BANC OF CALIFORNIA, INC. (BANC) FY 2022 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: 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.

Allowance for Credit Losses (“ACL”). The ACL is estimated on a quarterly basis and represents management’s estimate of CECL in our loan portfolio. The ACL estimate is based on the accounting standard commonly known as CECL. 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 noncancellable loan commitments.

Business Combinations. Business combinations are accounted for using the acquisition method of accounting under ASC Topic 805, Business Combinations. Under the acquisition method, we measure 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.

We allocate the fair value of the purchase consideration to the assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. The fair values of other intangibles are determined utilizing information available near the acquisition date based on expectations and assumptions that are deemed reasonable by management. The estimates used to determine the fair values of assets and liabilities acquired in a business combination can be complex and require judgment, as such we typically engage third-party valuation specialists for significant items.

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. We use the multi-period excess earnings method to value developed technology, the foregone cash flow method to value client relationships, and the relief from royalty method to value trademarks. Non-compete agreements are estimated using a with and without scenario where cash flows are projected through the term of the non-compete agreement assuming the agreement is in place and compare to cash flows assuming it is not in place. In valuing these intangibles, we make forward looking assumptions regarding expected future revenues and expenses to develop the underlying forecasts, applied contributory asset charges, discount rates, useful lives and other estimates. 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.

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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 judgment 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 our application of the CECL method.

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, we establish an initial ACL for acquired non-PCD loans through a charge to the provision for credit losses. This initial ACL is determined using our application of the CECL method.

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 in our portfolio.

The estimates used to determine the fair values of PCD and non-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 Income 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 evaluates both positive and negative evidence on a quarterly basis, including the consideration of several 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 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.

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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 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 share, return on average tangible common equity, adjusted noninterest income, adjusted noninterest expense, adjusted noninterest income to adjusted total revenue, adjusted noninterest expense to average total assets, PTPP income, adjusted PTPP income, PTPP income ROAA, adjusted PTPP income ROAA, efficiency ratio, adjusted efficiency ratio, adjusted net income, adjusted net income available to common stockholders, adjusted diluted EPS and adjusted ROAA constitute supplemental financial information determined by methods other than in accordance with GAAP. These non-GAAP measures are used by management in our analysis of our 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 is calculated by adjusting net income for tax-effected noninterest income and noninterest expense adjustments and the tax impact from the exercise of stock appreciation rights for the periods indicated. 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. Adjusted diluted EPS is computed by dividing adjusted net income available to common stockholders by the weighted average diluted common shares outstanding.

Management believes the presentation of these financial measures adjusting the impact of these items 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 at a statutory tax rate of 29.6%.

(1)Non-GAAP measure.

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(1)Non-GAAP measure.

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(1)Net income for the years ended December 31, 2022, 2021 and 2020 include a $(7.7) million, zero and $2.0 million pre-tax (loss) gain on sale of securities.

(2)Net income for the year ended December 31, 2022 includes a $31.3 million pre-tax reversal of credit losses due to the recovery from the settlement of a previously charged-off loan; there is no similar recovery in any of the other periods presented. The Bank previously recognized a $35.1 million charge-off for this loan during the third quarter of 2019.

(3)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-PCD loans acquired in the PMB Acquisition.

(4)Tax impact of adjustments shown at a statutory tax rate of 29.6%.

(5)Non-GAAP measure.

(6)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 28 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 also acquired Deepstack Technologies in 2022 to be able to offer full stack payment processing solutions and further our ability to serve as the hub of our clients' financial services ecosystem. We continue to grow average loans and earning assets, improve our deposit mix, manage our cost of deposits, and maintain disciplined expense control.

Financial Highlights

For the years ended December 31, 2022, 2021 and 2020, net income (loss) available to common stockholders was $115.8 million, $50.6 million and $(1.1) million, or $1.89, $0.95, and $(0.02) per diluted common share. On an adjusted basis(1) , net income available to common stockholders was $128.4 million, $61.4 million and $16.8 million for the years ended December 31, 2022, 2021 and 2020, or $2.10, $1.15 and $0.33 per diluted common share (refer to section 'Non-GAAP Measures'). Net income and adjusted net income available to common stockholders for 2022 included a pre-tax $31.3 million recovery from the settlement of a previously charged-off loan.

Total assets were $9.20 billion at December 31, 2022, a decrease of $196.7 million, or 2.1%, from $9.39 billion at December 31, 2021.

2022 financial and strategic highlights include(1):

•Diluted EPS of $1.89 and adjusted diluted EPS of $2.10

•Noninterest-bearing deposits represented 39% of average deposits compared to 30% in the prior year

•Net interest margin of 3.59%, an increase of 33 basis points

•Return on average assets of 1.29% and adjusted return on average assets of 1.39%

•Book value per share of $16.26, up from $15.48

•Tangible common equity per share of $14.19, up from $13.88

•Completed $75.0 million in common stock repurchases representing 7% of the shares outstanding at the time this program was authorized

•$31.3 million pre-tax recovery from the settlement of a previously charged-off loan

•Redeemed all Series E Preferred Stock for total consideration of $98.7 million with annual savings of $6.9 million

•Completed the acquisition of Deepstack Technologies on September 15, 2022

(1) Adjusted net income available to common stockholders, adjusted diluted EPS, adjusted return on average assets, and tangible common equity per share represent non-GAAP measures; see "Non-GAAP Measures"

Refer to the 2021 Form 10-K filed on March 1, 2022 for discussion related to 2021 activity compared to 2020 activity.

Economy

Elevated inflation levels and a significant rise in market interest rates dramatically changed the operating environment during 2022 and contributed to headwinds in the market. As our assets and liabilities are primarily monetary in nature, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general. Additionally, interest rates generally increase as the rate of inflation increases.

The rising interest rate environment may lead to lower demand for loans, higher credit losses, decreased values for our investment securities, among other negative effects. Additionally, it may create more intense competition for low-cost deposits, potential for deposit outflows as rate-sensitive depositors seek higher yielding products or investment alternatives, and increased deposit rates and borrowing costs.

We delivered positive results this year, driven by continued execution of strategic initiatives to build long-term franchise value while maintaining disciplined expense management. We also remained steadfastly focused on credit quality and continued to grow a stable, high quality deposit base by bringing new commercial relationships to the bank. Through our disciplined approach, we believe that we are well positioned to manage through the uncertainty in the macroeconomic environment.

Business Combinations

Deepstack Acquisition

On September 15, 2022, we completed the acquisition of the assets of Global Payroll Gateway, Inc. and its wholly owned subsidiary, Deepstack Technologies, LLC (collectively, "Deepstack"), for $24 million in total consideration. The purchase was

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accounted for as a business combination under U.S. GAAP and assets purchased and liabilities assumed were recorded at their respective acquisition date estimated fair values. During the measurement period (not to exceed one year from the acquisition date), the fair value of assets acquired and liabilities assumed are subject to adjustment if additional information becomes available to indicate a more accurate or appropriate value for an asset or liability.

Deepstack's results of operations have been included in our results since the September 15, 2022 acquisition date. Transaction costs related to the acquisition were $2.1 million for the year ended December 31, 2022.

The fair value amounts of identified assets acquired and liabilities assumed as part of the Deepstack acquisition are as follows:

Total consideration of $24 million includes cash consideration paid of $14.4 million, common stock issued of $7.2 million, or 412,473 shares, and additional cash consideration of $2.4 million expected to be paid 18 months after the acquisition date.

The acquisition of Deepstack resulted in the recognition of $2.8 million in developed technology and $1.0 million in other intangibles, including trademarks, client relationships and non-compete agreements. Goodwill in the amount of $18.2 million was also recognized and represents the strategic, operational and financial benefits expected from integrating the payment processing solutions and technology of Deepstack into our operations.

Pacific Mercantile Bancorp Acquisition

On October 18, 2021, we completed our merger with PMB, pursuant to which PMB merged with and into the Company, with the Company as the surviving corporation. PMB was the bank holding company of the wholly-owned subsidiary Pacific Mercantile Bank, a California state chartered commercial bank headquartered in Costa Mesa, California which operated seven banking offices, including three full service branches, located throughout Southern California.

Under the terms and conditions of the merger, each outstanding share of PMB common stock, aggregating 23,713,417 shares, was converted into the right to receive 0.5 of a share of the Company's common stock. In addition, at the effective time of the merger, we paid $3.2 million in cash for all outstanding PMB share-based awards, including outstanding shares subject to unvested restricted stock awards. In the merger, we issued 11,856,713 shares of common stock with an estimated fair value of $222.2 million based upon the $18.74 closing price of the Company's common stock on October 18, 2021. Together with the cash consideration, this resulted in an aggregate purchase price of $225.4 million. The operating results of PMB have been included since the date of acquisition and consequently, may impact the comparison of the financial results for the periods presented.

Goodwill in the amount of $59.0 million was recognized and represents the synergies and economies of scale expected

from combining the operations of PMB with ours. Refer to Note 2 - Business Combinations and Note 8 - Goodwill and Other Intangibles in Item 8 of this Annual Report for further information.

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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, 2022 and 2021. For further discussion of financial results for the years ended December 31, 2021 and 2020, refer to Item 7 of the 2021 Form 10-K filed on March 1, 2022.

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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)Includes average loans held for sale of $3.9 million, $2.4 million and $15.8 million for the years ended December 31, 2022, 2021 and 2020, which are included in other assets in the accompanying consolidated statements of financial condition.

(2)Total loans are net of deferred fees, related direct costs, premiums and discounts, but exclude the allowance for credit losses. Nonaccrual loans are included in the average balance. Interest income includes net (amortization) accretion of deferred loan (costs) fees and purchased (premiums) discounts of $(64) thousand, $348 thousand and $3.5 million for the years ended December 31, 2022, 2021 and 2020, respectively, are included in interest income.

(3)Includes average balance of FHLB, FRB and other bank stock at cost and average time deposits with other financial institutions.

(4)Includes average balance of BOLI of $125.2 million, $114.9 million and $110.6 million for the years ended December 31, 2022, 2021 and 2020.

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

(6)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.

(7)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, 2022 Compared to Year Ended December 31, 2021

Net interest income increased $60.6 million, or 23.9%, to $314.4 million for the year ended December 31, 2022 due to higher average balances and yield on interest-earning assets, partially offset by higher average balances and costs of interest-bearing liabilities. Interest income increased $81.1 million and interest expense increased $20.5 million as average earning assets increased $961.9 million and average total funding sources increased $953.3 million due largely to the impact of the acquisition of PMB in the fourth quarter of 2021.

The net interest margin increased 33 basis points to 3.59% as the average earning-assets yield increased 52 basis points and the average cost of total funding increased 19 basis points between periods. The yield on average interest-earning assets increased to 4.26% for the year ended December 31, 2022, from 3.74% for the same period in 2021 due mostly to higher market interest rates and changes in the mix of interest-earning assets. Average loans represented 82.8% of average earnings assets in 2022 compared to 78.8% for the full year in 2021. Average loans increased by $1.11 billion from organic loan growth and the impact of the PMB Acquisition. The yield on average loans increased 28 basis points to 4.52% for the year ended December 31, 2022 compared to the full year of 2021. The yield on average investment securities and other interest-earning assets increased 100 basis points and 149 basis points, respectively, for the year ended December 31, 2022, compared to the full year of 2021.

The average cost of funds increased 19 basis points to 0.71% for the year ended December 31, 2022 from 0.52% for 2021. This increase was driven by the higher cost of average interest-bearing liabilities, partially offset by the overall improved funding mix, including higher average noninterest-bearing deposits as a result of growth from business development efforts and the impact of the acquisition of PMB. The cost of average interest-bearing liabilities increased 36 basis points to 1.08% for the year ended December 31, 2022 compared to 0.72% for the same period in 2021 and included a 35 basis point increase in the cost of average interest-bearing deposits to 0.62%. Average noninterest-bearing deposits were $842.2 million higher for the year ended December 31, 2022 compared to 2021 while average total deposits were $795.2 million higher. Average noninterest-bearing deposits represented 38.6% of total average deposits for the year ended December 31, 2022 compared to 30.4% for 2021. The average cost of total deposits increased 19 basis points to 0.38% for the year ended December 31, 2022 compared to the full year of 2021.

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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 earnings and is adjusted in each period to a level required to cover current expected credit losses in our loan portfolio and unfunded noncancellable loan commitments. The following table presents the components of our provision for credit losses:

During the year ended December 31, 2022, the provision for credit losses was a reversal of $31.5 million, compared to a provision for credit losses of $6.9 million during 2021. The reversal of credit losses for the year ended December 31, 2022 was due to a $31.3 million recovery from the settlement of a loan previously charged-off in 2019. The provision for credit losses during the year ended December 31, 2021 included a $11.3 million charge related to establishing the initial allowance for credit losses established for non-PCD loans acquired in the PMB Acquisition. This charge was offset by the benefit of improvements in key macroeconomic forecast variables. The provision for credit losses during the year ended December 31, 2020 reflected the adoption of the CECL method of accounting, 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 years indicated:

Year Ended December 31, 2022 Compared to Year Ended December 31, 2021

Noninterest income for the year ended December 31, 2022 decreased $2.0 million to $17.4 million compared to 2021. The decrease was mainly due to a $7.7 million loss on the sale of investment securities, offset by higher customer service fees, loan servicing income, income from bank-owned life insurance, and all other income. Many of these increases are a result of including PMB's operations for the full year in 2022 compared to 2021. Customer services fees increased $1.9 million due mostly to higher deposit activity fees of $2.6 million attributed to higher average deposit balances, partially offset by lower loan fees of $755 thousand. Loan servicing income increased $923 thousand due mostly to the acquisition of mortgage servicing rights at the end of the second quarter of 2022. Income from bank-owned life insurance increased $531 thousand due to higher average balances gained in the PMB acquisition and all other income increased $2.4 million due mostly to higher gains from equity investments. Gains or losses from equity investments are recorded based on the most recent information

available from the investee and fluctuates based on their underlying performance.

Noninterest Expense

The following table presents noninterest expense for the years indicated:

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Year Ended December 31, 2022 Compared to Year Ended December 31, 2021

Noninterest expense for the year ended December 31, 2022 increased $10.7 million to $194.4 million compared to 2021. The increase was primarily due to: (i) higher salaries and employee benefits of $9.7 million and occupancy and equipment expense of $3.4 million due mainly to the increases in personnel and facilities from the acquisition of PMB, (ii) higher professional fees of $4.4 million, due mostly to a $2.6 million increase in indemnified legal fees (net of insurance recoveries) and a $1.8 million increase in other professional fees, (iii) higher all other expenses of $3.7 million due to including the operations of PMB since the date of acquisition, (iv) higher loss in alternative energy partnership investments of $2.5 million, and (v) higher amortization of intangible assets of $429 thousand due to the acquisitions of PMB in 2021 and Deepstack in 2022. These increases were partially offset by lower acquisition, integration and transaction costs of $13.8 million.

Income Tax Expense

Income tax expense totaled $47.9 million for the year ended December 31, 2022, representing an effective tax rate of 28.4%, compared to $20.3 million and an effective tax rate of 24.5% for 2021. The effective tax rate for the year ended December 31, 2022 was higher than the prior year due in part to 2021 including a net tax benefit of $2.5 million resulting from the exercise of all previously issued outstanding stock appreciation rights.

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

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 $356.5 million and $28.9 million as of December 31, 2022 and 2021 were pledged to secure FHLB advances, public deposits and for other purposes as required or permitted by law.

Investment Securities Held-to-Maturity

Securities held-to-maturity totaled $328.6 million at December 31, 2022 and included $214.4 million in agency securities and $114.2 million in municipal securities. During 2022, we transferred certain longer-duration fixed-rate mortgage-backed securities and municipal securities from the available-for-sale portfolio to the held-to-maturity portfolio to lower the adverse impact rising interest rates may have on the fair value of such securities and consequently tangible equity. At the time of the transfer, the securities had a fair value of $329.4 million, including an unrealized gross loss of $16.6 million, which became part of the securities' amortized cost basis. This amount, along with the unrealized loss included in accumulated other comprehensive income, is then amortized over the life of the security as an adjustment to its yield using the interest method. As a result, there is no impact on the consolidated statements of operations.

The following table presents the amortized cost and fair value of investment securities held-to-maturity as of the dates indicated:

There were no investment securities held-to-maturity at December 31, 2021

Investment Securities Available-for-Sale

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

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Securities available-for-sale totaled $868.3 million at December 31, 2022, a decrease of $447.4 million, or 34.0%, from $1.32 billion at December 31, 2021. The decrease was mainly due to the transfer of certain securities to the held-to-maturity portfolio as described above, principal payments of $36.9 million, collateralized loan obligation (CLO) payoffs of $28.5 million, sales of $128.8 million and higher unrealized net losses of $60.0 million, offset by purchases of $152.3 million.

Net unrealized losses on securities available-for-sale were $41.3 million at December 31, 2022, compared to net unrealized gains of $11.0 million at December 31, 2021. The net unrealized (losses) gains on securities available-for-sale, net of tax, are reflected in accumulated other comprehensive (loss) income. Increases in longer term market interest rates resulted in higher net unrealized losses in our securities portfolio and stockholders’ equity. As market interest rates increase, bond prices tend to fall and, consequently, the fair value of our securities may also decrease. To this end, we may have further net unrealized losses on our securities classified as available–for-sale, which would negatively affect our total and tangible stockholders’ equity.

CLOs totaled $476.6 million and $519.0 million and were all AAA and AA rated at December 31, 2022 and 2021. We perform due diligence and ongoing credit quality review of our CLO holdings, which includes monitoring performance factors such as external credit ratings, collateralization levels, collateral concentration levels, and other performance factors.

We did not record credit impairment for any investment securities for the years ended December 31, 2022, 2021 or 2020. We monitor our securities portfolio to ensure all of our investments have adequate credit support and we consider the lowest credit rating for identification of potential credit impairment. As of December 31, 2022, 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, 2022, 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. As of December 31, 2022, all of our investment securities in an unrealized loss position received an investment grade credit rating. The overall net decreases in fair value during the period were attributable to a combination of changes in interest rates and credit market conditions.

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The following table presents the fair values and weighted average yields using amortized cost of the securities held-to-maturity portfolio as of December 31, 2022, based on the earlier of contractual maturity dates or next repricing dates:

The following table presents the fair values and weighted average yields using amortized cost of the securities available-for-sale portfolio as of December 31, 2022, based on the earlier of contractual maturity dates or next repricing dates:

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Loans Receivable

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

(1)Includes warehouse lending balances of $602.5 million and $1.60 billion at December 31, 2022 and 2021.

(2)Includes PPP loans totaling $5.7 million and $123.1 million at December 31, 2022 and 2021.

(3)Total loans includes net deferred loan origination costs (fees), purchased premiums/(discounts), and fair value allocations of premiums (discounts) of $7.1 million and $5.5 million at December 31, 2022 and 2021.

Total loans were $7.12 billion at December 31, 2022, a decrease of $136.4 million, or 1.9%, from $7.25 billion at December 31, 2021. The decrease was due to lower warehouse lending balances of $1.00 billion and other paydowns and payoffs of $2.63 billion, partially offset by loan fundings and advances of $3.50 billion, including SFR purchases of $814.3 million.

Total commercial loans, excluding warehouse lending and SBA, increased $516.1 million, or 13.2% on an annualized basis during the year ended December 31, 2022.

We ceased originating SFR mortgage loans in 2019, however we have purchased 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, 2022, loans secured by residential real estate (single-family, multifamily, single-family construction, and warehouse lending credit facilities) represent approximately 62.6% of our total loans outstanding.

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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, 2022:

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The following table presents the interest rate profile of the loan portfolio due after one year at December 31, 2022:

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 warehouse credit facilities).

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

Non-Traditional Mortgage ("NTM") Portfolio

NTM loans are included in our SFR mortgage portfolio and are comprised primarily of interest only loans. As of December 31, 2022 and 2021, the NTM loans totaled $862.3 million, or 12.1% of total loans, and $635.3 million, or 8.8% of total loans, respectively. The total NTM portfolio increased by $227.1 million, or 35.7%, during the year ended December 31, 2022. The increase was due to loan purchases, partially offset by principal paydowns and payoffs.

We no longer originate SFR loans, however we have purchased 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. Interest only loans are primarily SFR first mortgage loans that generally have a 30 to 40-year term at the time of origination and include payment features that allow interest only payments in initial periods before converting to a fully amortizing loan.

At December 31, 2022 and 2021, nonperforming NTM loans totaled $3.0 million and $4.0 million.

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 first lien loans are LTV ratios. At December 31, 2022, our NTM first lien portfolio had a weighted average LTV of approximately 59%.

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 of $91.2 million, or 1.28% of total loans, at December 31, 2022, compared to $72.8 million, or 1.00% of total loans, at December 31, 2021. The $18.5 million increase is mostly due to a net increase in delinquent SFR loans, which are well secured with low loan-to-value ratios, of $28.9 million, offset by a $8.7 million reduction in delinquent SBA loans. The $10.3 million of SBA loans greater than 89 days past due includes $8.6 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 as of the dates indicated:

Nonperforming assets totaled $55.3 million or 0.60% of total assets at December 31, 2022, compared to $52.6 million or 0.56% of total assets at December 31, 2021. The $2.7 million increase in nonaccrual loans during the year was primarily due to the

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addition of $43.9 million in nonaccrual loans, offset by $9.0 million of loans returning to accrual status and $32.2 million of other pay offs or pay downs.

At December 31, 2022, nonperforming loans included (i) SFR mortgages of $21.1 million, (ii) $8.9 million of commercial loans in a current payment status, which however are on nonaccrual based on other criteria, and (iii) other commercial loans of $25.3 million. Excluding SFR mortgages, which are well secured with low loan-to-value ratios, non-performing loans decreased $11.3 million during the year. During the year ended December 31, 2022, a $7.4 million partial charge-off was recognized on a PCD commercial and industrial loan, which has a remaining carrying value of $4.0 million at year end.

With respect to loans that were on nonaccrual status as of December 31, 2022, the gross interest income that would have been recorded during the year ended December 31, 2022 had such loans been current in accordance with their original terms and been outstanding throughout the year ended December 31, 2022 (or since origination, if held for part of the year ended December 31, 2022), was $3.1 million. The amount of interest income on such loans that was included in net income for the year ended December 31, 2022 was $2.3 million.

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 relative to current or prevailing market terms 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, 2022 and 2021, we had 15 and 18 loans with an aggregate balance of $16.1 million and $16.7 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, 2022, of the 15 loans classified as TDRs, 6 loans totaling $2.7 million were making payments according to their modified terms and were in accruing status. 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 in accruing status.

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 higher 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, 2022 and 2021, we had classified assets totaling $119.0 million and $101.4 million. The total amount classified represented 1.29% and 1.08% of our total assets at December 31, 2022 and 2021.

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The following table presents the risk categories for total loans as of December 31, 2022:

(1)There were no loans classified "loss" at December 31, 2022.

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.

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 released by the model provider during December 31, 2022. The published forecasts consider the FRB's monetary policy, labor market constraints, rising inflation, higher oil prices and the military conflict between Russia and Ukraine, among other factors.

The ACL also incorporates 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 noncancellable loan commitments, totaled $91.3 million, or 1.28% of total loans at December 31, 2022 compared to $98.2 million or 1.35% at December 31, 2021. The $6.9 million decrease in the ACL was due primarily to net charge offs of $6.7 million, which included the charge-off a $7.1 million specific reserve related to a PCD loan; lower general reserves of $1.4 million due to changes in portfolio mix including lower loan balances offset by the impact of weaker economic forecasts, and $0.3 million lower RUC from lower volume of unfunded noncancellable commitments; partially offset by new specific reserves totaling $1.5 million. The $31.3 million recovery in the first quarter of 2022 from the settlement of a loan previously charged-off in 2019 also resulted in a reversal of provision for credit losses and therefore had no net impact on the ACL.

The ACL coverage of nonperforming loans was 165% at December 31, 2022 compared to 187% at December 31, 2021.

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: