HOPE BANCORP INC (HOPE) FY 2021 MD&A

Item 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with our Consolidated Financial Statements and accompanying notes presented elsewhere in this Report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those set forth under Item 1A “Risk Factors” and elsewhere in this Report. Please see the “Forward Looking Information” immediately preceding Part I of this Report.

Overview

We offer a full range of commercial and retail banking loan and deposit products through Bank of Hope. We have 54 banking offices in California, New York/New Jersey, Illinois, Washington, Texas, Virginia, Georgia and Alabama. We have 11 loan production offices located in Atlanta, Houston, Dallas, Denver, Portland, Seattle, Fremont, and in Southern California. We offer our banking services through our network of banking offices and loan production offices to our customers who typically are small to medium-sized businesses in our market areas. We accept deposits and originate a variety of loans including commercial business loans, real estate loans, trade finance loans, SBA loans, and consumer loans.

Our principal business involves earning interest on loans and investment securities that are funded primarily by customer deposits, wholesale deposits, and other borrowings. Our operating income and net income are derived primarily from the difference between interest income received from interest earning assets and interest expense paid on interest bearing liabilities and, to a lesser extent, from fees received in connection with servicing loan and deposit accounts and income from the sale of loans. Our major expenses are the interest we pay on deposits and borrowings, provisions for credit losses and general operating expenses, which primarily consist of salaries and employee benefits, occupancy costs, and other operating expenses. Interest rates are highly sensitive to many factors that are beyond our control, such as changes in the national economy and in the related monetary policies of the FRB, inflation, unemployment, consumer spending and political changes and events. We cannot predict the impact that these factors and future changes in domestic and foreign economic and political conditions might have on our performance.

Our results are affected by economic conditions in our markets and to a lesser degree in South Korea. A decline in economic and business conditions in our market areas or in South Korea may have a material adverse impact on the quality of our loan portfolio or the demand for our products and services, which in turn may have a material adverse effect on our financial condition and results of operations.

COVID-19 Pandemic

On March 11, 2020, the World Health Organization declared the novel coronavirus (“COVID-19”) a global pandemic. The COVID-19 pandemic has had a material and adverse impact on our business, financial condition, and results of operations and any further impact will depend on future developments that cannot be predicted, including the scope and duration of the pandemic, the economic implications of the same, effectiveness of vaccines being distributed, and the continued actions taken by governmental authorities in response to the pandemic.

The COVID-19 pandemic substantially and negatively impacted the United States economy and disrupted global supply chains. In addition, the pandemic has resulted in permanent and temporary closures of countless businesses and the institution of social distancing and sheltering in place requirements in most states and communities. Although the United States has seen a recent decline in new cases of COVID-19 as a result of the vaccination efforts underway, and many states have now relaxed most of the business closures and other social distancing requirements, concerns over COVID-19 still exist.

The demand for our products and services has been and may again be adversely impacted, which could materially and adversely affect our financial condition and results of operations. Furthermore, the pandemic could result in the recognition of amplified credit losses in our loan portfolios and increases in our allowance for credit losses. Similarly, because of economic volatility and uncertain market conditions, we may be required to recognize impairments on goodwill or impairment on other financial instruments we hold. The extent to which the COVID-19 pandemic impacts our business, results of operations, and financial condition, as well as our regulatory capital and liquidity ratios, will depend on future developments, that cannot be predicted, including the continued effectiveness of vaccines, the scope and duration of the pandemic, the impact of COVID-19, including potential new variants, the economic implications of the same, and actions taken by governmental authorities and other third parties in response to the pandemic.

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On March 27, 2020, former President Donald Trump signed into law the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act in response to the global pandemic. The CARES Act provided approximately $2.2 trillion in emergency economic relief funds, expanded SBA lending and provided temporary relief of certain modifications from TDR classification. In December 2020, the President signed the Consolidated Appropriations Act of 2021 which included another $900 billion in stimulus relief for the COVID-19 pandemic to provide emergency economic relief funds, further expanded SBA lending with additional funds for SBA Paycheck Protection Program (“PPP”), and provided an extension for the relief of certain modifications from TDR classification. We have assisted many of our customers in availing themselves of certain provisions of the CARES Act by providing loan modifications to borrowers consisting of mostly payment deferrals (see “COVID-19 Related Loan Modifications” in the Financial Conditions section of the MD&A for more information). We funded $480.2 million in SBA PPP loans in 2020 and funded $324.5 million in second round PPP loans during the year ended December 31, 2021.

On March 11, 2021, President Joe Biden signed into law the American Rescue Plan Act of 2021. The American Rescue Plan is a $1.9 trillion rescue package designed to help the United States recovery from the impact that the COVID-19 pandemic has had on the country. On September 9, 2021, President Biden announced executive orders for new federal vaccine requirements that includes a mandate to all employers with more than 100 workers to require employees to be vaccinated or tested for the COVID-19 virus on a weekly basis. Since we have more than 100 employees, this vaccine mandate would apply to our operations. However, the validity of the mandate continues to be challenged in the courts.

At December 31, 2021, all of our regulatory capital ratios for Hope Bancorp and the Bank were in excess of the minimum requirements set by our regulators. While we currently believe that we have sufficient excess capital and liquidity to withstand the economic impact of the COVID-19 pandemic, further economic deterioration or an extended recession could adversely impact our capital and liquidity positions.

Pandemic Response Plan

With the onset of the COVID-19 virus, we activated a Pandemic Response Plan in January 2020, in advance of the declaration of the COVID-19 pandemic. As part of the Pandemic Response Plan, a Pandemic Response Team and a Business Continuity Program Team were formed which closely monitor the COVID-19 situation, identifying issues and developing responses to reduce risks related to COVID-19 to our customers, employees, and communities. As part of our overall efforts to help contain the spread of the virus, we made a number of adjustments in our branch operations and regularly communicate with our staff to keep them apprised of the latest information. The goal of the Pandemic Response Plan is to protect the health of our customers, employees, and communities while continuing to meet the needs of our customers. The Pandemic Response Team and Business Continuity Program Team will continue to monitor the COVID-19 situation and take additional actions in an effort to ensure the safe continued operations of the Bank.

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Selected Financial Data

The following table presents selected financial and other data for each of the years in the five-year period ended December 31, 2021. The information below should be read in conjunction with, the more detailed information included elsewhere herein, including our Audited Consolidated Financial Statements and Notes thereto.

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(1)Net income divided by average assets.

(2)Net income divided by average stockholders’ equity.

(3)Difference between the average yield earned on interest earning assets and the average rate paid on interest bearing liabilities.

(4)Net interest income expressed as a percentage of average interest earning assets.

(5)Interest income divided by average interest earning assets.

(6)Interest expense divided by average interest bearing liabilities.

(7)Noninterest expense divided by the sum of net interest income plus noninterest income.

(8)Excludes delinquent SBA loans that are guaranteed and currently in liquidation.

(9)Excludes acquired credit impaired loans totaling $13.2 million, $14.1 million, and $18.1 million as of December 31, 2019, 2018, and 2017, respectively.

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Critical Accounting Policies

Our financial statements are prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and generally accepted practices within the banking industry. The financial information contained within these statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. All of our significant accounting policies are described in Note 1 of our Consolidated Financial Statements presented elsewhere in this Report and are essential to understanding Management’s Discussion and Analysis of Financial Condition and Results of Operations. GAAP requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may materially and adversely differ from these estimates under different assumptions or conditions.

The following is a summary of the more subjective and complex accounting estimates and judgements affecting the financial condition and results reported in our financial statements. In each area, we have identified the variables we believe to be the most important in the estimation process. We use the best information available to us to make the estimations necessary to value the related assets and liabilities in each of these areas. Management has reviewed these critical accounting estimates and related disclosures with our Audit Committee.

Business Combinations

Description - Mergers and acquisitions are accounted for in accordance with ASC 805 “Business Combinations” using the acquisition method of accounting. Assets and liabilities acquired and assumed are generally recorded at their fair values as of the date of the transaction. The excess of purchase price over the fair value of assets acquired and liabilities assumed is recorded as goodwill. If the fair value of net assets acquired exceeds the purchase consideration, a bargain purchase is recorded. Critical accounting policies related to acquired loans is discussed in more detail below under “Purchase Credit Deteriorated Loans” (“PCD”).

Subjective Estimates and Judgments - Determining the fair value of assets and liabilities acquired often involves estimates based on internal estimate or third-party valuations using a discounted cash flow analysis or other valuation techniques that may include the use of estimates. In addition, the determination of the useful lives over which intangible assets will be amortized is subjective in nature.

Impact if Actual Results Differ From Estimates and Judgments - Changes to estimates and judgments used in business combinations could result in a significant difference in the fair value of assets and liabilities acquired which would impact total goodwill or bargain purchase gain recorded. A change in the useful life of intangible assets could impact amortization amounts which could have an impact on our earnings.

Investment Securities

Description - We evaluate securities in unrealized loss position for impairment related to credit losses on at least a quarterly basis. Based on our evaluation, we do not believe that we had any investment securities available for sale with unrealized losses with a credit loss impairment as of December 31, 2021. Investment securities are discussed in more detail under “Financial Condition - Investment Security Portfolio”.

Subjective Estimates and Judgments - Significant judgment is involved in determining when a decline in fair value is credit impaired. Securities in unrealized loss positions are first assessed as to whether we intend to sell, or if it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If one of the criteria is met, the security’s amortized cost basis is written down to fair value through current earnings. For securities that do not meet these criteria, we evaluate whether the decline in fair value resulted from credit losses or other factors. In evaluating whether a credit loss exists, we set up an initial filter for impairment triggers. Once the quantitative filters have been triggered, the securities are placed on a watch list and an additional assessment is performed to identify whether a credit impairment exists. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security and the issuer, among other factors.

Impact if Actual Results Differ From Estimates and Judgments - Changes in management’s assessment of the factors used to determine if an investment security is credit impaired could lead to additional impairment charges. Additionally, a security that had no apparent risk could be affected by a sudden or acute market condition and necessitate an impairment charge.

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Allowance for Credit Losses

Description - The allowance for credit losses is maintained at a level believed adequate by management to absorb expected lifetime losses in the consolidated loan portfolio. The adequacy of the allowance for credit losses is determined by management based upon an evaluation and review of the credit quality of the loan portfolio, consideration of current and projected economic conditions and variables, and historical loss experience, relevant internal and external factors that affect the collection of a loan, and other pertinent factors. The allowance for credit losses is discussed in more detail under “Financial Condition - Allowance for Credit Losses”.

Subjective Estimates and Judgments - We determine the adequacy of the allowance for credit losses by analyzing and estimating lifetime expected losses in the loan portfolio. The allowance for credit losses requires estimates that are not limited to current and projected economic conditions, the adequacy of and value of underlying collateral on real estate loans, the financial strength of the borrower, qualitative assessments, and other relevant factors. Specifically, the provision for credit losses represents the amount charged against current period earnings to achieve an allowance for credit losses that, in our judgment, is adequate to absorb lifetime expected losses in the loan portfolio.

Impact if Actual Results Differ From Estimates and Judgments - Adverse changes in management’s assessment of the assumptions and factors used to determine the allowance for credit losses could lead to additional provision for credit losses. Actual credit losses could differ materially from management’s estimates if actual losses and conditions differ significantly from the assumptions used. These factors and conditions include general economic conditions within our market, industry trends and concentrations, real estate and other collateral values, interest rates, and the financial conditions of our borrowers. While management believes that it has established adequate allowances for lifetime losses on loans, actual results may prove different and the differences could be significant.

Goodwill

Description - Goodwill is generally determined as the excess of the fair value of the consideration paid over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill recorded in a purchase business combination is determined to have an indefinite useful life and is not amortized but tested for impairment at least annually. Goodwill may also be tested for impairment on an interim basis if circumstances change or an event occurs between annual tests that would more likely than not reduce the fair value of the reporting unit below its carrying amount. An impairment loss must be recognized for any excess of carrying value over fair value of the goodwill.

Subjective Estimates and Judgments - Before applying the goodwill impairment test, in accordance with ASC 350 “Intangibles - Goodwill and Other”, we perform a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount. If we conclude that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, we do not perform Step 1 of the impairment analysis. We assess certain qualitative factors to determine whether impairment is likely including: our market capitalization, capital adequacy, continued performance compared to peers, and continued improvement in asset quality trends, among others. This qualitative assessment can be subjective in nature and includes a certain amount of management judgment in determining whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount.

In the event we perform an impairment test, the determination of fair value is based on valuations using management assumptions and estimates including developing cash flow projections, selecting appropriate discount rates, calculation of a terminal growth rate, minimum target capitalization levels, identifying relevant market comparables, incorporating current and projected economic conditions, and selecting an appropriate control premium.

Impact if Actual Results Differ From Estimates and Judgments - Changes in qualitative factors assessed, changes to assumptions used in the impairment test, selection and weighting of the various fair value techniques, and downturns in economic or business conditions, could have a significant adverse impact on the carrying value of goodwill and could result in impairment losses which could have a material impact our financial condition and earnings.

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Income Taxes

Description - We use the asset and liability method of accounting for income taxes in which deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of our asset and liabilities. The realization of the net deferred tax asset generally depends upon future levels of taxable income and the existence of prior years’ taxable income, to which “carry back” refund claims could be made. A valuation allowance is maintained, when necessary, to reduce deferred tax assets that management estimates are more likely than not to be unrealizable based on available evidence at the time the estimate is made. Furthermore, tax positions that could be deemed uncertain are required to be disclosed and reserved for if it is more likely than not that the position would not be sustained upon audit examination. Taxes are discussed in more detail in Note 11 to our Consolidated Financial Statements presented elsewhere in this Report.

Subjective Estimates and Judgments - Significant management judgment is required in determining income tax expense and deferred tax assets and liabilities. Some judgments are subjective and involve estimates and assumptions about matters that are inherently uncertain. In determining the valuation allowance, we use historical and forecasted future operating results. In determining the level of reserve needed for uncertain tax positions, we consider relevant current legislation and court rulings, among other authoritative items, to determine the level of exposure inherent in our tax positions. Management believes that the accounting estimate related to the valuation allowance and uncertain tax positions are a critical accounting estimate because the underlying assumptions can change from period to period.

Impact if Actual Results Differ From Estimates and Judgments - Although management believes that the judgments and estimates used are reasonable, should actual factors and conditions differ materially from those considered by management, the actual realization of the net deferred tax asset and tax positions taken could differ materially from the amounts recorded in the financial statements. If we are not able to realize all or part of our net deferred tax asset in the future or if a tax position is overturned by a taxing authority, an adjustment to the deferred tax asset valuation allowance would be charged to income tax expense in the period such determination was made which could have a material impact on our earnings.

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Results of Operations

Operations Summary

Our most significant source of income is net interest income, which is the difference between our interest income and our interest expense. Generally, interest income is generated from the loans we extend to our customers and from investments, and interest expense is generated from interest bearing deposits our customers have with us and from borrowings or debt that we may have, such as FHLB advances, federal funds purchased, convertible notes, and subordinated debentures. Our ability to generate profitable levels of net interest income is largely dependent on our ability to manage the levels of interest earning assets and interest bearing liabilities, and the rates received or paid on them, as well as our ability to maintain sound asset quality and appropriate levels of capital and liquidity. As mentioned above, interest income and interest expense may fluctuate based on factors beyond our control, such as economic or political conditions and policies.

We attempt to minimize the effect of interest rate fluctuations on net interest margin by monitoring our interest sensitive assets and our interest sensitive liabilities. Net interest income can be affected by a change in the composition of assets and liabilities, such as replacing higher yielding loans with a like amount of lower yielding investment securities. Changes in the level of nonaccrual loans and changes in volume and interest rates can also affect net interest income. Volume changes are caused by differences in the level of interest earning assets and interest bearing liabilities. Interest rate changes result from differences in yields earned on assets and rates paid on liabilities.

The other source of our income is noninterest income, including service charges and fees on deposit accounts, loan servicing fees, fees from trade finance activities, net gains on sale of loans that were held for sale and investment securities available for sale, and other income and fees. Our noninterest income can be reduced by charges from the credit impairment of our investment securities.

In addition to interest expense, our income is also impacted by provisions for credit losses and noninterest expense, primarily salaries and benefits and occupancy expense. The following table presents our condensed consolidated statements of income and the changes year over year.

Net Income

Our net income was $204.6 million for 2021 compared to $111.5 million for 2020 and $171.0 million for 2019. Our diluted earnings per common share totaled $1.66, $0.90, and $1.35 for the years 2021, 2020, and 2019, respectively. The return on average assets was 1.17%, 0.68%, and 1.12 % and the return on average stockholders’ equity was 9.88%, 5.49%, and 8.63% for the years 2021, 2020, and 2019, respectively. The increase in net income for 2021 compared to 2020 was due to a decrease in provision for credit losses and a decrease in interest expense offset partially by a decline in interest income. 2020 marked an unprecedented year with the COVID-19 pandemic which had a significantly adverse effect on the economy. The impact of the COVID-19 pandemic on our loan portfolio combined with the adoption of CECL resulted in a large increase in allowance for credit losses leading to significant increases in provision for credit losses for 2020 compared to 2019.

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Impact of Acquisitions

Income before income tax provision for the years ended December 31, 2021, 2020, and 2019 were impacted by the accretion of discounts and the amortization of premiums relating to past acquisitions. The following table summarizes the accretion and amortization adjustments that were included in net income for the years indicated below:

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Net Interest Margin and Net Interest Rate Spread

We analyze our earnings performance using, among other measures, net interest spread and net interest margin. The net interest spread represents the difference between the weighted average yield earned on interest earning assets and the weighted average rate paid on interest bearing liabilities. Net interest income, when expressed as a percentage of average total interest earning assets, is referred to as the net interest margin. Our net interest margin is affected by changes in the yields earned on assets and rates paid on liabilities, as well as the ratio of the amounts of interest earning assets to interest bearing liabilities.

Interest rates charged on our loans are affected principally by the demand for such loans, the supply of money available for lending purposes, the interest rate environment, and other competitive factors. These factors are in turn affected by general economic conditions and other factors beyond our control, such as federal economic policies, the general supply of money in the economy, legislative tax policies, governmental budgetary matters, and the actions of the FRB.

The following table presents our net interest margin, net interest rate spread, and our condensed consolidated average balance sheet information, together with interest rates earned and paid on the various sources and uses of funds, for the years indicated:

(1) Interest income on loans includes accretion of net deferred loan origination fees and costs, prepayment fees received on loan pay-offs and accretion of discounts on acquired loans. See the table below for detail.

(2) Average balances of loans are net of deferred loan origination fees and costs and include nonaccrual loans and loans held for sale.

(3) Interest income and yields are not presented on a tax-equivalent basis.

(4) Yield on interest earning assets minus cost of interest bearing liabilities.

(5) Cost on interest bearing liabilities and noninterest bearing deposits.

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The following table presents net loan origination fees, loan prepayments fee income, interest reversed for nonaccrual loans, and discount accretion income included as part of loan interest income for the years indicated:

Net Interest Income

Net interest income was $512.8 million for 2021, compared to $467.5 million for 2020 and $466.6 million for 2019. Changes in net interest income are a function of changes in interest rates and volumes of interest earning assets and interest bearing liabilities. The table below sets forth information regarding the changes in interest income and interest expense for the periods indicated. The total change for each category of interest earning assets and interest bearing liabilities is segmented into the change attributable to variations in volume (changes in volume multiplied by the old rate) and the change attributable to variations in interest rates (changes in rates multiplied by the old volume). Nonaccrual loans are included in average loans used to compute this table.

Net interest income before provision for credit losses increased by $45.3 million, or 10%, for 2021 compared to 2020. The increase was primarily due to a decrease in cost of interest bearing deposits which decreased by 68 basis points for 2021 compared to 2020 and a decline in time deposit balances. The decrease in interest bearing deposit expenses contributed to a decrease in total interest expense of $77.6 million for 2021 compared to 2020. The decrease in interest expense was partially offset by a decrease in interest income of $32.3 million due to the origination of lower rate loans compared to the existing portfolio.

Net interest income before provision for credit losses increased by $903 thousand, or less than 1%, for 2020 compared to 2019. The increase was primarily due to a decrease in cost of interest bearing deposits which decreased by 95 basis points for 2020 compared to 2019. This decrease in cost of interest bearing deposits resulted in a decrease to interest expense of $86.8 million. The decrease in interest expense was partially offset by a decrease in interest income of $85.9 million due to decrease in interest rates in 2020 compared to the previous year.

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Interest Income

Interest income was $566.5 million for 2021, compared to $598.9 million for 2020 and $684.8 million for 2019. The yield on average interest earning assets was 3.42% for 2021, compared to 3.84% for 2020 and 4.81% for 2019.

Comparison of 2021 with 2020

The decrease in interest income of $32.3 million, or 5%, for 2021 compared to 2020 was primarily due to new loans originated at lower interest rates and a decline in discount accretion income. Average total loans increased by $644.9 million for 2021 compared to 2020. Discount accretion income on acquired loans decreased to $9.9 million for 2021 compared to $23.1 million for 2020. Interest income from investment securities also declined due to the sale and pay-down of higher yielding securities in combination with the purchase of lower yielding securities which contributed to the decline in interest income.

Comparison of 2020 with 2019

The decrease in interest income of $85.9 million, or 13%, for 2020 compared to 2019 was primarily a result of the decline in interest rate in 2020. As a result of the COVID-19 pandemic and its impact to the U.S. economy, the FOMC lowered the target federal funds rate by a total of 1.50% in March 2020 to 0.00%-0.25%. The reduction in interest rates in March 2020 had a large impact on our loan yields and interest income as our variable rate loans repriced to lower interest rates and new loans were originated at lower rates. Average total loans increased by $699.8 million for 2020 compared to 2019. Discount accretion income on acquired loans decreased to $23.1 million for 2020 compared to $31.8 million for 2019.

Interest Expense

Deposits

Interest expense on deposits was $42.0 million for 2021 compared to $110.4 million for 2020 and $190.2 million for 2019. The average cost of deposits was 0.29% for 2021, compared to 0.81% for 2020 and 1.58% for 2019. The average cost of interest bearing deposits was 0.46% for 2021, compared to 1.14% for 2020 and 2.09% for 2019.

Comparison of 2021 with 2020

The decrease in interest expense on total deposits of $68.4 million, or 62%, for 2021 compared to 2020 was due to a reduction in rates paid on interest bearing deposits in 2021 compared to 2020. Management reduced rates on most of its deposit products several times in 2021 to offset the decline in loan yields. The average balance of noninterest bearing deposits accounted for 38% of total average deposits for the year ended December 31, 2021 compared to 28% for the year ended December 31, 2020.

Comparison of 2020 with 2019

The decrease in interest expense on total deposits of $79.8 million, or 42%, for 2020 compared to 2019 was due to a reduction in rates paid on interest bearing deposits in 2020 compared to 2019. We reduced the rates paid on our various deposits multiple times in 2020. The reduction in deposit rates was both a result of the interest rate cuts in March 2020 and due to a significant increase in liquidity throughout 2020. The increase in liquidity in 2020 resulted in a reduction in loan funding needs which had an impact on the overall rates paid on deposits as we were less eager to compete for additional sources of funds. The average balance of noninterest bearing deposits accounted for 28% of total average deposits at December 31, 2020 compared to 24% at December 31, 2019.

FHLB Advances and Federal Funds Purchased

FHLB advances and federal funds purchased include borrowings from the FHLB and federal funds purchased. As part of our asset-liability management, we utilize FHLB advances to supplement our deposit source of funds. Therefore, there may be fluctuations in these balances depending on the short-term liquidity and longer-term financing needs of the Bank.

Average FHLB advances were $208.7 million for 2021, compared to $435.8 million in 2020 and $688.7 million in 2019. Interest expense on FHLB advances was $2.6 million for 2021 compared to $6.9 million for 2020 and $12.0 million for 2019. The average cost of FHLB advances was 1.23% for 2021, compared to 1.58% for 2020 and 1.75% for 2019. The average cost of FHLB advances for 2019 included $1.3 million in amortization of premiums recorded on advances acquired from prior acquisitions. The premiums were fully amortized as of December 31, 2019. During 2021, we repaid $2.27 billion in FHLB advances with an average rate of 0.15% and borrowed $2.32 billion in advances with an average rate of 0.15%. In 2020, $300.0 million in FHLB advances were paid off before maturity and we paid a prepayment penalty of $3.6 million.

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Convertible Notes

In 2018, we issued $217.5 million in senior convertible notes. The carrying balance of our convertible notes include issuance costs to be capitalized. The cost of our convertible notes for 2021 was 2.42% compared to 4.61% for 2020 and 4.64% for 2019. The cost of our convertible notes for 2021 consisted of the 2.00% coupon rate and non-cash interest expense from the capitalization of issuance cost. The cost of our convertible notes for 2020 and 2019 also included non-cash interest expense from the amortization of the convertible notes discount. On January 1, 2021, we early adopted ASU 2020-06, which eliminated the discount on our convertible notes and reduced interest expense for 2021 by approximately $4.2 million, compared to 2020.

Other Borrowings

Other borrowings consist of subordinated debentures which bear interest at the 3-month LIBOR rate plus a designated spread. There were no changes in our balance of subordinated debentures during 2021 or 2020 aside from the increases related to the discount accretion on subordinated debentures acquired from previous acquisitions. The average rate on other borrowings decreased to 3.82% for 2021 compared to 4.63% for 2020 and 6.74% for 2019. The change in cost of other borrowings for 2021 and 2020 compared to prior years was due to changes in the 3-month LIBOR rate.

Provision for Credit Losses

The provision for credit losses reflects our judgment of the current period cost associated with credit risk inherent in our loan portfolio. The provision for credit losses for each period is dependent upon many factors, including loan growth, net charge offs, changes in the composition of the loan portfolio, delinquencies, assessments by management, third parties’ and regulators’ examination of the loan portfolio, the value of the underlying collateral on problem loans, the general economic conditions in our market areas, and future projections of the economy. Specifically, the provision for credit losses represents the amount charged against current period earnings to achieve an allowance for credit losses that, in our judgment, is adequate to absorb probable lifetime losses inherent in our loan portfolio. Periodic fluctuations in the provision for credit losses result from management’s assessment of the adequacy of the allowance for credit losses; however, actual credit losses could potentially vary materially from current estimates. If the allowance for credit losses is inadequate, we may be required to record additional provision for credit losses, which could have a material adverse effect on our business, financial condition, and results of operations.

With the adoption of ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“CECL”) in 2020, our provision for credit losses was more volatile due to changes in the calculation of the allowance for credit losses and especially due to the volatility that arose from the COVID-19 pandemic. Due to the economic recovery during the year, provision for credit losses in 2021 were much less volatile. CECL requires the measurement of all expected credit losses for financial assets carried at amortized cost based on historical experience, current macroeconomic conditions, and reasonable and supportable forecasts.

Comparison of 2021 with 2020

The negative provision for credit losses was $12.2 million for 2021, a decrease of $107.2 million from $95.0 million in provision for credit losses for 2020. The decrease in provision for credit losses for 2021 compared to 2020 was due to management’s efforts of de-risking and rebalancing our loan portfolio and the economic recovery and improved future economic forecasts for 2021 compared to 2020. In 2020, due to the COVID-19 pandemic, we recorded additional reserves to reflect the economic decline that impacted the global economy, including additional risks associated with the large amount of loans that were modified as a result of the hardships experienced by borrowers due to the effects of COVID-19. The balance of loans modified due to COVID-19 was approximately 10.2% of the total portfolio as of December 31, 2020, but has declined significantly to less than 1.0% of the total loan portfolio as of December 31, 2021. The decline in COVID-19 modified loans and overall reduction of credit risk in our loan portfolio contributed to the recapture of provision for credit losses for 2021 compared to 2020. The allowance for credit losses coverage ratio was 1.01% of total loans at December 31, 2021 compared to 1.52% at December 31, 2020.

During the year ended December 31, 2021, we sold $275.3 million in loans most of which had borrowers with elevated credit risk that we felt had potential for future losses. The strategic sales of and transfer to loans held for sale of loans with elevated credit risk helped to significantly improve the overall credit quality of the loan portfolio which reduced the required allowance for credit losses and contributed to the decline in provision for credit losses for the year ended December 31, 2021 compared to 2020.

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Comparison of 2020 with 2019

The provision for credit losses was $95.0 million for 2020, an increase of $87.7 million, or 1,201%, from $7.3 million for 2019. The increase in provision for credit losses for 2020 compared to 2019 was due to both the adoption of CECL and due to the impact of the COVID-19 pandemic. The COVID-19 pandemic adversely affected many industries with the hospitality sector being one of the hardest hit. Hotel/motel loans made up a large percentage of our loan portfolio at approximately 12% at December 31, 2020. As a result, our estimated allowance for credit losses experienced large increases in 2020 to reflect the projected impact of COVID-19 pandemic on our loan portfolio at that time. The allowance for credit losses coverage ratio was 1.52% of total loans at December 31, 2020 compared to 0.77% at December 31, 2019.

See Note 1 “Significant Accounting Policies” of the Notes to Consolidated Financial Statements for further discussion of our allowance for credit losses methodology since 2020 and for a discussion of our former incurred loss allowance for loan losses methodology, please refer to our Annual Report on Form 10-K for the year ended December 31, 2019.

Noninterest Income

Noninterest income is primarily comprised of service fees on deposit accounts, international service fees (fees received on trade finance letters of credit), loan servicing fees, wire transfer fees, swap fee income, net gains on sales of loans, net gains on sales and calls of securities available for sale, and other income which includes earnings on bank owned life insurance, changes in the fair value of our equity investments with readily determinable fair value, and other miscellaneous income. Noninterest income was $43.6 million for 2021 compared to $53.4 million for 2020, and $49.7 million for 2019.

A breakdown of noninterest income by category is shown below:

Comparison of 2021 with 2020

The decrease in service fees on deposit accounts for 2021 compared to 2020 was due to a decrease in customer analysis fees driven by risk management’s decision to discontinue our relationships with customers in the check cashing industry and a decline in and non-sufficient funds fees. In addition, due to the COVID-19 pandemic and social distancing and related restrictions, deposit activity for 2021 was greatly reduced compared to the 2020. As a result, demand deposit account transactions declined which negatively impacted the amount of non-sufficient fees earned.

International service fees increased for 2021 compared to 2020 due to an increase in fees generated from trade finance loans. International service fees are earned from trade finance loans and as the balance of these loans have increased, the associated fee income earned has also increased. The balance of trade finance loans increased to $146.8 million at December 31, 2021 from $102.8 million at December 31, 2020.

Loan servicing fees, net represents income earned from servicing SBA and residential mortgage loans that were previously sold. We retain servicing on most of the loans that we choose to sell. The increase in loan servicing fees, net for 2021 compared to 2020 was due to a reduction in payoffs of serviced loans. Payoffs of serviced loans were higher during 2020, which resulted in the full amortization of the remaining servicing asset, which is recorded as a reduction to loan servicing fee income.

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Wire transfer fees declined slightly for 2021 compared to 2020 due to the COVID-19 pandemic, which resulted in continued decline in deposit related transactions, including wire transfers.

Swap fee income represents fees earned from back to back swap transactions for our loan customers. The number of swap transactions decreased in 2021 which resulted in a decrease in swap fee income for 2021 compared to 2020.

In 2018, we stopped the practice of regularly selling the guaranteed portion of SBA loans due to the reduction in premium rates paid in the secondary market. However, premiums paid for SBA guaranteed loans have increased due to the low interest rate environment and increased liquidity held by banks and other financial institutions. As a result, we decided to return to the practice of regularly selling SBA guaranteed loans in 2021. During the year ended December 31, 2021, we sold $102.4 million in SBA guaranteed loans and recorded $8.4 million in net gains on sale of SBA loans. The SBA loans that we sold were mostly seasoned loans that were originated in 2018 and 2019. We chose to focus on selling seasoned loans first as these loans have higher prepayment risk compared to newly originated loans. We did not record any net gains on sales of SBA loans in 2020.

Net gain on sale of residential mortgage loans decreased in 2021 compared to 2020 due to a decrease in loans sold and a decrease in premiums received. During 2021, we sold $186.5 million in residential mortgage loans compared to $298.4 million residential mortgage loans sold in 2020. The average weighted premium on residential mortgage loans sold was 2.38% for 2021 compared to 2.68% for 2020.

There were no net gains on sales of securities available for sale during 2021 as there were no securities sold. During 2020, we sold investment securities with a total book value of $160.5 million for a net gain of $7.5 million.

Comparison of 2020 with 2019

The decrease in service fees on deposit accounts for 2020 compared to 2019 was due to a decrease in non-sufficient funds fees collected on deposit accounts and a decline in analysis fees income. As a result of the COVID-19 pandemic and the stay at home orders issued by many states for many months in 2020, deposit activity for 2020 was greatly reduced compared to 2019. As a result, demand deposit account transactions and non-sufficient funds had significant declines in 2020. Analysis fee income declined for 2020 compared to 2019 due to the closing of higher risk deposit accounts during the year. The analysis fees collected on these accounts were on the higher end and the closing of these accounts contributed to the decline in service fee on deposits accounts for 2020 compared to 2019.

International service fees declined for 2020 compared to 2019 due to a decline in fees generated from trade finance loans. International service fees are earned from trade finance loans and as the balance of these loans have declined, the associated fee income earned has also declined. The balance of trade finance loans declined to $102.8 million at December 31, 2020 from $160.9 million at December 31, 2019.

Loan servicing fees, net represents income earned from servicing SBA and residential mortgage loans that were previously sold. We retain servicing on most of the loans that we choose to sell. The increase in loan servicing fees, net for 2020 compared to 2019 was due to a reduction in payoffs of serviced loans. Payoffs of serviced loans were higher during 2019, which resulted in the full amortization of the remaining servicing asset, which is recorded as a reduction to loan servicing fee income.

Wire transfer fees declined for 2020 compared to 2019 due to the COVID-19 pandemic, which resulted in a significant decline in deposit related transactions, including wire transfers.

Swap fee income represents fees earned from back to back swap transactions for our loan customers. Due to the volatility in interest rates we have experienced in the past twelve months, the number of swap transactions increased in 2020 which resulted in an increase in swap fee income for 2020 compared to 2019.

Net gain on sale of other loans increased in 2020 compared to 2019 due to an increase in loans sold and an increase in premiums received. Net gains on sales of other loans represents net gains primarily from the sale of residential mortgage loans. We sold $298.4 million in residential mortgage loans compared to $209.4 million residential mortgage loans sold in 2019. The average weighted premium on residential mortgage loans sold was 2.68% for 2020 compared to 2.06% for 2019.

During 2020, we sold investment securities with a total book value of $160.5 million for a net gain of $7.5 million. This compares to investment securities with a total book value of $115.3 million sold during 2019.

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Noninterest Expense

Noninterest expense is primarily comprised of salaries and employee benefit expense, occupancy expense, furniture and equipment expense, advertising and marketing expenses, data processing and communications expenses, professional fees, investment in affordable housing partnership expenses, and other expenses. Noninterest expense was $293.3 million for 2021, compared to $283.6 million for 2020 and $282.6 million for 2019. The increases in noninterest expenses were $9.7 million, or 3%, for 2021 compared to 2020, and $1.0 million, or less than 1%, for 2020 compared to 2019. Noninterest expense as a percentage of average assets for 2021 was 1.68% compared to 1.72% for 2020 and 1.86% for 2019.

A breakdown of noninterest expense by category is provided below:

Comparison of 2021 with 2020

The increase in noninterest expense for 2021 compared to 2020 was due mostly to increases in salaries and employee benefits, professional fees, advertising and marketing, software impairments, and data processing, partially offset by declines in FHLB advance prepayment fee, credit related expenses, branch restructuring costs, OREO expense, net and investment in affordable housing partnerships expenses.

Salaries and employee benefits expense increased $12.2 million for 2021 compared to 2020. The increase in salaries and employee benefits was due to increases in salaries paid in 2021, bonus reserves, group insurance and a decrease in payroll related origination costs compared to 2020. These increases were partially offset by declines in other compensation, vacation accrual, and officer life insurance expense. Salaries and employee benefits for 2021 and 2020 included deferred originations costs which were recorded from the origination of $324.5 million and $480.2 million, respectively, in SBA PPP loans. SBA PPP loan origination costs of $2.2 million and $5.3 million was recorded during 2021 and 2020, respectively, which initially reduced salaries and benefits and is then amortized through the life of the loans as a reduction to interest income. The number of full-time equivalent employees increased from 1,408 at December 31, 2020 to 1,476 at December 31, 2021.

Furniture and equipment expense increased for 2021 compared to 2020 due to additional expenditures made for software subscriptions, licenses, and IT related equipment and services.

Advertising and marketing expense increased for 2021 compared to 2020 due to the renewal of public sponsorship fees and deposit promotion expenses. The increase in advertising and marketing expense reflects additional fees for the sponsorship of the Bank of Hope Ladies Professional Golf Association (“LPGA”) Match Play. In 2017, we began our annual sponsorship of the LGPA’s event, but chose not to sponsor the event in 2020. However, in 2021, we again became the main sponsor for the Bank of Hope LPGA Match Play event for which sponsorship fees of $1.5 million were paid in 2021. Advertising and marketing expenses for 2021 also included $1.1 million in expenses related to deposit promotions held during the first half of the year. There were no deposit promotion expenses for periods in 2020.

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Data processing and communications expense increased for 2021 compared to 2020 due to fully amortized contract incentive which reduced the data process and communication expense in 2020.

Professional fees increased by $4.0 million in 2021 compared to 2020. The increase in professional fees for 2021 was due to increases in legal fees related to litigation fees paid to attorneys for current and resolved legal cases.

Investment in affordable housing partnership expenses decreased in 2021 compared to 2020. We make investment in affordable housing partnerships and receive Community Reinvestment Act credits and tax credits, which reduces our overall tax provision rate. Investments in affordable housing partnership expenses are recorded based on benefit schedules of individual investment projects under the equity method of accounting. The benefit schedules show tax loss/deductions investors can take each year. We amortize the initial cost of investments in affordable housing partnership by tax loss/deductions. This amortization expense is more than offset by both tax credits received, which reduces our tax provision expense dollar for dollar and the tax benefits related to any tax losses generated through the affordable housing project’s expenditures. Total tax credits related to our investment in affordable housing partnership investment was approximately $10.4 million for the year ended December 31, 2021 compared to $10.5 million for the year ended December 31, 2020. The balance of investments in affordable housing partnerships decreased from $69.5 million at December 31, 2020 to $58.4 million at December 31, 2021.

The FDIC assessment premium utilizes an initial base assessment rate, which is calculated as a percentage of our average consolidated total assets less average tangible equity. In addition to the initial assessment base, adjustments are added based upon our regulatory rating and selected financial measures. The decrease in FDIC assessment fees for 2021 compared to the 2020 was due to a decline in assessment fees adjustments related to the balance of brokered deposits.

Credit related expenses decreased in 2021 compared to 2020 due to decreases in legal expenses, loan related expenses and negative provision for unfunded commitments. With the overall improvements in credit quality in 2021, fees related to the collection of loans declined by approximately $894 thousand in 2021 compared to 2020. For 2021, we recorded a credit for unfunded commitments totaling $195 thousand compared to $660 thousand in provision for unfunded commitments for 2020 resulting in a decline of $855 thousand.

The decrease in OREO expense for 2021 compared to 2020 was due to a decrease in valuation expenses and an overall decline in OREO maintenance expenses. The value of OREO was much less volatile in 2021 compared to 2020 and with the continued decline in OREO balances, OREO maintenance and valuation expenses were reduced in 2021 compared to 2020. The balance of OREO declined from $20.1 million at December 31, 2020 to $2.6 million at December 31, 2021.

In 2021, we did not have any FHLB prepayment fees or branch restructuring expenses.

Comparison of 2020 with 2019

The increase in noninterest expense for 2020 over 2019 was due mostly to increases in OREO expenses, investment in affordable housing partnership expenses, FHLB prepayment fee, and branch restructuring expenses, partially offset by significant declines in professional fees, advertising and marketing, occupancy, and data processing expenses.

Salaries and employee benefits expense increased $1.7 million for 2020 compared to 2019. The increase in salaries and employee benefits was due to an increase in salaries paid in 2020 and an increase in stock compensation expenses compared to 2019. These increases were partially offset by declines in payroll related loan origination costs, temporary personnel, bonus provision, and group insurance expenses. Salaries and employee benefits for 2020 included deferred originations costs which were recorded from the origination of $480.1 million in SBA PPP loans during the 2020. SBA PPP loan origination costs of $5.3 million was recorded during the second quarter of 2020 which initially reduced salaries and benefits and going forward is amortized through the life of the loans as a reduction to interest income. The number of full-time equivalent employees decreased from 1,441 at December 31, 2019 to 1,408 at December 31, 2020. During the third quarter of 2020, we implemented a 4% reduction in staff in light of the impact that COVID-19 is having on our operations. The staff reduction is expected to result in approximately $6.4 million in annual savings to salaries and employee benefits.

Occupancy expense declined for 2020 compared to 2019 due to the decline in rent expenses and other occupancy related expenditures. In December 2020, we implemented our previously planned branch consolidation plan in which we closed five branch offices. As a result, we recorded $2.4 million in restructuring costs related to the write-down of related ROU assets, severance payments, and other costs. The branch consolidation resulted in approximately $2.6 million in annual cost savings starting in 2021.

Furniture and equipment expense increased for 2020 compared to 2019 due to additional expenditures made for software subscriptions, licenses, and IT related equipment and services.

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Advertising and marketing expense decreased for 2020 compared to 2019 due to the decline in public sponsorship fees. In 2020, we did not sponsor the annual LPGA event for which sponsorship fees were $1.5 million in 2019.

Data process and communications expense decreased for 2020 compared to 2019 due to an overall decline in core data processing fees as the number of loan and deposit transactions have declined.

Professional fees experienced a large decrease of $14.4 million in 2020 compared to 2019. The decrease in professional fees for 2020 was due to decreases in fees related to the implementation of CECL, IT related professional fees, and internal audit service fees. With the expansion of our internal audit department, we were able to significantly reduce internal audit service fees in 2020 as much more of the work is now performed internally.

Investment in affordable housing partnership expenses increased in 2020 compared to 2019. We make investments in affordable housing partnerships and receive Community Reinvestment Act credits and tax credits, which reduces our overall tax provision rate. Investments in affordable housing partnership expenses are recorded based on benefit schedules of individual investment projects under the equity method of accounting. The benefit schedules show tax loss/deductions investors can take each year. We amortize the initial cost of investments in affordable housing partnership by tax loss/deductions. This amortization expense is more than offset by both tax credits received, which reduces our tax provision expense dollar for dollar and the tax benefits related to any tax losses generated through the affordable housing project’s expenditures. Total tax credits related to our investment in affordable housing partnership investment was approximately $10.5 million for the year ended December 31, 2020. The balance of investments in affordable housing partnerships decreased from $82.6 million at December 31, 2019 to $69.5 million at December 31, 2020.

The FDIC assessment premium utilizes an initial base assessment rate, which is calculated as a percentage of our average consolidated total assets less average tangible equity. In addition to the initial assessment base, adjustments are added based upon our regulatory rating and selected financial measures. The increase in FDIC assessment fees for 2020 compared to the 2019 was largely due to a $1.5 million small bank assessment credit that was received during the third quarter of 2019 which reduced FDIC assessment fees for 2019. There were no recorded credits for 2020 which resulted in an increase in these fees.

Credit related expenses increased in 2020 compared to 2019 due to an increase in credit related provision expenses. In 2020 we set aside $1.0 million in provisions for accrued interest for loans currently on payment deferrals related to COVID-19. We had no such provision in 2019. In addition, provision for unfunded loan commitments which is included in credit related expenses increased by $760 thousand in 2020 compared to 2019.

The increase in OREO expense for 2020 compared to 2019 was due to an increase in valuation expenses for OREO in 2020. The overall value OREO experienced significant declines in 2020 compared to 2019 which resulted in much higher OREO related expense in 2020.

In 2020, we utilized a portion of our excess liquidity to payoff $300.0 million in FHLB advances. These advances were paid off before maturity and resulted in a prepayment fee of $3.6 million. There was no FHLB advance prepayment penalty incurred in 2019. The FHLB advances repaid had an average weighted rate of 1.68% and had remaining maturities ranging from 4 months to 2.4 years.

In 2020, we recorded branch restructuring costs of $2.4 million related to our branch consolidation plan. The $2.4 million in restructuring costs consisted of $349 thousand in severance payments, $2.0 million in occupancy expense most of which was related to the write-down of ROU assets, and $55 thousand in other various expenditures. There was no branch restructuring cost incurred in 2019.

Income Tax Provision

The provision for income taxes for 2021 was $70.7 million, compared to $30.8 million in 2020 and $55.3 million in 2019. The effective income tax rate was 25.68% for 2021 compared to 21.63% for 2020 and 24.44% for 2019. The increase in effective tax rate for 2021 compared to 2020 was primarily due to affordable housing partnership investment tax credits benefit having a lower effect on larger annual pre-tax book income and higher state tax rate.

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Financial Condition

Our total assets were $17.89 billion at December 31, 2021 compared to $17.11 billion at December 31, 2020, an increase of $782.4 million, or 4.6% year over year. The increase in assets for 2021 compared to 2020 was principally due to the increase in securities available-for-sale and loans receivable.

Investment Security Portfolio

The main objectives of our investment strategy are to provide sources of liquidity while managing our interest rate risk and to generate an adequate level of interest income without taking undue risks. Our investment policy permits investments in various types of securities, certificates of deposits, and federal funds sold in compliance with various restrictions in the policy. All of our investment securities are classified as available for sale. The securities for which we have the ability and intent to hold to maturity may be classified as held to maturity securities. However, we do not currently maintain a held-for-maturity or trading portfolio.

Our available for sale securities totaled $2.67 billion at December 31, 2021, compared to $2.29 billion at December 31, 2020. We had no securities that were categorized as held to maturity at December 31, 2021 or 2020. We had securities that were called, matured, or paid down totaling $694.7 million, and purchased $1.16 billion. There were no sales of investment securities in 2021. At December 31, 2021, $362.2 million in securities were pledged to secure public deposits, or for other purposes required or permitted by law, $359.8 million in securities were pledged in the State of California time deposit program, and $846 thousand was pledged for other public deposits.

Our investment portfolio consists of government sponsored enterprise (“GSE”) bonds, mortgage backed securities (“MBS”), collateralized mortgage obligations (“CMOs”), asset-backed securities, corporate securities, and municipal securities.

Our available for sale securities portfolio is primarily invested in residential CMOs and residential and commercial MBS, which combined to represent 89% and 96% of our total available for sale portfolio as of December 31, 2021 and 2020, respectively. At December 31, 2021 and 2020, all of our CMOs and MBS were issued by the Government National Mortgage Association (“GNMA”), Fannie Mae (“FNMA”), or Freddie Mac (“FHLMC”), which guarantee the contractual cash flows of these investments. All of our corporate, asset-backed, and municipal securities at December 31, 2021 were rated as investment grade.

The following table presents the amortized cost, estimated fair value, and net unrealized gain and losses on our investment securities as of the dates indicated:

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The following table summarizes the maturity of securities based on carrying value and their related weighted average yield (non-tax equivalent) at December 31, 2021:

* Investments in U.S. Government agency and U.S. Government sponsored enterprises

The following table shows our investments with gross unrealized losses and their estimated fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2021:

* Investments in U.S. Government agency and U.S. Government sponsored enterprises

We performed an analysis on our investment portfolio as of December 31, 2021 and concluded that an allowance for credit losses was not required. The majority of our investment portfolio consists of securities issued by U.S. Government agencies or U.S. Government sponsored enterprises which we determined have zero loss expectation. At December 31, 2021, we also had one corporate security not issued by U.S. Government agencies or U.S. Government sponsored enterprises that was in an unrealized loss position. Based on our analysis of this investment, we concluded a credit loss did not exist due to the issuer’s financial strength, high bond ratings, and because we still expect full payment of principal and interest.

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Equity Investments

As of December 31, 2021, equity investments totaled $57.9 million compared to $59.7 million at December 31, 2020. In 2020, we purchased $10.0 million in equity investments which were comprised of $5.0 million in mutual funds and $5.0 million in CRA investments. No purchases were made in 2021. For the year ended December 31, 2021, we recorded a decrease in equity investments due to return of equity investments of $1.3 million and change in fair value of $789 thousand. Equity investments as of December 31, 2021 included $26.8 million in equity investments with readily determinable fair values and $31.0 million in equity investments without readily determinable fair values.

Equity investments with readily determinable fair values at December 31, 2021 consisted of mutual funds totaling $26.8 million. Changes to the fair value of equity investments with readily determinable fair values is recorded in other noninterest income. Equity investments without readily determinable fair values at December 31, 2021 included $29.7 million in CRA investments, $1.0 million in Community Development Financial Institutions investments, and $370 thousand in correspondent bank stock. Equity investments without readily determinable fair values are carried at cost, less impairment, and adjustments are made to the carrying balance based on observable price changes. There were no impairments or observable price changes for these investments during the year ended December 31, 2021.

Loans Held For Sale

Loans held for sale at December 31, 2021 totaled $99.0 million compared to $17.7 million at December 31, 2020, representing an increase of $81.3 million, or 458.2%. The increase in loans held for sale was largely due to increases in SBA loan held for sale, higher residential mortgage loans held for sale, and the transfer of substandard loans from loans receivable to loans held for sale in 2021. The transfer of the substandard loans to held for sale is in line with management’s strategic plan to improve the credit quality of the loan portfolio through the sale of loans with elevated credit risk. Loans held for sale at December 31, 2021 included $49.7 million in SBA loans held for sale, $26.2 million in commercial real estate and commercial business loans with elevated credit risk, and $23.2 million in residential mortgage loans held for sale. At December 31, 2020, loans held for sale consisted of entirely residential mortgage loans totaling $17.7 million.

Loan Portfolio

We offer a variety of products designed to meet the credit needs of our borrowers. Our lending activities primarily consist of real estate loans, commercial business loans, residential mortgage, and consumer loans. Gross loans receivable rose by $389.5 million to $13.95 billion at December 31, 2021 from $13.56 billion at December 31, 2020.

We experienced an increase in real estate residential, real estate commercial, commercial business and consumer loans in 2021 compared to the previous year. Only construction loans and residential mortgage loans experienced declines in 2021 compared to 2020. The rates of interest charged on variable rate loans are set at specified spreads based on the prime lending rate, LIBOR, and SOFR rates and vary as the rate indices vary. Approximately 41% of our total loans were variable rate loans at December 31, 2021 compared to 42% at December 31, 2020. Real estate loans as a percentage to total loans was 65% at December 31, 2021, unchanged from 65% at December 31, 2020.

With certain exceptions, we are permitted under applicable law to make unsecured loans to single borrowers (including certain related persons and entities) in aggregate amounts of up to 15% of the sum of our total capital, our allowance for credit losses (as defined for regulatory purposes) at the Bank level, and certain capital notes and debentures issued by us. As of December 31, 2021, our lending limit was approximately $378.5 million per borrower for unsecured loans. For lending limit purposes, a secured loan is defined as a loan secured by collateral having a current fair value of at least 100% of the amount of the loan or extension of credit at all times and satisfying certain other requirements. In addition to unsecured loans, we are permitted to make such collateral-secured loans in an additional amount up to 10% (for a total of 25%) of our total capital and the allowance for credit losses for a total limit of approximately $630.9 million to one borrower as of December 31, 2021. The largest aggregate amount of loans that the Bank had outstanding to any one borrower and related entities was $197.6 million, of which the entire amount was performing and in good standing at December 31, 2021.

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The following table shows the composition of our loan portfolio by type of loan on the dates indicated:

Real Estate Loans

Our real estate loans consist primarily of loans secured by deeds of trust on commercial real estate, including SBA loans secured by commercial real estate. It is our general policy to restrict commercial real estate loan amounts to 75% of the appraised value of the property at the time of loan funding. We offer both fixed and floating interest rate loans. The maturities on such loans are generally up to seven years (with payments determined on the basis of principal amortization schedules of up to 25 years and a balloon payment due at maturity). Real estate loans secured by non-consumer residential real estate comprise less than 1% of the total loan portfolio (consumer residential mortgage loans are classified separately and included in consumer loans). Construction loans are also a small portion of the total real estate portfolio, comprising approximately 2% of total loans outstanding. Total real estate loans, consisting primarily of commercial real estate loans, increased $333.8 million or, 4%, to $9.11 billion at December 31, 2021 from $8.77 billion at December 31, 2020. Real estate loans increased by $333.8 million in 2021 from 2020 due to record loan originations in 2021.

Other Loans

Commercial business loans include term loans to businesses, lines of credit, trade finance facilities, commercial SBA loans, equipment leasing loans, warehouse lines of credit and SBA Paycheck Protection Program (“PPP”) loans. Business term loans are generally provided to finance business acquisitions, working capital, and/or equipment purchases. Lines of credit are generally provided to finance short-term working capital needs. Trade finance facilities are generally provided to finance import and export activities. SBA loans are provided to small businesses under the U.S. SBA guarantee program. Short-term credit facilities (payable within one year) typically provide for periodic interest payments, with principal payable at maturity. Term loans (usually 5 to 7 years) normally provide for monthly payments of both principal and interest. SBA commercial loans usually have a longer maturity (7 to 10 years). These credits are reviewed on a periodic basis, and most loans are secured by business assets and/or real estate. Warehouse lines of credit are utilized by mortgage originators to fund mortgages which are then pledged to the Bank as collateral until the mortgage loans are sold and the lines of credit are paid down. The typical duration of these lines of credit from the time of funding to pay-down ranges from 10-30 days. Although collateralized by mortgage loans, the structure of warehouse lending agreements results in the commercial business classification for warehouse lines of credit. During 2021, commercial business loans increased $50.9 million, or 1%, to $4.21 billion at December 31, 2021 from $4.16 billion at December 31, 2020. The increase in commercial business loans was due to an increase in commercial term loans and syndicated loans in 2021.

Residential mortgage loans represented approximately 5% of the total loan portfolio. The residential mortgage portfolio declined from $582.2 million at December 31, 2020, or less than 1%, to $579.6 million at December 31, 2021. Consumer loans comprise less than 1% of the total loan portfolio. Most of our consumer loan portfolio includes automobile loans, home equity lines and loans, signature term loans and lines of credit, and credit card loans. Consumer loans increased $7.5 million, or 15%, to $58.5 million at December 31, 2021 from $51.1 million at December 31, 2020.

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Loan Commitments

We provide lines of credit to business customers usually on an annual renewal basis. We normally do not make loan commitments in material amounts for periods in excess of one year.

The following table shows our loan commitments and letters of credit outstanding at the dates indicated:

Nonperforming Assets

Nonperforming assets consist of nonaccrual loans, accruing loans that are 90 days or more past due, accruing restructured loans, and OREO.

Loans are placed on nonaccrual status when they become 90 days or more past due, unless the loan is both well-secured and in the process of collection. Loans may be placed on nonaccrual status earlier if the full and timely collection of principal or interest becomes uncertain. When a loan is placed on nonaccrual status, unpaid accrued interest is charged against interest income. Loans are charged off when collection of the loan is determined to be unlikely. Loans are restructured when, for economic or legal reasons related to the borrower’s financial difficulties, the Bank grants a concession to the borrower that it would not otherwise consider. OREO consists of real estate acquired by the Bank through foreclosure or similar means, including by deed from the owner in lieu of foreclosure, and is held for future sale.

Nonperforming assets were $111.8 million at December 31, 2021 compared to $143.3 million at December 31, 2020. Nonperforming assets at December 31, 2021 decreased from December 31, 2020 due primarily to the decreases in nonaccrual loans and OREO, partially offset by increases in accruing restructured loans and loans past due 90 days or more and still accruing. The following table illustrates the composition of nonperforming assets and nonperforming loans as of the dates indicated:

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(1) Nonaccrual loans exclude the guaranteed portion of delinquent SBA loans that are in liquidation and excludes PCI loans for periods prior to 2020.

(2) Excludes PCI loans for periods prior to 2020.

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COVID-19 Related Loan Modifications

In 2020, we received a large number of modification requests from borrowers affected by the COVID-19 pandemic. Subsequently many of those requests for modifications were granted during the second quarter of 2020. As of December 31, 2020, loans that were modified due to hardship caused by the COVID-19 pandemic totaled $1.38 billion or approximately 10.2% of our total loan portfolio. COVID-19 modifications at December 31, 2021 declined to $22.8 million or 0.2% of the loan portfolio. Based on the expiration schedule of modifications as of December 31, 2021, we expect all modifications to expire in 2022. For the most part, we currently do not offer additional COVID-19 modifications, aside from a small number of modifications to residential mortgage borrowers on a case by case basis.

In accordance with the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act and interagency guidance, qualifying modifications provide banks the option to temporarily suspend certain requirements under U.S. GAAP related to TDRs for a limited period of time to account for the effects of COVID-19. This timeframe was extended in December 2020 to the earlier of January 1, 2022 or 60 days after the end of the coronavirus emergency declaration. As of December 31, 2021, loans modified under Section 4013 of the CARES Act and interagency guidance were not included as TDRs. All COVID-19 modifications are being monitored by management for potential downgrades to classified and nonaccrual status as the CARES Act provides temporary relief of certain modifications from TDR classification, but not from classified or nonaccrual status.

The following tables present total COVID-19 related modifications by loan type as of December 31, 2021 and 2020:

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Maturity of Loans

The following table illustrates the maturity distribution intervals of loans outstanding as of December 31, 2021.

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(1) Includes hybrid loans (loans with fixed interest rates for a specified period and then convert to variable interest rates) in fixed interest rate periods as of December 31, 2021.

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Concentrations

Our lending activities are predominately in California, New Jersey and the New York City, Houston, Dallas, Chicago, and Seattle metropolitan areas. At December 31, 2021, loans from California represented 59% of the total loans outstanding and loans from New York and New Jersey represented 17%. The remaining 24% of total loans outstanding represented loans from other states. Although we have a diversified loan portfolio, a substantial portion of the loan portfolio and credit performance depends on the economic stability of Southern California. Within the California market, most of our business activity is with customers located within Southern California (52%). Therefore, our exposure to credit risk is significantly affected by changes in the economy in the Southern California area. Within our commercial real estate loan portfolio, the largest industry concentrations are retail building (27%), hotel/motel (15%), industrial & warehouse (10%), and gas station & car wash (12%). Within our commercial and business loan portfolio, the largest industry concentrations are finance and insurance (26%), wholesalers (15%), retail trade (12%), and manufacturing (13%).

Allowance for Credit Losses

The Bank has implemented a multi-faceted process to identify, manage, and mitigate the credit risks that are inherent in the loan portfolio. For new loans, each loan application package is fully analyzed by experienced reviewers and approvers. In accordance with current lending approval authority guidelines, a majority of loans are approved by the Management Loan Committee (“MLC”) and Directors Loan Committee (“DLC”). For existing loans, the Bank maintains a systematic loan review program, which includes internally conducted reviews and periodic reviews by external loan review consultants. Based on these reviews, loans are graded as to their overall credit quality, which is measured based on: payment capacity and collateral documentation; proper lien perfection; proper approval by loan committee(s); adherence to any loan agreement covenants; compliance with internal policies and procedures, and with laws and regulations; adequacy and strength of repayment sources including borrower or collateral generated cash flow; payment performance; and liquidation value of the collateral. We closely monitor loans that management has determined require further supervision because of the loan size, loan structure, and/or specific circumstances of the borrower.

When principal or interest on a loan is 90 days or more past due, a loan is generally placed on nonaccrual status unless it is considered to be both well-secured and in the process of collection. Further, a loan is considered a loss in whole or in part when (1) it appears that loss exposure on the loan exceeds the collateral value for the loan, (2) servicing of the unsecured portion has been discontinued, or (3) collection is not anticipated due to the borrower’s financial condition and general economic conditions in the borrower’s industry. Any loan or portion of a loan judged by management to be uncollectible is charged against the allowance for credit losses, while any recoveries are credited to the allowance.

Allowance for Credit Loss

On January 1, 2020 the Company adopted ASU 2016-13, “Measurement of Credit Losses on Financial Instruments”, or CECL, which significantly changed the credit losses estimation model for loan and investments. On March 27, 2020, former President Donald Trump signed into law the CARES Act in response to the global pandemic. The CARES Act includes a provision that temporarily delays the required implementation date of ASU 2016-13. However, we chose not to elect to delay the adoption of ASU 2016-13 and implemented the CECL methodology as of January 1, 2020. On January 1, 2020, we recorded a $26.2 million day 1 CECL adjustment as a result of adopting the new standard.

The allowance for credit losses (“ACL”) was $140.6 million at December 31, 2021 compared to allowance for credit losses of $206.7 million at December 31, 2020. We recorded a negative provision for credit losses of $12.2 million in 2021 compared to a provision for credit losses of $95.0 million in 2020, and a provision for loan losses of $7.3 million in 2019. During 2021, we charged off $62.2 million in loans outstanding and recovered $8.2 million in loans previously charged off. The increase in charge off for 2021 was largely due to the charge off of one loan relationship totaling $29.6 million and the charge off of $25.4 million in loans with elevated credit risk which were sold during the year. Total criticized loans, or loan rated special mention, substandard, doubtful, or loss at December 31, 2021 totaled $499.6 million compared to $551.5 million at December 31, 2020. The ACL was 1.01% of loans receivable at December 31, 2021 and 1.52% of loans receivable at December 31, 2020. The ACL to loans receivable ratio does not include non-credit related discount on acquired loans. Total discount on acquired loans at December 31, 2021 and 2020 totaled $12.4 million and $23.3 million, respectively. ACL on individually evaluated loans decreased to $5.1 million at December 31, 2021 from $7.3 million at December 31, 2020. In addition to allowance for credit losses, we had $1.1 million in allowances for unfunded loan commitments as of December 31, 2021, compared to $1.3 million as of December 31, 2020.

The decline in ACL from December 31, 2020 to December 31, 2021 was due to significant improvements in projected economic forecasts as the impact that the COVID-19 pandemic is projected to have on the economy has declined. In addition, through internal resolution and the sale of problem loans, we were able to reduce a significant portion of loans with elevated credit risk. The overall improvement in credit quality contributed to the decline in ACL in 2021 compared to 2020.

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The following table presents total nonaccrual and delinquent loans (loans past due 30+ days) as of the dates indicated:

We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt including but not limited to current financial information, historical payment experience, credit documentation, public information, and current economic trends. We analyze loans individually by classifying the loans as to credit risk. This analysis includes all non-homogeneous loans. Homogeneous loans are not risk rated and credit risk is analyzed largely by the number of days past due.

This analysis is performed on at least a quarterly basis. We use the following definitions for risk ratings:

•Pass: Loans that meet a preponderance or more of our underwriting criteria and evidence an acceptable level of risk.

•Special Mention: Loans that have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

•Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the repayment of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

•Doubtful/Loss: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses make collection or repayment in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans assigned a risk rating of Special Mention, Substandard, Doubtful, or Loss are referred to as Criticized Loans and loans assigned a risk rating of Substandard, Doubtful, or Loss are separately referred to as Classified Loans. The following table provides the detail of Criticized Loans by risk rating as of the dates indicated:

In 2021, we completed the sale of approximately $275.3 million in loans with elevated credit risk or were likely to exhibit credit issues in the future. Of the loans sold, $182.6 million were rated as substandard and $68.4 million were rated as special mention at the time of the sale. Approximately 53% of the loans that were sold as part of this de-risking strategy were commercial real estate loans secured by hotels or motels as these industries were hardest hit by the pandemic and could take a while before the industry fully recovers. As a result, substandard loans experienced a significant decline as of December 31, 2021 to $242.4 million compared to $366.6 million at December 31, 2020.

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The following table shows the provision for credit losses, the amount of loans charged off, and recoveries on loans previously charged off together with the balance in the allowance for credit losses at the beginning and end of each year, the amount of average and total loans outstanding as well as other pertinent ratios as of the dates and for the years indicated: