide additional assistance as needed and we continue to actively monitor and manage all lending relationships in a manner that we believe supports our clients and protects the Bank.

The following table presents the composition of our loan portfolio for borrowers that received payment relief as of December 31, 2021 and 2020:

(1)Excludes loans in forbearance that are current

(2)Excludes loans delinquent prior to COVID-19

Other Efforts

We continue to support and seek to meet the immediate needs of the most vulnerable members of our community. We do this by providing donations, grants and sponsorships that support affordable housing, workforce and economic development and community services. Our employee volunteers have continued to provide financial literacy classes in a virtual environment as well as developing a virtual tour of the Bank’s headquarters that introduces students to a variety of different career paths and business unit leaders.

For a discussion of the risk factors related to COVID-19, please refer to Part I, Item 1A. - Risk Factors in this Annual Report.

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Results of Operations

The following table presents condensed statements of operations for the periods indicated:

(1)Non-GAAP measure. See non-GAAP measures for reconciliation of the calculation.

(2)Ratio of dividends declared per common share to basic earnings per common share.

Management's Discussion and Analysis of Financial Condition and Results of Operations generally includes tables with 3 year financial performance, accompanied by narrative for the years ended December 31, 2021 and 2020. For further discussion of prior period financial results presented herein, refer to Item 7 of the 2020 Form 10-K filed on February 26, 2021.

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Net Interest Income

The following table presents interest income, average interest-earning assets, interest expense, average interest-bearing liabilities, and their corresponding yields and costs expressed both in dollars and rates, on a consolidated operations basis, for the years indicated:

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(1)Total loans are net of deferred fees, related direct costs, premiums, and discounts, but exclude the allowance for loan losses. Nonaccrual loans are included in the average balance. Interest income includes net accretion/(amortization) of $348 thousand, $3.5 million and $(551) thousand for deferred fees, related direct costs, premiums, and discounts for the years ended December 31, 2021, 2020 and 2019. Total loans includes average loans held for sale of $2.4 million, $15.8 million and $80.1 million for the years ended December 31, 2021, 2020 and 2019.

(2)Includes average balance of FHLB and Federal Reserve Bank stock at cost and average time deposits with other financial institutions.

(3)Includes average balance of BOLI of $114.9 million, $110.6 million and $108.1 million for the years ended December 31, 2021, 2020 and 2019.

(4)Net interest income divided by average interest-earning assets.

(5)Total deposits is the sum of interest-bearing deposits and noninterest-bearing deposits. The cost of total deposits is calculated as total interest expense on interest-bearing deposits divided by average total deposits.

(6)Total funding is the sum of interest-bearing liabilities and noninterest-bearing deposits. The cost of total funding is calculated as total interest expense on interest-bearing liabilities divided by average total funding.

Year Ended December 31, 2021 Compared to Year Ended December 31, 2020

Net interest income for the year ended December 31, 2021 increased $29.2 million to $253.8 million from $224.6 million for 2020. Net interest income was positively impacted by higher average interest-earning assets, lower average interest-bearing liabilities and improved funding costs, offset by lower yields on average interest-earning assets. For the year ended December 31, 2021, average interest-earning assets increased $628.3 million to $7.79 billion, and the net interest margin increased 13 basis points to 3.26% compared to 3.13% for 2020.

The net interest margin expanded due to a 47 basis point decrease in the average cost of funds outpacing a 32 basis point decline in the average interest-earning assets yield. The average yield on interest-earning assets decreased to 3.74% for the year ended December 31, 2021, from 4.06% for 2020 due mostly to the impact of lower average market interest rates on loan and securities yields over these same timeframes. The average fed funds rate for the year ended December 31, 2021 was 0.08% compared to 0.38% for 2020. The average yield on loans was 4.24% for the year ended December 31, 2021, compared to 4.52% for 2020 and the average yield on securities decreased 48 basis points to 2.13% due mostly to CLOs repricing during the lower rate environment.

The average cost of funds decreased to 0.52% for the year ended December 31, 2021, from 0.99% for 2020. This decrease was driven by the lower average cost of interest-bearing liabilities and the overall improved funding mix, including higher average noninterest-bearing deposits. The average cost of interest-bearing liabilities decreased 51 basis points to 0.72% for the year ended December 31, 2021 from 1.23% for 2020 due to the combination of actively managing deposit pricing down into the lower interest rate environment, repricing downward of certain term FHLB advances that were refinanced and the overall reduced usage of overnight FHLB advances to fund loan growth. Compared to 2020, the average cost of interest-bearing deposits declined 58 basis points to 0.27% and the average cost of total deposits decreased 47 basis points to 0.19%. Additionally, average noninterest-bearing deposits increased by $673.8 million, or 50.9%, for the year ended December 31, 2021 when compared to 2020.

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Rate/Volume Analysis

The following table presents the changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. Information is provided on changes attributable to (i) changes in volume multiplied by the prior rate and (ii) changes in rate multiplied by the prior volume. Changes attributable to both rate and volume which cannot be segregated have been allocated proportionately to the change due to volume and the change due to rate.

Provision for Credit Losses

The provision for credit losses is charged to operations to adjust the allowance for credit losses to the level required to cover current expected credit losses in our loan portfolio and unfunded commitments. The following table presents the components of our provision for credit losses:

During the year ended December 31, 2021, the provision for credit losses was $6.9 million, compared to $29.7 million during 2020. The lower provision for credit losses was due primarily to improvements in key macro-economic forecast variables, such as unemployment and gross domestic product, lower specific reserves and consideration of credit quality metrics, offset partially by higher provisions for higher period end loan balances of $1.35 billion, including the $11.3 million charge related to the initial allowance for credit losses established for non-PCD loans and unfunded loan commitments acquired in the PMB Acquisition.

The provision for credit losses during the year ended December 31, 2020 reflected the adoption of the CECL model, the estimated impact of the COVID-19 pandemic on our loans, and higher specific reserves.

See further discussion in Allowance for Credit Losses included in this Item 7.

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Noninterest Income

The following table presents noninterest income for the periods indicated:

Year Ended December 31, 2021 Compared to Year Ended December 31, 2020

Noninterest income for the year ended December 31, 2021 increased $412 thousand to $18.9 million compared to 2020. The increase in noninterest income was mainly due to higher customer service fees, income from bank-owned life insurance, and fair value gain for loans held for sale, offset partially by lower net gain on sale of securities and all other income. The $1.9 million increase in customer services fees was due mostly to higher deposit activity fees of $2.1 million. The increase in deposit activity fees is attributed to higher average deposit balances and our initiative to bring our service fee schedules more in line with market. Fair value adjustment for loans held for sale improved $1.7 million as 2020 included valuation losses due to the impact of the decreases in market interest rates. There were no gains from sales of securities for the year ended December 31, 2021, compared to $2.0 million in net gains in 2020 from the sale of $20.7 million in securities, primarily consisting of corporate securities. The $1.7 million decrease in all other income is due mostly to 2020 including legal settlement income of $3.2 million and earnout income of $1.6 million from the 2017 sale of our Banc Home Loans division; there was no similar income in 2021. These increases within other income were partially offset by higher loan processing fees of $1.1 million and interest rate swap income of $502 thousand and an $841 thousand gain related to the sale-leaseback transaction for one of our branch locations,

Noninterest Expense

The following table presents noninterest expense for the periods indicated:

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Year Ended December 31, 2021 Compared to Year Ended December 31, 2020

Noninterest expense for the year ended December 31, 2021 decreased $15.8 million to $183.2 million compared to the prior year. The decrease was primarily due to: (i) 2020 including a $26.8 million one-time charge related to the termination of our LAFC naming rights agreements and a $2.5 million debt extinguishment fee for the early repayment of certain FHLB term advances, (ii) a $5.2 million decrease in professional fees due mostly to a $3.0 million decrease in legal fees, net of insurance recoveries and a $1.9 million decrease in other professional fees, (iii) a $2.8 million decrease in lower advertising fees due to the termination of the LAFC agreements in May 2020, and (iv) a $1.7 million decrease in all other expense resulting from a $1.2 million charge in 2020 for two legacy legal settlements combined with overall expense reduction efforts. These decreases were partially offset by: (i) a $6.5 million increase in salaries and employee benefits due to the increase in personnel from the PMB Acquisition and higher commissions and incentive-based compensation as a result of higher production and financial performance levels, (ii) merger-related costs of $15.9 million, and (iii) higher operating costs in most other categories due to the impact of the PMB Acquisition.

Income Tax Expense

Income tax expense totaled $20.3 million for the year ended December 31, 2021, representing an effective tax rate of 24.5%, compared to $1.8 million and an effective tax rate of 12.4% for 2020. The effective tax rate for the year ended December 31, 2021 differs from the 28.9% combined federal and state statutory rate due primarily to the net tax benefit of $2.5 million resulting from the exercise of all previously issued outstanding stock appreciation rights in the first quarter of 2021, the impact of nondeductible transaction costs in the PMB Acquisition, and other discrete tax items.

Our effective tax rate for the year ended December 31, 2021 was higher than the effective tax rate for the year ended December 31, 2020 due mainly to (i) higher pre-tax income, (ii) lower net tax effects of our qualified affordable housing partnerships and investments in alternative energy partnerships, offset by (iv) higher tax benefit from share-based awards of $2.5 million, primarily from the exercise of all previously issued outstanding stock appreciation rights in the first quarter of 2021. During the year ended December 31, 2021, our qualified affordable housing partnerships resulted in a reduction of our effective tax rate as the tax deductions and credits outpaced the increase in the effective tax rate due to higher proportional amortization.

For additional information, see Note 13 — Income Taxes of the Notes to Consolidated Financial Statements included in Item 8.

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Financial Condition

Investment Securities

At December 31, 2021 and 2020, all of our investment securities were classified as available-for-sale.

The primary goal of our investment securities portfolio is to provide a relatively stable source of interest income while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk, and interest rate risk. Certain investment securities can be pledged as collateral to obtain public deposits or to provide a secondary source of liquidity in the form of secured borrowings from the FHLB, the Federal Reserve Discount Window, or other financial institutions for repurchase agreements. Investment securities with carrying values of $28.9 million and $43.7 million as of December 31, 2021 and 2020 were pledged to secure FHLB advances, public deposits and for other purposes as required or permitted by law.

The following table presents the amortized cost and fair value of the investment securities portfolio and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) as of the dates indicated:

Securities available-for-sale totaled $1.32 billion at December 31, 2021, an increase of $84.3 million, or 6.8%, from $1.23 billion at December 31, 2020. The increase was mainly due to purchases of $287.7 million, including $158.1 million in U.S. government agency securities, $55.9 million in non-agency residential mortgage-backed securities, $53.7 million in municipal securities and $20.0 million in corporate debt securities, offset partially by CLO resets totaling $166.2 million and principal reductions of other securities of $35.6 million.

At December 31, 2021, CLOs totaled $519.0 million, or 39.4% of total securities available-for-sale, compared to $677.8 million, or 55.1% of total securities available-for-sale, at December 31, 2020. CLOs are floating rate debt securities backed by pools of senior secured commercial loans to a diverse group of companies across a broad spectrum of industries. Underlying loans are generally secured by a company’s assets such as inventory, equipment, property, and/or real estate. CLOs are structured to diversify exposure to a broad sector of industries. The payments on these commercial loans support interest and principal on the CLOs across classes that range from AAA-rated to equity-grade tranches. At December 31, 2021, all of our CLO holdings were AAA and AA rated. We also perform ongoing credit quality review of our CLO holdings, which includes

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monitoring performance factors such as external credit ratings, collateralization levels, collateral concentration levels, and other performance factors. We only acquire CLOs that we believe are Volcker Rule compliant.

We did not record credit impairment for any investment securities for the year ended December 31, 2021 and 2020.

We monitor our securities portfolio to ensure it has adequate credit support. As of December 31, 2021, we believe there was no credit impairment and we did not have the current intent to sell securities with a fair value below amortized cost at December 31, 2021, and it is more likely than not that we will not be required to sell such securities prior to the recovery of their amortized cost basis. We consider the lowest credit rating for identification of potential credit impairment. As of December 31, 2021, all of our investment securities received an investment grade credit rating.

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The following table presents maturities, based on the earlier of maturity dates or next repricing dates, and weighted average yield information of the investment securities portfolio as of December 31, 2021:

(1)Weighted average yields are based on the amortized cost basis of securities available-for-sale at December 31, 2021.

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Loans Held-for-Sale

Total loans held-for-sale carried at fair value were $3.4 million and $1.4 million at December 31, 2021 and December 31, 2020 and consisted mainly of repurchased conforming SFR mortgage loans and repurchased GNMA loans that were previously sold and became delinquent more than 90 days. The increase was mainly due to repurchases of $1.9 million during the year. During the year ended December 31, 2021, $14.9 million of loans held for investment were transferred into loans held-for-sale and subsequently sold resulting in a gain of $275 thousand. There were zero and $1.14 billion of transfers of loans into held-for-sale for the years ended December 31, 2020 and 2019.

At December 31, 2021 and 2020, there was $128 thousand and $654 thousand in loans held-for-sale on non-accrual status.

Loans Receivable, Net

The following table presents the composition of our loan portfolio as of the dates indicated:

(1)Includes warehouse lending balances of $1.60 billion and $1.34 billion at December 31, 2021 and December 31, 2020.

(2)Includes PPP loans totaling $123.1 million and $210.0 million, which included $772 thousand and $1.6 million of net unamortized loan fees at December 31, 2021 and 2020.

(3)Total loans includes deferred loan origination costs/(fees), purchased premiums/(discounts), and fair value adjustments of $5.5 million and $6.2 million at December 31, 2021 and 2020.

Total loans were $7.25 billion at December 31, 2021, an increase of $1.35 billion, or 22.9%, from $5.90 billion at December 31, 2020. The increase was due to the $905.3 million in loans added in the PMB Acquisition and outstanding at the end of the year as well as organic production and loan purchases of $2.17 billion and net growth in the warehouse lending portfolio of $262.5 million, partially offset by repayments and other reductions of $2.02 billion. The $1.35 billion increase included higher commercial and industrial (C&I) loans of $580.7 million, commercial real estate loans of $503.9 million, multifamily loans of $71.2 million, single family residential loans of $189.8 million and construction loans of $5.8 million, offset partially by lower SBA loans of $67.9 million due mostly to SBA PPP activity. The PMB Acquisition added $76.3 million in SBA PPP loans at acquisition date to the additional $143.7 million in new PPP loan originations, which was offset by $300.5 million of PPP loan forgiveness during the year. At December 31, 2021, SBA loans included $123.1 million of PPP loans, net of fees.

During the year, we purchased $825.5 million in loans, comprised of single family residential loans of $795.8 million and multifamily loans of $29.8 million. We ceased originating SFR mortgage loans in 2019, however we have and may continue to purchase these loans as part of an overall strategy to manage portfolio runoff and overall portfolio concentration risk.

We continue to focus the real estate loan portfolio toward relationship-based multifamily, bridge, light infill construction, and commercial real estate loans. As of December 31, 2021, loans secured by residential real estate (single-family, multifamily, single-family construction, and warehouse lending credit facilities) represent approximately 63% of our total loans outstanding.

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The C&I portfolio has limited exposure to certain business sectors undergoing severe stress as a result of the pandemic. The following table summarizes the balances of the C&I portfolio by industry concentration and the percentage of total outstanding C&I loan balances:

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The following table presents the contractual maturity with the weighted-average contractual yield of the loan portfolio as of December 31, 2021:

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The following table presents the interest rate profile of the loan portfolio due after one year at December 31, 2021:

Loan Originations, Purchases, Sales and Repayments

The following table presents loan originations, purchases, sales, and repayment activities, excluding loans originated for sale, for the periods indicated:

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(1)Amounts represent disbursements on credit lines, principal paydowns and payoffs and other net activity for loans subsequent to origination (excluding our warehouse credit facilities).

(2)Amounts represent net disbursement and repayment activity subsequent to origination for our warehouse credit facilities which are included in commercial and industrial loans.

Non-Traditional Mortgage ("NTM") Portfolio

As of December 31, 2021 and 2020, the NTM loans totaled $635.3 million, or 8.8% of total loans, and $437.1 million, or 7.4% of total loans, respectively. These loans are included in our consumer portfolio and comprised of three interest only products: interest only loans, Green Loans and a small number of additional loans with the potential for negative amortization.

Interest only loans are primarily SFR first mortgage loans with payment features that allow interest only payments in initial periods before converting to a fully amortizing loan. At December 31, 2021 and 2020, interest only loans totaled $613.3 million and $401.6 million. The $211.7 million increase was due to loan purchases during 2021. As of December 31, 2021 and 2020, $4.0 million and $4.7 million of interest only loans were nonperforming. Green Loans are SFR first and second mortgage lines of credit with a linked checking account that allows all types of deposits and withdrawals to be performed. Green Loans are generally interest only for a 15-year term with a balloon payment due at maturity. At December 31, 2021 and 2020, Green Loans totaled $21.5 million and $33.2 million. As of December 31, 2021, none of our Green Loans were nonperforming compared to $4.0 million at December 31, 2020. Negative amortization loans totaled $473 thousand and $2.3 million at December 31, 2021 and 2020. We discontinued origination of negative amortization loans in 2007. At December 31, 2021 and 2020, none of the loans with the potential for negative amortization were nonperforming.

We no longer originate SFR loans, however we have and may continue to purchase pools of loans that include NTM loans such as interest only loans with maturities of up to 40 years and flexible initial repricing dates, ranging from 1 to 10 years, and periodic repricing dates through the life of the loan.

Non-Traditional Mortgage Loan Credit Risk Management

We perform detailed reviews of collateral values on loans collateralized by residential real property included in our NTM portfolio based on appraisals or estimates from third party Automated Valuation Models (“AVMs”) to analyze property value trends periodically. AVMs are used to identify loans that may have experienced potential collateral deterioration. Once a loan has been identified that may have experienced collateral deterioration, we will obtain updated drive by or full appraisals in order to confirm the valuation. This information is used to update key monitoring metrics such as LTV ratios. Additionally, FICO scores are obtained in conjunction with the collateral analysis. In addition to LTV ratios and FICO scores, we evaluate the portfolio on a specific loan basis through delinquency and portfolio charge-offs to determine whether any risk mitigation or portfolio management actions are warranted. The borrowers may be contacted as necessary to discuss material changes in loan performance or credit metrics.

Our risk management policy and credit monitoring include reviewing delinquency, FICO scores, and LTV ratios on the NTM loan portfolio. We also continuously monitor market conditions for our geographic lending areas. We have determined that the most significant performance indicators for NTM are LTV ratios and FICO scores. The loan review provides an effective method of identifying borrowers who may be experiencing financial difficulty before they fail to make a loan payment. Upon receipt of the updated FICO scores, an exception report is run to identify loans with a decrease in FICO score of 10% or more and a resulting FICO score of 620 or less. The loans are then further analyzed to determine if the risk rating should be downgraded, which may require an increase in the ALL we need to establish for potential losses. A report is prepared and regularly monitored.

NTM loans may entail greater risk than do traditional SFR mortgage loans. For additional information regarding NTMs, see Note 5 — Loans and Allowance for Credit Losses of the Notes to Consolidated Financial Statements included in Item 8.

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Asset Quality

Past Due Loans

The following table presents a summary of total loans that were past due as of the dates indicated:

Total past due loans totaled $72.8 million or 1.00% of total loans at December 31, 2021, compared to $31.6 million or 0.54% of total loans at December 31, 2020. The $41.1 million increase is mostly due to additions of (i) $19.1 million in loans acquired in the PMB Acquisition consisting mostly of $10.1 million in commercial & industrial loans and $8.5 million in SBA PPP loans and (ii) a $9.0 million increase in single-family residential mortgage loans. The $15.9 million of SBA loans greater than 89 days past due includes $5.5 million of loans acquired from PMB and $6.4 million in loans that are guaranteed and were repurchased solely for the purpose of resolving the credit through the SBA.

Non-performing Assets

The following table presents a summary of nonperforming assets, excluding loans held-for-sale, as of the dates indicated:

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Nonperforming assets totaled $52.6 million or 0.56% of total assets at December 31, 2021, compared to $36.6 million or 0.46% of total assets at December 31, 2020. The $16.7 million increase in nonaccrual loans during the year was primarily due to the addition of $21.6 million in nonaccrual loans from the PMB Acquisition, partially offset by loans returning to accrual status and other pay offs or pay downs. As of December 31, 2021, $19.8 million, or 38% of nonperforming loans relates to loans in a current payment status.

At December 31, 2021, nonperforming loans included (i) a $12.8 million commercial & industrial relationship acquired from PMB, (ii) SBA PPP loans of $5.5 million and other SBA loans totaling $11.1 million, of which $14.3 million is guaranteed, (iii) SFR loans totaling $7.1 million, and (iv) other commercial loans of $15.8 million.

With respect to loans that were on nonaccrual status as of December 31, 2021, the gross interest income that would have been recorded during the year ended December 31, 2021 had such loans been current in accordance with their original terms and been outstanding throughout the year ended December 31, 2021 (or since origination, if held for part of the year ended December 31, 2021), was $2.3 million. The amount of interest income on such loans that was included in net income for the year ended December 31, 2021 was $913 thousand.

Troubled Debt Restructured Loans

Loans that we modify or restructure where the debtor is experiencing financial difficulties and make a concession to the borrower in the form of changes in the amortization terms, reductions in the interest rates, the acceptance of interest only payments and, in limited cases, reductions in the outstanding loan balances are classified as troubled debt restructurings (“TDRs“). TDRs are loans modified for the purpose of alleviating temporary impairments to the borrower’s financial condition. A workout plan between a borrower and us is designed to provide a bridge for the cash flow shortfalls in the near term. If the borrower works through the near-term issues, in most cases, the original contractual terms of the loan will be reinstated.

At December 31, 2021 and 2020, we had 18 and 13 loans with an aggregate balance of $16.7 million and $9.0 million classified as TDRs. When a loan becomes a TDR we cease accruing interest, and classify it as nonaccrual until the borrower demonstrates that the loan is again performing.

At December 31, 2021, of the 18 loans classified as TDRs, 11 loans totaling $12.5 million were making payments according to their modified terms and were less than 90-days delinquent under the modified terms and were in accruing status. At December 31, 2020, of the 13 loans classified as TDRs, 10 loans totaling $4.7 million were making payments according to their modified terms and were less than 90-days delinquent under the modified terms and were in accruing status.

As of December 31, 2021 and 2020, we had $24.6 million and $170.4 million of loans that would have been considered a TDR under GAAP but were provided relief from TDR accounting under the CARES Act.

Risk Ratings

Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered to be of lesser quality, as substandard, doubtful or loss. An asset is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all of the weaknesses inherent in those classified substandard, with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve or charge-off is not warranted.

When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allocation allowances for loan losses in an amount deemed prudent by management and approved by the Board of Directors. General allocation allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as loss, it is required either to establish a specific allocation allowance for losses equal to 100% of that portion of the asset so classified or to charge-off such amount. An institution’s determination as to the classification of its assets and the amount of its specific allocation allowances are subject to review by their regulators, which may order the establishment of additional general or specific loss allocation allowances.

In connection with the filing of the Bank’s periodic reports with the OCC and in accordance with policies for the Bank's classification of assets, the Bank regularly reviews the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations. On the basis of management’s review of assets, at December 31, 2021 and 2020, we had classified assets totaling $101.4 million and $90.7 million. The total amount classified represented 1.08% and 1.15% of our total assets at December 31, 2021 and 2020.

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The following table presents the risk categories for total loans as of December 31, 2021:

(1)There were no loans classified "doubtful" or "loss" at December 31, 2021.

The following table presents the risk categories for total loans as of December 31, 2020:

(1)There were no loans classified "loss" at December 31, 2020.

Allowance for Credit Losses

The following table provides a summary of components of the ACL and related ratios as of the dates indicated:

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The ACL methodology uses a nationally recognized, third-party model that includes many assumptions based on historical and peer loss data, current loan portfolio risk profile including risk ratings, and economic forecasts including macroeconomic variables (MEVs) released by our model provider during December 2021. The December 2021 forecasts reflect a more favorable view of the economy (i.e. higher GDP growth rates and lower unemployment rates) compared to December 2020 forecasts. While the current forecasts generally reflect an improving economy with the availability of the vaccine and other factors, there continues to be uncertainty regarding the impact of inflation (lasting or transitory), COVID-19 variants, further government stimulus, supply chain issues, and the ultimate pace of the recovery. Accordingly, our economic assumptions, the resulting ACL level and resulting provision consider all of the potential uncertainties and underlying assumptions, both positive and negative. The ACL also incorporated qualitative factors to account for certain loan portfolio characteristics that are not taken into consideration by the third-party model including underlying strengths and weaknesses in various segments of the loan portfolio. As is the case with all estimates, the ACL is expected to be impacted in future periods by economic volatility, changing economic forecasts, underlying model assumptions, and asset quality metrics, all of which may be better than or worse than current estimates.

The ACL process involves subjective and complex judgments as well as adjustments for numerous factors including those described in the federal banking agencies' joint interagency policy statement on ALL, which include underwriting experience and collateral value changes, among others.

The ACL, which includes the reserve for unfunded loan commitments, totaled $98.2 million, or 1.35% of total loans at December 31, 2021 compared to $84.2 million or 1.43% at December 31, 2020. The $14.0 million increase in the ACL during the year ended December 31, 2021 was due to (i) a $13.7 million initial allowance for credit losses established for PCD loans from the PMB Acquisition, (ii) an $11.3 million initial charge for all other loans and unfunded commitments acquired from PMB, (iii) higher specific reserves of $3.3 million, (iv) reductions of $7.7 million due to improved economic assumptions and asset quality trends, offset partially by the impact of higher period-end portfolio balances as a result of organic growth, and (v) net charge-offs of $6.5 million, including $2.3 million of net charge-offs related to loans acquired in the PMB Acquisition. The ACL coverage of nonperforming loans was 187% at December 31, 2021 compared to 230% at December 31, 2020.

The following table presents a summary of net (charge-offs) recoveries and the annualized ratio of net charge-offs to average loans by loan class for the periods indicated:

Net charge-offs decreased to $6.5 million, or 0.11% of average loans for the year ended December 31, 2021 from $13.6 million, or 0.24% of average loans for 2020. During 2020, a $16.1 million legacy shared national credit was resolved resulting in a charge-off of $10.7 million.

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